##### Table of Contents



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 FORM 10-Q
 þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the quarterly period ended: June 30, 2006
 OR
 o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the transition period from  to.
 Commission file number: 0-17972
 
 DIGI INTERNATIONAL INC.
  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, including zip code)
 (952) 912-3444
 (Registrants telephone number, including area code)
  þ o
  o þ o
  o þ




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##### 



PagePART I.
    
    FINANCIAL INFORMATIONITEM 1.
    
    Condensed Consolidated Financial Statements (unaudited):Condensed Consolidated Statements of Operations for the three months
and nine months ended June 30, 2006 and 2005
    
    
    3Condensed Consolidated Balance Sheets as of
June 30, 2006 and September 30, 2005
    
    
    4Condensed Consolidated Statements of Cash Flows for
the nine months ended June 30, 2006 and 2005
    
    
    5Notes to Condensed Consolidated Financial
Statements
    
    
    6ITEM 2.
    
    Managements Discussion and Analysis of Financial Condition and
Results of Operations
    
    
    16Forward-looking Statements
    
    
    16ITEM 3.
    
    Quantitative and Qualitative Disclosures About Market Risk
    
    
    23ITEM 4.
    
    Controls and Procedures
    
    
    24PART II.
    
    OTHER INFORMATIONITEM 1.
    
    Legal Proceedings
    
    
    25ITEM 1A.
    
    Risk Factors
    
    
    25ITEM 2.
    
    Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    25ITEM 3.
    
    Defaults Upon Senior Securities
    
    
    25ITEM 4.
    
    Submission of Matters to a Vote of Securities Holders
    
    
    25ITEM 5.
    
    Other Information
    
    
    25ITEM 6.
    
    Exhibits
    
    
    25Rule 13a-14(a)/15d-14(a) Certification of Chief Executive OfficerRule 13a-14(a)/15d-14(a) Certification of Chief Financial OfficerSection 1350 Certification
  2




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##### Table of Contents



PART I. FINANCIAL INFORMATION
 
 ITEM 1. FINANCIAL STATEMENTS
 DIGI INTERNATIONAL INC.
 
 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
 (UNAUDITED)
 Three months ended June 30,
    
    
    Nine months ended June 30,2006
    
    
    2005
    
    
    2006
    
    
    2005(in thousands, except per common share data)Net sales
    
    $
    35,860
    
    
    $
    30,208
    
    
    $
    103,616
    
    
    $
    88,989Cost of sales
    
    
    15,222
    
    
    
    12,003
    
    
    
    44,126
    
    
    
    34,489Gross profit
    
    
    20,638
    
    
    
    18,205
    
    
    
    59,490
    
    
    
    54,500Operating expenses:Sales and marketing
    
    
    7,277
    
    
    
    6,446
    
    
    
    20,830
    
    
    
    19,300Research and development
    
    
    5,402
    
    
    
    3,778
    
    
    
    15,227
    
    
    
    11,850General and administrative
    
    
    4,208
    
    
    
    3,998
    
    
    
    13,591
    
    
    
    11,070Acquired in-process research and development
    
    
    
    
    
    
    300
    
    
    
    
    
    
    
    300Total operating expenses
    
    
    16,887
    
    
    
    14,522
    
    
    
    49,648
    
    
    
    42,520Operating income
    
    
    3,751
    
    
    
    3,683
    
    
    
    9,842
    
    
    
    11,980Interest income and other, net
    
    
    575
    
    
    
    306
    
    
    
    1,461
    
    
    
    809Income before income taxes
    
    
    4,326
    
    
    
    3,989
    
    
    
    11,303
    
    
    
    12,789Income tax provision (benefit)
    
    
    978
    
    
    
    1,505
    
    
    
    3,205
    
    
    
    (1,455
    )Net income
    
    $
    3,348
    
    
    $
    2,484
    
    
    $
    8,098
    
    
    $
    14,244Net income per common share:Basic
    
    $
    0.14
    
    
    $
    0.11
    
    
    $
    0.35
    
    
    $
    0.64Diluted
    
    $
    0.14
    
    
    $
    0.11
    
    
    $
    0.34
    
    
    $
    0.61Weighted average common shares, basic
    
    
    23,124
    
    
    
    22,588
    
    
    
    22,968
    
    
    
    22,381Weighted average common shares, diluted
    
    
    23,904
    
    
    
    23,296
    
    
    
    23,695
    
    
    
    23,420
  3




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DIGI INTERNATIONAL INC.
 
