10-Q 1 dgii-2017331x10qq2.htm 10-Q Document
 
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q

þ
 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended: March 31, 2017
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
digilogoregistered.jpg
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)
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 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,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer
 
o
 
Accelerated filer
 
 þ
Non-accelerated filer
 
o (Do not check if a smaller reporting company)
 
Smaller reporting company
 
o
 
 
 
 
Emerging growth company
 
o
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. 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
On April 30, 2017, there were 26,537,337 shares of the registrant’s $.01 par value Common Stock outstanding.
 



INDEX
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


i


PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

DIGI INTERNATIONAL INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
 
Three months ended March 31,
 
Six months ended March 31,
 
2017
 
2016
 
2017
 
2016
 
(in thousands, except per share data)
Revenue:
 
 
 
 
 
 
 
Hardware product
$
41,766

 
$
48,732

 
$
84,939

 
$
96,979

Service
3,849

 
1,430

 
5,851

 
3,442

Total revenue
45,615

 
50,162

 
90,790

 
100,421

Cost of sales:
 
 
 
 
 
 
 
Cost of hardware product
21,489

 
24,283

 
43,927

 
48,993

Cost of service
2,224

 
1,137

 
3,508

 
2,329

Total cost of sales
23,713

 
25,420

 
47,435

 
51,322

Gross profit
21,902

 
24,742

 
43,355

 
49,099

Operating expenses:
 
 
 
 
 
 
 
Sales and marketing
8,731

 
8,165

 
17,053

 
16,683

Research and development
6,979

 
7,757

 
13,884

 
15,595

General and administrative
4,680

 
5,065

 
8,484

 
9,126

Restructuring charge

 
102

 

 
753

Total operating expenses
20,390

 
21,089

 
39,421

 
42,157

Operating income
1,512

 
3,653

 
3,934

 
6,942

Other (expense) income, net:
 
 
 
 
 
 
 
Interest income
120

 
130

 
279

 
238

Interest expense
(10
)
 
(118
)
 
(43
)
 
(126
)
Other (expense) income, net
(143
)
 
(284
)
 
431

 
(161
)
Total other (expense) income, net
(33
)
 
(272
)
 
667

 
(49
)
Income from continuing operations, before income taxes
1,479

 
3,381

 
4,601

 
6,893

Income tax provision
148

 
1,155

 
913

 
1,536

Income from continuing operations
1,331

 
2,226

 
3,688

 
5,357

(Loss) income from discontinued operations, after income taxes

 
(89
)
 

 
3,230

Net income
$
1,331

 
$
2,137

 
$
3,688

 
$
8,587

 
 
 
 
 
 
 
 
Basic net income per common share:
 
 
 
 
 
 
 
Continuing operations
$
0.05

 
$
0.09

 
$
0.14

 
$
0.21

Discontinued operations
$

 
$

 
$

 
$
0.13

Net income (1)
$
0.05

 
$
0.08

 
$
0.14

 
$
0.34

Diluted net income per common share:
 
 
 
 
 
 
 
Continuing operations
$
0.05

 
$
0.09

 
$
0.14

 
$
0.21

Discontinued operations
$

 
$

 
$

 
$
0.12

Net income (1)
$
0.05

 
$
0.08

 
$
0.14

 
$
0.33

Weighted average common shares:
 
 
 
 
 
 
 
Basic
26,477

 
25,820

 
26,324

 
25,574

Diluted
27,252

 
25,998

 
27,134

 
26,116

(1) Earnings per share presented are calculated by line item and may not add due to the use of rounded amounts.

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

1


DIGI INTERNATIONAL INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(UNAUDITED)
 
Three months ended March 31,
 
Six months ended March 31,
 
2017
 
2016
 
2017
 
2016
 
(in thousands)
Net income
$
1,331

 
$
2,137

 
$
3,688

 
$
8,587

Other comprehensive income (loss), net of tax:
 
 
 
 
 
 
 
Foreign currency translation adjustment
1,277

 
1,421

 
(2,478
)
 
(446
)
Change in net unrealized gain (loss) on investments
14

 
106

 
(10
)
 
43

Less income tax (provision) benefit
(5
)
 
(39
)
 
4

 
(16
)
Reclassification of realized gain on investments included in net income (1)

 

 

 
(7
)
Less income tax benefit (2)

 

 

 
3

Other comprehensive income (loss), net of tax
1,286

 
1,488

 
(2,484
)
 
(423
)
Comprehensive income
$
2,617

 
$
3,625

 
$
1,204

 
$
8,164

(1) Recorded in Other (expense) income, net on our Condensed Consolidated Statements of Operations.
(2) Recorded in Income tax provision in our Condensed Consolidated Statements of Operations.
The accompanying notes are an integral part of the condensed consolidated financial statements.


2


DIGI INTERNATIONAL INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
 
March 31, 2017
 
September 30, 2016
 
(in thousands, except share data)
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
71,895

 
$
75,727

Marketable securities
36,081

 
58,382

Accounts receivable, net
28,720

 
28,685

Inventories
30,519

 
26,276

Receivable from sale of business
1,978

 
2,997

Other
4,399

 
3,578

Total current assets
173,592

 
195,645

Marketable securities, long-term
2,262

 
3,541

Property, equipment and improvements, net
13,613

 
14,041

Identifiable intangible assets, net
13,164

 
4,041

Goodwill
129,921

 
109,448

Deferred tax assets
6,974

 
7,295

Receivable from sale of business

 
1,959

Other
153

 
196

Total assets
$
339,679

 
$
336,166

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
10,754

 
$
8,569

Income taxes payable
131

 
167

Accrued compensation
4,198

 
10,787

Accrued professional fees
1,134

 
753

Unearned revenue
1,636

 
361

Contingent consideration on acquired businesses
1,234

 
513

Other
2,703

 
2,658

Total current liabilities
21,790

 
23,808

Income taxes payable
1,380

 
1,490

Deferred tax liabilities
532

 
616

Contingent consideration on acquired businesses
8,834

 
9,447

Other non-current liabilities
740

 
776

Total liabilities
33,276

 
36,137

Contingencies (see Note 11)

 

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; 32,954,369 and 32,471,175 shares issued
330

 
325

Additional paid-in capital
242,836

 
237,492

Retained earnings
144,800

 
141,112

Accumulated other comprehensive loss
(27,175
)
 
(24,691
)
Treasury stock, at cost, 6,425,658 and 6,430,797 shares
(54,388
)
 
(54,209
)
Total stockholders’ equity
306,403

 
300,029

Total liabilities and stockholders’ equity
$
339,679

 
$
336,166

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

3


DIGI INTERNATIONAL INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
 
Six months ended March 31,
 
2017
 
2016
 
(in thousands)
Operating activities:
 
 
 
Net income
$
3,688

 
$
8,587

Adjustments to reconcile net income to net cash (used in) provided by operating activities:
 
 
 
Depreciation of property, equipment and improvements
1,449

 
1,405

Amortization of identifiable intangible assets
941

 
1,001

Stock-based compensation
2,328

 
1,719

Excess tax benefits from stock-based compensation
(315
)
 
(202
)
Deferred income tax provision
242

 
1,397

Gain on sale of business

 
(2,870
)
Change in fair value of contingent consideration
(684
)
 
123

Bad debt/product return provision
296

 
168

Inventory obsolescence
600

 
834

Restructuring charges

 
753

Other
51

 
59

Changes in operating assets and liabilities (net of acquisitions)
(9,473
)
 
(1,486
)
Net cash (used in) provided by operating activities
(877
)
 
11,488

Investing activities:
 
 
 
Purchase of marketable securities
(33,470
)
 
(22,056
)
Proceeds from maturities and sales of marketable securities
57,039

 
27,509

Proceeds from sale of Etherios
3,000

 
2,849

Acquisition of businesses, net of cash acquired
(29,994
)
 
(2,860
)
Purchase of property, equipment, improvements and certain other identifiable intangible assets
(984
)
 
(1,209
)
Net cash (used in) provided by investing activities
(4,409
)
 
4,233

Financing activities:
 
 
 
Acquisition earn-out payments
(518
)
 

Excess tax benefits from stock-based compensation
315

 
202

Proceeds from stock option plan transactions
3,246

 
6,267

Proceeds from employee stock purchase plan transactions
479

 
494

Purchases of common stock
(587
)
 
(503
)
Net cash provided by financing activities
2,935

 
6,460

Effect of exchange rate changes on cash and cash equivalents
(1,481
)
 
71

Net (decrease) increase in cash and cash equivalents
(3,832
)
 
22,252

Cash and cash equivalents, beginning of period
75,727

 
45,018

Cash and cash equivalents, end of period
$
71,895

 
$
67,270

 
 
 
 
Supplemental schedule of non-cash investing and financing activities:
 
