10-K 1 dgii-fy2015930x10k.htm 10-K 10-K
 
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
þ
 
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended: September 30, 2015
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.
(Exact name of registrant as specified in its charter)
Delaware
 
41-1532464
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification Number)
11001 Bren Road East
 
 
Minnetonka, Minnesota
 
55343
(Address of principal executive offices)
 
(Zip Code)
(952) 912-3444
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
 
Name of each exchange on which registered
Common Stock, par value $.01 per share
 
The NASDAQ Global Select Market
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No þ
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No þ
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files.) Yes þ No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer o
 
Accelerated filer þ
 
Non-accelerated filer o
 
Smaller reporting company o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o No þ
The aggregate market value of voting stock held by non-affiliates of the Registrant as of the last business day of the Registrant's most recently competed second fiscal quarter was $246,475,812 based on a closing price of $9.98 per common share as reported on the NASDAQ Global Select Market. (For purposes of this calculation all of the registrant's directors and executive officers are deemed affiliates of the registrant.)
Shares of common stock outstanding as of November 23, 2015: 25,299,260
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's Proxy Statement for its 2016 Annual Meeting of Stockholders are incorporated by reference into Part III hereto.
 



INDEX
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 EX-21
 EX-23
 EX-24
 EX-31.A
 EX-31.B
 EX-32
 EX-101 INSTANCE DOCUMENT
 EX-101 SCHEMA DOCUMENT
 EX-101 CALCULATION LINKBASE DOCUMENT
 EX-101 DEFINITION LINKBASE DOCUMENT
 EX-101 LABELS LINKBASE DOCUMENT
 EX-101 PRESENTATION LINKBASE DOCUMENT


2


PART I.
FORWARD-LOOKING STATEMENTS
This Annual Report contains certain statements that are “forward-looking statements” as that term is defined under the Private Securities Litigation Reform Act of 1995, and within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended.
Words such as “assume,” “believe,” “anticipate,” “intend,” “estimate,” “target,” “may,” “will,” “expect,” “plan,” “project,” “should,” or “continue” or the negative thereof or other expressions, which are predictions of or indicate future events and trends and which do not relate to historical matters, identify forward-looking statements. Among other items, these statements relate to expectations of the business environment in which the company operates, projections of future performance, perceived marketplace opportunities and statements regarding our mission and vision. Such statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions, including risks related to the highly competitive market in which our company operates, rapid changes in technologies that may displace products sold by us, declining prices of networking products, our reliance on distributors and other third parties to sell our products, delays in product development efforts, uncertainty in user acceptance of our products, the ability to integrate our products and services with those of other parties in a commercially accepted manner, potential liabilities that can arise if any of our products have design or manufacturing defects, our ability to defend or settle satisfactorily any litigation, uncertainty in global economic conditions and economic conditions within particular regions of the world which could negatively affect product demand and the financial solvency of customers and suppliers, the impact of natural disasters and other events beyond our control that could negatively impact our supply chain and customers, potential unintended consequences associated with restructuring or other similar business initiatives that my impact our ability to retain important employees, the ability to achieve the anticipated benefits and synergies associated with acquisitions, and changes in our level of revenue or profitability which can fluctuate for many reasons beyond our control.
These and other risks, uncertainties and assumptions identified from time to time in our filings with the United States Securities and Exchange Commission, including without limitation, those described in Item 1A, Risk Factors, of this Form 10-K and subsequent quarterly reports of Form 10-Q and other filings, could cause our future results to differ materially from those expressed in any forward-looking statements made by us or on our behalf. Many of such factors are beyond our ability to control or predict. These forward-looking statements speak only as of the date for which they are made. We disclaim any intent or obligation to update any forward-looking statements, whether as a result of new information, future events or otherwise.
ITEM 1. BUSINESS
General Background and Product Offerings
Digi International Inc. (“Digi,” “we,” “our,” or “us”) was incorporated in 1985 as a Minnesota corporation. We were reorganized as a Delaware corporation in 1989 in conjunction with our initial public offering. Our common stock is traded on the NASDAQ Global Select Market under the symbol DGII. Our World Headquarters is located at 11001 Bren Road East, Minnetonka, Minnesota 55343. Our telephone number is (952) 912-3444.
We are a leading provider of Internet of Things (IoT) networking hardware products and solutions that enable the connection, monitoring and control of local or remote physical assets by electronic means. These networking products and solutions can connect communication hardware to a physical asset, convey information about the asset’s status and performance to a computer system and then use that information to improve or automate one or more processes. These products and solutions are deployed via both wired and, ever increasingly, wireless networks. Our solutions are deployed by a wide range of businesses and institutions. Any business that utilizes a significant number of devices, whose operation could benefit from remote monitoring or control, may realize benefits from IoT networking.
Our present portfolio primarily includes:
Wireless and wired hardware products that have been the historical foundation of our business;
Services and solutions that include the following offerings:
Digi Cold Chain Solutions is a wireless end-to-end solution that utilizes sensors, gateways and an easy-to-use software application that enables companies to monitor the temperature of perishable goods effectively and economically. Our Digi Cold Chain Solutions are the result of our acquisition of Bluenica Corporation on October 5, 2015 (see Note 18 to our Consolidated Financial Statements).

3


Digi Device Cloud and Digi Remote Manager - Digi Device Cloud (Device Cloud) is a platform as-a-service (PaaS) offering that provides a secure environment for customers to aggregate their interaction with a large number of disparate devices and connect enterprise applications to these devices. This allows for devices to be monitored and controlled remotely and allows customers collect, interpret and utilize data from many devices to operate their businesses more easily and efficiently. Digi Remote Manager™ is a complete, centralized remote device management solution that is housed on the Digi Device Cloud and allows customers to meet service level commitments and stay compliant with Payment Card Industry (PCI) standards. Digi Remote Manager™ also allows customers to monitor, diagnose and fix remote devices without sending a technician on site.
Wireless Design Services provide customers with turn-key wireless networking product design, testing, and certification for a wide range of wireless technology platforms and applications to improve speed to market and reduce risk.
Digi Enterprise Support Services provide technical help for customers with programming and implementation challenges related to Digi products. These services help ensure optimal performance. We also offer implementation services that support features like Digi Remote Manager™ web service programming, code debugging and review and provide API assistance for any Digi product or development kit.
On October 23, 2015, West Monroe Partners, LLC purchased our Etherios CRM consulting services business, which focused on integration and configuration of enterprise resource management (ERM) systems, including customer relationship management (CRM) systems. This part of our business principally provided integration and configuration of salesforce.com products. For more information on this divestiture see Note 18 to the Consolidated Financial Statements.
For more in-depth descriptions of our primary hardware products, please refer to the heading “Listing of Principal Hardware Products and Services” at the end of Part I, Item 1 of this Form 10-K.
Our hardware product revenue represented 91.8%, 89.7% and 88.6% of our total revenue in fiscal 2015, 2014 and 2013, respectively. Our service revenue represented 8.2%, 10.3% and 11.4% of our total revenue in fiscal 2015, 2014 and 2013, respectively.
Our corporate website address is www.digi.com. In the “Company - Investor Relations” section of our website, we make our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, our proxy statement and any amendments to these reports available free of charge as soon as reasonably practicable after these reports are filed with or furnished to the United States Securities and Exchange Commission (the “SEC”). Each of these documents can also be obtained free of charge (except for a reasonable charge for duplicating exhibits to our reports on Form 10-K, 10-Q or 8-K) in print by any stockholder who requests them from our investor relations personnel. The Investor Relations email address is ir@digi.com and its mailing address is: Investor Relations Administrator, Digi International Inc., 11001 Bren Road East, Minnetonka, Minnesota 55343. These reports can also be accessed via the SEC website, www.sec.gov, or via the SEC’s Public Reference Room located at 100 F Street, N.E., Washington, D.C. 20549. Information concerning the operation of the SEC’s Public Reference Room can be obtained by calling 1-800-SEC-0330.
Information on our website is not incorporated by reference into this report or any other report we file with or furnish to the SEC.
Industry and Marketplace Conditions
Long-Term Growth Prospects
For several years a wide range of sources have provided strong long-term growth projections for IoT hardware and software networking products and related services. We believe our company is well positioned to capitalize on this potential growth given our present market position as a leading provider of IoT networking products and our long-standing experience and expertise in developing and deploying these solutions.
We believe IoT networking is poised for strong long term growth in our view for these primary reasons:
The cost of deploying sensors and transmitting data used to capture and share information from equipment, machines and other devices is falling rapidly; and
Businesses and institutions desire to operate more efficiently and productively in a competitive global marketplace.
With tens of billions of electronic devices deployed around the world, we believe the capacity of organizations to conduct more efficient operations by gathering and analyzing data is immense. The willingness of organizations to deploy networking

4


products and applications to capture and analyze that data will depend on how efficiently these networking solutions can be deployed and maintained and the expected benefits to be derived in doing so. We believe a critical element in our ability to grow our business will be our ability to develop and market IoT networking solutions at price points that can provide customers with a demonstrable return on their investment operating in mission-critical applications.
Market Conditions
In fiscal 2015, the marketplace for IoT products and services generally expanded. Within our own business this expansion was most pronounced for cellular routers and gateways and RF products that are used by customers to connect equipment and machine data to networks using wireless technology. We expect this growth trend to continue in fiscal 2016, although it is susceptible to downturns in general economic conditions as well as uncertainty or changes in the regulatory environments. These impacts may be more pronounced in certain industries. For instance, in fiscal 2015 the oil and gas marketplace for IoT networking products and services was more challenging than in prior years because the price for these natural resources declined significantly.
Strategy
Long-Term Goal
Our primary long-term goal is to continue to be a leading global provider of IoT networking hardware and solutions that enables electronic devices to be provisioned, maintained, monitored, analyzed and managed remotely by businesses. In our present business, IoT networking includes the following components that can be provided together or separately:
custom designed or off-the-shelf hardware that enables the delivery of data from devices to networks;
software applications that allow customers to monitor and manage networked devices. For instance, our Digi Cold Chain solutions are deployed with applications that enable customers to monitor the performance of refrigeration units on any computer or smart-phone with an easy to configure and intuitive user interface;
our Device Cloud, which aggregates and hosts device data securely as well as related software applications such as our Digi Remote Device Manager; and
professional services such as those offered by our Wireless Design Services group that help customers define front-end requirements for their products and deploy IoT solutions.
Current Status of Our Business
Following the appointment of Ronald E. Konezny as our Chief Executive Officer (CEO) in December 2014, we have been focused on driving the scale and leverage of our businesses, simplifying our operations and improving our profitability. While this remains an ongoing effort, we have taken or expect to take a number of actions such as:
In the second quarter of fiscal 2015, we restructured our services business so the ongoing costs associated with our operations were more aligned to our ability to generate revenue.
In the second quarter of fiscal 2015, we closed our operations in India.
Throughout fiscal 2015, we continued an initiative we started in fiscal 2014 to globally expand our relationships with large distributors such as DigiKey. We believe this will strengthen our sales channel and enable us to more easily service our customers around the world.
In October 2015, we sold our Etherios CRM consulting business to West Monroe Partners, LLC. While we initially acquired Etherios in large part because we believed it would help drive engagements with companies looking to deploy IoT solutions within their businesses, we were not rewarded in the marketplace as we had hoped. In turn, we were operating a business that was not fully tied to our core expertise. The divestiture brings more focus to our core business and is expected to increase our profitability by lowering our operating expenses.
In the first quarter of fiscal 2016, we plan to consolidate office locations in the Minneapolis area, moving our Wireless Design Services team from an office in downtown Minneapolis to our World Headquarters in suburban Minnetonka.
We have placed greater emphasis on controlling operating expenses across all areas of our business.

5


During fiscal 2015, we started an initiative to reduce the number of product stock keeping units (SKUs) we produce, which we believe will have significant implications on our ability to manage inventory effectively, improve channel stocking strategies and control costs.
In addition to the above initiatives, we also have been examining ways to expand the scope and scale of our business to enhance our existing operations. In October 2015, we acquired Bluenica Corporation, a company that uses wireless sensors, gateways and a software application to enable companies to monitor the temperature of food and other perishable goods remotely. The acquisition leverages our existing strength as a provider of IoT hardware and related software while providing us with a recurring revenue stream. We intend to investigate other potential investments that we believe could compliment our existing business.
Acquisitions and Dispositions
On October 5, 2015, we acquired Bluenica Corporation, a company focused on temperature monitoring of perishable goods in the food industry by using wireless sensors which are installed in grocery and convenience stores, restaurants, and in products during shipment and storage to ensure that quality, freshness and public health requirements are met (see Note 18 to our Consolidated Financial Statements).  Bluenica forms the basis of the Digi Cold Chain solutions business.
On October 31, 2012, we acquired Etherios, Inc., a provider of consulting and professional services that uses a new cloud-based method for integrating machines into core business process via the salesforce.com service cloud (see Note 2 to our Consolidated Financial Statements). On October 23, 2015, we entered into a stock purchase agreement with West Monroe Partners, LLC, pursuant to which they acquired this business (see Note 18 to our Consolidated Financial Statements).
These are the only acquisitions and dispositions we have completed in the past five years. We will continue to evaluate strategic opportunities to acquire businesses as they arise.
Sales Channels
We sell our products through a global network of distributors, systems integrators and value added resellers (VARs). We also complete sales through our own dedicated sales organization to original equipment manufacturers (OEMs) and other customers.
Distributors
Our larger distributors, based on sales we make to them, include A-Unit Electronic Co., Ltd., Anewtech Systems Pte Ltd., Anixter International, Arrow Electronics, Inc., Atlantik Elektronik GmbH, Avnet, Digi-Key Corporation, Express Systems & Peripherals, Future Electronics, Ingram Micro, Melchoni S.p.A., Miel, Mouser Electronics, Novotech, Scansource Corporation, Solid State Supplies, Ltd., Synnex, Tech Data Corporation and Tokyo Electron Device Ltd.  We also maintain relationships with many other distributors in the U.S., Canada, Europe, Asia Pacific and Latin America.
Strategic Sales Relationships
We maintain alliances with other industry leaders to develop and market technology solutions. These include many major communications hardware and software vendors, operating system suppliers, computer hardware manufacturers, enterprise application providers and cellular carriers. Among others, partners include: AT&T, Bell Mobility, Ericsson, Freescale, Qualcomm, Rogers, Silicon Laboratories, Sprint, Telus, Verizon and several other cellular carriers worldwide. Furthermore, we maintain a worldwide network of authorized developers that extends our reach into certain other technology applications and geographical regions.
We have established relationships with equipment vendors in a range of industries such as energy, industrial, retail, transportation, medical, and government that allow the vendors to ship our products and services as component parts of their overall solutions. Our products are used by many of the world’s leading telecommunications companies and Internet service providers, including AT&T Inc., Sprint Nextel Corp. and Verizon Communications Inc.
No single customer comprised more than 10% of our consolidated revenue for any of the years ended September 30, 2015, 2014 or 2013.

