Digi International Annual Report 2013

Plain-text annual report

UNITED STATES SECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549FORM 10-K ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934For the fiscal year ended: September 30, 2013ORo TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934For the transition period from to .Commission file number: 1-34033DIGI 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 registeredCommon Stock, par value $.01 per share The NASDAQ Global Select MarketSecurities registered pursuant to Section 12(g) of the Act: NoneIndicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No 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 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 preceding12 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  NooIndicate 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 andposted 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 tosubmit and post such files.) Yes  No oIndicate 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, tothe 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. oIndicate 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 “largeaccelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):Large accelerated filer o Accelerated filer  Non-accelerated filer o Smaller reporting company o (Do not check if a smaller reportingcompany) Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o No 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$231,361,444 based on a closing price of $8.93 per common share as reported on the NASDAQ Global Select Market.Shares of common stock outstanding as of November 20, 2013: 25,746,358DOCUMENTS INCORPORATED BY REFERENCEPortions of the Registrant's Proxy Statement for its 2014 Annual Meeting of Stockholders are incorporated by reference into Part III hereto. INDEX PagePART I. Forward-Looking Statements4ITEM 1. Business4ITEM 1A. Risk Factors11ITEM 1B. Unresolved Staff Comments19ITEM 2. Properties20ITEM 3. Legal Proceedings21ITEM 4. Mine Safety Disclosures21 PART II. ITEM 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities22ITEM 6. Selected Financial Data24ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations25ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk38ITEM 8. Financial Statements and Supplementary Data39ITEM 9. Changes in And Disagreements with Accountants On Accounting and Financial Disclosure68ITEM 9A. Controls and Procedures68ITEM 9B. Other Information68 PART III. ITEM 10. Directors, Executive Officers and Corporate Governance69ITEM 11. Executive Compensation70ITEM 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters70ITEM 13. Certain Relationships and Related Transactions, and Director Independence70ITEM 14. Principal Accounting Fees and Services70 PART IV. ITEM 15. Exhibits, Financial Statement Schedules71 EX-10(l) EX-10(m) 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 DOCUMENT23Table of ContentsPART I.FORWARD-LOOKING STATEMENTSThis Annual Report contains certain statements that are “forward-looking statements” as that term is defined under the Private Securities Litigation Reform Actof 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, asamended.Words such as “assume,” “believe,” “anticipate,” “intend,” “estimate,” “target,” “may,” “will,” “expect,” “plan,” “project,” “should,” or “continue” or thenegative thereof or other expressions, which are predictions of or indicate future events and trends and which do not relate to historical matters, identifyforward-looking statements. Among other items, these statements relate to expectations of the business environment in which we operate, projections of futureperformance, perceived marketplace opportunities and statements regarding our mission and vision. Such statements are not guarantees of future performanceand involve certain risks, uncertainties and assumptions, including risks related to the highly competitive market in which our company operates, rapidchanges in technologies that may displace products sold by us, declining prices of networking products, our reliance on distributors and other third parties tosell our products, delays in product development efforts, uncertainty in user acceptance of our products, the ongoing shift of our sales efforts to focus more onthe delivery of broader based solutions which can be a more complex sales process, has not been a historical sales focus of our company and can involvelonger sales cycles than the sale of our legacy hardware products, the ability to integrate our products and services with those of other parties in a commerciallyaccepted manner, potential liabilities that can arise if any of our products have design or manufacturing defects, our ability to defend or settle satisfactorilyany litigation, including, but not limited to, any litigation involving allegations we have breached intellectual property rights, uncertainty in global economicconditions and economic conditions within particular regions of the world which could negatively affect product demand and the financial solvency ofcustomers and suppliers, the impact of natural disasters and other events beyond our control that could negatively impact our supply chain and customers,the ability to achieve the anticipated benefits and synergies associated with acquisitions, and changes in our level of revenue or profitability which canfluctuate 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 factorsare 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 orobligation to update any forward-looking statements, whether as a result of new information, future events or otherwise.ITEM 1. BUSINESSGeneral Background and Product OfferingsDigi International Inc. (“Digi,” “we,” “our,” or “us”) was incorporated in 1985 as a Minnesota corporation. We were reorganized as a Delaware corporation in1989 in conjunction with our initial public offering. Our common stock is traded on the NASDAQ Global Select Market under the symbol DGII. Our WorldHeadquarters is located at 11001 Bren Road East, Minnetonka, Minnesota 55343. Our telephone number is (952) 912-3444.We are a leading provider of machine-to-machine (M2M) networking hardware and solutions that enable the connection, monitoring and control of local orremote physical assets by electronic means. These networking products and solutions can connect communication hardware to a physical asset, conveyinformation about the asset's status and performance to a computer system and then use that information to improve or automate one or more processes.Increasingly these products and solutions are being deployed via wireless networks as wireless networking technologies become more and more prevalent.Our solutions portfolio primarily includes:•Wireless and wired hardware products, that have been the historical foundation of our business;•Services and solutions that include the following product offerings:◦Professional consulting services focused on integration and configuration of enterprise resource management (ERM) systems including customerrelationship management (CRM) systems;◦Product design and development services providing customers turn-key wireless networking products that can use a wide range of wireless technologyplatforms;4Table of Contents◦The Device Cloud by Etherios™ (Device Cloud) a platform as-a-service (PAAS) offering. The Device Cloud provides a secure environment in whichcustomers can aggregate interaction with a large number of disparate devices and connect enterprise applications to these devices. This allows fordevices to be monitored and controlled remotely and allows customers to easily collect, interpret and utilize data from many devices to operate theirbusinesses more efficiently.◦Application development services;◦The Social Machine®, which is an application offering for which we won our first contract late in fiscal 2013. This application enables users ofsalesforce's Force.com platform to track and control devices and improve business outcomes.For more in-depth descriptions of our primary hardware products, please refer to the heading “Listing of Principal Hardware Products” at the end of Part I,Item 1 of this Form 10-K.Our solutions are deployed by a wide range of businesses and institutions. Any business that utilizes a significant number of devices, whose operation couldbenefit from remote monitoring or control, may realize benefits from M2M networking.Our hardware product revenue represented 88.6%, 94.7% and 94.6% of our total revenue in fiscal 2013, 2012 and 2011, respectively. Our services revenue,which represented 11.4%, 5.3% and 5.4% of our total revenue in fiscal 2013, 2012 and 2011, respectively, includes any revenues from wireless productdesign and development services, customer relationship management (CRM) consulting services, application development services, PAAS recurring revenuegenerated from our Device Cloud platform, and post-contract customer support and fees associated with technical support and training.Our corporate website address is www.digi.com. In the About Us - 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 asreasonably practicable after these reports are filed with or furnished to the United States Securities and Exchange Commission (the “SEC”). Each of thesedocuments 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 byany 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 theSEC 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 theoperation 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 ConditionsLong-Term Growth ProspectsWe believe that the marketplace for M2M networking solutions is poised for strong long-term growth. We also believe that our company is well positioned tocapitalize on this potential growth given the breadth of our product and service offerings as well as the depth of our experience and our expertise in developingand deploying M2M networking solutions. We expect there to be significant growth opportunities for many of our hardware products as well as ournetworking solutions and related services. We expect the M2M networking marketplace will attract a wide range of competitors, many of whom likely willhave significantly more resources and operational scale than us.We believe M2M networking is poised for strong long-term growth for two primary reasons:•The cost of connecting devices, sensors, machines, or other assets into networks has dropped dramatically over the past several years; and•Businesses and institutions want and need 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 gatheringand analyzing data is immense. The willingness of organizations to deploy networking products and applications to capture and analyze that data will dependon how efficiently these networking solutions can be deployed and maintained and the expected benefits to be derived in doing so. We therefore believe a criticalelement in our5Table of Contentsability to grow our business will be whether we can continue to develop and market M2M networking solutions at price points that can provide customers witha demonstrable return on their investment.Short-Term Impacts of Economic and Regulatory ConditionsWhile we believe the long-term prospects for M2M networking are strong, we also feel this marketplace is susceptible to downturns in general economicconditions as well as uncertainty or changes in regulatory regimes. Sales cycles for networking equipment and solutions can be long and can requiresignificant expenditures by customers. In turn, the willingness of customers to make purchases in times of economic or regulatory uncertainty that impacttheir businesses may be compromised.StrategyLong-Term GoalOur primary long-term goal is to be the leading global provider of M2M networking solutions that enable electronic devices to be provisioned, maintained,monitored, analyzed and managed remotely by businesses. In our business, M2M networking solutions include the following components that can beprovided together or separately:•custom designed or off-the-shelf hardware that enables the delivery of data from devices to networks;•software applications, such as The Social Machine®, that allow customers to monitor and manage networked devices;•our Device Cloud to aggregate and host device data securely as well as related software applications such as The Social Machine® ; and•professional services to help customers define front-end requirements, deploy M2M solutions and provide ongoing support.Current Business InitiativesTo advance our primary long-term goal, we presently are focused on the following four strategic business initiatives:1.Continued development and delivery of hardware products (especially wireless products) that remain the foundation of our business;2.The ongoing development and enhancement of The Social Machine® and other software applications, as well as enhancements to the Device Cloud andthe expansion of our ability to provide related services that enable customers to deploy these solutions;3.The further development of sales and marketing capabilities that are increasingly focused on broad-based M2M solutions as opposed to solely hardwarefocus; and4.The expansion of strategic relationships with other key participants in the M2M ecosystem such as key channel distributors, telecommunicationsservice providers, enterprise application providers, systems integrators and integrated circuit manufacturers.Continued Delivery of Hardware Products. Hardware products remain the core driver behind our revenue and profitability at this time. We believe ourexpertise with this segment of the M2M marketplace provides us with an advantage in constructing broad based end-to-end solutions for customers. We believewe must continue to be an industry leader in the provision of hardware products that meet the needs of our legacy customers and the evolving marketplace.Development of Software Applications, the Device Cloud Platform and Services Capabilities. We believe strengthening our capabilities to develop and sellsoftware applications (such as The Social Machine®), the Device Cloud platform and related services that help customers deploy these solutions is important.Over time, more and more of our customers are seeking solutions that link numerous devices in various locations to software applications that enable them tomonitor, control and analyze device performance remotely. In turn, we have increased our offerings to deliver these solutions. We recently launched The SocialMachine®, an M2M application that enables users of salesforce's Force.com platform to connect and monitor devices. We won our first contract for thisapplication late in fiscal 2013 and expect that revenue should begin in fiscal 2014.6Table of ContentsWe believe the business potential associated with delivering end-to-end wireless solutions is significant. By deploying software applications such as The SocialMachine® and utilizing the Device Cloud to provide a highly secure and reliable means of enabling devices to be connected, we believe we can derive recurringrevenue streams that generally are not associated with sales of hardware.The product development demands and customer support requirements of these solutions are different from hardware. As such we likely will expenddisproportionately more research and development resources on these initiatives relative to the level of revenue these solutions presently represent in ourbusiness. We also may find it appropriate to acquire businesses or solution sets in an effort to expand our capabilities and accelerate our growth such as wedid with our acquisition of Etherios, Inc. in October 2012.Development of Sales and Marketing Efforts Towards Broader-Based M2M Solutions. We are also focused on further enhancing our marketing and salescapabilities to sell broader-based M2M solutions. The marketing and sales of such solutions is often fundamentally different from sales of hardware productsalone. Often these sales involve interactions with individuals in the executive level (C Suite) of customers' organizations, requiring us to recruit solution-basedsales skills for our sales force. These skills require personnel and channel partners who can analyze business problems and provide a solution that deliversappropriate hardware and software as well as a return on the investment made to deploy the solution. Over the past year we have taken a number of steps toenhance our capabilities in this area. We have invested in training and hired additional personnel in sales and engineering with the appropriate backgrounds tomarket and sell broad-based M2M solutions. Our acquisition of Etherios on October 31, 2012 further advanced these capabilities by expanding our ability todevelop and deploy software applications and solutions to help businesses effectively configure their ERM system, frequently involving M2M networking. Weare also seeking to expand the scope of our relationships with major electronics distributors that have the requisite skills to sell broader solutions to furtherenhance our solutions sales channels.Further Expansion of Strategic Relationships. As the marketplace for M2M connectivity solutions continues to expand, we intend to expand our number ofstrategic relationships. Our recent acquisition of Etherios provides us with a strong relationship with salesforce.com, a major enterprise application provider. Inaddition to providing implementation services to salesforce.com customers, we sell The Social Machine® which enables salesforce.com customers to monitorand control devices on the Force.com platform. We are focused on expanding the breadth of our relationships with technology partners and major distributorsso they can assist with selling not only our hardware products but also our broader based M2M solutions offerings. We also are seeking to enhance ourrelationships with telecommunications service providers and systems integrators and to enhance their product offerings. Like many of our customers, ourexisting and potential strategic partners perceive a large market opportunity with customers seeking to deploy more “intelligent” network enabled devices andbroader based M2M solutions to service their customers and end users. We therefore intend to focus a significant amount of our business developmentresources to leverage strategic partners with our evolving solutions expertise.AcquisitionsWe completed the following acquisitions in the past five fiscal years.•On October 31, 2012 we acquired Etherios, Inc., a provider of consulting and professional services that uses a new cloud-based method for integratingmachines into core business process via the salesforce.com service cloud (see Note 2 to our Consolidated Financial Statements).•In June 2009, we acquired substantially all the assets of MobiApps Holdings Private Limited (MobiApps), a developer of M2M communicationstechnology focusing on satellite, cellular and hybrid satellite/cellular solutions. MobiApps has locations in India, Singapore and the U.S. We recentlymade the decision to discontinue sales of certain MobiApps' products and solutions.Sales ChannelsWe sell our products through a global network of distributors, systems integrators and value added resellers (VARs), and to original equipment manufacturers(OEMs).DistributorsOur larger distributors, based on sales we make to them, include Synnex, Arrow Electronics, Inc., Ingram Micro, Tech Data Corporation, Future Electronics,Miel, Atlantik Elektronik GmbH and Express Systems & Peripherals, Avnet, Digi-Key Corporation and Mouser Electronics. We also maintain relationshipswith many other distributors in the U.S., Canada, Europe, Asia and Latin America. Additionally, we maintain strong relationships with catalog resellers suchas CDW, Insight, Dell and Software House International. 7Table of ContentsStrategic Sales RelationshipsWe maintain alliances with other industry leaders to develop and market technology solutions. These include many major communications hardware andsoftware vendors, operating system suppliers, computer hardware manufacturers, enterprise application providers and cellular carriers. Among others, keypartners include: Intel, Wind River, VMware, Silicon Laboratories, Freescale, Qualcomm, Ericsson, AT&T, Sprint, Verizon, Bell Mobility, Telus, Rogersand several other cellular carriers worldwide. Furthermore, we maintain a worldwide network of authorized developers that extends our reach into certain othertechnology applications and geographical regions. We also gained a relationship with salesforce.com through our acquisition of Etherios, Inc. Etherios is asalesforce.com Platinum Partner with respect to providing salesforce.com customers with consulting and implementation services.We have established relationships with equipment vendors, such as Siemens AG, in a range of industries such as medical device, fleet management and tankmanagement that allow the vendors to ship our products and services as component parts of their overall solutions. Many of the world's leadingtelecommunications companies and Internet service providers also rely on our products, including AT&T Inc., Sprint Nextel Corp. and VerizonCommunications Inc.No single customer comprised more than 10% of our consolidated revenue for any of the years ended September 30, 2013, 2012 or 2011.CompetitionWe 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. We compete for customers on thebasis of existing and planned product features, service and software application capabilities, company reputation, brand recognition, technical support,relationships with partners, quality and reliability, product development capabilities, price and availability. While we have no competitors that offer acomparable 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 asthe marketplace for M2M connectivity products and solutions continues to grow and as we continue to expand our product and service offerings, it is likelywe will encounter increased competition, some of whom may be parties who have significantly more resources than we possess.Manufacturing OperationsOur manufacturing operations are conducted through a combination of internal manufacturing and external subcontractors specializing in various parts of themanufacturing process. We rely on third party foundries for our semiconductor devices that are Application Specific Integrated Circuits (ASICs). Thisapproach 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. Ifthese suppliers are unable to provide a timely and reliable supply of components, we could experience manufacturing delays that could adversely affect ourconsolidated results of operations.SeasonalityIn 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 andfewer shipping days.Working CapitalWe fund our business operations through a combination of cash and cash equivalents, marketable securities and cash generated from operations. We believethat our current financial resources, cash generated from operations, and our capacity for debt and/or equity financing will be sufficient to fund our businessoperations for the next twelve months and beyond.Research & Development and Intellectual Property RightsDuring fiscal years 2013, 2012 and 2011, our research and development expenditures were $30.3 million, $30.8 million and $31.6 million, respectively. Aswe expand our capabilities with respect to software applications and the Device Cloud, we expect to spend a disproportionate amount of our research anddevelopment resources on these initiatives relative to the percent of revenue they generate for us at present.8Table of ContentsDue to rapidly changing technology in the communications technology industry, we believe that our success depends primarily upon the product developmentskills of our personnel, and the ability to integrate acquired technologies with organically developed technologies. We have incurred in-process research anddevelopment charges in connection with our past acquisitions, which were expensed upon consummation of the acquisitions. Effective October 1, 2009 in-process research and development costs became capitalized according to authoritative guidance issued by the Financial Accounting Standards Board (FASB)related to business combinations. Such acquired in-process research and development charges will be disclosed separately and will be incremental to ourresearch and development expenditures above discussed. Since this guidance was effective, we have not completed any acquisitions that included in-processresearch and development.Our proprietary rights and technology are protected by a combination of copyrights, trademarks, trade secrets and patents.We have established common law and registered trademark rights on a family of marks for a number of our products. Our products and services primarilyare sold under the Digi, Etherios and Rabbit brands. We believe that the Digi and Rabbit brands have established strong identities with our targeted customerbase and our customers associate the Digi brand with “reliability” and the Rabbit brand with “ease of integration.” We also believe that the Etherios brand hasa strong established identity and that our customers associate this brand with "expertise in Cloud Solutions." Many of our customers choose us because theyare building a very complex system solution and they want the highest level in product reliability.Our patents are applicable to specific technologies and currently are valid for varying periods of time based on the date of patent application or patent grant inthe U.S. and the legal term of patents in the various foreign countries where patent protection is obtained. We believe our intellectual property has significantvalue and is an important factor in the marketing of our company and products.BacklogBacklog as of September 30, 2013 and 2012 was $21.1 million and $23.1 million, respectively. The majority of the backlog at September 30, 2013 isexpected to be shipped in fiscal 2014. Backlog as of any particular date is not necessarily indicative of our future sales trends.EmployeesWe had 686 employees on September 30, 2013. We consider our relations with our employees to be good.Geographic Areas and Currency RisksOur customers are located throughout North America, Europe, Middle East & Africa (EMEA), Asia and Latin America. We are exposed to foreign currencyrisk associated with certain sales transactions being denominated in Euros, British Pounds, Japanese Yen and Indian Rupees and foreign currency translationrisk 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 netliability position for U.S. dollar accounts in our foreign locations to reduce our foreign currency risk. We have not implemented a formal hedging strategy toreduce foreign currency risk.During 2013, we had approximately $78.8 million of revenue related to foreign customers including export sales, of which $24.3 million was denominated inforeign currency, predominantly the Euro and British Pound. During both 2012 and 2011, we had approximately $78.2 million and $85.5 million,respectively, of revenue to foreign customers including export sales, of which $23.4 million and $28.8 million, respectively, were denominated in foreigncurrency, predominantly the Euro and British Pound. In future periods, we expect a significant portion of sales will continue to be made in Euros and BritishPounds.Financial information about geographic areas appears in Note 4 to our Consolidated Financial Statements in this Form 10-K.PRINCIPAL HARDWARE PRODUCTSCellular Routers - Cellular routers provide connectivity for devices over a cellular data network. They can be used as a cost effective alternative to landlinesfor primary or backup connectivity for hard to reach sites and devices. We introduced the first intelligent high-speed cellular router in 2005 to address thegrowing need for customers to connect remote sites and devices. These products have been certified by the major wireless providers in North America andabroad, including AT&T®, Verizon Wireless®, Sprint®, Bell Mobility and Rogers. All of our cellular products include a unique remote managementplatform 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 is enabled via the Device Cloud platform for many of these products.9Table of ContentsWireless Gateways - A gateway aggregates local wireless data traffic and transports it over a cellular or other Internet Protocol (IP)- based network, usuallyback to a central application or database. Our gateway products enable devices or groups of devices to be networked in locations where there is no existingnetwork or where access to a network is prohibited. These gateways can work in conjunction with our wireless adapters and wireless embedded modules toenable customers to monitor and manage remote devices in a non-intrusive and economical way. All of our gateway products are linked with the Device Cloudfor secure management of devices across remote networks, application connectivity and customization.Wireless Communication Adapters - Our wireless communication adapters are small box or module products that utilize a variety of wireless protocols forPC-to-device or device-to-device connectivity, often in locations where deploying a wired network is not possible either because of cost, disruption orimpracticality. By supporting ZigBee®, Wi-Fi® and proprietary RF technologies, we can meet most customer application requirements, such as serial cablereplacement, Ethernet cable replacement, mesh networking, low cost/low power remote monitoring, simple I/O control functions, environmental sensors andlong distance connectivity. In conjunction with one of our gateways, wireless communication adapters can be connected into the Device Cloud for remotemanagement, application connectivity and customization.Wireless and Wired Modules - Developing a device around a chip or microprocessor involves a high level of complexity. A module is a group of componentsthat are set up to work together, eliminating much of that complexity. An embedded module that is placed into a larger device (e.g. a parking meter, a medicaldevice, an environmental sensor, etc.) may provide somewhat less flexibility than a chip, but is much easier to implement into a product design. A number ofthese modules can be connected directly to the Device Cloud, enabling remote management and remote application connectivity.Our modules can be divided into two categories: processor modules and communications modules and provide a full range of wireless and wired connectivityoptions. Processor modules provide customers with a networked platform for use as the main processor in an embedded system and the flexibility to add incustom features and functionality, as this ensures a quick time to market development cycle for a network-enabled device. These modules are targeted as thecore processors for products such as access control systems, Smart Energy devices, Point-of-Sale (POS) systems, Radio Frequency ID (RFID) readers,medical devices and instrumentation and networked displays. Communication modules are ideal for network-enabling and web-enabling a device. They enablecustomers who wish to easily accommodate both wired and wireless functionality in one product design. These modules make it very easy to add most anytype of connectivity, especially wireless connectivity with our Xbee family. Typically with a communication module, there is another processor performing thecentral processing. Adding wired or wireless network communication to a device allows companies to manage that device over a network or by electronicmeans.Integrated Circuits (Chips) - A chip (or microprocessor) provides the “brains” and processing power of an intelligent electronic device or communicationsub-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 ofdevelopment expertise. Building a solution from the chip level offers a low cost of the end design, but the level of complexity in product development canincrease risk and prolong time to market. Our chips are the building blocks for many of our products (whether or not designed to be embedded into a largerproduct). By using our own microprocessors we can ensure complete hardware/software compatibility for product designs for certain of our products. We nolonger develop new chips and now use Commercial Off the Shelf (COTS) technology from companies such as Freescale and Ember for our new products, aswe do not have a core competency in the semi-conductor business and we believe that it is more effective to partner with companies who can provide thisexpertise.Software and Development Tools for Chips and Modules - Coupled with the chips and modules are a variety of development tools and associatedsoftware to make application development easy. We provide software and tools for a variety of operating environments and developer skill sets. These includeLinux® and Microsoft® Windows® Embedded CE as well as our own Net+OS, Dynamic C and Python based Device Cloud by Etherios™ Dia.Single Board Computers - Single-board computers (SBCs) are complete systems on a single circuit board. They are essentially a programmable box productwithout the enclosure - everything is on the board and ready to be embedded into a larger system. They offer the same benefits as the processor modules, buteliminate the need for additional interface circuitry because they include all of the key device interface components on one circuit board.Serial Servers - Serial Servers (also known as device servers and terminal servers) add wired or wireless network connectivity to a serial device. Theytransfer data between a serial port and an Ethernet network, turning a previously isolated device with a serial port into a fully collaborative networkcomponent. Current applications include building automation, health care, process control, and secure console port management on servers, routers, switchesand other network equipment. Many of our serial servers can also leverage the Device Cloud for application connectivity, remote management andcustomization.10Table of ContentsConsole Servers - Console servers, or console management servers, provide access to the serial ports of network equipment such as servers, routers orswitches. Our intelligent console servers enable customers to access, monitor or manage their network devices across multiple sites, both remotely over thenetwork or via their console ports even during network outages. These console servers provide advanced auditing and logging capabilities