##### 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, 2008
 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
    
    (I.R.S. Employerincorporation or organization)
    
    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)
 þ 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




---



##### 



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, 2008 and 2007
    
    
    3Condensed Consolidated Balance Sheets as of
June 30, 2008 and September 30, 2007
    
    
    4Condensed Consolidated Statements of Cash Flows for
the nine months ended June 30, 2008 and 2007
    
    
    5Notes to Condensed Consolidated Financial
Statements
    
    
    6ITEM 2. Managements Discussion and Analysis of Financial Condition and
Results of Operations
    
    
    17Forward-looking Statements
    
    
    17ITEM 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    27ITEM 4. Controls and Procedures
    
    
    28PART II. OTHER INFORMATIONITEM 1. Legal Proceedings
    
    
    29ITEM 1A. Risk Factors
    
    
    29ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    29ITEM 3. Defaults Upon Senior Securities
    
    
    29ITEM 4. Submission of Matters to a Vote of Security Holders
    
    
    29ITEM 5. Other Information
    
    
    29ITEM 6. Exhibits
    
    
    30Exhibit 3(b)Exhibit 31(a)Exhibit 31(b)Exhibit 32
   2




---



##### 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 30,2008
    
    
    2007
    
    
    2008
    
    
    2007(in thousands, except per common share data)Net sales
    
    $
    46,995
    
    
    $
    43,527
    
    
    $
    134,639
    
    
    $
    128,193Cost of sales (exclusive of amortization of purchased
and core technology shown separately below)
    
    
    21,200
    
    
    
    19,392
    
    
    
    59,729
    
    
    
    57,257Amortization of purchased and core technology
    
    
    938
    
    
    
    1,132
    
    
    
    2,981
    
    
    
    3,409Gross profit
    
    
    24,857
    
    
    
    23,003
    
    
    
    71,929
    
    
    
    67,527Operating expenses:Sales and marketing
    
    
    9,493
    
    
    
    8,517
    
    
    
    27,213
    
    
    
    25,102Research and development
    
    
    6,995
    
    
    
    6,039
    
    
    
    20,113
    
    
    
    18,079General and administrative
    
    
    3,484
    
    
    
    3,349
    
    
    
    11,466
    
    
    
    10,229Acquired in-process research & development
    
    
    1,900
    
    
    
    
    
    
    
    1,900
    
    
    
    Total operating expenses
    
    
    21,872
    
    
    
    17,905
    
    
    
    60,692
    
    
    
    53,410Operating income
    
    
    2,985
    
    
    
    5,098
    
    
    
    11,237
    
    
    
    14,117Interest income, netInterest income
    
    
    776
    
    
    
    872
    
    
    
    2,850
    
    
    
    2,444Interest expense
    
    
    (64
    )
    
    
    (17
    )
    
    
    (90
    )
    
    
    (59
    )Total interest income, net
    
    
    712
    
    
    
    855
    
    
    
    2,760
    
    
    
    2,385Income before income taxes
    
    
    3,697
    
    
    
    5,953
    
    
    
    13,997
    
    
    
    16,502Income tax provision
    
    
    1,712
    
    
    
    (845
    )
    
    
    5,245
    
    
    
    2,305Net income
    
    $
    1,985
    
    
    $
    6,798
    
    
    $
    8,752
    
    
    $
    14,197Net income per common share:Basic
    
    $
    0.08
    
    
    $
    0.27
    
    
    $
    0.34
    
    
    $
    0.56Diluted
    
    $
    0.08
    
    
    $
    0.26
    
    
    $
    0.33
    
    
    $
    0.55Weighted average common shares, basic
    
    
    25,742
    
    
    
    25,294
    
    
    
    25,683
    
    
    
    25,186Weighted average common shares, diluted
    
    
    26,079
    
    
    
    26,152
    
    
    
    26,353
    
    
    
    26,032
   3




---



##### Table of Contents



DIGI INTERNATIONAL INC.
 