 
 
Receivable related to sale of Etherios
$

 
$
4,906

Liability related to acquisition of businesses
$
(1,310
)
 
$
(10,550
)
Accrual for purchase of property, equipment, improvements and certain other identifiable intangible assets
$
(66
)
 
$

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

4

DIGI INTERNATIONAL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)


1. BASIS OF PRESENTATION OF UNAUDITED INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS AND SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation
The interim unaudited condensed consolidated financial statements included in this Form 10-Q have been prepared by Digi International Inc. (the “Company,” “Digi,” “we,” “our,” or “us”) pursuant to the rules and regulations of the United States Securities and Exchange Commission (the “SEC”). Certain information and footnote disclosures, normally included in consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”), have been condensed or omitted pursuant to such rules and regulations. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes thereto, including (but not limited to) the summary of significant accounting policies, presented in our Annual Report on Form 10-K for the year ended September 30, 2016, as filed with the SEC (“2016 Financial Statements”).
The condensed consolidated financial statements presented herein reflect, in the opinion of management, all adjustments which consist only of normal, recurring adjustments necessary for a fair presentation of the condensed consolidated balance sheets and condensed consolidated statements of operations, comprehensive income and cash flows for the periods presented. The condensed consolidated results of operations for any interim period are not necessarily indicative of results for the full year. The year-end condensed consolidated balance sheet data were derived from our 2016 Financial Statements, but do not include all disclosures required by U.S. GAAP.
Reclassifications
Certain prior year amounts have been reclassified to conform to our fiscal year 2017 presentation. On the Condensed Consolidated Balance Sheet for the period ended September 30, 2016, Unearned revenue and Accrued professional fees have been reclassified from Other current liabilities to its own respective line item. In the Condensed Consolidated Cash Flows, for the six months ended March 31, 2016, the Change in fair value of contingent consideration within the Operating activities was reclassified from Other to its own line item. These reclassifications had no impact on our consolidated net sales or our consolidated net income.
Recently Issued Accounting Pronouncements
Not Yet Adopted
In January 2017, the Financial Accounting Standards Board (“FASB”) issued ASU 2017-04, “Intangibles-Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment.” ASU 2017-04 eliminates the second step in the goodwill impairment test which requires an entity to determine the implied fair value of the reporting unit’s goodwill. Instead, an entity should perform its annual or interim goodwill impairment test by comparing the fair value of a reporting unit with its carrying value and recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value, not to exceed the total amount of goodwill allocated to the reporting unit. The standard, which should be applied prospectively, is effective for fiscal years beginning after December 15, 2019, which for us is our fiscal year beginning October 1, 2020. Early adoption is permitted. We are currently evaluating the impact of the adoption of ASU 2017-04 on our consolidated financial statements.
In August 2016, FASB issued ASU 2016-15, “Statement of Cash Flows (Topic 230), Classification of Certain Cash Receipts and Cash Payments.” The amendments in this update provide guidance on eight specific cash flow issues, thereby reducing the diversity in practice in how certain transaction are classified in the statement of cash flows. This ASU is effective for annual periods and interim periods for those annual periods beginning after December 15, 2017, which for us is the first quarter ended December 31, 2018. Early adoption is permitted. We are currently evaluating the impact of the adoption of ASU 2016-15 on our consolidated financial statements.
In June 2016, the FASB issued ASU 2016-13, “Financial Instruments - Credit Losses (Topic 326), Measurement of Credit Losses on Financial Instruments.” The amendments in this update replace the incurred loss impairment methodology in current U.S. GAAP with a methodology that reflects expected credit losses. This update is intended to provide financial statement users with more decision-useful information about the expected credit losses. This ASU is effective for annual periods and interim periods for those annual periods beginning after December 15, 2019, which for us is the first quarter ended

5


1. BASIS OF PRESENTATION OF UNAUDITED INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
December 31, 2020. Entities may early adopt beginning after December 15, 2018. We are currently evaluating the impact of the adoption of ASU 2016-13 on our consolidated financial statements.
In March 2016, FASB issued ASU 2016-09, “Improvements to Employee Share-Based Payment Accounting.” This update includes provisions intended to simplify various aspects related to how share-based payments are accounted for and presented in the financial statements. This ASU is effective for annual periods and interim periods within those annual periods beginning after December 15, 2016, which for us is the first fiscal quarter ending December 31, 2017. Early adoption is permitted. We will adopt ASU 2016-09 beginning October 1, 2017. We are currently evaluating the impact of the adoption of ASU 2016-09 on our consolidated financial statements. Prospectively, beginning October 1, 2017, excess tax benefits and tax deficiencies will be reflected as income tax benefit or expense in our Consolidated Statement of Operations and could result in a material impact. The extent of the excess tax benefits or tax deficiencies are subject to variation in our stock price and the timing of restricted stock unit (“RSU”) vestings and employee stock option exercises.
In February, 2016, FASB issued ASU 2016-02, “Leases (Topic 842)”, which amends the existing guidance to require lessees to recognize lease assets and lease liabilities from operating leases on the balance sheet. This ASU is effective using the modified retrospective approach for annual periods and interim periods within those annual periods beginning after December 15, 2018, which for us is the first fiscal quarter ending December 31, 2019. Early adoption is permitted. We are currently evaluating the impact of the adoption of ASU 2016-02 on our consolidated financial statements.
In January 2016, FASB issued ASU 2016-01, “Financial Instruments - Overall: Recognition and Measurement of Financial Assets and Financial Liabilities.” ASU 2016-01 will require equity investments in unconsolidated entities (other than those accounted for using the equity method of accounting) to be measured at fair value with changes in fair value recognized in net income. The amendments in this update will also simplify the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment, eliminate the requirement for public business entities to disclose the method and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet and require these entities to use the exit price notion when measuring fair value of financial instruments for disclosure purposes. This ASU would also change the presentation and disclosure requirements for financial instruments. In addition, this ASU clarifies the guidance related to valuation allowance assessment when recognizing deferred tax assets resulting from unrealized losses on available-for-sale debt securities. The amendments in this ASU are effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years, which for us is the first fiscal quarter ending December 31, 2018. Early adoption is permitted for financial statements of fiscal years and interim periods that have not been issued. We are currently evaluating the impact of the adoption of ASU 2016-01.
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 be recorded at lower of cost or 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 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 our annual period 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 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

6


1. BASIS OF PRESENTATION OF UNAUDITED INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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. In addition, the FASB issued ASU 2016-08, ASU 2016-10 and ASU 2016-12 in March 2016, April 2016 and May 2016, respectively, to provide interpretive clarifications on the new guidance in ASC Topic 606. We are currently working through an adoption plan and have identified our revenue streams and completed a preliminary analysis of how we currently account for revenue transactions compared to the revenue accounting required under the new standard.  We intend to complete our adoption plan in fiscal 2017.  This plan includes a review of transactions supporting each revenue stream to determine the impact of accounting treatment under ASC 606, evaluation of the method of adoption, and completing a rollout plan for implementation of the new standard with affected functions in our organization.  Because of the nature of the work that remains, at this time we are unable to reasonably estimate the impact of adoption on our consolidated financial statements.  We plan to adopt the new guidance beginning October 1, 2018.
2. ACQUISITIONS
On May 4, 2017, we announced the rebranding of our Digi Cold Chain Solutions to Digi Smart Solutions™ group.
Acquisition of SMART Temps, LLC
On January 9, 2017, we purchased all of the outstanding interests of SMART Temps, LLC (“SMART Temps”), an Indiana-based provider of real-time temperature management for pharmacies, education, and hospital settings as well as real-time temperature management for blood bank, laboratory environments, restaurants, and grocery. We believe this is a complementary acquisition for us as the acquired technology will continue to be supported to further enhance our portfolio of products for the Digi Smart Solution’s market.
The terms of the acquisition included an upfront cash payment together with future earn-out payments. Cash of $28.8 million (excluding cash acquired of $0.5 million) was paid at time of closing. The earn-out payments are scheduled to be paid after December 31, 2017 which is the end of the earn-out period. The cumulative amount of these earn-out payments will not exceed $7.2 million. The fair value of this contingent consideration was $10,000 at the date of acquisition and March 31, 2017 (see Note 7 to the Condensed Consolidated Financial Statements). We have determined that the earn-out will be considered as part of the purchase price consideration as there are no continuing employment requirements associated with the earn-out.
The purchase price was allocated to the estimated fair value of assets acquired and liabilities assumed. The preliminary purchase price allocation resulted in the recognition of $18.6 million of goodwill. For tax purposes, this acquisition is treated as an asset acquisition, therefore the goodwill is deductible. We believe that the acquisition resulted in the recognition of goodwill because this is a complementary acquisition for us and will provide a source of recurring revenue in a new vertically focused solutions business.
The SMART Temps acquisition has been accounted for using the acquisition method of accounting which requires, among other things, that assets acquired and liabilities assumed pursuant to the purchase agreement be recognized at fair value as of the acquisition date. The following table summarizes the preliminary values of SMART Temps assets acquired and liabilities assumed as of the acquisition date (in thousands):
Cash
$
28,754

