##### 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, 2010
 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: 1-34033
 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) (Zip Code)
 (952) 912-3444  (Registrants telephone number, including area code)
 Yes þ No o
 Yes
o No o
  Large accelerated filer o
    
    Accelerated filer þ
    
    Non-accelerated filer o
    
    Smaller reporting company o(Do not check if a smaller reporting company)
 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, 2010 and 2009
    
    
    3Condensed Consolidated Balance Sheets as of
June 30, 2010 and September 30, 2009
    
    
    4Condensed Consolidated Statements of Cash Flows for
the nine months ended June 30, 2010 and 2009
    
    
    5Notes to Condensed Consolidated Financial
Statements
    
    
    6ITEM 2. Managements Discussion and Analysis of Financial Condition and
Results of Operations
    
    
    18Forward-looking Statements
    
    
    18ITEM 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    25ITEM 4. Controls and Procedures
    
    
    26PART II. OTHER INFORMATIONITEM 1. Legal Proceedings
    
    
    28ITEM 1A. Risk Factors
    
    
    28ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    28ITEM 3. Defaults Upon Senior Securities
    
    
    28ITEM 4. Submission of Matters to a Vote of Security Holders
    
    
    28ITEM 5. Other Information
    
    
    28ITEM 6. Exhibits
    
    
    29Exhibit 10Exhibit 31(A)Exhibit 31(B)Exhibit 32
   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 30,2010
    
    
    2009
    
    
    2010
    
    
    2009(in thousands, except per common share data)Net sales
    
    $
    47,238
    
    
    $
    44,470
    
    
    $
    135,282
    
    
    $
    125,916Cost of sales (exclusive of amortization of
purchased
and core technology shown separately below)
    
    
    22,496
    
    
    
    21,986
    
    
    
    63,913
    
    
    
    60,963Amortization of purchased and core technology
    
    
    1,024
    
    
    
    1,047
    
    
    
    3,190
    
    
    
    3,099Gross profit
    
    
    23,718
    
    
    
    21,437
    
    
    
    68,179
    
    
    
    61,854Operating expenses:Sales and marketing
    
    
    9,089
    
    
    
    8,624
    
    
    
    27,932
    
    
    
    27,225Research and development
    
    
    7,159
    
    
    
    6,823
    
    
    
    20,723
    
    
    
    19,993General and administrative
    
    
    4,926
    
    
    
    3,435
    
    
    
    13,308
    
    
    
    10,716Restructuring
    
    
    
    
    
    
    1,953
    
    
    
    (352
    )
    
    
    1,953Total operating expenses
    
    
    21,174
    
    
    
    20,835
    
    
    
    61,611
    
    
    
    59,887Operating income
    
    
    2,544
    
    
    
    602
    
    
    
    6,568
    
    
    
    1,967Other income, net:Interest income
    
    
    94
    
    
    
    275
    
    
    
    277
    
    
    
    1,259Interest expense
    
    
    (26
    )
    
    
    (67
    )
    
    
    (110
    )
    
    
    (202
    )Other (expense) income
    
    
    (16
    )
    
    
    559
    
    
    
    247
    
    
    
    364Total other income, net
    
    
    52
    
    
    
    767
    
    
    
    414
    
    
    
    1,421Income before income taxes
    
    
    2,596
    
    
    
    1,369
    
    
    
    6,982
    
    
    
    3,388Income tax (benefit) provision
    
    
    (1,216
    )
    
    
    (24
    )
    
    
    285
    
    
    
    264Net income
    
    $
    3,812
    
    
    $
    1,393
    
    
    $
    6,697
    
    
    $
    3,124Net income per common share:Basic
    
    $
    0.15
    
    
    $
    0.06
    
    
    $
    0.27
    
    
    $
    0.13Diluted
    
    $
    0.15
    
    
    $
    0.06
    
    
    $
    0.27
    
    
    $
    0.12Weighted average common shares:Basic
    
    
    24,930
    
    
    
    24,607
    
    
    
    24,815
    
    
    
    24,982Diluted
    
    
    25,272
    
    
    
    24,875
    
    
    
    25,123
    
    
    
    25,250
   3




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##### Table of Contents



DIGI INTERNATIONAL INC.
 
 CONDENSED CONSOLIDATED BALANCE SHEETS
 (UNAUDITED)
 June 30,
    
    
    September 30,2010
    
    
    2009(in thousands, except share data)ASSETSCurrent assets:Cash and cash equivalents
    
    $
    35,212
    
    
    $
    48,434Marketable securities
    
    
    42,963
    
    
    
    22,311Accounts receivable, net
    
    
    24,299
    
    
    
    19,032Inventories
    
    
    27,817
    
    
    
    26,619Other
    
    
    5,613
    
    
    
    6,259Total current assets
    
    
    135,904
    
    
    
    122,655Marketable securities, long-term
    
    
    4,307
    
    
    
    5,063Property, equipment and improvements, net
    
    
    16,376
    
    
    
    16,678Identifiable intangible assets, net
    
    
    21,239
    
    
    
    26,877Goodwill
    
    
    85,190
    
    
    
    86,558Other
    
    
    879
    
    
    