that complementregulatory compliance efforts such as the Sarbanes-Oxley Act of 2002 and Health Insurance Portability and Accountability Act of 1996 (HIPAA).USB Connected Products - The Universal Serial Bus (USB) is a “plug-and-play” interface between a computer and peripheral devices. In recent years, manyserial ports on PCs have been replaced with USB ports, due in large part to the usability and cost effectiveness of USB devices. We have one of the mostcomprehensive and advanced USB port expansion product lines in the industry. Our USB-to-serial converters enable customers to expand a single USB portinto multiple serial ports to connect legacy peripheral devices. The product line also includes USB hubs that add additional USB or powered USB ports,which are often used in retail environments, and a network-enabled hub that connects USB devices over an IP network, which is an industry first.Serial Cards - A serial card plugs into the expansion slot of a computer to provide serial ports for device connectivity. We remain a global leader in thiscategory and offer one of the most extensive serial card product families. Our products support a wide range of operating systems, port densities, bus types,expansion options and applications. As Ethernet connections extend beyond current applications, the serial card products are gradually transitioning tonetwork-attached and/or USB-attached devices.Satellite Communication Devices - Our acquisition of MobiApps Holdings Private Limited (MobiApps) in June 2009 added satellite communicationproducts that provide worldwide satellite data transmit/receive capabilities for customers involved in satellite-based tracking and industrial remotecommunications. Operating over the ORBCOMM low-earth orbit satellite network, these products allow clients to monitor, track and manage their fixed andmobile assets around the world. We recently determined we would be discontinuing the sale of these products during fiscal 2014 as management determined toend-of-life certain product lines acquired in connection with the MobiApps acquisition due to various factors impacting the viability of these product lines.ITEM 1A. RISK FACTORSMultiple risk factors exist which could have a material effect on our operations, results of operations, profitability, financial position, liquidity, capitalresources and common stock.Risks Relating to Our BusinessOur dependence on new product development and the rapid technological change that characterizes our industry makes us susceptible to loss ofmarket share resulting from competitors' product introductions and enhancements, service capabilities and similar risks.The M2M networking market is characterized by rapidly changing technologies, evolving industry standards, frequent new product introductions, shortproduct life cycles in certain instances and rapidly changing customer requirements. The introduction of products and enhancements embodying newtechnologies and the emergence of new industry standards can render existing products obsolete and unmarketable. Our future success will depend on ourability to enhance our existing products, to introduce new products to meet changing customer requirements and emerging technologies, and to demonstrate theperformance advantages and cost-effectiveness of our products over competing products. Failure by us to modify our products to support new alternativetechnologies or failure to achieve widespread customer acceptance of such modified products could cause us to lose market share and cause our revenue todecline. Further, if competitors offer better services capabilities associated with the implementation and use of products in communication networks, ourbusiness could be impacted negatively.We may experience delays in developing and marketing product enhancements or new products that respond to technological change, evolving industrystandards and changing customer requirements. There can be no assurance that we will not experience difficulties that could delay or prevent the successfuldevelopment, introduction, and marketing of these products or product enhancements, or that our new products and product enhancements will meet therequirements of the marketplace adequately and achieve any significant or sustainable degree of market acceptance in existing or additional markets. Inaddition, the future introductions or announcements of products by us or one of our competitors embodying new technologies or changes in industrystandards or customer requirements could render our then-existing products obsolete or unmarketable. This risk may become more pronounced as newcompetitors enter the marketplace, especially if these competitors have more11Table of Contentsresources than us to develop and market new products and technologies and provide related services. There can be no assurance that the introduction orannouncement 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, andsupporting products. We are employing significant human and financial resources to develop and deploy this cloud-based platform and related softwareapplications. While we believe our wireless, device networking and connectivity expertise, investments in infrastructure, and our innovative environmentprovide 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.Because these are relatively new solutions in the marketplace, we expect we may encounter competition from other solutions providers, many of whom mayhave more significant resources than us with which to compete. Whether we are successful in this new business model depends on a number of factors,including:•our ability to put in place effectively and continuously evolve the infrastructure to deploy our solutions;•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 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 moreeffectively 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 revenueand 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 thefiscal years ended 2013, 2012 and 2011, our research and development expenses comprised 15.5%, 16.2% and 15.5%, respectively, of our revenue. If we areunable to develop new products, applications and services as a result of our research and development efforts, or if the products, applications and services wedevelop are not successful, our business could be harmed. Even if we develop new products, applications and services that are accepted by our targetmarkets, 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 themarketplace. Even if we identify new technologies that we believe would be complementary to our internally developed technologies, we may not be successfulin obtaining those technologies or we may not be able to acquire the technologies at a price that is acceptable to us.A substantial portion of our recent 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 nothistorically been sold, such as markets for industrial automation equipment and medical equipment. In addition, we expect to devote a disproportionateamount of our research and development resources to the development of software applications (e.g. The Social Machine® and others) and our Device Cloudby Etherios™ (Device Cloud) cloud-based platform relative to the amount of revenue those solutions produce for our business presently. We believe these areasof investment are necessary as we work to transform our business to provide broader based M2M solutions to the marketplace. This disproportionateinvestment, however, may cause us not to develop various hardware products, the area of our business that currently delivers the significant majority of bothour revenue and profits. Our financial performance is dependent upon the development of the intelligent device and software solutions markets that we aretargeting, the increasing adoption of these technologies and our ability to compete successfully and sell our products and solutions.12Table of ContentsOur gross profits may be subject to decline.Our gross profits may be subject to decline which could decrease our overall profitability and impact our financial performance adversely. Many of thehardware products we sell are advancing towards the end of their product life cycle. These mature hardware products typically sell at higher gross marginsthan sales of our other product and service offerings. In fiscal 2013, sales of mature hardware products represented about 43.3% of our overall revenue. Inrecent years, revenues from the sale of these mature hardware products have been declining at a rate of between 5% and 15%, a trend we expect to continue. Inaddition, ongoing cost pressures in our industry create downward pressure on the prices at which we and other manufacturers can sell hardware products. While part of our longer term strategy is to sell software applications and M2M solutions such as The Social Machine® and the Device Cloud by Etherios™which can provide recurring revenues at relatively high gross profit levels, these and similar offerings are at early stages of adoption by customers and theirsales growth is not necessarily predictable or assured. As such, our gross profit levels may be subject to decline unless we can implement cost reductioninitiatives 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 maturehardware products decreases due to the adoption of new technologies, we expect that our revenue from these products will continue to decline. As a result, ourfuture 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 existingproducts. Announcements of currently planned or other new products may cause customers to defer or stop purchasing our products until new productsbecome available. Furthermore, the introduction of new or enhanced products requires us to manage the transition from older product inventories and ensurethat adequate supplies of new products can be delivered to meet customer demand. Our failure to anticipate the revenue declines associated with older productsor manage transitions from older products effectively could result in inventory obsolescence and also have a material adverse effect on our revenue andprofitability.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 significantlyby new product introductions and marketing activities of industry participants. Certain of our competitors and potential competitors may have greaterfinancial, technological, manufacturing, marketing, and personnel resources than us. In addition, the amount of competition we face in the marketplace maychange and grow as the market for M2M networking solutions grows and new entrants enter the marketplace. Present and future competitors may be able toidentify new markets and develop products more quickly, which are superior to those developed by us. They may also adapt new technologies faster, devotegreater resources to research and development, promote products more aggressively, and price products more competitively than us. Competition may alsointensify 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 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 for59.1%, 61.4% and 64.1% of our total revenue in fiscal 2013, 2012 and 2011 respectively. To the extent our channel partners are unsuccessful in selling ourproducts or if we are unable to obtain and retain a sufficient number of high-quality channel partners, our operating results could be materially and adverselyaffected. In addition, our channel partners may also market, sell and support products and services that are competitive with ours, and may devote moreresources 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. Inthese cases, one or more of our important channel partners may stop selling our products completely. Our channel partner sales structure also could subject usto lawsuits, potential liability and reputational harm if, for example, any of our channel partners misrepresents the functionality of our products or services tocustomers, or violates laws or our corporate policies. If we fail to effectively manage our existing or future sales channel partners effectively, our business andoperating results could be materially and adversely affected.13Table of ContentsOur ability to grow our business is dependent in part on strategic relationships we develop and maintain with third parties as well as our ability tointegrate and assure use of our products and services in coordination with the products and services of certain strategic partners in a commerciallyacceptable manner.We believe that our ability to increase the sales of our products depends in part upon maintaining and strengthening relationships with our current strategicpartners and new strategic partners in the future. We believe our development of a broad based M2M solutions business is enhanced greatly by a variety ofstrategic relationships with parties such as telecommunications carriers, systems integrators, enterprise application providers and other strategic technologycompanies. Once a relationship is established, we likely will dedicate significant time and resources to it in an effort to advance our business interests andthere is no assurance any strategic relationship will generate enough revenue to offset the significant resources we use to advance the relationship. Parties withwhom we establish strategic relationships may also work with companies that compete with us. We also have limited, if any, control as to whether theseparties devote adequate resources to promoting, selling, and implementing our products. Further, new or emerging technologies, technological trends or changesin customer requirements may result in certain companies with whom we maintain strategic relationships de-emphasizing their dealings with us or becomingpotential competitors in the future. We also have limited, if any, control as to other business activities of these parties and we could experience reputationalharm because of our association with such parties if they fail to execute on business initiatives, are accused of breaking the law or otherwise suffer reputationalharm for other reasons. All of these factors could have a material and adverse affect on 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 otherparties. Identifying appropriate parties for these relationships as well as negotiating and documenting business agreements with them requires significant timeand resources. We expect these agreements typically to be non-exclusive and not to prohibit the other party from working with our competitors or offeringcompeting services. Once the relationship is established we may also encounter difficulties in combining our products and services in a commerciallyacceptable manner. We expect this type of dynamic where our ability to realize sales opportunities is dependent on how our products and services interact withthose sold by third parties may become more common as the marketplace for M2M networking evolves. There can be no guaranty in any particular instancethat 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 cannotguaranty the resulting products and services will be effectively marketed or sold 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 thatform a part of our solutions, that 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 M2M solutions, including the Device Cloud, weexpect to store, convey and potentially process increasing amounts of data produced by customer devices. This data may include confidential or proprietaryinformation, intellectual property or personally identifiable information of our customers or other third parties with whom they do business. It is important forus to maintain solutions and related infrastructure that are perceived by our customers and other parties with whom we do business to provide a reasonablelevel of reliability and security. Despite available security measures and other precautions, the infrastructure and transmission methods used by our productsand services may be vulnerable to interception, attack or other disruptive problems. Continued high-profile data breaches at other companies evidence anexternal environment that is becoming increasingly hostile to information security. Improper disclosure of data or perception that our data security isinsufficient could harm our reputation, give rise to legal proceedings, or subject our company to liability under laws that protect data, any of which couldresult 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 failurewith 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 andfix these incidents would increase our expenses. These types of security incidents could also lead to lawsuits, regulatory investigations and increased legalliability, including in some cases contractual costs related to customer notification and fraud monitoring. Further, as regulatory focus on privacy and datasecurity issues continues to increase and worldwide laws and regulations concerning the protection of information become more complex, the potential risksand costs of compliance to our business will intensify.Any acquisitions we have made or will make 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 stockthat would dilute our current stockholders' percentage ownership, incur debt, assume liabilities, or incur large and immediate write-offs.14Table of ContentsOur 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 mightacquire 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 resultsof operations. Moreover, from time to time, we may enter into negotiations for a proposed acquisition, but be unable or unwilling to consummate theacquisition under consideration. This could cause significant diversion of management's attention and out-of-pocket expenses for us. We could also be exposedto litigation as a result of any consummated or unconsummated acquisition.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 toaccurately forecast and plan future business activities, which may cause them to slow or suspend spending on products and services. Our customers mayfind 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 timelypayments 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 ourcash position, liquidity and financial condition. We cannot predict the timing or the duration of an economic downturn in the economy, should one occur.We do not have any large scale customers that represent more than 10% of our revenue. Our revenue may be subject to fluctuations based on the levelof significant one time purchases.No single customer has represented more than 10% of our revenue in any of the last three fiscal years. Many of our customers make significant one timehardware purchases for large projects which are not repeated. As a result our revenue may be subject to significant fluctuations based on whether we are able toclose significant sales opportunities. Our failure to complete one or a series of significant sales opportunities in a particular fiscal period could have a materialadverse effect on our revenue for that period.The ongoing shift of our sales efforts to focus more on the delivery of broader based solutions involves a more complex sales process and may involvelonger sales cycles than the sale of our legacy hardware products.We are migrating more of our sales resources towards the delivery of broader based solutions that can include the sale of hardware, custom applications andapplication hosting rather than the sale of only hardware point products. The sale of broader based solutions is often more complex than the sale of hardwareproducts on a standalone basis and often involves the delivery of a value proposition that is based on business factors other than product features andfunctionality that drive many hardware sales. These sales also are more likely to be subject to increased levels of internal review by our customers comparedto hardware point product sales and can have longer sales cycles as well. Sales of these types of solutions have not been a focal point of our companyhistorically and our failure to develop our solutions based sales capabilities could have a material adverse impact on our long term business prospects. Inaddition, the migration of more sales and marketing resources towards the delivery of broader based solutions could affect our sales and results of operationsfrom quarter to quarter adversely as we devote less resources towards hardware point product sales that have traditionally represented the significant majorityof our revenue and more towards the develop of new sales channels for broader based solutions.15Table of ContentsThe 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 typically involves a significant technical evaluation and commitment of capital and other resources by potential customers and endusers, as well as delays frequently associated with end users' internal procedures to deploy new technologies within their products and to test and accept newtechnologies. For these and other reasons, the sales cycle associated with certain of our products is typically lengthy and is subject to a number of significantrisks, such as end users' internal purchasing reviews, that are beyond our control. Because of the lengthy sales cycle and the large size of certain customerorders, 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 ourcustomer 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 thatspecialize in such services. Although most of the components of our products are available from multiple vendors, we have several single-source supplierrelationships, either because alternative sources are not available or because the relationship is advantageous to us. There can be no assurance that oursuppliers will be able to meet our future requirements for products and components in a timely fashion. In addition, the availability of many of thesecomponents to us is dependent in part on our ability to provide our suppliers with accurate forecasts of our future requirements. Delays or lost revenue couldbe caused by other factors beyond our control, including late deliveries by vendors of components. If we are required to identify alternative suppliers for any ofour required components, qualification and pre-production periods could be lengthy and may cause an increase in component costs and delays in providingproducts to customers. Any extended interruption in the supply of any of the key components currently obtained from limited sources could disrupt ouroperations 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 ourability 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/orapprovals by certain governmental bodies. Failure to obtain these approvals, or delays in receiving the approvals, could impact our ability to enter our targetedmarkets 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 networkcapacity, reliability and security to our customers. Our financial condition could be impacted if our wireless carriers were to increase the prices of theirservices, 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 andprofitability.Certain of our components and other materials used in producing our products are from regions susceptible to natural disasters. If we are unable to procurenecessary materials, we could experience a disruption to our supply chain that would hinder our ability to produce our products in a timely manner, or causeus 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. In addition, our customers may not follow their normal purchasing patterns or temporarily cease purchasingfrom us due to impacts to their businesses in the region, creating unexpected fluctuations or decreases in our revenue and profitability. Natural disasters inother parts of the world on which our operations are reliant also could have material adverse impacts on our business.Our use of suppliers in Southeast Asia involves risks that could negatively impact us.We purchase a number of components from suppliers in Southeast Asia. Product delivery times may be extended due to the distances involved, requiring morelead time in ordering. In addition, ocean freight delays may occur as a result of labor problems, weather delays or expediting and customs issues. Anyextended delay in receipt of the component parts could eliminate anticipated cost savings and have a material adverse effect on our customer relationships andprofitability.16Table of ContentsOur 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 ofcopyrights, trademarks, trade secrets and patents.We enter into confidentiality agreements with all employees, and sometimes with our customers and potential customers, and limit access to the distribution ofour proprietary information. There can be no assurance that the steps taken by us in this regard will be adequate to prevent the misappropriation of ourtechnology. Our pending patent applications may be denied and any patents, once issued, may be circumvented by our competitors. Furthermore, there can beno assurance that others will not develop technologies that are superior to our technologies. Despite our efforts to protect our proprietary rights, unauthorizedparties 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 foreigncountries 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 ourproprietary rights in the United States or abroad will be adequate or that competing companies will not independently develop similar technologies. Our failureto 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 andrequire 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, wereceive notification of a third-party claim that our products infringe other intellectual property rights. Any litigation to determine the validity of third-partyinfringement claims, whether or not determined in our favor or settled by us, may be costly and divert the efforts and attention of our management andtechnical personnel from productive tasks, which could have a material adverse effect on our ability to operate our business and service the needs of ourcustomers. There can be no assurance that any infringement claims by third parties, if proven to have merit, will not materially adversely affect our businessor 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 andsale of infringing products, discontinue the use of certain processes or be required to obtain a license under the intellectual property rights of the third partyclaiming 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 ourproducts, 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 asubstitute technology on commercially reasonable terms could have a material adverse effect on our business 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 ouroverall 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, longeraccounts receivable payment cycles, potentially adverse tax consequences, and export license requirements. In addition, we are subject to the risks inherent inconducting business internationally, including political and economic instability and unexpected changes in diplomatic and trade relationships. In manymarkets where we operate business and cultural norms are different than those in the United States and practices that may violate laws and regulationsapplicable to us like the Foreign Corrupt Practices Act (“FCPA”) unfortunately are more commonplace. Although we have implemented policies and procedureswith the intention of ensuring compliance with these laws and regulations, our employees, contractors and agents, as well as channel partners involved in ourinternational sales, may take actions in violation of our policies. Many of our vendors and strategic business allies also have international operations and aresubject to the risks described above. Even if we are able to successfully manage the risks of international operations, our business may be adversely affectedif 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 nothave a material adverse effect on our business strategy and financial condition.Our failure to comply effectively with regulatory laws pertaining to our foreign operations could have a material adverse effect on our revenue andprofitability.We are required to comply with U.S. government export regulations in the sale of our products to foreign customers, including requirements to properlyclassify 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 otheranti-corruption laws, such as the UK Anti-Bribery Act, of all other countries in which we do business, directly or indirectly, including compliance with theanti-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 the17Table of Contentsaforementioned regulations could also deter us from selling our products in international jurisdictions, which could have a material adverse effect on ourrevenue and profitability.Foreign currency exchange rates may adversely affect our results.We are exposed to a variety of market risks, including the effects of changes in foreign currency exchange rates on our costs and revenue. Because ourfinancial statements are denominated in U.S. Dollars and approximately 12.4% of our revenue is denominated in a currency other than U.S. Dollars, such asEuros, British Pounds, Indian Rupees and Yen, our sales and earnings may be adversely impacted if the U.S. dollar strengthens significantly against theseforeign 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 toattract 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 onour 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 andcountries may pass new regulations requiring our products to meet certain requirements to use environmentally friendly components. The European Union hasissued two directives relating to chemical substances in electronic products. The Waste Electrical and Electronic Equipment Directive (WEEE) makesproducers of certain electrical and electronic equipment financially responsible for collection, reuse, recycling, treatment and disposal of equipment placed inthe European Union market. The Restrictions of Hazardous Substances Directive (RoHS) bans the use of certain hazardous materials in electric and electricalequipment which are put on the market in the European Union. In the future, China and other countries including the United States are expected to adoptfurther environmental compliance programs. If we fail to comply with these regulations, we may not be able to sell our products in jurisdictions where theseregulations 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. Thesemarketable securities are classified as available-for-sale and are carried at fair market value. Some of our investments could experience reduced liquidity andcould result in an impairment charge should the impairment be considered as other-than-temporary. This loss would be recorded in our consolidated statementof 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 statutorytax 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 besubject to the examination of our income tax returns by the Internal Revenue Service and other U.S. and international tax authorities. We regularly assess thepotential outcomes resulting from these examinations to determine the adequacy of our provision for income taxes. There can be no assurance that the outcomesfrom these examinations will not have an effect on our consolidated operating results and financial condition.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 provisionfor income taxes, including our reserves for uncertain tax positions. In the ordinary course of business, there are many transactions and calculations where theultimate tax determination is uncertain. We regularly are under audit by tax authorities. Although we believe our tax estimates are reasonable, the finaldetermination of tax audits could be materially different from our historical income tax provisions and accruals. The results of an audit could have a materialeffect on our consolidated financial position, results of operations, or cash flows in the period or periods for which that determination is made.18Table of ContentsRisks Related to Our Common StockThe 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 fluctuatein the future. During fiscal year 2013, the closing price of our common stock on the NASDAQ Global Select Market ranged from $8.56 to $10.50 per share.Our closing sale price on November 15, 2013 was $10.66 per share. Announcements by us or others regarding the receipt of customer orders, quarterlyvariations in operating results, 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.