Digi International
Annual Report 2016

Plain-text annual report

UNITED STATES SECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549FORM 10-Kþ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934For the fiscal year ended: September 30, 2016oro 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 þIndicate 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 þIndicate 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 þ No oIndicate 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 to submit andpost such files.) Yes þ 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, to thebest 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 þ Non-accelerated filer o Smaller reporting company oIndicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o No þThe 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$240,899,354 based on a closing price of $9.43 per common share as reported on the NASDAQ Global Select Market. (For purposes of this calculation all of the registrant'sdirectors and executive officers are deemed affiliates of the registrant.)Shares of common stock outstanding as of December 9, 2016: 26,321,953DOCUMENTS INCORPORATED BY REFERENCEPortions of the Registrant's Proxy Statement for its 2017 Annual Meeting of Stockholders are incorporated by reference into Part III hereto. INDEX PagePART I. ITEM 1. Business1ITEM 1A. Risk Factors7ITEM 1B. Unresolved Staff Comments17ITEM 2. Properties18ITEM 3. Legal Proceedings18ITEM 4. Mine Safety Disclosures18 PART II. ITEM 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities19ITEM 6. Selected Financial Data21ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations22ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk35ITEM 8. Financial Statements and Supplementary Data36ITEM 9. Changes in and Disagreements with Accountants On Accounting and Financial Disclosure70ITEM 9A. Controls and Procedures70ITEM 9B. Other Information71 PART III. ITEM 10. Directors, Executive Officers and Corporate Governance72ITEM 11. Executive Compensation73ITEM 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters73ITEM 13. Certain Relationships and Related Transactions, and Director Independence73ITEM 14. Principal Accounting Fees and Services73 PART IV. ITEM 15. Exhibits, Financial Statement Schedules74 iTable of ContentsPART I.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. The telephone number at our World Headquarters is (952) 912-3444.We are a leading global provider of business and mission-critical machine-to-machine (M2M) and Internet of Things (IoT) connectivity products andservices. We help our customers create next-generation connected products and deploy and manage critical communications infrastructures in demandingenvironments with high levels of security and reliability. We create secure, easy to implement embedded solutions and services to help customers build IoTconnectivity. We also deploy ready to use, complete box solutions to connect remote machinery. In addition, we manage cloud services, offer professionalservices and complete IoT solutions. Most recently we formed a cold chain solution that offers automated wireless temperature monitoring as well asemployee task management services to restaurants, convenience stores, warehouses and other businesses that have perishable or temperature sensitive goods.Our products and services are used by a wide range of businesses and institutions.Our present portfolio primarily includes:•Wireless and wired hardware products that have been the historical foundation of our business;•Services include the following offerings:◦Digi Cold Chain Solutions is a wireless end-to-end solution that utilizes sensors, gateways and an easy-to-use software application that enablescompanies to monitor automatically the temperature of perishable goods effectively and economically. Our Digi Cold Chain Solutions are the result ofour acquisition of Bluenica Corporation in October 2015 (see Note 2 to our Consolidated Financial Statements). On November 1, 2016, we acquiredPittsburgh-based FreshTemp, LLC (FreshTemp). This acquisition expands our offerings and customer base in this market space (see Note 19 to ourConsolidated Financial Statements). FreshTemp helps organizations track the completion of employee tasks in real time via the use of softwareapplications in which employees log their activities in real-time.◦Wireless Design Services provide customers with turn-key wireless networking product design, testing, and certification for a wide range of wirelesstechnology platforms and applications to improve speed to market and reduce risk.◦Digi Support Services provides various levels of technical support to customers with programming and implementation challenges related to Digiproducts. We offer base support up to our highest level of professional support which includes implementation planning, application development, on-site support, installation and customer training. These support services help minimize design risk and ensure optimal performance.