 CONDENSED CONSOLIDATED BALANCE SHEETS
 (UNAUDITED)
 June 30,
    
    
    September 30,2008
    
    
    2007(in thousands, except share data)ASSETSCurrent assets:Cash and cash equivalents
    
    $
    16,751
    
    
    $
    18,375Marketable securities
    
    
    52,877
    
    
    
    67,111Accounts receivable, net
    
    
    26,032
    
    
    
    21,022Inventories
    
    
    28,529
    
    
    
    26,130Other
    
    
    4,885
    
    
    
    4,961Total current assets
    
    
    129,074
    
    
    
    137,599Marketable securities, long-term
    
    
    7,921
    
    
    
    2,081Property, equipment and improvements, net
    
    
    15,382
    
    
    
    19,987Identifiable intangible assets, net
    
    
    32,951
    
    
    
    24,214Goodwill
    
    
    82,831
    
    
    
    66,817Other
    
    
    1,456
    
    
    
    1,128Total assets
    
    $
    269,615
    
    
    $
    251,826LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Capital lease obligations, current portion
    
    $
    278
    
    
    $
    379Accounts payable
    
    
    10,667
    
    
    
    6,554Income taxes payable
    
    
    1,183
    
    
    
    3,156Accrued expenses:Compensation
    
    
    5,015
    
    
    
    7,080Other
    
    
    3,982
    
    
    
    4,727Total current liabilities
    
    
    21,125
    
    
    
    21,896Capital lease obligations, net of current portion
    
    
    135
    
    
    
    358Income taxes payable  long-term
    
    
    3,983
    
    
    
    Deferred gain on building sale  leaseback
    
    
    1,120
    
    
    
    Net deferred tax liabilities
    
    
    7,596
    
    
    
    6,667Total liabilities
    
    
    33,959
    
    
    
    28,921Stockholders 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;
28,332,658 and 28,153,763 shares issued
    
    
    283
    
    
    
    281Additional paid-in capital
    
    
    176,687
    
    
    
    172,156Retained earnings
    
    
    75,026
    
    
    
    66,782Accumulated other comprehensive income
    
    
    1,492
    
    
    
    2,121Treasury stock, at cost, 2,521,147 and 2,606,419 shares
    
    
    (17,832
    )
    
    
    (18,435
    )Total stockholders equity
    
    
    235,656
    
    
    
    222,905Total liabilities and stockholders equity
    
    $
    269,615
    
    
    $
    251,826
   4




---



##### Table of Contents



DIGI INTERNATIONAL INC.
 
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
 (UNAUDITED)
 Nine months ended June 30,2008
    
    
    2007(in thousands)Operating activities:Net income
    
    $
    8,752
    
    
    $
    14,197Adjustments to reconcile net income to net cash
provided by operating activities:Depreciation of property, equipment and improvements
    
    
    1,894
    
    
    
    1,878Amortization of identifiable intangible assets and other assets
    
    
    5,033
    
    
    
    5,769Gain on sale of property, equipment and improvements
    
    
    (94
    )
    
    
    Excess tax benefits from stock-based compensation
    
    
    (177
    )
    
    
    (315
    )Stock-based compensation
    
    
    2,702
    
    
    
    2,258Deferred income tax benefit
    
    
    (2,696
    )
    
    
    (1,612
    )Acquired in-process research and development
    
    
    1,900
    
    
    
    Other
    
    
    222
    
    
    
    18Changes in operating assets and liabilities, excluding impact of acquisition:Accounts receivable
    
    
    (2,903
    )
    
    
    (1,109
    )Inventories
    
    
    (924
    )
    
    
    (3,543
    )Other assets
    
    
    253
    
    
    
    709Accounts payable and accrued expenses
    
    
    (156
    )
    
    
    (903
    )Income taxes payable
    
    
    1,221
    
    
    
    1,328Net cash provided by operating activities
    
    
    15,027
    
    
    
    18,675Investing activities:Purchase of held-to-maturity marketable securities
    
    
    (57,273
    )
    
    
    (56,593
    )Proceeds from maturities of held-to-maturity marketable securities
    
    
    65,667
    
    
    
    55,902Acquisition of Sarian, Inc., net of cash acquired
    
    
    (27,811
    )
    
    
    Contingent purchase price payments related to prior business acquisitions
    
    
    (1,315
    )
    
    
    (781
    )Increase in non-current restricted cash
    
    
    (392
    )
    
    
    Proceeds from sale-leaseback and sale of other property,
equipment, improvements
    
    
    6,915
    
    
    
    17Purchase of property, equipment, improvements and certain
other intangible assets
    
    
    (2,567
    )
    
    
    (2,329
    )Net cash used in investing activities
    
    
    (16,776
    )
    
    
    (3,784
    )Financing activities:Payments on capital lease obligations
    
    
    (293
    )
    
    
    (287
    )Borrowing on note payable
    
    
    25,000
    
    
    
    Payment on note payable
    
    
    (25,000
    )
    
    
    Excess tax benefits from stock-based compensation
    
    
    177
    
    
    
    315Proceeds from stock option plan transactions
    
    
    1,679
    
    
    
    2,433Proceeds from employee stock purchase plan transactions
    
    
    802
    
    
    
    954Net cash provided by financing activities
    
    
    2,365
    
    
    
    3,415Effect of exchange rate changes on cash and cash equivalents
    
    
    (2,240
    )
    
    
    88Net (decrease) increase in cash and cash equivalents
    
    
    (1,624
    )
    
    
    18,394Cash and cash equivalents, beginning of period
    
    
    18,375
    
    
    
    15,674Cash and cash equivalents, end of period
    
    $
    16,751
    
    
    $
    34,068
   5




---



##### Table of Contents



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




---



##### Table of Contents



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 1.
    