 CONDENSED CONSOLIDATED BALANCE SHEETS
 (UNAUDITED)
 June 30, 2006
    
    
    September 30, 2005(in thousands, except share data)ASSETSCurrent assets:Cash and cash equivalents
    
    $
    14,422
    
    
    $
    12,990Marketable securities
    
    
    51,442
    
    
    
    37,184Accounts receivable, net
    
    
    19,232
    
    
    
    16,897Inventories
    
    
    19,090
    
    
    
    18,527Other
    
    
    5,419
    
    
    
    5,115Total current assets
    
    
    109,605
    
    
    
    90,713Property, equipment and improvements, net
    
    
    19,904
    
    
    
    20,808Identifiable intangible assets, net
    
    
    21,152
    
    
    
    26,342Goodwill
    
    
    38,612
    
    
    
    38,675Other
    
    
    1,041
    
    
    
    1,093Total assets
    
    $
    190,314
    
    
    $
    177,631LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Capital lease obligations, current portion
    
    $
    406
    
    
    $
    414Accounts payable
    
    
    5,235
    
    
    
    6,272Income taxes payable
    
    
    6,944
    
    
    
    3,306Accrued expenses:Compensation
    
    
    4,223
    
    
    
    5,308Other
    
    
    5,172
    
    
    
    5,048Deferred revenue
    
    
    293
    
    
    
    370Total current liabilities
    
    
    22,273
    
    
    
    20,718Capital lease obligations, net of current portion
    
    
    817
    
    
    
    1,181Net deferred tax liabilities
    
    
    255
    
    
    
    2,195Total liabilities
    
    
    23,345
    
    
    
    24,094Commitments and contingenciesStockholders 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;
25,873,164 and 25,456,755 shares issued
    
    
    259
    
    
    
    255Additional paid-in capital
    
    
    141,649
    
    
    
    136,513Retained earnings
    
    
    43,994
    
    
    
    35,896Accumulated other comprehensive income
    
    
    396
    
    
    
    639Treasury stock, at cost, 2,732,834 and 2,794,562 shares
    
    
    (19,329
    )
    
    
    (19,766
    )Total stockholders equity
    
    
    166,969
    
    
    
    153,537Total liabilities and stockholders equity
    
    $
    190,314
    
    
    $
    177,631
  4




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DIGI INTERNATIONAL INC.
 
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
 (UNAUDITED)
 Nine months ended June 30,2006
    
    
    2005(in thousands)Operating activities:Net income
    
    $
    8,098
    
    
    $
    14,244Adjustments to reconcile net income to net cash
provided by operating activities:Depreciation of property, equipment and improvements
    
    
    1,949
    
    
    
    1,710Amortization of identifiable intangible assets and other assets
    
    
    5,744
    
    
    
    4,667Acquired in-process research and development
    
    
    
    
    
    
    300Deferred income taxes
    
    
    (1,987
    )
    
    
    (3,602
    )Tax benefit related to the exercise of stock options
    
    
    
    
    
    
    2,045Stock-based compensation
    
    
    1,742
    
    
    
    Other
    
    
    (436
    )
    
    
    (479
    )Changes in operating assets and liabilities:Accounts receivable
    
    
    (696
    )
    
    
    (1,949
    )Inventories
    
    
    (1,068
    )
    
    
    169Other assets
    
    
    (293
    )
    
    
    (709
    )Accounts payable and accrued expenses
    
    
    (2,838
    )
    
    
    (1,879
    )Income taxes payable
    
    
    3,636
    
    
    
    (3,276
    )Net cash provided by operating activities
    
    
    13,851
    
    
    
    11,241Investing activities:(Purchase) settlement of held-to-maturity marketable securities, net
    
    
    (14,258
    )
    
    
    19,836Purchase of property, equipment, improvements and certain
other identifiable intangible assets
    
    
    (1,055
    )
    
    
    (772
    )Acquisitions, net of cash acquired
    
    
    
    
    
    
    (53,665
    )Net cash used in investing activities
    
    
    (15,313
    )
    
    
    (34,601
    )Financing activities:Borrowing from short-term loans, net of payments
    
    
    
    
    
    
    5,000Payments on line of credit
    
    
    
