DIGI INTERNATIONAL INC - Annual Report: 2010 (Form 10-K)

 

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

 

þ		ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission file number: 1-34033

DIGI INTERNATIONAL INC.

(Exact name of registrant as specified in its charter)

Delaware		41-1532464
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification Number)

11001 Bren Road East
Minnetonka, Minnesota 55343
(Address of principal executive offices) (Zip Code)

(952) 912-3444
(Registrant’s telephone number, including area code)

Title of each class		Name of each exchange on which registered
Common Stock, par value $.01 per share		The NASDAQ Global Select Market

Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No þ

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No þ

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months, and (2) has been subject to such filing requirements for the past 90 days.

Yes þ No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files.) Yes o No o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. þ

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o No þ

The aggregate market value of voting stock held by non-affiliates of the Registrant as of the last business day of the Registrant’s most recently completed second fiscal quarter was $262,852,499 based on a closing price of $10.64 per common share as reported on the NASDAQ Global Select Market (formerly the NASDAQ National Market).

Shares of common stock outstanding as of November 23, 2010: 25,107,340

 

 

INDEX

DOCUMENTS INCORPORATED BY REFERENCE

The following table shows, except as otherwise noted, the location of information required in this Form 10-K, in our Annual Report to Stockholders for the year ended September 30, 2010 and Proxy Statement for our Annual Meeting of Stockholders scheduled for January 20, 2011. All such information set forth below under the heading “Page/Reference” is incorporated herein by reference, or included in this Form 10-K on the pages indicated.

				ITEM IN FORM 10-K		PAGE/REFERENCE
PART I.
ITEM 1.				Business			4
ITEM 1A.				Risk Factors			14
ITEM 1B.				Unresolved Staff Comments			22
ITEM 2.				Properties			23
ITEM 3.				Legal Proceedings			24
PART II.
ITEM 5.				Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities			25
ITEM 6.				Selected Financial Data			27
ITEM 7.				Management’s Discussion and Analysis of Financial Condition and Results of Operations			28
ITEM 7A.				Quantitative and Qualitative Disclosures About Market Risk			42
ITEM 8.				Financial Statements and Supplementary Data			43
ITEM 9.				Changes in and Disagreements with Accountants On Accounting and Financial Disclosure			73
ITEM 9A.				Controls and Procedures			73
ITEM 9B.				Other Information			74

				ITEM IN FORM 10-K		PAGE/REFERENCE
PART III.
ITEM 10.				Directors, Executive Officers and Corporate Governance			76
ITEM 11.				Executive Compensation			77
ITEM 12.				Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters			77
ITEM 13.				Certain Relationships and Related Transactions and Director Independence			77
ITEM 14.				Principal Accounting Fees and Services			77
PART IV.
ITEM 15.				Exhibits, Financial Statement Schedules			78
EX-3.B
EX-21
EX-23
EX-24
EX-31.A
EX-31.B
EX-32

PART I

FORWARD-LOOKING STATEMENTS

This Annual Report 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.

The words “believe,” “anticipate,” “intend,” “estimate,” “target,” “may,” “will,” “expect,” “plan,” “project,” “should,” or “continue” or the negative thereof or other expressions, which are predictions of or indicate future events and trends and which do not relate to historical matters, identify forward-looking statements. Such statements are based on information available to us as of the time of such statements and relate to, among other things, expectations of the business environment in which we operate, projections of future performance, perceived opportunities in the market and statements regarding our mission and vision. Forward-looking statements involve known and unknown risks, uncertainties and other factors, which may cause our actual results, performance or achievements to differ materially from anticipated future results, performance or achievements expressed or implied by such forward-looking statements. We undertake no obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future events or otherwise.

Our future operating results and performance trends may be affected by a number of factors, including, without limitation, those described in Item 1A, Risk Factors, of this Form 10-K. Those risk factors, and other risks, uncertainties and assumptions identified from time to time in our filings with the Securities and Exchange Commission, including without limitation, our quarterly reports on Form 10-Q and our registration statements, could cause our actual future results to differ materially from those projected in the forward-looking statements as a result of the factors set forth in our various filings with the Securities and Exchange Commission and of changes in general economic conditions, changes in interest rates and/or exchange rates and changes in the assumptions used in making such forward-looking statements.

ITEM 1.		BUSINESS

The terms “we,” “our” or “us” mean Digi International Inc. and all of the subsidiaries included in the consolidated financial statements unless the context indicates otherwise.

COMPANY OVERVIEW

Digi International Inc. was formed in 1985 as a Minnesota corporation and reorganized as a Delaware corporation in 1989 in conjunction with its initial public offering. Our common stock is traded on the NASDAQ Global Select Market under the symbol DGII. With our global headquarters in Minnetonka, Minnesota, and regional sales offices throughout North America, Europe and Asia, our products are available through approximately 280 distributors located in approximately 70 countries. We also have engineering locations in North America, Europe and India.

Our first products (sold under the DigiBoard^® brand) were box and board-level serial port adapters that were used to directly connect multiple peripherals, such as standalone computer terminals, to personal computers or a host computer system. During the 1990s, Ethernet became the connectivity infrastructure for businesses and over time it has been extended into factories, retail stores, restaurants, hospitals and many other environments. During the same period, the semiconductor industry was also in a phase of rapid advancement. Complete systems were being built on a single integrated circuit (chip). As part of a box or board level product, these chips could be used to build a network interface for virtually any device for which network connectivity was required. Recognizing the developing opportunities for device connectivity, we implemented a strategy in early 2000 to leverage the brand strength that we had established with the DigiBoard product line by organically

ITEM 1.		BUSINESS (CONTINUED)

COMPANY OVERVIEW (CONTINUED)

developing or acquiring next-generation connectivity products and technologies that would extend the value of the Digi brand into an array of device networking applications.

During the course of the past several years, we augmented our strategy with an increased emphasis on developing wireless device connectivity solutions. In fiscal 2007, we launched our “Drop-in Networking” initiative which provides end-to-end wireless access to electronic devices in places where wires will not work or cannot be used. Drop-in Networking enables our customers to differentiate their products, provide better customer service and frequently create new revenue streams. Our Drop-in Networking initiative provides opportunities for us in the next wave of Internet growth. The initial wave was focused on connecting people, first with personal computers and then with cell phones, PDAs and other related consumer devices. This next wave focuses on connecting devices and machines. We believe that the Internet will support billions of new devices in the next several years. We are ideally positioned to take full advantage of the second wave of Internet growth with our Drop-in Networking Solutions that will provide significant market expansion in what is now being referred to in the market as wireless machine to machine (M2M) connectivity.

M2M communication works by connecting communication hardware to a physical asset so that information about its status and performance can be sent to a computer system and used to automate a business process or a human action so that a person does not have to do it manually. By incorporating products from both our embedded and non-embedded categories, our Drop-In Networking Solutions are making it easy for customers to effectively “drop-in” a wireless M2M solution.

In fiscal 2009, we expanded on our Drop-in Networking initiative and introduced the iDigi^® M2M network operating platform. This Platform as a Service (PaaS) quickly and easily connects remote assets to a customer’s business applications. The iDigi^® platform also includes a control center application (iDigi Manager Pro™) which enables easy provisioning, maintenance and management of the devices themselves as well as the associated connectivity. The iDigi^® platform runs on a grid of Digi-managed servers. As an on-demand model, customers pay only for services consumed, conserving capital and requiring minimal infrastructure to operate.

With our breadth of products, services and management software, as well as partnerships with leading device manufacturers and application providers, we are now able to offer complete Digi Solution bundles — end-to-end, fully customizable, industry-specific solutions that can be deployed with unprecedented speed. Digi Energy, Digi Tank and Digi Fleet, the first Digi solution offerings, provide scalable, real-time monitoring and management capabilities that have previously not been available.

Digi Energy — Digi Energy was launched as the first Digi solution bundle, targeting the Smart Grid efforts of energy services providers. Creating a Smart Grid using new levels of monitoring and control to improve the efficiency, security and reliability of the grid is a major focus in the world today.

In 2010, we extended our Digi Energy offering and introduced Digi X-Grid™ solutions, which provide connectivity, control and support of all devices in the “Extended Grid.” The Extended Grid comprises devices that exist beyond the meter in homes and businesses. It is only by leveraging these devices and thereby enabling end users of energy to be actively engaged with energy producers that we can recognize the full benefits of the Smart Grid. We provide provisioning tools, Smart Energy profile certified products (e.g., gateways, modules), the iDigi^® platform and other services; our partners provide devices such as meters and in-home displays, plus application integration. Together with our partners, we are making the Extended Grid a reality, with over 30,000 gateways deployed in Residential Energy Management solutions today and over 100,000 under contract.

ITEM 1.		BUSINESS (CONTINUED)

COMPANY OVERVIEW (CONTINUED)

Digi Tank — Our second Digi solution bundle is optimized for remote tank monitoring of storage tanks containing liquids, solids and gases. Tank monitoring can reduce supply chain costs and insure tank-stored inputs to a production process are available and of necessary quality. Digi Tank solutions include our wired and wireless communication gateways, ZigBee modules and ZigBee adapters; the iDigi^® platform, which provides management, messaging and storage services to connect remote assets and enterprise applications; iDigi^® Device Integration Application (iDigi^® Dia) device connection software; a growing list of wireless sensor partners; iDigi^® application partners, with ready-to-implement tank management applications; and Digi Professional Services for device and solution design, deployment planning, integration and optimization.

Digi Fleet — Digi Fleet is the third Digi solution bundle. Comprised of our rugged mobile gateways with support for Wi-Fi, cellular, ZigBee and satellite technologies, as well as the iDigi^® platform and Digi Professional Services, Digi Fleet solutions provide tracking, monitoring and management of large numbers of high-value mobile assets. These solutions improve efficiency, reduce costs and meet government regulations for connecting and monitoring tractors, trailers and containers.

We continue to leverage a common core technology base to develop and provide innovative connectivity solutions to our customers. Core technology is used across product lines to provide additional functionality for customers, allowing them to get to market with network-enabled devices faster. We have positioned ourselves in the growing market of integrated hardware and software connectivity solutions to network-enable the coming generation of intelligent devices in business applications. Our Drop-in Networking products and iDigi^® brand are enabling us to pivot our business from point products to solutions. We have strategic goals for the next three to five years to change our revenue mix to be 60% wireless, 60% international, and at least 15% services. We believe we are making progress towards these goals by increasing our investment in wireless products, expanding internationally, and providing full solutions which include product and services offerings to our customers.

PRODUCTS

Our products are divided into two categories: embedded and non-embedded. An embedded product is incorporated by a product developer into an electronic device (e.g., utility meter, environmental sensors, retail scanner, and medical instruments) to provide processing power and wired or wireless network connectivity to that device. Additional hardware and/or software development is required on the part of the customer when using an embedded product as the product usually is an integrated internal part of the device.

A non-embedded product is connected externally to a device or larger system (e.g., retail checkout, building access control panel, traffic controller) to provide network connectivity or port expansion. Non-embedded products generally do not require additional hardware development and can often be used right out of the box, although they do provide an environment for adding custom software as well. These products provide an economical way to network-enable previously deployed devices, allowing companies to utilize the latest technologies without the cost of replacing existing equipment.

Embedded Networking Products

Modules — Developing a device around a chip or microprocessor involves a high level of complexity. A module is a group of components that are set up to work together, eliminating much of that complexity. An embedded module may provide somewhat less flexibility than a chip, but is much easier to implement into a product design. A number of these modules can be directly connected to iDigi^®, enabling remote management and remote application connectivity.

ITEM 1.		BUSINESS (CONTINUED)

PRODUCTS (CONTINUED)

Our modules can be divided into two categories: processor modules and communications modules. Processor modules provide customers with a networked platform for use as the main processor in an embedded system and the flexibility to add in custom features and functionality, as this ensures a quick time to market development cycle for a network-enabled device. These modules are targeted as the core processors for products such as access control systems, Smart Energy devices, Point-of-Sale (POS) systems, Radio Frequency ID (RFID) readers, medical devices and instrumentation and networked displays. Communication modules are ideal for network-enabling and web-enabling a device. They enable customers who wish to easily accommodate both wired and wireless functionality in one product design. These modules make it very easy to add most any type of connectivity, especially wireless connectivity. Typically with a communication module, there is another processor performing the central processing. Adding wired or wireless network communication to a device allows companies to manage that device over a network or via the Internet.

Chips — A chip (or microprocessor) provides the “brains” and processing power of an intelligent electronic device or communication sub-system. Some of our higher volume customers choose to purchase chips and build their own products. Chips are low cost but require the highest level of development expertise. Building a solution from the chip level offers a low cost of the end design, but the level of complexity in product development can increase risk and prolong time to market.

Our chips are the building blocks for many of our embedded and non-embedded products. By using our own microprocessors we can ensure complete hardware/software compatibility for product designs. In addition this allows us to guarantee long-term availability to our module customers. This is a significant advantage since many of these products are expected to be in use for five to ten years once they are developed.

Software and Development Tools — Coupled with the chips and modules are a variety of development tools and associated software to make application development easy. We provide software and tools for a variety of operating environments and developer skill sets. These include Linux^® and Microsoft^® Windows^® Embedded CE as well as our own Net+OS, Dynamic C and Python based iDigi^® Dia.

Single Board Computers — Single-board computers (SBCs) are complete systems on a single circuit board. They are essentially a programmable box product without the enclosure — everything is on the board and ready to be embedded into a larger system. They offer the same benefits as the processor modules, but eliminate the need for additional interface circuitry because they include all of the key device interface components on one circuit board.

Satellite — Our acquisition of MobiApps Holdings Private Limited (MobiApps) in June 2009 added satellite communication products that provide worldwide satellite data transmit/receive capabilities for customers involved in satellite-based tracking and industrial remote communications. Operating over the ORBCOMM low-earth orbit satellite network, these products can significantly improve asset utilization by allowing clients to monitor, track and manage their fixed and mobile assets around the world.