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 yearsafter the date of the transaction in which the person became an interested stockholder unless certain requirements are met, and majority stockholder approval isrequired 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 withinterested 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 inour charter documents may also delay, defer or prevent a change of control. For instance, our Certificate of Incorporation provides that our Board of Directorshas 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 aclassified 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 thethree-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. UnderDelaware law, directors serving on a classified board may not be removed by shareholders except for cause. Also, pursuant to the terms of our shareholderrights plan, each outstanding share of common stock has one attached right. The rights will cause substantial dilution of the ownership of a person or groupthat 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 theseanti-takeover provisions may be to deter business combination transactions not approved by our Board of Directors, including acquisitions that may offer apremium over the market price to some or all stockholders.If our stock price declines, we may need to recognize an impairment of our goodwill.If the price of our common stock declines and reduces our market value, we could have an impairment of our goodwill. Our value is dependent uponcontinued future growth in demand for our products and solutions. If such growth does not materialize or our forecasts are significantly reduced, our marketvalue may decline and impair our goodwill. Goodwill is tested for impairment on an annual basis as of June 30, or more frequently if events or circumstancesoccur which could indicate impairment.ITEM 1B. UNRESOLVED STAFF COMMENTSNone.19Table of ContentsITEM 2. PROPERTIESThe following table contains a listing of our significant property locations as of September 30, 2013:Location of PropertyUse of Facility ApproximateSquare Footage Ownership or LeaseExpiration DateMinnetonka, MN(Corporate headquarters)Research & development, sales, sales support,marketing and administration 130,000 Owned Eden Prairie, MNManufacturing and warehousing 58,000 Owned Minneapolis, MNEngineering services 16,837 November 2016 San Francisco, CASales 1,702 September 2017 Chicago, ILSales, marketing and administration 2,739 July 2014 Waltham, MAResearch & development, sales and sales support 6,836 October 2015 Austin, TXSales, sales support and marketing 6,563 March 2014 Dallas, TXSales and administration 2,119 August 2014 Lindon, UTSales, marketing, research & development and administration 11,986 December 2015 Herndon, VASales, marketing and technical support 2,416 October 2014 Hong Kong, ChinaSales, marketing and administration 1,656 April 2016 Beijing, ChinaSales, marketing and administration 3,149 November 2014 Shanghai, ChinaSales, marketing and administration 1,991 May 2014 Dortmund, GermanySales, sales support, marketing and administration 9,293 March 2016 Neuilly sur Seine, FranceSales and marketing 2,895 January 2015 Logrono, SpainSales, research & development and administration 3,228 October 2018 Tokyo, JapanSales 1,371 Perpetual Bangalore, IndiaSales, research & development and administration 17,400 March 2015 SingaporeSales, marketing and administration 2,530 June 2014In addition to the above locations, we perform research and development activities in various other locations in the United States and sales activities in variousother locations in Europe and Asia which are not deemed to be principal locations and which are not listed above. We believe that our facilities are adequate forour needs.20Table of ContentsITEM 3. LEGAL PROCEEDINGSIn the normal course of business, we are subject to various claims and litigation, which may include, but are not limited to, patent infringement andintellectual 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 ouroperations in any particular period.ITEM 4. MINE SAFETY DISCLOSURESNone.21PART II.ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OFEQUITY SECURITIESStock ListingOur common stock trades under the symbol DGII on the NASDAQ Global Select Market tier of the NASDAQ Stock Market LLC. On November 15, 2013,the number of holders of our common stock was approximately 5,995, of which 145 were record holders.The high and low sale prices for our common stock for each quarter during the years ended September 30, 2013 and 2012, as reported on the NASDAQStock Market LLC, were:Stock Prices2013 First Second Third FourthHigh $10.29 $10.36 $10.23 $10.54Low $8.66 $8.75 $8.51 $9.01 2012 First Second Third FourthHigh $14.21 $12.58 $11.46 $11.27Low $9.87 $9.97 $8.12 $8.30Dividend PolicyWe 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 forperiodic stock repurchases, and does not anticipate paying cash dividends in the foreseeable future.Issuer Repurchases of Equity SecuritiesOn October 29, 2013, subsequent to the end of fiscal 2013, our Board of Directors authorized a new program to repurchase up to $20 million of our commonstock primarily to support our employee stock purchase program and to return capital to shareholders. This new repurchase authorization expires on October31, 2014 and replaces the below described program. Shares repurchased under the new program may be made through open market and privately negotiatedtransactions from time to time and in amounts that management deems appropriate. The timing of share repurchases will depend upon market conditions andother corporate considerations.On July 25, 2012, our Board of Directors authorized a program to repurchase up to $20 million of our common stock. This repurchase authorization expiredon September 30, 2013. We repurchased 1,481,365 shares for $14.1 million under this program during fiscal 2013.The following table presents our repurchases during the fourth quarter of fiscal 2013:Period Total Number ofShares Purchased Average Price Paidper Share Total Number ofShares Purchased asPart of a PubliclyAnnounced Program Maximum DollarValue of Shares thatMay Yet Be PurchasedUnder the ProgramJuly 1, 2013 - July 31, 2013 58,358 $9.88 58,358 $8,846,545.42August 1, 2013 - August 31, 2013 147,103 $9.61 147,103 $7,433,166.07September 1, 2013 - September 30, 2013 151,992 $9.81 151,992 $5,941,735.53Total 357,453 $9.74 357,453 $5,941,735.5322Table of ContentsITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OFEQUITY SECURITIES (CONTINUED)Performance EvaluationThe 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, 2008 to September 30, 2013, the last day of fiscal 2013, with the total cumulative return on the CRSP Total Return Indexfor the NASDAQ Stock Market - U.S. Companies (the “CRSP Index”) and the CRSP Index for NASDAQ Telecommunications Stocks (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 graphand table was set to $100 on September 30, 2008, for our Common Stock, the CRSP Index and the Peer Index and assumes the reinvestment of all dividends. FY08 FY09 FY10 FY11 FY12 FY13Digi International Inc. $100.00 $83.53 $93.04 $107.84 $99.61 $97.94CRSP Index $100.00 $101.87 $114.87 $119.98 $158.04 $193.09Peer Index $100.00 $99.77 $126.93 $132.23 $191.09 $255.6223Table of ContentsITEM 6. SELECTED FINANCIAL DATA(in thousands, except per common share data amounts and number of employees)For Fiscal Years Ended September 30,2013 2012 2011 2010 2009Revenue (1)$195,381 $190,558 $204,160 $182,548 $165,928Gross profit$100,123 $100,337 $106,588 $92,209 $81,265Sales and marketing40,513 39,242 39,549 37,010 35,304Research and development30,327 30,767 31,642 27,825 26,381General and administrative (2)(3)21,423 18,188 18,206 17,889 14,557Restructuring charges, net313 1,259 154 (468) 1,953Operating Income7,547 10,881 17,037 9,953 3,070Total other income (expense), net691 16 (522) 566 1,212Income before income taxes8,238 10,897 16,515 10,519 4,282Income tax provision (4)2,433 3,282 5,496 1,578 199Net income$5,805 $7,615 $11,019 $8,941 $4,083 Net income per common share - basic$0.22 $0.30 $0.44 $0.36 $0.16Net income per common share - diluted$0.22 $0.29 $0.43 $0.36 $0.16 Balance sheet data as of September 30, Working capital (total current assets less total current liabilities)$128,014 $155,377 $142,748 $122,105 $106,121Total assets$299,953 $293,084 $283,895 $266,965 $258,948Long-term debt and capital lease obligations$— $— $— $— $9Stockholders' equity$274,266 $270,857 $260,716 $240,556 $229,586Book value per common share (stockholders' equity divided byoutstanding shares)$10.73 $10.45 $10.17 $9.59 $9.29Number of employees as of September 30686 643 691 648 634(1)Acquisitions provided the following revenue during the year of acquisition: Etherios in fiscal 2013 of $11.0 million and MobiApps in fiscal 2009 of$0.4 million.(2)Included in general and administrative expense in fiscal 2010 is investigation and remediation expenses of $1.4 million ($0.9 million after tax).(3)Included in general and administrative expense in fiscal 2013 is $1.5 million ($1.0 after tax) related to the patent infringement lawsuit settlement forU.S. Ethernet Innovations. (See Note 16 to our Consolidated Financial Statements).(4)In fiscal 2013, 2012 and 2011, we recorded net discrete tax benefits of $0.8 million, $1.5 million and $0.7 million, respectively (see Note 10 to ourConsolidated Financial Statements). In fiscal 2010 we reversed income tax reserves of $2.3 million associated primarily with the closing of prior taxyears through statute expiration and the conclusion of a U.S. federal income tax audit. In fiscal 2009 we recorded a net discrete tax benefit of $1.2million resulting from the reversal of tax reserves associated with the extension of the research and development credit, the resolution of certain statetax matters and the closing of a prior tax year.24Table of ContentsITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONSOur management’s discussion and analysis should be read in conjunction with our consolidated financial statements and other information in this AnnualReport on Form 10-K for the fiscal year ended September 30, 2013.OVERVIEWWe are a leading provider of machine-to-machine (M2M) networking hardware and solutions that enable the connection, monitoring and control of local orremote physical assets by electronic means. These networking products and solutions can connect communication hardware to a physical asset, conveyinformation about the asset's status and performance to a computer system and then use that information to improve or automate one or more processes. Aswireless communications become more and more prevalent, these products and solutions are increasingly deployed via wireless networks. Our wireless andwired hardware products have been the historical foundation of our business. In fiscal 2013, we acquired Etherios, Inc., a Platinum Partner of salesforce.comand experienced in end user implementation of the Salesforce Service Cloud. Etherios provides consulting and professional services that uses a new cloud-based method for integrating machines into core business processes via the salesforce.com service cloud. We renamed our iDigi® cloud-based internet platformto Device Cloud by Etherios™ (Device Cloud). Device Cloud provides a secure environment in which customers can aggregate interaction with large numbersof disparate devices and connect enterprise applications to these devices. Device Cloud is a platform-as-a-service (PAAS) offering that allows devices to bemonitored and controlled remotely and lets customers easily collect, interpret and utilize data from many devices to operate their businesses more efficiently.We also assist customers by providing application development and hosting services. Among our application offerings is The Social Machine®, whichenables users of the Force.com platform (an offering of salesforce.com) to monitor and control devices. We also provide consulting and integration services thatease the deployment of M2M communications solutions and salesforce.com implementations. Our products are deployed by a wide range of businesses andinstitutions as any entity that utilizes a significant number of devices in the conduct of its operations may realize benefits from M2M networking.We have a single operating and reporting segment. Our revenue consists of hardware product revenue and service revenue. Our hardware product offerings arecomprised of growth hardware products that include wireless hardware products and ARM-based embedded modules, as well as mature hardware productsthat include primarily wired hardware products. Our service offerings include wireless product design and development services, customer relationshipmanagement (CRM) consulting services, application development services, licenses to use The Social Machine® application for use on the Force.com platformand our PAAS recurring revenue generated from Device Cloud platform, post-contract customer support and fees associated with technical support andtraining.We utilize many financial, operational, and other metrics to evaluate our financial condition and financial performance. Below we highlight the fiscal 2013metrics that we feel are most important in these evaluations:•Revenue was $195.4 Million. Our revenue was $195.4 million in fiscal 2013, and increased by $4.8 million, or 2.5%, compared to revenue ofapproximately $190.6 million in fiscal 2012. The increase in revenue was primarily attributable to an increase in revenue from professional servicesby Etherios which was acquired on October 31, 2012, partially offset by a decrease in revenue associated with our mature hardware products.•Gross Margin was 51.2%. Our gross margin decreased as a percentage of revenue to 51.2% in fiscal 2013 from 52.7% in fiscal 2012. Thedecrease primarily resulted from lower sales of our mature hardware products which have higher gross margins than our growth hardware products,lower gross margins for services revenue and increased costs to operate the Device Cloud. These impacts were partially offset by a reduction in theamortization of purchased and core technology, as certain intangibles were fully amortized.•Net Income was $5.8 Million and Earnings Per Diluted Share were $0.22. Our net income was $5.8 million in fiscal 2013, a decrease of $1.8million, or 23.5%, compared to net income of $7.6 million in fiscal 2012. Earnings per diluted share were $0.22 in fiscal 2013 compared to $0.29in fiscal 2012. Although revenue increased by 2.5% in fiscal 2013 compared to the prior fiscal year, lower gross margins resulted in relatively flatgross profit in fiscal 2013 compared to fiscal 2012. Operating expenses were also higher in fiscal 2013 than in the previous year, primarily due toincreased operating expenses associated with the operations of Etherios and a patent litigation settlement.•Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA). Our EBITDA was $15.9 million, or 8.2% of revenue in fiscal 2013compared to $18.4 million, or 9.7% of revenue in fiscal 2012. We believe that the presentation of EBITDA as a percentage of revenue, which is anon-GAAP financial measure, is useful because it25Table of ContentsITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(CONTINUED)provides a reliable and consistent approach to measure our performance from year to year and to assess our performance against that of othercompanies. We also believe this information helps compare operating results and corporate performance exclusive of the impact of our capitalstructure and the method by which assets were acquired. EBITDA is also used as an internal metric for executive compensation, as well as incentivecompensation for the rest of the employee base. It is monitored quarterly for these purposes. Below is a table reconciling net income to EBITDA (inthousands): Year ended September 30, 2013 2012Net income $5,805 $7,615Interest income, net (168) (266)Income tax provision 2,433 3,282Depreciation and amortization 7,877 7,815Earnings before interest, taxes, depreciation and amortization $15,947 $18,446•Our Balance Sheet was Impacted by Investing and Financing Decisions. Our current ratio was 7.0 to 1 at September 30, 2013 compared to 9.5to 1 at September 30, 2012. Cash and cash equivalents and marketable securities, including long-term marketable securities, decreased $14.9million to $105.7 million at September 30, 2013 from $120.6 million at September 30, 2012. During fiscal 2013, we spent $12.9 million, net ofcash acquired, for the acquisition of Etherios, Inc. In addition, we repurchased $14.1 million of our common stock in fiscal 2013 (see Note 12 to ourConsolidated Financial Statements).We accomplished a number of key initiatives in fiscal 2013 and also faced significant challenges relative to our business.Accomplishments•After declining sales in fiscal 2012, we grew revenue in fiscal 2013 by 2.5% to $195.4 million, which included revenue from Etherios acquired inOctober 2012;•We generated sequential and year-over-year revenue growth in each of the last three quarters of fiscal 2013;•Revenue of our growth products portfolio, which includes service revenue, grew year-over-year in every quarter of fiscal 2013, culminating in 24.9%growth in the fourth fiscal quarter. Our service revenue included revenue from Etherios from the date of acquisition;•Collectively, our growth hardware products and services revenue grew 11.6% during the fiscal year, more than offsetting the expected and ongoingdecline in sales of our mature hardware products;•We completed the acquisition of Etherios, Inc. in the first quarter of fiscal 2013, a transaction that has enhanced our solutions offerings via theirplatinum partner relationship with salesforce.com and the introduction of The Social Machine®, an application that enables businesses to monitordevices on the Force.com platform;•We continued to enhance our capabilities to sell end-to-end solutions. In addition to Etherios's sales personnel accustomed to making sales of servicesand solutions, we hired a new Senior Vice President of Global Sales and a new Vice President of Global Marketing. Historically we had one executiveoverseeing these positions. The individuals hired into these positions have significant experience working in organizations that sell broader basedsolutions as opposed to point hardware products.•We purchased $14.1 million of our common stock pursuant to a share repurchase plan.Challenges•Revenue from our mature hardware products declined by 7.3% during fiscal 2013, which was aligned with our expectations. These products remainhighly profitable and are a significant source of cash, but their ongoing decline in sales volume creates headwinds to overall revenue growth. Weexpect continued future decreases in mature product revenue of 5% - 15% annually.26Table of ContentsITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(CONTINUED)•Net income fell from $7.6 million in fiscal 2012 to $5.8 million in fiscal 2013. While revenue increased in fiscal 2013, gross profit was flat andoperating expenses were higher than the previous year due to incremental operating expenses associated with Etherios which was acquired on October31, 2012 and a patent litigation settlement.•The global economic environment continued to be volatile in fiscal 2013. Revenue in North America increased $4.2 million, or 3.7%, versus fiscal2012, primarily as a result of our acquisition of Etherios. Revenue in EMEA increased by $1.8 million, or 3.8%, over fiscal 2012. Revenue inAPAC and Latin America decreased by $0.4 million, or 1.3%, and $0.8 million, or 12.0%, respectively, year-over-year compared to fiscal 2012.CONSOLIDATED RESULTS OF OPERATIONSThe following table sets forth selected information derived from our Consolidated Statements of Operations, expressed in dollars and as a percentage of revenueand as a percentage of change from year-to-year for the years indicated.($ in thousands)Year ended September 30, % Increase (decrease) 2013 2012 2011 2013compared to2012 2012compared to2011Revenue: Hardware product$173,078 88.6% $180,434 94.7% $193,113 94.6 % (4.1)% (6.6)%Service22,303 11.4 10,124 5.3 11,047 5.4 120.3 (8.4)Total revenue195,381 100.0 190,558 100.0 204,160 100.0 2.5 (6.7)Cost of sales: Cost of hardware product82,276 42.1 84,714 44.4 92,737 45.4 (2.9) (8.7)Cost of service12,982 6.7 5,507 2.9 4,835 2.4 135.7 13.9Total cost of sales95,258 48.8 90,221 47.397,572 47.8 5.6 (7.5)Gross profit100,123 51.2 100,337 52.7106,588 52.2 (0.2) (5.9)Operating expenses: Sales and marketing40,513 20.7 39,242 20.6 39,549 19.4 3.2 (0.8)Research and development30,327 15.5 30,767 16.2 31,642 15.5 (1.4) (2.8)General and administrative21,423 11.0 18,188 9.5 18,206 8.9 17.8 (0.1)Restructuring charges, net313 0.2 1,259 0.7 154 0.1 (75.1) 717.5Total operating expenses92,576 47.4 89,456 47.089,551 43.9 3.5 (0.1)Operating income7,547 3.8 10,881 5.717,037 8.3 (30.6) (36.1)Other income (expense), net691 0.4 16 —(522) (0.2) 4,218.8 (103.1)Income before income taxes8,238 4.2 10,897 5.716,515 8.1 (24.4) (34.0)Income tax provision2,433 1.2 3,282 1.75,496 2.7 (25.9) (40.3)Net income$5,805 3.0% $7,615 4.0%$11,019 5.4 % (23.8)% (30.9)%REVENUEOverviewTotal revenue was $195.4 million in fiscal 2013 compared to $190.6 million in fiscal 2012, an increase of $4.8 million or 2.5%. Revenue in fiscal 2013included $11.0 million of revenue from Etherios since the date of acquisition on October 31, 2012, partially offset by a decrease in revenue associated with ourmature hardware products. Total revenue was $190.6 million in fiscal 2012 compared to $204.2 million in fiscal 2011, a decrease of $13.6 million or 6.7%.We did not experience a material change in revenue due to pricing during fiscal 2013, 2012 or 2011.Fluctuation in foreign currency rates compared to the prior year's rates had an unfavorable impact on revenue of $0.1 million in fiscal 2013 and $1.4 millionin fiscal 2012. In fiscal 2011 foreign currency rates had a favorable impact on revenue of $0.9 million.27Table of ContentsITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(CONTINUED)Hardware ProductsOur growth hardware product offerings include all wireless products, as well as the ARM-based embedded module product line. Our mature hardware productofferings include generally all wired products.The following summarizes our product revenue by growth hardware and mature hardware product categories: Product Revenue % of Product Revenue($ in millions)2013 2012 2011 2013 2012 2011Growth hardware products$88.5 $89.2 $90.5 51.1% 49.4% 46.9%Mature hardware products84.6 91.3 102.6 48.9% 50.6% 53.1%Total product revenue$173.1 $180.5 $193.1 100.0% 100.0% 100.0%Growth hardware product revenue decreased by $0.7 million, or 0.8%, in fiscal 2013 compared to fiscal 2012. Growth hardware product revenue decreased$2.3 million primarily due to a decrease in revenue from modules, satellite-related products and wireless communication adapters, partially offset by anincrease in revenue of $1.6 million related to cellular products.Growth hardware product revenue decreased $1.3 million, or 1.5%, in fiscal 2012 compared to fiscal 2011 due to a decrease in revenue of $6.9 millionrelated to cellular, wireless communication adapters and serial servers, partially offset by an increase in revenue of $5.6 million related to modules andsatellite-related products.Revenue of our mature hardware products generally has decreased as expected for both the twelve month periods ended September 30, 2013 and 2012 ascompared to the same periods from the previous year. Our serial servers, Rabbit-branded modules, chips and USB hardware offerings are mature hardwareproducts. We expect that revenue of these products will continue to decrease in the future as they are in the mature portion of their product life cycles. Revenueof mature products can fluctuate due to large orders from customers as product lines mature.ServicesOur services offerings, which we consider to be part of our growth portfolio, include wireless product design and development services, CRM consultingservices, application development services, licenses to use The Social Machine® application for use on the Force.com platform, our PAAS recurring revenuegenerated from Device Cloud platform, and post-contract customer support and fees associated with technical support and training. The majority of ourservice revenue is generated from CRM consulting services and wireless product design and development services. A smaller amount of revenue was generatedfrom application development services, PAAS recurring revenue from the Device Cloud platform, post-contract customer support, and fees associated withtechnical support and training. No revenue was recorded in fiscal 2013 for licenses to use The Social Machine® application as we won our first contract latein fiscal 2013.Service revenue for fiscal 2013 was $22.3 million compared to $10.1 in the prior fiscal year, an increase of $12.2 million, or 120.2%. Our service revenue infiscal 2013 included $11.0 million of revenue from Etherios which was acquired on October 31, 2012. In addition, wireless design services revenue increased$0.9 million compared to the prior fiscal year, driven by improved sales processes that included, among other items, the introduction of new opportunities forthis offering from sales leads developed in other parts of our business.Service revenue for fiscal 2012 was $10.1 million compared to $11.1 in the prior fiscal year, a decrease of $1.0 million, or 8.3%. Wireless design servicesrevenue in fiscal 2012 decreased $0.7 million compared to the prior fiscal year.28Table of ContentsITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(CONTINUED)Revenue by Geographic LocationOur revenue by geographic location of our customers is as follows: Revenue % of Revenue($ in millions)2013 2012 2011 2013 2012 2011North America, primarily United States$116.6 $112.4 $118.7 59.7% 59.0% 58.1%Europe, Middle East & Africa48.8 47.0 52.1 25.0% 24.7% 25.5%Asia24.5 24.9 27.0 12.5% 13.0% 13.2%Latin America5.5 6.3 6.4 2.8% 3.3% 3.2%Total revenue$195.4 $190.6 $204.2 100.0% 100.0% 100.0%North America revenue in fiscal 2013 increased $4.2 million, or 3.7%, compared to fiscal 2012 primarily due to increased service revenue associated with theacquisition of Etherios. This was offset partially by the decline of mature hardware products revenue, as expected. North America revenue in fiscal 2012decreased $6.3 million, or 5.3%, compared to fiscal 2011 due to a lower than anticipated closure rate on large projects.Revenue in EMEA increased $1.8 million, or 3.8%, in fiscal 2013 over fiscal 2012 mostly due to an improvement in general economic conditions in theEuropean countries and large customer projects that closed during fiscal 2013. EMEA revenue decreased $5.1 million, or 9.8%, in fiscal 2012 from fiscal2011. This primarily was due to poor economic conditions in the EMEA market, a lower than anticipated closure rate on large projects and the weakening ofthe Euro versus the U.S. Dollar.Asia revenue decreased $0.4 million, or 1.3%, in fiscal 2013 from fiscal 2012 mostly related to lower revenue from satellite products for which we haveinitiated end-of-life actions. Revenue in Asian countries decreased by $2.1 million, or 7.8%, in fiscal 2012 compared to fiscal 2011 mostly related to lowerrevenue from mature products.Latin America revenue decreased by $0.8 million, or 12.0%, in fiscal 2013 compared to fiscal 2012 primarily due to a longer than anticipated time to closenew customer projects as our distributors have been impacted by certain regulatory changes in Argentina and unfavorable economic conditions in Mexico andBrazil. Latin America revenue decreased slightly by $0.1 million, or 2.6%, in fiscal 2012 from fiscal 2011.Revenue by Distribution ChannelThe following table presents our revenue by distribution channel: Revenue % of Revenue($ in millions)2013 2012 2011 2013 2012 2011Direct/OEM channel$80.0 $73.6 $73.3 40.9% 38.6% 35.9%Distributors channel115.4 117.0 130.9 59.1% 61.4% 64.1%Total revenue$195.4 $190.6 $204.2 100.0% 100.0% 100.0%During fiscal 2013, revenue in our Direct/OEM channel increased $6.4 million, or 8.8%, compared to revenue in fiscal 2012. During fiscal 2013, revenue byour distributors decreased by $1.6 million, or 1.4%, compared to revenue in fiscal 2012. We believe the decrease in revenue in the Distributors channelcompared to the Direct/OEM channels was due to the decrease in sales of our mature hardware products which are sold more prevalently through distributorsas compared to our growth hardware products as well as a decrease in our revenue in APAC and Latin America, most of which is through distributors.Revenue in our Direct/OEM channel increased primarily due to an increase in revenue for our service offerings, which are typically sold through directchannels.During fiscal 2012, revenue by our distributors decreased by $13.9 million, or 10.6%, compared to revenue in fiscal 2011. Revenue in fiscal 2012 in ourDirect/OEM channel increased by $0.3 million, or 0.3%, compared to the prior fiscal year. The decrease in revenue in the Distributors channel compared to theDirect/OEM channels was due to lower revenue from mature products, lower than anticipated closure rates on large projects, and foreign currency impacts.29Table of ContentsITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(CONTINUED)GROSS PROFIT2013 Compared to 2012Gross profit was $100.1 million and $100.3 million in fiscal 2013 and 2012, respectively, a decrease of $0.2 million, or 0.2%. The gross margin for fiscal2013 was 51.2% compared to 52.7% in fiscal 2012, a decrease of 1.5 percentage points.Hardware product gross profit was $90.8 million and $95.7 million in fiscal 2013 and 2012, respectively, a decrease of $4.9 million, or 5.1%. Thehardware product gross margin for fiscal 2013 was 52.5% compared to 53.0% in fiscal 2012, a decrease of 0.5 percentage points, primarily due to lower salesof mature hardware products which generally have higher margins than our growth hardware products. This product mix impact was offset partially by adecrease in amortization of purchased and core technology as certain intangibles were fully amortized.Service gross profit was $9.3 million and $4.6 million in fiscal 2013 and 2012, respectively, an increase of $4.7 million, or 101.9%. The service grossmargin for fiscal 2013 was 41.8% compared to 45.6% in fiscal 2012, a decrease of 3.8 percentage points. The decrease is a result of lower gross margins forour CRM consulting services as compared to our wireless product design and development services and other services offerings. We expect our service grossmargin to vary from quarter to quarter for the foreseeable future as our CRM consulting services and our wireless product design and development servicesmargins are dependent on the utilization rates of our personnel.2012 Compared to 2011Gross profit was $100.3 million and $106.6 million in fiscal 2012 and 2011, respectively, a decrease of $6.3 million, or 5.9%. The gross margin for fiscal2012 was 52.7% compared to 52.2% in fiscal 2011, an increase of 0.5 percentage points.Hardware product gross profit was $95.7 million and $100.4 million in fiscal 2012 and 2011, respectively, a decrease of $4.7 million, or 4.6%. Thehardware product gross margin for fiscal 2012 was 53.0% compared to 52.0%, an increase of 1.0 percentage point. The increase primarily resulted from areduction in the amortization of purchased and core technology as certain intangibles were fully amortized, reduced costs through the restructuring of Europeanoperations and cost reduction initiatives for the production of our hardware products. This was partially offset by increased expenses associated withmitigating the effects of flooding in Thailand in October, 2011 which impacted a significant contract manufacturer.Service gross profit was $4.6 million and $6.2 million in fiscal 2012 and 2011, respectively, a decrease of $1.6 million, or 25.7%. The service gross marginfor fiscal 2012 was 45.6% compared to 56.2% in fiscal 2011, a decrease of 10.5 percentage points, mostly related to the increased costs to operate the DeviceCloud in fiscal 2012.OPERATING EXPENSES2013 Compared to 2012Operating expenses were $92.6 million in fiscal 2013, an increase of $3.1 million, or 3.5%, compared to $89.5 million in fiscal 2012. The following chartprovides the more significant reasons for the fluctuations in expenses for the years ended September 30, 2013 compared to fiscal 2012 and expressed as apercentage of total revenue: Year ended September 30, $ incr.