Fair value of contingent consideration on acquired business
10

Total purchase price consideration
$
28,764

 
 
Fair value of net tangible assets acquired
$
897

Fair value of identifiable intangible assets acquired:
 
Purchased and core technology
4,000

Customer relationships
4,000

Trade name and trademarks
711

Non-compete agreements
600

Goodwill
18,556

Total
$
28,764


7


2. ACQUISITIONS (CONTINUED)
Operating results for SMART Temps are included in our Condensed Consolidated Statements of Operations from January 9, 2017. The Condensed Consolidated Balance Sheet as of March 31, 2017 reflects the preliminary allocation of the purchase price to the assets acquired and liabilities assumed based on their estimated fair values at the date of acquisition. The purchase price may vary as the identifiable intangibles values and net working capital values are preliminary, and we expect to finalize them by the end of fiscal 2017.
As of the date of acquisition, the weighted average useful life for all the identifiable intangibles listed above was 10.5 years. For purposes of determining fair value, the purchased and core technology identified above is assumed to have a useful life of ten years, the customer relationships are assumed to have useful lives of twelve years, the trade name and trademarks are assumed to have useful lives of ten years and the non-compete agreements are assumed to have useful lives of five years. Useful lives for identifiable intangible assets are estimated at the time of acquisition based on the periods of time from which we expect to derive benefits from the identifiable intangible assets.
The amounts of revenue and net loss included in the Condensed Consolidated Statements of Operations from the acquisition date of January 9, 2017 were $1.3 million and $(0.4) million, respectively. Costs directly related to the acquisition, including legal, accounting and valuation fees of approximately $0.8 million have been charged directly to operations and are included in general and administrative expense in our Condensed Consolidated Statements of Operations.
The following consolidated pro forma information is as if the acquisition had occurred on October 1, 2015 (in thousands):
 
Three months ended
March 31,
 
Six months ended March 31,
 
2016
 
2017
 
2016
Revenue
$
51,041

 
$
91,724

 
$
103,011

Income from continuing operations
$
1,892

 
$
3,112

 
$
4,804

Net income
$
1,803

 
$
3,112

 
$
8,034

Pro forma income from continuing operations and net income were both adjusted to exclude interest expense related to debt that was paid off prior to acquisition, adjust amortization to the fair value of the intangibles acquired and remove any costs that SMART Temps incurred associated with the sale transaction.
Acquisition of FreshTemp, LLC
On November 1, 2016, we purchased all of the outstanding interests of FreshTemp, LLC (“FreshTemp”), a Pittsburgh-based provider of temperature monitoring and task management solutions for the food industry. We believe this is a complementary acquisition for us as the acquired technology will continue to be supported to create an advanced portfolio of products for the Digi Smart Solution's market.
The terms of the acquisition included an upfront cash payment together with future earn-out payments and a holdback amount. Cash of $1.7 million was paid at time of closing. The earn-out payments are based on revenue related to certain customer contracts entered into by June 30, 2017. The final calculation date will be on June 30, 2018. The cumulative amount of these earn-out payments will not exceed $2.3 million. The fair value of this contingent consideration was $1.3 million at the date of acquisition and $1.5 million at March 31, 2017 (see Note 7 to the Condensed Consolidated Financial Statements). We have determined that the earn-out will be considered as part of the purchase price consideration as there are no continuing employment requirements associated with the earn-out. Costs directly related to the acquisition, including legal, accounting and valuation fees, of approximately $50,000 have been charged directly to operations and are included in general and administrative expense in our Condensed Consolidated Statements of Operations.
The purchase price was allocated to the estimated fair value of assets acquired and liabilities assumed. The purchase price allocation resulted in the recognition of $2.7 million of goodwill. For tax purposes, this acquisition is treated as an asset acquisition, therefore the goodwill is deductible. We believe that the acquisition resulted in the recognition of goodwill because this is a complementary acquisition for us and will provide a source of recurring revenue in a new vertically focused solutions business.
The FreshTemp acquisition has been accounted for using the acquisition method of accounting which requires, among other things, that assets acquired and liabilities assumed pursuant to the purchase agreement be recognized at fair value as of the acquisition date.

8


2. ACQUISITIONS (CONTINUED)
The following table summarizes the final values of FreshTemp assets acquired and liabilities assumed as of the acquisition date (in thousands):
Cash
$
1,697

Purchase price payable upon completion of diligence matters
303

Fair value of contingent consideration on acquired business
1,300

Working capital adjustment
(37
)
Total purchase price consideration
$
3,263

 
 
Fair value of net tangible assets acquired
$
(37
)
Fair value of identifiable intangible assets acquired:
 
Purchased and core technology
400

Customer relationships
250

Goodwill
2,650

Total
$
3,263

Operating results for FreshTemp are included in our Condensed Consolidated Statements of Operations from November 1, 2016. The Condensed Consolidated Balance Sheet as of March 31, 2017 reflects the final allocation of the purchase price to the assets acquired and liabilities assumed based on their estimated fair values at the date of acquisition. The identifiable intangibles values and net working capital values were finalized in the second fiscal quarter of 2017.
The weighted average useful life for all the identifiable intangibles listed above is 5.8 years. For purposes of determining fair value, the purchased and core technology identified above is assumed to have a useful life of five years and the customer relationships are assumed to have useful lives of seven years. Useful lives for identifiable intangible assets are estimated at the time of acquisition based on the periods of time from which we expect to derive benefits from the identifiable intangible assets.
Since the FreshTemp acquisition occurred close to the beginning of our fiscal 2017, the pro forma amounts would not be materially different from actual amounts. Revenue for both the three and six months ended March 31, 2017 related to the FreshTemp acquisition was $0.2 million. As our operating costs related to the FreshTemp acquisition are integrated into the Company’s operating income and related earnings per share, the separate FreshTemp amounts are not determinable for fiscal 2017. Pro forma information for fiscal 2016 was not materially different from actual amounts.
Acquisition of Bluenica Corporation
On October 5, 2015, we purchased all of the outstanding stock of Bluenica Corporation (“Bluenica”), 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.  This acquisition formed the basis for our Digi Smart Solutions.
The terms of the acquisition included an upfront cash payment together with earn-out payments.  Cash of $2.9 million was paid at time of closing.  The earn-out payments are scheduled to be paid in installments over a four-year period based on revenue achievement of the acquired business. Each of the earn-out payments will be calculated based on the revenue performance of Digi Smart Solutions for each respective earn-out period. The cumulative amount of these earn-out payments will not exceed $11.6 million.  An additional payment, not to exceed $3.5 million, may also be due depending on revenue performance.
The fair value of this contingent consideration was $10.4 million at the date of acquisition and $8.6 million at March 31, 2017 (see Note 7 to the Condensed Consolidated Financial Statements). We have determined that the earn-out will be considered as part of the purchase price consideration as there are no continuing employment requirements associated with the earn-out.
The purchase price was allocated to the estimated fair value of assets acquired and liabilities assumed. The purchase price allocation resulted in the recognition of $11.0 million of goodwill. We believe that the acquisition resulted in the recognition of goodwill because this is a complementary acquisition for us and will provide a source of recurring revenue in a new vertically focused solutions business. Operating results for Bluenica are included in our Condensed Consolidated Statements of Operations from October 6, 2015.