Non-Embedded Networking Products

Cellular Routers — Cellular routers provide connectivity for devices over a cellular data network. They can be used as a cost effective alternative to landlines for primary or backup connectivity for hard to reach sites and devices. We introduced the first intelligent high-speed cellular router in 2005 to address the growing need for customers to connect remote sites and devices. These products have been certified by the major wireless providers in North America and abroad, including AT&T^®, Verizon Wireless^®, Sprint^®, Bell Mobility and Rogers. All of our cellular products include a unique remote management platform that provides secure

ITEM 1.		BUSINESS (CONTINUED)

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management of devices across remote networks. In addition, application connectivity, management and customization is enabled via the iDigi^® platform for many of these products.

Gateways — A gateway aggregates local wireless data traffic and transports it over a cellular or other Internet Protocol (IP)-based network, usually back to a central application or database. Our gateway products, part of our Drop-in Networking solution, enable devices or groups of devices to be networked in locations where there is no existing network or where access to a network is prohibited. These gateways can work in conjunction with our wireless adapters and wireless embedded modules to enable customers to monitor and manage remote devices in a non-intrusive and economical way. All of our gateway products are linked with iDigi^® for secure management of devices across remote networks, application connectivity and customization.

Wireless Communication Adapters — Our wireless communication adapters are small box products that utilize a variety of wireless protocols for PC-to-device or device-to-device connectivity, often in locations where deploying a wired network is not possible either because of cost, disruption or impracticality. By supporting ZigBee^®, Wi-Fi^® and proprietary RF technologies, we can meet most customer application requirements, such as serial cable replacement, Ethernet cable replacement, mesh networking, low cost/low power remote monitoring, simple I/O control functions, environmental sensors and long distance connectivity. In conjunction with one of our gateways, wireless communication adapters plug into iDigi^® for remote management, application connectivity and customization.

Serial Servers — Serial Servers (also known as device servers and terminal servers) add wired or wireless network connectivity to a serial device. They transfer data between a serial port and an Ethernet network, turning a previously isolated device with a serial port into a fully collaborative network component. We believe that serial servers will remain an important product category as Ethernet based serial connections continue to extend beyond their current applications into many new markets such as building automation, healthcare, process control, and secure console port management on servers, routers, switches and other network equipment. Many of our serial servers can also leverage iDigi^® for application connectivity, remote management and customization.

Console Servers — Console servers, or console management servers, provide access to the serial ports of network equipment such as servers, routers or switches. Our intelligent console servers enable customers to access, monitor or manage their network devices across multiple sites, both remotely over the network or via their console ports even during network outages. These console servers provide advanced auditing and logging capabilities that complement regulatory compliance efforts such as the Sarbanes-Oxley Act of 2002 and Health Insurance Portability and Accountability Act of 1996 (HIPAA).

USB Connected Products — The Universal Serial Bus (USB) is a “plug-and-play” interface between a computer and peripheral devices. In recent years, many serial ports on PCs have been replaced with USB ports, due in large part to the usability and cost effectiveness of USB devices. We have one of the most comprehensive and advanced USB port expansion product lines in the industry. Our USB-to-serial converters enable customers to expand a single USB port into multiple serial ports to connect legacy peripheral devices. The product line also includes USB hubs that add additional USB or powered USB ports, which are often used in retail environments, and a network-enabled hub that connects USB devices over an IP network, which is an industry first.

Serial Cards — A serial card plugs into the expansion slot of a computer to provide serial ports for device connectivity. We are a global leader in this category and offer one of the most extensive serial card product families. Our products support a wide range of operating systems, port densities, bus types, expansion options

ITEM 1.		BUSINESS (CONTINUED)

PRODUCTS (CONTINUED)

and applications. As Ethernet connections extend beyond current applications, the serial card products are gradually transitioning to network-attached and/or USB-attached devices. We have strengthened our product offering to meet customer needs and fully support this mature product line while working to seamlessly transition customers to newer technologies.

SERVICES

We also provide a variety of services to complement our products. Our services are included under our embedded product grouping as they are not material to our consolidated financial statements.

iDigi^® — iDigi^® is an M2M network operating platform, used by software developers and organizations responsible for supporting the network. iDigi^® is used to connect enterprise applications to remote devices.

Digi m-Trak™ — The Digi m-Trak™ mobile asset tracking solution provides reliable, cost-effective fleet monitoring and management. Combining GPS technology and wireless communication with an easy-to-use web-based management application, the Digi m-Trak™ system ensures constant, on-demand access to fleet information at any time, from any place. Digi m-Trak™ is only available in India, and parts of the Middle East, Africa, and Southeast Asia.

Engineering Design Services — Through our subsidiary, Spectrum Design Solutions, Inc. (Spectrum), we offer engineering design services to customers that are challenged with their wireless development projects. Our specialized engineers have extensive experience in wireless technologies such as Global System for Mobile communication (GSM), Code Division Multiple Access (CDMA), Global Positioning System (GPS), Wi-Fi and proprietary radio frequency (RF) as well as Application Specific Integrated Circuit (ASIC) design, Field Programmable Gate Array (FPGA) integration, embedded software and complete turn-key product development which allows them to address virtually any wireless development need.

APPLICATION MARKETS

We believe we are a worldwide leader in commercial grade device connectivity, through network-enabling devices in stores, factories, office buildings, banks, gas stations, oil rigs, hospitals, and many other vertical environments. We are heavily focused on four application markets and we offer solution bundles as described above for energy, tank and fleet.

Smart Energy — Our products, including Digi X-Grid™ solutions, simplify and accelerate the integration of energy management systems with remote energy assets. These energy management systems are necessary for Smart Grid initiatives encompassing both energy distribution and energy consumption management. Migrating to IP-based network communications can be a challenge for utility companies, due to compatibility issues between field equipment and the applications used with them. Our products enable companies to network-enable existing products in the field without replacing hardware or rewriting existing application software and are used in Automated Meter Reading (AMR), Automated Meter Intelligence (AMI), Energy Management Services, Distribution Automation and other smart energy applications.

Tank Monitoring/Management — Our wireless Tank Monitoring/Management solutions help companies more efficiently integrate, manage and monitor remotely deployed tanks of liquids, solids and gases. We offer end-to-end, fully customizable wireless hardware, a software platform and services that can be used to create and deploy secure, highly scalable and flexible tank monitoring solutions with unprecedented speed.

ITEM 1.		BUSINESS (CONTINUED)

APPLICATION MARKETS (CONTINUED)

Fleet Management — Some of our newest products have extended our network connectivity expertise into Fleet Management. Using a combination of cellular, satellite, Wi-Fi and ZigBee wireless connectivity, these solutions provide improved operating efficiency and asset management. We provide equipment and applications for connecting and tracking commercial vehicles, primarily focused on long-haul trucking, but extending to other areas of public and private fleets, including taxis, public transit, emergency service vehicles, heavy equipment and others. Applications also include container/traffic tracking, stolen vehicle recovery, and recording driver behavior metrics.

Medical/Healthcare — We provide a way to network-enable medical equipment and devices to receive, monitor and access patient information quickly, easily, and accurately, utilizing the hospital’s existing Ethernet or wireless network to improve patient care and reduce operating costs.

In addition, we have a long history of successful deployments in other application markets, including Remote Device Management, Building Automation/Security, Traffic Management, Industrial Automation, Retail/Point-of-Sale (POS), Data Center Management, Digital Signage, and Government.

ACQUISITIONS

We have made several acquisitions in the past five fiscal years that are consistent with our corporate strategy.

	•		In July 2006, we acquired MaxStream®, Inc. (MaxStream), a leader in the wireless device networking market. MaxStream supplies device manufacturers and integrators with reliable wireless modules and box products that are easy to use and allow customers to wirelessly monitor and control electronic devices. Typical applications include automated utility meter reading, oil and gas monitoring, remote control and monitoring of commercial heating and air conditioning systems, vehicle information access for fleet management, industrial controls, wireless sensors, and electronic signals. MaxStream was also a pioneer in the field of ZigBee®/802.15.4 wireless communications. The MaxStream acquisition significantly expanded our wireless offering both with embedded modules and non-embedded wireless communications adapters. The products also play a key role in our Drop-in Networking initiative. Effective October 1, 2007, MaxStream merged into Digi International Inc.
	•		In April 2008, we acquired Sarian Systems, Ltd. (Sarian), a leader in the European wireless router market. Sarian designs, develops and manufactures advanced wireless/cellular IP-based routing equipment for mission critical applications. Sarian developed its own comprehensive IP-based operating system and software and can offer customers technical excellence, flexibility and rapid customization. Sarian has a strong customer base in ATM connectivity, retail and payment systems connectivity, remote monitoring telemetry, lottery terminal connectivity and wireless backup of wired broadband connections. Effective October 1, 2009, Sarian merged into Digi International (UK) Ltd.
	•		In July 2008, we acquired Spectrum Design Solutions, Inc. (Spectrum), a leading design services organization. Spectrum is a wholly owned subsidiary of Digi International Inc. Spectrum focuses on solving a customer’s wireless development challenges. Spectrum’s engineers have extensive experience in wireless technologies such as GSM, CDMA, GPS, Wi-Fi and proprietary RF as well as ASIC design, FPGA integration, embedded software and complete turn-key product development which allows them to address virtually any wireless development need.

ITEM 1. BUSINESS (CONTINUED)

ACQUISITIONS (CONTINUED)

•

In June 2009, we acquired substantially all the assets of MobiApps Holdings Private Limited (MobiApps), a developer of M2M communications technology focusing on satellite, cellular and hybrid satellite/cellular solutions. MobiApps has locations in India, Singapore and in the U.S. Pursuant to the terms of the asset purchase agreements, Digi International acquired the U.S. assets located in Herndon, Virginia. In addition, we established Digi Wireless Singapore Pte. Ltd. and Digi m2m Solutions India Private Limited, which acquired the assets of MobiApps’ affiliate companies, located in Singapore and India, respectively. MobiApps provides a new generation of products based on its own custom designed and patented mixed signal ASIC, which dramatically reduces the complexity and improves performance of satellite M2M system solutions. Satellite M2M applications include fleet management, marine vessel tracking, container tracking, agricultural monitoring, energy management, and remote field service applications. Satellite is especially suited to applications that cross country and continental boundaries, providing connectivity in very remote locations, and providing mission critical wireless backup solutions when cellular coverage is insufficient. MobiApps also has cellular and hybrid cellular/satellite products packaged with various asset tracking management services, including vehicle tracking, taxi dispatch and employee tracking, focused on markets in India and Southeast Asia.

Our products are sold under the Digi, Rabbit, iDigi®, Digi m-Trak™ and Spectrum brands. We believe the Digi and Rabbit brands have established strong identities with our targeted customer base and we believe our customers associate the Digi brand with “reliability” and the Rabbit brand with “ease of integration.” Many of our customers choose us because they are building a very complex system solution and they want the highest level in product reliability. In the core module and semiconductor application environments, ease of integration is a powerful brand identity.

DISTRIBUTION AND PARTNERSHIPS

We sell our products through a global network of distributors, systems integrators, value added resellers (VARs) and to original equipment manufacturers (OEMs).

Our larger distributors include Tech Data Corporation, Arrow Electronics, Inc./NuHorizons, Ingram Micro, Synnex, Future Electronics, Miel, Atlantik Elektronik GmbH, B&B Electronics Manufacturing and Express Systems & Peripherals. We also maintain relationships with many other distributors in the U.S., Canada, Europe, Asia and Latin America. Additionally, we maintain strong relationships with catalog distributors CDW, Insight, Digi-Key and Mouser Electronics.

We maintain strategic alliances with other industry leaders to develop and market technology solutions. These include most major communications hardware and software vendors, operating system suppliers, computer hardware manufacturers, cellular carriers and Smart Grid vendors. Key partners include: Microsoft, VMware, Hewlett Packard, IBM, Dell, Toshiba, Atmel, Ember, Freescale, Qualcomm, Sierra Wireless, Ericsson, Itron, AT&T, Sprint, Verizon, Bell Mobility, Rogers and several other cellular carriers worldwide. Furthermore, we maintain a worldwide network of authorized developers that extends our reach into certain other technology applications and geographical regions. With our MobiApps acquisition, we are now partnering with ORBCOMM Inc. MobiApps’ satellite communication products utilize ORBCOMM Inc.’s low-earth orbit (LEO) satellite network to monitor, track and manage customers’ fixed and mobile assets around the world.

Our customer base includes many of the world’s largest companies. We have strategic sales relationships with leading vendors, allowing them to ship our products and services as component parts of their overall solutions. These vendors include IBM, Comverge, Xata, Itron and Gilbarco, among others. Many of the world’s leading

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telecommunications companies and Internet service providers also rely on our products, including Alcatel-Lucent, AT&T, Sprint, Verizon and Siemens.

No customer comprised more than 10% of our net sales for the years ended September 30, 2010, 2009 and 2008.

We compete in the communications technology industry, which is characterized by rapid technological advances and evolving industry standards. The market can be significantly affected by new product introductions and marketing activities of industry participants. We compete for customers on the basis of existing and planned product features, service capabilities, company reputation, brand recognition, technical support, relationships with partners, quality and reliability, product development capabilities, price and availability. While we have no competitors that carry a comparable range of products, we do have various competitors based on specific products.

We are a leader in device networking for business, developing reliable products and technologies to connect and securely manage local or remote electronic devices over the network, via the Internet, or via satellite. Our enterprise solutions include embedded or non-embedded products or combinations of these products.

OPERATIONS

Our operations are conducted through a combination of internal manufacturing and external subcontractors specializing in various parts of the manufacturing process. We rely on third party foundries for our semiconductor devices (ASICs). This approach is beneficial because it allows us to reduce our fixed costs, maintain production flexibility and optimize our profits.

Our products are manufactured to our designs with standard and semi-custom components. Most of these components are available from multiple vendors. We have several single-sourced supplier relationships, either because alternative sources are not available or because the relationship is advantageous to us. If these suppliers are unable to provide a timely and reliable supply of components, we could experience manufacturing delays that could adversely affect our consolidated results of operations.

SEASONALITY

In general, our business is not considered to be highly seasonal, although our first fiscal quarter revenue is often less than other quarters due to holidays and fewer shipping days.