    1,117Total assets
    
    $
    263,895
    
    
    $
    258,948LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    10,171
    
    
    $
    5,567Accrued compensation
    
    
    4,632
    
    
    
    3,275Accrued professional fees
    
    
    1,489
    
    
    
    696Accrued warranty
    
    
    909
    
    
    
    970Deferred payment on acquisition
    
    
    
    
    
    
    2,966Restructuring
    
    
    202
    
    
    
    721Other
    
    
    2,514
    
    
    
    2,339Total current liabilities
    
    
    19,917
    
    
    
    16,534Income taxes payable
    
    
    2,639
    
    
    
    4,893Deferred tax liabilities
    
    
    2,558
    
    
    
    4,331Deferred payment on acquisition
    
    
    2,888
    
    
    
    2,812Other noncurrent liabilities
    
    
    517
    
    
    
    792Total liabilities
    
    
    28,519
    
    
    
    29,362Commitments 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;
28,581,979 and 28,409,198 shares issued
    
    
    286
    
    
    
    284Additional paid-in capital
    
    
    184,284
    
    
    
    181,282Retained earnings
    
    
    89,405
    
    
    
    82,708Accumulated other comprehensive loss
    
    
    (11,157
    )
    
    
    (6,527
    )Treasury stock, at cost, 3,613,602 and 3,708,302 shares
    
    
    (27,442
    )
    
    
    (28,161
    )Total stockholders equity
    
    
    235,376
    
    
    
    229,586Total liabilities and stockholders equity
    
    $
    263,895
    
    
    $
    258,948
   4




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##### Table of Contents



DIGI INTERNATIONAL INC.
 
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
 (UNAUDITED)
 Nine months ended June 30,2010
    
    
    2009(in thousands)Operating activities:Net income
    
    $
    6,697
    
    
    $
    3,124Adjustments to reconcile net income to net cash
provided by (used in) operating activities:Depreciation of property, equipment and improvements
    
    
    2,002
    
    
    
    1,899Amortization of identifiable intangible assets and other assets
    
    
    5,743
    
    
    
    5,531Stock-based compensation
    
    
    2,603
    
    
    
    2,690Excess tax benefits from stock-based compensation
    
    
    (39
    )
    
    
    (44
    )Deferred income tax benefit
    
    
    (2,201
    )
    
    
    (2,346
    )Restructuring
    
    
    (352
    )
    
    
    1,519Other
    
    
    1,159
    
    
    
    (67
    )Changes in operating assets and liabilities
    
    
    (3,287
    )
    
    
    (8,033
    )Net cash provided by operating activities
    
    
    12,325
    
    
    
    4,273Investing activities:Purchase of marketable securities
    
    
    (38,538
    )
    
    
    (21,615
    )Proceeds from maturities of marketable securities
    
    
    18,615
    
    
    
    45,275Deferred cash payout for acquisition of Spectrum Design Solutions, Inc.
    
    
    (3,000
    )
    
    
    Acquisition of assets of MobiApps Holdings Private Limited
    
    
    
    
    
    
    (2,969
    )Proceeds from sale of property and equipment
    
    
    11
    
    
    
    Purchase of property, equipment, improvements and certain
other intangible assets
    
    
    (2,337
    )
    
    
    (2,327
    )Net cash (used in) provided by investing activities
    
    
    (25,249
    )
    
    
    18,364Financing activities:Payments on capital lease obligations
    
    
    (8
    )
    
    
    (311
    )Excess tax benefits from stock-based compensation
    
    
    39
    
    
    
    44Proceeds from stock option plan transactions and other
    
    
    1,097
    
    
    
    125Proceeds from employee stock purchase plan transactions
    
    
    691
    
    
    
    787Purchase of treasury stock
    
    
    
    
    
    
    (6,576
    )Net cash provided by (used in) financing activities
    
    
    1,819
    
    
    
    (5,931
    )Effect of exchange rate changes on cash and cash equivalents
    
    
    (2,117
    )
    
    
    (1,211
    )Net (decrease) increase in cash and cash equivalents
    
    
    (13,222
    )
    
    
    15,495Cash and cash equivalents, beginning of period
    
    
    48,434
    
    
    
    14,176Cash and cash equivalents, end of period
    
    $
    35,212
    
    
    $
    29,671
   5




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##### Table of Contents



DIGI INTERNATIONAL INC.
 
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 (UNAUDITED)
 1.
    
    BASIS OF PRESENTATION OF UNAUDITED INTERIM CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS AND SIGNIFICANT ACCOUNTING POLICIES
 Basis of Presentation
   Recently Issued Accounting Pronouncements
     6




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##### Table of Contents



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 2.
    
    NET INCOME PER COMMON SHARE
   Three months ended June 30,
    
    
    Nine months ended June 30,2010
    
    
    2009
    
    
    2010
    
    
    2009Numerator:Net income
    
    $
    3,812
    
    
    $
    1,393
    
    
    $
    6,697
    
    
    $
    3,124Denominator:Denominator for basic net income per common
share  weighted average shares outstanding
    
    
    24,930
    
    
    
    24,607
    
    
    
    24,815
    
    
    
    24,982Effect of dilutive securities:Employee stock options and employee
stock purchase plan
    
    
    342
    
    
    
    268
    
    
    
    308
    
    
    
    268Denominator for diluted net income per common
share  adjusted weighted average shares
    
    
    25,272
    
    
    
    24,875
    
    
    
    25,123
    
    
    
    25,250Net income per common share, basic
    
    $
    0.15
    
    
    $
    0.06
    
    
    $
    0.27
    
    
    $
    0.13Net income per common share, diluted
    
    $
    0.15
    
    
    $
    0.06
    
    
    $
    0.27
    
    
    $
    0.12
   7




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##### Table of Contents



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 3.
    