9


3. DISCONTINUED OPERATIONS
On October 23, 2015, we sold all the outstanding stock of our wholly owned subsidiary, Etherios Inc. (“Etherios”) to West Monroe Partners, LLC. We sold Etherios as part of a strategy to focus on providing highly reliable machine connectivity solutions for business and mission-critical application environments. Etherios was included in our single operating segment.
The terms of the sale agreement provided that West Monroe Partners, LLC would pay us $3.0 million on October 23, 2016 and $2.0 million on October 23, 2017. The present value of these amounts was included within the total fair value of consideration received. These receivable amounts are unsecured and non-interest bearing. We received $3.0 million in October 2016. The carrying value of the remaining receivable of $2.0 million presented on our Condensed Consolidated Balance Sheet at March 31, 2017 approximates its fair value, which was determined using Level 3 cash flow fair value measurement techniques.
Goodwill was included in the net assets of Etherios based on the relative fair value of Etherios compared to the fair value of the Company, as the Company consists of a single reporting unit for goodwill impairment testing purposes.
As a condition to the sale agreement, we retained the operating leases in the Dallas and Chicago locations. Digi ceased using these facilities in October 2015 and has sublet the Dallas location to West Monroe Partners, LLC through December 31, 2017. In January 2017, we signed an early-termination agreement along with an immaterial payment to exit our Chicago lease. Also in connection with the sale, we assigned our San Francisco lease to West Monroe Partners, LLC.
Income from discontinued operations, after income taxes, as presented in the Condensed Consolidated Statements of Operations for the three and six months ended March 31, 2016 is as follows (in thousands):
 
Three months ended March 31, 2016
 
Six months ended March 31, 2016
Service revenue
$

 
$
891

Cost of service

 
713

Gross profit

 
178

Operating expenses:
 
 
 
Sales and marketing

 
148

Research and development

 
103

General and administrative

 
43

Total operating expenses

 
294

Loss from discontinued operations, before income taxes

 
(116
)
(Loss) gain on sale of discontinued operations, before income taxes
(42
)
 
2,870

Total (loss) income from discontinued operations, before income taxes
(42
)
 
2,754

Income tax expense (benefit) on discontinued operations
47

 
(476
)
(Loss) income from discontinued operations, after income taxes
$
(89
)
 
$
3,230

Income tax benefit on discontinued operations for the six months ended March 31, 2016, was $0.5 million, which primarily represented income tax benefits for deductible transaction costs, partially offset by a tax expense for equity awards for which we will not receive a tax deduction. For tax purposes, this transaction resulted in a capital loss, as the tax basis of the Etherios stock was higher than the book basis of the assets that were sold. Since we do not expect to be able to utilize this capital loss in the five year carryforward period, a deferred tax asset offset by a full valuation allowance was recorded in the third quarter of fiscal 2016 upon completion of the capital loss calculation.
The following table presents amortization, depreciation and purchases of property, equipment, improvements and certain other identifiable intangible assets of the discontinued operations related to Etherios (in thousands):
 
Six months ended
 
March 31, 2016
Amortization of identifiable intangible assets
$
30

Depreciation of property, equipment and improvements
$

Purchases of property, equipment, improvements and certain other identifiable intangible assets
$



10


4. EARNINGS PER SHARE
Basic net income per common share is calculated based on the weighted average number of common shares outstanding during the period. Diluted net income per common share is computed by dividing net income by the weighted average number of common shares and potentially dilutive common shares outstanding during the period. Potentially dilutive common shares result from dilutive common stock options and restricted stock units. The following table is a reconciliation of the numerators and denominators in the net income per common share calculations (in thousands, except per common share data):
 
Three months ended March 31,
 
Six months ended March 31,
 
2017
 
2016
 
2017
 
2016
Numerator:
 
 
 
 
 
 
 
Income from continuing operations
$
1,331

 
$
2,226

 
$
3,688

 
$
5,357

(Loss) income from discontinued operations, after income taxes

 
(89
)
 

 
3,230

Net income
$
1,331

 
$
2,137

 
$
3,688

 
$
8,587

 
 
 
 
 
 
 
 
Denominator:
 
 
 
 
 
 
 
Denominator for basic net income per common share — weighted average shares outstanding
26,477

 
25,820

 
26,324

 
25,574

Effect of dilutive securities:
 
 
 
 
 
 
 
Stock options and restricted stock units
775

 
178

 
810

 
542

Denominator for diluted net income per common share — adjusted weighted average shares
27,252

 
25,998

 
27,134

 
26,116

 
 
 
 
 
 
 
 
Basic net income per common share:
 
 
 
 
 
 
 
Continuing operations
$
0.05

 
$
0.09

 
$
0.14

 
$
0.21

Discontinued operations
$

 
$

 
$

 
$
0.13

Net income (1)
$
0.05

 
$
0.08

 
$
0.14

 
$
0.34

Diluted net income per common share:
 
 
 
 
 
 
 
Continuing operations
$
0.05

 
$
0.09

 
$
0.14

 
$
0.21

Discontinued operations
$

 
$

 
$

 
$
0.12

Net income (1)
$
0.05

 
$
0.08

 
$
0.14

 
$
0.33

(1)
Earnings per share presented are calculated by line item and may not add due to the use of rounded amounts.
For the three months ended March 31, 2017 and 2016, there were 730,400 and 2,735,177 potentially dilutive shares, respectively, and for the six months ended March 31, 2017 and 2016, there were 1,077,150 and 1,495,104 potentially dilutive shares, respectively, related to stock options to purchase common shares that were not included in the above computation of diluted earnings per common share. This is because the options’ exercise prices were greater than the average market price of our common shares.

11


5. SELECTED BALANCE SHEET DATA
The following table shows selected balance sheet data (in thousands):
 
March 31,
2017
 
September 30, 2016
Accounts receivable, net:
 
 
 
Accounts receivable
$
31,195

 
$
30,885

Less allowance for doubtful accounts
257

 
209

Less reserve for future returns and pricing adjustments
2,218

 
1,991

Accounts receivable, net
$
28,720

 
$
28,685

Inventories:
 
 
 
Raw materials
$
23,922

 
$
21,116

Work in process
591

 
802

Finished goods
6,006

 
4,358

Inventories
$
30,519

 
$
26,276

Inventories are stated at the lower of cost or market value, with cost determined using the first-in, first-out method.
6. MARKETABLE SECURITIES
Our marketable securities consist of certificates of deposit, commercial paper, corporate bonds and government municipal bonds. We analyze our available-for-sale marketable securities for impairment on an ongoing basis. When we perform this analysis, we consider factors such as the length of time and extent to which the securities have been in an unrealized loss position and the trend of any unrealized losses. We also consider whether an unrealized loss is a temporary loss or an other-than-temporary loss based on factors such as: (a) whether we have the intent to sell the security, (b) whether it is more likely than not that we will be required to sell the security before its anticipated recovery, or (c) permanent impairment due to bankruptcy or insolvency.
In order to estimate the fair value for each security in our investment portfolio, we obtain quoted market prices and trading activity for each security where available. We obtain relevant information from our investment advisor and, if warranted, also may review the financial solvency of certain security issuers. As of March 31, 2017, 14 of our 42 securities that we held were trading below our amortized cost basis. We determined each decline in value to be temporary based upon the above described factors. We expect to realize the fair value of these securities, plus accrued interest, either at the time of maturity or when the security is sold. All of our current holdings are classified as available-for-sale marketable securities and are recorded at fair value on our consolidated balance sheet with the unrealized gains and losses recorded in accumulated other comprehensive income (loss). All of our current marketable securities will mature in less than one year and our non-current marketable securities will mature in less than two years. Our balance sheet classification of available for sale securities is based on our best estimate of when we expect to liquidate such investments and, presently, is consistent with the stated maturity dates of such investments. However, we are not committed to holding these investments until their maturity and may determine to liquidate some or all of these investments earlier based on our liquidity and other needs. During the six months ended March 31, 2017 and 2016, we received proceeds from our available-for-sale marketable securities of $57.0 million and $27.5 million, respectively.

12


6. MARKETABLE SECURITIES (CONTINUED)
At March 31, 2017 our marketable securities were (in thousands):
 
Amortized
Cost (1)
 
Unrealized
Gains
 
Unrealized
Losses
 
Fair Value (1)
Current marketable securities:
 
 
 
 
 
 
 
Corporate bonds
$
25,360

 
$

 
$
(29
)
 
$
25,331

Commercial paper
5,988

 

 
(2
)
 
5,986

Certificates of deposit
4,757

 
7

 

 
4,764

Current marketable securities
36,105

 
7

 
(31
)
 
36,081

Non-current marketable securities:
 
 
 
 
 
 
 
Certificates of deposit
2,253

 
9

 

 
2,262

Total marketable securities
$
38,358

 
$
16

 
$
(31
)
 
$
38,343

(1)
Included in amortized cost and fair value is purchased and accrued interest of $189.
At September 30, 2016 our marketable securities were (in thousands):
 
Amortized
Cost (1)
 
Unrealized
Gains
 
Unrealized
Losses
 
Fair Value (1)
Current marketable securities:
 
 
 
 
 
 
 
Corporate bonds
$
28,801

 
$

 
$
(34
)
 
$
28,767

Commercial paper
23,963

 

 
(20
)
 
23,943

Certificates of deposit
3,755

 
13

 

 
3,768

Government municipal bonds
1,904

 

 

 
1,904

Current marketable securities
58,423

 
13

 
(54
)
 
58,382

Non-current marketable securities:
 
 
 
 
 
 
 
Certificates of deposit
3,505

 
36

 

 
3,541

Total marketable securities
$
61,928

 
$
49

 
$
(54
)
 
$
61,923

(1)
Included in amortized cost and fair value is purchased and accrued interest of $271.
The following tables show the fair values and gross unrealized losses of our available-for-sale marketable securities that have been in a continuous unrealized loss position deemed to be temporary, aggregated by investment category (in thousands):
 