    BASIS OF PRESENTATION OF UNAUDITED INTERIM CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
      7




---



##### 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 30,2008
    
    
    2007
    
    
    2008
    
    
    2007Numerator:Net income
    
    $
    1,985
    
    
    $
    6,798
    
    
    $
    8,752
    
    
    $
    14,197Denominator:Denominator for basic net income per common
share  weighted average shares outstanding
    
    
    25,742
    
    
    
    25,294
    
    
    
    25,683
    
    
    
    25,186Effect of dilutive securities:Employee stock options and employee
stock purchase plan
    
    
    337
    
    
    
    858
    
    
    
    670
    
    
    
    846Denominator for diluted net income per common
share  adjusted weighted average shares
    
    
    26,079
    
    
    
    26,152
    
    
    
    26,353
    
    
    
    26,032Net income per common share, basic
    
    $
    0.08
    
    
    $
    0.27
    
    
    $
    0.34
    
    
    $
    0.56Net income per common share, diluted
    
    $
    0.08
    
    
    $
    0.26
    
    
    $
    0.33
    
    
    $
    0.55
   8




---



##### Table of Contents



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 3.
    
    COMPREHENSIVE INCOME
  Three months ended June 30,
    
    

Nine months ended June 30,2008
    
    
    2007
    
    
    2008
    
    
    2007Net income
    
    $
    1,985
    
    
    $
    6,798
    
    
    $
    8,752
    
    
    $
    14,197Foreign currency
translation gain
(loss)
    
    
    (1,342
    )
    
    
    (154
    )
    
    
    (629
    )
    
    
    486Comprehensive income
    
    $
    643
    
    
    $
    6,644
    
    
    $
    8,123
    
    
    $
    14,683
 4.
    
    ACQUISITIONS
 Sarian Systems, Ltd.
    Cash, including direct acquisition costs
    
    $
    30,920Fair value of net tangible assets acquired, including cash of $3.1 million
    
    $
    4,055Identifiable intangible assets:Existing purchased and core technology
    
    
    7,800Existing customer relationships
    
    
    4,800Trade names
    
    
    340Non-compete agreements
    
    
    300In-process research and development
    
    
    1,900Goodwill
    
    
    15,432Deferred tax liabilities related to identifiable intangibles
    
    
    (3,707
    )$
    30,920
  9




---



##### Table of Contents



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 4.
    
    ACQUISITIONS (CONTINUED)
    IPV6
    
    $
    1,300Gate Array
    
    
    400VPN technologies
    
    
    200Total in-process research and development
    
    $
    1,900
   
    
    The estimated revenues were based upon our estimate of revenue growth for each of the
products over the next ten fiscal years, using the assumption that all revenue recorded
after the ten year period will be generated from future technologies.
 
    
    The estimated operating expenses were based on consideration of historical selling,
general and administrative expenses as a percentage of sales and Sarians projected
operating expenses.
 
    
    Maintenance research and development, defined as the research and development necessary
to sustain the existing technology and its revenue stream, was also included as an
operating expense. The estimated remaining cost to complete each in-process research and
development technology was also included in operating expenses.When applying the excess earnings method, the cash flows expected to be generated by an asset
are discounted to their present value equivalent using a rate of return that reflects the
relative risk of the investment, as well as the time value of money. This return, known as
the weighted average cost of capital (WACC), is an overall rate based upon the individual
rates of return for invested capital (equity and interest-bearing debt). The discount rate
used in the excess earnings method was 35%. Premiums were added to the WACC to account for
the inherent risks in the development of the products, the risks of the products being
completed on schedule, and the risk of the eventual sales of the product meeting the
expectations of the Company. We used a 35% rate of return for the in-process research and
development projects.
  10




---



##### Table of Contents



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 4.
    