6


Competition
We compete primarily in the communications technology industry, which is characterized by rapid technological advances and evolving industry standards. The market can be affected significantly by new product introductions and marketing activities of industry participants. In addition, we may compete with other companies to acquire new businesses or technologies and the competition to secure such assets may be intense. We compete for customers on the basis of existing and planned product features, service and software application capabilities, company reputation, brand recognition, technical support, alliance relationships, quality and reliability, product development capabilities, price and availability. While no competitor offers a comparable range of products and services, various companies do compete with us with respect to one or more of our products or solutions. We believe that as the marketplace for IoT connectivity products and solutions continues to grow and as we continue to expand our product and service offerings, it is likely we will encounter increased competition, some of whom may have access to significantly more financial and technical resources than we possess.
Manufacturing Operations
Our manufacturing operations are conducted through a combination of internal manufacturing and external subcontractors specializing in various parts of the manufacturing process.  We rely on third party foundries for our semiconductor devices that are Application Specific Integrated Circuits (ASICs) and we outsource printed circuit board production.  This approach allows us to reduce our fixed costs, maintain production flexibility and optimize our profits.
Our products are manufactured to our designs with standard and semi-custom components. Most of these components are available from multiple vendors. We have several single-sourced supplier relationships, either because alternative sources are not available or because the relationship is advantageous to us. If these suppliers are unable to provide a timely and reliable supply of components, we could experience manufacturing delays that could adversely affect our consolidated results of operations in a material way. For instance, in November 2014 a fire disrupted the operations at one of our contract manufacturers in Thailand. We utilized alternate suppliers, as well as expanded production at our own manufacturing facility to mitigate the impact of the supply chain disruption resulting from the fire.
Seasonality
In general, our business is not considered to be highly seasonal, although our first fiscal quarter revenue is often less than other quarters due to holidays and fewer shipping days.
Working Capital
We fund our business operations through a combination of cash and cash equivalents, marketable securities and cash generated from operations. We believe that our current financial resources, cash generated from operations, and our capacity for debt and/or equity financing will be sufficient to fund our business operations for the next twelve months and beyond.
Research & Development and Intellectual Property Rights
During fiscal years 2015, 2014 and 2013, our research and development expenditures were $32.0 million, $29.8 million and $30.3 million, respectively.
Due to rapidly changing technology in the communications technology industry, we believe a large part of our success depends upon the product and service development skills of our personnel as well as our ability to integrate any acquired technologies with organically developed technologies.
Our proprietary rights and technology are protected by a combination of copyrights, patents, trade secrets and trademarks.
We have established common law and registered trademark rights on a family of marks for a number of our products. Our products and services primarily are sold under the Digi, Rabbit® and Xbee® brands. We believe that the Digi and Rabbit® brands have established strong identities with our targeted customer base and our customers associate the Digi brand with “reliability” and the Rabbit® brand with “ease of integration.” We believe that our customers associate Xbee® with “ease of use.” Many of our customers choose us because they are building a very complex system solution and they want the highest level in product reliability and ease of integration and use. Our Etherios® brand was sold in connection with the sale of Etherios, Inc. in October 2015.
Our patents are applicable to specific technologies and are valid for varying periods of time based on the date of patent application or patent grant in the U.S. and the legal term of patents in the various foreign countries where patent protection is

7


obtained. We believe our intellectual property has significant value and is an important factor in the marketing of our company and products.
Backlog
Backlog as of September 30, 2015 and 2014 was $27.2 million and $26.2 million, respectively. The majority of the backlog at September 30, 2015 is expected to be shipped in fiscal 2016. Backlog as of any particular date is not necessarily indicative of our future sales trends.
Employees
We had 565 employees on September 30, 2015. We consider our relations with our employees to be good. Approximately 50 employees were included in the sale of Etherios, Inc. in October 2015 and consequently their employment with us was terminated.
Geographic Areas and Currency Risks
Our customers are located throughout North America, Europe, Middle East & Africa (EMEA), Asia Pacific and Latin America. We are exposed to foreign currency transaction risk associated with certain sales being denominated in Euros, British Pounds and Japanese Yen and foreign currency translation risk as the financial position and operating results of our foreign subsidiaries are translated into U.S. Dollars for consolidation. We manage our net asset or net liability position for U.S. dollar accounts in our foreign locations to reduce our foreign currency risk. We have not implemented a formal hedging strategy to reduce foreign currency risk.
During 2015, we had approximately $76.3 million of revenue related to foreign customers including export sales, of which $21.3 million was denominated in foreign currency, predominantly the Euro and British Pound. During 2014 and 2013, we had approximately $76.3 million and $78.8 million, respectively, of revenue to foreign customers including export sales, of which $23.3 million and $24.3 million, respectively, were denominated in foreign currency, predominantly the Euro and British Pound. In future periods, we expect a significant portion of sales will continue to be made in Euros and British Pounds.
Financial information about geographic areas appears in Note 4 to our Consolidated Financial Statements in this Form 10-K.
PRINCIPAL HARDWARE PRODUCTS AND SERVICES
Hardware Products
Cellular routers and gateways - Cellular routers provide connectivity for devices over a cellular data network. They can be used as a cost effective alternative to landlines for primary or backup connectivity for remote locations and devices. These products have been certified by the major wireless providers in North America and abroad, including AT&T®, Verizon Wireless®, Sprint®, Bell Mobility and Rogers. Cellular gateway products enable devices or groups of devices to be networked in locations where there is no existing network or where access to a network is prohibited. All of our cellular products include a unique remote management platform that provides secure management of devices across remote networks and can all use the Device Cloud for remote management. In addition, application connectivity, management and customization are enabled via the Device Cloud platform for many of these products.
Radio Frequency (RF) - Our RF products are small box or module products that utilize a variety of wireless protocols for PC-to-device or device-to-device connectivity, often in locations where deploying a wired network is not possible either because of cost, disruption or impracticality. By supporting ZigBee®, Wi-Fi® and other radio frequency "RF" technologies, we can meet most customer application requirements. In conjunction with one of our gateways, RF products can be connected into the Device Cloud for remote management, application connectivity and customization.
Embedded - Our Connect, Rabbit®, and ARM-based embedded systems on module, and single board computers are designed and developed with small footprints, low power consumption and software, making them ideal for medical, transportation and industrial device manufacturers. A number of these modules can be connected directly to the Device Cloud, enabling remote management and remote application connectivity. Also included in our embedded grouping are our chips (or microprocessors) that provides the “brains” and processing power of an intelligent electronic device or communication sub-system. Some of our higher volume customers choose to purchase chips and build their own products. Chips are low cost but require the highest level of development expertise. We do not develop chips and use Commercial-Off-the-Shelf (COTS) technology from companies such as Freescale and Ember for our products.

8


Network - Our network product category consists of:
Console servers - Our console servers provide a secure remote graphical access to computer systems and network equipment that can communicate with virtually any server or device.
USB - Our Universal Serial Bus (USB) solutions include USB-to-serial converters that offer instant I/O expansion for peripheral device connectivity. We also offer USB over IP products that connect USB and serial devices on a wired or wireless LAN, while eliminating the need to locally-attached host PCs. In addition, we also offer multiport USB hubs which offer a simple solution for adding switched USB ports to a PC, server or thin client.
Serial servers - Our serial servers (also known as device servers and terminal servers) provide secure, reliable and flexible serial-to-Ethernet integration of most devices into wired Ethernet networks. They are used for a variety of applications such as automation, robotics control, centralized device monitoring and management, data acquisition and point-of-sale applications.
Services
Digi Cold Chain Solutions - Our Digi Cold Chain Solutions is an end-to-end, cost-effective system that uses sensors, gateways and a cloud based application to enable customers such as restaurants, groceries and convenience stores to monitor wirelessly the temperature of food and other perishable goods. Our Digi Cold Chain Solutions was introduced as a result of our acquisition of Bluenica Corporation on October 5, 2015 (see Note 18 to our Consolidated Financial Statements).
Digi Device Cloud and Digi Remote Manager™ - Our Digi Device Cloud is a platform as-a-service (PaaS) offering that provides a secure environment for customers to aggregate their interaction with a large number of disparate devices and connect them to enterprise applications. This allows for devices to be monitored and controlled remotely and allows customers to collect, interpret and utilize data from many devices to operate their businesses more easily and efficiently. The Digi Remote Manager™ is a complete centralized remote device management solution that is housed on the Digi Device Cloud and allows customers to meet service level commitments and stay compliant with Payment Card Industry (PCI) standards. Digi Remote Manager™ also allows customers to monitor, diagnose and fix remote devices without sending a technician on site.
Wireless Design Services - Our Wireless Design Services provide customers turn-key wireless networking product designs, testing, and certification for a wide range of wireless technology platforms and applications.
Digi Enterprise Support Services - Our Enterprise Support Services provide technical help for customers with programming and implementation challenges related to Digi products. These services help minimize design risk and ensure optimal performance. We also offer implementation services that cover support for features like Digi Remote Manager™ web service programming, code debugging and review and application program interface (API) assistance for any Digi product or development kit.
Etherios CRM Services - Our Etherios team provided professional consulting services that are focused on integration and configuration of enterprise resource management (ERM) systems including customer relationship management (CRM) systems. Our Etherios team had capabilities that span operational strategy, technical design and architecture, system integration, implementation, program management, and change management services principally on salesforce.com projects. On October 23, 2015, we sold our Etherios business, which included Etherios CRM Services (see Note 18 to the Consolidated Financial Statements).
ITEM 1A. RISK FACTORS
Multiple risk factors exist which could have a material effect on our operations, results of operations, profitability, financial position, liquidity, capital resources and common stock.
Risks Relating to Our Business
Our dependence on new product development and the rapid technological change that characterizes our industry makes us susceptible to loss of market share resulting from competitors’ product introductions and enhancements, service capabilities and similar risks.
Our industry is characterized by rapidly changing technologies, evolving industry standards, frequent new product introductions, short product life cycles in certain instances and rapidly changing customer requirements. The introduction of products and enhancements embodying new technologies and the emergence of new industry standards can render existing products obsolete and unmarketable.

9


Our future success will depend on our ability to enhance our existing products, to introduce new products to meet changing customer requirements and emerging technologies, and to demonstrate the performance advantages and cost-effectiveness of our products over competing products. Failure by us to modify our products to support new alternative technologies or failure to achieve widespread customer acceptance of such modified products could cause us to lose market share and cause our revenue to decline. Further, if competitors offer better service capabilities associated with the implementation and use of products in communication networks, our business could be impacted negatively.
We may experience delays in developing and marketing product enhancements or new products that respond to technological change, evolving industry standards and changing customer requirements. There can be no assurance that we will not experience difficulties that could delay or prevent the successful development, introduction, and marketing of these products or product enhancements, or that our new products and product enhancements will meet the requirements of the marketplace adequately and achieve any significant or sustainable degree of market acceptance in existing or additional markets. In addition, the future introductions or announcements of products by us or one of our competitors embodying new technologies or changes in industry standards or customer requirements could render our then-existing products obsolete or unmarketable. This risk may become more pronounced as new competitors enter the marketplace, especially if these competitors have more resources than us to develop and market new products and technologies and provide related services. There can be no assurance that the introduction or announcement of new product offerings by us or one or more of our competitors will not cause customers to defer their purchase of our existing products, which could cause our revenue to decline.
Our participation in a services and solutions model, using cloud-based services, presents execution and competitive risks.
We are deploying a services and solutions model using our own internally developed hosted services and cloud-based platform, software applications, and supporting products and services. We are employing significant human and financial resources to develop and deploy this cloud-based platform and related software applications and services. As we are working to grow and scale this part of our business, these investments have impacted our gross margins and profitability adversely in the past and may continue to do so in the future. While we believe our wireless, device networking and connectivity expertise, investments in infrastructure, and our innovative environment provide us with a strong foundation to compete, it is uncertain whether our strategies will attract the users or generate the revenue required to be successful. We expect to encounter competition from other solutions providers, many of whom may have more significant resources than us with which to compete. Whether we are successful in this business model depends on a number of factors, including:
our ability to put in place the infrastructure to deploy and evolve our solutions effectively and continuously ;
the features and functionality of our platform relative to any competing platforms as well as our ability to market our platform effectively;
our ability to engage in successful strategic relationships with third parties such as telecommunications carriers, chip makers and systems integrators;
competing effectively for market share; and
deploying complete end-to-end solutions that meet the needs of the marketplace generally as well as the particular requirements of our customers more effectively and efficiently than competitive solutions.
We intend to continue to devote significant resources to our research and development, which, if not successful, could cause a decline in our revenue and harm our business.
We intend to continue to devote significant resources to research and development in the coming years to enhance and develop additional products. For the fiscal years ended 2015, 2014 and 2013, our research and development expenses comprised 15.1%, 15.5% and 15.5%, respectively, of our revenue. If we are unable to develop new products, applications and services as a result of our research and development efforts, or if the products, applications and services we develop are not successful, our business could be harmed. Even if we develop new products, applications and services that are accepted by our target markets, the net revenue from these products, applications and services may not be sufficient to justify our investment in research and development.
Many of our products, applications and services have been developed through a combination of internally developed technologies and acquired technologies. Our ability to continue to develop new products, applications and services partially is dependent on finding and acquiring new technologies in the marketplace. Even if we identify new technologies that we believe would be complementary to our internally developed technologies, we may not be successful in obtaining those technologies or we may not be able to acquire the technologies at a price that is acceptable to us.

10


A substantial portion of our development efforts have been directed toward the development of new products targeted to manufacturers of intelligent, network-enabled devices and other embedded systems in various markets, including markets in which networking solutions for embedded systems have not historically been sold, such as markets for industrial automation equipment and medical equipment.
Our gross margins may be subject to decline.
Our gross margins may be subject to decline which could decrease our overall profitability and impact our financial performance adversely.  Many of the hardware products we sell are approaching the end of their product life cycle.  These mature hardware products typically sell at higher gross margins than our other product and service offerings.  In fiscal 2015, sales of mature hardware products represented about 37.2% of our overall revenue.  For several years revenues from the sale of these mature hardware products have been declining at a rate of between 1% and 10%, a trend we expect to continue.  In addition, ongoing cost pressures in our industry create downward pressure on the prices at which we and other manufacturers can sell hardware products.  We also have indicated that we would be willing to realize lower levels of gross margins from customers in return for long-term, binding purchase commitments, a strategy that, if successful, could also put downward pressure on our gross margins. While part of our longer term strategy is to sell software applications and IoT solutions such as Digi Cold Chain which can provide recurring revenues at relatively high gross margin, these types of offerings are at early stages of adoption by customers and their sales growth is not necessarily predictable or assured.  As such, our gross margins may be subject to decline unless we can implement cost reduction initiatives effectively to offset the impact of these factors.
Certain of our products are sold into mature markets, which could limit our ability to continue to generate revenue from these products.
Many of our hardware products are sold into mature markets that are characterized by a trend of declining demand.  As the overall market for these mature hardware products decreases due to the adoption of new technologies, we expect that our revenue from these products will continue to decline.  As a result, our future prospects depend in part on our ability to acquire or develop and successfully market additional products that address growth markets.
Our failure to anticipate or manage product transitions effectively could have a material adverse effect on our revenue and profitability.
From time to time, we or our competitors may announce new products, capabilities, or technologies that may replace or shorten the life cycles of our existing products. Announcements of currently planned or other new products may cause customers to defer or stop purchasing our products until new products become available. Furthermore, the introduction of new or enhanced products requires us to manage the transition from older product inventories and ensure that adequate supplies of new products can be delivered to meet customer demand. Our failure to anticipate the revenue declines associated with older products or manage transitions from older products effectively could result in inventory obsolescence and also have a material adverse effect on our revenue and profitability.
Our failure to compete successfully in our highly competitive market could result in reduced prices and loss of market share.
The market in which we operate is characterized by rapid technological advances and evolving industry standards. The market can be affected significantly by new product introductions and marketing activities of industry participants. Certain of our competitors and potential competitors may have greater financial, technological, manufacturing, marketing, and personnel resources than us. In addition, the amount of competition we face in the marketplace may change and grow as the market for our industry grows and new entrants enter the marketplace. Present and future competitors may be able to identify new markets and develop products more quickly, which are superior to those developed by us. They may also adapt new technologies faster, devote greater resources to research and development, promote products more aggressively, and price products more competitively than us. Competition may also intensify or we may no longer be able to compete effectively in the markets in which we compete.
Our ability to sustain and grow our business depends in large part on the success of our channel partner distributors and resellers.
A substantial part of our revenue is generated through sales by channel partner distributors and resellers. Sales through our channel partners accounted for 59.1%, 59.9% and 59.1% of our total revenue in fiscal 2015, 2014 and 2013 respectively. Further, in recent years we have been taking steps to expand our relationship with certain distributors who have global reach, an effort that could potentially increase the percent of our revenue driven through channel partners or our reliance on certain channel partners to drive sales. To the extent our channel partners are unsuccessful in selling our products or if we are unable to obtain and retain a sufficient number of high-quality channel partners, our operating results could be materially and