March 31, 2017
 
Less than 12 Months
 
More than 12 Months
 
Fair Value
 
Unrealized Losses
 
Fair Value
 
Unrealized Losses
Corporate bonds
$
25,331

 
$
(29
)
 
$

 
$

Commercial paper
5,986

 
(2
)
 

 

Total
$
31,317

 
$
(31
)
 
$

 
$

 
September 30, 2016
 
Less than 12 Months
 
More than 12 Months
 
Fair Value
 
Unrealized Losses
 
Fair Value
 
Unrealized Losses
Corporate bonds
$
24,454

 
$
(33
)
 
$
4,102

 
$
(1
)
Commercial paper
23,943

 
(20
)
 

 

Total
$
48,397

 
$
(53
)
 
$
4,102

 
$
(1
)

13


7. FAIR VALUE MEASUREMENTS
Fair value is defined as the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants as of the measurement date. This standard also establishes a hierarchy for inputs used in measuring fair value. This standard maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available. Observable inputs are inputs market participants would use in valuing the asset or liability based on market data obtained from independent sources. Unobservable inputs are inputs that reflect our assumptions about the factors market participants would use in valuing the asset or liability based upon the best information available in the circumstances.
The categorization of financial assets and liabilities within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement. The hierarchy is broken down into three levels. Level 1 inputs are quoted prices in active markets for identical assets or liabilities. Level 2 inputs include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, and inputs (other than quoted prices) that are observable for the asset or liability, either directly or indirectly. Level 3 inputs are unobservable for the asset or liability and their fair values are determined using pricing models, discounted cash flow methodologies or similar techniques and at least one significant model assumption or input is unobservable. Level 3 may also include certain investment securities for which there is limited market activity or a decrease in the observability of market pricing for the investments, such that the determination of fair value requires significant judgment or estimation.
Fair value is applied to financial assets such as our marketable securities, which are classified and accounted for as available-for-sale and to financial liabilities for contingent consideration. These items are stated at fair value at each reporting period using the above guidance.
The following tables provide information by level for financial assets and liabilities that are measured at fair value on a recurring basis (in thousands):
 
Total Fair
Value at
 
Fair Value Measurements Using
 Inputs Considered as
 
March 31, 2017
 
Level 1
 
Level 2
 
Level 3
Assets:
 
 
 
 
 
 
 
Money market
$
37,125

 
$
37,125

 
$

 
$

Corporate bonds
25,331

 

 
25,331

 

Commercial paper
5,986

 

 
5,986

 

Certificates of deposit
7,026

 

 
7,026

 

Total assets measured at fair value
$
75,468

 
$
37,125

 
$
38,343

 
$

Liabilities:
 
 
 
 
 
 
 
Contingent consideration on acquired businesses
10,068

 
$

 
$

 
$
10,068

Total liabilities measured at fair value
$
10,068

 
$

 
$

 
$
10,068


 
Total Fair
Value at
 
Fair Value Measurements Using
 Inputs Considered as
 
September 30, 2016
 
Level 1
 
Level 2
 
Level 3
Assets:
 
 
 
 
 
 
 
Money market
$
44,319

 
$
44,319

 
$

 
$

Corporate bonds
28,767

 

 
28,767

 

Commercial paper
23,943

 

 
23,943

 

Certificates of deposit
7,309

 

 
7,309

 

Government municipal bonds
1,904

 

 
1,904

 

Total assets measured at fair value
$
106,242

 
$
44,319

 
$
61,923

 
$

Liabilities:
 
 
 
 
 
 
 
Contingent consideration on acquired businesses
$
9,960

 
$

 
$

 
$
9,960

Total liabilities measured at fair value
$
9,960

 
$

 
$

 
$
9,960


14


7. FAIR VALUE MEASUREMENTS (CONTINUED)
Our money market funds, which have been determined to be cash equivalents, are measured at fair value using quoted market prices in active markets for identical assets and are therefore classified as Level 1 assets. We value our Level 2 assets using inputs that are based on market indices of similar assets within an active market. There were no transfers into or out of our Level 2 financial assets during the six months ended March 31, 2017.
The use of different assumptions, applying different judgment to matters that inherently are subjective and changes in future market conditions could result in different estimates of fair value of our securities or contingent consideration, currently and in the future. If market conditions deteriorate, we may incur impairment charges for securities in our investment portfolio. We may also incur changes to our contingent consideration liability as discussed below.
As discussed in Note 2, we are required to make contingent payments for our acquisitions. In connection with the Bluenica acquisition, we are required to make contingent payments over a period of up to four years, subject to Digi Smart Solutions achieving specified revenue thresholds. The fair value of the liability for contingent payments recognized upon acquisition was $10.4 million. In connection with the FreshTemp acquisition, we are required to make a contingent payment after June 30, 2018, for revenue related to specific customer contracts signed by June 30, 2017. The fair value of the liability recognized upon acquisition was $1.3 million. For the SMART Temps acquisition, we are required to make a contingent payment after December 31, 2017 based on achieving specified revenue thresholds. The fair value of the liability for contingent payments recognized upon acquisition was $10,000. The fair values of these contingent payments was estimated by discounting to present value the probability-weighted contingent payments expected to be made. Assumptions used in these calculations include the discount rate and various probability factors. This liability is considered to be a Level 3 financial liability that is re-measured each reporting period as a charge or credit to general and administrative expense within the Condensed Consolidated Statements of Operations.
The following table presents a reconciliation of the contingent consideration liability measured at fair value on a recurring basis using significant unobservable inputs (Level 3) (in thousands):
 
Three months ended March 31,
 
Six months ended March 31,
 
2017
 
2016
 
2017
 
2016
Fair value at beginning of period
$
10,660

 
$
10,400

 
$
9,960

 
$

Purchase price contingent consideration
10

 

 
1,310

 
10,400

Contingent consideration payments

 

 
(518
)
 

Change in fair value of contingent consideration
(602
)
 
122

 
(684
)
 
122

Fair value at end of period
$
10,068

 
$
10,522

 
$
10,068

 
$
10,522

The change in fair value of contingent consideration relates to the acquisitions of Bluenica, FreshTemp and SMART Temps and is included in general and administrative expense. The change in fair value of contingent consideration reflects our estimate of the probability of achieving the relevant targets and is discounted based on our estimated discount rate. We have estimated the fair value of the contingent consideration based on the probability of achieving the specified revenue thresholds at 94.8% to 98.0% for Bluenica, between 25% and 100% for FreshTemp and 0.4% for SMART Temp. A significant increase (decrease) in our estimates of achieving the relevant targets could materially increase (decrease) the fair value of the contingent consideration liability.

15


8. GOODWILL AND OTHER IDENTIFIABLE INTANGIBLE ASSETS, NET
Amortizable identifiable intangible assets were (in thousands):
 
March 31, 2017
 
September 30, 2016
 
Gross
carrying
amount
 
Accum.
amort.
 
Net
 
Gross
carrying
amount
 
Accum.
amort.
 
Net
Purchased and core technology
$
50,720

 
$
(45,079
)
 
$
5,641

 
$
46,594

 
$
(44,999
)
 
$
1,595

License agreements
18

 
(12
)
 
6

 
18

 
(10
)
 
8

Patents and trademarks
12,334

 
(10,974
)
 
1,360

 
11,619

 
(10,871
)
 
748

Customer relationships
21,517

 
(15,930
)
 
5,587

 
17,463

 
(15,773
)
 
1,690

Non-compete agreements
600

 
(30
)
 
570

 

 

 

Total
$
85,189

 
$
(72,025
)
 
$
13,164

 
$
75,694

 
$
(71,653
)
 
$
4,041

Amortization expense was $0.6 million and $0.5 million for the three month periods ended March 31, 2017 and 2016, respectively. Amortization expense was $0.9 million and $1.0 million for the six month periods ended March 31, 2017 and 2016, respectively. Amortization expense is recorded on our consolidated statements of operations within cost of sales and in general and administrative expense. Estimated amortization expense related to identifiable intangible assets for the remainder of fiscal 2017 and the five succeeding fiscal years is (in thousands):
2017 (six months)
$
1,255

2018
2,475

2019
1,989

2020
1,476

2021
1,268

2022
1,097

The changes in the carrying amount of goodwill are (in thousands):
 
Six months ended
March 31,
 
2017
 
2016
Beginning balance, October 1
$
109,448

 
$
100,183

Acquisitions
21,206

 
11,020

Foreign currency translation adjustment
(733
)
 