($ in thousands) 2013 2012 (decr.)Incremental ongoing expenses for Etherios $4,535 2.3% $— —% $4,535Patent litigation 1,525 0.8 200 0.1 1,325Restructuring 313 0.2 1,259 0.7 (946)Impairment of identifiable intangibles 361 0.2 — — 361All other operating expenses 85,842 43.9 87,997 46.2 (2,155)Total operating expenses $92,576 47.4% $89,456 47.0% $3,120Sales and marketing expenses were $40.5 million in fiscal 2013, an increase of $1.3 million, or 3.2%, compared to $39.2 million in fiscal 2012. Thisincrease was due primarily to the incremental sales and marketing expenses of Etherios of $1.3 million since the date of acquisition.30Table of ContentsITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(CONTINUED)Research and development expenses were $30.3 million in fiscal 2013, a decrease of $0.5 million or 1.4%, compared to $30.8 million in fiscal 2012, due to anet decrease in expenses of $1.7 million mostly for consulting services and compensation-related expenses. This was partially offset by an increase of $1.2million related to incremental research and development expenses of Etherios since the date of acquisition.General and administrative expenses were $21.4 million in fiscal 2013, an increase of $3.2 million or 17.8%, compared to $18.2 million in fiscal 2012. Thisincrease was due primarily to the incremental general and administrative expenses of Etherios of $2.0 million since the date of acquisition and a settlement onthe U.S. Ethernet Innovations lawsuit of $1.5 million in fiscal 2013. We also recorded a $0.4 million impairment charge in fiscal 2013 for certain identifiableintangible assets. These increases were partially offset by a decrease of $0.3 million in compensation-related expenses and other miscellaneous general andadministrative expenses of $0.4 million as compared to the prior fiscal year.Restructuring expenses were $0.3 million in fiscal 2013, a decrease of $1.0 million, compared to $1.3 million in fiscal 2012. On September 27, 2013, werecorded a $0.4 million charge related to the restructuring of certain of our operations in the U.S. (see Note 9 to our Consolidated Financial Statements). Duringfiscal 2012, we recorded a $1.0 million charge related to our 2012 restructuring that was announced on April 26, 2012. In addition, we recorded an additional$0.3 million charge related to the Breisach, Germany restructuring announced on July 21, 2011.2012 Compared to 2011Operating expenses were essentially flat at $89.5 million in fiscal 2012 and $89.6 million in fiscal 2011. Below is a summary of our operating expenses byfunction.Sales and marketing expenses were $39.2 million in fiscal 2012, a decrease of $0.4 million or 0.8%, compared to $39.6 million in fiscal 2011. Commissionexpense decreased by $0.6 million, partially offset by a $0.2 million increase in other compensation-related expenses.Research and development expenses were $30.8 million in fiscal 2012, a decrease of $0.8 million or 2.8%, compared to $31.6 million in fiscal 2011.Compensation expenses were reduced by $1.1 million resulting primarily from lower incentive compensation payouts compared to the prior fiscal year, as wellas lower headcount. In addition, professional services expenses decreased by $0.3 million compared to the prior fiscal year. This was partially offset by anincrease of $0.6 million in other miscellaneous research and development expenses.General and administrative expenses were $18.2 million in both fiscal 2012 and 2011. General and administrative expenses decreased by $0.6 million inamortization expense as certain intangible assets were fully amortized. Compensation-related expenses decreased by $0.4 million due to a decrease in headcountand lower incentive compensation payouts. This was offset by increases of $0.4 million in bad debt expense, $0.3 million in professional fees and $0.3million in other general and administrative expenses.Restructuring expenses were $1.3 million in fiscal 2012, an increase of $1.1 million, compared to $0.2 million in fiscal 2011. During fiscal 2012, werecorded $1.0 million related to our 2012 restructuring that was announced on April 26, 2012. In addition, we recorded an additional $0.3 million related tothe Breisach, Germany restructuring announced on July 21, 2011. In fiscal 2011 we recorded $0.2 million related to the above mentioned restructuring forBreisach, Germany. For further information on restructuring, see Note 9 to our Consolidated Financial Statements.OTHER INCOME (EXPENSE), NET2013 Compared to 2012Other income, net was $0.7 million in fiscal 2013 compared to a minimal amount of income in fiscal 2012. We recorded $0.4 million of foreign currency nettransaction gains in fiscal 2013 compared to foreign currency net transaction losses of $0.4 million in fiscal 2012. This was partially offset by a decrease ininterest income on marketable securities and cash and cash equivalents of $0.1 million, primarily due to the decrease in our average investment balance from$94.4 million in fiscal 2012 to $80.2 million in fiscal 2013. Our average interest rate remained at 0.3% in both fiscal 2013 and fiscal 2012.31Table of ContentsITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(CONTINUED)2012 Compared to 2011Total other income, net was minimal in fiscal 2012 and $0.5 million in fiscal 2011, a decrease of $0.5 million. This decrease was mostly due to a reductionof $0.3 million in foreign currency net transaction losses in fiscal 2012 as compared to fiscal 2011. Also during fiscal 2012 we recorded a gain on the sale ofan investment of $0.1 million and recorded an additional $0.1 million in interest income. Our average investment balance increased from $85.9 million infiscal 2011 to $94.4 million in fiscal 2012, but our interest income remained the same as the prior fiscal year since we earned an average interest rate of 0.3%in both fiscal 2012 and fiscal 2011.INCOME TAXESOur effective income tax rate was 29.5%, 30.1% and 33.3% for fiscal years 2013, 2012 and 2011, respectively. Our effective tax rate will vary based on avariety of factors, including overall profitability, the geographical mix of income before taxes and related statutory tax rate in each jurisdiction, and discreteevents, such as settlements of audits.During fiscal 2013, we recorded a discrete tax benefit of $0.8 million, related to the January 2, 2013 enactment of the American Taxpayers Relief Act of 2012extending 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 thestatute of limitations from various U.S. and foreign tax jurisdictions. These discrete tax benefits reduced our effective tax rate by 9.2 percentage points for thetwelve month period ended September 30, 2013. During fiscal 2013, the income tax provision before discrete tax benefits was higher than the federal statutoryrate primarily due to an increase in certain reserves for unrecognized tax benefits and a reduction in domestic tax benefits.During fiscal 2012, we recorded a discrete tax benefit of $1.5 million, related to additional research and development tax credits identified for fiscal yearsended September 30, 2009, 2010 and 2011, reversal of tax reserves for closure of various jurisdictions' tax matters and tax rate reductions in foreignjurisdictions. These discrete tax benefits reduced our effective tax rate by 14.1 percentage points for the twelve month period ended September 30, 2012. Duringfiscal 2012, the income tax provision before discrete tax benefits was higher than the statutory rate primarily due to an increase in certain reserves forunrecognized tax benefits, an adjustment for foreign income taxed at the U.S. rate, partially offset by an adjustment in domestic tax benefits.During fiscal 2011, we recorded a discrete tax benefit of $0.7 million. This benefit primarily resulted from the reversal of tax reserves from variousjurisdictions, primarily foreign, related to the expiration of the statute of limitations. It also resulted from the enactment of the Tax Relief, UnemploymentInsurance Reauthorization, and Job Creation Act of 2010 extending the research and development tax credit that allowed us to record tax credits earned duringthe last three quarters of fiscal 2010 in the first quarter of fiscal 2011. This benefit reduced our effective tax rate by 4.4 percentage points for the twelve monthperiod ended September 30, 2011.INFLATIONManagement believes that during fiscal years 2013, 2012 and 2011, inflation has not had a material effect on our operations or on our consolidated financialposition.LIQUIDITY AND CAPITAL RESOURCESWe have financed our operations principally with funds generated from operations. We held cash, cash equivalents and short-term marketable securities of$88.3 million, $118.6 million and $106.2 million at September 30, 2013, 2012 and 2011, respectively. Our working capital was $128.0 million, $155.4million and $142.7 million at September 30, 2013, 2012 and 2011, respectively. The decrease of cash, cash equivalents and short-term marketable securitiesand working capital during fiscal 2013 was attributable primarily to the acquisition of Etherios and repurchases of common stock.32Table of ContentsITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(CONTINUED)Consolidated Statements of Cash Flows Highlights: Year ended September 30,($ in thousands)2013 2012 2011Operating activities$11,748 $15,127 $21,839Investing activities(19,739) (10,954) (22,399)Financing activities(10,790) 2,311 4,639Effect of exchange rate changes on cash and cash equivalents(145) (922) (338)Net (decrease) increase in cash and cash equivalents$(18,926) $5,562 $3,741Net cash provided by operating activities was $11.7 million during fiscal 2013 compared to $15.1 million in fiscal 2012, a net decrease of $3.4 million. Thisnet decrease was primarily due to a decrease in net income of $1.8 million and a net decrease in working capital of $1.7 million. Cash flows decreased fromworking capital due to a $5.0 million decrease in income taxes payable primarily pertaining to timing of tax payments, net of refunds, as well as lower incometax accruals, and an increase in accounts receivable and inventory of $2.0 million and $1.0 million, respectively. Accrued liabilities increased by $3.5 millionand accounts payable increased by $3.2 million, partially offsetting the aforementioned items.Net cash provided by operating activities was $15.1 million during fiscal 2012 compared to $21.8 million during fiscal 2011, a net decrease of $6.7 million.This net decrease is due to: a decrease in net income of $3.4 million, net decreases in non-cash items of $1.0 million and an increase in net working capital of$2.3 million. Accrued expenses decreased by $5.1 million, partially offset by an increase of $2.8 million related to income taxes.Net cash used in investing activities was $19.7 million in fiscal 2013 as compared to $11.0 million in fiscal 2012. We spent $12.9 million on the acquisitionof Etherios, net of cash acquired, partially offset by $3.1 million fewer net purchases of marketable securities in fiscal 2013 compared to fiscal 2012 and$1.1 million fewer capital expenditures in fiscal 2013 as compared to fiscal 2012.Net cash used by investing activities was $11.0 million in fiscal 2012 as compared to $22.4 million in fiscal 2011. Our net purchases of marketablesecurities were $9.5 million less in fiscal 2012 as compared to fiscal 2011. We spent $3.0 million for the final deferred payment related to the Spectrumacquisition in fiscal 2011. We spend an additional $1.2 million for purchases of capital expenditures in fiscal 2012 compared to fiscal 2011.Net cash used by financing activities was $10.8 million in fiscal 2013 as compared to net cash provided by financing activities of $2.3 million in fiscal 2012.We used $14.1 million of cash to repurchase our common stock, offset by an increase in proceeds from additional exercises of stock options of $1.1 million.Net cash provided by financing activities was $2.3 million in fiscal 2012 as compared to $4.6 million in fiscal 2011, a net decrease of $2.3 million, resultingprimarily from fewer exercises of stock options.We expect positive cash flows from operations and believe that our current cash, cash equivalents and marketable securities balances, cash generated fromoperations and our ability to secure debt and/or equity financing will be sufficient to fund our business operations, common stock repurchases and capitalexpenditures for the next twelve months and beyond. On October 29, 2013 our Board of Directors authorized a new program to repurchase up to $20 millionof our common stock. This repurchase authorization expires on October 31, 2014.At September 30, 2013, our total cash and cash equivalents and marketable securities balance, including long-term marketable securities was $105.7 million.This balance includes approximately $35.5 million of cash and cash equivalents held by our controlled foreign subsidiaries of which $24.4 million representsaccumulated undistributed foreign earnings. Although we have no current need or intention to repatriate historical earnings in the form of cash in the UnitedStates, if we change our assertion from indefinitely reinvesting undistributed foreign earnings, we would have to accrue applicable taxes. The amount of anytaxes 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, weestimate the unrecognized deferred tax liability to be in the range of $1.5 million to $2.5 million, which could have a material impact on our currentconsolidated balance sheet, results of operations and cash flows.33Table of ContentsITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(CONTINUED)The following summarizes our contractual obligations at September 30, 2013: Payments due by fiscal period($ in thousands) Total Less than 1 year 1-3 years 3-5 years ThereafterOperating leases $5,549 $2,527 $2,787 $235 $—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 $3.9 million as of September 30, 2013. Due to the nature of theunderlying liabilities and the extended time often needed to resolve income tax uncertainties, we cannot make reliable estimates of the amount or timing of futurecash 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 licensedproducts and we cannot make reliable estimates of the amount of cash payments.FOREIGN CURRENCYWe are exposed to foreign currency risk associated with certain sales transactions being denominated in Euros, British Pounds, Japanese Yen and IndianRupees and foreign currency translation risk as the financial position and operating results of our foreign subsidiaries are translated into U.S. Dollars forconsolidation. 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 havenot implemented a formal hedging strategy to reduce foreign currency risk.During 2013, we had approximately $78.8 million of revenue related to foreign customers including export sales, of which $24.3 million was denominated inforeign currency, predominantly the Euro and British Pound. During 2012 and 2011, we had approximately $78.2 million and $85.5 million, respectively,of revenue to foreign customers including export sales, of which $23.4 million and $28.8 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.RECENT ACCOUNTING DEVELOPMENTSAdoptedIn April 2013, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update ("ASU") 2013-07, "Presentation of FinancialStatements (Topic 205); Liquidation Basis of Accounting." The objective of this guidance is to clarify when an entity should apply the liquidation basis ofaccounting and to provide principles for the measurement of assets and liabilities under the liquidation basis of accounting, as well as any requireddisclosures. The amendments in this standard are effective prospectively for entities that determine liquidation is imminent during annual reporting periodsbeginning after December 15, 2013, and interim reporting periods therein. Early adoption is permitted. We adopted this guidance in the third quarter of fiscal2013. Since liquidation is not imminent, the adoption did not have an impact on our consolidated financial statements.In February 2013, the FASB issued ASU 2013-02, "Comprehensive Income (Topic 220); Reporting of Amounts Reclassified Out of Accumulated OtherComprehensive Income." This updated guidance improves the reporting of significant items reclassified out of accumulated other comprehensive income andrequires an entity to present, either on the face of the statement where net income is presented or in the notes, separately for each component of comprehensiveincome, the current period reclassifications out of accumulated other comprehensive income by the respective line items of net income affected by thereclassification. The updated guidance was effective prospectively for reporting periods beginning after December 15, 2012. We adopted this guidancebeginning January 1, 2013. Other than requiring additional disclosures that are in the footnotes to the Statements of Comprehensive Income, the adoption didnot have an effect on our consolidated financial statements.In July 2012, the FASB issued ASU 2012-02, "Intangibles - Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment." TheFASB amended its guidance on testing of indefinite-lived intangible assets for impairment. Under the amended guidance, companies may perform a qualitativeassessment to determine whether further impairment testing is necessary, similar to the amended goodwill impairment testing guidance noted below. Theguidance for indefinite-lived intangible assets is effective for annual and interim tests performed for fiscal years beginning after34Table of ContentsITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(CONTINUED)September 15, 2012, with an option for early adoption. We adopted ASU 2012-02 in the first quarter of fiscal 2013. As we do not have any indefinite-livedintangible assets, this pronouncement does not have an effect on our consolidated financial statements.Not AdoptedIn July 2013, the 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 requires an entity to present an unrecognized tax benefit, or a portion of an unrecognized tax benefit, as areduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward, except as follows: to the extent a netoperating loss carryforward, a similar tax loss, or a tax credit carryforward is not available at the reporting date under the tax law of the applicable jurisdictionto settle any additional income taxes that would result from the disallowance of a tax position or the tax law of the applicable jurisdiction does not require theentity to use, and the entity does not intend to use, the deferred tax asset for such purpose, the unrecognized tax benefit should be presented in the financialstatements as a liability and should not be combined with deferred tax assets. ASU No. 2013-11 is effective prospectively for fiscal years (and interimreporting periods within those years) beginning after December 15, 2014. We will adopt this guidance beginning with our fiscal quarter ending December 31,2015. We are evaluating the impact of the adoption of ASU 2013-11 and do not expect it to have a material impact on our consolidated financial statements.In March 2013, the FASB issued ASU 2013-05, "Foreign Currency Matters (Topic 830); Parent’s Accounting for the Cumulative Translation Adjustmentupon Derecognition of Certain Subsidiaries or Groups of Assets within a Foreign Entity or of an Investment in a Foreign Entity." This guidance applies to therelease 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 acontrolling financial interest in a subsidiary or group of assets that is a business (other than a sale of in substance real estate or conveyance of oil and gasmineral rights) within a foreign entity. ASU No. 2013-05 is effective prospectively for fiscal years (and interim reporting periods within those years) beginningafter December 15, 2013. We will adopt this guidance beginning with our fiscal quarter ending December 31, 2014. We currently are reviewing the provisionsof ASU No. 2013-05 but do not expect it to have an effect on our consolidated financial statements as we currently do not intend to sell any foreign entities forwhich we hold a controlling financial interest.CRITICAL ACCOUNTING POLICIES AND ESTIMATESOur discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have beenprepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these consolidated financialstatements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, the disclosure ofcontingent assets and liabilities and the values of purchased assets and assumed liabilities in acquisitions. We base our estimates on historical experience andvarious other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about thecarrying 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 financialstatements.REVENUE RECOGNITIONOur revenue is derived primarily from the sale of wired and wireless hardware products to our distributors and Direct/OEM customers. We recognize hardwareproduct revenue when persuasive evidence of an arrangement exists, delivery has occurred, the sales price is fixed or determinable, collectability is reasonablyassured and there are no post-delivery obligations, other than warranty. Under these criteria, product revenue generally is recognized upon shipment of productto customers. Sales to authorized domestic distributors and Direct / OEMs are made with certain rights of return and price adjustment provisions. Estimatedreserves for future returns and pricing adjustments are established by us based on an analysis of historical patterns of returns and price adjustments as wellas an analysis of authorized returns compared to received returns, current on-hand inventory at distributors, 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. Materialdifferences between the historical trends used to determine estimated reserves and actual returns and pricing adjustments could result in a material change toour consolidated results of operations or financial position. We have applied consistent methodologies for35Table of ContentsITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(CONTINUED)estimating reserves for future returns and pricing adjustments for all years presented. The reserve for future returns and pricing adjustments was $1.8 millionat September 30, 2013 and $1.4 million at September 30, 2012.Revenue recognized for service revenue as a percentage of total revenue represented 11.4%, 5.3% and 5.4% in fiscal 2013, 2012 and 2011, respectively. Ourservice revenue is derived primarily from professional and engineering services performed by our Etherios CRM and wireless design teams. We also havesome service revenue that is derived from our Device Cloud by Etherios, which is a platform-as-a-service (PAAS) offering in which customers pay for servicesconsumed in terms of devices being managed and monitored, or as a monthly service fee for access to information. In addition, we have small amounts ofrevenue from technical support and training. We recognize service revenue from our Etherios CRM professional services, wireless design services, and DeviceCloud based upon performance, including final product delivery and customer acceptance. In addition, we recognize small amounts of revenue from technicalsupport and training as the services are performed. Such revenue is deferred and recognized over the life of the contract as the service is performed.MARKETABLE SECURITIESWe regularly monitor and evaluate the realizable value of our marketable securities. When assessing marketable securities for other-than-temporary declines invalue, 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 valueof 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, theperformance of the issuer's stock price in relation to the stock price of its competitors within the industry, expected market volatility, analystrecommendations, the views of external investment managers, any news or financial information that has been released specific to the investee and the outlookfor the overall industry in which the issuer operates. If events and circumstances indicate that a decline in the value of these securities has occurred and isother-than-temporary, we would record a charge to other income (expense).ACCOUNTS RECEIVABLE AND ALLOWANCE FOR DOUBTFUL ACCOUNTSWe maintain an allowance for doubtful accounts, which reflects the estimate of losses that may result from the inability of some of our customers to makerequired payments. The estimate for the allowance for doubtful accounts is based on known circumstances regarding collectability of customer accounts andhistorical 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 actualcollection experience could result in a material change to our consolidated results of operations or financial position. The allowance for doubtful accounts was$0.3 million at both September 30, 2013 and September 30, 2012.INVENTORIESInventories 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 ourinventories for estimated excess and obsolete inventories equal to the difference between the cost of inventory and its estimated realizable value based uponassumptions about future product demand and market conditions. Once the new cost basis is established, the value is not increased with any changes incircumstances that would indicate an increase in value after the remeasurement. If actual product demand or market conditions are less favorable than thoseprojected by management, additional inventory write-downs may be required that could result in a material change to our consolidated results of operations orfinancial position. We have applied consistent methodologies for the net realizable value of inventories.GOODWILLGoodwill 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, ormore frequently if events or circumstances occur which could indicate impairment. At June 30, 2013, our market capitalization was $241.4 million comparedto our carrying value of $272.3 million. Our market capitalization plus our estimated control premium of 40% resulted in a fair value in excess of our carryingvalue by a margin of 24%. 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. At September 30, 2013, our market capitalization was $255.3 million compared to our carrying value of$274.3 million. Since there were no triggering events through September 30, 2013, and our market capitalization plus our estimated control premium of 40%resulted in a fair value in excess of our carrying value by a margin of 30%, no impairment was indicated.36Table of ContentsITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(CONTINUED)The control premium used in our annual goodwill assessment at June 30, 2013 and our further evaluation of goodwill at September 30, 2013 was based on acontrol premium study as of June 30, 2012, resulting in a range of control premium of 30% to 45%. We concluded that a 40% control premium bestrepresented the amount an investor would pay, over and above market capitalization, in order to obtain a controlling interest given current economic conditionsin both fiscal 2012 and fiscal 2013. We chose 40% as it approximated the midpoint of the range and reflected the overall increase in control premiums over thepast several years.INCOME TAXESWe 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 eachof these jurisdictions. This determination requires us to make several estimates and assumptions. Tax audits associated with the allocation of this income, andother 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 ourconsolidated financial position and results of operations and could result in potential cash outflows.We have unrecognized tax benefits of $3.9 million classified as a long-term liability. We expect that it is reasonably possible that the total amounts ofunrecognized tax benefits will decrease approximately $0.2 million to $0.3 million over the next 12 months due to the expiration of statute of limitations. Thetotal amount of unrecognized tax benefits that if recognized would affect our effective tax rate is $3.4 million. We recognize interest and penalties related toincome tax matters in income tax expense.WARRANTIESIn general, we warrant our products to be free from defects in material and workmanship under normal use and service. The warranty periods generally rangefrom one to five years. We typically have the option to repair or replace products we deem defective due to material or workmanship. Estimated warranty costsare accrued in the period that the related revenue is recognized based upon an estimated average per unit repair or replacement cost applied to the estimatednumber of units under warranty. These estimates are based upon historical warranty incidents and are evaluated on an ongoing basis to ensure the adequacy ofthe warranty accrual. The product warranty accrual was $1.1 million and $1.0 million at September 30, 2013 and September 30, 2012, respectively.37Table of ContentsITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKINTEREST RATE RISKOur 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 RISKWe are exposed to foreign currency risk associated with certain sales transactions being denominated in Euros, British Pounds, Japanese Yen or Indian Rupeesand foreign currency translation risk as the financial position and operating results of our foreign subsidiaries are translated into U.S. Dollars forconsolidation. 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 havenot implemented a formal hedging strategy.The table below compares the average monthly exchange rates of the Euro, British Pound, Japanese Yen and Indian Rupee to the U.S. Dollar: Twelve months ended September 30, % increase 2013 2012 (decrease)Euro1.3120 1.2988 1.0 %British Pound1.5616 1.5762 (0.9)%Japanese Yen0.0109 0.0127 (14.2)%Indian Rupee0.0178 0.0190 (6.3)%A 10.0% change from the 2013 average exchange rate for the Euro, British Pound, Yen and Rupee to the U.S. Dollar would have resulted in a 1.2% increase ordecrease in annual revenue and a 2.1% increase or decrease in stockholders' equity. The above analysis does not take into consideration any pricingadjustments we may make in response to changes in the exchange rate.CREDIT RISKWe have some exposure to credit risk related to our accounts receivable portfolio. Exposure to credit risk is controlled through regular monitoring of customerfinancial 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 governmentmunicipal bonds. We may have some credit exposure related to the fair value of our securities, which could change based on changes in market conditions. Ifmarket conditions deteriorate or, if these securities experience credit rating downgrades, we may incur impairment charges for securities in our investmentportfolio.38Table of ContentsITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATAREPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRMTo 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, stockholders’equity and of cash flows present fairly, in all material respects, the financial position of Digi International Inc. and its subsidiaries at September 30, 2013 andSeptember 30, 2012, and the results of their operations and their cash flows for each of the three years in the period ended September 30, 2013 in conformitywith accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the indexappearing under Item 15(a)(2) presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidatedfinancial statements. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of September30, 2013, based on criteria established in Internal Control - Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of theTreadway Commission (COSO). The Company's management is responsible for these financial statements and financial statement schedule, for maintainingeffective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included inManagement’s Report on Internal Control over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on these financialstatements, on the financial statement schedule, and on the Company's internal control over financial reporting based on our integrated audits. We conductedour audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan andperform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal controlover financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidencesupporting 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 ofinternal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness ofinternal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. Webelieve 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 andthe preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control overfinancial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflectthe transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permitpreparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are beingmade only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention ortimely 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 ofeffectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliancewith the policies or procedures may deteriorate./s/ PricewaterhouseCoopers LLPMinneapolis, MinnesotaNovember 22, 201339Table of ContentsITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA (CONTINUED)DIGI INTERNATIONAL INC.CONSOLIDATED STATEMENTS OF OPERATIONS Fiscal years ended September 30, 2013 2012 2011 (in thousands, except per common share data)Revenue: Hardware product$173,078 $180,434 $193,113Service22,303 10,124 11,047Total revenue195,381 190,558 204,160Cost of sales: Cost of hardware product82,276 84,714 92,897Cost of service12,982 5,507 4,675Total cost of sales95,258 90,221 97,572Gross profit100,123 100,337 106,588Operating expenses: Sales and marketing40,513 39,242 39,549Research and development30,327 30,767 31,642General and administrative21,423 18,188 18,206Restructuring charges, net313 1,259 154Total operating expenses92,576 89,456 89,551Operating income7,547 10,881 17,037Other income (expense), net: Interest income210 289 251Interest expense(42) (23) (86)Other income (expense), net523 (250) (687)Total other income (expense), net691 16 (522)Income before income taxes8,238 10,897 16,515Income tax provision2,433 3,282 5,496Net income$5,805 $7,615 $11,019Net income per common share: Basic0.22 0.30 0.44Diluted0.22 0.29 0.43Weighted average common shares: Basic25,956 25,743 25,312Diluted26,237 26,146 25,819The accompanying notes are an integral part of the consolidated financial statements.40Table of ContentsITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA (CONTINUED)DIGI INTERNATIONAL INC.CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME Fiscal years ended September 30, 2013 2012 2011 (in thousands)Net income$5,805 $7,615 $11,019Other comprehensive income (loss), net of tax: Foreign currency translation adjustment(1,826) (3,354) (770)Change in net unrealized (loss) gain on investments(63) 126 (170)Less income tax benefit (provision)24 (51) 66Reclassification of realized loss on investments included in net income (1)— 15 10Less income tax benefit (2)— (4) (4)Other comprehensive loss, net of tax(1,865) (3,268) (868)Comprehensive income$3,940 $4,347 $10,151(1)Recorded in Other income (expense), net in our Consolidated Statements of Operations.