    ACQUISITIONS (CONTINUED)
   Three months ended June 30,
    
    
    Nine months ended June 30,2008
    
    
    2007
    
    
    2008
    
    
    2007Net sales
    
    $
    47,787
    
    
    $
    46,784
    
    
    $
    142,317
    
    
    $
    135,923Net income
    
    $
    1,389
    
    
    $
    6,531
    
    
    $
    7,938
    
    
    $
    13,061Net income per common share, basic
    
    $
    0.05
    
    
    $
    0.26
    
    
    $
    0.31
    
    
    $
    0.52Net income per common share, diluted
    
    $
    0.05
    
    
    $
    0.25
    
    
    $
    0.30
    
    
    $
    0.50
  FS Forth-Systeme GmbH/Sistemas Embebidos S.A.
  5.
    
    SELECTED BALANCE SHEET DATA
(in thousands)
 June 30, 2008
    
    
    September 30, 2007Accounts receivable, net:Accounts receivable
    
    $
    26,612
    
    
    $
    21,501Less allowance for doubtful accounts
    
    
    580
    
    
    
    479$
    26,032
    
    
    $
    21,022Inventories:Raw materials
    
    $
    22,446
    
    
    $
    20,097Work in process
    
    
    1,748
    
    
    
    816Finished goods
    
    
    4,335
    
    
    
    5,217$
    28,529
    
    
    $
    26,130Other accrued expenses:Product warranty accrual
    
    $
    1,124
    
    
    $
    1,155Accrued professional fees
    
    
    626
    
    
    
    522Other accrued expenses
    
    
    2,232
    
    
    
    2,100Contingent
purchase price accrual  FS Forth
    
    
    
    
    
    
    950$
    3,982
    
    
    $
    4,727
   11




---



##### Table of Contents



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
   June 30, 2008
    
    
    September 30, 2007Gross
    
    
    
    
    
    
    
    
    
    
    Grosscarrying
    
    
    Accum.
    
    
    
    
    
    
    carrying
    
    
    Accum.amount
    
    
    amort.
    
    
    Net
    
    
    amount
    
    
    amort.
    
    
    NetPurchased and core technology
    
    $
    46,634
    
    
    $
    (29,759
    )
    
    $
    16,875
    
    
    $
    38,702
    
    
    $
    (26,689
    )
    
    $
    12,013License agreements
    
    
    2,440
    
    
    
    (2,440
    )
    
    
    
    
    
    
    2,440
    
    
    
    (2,290
    )
    
    
    150Patents and trademarks
    
    
    8,633
    
    
    
    (4,447
    )
    
    
    4,186
    
    
    
    7,925
    
    
    
    (3,818
    )
    
    
    4,107Customer maintenance contracts
    
    
    700
    
    
    
    (446
    )
    
    
    254
    
    
    
    700
    
    
    
    (394
    )
    
    
    306Customer relationships
    
    
    16,602
    
    
    
    (5,251
    )
    
    
    11,351
    
    
    
    11,613
    
    
    
    (3,975
    )
    
    
    7,638Non-compete agreements
    
    
    302
    
    
    
    (17
    )
    
    
    285
    
    
    
    
    
    
    
    
    
    
    
    Total
    
    $
    75,311
    
    
    $
    (42,360
    )
    
    $
    32,951
    
    
    $
    61,380
    
    
    $
    (37,166
    )
    
    $
    24,214
   2008 (three months)
    
    $
    1,5552009
    
    
    6,0452010
    
    
    5,4802011
    
    
    4,8772012
    
    
    4,2552013
    
    
    3,508
  Beginning balance, October 1, 2007
    
    $
    66,817Acquisition of Sarian
    
    
    15,432Foreign currency translation adjustment
    
    
    582Ending balance, June 30, 2008
    
    $
    82,831
 7.
    
    INCOME TAXES
    12




---



##### Table of Contents



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 7.
    
    INCOME TAXES (CONTINUED)
   Three months ended June 30,
    
    
    Nine months ended June 30,2008
    
    
    2007
    
    
    2008
    
    
    2007Effective tax rate before impact of discrete tax
events & non-deductible in-process research
and development
    
    
    37.3
    %
    
    
    35.0
    %
    
    
    35.1
    %
    
    
    36.1
    %Impact of non-deductible in-process research and
development charge
    
    
    14.4
    %
    
    
    0.0
    %
    
    
    3.8
    %
    
    
    0.0
    %Impact of discrete tax events
    
    
    -5.4
    %
    
    
    -49.2
    %
    
    
    -1.4
    %
    
    
    -22.1
    %Effective tax rate
    
    
    46.3
    %
    
    
    -14.2
    %
    
    
    37.5
    %
    
    
    14.0
    %
      13




---



##### Table of Contents



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 8.
    