(496
)
Ending balance, March 31
$
129,921

 
$
110,707

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. The calculation of goodwill impairment requires us to make assumptions about the fair value of our one reporting unit, which historically has been approximated by using our market capitalization plus a control premium. Control premium assumptions require judgment and actual results may differ from assumed or estimated amounts.
Our test for potential goodwill impairment is a two-step approach. We estimate the fair value for our one reporting unit by comparing its fair value (market capitalization plus control premium) to our carrying value. If the carrying value of the reporting unit exceeds its estimated fair value, the second step of the goodwill impairment analysis requires us to measure the amount of the impairment loss. An impairment loss is calculated by comparing the implied fair value of the goodwill to its carrying amount. To calculate the implied fair value of goodwill, the fair value of the reporting unit’s assets and liabilities, excluding goodwill, is estimated. The excess of the fair value of the reporting unit over the amount assigned to its assets and liabilities, excluding goodwill, is the implied fair value of the reporting unit’s goodwill.
If our stock price or control premium declines, the first step of our goodwill impairment analysis may fail. We have identified factors that could result in additional interim goodwill impairment testing. For example, we would perform the second step of the impairment testing if our stock price fell below certain thresholds for a significant period of time, or if our control premium significantly decreased. Events or circumstances may occur that could negatively impact our stock price, including changes in our anticipated revenues and profits and our ability to execute on our strategies. In addition, our control premium could decline due to changes in economic conditions in the technology industry or more generally in the financial markets. An impairment

16


8. GOODWILL AND OTHER IDENTIFIABLE INTANGIBLE ASSETS, NET (CONTINUED)
could have a material effect on our consolidated balance sheet and results of operations. There were no triggering events during the second quarter of fiscal 2017. We have had no goodwill impairment losses since the adoption of Accounting Standards Codification (“ASC”) 350, Intangibles-Goodwill and Others, in fiscal 2003.
9. INCOME TAXES
Income tax provision for continuing operations was $0.9 million for the six months ended March 31, 2017. Net tax benefits specific to the six months ended March 31, 2017 were $0.1 million resulting primarily from the reversal of tax reserves due to the expiration of statutes of limitation from U.S. and foreign tax jurisdictions. For the six months ended March 31, 2017, our continuing operations effective tax rate before items specific to the period was less than the U.S. statutory rate due primarily to the mix of income between taxing jurisdictions, certain of which have lower statutory tax rates than the U.S., and also due to certain tax credits in the U.S.
Income tax provision for continuing operations was $1.5 million for the six months ended March 31, 2016. Net tax benefits specific to the six months ended March 31, 2016 were $0.7 million which resulted from the reinstatement of the federal research and development tax credit for calendar year 2015 and reversal of tax reserves due to the expiration of statutes of limitation from U.S. and foreign tax jurisdictions. For the six months ended March 31, 2016, our continuing operations effective tax rate before items specific to the period was less than the U.S. statutory rate primarily due to the mix of income between taxing jurisdictions, certain of which have lower statutory tax rates than the U.S., and certain tax credits in the U.S.
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 tax items specific to the period, such as settlements of audits. We expect that we may record other benefits or expenses in the future that are specific to a particular quarter such as expiration of statutes of limitation, the completion of tax audits, or legislation that is enacted for both U.S. and foreign jurisdictions.
A reconciliation of the beginning and ending amount of unrecognized tax benefits is (in thousands):
Unrecognized tax benefits as of September 30, 2016
$
1,708

Decreases related to:
 
Expiration of statute of limitations
(79
)
Unrecognized tax benefits as of March 31, 2017
$
1,629

The total amount of unrecognized tax benefits that, if recognized, would affect our effective tax rate is $1.4 million, after considering the impact of interest and deferred benefit items. We expect that the total amount of unrecognized tax benefits will decrease by approximately $0.7 million over the next 12 months.
10. PRODUCT WARRANTY OBLIGATION
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 either repair or replace products we deem defective with regard 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 following table summarizes the activity associated with the product warranty accrual (in thousands) and is included on our Condensed Consolidated Balance Sheets within current liabilities:
 
Balance at
 
Warranties
 
Settlements
 
Balance at
Period
January 1
 
issued
 
made
 
March 31
Three months ended March 31, 2017
$
1,025

 
$
62

 
$
(195
)
 
$
892

Three months ended March 31, 2016
$
968

 
$
172

 
$
(196
)
 
$
944

 
 
 
 
 
 
 
 
 
Balance at
 
Warranties
 
Settlements
 
Balance at
Period
October 1
 
issued
 
made
 
March 31
Six months ended March 31, 2017
$
1,033

 
$
231

 
$
(372
)
 
$
892

Six months ended March 31, 2016
$
1,014

 
$
292

 
$
(362
)
 
$
944


17


10. PRODUCT WARRANTY OBLIGATION (CONTINUED)
We are not responsible for, and do not warrant that, custom software versions, created by original equipment manufacturer (“OEM”) customers based upon our software source code, will function in a particular way, will conform to any specifications or are fit for any particular purpose. Further, we do not indemnify these customers from any third-party liability as it relates to or arises from any customization or modifications made by the OEM customer.
11. CONTINGENCIES
In the normal course of business, we are subject to various claims and litigation. There can be no assurance that any claims by third parties, if proven to have merit, will not materially adversely affect our business, liquidity or financial condition.
12. STOCK-BASED COMPENSATION
Stock-based awards were granted under the 2017 Omnibus Incentive Plan (the “2017 Plan”) beginning January 30, 2017 and, prior to that, were granted under the 2016 Omnibus Incentive Plan (the “2016 Plan”). Upon stockholder approval of the 2017 Plan, we ceased granting awards under any prior plan. Shares remaining in the 2016 Plan were moved into the 2017 Plan. The authority to grant options under the 2017 Plan and to set other terms and conditions rests with the Compensation Committee of the Board of Directors.
The 2017 Plan authorizes the issuance of up to 1,500,000 common shares in connection with awards of stock options, stock appreciation rights, restricted stock, restricted stock units, performance-based full value awards or other stock-based awards. Eligible participants include our employees, our affiliates, non-employee directors of our Company and any consultant or advisor who is a natural person and provides services to us or our affiliates. Options that have been granted under the 2017 Plan typically vest over a four-year period and will expire if unexercised after seven years from the date of grant. Restricted stock unit awards (“RSUs”) that have been granted to directors typically vest in one year. RSUs that have been granted to executives and employees typically vest in January over a four-year period. Awards may be granted under the 2017 Plan until January 29, 2027. Options under the 2017 Plan can be granted as either incentive stock options (“ISOs”) or non-statutory stock options (“NSOs”). The exercise price of options and the grant date price of restricted stock units shall be determined by our Compensation Committee but shall not be less than the fair market value of our common stock based on the closing price on the date of grant. Upon exercise, we issue new shares of stock. As of March 31, 2017, there were approximately 1,465,545 shares available for future grants under the 2017 Plan.
The 2016 Plan, under which grants ceased upon approval of the 2017 Plan, initially authorized the issuance of up to 1,500,000 common shares in connection with awards of stock options, stock appreciation rights, restricted stock, restricted stock units, performance-based full value awards or other stock-based awards. Eligible participants included our employees, our affiliates, non-employee directors of our Company and any consultant or advisor who is a natural person and provides services to us or our affiliates. Options that were granted under the 2016 Plan typically vested over a four-year period and expired if unexercised after seven years from the date of grant. RSUs that were granted to directors typically vested in one year. RSUs that were granted to executives and employees typically vested in November or January over a four-year period. Options under the 2016 Plan could be granted as either ISOs or NSOs. The exercise price of options and the grant date price of restricted stock was determined by our Compensation Committee but were not less than the fair market value of our common stock based on the closing price on the date of grant. Upon exercise, we issued new shares of stock.
Our equity plans and corresponding forms of award agreements generally have provisions allowing employees to elect to satisfy tax withholding obligations through the delivery of shares, having us retain a portion of shares issuable under the award or paying cash to us for the withholding. During the six months ended March 31, 2017 and 2016, our employees forfeited 43,160 shares and 42,427 shares, respectively in order to satisfy $0.6 million and $0.5 million, respectively of withholding tax obligations related to stock-based compensation, pursuant to terms of awards under our board and shareholder-approved compensation plans for each respective period.
Cash received from the exercise of stock options was $3.2 million and $6.3 million during the six months ended March 31, 2017 and 2016, respectively. There were $0.3 million and $0.2 million in excess tax benefits from stock-based compensation for the six months ended March 31, 2017 and 2016, respectively.
We sponsor an Employee Stock Purchase Plan (the “Purchase Plan”), covering all domestic employees with at least 90 days of continuous service and who are customarily employed at least 20 hours per week. The Purchase Plan allows eligible participants the right to purchase common stock on a quarterly basis at the lower of 85% of the market price at the beginning or end of each three-month offering period. Employee contributions to the Purchase Plan were $0.5 million during both six