(2)Recorded in Income tax provision in our Consolidated Statements of Operations.The accompanying notes are an integral part of the consolidated financial statements.41Table of ContentsITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA (CONTINUED)DIGI INTERNATIONAL INC.CONSOLIDATED BALANCE SHEETS As of September 30, 2013 2012 (in thousands, except share data)ASSETS Current assets: Cash and cash equivalents$41,320 $60,246Marketable securities47,006 58,372Accounts receivable, net26,829 24,634Inventories26,140 24,435Deferred tax assets3,174 3,389Other4,835 2,493Total current assets149,304 173,569Marketable securities, long-term17,389 2,016Property, equipment and improvements, net13,910 15,157Identifiable intangible assets, net9,728 10,629Goodwill103,569 86,209Deferred tax assets5,832 5,010Other221 494Total assets$299,953 $293,084LIABILITIES AND STOCKHOLDERS’ EQUITY Current liabilities: Accounts payable$8,906 $6,040Income taxes payable— 1,269Accrued compensation7,410 5,744Accrued warranty1,063 1,021Other3,911 4,118Total current liabilities21,290 18,192Income taxes payable3,903 3,294Deferred tax liabilities415 630Other noncurrent liabilities79 111Total liabilities25,687 22,227Commitments 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; 30,264,224 and 29,268,788 shares issued303 293Additional paid-in capital211,982 199,495Retained earnings116,088 110,283Accumulated other comprehensive loss(15,590) (13,725)Treasury stock, at cost, 4,708,965 and 3,356,453 shares(38,517) (25,489)Total stockholders’ equity274,266 270,857Total liabilities and stockholders’ equity$299,953 $293,084The accompanying notes are an integral part of the consolidated financial statements.42Table of ContentsITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA (CONTINUED)DIGI INTERNATIONAL INC.CONSOLIDATED STATEMENTS OF CASH FLOWS Fiscal years ended September 30, 2013 2012 2011Operating activities: (in thousands)Net income $5,805 $7,615 $11,019Adjustments to reconcile net income to net cash provided by operating activities: Depreciation of property, equipment and improvements 3,461 3,339 3,006Amortization of identifiable intangible assets 4,416 4,476 6,171Stock-based compensation 3,773 3,727 3,444Excess tax benefits from stock-based compensation (67) (198) (796)Deferred income tax benefit (2,055) (2,452) (1,205)Bad debt/product return provision 811 500 90Inventory obsolescence 1,258 1,413 1,935Intangible impairment charge 361 — —Restructuring charges, net 313 1,259 154Other (85) 13 263Changes in operating assets and liabilities (net of acquisition): Accounts receivable (2,368) (343) (2,756)Inventories (2,972) (1,958) 623Other assets (212) 168 (602)Income taxes (2,634) 2,330 (432)Accounts payable 1,413 (1,759) (1,227)Accrued expenses 530 (3,003) 2,152Net cash provided by operating activities 11,748 15,127 21,839Investing activities: Purchase of marketable securities (67,159) (72,669) (61,506)Proceeds from maturities of marketable securities 63,089 65,533 44,843Acquisition of businesses, net of cash acquired (12,919) — (3,000)Proceeds from sale of investment 136 135 —Purchase of property, equipment, improvements and certain other intangible assets (2,886) (3,953) (2,736)Net cash used in investing activities (19,739) (10,954) (22,399)Financing activities: Excess tax benefits from stock-based compensation 67 198 796Proceeds from stock option plan transactions 2,193 1,072 2,853Proceeds from employee stock purchase plan transactions 1,008 1,041 990Purchase of common stock (14,058) — —Net cash (used in) provided by financing activities (10,790) 2,311 4,639Effect of exchange rate changes on cash and cash equivalents (145) (922) (338)Net (decrease) increase in cash and cash equivalents (18,926) 5,562 3,741Cash and cash equivalents, beginning of period 60,246 54,684 50,943Cash and cash equivalents, end of period $41,320 $60,246 $54,684 Supplemental disclosures of cash flow information: Interest paid $42 $23 $86Income taxes paid, net $6,300 $3,201 $7,065Supplemental schedule of non-cash investing activities: Accrual for capitalized intangible asset $42 $— $—Issuance of common stock for business acquisition $6,741 $— $—The accompanying notes are an integral part of the consolidated financial statements.43Table of ContentsITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA (CONTINUED)DIGI INTERNATIONAL INC.CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITYFor fiscal years ended September 30, 2013, 2012 and 2011 Accumulated Additional Other Total Common Stock Treasury Stock Paid-In Retained Comprehensive Stockholders' Shares Par Value Shares Value Capital Earnings Loss EquityBalances, September 30, 2010 28,666 $287 3,584 $(27,218) $185,427 $91,649 $(9,589) $240,556Net income 11,019 11,019Other comprehensive loss (868) (868)Employee stock purchase issuances (112) 852 138 990Issuance of stock upon exercise of stockoptions 435 4 2,849 2,853Tax benefit realized upon exercise of stockoptions 2,722 2,722Stock-based compensation expense 3,444 3,444Balances, September 30, 2011 29,101 $291 3,472 $(26,366) $194,580 $102,668 $(10,457) $260,716Net income 7,615 7,615Other comprehensive loss (3,268) (3,268)Employee stock purchase issuances (116) 877 164 1,041Issuance of stock upon exercise of stockoptions 168 2 1,070 1,072Tax benefit realized upon exercise of stockoptions (46) (46)Stock-based compensation expense 3,727 3,727Balances, September 30, 2012 29,269 $293 3,356 $(25,489) $199,495 $110,283 $(13,725) $270,857Net income 5,805 5,805Other comprehensive loss (1,865) (1,865)Employee stock purchase issuances (128) 1,030 (22) 1,008Repurchase of common stock 1,481 (14,058) (14,058)Issuance of stock upon exercise of stockoptions 280 3 2,190 2,193Tax benefit realized upon exercise of stockoptions (188) (188)Acquisition of Etherios, Inc. 715 7 6,734 6,741Stock-based compensation expense 3,773 3,773Balances, September 30, 2013 30,264 $303 4,709 $(38,517) $211,982 $116,088 $(15,590) $274,266The accompanying notes are an integral part of the consolidated financial statements.44Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIESBusiness DescriptionWe are a leading provider of machine to machine (M2M) networking products and end-to-end solutions that enable the connection, monitoring and control oflocal or remote physical assets by electronic means. Our products are deployed by a wide range of businesses and institutions. We focus a significant amountof our development, sales and marketing efforts on continuing to develop, manufacture and market a wide range of hardware products that have been thehistorical backbone of our business since its inception; and expand and enhance our deployment of software applications and cloud-based platform solutionsthat enable electronic devices to interface with business applications.Principles of ConsolidationThe consolidated financial statements include our accounts and the accounts of our wholly-owned subsidiaries. All intercompany accounts and transactionshave been eliminated in consolidation.Changes in PresentationBeginning with this 10-K, we began presenting product and service revenue, as well as cost of product and service revenue, on the face of our incomestatement. The prior year data for these line items has been recast accordingly. These reclassifications had no effect on reported consolidated net earnings.Cash EquivalentsCash equivalents consist of money market accounts and other highly liquid investments purchased with an original maturity of three months or less. Thecarrying amounts approximate fair value due to the short maturities of these investments.Marketable SecuritiesMarketable securities consist of certificates of deposit, commercial paper, corporate bonds and government municipal bonds. All marketable securities areaccounted for as available-for-sale and are carried at fair value on our consolidated balance sheets with unrealized gains and losses recorded in accumulatedother comprehensive loss within stockholders' equity. In order to estimate the fair value for each security in our investment portfolio, we obtain quoted marketprices and trading activity for each security where available. We obtain relevant information from our investment advisor and, if warranted, also may reviewthe financial solvency of certain security issuers.We regularly monitor and evaluate the value of our marketable securities. When assessing marketable securities for other-than-temporary declines in value, weconsider 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 theinvestment 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 performanceof the issuer's stock price in relation to the stock price of its competitors within the industry, expected market volatility, analyst recommendations, the views ofexternal investment managers, any news or financial information that has been released specific to the investee and the outlook for the overall industry inwhich the issuer operates. If events and circumstances indicate that a decline in the value of a security has occurred and is other-than-temporary, we wouldrecord a charge to other income (expense).Accounts ReceivableAccounts receivable are stated at the amount we expect to collect, which is net of an allowance for doubtful accounts for estimated losses resulting from theinability of our customers to make required payments. The following factors are considered when determining the collectability of specific customeraccounts: customer creditworthiness, past transaction history with the customer, and changes in customer payment terms or practices. In addition, overallhistorical collection experience, current economic industry trends, and a review of the current status of trade accounts receivable are considered whendetermining the required allowance for doubtful accounts. Based on our assessment, we provide for estimated uncollectible amounts through a charge toearnings and a credit to our allowance for doubtful accounts. Balances that remain outstanding after we have used reasonable collection efforts are written offthrough a charge to the allowance for doubtful accounts and a credit to accounts receivable.45Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)InventoriesInventories are stated at the lower of cost or fair market value, with cost determined using the first-in, first-out method. Appropriate consideration is given todeterioration, obsolescence and other factors in evaluating fair market value.Property, Equipment and Improvements, NetProperty, equipment and improvements are carried at cost, net of accumulated depreciation. Depreciation is provided by charges to operations using thestraight-line method over the estimated asset useful lives. Furniture and fixtures and other equipment are depreciated over a period of three to seven years.Building improvements and buildings are depreciated over ten and thirty-nine years, respectively. Equipment under capital lease is depreciated over the lesserof the lease term or its depreciable life.Expenditures for maintenance and repairs are charged to operations as incurred, while major renewals and betterments are capitalized. The assets and relatedaccumulated depreciation accounts are adjusted for asset retirements and disposals with the resulting gain or loss included in operations.Identifiable Intangible AssetsPurchased proven technology, license agreements, covenants not to compete and other identifiable intangible assets are recorded at fair value when acquired in abusiness acquisition, or at cost when not purchased in a business acquisition. Purchased in-process research and development costs (IPR&D) related tobusiness combinations are capitalized and amortized once placed in service. All other identifiable intangible assets are amortized on either a straight-line basisover their estimated useful lives of three to thirteen years or based on the pattern in which the asset is consumed. Useful lives for identifiable intangible assetsare estimated at the time of acquisition based on the periods of time from which we expect to derive benefits from the identifiable intangible assets. Amortizationof purchased and core technology is included in cost of product in the Consolidated Statements of Operations. Amortization of all other acquired identifiableintangible assets is charged to operating expenses as a component of general and administrative expense.Identifiable intangible assets are reviewed for impairment annually or whenever events or circumstances indicate that undiscounted expected future cash flowsare not sufficient to recover the carrying value amount. We measure impairment loss by utilizing an undiscounted cash flow valuation technique using fairvalues indicated by the income approach. Impairment losses, if any, would be recorded in the period the impairment is identified. During the fourth quarter offiscal 2013, we recorded an impairment charge of $0.4 million included in general and administrative expense on our Consolidated Statements of Operationsfor our single operating and reporting segment (see Note 3 to our Consolidated Financial Statements). There were no other impairments identified in fiscal 2013and there were no impairments identified during fiscal years 2012 or 2011.GoodwillGoodwill 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, ormore frequently if events or circumstances occur which could indicate impairment. The calculation of goodwill impairment requires us to make assumptionsabout the fair value of our one reporting unit, which historically has been approximated by using our market capitalization plus a control premium. Controlpremium assumptions require judgment and actual results may differ from assumed or estimated amounts.In June 2012 we performed a control premium study to determine the appropriate control premium to include in the calculation of fair value, using a thirdparty valuation firm to assist us in performing the control premium analysis. In order to estimate the range of control premiums appropriate for us, threemethodologies were used, including: (1) analysis of individual transactions within our industry; (2) analysis of industry-wide data, and (3) analysis of globaltransaction data. Individual transactions in the Communication Equipment or Computer & Peripherals industries were used to find transactions of targetcompanies that operated in similar markets and shared similar operating characteristics with Digi. Transaction screening criteria included selection oftransactions with the following characteristics:•At least 50 percent of a target company's equity sought by an acquirer,•Target company considered operating (not in bankruptcy),46Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)•Target company had publicly traded stock outstanding at the transaction date, and•Transactions announced between June 30, 2007 and the valuation date.In analyzing industry-wide data, transactions in three industries were identified that encompassed the products offered by us: Office Equipment andComputer Hardware, Communications, and Computer, Supplies and Services. Finally, control premiums were considered for both domestic andinternational transactions. The control premium analysis resulted in a range of control premium of 30% to 45%. We reviewed the data provided and estimatedthat a 40% control premium best represented the amount an investor would likely pay, over and above market capitalization, in order to obtain a controllinginterest given the economic conditions at that time. We chose 40% as it approximated the midpoint of the range and reflected the overall increase in controlpremiums over the past several years. Based on our industry knowledge and recent discussions with our third party valuation firm, we concluded that thecontrol premium study that was performed in conjunction with our annual goodwill impairment assessment at June 30, 2012 remained valid and that the 40%control premium used in our prior year's assessment continued to best represent the amount an investor likely would pay, over and above marketcapitalization, in order to obtain a controlling interest given current economic conditions in both fiscal 2012 and fiscal 2013.At June 30, 2013, our market capitalization was $241.4 million compared to our carrying value of $272.3 million. Our market capitalization plus ourestimated control premium of 40% resulted in a fair value in excess of our carrying value by a margin of 24%. As a result, no impairment was indicated andwe were not required to complete the second step of the goodwill impairment analysis. No goodwill impairment charges were recorded. At September 30, 2013,our market capitalization was $255.3 million compared to our carrying value of $274.3 million. Since there were no triggering events through September 30,2013, and our market capitalization plus our estimated control premium of 40% resulted in a fair value in excess of our carrying value by a margin of 30%, noimpairment was indicated.As of June 30, 2012, our market capitalization was $264.3 million compared to our carrying value of $265.7 million. Our market capitalization plus ourestimated control premium of 40% resulted in a fair value in excess of our carrying value by a margin of 39% and therefore no impairment was indicated.If our stock price or control premium declines, the first step of our goodwill impairment analysis may fail. We have defined the criteria that could result inadditional interim goodwill impairment testing. We would perform the second step of the impairment testing if our stock price fell below defined thresholds fora significant period of time, or if our control premium significantly decreased. Events or circumstances may occur that could negatively impact our stockprice, including changes in our anticipated revenue and profits and our ability to execute on our strategies. In addition, our control premium could decline dueto changes in economic conditions, in the technology industry, in the financial markets or more generally. An impairment could have a material effect on ourconsolidated balance sheet and results of operations. We have had no goodwill impairment losses since the adoption of Accounting Standards Codification(ASC) 350, Intangibles-Goodwill and Others, in fiscal 2003.Revenue RecognitionWe recognize revenue in accordance with authoritative guidance issued by FASB related to revenue recognition.Hardware product revenue as a percentage of total revenue was 88.6%, 94.7% and 94.6% in fiscal 2013, 2012 and 2011, respectively. We recognize hardwareproduct revenue when persuasive evidence of an arrangement exists, delivery has occurred, the sales price is fixed or determinable, collectability is reasonablyassured and there are no post-delivery obligations, other than warranty. Under these criteria, product revenue generally is recognized upon shipment of productto customers. Sales to authorized domestic distributors and Direct / OEMs are made with certain rights of return and price adjustment provisions. Estimatedreserves for future returns and pricing adjustments are established by us based on an analysis of historical patterns of returns and price adjustments as wellas an analysis of authorized returns compared to received returns, current on-hand inventory at distributors, 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 revenue is recorded.Revenue recognized for service revenue as a percentage of total revenue represented 11.4%, 5.3% and 5.4% in fiscal 2013, 2012 and 2011, respectively. Ourservice revenue is derived primarily from professional and engineering services performed by our Etherios customer relationship management (CRM) andwireless design teams. We also have some service revenue that is derived from our Device Cloud by Etherios, 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 toinformation. In addition, we have small amounts of revenue from technical support and training. We recognize service revenue from our47Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)Etherios CRM professional services, wireless design services, and Device Cloud based upon performance, including final product delivery and customeracceptance. In addition, we recognize small amounts of revenue from technical support and training as the services are performed. Such revenue is deferredand recognized over the life of the contract as the service is performed.Research and DevelopmentResearch and development costs are expensed when incurred. Research and development costs include compensation, allocation of corporate costs,depreciation, utilities, professional services and prototypes. Software development costs are expensed as incurred until the point that technological feasibilityand proven marketability of the product are established. To date, the time period between the establishment of technological feasibility and completion ofsoftware development has been short, and no significant development costs have been incurred during that period. Accordingly, we have not capitalized anysoftware development costs to date.Income TaxesDeferred income taxes are recognized for the tax consequences in future years of differences between the tax basis of assets and liabilities and their financialreporting amounts at each year end based on enacted tax laws and statutory tax rates applicable to the periods in which the differences are expected to affecttaxable income. Income tax expense is equal to the tax payable for the period and the change during the period in deferred tax assets and liabilities and alsochanges in income tax reserves.Net Income Per Common ShareBasic net income per common share is calculated based on the weighted average number of common shares outstanding during the period. Diluted net incomeper common share is computed by dividing net income by the weighted average number of common and potentially dilutive common shares outstandingduring the period. Potentially dilutive common shares of our stock result from dilutive common stock options and restricted stock units. We use the treasurystock method to calculate the weighted-average shares used in the diluted earnings per share computation. Under the treasury stock method, the proceeds fromexercise of an option, the amount of compensation cost, if any, for future service that we have not yet recognized, and the amount of estimated tax benefits thatwould be recorded in paid-in capital, if any, when the option is exercised are assumed to be used to repurchase shares in the current period.The following table is a reconciliation of the numerators and denominators in the net income per common share calculations (in thousands, except per commonshare data): Fiscal years ended September 30, 2013 2012 2011Numerator: Net income$5,805 $7,615 $11,019Denominator: Denominator for basic net income per common share — weighted average shares outstanding25,956 25,743 25,312Effect of dilutive securities: Stock options and restricted stock units281 403 507Denominator for diluted net income per common share — adjusted weighted average shares26,237 26,146 25,819Net income per common share, basic$0.22 $0.30 $0.44Net income per common share, diluted$0.22 $0.29 $0.43Because their effect would be anti-dilutive at period end, certain potentially dilutive shares related to stock options to purchase common shares were notincluded in the above computation of diluted earnings per share because the options' exercise prices were greater than the average market price of our commonshares. At September 30, 2013, 2012 and 2011, potentially dilutive shares related to such stock options were 3,939,541, 2,023,213 and 1,831,713,respectively.48Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)Stock-Based CompensationStock-based compensation expense represents the cost of employee services received in exchange for an award of equity instruments based on the grant datefair value of the award. This cost must be recognized over the period during which an employee is required to provide the service (usually the vesting period).Foreign Currency TranslationFinancial position and results of operations of our international subsidiaries are measured using local currencies as the functional currency, except for ourSingapore location which uses the U.S. Dollar as its local currency. Assets and liabilities of these operations are translated at the exchange rates in effect at theend of each reporting period. Statements of operations accounts are translated at the weighted average rates of exchange prevailing during each reporting period.Translation adjustments arising from the use of differing currency exchange rates from period to period are included in accumulated other comprehensiveincome (loss) in stockholders' equity. Gains and losses on foreign currency exchange transactions, as well as translation gains or losses on transactionsdenominated in currencies other than an entity's functional currency are reflected in the statement of operations. During fiscal 2013, 2012 and 2011 there werenet transaction gains (losses) of $0.4 million, $(0.4) million and $(0.7) million, respectively, that were recorded in other income (expense). We manage our netasset 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 hedgingstrategy.Use of Estimates and Risks and UncertaintiesThe preparation of consolidated financial statements in conformity with generally accepted accounting principles in the United States requires management tomake estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of thefinancial statements and the reported amount of revenue and expenses during the reporting period. Actual results could differ from those estimates. Estimatesthat could significantly affect our results of operations or financial condition involve the assignment of fair values upon acquisition of goodwill and otherintangible assets and testing for impairment; the determination of our allowance for doubtful accounts and reserve for future returns and pricing adjustments;the estimation of our inventory obsolescence, warranty reserve, income tax reserves and other contingencies.Comprehensive Income (Loss)Our comprehensive income (loss) is comprised of net income, foreign currency translation adjustments and unrealized gains and losses on available-for-salemarketable securities, which are charged or credited to the accumulated other comprehensive income (loss) account in stockholders' equity.Recent Accounting DevelopmentsAdoptedIn April 2013, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update ("ASU") 2013-07, "Presentation of FinancialStatements (Topic 205); Liquidation Basis of Accounting." The objective of this guidance is to clarify when an entity should apply the liquidation basis ofaccounting and to provide principles for the measurement of assets and liabilities under the liquidation basis of accounting, as well as any requireddisclosures. The amendments in this standard are effective prospectively for entities that determine liquidation is imminent during annual reporting periodsbeginning after December 15, 2013, and interim reporting periods therein. Early adoption is permitted. We adopted this guidance in the third quarter of fiscal2013. Since liquidation is not imminent, the adoption did not have an impact on our consolidated financial statements.In February 2013, the FASB issued ASU 2013-02, "Comprehensive Income (Topic 220); Reporting of Amounts Reclassified Out of Accumulated OtherComprehensive Income." This updated guidance improves the reporting of significant items reclassified out of accumulated other comprehensive income andrequires an entity to present, either on the face of the statement where net income is presented or in the notes, separately for each component of comprehensiveincome, the current period reclassifications out of accumulated other comprehensive income by the respective line items of net income affected by thereclassification. The updated guidance was effective prospectively for reporting periods beginning after December 15, 2012. We adopted this guidancebeginning January 1, 2013. Other than requiring additional disclosures that are in the footnotes49Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)to the Statements of Comprehensive Income, the adoption did not have an effect on our consolidated financial statements.In July 2012, the FASB issued ASU 2012-02, "Intangibles - Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment." TheFASB amended its guidance on testing of indefinite-lived intangible assets for impairment. Under the amended guidance, companies may perform a qualitativeassessment to determine whether further impairment testing is necessary, similar to the amended goodwill impairment testing guidance noted below. Theguidance for indefinite-lived intangible assets is effective for annual and interim tests performed for fiscal years beginning after September 15, 2012, with anoption for early adoption. We adopted ASU 2012-02 in the first quarter of fiscal 2013. As we do not have any indefinite-lived intangible assets, thispronouncement does not have an effect on our consolidated financial statements.Not AdoptedIn July 2013, the 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 requires an entity to present an unrecognized tax benefit, or a portion of an unrecognized tax benefit, as areduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward, except as follows: to the extent a netoperating loss carryforward, a similar tax loss, or a tax credit carryforward is not available at the reporting date under the tax law of the applicable jurisdictionto settle any additional income taxes that would result from the disallowance of a tax position or the tax law of the applicable jurisdiction does not require theentity to use, and the entity does not intend to use, the deferred tax asset for such purpose, the unrecognized tax benefit should be presented in the financialstatements as a liability and should not be combined with deferred tax assets. ASU No. 2013-11 is effective prospectively for fiscal years (and interimreporting periods within those years) beginning after December 15, 2014. We will adopt this guidance beginning with our fiscal quarter ending December 31,2015. We are evaluating the impact of the adoption of ASU 2013-11 and do not expect it to have a material impact on our consolidated financial statements.In March 2013, the FASB issued ASU 2013-05, "Foreign Currency Matters (Topic 830); Parent’s Accounting for the Cumulative Translation Adjustmentupon Derecognition of Certain Subsidiaries or Groups of Assets within a Foreign Entity or of an Investment in a Foreign Entity." This guidance applies to therelease 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 acontrolling financial interest in a subsidiary or group of assets that is a business (other than a sale of in substance real estate or conveyance of oil and gasmineral rights) within a foreign entity. ASU No. 2013-05 is effective prospectively for fiscal years (and interim reporting periods within those years) beginningafter December 15, 2013. We will adopt this guidance beginning with our fiscal quarter ending December 31, 2014. We currently are reviewing the provisionsof ASU No. 2013-05 but do not expect it to have an effect on our consolidated financial statements as we currently do not intend to sell any foreign entities forwhich we hold a controlling financial interest.2. ACQUISITIONEtherios, Inc.On October 31, 2012, we acquired Etherios, Inc. ("Etherios"). The total purchase price of $20.4 million included $13.7 million in cash (excluding cashacquired of $0.8 million) and $6.7 million represented by 715,571 shares of our common stock. The common stock issued was valued at $9.42 percommon share.Cash in the amount of $2.35 million was deposited to an escrow fund with a third party agent. Of the $2.35 million escrow, $0.3 million related to aholdback amount pending final determination of the unpaid debt and working capital as shown on the closing balance sheet. This holdback amount was paidin February 2013 as there were no changes to the closing balance sheet. An additional $2.05 million is held in escrow for a period not to exceed eighteen monthsfrom the date of closing to satisfy possible claims that may arise pursuant to specific representation and warranty sections of the stock purchase agreement.The escrowed amounts have been included in the determination of the purchase consideration on the date of acquisition as management believes that therepresentation and warranty matters are determinable beyond a reasonable doubt.Costs related to the acquisition, which include legal, accounting and valuation fees, in the amount of $0.2 million have been charged directly to operations andare included in general and administrative expense in our Consolidated Statements of Operations for fiscal 2013.50Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS2. ACQUISITION (CONTINUED)The purchase price was allocated to the estimated fair value of assets acquired and liabilities assumed. The purchase price allocation resulted in the recognitionof $17.3 million of goodwill. We believe that the acquisition resulted in the recognition of goodwill primarily because Etherios is a salesforce.com PlatinumPartner and experienced in end user implementation of the Salesforce Service Cloud. Although we believe the relationship with salesforce.com is important tous, it is not an exclusive relationship and requires Etherios to compete with others for business opportunities. Accordingly, we have determined that thisrelationship cannot be valued as a separate intangible asset of Etherios and as a result is a component of goodwill.As salesforce.com has signaled its intent for the Service Cloud to be used as a means to monitor machines, we also believe that the acquisition of Etherios willlikely further enhance our solutions offerings and provide another channel for revenue of our networking products.Etherios' operating results are included in our Consolidated Results of Operations from the day following the acquisition on October 31, 2012. TheConsolidated Balance Sheet as of September 30, 2013 reflects the allocation of the purchase price to the assets acquired and liabilities assumed based on theirestimated fair values at the date of acquisition.The Etherios acquisition has been accounted for using the acquisition method of accounting which requires, among other things, that most assets acquiredand liabilities assumed pursuant to the stock purchase agreement be recognized at fair value as of the acquisition date. The table below sets forth the finalpurchase price allocation (in thousands):Cash, including cash in escrow$13,696Common stock6,741Total$20,437 Fair value of net tangible assets acquired$1,142Fair value of identifiable intangible assets acquired: Existing customer relationships1,400Non-compete agreements1,100Trade name440Order backlog360Goodwill17,282Deferred tax liabilities related to identifiable intangibles(1,287)Total$20,437The weighted average useful life for all the identifiable intangibles listed above is 5.7 years. For purposes of determining fair value, the existing customerrelationships identified above are assumed to have useful lives ranging between six to eight years, non-compete agreements are assumed to have useful lives offive years, the trade name is assumed to have a useful life of seven years, and the order backlog is assumed to have a useful life of one year. Useful lives foridentifiable intangible assets are estimated at the time of acquisition based on the periods of time from which we expect to derive benefits from the identifiableintangible assets. The identifiable intangible assets are amortized using the straight-line method which reflects the pattern in which the asset are expected to beconsumed.We have determined that the Etherios acquisition is not material to our consolidated results of operations or financial position; therefore, pro forma financialinformation for fiscal 2013 and 2012 is not presented.51Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS3. GOODWILL AND OTHER IDENTIFIABLE INTANGIBLE ASSETS, NETIdentifiable Intangible Assets, NetAmortizable identifiable intangible assets, net as of September 30, 2013 and 2012 are comprised of the following (in thousands): September 30, 2013 September 30, 2012 Grosscarryingamount Accum.amort. Net Grosscarryingamount Accum.amort. NetPurchased and core technology$45,960 $(44,306) $1,654 $46,597 $(43,639) $2,958License agreements2,440 (2,440) — 2,840 (2,682) 158Patents and trademarks11,322 (9,000) 2,322 10,943 (8,469) 2,474Customer maintenance contracts— — — 700 (700) —Customer relationships18,954 (14,130) 4,824 17,504 (12,465) 5,039Non-compete agreements1,100 (202) 898 1,045 (1,045) —Order backlog360 (330) 30 — — —Total$80,136 $(70,408) $9,728 $79,629 $(69,000) $10,629During the fourth quarter of fiscal 2013, we recorded an impairment charge of $0.4 million in general and administrative expense on our ConsolidatedStatements of Operations for our single operating and reporting segment. Management determined to end-of-life certain product lines acquired in connectionwith the MobiApps acquisition due to various factors impacting the viability of these product lines. These products lines utilized certain identifiable intangibletechnology assets which were part of the assets purchased at the time of acquisition. The impairment charge consisted of $0.2 million for patented satellitetechnology and $0.1 million relating to an associated license agreement as the net carrying