WORKING CAPITAL

We fund our business operations through a combination of cash and cash equivalents, marketable securities and cash generated from operations. We believe that these current financial resources, cash generated from operations, and our capacity for debt and/or equity financing will be sufficient to fund our business operations for the next twelve months and beyond.

RESEARCH AND PATENTS

During fiscal years 2010, 2009 and 2008, our research and development expenditures were $27.8 million, $26.4 million and $27.1 million, respectively. From time to time, we have customers that pay for us to develop highly customizable products and we charge them fair market value for the services performed. Due to rapidly

ITEM 1.		BUSINESS (CONTINUED)

RESEARCH AND PATENTS (CONTINUED)

changing technology in the communications technology industry, we believe that our success depends primarily upon the product development skills of our personnel, and the ability to integrate acquired technologies with organically developed technologies. We have incurred in-process research and development charges in connection with our past acquisitions, which were expensed upon consummation of the acquisitions. Effective October 1, 2009 in-process research and development costs are capitalized according to new authoritative guidance issued by the Financial Accounting Standards Board (FASB) related to business combinations. Such acquired in-process research and development charges will be disclosed separately and will be incremental to the research and development expenditures disclosed above. We have not yet incurred any capitalized in-process research and development.

Our proprietary rights and technology are protected by a combination of copyrights, trademarks, trade secrets and patents. We have established common law and registered trademark rights on a family of marks for a number of our products. Our patents are applicable to specific technologies and currently are valid for varying periods of time based on the date of patent application or patent grant in the U.S. and the legal term of patents in the various foreign countries where patent protection is obtained. We believe our intellectual property has significant value and is an important factor in the marketing of our company and products.

BACKLOG

Backlog as of September 30, 2010 and 2009 was $26.8 million and $13.6 million, respectively. Most of the backlog at September 30, 2010 is expected to be shipped in fiscal 2011. Our backlog increase as of September 30, 2010 as compared to September 30, 2009 is primarily due to an improvement in domestic economic conditions and an increase in wireless customer orders. Backlog as of any particular date is not necessarily indicative of our future sales trends.

EMPLOYEES

We had 648 employees on September 30, 2010.

GEOGRAPHIC AREAS

Our customers are located throughout North America, Europe, Middle East & Africa (EMEA), Asia and Latin America. We are exposed to foreign currency risk associated with certain sales transactions being denominated in Euros, British Pounds and Japanese Yen and foreign currency translation risk as the financial position and operating results of our foreign subsidiaries are translated into U.S. Dollars for consolidation. We have not implemented a formal hedging strategy to reduce foreign currency risk.

During 2010, we had approximately $75.2 million of net sales related to foreign customers including export sales, of which $27.6 million was denominated in foreign currency, predominantly the Euro and British Pound. During 2009 and 2008, we had approximately $75.2 million and $76.1 million, respectively, of net sales to foreign customers including export sales, of which $33.4 million and $45.7 million, respectively, were denominated in foreign currency, predominantly the Euro and British Pound in fiscal 2009 and predominantly the Euro in fiscal 2008. In future periods, a significant portion of sales will continue to be made in Euros and British Pounds. Financial information about geographic areas appears in Note 4 to our Consolidated Financial Statements in this Form 10-K.

ITEM 1.		BUSINESS (CONTINUED)

DIGI INTERNATIONAL WEBSITE

Our Annual Reports on Form 10-K, Proxy Statements, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K, and any amendments to these reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 are available through our website (www.digi.com) under the “About us — Investor Relations” caption or by writing to us. This information is available free of charge as soon as reasonably practicable after we electronically file such material with the Securities and Exchange Commission. These reports can also be accessed via the SEC website, www.sec.gov, or via the SEC’s Public Reference Room located at 100 F Street, N.E., Washington, D.C. 20549. Information concerning the operation of the SEC’s Public Reference Room can be obtained by calling 1-800-SEC-0330.

We are not including the information on our website as part of, or incorporating it by reference into, our Form 10-K.

ITEM 1A.		RISK FACTORS

Multiple risk factors exist which could have a material effect on our operations, results of operations, profitability, financial position, liquidity, capital resources and common stock.

Risks Relating to Our Business

Our dependence on new product development and the rapid technological change that characterizes our industry makes us susceptible to loss of market share resulting from competitors’ product introductions and similar risks.

The communications technology industry is characterized by rapidly changing technologies, evolving industry standards, frequent new product introductions, short product life cycles and rapidly changing customer requirements. The introduction of products embodying new technologies and the emergence of new industry standards can render existing products obsolete and unmarketable. Our future success will depend on our ability to enhance our existing products, to introduce new products to meet changing customer requirements and emerging technologies, and to demonstrate the performance advantages and cost-effectiveness of our products over competing products. Failure by us to modify our products to support new alternative technologies or failure to achieve widespread customer acceptance of such modified products could cause us to lose market share and cause our revenues to decline.

We may experience delays in developing and marketing product enhancements or new products that respond to technological change, evolving industry standards and changing customer requirements. There can be no assurance that we will not experience difficulties that could delay or prevent the successful development, introduction, and marketing of these products or product enhancements, or that our new products and product enhancements will adequately meet the requirements of the marketplace and achieve any significant or sustainable degree of market acceptance in existing or additional markets. In addition, the future introductions or announcements of products by us or one of our competitors embodying new technologies or changes in industry standards or customer requirements could render our then-existing products obsolete or unmarketable. There can be no assurance that the introduction or announcement of new product offerings by us or one or more of our competitors will not cause customers to defer their purchase of our existing products, which could cause our revenues to decline.

ITEM 1A.		RISK FACTORS (CONTINUED)

We intend to continue to devote significant resources to our research and development, which, if not successful, could cause a decline in our revenues and harm our business.

We intend to continue to devote significant resources to research and development in the coming years to enhance and develop additional products. For the fiscal years ended 2010, 2009 and 2008, our research and development expenses comprised 15.2%, 15.9% and 14.6%, respectively, of our net sales. If we are unable to develop new products as a result of our research and development efforts, or if the products we develop are not successful, our business could be harmed. Even if we develop new products that are accepted by our target markets, the net revenues from these products may not be sufficient to justify our investment in research and development.

Many of our products have been developed through a combination of internally developed technologies and acquired technologies. Our ability to continue to develop new products is partially dependent on finding and acquiring new technologies in the marketplace. Even if we identify new technologies that we believe would be complementary to our internally developed technologies, we may not be successful in acquiring those technologies or we may not be able to acquire the technologies at a price that is acceptable to us.

A substantial portion of our recent development efforts have been directed toward the development of new products targeted to manufacturers of intelligent, network-enabled devices and other embedded systems in various markets, including markets in which networking solutions for embedded systems have not historically been sold, such as markets for industrial automation equipment, security equipment and medical equipment. Our financial performance is dependent upon the development of the intelligent device markets that we are targeting, the increasing adoption of wireless technologies by these markets and our ability to successfully compete and sell our products to manufacturers of these intelligent devices.

Certain of our products are sold into mature markets, which could limit our ability to continue to generate revenue from these products.

Certain of our products provide asynchronous and synchronous data transmissions via add-on cards. The market for add-on asynchronous and synchronous data communications cards is mature. As the overall market for these products decreases due to the adoption of new technologies, we expect that our revenues from these products will continue to decline. As a result, our future prospects depend in part on our ability to acquire or develop and successfully market additional products that address growth markets.

Our failure to effectively manage product transitions could have a material adverse effect on our revenues and profitability.

From time to time, we or our competitors may announce new products, capabilities, or technologies that may replace or shorten the life cycles of our existing products. Announcements of currently planned or other new products may cause customers to defer or stop purchasing our products until new products become available. Furthermore, the introduction of new or enhanced products requires us to manage the transition from older product inventories and ensure that adequate supplies of new products can be delivered to meet customer demand. Our failure to effectively manage transitions from older products could result in inventory obsolescence and have a material adverse effect on our revenues and profitability.

ITEM 1A.		RISK FACTORS (CONTINUED)

Our failure to compete successfully in our highly competitive market could result in reduced prices and loss of market share.

The market in which we operate is characterized by rapid technological advances and evolving industry standards. The market can be significantly affected by new product introductions and marketing activities of industry participants. We compete for customers on the basis of existing and planned product features, company reputation, brand recognition, technical support, relationships with partners, quality and reliability, product development capabilities, price, and availability. Certain of our competitors and potential competitors may have greater financial, technological, manufacturing, marketing, and personnel resources than us. Present and future competitors may be able to identify new markets and develop products more quickly, which are superior to those developed by us. They may also adapt new technologies faster, devote greater resources to research and development, promote products more aggressively, and price products more competitively than us. There are no assurances that competition will not intensify or that we will be able to compete effectively in the markets in which we compete.

Our inability to obtain the appropriate telecommunications or satellite carrier certifications or approvals from other governmental regulatory bodies could impede our ability to grow revenues in our wireless products.

The sale of our wireless products in certain geographical markets is sometimes dependent on the ability to gain telecommunications or satellite carrier certifications and/or approvals by certain governmental bodies. Failure to obtain these approvals, or delays in receiving the approvals, could impact our ability to enter our targeted markets or to compete effectively or at all in these markets and could have an adverse impact on our revenues.

Our entry into a services and solutions model, using cloud-based services, presents execution and competitive risks.

We are deploying a services and solutions model using our own internally developed hosted services and cloud-based platform, software, and supporting products. We are employing significant human and financial resources to develop and deploy this cloud-based platform and strategies. While we believe our wireless, device networking and connectivity expertise, investments in infrastructure, and our innovative environment provide us with a strong foundation to compete, it is uncertain whether our strategies will attract the users or generate the revenue required to be successful. Whether we are successful in this new business model depends on our execution in a number of areas, including:

	•		our ability to quickly and effectively put in place the infrastructure to deploy our solution;
	•		competing effectively in our targeted application markets, including energy, tank monitoring, fleet management and medical; and
	•		deploying complete end-to-end solutions that accelerate our customers’ time to market.

We are dependent on wireless communication networks owned and controlled by others.

Our revenues could decline if we are unable to deliver continued access to satellite and digital cellular wireless carriers that we depend on to provide sufficient network capacity, reliability and security to our customers. Our financial condition could be impacted if our wireless carriers were to increase the prices of their services, or to suffer operational or technical failures.

ITEM 1A.		RISK FACTORS (CONTINUED)

The cyclicality of the semiconductor industry may result in substantial period-to-period fluctuations in operating results.

Our semiconductor products provide networking capabilities for intelligent, network-enabled devices and other embedded systems. The semiconductor industry is highly cyclical and subject to rapid technological change and has been subject to significant economic downturns at various times, characterized by diminished product demand, accelerated erosion of average selling prices and production overcapacity. The semiconductor industry also periodically experiences increased demand and production capacity constraints. As a result, we may experience substantial period-to-period fluctuations in operating results due to general semiconductor industry conditions.

Loss of one or more of our large customers could have an adverse effect on our revenues.

Our sales are primarily made on the basis of purchase orders rather than under long-term agreements, and therefore, any customer could cease purchasing our products at any time without penalty. The decision of any large customer, including our distributors, to cease using our products or a material decline in the number of units purchased by such a customer could have a material adverse effect on our revenues.

The long and variable sales cycle for certain of our products makes it more difficult for us to predict our operating results and manage our business.

The sale of our products typically involves a significant technical evaluation and commitment of capital and other resources by potential customers and end users, as well as delays frequently associated with end users’ internal procedures to deploy new technologies within their products and to test and accept new technologies. For these and other reasons, the sales cycle associated with certain of our products is typically lengthy and is subject to a number of significant risks, including end users’ internal purchasing reviews, that are beyond our control. Because of the lengthy sales cycle and the large size of certain customer orders, if orders forecasted for a specific customer are not realized or delayed, our operating results could be materially adversely affected.

We depend on manufacturing relationships and on limited-source suppliers, and any disruptions in these relationships may cause damage to our customer relationships.

We procure all parts and certain services involved in the production of our products and subcontract most of our product manufacturing to outside firms that specialize in such services. Although most of the components of our products are available from multiple vendors, we have several single-source supplier relationships, either because alternative sources are not available or because the relationship is advantageous to us. There can be no assurance that our suppliers will be able to meet our future requirements for products and components in a timely fashion. In addition, the availability of many of these components to us is dependent in part on our ability to provide our suppliers with accurate forecasts of our future requirements. Delays or lost sales could be caused by other factors beyond our control, including late deliveries by vendors of components. If we are required to identify alternative suppliers for any of our required components, qualification and pre-production periods could be lengthy and may cause an increase in component costs and delays in providing products to customers. Any extended interruption in the supply of any of the key components currently obtained from limited sources could disrupt our operations and have a material adverse effect on our customer relationships and profitability.

ITEM 1A.		RISK FACTORS (CONTINUED)

Our use of suppliers in Southeast Asia involves risks that could negatively impact us.

We purchase printed circuit boards from suppliers in Southeast Asia. Product delivery times may be extended due to the distances involved, requiring more lead time in ordering. In addition, ocean freight delays may occur as a result of labor problems, weather delays or expediting and customs issues. Any extended delay in receipt of the component parts could eliminate anticipated cost savings and have a material adverse effect on our customer relationships and profitability.

Our ability to compete could be jeopardized if we are unable to protect our intellectual property rights.

Our ability to compete depends in part on our proprietary rights and technology. Our proprietary rights and technology are protected by a combination of copyrights, trademarks, trade secrets and patents.

We enter into confidentiality agreements with all employees, and sometimes with our customers and potential customers, and limit access to the distribution of our proprietary information. There can be no assurance that the steps taken by us in this regard will be adequate to prevent the misappropriation of our technology. Our pending patent applications may be denied and any patents, once issued, may be circumvented by our competitors. Furthermore, there can be no assurance that others will not develop technologies that are superior to our technologies. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy aspects of our products or to obtain and use information that we regard as proprietary. In addition, the laws of some foreign countries do not protect our proprietary rights as fully as do the laws of the United States. There can be no assurance that our means of protecting our proprietary rights in the United States or abroad will be adequate or that competing companies will not independently develop similar technology. Our failure to adequately protect our proprietary rights could have a material adverse effect on our competitive position and result in loss of revenue.