    
    
    
    (1,250
    )Payments on capital lease obligations
    
    
    (372
    )
    
    
    (38
    )Proceeds from exercise of stock options
    
    
    2,931
    
    
    
    5,415Tax benefit related to the exercise of stock options
    
    
    485
    
    
    
    Proceeds from employee stock purchase plan transactions
    
    
    555
    
    
    
    576Net cash provided by financing activities
    
    
    3,599
    
    
    
    9,703Effect of exchange rate changes on cash and cash equivalents
    
    
    (705
    )
    
    
    474Net increase (decrease) in cash and cash equivalents
    
    
    1,432
    
    
    
    (13,183
    )Cash and cash equivalents, beginning of period
    
    
    12,990
    
    
    
    19,528Cash and cash equivalents, end of period
    
    $
    14,422
    
    
    $
    6,345
  5




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DIGI INTERNATIONAL INC.
 
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 (UNAUDITED)
  Basis of Presentation
   Recently Issued Accounting Pronouncements
     Three months ended
    
    
    Nine months endedJune 30,
    
    
    June 30,2006
    
    
    2005
    
    
    2006
    
    
    2005Net income
    
    $
    3,348
    
    
    $
    2,484
    
    
    $
    8,098
    
    
    $
    14,244Foreign currency translation
gain (loss), net of income tax
    
    
    85
    
    
    
    (496
    )
    
    
    (243
    )
    
    
    384Comprehensive income
    
    $
    3,433
    
    
    $
    1,988
    
    
    $
    7,855
    
    
    $
    14,628
 6




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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
    Three months ended June 30,
    
    
    Nine months ended June 30,2006
    
    
    2005
    
    
    2006
    
    
    2005Numerator:Net income
    
    $
    3,348
    
    
    $
    2,484
    
    
    $
    8,098
    
    
    $
    14,244Denominator:Denominator for basic net income per common
share  weighted average shares outstanding
    
    
    23,124
    
    
    
    22,588
    
    
    
    22,968
    
    
    
    22,381Effect of dilutive securities:Employee stock options and employee
stock purchase plan
    
    
    780
    
    
    
    708
    
    
    
    727
    
    
    
    1,039Denominator for diluted net income per common
share  adjusted weighted average shares
    
    
    23,904
    
    
    
    23,296
    
    
    
    23,695
    
    
    
    23,420Net income per common share, basic
    
    $
    0.14
    
    
    $
    0.11
    
    
    $
    0.35
    
    
    $
    0.64Net income per common share, diluted
    
    $
    0.14
    
    
    $
    0.11
    
    
    $
    0.34
    
    
    $
    0.61
    7




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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
         8




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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
   Weighted Average
    
    
    Weighted Average
    
    
    AggregateAvailable
    
    
    Options
    
    
    Exercise Price per
    
    
    Contractual Term
    
    
    Intrinsicfor Grant
    
    
    Outstanding
    
    
    Common Share
    
    
    (in years)
    
    
    ValueBalances, September 30, 2005
    
    
    950
    
    
    
    4,511
    
    
    $
    9.98Granted
    
    
    (468
    )
    
    
    468
    
    
    
    12.33Exercised
    
    
    
    
    
    
    (417
    )
    
    
    7.04Forfeited
    
    
    92
    
    
    
    (92
    )
    
    
    10.15Expired
    
    
    25
    
    
    
    (25
    )
    
    
    22.73Balances, June 30, 2006
    
    
    599
    
    
    
    4,445
    
    
    $
    10.43
    
    
    
    5.55
    
    
    $
    13,899Exercisable at June 30, 2006
    
    
    
    
    
    
    3,420
    
    
    $
    9.96
    
    
    
    4.56
    
    
    $
    12,771
  Risk free interest rate
    
    
    4.28% - 4.97
    %Expected option holding period
    
    3 - 5 yearsExpected volatility
    
    
    50% - 60%Weighted average volatility
    
    
    55%Expected dividend yield
    
    
    0
   Weighted AverageGrant DateNumber of
    
    Fair Value perOptions
    
    Common ShareNonvested at September 30, 2005
    
    
    967
    
    
    $
    4.81Granted
    
    
    468
    
    
    
    5.79Vested
    
    
    (318
    )
    
    
    4.08Forfeited
    
    
    (92
    )
    