values of these intangible assets are not recoverable and theundiscounted future cash flows do not exceed the net carrying value of the assets. We also wrote off $0.1 million of various patents that were abandoned.Amortization expense for fiscal years 2013, 2012 and 2011 is as follows (in thousands):Fiscal yearTotal2013$4,4162012$4,4762011$6,171Estimated amortization expense for the next five years is as follows (in thousands):Fiscal yearTotal2014$3,6192015$2,7242016$1,5402017$7022018$482The changes in the carrying amount of goodwill were (in thousands): Fiscal years ended September 30, 2013 2012Beginning balance, October 1$86,209 $86,012Acquisition of Etherios, Inc.17,282 —Foreign currency translation adjustment78 197Ending balance, September 30$103,569 $86,20952Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS4. SEGMENT INFORMATION AND MAJOR CUSTOMERSWe operate under a single operating and reporting segment. Our revenue consists of hardware product revenue and service revenue. Our hardware productofferings are comprised of growth hardware products that include wireless hardware products and ARM-based embedded modules, as well as maturehardware products that include primarily wired hardware products. Our service offerings include wireless product design and development services, CRMconsulting services, application development services, licenses to use The Social Machine® application for use on the Force.com platform and our PAASrecurring revenue generated from Device Cloud platform, post-contract customer support and fees associated with technical support and training.The following table presents revenue for our growth and mature categories (in thousands): Fiscal years ended September 30, 2013 2012 2011Growth hardware products and all services$110,741 $99,257 $101,565Mature hardware products84,640 91,301 102,595Total revenue$195,381 $190,558 $204,160The information in the following table provides revenue by the geographic location of the customer for the fiscal years ended September 30, 2013, 2012 and2011 (in thousands): Fiscal years ended September 30, 2013 2012 2011North America, primarily United States$116,541 $112,398 $118,654Europe, Middle East & Africa48,815 47,042 52,125Asia24,507 24,844 26,939Latin America5,518 6,274 6,442Total revenue$195,381 $190,558 $204,160Net property, equipment and improvements by geographic location are as follows (in thousands): Fiscal years ended September 30, 2013 2012 2011United States$13,321 $14,233 $14,169International, primarily Europe589 924 1,201Total net property, equipment and improvements$13,910 $15,157 $15,370Our U.S. export sales comprised 41.7% , 39.6% and 37.5% of revenue for the fiscal years ended September 30, 2013, 2012 and 2011.No single customer exceeded 10% of revenue for any of the periods presented. We had one customer, a distributor, whose accounts receivable balancecomprised 13.8% of total accounts receivable at September 30, 2013. No single customer exceeded 10% of total accounts receivable for any other periodpresented.53Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS5. SELECTED BALANCE SHEET DATA(in thousands) As of September 30, 2013 2012Accounts receivable, net: Accounts receivable$27,142 $24,929Less allowance for doubtful accounts313 295Total accounts receivable, net$26,829 $24,634 Inventories: Raw materials$21,171 $18,159Work in process224 428Finished goods4,745 5,848Total inventories$26,140 $24,435 Property, equipment and improvements, net: Land$1,800 $1,800Buildings10,522 10,522Improvements3,863 3,763Equipment14,989 14,093Purchased software12,296 11,971Furniture and fixtures2,481 2,595Total property, equipment and improvements, gross45,951 44,744Less accumulated depreciation and amortization32,041 29,587Total property, equipment and improvements, net$13,910 $15,15754Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS6. MARKETABLE SECURITIESOur 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 towhich 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 temporaryloss or an other-than-temporary loss such as: (a) whether we have the intent to sell the security, or (b) whether it is more likely than not that we will be requiredto 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, whereavailable. We also review the financial solvency of each security issuer and obtain other relevant information from our investment advisor. As ofSeptember 30, 2013, 72 of our 80 securities that we are holding were trading below our amortized cost basis. We determined each decline in value to betemporary 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 orwhen 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 consolidatedbalance sheet with the unrealized gains and losses recorded in accumulated other comprehensive loss. All of our current marketable securities will mature inless than one year and our non-current marketable securities will mature in less than 3 years. We received proceeds from the sale of our available-for-salemarketable securities of $63.1 million , $65.5 million and $44.8 million for fiscal 2013, 2012 and 2011, respectively.At September 30, 2013 our marketable securities were (in thousands): AmortizedCost (1) UnrealizedGains UnrealizedLosses Fair Value (1)Current marketable securities: Corporate bonds$35,161 $10 $(30) $35,141Certificates of deposit1,753 — (2) 1,751Government municipal bonds10,115 — (1) 10,114Current marketable securities47,029 10 (33) 47,006Non-current marketable securities: Corporate bonds6,439 — (6) 6,433Certificates of deposit11,003 — (47) 10,956Non-current marketable securities17,442 — (53) 17,389Total marketable securities$64,471 $10 $(86) $64,395(1)Included in amortized cost and fair value is purchased and accrued interest of $629.At September 30, 2012 our marketable securities were (in thousands): AmortizedCost (1) UnrealizedGains UnrealizedLosses Fair Value (1)Current marketable securities: Corporate bonds$39,306 $14 $(19) $39,301Commercial paper2,000 — — 2,000Certificates of deposit7,262 — (4) 7,258Government municipal bonds9,814 1 (2) 9,813Current marketable securities58,382 15 (25) 58,372Non-current marketable securities: Corporate bonds2,019 — (3) 2,016Total marketable securities$60,401 $15 $(28) $60,388(1)Included in amortized cost and fair value is purchased and accrued interest of $485.55Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS6. MARKETABLE SECURITIES (CONTINUED)The following tables show the fair values and gross unrealized losses of our available-for-sale securities that have been in a continuous unrealized loss positiondeemed to be temporary, aggregated by investment category (in thousands): September 30, 2013 Less than 12 Months More than 12 Months Fair Value Unrealized Losses Fair Value Unrealized LossesCorporate bonds$29,911 $(35) $2,001 $(1)Certificates of deposit12,451 (49) — —Government municipal bonds6,182 (1) — —Total$48,544 $(85) $2,001 $(1) September 30, 2012 Less than 12 Months More than 12 Months Fair Value Unrealized Losses Fair Value Unrealized LossesCorporate bonds$6,246 $(22) $— $—Commercial paper2,000 — — —Certificates of deposit5,114 (4) — —Government municipal bonds21,143 (2) — —Total$34,503 $(28) $— $—7. FAIR VALUE MEASUREMENTSFair 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 asof the measurement date. This standard also establishes a hierarchy for inputs used in measuring fair value. This standard maximizes the use of observableinputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available. Observable inputs are inputsmarket participants would use in valuing the asset or liability based on market data obtained from independent sources. Unobservable inputs are inputs thatreflect our assumptions about the factors market participants would use in valuing the asset or liability based upon the best information available in thecircumstances. The categorization of financial assets and liabilities within the valuation hierarchy is based upon the lowest level of input that is significant tothe fair value measurement.The hierarchy is broken down into the following 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 inmarkets 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 flowmethodologies or similar techniques and at least one significant model assumption or input is unobservable. Level 3 may also include certaininvestment securities for which there is limited market activity or a decrease in the observability of market pricing for the investments, such that thedetermination 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. These items are statedat fair value at each reporting period using the above guidance.56Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS7. FAIR VALUE MEASUREMENTS (CONTINUED)The following tables provide information by level for financial assets that are measured at fair value on a recurring basis (in thousands): Fair Value Measurements at September 30, 2013 using: Total carryingvalue atSeptember 30, 2013 Quoted price inactive markets(Level 1) Significant otherobservable inputs(Level 2) Significantunobservable inputs(Level 3)Cash equivalents: Money market$3,957 $3,957 $— $—Available-for-sale marketable securities: Corporate bonds41,574 — 41,574 —Certificates of deposit12,707 — 12,707 —Government municipal bonds10,114 — 10,114 —Total cash equivalents and marketablesecurities measured at fair value$68,352 $3,957 $64,395 $— Fair Value Measurements at September 30, 2012 using: Total carryingvalue atSeptember 30, 2012 Quoted price inactive markets(Level 1) Significant otherobservable inputs(Level 2) Significantunobservable inputs(Level 3)Cash equivalents: Money market$28,355 $28,355 $— $—Available-for-sale marketable securities: Corporate bonds41,317 — 41,317 —Commercial paper2,000 — 2,000 —Certificates of deposit7,258 — 7,258 —Government municipal bonds9,813 — 9,813 —Total cash equivalents and marketablesecurities measured at fair value$88,743 $28,355 $60,388 $—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. Wevalue our Level 2 assets using inputs that are based on market indices of similar assets within an active market. There were no transfers in to or out of ourLevel 2 financial assets during the twelve months ended September 30, 2013.We had no financial assets valued with Level 3 inputs as of September 30, 2013 nor did we purchase or sell any Level 3 financial assets during the twelvemonths ended September 30, 2013.The use of different assumptions, applying different judgment to matters that are inherently subjective and changes in future market conditions could result indifferent estimates of fair value of our securities, currently and in the future. If market conditions deteriorate, we may incur impairment charges for securitiesin our investment portfolio.8. PRODUCT WARRANTY OBLIGATIONIn general, we warrant our hardware products to be free from defects in material and workmanship under normal use and service. The warranty periodsgenerally range from one to five years. We typically have the option to either repair or replace hardware products we deem defective with regard to material orworkmanship. Estimated warranty costs are accrued in the period that the related revenue is recognized based upon an estimated average per unit repair orreplacement cost applied to the estimated number of units under warranty. These estimates are based upon historical warranty incidents and are evaluated onan ongoing basis to ensure the adequacy of the warranty accrual.57Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS8. PRODUCT WARRANTY OBLIGATION (CONTINUED)The following table summarizes the activity associated with the product warranty accrual (in thousands) and is listed on our Consolidated Balance Sheetsunder Current Liabilities: Balance at Warranties Settlements Balance atFiscal yearOctober 1 issued made September 302013$1,021 $669 $(627) $1,0632012$941 $730 $(650) $1,0212011$877 $885 $(821) $941We are not responsible for, and do not warrant that, custom software versions, created by original equipment manufacturer (OEM) customers based upon oursoftware source code, will function in a particular way, will conform to any specifications or are fit for any particular purpose. Further, we do not indemnifythese customers from any third-party liability as it relates to or arises from any customization or modifications made by the OEM customer.9. RESTRUCTURING2013 RestructuringOn September 27, 2013, we announced our intention to restructure certain of our operations in the U.S. The restructuring was primarily associated with costreduction initiatives and resulted in the elimination of 15 positions in our work force. We recorded a restructuring charge of $0.4 million for severance duringthe fourth quarter of fiscal 2013. The payments associated with these charges and all the actions associated with the restructuring are expected to be completedby the first quarter of fiscal 2014.Below is a summary of the restructuring charges and other activity within the restructuring accrual (in thousands): EmployeeTerminationCosts Other TotalBalance at September 30, 2012$— $— $—Restructuring charge350 — 350Balance at September 30, 2013$350 $— $3502012 RestructuringOn April 26, 2012, we announced our intention to restructure certain of our operations. The restructuring relates primarily to changes being implemented tofocus on a shift in our business to more aggressively sell end-to-end M2M solutions. As a result of this restructuring, we eliminated employment positions inour work force and have moved to hire new employees or re-assign existing employees into newly created positions. We recorded $1.0 million of restructuringcharges on a pre-tax basis. These charges were incurred in connection with reductions in force of 30 employees and represented severance of $0.6 million andexpenses from vacating facilities in Davis, California and Huntington Beach, California of approximately $0.4 million. The payments associated with thesecharges and all the actions associated with the restructuring were completed by the second quarter of fiscal 2013.Below is a summary of the restructuring charges and other activity within the restructuring accrual (in thousands): EmployeeTerminationCosts Other TotalBalance at September 30, 2011$— $— $—Restructuring charge568 395 963Payments(555) (287) (842)Balance at September 30, 201213 108 121Payments— (84) (84)Reversals(13) (24) (37)Balance at September 30, 2013$— $— $—58Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS10. INCOME TAXESThe components of income before income taxes are as follows (in thousands): Fiscal years ended September 30, 2013 2012 2011United States$(395) $2,808 $10,173International8,633 8,089 6,342Total income before income taxes$8,238 $10,897 $16,515The components of the income tax provision are as follows (in thousands): Fiscal years ended September 30, 2013 2012 2011Current: Federal$1,418 $2,203 $3,880State263 400 342Foreign3,148 3,131 2,479Deferred: U.S.(2,270) (2,229) (776)Foreign(126) (223) (429)Total income tax provision$2,433 $3,282 $5,496The net deferred tax asset consists of the following (in thousands): As of September 30, 2013 2012Current deferred tax asset$3,174 $3,389Non-current deferred tax asset5,832 5,010Current deferred tax liability(60) (16)Non-current deferred tax liability(415) (630)Net deferred tax asset$8,531 $7,753 Uncollectible accounts and other reserves$1,138 $1,820Depreciation and amortization255 13Inventories1,530 1,263Compensation costs8,025 7,034Tax carryforwards705 679Valuation allowance(515) (499)Identifiable intangible assets(2,607) (2,557)Net deferred tax asset$8,531 $7,753As of September 30, 2013, we have tax credit carryforwards in a foreign jurisdiction of $0.2 million, the majority of which will expire in 2027. We havegenerally concluded that it is more likely than not that our deferred tax assets will be realized based on future projected taxable income and the anticipatedfuture reversal of deferred tax liabilities. Our valuation allowance for certain foreign locations at both September 30, 2013 and 2012 was $0.5 million. Theamount of the deferred tax assets actually realized could vary if there are differences in the timing or amount of future reversals of existing deferred taxliabilities or changes in the amounts of future taxable income. If our future taxable income projections are not realized, an additional valuation allowance maybe required, and would be reflected as income tax expense at the time that any such change in future taxable income is determined.59Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS10. INCOME TAXES (CONTINUED)The reconciliation of the statutory federal income tax rate to our effective income tax rate is as follows: Fiscal years ended September 30, 2013 2012 2011Statutory income tax rate34.0 % 35.0 % 35.0 %Increase (decrease) resulting from: State taxes, net of federal benefits(0.4)% 0.7 % 0.5 %Utilization of tax credits(7.3)% (2.2)% (1.4)%Manufacturing deduction(0.8)% 0.2 % (3.1)%Discrete tax benefits(9.2)% (14.1)% (4.4)%Foreign operations2.0 % 3.7 % 1.1 %Adjustment of tax contingency reserves9.7 % 4.9 % 2.6 %Other, net1.5 % 1.9 % 3.0 %Effective income tax rate29.5 % 30.1 % 33.3 %During fiscal 2013, we recorded a discrete tax benefit of $0.8 million, related to the January 2, 2013 enactment of the American Taxpayers Relief Act of 2012extending 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 thestatute of limitations from various U.S. and foreign tax jurisdictions. These discrete tax benefits reduced our effective tax rate by 9.2 percentage points for thetwelve month period ended September 30, 2013. During fiscal 2013, the income tax provision before discrete tax benefits was higher than the federal statutoryrate primarily due to an increase in certain reserves for unrecognized tax benefits and a reduction in domestic tax benefits.During fiscal 2012, we recorded a discrete tax benefit of $1.5 million, related to additional research and development tax credits identified for fiscal yearsended September 30, 2009, 2010 and 2011, reversal of tax reserves for closure of various jurisdictions' tax matters and tax rate reductions in foreignjurisdictions. These discrete tax benefits reduced our effective tax rate by 14.1 percentage points for the twelve month period ended September 30, 2012. Duringfiscal 2012, the income tax provision before discrete tax benefits was higher than the statutory rate primarily due to an increase in certain reserves forunrecognized tax benefits, an adjustment for foreign income taxed at the U.S. rate, partially offset by an adjustment in domestic tax benefits.During fiscal 2011, we recorded a discrete tax benefit of $0.7 million. This benefit primarily resulted from the reversal of tax reserves from variousjurisdictions, primarily foreign, related to the expiration of the statute of limitations. It also resulted from the enactment of the Tax Relief, UnemploymentInsurance Reauthorization, and Job Creation Act of 2010 extending the research and development tax credit that allowed us to record tax credits earned duringthe last three quarters of fiscal 2010 in the first quarter of fiscal 2011. This benefit reduced our effective tax rate by 4.4 percentage points for the twelve monthperiod ended September 30, 2011.A reconciliation of the beginning and ending amount of unrecognized tax benefits is (in thousands): Fiscal years ended September 30, 2013 2012 2011Unrecognized tax benefits at beginning of fiscal year$2,720 $2,061 $2,265Increases related to: Prior year income tax positions162 631 32Current year income tax positions733 441 392Decreases related to: Prior year income tax positions— (94) —Expiration of statute of limitations(283) (319) (628)Unrecognized tax benefits at end of fiscal year$3,332 $2,720 $2,06160Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS10. INCOME TAXES (CONTINUED)The total amount of unrecognized tax benefits that, if recognized, would affect our effective tax rate is $3.4 million. We expect that it is reasonably possible thatthe total amounts of unrecognized tax benefits will decrease $0.2 million to $0.3 million over the next 12 months due to the expiration of the statute oflimitations.We recognize interest and penalties related to income tax matters in income tax expense. During the fiscal years ended September 30, 2013, 2012 and 2011,there were insignificant amounts of interest and penalties related to income tax matters in income tax expense. We had accrued interest and penalties related tounrecognized tax benefits as of both September 30, 2013 and September 30, 2012, of $0.6 million. Our long-term income taxes payable on our consolidatedbalance sheets includes these accrued interest and penalties in addition to the unrecognized tax benefits in the table above.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 eachof these jurisdictions. This determination requires us to make several estimates and assumptions. Tax audits associated with the allocation of this income, andother complex issues, may require an extended period of time to resolve and may result in adjustments to our income tax balances in those years that arematerial to our consolidated balance sheet and results of operations. We are no longer subject to income tax examination for tax years prior to fiscal 2009 in thecase of U.S. federal tax authorities and prior to fiscal 2008 for foreign income tax authorities. For state taxing authorities, consisting primarily of Minnesotaand California, we are no longer subject to income tax examination for tax years generally before fiscal 2009.At September 30, 2013, we had approximately $24.4 million of accumulated undistributed foreign earnings, for which we have not accrued additional U.S.tax. Our policy is to reinvest earnings of our foreign subsidiaries indefinitely to fund current operations and provide for future international expansionopportunities, and only repatriate earnings to the extent that U.S. taxes have already been recorded. Although we have no current need or intention to repatriatehistorical earnings in the form of cash in the United States, if we change our assertion from indefinitely reinvesting undistributed foreign earnings, we wouldhave 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 ofsuch repatriation. Under current tax laws, we estimate the unrecognized deferred tax liability to be in the range of $1.5 million to $2.5 million, which couldhave a material impact on our current consolidated balance sheet, results of operations and cash flows.11. STOCK-BASED COMPENSATIONStock-based awards are granted under the terms of the 2013 Omnibus Incentive Plan (the Incentive Plan), as well as the 2000 Omnibus Stock Plan as amendedand restated as of December 4, 2009 (the Omnibus Plan), which expired during the second quarter of fiscal 2013. Stock-based awards are also granted underthe Stock Option Plan as amended and restated as of November 27, 2006 (the Stock Option Plan) and Non-Officer Stock Option Plan as amended andrestated as of November 27, 2006 (the Non-Officer Plan), both of which expired during the first quarter of fiscal 2007 (the Plans). Additional awards cannotbe made under the Omnibus Plan, the Stock Option Plan or the Non-Officer Plan. The authority to grant options under the Incentive Plan and set other termsand conditions rests with the Compensation Committee of the Board of Directors.The Stock Option Plan and the Non-Officer Plan include non-statutory stock options (NSOs) and the Stock Option Plan also includes incentive stock options(ISOs) to employees and others who provide services to us, including consultants, advisers and directors. Options granted under these plans generally vestover a four year service period and will expire if unexercised after ten years from the date of grant. Share awards vest upon continued employment. The exerciseprice for ISOs and non-employee director options granted under the Stock Option Plan was set at the fair market value of our common stock based on theclosing price on the date of grant. The exercise price for NSOs granted under the Stock Option Plan or the Non-Officer Plan was set by the CompensationCommittee of the Board of Directors and was set to the exercise price based on the closing price on the date of grant.The Incentive Plan authorizes the issuance of up to 1,750,000 common shares in connection with awards of stock options, stock appreciation rights,restricted stock, restricted stock units, performance-based full value awards or stock awards. Eligible participants include our employees, non-employeedirectors, consultants and advisors. Awards may be granted under the Incentive Plan until January 28, 2023 as the Incentive Plan was ratified on January 28,2013 at the Annual Meeting of Stockholders. Options under the Omnibus Plan can be granted as either ISOs or NSOs. The exercise price shall be determinedby 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. As ofSeptember 30, 2013, there were approximately 1.5 million shares available for future grants under the Incentive Plan.61Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS11. STOCK-BASED COMPENSATION (CONTINUED)The Omnibus Plan authorized the issuance of up to 5,750,000 common shares in connection with awards of stock options, stock appreciation rights,restricted stock, performance units or stock awards. Eligible participants include our employees, non-employee directors, consultants and advisors. Awardswere eligible to be granted under the Omnibus Plan until December 4, 2019 as an authorization to issue an additional 2,500,000 common shares was ratifiedon January 25, 2010 at the Annual Meeting of Stockholders; however the plan was terminated as to future awards on January 28, 2013 at the Annual Meetingof Stockholders. Options under the Omnibus Plan could be granted as either ISOs or NSOs. The exercise price was determined by our CompensationCommittee but could not be less than the fair market value of our common stock based on the closing price on the date of grant.We recorded cash received from the exercise of stock options of $2.2 million, $1.1 million and $2.9 million during fiscal years 2013, 2012 and 2011,respectively. The excess tax benefits from stock-based compensation were $0.1 million during fiscal 2013, $0.2 million during fiscal 2012 and $0.8 millionduring fiscal year 2011. Upon exercise, we issue new shares of stock. The Plans have provisions allowing employees to elect to pay their withholdingobligation through share reduction. No employees elected to pay income tax withholding obligations through share reduction during fiscal years 2013, 2012and 2011.Also, we sponsor an Employee Stock Purchase Plan as amended and restated as of December 4, 2009 and November 27, 2006 (the Purchase Plan), coveringall domestic employees with at least 90 days of continuous service and who are customarily employed at least 20 hours per week. The Purchase Plan allowseligible 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. The Purchase Plan was ratified on January 25, 2010 at the Annual Meeting of Stockholders to increase the number of shares reservedfor future purchases to the Purchase Plan by 250,000 shares bringing the total number of shares to 2,000,000 shares of our Common Stock that may bepurchased under the plan. Employee contributions to the Purchase Plan were $1.0 million in fiscal 2013, 2012 and 2011. Pursuant to the Purchase Plan,128,853, 115,477, and 112,285 common shares were issued to employees during the fiscal years ended 2013, 2012 and 2011, respectively. Shares areissued under the Purchase Plan from treasury stock. As of September 30, 2013, 70,827 common shares were available for future issuances under thePurchase Plan.Stock-based compensation expense is included in the consolidated results of operations as follows (in thousands): Fiscal years ended September 30, 2013 2012 2011Cost of sales$183 $166 $136Sales and marketing1,261 1,271 1,156Research and development772 724 771General and administrative1,556 1,566 1,381Stock-based compensation before income taxes3,772 3,727 3,444Income tax benefit(1,192) (1,240) (1,143)Stock-based compensation after income taxes$2,580 $2,487 $2,301Stock-based compensation cost capitalized as part of inventory was immaterial as of September 30, 2013, 2012 and 2011.62Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS11. STOCK-BASED COMPENSATION (CONTINUED)A summary of options and common shares reserved for grant under the Plans and Assumed Plans are as follows (in thousands, except per common shareamounts): OptionsOutstanding Weighted AverageExercised Price Weighted AverageContractual Term (inyears) AggregateIntrinsic Value(1)Balance at September 30, 2012 5,754 $10.76 Additional shares approved for grant Granted 1,049 9.33 Exercised (280) 9.76 Cancelled (244) 10.35 Balance at September 30, 2013 6,279 $10.67 5.6 $3,152 Exercisable at September 30, 2013 4,562 $11.00 4.6 $2,357(1) The aggregate intrinsic value represents the total pre-tax intrinsic value, based on our closing stock price of $9.99 as of September 30, 2013, which wouldhave 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 optionsexercised during each of the twelve months ended September 30, 2013, 2012 and 2011 was $0.5 million, $0.7 million and $2.4 million, respectively.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: Fiscal years ended September 30, 2013 2012 2011Fair value of options granted (in thousands)$3,950 $4,086 $4,948Weighted average per option grant date fair value$3.77 $4.45 $4.14Assumptions used for option grants: Risk free interest rate0.88% - 1.78% 0.84% - 1.33% 1.58% - 2.14%Expected term6.25 years 6.25 years 5.25 yearsExpected volatility40% 41% - 42% 41% - 44%Weighted average volatility40% 41% 43%Expected dividend yield0 0 0The fair value of each option award granted during the periods presented was estimated using the Black-Scholes option valuation model that uses theassumptions noted in the table above. Expected volatilities are based on the historical volatility of our stock. We use historical data to estimate option exerciseand employee termination information within the valuation model; separate groups of grantees that have similar historical exercise behaviors are consideredseparately for valuation purposes. The expected term of options granted is derived from the vesting period and historical information and represents the periodof 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 grantwhose maturity equals the expected term of the option.63Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS11. STOCK-BASED COMPENSATION (CONTINUED)A summary of our non-vested options as of September 30, 2013 and changes during the twelve months then ended is presented below (in thousands, except percommon share amounts): Number of Options Weighted Average Grant DateFair Value per Common ShareNonvested at September 30, 20121,756 $3.58Granted1,049 $3.77Vested(844) $3.71Forfeited(244) $4.05Nonvested at September 30, 20131,717 $3.56We use historical data to estimate pre-vesting forfeiture rates. The pre-vesting forfeiture rate used in fiscal 2013 was 2.0%. As of September 30, 2013 the totalunrecognized compensation cost related to non-vested stock-based compensation arrangements, net of expected forfeitures, was $6.0 million and the relatedweighted average period over which it is expected to be recognized is approximately 2.5 years.At September 30, 2013, the weighted average exercise price and remaining life of the stock options are as follows (in thousands, except remaining life andexercise price):Options Outstanding Options ExercisableRange of Exercise Prices Options Outstanding Weighted AverageRemainingContractual Life (InYears) Weighted AverageExercise Price Number of SharesVested Weighted AverageExercise Price$6.75 - $8.03 752 6.03 $8.01 726 $8.01$8.04 - $9.50 1,312 7.48 $9.02 440 $8.49$9.51 - $10.00 1,274 5.99 $9.68 905 $9.70$10.01 - $11.00 1,183 6.15 $10.65 786 $10.66$11.01 - $13.00 616 3.64 $12.36 594 $12.37$13.01 - $15.00 656 2.61 $13.98 626 $13.95$15.01 - $16.88 486 3.47 $15.27 485 $15.27$6.75 - $16.88 6,279 5.56 $10.67 4,562 $11.00The total grant date fair value of shares vested was $3.1 million in fiscal 2013, $3.0 million in fiscal 2012 and $3.7 million in fiscal 2011.A summary of our non-vested restricted stock units as of September 30, 2013 and changes during the twelve months then ended is presented below (inthousands, except per common share amounts): Number of Options Weighted Average Grant DateFair Value per Common ShareNonvested at September 30, 2012— $—Granted49 $9.71Vested— $—Forfeited— $—Nonvested at September 30, 201349 $9.71As of September 30, 2013, the total unrecognized compensation cost related to non-vested restricted stock units was $0.3 million and the related weightedaverage period over which it is expected to be recognized is approximately 0.9 years.64Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS12. COMMON STOCK REPURCHASEOn July 25, 2012 our Board of Directors authorized a program to repurchase up to $20.0 million of our common stock, primarily to support our employeestock purchase program and to return capital to shareholders. This repurchase authorization expired on September 30, 2013. We repurchased 1,481,365shares for $14.1 million under this program during fiscal 2013.13. SHARE RIGHTS PLANUnder our share rights plan, each right entitles its holder to buy one one-hundredth of a share of a Series A Junior Participating Preferred Stock at an exerciseprice of $60, subject to adjustment. The rights are not exercisable until a specified distribution date as defined in the Share Rights Agreement. The Rights willexpire on June 30, 2018, unless extended or earlier redeemed or exchanged by us as defined in the Share Rights Agreement.14. EMPLOYEE BENEFIT PLANSWe currently have a savings and profit sharing plan pursuant to Section 401(k) of the Internal Revenue Code (the Code), whereby eligible employees maycontribute up to 25% of their pre-tax earnings, not to exceed amounts allowed under the Code.We provide a match of 100% on the first 3% of each employee's bi-weekly contribution and a 50% match on the next 2% of each employee's bi-weeklycontribution. In addition, we may make contributions to the plan at the discretion of the Board of Directors. We provided matching contributions of $1.4million for fiscal 2013 and $1.3 million for both fiscal 2012 and 2011.15. COMMITMENTSWe have entered into various operating lease agreements