From time to time, we are subject to claims and litigation regarding intellectual property rights or other claims, which could seriously harm us and require us to incur significant costs.

The communications technology industry is characterized by frequent litigation regarding patent and other intellectual property rights. From time to time, we receive notification of a third-party claim that our products infringe other intellectual property rights. Any litigation to determine the validity of third-party infringement claims, whether or not determined in our favor or settled by us, may be costly and divert the efforts and attention of our management and technical personnel from productive tasks, which could have a material adverse effect on our ability to operate our business and service the needs of our customers. There can be no assurance that any infringement claims by third parties, if proven to have merit, will not materially adversely affect our business or financial condition. In the event of an adverse ruling in any such matter, we may be required to pay substantial damages, cease the manufacture, use and sale of infringing products, discontinue the use of certain processes or be required to obtain a license under the intellectual property rights of the third party claiming infringement. There can be no assurance that a license would be available on reasonable terms or at all. Any limitations on our ability to market our products, or delays and costs associated with redesigning our products or payments of license fees to third parties, or any failure by us to develop or license a substitute technology on commercially reasonable terms could have a material adverse effect on our business and financial condition.

ITEM 1A.		RISK FACTORS (CONTINUED)

We face risks associated with our international operations and expansion that could impair our ability to grow our revenues abroad.

We believe that our future growth is dependent in part upon our ability to increase sales in international markets. These sales are subject to a variety of risks, including fluctuations in currency exchange rates, tariffs, import restrictions and other trade barriers, unexpected changes in regulatory requirements, longer accounts receivable payment cycles, potentially adverse tax consequences, and export license requirements. In addition, we are subject to the risks inherent in conducting business internationally, including political and economic instability and unexpected changes in diplomatic and trade relationships. There can be no assurance that one or more of these factors will not have a material adverse effect on our business strategy and financial condition.

The loss of key personnel could prevent us from executing our business strategy.

Our business and prospects depend to a significant degree upon the continuing contributions of our executive officers and our key technical personnel. Competition for such personnel is intense, and there can be no assurance that we will be successful in attracting and retaining qualified personnel. Failure to attract and retain key personnel could result in our failure to execute our business strategy.

Any acquisitions we have made or will make could disrupt our business and seriously harm our financial condition.

We will continue to consider acquisitions of complementary businesses, products or technologies. In the event of any future purchases, we could issue stock that would dilute our current stockholders’ percentage ownership, incur debt, assume liabilities, or incur large and immediate write-offs.

Our operation of any acquired business may also involve numerous risks, including:

•		problems combining the purchased operations, technologies, or products;
•		unanticipated costs;
•		diversion of management’s attention from our core business;
•		difficulties integrating businesses in different countries and cultures;
•		adverse effects on existing business relationships with suppliers and customers;
•		risks associated with entering markets in which we have no or limited prior experience; and
•		potential loss of key employees, particularly those of the purchased organization.

We cannot assure that we will be able to successfully integrate any businesses, products, technologies, or personnel that we have acquired or that we might acquire in the future and any failure to do so could disrupt our business and have a material adverse effect on our consolidated financial condition and results of operations. Moreover, from time to time, we may enter into negotiations for a proposed acquisition, but be unable or unwilling to consummate the acquisition under consideration. This could cause significant diversion of management’s attention and out-of-pocket expenses for us. We could also be exposed to litigation as a result of an unconsummated acquisition, including claims that we failed to negotiate in good faith or misappropriated confidential information.

Unanticipated changes in our tax rates could affect our future results.

Our future effective tax rates could be favorably or unfavorably affected by unanticipated changes in the mix of earnings in countries with differing statutory tax rates, changes in the valuation of our deferred tax assets and liabilities, or by changes in tax laws or our interpretation of such laws. In addition, we may be subject to the

ITEM 1A.		RISK FACTORS (CONTINUED)

examination of our income tax returns by the Internal Revenue Service and other U.S. and international tax authorities. We regularly assess the potential outcomes resulting from these examinations to determine the adequacy of our provision for income taxes. There can be no assurance that the outcomes from these examinations will not have an effect on our operating results and consolidated financial condition.

Our failure to effectively comply with the requirements of applicable environmental legislation and regulation could have a material adverse effect on our revenues and profitability.

Production and marketing of products in certain states and countries may subject us to environmental and other regulations. In addition, certain states and countries may pass new regulations requiring our products to meet certain requirements to use environmentally friendly components. The European Union has issued two directives relating to chemical substances in electronic products. The Waste Electrical and Electronic Equipment Directive (WEEE) makes producers of certain electrical and electronic equipment financially responsible for collection, reuse, recycling, treatment and disposal of equipment placed in the European Union market after August 13, 2005. The Restrictions of Hazardous Substances Directive (RoHS) bans the use of certain hazardous materials in electric and electrical equipment which are put on the market in the European Union after July 1, 2006. In the future, China and other countries including the United States are expected to adopt further environmental compliance programs. If we fail to comply with these regulations, we may not be able to sell our products in jurisdictions where these regulations apply, which could have a material adverse effect on our revenues and profitability.

Our failure to effectively comply with regulatory laws pertaining to our foreign operations could have a material adverse effect on our revenues and profitability.

We are required to comply with U.S. government export regulations in the sale of our products to foreign customers, including requirements to properly classify and screen our products against a denied parties list prior to shipment. We are also required to comply with the provisions of the Foreign Corrupt Practices Act (FCPA) and all other anti-corruption laws of all other countries in which we do business, directly or indirectly, including compliance with the anti-bribery prohibitions and the accounting and recordkeeping requirements of this law. Violations of the FCPA could trigger sanctions, including ineligibility for U.S. government insurance and financing, as well as large fines. Failure to comply with the aforementioned regulations could also deter us from selling our products in international jurisdictions, which could have a material adverse effect on our revenues and profitability.

Negative conditions in the global credit markets may impair a portion of our investment portfolio.

Our investment portfolio consists of certificates of deposit, corporate bonds and government municipal bonds. These marketable securities are classified as available-for-sale and are carried at fair market value. Some of our investments could experience reduced liquidity, resulting in an adjustment and could result in an impairment charge should the impairment be considered as other-than-temporary. This loss would be recorded in our consolidated statement of operations, which could materially adversely impact our consolidated results of operations and financial condition.

Our consolidated operating results and financial condition may be adversely impacted by worldwide economic conditions and credit tightening.

If worldwide economic conditions experience a significant downturn, these conditions may make it difficult or impossible for our customers and suppliers to accurately forecast and plan future business activities, which may cause them to slow or suspend spending on products and services. Our customers may find it difficult to gain sufficient credit in a timely manner, which could result in an impairment of their ability to place orders with us

ITEM 1A.		RISK FACTORS (CONTINUED)

or to make timely payments to us for previous purchases. If this occurs, our revenue may be reduced, thereby having a negative impact on our results of operations. In addition, we may be forced to increase our allowance for doubtful accounts and our days sales outstanding may increase, which would have a negative impact on our cash position, liquidity and financial condition. We cannot predict the timing or the duration of an economic downturn in the economy.

We may have additional tax liabilities.

We are subject to income taxes in the United States and many foreign jurisdictions. Significant judgment is required in determining our worldwide provision for income taxes, including our reserves for uncertain tax positions. In the ordinary course of business, there are many transactions and calculations where the ultimate tax determination is uncertain. We regularly are under audit by tax authorities. Although we believe our tax estimates are reasonable, the final determination of tax audits could be materially different from our historical income tax provisions and accruals. The results of an audit could have a material effect on our financial position, results of operations, or cash flows in the period or periods for which that determination is made.

Risks Related to Our Common Stock

If our stock price declines, we may need to recognize an impairment of our goodwill.

If the price of our common stock declines, we could have an impairment of our goodwill. Our value is dependent upon continued future growth in demand for our products and solutions. If such growth does not materialize or our forecasts are significantly reduced, we may impair our goodwill. We perform our annual goodwill impairment assessment on our one reporting unit at June 30 each year.

The price of our common stock has been volatile and could continue to fluctuate in the future.

The market price of our common stock, like that of many other high-technology companies, has fluctuated significantly and is likely to continue to fluctuate in the future. During fiscal year 2010, the closing price of our common stock on the NASDAQ Global Select Market ranged from $7.19 to $12.30 per share. Our closing sale price on November 23, 2010 was $9.68 per share. Announcements by us or others regarding the receipt of customer orders, quarterly variations in operating results, acquisitions or divestitures, additional equity or debt financings, results of customer field trials, scientific discoveries, technological innovations, litigation, product developments, patent or proprietary rights, government regulation and general market conditions may have a significant impact on the market price of our common stock.

Certain provisions of the Delaware General Corporation Law and our charter documents have an anti-takeover effect.

There exist certain mechanisms under the Delaware General Corporation Law and our charter documents that may delay, defer or prevent a change of control. For instance, under Delaware law, we are prohibited from engaging in certain business combinations with interested stockholders for a period of three years after the date of the transaction in which the person became an interested stockholder unless certain requirements are met, and majority stockholder approval is required for certain business combination transactions with interested parties.

Our Certificate of Incorporation contains a “fair price” provision requiring majority stockholder approval for certain business combination transactions with interested parties, and this provision may not be changed without the vote of at least 80% of the outstanding shares of our voting stock. Other mechanisms in our charter documents may also delay, defer or prevent a change of control. For instance, our Certificate of Incorporation provides that our Board of Directors has authority to issue series of our preferred stock with such voting rights

ITEM 1A.		RISK FACTORS (CONTINUED)

and other powers as the Board of Directors may determine. Furthermore, we have a classified board of directors, which means that our directors are divided into three classes that are elected to three-year terms on a staggered basis. Since the three-year terms of each class overlap the terms of the other classes of directors, the entire board of directors cannot be replaced in any one year. Under Delaware law, directors serving on a classified board may not be removed by shareholders except for cause. Also, pursuant to the terms of our shareholder rights plan, each outstanding share of common stock has one attached right. The rights will cause substantial dilution of the ownership of a person or group that attempts to acquire us on terms not approved by the Board of Directors and may have the effect of deterring hostile takeover attempts. The effect of these anti-takeover provisions may be to deter business combination transactions not approved by our Board of Directors, including acquisitions that may offer a premium over the market price to some or all stockholders.

ITEM 1B.		UNRESOLVED STAFF COMMENTS

None.

ITEM 2.		PROPERTIES

The following table contains a listing of our current property locations:

								Ownership or
				Approximate				Lease
Location of				Square				Expiration
Property		Use of Facility		Footage				Date
Minnetonka, MN		Research & development, sales, sales support,			130,000			Owned
(Corporate headquarters)		marketing and administration
Eden Prairie, MN		Manufacturing and warehousing			58,000			Owned
Minneapolis, MN		Engineering services			16,837			November 2016
Waltham, MA		Research & development, sales and sales support			6,836			October 2015
Austin, TX		Sales, sales support, marketing and administration			6,563			March 2014
Davis, CA		Sales, sales support, research & development			24,000			December 2012
Lindon, UT		Sales, marketing, research & development and administration			11,986			December 2015
Herndon, VA		Sales, marketing and tech support			2,416			October 2011
Hong Kong, China		Sales, marketing and administration			4,061			February 2013
Beijing, China		Sales, marketing and administration			2,372			November 2012
Shanghai, China		Sales, marketing and administration			1,251			June 2012
Dortmund, Germany		Sales, sales support, marketing and administration			21,485			March 2013
Breisach, Germany		Sales, marketing, research & development, manufacturing, warehousing and administration			8,748			July 2013
Neuilly sur Seine, France		Sales and marketing			2,895			January 2015
Ilkley, UK		Sales, sales support, marketing and administration			5,475			October 2015
Logrono, Spain		Sales, research & development and administration			3,228			January 2017
Tokyo, Japan		Sales			1,371			November 2011
Bangalore, India		Sales, research & development and administration			9,189			July 2014

In addition to the above locations, we perform research and development activities in various other locations in the United States and sales activities in various other locations in Europe and Asia which are not deemed to be principal locations and which are not listed above. We believe that our facilities are adequate for our needs. In February 2008, we sold our facility in Dortmund, Germany and leased back approximately 40% of the property for a period of five years, with a renewal option for an additional five years.

ITEM 3.		LEGAL PROCEEDINGS

Initial Public Offering Securities Litigation

On April 19, 2002, a consolidated amended class action complaint was filed in the United States District Court for the Southern District of New York asserting claims relating to the initial public offering (IPO) of our subsidiary NetSilicon, Inc. and approximately 300 other public companies. We acquired Net Silicon, Inc. on February 13, 2002. The complaint names us as a defendant along with NetSilicon, certain of its officers and certain underwriters involved in NetSilicon’s IPO, among numerous others, and asserts, among other things, that NetSilicon’s IPO prospectus and registration statement violated federal securities laws because they contained material misrepresentations and/or omissions regarding the conduct of NetSilicon’s IPO underwriters in allocating shares in NetSilicon’s IPO to the underwriters’ customers. We believe that the claims against the NetSilicon defendants are without merit and have defended the litigation vigorously. Pursuant to a stipulation between the parties, the two named officers were dismissed from the lawsuit, without prejudice, on October 9, 2002.

As previously disclosed, the parties advised the District Court on February 25, 2009 that they had reached an agreement-in-principle to settle the litigation in its entirety. A stipulation of settlement was filed with the District Court on April 2, 2009. On June 9, 2009, the District Court preliminarily approved the proposed global settlement. Notice was provided to the class, and a settlement fairness hearing, at which members of the class had an opportunity to object to the proposed settlement, was held on September 10, 2009. On October 6, 2009, the District Court issued an order granting final approval to the settlement. Several objectors have since appealed the order approving the settlement, and those appeals remain pending.

Under the settlement, our insurers are to pay the full amount of settlement share allocated to us, and we would bear no financial liability beyond our deductible of $250,000. While there can be no guarantee as to the ultimate outcome of this pending lawsuit, we expect that our liability insurance will be adequate to cover any potential unfavorable outcome, less the applicable deductible amount of $250,000 per claim. As of September 30, 2010, we have an accrued liability for the anticipated settlement of $300,000 which we believe is adequate and reflects the amount of loss that is probable and a receivable related to the insurance proceeds of $50,000, which represents the anticipated settlement of $300,000 less our $250,000 deductible. In the event we should have losses that exceed the limits of the liability insurance, such losses could have a material adverse effect on our business and our consolidated results of operations or financial condition.