18


12. STOCK-BASED COMPENSATION (CONTINUED)
month periods ended March 31, 2017 and 2016. Pursuant to the Purchase Plan, 48,299 and 55,343 common shares were issued to employees during the six months ended March 31, 2017 and 2016, respectively. Shares are issued under the Purchase Plan from treasury stock. As of March 31, 2017, 465,317 common shares were available for future issuances under the Purchase Plan.
Stock-based compensation expense is included in the consolidated results of operations as follows (in thousands):
 
Three months ended March 31,
 
Six months ended March 31,
 
2017
 
2016
 
2017
 
2016
Cost of sales
$
54

 
$
51

 
$
116

 
$
105

Sales and marketing
345

 
227

 
685

 
426

Research and development
155

 
147

 
337

 
295

General and administrative
601

 
478

 
1,190

 
888

Stock-based compensation before income taxes
1,155

 
903

 
2,328

 
1,714

Income tax benefit
(382
)
 
(293
)
 
(757
)
 
(550
)
Stock-based compensation after income taxes
$
773

 
$
610

 
$
1,571

 
$
1,164

Stock-based compensation cost capitalized as part of inventory was immaterial as of March 31, 2017 and September 30, 2016.
The following table summarizes our stock option activity (in thousands, except per common share amounts):
 
 
Options Outstanding
 
Weighted Average Exercised Price
 
Weighted Average Contractual Term (in years)
 
Aggregate Intrinsic Value (1)
Balance at September 30, 2016
 
3,963

 
$10.36
 
 
 
 
Granted
 
598

 
12.87
 
 
 
 
Exercised
 
(305
)
 
10.64
 
 
 
 
Forfeited / Canceled
 
(223
)
 
13.30
 
 
 
 
Balance at March 31, 2017
 
4,033

 
$10.55
 
4.7
 
$
7,283

 
 
 
 
 
 
 
 
 
Exercisable at March 31, 2017
 
2,676

 
$10.19
 
3.9
 
$
5,459

(1) The aggregate intrinsic value represents the total pre-tax intrinsic value, based on our closing stock price of $11.90 as of March 31, 2017, which would have been received by the option holders had all option holders exercised their options as of that date. The intrinsic value of an option is the amount by which the fair value of the underlying stock exceeds its exercise price.
The total intrinsic value of all options exercised during the six months ended March 31, 2017 was $0.9 million and during the six months ended March 31, 2016 was $1.7 million.
The table below shows the weighted average fair value, which was determined based upon the fair value of each option on the grant date utilizing the Black-Scholes option-pricing model and the related assumptions:
 
Six months ended March 31,
 
2017
 
2016
Weighted average per option grant date fair value
$4.64
 
$3.92
Assumptions used for option grants:
 
 
 
Risk free interest rate
1.46% - 1.96%
 
1.61% - 1.85%
Expected term
6.00 years
 
6.00 years
Expected volatility
33% - 34%
 
32%
Weighted average volatility
34%
 
32%
Expected dividend yield
0
 
0

19


12. STOCK-BASED COMPENSATION (CONTINUED)
The fair value of each option award granted during the periods presented was estimated using the Black-Scholes option valuation model that uses the assumptions noted in the table above. Expected volatilities are based on the historical volatility of our stock. We use historical data to estimate option exercise and employee termination information within the valuation model. The expected term of options granted is derived from the vesting period and historical information and represents the period of time that options granted are expected to be outstanding. The risk-free rate used is the zero-coupon U.S. Treasury bond rate in effect at the time of the grant whose maturity equals the expected term of the option.
We use historical data to estimate pre-vesting forfeiture rates. The pre-vesting forfeiture rate used during the six months ended March 31, 2017 was 10.0%. As of March 31, 2017 the total unrecognized compensation cost related to non-vested stock options, net of expected forfeitures, was $4.3 million and the related weighted average period over which it is expected to be recognized is approximately 3.4 years.
A summary of our non-vested restricted stock units as of March 31, 2017 and changes during the six months then ended is presented below (in thousands, except per common share amounts):
 
Number of Awards
 
Weighted Average Grant Date Fair Value
Nonvested at September 30, 2016
505

 
$
9.67

Granted
283

 
$
12.78

Vested
(178
)
 
$
9.31

Canceled
(3
)
 
$
10.89

Nonvested at March 31, 2017
607

 
$
11.22

As of March 31, 2017, the total unrecognized compensation cost related to non-vested restricted stock units was $4.9 million, and the related weighted average period over which it is expected to be recognized is approximately 1.7 years.
13. RESTRUCTURING
Below is a summary of the restructuring charges and other activity (in thousands):
 
Q2 2016
Restructuring
 
Q1 2016
Restructuring
 
 
 
Employee
Termination
Costs
 
Employee
Termination
Costs
 
Other
 
Total
Balance at September 30, 2015
$

 
$

 
$

 
$

Restructuring charge

 
480

 
171

 
651

Balance at December 31, 2015
$

 
$
480

 
$
171

 
$
651

Restructuring charge
78

 

 
24

 
102

Payments
(76
)
 
(113
)
 
(195
)
 
(384
)
Foreign currency fluctuation

 
13

 

 
13

Balance at March 31, 2016
$
2

 
$
380

 
$

 
$
382

Q1 2016 Restructuring
In November 2015, we approved a restructuring plan impacting our corporate staff. The plan closed our Dortmund, Germany office and relocated certain employees to our Munich, Germany office. We also recorded a contract termination charge as we relocated employees in our Minneapolis, Minnesota office to our World Headquarters in Minnetonka, Minnesota, in December 2015. We recorded a restructuring charge of $0.7 million that included $0.5 million of severance and $0.2 million of contract termination costs during the first quarter of fiscal 2016. This restructuring resulted in an elimination of approximately 10 positions. The payments associated with these charges were completed in the third quarter of fiscal 2016.

20


13. RESTRUCTURING (CONTINUED)
Q2 2016 Restructuring
In January 2016, we approved a restructuring plan impacting our wireless design services group. This restructuring resulted in an elimination of 5 positions. We recorded a restructuring charge of $0.1 million related to severance during the second quarter of fiscal 2016 and paid the majority of the severance during that same quarter.
14. COMMON STOCK REPURCHASE
On April 26, 2016, our Board of Directors authorized a program to repurchase up to $15.0 million of our common stock primarily to return capital to shareholders. This repurchase authorization expired on May 1, 2017. Shares repurchased under the new program could be made through open market and privately negotiated transactions from time to time and in amounts that management deemed appropriate. The amount and timing of share repurchases depended upon market conditions and other corporate considerations. There were no shares repurchased under this program.
15. SUBSEQUENT EVENT
On May 2, 2017, our Board of Directors authorized a new program to repurchase up to $20.0 million of our common stock primarily to return capital to shareholders. This repurchase authorization expires on May 1, 2018. Shares repurchased under the new program will be made through open market and privately negotiated transactions from time to time and in amounts that management deems appropriate. The amount and timing of share repurchases depends upon market conditions and other corporate considerations.



21


ITEM 2. 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 Annual Report on Form 10-K for the fiscal year ended September 30, 2016, as well as our subsequent reports on 8-K and any amendments thereto.

SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
This Form 10-Q 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.
Forward-Looking Statements
The words “anticipate,” “assume,” “believe,” “continue,” “estimate,” “expect,” “intend,” “may,” “plan,” “should,” or “will” or the negative thereof or other variations thereon or similar terminology, 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 we operate, estimated future values and 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 may impact our operations and our ability to retain important employees, the ability to achieve the anticipated benefits and synergies associated with acquisitions or divestitures, 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, our Annual Report on Form 10-K for the year ended September 30, 2016, and subsequent quarterly reports on Form 10-Q and other filings, could cause the company’s 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.
Presentation of Non-GAAP Financial Measures
This report includes EBITDA from continuing operations, which is a non-GAAP measure. We understand that there are material limitations on the use of non-GAAP measures. Non-GAAP measures are not substitutes for GAAP measures, such as net income, for the purpose of analyzing financial performance. The disclosure of these measures does not reflect all charges and gains that were actually recognized by the company. Non-GAAP measures are not prepared in accordance with, or as an alternative for measures prepared in accordance with, generally accepted accounting principles and may be different from non-GAAP measures used by other companies. In addition, non-GAAP measures are not based on any comprehensive set of accounting rules or principles. We believe that non-GAAP measures have limitations in that they do not reflect all of the amounts associated with our results of operations as determined in accordance with GAAP and that these measures should only be used to evaluate our results of operations in conjunction with the corresponding GAAP measures. Additionally, we understand that EBITDA from continuing operations does not reflect our cash expenditures, the cash requirements for the replacement of depreciated and amortized assets, or changes in or cash requirements for our working capital needs.
We believe that the presentation of EBITDA from continuing operations as a percentage of revenue is useful because it provides a reliable and consistent approach to measuring our performance from year to year and in assessing our performance against that of other companies. We 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. EBITDA from continuing operations is used as an internal metric for executive compensation, as well as incentive compensation for the rest of the employee base, and it is monitored quarterly for these purposes.