    
    5.55Nonvested at June 30, 2006
    
    
    1,025
    
    
    $
    5.42
 9




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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
    Three months ended
    
    
    Nine months endedJune 30, 2005
    
    
    June 30, 2005Net income as reported
    
    $
    2,484
    
    
    $
    14,244Add: Total stock-based compensation
expense included in reported net income,
net of related tax effects
    
    
    
    
    
    
    37Deduct: Total stock-based compensation
expense determined under fair value
based method for all awards, net of
related tax effects
    
    
    (311
    )
    
    
    (1,044
    )Pro forma net income
    
    $
    2,173
    
    
    $
    13,237Net income per common share:Basic  as reported
    
    $
    0.11
    
    
    $
    0.64Basic  pro forma
    
    $
    0.10
    
    
    $
    0.59Diluted  as reported
    
    $
    0.11
    
    
    $
    0.61Diluted  pro forma
    
    $
    0.09
    
    
    $
    0.57
  Rabbit Semiconductor Inc.
    10




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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
   Three months ended June 30, 2005
    
    Nine months ended June 30, 2005Pro forma
    
    As Reported
    
    Pro forma
    
    As ReportedNet sales
    
    $
    34,227
    
    
    $
    30,208
    
    
    $
    107,160
    
    
    $
    88,989Net income
    
    $
    1,015
    
    
    $
    2,484
    
    
    $
    11,803
    
    
    $
    14,244Net income per common share, basic
    
    $
    0.04
    
    
    $
    0.11
    
    
    $
    0.53
    
    
    $
    0.64Net income per common share, diluted
    
    $
    0.04
    
    
    $
    0.11
    
    
    $
    0.50
    
    
    $
    0.61
  FS Forth-Systeme GmbH/Sistemas Embebidos S.A.
      June 30,
    
    
    September 30,2006
    
    
    2005Raw materials
    
    $
    14,406
    
    
    $
    15,074Work in process
    
    
    1,051
    
    
    
    569Finished goods
    
    
    3,633
    
    
    
    2,884$
    19,090
    
    
    $
    18,527
 11




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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
   June 30, 2006
    
    September 30, 2005Gross
    
    
    
    
    
    
    
    
    
    Grosscarrying
    
    Accum.
    
    
    
    
    
    carrying
    
    Accum.amount
    
    amort.
    
    Net
    
    amount
    
    amort.
    
    NetPurchased and core technology
    
    $
    41,114
    
    
    $
    (30,159
    )
    
    $
    10,955
    
    
    $
    41,086
    
    
    $
    (26,517
    )
    
    $
    14,569License agreements
    
    
    2,440
    
    
    
    (1,790
    )
    
    
    650
    
    
    
    2,440
    
    
    
    (1,490
    )
    
    
    950Patents and trademarks
    
    
    5,911
    
    
    
    (2,597
    )
    
    
    3,314
    
    
    
    5,691
    
    
    
    (1,956
    )
    
    
    3,735Customer maintenance contracts
    
    
    700
    
    
    
    (306
    )
    
    
    394
    
    
    
    700
    
    
    
    (254
    )
    
    
    446Customer relationships
    
    
    7,854
    
    
    
    (2,015
    )
    
    
    5,839
    
    
    
    7,803
    
    
    
    (1,161
    )
    
    
    6,642Total
    
    $
    58,019
    
    
    $
    (36,867
    )
    
    $
    21,152
    
    
    $
    57,720
    
    
    $
    (31,378
    )
    
    $
    26,342
   2006 (three months)
    
    $
    1,7802007
    
    
    5,8702008
    
    
    4,0212009
    
    
    2,7412010
    
    
    2,6052011
    
    
    2,268
  Nine months ended June 30,2006
    
    
    2005Beginning balance, October 1
    
    $
    38,675
    
    
    $
    5,816Acquisition of Rabbit
    
    
    
    
    
    
    32,517Acquisition of FS Forth
    
    
    
    
    
    
    2,365Purchase price adjustment  FS Forth
    
    
    (147
    )
    
    
    Foreign currency translation adjustment
    
    
    84
    
    
    
    (156
    )Ending balance, June 30
    
    $
    38,612
    
    
    $
    40,542
    12




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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
     Three months ended June 30,Balance at
    