◦Digi Device Cloud™ and Digi Remote Manager™ - Digi Device Cloud™ (Device Cloud) is a platform as-a-service (PaaS) offering that provides asecure environment for customers to aggregate their interaction with a large number of disparate devices and connect enterprise applications to thesedevices. This allows for devices to be monitored and controlled remotely and permits customers to collect, interpret and utilize data from many devicesto operate their businesses efficiently and with greater ease. Digi Remote Manager™ is a complete, centralized remote device management solutionthat is housed on the Digi Device Cloud™ and allows customers to meet service level commitments and stay compliant with Payment Card Industry(PCI) standards. Digi Remote Manager™ also allows customers to monitor, diagnose and fix remote devices without sending a technician on site.In October 2015, we sold our Etherios, Inc. CRM consulting services business (“Etherios”), which focused on integration and configuration of enterpriseresource management (ERM) systems, including customer relationship management (CRM) systems. This part of our business principally providedintegration and configuration of salesforce.com products. As a result of the sale of Etherios, we have accounted for it as a discontinued operation.Accordingly, amounts in the Consolidated Statement of Operations, the Consolidated Balance Sheets and notes thereto, for all periods affected, have beenreclassified to reflect discontinued operations accounting for that business. For more information on this divestiture see Note 3 to the Consolidated FinancialStatements.For more in-depth descriptions of our primary hardware products, please refer to the heading “Listing of Principal Hardware1Table of ContentsProducts and Services” at the end of Part I, Item 1 of this Form 10-K.Our hardware product revenue represented 96.6%, 95.9% and 94.4% of our total revenue in fiscal 2016, 2015 and 2014, respectively. Our service revenuerepresented 3.4%, 4.1% and 5.6% of our total revenue in fiscal 2016, 2015 and 2014, respectively.Our corporate website address is www.digi.com. In the “Company - Investor Relations” section of our website, we make our annual reports on Form 10-K,quarterly reports on Form 10-Q, current reports on Form 8-K, our proxy statement and any amendments to these reports available free of charge as soon 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 ConditionsCurrent Market ConditionsWe believe the marketplace for IoT products and services will continue to expand generally. While we realized significant revenue growth in fiscal 2015, ourbusiness stagnated in fiscal 2016 primarily because certain significant customers of our cellular and RF products slowed their purchases of our products.While we generally expect the trend of marketplace growth to continue, it is susceptible to downturns in general economic conditions as well as uncertaintyor changes in the regulatory environments. These impacts may be more pronounced in certain industries. For instance, the oil and gas marketplace for IoTnetworking products has been more challenging in recent years because of lower prices for these natural resources. Further, as demonstrated in fiscal 2016,our own ability to grow our core hardware business can be subject to fluctuation. Sales of many of our products are subject to large non-repeatable customerdeployments. If we are unable to identify and commence new deployments with equal or greater significance than completed projects, our growth from periodto period may be inconsistent. In turn, if we do not replace significant opportunities as they conclude with similar opportunities of scale, our growth fromperiod to period may be inconsistent.StrategyCurrent Status of Our BusinessSince appointing Ronald E. Konezny as our Chief Executive Officer in December, 2014, we have focused on:•Simplifying our operations;•Improving our operating expense model and profitability; and•Exploring ways to drive greater revenue growth.Among other actions we have taken to advance these aims during that time include:•We have taken steps to contain our operating expenses and delivered higher levels of profitability despite decreased revenue in fiscal 2016.•We focused our business and improved our operating model by selling our Etherios CRM consulting business in October 2015. We acquiredEtherios with the expectation that it would drive engagements with companies that utilize the salesforce.com platform and were looking to deploysolutions within their businesses. We were not, however, rewarded in the marketplace as we had hoped. As a result, we disposed of a consultingbusiness that was losing money and not fully tied to our core hardware expertise.•We have consolidated and relocated office locations. In the first quarter of fiscal 2016, we moved our Wireless Design Services team from an officein downtown Minneapolis to our World Headquarters in suburban Minnetonka. At first, this move was disruptive for some employees of the WirelessDesign Services team and the revenues of the business2Table of Contentsconsequently suffered due to attrition. However, as of the fourth quarter of fiscal 2016 business results have begun to rebound. Additionally, weclosed our office location in Dortmund, Germany in the third quarter of fiscal 2016 and moved the corresponding positions to our existing office inMunich, Germany. These moves improved our operating expenses and better positions our employees to drive positive results in our operationsthrough increased collaboration. We also expect to benefit from closer proximity to certain key customers in the Munich area.