    COMPREHENSIVE INCOME (LOSS)
  Three months ended June 30,
    
    
    Nine months ended June 30,2010
    
    
    2009
    
    
    2010
    
    
    2009Net income
    
    $
    3,812
    
    
    $
    1,393
    
    
    $
    6,697
    
    
    $
    3,124Other comprehensive income (loss):Change in foreign currency translation adjustment
    
    
    (1,745
    )
    
    
    2,919
    
    
    
    (4,591
    )
    
    
    (6,695
    )Change in unrealized gain (loss) on investments
    
    
    (34
    )
    
    
    (47
    )
    
    
    (27
    )
    
    
    (50
    )Less income tax benefit
    
    
    13
    
    
    
    19
    
    
    
    10
    
    
    
    20Reclassification of gain included in net income
    
    
    
    
    
    
    
    
    
    
    (36
    )
    
    
    Less income tax benefit
    
    
    
    
    
    
    
    
    
    
    14
    
    
    
    Comprehensive income (loss)
    
    $
    2,046
    
    
    $
    4,284
    
    
    $
    2,067
    
    
    $
    (3,601
    )
 4.
    
    SELECTED BALANCE SHEET DATA
(in thousands)
 June 30, 2010
    
    
    September 30, 2009Accounts receivable, net:Accounts receivable
    
    $
    24,871
    
    
    $
    19,656Less allowance for doubtful accounts
    
    
    572
    
    
    
    624$
    24,299
    
    
    $
    19,032Inventories:Raw materials
    
    $
    23,024
    
    
    $
    21,359Work in process
    
    
    325
    
    
    
    452Finished goods
    
    
    4,468
    
    
    
    4,808$
    27,817
    
    
    $
    26,619
  5.
    
    ACQUISITION
 MobiApps Holdings Private Limited
   8




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##### Table of Contents



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 6.
    
    MARKETABLE SECURITIES
     Amortized
    
    
    Unrealized
    
    
    UnrealizedCost (1)
    
    
    Gains
    
    
    Losses (2)
    
    
    Fair Value (1)Current marketable securities:Corporate bonds
    
    $
    28,992
    
    
    $
    5
    
    
    $
    (68
    )
    
    $
    28,929Commercial paper
    
    
    1,999
    
    
    
    
    
    
    
    
    
    
    
    1,999Certificates of deposit
    
    
    5,500
    
    
    
    
    
    
    
    (6
    )
    
    
    5,494Government municipal bonds
    
    
    6,545
    
    
    
    
    
    
    
    (4
    )
    
    
    6,541Current marketable securities
    
    
    43,036
    
    
    
    5
    
    
    
    (78
    )
    
    
    42,963Non-current marketable securities:Corporate bonds
    
    
    2,175
    
    
    
    
    
    
    
    (8
    )
    
    
    2,167Government municipal bonds
    
    
    2,136
    
    
    
    4
    
    
    
    
    
    
    
    2,140Non-current marketable securities
    
    
    4,311
    
    
    
    4
    
    
    
    (8
    )
    
    
    4,307Total marketable securities
    
    $
    47,347
    
    
    $
    9
    
    
    $
    (86
    )
    
    $
    47,270
 (1)
    
    Included in amortized cost and fair value is purchased and accrued interest of $578.(2)
    
    The aggregate related fair value of securities with unrealized losses as of June 30, 2010 was
$36,008.  9




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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 6.
    
    MARKETABLE SECURITIES (CONTINUED)
  Amortized
    
    
    Unrealized
    
    
    UnrealizedCost (1)
    
    
    Gains
    
    
    Losses (3)
    
    
    Fair Value (1)Current marketable securities:Corporate bonds (2)
    
    $
    4,236
    
    
    $
    18
    
    
    $
    
    
    
    $
    4,254Certificates of deposit
    
    
    10,022
    
    
    
    4
    
    
    
    (1
    )
    
    
    10,025Government municipal bonds
    
    
    8,023
    
    
    
    11
    
    
    
    (2
    )
    
    
    8,032Current marketable securities
    
    
    22,281
    
    
    
    33
    
    
    
    (3
    )
    
    
    22,311Non-current marketable securities:Corporate bonds
    
    
    5,107
    
    
    
    
    
    
    
    (44
    )
    
    
    5,063Total marketable securities
    
    $
    27,388
    
    
    $
    33
    
    
    $
    (47
    )
    
    $
    27,374
 (1)
    
    Included in amortized cost and fair value is purchased and accrued interest of $264.(2)
    
    The Lehman Brothers Bond is included in amortized cost at a fair value of $134.(3)
    
    The aggregate related fair value of securities with unrealized losses as of September 30, 2009
was $9,009. 7.
    