Shareholder Derivative Litigation

On June 18, 2010 and June 24, 2010, respectively, two shareholders filed derivative actions against our directors, our former Chief Financial Officer, and another executive officer, in the Hennepin County District Court, State of Minnesota, in Minneapolis. Digi also was named as a nominal defendant in the actions. The complaints alleged that the individual defendants caused us to operate in countries with dubious business practices without having internal controls or an accounting system that were adequate to ensure that we did not violate the Foreign Corrupt Practices Act. The complaints alleged causes of action against the individual defendants for (1) breach of fiduciary duty, (2) waste of corporate assets, and (3) unjust enrichment. The complaints sought to recover, purportedly on our behalf, unspecified damages, equitable relief, attorneys’ fees, and costs of litigation. On August 2, 2010, we filed a motion to dismiss these lawsuits. On August 16, 2010, the derivative actions were dismissed without prejudice.

Patent Infringement Lawsuit

On May 11, 2010, SIPCO, LLC filed a patent infringement lawsuit against Digi in federal court in the Eastern District of Texas. The lawsuit included allegations against Digi and five other companies pertaining to the infringement of SIPCO’s patents by wireless mesh networking products. The lawsuit seeks monetary and non-monetary relief. We cannot predict the outcome of this matter at this time or whether it will have a materially adverse impact on our business prospects and our consolidated financial condition, results of operations or cash flow.

ITEM 3.		LEGAL PROCEEDINGS (CONTINUED)

In addition to the matters discussed above, in the normal course of business, we are subject to various claims and litigation, including patent infringement and intellectual property claims. Our management expects that these various claims and litigation will not have a material adverse effect on our consolidated results of operations or financial condition.

PART II

ITEM 5.		MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Stock Listing

Our Common Stock trades under the symbol DGII. Since July 3, 2006, our Common Stock has traded on the NASDAQ Global Select Market tier of the NASDAQ Stock Market LLC and prior to that time was traded on the NASDAQ National Market tier. On November 23, 2010, the number of holders of our Common Stock was approximately 8,761 consisting of 180 record holders and approximately 8,581 stockholders whose stock is held by a bank, broker or other nominee.

High and low sale prices for each quarter during the years ended September 30, 2010 and 2009, as reported on the NASDAQ Stock Market LLC, were as follows:

Stock Prices

2010		First				Second				Third				Fourth
High		$	9.57			$	12.32			$	11.48			$	9.55
Low		$	6.99			$	8.87			$	7.86			$	7.29

2009		First				Second				Third				Fourth
High		$	11.10			$	8.98			$	10.72			$	10.87
Low		$	6.88			$	6.26			$	6.40			$	8.11

Dividend Policy

We have never paid cash dividends on our Common Stock. Our Board of Directors presently intends to retain all earnings for use in our business, except for periodic stock repurchases, and does not anticipate paying cash dividends in the foreseeable future.

Issuer Repurchases of Equity Securities

We did not repurchase any of our equity securities in the fourth quarter or fiscal year ended September 30, 2010. Of the 1,500,000 shares authorized to be repurchased, 135,638 shares remained available for repurchase at September 30, 2010.

ITEM 5.		MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES (CONTINUED)

Performance Evaluation

The graph below compares the total cumulative stockholders’ return on our Common Stock for the period from the close of the Nasdaq Stock Market — U.S. Companies on September 30, 2005 to September 30, 2010, the last day of fiscal 2010, with the total cumulative return on the CRSP Total Return Index for the Nasdaq Stock Market — U.S. Companies (the “CRSP Index”) and the CRSP Index for Nasdaq Telecommunications Stocks (the “Peer Index”) over the same period. We have determined that our line of business is mostly comparable to those companies in the Peer Index. The index level for the graph and table was set to $100 on September 30, 2005, for our Common Stock, the CRSP Index and the Peer Index and assumes the reinvestment of all dividends.

		FY05				FY06				FY07				FY08				FY09				FY010
Digi International Inc.			100.00				125.82				132.71				95.06				79.40				88.44
CRSP Index			100.00				105.44				124.80				98.40				78.96				89.24
Peer Index			100.00				111.56				130.79				90.70				90.50				115.14

ITEM 6.		SELECTED FINANCIAL DATA

(In thousands except per common share amounts and number of employees)

For the fiscal years ended September 30		2010				2009				2008				2007				2006
Net sales (1)		$	182,548			$	165,928			$	185,056			$	173,263			$	144,663
Gross profit		$	92,209			$	81,265			$	97,869			$	91,346			$	77,505
Sales and marketing			37,010				35,304				36,879				33,499				28,591
Research and development			27,825				26,381				27,040				24,176				20,861
General and administrative (2)			17,889				14,557				16,035				13,343				12,830
Restructuring (benefit) costs			(468	)			1,953				—				—				—
Acquired in-process research and development			—				—				1,900				—				2,000
Operating income			9,953				3,070				16,015				20,328				13,223
Total other income, net (3)			566				1,212				2,900				3,396				2,044
Income before income taxes			10,519				4,282				18,915				23,724				15,267
Income tax provision (4)			1,578				199				6,564				3,951				4,154
Net income		$	8,941			$	4,083			$	12,351			$	19,773			$	11,113
Net income per common share, basic:
Basic		$	0.36			$	0.16			$	0.48			$	0.78			$	0.48
Diluted		$	0.36			$	0.16			$	0.47			$	0.76			$	0.46
Balance sheet data as of September 30:
Working capital (total current assets less total current liabilities)		$	122,105			$	106,121			$	112,236			$	115,703			$	83,341
Total assets		$	266,965			$	258,948			$	271,416			$	251,826			$	225,321
Long-term debt and capital lease obligations		$	—			$	9			$	345			$	358			$	725
Stockholders’ equity		$	240,556			$	229,586			$	231,934			$	222,905			$	193,830
Book value per common share (stockholders’ equity divided by outstanding shares)		$	9.59			$	9.29			$	9.14			$	8.73			$	7.74
Number of employees as of September 30			648				634				663				564				549

ITEM 7.		MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

OVERVIEW

We operate in the communications technology industry, which is characterized by rapid technological advances and evolving industry standards. The market can be significantly affected by new product introductions and marketing activities of industry participants. We compete for customers on the basis of existing and planned product features, service capabilities, company reputation, brand recognition, technical support, relationships with partners, quality and reliability, product development capabilities, price and availability. We help customers connect, monitor, and control local or remote electronic devices over a network, via the Internet or via satellite.

Our revenues consist of products that are in non-embedded and embedded product groupings. The embedded products include modules, chips, software and development tools, single-board computers, satellite communication products and engineering design services. Non-embedded products include cellular routers, cellular gateway products, wireless communications adapters, serial servers, console servers, USB connected products, remote display products and serial cards. Our non-embedded serial cards are in the mature phase of their product life cycles. Our strategy is to focus on key applications, customers and markets to efficiently manage the migration from products that are in the mature phase of their product life cycles to other newer technologies.

We experienced an increase in both revenue and profitability in fiscal 2010 compared to the prior fiscal year as we partially recovered from the domestic economic downturn and benefited from actions taken in fiscal 2009 to position ourselves for growth. Our business was negatively impacted by the effects of the severe downturn in the economy in fiscal 2009, and we experienced a reduction in demand for our products in all geographic locations. In response to the depressed economic conditions, we put in place a restructuring plan that included various cost reduction actions. We also reduced our investment in lower growth product lines while increasing our investment in wireless products and solutions that include hardware, software and services. These actions allowed us to reduce our profit breakeven point and remain profitable despite the negative economic conditions that existed throughout fiscal 2009.

Net sales were $182.5 million for fiscal 2010 compared to $165.9 million in fiscal 2009, an increase of $16.6 million, or 10.0%. Our wireless product net sales grew from $56.2 million, or 33.9% of net sales, in fiscal 2009 to $66.4 million, or 36.3% of net sales, in fiscal 2010, an increase of 18.0%. We expect continued strength in wireless products net sales resulting from large customer opportunities for our wireless solutions, primarily in the Smart Grid, fleet management and medical markets.

Gross profit increased by $10.9 million, or 13.5% in fiscal 2010. Gross margin improved from 49.0% for the fiscal year ended September 30, 2009 to 50.5% for the fiscal year ended September 30, 2010. The business restructuring discussed above contributed to the improvement in our gross margin, in addition to other cost reduction initiatives.

Total operating expenses were $82.3 million in fiscal 2010 compared to $78.2 million in fiscal 2009, an increase of $4.1 million, or 5.2%. We suspended our non-sales incentive compensation program for fiscal 2009, for both executive management as well as a large part of the employee base. This program was reinstated at a reduced level for fiscal 2010. We also reduced our sales commission program in the last half of fiscal 2009 and we fully restored the program in fiscal 2010. Also, during the last six months of fiscal 2010, we incurred $1.4 million of expense related to the investigation and remediation that is discussed in Note 19 to our consolidated financial statements.

ITEM 7.		MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)

OVERVIEW (CONTINUED)

Net income was $8.9 million, or 4.9% of net sales, in fiscal 2010 compared to $4.1 million, or 2.5% of net sales in fiscal 2009. Net income during fiscal 2010 benefited by $2.3 million, resulting from the reversal of tax reserves associated with the statutory closing of a prior tax year and the conclusion of an audit of prior tax years. Net income during fiscal 2009 benefited by $1.2 million, resulting from the reversal of tax reserves associated with the extension of the research and development credit, the resolution of certain state tax matters, and the closing of a prior tax year.

CONSOLIDATED RESULTS OF OPERATIONS

The following table sets forth selected information from our Consolidated Statements of Operations, expressed as a percentage of net sales and as a percentage of change from year-to-year for the years indicated.

																										% Increase (decrease)
																										2010				2009
		Year ended September 30,																								compared				compared
($ in thousands)		2010								2009								2008								to 2009				to 2008
Net sales		$	182,548				100.0	%		$	165,928				100.0	%		$	185,056				100.0	%			10.0	%			(10.3	)%
Cost of sales (exclusive of amortization of purchased and core technology shown separately below)			86,266				47.3				80,470				48.5				83,096				44.9				7.2				(3.2	)
Amortization of purchased and core technology			4,073				2.2				4,193				2.5				4,091				2.2				(2.9	)			2.5
Gross profit			92,209				50.5				81,265				49.0				97,869				52.9				13.5				(17.0	)
Operating expenses:
Sales and marketing			37,010				20.3				35,304				21.3				36,879				20.0				4.8				(4.3	)
Research and development			27,825				15.2				26,381				15.9				27,040				14.6				5.5				(2.4	)
General and administrative			17,889				9.8				14,557				8.7				16,035				8.6				22.9				(9.2	)
Restructuring (benefit) costs			(468	)			(0.3	)			1,953				1.2				—				—				(124.0	)			N/M
In-process research and development			—				—				—				—				1,900				1.0				N/M				(100.0	)
Total operating expenses			82,256				45.0				78,195				47.1				81,854				44.2				5.2				(4.5	)
Operating income			9,953				5.5				3,070				1.9				16,015				8.7				224.2				(80.8	)
Total other income, net			566				0.3				1,212				0.7				2,900				1.5				(53.3	)			(58.2	)
Income before income taxes			10,519				5.8				4,282				2.6				18,915				10.2				145.7				(77.4	)
Income tax provision			1,578				0.9				199				0.1				6,564				3.5				693.0				(97.0	)
Net income		$	8,941				4.9	%		$	4,083				2.5	%		$	12,351				6.7	%			119.0	%			(66.9	)%

N/M means not meaningful

NET SALES

Net sales were $182.5 million in fiscal 2010 compared to $165.9 million in fiscal 2009, an increase of $16.6 million or 10.0%, primarily due to an increase of $26.8 million in the net sales of modules, cellular products, serial servers, wireless communication adaptors, USB products, engineering design services and satellite-related products. This was partially offset by a decrease of $4.9 million in net sales of products included in our product portfolio resulting from the Sarian acquisition which were higher in fiscal 2009, primarily due to a large sale to a legacy customer, and a decrease of $5.3 million in net sales due to large sales of a discontinued chip set in fiscal 2009. The increase in net sales in fiscal 2010 compared to fiscal 2009 is primarily driven by increased volume and demand rather than pricing changes. We did not experience a material change in revenue due to pricing. As we continue to focus on growing our wireless sales, our wireless product net sales grew from $56.2 million, or 33.9% of net sales, in fiscal 2009, to $66.4 million, or 36.3% of net sales, in fiscal 2010, or an increase of 18.0%.

Net sales were $165.9 million in fiscal 2009 compared to $185.1 million in fiscal 2008, a decrease of $19.2 million or 10.3%. Revenue decreased primarily due to weakened economic conditions and changes in product

ITEM 7.		MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)

NET SALES (CONTINUED)

mix. Net sales in fiscal 2009 and 2008 included $20.7 million and $6.5 million of net sales from Sarian and Spectrum products, respectively. Fiscal 2009 net sales also included $0.4 million attributable to MobiApps which was acquired on June 8, 2009. Fiscal 2008 net sales also included $6.5 million of net sales from Sarian and Spectrum from their dates of acquisition. Net sales from all other product lines decreased by $33.8 million, or 18.9%, during fiscal 2009 as compared to fiscal 2008, primarily due to weakened economic conditions, except for increases in net sales of cellular, wireless communication adapters and chips and software.

Fluctuation in foreign currency rates compared to the prior year’s rates had an unfavorable impact on net sales of $0.3 million in fiscal 2010 and $5.9 million in fiscal 2009 and a favorable impact on net sales of $2.2 million in fiscal 2008.