•During fiscal 2016, we continued to reduce the number of hardware product stock keeping units (SKUs) we produce. We expect this effort tosimplify our operations will have a significant impact on our ability to manage inventory effectively, improve channel stocking strategies andcontrol costs. At present, SKUs have been reduced from close to 5,000 to approximately 2,700.•Our recent acquisitions enhance our opportunity to develop a high-growth hardware enabled service business with significant recurring revenuepotential. In October 2015, we acquired Bluenica Corporation, a company focused on automating temperature monitoring of perishable goods in thefood industry by using wireless sensors and a web-based application. In November 2016, we also acquired Pittsburgh-based FreshTemp, LLC. See"Acquisitions and Dispositions" below for further discussion. These acquisitions will provide us with an advanced portfolio of products for the coldchain market.Long Term StrategyWe are focused on creating a high-growth business that leverages our long-term strengths of providing reliable and secure equipment and solutions for theM2M marketplace. We intend to continue to take steps to simplify our operations, improve operating expenses to increase our profit leverage and expand ourbusiness in ways that we believe can drive growth. We will continue to seek and evaluate acquisitions that will further enhance Digi Cold Chain Solutions aswe believe this marketplace offers a path to a significant base of recurring revenue that can provide both stability and significant growth for us. Ifopportunities present themselves, we may also seek to acquire hardware or other businesses that we believe can improve our market position in our core IoThardware business.Acquisitions and DispositionsAcquisitionsIn October 2015, we acquired Bluenica Corporation, a company focused on temperature monitoring of perishable goods in the food industry by usingwireless sensors which are installed in grocery and convenience stores, restaurants, and in products during shipment and storage to ensure that quality,freshness and public health requirements are met (see Note 2 to our Consolidated Financial Statements). This Company formed the initial basis for Digi Cold Chain Solutions and was purchased for several reasons. First, it provided us with the opportunity todevelop a recurring revenue business that is focused on a large addressable market that has not been penetrated significantly. Restaurants, pharmacies,hospitals and other businesses that maintain significant inventories of perishable goods are an enormous market. These businesses by and large presently relyprimarily on employees to log the temperature of these goods periodically using pencil and paper. This is not as cost effective or secure as using wirelesscommunications sensors to provide real time alerts at all times. Second, at present this marketplace primarily is served by smaller companies that lack theinfrastructure to provide hardware enabled service to customers in as effective and efficient a manner as we are able to do because of our long-standinghistory as an IoT hardware provider. Third, we believe customers in this marketplace will not require significant customization or development of existingproducts before they will commit to purchase the solution. This differs from many of our present customers who often ask us to create a highly customizedproduct that cannot be easily sold to other parties. This potential for repeatable sales of an established product suite appeals to us. Fourth, by protectingvaluable goods that impact health and safety, the solution provides a clear return on investment for potential customers whose business and reputation ishighly reliant on maintaining inventory that is safe for human consumption.We have further enhanced Digi Cold Chain Solutions with the November 1, 2016 acquisition of Pittsburgh based FreshTemp, LLC (FreshTemp). FreshTempoffers restaurants, convenience stores and other retailers the ability to monitor the temperature of food products automatically through the use of wirelesssensors. The company also enables these businesses to track in real time the completion of operational tasks by their employees that could impact humanhealth and safety - a capability that we believe enhances our product offering.3Table of ContentsDispositionOn October 23, 2015, we entered into a stock purchase agreement with West Monroe Partners, LLC, pursuant to which they acquired our Etherios CRMconsulting services business. We sold Etherios as part of a strategy to focus on providing highly reliable machine connectivity solutions for business andmission-critical application environments (see Note 3 to our Consolidated Financial Statements).These are the only acquisitions and dispositions we have completed in the past five years. We will continue to evaluate strategic opportunities to acquirebusinesses as they arise and may seek to divest businesses or assets we no longer consider appropriate to our long-term strategy.Sales ChannelsWe sell our products through a global network of