    FINANCIAL GUARANTEES
  Three months ended June 30,Balance at
    
    
    Warranties
    
    
    Settlements
    
    
    Balance atApril 1
    
    
    issued
    
    
    made
    
    
    June 302008
    
    $
    1,133
    
    
    $
    218
    
    
    $
    (227
    )
    
    $
    1,1242007
    
    $
    1,006
    
    
    $
    176
    
    
    $
    (223
    )
    
    $
    959
 Nine months ended June 30,Balance at
    
    
    Warranties
    
    
    Settlements
    
    
    Balance atOctober 1
    
    
    issued (1)
    
    
    made
    
    
    June 302008
    
    $
    1,155
    
    
    $
    576
    
    
    $
    (607
    )
    
    $
    1,1242007
    
    $
    1,104
    
    
    $
    485
    
    
    $
    (630
    )
    
    $
    959
 (1)
    
    Warranties issued include a decrease in estimate adjustment of $132,000 in the first quarter of fiscal 2007.  9.
    
    CONTINGENCIES
 Legal Proceedings
   14




---



##### Table of Contents



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 9.
    
    CONTINGENCIES (CONTINUED)
  In re Initial Public Offering Securities Litigation en banc
    15




---



##### Table of Contents



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 9.
    
    CONTINGENCIES (CONTINUED)
   10.
    
    SALE AND LEASEBACK OF BUILDING
   11.
    
    SHORT-TERM LOAN
  12.
    
    SUBSEQUENT EVENTS
    16




---



##### 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
    CRITICAL ACCOUNTING POLICIES
    17




---



##### Table of Contents



ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(CONTINUED)
 OVERVIEW
     Net sales of $47.0 million for the three months ended June 30, 2008 represented an
increase of $3.5 million, or 8.0%, compared to net sales of $43.5 million for the three
months ended June 30, 2007. Sarian Systems, Ltd. (Sarian), which was acquired on April
28, 2008, provided $2.4 million of revenue from Sarian-branded products for the three months
ended June 30, 2008. Revenue in North America was $26.1 million in the third fiscal quarter
of 2008 compared to $27.9 million in the same period a year ago, a decrease of $1.8 million,
or 6.6%, primarily due to the slowing of the U.S. economy and a decrease in revenue from
certain key customers. International revenue was $20.9 million in the third fiscal quarter
of 2008 compared to $15.6 million in the third fiscal quarter of 2007, an increase of $5.3
million, or 34.1%, of which $2.4 million was from revenue from Sarian-branded products.
  Gross profit margin increased to 52.9% for the three months ended June 30, 2008 as
compared to 52.8% for the three months ended June 30, 2007. Gross profit margin increased
to 53.4% for the nine months ended June 30, 2008 as compared to 52.7% for the nine months
ended June 30, 2007. The increase in gross profit margin for both the three and nine months
ended June 30, 2008 was primarily due to reduced amortization of purchased and core
technology due to certain technologies becoming fully amortized and favorable product mix
changes within both the embedded and non-embedded product groups, offset by a decrease due
to Sarian-branded products which provide lower gross profit margins than our other product
lines.
  18




---



##### Table of Contents



ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(CONTINUED)
 OVERVIEW (CONTINUED)
  Total operating expenses for the three months ended June 30, 2008 were $21.9
million, or 46.5% of net sales, compared to $17.9 million, or 41.1% of net sales, for the
three months ended June 31, 2007, an increase of $4.0 million. Total operating expenses for
the nine months ended June 30, 2008 were $60.7 million, or 45.1% of net sales, compared to
$53.4 million, or 41.7% of net sales, for the nine months ended June 30, 2007, an increase
of $7.3 million. Operating expenses increased by 22.2% and 13.6% for the three months and
nine months ended June 30, 2008, respectively, compared to the same periods in 2007 due
mostly to a charge of $2.1 million for in-process research and development and other
acquisition-related expenses, as well as incremental ongoing operating expenses for Sarian
from the date of acquisition of $0.6 million both of which were incurred during the three
month period ended June 30, 2008. In addition, operating expenses increased as a result of
our Drop-In Networking initiative.
  Net income decreased $4.8 million to $2.0 million, or $0.08 per diluted share, for
the three months ended June 30, 2008, compared to $6.8 million, or $0.26 per diluted share,
for the three months ended June 30, 2007. Net income decreased $5.4 million to $8.8
million, or $0.33 per diluted share, for the nine months ended June 30, 2008, compared to
$14.2 million, or $0.55 per diluted share, for the nine months ended June 30, 2007.
  Our net working capital position (total current assets less total current
liabilities) decreased $7.8 million to $107.9 million during the nine months ended June 30,
2008 and our current ratio was 6.1 to 1 as of that date. Cash and cash equivalents and
short-term marketable securities decreased $15.9 million to $69.6 million during the nine
month period which includes payments of $27.8 million, net of cash acquired of $3.1 million,
for the acquisition of Sarian, offset by 4.5 million Euros ($6.9 million) received from the
building sale in Dortmund, Germany. At June 30, 2008, we had no debt other than capital
lease obligations.
  19