22

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

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 our condensed consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, the disclosure of contingent assets and liabilities and the values of purchased assets and assumed liabilities in acquisitions. We base our estimates on historical experience and various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates.
A description of our critical accounting policies and estimates was provided in the Management’s Discussion and Analysis of Financial Condition and Results of Operations section of our Annual Report on Form 10-K for the year ended September 30, 2016. There have been no material changes to our critical accounting policies as disclosed in that report.
OVERVIEW
We are a leading global provider of business and mission-critical machine-to-machine (“M2M”) and Internet-of-Things (“IoT”) connectivity products and services. We help our customers create next generation connected products and deploy and manage critical communications infrastructures in demanding environments with high levels of security and reliability. We create secure, easy to implement embedded solutions and services to help customers build IoT connectivity. We also deploy ready to use, complete box solutions to connect remote machinery. In addition, we manage cloud services, offer professional services and complete IoT solutions. We formed a smart solution that offers automated wireless temperature monitoring as well as employee task management services to healthcare and food service industries. Our products and services are used by a wide range of businesses and institutions. We have a single reporting segment. 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.
Our revenue consists of hardware product revenue and service revenue. Our hardware product offerings are comprised of our cellular routers and gateways, radio frequency (“RF”), embedded and network products. 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.
On May 4, 2017, we announced the rebranding of our Digi Cold Chain Solutions to Digi Smart Solutions™ group.
Our service offerings include Digi Smart Solutions, wireless design services, Digi Device Cloud (which includes Digi Remote Manager™) and support services. We have formed Digi Smart Solutions through a series of acquisitions including the October 2015 acquisition of Bluenica Corporation (“Bluenica”), the November 2016 acquisition of FreshTemp, LLC (“FreshTemp”) and the January 2017 acquisition of SMART Temps, LLC (“SMART Temps”) to enhance and expand the capabilities of Digi Smart Solutions.
We utilize many financial, operational, and other metrics to evaluate our financial condition and financial performance. Below we highlight the metrics for the second quarter of fiscal 2017 that we feel are most important in these evaluations:
Total Revenue was $45.6 Million. Our revenue was $45.6 million for the second quarter of fiscal 2017 compared to $50.2 million in the second quarter of fiscal 2016. There was a decrease in hardware product revenue of $7.0 million, or 14.3%. Hardware product revenue performance decreased in all product categories, with the exception of RF which increased $0.1 million in the three months ended March 31, 2017 compared to the same period a year ago. Revenue was unfavorably impacted by $0.2 million due to the weakening of the British Pound and Euro compared to the U.S. Dollar.
Service revenue increased by $2.4 million, or 169.2% in the second quarter of fiscal 2017 compared to the second quarter of fiscal 2016. This increase was driven primarily by the continued growth and expansion of Digi Smart Solutions which included incremental revenue from our recent acquisitions of SMART Temps and FreshTemp of $1.5 million (see Note 2 to our Condensed Consolidated Financial Statements).

23


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






Gross Margin was 48.0%. Our gross margin decreased as a percentage of revenue to 48.0% in the second quarter of fiscal 2017 as compared to 49.3% in the second quarter of fiscal 2016. Gross margin was negatively impacted by product mix, primarily resulting from lower revenue performance in our network category which are traditionally higher margin products.
Income tax provision for the second fiscal quarter of 2017 was $0.1 million. Income tax provision for the second fiscal quarter of 2016 was $1.2 million, which included a tax benefit of $0.5 million specific to that period for the reinstatement of the federal research and development tax credit for calendar year 2015.
Net income for the second fiscal quarter of 2017 was $1.3 million, or $0.05 per diluted share. Net income for the second fiscal quarter of 2016 was $2.1 million, or $0.08 per diluted share.
EBITDA from continuing operations for the second fiscal quarter of 2017 was $2.8 Million, or 6.0% of total revenue. In the second fiscal quarter of fiscal 2016, EBITDA from continuing operations was $4.6 million, or 9.1% of total revenue.
Below is a reconciliation of Income from continuing operations to EBITDA from continuing operations (in thousands):
 
Three months ended March 31,
 
2017
 
2016
 
 
 
% of total
revenue
 
 
 
% of total
revenue
Total revenue
$
45,615

 
100.0
%
 
$
50,162

 
100.0
%
 
 
 
 
 
 
 
 
Income from continuing operations
$
1,331

 
 
 
$
2,226

 
 
Interest income, net
(110
)
 
 
 
(12
)
 
 
Income tax provision
148

 
 
 
1,155

 
 
Depreciation and amortization
1,389

 
 
 
1,214

 
 
EBITDA from continuing operations
$
2,758

 
6.0
%
 
$
4,583

 
9.1
%

24

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

CONSOLIDATED RESULTS OF OPERATIONS
The following table sets forth selected information derived from our interim condensed consolidated statements of operations (dollars in thousands):
 
Three months ended March 31,
% incr.
 
Six months ended March 31,
% incr.
 
2017
 
2016
(decr.)
 
2017
 
2016
(decr.)
Revenue:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Hardware product
$
41,766

 
91.6
 %
 
$
48,732

 
97.1
 %
(14.3
)
 
$
84,939

 
93.6
%
 
$
96,979

 
96.6
 %
(12.4
)
Service
3,849

 
8.4

 
1,430

 
2.9

169.2

 
5,851

 
6.4

 
3,442

 
3.4

70.0

Total revenue
45,615

 
100.0

 
50,162

 
100.0

(9.1
)
 
90,790

 
100.0

 
100,421

 
100.0

(9.6
)
Cost of sales:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Cost of hardware product
21,489

 
47.1

 
24,283

 
48.4

(11.5
)
 
43,927

 
48.4

 
48,993

 
48.8

(10.3
)
Cost of service
2,224

 
4.9

 
1,137

 
2.3

95.6

 
3,508

 
3.9

 
2,329

 
2.3

50.6

Total cost of sales
23,713

 
52.0

 
25,420

 
50.7

(6.7
)
 
47,435

 
52.3

 
51,322

 
51.1

(7.6
)
Gross profit
21,902

 
48.0

 
24,742

 
49.3

(11.5
)
 
43,355

 
47.7

 
49,099

 
48.9

(11.7
)
Operating expenses
20,390

 
44.7

 
21,089

 
42.0

(3.3
)
 
39,421

 
43.4

 
42,157

 
42.0

(6.5
)
Operating income
1,512

 
3.3

 
3,653

 
7.3

(58.6
)
 
3,934

 
4.3

 
6,942

 
6.9

(43.3
)
Other (expense) income, net
(33
)
 
(0.1
)
 
(272
)
 
(0.6
)
(87.9
)
 
667

 
0.8

 
(49
)
 

NM

Income from continuing operations, before income taxes
1,479

 
3.2

 
3,381

 
6.7

(56.3
)
 
4,601

 
5.1

 
6,893

 
6.9

(33.3
)
Income tax provision
148

 
0.3

 
1,155

 
2.3

(87.2
)
 
913

 
1.0

 
1,536

 
1.5

(40.6
)
Income from continuing operations
1,331

 
2.9
 %
 
2,226

 
4.4
 %
(40.2
)
 
3,688

 
4.1

 
5,357

 
5.4

(31.2
)
(Loss) income from discontinued operations, after income taxes

 

 
(89
)
 
(0.1
)
(100.0
)
 

 

 
3,230

 
3.2

(100.0
)
Net income
$
1,331

 
2.9
 %
 
$
2,137

 
4.3
 %
(37.7
)
 
$
3,688

 
4.1
%
 
$
8,587

 
8.6
 %
(57.1
)
NM means not meaningful
REVENUE
Hardware Products
Below is our revenue by product category:
 
Three months ended March 31,
% incr.
 
Six months ended March 31,
% incr.
($ in thousands)
2017
 
2016
(decr.)
 
2017
 
2016
(decr.)
Cellular routers and gateways
$
11,448

 
27.4
%
 
$
12,910

 
26.5
%
(11.3
)
 
$
25,204

 
29.7
%
 
$
25,070

 
25.8
%
0.5

RF
7,961

 
19.1

 
7,879

 
16.2

1.0

 
14,535

 
17.1

 
17,065

 
17.6

(14.8
)
Embedded
11,712

 
28.0

 
13,795

 
28.3

(15.1
)
 
23,553

 
27.7

 
26,923

 
27.8

(12.5
)
Network
10,645

 
25.5

 
14,148