distributors, systems integrators and value added resellers (VARs) which accounted for 66.1%, 61.8% and63.0% of our total revenue in fiscal 2016, 2015 and 2014, respectively. We also complete sales through our own dedicated sales organization to originalequipment manufacturers (OEMs) and other customers which accounted for 33.9%, 38.2% and 37.0% of our total revenue in fiscal 2016, 2015 and 2014,respectively.DistributorsOur larger distributors, based on sales we make to them, include Alcom Electronics BV, Anewtech Systems Pte Ltd., Arrow Electronics, Inc., AstoneTechnologies, Atlantik Elektronik GmbH, Avnet, Codico GmbH, Digi-Key Corporation, Express Systems & Peripherals, Future Electronics, Ingram Micro,Melchoni S.p.A., Miel, Mouser Electronics, Novotech, Sapply Pty. Ltd., Scansource Corporation, Solid State Supplies, Ltd., Sphinx Computer VertriebsGmbH, Synnex, Tech Data Corporation and Tokyo Electron Device Ltd. We also maintain relationships with many other distributors in the U.S., Canada,Europe, Asia Pacific and Latin America.Strategic Sales 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, partnersinclude: AT&T, Bell Mobility, Ericsson, NXP, Qualcomm, Telit, Rogers, Silicon Laboratories, Sprint, Telus, Verizon and several other cellular carriersworldwide. Furthermore, we maintain a worldwide network of authorized developers that extends our reach into certain other technology applications andgeographical regions.We have established relationships with equipment vendors in a range of industries such as energy, industrial, retail, transportation, medical, and governmentthat allow the vendors to ship our products and services as component parts of their overall solutions. Our products are used by many of the world’s leadingtelecommunications companies and Internet service providers, including AT&T Inc., Sprint Corporation and Verizon Communications Inc.No single customer comprised more than 10% of our consolidated revenue for any of the years ended September 30, 2016, 2015 or 2014.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. In addition, we may compete withother companies to acquire new businesses or technologies and the competition to secure such assets may be intense. We compete for customers on the basisof existing and planned product features, service and software application capabilities, company reputation, brand recognition, technical support, alliancerelationships, quality and reliability, product development capabilities, price and availability. While no competitor offers a comparable range of productsand services, various companies do compete with us with respect to one or more of our products or solutions. With respect to many of our product and serviceofferings, we face competition from companies who dedicate more resources and attention to that particular offering than we are able to do given the breadthof our business. As marketplace for IoT connectivity products and solutions continues to grow, we expect to encounter increased competition. Some of thesecompetitors may have access to significantly more financial and technical resources than we possess.4Table of ContentsManufacturing 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) and weoutsource printed circuit board production. This approach allows us to reduce our fixed costs, maintain production flexibility and optimize our profits.Our products are manufactured to our designs with standard and custom components. Most of the components are available from multiple vendors. We haveseveral single-sourced supplier relationships, either because alternative sources are not available or because the relationship is advantageous to us. If thesesuppliers are unable to provide a timely and reliable supply of components, we could experience manufacturing delays that could adversely affect ourconsolidated results of operations in a material way.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 2016, 2015 and 2014, our research and development expenditures were $31.0 million, $29.9 million and $28.9 million, respectively.Due to rapidly changing technology in the communications technology industry, we believe a large part of our success depends upon the product and servicedevelopment skills of our personnel as well as our ability to integrate any acquired technologies with organically developed technologies. While we dedicatesignificant resources to research and development, many of our competitors are focused on a smaller set of products than us and are likely able to dedicatemore resources than us toward the portions of the market in which we compete.Our proprietary rights and technology are protected by a combination of copyrights, patents, trade secrets and trademarks.We have established common law and registered trademark rights on a family of marks for a number of our products. Our products and services primarily aresold under the Digi, Rabbit® and Xbee® 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 believe that our customers associateXbee® with “ease of use.” Many of our customers choose us because they are building a very complex system solution and they want the highest level inproduct reliability and ease of integration and use. Our Etherios® brand was sold in connection with the sale