11


adversely affected. In addition, our channel partners may also market, sell and support products and services that are competitive with ours, and may devote more resources to the marketing, sales and support of such products. They also may have incentives to promote our competitors’ products in lieu of our products, particularly for our competitors with larger volumes of orders, more diverse product offerings and a longer relationship with our distributors and resellers. In these cases, one or more of our important channel partners may stop selling our products completely. Our channel partner sales structure also could subject us to lawsuits, potential liability and reputational harm if, for example, any of our channel partners misrepresents the functionality of our products or services to customers, or violates laws or our corporate policies. If we fail to manage our existing or future sales channel partners effectively, our business and operating results could be materially and adversely affected.
Our ability to grow our business is dependent in part on strategic relationships we develop and maintain with third parties as well as our ability to integrate and assure use of our products and services in coordination with the products and services of certain strategic partners in a commercially acceptable manner.
We believe that our ability to increase our sales depends in part on maintaining and strengthening relationships with parties such as telecommunications carriers, systems integrators, enterprise application providers and other strategic technology companies. Once a relationship is established, we likely will dedicate significant time and resources to it in an effort to advance our business interests and there is no assurance any strategic relationship will generate enough revenue to offset the significant resources we use to advance the relationship. Parties with whom we establish strategic relationships may also work with companies that compete with us. We also have limited, if any, control as to whether these parties devote adequate resources to promoting, selling, and implementing our products. Further, new or emerging technologies, technological trends or changes in customer requirements may result in certain companies with whom we maintain strategic relationships de-emphasizing their dealings with us or becoming potential competitors in the future. We also have limited, if any, control as to other business activities of these parties and we could experience reputational harm because of our association with such parties if they fail to execute on business initiatives, are accused of breaking the law or otherwise suffer reputational harm for other reasons. All of these factors could materially and adversely impact our business and results of operations.
In some cases we expect the establishment of a strategic relationship with a third party to result in integrations of our products or services with those of other parties. Identifying appropriate parties for these relationships as well as negotiating and documenting business agreements with them requires significant time and resources. We expect these agreements typically to be non-exclusive and not to prohibit the other party from working with our competitors or offering competing services. Once the relationship is established we may also encounter difficulties in combining our products and services in a commercially acceptable manner. We expect this type of dynamic where our ability to realize sales opportunities is dependent on how our products and services interact with those sold by third parties may become more common as the marketplace in our industry evolves. There can be no guaranty in any particular instance that we will be successful in making our products interact with those of other parties in a commercially acceptable manner and, even if we do, we cannot guaranty the resulting products and services will be marketed or sold effectively via the relationship.
We are subject to various cybersecurity risks, which are particularly acute in the cloud-based technologies operated by us and other third parties that form a part of our solutions. These risks may increase our costs and could damage our brand and reputation.
As we continue to direct a substantial portion of our sales and development efforts toward broader based solutions, such as the Device Cloud and Digi Cold Chain solutions, we expect to store, convey and potentially process increasing amounts of data produced by devices. This data may include confidential or proprietary information, intellectual property or personally identifiable information of our customers or other third parties with whom they do business.  It is important for us to maintain solutions and related infrastructure that are perceived by our customers and other parties with whom we do business to provide a reasonable level of reliability and security.  Despite available security measures and other precautions, the infrastructure and transmission methods used by our products and services may be vulnerable to interception, attack or other disruptive problems.  Continued high-profile data breaches at other companies evidence an external environment that is becoming increasingly hostile to information security.  Improper disclosure of data or perception that our data security is insufficient could harm our reputation, give rise to legal proceedings, or subject our company to liability under laws that protect data, any of which could result in increased costs and loss of revenue.
If a cyberattack or other security incident were to allow unauthorized access to or modification of our customers’ data or our own data, whether due to a failure with our systems or related systems operated by third parties, we could suffer damage to our brand and reputation. The costs we would incur to address and fix these incidents could significantly increase our expenses. These types of security incidents could also lead to lawsuits, regulatory investigations and increased legal liability, including in some cases contractual costs related to customer notification and fraud monitoring. Further, as regulatory focus on privacy and

12


data security issues continues to increase and worldwide laws and regulations concerning the protection of information become more complex, the potential risks and costs of compliance to our business will intensify.
Acquisitions could disrupt our business and seriously harm our financial condition.
We will continue to consider acquisitions of complementary businesses, products or technologies. In the event of any future acquisitions, we could issue stock that would dilute our current stockholders’ percentage ownership, incur debt, assume liabilities, or incur large and immediate write-offs.
Our operation of any acquired business also involves numerous risks, including but not limited to:
problems combining the purchased operations, technologies, or products;
unanticipated costs;
diversion of management’s attention from our core business;
difficulties integrating businesses in different countries and cultures;
adverse effects on existing business relationships with suppliers and customers;
risks associated with entering markets in which we have no or limited prior experience; and
potential loss of key employees, particularly those of the purchased organization.
We cannot assure that we will be able to successfully integrate any businesses, products, technologies, or personnel that we have acquired or that we might acquire in the future and any failure to do so could disrupt our business and have a material adverse effect on our consolidated financial condition and results of operations. Moreover, from time to time, we may enter into negotiations for a proposed acquisition, but be unable or unwilling to consummate the acquisition under consideration. This could cause significant diversion of management’s attention and out-of-pocket expenses for us. We could also be exposed to litigation as a result of any consummated or unconsummated acquisition.
If we fail to establish and maintain effective internal control over financial reporting, our ability to accurately report our financial results could be adversely affected.
If any material weakness in our internal control over financial reporting is discovered or occurs in the future, our consolidated financial statements may contain material misstatements and we could be required to restate our financial results. Further, regardless of how well designed, operated and evaluated it may be, any system of internal control over financial reporting can provide only reasonable, not absolute, assurance that its objective will be satisfied. We cannot be certain that, in the future, material weaknesses will not exist or otherwise be discovered. If we fail to maintain effective internal control over financial reporting, the accuracy and timing of our financial reporting may be adversely affected by misstatements or restatements of our consolidated financial statements, our business and financial condition could be harmed. Further, we experienced a material weakness in internal control in fiscal 2014. While this material weakness has been remediated, investors may lose confidence in our reported financial information and the market price of our common shares may decline if we experience any further material weaknesses.
Our consolidated operating results and financial condition may be adversely impacted by worldwide economic conditions and credit tightening.
If worldwide economic conditions experience a significant downturn, these conditions may make it difficult or impossible for our customers and suppliers to accurately forecast and plan future business activities, which may cause them to slow or suspend spending on products and services. Our customers may find it difficult to gain sufficient credit in a timely manner, which could result in an impairment of their ability to place orders with us or to make timely payments to us for previous purchases. If this occurs, our revenue may be reduced, thereby having a negative impact on our results of operations. In addition, we may be forced to increase our allowance for doubtful accounts and our days sales outstanding may increase, which would have a negative impact on our cash position, liquidity and financial condition. We cannot predict either the timing or duration of an economic downturn in the economy, should one occur.

13


Our revenue may be subject to fluctuations based on the level of significant one time purchases.
No single customer has represented more than 10% of our revenue in any of the last three fiscal years. However, many of our customers make significant one-time hardware purchases for large projects that are not repeated. As a result, our revenue may be subject to significant fluctuations based on whether we are able to close significant sales opportunities. Our failure to complete one or a series of significant sales opportunities in a particular fiscal period could have a material adverse effect on our revenue for that period.
The long and variable sales cycle for certain of our products makes it more difficult for us to predict our operating results and manage our business.
The sale of our products and services can involve a significant technical evaluation and commitment of capital and other resources by potential customers and end users, as well as delays frequently associated with end users’ internal procedures to deploy new technologies within their products and to test and accept new technologies. For these and other reasons, the sales cycle associated with certain of our products is typically lengthy and is subject to a number of significant risks, such as end users’ internal purchasing reviews, that are beyond our control. Because of the lengthy sales cycle and the large size of certain customer orders, if orders forecasted for a specific customer are not realized or delayed, our operating results could be materially adversely affected.
We depend on manufacturing relationships and on limited-source suppliers, and any disruptions in these relationships may cause damage to our customer relationships.
We procure all parts and certain services involved in the production of our products and subcontract most of our product manufacturing to outside firms that specialize in such services. Although most of the components of our products are available from multiple vendors, we have several single-source supplier relationships, either because alternative sources are not available or because the relationship is advantageous to us. There can be no assurance that our suppliers will be able to meet our future requirements for products and components in a timely fashion. In addition, the availability of many of these components to us is dependent in part on our ability to provide our suppliers with accurate forecasts of our future requirements. Delays or lost revenue could be caused by other factors beyond our control, including late deliveries by vendors of components, or force majeure events. For instance, a fire in November 2014 disrupted the operations at one of our contract manufacturers in Thailand. If we are required to identify alternative suppliers for any of our required components, qualification and pre-production periods could be lengthy and may cause an increase in component costs and delays in providing products to customers. Any extended interruption in the supply of any of the key components currently obtained from limited sources could disrupt our operations and have a material adverse effect on our customer relationships and profitability.
Our inability to obtain the appropriate telecommunications carrier certifications or approvals from governmental regulatory bodies could impede our ability to grow revenue in our wireless products.
The sale of our wireless products in certain geographical markets is sometimes dependent on the ability to gain telecommunications carrier certifications and/or approvals by certain governmental bodies.  Failure to obtain these approvals, or delays in receiving the approvals, could impact our ability to enter our targeted markets or to compete effectively or at all in these markets and could have an adverse impact on our revenue.
We are dependent on wireless communication networks owned and controlled by others.
Our revenue could decline if we are unable to deliver continued access to digital cellular wireless carriers that we depend on to provide sufficient network capacity, reliability and security to our customers. Our financial condition could be impacted if our wireless carriers were to increase the prices of their services, or to suffer operational or technical failures.
The impact of natural disasters could negatively impact our supply chain and customers resulting in an adverse impact to our revenue and profitability.
Certain of our components and other materials used in producing our products are from regions susceptible to natural disasters. If we are unable to procure necessary materials, we could experience a disruption to our supply chain that would hinder our ability to produce our products in a timely manner, or cause us to seek other sources of supply, which may be more costly or which we may not be able to procure on a timely basis. We also risk damage to any tooling, equipment or inventory at the supplier’s facilities. For instance, flooding in October 2011 and a fire in November 2014 disrupted the operations at one of our contract manufacturers in Thailand. In addition, our customers may not follow their normal purchasing patterns or temporarily cease purchasing from us due to impacts to their businesses in the region, creating unexpected fluctuations or decreases in our

14


revenue and profitability. Natural disasters in other parts of the world on which our operations are reliant also could have material adverse impacts on our business.
Our use of suppliers in other parts of the world involves risks that could negatively impact us.
We purchase a number of components from suppliers in other parts of the world. Product delivery times may be extended due to the distances involved, requiring more lead time in ordering. In addition, ocean freight delays may occur as a result of labor problems, weather delays or expediting and customs issues. Any extended delay in receipt of the component parts could eliminate anticipated cost savings and have a material adverse effect on our customer relationships and profitability.
Our ability to compete could be jeopardized if we are unable to protect our intellectual property rights.
Our ability to compete depends in part on our proprietary rights and technology. Our proprietary rights and technology are protected by a combination of copyrights, patents, trade secrets and trademarks.
We enter into confidentiality agreements with our employees, and sometimes with our customers, potential customers and other third parties, and limit access to the distribution of our proprietary information. There can be no assurance that the steps taken by us in this regard will be adequate to prevent the misappropriation of our technology. Our pending patent applications may be denied and any patents, once issued, may be circumvented by our competitors. Furthermore, there can be no assurance that others will not develop technologies that are superior to our technologies. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy aspects of our products or to obtain and use information that we regard as proprietary. In addition, the laws of some foreign countries do not protect our proprietary rights as fully as do the laws of the United States. There can be no assurance that our means of protecting our proprietary rights in the United States or abroad will be adequate or that competing companies will not independently develop similar technologies. Our failure to adequately protect our proprietary rights could have a material adverse effect on our competitive position and result in loss of revenue.
From time to time, we are subject to claims and litigation regarding intellectual property rights or other claims, which could seriously harm us and require us to incur significant costs.
The communications technology industry is characterized by frequent litigation regarding patent and other intellectual property rights. From time to time, we receive notification of a third-party claim that our products infringe other intellectual property rights. Any litigation to determine the validity of third-party infringement claims, whether or not determined in our favor or settled by us, may be costly and divert the efforts and attention of our management and technical personnel from productive tasks, which could have a material adverse effect on our ability to operate our business and service the needs of our customers. There can be no assurance that any infringement claims by third parties, regardless if they have merit, will not materially adversely affect our business, operating results or financial condition. In the event of an adverse ruling in any such matter, we may be required to pay substantial damages, cease the manufacture, use and sale of infringing products, discontinue the use of certain processes or be required to obtain a license under the intellectual property rights of the third party claiming infringement. There can be no assurance that a license would be available on reasonable terms or at all. Any limitations on our ability to market our products, or delays and costs associated with redesigning our products or payments of license fees to third parties, or any failure by us to develop or license a substitute technology on commercially reasonable terms could have a material adverse effect on our business, operating results and financial condition.
We face risks associated with our international operations and expansion that could impair our ability to grow our revenue abroad as well as our overall financial condition.
We believe that our future growth is dependent in part upon our ability to increase sales in international markets. These sales are subject to a variety of risks, including fluctuations in currency exchange rates, tariffs, import restrictions and other trade barriers, unexpected changes in regulatory requirements, longer accounts receivable payment cycles, potentially adverse tax consequences, and export license requirements. In addition, we are subject to the risks inherent in conducting business internationally, including political and economic instability and unexpected changes in diplomatic and trade relationships. In many markets where we operate business and cultural norms are different than those in the United States and practices that may violate laws and regulations applicable to us like the Foreign Corrupt Practices Act (FCPA) and the UK Anti-Bribery Act (UKBA) are more commonplace. Although we have implemented policies and procedures with the intention of ensuring compliance with these laws and regulations, our employees, contractors and agents, as well as channel partners involved in our international sales, may take actions in violation of our policies. Many of our vendors and strategic business allies also have international operations and are subject to the risks described above. Even if we are able to successfully manage the risks of international operations, our business may be adversely affected if one or more of our business partners are not able to successfully manage these risks. There can be no assurance that one or more of these factors will not have a material adverse effect on our business strategy and financial condition.