    Warranties
    
    Settlements
    
    Balance atMarch 31
    
    issued
    
    made
    
    June 302006
    
    $
    1,050
    
    
    $
    160
    
    
    $
    (128
    )
    
    $
    1,0822005
    
    $
    900
    
    
    $
    274
    
    
    $
    (126
    )
    
    $
    1,048
 Nine months ended June 30,Balance at
    
    Warranties
    
    Settlements
    
    Balance atOctober 1
    
    issued
    
    made
    
    June 302006
    
    $
    1,187
    
    
    $
    268
    (1)
    
    $
    (373
    )
    
    $
    1,0822005
    
    $
    855
    
    
    $
    610
    
    
    $
    (417
    )
    
    $
    1,048
 
 (1)
    
    Warranties issued includes a decrease in estimate adjustment of $117,000 in the first quarter of fiscal 2006.  13




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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
         14




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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
        15




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ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
        OVERVIEW
  16




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ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
 OVERVIEW (CONTINUED)
        17




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ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
 OVERVIEW (CONTINUED)
    CONSOLIDATED RESULTS OF OPERATIONS
  Three months ended June 30,
    
    
    Nine months ended June 30,2006 (1)
    
    
    2005
    
    
    2006 (1)
    
    
    2005Net sales
    
    $
    35,860
    
    
    
    100.0
    %
    
    $
    30,208
    
    
    
    100.0
    %
    
    $
    103,616
    
    
    
    100.0
    %
    
    $
    88,989
    
    
    
    100.0
    %Cost of sales
    
    
    15,222
    
    
    
    42.4
    
    
    
    12,003
    
    
    
    39.7
    
    
    
    44,126
    
    
    
    42.6
    
    
    
    34,489
    
    
    
    38.8Gross profit
    
    
    20,638
    
    
    
    57.6
    
    
    
    18,205
    
    
    
    60.3
    
    
    
    59,490
    
    
    
    57.4
    
    
    
    54,500
    
    
    
    61.2Operating expenses:Sales and marketing
    
    
    7,277
    
    
    
    20.3
    
    
    
    6,446
    
    
    
    21.3
    
    
    
    20,830
    
    
    
    20.1
    
    
    
    19,300
    
    
    
    21.6Research and development
    
    
    5,402
    
    
    
    15.1
    
    
    
    3,778
    
    
    
    12.5
    
    
    
    15,227
    
    
    
    14.7
    
    
    
    11,850
    
    
    
    13.3General and administrative
    
    
    4,208
    
    
    
    11.7
    
    
    
    3,998
    
    
    
    13.3
    
    
    
    13,591
    
    
    
    13.1
    
    
    
    11,070
    
    
    
    12.5Acquired in-process research
and development
    
    
    
    
    
    
    0.0
    
    
    
    300
    
    
    
    1.0
    
    
    
    
    
    
    
    0.0
    
    
    
    300
    
    
    
    0.3Total operating expenses
    
    
    16,887
    
    
    
    47.1
    
    
    
    14,522
    
    
    
    48.1
    
    
    
    49,648
    
    
    
    47.9
    
    
    
    42,520
    
    
    
    47.7Operating income
    
    
    3,751
    
    
    
    10.5
    
    
    
    3,683
    
    
    
    12.2
    
    
    
    9,842
    
    
    
    9.5
    
    
    
    11,980
    
    
    
    13.5Interest income and other, net
    
    
    575
    
    
    
    1.6
    
    
    
    306
    
    
    
    1.0
    
    
    
    1,461
    
    
    
    1.4
    
    
    
    809
    
    
    
    0.9Income before income taxes
    
    
    4,326
    
    
    
    12.1
    
    
    
    3,989
    
    
    
    13.2
    
    
    
    11,303
    
    
    
    10.9
    
    
    
    12,789
    
    
    
    14.4Income tax provision (benefit)
    
    
    978
    
    
    
    2.8
    
    
    
    1,505
    
    
    
    5.0
    
    
    
    3,205
    
    
    
    3.1
    
    
    
    (1,455
    )
    
    
    (1.6
    )Net income
    
    $
    3,348
    
    
    
    9.3
    %
    
    $
    2,484
    
    
    
    8.2
    %
    
    $
    8,098
    
    
    
    7.8
    %
    
    $
    14,244
    
    
    
    16.0
    %
 
 (1)
    