of Etherios, Inc. in October 2015.Our patents are applicable to specific technologies and are valid for varying periods of time based on the date of patent application or patent grant in the U.S.and the legal term of patents in the various foreign countries where patent protection is obtained. We believe our intellectual property has significant valueand is an important factor in the marketing of our company and products.BacklogBacklog as of September 30, 2016 and 2015 was $25.3 million and $27.2 million, respectively. The majority of the backlog at September 30, 2016 isexpected to be shipped in fiscal 2017. Backlog as of any particular date is not necessarily indicative of our future sales trends.EmployeesWe had 515 employees on September 30, 2016. We consider our relations with our employees to be good.5Table of ContentsGeographic Areas and Currency RisksOur customers are located throughout North America, Europe, Middle East & Africa (EMEA), Asia Pacific and Latin America. We are exposed to foreigncurrency transaction risk associated with certain sales being denominated in Euros, British Pounds, Japanese Yen and Canadian Dollar and foreign currencytranslation risk as the financial position and operating results of our foreign subsidiaries are translated into U.S. Dollars for consolidation. 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 to reduce foreign currency risk.During 2016, we had approximately $71.5 million of revenue related to foreign customers including export sales, of which $22.9 million was denominated inforeign currency, predominantly the Euro and British Pound. During fiscal 2015 and 2014, we had approximately $76.2 million and $76.3 million,respectively of revenue to foreign customers including export sales, of which $21.3 million and $23.3 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 5 to our Consolidated Financial Statements in this Form 10-K.PRINCIPAL HARDWARE PRODUCTS AND SERVICESHardware ProductsCellular routers and gateways - Cellular routers provide connectivity for devices over a cellular data network. They can be used as a cost effectivealternative to landlines for primary or backup connectivity for remote locations and devices. These products have been certified by the major wirelessproviders in North America and abroad, including, among others, AT&T®, Verizon Wireless®, Sprint®, Bell Mobility, Rogers and Vodafone. Cellulargateway products enable devices or groups of devices to be networked in locations where there is no existing network or where access to a network isprohibited. All of our cellular products include a unique remote management platform that provides secure management of devices across remote networksand can all use the Device Cloud for remote management. In addition, application connectivity, management and customization are enabled via the DeviceCloud platform for many of these products.Radio Frequency (RF) - Our RF products are small box or module products that utilize a variety of wireless protocols for PC-to-device or device-to-deviceconnectivity, often in locations where deploying a wired network is not possible either because of cost, disruption or impracticality. By supporting ZigBee®,Wi-Fi® and other radio frequency "RF" technologies, we can meet most customer application requirements. In conjunction with one of our gateways, RFproducts can be connected into the Device Cloud for remote management, application connectivity and customization.Embedded - Our Connect, Rabbit®, and ARM-based embedded systems on module, and single board computers are designed and developed with smallfootprints, low power consumption and software, making them ideal for medical, transportation and industrial device manufacturers. A number of thesemodules can be connected directly to the Device Cloud or other similar platforms, enabling remote management and remote application connectivity. Alsoincluded in our embedded grouping are our chips (or microprocessors) that provides the “brains” and processing power of an intelligent electronic device orcommunication sub-system. Some of our higher volume customers choose to purchase chips and build their own products. Chips are low cost but require thehighest level of development expertise. Chip development is not part of our strategy; instead we use commercial-off-the-shelf technology from companiessuch as Freescale and Ember for our products.Network - Our network product category consists of:•Console servers - Our console servers provide a secure remote graphical access to computer systems and network equipment that can communicatewith virtually any server or device.•Serial servers - Our serial servers (also known as device servers and terminal servers) provide secure, reliable and flexible serial-to-Ethernetintegration of most devices into wired Ethernet networks. They are used for a variety of applications such as automation, robotics control,centralized device monitoring and management, data acquisition and point-of-sale applications.