Net Sales by Product Category

The following table presents our revenue by product category:

		Net Sales												% of Net Sales
($ in millions)		2010				2009				2008				2010				2009				2008
Non-embedded		$	100.1			$	91.2			$	98.5				54.9	%			55.0	%			53.2	%
Embedded			82.4				74.7				86.6				45.1	%			45.0	%			46.8	%
Total		$	182.5			$	165.9			$	185.1				100.0	%			100.0	%			100.0	%

Non-Embedded

Non-embedded products net sales increased $8.9 million, or 9.7%, in fiscal 2010 compared to fiscal 2009. The increase was mostly due to a $13.8 million increase in net sales of cellular products, serial servers, wireless communication adaptors and USB products, offset by a decrease of $4.9 million in net sales of products included in our product portfolio resulting from the Sarian acquisition which were higher in fiscal 2009 primarily due to a large sale to a legacy customer.

Non-embedded products net sales decreased $7.3 million, or 7.3%, in fiscal 2009 compared to fiscal 2008 due mostly to decreases in sales of serial cards, serial servers and USB connected products, partially offset by increases in cellular and wireless communication adapters. Non-embedded net sales related to Sarian branded products were $16.2 million in fiscal 2009 compared to $5.7 million in fiscal 2008, which included five months of Sarian net sales from the date of acquisition.

Embedded

Embedded products net sales increased $7.7 million, or 10.4%, in fiscal 2010 compared to fiscal 2009. The increase was primarily due to a $13.0 million increase in net sales of modules and satellite-related products, partially offset by a decrease of $5.3 million primarily related to large sales of a discontinued chip set in fiscal 2009.

Embedded products net sales decreased $11.9 million, or 13.8%, in fiscal 2009 compared to fiscal 2008 due mostly to decreases of modules and network interface cards, partially offset by an increase in chips and software. Embedded net sales in fiscal 2009 also include incremental net sales of $3.8 million from Spectrum design services.

ITEM 7.		MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)

NET SALES (CONTINUED)

Net Sales by Distribution Channel

The following table presents our revenue by distribution channel:

		Net Sales												% of Net Sales
($ in millions)		2010				2009				2008				2010				2009				2008
Direct / OEM channel		$	66.2			$	78.5			$	87.5				36.3	%			47.3	%			47.3	%
Distribution channel			116.3				87.4				97.6				63.7	%			52.7	%			52.7	%
Total company		$	182.5			$	165.9			$	185.1				100.0	%			100.0	%			100.0	%

During fiscal 2010, net sales in the Distribution channel increased by $28.9 million, or 33% compared to net sales in fiscal 2009. Net sales in fiscal 2010 in the Direct / OEM channel decreased by $12.3 million, or 15.7% compared to the prior fiscal year. The increase in net sales in the Distribution channel compared to the Direct / OEM channel is primarily due to fulfillment of customer orders for wireless products.

The decreases in net sales in both the Direct / OEM and the Distribution channels during fiscal 2009 compared to fiscal 2008 primarily resulted from a weakened economy.

We continued to focus on maintaining our channel strategy, which includes employing additional channel partners and releasing complementary products.

Net Sales by Geographic Area

Our revenue by geographic location of our customers is as follows:

		Net Sales												% of Net Sales
($ in millions)		2010				2009				2008				2010				2009				2008
North America		$	107.3			$	90.7			$	107.3				58.8	%			54.7	%			58.0	%
Europe, Middle East & Africa			47.7				56.0				53.0				26.2	%			33.7	%			28.6	%
Asian countries			22.7				15.6				19.7				12.4	%			9.4	%			10.6	%
Latin America			4.8				3.6				5.1				2.6	%			2.2	%			2.8	%
Total net sales		$	182.5			$	165.9			$	185.1				100.0	%			100.0	%			100.0	%

Net sales in fiscal 2010 increased $16.6 million over fiscal 2009 as the U.S. economy partially recovered from the domestic economic downturn. International net sales remained the same and were $75.2 million, or 41.2% of net sales, in fiscal 2010, compared to $75.2 million, or 45.3% of net sales, in fiscal 2009.

Net sales in fiscal 2010 for North America increased $16.6 million due to an increase in non-embedded products of $11.8 million and embedded products of $4.8 million. Net sales in fiscal 2009 as compared to fiscal 2008 decreased $20.5 million in North America, partially offset by incremental revenue of $3.8 million from the Spectrum acquisition in July 2008.

Net sales in Europe, Middle East, and Africa (“EMEA”) decreased $8.3 million from fiscal 2009 to fiscal 2010 as fiscal 2009 included large sales of a discontinued chip set and a large sale to a legacy customer of Sarian. The increase in net sales in EMEA during fiscal 2009 and 2008 is primarily due to the acquisition of Sarian in April 2008, which provided revenue of $16.2 million and $5.7 million, respectively.

ITEM 7.		MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)

NET SALES (CONTINUED)

Revenue for the Latin America and Asian countries increased by $8.3 million in fiscal 2010 compared to fiscal 2009, and revenue decreased by $5.6 million in fiscal 2009 compared to fiscal 2008. The increase in revenue for fiscal 2010 for both Latin America and Asian countries was due to an increase of $4.9 million of embedded products and $3.4 million of non-embedded products. Also in fiscal 2010, we recorded a full year of net sales related to the MobiApps acquisition compared to three months of net sales in fiscal 2009. The decrease in revenue for fiscal 2009 compared to fiscal 2008 for Latin America was primarily due to a reduction in net sales of non-embedded products and for Asian countries was due to a reduction in net sales of both embedded and non-embedded products primarily resulting from the global economic conditions in both regions. MobiApps revenue of $0.3 million from date of acquisition of June 2009 is included in fiscal 2009 Asian countries revenue.

GROSS PROFIT

2010 compared to 2009

Gross profit was $92.2 million and $81.3 million in fiscal 2010 and 2009, respectively, an increase of $10.9 million, or 13.5%. The gross margin for fiscal 2010 was 50.5% compared to 49.0% in fiscal 2009. Gross margin increased 2.1% primarily due to a reduction of costs as a result of the business restructuring in fiscal 2009 and other cost reduction initiatives and also increased 0.3% related to a reduction in amortization of purchased and core technology as some technology is fully amortized. This was partially offset by a 0.9% decrease in gross margin due to unfavorable product mix primarily related to cellular and certain embedded products. Amortization of purchased and core technology was $4.1 million or 2.2% of net sales in fiscal 2010 as compared to $4.2 million or 2.5% of net sales in fiscal 2009.

2009 Compared to 2008

Gross margin for fiscal 2009 was 49.0% compared to 52.9% for 2008. The decrease in gross margin is primarily a result of product and customer mix changes as we had a large sale to a legacy customer which generated a lower gross margin. The gross margin also decreased due to an increase in the amortization of purchased and core technology due to the acquisitions of Sarian, Spectrum and MobiApps. Amortization of purchased and core technology was $4.2 million or 2.5% of net sales in fiscal 2009 as compared to $4.1 million or 2.2% of net sales in fiscal 2008.

OPERATING EXPENSES

2010 Compared to 2009

Operating expenses were $82.3 million in fiscal 2010, an increase of $4.1 million or 5.2%, compared to $78.2 million in fiscal 2009. Compensation-related expenses, including salaries, incentive compensation, commissions and stock-based compensation increased $1.8 million as we fully restored the sales commission program and partially reinstated our non-sales incentive compensation program for fiscal 2010. We also incurred professional fees of $1.4 million related to the investigation and remediation that is discussed in Note 19 to our consolidated financial statements and incremental ongoing expenses related to the fiscal 2009 MobiApps acquisition of $1.6 million.

Sales and marketing expenses were $37.0 million in fiscal 2010, an increase of $1.7 million or 4.8%, compared to $35.3 million in fiscal 2009. The increase was due to an increase of $1.0 million in commission expense, $0.4 million in incremental expenses for MobiApps and $0.3 million of other various sales and marketing expenses.

ITEM 7.		MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)

OPERATING EXPENSES (CONTINUED)

Research and development expenses were $27.8 million in fiscal 2010, an increase of $1.4 million or 5.5%, compared to $26.4 million in fiscal 2009. The increase was due to an increase of $0.9 million in professional services, contract labor and certification testing, $0.7 million in incremental expenses for MobiApps, and $0.4 million of compensation-related expenses, offset by a net reduction of $0.6 million of expense primarily related to a development project that was completed in fiscal 2009.

General and administrative expenses were $17.9 million in fiscal 2010, an increase of $3.4 million or 22.9%, compared to $14.5 million in fiscal 2009. General and administrative expenses increased by $2.0 million due to increased professional fees which includes $1.4 million of investigation and remediation fees (see Note 19 to our Consolidated Financial Statements). In addition, the incremental expenses for MobiApps increased general and administrative expenses by $0.5 million, compensation-related expenses increased by $0.3 million and other miscellaneous general and administrative expenses increased by $0.6 million.

2009 Compared to 2008

Operating expenses were $78.2 million in fiscal 2009, a decrease of $3.7 million or 4.5%, compared to $81.9 million in fiscal 2008. Compensation-related expenses, including salaries, incentive compensation and stock-based compensation, decreased by $3.2 million in fiscal 2009 as compared to fiscal 2008 due to the suspension of our non-sales incentive program for fiscal 2009 and a reduction of our sales commission program in the last half of fiscal 2009 as well as a reduction in the number of employees. Incremental operating expenses resulting from the acquisitions of Sarian, Spectrum and MobiApps were $4.4 million. We recorded a charge of $1.9 million for in-process research and development incurred in 2008 resulting from the Sarian acquisition. On April 23, 2009, we announced a restructuring initiative that resulted in a restructuring charge of $2.0 million.

Sales and marketing expenses were $35.3 million in fiscal 2009, a decrease of $1.6 million or 4.3%, compared to $36.9 million in fiscal 2008. Sales and marketing expenses decreased by $0.9 million for compensation-related expenses, $1.2 million for advertising and marketing literature, $0.5 million for reduced travel and entertainment and by $0.3 million for miscellaneous other sales and marketing expenses. This was partially offset by incremental expenses related to Sarian, Spectrum and MobiApps which increased sales and marketing expenses by $1.3 million.

Research and development expenses were $26.4 million in fiscal 2009, a decrease of $0.7 million or 2.4%, compared to $27.1 million in fiscal 2008. Research and development expenses decreased by $1.2 million for compensation-related expenses, $0.3 million for product certifications and $0.5 million for other research and development expenses. This was partially offset by incremental expenses for Sarian, Spectrum and MobiApps which increased research and development expenses by $1.3 million.

General and administrative expenses were $14.5 million in fiscal 2009, a decrease of $1.5 million or 9.2%, compared to 16.0 million in fiscal 2008. The reduction in general and administrative expenses were due to decreases of $1.1 million for compensation-related expenses, $0.6 million for professional fees, $0.5 million for amortization and depreciation, $0.6 million for bad debt expense and a $0.5 million decrease in other general and administrative expenses. This was partially offset by incremental expenses of $1.8 million due to Sarian, Spectrum and MobiApps.

ITEM 7.		MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)

RESTRUCTURING

On April 23, 2009 we announced a business restructuring to increase our focus on wireless products and solutions that include hardware, software and services. The restructuring included the closing of an engineering facility in Long Beach, California, and the relocation and consolidation of the manufacturing facility in Davis, California to our Minnetonka, Minnesota headquarters. We paid a lease cancellation fee for one of the leased facilities in Davis and had vacated the facility as of September 30, 2009. We continue to maintain non-manufacturing activities at the remaining leased facility in Davis, California. As a result of these initiatives, during the third quarter of fiscal 2009 we recorded a $2.0 million charge, which consisted of $1.8 million for employee termination costs for 86 positions and $0.2 million for contract termination fees and other relocation costs.

All 86 positions were vacated as of September 30, 2009. The employee termination costs included severance and the associated costs of continued medical benefits and outplacement services. The other restructuring expenses included contract termination fees for non-renewal of lease terms relating to one of the facilities in Davis, California and relocation expenses for employees.

During fiscal 2010, we recorded an additional $0.1 million for an additional six months of continued medical benefits as a result of new healthcare legislation passed in December 2009 related to the aforementioned restructuring. Also during fiscal 2010 we reversed $0.5 million of the restructuring accrual since costs associated with continued medical benefits and relocation were lower than expected.

ACQUIRED IN-PROCESS RESEARCH AND DEVELOPMENT

Sarian Systems, Ltd.

On April 28, 2008, we acquired Sarian Systems, Ltd. (“Sarian”). Prior to the acquisition, Sarian was a privately held corporation. Sarian is located in the United Kingdom and is a leader in the European wireless router market. The total purchase price of $30.9 million was for all of the outstanding ordinary shares of Sarian.

At the time of acquisition, Sarian had development projects in process associated with the IPV6, Gate Array and VPN technologies. We estimated that $1.9 million of the purchase price represented the fair value of acquired in-process research and development related to the products listed below (in thousands):

IPV6		$	1,300
Gate Array			400
VPN technologies			200
Total in-process research and development		$	1,900

These products were under development, had a measurable percentage completed and a documented expected life, had not yet reached technological feasibility, and had no alternative future uses. This amount was expensed as a non-deductible tax charge upon consummation of the acquisition.

All of the acquired development projects were completed in fiscal 2009.

ITEM 7.		MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)

OTHER INCOME, NET

2010 Compared to 2009

Total other income, net was $0.6 million in fiscal 2010, a decrease of $0.6 million compared to $1.2 million in fiscal 2009. We realized interest income on marketable securities and cash and cash equivalents of $0.4 million in fiscal 2010 compared to $1.4 million in fiscal 2009. Although our average investment balance during fiscal 2010 was $69.0 million compared to $57.6 million in fiscal 2009, the decrease in interest income was primarily due to a lower than average interest rate as we earned an average interest rate of 0.5% during fiscal 2010 compared to 2.4% during fiscal 2009. Interest expense was $0.1 million in fiscal 2010 as compared to $0.3 million in fiscal 2009 as we made one of the deferred payments during fiscal 2010 for the Spectrum acquisition. Other income, net also increased $0.3 million related to a net increase in foreign currency transaction gains in fiscal 2010 compared to fiscal 2009.