    FAIR VALUE MEASUREMENTS
   
    
    Level 1  Inputs are quoted prices in active markets for identical assets or liabilities.
    
    Level 2  Inputs include quoted prices for similar assets or liabilities in active
markets, quoted prices for identical or similar assets or liabilities in markets that
are not active, and inputs (other than quoted prices) that are observable for the asset
or liability, either directly or indirectly.
    
    Level 3  Inputs are unobservable for the asset or liability. See the section below
titled Level 3 Valuation Techniquesfor further discussion of how we determine fair
value for investments classified as Level 3.
 Assets and Liabilities that are Measured at Fair Value on a Recurring Basis
   10




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##### Table of Contents



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 7.
    
    FAIR VALUE MEASUREMENTS (CONTINUED)
  Fair Value Measurements at June 30, 2010 Using:Total carrying
    
    
    Quoted price in
    
    
    Significant other
    
    
    Significantvalue at
    
    
    active markets
    
    
    observable inputs
    
    
    unobservable inputsJune 30, 2010
    
    
    (Level 1)
    
    
    (Level 2)
    
    
    (Level 3)Cash equivalents:Money market
    
    $
    16,622
    
    
    $
    16,622
    
    
    $
    
    
    
    $
    Available-for-sale marketable securities:Corporate bonds
    
    
    31,096
    
    
    
    
    
    
    
    31,096
    
    
    
    Commercial paper
    
    
    1,999
    
    
    
    
    
    
    
    1,999
    
    
    
    Certificates of deposit
    
    
    5,494
    
    
    
    
    
    
    
    5,494
    
    
    
    Government municipal bonds
    
    
    8,681
    
    
    
    
    
    
    
    8,681
    
    
    
    Total cash equivalents and marketable
securities measured at fair value
    
    $
    63,892
    
    
    $
    16,622
    
    
    $
    47,270
    
    
    $
    
   Level 2 Valuation Techniques
  Level 3 Valuation Techniques
   11




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##### Table of Contents



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 7.
    
    FAIR VALUE MEASUREMENTS (CONTINUED)
  8.
    
    GOODWILL AND OTHER IDENTIFIABLE INTANGIBLE ASSETS
  June 30, 2010
    
    
    September 30, 2009Gross
    
    
    
    
    
    
    
    
    
    
    Grosscarrying
    
    
    Accum.
    
    
    
    
    
    
    carrying
    
    
    Accum.amount
    
    
    amort.
    
    
    Net
    
    
    amount
    
    
    amort.
    
    
    NetPurchased and core technology
    
    $
    46,116
    
    
    $
    (37,786
    )
    
    $
    8,330
    
    
    $
    46,583
    
    
    $
    (34,893
    )
    
    $
    11,690License agreements
    
    
    2,840
    
    
    
    (2,519
    )
    
    
    321
    
    
    
    2,840
    
    
    
    (2,464
    )
    
    
    376Patents and trademarks
    
    
    9,718
    
    
    
    (6,326
    )
    
    
    3,392
    
    
    
    9,292
    
    
    
    (5,536
    )
    
    
    3,756Customer maintenance contracts
    
    
    700
    
    
    
    (586
    )
    
    
    114
    
    
    
    700
    
    
    
    (534
    )
    
    
    166Customer relationships
    
    
    17,163
    
    
    
    (8,433
    )
    
    
    8,730
    
    
    
    17,607
    
    
    
    (7,334
    )
    
    
    10,273Non-compete agreements
    
    
    1,028
    
    
    
    (676
    )
    
    
    352
    
    
    
    1,041
    
    
    
    (425
    )
    
    
    616Total
    
    $
    77,565
    
    
    $
    (56,326
    )
    
    $
    21,239
    
    
    $
    78,063
    
    
    $
    (51,186
    )
    
    $
    26,877
   2010 (three months)
    
    $
    1,8072011
    
    
    6,6382012
    
    
    4,6852013
    
    
    3,0002014
    
    
    2,3622015
    
    
    1,268
  Nine months ended June 30,2010
    
    
    2009Beginning balance, October 1
    
    $
    86,558
    
    
    $
    86,578Acquisition of MobiApps
    
    
    
    
    
    
    1,683Foreign currency translation adjustment
    
    
    (1,368
    )
    
    
    (1,424
    )Ending balance, June 30
    
    $
    85,190
    
    
    $
    86,837
   12




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##### Table of Contents



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 8.
    
    GOODWILL AND OTHER IDENTIFIABLE INTANGIBLE ASSETS (CONTINUED)
    9.
    
    INCOME TAXES
     13




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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 9.
    
    INCOME TAXES (CONTINUED)
 Nine months ended June 30,2010
    
    
    2009Effective tax rate before impact of discrete tax benefits from
the reversal of tax reserves and retroactive extension of the
research and development credit
    
    
    36.6
    %
    
    
    33.9
    %Impact of discrete tax benefits
    
    
    -32.5
    %
    
    
    -26.1
    %Effective tax rate
    
    
    4.1
    %
    
    
    7.8
    %
  Uncertain tax positions as of March 31, 2010
    
    $
    4,076Increases related to:Prior year income tax positions
    
    
    36Decreases related to:Prior year income tax positions
    
    
    (1,708
    )Expiration of the statute of limitations
    
    
    (298
    )Uncertain tax positions as of June 30, 2010
    
    $
    2,106
     10.
    