15


Our failure to comply effectively with regulatory laws pertaining to our foreign operations could have a material adverse effect on our revenue and profitability.
We are required to comply with U.S. government export regulations in the sale of our products to foreign customers, including requirements to properly classify and screen our products against a denied parties list prior to shipment. We are also required to comply with the provisions of the FCPA and all other anti-corruption laws, such as UKBA, of all other countries in which we do business, directly or indirectly, including compliance with the anti-bribery prohibitions and the accounting and recordkeeping requirements of this law. Violations of the FCPA or other similar laws could trigger sanctions, including ineligibility for U.S. government insurance and financing, as well as large fines. Failure to comply with the aforementioned regulations could also deter us from selling our products in international jurisdictions, which could have a material adverse effect on our revenue and profitability.
Foreign currency exchange rates may adversely affect our operating results.
We are exposed to a variety of market risks, including the effects of changes in foreign currency exchange rates on transactions that are denominated in foreign currencies. Because our financial statements are denominated in U.S. Dollars and approximately 10% of our revenue is denominated in a currency other than U.S. Dollars, such as Euros, British Pounds and Yen, our revenues and earnings may be adversely impacted if the U.S. dollar strengthens significantly against these foreign currencies.
The loss of key personnel could prevent us from executing our business strategy.
Our business and prospects depend to a significant degree upon the continuing contributions of our executive officers and key technical and other personnel. Competition for such personnel is intense, and there can be no assurance that we will be successful in attracting and retaining qualified personnel. Failure to attract and retain key personnel could result in our failure to execute our business strategy.
Our failure to comply effectively with the requirements of applicable environmental legislation and regulation could have a material adverse effect on our revenue and profitability.
Production and marketing of products in certain states and countries may subject us to environmental and other regulations. In addition, certain states and countries may pass new regulations requiring our products to meet certain requirements to use environmentally friendly components. The European Union has issued two directives relating to chemical substances in electronic products. The Waste Electrical and Electronic Equipment Directive (WEEE) makes producers of certain electrical and electronic equipment financially responsible for collection, reuse, recycling, treatment and disposal of equipment placed in the European Union market. The Restrictions of Hazardous Substances Directive (RoHS) bans the use of certain hazardous materials in electric and electrical equipment which are put on the market in the European Union. In the future, China and other countries including the United States are expected to adopt further environmental compliance programs. If we fail to comply with these regulations, we may not be able to sell our products in jurisdictions where these regulations apply, which could have a material adverse effect on our revenue and profitability.
Negative conditions in the global credit markets may impair a portion of our investment portfolio.
Our investment portfolio consists of certificates of deposit, commercial paper, money market funds, corporate bonds and government municipal bonds. These marketable securities are classified as available-for-sale and are carried at fair market value. Some of our investments could experience reduced liquidity and could result in an impairment charge should the impairment be considered as other-than-temporary. This loss would be recorded in our consolidated statement of operations, which could materially adversely impact our consolidated results of operations and financial condition.
Unanticipated changes in our tax rates could affect our future results.
Our future effective tax rates could be favorably or unfavorably affected by unanticipated changes in the mix of earnings in countries with differing statutory tax rates, changes in the valuation of our deferred tax assets and liabilities, or by changes in tax laws or our interpretation of such laws. In addition, we may be subject to the examination of our income tax returns by the Internal Revenue Service and other U.S. and international tax authorities. We regularly assess the potential outcomes resulting from these examinations to determine the adequacy of our provision for income taxes. There can be no assurance that the outcomes from these examinations will not have an effect on our consolidated operating results and financial condition.

16


We may have additional tax liabilities.
We are subject to income taxes in the United States and many foreign jurisdictions.  Significant judgment is required in determining our worldwide provision for income taxes, including our reserves for uncertain tax positions.  In the ordinary course of business, there are many transactions and calculations where the ultimate tax determination is uncertain.  We regularly are under audit by tax authorities.  Although we believe our tax estimates are reasonable, the final determination of tax audits could be materially different from our historical income tax provisions and accruals.  The results of an audit could have a material effect on our consolidated financial position, results of operations, or cash flows in the period or periods for which that determination is made.
Risks Related to Our Common Stock
The price of our common stock has been volatile and could continue to fluctuate in the future.
The market price of our common stock, like that of many other high-technology companies, has fluctuated significantly and is likely to continue to fluctuate in the future. During fiscal year 2015, the closing price of our common stock on the NASDAQ Global Select Market ranged from $7.14 to $11.86 per share. Our closing sale price on November 23, 2015 was $12.50 per share. Announcements by us or others regarding the receipt of customer orders, quarterly variations in operating results, departures of key personnel, acquisitions or divestitures, additional equity or debt financings, results of customer field trials, scientific discoveries, technological innovations, litigation, product developments, patent or proprietary rights, government regulation and general market conditions and risks may, for example, have a significant impact on the market price of our common stock.
If our stock price declines over a sustained period of time or our profits significantly decrease, we may need to recognize an impairment of our goodwill.
The price of our common stock could decline. If such a decline continued over a sustained period of time, we could have an impairment of our goodwill. Our market value is dependent upon certain factors, including continued future growth of our products and solutions. If such growth does not materialize or our forecasts are not met, our profits could be significantly reduced and our market value may decline, which could result in an impairment of our goodwill. Goodwill is tested for impairment on an annual basis as of June 30, or more frequently if events or circumstances occur which could indicate impairment.
Certain provisions of the Delaware General Corporation Law and our charter documents have an anti-takeover effect.
There exist certain mechanisms under the Delaware General Corporation Law and our charter documents that may delay, defer or prevent a change of control. For instance, under Delaware law, we are prohibited from engaging in certain business combinations with interested stockholders for a period of three years after the date of the transaction in which the person became an interested stockholder unless certain requirements are met, and majority stockholder approval is required for certain business combination transactions with interested parties.
Our Certificate of Incorporation contains a “fair price” provision requiring majority stockholder approval for certain business combination transactions with interested parties, and this provision may not be changed without the vote of at least 80% of the outstanding shares of our voting stock. Other mechanisms in our charter documents may also delay, defer or prevent a change of control. For instance, our Certificate of Incorporation provides that our Board of Directors has authority to issue series of our preferred stock with such voting rights and other powers as the Board of Directors may determine. Furthermore, we have a classified board of directors, which means that our directors are divided into three classes that are elected to three-year terms on a staggered basis. Since the three-year terms of each class overlap the terms of the other classes of directors, the entire board of directors cannot be replaced in any one year. Under Delaware law, directors serving on a classified board may not be removed by shareholders except for cause. Also, pursuant to the terms of our shareholder rights plan, each outstanding share of common stock has one attached right. The rights will cause substantial dilution of the ownership of a person or group that attempts to acquire us on terms not approved by the Board of Directors and may have the effect of deterring hostile takeover attempts. The effect of these anti-takeover provisions may deter business combination transactions not approved by our Board of Directors, including acquisitions that may offer a premium over the market price to some or all stockholders.

ITEM 1B. UNRESOLVED STAFF COMMENTS

None.

17


ITEM 2. PROPERTIES
The following table contains a listing of our significant property locations as of September 30, 2015:
Location of Property
Use of Facility
 
Approximate Square Footage
 
Ownership or Lease Expiration Date
Minnetonka, MN
(Corporate headquarters)
Research & development, sales, sales support,
marketing and administration
 
130,000

 
Owned
 
 
 
 
 
 
Eden Prairie, MN
Manufacturing and warehousing
 
58,000

 
Owned
 
 
 
 
 
 
Minneapolis, MN
Engineering services
 
16,837

 
November 2016
 
 
 
 
 
 
Waltham, MA
Research & development, sales and sales support
 
4,249

 
October 2020
 
 
 
 
 
 
Rochester, MN
Engineering services
 
3,090

 
September 2016
 
 
 
 
 
 
Lindon, UT
Sales, technical support, research & development and administration
 
11,986

 
December 2020
 
 
 
 
 
 
Herndon, VA
Sales, marketing and technical support
 
2,416

 
October 2017
 
 
 
 
 
 
Hong Kong, China
Sales, marketing and administration
 
1,656

 
April 2016
 
 
 
 
 
 
Beijing, China
Sales, marketing and administration
 
3,149

 
November 2016
 
 
 
 
 
 
Shanghai, China
Sales, marketing and administration
 
1,991

 
May 2017
 
 
 
 
 
 
Dortmund, Germany
Sales, sales support, marketing and administration
 
9,293

 
March 2016
 
 
 
 
 
 
Ismaning, Germany
Sales, sales support and marketing
 
6,878

 
September 2019
 
 
 
 
 
 
Neuilly sur Seine, France
Sales and marketing
 
2,895

 
January 2018
 
 
 
 
 
 
Logrono, Spain
Sales, research & development and administration
 
3,228

 
November 2018
 
 
 
 
 
 
Tokyo, Japan
Sales
 
1,371

 
Perpetual
 
 
 
 
 
 
Singapore
Sales, marketing and administration
 
3,498

 
April 2017
In addition to the above locations, we perform sales activities in various other locations in Europe which are not deemed to be principal locations and which are not listed above. In connection with our sale of the Etherios business on October 23, 2015, we no longer maintain operations in Chicago, IL, Dallas, TX or San Francisco, CA.

ITEM 3. LEGAL PROCEEDINGS
In the normal course of business, we are subject to various claims and litigation, which may include, but are not limited to, patent infringement and intellectual property claims. While we are unable to predict the outcome of any potential claims or litigation due to the inherent unpredictability of these matters, we believe that it is possible that we could, in the future, incur judgments or enter into settlements of claims that could have a material adverse effect on our operations in any particular period.
ITEM 4. MINE SAFETY DISCLOSURES

None.


18


PART II.
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Stock Listing
Our common stock trades under the symbol DGII on the NASDAQ Global Select Market tier of the NASDAQ Stock Market LLC. On November 23, 2015 there were 129 shareholders of record.
The high and low sale prices for our common stock for each quarter during the years ended September 30, 2015 and 2014, as reported on the NASDAQ Stock Market LLC, were:
Stock Prices
2015
 
First
 
Second
 
Third
 
Fourth
High
 
$
9.45

 
$
10.78

 
$
10.69

 
$
12.08

Low
 
$
6.90

 
$
8.23

 
$
8.95

 
$
9.39

 
 
 
 
 
 
 
 
 
2014
 
First
 
Second
 
Third
 
Fourth
High
 
$
12.50

 
$
12.75

 
$
10.73

 
$
9.53

Low
 
$
9.39

 
$
9.38

 
$
7.90

 
$
7.46

Dividend Policy
We have never paid cash dividends on our common stock. Our Board of Directors presently intends to retain all earnings for use in our business, except for periodic stock repurchases, and does not anticipate paying cash dividends in the foreseeable future.
Issuer Repurchases of Equity Securities
On October 28, 2014, our Board of Directors authorized a program to repurchase up to $15.0 million of our common stock, primarily to return capital to shareholders and to support our employee stock purchase program. This repurchase authorization began on November 1, 2014 and expired on October 31, 2015. Shares repurchased under this program were permitted either through open market or privately negotiated transactions from time to time and in amounts that management deemed appropriate. There were no shares repurchased under this program.
On October 29, 2013, our Board of Directors authorized a program to repurchase up to $20.0 million of our common stock. We repurchased 287,787 shares for $2.2 million under this program during the first quarter of fiscal 2015. This repurchase authorization expired on October 31, 2014.

19


ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES (CONTINUED)
Performance Evaluation
The graph below compares the total cumulative stockholders’ return on our Common Stock for the period from the close of the NASDAQ Stock Market - U.S. Companies on September 30, 2010 to September 30, 2015, the last day of fiscal 2015, with the total cumulative return for the NASDAQ U.S. Benchmark TR Index (the "U.S. Benchmark Index") and the NASDAQ Telecommunications Index (the “Peer Index”) over the same period. We have determined that our line of business is mostly comparable to those companies in the Peer Index. The index level for the graph and table was set to $100 on September 30, 2010, for our Common Stock, the U.S. Benchmark Index and the Peer Index and assumes the reinvestment of all dividends.
 
 
FY10
 
FY11
 
FY12
 
FY13
 
FY14
 
FY15
Digi International Inc.
 
$
100.00

 
$
115.91

 
$
107.06

 
$
105.27

 
$
79.03

 
$
124.24

U.S. Benchmark Index
 
$
100.00

 
$
99.95

 
$
130.07

 
$
158.04

 
$
186.25

 
$
184.93

Peer Index
 
$
100.00

 
$
109.03

 
$
144.98

 
$
147.45

 
$
167.13

 
$
155.21



20


ITEM 6. SELECTED FINANCIAL DATA
(in thousands, except per common share data amounts and number of employees)
For Fiscal Years Ended September 30,
2015
 
2014
 
2013
 
2012
 
2011
Revenue (1)
$
212,858

 
$
192,701

 
$
195,381

 
$
190,558

 
$
204,160

Gross profit
$
98,031

 
$
90,484

 
$
100,123

 
$
100,337

 
$
106,588

Sales and marketing
39,544

 
40,576

 
40,513

 
39,242

 
39,549

Research and development
32,047

 
29,789

 
30,327

 
30,767

 
31,642

General and administrative (2)
19,514

 
19,913

 
21,423

 
18,188

 
18,206

Restructuring charges, net
509

 
81

 
313

 
1,259

 
154

Operating income
6,417

 
125

 
7,547

 
10,881

 
17,037

Total other income (expense), net (3)
2,228

 
672

 
691

 
16

 
(522
)
Income before income taxes
8,645

 
797

 
8,238

 
10,897

 
16,515

Income tax provision (benefit) (4)
2,057

 
(954
)
 
2,433

 
3,282

 
5,496

Net income
$
6,588

 
$
1,751

 
$
5,805

 
$
7,615

 
$
11,019

 
 
 
 
 
 
 
 
 
 
Net income per common share - basic
$
0.27

 
$
0.07

 
$
0.22

 
$
0.30

 
$
0.44

Net income per common share - diluted
$
0.26

 
$
0.07

 
$
0.22

 
$
0.29

 
$
0.43

 
 
 
 
 
 
 
 
 
 
Balance sheet data as of September 30,
 
 
 
 
 
 
 
 
 
Working capital (current assets less current liabilities)
$
136,996

 
$
125,927

 
$
127,672

 
$
155,035

 
$
142,406

Total assets
$
300,360

 
$
290,459

 
$
299,930

 
$
293,403

 
$
283,875

Stockholders' equity
$
274,938

 
$
265,298

 
$
274,243

 
$
270,834

 
$
260,693

Book value per common share (stockholders' equity divided by outstanding shares)
$
10.98

 
$
10.88

 
$
10.73

 
$
10.45

 
$
10.17

Number of employees as of September 30
565

 
649

 
686

 
643

 
691

(1)
Etherios, acquired on October 31, 2012, provided $11.0 million of revenue in fiscal 2013.
(2)
Included in general and administrative expense in fiscal 2013 is $1.5 million ($1.0 million after tax) related to the patent infringement lawsuit settlement for U.S. Ethernet Innovations. (See Note 16 to our Consolidated Financial Statements).
(3)
Included in total other income (expense), net for fiscal 2015 is a $1.4 million gain from the settlement of a property and casualty insurance claim related to the replacement of our capital equipment destroyed in the fire at our subcontract manufacturer's location in Thailand.
(4)
In fiscal 2015, 2014 and 2013, we recorded net tax benefits of $0.9 million, $1.4 million and $0.8 million, respectively (see Note 10 to our Consolidated Financial Statements). In fiscal 2012 we recorded $1.5 million of additional research and development tax credits pertaining to prior fiscal years and reversed tax reserves for closure of various jurisdiction's tax matters and tax rate reductions in foreign jurisdictions. In fiscal 2011, we reversed $0.7 million of income tax reserves from various jurisdictions, primarily foreign, related to the expiration of the statute of limitations.