for office facilities and equipment, the last of which expires in fiscal 2018. The office facility leasesgenerally require us to pay a pro-rata share of the lessor's operating expenses. Certain operating leases contain escalation clauses and are being amortized on astraight-line basis over the term of the lease.The following schedule reflects future minimum rental commitments under noncancelable operating leases (in thousands):Fiscal year Amount2014 $2,5272015 1,7142016 1,0722017 2342018 2Thereafter —Total minimum payments required $5,549The following schedule shows the composition of total rental expense for all operating leases for the years ended September 30 (in thousands): Fiscal years ended September 30, 2013 2012 2011Rentals$3,053 $3,093 $3,275Less: sublease rentals(31) (41) (17)Total rental expense$3,022 $3,052 $3,25816. CONTINGENCIESInitial Public Offering Securities LitigationOn April 19, 2002, a consolidated amended class action complaint was filed in the United States District Court for the Southern District of New Yorkasserting claims relating to the initial public offering (“IPO”) of our subsidiary NetSilicon, Inc. and approximately 300 other public companies. We acquiredNetSilicon on February 13, 2002. The complaint named us as a defendant along with NetSilicon, certain of its officers and certain underwriters involved inNetSilicon's IPO, among numerous65Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS16. CONTINGENCIES (CONTINUED)others, and asserted, among other things, that NetSilicon's IPO prospectus and registration statement violated federal securities laws because they containedmaterial misrepresentations and/or omissions regarding the conduct of NetSilicon's IPO underwriters in allocating shares in NetSilicon's IPO to theunderwriters' customers. We believed that the claims against the NetSilicon defendants were without merit and we defended the litigation vigorously. Pursuantto a stipulation between the parties, the two named officers were dismissed from the lawsuit, without prejudice, on October 9, 2002.As previously disclosed, the parties advised the District Court on February 25, 2009 that they had reached an agreement-in-principle to settle the litigation inits entirety. A stipulation of settlement was filed with the District Court on April 2, 2009. On June 9, 2009, the District Court preliminarily approved theproposed global settlement. Notice was provided to the class, and a settlement fairness hearing, at which members of the class had an opportunity to object tothe proposed settlement, was held on September 10, 2009. On October 6, 2009, the District Court issued an order granting final approval to the settlement.Ten appeals were filed objecting to the definition of the settlement class and fairness of the settlement. Five of those appeals were dismissed with prejudice onOctober 6, 2010. On May 17, 2011, the Court of Appeals dismissed four of the remaining appeals. On January 10, 2012, the last remaining appeal wasdismissed with prejudice, as a result of which the settlement became final, by its terms.In March 2012, our insurers paid to the plaintiffs on our behalf the full amount of the settlement share allocated to us of $337,838. We have no financialliability under the terms of the settlement agreement. As a result, during the second fiscal quarter of 2012, we reversed our accrued liability of $300,000 andthe related receivable of $50,000. These amounts originally represented our estimated settlement of $300,000 less our $250,000 deductible.Patent Infringement LawsuitsOn May 29, 2012, U.S. Ethernet Innovations, LLC filed a patent infringement lawsuit against us in federal court in the Eastern District of Texas. Thelawsuit included allegations against us and one other company pertaining to the infringement of four patents related to Ethernet technology. On April 22, 2013,we announced the settlement of this patent infringement lawsuit for $1.5 million, which was recorded in general and administrative expense on ourConsolidated Statements of Operations during the second quarter of fiscal 2013. The settlement was paid during the third quarter of fiscal 2013. Thesettlement fully resolves the claims by USEI with no future payment obligations. Net of taxes, the settlement was $1.0 million and therefore reduced earningsper diluted share for the second quarter of fiscal 2013 by approximately $0.04.On May 11, 2010, SIPCO, LLC filed a complaint naming us as a defendant in federal court in the Eastern District of Texas. This claim subsequently wasmoved to the Northern District of Georgia. The complaint included allegations against us and five other companies pertaining to the infringement of SIPCO'spatents by wireless mesh networking and multi-port networking products. On October 23, 2012, we settled the lawsuit for a payment of $500,000 which wasrecorded in general and administrative expense on our Consolidated Statements of Operations during the fourth quarter of fiscal 2012, and we entered into aroyalty-bearing license agreement for future sales of licensed products sold during the term of the agreement through 2018. We do not expect this licenseagreement to have a material impact on our consolidated financial statements in the future.Collection MatterIn December 2011, our wholly owned subsidiary, Spectrum Design Services, Inc. (now renamed Etherios Design Services), brought claims against Iota, Inc.(“Iota”) and Corsair Engineering, Inc. (“Corsair”) in Minnesota State District Court. The claims were made to collect unpaid receivables from Iota that weresubject to a payment guaranty from Corsair. These claims arose out of a contract between Iota and Spectrum for the development of a custom product forIota. Spectrum ceased work on the project for non-payment of invoices before making its claims. During our second quarter of fiscal 2012, Iota and Corsairremoved the cases to Federal District Court in Minnesota and Iota asserted counterclaims against Spectrum for breach of contractual warranty, breach ofcontract and negligent misrepresentation. The counterclaims alleged damages for recovery of over $300,000 previously paid by Iota to Spectrum as well as lostprofits and other damages. In connection with the mediation completed on June 29, 2012, we, Iota and Corsair signed an agreement to dismiss all claimsrelated to this matter and reached a settlement on the unpaid receivable. The settlement did not have a material impact to us.In addition to the matters discussed above, in the normal course of business, we are subject to various claims and litigation, which may include, but are notlimited to, patent infringement and intellectual property claims. While we are unable to predict the outcome of any potential claims or litigation due to theinherent unpredictability of these matters, we believe that it is possible that we could, in the future, incur judgments or enter into settlements of claims thatcould have a material adverse effect on our operations in any particular period.66Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS17. QUARTERLY FINANCIAL DATA (UNAUDITED)(in thousands, except per common share data) Quarter ended Dec. 31 March 31 June 30 Sept. 30Fiscal 2013 Revenue$46,991 $48,197 $48,824 $51,369Gross profit24,479 24,961 24,720 25,963Net income (1)(2)(3)(4)1,230 1,000 1,528 2,047Net income per common share - basic0.05 0.04 0.06 0.08Net income per common share - diluted0.05 0.04 0.06 0.08 Fiscal 2012 Revenue$46,662 $49,016 $47,632 $47,248Gross profit24,430 25,783 25,304 24,820Net income (1)(2)724 2,122 2,307 2,462Net income per common share - basic0.03 0.08 0.09 0.10Net income per common share - diluted0.03 0.08 0.09 0.09(1)During fiscal 2013 and 2012, we recorded discrete tax benefits of $0.8 million and $1.5 million, respectively. We recorded a benefit of $0.1 million inthe first quarter of fiscal 2013 resulting from the release of income tax reserves due to the expiration of the statute of limitations from various U.S. andforeign tax jurisdictions. During the second quarter of fiscal 2013, we recorded a discrete tax benefit of $0.4 million resulting from the enactment oflegislation on January 2, 2013 extending the research and development credit for the last three quarters of fiscal 2012. In the third quarter of fiscal 2013,we recorded a benefit of $0.1 million for the release of income tax reserves due to the expiration of the statute of limitations for U.S. Federal income tax forfiscal 2009. In the fourth quarter of fiscal 2013, we recorded $0.2 million for the reversal of tax reserves resulting from expiration of the statute oflimitations for state income taxes.We recorded a benefit of $0.1 million in the first quarter of fiscal 2012 resulting from the release of income tax reserves due to the expiration of the statuteof limitations from various U.S. tax jurisdictions. During the third quarter of fiscal 2012, we recorded $1.1 million for additional research anddevelopment tax credits identified for fiscal years ended September 30, 2009, 2010 and 2011 from a recently completed research and development taxcredit study. During the fourth quarter of fiscal 2012, we recorded $0.3 million relating to expiration of statute of limitations for state income taxes and areduction in a foreign statutory rate.(2)During fiscal 2013, we recorded a business restructuring accrual of $0.4 million ($0.2 million after tax) in the fourth quarter of fiscal 2013. Duringfiscal 2012, we recorded a business restructuring accrual of $0.2 million ($0.2 million after tax) in the first quarter, $0.1 million ($0.0 million after tax)in the second quarter and $1.0 million ($0.6 million after tax) in the third quarter.(3)During the second quarter of fiscal 2013, we recorded a charge of $1.5 million ($1.0 million after tax) for the settlement of a patent infringement lawsuit.(4)During the fourth quarter of fiscal 2013, we recorded a charge of $0.4 million ($0.2 million after tax) for impairment of certain intangibles.18. SUBSEQUENT EVENTSOn October 29, 2013, our Board of Directors authorized a new program to repurchase up to $20 million of our common stock. This new repurchaseauthorization expires on October 31, 2014 and replaces the program that expired on September 30, 2013. In connection with this new repurchase authorization,the Board confirmed the expiration of the prior repurchase authorization. Shares repurchased under the new program may be made through open market andprivately negotiated transactions from time to time and in amounts that management deems appropriate. The timing of share repurchases will depend uponmarket conditions and other corporate considerations.On October 31, 2013, we announced our intention to restructure certain of our operations in India. The restructuring was primarily associated with costreduction initiatives resulting in the elimination of approximately 40 engineering and sales positions in our work force. We expect to record a restructuringcharge of $0.2 million related to severance during the first quarter of fiscal 2014.67Table of ContentsITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURENone.ITEM 9A. CONTROLS AND PROCEDURESEvaluation of Disclosure Controls and ProceduresAs of the end of the period covered by this report, we conducted an evaluation, under the supervision and with the participation of the principal executiveofficer and principal financial officer, of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities ExchangeAct of 1934 (the “Exchange Act”)). Based on this evaluation, the principal executive officer and principal financial officer concluded that our disclosurecontrols and procedures are effective.Management's Report on Internal Control over Financial ReportingManagement is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rules 13a - 15(f) and 15d - 15(f)under the Exchange Act).We assessed the effectiveness of our internal control over financial reporting as of September 30, 2013 using the framework set forth by the Committee ofSponsoring Organizations of the Treadway Commission (COSO) in Internal Control - Integrated Framework (1992). Based on this assessment, managementconcluded that our internal control over financial reporting was effective as of September 30, 2013. The effectiveness of our internal control over financialreporting as of September 30, 2013 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in theirreport which appears in Item 8 of this report.Changes in Internal Control Over Financial ReportingThere was no change in our internal control over financial reporting identified in connection with the evaluation required by Rule 13a-15(d) and 15d-15(d) ofthe Exchange Act that occurred during the quarterly period ended September 30, 2013 that has materially affected, or is reasonably likely to materially affect,our internal control over financial reporting.ITEM 9B. OTHER INFORMATIONNone68Table of ContentsPART III.ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCEIncorporated into this item by reference is the information appearing under the headings “Proposal No. 1 - Election of Directors” and “Security Ownership ofPrincipal Stockholders and Management” in our Proxy Statement for our 2014 Annual Meeting of Stockholders we will file with the SEC (the “ProxyStatement”).Executive Officers of the RegistrantAs of the date of filing this Form 10-K, the following individuals were executive officers of the Registrant:Name Age PositionJoseph T. Dunsmore 55 Chairman, President and Chief Executive OfficerSteven E. Snyder 57 Senior Vice President, Chief Financial Officer and TreasurerMichael R. Dannenfeldt 36 Senior Vice President, Etherios SolutionsJon A. Nyland 50 Vice President Manufacturing OperationsKevin C. Riley 52 Senior Vice President of Global SalesTracy L. Roberts 51 Vice President of Human Resources and Information TechnologyDavid H. Sampsell 45 Vice President, General Counsel and Corporate SecretaryJoel K. Young 48 Senior Vice President of Research and Development and Chief Technical OfficerMr. Dunsmore joined our Company in October 1999 as President and Chief Executive Officer and a member of the Board of Directors and was electedChairman of the Board in May 2000. Prior to joining us, Mr. Dunsmore was Vice President of Access for Lucent Microelectronics, a telecommunicationscompany now known as Agere Systems Inc., since June 1999. From October 1998 to June 1999, he acted as an independent consultant to various hightechnology companies. From February 1998 to October 1998, Mr. Dunsmore was Chief Executive Officer of NetFax, Inc., a telecommunications company.From October 1995 to February 1998, he held executive management positions at US Robotics and then at 3COM after 3COM acquired US Robotics in June1997. Prior to that, Mr. Dunsmore held various marketing management positions at AT&T Paradyne Corporation from May 1983 to October 1995. Mr.Dunsmore served as a director of Analysts International Corporation from January 2008 until the time it was merged with a third party in October 2013.Mr. Snyder joined our company in November 2010 as Senior Vice President, Chief Financial Officer and Treasurer. Prior to joining us, Mr. Snyder mostrecently served as Chief Financial Officer at Gearworks, Inc. from November 2008 to September 2009. In August 2009, Gearworks, Inc. merged with Xora,Inc. From January 2003 to June 2008, he served as an officer at Xiotech Corporation, a privately held data storage company. He served as Chief FinancialOfficer and Vice President Manufacturing from his hiring in October 2007 and as the General Manager of the storage solutions group from October 2007 toJune 2008. Prior to that, Mr. Snyder served as Chief Financial Officer at several companies, including Ancor Communications, Inc., then a publicly tradeddeveloper and manufacturer of fiber channel switching products for data center networks which was acquired by QLogic Corporation in 2000. Mr. Snyderalso spent ten years at Cray Research, Inc. in progressively responsible financial roles. Earlier roles included seven years in various financial positions atControl Data Corporation and two years with KPMG Peat Marwick.Mr. Dannenfeldt joined our company in October 2012 as Senior Vice President, Etherios Solutions. In March 2008, Mr. Dannenfeldt founded Etherios, Inc., aworld-class cloud computing services provider and salesforce.com Platinum Partner acquired by our company in October 2012. Prior to founding Etherios,Mr. Dannenfeldt worked as a technical leader on large enterprise Siebel CRM implementations in the U.S. and Europe. Mr. Dannenfeldt joined salesforce.comin 2004 as its first technical architect in the U.S. Central region. He is the co-creator and an advisor to salesforce.com on numerous Force.com Platformtechnical training courses and certification programs, is a technical salesforce.com Authorized Instructor, and holds salesforce.com Service Cloud andAdvanced Developer certifications.Mr. Nyland joined our company in 1993 as Manager of Manufacturing and Test Engineering. He served in roles of increasing responsibility until he waspromoted in April 1999 to his current position of Vice President of Manufacturing Operations. Prior to joining us, from 1985 to 1993, Mr. Nyland heldengineering and consulting positions with ITT Corporation; Minnesota Technology; and Turtle Mountain Corporation.69Table of ContentsITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE (CONTINUED)Mr. Riley joined our company in January 2013 as Senior Vice President of Global Sales. Prior to joining us, Mr. Riley served as Senior Vice President - GlobalMarkets for Infor Global Solutions, an enterprise software solutions company, where he led four global business units to profitable growth from January 2010to November 2011. Prior to his time at Infor, he was Vice President and General Manager at Oracle, an enterprise software company. from September 2008 toJanuary 2010, and President of Global Knowledge Software from September 2002 to September 2008, when Global Knowledge Software was acquired byOracle. He has also served as President and Chief Operating Officer for Learn2 Corporation from 1999 to 2002.Ms. Roberts has served as our Vice President of Human Resources and Information Technology since March 2005 and has been employed by our companysince June 1999. Prior to joining us, Ms. Roberts served as the Director of Human Resources at Novartis Nutrition Corporation where she served the medicalnutritional business unit. Prior to her time at Novartis, Ms. Roberts had an extensive career with Cray Research (now Silicon Graphics) including variousroles with Human Resources and Marketing.Mr. Sampsell joined our company in April 2011 as Vice President, General Counsel and Corporate Secretary. Prior to joining us, Mr. Sampsell worked ascorporate counsel at ADC Telecommunications, Inc., a supplier of network infrastructure products and services, from December 1999 until March 2011.ADC Telecommunications, Inc. was acquired by TE Connectivity in December 2010. His most recent role at ADC was as Associate General Counseloverseeing corporate transactions and securities law compliance. Prior to joining ADC, Mr. Sampsell was an attorney in private practice with Leonard, Streetand Deinard, P.A. from 1996 to 1999 and Moore & Van Allen, PLLC from 1993 to 1996.Mr. Young joined our company in July 2000 as Vice President of Engineering and was named Vice President of Research and Development and Chief TechnicalOfficer in November 2005. In October 2006, Mr. Young was named Senior Vice President of Research and Development and Chief Technical Officer. Prior tojoining us, Mr. Young served as a Vice President for Transcrypt International, a provider of encryption products, in various engineering, sales and marketingpositions from February 1996 to June 2000. Before that, he held various engineering and management positions at AT&T and AT&T Bell Laboratories from1986 to 1996.Code of EthicsWe have in place a “code of ethics” within the meaning of Rule 406 of Regulation S-K, which is applicable to our senior financial management, includingspecifically our principal executive officer, principal financial officer and controller. A copy of this code of ethics is available on our website (www.digi.com)under the “About us - Investor Relations - Corporate Governance” caption. We intend to satisfy our disclosure obligations regarding any amendment to, or awaiver from, a provision of this code of ethics by posting such information on the same website. We also have a “code of conduct” that applies to all directors,officers and employees, a copy of which is available through our website (www.digi.com) under the “About us - Investor Relations - Corporate Governance”caption.ITEM 11. EXECUTIVE COMPENSATIONIncorporated into this item by reference is the information appearing under the heading “Compensation of Directors,” “Executive Compensation,” theinformation regarding compensation committee interlocks and insider participation under the heading “Proposal No. 1 - Election of Directors” on our ProxyStatement.ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDERMATTERSIncorporated into this item by reference is the information appearing under the headings “Security Ownership of Principal Stockholders and Management” and“Equity Compensation Plan Information” in our Proxy Statement.ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCEIncorporated into this item by reference is the information regarding director independence under the heading “Proposal No. 1 - Election of Directors” and theinformation regarding related person transactions under the heading “Related Person Transaction Approval Policy” on our Proxy Statement.ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICESIncorporated into this item by reference is the information under “Proposal No. 5 - Ratification of Independent Registered Public Accounting Firm” in our ProxyStatement.70Table of ContentsPART IV.ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES(a)Consolidated Financial Statement and Schedules of the Company (filed as part of this Annual Report on Form 10-K) 1.Consolidated Statements of Operations for fiscal years ended September 30, 2013, 2012 and 2011 Consolidated Statements of Comprehensive Income for fiscal years ended September 30, 2013, 2012 and 2011 Consolidated Balance Sheets as of September 30, 2013 and 2012 Consolidated Statements of Cash Flows for fiscal years ended September 30, 2013, 2012 and 2011 Consolidated Statements of Stockholders' Equity for fiscal years ended September 30, 2013, 2012 and 2011 Notes to Consolidated Financial Statements 2.Schedule of Valuation and Qualifying Accounts 3.Report of Independent Registered Certified Public Accounting Firm (b)Exhibits Exhibit Number Description 3(a) Restated Certificate of Incorporation of the Company, as amended (1) 3(b) Amended and Restated By-Laws of the Company (2) 4(a) Share Rights Agreement, dated as of April 22, 2008, between the Company and Wells Fargo Bank, N.A., as Rights Agent(3) 4(b) Form of Amended and Restated Certificate of Powers, Designations, Preferences and Rights of Series A Junior ParticipatingPreferred Shares (4) 10(a) English Language Summary of Sale and Leaseback Agreement dated February 18, 2008 between Digi International GmbHand Deutsche Structured Finance GmbH & Co. Alphard KG (5) 10(b) Digi International Inc. Stock Option Plan as Amended and Restated as of November 27, 2006* (6) 10(b)(i) Form of Notice of Grant of Stock Options and Option Agreement (for grants under Digi International Inc. Stock OptionPlan)* (7) 10(c) Digi International Inc. Non-Officer Stock Option Plan, as Amended and Restated as of November 27, 2006 (8) 10(d) Digi International Inc. Employee Stock Purchase Plan, as amended and restated as of December 4, 2009* (9) 10(e) Digi International Inc. 2000 Omnibus Stock Plan, as amended and restated as of December 4, 2009* (10) 10(e)(i) Form of Notice of Grant of Stock Options and Option Agreement (for grants under Digi International Inc. 2000 OmnibusStock Plan before January 26, 2010)* (11) 10(e)(ii) Form of Notice of Grant of Stock Options and Option Agreement (amended form for grants under Digi International Inc.2000 Omnibus Stock Plan on or after January 26, 2010 provided Addendum 1A applies only to certain grants made on andafter November 22, 2011)* (12) 10(f) Digi International Inc. 2013 Omnibus Incentive Plan* (13) 10(f)(i) Form of Notice of Grant of Stock Options and Option Agreement including Addendums to Option Agreement that mayapply to certain grants (for grants under Digi International Inc. 2013 Omnibus Incentive Plan)* (14) 10(f)(ii) Form of (Director) Restricted Stock Unit Award Agreement (for awards under Digi International Inc. 2013 OmnibusIncentive Plan)* (15)71Table of ContentsITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES (CONTINUED) 10(g) Form of indemnification agreement with directors and officers of the Company* (16) 10(h) Agreement between the Company and Lawrence A. Kraft, dated February 4, 2003* (17) 10(h)(i) Amendment to Agreement between the Company and Lawrence A. Kraft dated July 30, 2007* (18) 10(i) Employment Agreement between the Company and Joseph T. Dunsmore dated September 27, 2006* (19) 10(j) Agreement between the Company and Joel K. Young dated July 30, 2007* (20) 10(k) Offer Letter Agreement, dated as of October 28, 2010 between the Company and Steven E. Snyder* (21) 10(l) Agreement between the Company and Jon A. Nyland dated September 17, 2013* 10(m) Offer Letter Agreement, dated as of April 8, 2011 between the Company and David H. Sampsell* 21 Subsidiaries of the Company 23 Consent of Independent Registered Public Accounting Firm 24 Powers of Attorney 31(a) Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer 31(b) Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer 32 Section 1350 Certification 101.INS XBRL Instance Document 101.SCH XBRL Taxonomy Extension Schema Document 101.CAL XBRL Taxonomy Calculation Linkbase Document 101.DEF XBRL Taxonomy Definition Linkbase Document 101.LAB XBRL Taxonomy Label Linkbase Document 101.PRE XBRL Taxonomy Presentation Linkbase Document* Management contract or compensatory plan or arrangement required to be filed as an exhibit to this Form 10‑K.(1)Incorporated by reference to Exhibit 3(a) to the Company's Form 10‑K for the year ended September 30, 1993 (File no. 0‑17972).(2)Incorporated by reference to Exhibit 3 to the Company's Form 8-K dated January 18, 2011 (File no. 1‑34033).(3)Incorporated by reference to Exhibit 4(a) to the Company's Registration Statement on Form 8-A filed on April 25, 2008 (File no. 1‑34033).(4)Incorporated by reference to Exhibit 4(b) to the Company's Registration Statement on Form 8-A filed on April 25, 2008 (File no. 1‑34033).(5)Incorporated by reference to Exhibit 10(a) to the Company's Form 10‑Q for the quarter ended March 31, 2008 (File no. 1‑34033).(6)Incorporated by reference to Exhibit 10(a) to the Company's Form 10‑K for the year ended September 30, 2006 (File no. 0‑17972).(7)Incorporated by reference to Exhibit 10(a) to the Company's Form 8-K dated September 13, 2004 (File no. 0‑17972).(8)Incorporated by reference to Exhibit 10(g) to the Company's Form 10‑K for the year ended September 30, 2006 (File no. 0‑17972).(9)Incorporated by reference to Exhibit 10(b) to the Company's Form 10‑Q for the quarter ended December 31, 2009 (File no. 1‑34033).72Table of ContentsITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES (CONTINUED)(10)Incorporated by reference to Exhibit 10(a) to the Company's Form 10‑Q for the quarter ended December 31, 2009 (File no. 1‑34033).(11)Incorporated by reference to Exhibit 10(o) to the Company's Form 10‑K for the year ended September 30, 2008 (File no. 1‑34033).(12)Incorporated by reference to Exhibit 10 (e)ii to the Company's Form 10‑Q for the year ended September 30, 2011 (File no. 1‑34033).(13)Incorporated by reference to Exhibit 99 to the Company's Registration Statement on Form S-8 filed on April 16, 2013 (File no. 333-187949).(14)Incorporated by reference to Exhibit 10(a)(i) to the Company's Form 10-Q for the quarter ended March 31, 2013 (File no. 1-34033).(15)Incorporated by reference to Exhibit 10(a)(ii) to the Company's Form 10-Q for the quarter ended March 31, 2013 (File no. 1-34033).(16)Incorporated by reference to Exhibit 10 to the Company's Form 10‑Q for the quarter ended June 30, 2010 (File no. 1‑34033).(17)Incorporated by reference to Exhibit 10(m) to the Company's Form 10‑K for the year ended September 30, 2006 (File no. 0‑17972).(18)Incorporated by reference to Exhibit 10(a) to the Company's Form 10‑Q for the quarter ended June 30, 2007 (File no. 0‑17972).(19)Incorporated by reference to Exhibit 10(d) to the Company's Form 10‑K for the year ended September 30, 2006 (File no. 0‑17972).(20)Incorporated by reference to Exhibit 10(b) to the Company's Form 10‑Q for the quarter ended June 30, 2007 (File no. 0‑17972).(21)Incorporated by reference to Exhibit 10 to the Company's Form 10‑Q for the quarter ended December 31, 2010 (File no. 1‑34033).73Table of ContentsSIGNATURESPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on itsbehalf by the undersigned, thereunto duly authorized, on November 22, 2013. DIGI INTERNATIONAL INC. By: /s/ Joseph T. Dunsmore Joseph T. DunsmoreChairman, President, Chief Executive Officer and DirectorPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant andin the capacities indicated on November 22, 2013. By: /s/ Joseph T. Dunsmore Joseph T. DunsmoreChairman, President, Chief Executive Officer and Director(Principal Executive Officer) By: /s/ Steven E. Snyder Steven E. SnyderSenior Vice President, Chief Financial Officer and Treasurer(Principal Financial Officer and Principal Accounting Officer) By:* Guy C. JacksonDirector By:* Satbir KhanujaDirector By:* Kenneth E. MillardDirector By:* Ahmed NawazDirector By:* William N. PriesmeyerDirector By:* Girish RishiDirector*Joseph T. Dunsmore, by signing his name hereto, does hereby sign this document on behalf of each of the above named directors of the Registrant pursuantto Powers of Attorney duly executed by such persons. By: /s/ Joseph T. Dunsmore Joseph T. DunsmoreAttorney-in-fact74Table of ContentsSCHEDULE II - VALUATION AND QUALIFYING ACCOUNTSDIGI INTERNATIONAL INC.