    As a result of adopting FAS No. 123R as of October 1, 2005 on a modified prospective basis,
stock-based compensation expense (pre-tax) is included in the consolidated results of operations
for the three and nine months ended June 30, 2006 as follows (in thousands): Three months ended
    
    
    Nine months endedJune 30, 2006
    
    
    June 30, 2006Cost of sales
    
    $
    22
    
    
    $
    65Sales and marketing
    
    
    185
    
    
    
    504Research and development
    
    
    132
    
    
    
    401General and administrative
    
    
    240
    
    
    
    772Totals
    
    $
    579
    
    
    $
    1,742
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ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
          19




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ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
        20




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ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
       Nine months endedJune 30, 2005Income tax benefit as reported
    
    $
    (1,455
    )Impact of favorable tax settlement
    
    $
    5,689Income tax provision excluding favorable tax settlement
    
    $
    4,234Net income as reported
    
    $
    14,244Net income excluding favorable tax settlement
    
    $
    8,555Effective income tax rate on pretax income as reported
    
    
    -11.4
    %Effective income tax rate on pretax income excluding favorable tax settlement
    
    
    33.1
    %Net income per common share, basic, as reported
    
    $
    0.64Net income per common share, diluted, as reported
    
    $
    0.61Net income per common share, basic, excluding favorable tax settlement
    
    $
    0.38Net income
per common share, diluted, excluding favorable tax settlement
    
    $
    0.37
  21




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ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
         22




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ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
    Payments due by fiscal periodLess thanTotal
    
    1 year
    
    1-3 years
    
    3-5 years
    
    ThereafterOperating leases
    
    $
    6,505
    
    
    $
    2,151
    
    
    $
    2,178
    
    
    $
    1,085
    
    
    $
    1,091Capital leases
    
    
    1,494
    
    
    
    526
    
    
    
    808
    
    
    
    160
    
    
    
    Total contractual cash obligations
    
    $
    7,999
    
    
    $
    2,677
    
    
    $
    2,986
    
    
    $
    1,245
    
    
    $
    1,091
    
 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
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##### Table of Contents



ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK (CONTINUED)
       
 ITEM 4. CONTROLS AND PROCEDURES
     24




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PART II. OTHER INFORMATION
 
 ITEM 1. LEGAL PROCEEDINGS
  
 ITEM 1A. RISK FACTORS
  
 ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
  
 ITEM 3. DEFAULTS UPON SENIOR SECURITIES
  
 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
  
 ITEM 5. OTHER INFORMATION
  
 ITEM 6. EXHIBITS
 Exhibit No.
    
    Description2
    (a)
    
    Purchase and Assignment Contract dated March 30, 2005 between Embedded Solutions AG,
Klaus Flesch, Angelika Flesch and Digi International GmbH (1)2
    (b)
    
    Agreement and Plan of Merger among Digi International Inc., Karat Sub Inc. and Z-World,
Inc. dated as of May 26, 2005 (excluding schedules and exhibits, which the Company agrees
to furnish supplementally to the Securities and Exchange Commission upon request) (2)2
    (c)
    
    Agreement and Plan of Merger among Digi International Inc., Ocean Acquisition Sub Inc.
and MaxStream, Inc. dated as of July 27, 2006 (excluding schedules and exhibits, which the
Company agrees to furnish supplementally to the Securities and Exchange Commission upon
request) (3)3
    (a)
    
    Restated Certificate of Incorporation of the Company, as amended (4)3
    (b)
    
    Amended and Restated By-Laws of the Company, as amended (5)
 25




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PART II. OTHER INFORMATION (CONTINUED)
 ITEM 6. EXHIBITS (CONTINUED)
 Exhibit No.
    
    Description4
    (a)
    
    Form of Rights Agreement, dated as of June 10, 1998 between Digi International
Inc. and Wells Fargo Bank Minnesota, National Association (formerly known as Norwest
Bank Minnesota, National Association), as Rights Agent (6)4
    (b)
    
    Amendment dated January 26, 1999, to Share Rights Agreement, dated as of June
10, 1998 between Digi International Inc. and Wells Fargo Bank Minnesota, National
Association (formerly known as Norwest Bank Minnesota, National Association), as
Rights Agent (7)31
    (a)
    
    Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer31
    (b)
    
    Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer32
    
    
    Section 1350 Certification
 
 (1)
    