    FINANCIAL GUARANTEES
   14




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##### Table of Contents



10.
    
    FINANCIAL GUARANTEES (CONTINUED)
  Three months ended June 30,Balance at
    
    
    Warranties
    
    
    Settlements
    
    
    Balance atFiscal year
    
    April 1
    
    
    issued
    
    
    made
    
    
    June 302010
    
    $
    965
    
    
    $
    161
    
    
    $
    (217
    )
    
    $
    9092009
    
    $
    1,143
    
    
    $
    9
    
    
    $
    (132
    )
    
    $
    1,020
 Nine months ended June 30,Balance at
    
    
    Warranties
    
    
    Settlements
    
    
    Balance atFiscal year
    
    October 1
    
    
    issued
    
    
    made
    
    
    June 302010
    
    $
    970
    
    
    $
    586
    
    
    $
    (647
    )
    
    $
    9092009
    
    $
    1,214
    
    
    $
    353
    
    
    $
    (547
    )
    
    $
    1,020
  11.
    
    CONTINGENCIES
 Initial Public Offering Securities Litigation
 In re Initial Public Offering Securities
Litigation
 Investigation As previously reported in the third
fiscal quarter 2010 earnings release of July 22, 2010, after receiving
allegations regarding possible violations of our gifts, travel and
entertainment policy for activities in the Asia Pacific (APAC) region by a few
employees, we initiated an investigation of these policy and corresponding
internal control issues, and any possible related violations of applicable law,
including the Foreign Corrupt Practices Act (FCPA). We voluntarily disclosed
the allegations to the United States Department of Justice (DOJ) and the
United States Securities and Exchange Commission (SEC). The investigation has
been under the direction of the Audit Committee, comprised solely of
independent directors, utilizing outside counsel, and focused on the APAC
region. For completeness purposes, the investigation reviewed certain other
foreign regions where no allegations have been made. At that time, we believed
the investigation was substantially complete, pending input from the DOJ and
the SEC. We have been providing the DOJ and SEC with updates and our proposed
remediation plan.
   15




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##### Table of Contents



11.
    
    CONTINGENCIES (CONTINUED)
 Digi has now received confirmation
through discussions with representatives of the DOJ and the SEC that they will
not be initiating any enforcement proceedings against Digi, including not
seeking any monetary or other sanctions. The investigation identified violations
of company policy that primarily involved three individuals in Hong Kong and
our Chief Financial Officer. The investigation also found an unsubstantiated
accrued liability recorded in Hong Kong. All four individuals were terminated
or had resigned from the company as of May 12, 2010. In the three and nine
months ended June 30, 2010, we incurred additional general and
administrative expense of $1.0 million related to the cost of the
investigation. As a result of the allegations and the
ultimate findings of the investigation, we performed an evaluation of our
internal controls over financial reporting during the third fiscal quarter of
2010 to consider the implications of these findings. A discussion of our
controls evaluation and changes in internal control over financial reporting,
including remediation efforts appears in Part I, Item 4 of this
Quarterly Report on Form 10-Q. While we determined that no adjustment was
required to our previously reported consolidated financial statements, we
recorded an immaterial out-of-period adjustment this period in order to correct
the unsubstantiated accrued liability in Hong Kong. Shareholder Derivative Litigation
  Patent Infringement Lawsuit
    16




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##### Table of Contents



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 12.
    
    RESTRUCTURING
   EmployeeTerminationCosts
    
    
    Other
    
    
    TotalBalance at September 30, 2009
    
    $
    620
    
    
    $
    101
    
    
    $
    721Restructuring charge
    
    
    75
    
    
    
    
    
    
    
    75Payments
    
    
    (231
    )
    
    
    (11
    )
    
    
    (242
    )Reversal
    
    
    (352
    )
    
    
    
    
    
    
    (352
    )Balance at June 30, 2010
    
    $
    112
    
    
    $
    90
    
    
    $
    202
   17




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##### Table of Contents



ITEM 2.
    
    MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
  SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
      OVERVIEW
   18




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##### Table of Contents



ITEM 2.
    
    MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(CONTINUED)
 OVERVIEW (CONTINUED)
        19




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##### Table of Contents



ITEM 2.
    
    MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(CONTINUED)
 CONSOLIDATED RESULTS OF OPERATIONS
  Three months ended June 30,
    
    
    % increase
    
    
    Nine months ended June 30,
    
    
    % increase2010
    
    
    2009
    
    
    (decrease)
    
    
    2010
    
    
    2009
    
    
    (decrease)Net sales
    
    $
    47,238
    
    
    
    100.0
    %
    
    $
    44,470
    
    
    
    100.0
    %
    
    
    6.2
    %
    
    $
    135,282
    
    
    
    100.0
    %
    
    $
    125,916
    
    
    
    100.0
    %
    
    
    7.4
    %Cost of sales (exclusive of amortization of purchased and core technology
shown separately below)
    
    
    22,496
    
    
    
    47.6
    
    
    
    21,986
    
    
    
    49.4
    
    
    
    2.3
    
    
    
    63,913
    
    
    
    47.2
    
    
    