---



##### 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,
    
    
    % increase2008
    
    
    2007
    
    
    (decrease)
    
    
    2008
    
    
    2007
    
    
    (decrease)Net sales
    
    $
    46,995
    
    
    
    100.0
    %
    
    $
    43,527
    
    
    
    100.0
    %
    
    
    8.0
    %
    
    $
    134,639
    
    
    
    100.0
    %
    
    $
    128,193
    
    
    
    100.0
    %
    
    
    5.0
    %Cost of sales (exclusive of
amortization of purchased and core
technology shown separately below)
    
    
    21,200
    
    
    
    45.1
    
    
    
    19,392
    
    
    
    44.6
    
    
    
    9.3
    
    
    
    59,729
    
    
    
    44.4
    
    
    
    57,257
    
    
    
    44.7
    
    
    
    4.3Amortization of purchased and
core technology
    
    
    938
    
    
    
    2.0
    
    
    
    1,132
    
    
    
    2.6
    
    
    
    (17.1
    )
    
    
    2,981
    
    
    
    2.2
    
    
    
    3,409
    
    
    
    2.6
    
    
    
    (12.6
    )Gross profit
    
    
    24,857
    
    
    
    52.9
    
    
    
    23,003
    
    
    
    52.8
    
    
    
    8.1
    
    
    
    71,929
    
    
    
    53.4
    
    
    
    67,527
    
    
    
    52.7
    
    
    
    6.5Operating expenses:Sales and marketing
    
    
    9,493
    
    
    
    20.2
    
    
    
    8,517
    
    
    
    19.6
    
    
    
    11.5
    
    
    
    27,213
    
    
    
    20.2
    
    
    
    25,102
    
    
    
    19.6
    
    
    
    8.4Research and development
    
    
    6,995
    
    
    
    14.9
    
    
    
    6,039
    
    
    
    13.8
    
    
    
    15.8
    
    
    
    20,113
    
    
    
    15.0
    
    
    
    18,079
    
    
    
    14.1
    
    
    
    11.3General and administrative
    
    
    3,484
    
    
    
    7.4
    
    
    
    3,349
    
    
    
    7.7
    
    
    
    4.0
    
    
    
    11,466
    
    
    
    8.5
    
    
    
    10,229
    
    
    
    8.0
    
    
    
    12.1Acquired in-process research
and development
    
    
    1,900
    
    
    
    4.0
    
    
    
    
    
    
    
    0.0
    
    
    
    N/A
    
    
    
    1,900
    
    
    
    1.4
    
    
    
    
    
    
    
    0.0
    
    
    
    N/ATotal operating expenses
    
    
    21,872
    
    
    
    46.5
    
    
    
    17,905
    
    
    
    41.1
    
    
    
    22.2
    
    
    
    60,692
    
    
    
    45.1
    
    
    
    53,410
    
    
    
    41.7
    
    
    
    13.6Operating income
    
    
    2,985
    
    
    
    6.4
    
    
    
    5,098
    
    
    
    11.7
    
    
    
    (41.4
    )
    
    
    11,237
    
    
    
    8.3
    
    
    
    14,117
    
    
    
    11.0
    
    
    
    (20.4
    )Interest income and other, net
    
    
    712
    
    
    
    1.5
    
    
    
    855
    
    
    
    2.0
    
    
    
    (16.7
    )
    
    
    2,760
    
    
    
    2.1
    
    
    
    2,385
    
    
    
    1.9
    
    
    
    15.7Income before income taxes
    
    
    3,697
    
    
    
    7.9
    
    
    
    5,953
    
    
    
    13.7
    
    
    
    (37.9
    )
    
    
    13,997
    
    
    
    10.4
    
    
    
    16,502
    
    
    
    12.9
    
    
    
    (15.2
    )Income tax provision (benefit)
    
    
    1,712
    
    
    
    3.6
    
    
    
    (845
    )
    
    
    (1.9
    )
    
    
    (302.6
    )
    
    
    5,245
    
    
    
    3.9
    
    
    
    2,305
    
    
    
    1.8
    
    
    
    127.5Net income
    
    $
    1,985
    
    
    
    4.2
    %
    
    $
    6,798
    
    
    
    15.6
    %
    
    
    (70.8
    )%
    
    $
    8,752
    
    
    
    6.5
    %
    
    $
    14,197
    
    
    