21



ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Our management’s discussion and analysis should be read in conjunction with our consolidated financial statements and other information in this Annual Report on Form 10-K for the fiscal year ended September 30, 2015.

OVERVIEW
We provide a wide range of wireless products for the IoT, a cloud computing platform tailored to enable monitoring and remote control of devices and development services to help customers get to market fast with wireless devices and applications. Our solution set is capable of allowing any device to communicate with any application, anywhere in the world.
We have a single operating and reporting segment.  Our revenue consists of hardware product revenue and service revenue. Our hardware product offerings are comprised of our cellular routers and gateways, RF, embedded and network products. Our service offerings include wireless design services, Digi Device Cloud (which includes Digi Remote Manager™) and enterprise support services. CRM consulting services are included in our fiscal 2015, 2014 and 2013 financial results. That business was sold during the first fiscal quarter of 2016 to West Monroe Partners, LLC. Digi Cold Chain solutions, which was formed in October 2015 through our acquisition of Bluenica Corporation, is also one of our service offerings. For more information on our acquisition and disposition, see Note 18 to our Consolidated Financial Statements.
We utilize many financial, operational, and other metrics to evaluate our financial condition and financial performance. Below we highlight the fiscal 2015 metrics that we feel are most important in these evaluations:
Revenue was $212.9 Million. We recorded record annual revenue in fiscal 2015. Our revenue increased by $20.2 million, or 10.5%, compared to revenue of approximately $192.7 million in fiscal 2014. The increase in revenue was primarily attributable to increases in revenue in our cellular router and gateway products and RF modules.
Gross Margin was 46.1%.  Our gross margin decreased as a percentage of revenue to 46.1% in fiscal 2015 from 47.0% in fiscal 2014. This decrease primarily was related to our hardware product gross margin, which was 48.3% in fiscal 2015, compared to 50.4% in the prior fiscal year. Our growth products increased as a percent of our total revenue in fiscal 2015, which created a decrease in gross margin as these products typically have a lower gross margin than our mature products. Additionally we incurred additional manufacturing expenses to recover from the impact of the fire at our subcontract manufacturer in Thailand that took place in November 2014. This was offset partially by an increase in service gross margin. Service gross margin for fiscal 2015 was 21.2% compared to 17.0% in the prior fiscal year as service gross margin benefited from improved utilization of consulting labor in connection with the restructuring of our CRM business in the second quarter of fiscal 2015.
Net Income was $6.6 Million and Earnings Per Diluted Share were $0.26. Our net income increased by $4.8 million, or 276.2%, compared to net income of $1.8 million in fiscal 2014. Earnings per diluted share were $0.26 in fiscal 2015, compared to $0.07 in fiscal 2014. The increases in both net income and earnings per diluted share resulted from an increase in gross profit of $7.5 million in fiscal 2015 partially offset by an increase in operating expenses of $1.3 million compared to the prior fiscal year. Our net income in fiscal 2015 also included $1.4 million of insurance proceeds associated with the fire at our subcontract manufacturer.
Adjusted Earnings Before Interest, Taxes, Depreciation and Amortization adjusted for gain from insurance recovery (Adjusted EBITDA) was $12.9 Million. Our Adjusted EBITDA was $12.9 million, or 6.1% of revenue, in fiscal 2015, compared to $7.8 million, or 4.0% of revenue, in fiscal 2014. We believe that the presentation of Adjusted EBITDA as a percentage of revenue, which is a non-GAAP financial measure, is useful because it provides a consistent approach to measuring our performance from year to year and to assess our performance against that of other companies. We also believe this information helps compare operating results and corporate performance exclusive of the impact of our capital structure and the method by which assets were acquired.  Earnings before interest, taxes, depreciation and amortization (EBITDA) is used as an internal metric for executive compensation, as well as incentive compensation for the rest of the employee base. It is monitored quarterly for these purposes. Below is a table reconciling net income to Adjusted EBITDA (in thousands):

22

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

 
 
Year ended September 30,
 
 
2015
 
2014
 
 
 
 
% of total revenue
 
 
 
% of total revenue
Total revenue
 
$
212,858

 
100.0
 %
 
$
192,701

 
100.0
 %
Net income
 
$
6,588

 
3.1
 %
 
$
1,751

 
0.9
 %
Gain from insurance recovery
 
(1,375
)
 
(0.7
)
 

 

Interest income, net
 
(214
)
 
(0.1
)
 
(171
)
 
(0.1
)
Income tax provision (benefit)
 
2,057

 
1.0

 
(954
)
 
(0.5
)
Depreciation and amortization
 
5,859

 
2.8

 
7,146

 
3.7

Adjusted earnings before interest, taxes, depreciation and amortization adjusted for gain from insurance recovery
 
$
12,915

 
6.1
 %
 
$
7,772

 
4.0
 %
Our Balance Sheet was Positively Impacted by Investing and Financing Decisions.  Our current ratio was 6.9 to 1 at September 30, 2015, compared to 6.8 to 1 at September 30, 2014.  Cash and cash equivalents and marketable securities, including long-term marketable securities, increased $13.9 million to $105.8 million at September 30, 2015 from $91.9 million at September 30, 2014.  During fiscal 2015, we repurchased $2.2 million of our common stock (see Note 12 to our Consolidated Financial Statements).
We accomplished a number of key initiatives in fiscal 2015 and also faced significant challenges relative to our business.
Accomplishments
We hired a new Chief Executive Officer, Ronald E. Konezny, and a new Chief Financial Officer, Michael Goergen, following the retirement announcements of former CEO, Joseph Dunsmore, in fiscal 2014 and former CFO, Steven Snyder, in fiscal 2015. We also elected a new director, Spiro C. Lazarakis.
We achieved record annual revenues of approximately $213 million in fiscal 2015 that, together with an increased focus on our operating expenses, drove a more than 275% increase in our net income.
Our cellular products experienced over 45% revenue growth vs. fiscal 2014. We believe this growth rate significantly outpaced the industry average.
Our RF products experienced over 18% revenue growth vs. fiscal 2014 despite headwinds relative to customers in industries facing economic difficulties such as oil and gas producers.
We expanded relationships with key customers of our embedded products which should provide us with steady streams of revenue for several years.
We expanded relationships with key distribution partners such as Mouser, Avnet and DigiKey to include global territories. We believe this further strengthens our ability to service customers outside of North America.
We restructured our services business during the second quarter of fiscal 2015 and completed the sale of our CRM consulting business in the first quarter of fiscal 2016. These actions are expected to improve our business focus, cost structure and profitability.
In early October, 2015 we completed the acquisition of Bluenica Corporation, which will serve as the basis for our Digi Cold Chain solution. We anticipate this industry-focused solution will provide us with a solid foundation of recurring revenue and a higher margin business.
Challenges
A key contract manufacturer in Thailand suffered a fire during the first quarter of fiscal 2015 that disrupted our manufacturing operations during the first half of fiscal 2015.
Our services business experienced a revenue decline of 12.6% during fiscal 2015 vs. fiscal 2014, including an approximate $2.0 million decline for Wireless Design Services.

23

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

As expected, our network products continued to experience revenue decline. In fiscal 2015 these products were down approximately 6% in fiscal 2015 as compared to fiscal 2014. This ongoing trend presents a challenge to us as these products produce higher gross margins than other products we sell. We expect continued future decreases in network product revenue of 5% to 15% annually.
Our EMEA sales were challenged by macro-economic conditions. Currency fluctuations in the region had a negative impact of $3.2 million on our revenue in fiscal 2015 as compared to fiscal 2014.
CONSOLIDATED RESULTS OF OPERATIONS
The following table sets forth selected information derived from our Consolidated Statements of Operations, expressed in dollars and as a percentage of revenue and as a percentage of change from year-to-year for the years indicated.
 
 
Year ended September 30,
 
% Increase (decrease)
($ in thousands)
 
2015
 
2014
 
2013
 
2015 compared to 2014
 
2014 compared to 2013
Revenue:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Hardware product
 
$
195,497

 
91.8
%
 
$
172,846

 
89.7
 %
 
$
173,078

 
88.6
%
 
13.1
 %
 
(0.1
)%
Service
 
17,361

 
8.2

 
19,855

 
10.3

 
22,303

 
11.4

 
(12.6
)
 
(11.0
)
Total revenue
 
212,858

 
100.0

 
192,701

 
100.0

 
195,381

 
100.0

 
10.5

 
(1.4
)
Cost of sales:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Cost of hardware product
 
101,155

 
47.5

 
85,737

 
44.5

 
82,276

 
42.1

 
18.0

 
4.2

Cost of service
 
13,672

 
6.4

 
16,480

 
8.5

 
12,982

 
6.7

 
(17.0
)
 
26.9

Total cost of sales
 
114,827

 
53.9

 
102,217

 
53.0


95,258

 
48.8

 
12.3

 
7.3

Gross profit
 
98,031

 
46.1

 
90,484

 
47.0


100,123

 
51.2

 
8.3

 
(9.6
)
Operating expenses:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Sales and marketing
 
39,544

 
18.6

 
40,576

 
21.1

 
40,513

 
20.7

 
(2.5
)
 
0.2

Research and development
 
32,047

 
15.1

 
29,789

 
15.5

 
30,327

 
15.5

 
7.6

 
(1.8
)
General and administrative
 
19,514

 
9.2

 
19,913

 
10.3

 
21,423

 
11.0

 
(2.0
)
 
(7.0
)
Restructuring charges, net
 
509

 
0.2

 
81

 

 
313

 
0.2

 
528.4

 
(74.1
)
Total operating expenses
 
91,614

 
43.1

 
90,359

 
46.9


92,576

 
47.4

 
1.4

 
(2.4
)
Operating income
 
6,417

 
3.0

 
125

 
0.1


7,547

 
3.8

 
5,033.6

 
(98.3
)
Other income, net
 
2,228

 
1.1

 
672

 
0.3


691

 
0.4

 
231.5

 
(2.7
)
Income before income taxes
 
8,645

 
4.1

 
797

 
0.4


8,238

 
4.2

 
984.7

 
(90.3
)
Income tax provision (benefit)
 
2,057

 
1.0

 
(954
)
 
(0.5
)

2,433

 
1.2

 
315.6

 
(139.2
)
Net income
 
$
6,588

 
3.1
%
 
$
1,751

 
0.9
 %

$
5,805

 
3.0
%
 
276.2
 %
 
(69.8
)%
REVENUE
Overview
Total revenue was $212.9 million in fiscal 2015 compared to $192.7 million in fiscal 2014, an increase of $20.2 million or 10.5%. Product revenue increased by $22.7 million, or 13.1%, partially offset by a decline in service revenue of $2.5 million, or 12.6%. Total revenue was $192.7 million in fiscal 2014 compared to $195.4 million in fiscal 2013, a decrease of $2.7 million or 1.4%. Product revenue decreased by $0.3 million, or 0.1%, and service revenue decreased by $2.4 million, or 11.0%. We did not experience a material change in revenue due to pricing during fiscal 2015, 2014 or 2013.
In fiscal 2015, foreign currency rates compared to the prior year's rates had an unfavorable impact on revenue of $3.4 million. Fluctuation in foreign currency rates compared to the prior year’s rates had a favorable impact on revenue of $0.8 million in fiscal 2014 and an unfavorable impact on revenue of $0.1 million in fiscal 2013.
Hardware Products
In an effort to provide further transparency of our financial information we have expanded our hardware product categories for revenue reporting. Beginning with the first quarter of fiscal 2016, we will transition away from reporting revenue in terms of

24

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

growth and mature hardware products and will report four product categories: Cellular routers and gateways, RF, Embedded and Network. We believe this is a more meaningful presentation and reflects how we are monitoring our revenue.
Our cellular product category includes our cellular routers and all gateways. Our RF product category includes our XBee® modules as well as other RF Solutions.  Our Embedded product category includes Digi Connect® and Rabbit® embedded systems on module and single board computers.  Our network product category, which has the highest concentration of mature products, includes console and serial servers and USB connected products.
Our growth hardware product offerings include all wireless products as well as the ARM-based embedded module product line with both wired and wireless connectivity. Our mature hardware product offerings include generally all wired products, such as our serial servers, Rabbit®-branded modules, chips and USB hardware offerings along with satellite-related products (which we discontinued in fiscal 2014).
The following summarizes our product revenue by product categories:
 
 
Product Revenue
 
% of Product Revenue
($ in millions)
 
2015
 
2014
 
2013
 
2015
 
2014
 
2013
Cellular routers and gateways
 
$
58.7

 
$
39.2

 
$
33.2

 
30.0
%
 
22.7
%
 
19.1
%
RF
 
34.4

 
29.1

 
29.2

 
17.6
%
 
16.8
%
 
16.9
%
Embedded
 
51.0

 
49.6

 
57.6

 
26.1
%
 
28.7
%
 
33.3
%
Network
 
51.4

 
54.9

 
53.1

 
26.3
%
 
31.8
%
 
30.7
%
Total product revenue
 
$
195.5

 
$
172.8

 
$
173.1

 
100.0
%
 
100.0
%
 
100.0
%
 
 
 
 
 
 
 
 
 
 
 
 
 
Growth hardware products
 
$
116.2

 
$
89.9

 
$
88.1

 
59.4
%
 
52.0
%
 
50.9
%
Mature hardware products
 
79.3

 
82.9

 
85.0

 
40.6
%
 
48.0
%
 
49.1
%
Total product revenue
 
$
195.5

 
$
172.8

 
$
173.1

 
100.0
%
 
100.0
%
 
100.0
%
2015 Compared to 2014
Cellular routers and gateway product revenue increased $19.5 million, or 49.6%, in fiscal 2015 as compared to fiscal 2014. These increases primarily were due to a growing market performance and expanding market share with large sales to certain customers of our cellular routers and gateway products. We believe sales of these products in fiscal 2015 significantly outpaced the industry growth rate. While we remain optimistic about the sales performance of these products in fiscal 2016, growth rates could differ materially from fiscal 2015. All of our cellular products are included in the growth product category.
RF product revenue increased $5.3 million, or 18.1%, in fiscal 2015 as compared to fiscal 2014 primarily due to larger sales to certain customers of modules and wireless communication adapters. All of our RF products are included in the growth product category.
Embedded product revenue increased by $1.4 million, or 2.8%, in fiscal 2015 as compared to fiscal 2014 primarily related to our embedded modules and chips, partially offset by a decrease in the sales of Rabbit®-branded modules, which are in the mature portion of their product life cycle.
Network product revenue decreased $3.5 million, or 6.3%, in fiscal 2015 as compared to fiscal 2014. The decrease was mostly due to a decrease in sales of serial cards which are in the mature portion of their product life cycle. There was also a decrease in USB connected products, device servers and satellite products (which have been discontinued), partially offset by an increase in revenue from terminal servers. All of our network products are included in the mature product category. We expect that revenue from these products will continue to decrease in the future.
2014 Compared to 2013
Cellular routers and gateway product revenue increased $6.0 million, or 18.0%, in fiscal 2014 as compared to fiscal 2013. This increase primarily was due to large sales to certain customers of our cellular routers and gateway products. All of our cellular products are included in the growth product category.