(in thousands)Description Balance atbeginning ofperiod Increase(Decrease) tocosts andexpenses Deductions Balance at end ofperiodValuation account - doubtful accounts September 30, 2013 $295 $309 $291(1) $313September 30, 2012 $339 $418 $462(1) $295September 30, 2011 $549 $(96) $114(1) $339 Reserve for future returns and pricing adjustments September 30, 2013 $1,362 $6,973 $6,565 $1,770September 30, 2012 $1,280 $4,881 $4,799 $1,362September 30, 2011 $1,106 $5,156 $4,982 $1,280(1)Uncollectible accounts charged against allowance, net of recoveries75Table of ContentsEXHIBIT INDEXExhibit Number DescriptionMethod of Filing3(a) Restated Certificate of Incorporation of the Company, as amendedIncorporation byReference 3(b) Amended and Restated By-Laws of the CompanyIncorporation byReference 4(a) Share Rights Agreement, dated as of April 22, 2008, between the Company and Wells Fargo Bank, N.A., asRights AgentIncorporation byReference 4(b) Form of Amended and Restated Certificate of Powers, Designations, Preferences and Rights of Series AJunior Participating Preferred SharesIncorporation byReference 10(a) English Language Summary of Sale and Leaseback Agreement dated February 18, 2008 between DigiInternational GmbH and Deutsche Structured Finance GmbH & Co. Alphard KGIncorporation byReference 10(b) Digi International Inc. Stock Option Plan as Amended and Restated as of November 27, 2006Incorporation byReference 10(b)(i) Form of Notice of Grant of Stock Options and Option AgreementIncorporation byReference 10(c) Digi International Inc. Non-Officer Stock Option Plan, as Amended and Restated as of November 27, 2006Incorporation byReference 10(d) Digi International Inc. Employee Stock Purchase Plan, as amended and restated as of December 4, 2009Incorporation byReference 10(e) Digi International Inc. 2000 Omnibus Stock Plan, as amended and restated as of December 4, 2009Incorporation byReference 10(e)(i) Form of Notice of Grant of Stock Options and Option AgreementIncorporation byReference 10(e)(ii) Form of Notice of Grant of Stock Options and Option AgreementIncorporation byReference 10(f) Digi International Inc. 2013 Omnibus Incentive PlanIncorporation byReference 10(f)(i) Form of Notice of Grant of Stock Options and Option Agreement including Addendums to Option Agreementthat may apply to certain grantsIncorporation byReference 10(f)(ii) Form of (Director) Restricted Stock Unit Award AgreementIncorporation byReference 10(g) Form of indemnification agreement with directors and officers of the CompanyIncorporation byReference 10(h) Agreement between the Company and Lawrence A. Kraft, dated February 4, 2003Incorporation byReference 10(h)(i) Amendment to Agreement between the Company and Lawrence A. Kraft dated July 30, 2007Incorporation byReference 10(i) Employment Agreement between the Company and Joseph T. Dunsmore dated September 27, 2006Incorporation byReference 10(j) Agreement between the Company and Joel K. Young dated July 30, 2007Incorporation byReference 10(k) Offer Letter Agreement, dated as of October 28, 2010 between the Company and Steven E. SnyderIncorporation byReference 10(l) Agreement between the Company and Jon A. Nyland dated September 17, 2013Electronically 76Table of ContentsExhibit Number DescriptionMethod of Filing 10(m) Offer Letter Agreement, dated as of April 8, 2011 between the Company and David H. SampsellElectronically 21 Subsidiaries of the CompanyElectronically 23 Consent of Independent Registered Public Accounting FirmElectronically 24 Powers of AttorneyElectronically 31(a) Rule 13a-14(a)/15d-14(a) Certification of Chief Executive OfficerElectronically 31(b) Rule 13a-14(a)/15d-14(a) Certification of Chief Financial OfficerElectronically 32 Section 1350 CertificationElectronically 101.INS XBRL Instance DocumentElectronically 101.SCH XBRL Taxonomy Extension Schema DocumentElectronically 101.CAL XBRL Taxonomy Calculation Linkbase DocumentElectronically 101.DEF XBRL Taxonomy Definition Linkbase DocumentElectronically 101.LAB XBRL Taxonomy Label Linkbase DocumentElectronically 101.PRE XBRL Taxonomy Presentation Linkbase DocumentElectronically77EXHIBIT 10(l)September 17, 2013Mr. Jon Nyland[ADDRESS]Dear Jon,On behalf of Digi International, I would like to offer you an addition to the terms and conditions of your employment:If Digi International should terminate your employment at any time in the future for reasons other than Cause, you will be provided with the followingseverance package in exchange for a full release of claims against the Company:1.Six months of base salary in effect at the time of termination. This shall be paid in a lump sum as soon as administratively feasible after the later ofthe date of termination or the date the release of claims has become irrevocable.2.A pro-rata bonus based on number of months worked in the fiscal year prior to a qualifying termination and the Company’s actual performanceagainst annual objections. This pro-rata bonus shall be paid no later than 2.5 months after the close of the fiscal year in which the qualifyingtermination occurs.For purposes of this agreement, “Cause” shall mean only the following: (i) indictment or conviction of, or a plea of nolo contendere to, (A) any felony (otherthan any felony arising out of negligence), or any misdemeanor involving moral turpitude with respect to the Company, or (B) any crime or offense involvingdishonesty with respect to the Company; (ii) theft or embezzlement of Company property or commission of similar acts involving dishonesty or moralturpitude; (iii) material negligence in the performance of your job duties after notice; (iv) failure to devote substantially all of his working time and effortsduring normal business hours to the Company's business; or (v) knowing engagement in conduct which is materially injurious to the Company.To accept this modification, please sign and return a copy of this letter.Sincerely,/s/ Tracy RobertsTracy RobertsVP, Talent and Information TechnologyAccepted:/s/ Jon Nyland 9/17/13Jon Nyland DateEXHIBIT 10(m)April 8, 2011Mr. David Sampsell[ADDRESS]Dear David,On behalf of Digi International Inc., I am pleased to offer you employment as VP, General Counsel & Corporate Secretary. This position is also designated asDigi’s Chief Compliance Officer. The position reports to Joe Dunsmore.CompensationYour annualized total compensation target for this position is $340,750. The annualized base salary is $235,000 with an annualized incentive target of$105,750.You will participate in Digi International’s Executive Incentive Plan. For the current fiscal year, your plan will contain the following components:Quarterly Performance: 40% of your incentive target will be based on achievement of quarterly revenue and profitability targets.Annual Performance: 60% of your incentive target will be based on achievement of the annual revenue and profitability targets.All payments are pro-rated based on length of service in the quarter and/or fiscal year.Stock OptionsWe will recommend to the Board of Directors an initial grant of 50,000 stock options. Your options will be at the market price at the time the board approvesyour grant and will vest over four years at a rate of 25% (12,500 shares) upon completion of one year, then proportionate monthly vesting thereafter. StockOption grants are approved at quarterly meetings held in November, January, April and July. We will request a change in control provision addendum to thisinitial grant, however, approval of this is subject to the discretion of the Compensation Committee.BenefitsDigi offers a comprehensive benefit program which includes Medical, Dental, Vision, Life and Disability Insurance, Medical and Dependent CareReimbursement Plans, 401(k) Savings Plan, Employee Stock Purchase Plan, and a Tuition Reimbursement Program. You will be eligible for participation inDigi’s health insurance programs on the first day active employment with the company and will be eligible for participation in the 401(k) Savings Plan on thefirst day of the month following date of hire. Stock Purchase Plan participation eligibility begins on the first of January, April, July and October following dateof hire.You will be eligible to participate in Digi’s $500,000 Executive Life Insurance program. If accepted by the carrier, Digi International will pay the full annualpremium. This is in additional to the basic and optional life insurance programs offered to all employees.Vacation eligibility begins on the date of hire. Upon hire, you will receive four weeks of vacation. You will not accrue above or below this amount regardless oftime taken. Should you leave the company at any point in the future, you will be paid for four weeks of accrued vacation.Severance AgreementIf Digi International should terminate your employment at any time in the future for reasons other than Cause, you will be provided with the followingseverance package in exchange for a full release of claims against the Company:1)Six months of base salary in effect at the time of termination. This shall be paid in a lump sum as soon as administratively feasible after the laterof the date of termination or the date the release of claims has become irrevocable.EXHIBIT 10(m)2)A pro-rata bonus based on number of months worked in the fiscal year prior to a qualifying termination and the Company’s actual performanceagainst annual objections. This pro-rata bonus shall be paid no later than 2.5 months after the close of the fiscal year in which the qualifying terminationoccurs.For purposes of this agreement, “Cause” shall mean only the following: (i) indictment or conviction of, or a plea of nolo contendere to, (A) any felony (otherthan any felony arising out of negligence), or any misdemeanor involving moral turpitude with respect to the Company, or (B) any crime or offense involvingdishonesty with respect to the Company; (ii) theft or embezzlement of Company property or commission of similar acts involving dishonesty or moralturpitude; (iii) material negligence in the performance of your job duties after notice; (iv) failure to devote substantially all of his working time and effortsduring normal business hours to the Company's business; or (v) knowing engagement in conduct which is materially injurious to the Company.Digi International Employment AgreementThis offer of employment is contingent upon your signature on the enclosed Digi International Employment, Confidential Information, and ArbitrationAgreement. Your signature constitutes acceptance of the terms and conditions contained in the Agreement, so please read it thoroughly prior to signing. Thisoffer is also conditioned upon Digi’s determination that you are not subject to any agreement with any former employer or any other party that would prohibityou from working in the position of VP, General Counsel & Corporate Secretary. If at any time in the future the Company determines that you are subject toan agreement that, in Digi’s sole discretion, would prohibit your employment by Digi, Digi may withdraw this offer of employment or terminate youremployment with the Company. This Employment Agreement must be signed prior to your first day of employment.Employment with Digi International Inc. is “at will,” which means that it is for no definite period and may be terminated by either you or Digi at any time forany reason without prior notice. I understand, agree, and acknowledge that any reliance on any statements by any representative of the company contrary tothis "at will" arrangement is unreasonable and may not form any basis for my reliance thereon.Digi International has partnered with Verified Credentials, a background screening organization, to administer confidential background checks. Within 48hours, we ask that you visit Verified Credential website at http://myvci.com/digiinternationalinc to complete a personal questionnaire using your full legalname including middle initial. If you are unable to access the internet within this timeframe, please contact me to further assist you in the process. This offeris contingent upon a finding of “no issue” with your background check. If information is revealed after your start date, Digi has the right to terminateemployment without prior notice.Commencement DateWe will negotiate your start date.Please inform me of your acceptance of this offer by April 8, 2011 and acknowledge your acceptance by signing one of the enclosed copies.Sincerely,Digi International Inc./s/ Tracy Roberts Tracy RobertsVP, Human Resources & Information TechnologyOffer accepted:/s/ David Sampsell April 25,2011David Sampsell Start DateEXHIBIT 10(m)DIGI INTERNATIONAL INC.EMPLOYMENT, CONFIDENTIAL INFORMATION,AND ARBITRATION AGREEMENTAs a condition of my employment with DIGI INTERNTIONAL INC., its subsidiaries, affiliates, successors or assigns (together the "Company"),and in consideration of my employment with the Company and my receipt of the compensation now and hereafter paid to me by Company, I agree to thefollowing:1. At‑Will Employment. I UNDERSTAND AND ACKNOWLEDGE THAT MY EMPLOYMENT WITH THE COMPANY IS FOR ANUNSPECIFIED DURATION AND CONSTITUTES "AT‑WILL" EMPLOYMENT. I ALSO UNDERSTAND THAT ANY REPRESENTATION TOTHE CONTRARY IS UNAUTHORIZED AND NOT VALID UNLESS OBTAINED IN WRITING AND SIGNED BY THE CHIEF EXECUTIVEOFFICER OF THE COMPANY. I ACKNOWLEDGE THAT THIS EMPLOYMENT RELATIONSHIP MAY BE TERMINATED AT ANY TIME, WITHOR WITHOUT GOOD CAUSE OR FOR ANY OR NO CAUSE, AT THE OPTION EITHER OF THE COMPANY OR MYSELF, WITH OR WITHOUTNOTICE.2. Confidential Information.(a) Company Information. I agree at all times during the term of my employment and thereafter, to hold in strictest confidence, and not to use ordisclose, except for the benefit of the Company, to any person, firm or corporation without written authorization of the Chief Executive Officer of theCompany, any Confidential Information of the Company. I understand that "Confidential Information" means any Company proprietary information,technical data, trade secrets or know-how, including, but not limited to, research and research plans, product plans, products, services, customer lists andcustomers (including, but not limited to, customers of the Company on whom I called or with whom I became acquainted during the term of my employment),markets, software, means of accessing the company’s computer systems or networks, developments, inventions, processes, formulas, technology, designs,drawings, engineering data, hardware configuration information, marketing, financial or other business information obtained by me either directly orindirectly in writing, orally or by observation. I further understand that Confidential Information does not include any of the foregoing items which hasbecome publicly known and made generally available through no wrongful act of mine or of others who were under confidentiality obligations as to the item oritems involved or improvements or new versions thereof.(b) Former Employer Information. I agree that I will not, during my employment with the Company, improperly use or disclose anyproprietary information or trade secrets of any former or concurrent employer or other person or entity and that I will not bring onto the premises of theCompany any unpublished document or proprietary information belonging to any such employer, person or entity unless consented to in writing by suchemployer, person or entity.(c) Third Party Information. I recognize that the Company has received and in the future will receive from third parties their confidential orproprietary information subject to a duty on the Company's part to maintain the confidentiality of such information and to use it only for certain limitedpurposes. I agree to hold all such confidential or proprietary information in the strictest confidence and not to disclose it to any person, firm or corporation orto use it except as necessary in carrying out my work for the Company consistent with the Company's agreement with such third party.3. Conflicting Employment. I agree that, during the term of my employment with the Company, I will not engage in any other employment, occupation,consulting or other business activity directly related to the business in which the Company is now involved or becomes involved during the term of myemployment, nor will I engage in any other activities that conflict with my obligations to the Company.4. Returning Company Documents. I agree that, at the time of leaving the employ of the Company, I will deliver to the Company (and will not keep in mypossession, recreate or deliver to anyone else) any and all devices, records, data, notes, reports, proposals, lists, correspondence, specifications, drawingsblueprints, sketches, materials, equipment, other documents or property, or reproductions of any aforementioned items developed by me pursuant to myemployment with the Company or otherwise belonging to the Company, its successors or assigns. In the event of the termination of my employment, I agree tosign, deliver and comply with the terms of the "Termination Certification" attached hereto as Exhibit A.5. Notification of New Employer. In the event that I leave the employ of the Company, I hereby grant consent to notification by the Company to my newemployer about my rights and obligations under this Agreement.EXHIBIT 10(m)6. Covenant Not to Compete. To the full extent permitted by law, I agree that during the course of my employment with Digi International and for a periodof twelve (12) months after the termination of my employment (whether voluntary or involuntary), I will not directly or indirectly provide any services to anyindividual, company, or other entity which is or plans to be directly competitive with Digi International's business, unless I have written consent of DigiInternational. This includes, but is not limited to, direct employment, independent contracting, and any consultancy relationships.7. Non-solicitation.(a) Non-solicitation of Employees. To the full extent permitted by law, during my employment and for a period of twelve (12) months immediatelyfollowing the termination of my employment with the Company for any reason, whether voluntary or involuntary, I shall not, by myself or in collaborationwith others, either directly or indirectly solicit, induce, recruit or encourage any of the Company’s employees to leave their employment, or take away suchemployees, or attempt to solicit, induce, recruit, encourage or take away employees of the Company, either for myself or any other person or entity.(b) Non-solicitation of Business. To the full extent permitted by law, for a period of twelve (12) months immediately following the termination ofmy employment with the Company for any reason, whether voluntary or involuntary, I will not divert or attempt to divert from the Company any business theCompany had enjoyed, solicited, or planned to solicit from its customers or potential customers during the eighteen (18) months prior to my termination ofemployment.8. Representations. I agree to execute any proper oath or verify any proper document required to carry out the terms of this Agreement. I represent that myperformance of all the terms of this Agreement will not breach any agreement to keep in confidence proprietary information acquired by me in confidence or intrust prior to my employment by the Company. I have not entered into, and I agree I will not enter into, any oral or written agreement in conflict herewith.9. Arbitration and Equitable Relief.(a) Arbitration. EXCEPT AS PROVIDED IN SECTION 8(b) BELOW, I AGREE THAT ANY DISPUTE OR CONTROVERSY ARISINGOUT OF, RELATING TO, OR CONCERNING ANY INTERPRETATION, CONSTRUCTION, PERFORMANCE OR BREACH OF THISAGREEMENT, SHALL BE SETTLED BY ARBITRATION TO BE HELD IN HENNEPIN COUNTY, MINNESOTA, IN ACCORDANCE WITH THEEMPLOYMENT DISPUTE RESOLUTION RULES THEN IN EFFECT OF THE AMERICAN ARBITRATION ASSOCIATION. THE ARBITRATORMAY GRANT INJUNCTIONS OR OTHER RELIEF IN SUCH DISPUTE OR CONTROVERSY. THE DECISION OF THE ARBITRATOR SHALL BEFINAL, CONCLUSIVE AND BINDING ON THE PARTIES TO THE ARBITRATION. JUDGMENT MAY BE ENTERED ON THE ARBITRATOR'SDECISION IN ANY COURT HAVING JURISDICTION. THE COMPANY AND I SHALL EACH PAY ONE-HALF OF THE COSTS AND EXPENSESOF SUCH ARBITRATION, AND EACH OF US SHALL SEPARATELY PAY OUR COUNSEL FEES AND EXPENSES.THIS ARBITRATION CLAUSE CONSTITUTES A WAIVER OF EMPLOYEE'S RIGHT TO A JURY TRIAL AND RELATES TO THERESOLUTION OF ALL DISPUTES RELATING TO ALL ASPECTS OF THE EMPLOYER/EMPLOYEE RELATIONSHIP (EXCEPT AS PROVIDEDIN SECTION 8(b) BELOW), INCLUDING, BUT NOT LIMITED TO, THE FOLLOWING CLAIMS:i. ANY AND ALL CLAIMS FOR WRONGFUL DISCHARGE OF EMPLOYMENT; BREACH OF CONTRACT, BOTH EXPRESSAND IMPLIED; BREACH OF THE COVENANT OF GOOD FAITH AND FAIR DEALING, BOTH EXPRESS AND IMPLIED; NEGLIGENT ORINTENTIONAL INFLICTION OF EMOTIONAL DISTRESS; NEGLIGENT OR INTENTIONAL MISREPRESENTATION; NEGLIGENT ORINTENTIONAL INTERFERENCE WITH CONTRACT OR PROSPECTIVE ECONOMIC ADVANTAGE; AND DEFAMATION;ii. ANY AND ALL CLAIMS FOR VIOLATION OF ANY FEDERAL, STATE OR MUNICIPAL STATUTE, INCLUDING, BUTNOT LIMITED TO, TITLE VII OF THE CIVIL RIGHTS ACT OF 1964, THE CIVIL RIGHTS ACT OF 1991, THE AGE DISCRIMINATION INEMPLOYMENT ACT OF 1967, THE AMERICANS WITH DISABILITIES ACT OF 1990, THE FAIR LABOR STANDARDS ACT, ANDMINNESOTA STATUTE SECTION 181, et seq.;iii. ANY AND ALL CLAIMS ARISING OUT OF ANY OTHER LAWS AND REGULATIONS RELATING TO EMPLOYMENT OREMPLOYMENT DISCRIMINATION.(b) Equitable Remedies. I AGREE THAT IT WOULD BE IMPOSSIBLE OR INADEQUATE TO MEASURE AND CALCULATE THECOMPANY'S DAMAGES FROM ANY BREACH OF THE COVENANTS SET FORTH IN SECTIONS 2, 4 AND 6 HEREIN. ACCORDINGLY, IAGREE THAT IF I BREACH ANY OF SUCH SECTIONS, THEEXHIBIT 10(m)COMPANY WILL HAVE AVAILABLE, IN ADDITION TO ANY OTHER RIGHT OR REMEDY AVAILABLE, THE RIGHT TO OBTAIN ANINJUNCTION FROM A COURT OF COMPETENT JURISDICTION RESTRAINING SUCH BREACH OR THREATENED BREACH AND TOSPECIFIC PERFORMANCE OF ANY SUCH PROVISION OF THIS AGREEMENT. I FURTHER AGREE THAT NO BOND OR OTHER SECURITYSHALL BE REQUIRED IN OBTAINING SUCH EQUITABLE RELIEF AND I HEREBY CONSENT TO THE ISSUANCE OF SUCH INJUNCTIONAND TO THE ORDERING OF SPECIFIC PERFORMANCE. IN THE EVENT THE COMPANY SEEKS AND OBTAINS EQUITABLE RELIEF HEREUNDER, IT SHALL BE ENTITLED TO RECOVER ITS REASONABLE ATTORNEY’S FEES AND COSTS FROM ME.(c) Consideration. I UNDERSTAND THAT EACH PARTY'S PROMISE TO RESOLVE CLAIMS BY ARBITRATION IN ACCORDANCEWITH THE PROVISIONS OF THIS AGREEMENT, RATHER THAN THROUGH THE COURTS, IS CONSIDERATION FOR OTHER PARTY'S LIKEPROMISE. I FURTHER UNDERSTAND THAT I AM OFFERED EMPLOYMENT IN CONSIDERATION OF MY PROMISE TO ARBITRATECLAIMS.10. General Provisions.(a) Governing Law; Consent to Personal Jurisdiction. This Agreement will be governed by the laws of the State of Minnesota. I herebyexpressly consent to the personal jurisdiction of the state and federal courts located in Minnesota for any lawsuit filed there against me by the Company arisingfrom or relating to this Agreement.(b) Entire Agreement. This Agreement sets forth the entire agreement and understanding between the Company and me relating to the subjectmatter herein and supersedes all prior discussions between us. No modification of or amendment to this Agreement, nor any waiver of any rights under thisagreement, will be effective unless in writing signed by the party to be charged. Any subsequent change or changes in my duties, salary or compensation willnot affect the validity or scope of this Agreement.(c) Severability. If one or more of the provisions in this Agreement are deemed void by law, then the remaining provisions will continue in fullforce and effect.(d) Successors and Assigns. This Agreement will be binding upon my heirs, executors, administrators and other legal representatives and will befor the benefit of the Company, its successors, and its assigns.Date: April 8, 2011/s/David Sampsell SignatureDavid SampsellWitness: /s/ Kathleen M. Heafey EXHIBIT 21Subsidiaries of the CompanyDigi International GmbHDigi International (HK) Ltd.Digi International KabushikikaishaDigi International LimitedDigi International SARLDigi International Spain S.A.Digi m2m Solutions India Pvt. Ltd.Digi Wireless Singapore Pte. Ltd.Etherios, Inc.ITK International, Inc.Etherios Design Services Inc.EXHIBIT 23CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRMWe hereby consent to the incorporation by reference in the Registration Statements on Form S-8 (Nos. 333-187949, 333-144872, 333-00099, 333-23857, 333-82674, 333-169427 and 333-169428) of Digi International Inc. of our report dated November 22, 2013 relating to the consolidated financial statements,financial statement schedule and the effectiveness of internal control over financial reporting, which appears in this Form 10‑K./s/PricewaterhouseCoopers LLPMinneapolis, MinnesotaNovember 22, 2013EXHIBIT 24DIGI INTERNATIONAL INC.Power of Attorneyof Director and OfficerThe undersigned director and officer of Digi International Inc., a Delaware corporation, does hereby make, constitute and appoint Steven E. Snyderthe undersigned's true and lawful attorney-in-fact, with power of substitution, for the undersigned and in the undersigned's name, place and stead, to sign andaffix the undersigned's name as such director and officer of said Corporation to an Annual Report on Form 10-K or other applicable form, and all amendmentsthereto, to be filed by said Corporation with the Securities and Exchange Commission, Washington, D.C., under the Securities Exchange Act of 1934, asamended, with all exhibits thereto and other supporting documents, with said Commission, granting unto said attorney-in-fact full power and authority to doand perform any and all acts necessary or incidental to the performance and execution of the powers herein expressly granted.IN WITNESS WHEREOF, the undersigned has hereunto set the undersigned's hand this 22nd day of November, 2013./s/ Joseph T. DunsmoreJoseph T. DunsmoreEXHIBIT 24DIGI INTERNATIONAL INC.Power of Attorneyof OfficerThe undersigned officer of Digi International Inc., a Delaware corporation, does hereby make, constitute and appoint Joseph T. Dunsmore, theundersigned's true and lawful attorney-in-fact, with power of substitution, for the undersigned and in the undersigned's name, place and stead, to sign andaffix the undersigned's name as such officer of said Corporation to an Annual Report on Form 10-K or other applicable form, and all amendments thereto, tobe filed by said Corporation with the Securities and Exchange Commission, Washington, D.C., under the Securities Exchange Act of 1934, as amended, withall exhibits thereto and other supporting documents, with said Commission, granting unto said attorney-in-fact full power and authority to do and perform anyand all acts necessary or incidental to the performance and execution of the powers herein expressly granted.IN WITNESS WHEREOF, the undersigned has hereunto set the undersigned's hand this 22nd day of November, 2013./s/ Steven E. SnyderSteven E. SnyderEXHIBIT 24DIGI INTERNATIONAL INC.Power of Attorneyof DirectorThe undersigned director of Digi International Inc., a Delaware corporation, does hereby make, constitute and appoint Joseph T. Dunsmore andSteven E. Snyder, and either of them, the undersigned's true and lawful attorneys-in-fact, with power of substitution, for the undersigned and in theundersigned's name, place and stead, to sign and affix the undersigned's name as such director of said Corporation to an Annual Report on Form 10-K or otherapplicable form, and all amendments thereto, to be filed by said Corporation with the Securities and Exchange Commission, Washington, D.C., under theSecurities Exchange Act of 1934, as amended, with all exhibits thereto and other supporting documents, with said Commission, granting unto said attorneys-in-fact, and either of them, full power and authority to do and perform any and all acts necessary or incidental to the performance and execution of the powersherein expressly granted.IN WITNESS WHEREOF, the undersigned has hereunto set the undersigned's hand this 22nd day of November, 2013./s/ Guy C. JacksonGuy C. JacksonEXHIBIT 24DIGI INTERNATIONAL INC.Power of Attorneyof DirectorThe undersigned director of Digi International Inc., a Delaware corporation, does hereby make, constitute and appoint Joseph T. Dunsmore andSteven E. Snyder, and either of them, the undersigned's true and lawful attorneys-in-fact, with power of substitution, for the undersigned and in theundersigned's name, place and stead, to sign and affix the undersigned's name as such director of said Corporation to an Annual Report on Form 10-K or otherapplicable form, and all amendments thereto, to be filed by said Corporation with the Securities and Exchange Commission, Washington, D.C., under theSecurities Exchange Act of 1934, as amended, with all exhibits thereto and other supporting documents, with said Commission, granting unto said attorneys-in-fact, and either of them, full power and authority to do and perform any and all acts necessary or incidental to the performance and execution of the powersherein expressly granted.IN WITNESS WHEREOF, the undersigned has hereunto set the undersigned's hand this 22nd day of November, 2013./s/ Kenneth E. MillardKenneth E. MillardEXHIBIT 24DIGI INTERNATIONAL INC.Power of Attorneyof DirectorThe undersigned director of Digi International Inc., a Delaware corporation, does hereby make, constitute and appoint Joseph T. Dunsmore andSteven E. Snyder, and either of them, the undersigned's true and lawful attorneys-in-fact, with power of substitution, for the undersigned and in theundersigned's name, place and stead, to sign and affix the undersigned's name as such director of said Corporation to an Annual Report on Form 10-K or otherapplicable form, and all amendments thereto, to be filed by said Corporation with the Securities and Exchange Commission, Washington, D.C., under theSecurities Exchange Act of 1934, as amended, with all exhibits thereto and other supporting documents, with said Commission, granting unto said attorneys-in-fact, and either of them, full power and authority to do and perform any and all acts necessary or incidental to the performance and execution of the powersherein expressly granted.IN WITNESS WHEREOF, the undersigned has hereunto set the undersigned's hand this 20th day of November, 2013./s/ Ahmed NawazAhmed NawazEXHIBIT 24DIGI INTERNATIONAL INC.Power of Attorneyof DirectorThe undersigned director of Digi International Inc., a Delaware corporation, does hereby make, constitute and appoint Joseph T. Dunsmore andSteven E. Snyder, and either of them, the undersigned's true and lawful attorneys-in-fact, with power of substitution, for the undersigned and in theundersigned's name, place and stead, to sign and affix the undersigned's name as such director of said Corporation to an Annual Report on Form 10-K or otherapplicable form, and all amendments thereto, to be filed by said Corporation with the Securities and Exchange Commission, Washington, D.C., under theSecurities Exchange Act of 1934, as amended, with all exhibits thereto and other supporting documents, with said Commission, granting unto said attorneys-in-fact, and either of them, full power and authority to do and perform any and all acts necessary or incidental to the performance and execution of the powersherein expressly granted.IN WITNESS WHEREOF, the undersigned has hereunto set the undersigned's hand this 22nd day of November, 2013./s/ William N. PriesmeyerWilliam N. PriesmeyerEXHIBIT 24DIGI INTERNATIONAL INC.Power of Attorneyof DirectorThe undersigned director of Digi International Inc., a Delaware corporation, does hereby make, constitute and appoint Joseph T. Dunsmore andSteven E. Snyder, and either of them, the undersigned's true and lawful attorneys-in-fact, with power of substitution, for the undersigned and in theundersigned's name, place and stead, to sign and affix the undersigned's name as such director of said Corporation to an Annual Report on Form 10-K or otherapplicable form, and all amendments thereto, to be filed by said Corporation with the Securities and Exchange Commission, Washington, D.C., under theSecurities Exchange Act of 1934, as amended, with all exhibits thereto and other supporting documents, with said Commission, granting unto said attorneys-in-fact, and either of them, full power and authority to do and perform any and all acts necessary or incidental to the performance and execution of the powersherein expressly granted.IN WITNESS WHEREOF, the undersigned has hereunto set the undersigned's hand this 22nd day of November, 2013./s/ Satbir Khanuja, Ph.D.Satbir Khanuja, Ph.D.EXHIBIT 24DIGI INTERNATIONAL INC.Power of Attorneyof DirectorThe undersigned director of Digi International Inc., a Delaware corporation, does hereby make, constitute and appoint Joseph T. Dunsmore andSteven E. Snyder, and either of them, the undersigned's true and lawful attorneys-in-fact, with power of substitution, for the undersigned and in theundersigned's name, place and stead, to sign and affix the undersigned's name as such director of said Corporation to an Annual Report on Form 10-K or otherapplicable form, and all amendments thereto, to be filed by said Corporation with the Securities and Exchange Commission, Washington, D.C., under theSecurities Exchange Act of 1934, as amended, with all exhibits thereto and other supporting documents, with said Commission, granting unto said attorneys-in-fact, and either of them, full power and authority to do and perform any and all acts necessary or incidental to the performance and execution of the powersherein expressly granted.IN WITNESS WHEREOF, the undersigned has hereunto set the undersigned's hand this 22nd day of November, 2013./s/ Girish D. RishiGirish D. RishiExhibit No. 31(a)CERTIFICATION PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002I, Joseph T. Dunsmore, certify that:1. I have reviewed this annual report on Form 10-K of Digi International Inc.;2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statementsmade, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financialcondition, results of operations and cash flows of the Registrant as of, and for, the periods presented in this report;4. The Registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in ExchangeAct Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the Registrantand have:(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure thatmaterial information relating to the Registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly duringthe period in which this report is being prepared;(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, toprovide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance withgenerally accepted accounting principles;(c) Evaluated the effectiveness of the Registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of thedisclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and(d) Disclosed in this report any change in the Registrant’s internal control over financial reporting that occurred during the Registrant’s most recent fiscalquarter (the Registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, theRegistrant’s internal control over financial reporting; and5. The Registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to theRegistrant’s auditors and the audit committee of the Registrant’s Board of Directors (or persons performing the equivalent functions):(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely toadversely affect the Registrant’s ability to record, process, summarize and report financial information; and(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the Registrant’s internal control overfinancial reporting. November 22, 2013/s/ Joseph T. Dunsmore Joseph T. Dunsmore President, Chief Executive Officer and Chairman Exhibit No. 31(b)CERTIFICATION PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002I, Steven E. Snyder, certify that:1. I have reviewed this annual report on Form 10-K of Digi International Inc.;2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statementsmade, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financialcondition, results of operations and cash flows of the Registrant as of, and for, the periods presented in this report;4. The Registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in ExchangeAct Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the Registrantand have:(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure thatmaterial information relating to the Registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly duringthe period in which this report is being prepared;(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, toprovide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance withgenerally accepted accounting principles;(c) Evaluated the effectiveness of the Registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of thedisclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and(d) Disclosed in this report any change in the Registrant’s internal control over financial reporting that occurred during the Registrant’s most recent fiscalquarter (the Registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, theRegistrant’s internal control over financial reporting; and5. The Registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to theRegistrant’s auditors and the audit committee of the Registrant’s Board of Directors (or persons performing the equivalent functions):(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely toadversely affect the Registrant’s ability to record, process, summarize and report financial information; and(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the Registrant’s internal control overfinancial reporting. November 22, 2013/s/ Steven E. Snyder Steven E. Snyder Senior Vice President, Chief Financial Officer and Treasurer Exhibit No. 32CERTIFICATION PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350, each of the undersigned certifies that:(1) The Annual Report on Form 10-K of the Company for the year ended September 30, 2013 (the "Report") fully complies with the requirements of section13(a) or 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78m or 78o(d)); and(2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. November 22, 2013 /s/ Joseph T. Dunsmore Joseph T. Dunsmore President, Chief Executive Officer, and Chairman November 22, 2013 /s/ Steven E. Snyder Steven E. Snyder Senior Vice President, Chief Financial Officer and Treasurer

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