    11.1
    %
    
    
    (38.4)
    %
   Three months ended June 30,
    
    
    % increase
    
    
    Nine months ended June 30,
    
    
    % increase($ in thousands)
    
    2008
    
    
    2007
    
    
    (decrease)
    
    
    2008
    
    
    2007
    
    
    (decrease)Non-embedded
    
    $
    26,325
    
    
    
    56.0
    %
    
    $
    24,750
    
    
    
    56.9
    %
    
    
    6.4
    %
    
    $
    71,540
    
    
    
    53.1
    %
    
    $
    74,361
    
    
    
    58.0
    %
    
    
    (3.8)
    %Embedded
    
    
    20,670
    
    
    
    44.0
    
    
    
    18,777
    
    
    
    43.1
    
    
    
    10.1
    
    
    
    63,099
    
    
    
    46.9
    
    
    
    53,832
    
    
    
    42.0
    
    
    
    17.2Total net sales
    
    $
    46,995
    
    
    
    100.0
    %
    
    $
    43,527
    
    
    
    100.0
    %
    
    
    8.0
    %
    
    $
    134,639
    
    
    
    100.0
    %
    
    $
    128,193
    
    
    
    100.0
    %
    
    
    5.0
    %
  20




---



##### Table of Contents



ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
     Three months ended June 30,
    
    
    $ increase
    
    
    % increase
    
    
    Nine months ended June 30,
    
    
    $ increase
    
    
    % increase($ in thousands)
    
    2008
    
    
    2007
    
    
    (decrease)
    
    
    (decrease)
    
    
    2008
    
    
    2007
    
    
    (decrease)
    
    
    (decrease)North America
    
    $
    26,131
    
    
    $
    27,968
    
    
    $
    (1,837
    )
    
    
    (6.6)
    %
    
    $
    78,214
    
    
    $
    83,541
    
    
    $
    (5,327
    )
    
    
    (6.4
    )%EMEA
    
    
    14,503
    
    
    
    10,657
    
    
    
    3,846
    
    
    
    36.1
    
    
    
    38,432
    
    
    
    30,555
    
    
    
    7,877
    
    
    
    25.8Asia Pacific
    
    
    5,075
    
    
    
    3,817
    
    
    
    1,258
    
    
    
    33.0
    
    
    
    14,225
    
    
    
    11,031
    
    
    
    3,194
    
    
    
    29.0Latin America
    
    
    1,286
    
    
    
    1,085
    
    
    
    201
    
    
    
    18.5
    
    
    
    3,768
    
    
    
    3,066
    
    
    
    702
    
    
    
    22.9Total net sales
    
    $
    46,995
    
    
    $
    43,527
    
    
    $
    3,468
    
    
    
    8.0
    %
    
    $
    134,639
    
    
    $
    128,193
    
    
    $
    6,446
    
    
    
    5.0
    %
      21




---



##### Table of Contents



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)
    
    2008
    
    
    2007
    
    
    (decrease)
    
    
    2008
    
    
    2007
    
    
    (decrease)Operating expenses:Sales and marketing
    
    $
    9,493
    
    
    
    20.2
    %
    
    $
    8,517
    
    
    
    19.6
    %
    
    $
    976
    
    
    $
    27,213
    
    
    
    20.2
    %
    
    $
    25,102
    
    
    
    19.6
    %
    
    $
    2,111Research and development
    
    
    6,995
    
    
    
    14.9
    
    
    
    6,039
    
    
    
    13.8
    
    
    
    956
    
    
    
    20,113
    
    
    
    15.0
    
    
    
    18,079
    
    
    
    14.1
    
    
    
    2,034General and administrative
    
    
    3,484
    
    
    
    7.4
    
    
    
    3,349
    
    
    
    7.7
    
    
    
    135
    
    
    
    11,466
    
    
    
    8.5
    
    
    
    10,229
    
    
    
    8.0
    
    
    
    1,237Acquired in-process
research and development
    
    
    1,900
    
    
    
    4.0
    
    
    
    
    
    
    
    0.0
    
    
    
    1,900
    
    
    
    1,900
    
    
    
    1.4
    
    
    
    
    
    
    
    0.0
    
    
    
    1,900Total operating expenses
    
    $
    21,872
    
    
    
    46.5
    %
    
    $
    17,905
    
    
    
    41.1
    %
    
    $
    3,967
    
    
    $
    60,692
    
    
    
    45.1
    %
    
    $
    53,410
    
    
    
    41.7
    %
    
    $
    7,282
      22




---



##### Table of Contents



ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
        Three months ended June 30,
    