2009 Compared to 2008

Other income, net was $1.2 million in fiscal 2009, a decrease of $1.7 million compared to $2.9 million in fiscal 2008. During fiscal 2009, we realized $1.4 million of interest income on marketable securities and cash and cash equivalents compared to $3.6 million during fiscal 2008. The decrease in interest income was due to lower average investment balances and lower average interest rates. The average investment balance during fiscal 2009 was $57.6 million compared to $77.1 million for fiscal 2008. We earned an average interest rate of 2.4% during fiscal 2009 compared to 4.5% for fiscal 2008. Other income, net also decreased $0.4 million related to a net decrease in foreign currency transaction gains in fiscal 2009 compared to fiscal 2008. Further, we recorded an other-than-temporary impairment charge of $1.0 million in fiscal 2008 related to a bond issued by Lehman Brothers. No additional impairment was recorded in fiscal 2009.

INCOME TAXES

Our effective income tax rate was 15.0%, 4.6% and 34.7% for fiscal 2010, 2009 and 2008, respectively.

During fiscal 2010, we reversed $2.3 million in income tax reserves associated primarily with the closing of prior tax years through statute expiration and the conclusion of a federal tax audit. While the statutes of limitations have not expired, U.S. federal income tax returns for the periods ended September 30, 2007 and September 30, 2008 have been audited by and settled with the Internal Revenue Service. The aforementioned income tax benefits resulting from the reversal of income tax reserves and other discrete tax benefits reduced the effective tax rate by 22 percentage points in fiscal 2010.

During fiscal 2009, we reversed $0.6 million in income tax reserves primarily associated with the statutory closing of a prior U.S. federal and state tax year and settlement of prior liabilities under amnesty programs. We recorded an additional current discrete tax benefit of $0.5 million resulting from the enactment on October 3, 2008 of the retroactive extension of the research and development tax credit for activity from January 1, 2008 to September 30, 2008. We also recorded adjustments to actual for items reported on the tax returns filed for fiscal 2007 and 2008. The aforementioned income tax benefits resulting from the reversal of income tax reserves and other discrete tax benefits reduced the effective tax rate by 27 percentage points in fiscal 2009.

During fiscal 2008, we reversed $0.3 million in income tax reserves primarily associated with the statutory closing of a prior U.S. federal and state tax year. We recorded an additional $0.2 million of discrete tax benefits as a result of a filing of a prior year tax return and adjustments to actual for items reported on the tax returns for fiscal 2007.

ITEM 7.		MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)

INFLATION

Management believes that during fiscal years 2010, 2009 and 2008, inflation has not had a material effect on our operations or on our consolidated financial position.

LIQUIDITY AND CAPITAL RESOURCES

We have financed our operations principally with funds generated from operations. We had cash, cash equivalents and short-term marketable securities of $87.6 million, $70.7 million and $73.5 million at September 30, 2010, 2009 and 2008, respectively. Our working capital was $122.1 million, $106.1 million and $112.2 million at September 30, 2010, 2009 and 2008, respectively.

Consolidated Statement of Cash Flow Highlights (in thousands)

		Year ended September 30,
		2010				2009				2008
Operating activities		$	16,095			$	15,686			$	24,070
Investing activities			(15,167	)			25,286				(22,370	)
Financing activities			2,604				(5,427	)			(2,564	)
Effect of exchange rate changes on cash and cash equivalents			(1,023	)			(1,287	)			(3,335	)
Net increase (decrease) in cash and cash equivalents		$	2,509			$	34,258			$	(4,199	)

Net cash provided by operating activities was $16.1 million during fiscal 2010 compared to $15.7 million during fiscal 2009, a net increase of $0.4 million. This net increase is due to an increase in net income of $4.9 million and a net increase of $0.2 million of other non-cash items, offset by a decrease of $1.0 million in deferred income taxes and a $3.7 million decrease due to changes in working capital. Changes in working capital decreased cash flows by $3.7 million primarily due to an $11.9 million decrease in accounts receivable as the receivables balance increased due to higher revenue in September 2010 than in September 2009. Inventory levels were approximately the same at September 30, 2010 and 2009, however inventories decreased $3.6 million at September 30, 2009 compared to 2008. This was offset by a net increase of $6.0 million related to changes in accounts payable and a net increase of $5.8 million related to changes in other assets and accrued expenses. Net cash provided by operating activities was $15.7 million during fiscal 2009 compared to $24.1 million for fiscal 2008, a net decrease of $8.4 million. This net decrease is primarily due to a decrease in net income of $8.3 million, and decreases of $1.0 million related to an other-than-temporary impairment charge during fiscal 2008, $1.1 million in deferred income taxes, and $1.9 million related to an in-process research and development charge in fiscal 2008. This was partially offset by an increase of $1.1 million of other non-cash items and an increase of $3.5 million due to changes in working capital. The changes in working capital increased cash flows by $3.5 million primarily due to increases resulting from changes in accounts receivable and inventories, partially offset by decreases in accounts payable, income taxes payable (receivable) and other accrued expenses.

Net cash used by investing activities was $15.2 million in fiscal 2010 as compared to net cash provided by investing activities of $25.3 million during fiscal 2009, a net decrease of $40.5 million. Net purchases of marketable securities in fiscal 2010 offset by net settlements of marketable securities in fiscal 2009 resulted in a net decrease of $41.3 million. We used cash of $3.0 million for a deferred payment related to the Spectrum acquisition. In fiscal 2009 we spent $3.0 million related to the acquisition of the assets of MobiApps and reduced our capital expenditures by $0.8 million. Net cash provided by investing activities was $25.3 million in

ITEM 7.		MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)

LIQUIDITY AND CAPITAL RESOURCES (CONTINUED)

fiscal 2009 as compared to net cash used by investing activities of $22.4 million in fiscal 2008, an increase of $47.7 million. The increase is a result of $23.5 million of additional net proceeds of marketable securities. Cash spent on acquisitions and contingent purchase price payments in fiscal 2008 was $33.2 million compared to $3.0 million in fiscal 2009. We spent $0.5 million less in fiscal 2009 as compared to fiscal 2008 on capital expenditures. In fiscal 2008 we received $6.9 million relating to the sale of our building in Dortmund, Germany in fiscal 2008 (see Note 12 to our Consolidated Financial Statements) offset by a deposit of $0.4 million in a restricted cash account related to the leaseback.

Net cash provided by financing activities was $2.6 million in fiscal 2010 as compared to net cash used in financing activities of $5.4 million in fiscal 2009, a net increase of $8.0 million. We spent $6.6 million related to treasury stock repurchases in fiscal 2009. In fiscal 2010 compared to fiscal 2009, we received an additional $1.1 million in proceeds from the exercise of stock options and employee stock purchase plan transactions and spent $0.3 million less in capital lease payments. Net cash used in financing activities was $5.4 million in fiscal 2009 as compared to $2.6 million in fiscal 2008, a net decrease of $2.9 million as a result of a $1.4 million decrease from the exercise of stock options and employee stock purchase plan transactions and $1.5 million of additional cash usage for the repurchase of treasury stock.

We expect positive cash flows from operations and believe that our current cash, cash equivalents and marketable securities balances, cash generated from operations and our ability to secure debt and/or equity financing will be sufficient to fund our business operations for the next twelve months and beyond.

The following summarizes our contractual obligations at September 30, 2010:

		Payments due by fiscal period
						Less than
(in thousands)		Total				1 year				1-3 years				3-5 years				Thereafter
Operating leases		$	7,370			$	2,389			$	3,516			$	1,222			$	243
Deferred payments on acquisition			3,000				3,000				—				—				—
Total contractual cash obligations		$	10,370			$	5,389			$	3,516			$	1,222			$	243

The operating lease agreements included above primarily relate to office space. The table above does not include possible payments for uncertain tax positions. Our reserve for uncertain tax positions, including accrued interest and penalties, was $2.8 million as of September 30, 2010. 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 cash payments that may be required to settle these liabilities.

FOREIGN CURRENCY

We are exposed to foreign currency risk associated with certain sales transactions being denominated in Euros, British Pounds or Japanese Yen and foreign currency translation risk as the financial position and operating results of our foreign subsidiaries are translated into U.S. Dollars for consolidation. We have not implemented a formal hedging strategy to reduce foreign currency risk.

During 2010, we had approximately $75.2 million of net sales related to foreign customers including export sales, of which $27.6 million was denominated in foreign currency, predominantly the Euro and British Pound.

ITEM 7.		MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)

FOREIGN CURRENCY (CONTINUED)

During 2009 and 2008, we had approximately $75.2 million and $76.1 million, respectively, of net sales to foreign customers including export sales, of which $33.4 million and $45.7 million, respectively, were denominated in foreign currency, predominantly the Euro and British Pound in fiscal 2009 and predominantly the Euro in fiscal 2008. In future periods, a significant portion of sales will continue to be made in Euros and British Pounds.

During fiscal 2008, we acquired Sarian for $30.9 million, which was partially financed by an intercompany loan from both Digi International Inc. for $25.0 million and Digi GmbH for $2.9 million. The Digi GmbH intercompany loan for $2.9 million was paid in March 2009 and the Digi International Inc. $25.0 million loan was converted to capital on October 1, 2008. The translation adjustments related to the $2.9 million intercompany loan were recorded in other income, net within our Consolidated Statements of Operations.

RECENT ACCOUNTING DEVELOPMENTS

In March 2010, the FASB (Financial Accounting Standards Board) issued an amendment to the accounting standards that provides guidance on criteria used to define a milestone and determines when it may be appropriate to apply the milestone method of revenue recognition for research or development transactions. Consideration that is contingent upon achievement of a milestone can be recognized in its entirety as revenue in the period in which the milestone is achieved only if the milestone meets all criteria to be considered substantive. In addition, certain disclosures related to the milestone method of revenue recognition will be required. We adopted this provision on October 1, 2010. We do not expect this amendment to have a material impact on our consolidated financial statements.

In October 2009, the FASB issued an amendment to the accounting standards that provides guidance for identifying separate deliverables in a revenue-generating transaction where multiple deliverables exist, and for allocating and recognizing revenue based on those separate deliverables. This guidance is expected to result in more multiple-deliverable arrangements being separable than under current guidance. This amendment is effective for revenue arrangements entered into or materially modified in our fiscal year beginning October 1, 2010. We adopted this provision on October 1, 2010. We do not expect this amendment to have a material impact on our consolidated financial statements.

In October 2009, the FASB issued an amendment to the accounting standards related to certain revenue arrangements that include software elements. This standard clarifies the existing accounting guidance such that tangible products that contain both software and non-software components that function together to deliver the product’s essential functionality shall be excluded from the scope of the software revenue recognition accounting standards. Accordingly, sales of these products may fall within the scope of other revenue recognition accounting standards or may now be within the scope of this standard and may require an allocation of the arrangement consideration for each element of the arrangement. This amendment is effective for revenue arrangements entered into or materially modified in our fiscal year beginning October 1, 2010. We adopted this provision on October 1, 2010. We do not expect this amendment to have a material impact on 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 in the United States of America. The preparation of these consolidated financial statements requires us to make

ITEM 7.		MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)

CRITICAL ACCOUNTING POLICIES AND ESTIMATES (CONTINUED)

estimates and judgments that affect the reported amounts of assets, liabilities, revenues 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 are 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.

REVENUE RECOGNITION

Our revenues are derived primarily from the sale of embedded and non-embedded products to our distributors and Direct (end-user) / OEM customers, and to a small extent from the sale of software licenses, fees associated with technical support, training, professional and engineering services and royalties. We recognize product revenue when persuasive evidence of an arrangement exists, delivery has occurred, the sales price is fixed or determinable, collectability is reasonably assured and there are no post-delivery obligations other than warranty.

Under these criteria, product revenue is generally recognized upon shipment of product to customers. Sales to authorized domestic distributors and Direct / OEMs are made with certain rights of return and price adjustment provisions. Estimated reserves for future returns and pricing adjustments are established by us based on an analysis of historical patterns of returns and price adjustments as well as an analysis of authorized returns compared to received returns, current on-hand inventory at distributors, and distribution sales for the current period. Estimated reserves for future returns and price adjustments are charged against revenues in the same period as the corresponding sales are recorded. Material differences between the historical trends used to determine estimated reserves and actual returns and pricing adjustments could result in a material change to our consolidated results of operations or financial position. We have applied consistent methodologies for estimating reserves for future returns and pricing adjustments for all years presented. The reserve for future returns and pricing adjustments was $1.1 million at both September 30, 2010 and 2009.

We also generate revenue from the sale of software licenses, post-contract customer support, fees associated with technical support, training, professional and engineering services and royalties. Revenue recognized resulting from such non-product sales represented 3.3%, 3.0% and 1.2% of net sales in fiscal 2010, 2009 and 2008, respectively. Our software development tools and development boards often include multiple elements, including hardware, software licenses, post-contract customer support, limited training and basic hardware design review. Our customers purchase these products and services during their product development process in which they use the tools to build network connectivity into the devices they are manufacturing. Revenue for software licenses, professional and engineering services and training is recognized upon performance, which includes delivery of a final product version and acceptance by the customer. Revenues from contracts with multiple element arrangements are recognized as each element is earned based on the relative fair value of each element provided the delivered elements have value to customers on a standalone basis. Amounts allocated to each element are based on its objectively determined fair value, such as the sales price for the product or service when it is sold separately.

ITEM 7.		MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)

CRITICAL ACCOUNTING POLICIES AND ESTIMATES (CONTINUED)

CASH EQUIVALENTS AND MARKETABLE SECURITIES

We regularly monitor and evaluate the realizable value of our marketable securities. When assessing marketable securities for other-than-temporary declines in value, we consider factors including how significant the decline in value is as a percentage of the original cost, how long the market value of the investment has been less than its original cost, the underlying factors contributing to a decline in the prices of securities in a single asset class, the performance of the issuer’s stock price in relation to the stock price of its competitors within the industry, expected market volatility, analyst recommendations, the views of external investment managers, any news or financial information that has been released specific to the investee and the outlook for the overall industry in which the issuer operates. If events and circumstances indicate that a decline in the value of these securities has occurred and is other-than-temporary, we would record a charge to other income (expense).