•USB - Our Universal Serial Bus (USB) solutions include USB-to-serial converters that offer instant I/O expansion for peripheral device connectivity.We also offer USB over IP products that connect USB and serial devices on a wired or wireless LAN, while eliminating the need for locally-attachedhost PCs. In addition, we also offer multiport USB hubs that offer a simple solution for adding switched USB ports to a PC, server or thin client.6Table of ContentsServicesDigi Cold Chain Solutions - Our Digi Cold Chain Solutions is an end-to-end, cost-effective system that uses sensors, gateways and a cloud based applicationto enable customers such as restaurants, groceries and convenience stores to monitor wirelessly the temperature of food and other perishable goods. Our DigiCold Chain Solutions was introduced as a result of our acquisition of Bluenica Corporation on October 5, 2015 (see Note 2 to our Consolidated FinancialStatements). Our acquisition of FreshTemp, LLC in November 2016 further expands our product suite through the addition of software offerings that helpcustomers track the completion of operating tasks in real-time that may impact health and safety.Wireless Design Services - Our Wireless Design Services provide customers turn-key wireless networking product designs, testing, and certification for awide range of wireless technology platforms and applications.Digi Support Services - Our Digi Support Services provides various levels of technical support to customers with programming and implementationchallenges related to Digi products. We offer base support up to our highest level of professional support which includes implementation planning,application development, on-site support, installation and customer training. These support services help minimize design risk and ensure optimalperformance.Digi Device Cloud™ and Digi Remote Manager™ - Our Digi Device Cloud™ is a platform as-a-service (PaaS) offering that provides a secure environmentfor customers to aggregate their interaction with a large number of disparate devices and connect them to enterprise applications. This allows for devices tobe monitored and controlled remotely and allows customers to collect, interpret and utilize data from many devices to operate their businesses more easilyand efficiently. The Digi Remote Manager™ is a complete centralized remote device management solution that is housed on the Digi Device Cloud™ andallows customers to meet service level commitments and stay compliant with Payment Card Industry (PCI) standards. Digi Remote Manager™ also allowscustomers to monitor, diagnose and fix remote devices without sending a technician on site.ITEM 1A. RISK FACTORSMultiple risk factors exist which could have a material effect on our operations, results of operations, financial position, liquidity, capital resources andcommon stock.Risks Relating to Our BusinessWe face intense competition from established companies that may have significant advantages over us and our products.The market for our products is intensely competitive. Certain of our competitors and potential competitors have or may develop greater financial,technological, manufacturing, marketing, and personnel resources than us either generally or relative to the product sets they sell in competition to us.Further, there are numerous companies competing with us in various segments of the market for our products, and their products may have advantages overour products in areas such as conformity to existing and emerging industry standards, interoperability with other products, management and securitycapabilities, performance, price, ease of use, scalability, reliability, flexibility, product features and technical support.Our current and potential competitors have or may develop one or more of the following significant advantages over us in the product areas where theycompete with us:•tighter focus on an individual product or product category;•greater financial, technical and marketing resources;•barriers to transition to our products;•higher brand recognition across larger geographic regions;•more comprehensive functionality;•longer-standing cooperative relationships with OEM and end-user customers;•superior customer service capacity and quality;•longer operating history; and•larger customer base.7Table of ContentsWe cannot provide assurance that we will be able to compete successfully with our current and potential competitors. Such competitors may be able to morequickly develop or adapt to new or emerging technologies and changes in customer requirements, or devote greater resources to the development, promotionand sale of their products. Additionally, it is probable that new competitors or new alliances among existing competitors could emerge and rapidly acquiresignificant market share.Our dependence on new product development and the rapid technological change that characterizes our industry makes us susceptible to loss of marketshare resulting from competitors’ product introductions and enhancements, service capabilities and similar risks.Our industry is characterized by rapidly changing technologies, evolving industry standards, frequent new product introductions, short product life cycles incertain instances and rapidly changing customer requirements. The introduction of products and enhancements embodying new technologies and theemergence of new industry standards can render existing products obsolete and unmarketable.Our future success will depend on our ability to enhance our