25

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

RF product revenue was flat in fiscal 2014 as compared to the prior fiscal year. All of our RF products are included in the growth product category.
Embedded product revenue decreased $7.9 million, or 13.7%, in fiscal 2014 as compared to fiscal 2013 related to modules as certain customers delayed purchases. Embedded products also declined since Rabbit®-branded modules and chips are in the mature portion of their product life cycles.
Network product revenue increased $1.7 million, or 3.3%, in fiscal 2014 as compared to fiscal 2013 primarily related to the increase in satellite product revenue resulting from the announcement of the discontinuation of these satellite products early in fiscal 2014 which prompted final purchases from customers. All of our network products are included in the mature product category.
Service
2015 Compared to 2014
Our service offerings in fiscal 2015 include wireless design services, Etherios CRM services, revenue generated from the Digi Device Cloud platform and our enterprise support services. The significant majority of our service revenue was generated from our Etherios CRM services and our wireless design services. We completed the sale of our Etherios business in the first quarter of fiscal 2016.
Service revenue for fiscal 2015 was $17.4 million compared to $19.9 million in the prior fiscal year, a decrease of $2.5 million, or 12.6%. The decrease was primarily due to declines of $2.0 million in fiscal 2015 of our wireless design services.
2014 Compared to 2013
Service revenue for fiscal 2014 was $19.9 million compared to $22.3 in the prior fiscal year, a decrease of $2.4 million, or 11.0%. The decrease is primarily due to a decline in revenue in fiscal 2014 of $1.4 million for our Etherios CRM services and $0.9 million for our wireless design services as certain customers cancelled or deferred projects that were not replaced.
Revenue by Geographic Location
Our revenue by geographic location of our customers was as follows:
 
 
Revenue
 
% of Revenue
($ in millions)
 
2015
 
2014
 
2013
 
2015
 
2014
 
2013
North America, primarily United States
 
$
136.6

 
$
116.4

 
$
116.6

 
64.2
%
 
60.4
%
 
59.7
%
Europe, Middle East & Africa
 
47.6

 
47.7

 
48.8

 
22.3
%
 
24.8
%
 
25.0
%
Asia
 
22.9

 
22.8

 
24.5

 
10.8
%
 
11.8
%
 
12.5
%
Latin America
 
5.8

 
5.8

 
5.5

 
2.7
%
 
3.0
%
 
2.8
%
Total revenue
 
$
212.9

 
$
192.7

 
$
195.4

 
100.0
%
 
100.0
%
 
100.0
%
2015 Compared to 2014
North America revenue in fiscal 2015 increased $20.2 million, or 17.3%, compared to fiscal 2014, as certain customers made large purchases of our cellular products. There was also an increase in revenue from our RF and embedded modules and serial servers, partially offset by a decline of $2.5 million in service revenue.
EMEA revenue decreased $0.1 million, or 0.4%, in fiscal 2015 as compared to fiscal 2014. The decrease primarily was due to fluctuations of foreign currency rates, which had an unfavorable impact on total revenue of $3.2 million for fiscal 2015 as compared to fiscal 2014 due to the weakening of the Euro and British Pound compared to the U.S. Dollar. This was offset partially by increased revenue from cellular products and embedded products compared to the prior fiscal year.
Asian countries revenue increased $0.1 million, or 0.6%, in fiscal 2015 as compared to fiscal 2014.
Latin America revenue remained flat in fiscal 2015 as compared to fiscal 2014.

26

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

2014 Compared to 2013
North America revenue in fiscal 2014 decreased $0.2 million, or 0.1%, compared to fiscal 2013. This was primarily due to a $2.4 million decrease in service revenue as certain customers cancelled or deferred projects that were not replaced and a reduction in embedded modules revenue that resulted from delays in purchases by certain OEM customers. This was offset partially by an increase in cellular products lines.
EMEA revenue decreased $1.1 million, or 2.2%, in fiscal 2014 from fiscal 2013. This primarily was due to lower project-based customer purchases, particularly in the cellular product lines. It was offset partially by a favorable impact from fluctuations in foreign currency rates due to the strengthening of the British Pound and Euro compared to the U.S. Dollar.
Revenue in Asian countries decreased by $1.7 million, or 7.1%, in fiscal 2014 compared to fiscal 2013 mostly related to lower revenue from chips, serial servers and USB connected products as they are all mature products. We also experienced a decrease in our embedded modules and cellular-related products. This was offset partially by an increase in satellite-related products as we experienced increased demand when we announced in early fiscal 2014 that these products would be discontinued.
Latin America revenue increased by $0.3 million, or 4.9%, in fiscal 2014 from fiscal 2013. This primarily was due to an increase in revenue from cellular products and embedded modules.
Revenue by Distribution Channel
The following table presents our revenue by distribution channel:
 
 
Revenue
 
% of Revenue
($ in millions)
 
2015
 
2014
 
2013
 
2015
 
2014
 
2013
Direct/OEM channel
 
$
87.0

 
$
77.2

 
$
80.0

 
40.9
%
 
40.1
%
 
40.9
%
Distributors channel
 
125.9

 
115.5

 
115.4

 
59.1
%
 
59.9
%
 
59.1
%
Total revenue
 
$
212.9

 
$
192.7

 
$
195.4

 
100.0
%
 
100.0
%
 
100.0
%
2015 Compared to 2014
During fiscal 2015, revenue in our Direct/OEM channel increased $9.8 million, or 12.6%, compared to revenue in fiscal 2014 due to large sales to certain customers. Revenue in fiscal 2015 for our distributors increased by $10.4 million, or 9.0%, compared to revenue in fiscal 2014. We have been taking steps to expand our relationship with certain distributors who have a global reach.
2014 Compared to 2013
Revenue in fiscal 2014 in our Direct/OEM channel decreased by $2.8 million, or 3.5%, compared to the prior fiscal year mostly due to a decrease in revenue from our service offerings, which are typically sold through direct channels. During fiscal 2014, revenue by our distributors increased by $0.1 million, or 0.1%, compared to revenue in fiscal 2013.
GROSS PROFIT
2015 Compared to 2014
Gross profit was $98.0 million and $90.5 million in fiscal 2015 and 2014, respectively, an increase of $7.5 million, or 8.3%. The gross margin for fiscal 2015 was 46.1% compared to 47.0% in fiscal 2014, a decrease of 0.9 percentage points.
Hardware product gross profit was $94.3 million and $87.1 million in fiscal 2015 and 2014, respectively, an increase of $7.2 million, or 8.3%. The hardware product gross margin for fiscal 2015 was 48.3% compared to 50.4% in fiscal 2014, a decrease of 2.1 percentage points, primarily due to the mix of our hardware products since we sold proportionately more growth hardware products in fiscal 2015 that generally have a lower gross margin compared to mature hardware products. In the future we expect to focus more on securing larger and longer-term opportunities that may impact our gross margins negatively. Additionally, for fiscal 2015, we incurred additional manufacturing expenses to recover from the impact of the Thailand fire that also reduced gross margin.

27

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

Service gross profit was $3.7 million and $3.4 million in fiscal 2015 and 2014, respectively, an increase of $0.3 million, or 9.3%. The service gross margin for fiscal 2015 was 21.2% compared to 17.0% in fiscal 2014, an increase of 4.2 percentage points. The increase is a direct result of improved utilization of consulting labor in connection with our restructuring (see Note 9 to our Consolidated Financial Statements). We expect our service gross margin to vary from quarter to quarter for the foreseeable future as our wireless product design and development services margins are dependent on the utilization rates of our personnel.
2014 Compared to 2013
Gross profit was $90.5 million and $100.1 million in fiscal 2014 and 2013, respectively, a decrease of $9.6 million, or 9.6%. The gross margin for fiscal 2014 was 47.0% compared to 51.2% in fiscal 2013, a decrease of 4.2 percentage points.
Hardware product gross profit was $87.1 million and $90.8 million in fiscal 2014 and 2013, respectively, a decrease of $3.7 million, or 4.1%. The hardware product gross margin for fiscal 2014 was 50.4% compared to 52.5% in fiscal 2013, a decrease of 2.1 percentage points. The decrease primarily resulted from a change in hardware product mix and customer mix as we sold more products that have a lower gross margin than our more mature products which have a higher gross margin.
Service gross profit was $3.4 million and $9.3 million in fiscal 2014 and 2013, respectively, a decrease of $5.9 million, or 63.8%. The service gross margin for fiscal 2014 was 17.0% compared to 41.8% in fiscal 2013, a decrease of 24.8 percentage points, mostly related to the underutilization of consulting labor that had been retained for the expected demand of our service offerings.
OPERATING EXPENSES
2015 Compared to 2014
Operating expenses were $91.6 million in fiscal 2015, an increase of $1.2 million, or 1.4%, compared to $90.4 million in fiscal 2014. Below is a summary of our operating expenses by function:
Sales and marketing expenses were $39.6 million and $40.6 million in fiscal 2015 and 2014, respectively, a decrease of $1.0 million or 2.5%. The decrease was primarily due to a reduction in travel, facility and compensation-related expenses of $1.5 million, partially offset by an increase in commissions of $0.5 million.
Research and development expenses were $32.0 million and $29.8 million in fiscal 2015 and 2014, respectively, an increase of $2.2 million or 7.6%. Compensation and employee-related expenses increased by $3.1 million primarily due to underutilization of billable research and development and using those employees resources for completing internal products. In addition, incentive compensation expenses increased due to improved company performance in fiscal 2015. This was partially offset by a decrease $0.9 million in other miscellaneous research and development costs and professional services.
General and administrative expenses were $19.5 million and $19.9 million in fiscal 2015 and 2014, respectively, a decrease of $0.4 million or 2.0%. This was primarily due a decrease of $0.7 million related to CEO transition expenses in the fiscal 2014 partially offset by CFO transition expenses in fiscal 2015. General and administrative expenses also decreased $1.0 million in fiscal 2015 compared to the prior fiscal year due to occupancy expenses, miscellaneous general and administrative expenses, depreciation and amortization as certain intangibles were fully amortized. This was partially offset by an increase in professional fees of $0.5 million and compensation and employee-related expenses of $0.8 million mostly related to increased incentive compensation expenses due to improved company performance in fiscal 2015.
Restructuring expenses were $0.5 million and $0.1 million in fiscal 2015 and fiscal 2014, respectively, an increase of $0.4 million. During fiscal 2015, we recorded $0.5 million related to the restructuring of our India and Etherios locations. During fiscal 2014, we recorded a restructuring charge in India of $0.2 million related to actions that were announced October 31, 2013, partially offset by a $0.1 million reversal of our 2013 restructuring of our U.S. operations. For further information on restructuring, see Note 9 to our Consolidated Financial Statements.
2014 Compared to 2013
Operating expenses were $90.4 million in fiscal 2014, a decrease of $2.2 million, or 2.4%, compared to $92.6 million in fiscal 2013. Below is a summary of our operating expenses by function:

28

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

Sales and marketing expenses were $40.6 million and $40.5 million in fiscal 2014 and 2013, respectively, an increase of $0.1 million or 0.2%. Commissions, travel and professional services increased by $0.7 million, partially offset by a $0.6 million decrease in trade show expenses.
Research and development expenses were $29.8 million and $30.3 million in fiscal 2014 and 2013, respectively, a decrease of $0.5 million or 1.8%. Compensation and employee-related expenses decreased by $0.7 million resulting primarily from lower headcount compared to the prior fiscal year. This was partially offset by $0.2 million in other miscellaneous research and development costs.
General and administrative expenses were $19.9 million and $21.4 million in fiscal 2014 and 2013, respectively, a decrease of $1.5 million or 7.0%. In fiscal 2013 we recorded a charge of $1.5 million due to a settlement on the U.S. Ethernet Innovations lawsuit and an asset impairment charge on identifiable intangible assets of $0.4 million. General and administrative expenses decreased $2.1 million in fiscal 2014 compared to the prior fiscal year due to outside services, occupancy expenses, and amortization as certain intangibles were fully amortized. This was partially offset by an increase in compensation and employee-related expenses of $1.4 million. We also incurred expenses in fiscal 2014 $1.0 million related to a transition agreement with our former Chief Executive Officer pertaining to his retirement which took place at the end of calendar 2014.
Restructuring expenses were $0.1 million in fiscal 2014 and $0.3 million in fiscal 2013. For further information on restructuring, see Note 9 to our Consolidated Financial Statements.
OTHER INCOME (EXPENSE), NET
2015 Compared to 2014
Other income, net was $2.2 million in fiscal 2015 compared to $0.7 million in fiscal 2014. In fiscal 2015, we recorded $1.4 million of gain from the settlement of a property and casualty insurance claim related to the replacement of our capital equipment destroyed in the fire at our subcontract manufacturer's location. We also recorded $0.6 million of foreign currency net transaction gains in fiscal 2015 as compared to $0.4 million of foreign currency net transaction gains in fiscal 2014. Our interest income remained mostly the same. Our average investment balance was $74.0 million in fiscal 2015 and $74.1 million in fiscal 2014. We earned an average interest rate of 0.3% in both fiscal 2015 and fiscal 2014.
2014 Compared to 2013
Total other income, net was $0.7 million in both fiscal 2014 and fiscal 2013. In fiscal 2014, we recorded $0.5 million of foreign currency net transaction gains compared to fiscal 2013 in which we recorded $0.4 million of foreign currency net transaction gains and $0.1 million gain on the sale of an investment. Our interest income on marketable securities and cash and cash equivalents declined slightly from fiscal 2013 to fiscal 2014 as our average investment balance decreased from $80.2 million in fiscal 2013 to $74.1 million in fiscal 2014. We earned an average interest rate of 0.3% in both fiscal 2014 and fiscal 2013.
INCOME TAXES
Our effective income tax rate was 23.8%, (119.7)% and 29.5% for fiscal years 2015, 2014 and 2013, respectively. Our effective tax rate will vary based on a variety of factors, including overall profitability, the geographical mix of income before taxes and related statutory tax rate in each jurisdiction, and discrete events, such as settlements of audits (see Note 10 to our Consolidated Financial Statements).
During fiscal 2015, we recorded net tax benefits of $0.9 million resulting from the reinstatement of the research and development tax credit for calendar year 2014, reversal of tax reserves due to the expiration of statute of limitations from U.S. and foreign tax jurisdictions and reversal of tax reserves due to the resolution of tax audits.
During fiscal 2014, we recorded net tax benefits of $1.4 million, related to the re-measurement and reversal of certain income tax reserves as a result of a federal income tax audit of fiscal 2012, the reassessment of state research and development tax credits and the release of income tax reserves due to the expiration of statute of limitations from U.S. and foreign tax jurisdictions.