    60,963
    
    
    
    48.4
    
    
    
    4.8Amortization of purchased and
core technology
    
    
    1,024
    
    
    
    2.2
    
    
    
    1,047
    
    
    
    2.4
    
    
    
    (2.2
    )
    
    
    3,190
    
    
    
    2.4
    
    
    
    3,099
    
    
    
    2.5
    
    
    
    2.9Gross profit
    
    
    23,718
    
    
    
    50.2
    
    
    
    21,437
    
    
    
    48.2
    
    
    
    10.6
    
    
    
    68,179
    
    
    
    50.4
    
    
    
    61,854
    
    
    
    49.1
    
    
    
    10.2Operating expenses
    
    
    21,174
    
    
    
    44.8
    
    
    
    20,835
    
    
    
    46.8
    
    
    
    1.6
    
    
    
    61,611
    
    
    
    45.5
    
    
    
    59,887
    
    
    
    47.5
    
    
    
    2.9Operating income
    
    
    2,544
    
    
    
    5.4
    
    
    
    602
    
    
    
    1.4
    
    
    
    322.6
    
    
    
    6,568
    
    
    
    4.9
    
    
    
    1,967
    
    
    
    1.6
    
    
    
    233.9Interest income and other, net
    
    
    52
    
    
    
    0.1
    
    
    
    767
    
    
    
    1.7
    
    
    
    (93.2
    )
    
    
    414
    
    
    
    0.3
    
    
    
    1,421
    
    
    
    1.1
    
    
    
    (70.9
    )Income before income taxes
    
    
    2,596
    
    
    
    5.5
    
    
    
    1,369
    
    
    
    3.1
    
    
    
    89.6
    
    
    
    6,982
    
    
    
    5.2
    
    
    
    3,388
    
    
    
    2.7
    
    
    
    106.1Income tax (benefit) provision
    
    
    (1,216
    )
    
    
    (2.6
    )
    
    
    (24
    )
    
    
    0.0
    
    
    
    N/M
    
    
    
    285
    
    
    
    0.2
    
    
    
    264
    
    
    
    0.2
    
    
    
    8.0Net income
    
    $
    3,812
    
    
    
    8.1
    %
    
    $
    1,393
    
    
    
    3.1
    %
    
    
    173.7
    %
    
    $
    6,697
    
    
    
    5.0
    %
    
    $
    3,124
    
    
    
    2.5
    %
    
    
    114.4
    %
    Three months ended June 30,
    
    
    % increase
    
    
    Nine months ended June 30,
    
    
    % increase($ in thousands)
    
    2010
    
    
    2009
    
    
    (decrease)
    
    
    2010
    
    
    2009
    
    
    (decrease)Non-embedded
    
    $
    24,948
    
    
    
    52.8
    %
    
    $
    24,026
    
    
    
    54.0
    %
    
    
    3.8
    %
    
    $
    74,755
    
    
    
    55.3
    %
    
    $
    70,081
    
    
    
    55.7
    %
    
    
    6.7
    %Embedded
    
    
    22,290
    
    
    
    47.2
    
    
    
    20,444
    
    
    
    46.0
    
    
    
    9.0
    
    
    
    60,527
    
    
    
    44.7
    
    
    
    55,835
    
    
    
    44.3
    
    
    
    8.4Total net sales
    
    $
    47,238
    
    
    
    100.0
    %
    
    $
    44,470
    
    
    
    100.0
    %
    
    
    6.2
    %
    
    $
    135,282
    
    
    
    100.0
    %
    
    $
    125,916
    
    
    
    100.0
    %
    
    
    7.4
    %
 Non-embedded
   20




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ITEM 2.
    
    MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(CONTINUED)
  Embedded
   Three months ended June 30,
    
    
    $ increase
    
    
    % increase
    
    
    Nine months ended June 30,
    
    
    $ increase
    
    
    % increase($ in thousands)
    
    2010
    
    
    2009
    
    
    (decrease)
    
    
    (decrease)
    
    
    2010
    
    
    2009
    
    
    (decrease)
    
    
    (decrease)North America (1)
    
    $
    28,477
    
    
    $
    22,631
    
    
    $
    5,846
    
    
    
    25.8
    %
    
    $
    80,517
    
    
    $
    66,500
    
    
    $
    14,017
    
    
    
    21.1
    %EMEA
    
    
    11,640
    
    
    
    17,094
    
    
    
    (5,454
    )
    
    
    (31.9
    )
    
    
    35,008
    
    
    
    45,356
    
    
    
    (10,348
    )
    
    
    (22.8
    )Asia countries (2)
    
    
    5,905
    
    
    
    3,991
    
    
    
    1,914
    
    
    
    48.0
    
    
    
    16,478
    
    
    
    11,601
    
    
    
    4,877
    
    
    
    42.0Latin America
    
    
    1,216
    
    
    
    754
    
    
    
    462
    
    
    
    61.3
    
    
    
    3,279
    
    
    
    2,459
    
    
    
    820
    
    
    
    33.3Total net sales
    
    $
    47,238
    
    
    $
    44,470
    
    
    $
    2,768
    
    
    
    6.2
    %
    
    $
    135,282
    
    
    $
    125,916
    
    
    $
    9,366
    
    
    
    7.4
    %
 (1)
    
    Includes Satellite net sales of $365 and $668 for the three and nine months ended June 30,
2010, respectively.(2)
    
    Includes Satellite net sales of $197 and $837 for the three and nine months ended June 30,
2010, respectively and $47 for both the three and nine months ended June 30, 2009.     21




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ITEM 2.
    
    MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
  Three months ended June 30,
    
    
    $ increase
    
    
    Nine months ended June 30,
    
    
    $ increase($ in thousands)
    
    2010
    
    
    2009
    
    
    (decrease)
    
    
    2010
    
    
    2009
    
    
    (decrease)Sales and marketing
    
    $
    9,089
    
    
    
    19.2
    %
    
    $
    8,624
    
    
    
    19.4
    %
    
    $
    465
    
    
    $
    27,932
    
    
    
    20.7
    %
    
    $
    27,225
    
    
    
    21.6
    %
    
    $
    707Research and development
    
    
    7,159
    
    
    
    15.2
    
    
    
    6,823
    
    
    
    15.3
    
    
    
    336
    
    
    
    20,723
    
    
    
    15.3
    
    
    
    19,993
    
    
    
    15.9
    
    
    
    730General and administrative
    
    
    4,926
    
    
    
    10.4
    
    
    
    3,435
    
    
    
    7.7
    
    
    
    1,491
    
    
    
    13,308
    
    
    
    9.8
    
    
    
    10,716
    
    
    
    8.5
    
    
    
    2,592Restructuring
    
    
    
    
    
    
    0.0
    
    
    
    1,953
    
    
    
    4.4
    
    
    
    (1,953
    )
    
    
    (352
    )
    
    
    (0.3
    )
    
    
    1,953
    
    
    
    1.5
    
    
    
    (2,305
    )Total operating expenses
    
    $
    21,174
    
    
    
    44.8
    %
    
    $
    20,835
    
    
    
    46.8
    %
    
    $
    339
    
    
    $
    61,611
    
    
    
    45.5
    %
    
    $
    59,887
    
    
    
    47.5
    %
    
    $
    1,724
      22




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ITEM 2.
    
    MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
          23




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ITEM 2.
    
    MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
         24




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ITEM 2.
    
    MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
   
 ITEM 3.
    
    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
       Nine months ended June 30,2010
    
    
    2009
    
    
    % increaseEuro
    
    
    1.3803
    
    
    
    1.3296
    
    
    
    3.8
    %British Pound
    
    
    1.5632
    
    
    
    1.5213
    
    
    
    2.8
    %Yen
    
    
    0.0110
    
    
    
    0.0105
    
    
    
    5.2
    %
   25




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##### Table of Contents



ITEM 3.
    
    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK (CONTINUED)
    
 ITEM 4.
    
    CONTROLS AND PROCEDURES
  As of the end of the period covered by
this report, we conducted an evaluation, under the supervision and with the
participation of the principal executive officer and principal financial
officer, of our disclosure controls and procedures (as defined in
Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934,
as amended (the “Exchange Act”)). Based on this evaluation, the
principal executive officer and principal financial officer concluded that our
disclosure controls and procedures were effective as of June 30, 2010 to
ensure that information required to be disclosed by us in reports that we file
or submit under the Exchange Act was recorded, processed, summarized and
reported within the time periods specified in Securities and Exchange
Commission rules and forms and is accumulated and communicated to our
management, including the principal executive officer and principal financial
officer, or persons performing similar functions, as appropriate to allow
timely decisions regarding required disclosure. INVESTIGATION IN HONG KONG The previously announced investigation,
which was the result of allegations that we learned of in April 2010, was
completed in July 2010 (refer to Note 11 of the Condensed Consolidated
Financial Statements for more detail). Soon after learning of these
allegations, the Company began to take immediate remedial actions. The
investigation identified violations of company policy that primarily involved
three individuals in Hong Kong and our Chief Financial Officer. The
investigation also found an unsubstantiated accrued liability recorded in Hong
Kong. All four individuals were terminated or had resigned from the company as
of May 12, 2010. As a result of the allegations and the
ultimate findings of the investigation, we performed an evaluation of our
internal controls over financial reporting during the third fiscal quarter of
2010 to consider the implications of these findings. We identified deficiencies
in the design of the internal reporting structure in Hong Kong, as well as
deficiencies in the design of certain controls in Hong Kong, including expense
reviews, cash controls, review of Hong Kong financial information and account
reconciliations in both Hong Kong and the corporate office, and in the
competency of those performing financial accounting and reporting activities in
Hong Kong. These deficiencies allowed inappropriate activities, such as those
that ultimately led to the investigation and terminations and resignation noted
above, to not be prevented or detected on a timely basis. We have determined
based on a review of the internal reporting structure and controls at Hong Kong
in comparison to our other locations that these issues were unique to the Hong
Kong entity and that the Company’s other entities had controls in place
that were operating and effective. While we determined that no adjustment was
required to our previously reported consolidated financial statements, we
determined that the aggregation of these control  26




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##### Table of Contents



ITEM 4.
    