    
    Nine months ended June 30,2008
    
    
    2007
    
    
    2008
    
    
    2007Effective tax rate before impact of discrete tax events &
non-deductible in-process research and development
    
    
    37.3
    %
    
    
    35.0
    %
    
    
    35.1
    %
    
    
    36.1
    %Impact of non-deductible in-process research and
development charge
    
    
    14.4
    %
    
    
    0.0
    %
    
    
    3.8
    %
    
    
    0.0
    %Impact of discrete tax events
    
    
    -5.4
    %
    
    
    -49.2
    %
    
    
    -1.4
    %
    
    
    -22.1
    %Effective tax rate
    
    
    46.3
    %
    
    
    -14.2
    %
    
    
    37.5
    %
    
    
    14.0
    %
   23




---



##### Table of Contents



ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
      Consolidated Statement of Cash Flow Highlights (in thousands)
 Nine months ended June 30,2008
    
    
    2007
    
    
    ChangeOperating activities
    
    $
    15,027
    
    
    $
    18,675
    
    
    $
    (3,648
    )Investing activities
    
    
    (16,776
    )
    
    
    (3,784
    )
    
    
    (12,992
    )Financing activities
    
    
    2,365
    
    
    
    3,415
    
    
    
    (1,050
    )Effect of exchange rate changes on cash
and cash equivalents
    
    
    (2,240
    )
    
    
    88
    
    
    
    (2,328
    )Net (decrease) increase in cash and cash equivalents
    
    $
    (1,624
    )
    
    $
    18,394
    
    
    $
    (20,018
    )
 Reconciliation of Net Income to Cash Inflows (Outflows) from Operating Activities (in thousands)
 Nine months ended June 30,2008
    
    
    2007
    
    
    ChangeNet income
    
    $
    8,752
    
    
    $
    14,197
    
    
    $
    (5,445
    )Deferred income taxes
    
    
    (2,696
    )
    
    
    (1,612
    )
    
    
    (1,084
    )Depreciation and amortization
    
    
    6,927
    
    
    
    7,647
    
    
    
    (720
    )Stock-based compensation
    
    
    2,702
    
    
    
    2,258
    
    
    
    444Excess tax benefits from stock-based compensation
    
    
    (177
    )
    
    
    (315
    )
    
    
    138Gain on sale of property, equipment and improvements
    
    
    (94
    )
    
    
    
    
    
    
    (94
    )Acquired in-process research and development
    
    
    1,900
    
    
    
    
    
    
    
    1,900Other reconciling items
    
    
    222
    
    
    
    18
    
    
    
    204Net income adjusted for non-cash expenses
    
    
    17,536
    
    
    
    22,193
    
    
    
    (4,657
    )Changes in working capital, excluding impact of
acquisition
    
    
    (2,509
    )
    
    
    (3,518
    )
    
    
    1,009Cash flows provided by operating activities
    
    $
    15,027
    
    
    $
    18,675
    
    
    $
    (3,648
    )
  24




---



##### Table of Contents



ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
        25




---



##### Table of Contents



ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
       26




---



##### Table of Contents



ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
    
 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
      27




---



##### Table of Contents



ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
       
 ITEM 4. CONTROLS AND PROCEDURES
     28




---



##### 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
   29




---



##### Table of Contents



PART II. OTHER INFORMATION
 
 ITEM 6. EXHIBITS
 Exhibit No.
    
    Description2
    (a)
    
    Share Purchase Agreement dated April 28, 2008 among Digi International Limited, a
subsidiary of Digi International Inc., and all of the shareholders of Sarian Systems
Limited (excluding schedules and exhibits which the Registrant agrees to furnish
supplementally to the Securities and Exchange Commission upon request) (1)3
    (a)
    
    Restated Certificate of Incorporation of the Company, as amended (2)3
    (b)
    
    Amended and Restated By-Laws of the Company4
    (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)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, 2008 (File No. 1-34033)(2)
    
    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)(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)  30




---



##### Table of Contents



DIGI INTERNATIONAL INC.Date:  August 7, 2008
    By:
    /s/ Subramanian KrishnanSubramanian KrishnanSenior Vice President, Chief Financial Officer

and Treasurer (Principal Financial and
Accounting Officer)  31




---



##### Table of Contents



Exhibit Number
    
    Document Description
    
    Form of Filing2
    (a)
    
    Share Purchase Agreement dated
April 28, 2008 among Digi International
Limited, a subsidiary of Digi International
Inc., and all of the shareholders of Sarian
Systems Limited (excluding schedules and
exhibits which the Registrant agrees to furnish
supplementally to the Securities and Exchange
Commission upon request)
    
    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
    
    Filed Electronically4
    (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 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
  32