29

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

During fiscal 2013, we recorded net tax benefits of $0.8 million related to the January 2, 2013 enactment of the American Taxpayers Relief Act of 2012 extending the research and development tax credit for the last three quarters of fiscal 2012 and the release of income tax reserves due to the expiration of the statute of limitations from various U.S. and foreign tax jurisdictions.
INFLATION
Management believes that during fiscal years 2015, 2014 and 2013, inflation has not had a material effect on our consolidated statement of operations or financial position.
LIQUIDITY AND CAPITAL RESOURCES
We have financed our operations principally with funds generated from operations. We held cash, cash equivalents and short-term marketable securities of $92.2 million, $80.4 million and $88.3 million at September 30, 2015, 2014 and 2013, respectively. Our working capital was $137.0 million, $125.9 million and $127.7 million at September 30, 2015, 2014 and 2013, respectively. The increase of cash, cash equivalents and short-term marketable securities and working capital during fiscal 2015 was attributable primarily to increases related to net income and less repurchases of our common stock than in fiscal 2014, partially offset by additional purchases of marketable securities.
Consolidated Statements of Cash Flows Highlights:
 
 
Year ended September 30,
($ in thousands)
 
2015
 
2014
 
2013
Operating activities
 
$
14,074

 
$
1,809

 
$
11,748

Investing activities
 
(19,454
)
 
16,579

 
(19,739
)
Financing activities
 
5,145

 
(10,960
)
 
(10,790
)
Effect of exchange rate changes on cash and cash equivalents
 
(2,237
)
 
(1,258
)
 
(145
)
Net (decrease) increase in cash and cash equivalents
 
$
(2,472
)
 
$
6,170

 
$
(18,926
)
2015 Compared to 2014
Net cash provided by operating activities was $14.1 million during fiscal 2015 compared to $1.8 million in fiscal 2014, a net increase of $12.3 million. This net increase was primarily due to increases in net income of $4.8 million, deferred income tax benefit of $4.2 million and a net increase in cash flows related to working capital of $4.6 million, partially offset by a decrease of $1.4 million for the non-cash adjustment related to the gain from insurance recovery. The net increase in cash flows related to working capital of $4.6 million was primarily due to a $4.8 million increase in accrued liabilities resulting from larger incentive compensation accruals on improved company performance in fiscal 2015. We also had an increase in cash flows as we spent $4.0 million less on inventory in fiscal 2015 compared to fiscal 2014. In addition, we had a $0.9 million increase in cash flows as our accounts receivable increased by a smaller amount in fiscal 2015 compared to fiscal 2014. This was partially offset by a $4.7 million decrease in cash flows related to accounts payable and a $0.4 million decrease related to income taxes payable.
Net cash used in investing activities was $19.5 million in fiscal 2015 compared to net cash provided of $16.6 million in fiscal 2014, a decrease of $36.1 million. There were net purchases of marketable securities in fiscal 2015 compared to net maturities of marketable securities in fiscal 2014 which accounted for $36.4 million of the decrease along with $1.1 million of additional purchases of capital expenditures. This was partially offset by an increase of $1.4 million related to the gain from insurance recovery.
Net cash provided by financing activities was $5.1 million in fiscal 2015 compared to net cash used by financing activities of $11.0 million in fiscal 2014. We had $13.4 million fewer repurchases of common stock in fiscal 2015 compared to fiscal 2014. We also had $2.7 million of additional proceeds from exercises of stock options and employee stock purchase plan transactions in fiscal 2015 compared to fiscal 2014.
2014 Compared to 2013
Net cash provided by operating activities was $1.8 million during fiscal 2014 compared to $11.7 million during fiscal 2013, a net decrease of $9.9 million. This net decrease is due to a decrease in net income of $4.1 million, net decreases in non-cash items of $2.5 million and a decrease in net working capital of $3.3 million. The decrease in cash flows related to working

30

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

capital is primarily due to an increase in inventory of $3.0 million due to large purchases of components that were being discontinued by the suppliers and delays in purchases by certain customers.
Net cash provided by investing activities was $16.6 million in fiscal 2014 compared to net cash used by investing activities of $19.7 million in fiscal 2013, an increase of $36.3 million. Marketable securities accounted for $24.0 million of the increase as we received net proceeds from maturities in fiscal 2014 compared to net purchases of marketable securities in fiscal 2013. We acquired Etherios in fiscal 2013 for $12.9 million, net of cash acquired. Our purchases of capital expenditures increased by $0.5 million in fiscal 2014 compared to the prior fiscal year. We received $0.1 million related to proceeds from an investment in fiscal 2013.
Net cash used in by financing activities was $11.0 million in fiscal 2014 compared to $10.8 million in fiscal 2013. We used $15.7 million of cash to repurchase our common stock in fiscal 2014, partially offset by $4.7 million of proceeds related to exercises of stock options and employee stock purchase plan transactions.
We expect positive cash flows from operations and believe that our current cash, cash equivalents and marketable securities balances, cash generated from operations and our ability to secure debt and/or equity financing will be sufficient to fund our business operations and capital expenditures for the next twelve months and beyond.
At September 30, 2015, our total cash and cash equivalents and marketable securities balance, including long-term marketable securities was $105.8 million. At September 30, 2015, we had $28.2 million of accumulated undistributed foreign earnings that are indefinitely reinvested in non-U.S. subsidiaries, resulting in slightly more than half of our cash and cash equivalents being held by non-U.S. subsidiaries. Approximately $28.3 million of cash and cash equivalents was being held by our controlled foreign subsidiaries at September 30, 2015. Although we have no current need or intention to repatriate historical earnings in the form of cash in the United States, if we change our assertion from indefinitely reinvesting undistributed foreign earnings, we would have to accrue applicable taxes. The amount of any taxes and the application of any tax credits would be determined based on the income tax laws at the time of such repatriation. Under current tax laws, we estimate the unrecognized deferred tax liability to be up to $0.8 million.
The following summarizes our contractual obligations at September 30, 2015:
 
 
Payments due by fiscal period
($ in thousands)
 
Total
 
Less than 1 year
 
1-3 years
 
3-5 years
 
Thereafter
Operating leases
 
$
4,252

 
$
1,993

 
$
1,775

 
$
484

 
$

The operating lease agreements included above primarily relate to office space. The table above does not include possible payments for uncertain tax positions. Our reserve for uncertain tax positions, including accrued interest and penalties, was $2.0 million as of September 30, 2015. Due to the nature of the underlying liabilities and the extended time often needed to resolve income tax uncertainties, we cannot make reliable estimates of the amount or timing of future cash payments that may be required to settle these liabilities.
The above table also does not include those obligations for royalties under license agreements as these royalties are calculated based on future sales of licensed products and we cannot make reliable estimates of the amount of cash payments.
FOREIGN CURRENCY
We are exposed to foreign currency transaction risk associated with certain sales being denominated in Euros, British Pounds, and Japanese Yen and foreign currency translation risk as the financial position and operating results of our foreign subsidiaries are translated into U.S. Dollars for consolidation. We manage our net asset or net liability position for U.S. dollar accounts in our foreign locations to reduce our foreign currency risk. We have not implemented a formal hedging strategy to reduce foreign currency risk.
During 2015, we had approximately $76.3 million of revenue related to foreign customers including export sales, of which $21.3 million was denominated in foreign currency, predominantly the Euro and British Pound. During 2014 and 2013, we had approximately $76.3 million and $78.8 million, respectively, of revenue to foreign customers including export sales, of which $23.3 million and $24.3 million, respectively, were denominated in foreign currency, predominantly the Euro and British Pound. In future periods, we expect a significant portion of sales will continue to be made in Euros and British Pounds.

31

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

RECENT ACCOUNTING DEVELOPMENTS
Adopted
In July 2013, the Financial Accounting Standards Board (“FASB”) issued ASU 2013-11, “Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists.” This guidance relates to the presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. The standard update provides that a liability related to an unrecognized tax benefit should be offset against same jurisdiction deferred tax assets for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward if such settlement is required or expected in the event the uncertain tax position is disallowed. This guidance was effective prospectively for fiscal years (and interim reporting periods within those years) beginning after December 15, 2013. We adopted this guidance during the fiscal quarter ended December 31, 2014, resulting in a reclassification of $0.4 million of unrecognized tax benefits to noncurrent deferred tax assets.
In March 2013, FASB issued ASU 2013-05, “Foreign Currency Matters (Topic 830): Parent’s Accounting for the Cumulative Translation Adjustment upon Derecognition of Certain Subsidiaries or Groups of Assets within a Foreign Entity or of an Investment in a Foreign Entity.” This guidance applies to the release of the cumulative translation adjustment into net income when a parent either sells a part or all of its investment in a foreign entity or no longer holds a controlling financial interest in a subsidiary or group of assets that is a business within a foreign entity. ASU 2013-05 was effective prospectively for fiscal years (and interim reporting periods within those years) beginning after December 15, 2013. We adopted this guidance during the fiscal quarter ended December 31, 2014. There was no impact on our condensed consolidated financial statements as we have not sold any foreign entities for which we hold a controlling financial interest.
Not Yet Adopted
In September 2015, FASB issued ASU 2015-16, "Simplifying the Accounting for Measurement-Period Adjustments." To simplify the accounting for adjustments made to provisional amounts recognized in a business combination, the amendments in this update eliminate the requirement to retrospectively account for those adjustments. The amendments in this update are effective for fiscal years beginning after December 15, 2015, including interim periods within those years, which for us will be the first fiscal quarter ending December 31, 2016. Earlier application is permitted for financial statements that have not been issued. We are currently evaluating the impact of the adoption of ASU 2015-16.
In July 2015, FASB issued ASU 2015-11, "Simplifying the Measurement of Inventory." This provision would require inventory that was previously recorded using first-in, first-out (FIFO) to lower of cost and net realizable value. Net realizable value is the estimated selling price in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. This guidance is effective for fiscal years beginning after December 15, 2016 and interim periods within those years, which for us will be the first fiscal quarter ending December 31, 2017. The amendments in this guidance should be applied prospectively with earlier application permitted as of the beginning of an interim or annual period. We are currently evaluating the impact of the adoption of ASU 2015-11 and whether it would have a material impact on our consolidated financial statements.
In April 2015, FASB issued ASU 2015-05, “Intangibles-Goodwill and Other-Internal-Use Software (Subtopic 350-40) - Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement. The new standard provides guidance to customers about whether a cloud computing arrangement includes a software license. If the arrangement does include a software license, the software license element of the arrangement should be accounted for in the same manner as the acquisition of other software licenses. This guidance is effective for fiscal years, and interim periods within those years, beginning after December 15, 2015, with early adoption permitted. We expect to adopt this guidance beginning with our fiscal quarter ending December 31, 2016. We do not expect this guidance to have a material impact on our consolidated financial statements.
In August 2014, FASB issued ASU 2014-15, “Presentation of Financial Statements - Going Concern.” This guidance requires management to evaluate whether there is substantial doubt about a company’s ability to continue as a going concern and to provide related footnote disclosures. These amendments are effective for the annual period ending after December 15, 2016, and for annual periods and interim periods thereafter, which for us, will be the fourth fiscal quarter ended September 30, 2017. Early adoption is permitted. While we are evaluating the impact of the adoption of ASU 2014-15, we do not expect it to have an impact on our consolidated financial statements.
In May 2014, FASB issued ASU 2014-09, “Revenue from Contracts with Customers.” This guidance provides a five-step analysis in determining when and how revenue is recognized so that an entity will recognize revenue when it transfers promised

32

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

goods or services to customers in an amount that reflects what it expects in exchange for the goods and services. It also requires more detailed disclosures to enable users of financial statements to understand the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers. In August 2015, the FASB issued ASU 2015-14 "Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date" which approved a one-year deferral of the effective date of ASU 2014-09. As a result of this deferral, ASU 2014-09 is effective for our fiscal 2019, including interim periods within that reporting period. The FASB also agreed to allow us to choose to adopt the standard effective for our fiscal 2018. We are assessing the adoption date and potential impact of adopting this ASU on our consolidated financial statements and related disclosures.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, the disclosure of contingent assets and liabilities and the values of purchased assets and assumed liabilities in acquisitions. We base our estimates on historical experience and various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates.
We believe the following critical accounting policies impact our more significant judgments and estimates used in the preparation of our consolidated financial statements.
REVENUE RECOGNITION
Our revenue is derived primarily from the sale of wired and wireless hardware products to our distributors and Direct/OEM customers. We recognize hardware product revenue when persuasive evidence of an arrangement exists, delivery has occurred, the sales price is fixed or determinable, collectability is reasonably assured and there are no post-delivery obligations, other than warranty. Under these criteria, product revenue generally is recognized upon shipment of product to customers. Sales to authorized domestic distributors and Direct / OEMs are made with certain rights of return and price adjustment provisions. Estimated reserves for future returns and pricing adjustments are established by us based on an analysis of historical patterns of returns and price adjustments as well as an analysis of authorized returns compared to received returns and distribution sales for the current period. Estimated reserves for future returns and price adjustments are charged against revenue in the same period as the corresponding sales are recorded. Material differences between the historical trends used to determine estimated reserves and actual returns and pricing adjustments could result in a material change to our consolidated results of operations or financial position. We have applied consistent methodologies for estimating reserves for future returns and pricing adjustments for all years presented. The reserve for future returns and pricing adjustments was $1.8 million at September 30, 2015 and $1.7 million at September 30, 2014.
Revenue recognized for service revenue as a percentage of total revenue represented 8.2%, 10.3% and 11.4% in fiscal 2015, 2014 and 2013, respectively. Our service revenue is derived primarily from professional and engineering services performed by our Etherios® CRM and wireless design teams.  We also have some service revenue that is derived from our Digi Device Cloud, which is a platform-as-a-service (PaaS) offering in which customers pay for services consumed in terms of devices being managed and monitored, or as a monthly service fee for access to information.  We recognize service revenue from our Etherios® CRM services, wireless design services, and Digi Device Cloud based upon performance, including, but not limited to, final product delivery and customer acceptance.  In addition, we recognize small amounts of revenue from enterprise support services which are recognized over the life of the contract, and training as the services are performed.
MARKETABLE SECURITIES
We regularly monitor and evaluate the realizable value of our marketable securities. When assessing marketable securities for other-than-temporary declines in value, we consider several factors. These factors include: how significant the decline in value is as a percentage of the original cost, how long the market value of the investment has been less than its original cost, the underlying factors contributing to a decline in the prices of securities in a single asset class, the performance of the issuer’s stock price in relation to the stock price of its competitors within the industry, expected market volatility, analyst recommendations, the views of external investment managers, any news or financial information that has been released specific to the investee and the outlook for the overall industry in which the issuer operates. If events and circumstances indicate that a