    Incorporated by reference to Exhibit 2(a) to the Companys Form 10-Q for the quarter ended
March 31, 2005 (File No. 0-17972)(2)
    
    Incorporated by reference to Exhibit 2 to the Companys Form 8-K dated May 26, 2006 (File No.
0-17972)(3)
    
    Incorporated by reference to Exhibit 2 to the Companys Form 8-K dated July 27, 2006 (File
No. 0-17972)(4)
    
    Incorporated by reference to Exhibit 3(a) to the Companys Form 10-K for the year ended
September 30, 1993 (File No. 0-17972)(5)
    
    Incorporated by reference to Exhibit 3(b) to the Companys Form 10-K for the year ended
September 30, 2001 (File No. 0-17972)(6)
    
    Incorporated by reference to Exhibit 1 to the Companys Registration Statement on Form 8-A
dated June 24, 1998 (File No. 0-17972)(7)
    
    Incorporated by reference to Exhibit 1 to Amendment 1 to the Companys Registration Statement
on Form 8-A dated February 5, 1999 (File No. 0-17972) 26




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DIGI INTERNATIONAL INC.Date: August 8, 2006
    
    By:
    
    /s/ Subramanian KrishnanSubramanian KrishnanChief Financial Officer(duly authorized officer andPrincipal Financial Officer)
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Exhibit Number
    
    Document Description
    
    Form of Filing2(a)
    
    Purchase and Assignment Contract
dated March 30, 2005 between Embedded
Solutions AG, Klaus Flesch, Angelika
Flesch and Digi International GmbH
(incorporated by reference to Exhibit 2(a)
to the Companys Form 10-Q for the quarter
ended March 31, 2005 (File No. 0-17972))
    
    Incorporated by Reference2(b)
    
    Agreement and Plan of Merger among Digi
International Inc., Karat Sub Inc. and
Z-World, Inc. dated as of May 26, 2005
(excluding schedules and exhibits, which the
Company agrees to furnish supplementally
to the Securities and Exchange Commission
upon request) (incorporated by reference to
Exhibit 2 to the Companys Form 8-K dated
May 26, 2005 (File No. 0-17972))
    
    Incorporated by Reference2(c)
    
    Agreement and Plan of Merger among
Digi International Inc., Ocean Acquisition
Sub Inc. and MaxStream, Inc. dated as
of July 27, 2006 (excluding schedules and
exhibits, which the Company agrees to
furnish supplementally to the Securities and
Exchange Commission upon request)
(incorporated by reference to Exhibit 2 to the
Companys Form 8-K dated July 27, 2006
(File No. 0-17972))
    
    Incorporated by Reference3(a)
    
    Restated Certificate of Incorporation
of the Company, as Amended (incorporated
by reference to the corresponding exhibit
number to the Companys Form 10-K for
the year ended September 30, 1993
(File No. 0-17972))
    
    Incorporated by Reference3(b)
    
    Amended and Restated By-Laws of the
Company (incorporated by reference to
the corresponding exhibit number to the
Companys Form 10-K for the year ended
September 30, 2001
(File No. 0-17972))
    
    Incorporated by Reference
 28




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Exhibit Number
    
    Document Description
    
    Form of Filing4(a)
    
    Form of Rights Agreement, dated as of
June 10, 1998 between Digi International Inc.
and Wells Fargo Bank Minnesota, National
Association (formerly known as Norwest Bank
Minnesota, National Association), as Rights
Agent (incorporated by reference to Exhibit 1
to the Companys Registration Statement on
Form 8-A dated June 24, 1998
(File No. 0-17972))
    
    Incorporated by Reference4(b)
    
    Amendment dated January 26, 1999, to Share
Rights Agreement, dated June 10, 1998
between Digi International Inc. and Wells Fargo
Bank Minnesota, National Association (formerly
known as Norwest Bank Minnesota, National
Association), as Rights Agent (incorporated
by reference to Exhibit 1 to Amendment No. 1
to the Companys Registration Statement on
Form 8-A dated February 5, 1999
(File No. 0-17972))
    
    Incorporated by Reference31(a)
    
    Rule 13a-14(a)/15d-14(a)
Certification of Chief Executive Officer
    
    Filed Electronically31(b)
    
    Rule 13a-14(a)/15d-14(a)
Certification of Chief Financial Officer
    
    Filed Electronically32
    
    Section 1350 Certification
    
    Filed Electronically
 29