ACCOUNTS RECEIVABLE AND ALLOWANCE FOR DOUBTFUL ACCOUNTS

We maintain an allowance for doubtful accounts, which reflects the estimate of losses that may result from the inability of some of our customers to make required payments. The estimate for the allowance for doubtful accounts is based on known circumstances regarding collectability of customer accounts and historical collections experience. If the financial condition of one or more of our customers were to deteriorate, resulting in an inability to make payments, additional allowances may be required. Material differences between the historical trends used to estimate the allowance for doubtful accounts and actual collection experience could result in a material change to our consolidated results of operations or financial position. The allowance for doubtful accounts was $0.5 million at September 30, 2010 and $0.6 million at September 30, 2009.

INVENTORIES

Inventories are stated at the lower of cost or fair market 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. Once the new cost basis is established, the value is not increased with any changes in circumstances that would indicate an increase after the remeasurement. 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. We have applied consistent methodologies for the net realizable value of inventories.

GOODWILL

Goodwill represents the excess of cost over the fair value of identifiable assets acquired. Goodwill is tested for impairment on an annual basis as of June 30, or more frequently if events or circumstances occur which could indicate impairment. At June 30, 2010, our market capitalization was below the carrying value of our reporting unit. However, our market capitalization plus our estimated control premium of 35% resulted in a fair value in excess of our carrying value and therefore no impairment was indicated. In order for our carrying value to equal fair value, we would have required approximately a 14% control premium. The control premium represents the amount an investor would pay, over and above market capitalization, in order to obtain a controlling interest in a company. The estimated control premium was determined by a review of premiums paid for similar companies over the past five years. At September 30, 2010, our market capitalization, which is an indicator of fair value, continued to be below the carrying value of our reporting unit; however, including the control premium there continued to be no indication of goodwill impairment at September 30, 2010. In order for our carrying value to equal fair value, we would have required approximately a 1% control premium.

ITEM 7.		MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)

CRITICAL ACCOUNTING POLICIES AND ESTIMATES (CONTINUED)

INCOME TAXES

We operate in multiple tax jurisdictions both in the U.S. and outside of the U.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 and could result in adjustments to our income tax balances that are material to our consolidated financial position and results of operations.

We have unrecognized tax benefits of $2.8 million classified as a long-term liability as we do not expect significant payments to occur over the next 12 months. The total amount of unrecognized tax benefits that if recognized would affect our effective tax rate is $2.2 million. We recognize interest and penalties related to income tax matters in income tax expense.

WARRANTIES

In general, we warrant our products to be free from defects in material and workmanship under normal use and service. The warranty periods range from one to five years from the date of receipt. We have the option to repair or replace products we deem defective due to material or workmanship. Estimated warranty costs are accrued in the period that the related revenue is recognized based upon an estimated average per unit repair or replacement cost applied to the estimated number of units under warranty. These estimates are based upon historical warranty incidents and are evaluated on an ongoing basis to ensure the adequacy of the warranty accrual. The product warranty accrual was $0.9 million at September 30, 2010 and $1.0 million at September 30, 2009.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

INTEREST RATE RISK

Our exposure to interest rate risk relates primarily to our investment portfolio. We do not use derivative financial instruments to hedge against interest rate risk.

FOREIGN CURRENCY RISK

We are exposed to foreign currency risk associated with certain sales transactions being denominated in Euros, British Pounds or Japanese Yen and foreign currency translation risk as the financial position and operating results of our foreign subsidiaries are translated into U.S. Dollars for consolidation. We have not implemented a formal hedging strategy to reduce foreign currency risk.

During fiscal 2010, the average monthly exchange rate for the Euro to the U.S. Dollar increased by approximately 0.2% from 1.3547 to 1.3574, the average monthly exchange rate for the British Pound to the U.S. Dollar increased approximately 0.5% from 1.5517 to 1.5596 and the average monthly exchange rate for the Japanese Yen to the U.S. Dollar increased by approximately 6.2% from .0105 to .0112. A 10.0% change from the 2010 average exchange rate for the Euro, British Pound and Yen to the U.S. Dollar would have resulted in a 1.5% increase or decrease in annual net sales and a 2.0% increase or decrease in stockholders’ equity. The above analysis does not take into consideration any pricing adjustments we may make in response to changes in the exchange rate.

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.

Investments are made in accordance with our investment policy and consist of certificates of deposit, corporate bonds and government bonds. We may have some exposure related to the fair value of our securities, which could change significantly based on changes in market conditions. If market conditions deteriorate, we may incur impairment charges for securities in our investment portfolio.

ITEM 8.		FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

REPORT OF INDEPENDENT REGISTERED CERTIFIED PUBLIC ACCOUNTING FIRM

To the Stockholders and Board of Directors of Digi International Inc.:

In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations, of cash flows and of stockholders’ equity and comprehensive income (loss) present fairly, in all material respects, the financial position of Digi International Inc. and its subsidiaries at September 30, 2010 and 2009, and the results of their operations and their cash flows for each of the three years in the period ended September 30, 2010 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the index appearing under Item 15(a)(2) presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of September 30, 2010, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for these financial statements and financial statement schedule, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in Management’s Report on Internal Control over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on these financial statements, on the financial statement schedule, and on the Company’s internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

/s/ PricewaterhouseCoopers LLP
Minneapolis, Minnesota
November 23, 2010

ITEM 8.		FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA (CONTINUED)

DIGI INTERNATIONAL INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per common share data)

For the fiscal years ended September 30,		2010				2009				2008
Net sales		$	182,548			$	165,928			$	185,056
Cost of sales (exclusive of amortization of purchased and core technology shown separately below)			86,266				80,470				83,096
Amortization of purchased and core technology			4,073				4,193				4,091
Gross profit			92,209				81,265				97,869
Operating expenses:
Sales and marketing			37,010				35,304				36,879
Research and development			27,825				26,381				27,040
General and administrative			17,889				14,557				16,035
Restructuring (benefit) costs			(468	)			1,953				—
Acquired in-process research & development			—				—				1,900
Total operating expenses			82,256				78,195				81,854
Operating income			9,953				3,070				16,015
Other income (expense):
Interest income			355				1,406				3,579
Interest expense			(138	)			(257	)			(174	)
Impairment of marketable security			—				—				(1,015	)
Other income, net			349				63				510
Total other income, net			566				1,212				2,900
Income before income taxes			10,519				4,282				18,915
Income tax provision			1,578				199				6,564
Net income		$	8,941			$	4,083			$	12,351
Net income per common share:
Basic		$	0.36			$	0.16			$	0.48
Diluted		$	0.36			$	0.16			$	0.47
Weighted average common shares, basic			24,865				24,901				25,659
Weighted average common shares, diluted			25,154				25,183				26,242

The accompanying notes are an integral part of the consolidated financial statements.

ITEM 8.		FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA (CONTINUED)

DIGI INTERNATIONAL INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)

As of September 30,		2010				2009
ASSETS
Current assets:
Cash and cash equivalents		$	50,943			$	48,434
Marketable securities			36,634				22,311
Accounts receivable, net			24,090				19,032
Inventories			26,550				26,619
Deferred tax assets			3,344				2,415
Other			2,141				3,844
Total current assets			143,702				122,655
Marketable securities			—				5,063
Property, equipment and improvements, net			16,396				16,678
Identifiable intangible assets, net			19,851				26,877
Goodwill			86,210				86,558
Deferred tax assets			320				440
Other			486				677
Total assets		$	266,965			$	258,948
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable		$	7,449			$	5,567
Accrued expenses:
Compensation			5,850				3,275
Warranty			877				970
Other			4,507				3,756
Deferred payment on acquisition			2,914				2,966
Total current liabilities			21,597				16,534
Deferred tax liabilities			1,457				4,331
Income taxes payable			2,838				4,893
Deferred payment on acquisition			—				2,812
Other noncurrent liabilities			517				792
Total liabilities			26,409				29,362
Commitments and contingencies
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; 28,666,311 and 28,409,198 shares issued			287				284
Additional paid-in capital			185,427				181,282
Retained earnings			91,649				82,708
Accumulated other comprehensive loss			(9,589	)			(6,527	)
Treasury stock, at cost, 3,584,215 and 3,708,302 shares			(27,218	)			(28,161	)
Total stockholders’ equity			240,556				229,586
Total liabilities and stockholders’ equity		$	266,965			$	258,948

The accompanying notes are an integral part of the consolidated financial statements.

ITEM 8.		FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA (CONTINUED)

DIGI INTERNATIONAL INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)

For the fiscal years ended September 30,		2010				2009				2008
Operating activities:
Net income		$	8,941			$	4,083			$	12,351
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation of property, equipment and improvements			2,649				2,581				2,488
Amortization of identifiable intangible assets and other assets			7,484				7,476				6,830
Bad debt/product return (benefit) provision, net			175				(265	)			308
Inventory obsolescence			848				881				536
Excess tax benefits from stock-based compensation			(47	)			(80	)			(184	)
Impairment on marketable security			—				—				1,015
Stock-based compensation			3,371				3,518				3,697
Deferred income taxes, net			(3,656	)			(2,714	)			(1,624	)
Restructuring			(468	)			—				—
Acquired in-process research & development			—				—				1,900
Other			27				(230	)			(145	)
Changes in operating assets and liabilities (net of acquisitions):
Accounts receivable			(6,525	)			5,384				(1,838	)
Inventories			(891	)			2,695				(3,093	)
Other assets			749				193				96
Income taxes (receivable) payable			(1,235	)			(1,090	)			7
Accounts payable			1,486				(4,561	)			3,322
Accrued expenses			3,187				(2,185	)			(1,596	)
Net cash provided by operating activities		$	16,095			$	15,686			$	24,070
Investing activities:
Purchase of marketable securities			(38,538	)			(30,489	)			(69,196	)
Proceeds from maturities of marketable securities			29,335				62,624				77,857
Proceeds from sale of property and equipment			11				10				6,954
Purchase of property, equipment, improvements and certain other intangible assets			(2,975	)			(3,873	)			(4,425	)
Increase in restricted cash — non-current			—				—				(392	)
Contingent purchase price payments related to acquisition			—				—				(1,315	)
Deferred cash payout for acquisition of business			(3,000	)			—				—
Acquisition of businesses, net of cash acquired			—				(2,986	)			(31,853	)
Net cash (used in) provided by investing activities			(15,167	)			25,286				(22,370	)
Financing activities:
Payments on capital lease obligations			(9	)			(336	)			(361	)
Borrowing on note payable			—				—				25,000
Payment on note payable			—				—				(25,000	)
Purchase of treasury stock			—				(6,576	)			(5,104	)
Proceeds from stock option plan transactions			1,672				423				1,699
Proceeds from employee stock purchase plan transactions			894				982				1,018
Excess tax benefits from stock-based compensation			47				80				184
Net cash provided by (used in) financing activities			2,604				(5,427	)			(2,564	)
Effect of exchange rates changes on cash and cash equivalents			(1,023	)			(1,287	)			(3,335	)
Net increase (decrease) in cash and cash equivalents			2,509				34,258				(4,199	)
Cash and cash equivalents, beginning of period			48,434				14,176				18,375
Cash and cash equivalents, end of period		$	50,943			$	48,434			$	14,176
Supplemental Cash Flows Information:
Interest paid		$	159			$	54			$	136
Income taxes paid, net		$	6,479			$	3,944			$	8,143
Other non-cash financing and investing items:
Deferred payment liability related to acquisition		$	—			$	—			$	5,537
Equipment acquired under capital lease		$	—			$	—			$	9

The accompanying notes are an integral part of the consolidated financial statements.

ITEM 8.		FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA (CONTINUED)

DIGI INTERNATIONAL INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY AND COMPREHENSIVE INCOME (LOSS)
(in thousands)

For the years ended September 30, 2010, 2009 and 2008

																										Accumulated
																		Additional								Other				Total
		Common Stock								Treasury Stock								Paid-In				Retained				Comprehensive				Stockholders’
		Shares				Par Value				Shares				Value				Capital				Earnings				Income				Equity
Balances, September 30, 2007			28,154			$	281				2,606			$	(18,435	)		$	172,156			$	66,782			$	2,121			$	222,905
Net income																							12,351								12,351
Foreign currency translation adjustment																											(4,018	)			(4,018	)
Total comprehensive income																															8,333
Cumulative effect from adoption of FIN 48																							(508	)							(508	)
Employee stock purchase issuances											(117	)			848				170												1,018
Purchase of treasury stock											471				(5,104	)															(5,104	)
Issuance of stock upon exercise of stock options			182				2												1,697												1,699
Tax benefit realized upon exercise of stock options																			(106	)											(106	)
Stock-based compensation expense																			3,697												3,697
Balances, September 30, 2008			28,336				283				2,960				(22,691	)			177,614				78,625				(1,897	)		$	231,934
Net income																							4,083								4,083
Foreign currency translation adjustment																											(4,622	)			(4,622	)
Net unrealized (loss) gain on investments (net of related tax effect of $2)																											(4	)			(4	)
Reclassification of gain into net income (net of related tax effect of $3)																											(4	)			(4	)
Total comprehensive loss																															(547	)
Employee stock purchase issuances											(145	)			1,106				(124	)											982
Purchase of treasury stock											893				(6,576	)															(6,576	)
Issuance of stock upon exercise of stock options			73				1												422												423
Tax benefit realized upon exercise of stock options																			(148	)											(148	)
Stock-based compensation expense																			3,518												3,518
Balances, September 30, 2009			28,409				284				3,708				(28,161	)			181,282				82,708				(6,527	)		$	229,586
Net income																							8,941								8,941
Foreign currency translation adjustment																											(3,074	)			(3,074	)
Net unrealized gain on investments (net of related tax effect of $22)																											34				34
Reclassification of gain into net income (net of related tax effect of $14)																											(22	)			(22	)
Total comprehensive income																															5,879
Employee stock purchase issuances											(124	)			943				(49	)											894
Issuance of stock upon exercise of stock options			257				3												1,669												1,672
Tax benefit realized upon exercise of stock options																			(846	)											(846	)
Stock-based compensation expense																			3,371												3,371
Balances, September 30, 2010			28,666				287				3,584				(27,218	)			185,427				91,649				(9,589	)		$	240,556