33

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

decline in the value of these securities has occurred and is other-than-temporary, we would record a charge to other income (expense).
ACCOUNTS RECEIVABLE AND ALLOWANCE FOR DOUBTFUL ACCOUNTS
We maintain an allowance for doubtful accounts, which reflects the estimate of losses that may result from the inability of some of our customers to make required payments. The estimate for the allowance for doubtful accounts is based on known circumstances regarding collectability of customer accounts and historical collections experience. If the financial condition of one or more of our customers were to deteriorate, resulting in an inability to make payments, additional allowances may be required. Material differences between the historical trends used to estimate the allowance for doubtful accounts and actual collection experience could result in a material change to our consolidated results of operations or financial position. The allowance for doubtful accounts was $0.5 million at September 30, 2015 and $0.4 million at September 30, 2014.
INVENTORIES
Inventories are stated at the lower of cost or fair market value, with cost determined using the first-in, first-out method. We reduce the carrying value of our inventories for estimated excess and obsolete inventories equal to the difference between the cost of inventory and its estimated realizable value based upon assumptions about future product demand and market conditions. Once the new cost basis is established, the value is not increased with any changes in circumstances that would indicate an increase in value after the remeasurement. If actual product demand or market conditions are less favorable than those projected by management, additional inventory write-downs may be required that could result in a material change to our consolidated results of operations or financial position. We have applied consistent methodologies for the net realizable value of inventories.
GOODWILL
Goodwill represents the excess of cost over the fair value of identifiable assets acquired.  Goodwill is tested for impairment on an annual basis as of June 30, or more frequently if events or circumstances occur which could indicate impairment.  At June 30, 2015, our market capitalization was $238.6 million compared to our carrying value of $270.6 million. Our market capitalization plus our estimated control premium of 35% resulted in a fair value in excess of our carrying value by a margin of 19%. As a result, no impairment was indicated and we were not required to complete the second step of the goodwill impairment analysis. No goodwill impairment charges were recorded. The control premium used in our annual goodwill assessment at June 30, 2015 was based on a control premium study as of June 2014, resulting in a range of control premium of 30% to 40%. We re-evaluated the data and concluded that a 35% control premium continues to best represent the amount an investor would likely pay, over and above market capitalization, in order to obtain a controlling interest given the economic conditions at June 30, 2015.
During the fourth quarter of fiscal 2015, we assessed various qualitative factors to determine whether or not an additional goodwill impairment assessment was required as of September 30, 2015. We concluded that no additional goodwill impairment assessment was required. We continue to monitor our stock price on a daily basis. If the stock price remained below certain thresholds for a significant period of time, we would complete an interim impairment assessment. We also monitor other events or circumstances that could have a significant impact on our operations. If one of these events or circumstances were to occur, we would evaluate whether an interim goodwill impairment assessment should be completed.
INCOME TAXES
We operate in multiple tax jurisdictions both in the U.S. and outside of the U.S. Accordingly, we must determine the appropriate allocation of income to each of these jurisdictions. This determination requires us to make several estimates and assumptions. Tax audits associated with the allocation of this income, and other complex issues, may require an extended period of time to resolve and could result in adjustments to our income tax balances that are material to our consolidated financial position and results of operations and could result in potential cash outflows.
We have unrecognized tax benefits of $2.0 million. We expect that it is reasonably possible that the total amounts of unrecognized tax benefits will decrease approximately $0.2 million over the next 12 months due to the expiration of various statutes of limitations. The total amount of unrecognized tax benefits that if recognized would affect our effective tax rate is $1.6 million.  We recognize interest and penalties related to income tax matters in income tax expense.

34

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

WARRANTIES
In general, we warrant our products to be free from defects in material and workmanship under normal use and service. The warranty periods generally range from one to five years. We typically have the option to repair or replace products we deem defective due to material or workmanship. Estimated warranty costs are accrued in the period that the related revenue is recognized based upon an estimated average per unit repair or replacement cost applied to the estimated number of units under warranty. These estimates are based upon historical warranty incidents and are evaluated on an ongoing basis to ensure the adequacy of the warranty accrual. The product warranty accrual was $1.0 million and $0.9 million at September 30, 2015 and September 30, 2014, respectively.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
INTEREST RATE RISK
Our exposure to interest rate risk relates primarily to our investment portfolio. We do not use derivative financial instruments to hedge against interest rate risk.
FOREIGN CURRENCY RISK
We are exposed to foreign currency transaction risk associated with certain sales being denominated in Euros, British Pounds or Japanese Yen and foreign currency translation risk as the financial position and operating results of our foreign subsidiaries are translated into U.S. Dollars for consolidation. We manage our net asset or net liability position for U.S. dollar accounts in our foreign locations to reduce our foreign currency risk. We have not implemented a formal hedging strategy.
The table below compares the average monthly exchange rates of the Euro, British Pound and Japanese Yen:
 
Fiscal year ended
September 30,
 
% increase
 
2015
 
2014
 
(decrease)
Euro
1.1499

 
1.3575

 
(15.3
)%
British Pound
1.5462

 
1.6570

 
(6.7
)%
Japanese Yen
0.0084

 
0.0098

 
(14.3
)%
A 10.0% change from the 2015 average exchange rate for the Euro, British Pound and Yen to the U.S. Dollar would have resulted in a 2.2% increase or decrease in fiscal 2015 annual revenue and a 2.0% increase or decrease in stockholders' equity at September 30, 2015. The above analysis does not take into consideration any pricing adjustments we may make in response to changes in the exchange rate.
CREDIT RISK
We have some exposure to credit risk related to our accounts receivable portfolio. Exposure to credit risk is controlled through regular monitoring of customer financial status, credit limits and collaboration with sales management on customer contacts to facilitate payment.
Investments are made in accordance with our investment policy and consist of certificates of deposit, money market funds, corporate bonds and government municipal bonds. We may have some credit exposure related to the fair value of our securities, which could change based on changes in market conditions. If market conditions deteriorate or, if these securities experience credit rating downgrades, we may incur impairment charges for securities in our investment portfolio.


35


ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of Digi International Inc.
In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations, comprehensive income (loss), stockholders’ equity and cash flows present fairly, in all material respects, the financial position of Digi International Inc. and its subsidiaries at September 30, 2015 and 2014, and the results of their operations and their cash flows for each of the three years in the period ended September 30, 2015 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the index appearing under Item 15(a)(2) presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of September 30, 2015, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company's management is responsible for these financial statements and financial statement schedule, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in Management’s Report on Internal Control Over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on these financial statements, on the financial statement schedule, and on the Company's internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.



/s/ PricewaterhouseCoopers LLP
Minneapolis, Minnesota
November 30, 2015

36


ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA (CONTINUED)



DIGI INTERNATIONAL INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
 
Fiscal years ended September 30,
 
2015
 
2014
 
2013
 
(in thousands, except per common share data)
Revenue:
 
 
 
 
 
Hardware product
$
195,497

 
$
172,846

 
$
173,078

Service
17,361

 
19,855

 
22,303

Total revenue
212,858

 
192,701

 
195,381

Cost of sales:
 
 
 
 
 
Cost of hardware product
101,155

 
85,737

 
82,276

Cost of service
13,672

 
16,480

 
12,982

Total cost of sales
114,827

 
102,217

 
95,258

Gross profit
98,031

 
90,484

 
100,123

Operating expenses:
 
 
 
 
 
Sales and marketing
39,544

 
40,576

 
40,513

Research and development
32,047

 
29,789

 
30,327

General and administrative
19,514

 
19,913

 
21,423

Restructuring charges, net
509

 
81

 
313

Total operating expenses
91,614

 
90,359

 
92,576

Operating income
6,417

 
125

 
7,547

Other income, net:
 
 
 
 
 
Interest income
218

 
176

 
210

Interest expense
(4
)
 
(5
)
 
(42
)
Other income, net
2,014

 
501

 
523

Total other income, net
2,228

 
672

 
691

Income before income taxes
8,645

 
797

 
8,238

Income tax provision (benefit)
2,057

 
(954
)
 
2,433

Net income
$
6,588

 
$
1,751

 
$
5,805

Net income per common share:
 
 
 
 
 
Basic
$
0.27

 
$
0.07

 
$
0.22

Diluted
$
0.26

 
$
0.07

 
$
0.22

Weighted average common shares:
 
 
 
 
 
Basic
24,645

 
25,345

 
25,956

Diluted
25,227

 
25,730

 
26,237

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





37


ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA (CONTINUED)



DIGI INTERNATIONAL INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
 
Fiscal years ended September 30,
 
2015
 
2014
 
2013
 
(in thousands)
Net income
$
6,588

 
$
1,751

 
$
5,805

Other comprehensive loss, net of tax:
 
 
 
 
 
Foreign currency translation adjustment
(4,323
)
 
(2,713
)
 
(1,826
)
Change in net unrealized (loss) gain on investments
(21
)
 
43

 
(63
)
Less income tax benefit (provision)
7

 
(17
)
 
24

Reclassification of realized loss on investments included in net income (1)
1

 

 

Other comprehensive loss, net of tax
(4,336
)
 
(2,687
)
 
(1,865
)
Comprehensive income (loss)
$
2,252

 
$
(936
)
 
$
3,940

(1)
Recorded in Other income, net in our Consolidated Statements of Operations.

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


38


ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA (CONTINUED)


DIGI INTERNATIONAL INC.
CONSOLIDATED BALANCE SHEETS
 
As of September 30,
 
2015
 
2014
 
(in thousands, except share data)
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
45,018

 
$
47,490

Marketable securities
47,191

 
32,898

Accounts receivable, net
29,205

 
28,576

Inventories
31,877

 
31,247

Deferred tax assets
3,379

 
3,221

Other
3,515

 
4,249

Total current assets
160,185

 
147,681

Marketable securities, long-term
13,626

 
11,541

Property, equipment and improvements, net
14,357

 
13,231

Identifiable intangible assets, net
4,179

 
6,785

Goodwill
102,097

 
103,398

Deferred tax assets
5,666

 
7,383

Other
250

 
440

Total assets
$
300,360

 
$
290,459

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
6,723

 
$
10,451

Income taxes payable
828

 

Accrued compensation
11,502

 
8,133

Other
4,136

 
3,170

Total current liabilities
23,189

 
21,754

Income taxes payable
1,546

 
2,724

Deferred tax liabilities
135

 
272

Other noncurrent liabilities
552

 
411

Total liabilities
25,422

 
25,161

Commitments and Contingencies (see Notes 15 & 16)

 

Stockholders’ equity:
 
 
 
Preferred stock, $.01 par value; 2,000,000 shares authorized; none issued and outstanding

 

Common stock, $.01 par value; 60,000,000 shares authorized; 31,534,198 and 30,703,895 shares issued
315

 
307

Additional paid-in capital
227,367

 
218,689

Retained earnings
124,404

 
117,816

Accumulated other comprehensive loss
(22,613
)
 
(18,277
)
Treasury stock, at cost, 6,487,248 and 6,313,937 shares
(54,535
)
 
(53,237
)
Total stockholders’ equity
274,938

 
265,298

Total liabilities and stockholders’ equity
$
300,360

 
$
290,459

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

39


ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA (CONTINUED)


DIGI INTERNATIONAL INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
 
 
Fiscal years ended September 30,
 
 
2015
 
2014
 
2013
Operating activities:
 
(in thousands)
Net income
 
$
6,588

 
$
1,751

 
$
5,805

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
 
 
 
Depreciation of property, equipment and improvements
 
2,949

 
3,557

 
3,461

Amortization of identifiable intangible assets
 
2,910

 
3,589

 
4,416

Stock-based compensation
 
4,301

 
4,330

 
3,773

Excess tax benefits from stock-based compensation
 

 
(44
)
 
(67
)
Deferred income tax benefit
 
(769
)
 
(2,783
)
 
(2,055
)
Gain on insurance settlement related to property and equipment
 
(1,375
)
 

 

Bad debt/product return provision
 
357

 
98

 
811

Inventory obsolescence
 
1,284

 
860

 
1,258

Intangible impairment charge
 

 

 
361

Restructuring charges, net
 
509

 
81

 
313

Other
 
87

 
3

 
(85
)
Changes in operating assets and liabilities (net of acquisition):
 
 
 
 
 
 
Accounts receivable
 
(1,794
)
 
(2,730
)
 
(2,368
)
Inventories
 
(1,913
)
 
(5,966
)
 
(2,972
)
Other assets
 
241

 
210

 
(212
)
Income taxes
 
387

 
(1,408
)
 
(2,634
)
Accounts payable
 
(3,769
)
 
970

 
1,413

Accrued expenses
 
4,081

 
(709
)
 
530

Net cash provided by operating activities
 
14,074

 
1,809

 
11,748

Investing activities:
 
 
 
 
 
 
Purchase of marketable securities
 
(54,427
)
 
(27,420
)
 
(67,159
)
Proceeds from maturities of marketable securities
 
38,028

 
47,420

 
63,089

Acquisition of businesses, net of cash acquired
 

 

 
(12,919
)
Proceeds from insurance settlement related to property and equipment
 
1,400

 

 

Proceeds from sale of property and equipment
 
45

 

 

Proceeds from sale of investment
 

 

 
136

Purchase of property, equipment, improvements and certain other intangible assets
 
(4,500
)
 
(3,421
)
 
(2,886
)
Net cash (used in) provided by in investing activities
 
(19,454
)
 
16,579

 
(19,739
)
Financing activities:
 
 
 
 
 
 
Excess tax benefits from stock-based compensation
 

 
44

 
67

Proceeds from stock option plan transactions
 
6,559

 
3,689

 
2,193

Proceeds from employee stock purchase plan transactions
 
925

 
1,009

 
1,008

Purchase of common stock
 
(2,339
)
 
(15,702
)
 
(14,058
)
Net cash provided by (used in) financing activities
 
5,145

 
(10,960
)
 
(10,790
)
Effect of exchange rate changes on cash and cash equivalents
 
(2,237
)
 
(1,258
)
 
(145
)
Net (decrease) increase in cash and cash equivalents
 
(2,472
)
 
6,170

 
(18,926
)
Cash and cash equivalents, beginning of period
 
47,490

 
41,320

 
60,246

Cash and cash equivalents, end of period
 
$
45,018

 
$
47,490

 
$
41,320

 
 
 
 
 
 
 
Supplemental disclosures of cash flow information:
 
 
 
 
 
 
Interest paid
 
$
4

 
$
5

 
$
42

Income taxes paid, net
 
$
1,296

 
$
3,197

 
$
6,300

Supplemental schedule of non-cash investing and financing activities:
 
 
 
 
 
 
Accrual for capitalized intangible asset
 
$
17

 
$

 
$
42

Issuance of common stock for business acquisition
 
$

 
$

 
$
6,741

Accrual for purchase of common stock
 
$

 
$
100

 
$


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

40


ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA (CONTINUED)


DIGI INTERNATIONAL INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

For fiscal years ended September 30, 2015, 2014 and 2013
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Accumulated
 
 
 
 
 
 
 
 
 
 
 
 
Additional
 
 
 
Other
 
Total
 
 
Common Stock
 
Treasury Stock
 
Paid-In
 
Retained
 
Comprehensive
 
Stockholders’
 
 
Shares
 
Par Value
 
Shares
 
Value
 
Capital
 
Earnings
 
Loss
 
Equity
Balances, September 30, 2012
 
29,269

 
$
293

 
3,356

 
$
(25,489
)
 
$
199,495

 
$
110,260

 
$
(13,725
)
 
$
270,834

Net income
 
 
 
 
 
 
 
 
 
 
 
5,805

 
 
 
5,805

Other comprehensive loss
 
 
 
 
 
 
 
 
 
 
 
 
 
(1,865
)
 
(1,865
)
Employee stock purchase issuances
 
 
 
 
 
(128
)
 
1,030

 
(22
)
 
 
 
 
 
1,008

Repurchase of common stock
 
 
 
 
 
1,481

 
(14,058
)
 
 
 
 
 
 
 
(14,058
)
Issuance of stock upon exercise of stock options
 
280

 
3

 
 
 
 
 
2,190

 
 
 
 
 
2,193

Tax impact from equity awards
 
 
 
 
 
 
 
 
 
(188
)
 
 
 
 
 
(188
)
Acquisition of Etherios, Inc.
 
715

 
7

 
 
 
 
 
6,734