    CONTROLS AND PROCEDURES (CONTINUED)
 deficiencies, combined with the
influence and span of control of our former CFO in the Hong Kong region and
collusion on the part of the individuals involved, resulted in a material
weakness in the Company’s control environment. A material weakness is a
deficiency, or a combination of deficiencies, in internal control over
financial reporting such that there is a reasonable possibility that a material
misstatement of the Company’s annual or interim financial statements will
not be prevented or detected on a timely basis. The control deficiencies at
Digi could have resulted in a material misstatement of the consolidated
financial statements that would not have been prevented or detected on a timely
basis. As described below, we determined that
this material weakness was remediated as of June 30, 2010. CHANGES IN INTERNAL CONTROL OVER
FINANCIAL REPORTING There have been changes in internal
control over financial reporting during the quarter ended June 30, 2010
that have materially affected, or are reasonably likely to materially affect
our internal control over financial reporting. In response to the material
weakness discussed above, the Company implemented the following remedial
actions which were all completed as of June 30, 2010:  •
  
  We terminated the three involved individuals in Hong Kong and our Chief
Financial Officer resigned.  •
  
  We realigned the reporting of our finance function in Hong Kong to ensure
appropriate segregation of duties, as well as the appropriate levels of review
and oversight by the corporate finance team. Further, the corporate finance
team performed, and continues to perform, a monthly detailed review of all
account reconciliations and transaction activity for the Hong Kong region.  •
  
  Additional controls over cash in Hong Kong were implemented in
May 2010. We restricted the use of petty cash in Hong Kong for payment of
business expenditures and the signers on the Hong Kong bank accounts were
replaced with two individuals in our corporate office. One of these individuals
must sign all checks and authorize all wire transfers. Requests for payment in
Hong Kong are forwarded to the corporate accounting department, along with
supporting back-up, for approval and payment.  •
  
  Representatives from the corporate office visited the Hong Kong office in
May and June 2010 to meet with employees and the outside accounting and
statutory auditing firms. During these visits, the corporate employees
reinforced the code of conduct, corporate policies, Digi’s intolerance
for violation of company policy and regulations, and appropriate expense
reporting procedures in Hong Kong. The corporate office will continue to visit
Hong Kong at least annually going forward to reinforce these policies.  •
  
  The corporate office performed a detailed balance sheet and income
statement review of the Hong Kong financial statements in each of May and
June 2010. We have incorporated this detailed monthly financial statement
review into our ongoing controls for Hong Kong.  •
  
  We improved controls over the review around travel and entertainment
expenses in Hong Kong which will be sustained going forward. The corporate
office is currently reviewing and approving all expense reports for Hong Kong
to ensure compliance to the gifts, travel and entertainment policy. These activities have been incorporated
into our internal control structure and were in place as of June 30, 2010
and will be sustained going forward such that the underlying control
deficiencies that aggregated to the material weakness have been substantially
remediated as of June 30, 2010, and therefore the material weakness no
longer exists as of June 30, 2010.  27




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##### Table of Contents



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
 Entry into a Material Definitive Agreement
    28




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ITEM 6.
    
    EXHIBITS
 Exhibit No.
    
    Description3
    (a)
    
    Restated Certificate of Incorporation of the Company, as amended (1)3
    (b)
    
    Amended and Restated By-Laws of the Company (2)4
    (a)
    
    Share Rights Agreement, dated as of April 22, 2008, between the Company and Wells
Fargo Bank, N.A., as Rights Agent (3)4
    (b)
    
    Form of Amended and Restated Certificate of Powers, Designations, Preferences and
Rights of Series A Junior Participating Preferred Shares (4)10
    
    
    Form of Indemnification Agreement with directors and officers of the Company31
    (a)
    
    Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer31
    (b)
    
    Rule 13a-14(a)/15d-14(a) Certification of Corporate Controller and Acting
Principal Financial Officer32
    
    
    Section 1350 Certification
 
 (1)
    
    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)(2)
    
    Incorporated by reference to Exhibit 3(b) to the Companys Form 10-Q for the quarter ended
June 30, 2008 (File No. 1-34033)(3)
    
    Incorporated by reference to Exhibit 4(a) to the Companys Registration Statement on Form 8-A
filed on April 25, 2008 (File No. 1-34033)(4)
    
    Incorporated by reference to Exhibit 4(b) to the Companys Registration Statement on Form 8-A
filed on April 25, 2008 (File No. 1-34033) 
  29




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##### Table of Contents



DIGI INTERNATIONAL INC.Date:  August 9, 2010
    By:
    /s/ Brenda MuellerBrenda MuellerCorporate Controller and Acting Principal Financial Officer

(Principal Financial and Accounting Officer)  30




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Exhibit Number
    
    Document Description
    
    Form of Filing3(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 Reference4(a)
    
    Share Rights Agreement, dated as of April 22, 2008, between the Company and Wells Fargo Bank, N.A., as Rights Agent
    
    Incorporated by Reference4(b)
    
    Form of Amended and Restated Certificate of Powers, Designations, Preferences and Rights of Series A Junior Participating Preferred Shares
    
    Incorporated by Reference10
    
    Form of Indemnification Agreement with directors and officers of the Company
    
    Filed Electronically31(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 Corporate Controller and Acting Principal Financial Officer
    
    Filed Electronically32
    
    Section 1350 Certification
    
    Filed Electronically
  31