existing products, to introduce new products to meet changing customer requirements andemerging technologies, and to demonstrate the performance advantages and cost-effectiveness of our products over competing products. Failure by us tomodify our products to support new alternative technologies or failure to achieve widespread customer acceptance of such modified products could cause usto lose market share and cause our revenue to decline. Further, if competitors offer better service capabilities associated with the implementation and use ofproducts in communication networks, our business could be impacted negatively.We may experience delays in developing and marketing product enhancements or new products that respond to technological change, evolving 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 more resources than us to develop and market new products and technologies andprovide related services. There can be no assurance that the introduction or announcement of new product offerings by us or one or more of our competitorswill not cause customers to defer their purchase of our existing products, which could cause our revenue to decline.We intend to continue to devote significant resources to our research and development, which, if not successful, could cause a decline in our revenue andharm our business.We intend to continue to devote significant resources to research and development in the coming years to enhance and develop additional products. Forfiscal 2016, 2015, and 2014, respectively, our research and development expenses were 15.2%, 14.7% and 15.8% of our revenue. If we are unable to developnew products, applications and services as a result of our research and development efforts, if we encounter delays in deploying these new products,applications and services, or if the products, applications and services we develop are not successful, our business could be harmed. Even if we develop newproducts, applications and services that are accepted by our target markets, the net revenue from these products, applications and services may not besufficient 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 acquiredtechnologies. Our ability to continue to develop new products, applications and services could be partially dependent on finding and acquiring newtechnologies in the marketplace. Even if we identify new technologies that we believe would be complementary to our internally developed technologies, wemay not be successful in obtaining those technologies or we may not be able to acquire the technologies at a price that is acceptable to us.A substantial portion of our development efforts have been directed toward the development of new products targeted to manufacturers of intelligent,network-enabled devices and other embedded systems in various markets, including markets in which networking solutions for embedded systems have nothistorically been sold, such as markets for industrial automation equipment and medical equipment.Our participation in a services and solutions model, using hardware and cloud-based services, presents execution and competitive risks.We are deploying a services and solutions model. Our Digi Cold Chain offering deploys hardware, software and cloud-based hosting. In other parts of ourbusiness we also offer our own internally developed hosted services and cloud-based platform,8Table of Contentssoftware applications, and supporting products and services. We are employing significant human and financial resources to develop and deploy theseofferings. As we work to grow and scale these offerings, these investments have impacted our gross margins and profitability adversely in the past and maycontinue to do so in the future. While we believe we have a strong foundation to compete, it is uncertain whether our strategies will attract the users orgenerate the revenue required to be successful. We have and will encounter competition from other solutions providers, many of whom may have moresignificant resources than us with which to compete. Whether we are successful in this business model depends on a number of factors, including:•our ability to put in place the infrastructure to deploy and evolve our solutions effectively and continuously;•the features and functionality of our offerings relative to competing offerings as well as our ability to market effectively;•our ability to engage in successful strategic relationships with third parties such as telecommunications carriers, component makers and systemsintegrators;•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.Our ability to sustain and grow our business depends in large part on the success of our channel partner distributors and resellers.A substantial part of our revenue is generated through sales by channel partner distributors and resellers. Sales through our channel partners accounted for66.1%, 61.8% and 63.0% of our total revenue in fiscal 2016, 2015 and 2014, respectively. Further, in recent years we have been taking steps to expand ourrelationship with certain distributors who have global reach, an effort that may increase the percent of our revenue driven through channel partners or ourreliance on certain channel partners to drive sales. To the extent our channel partners are unsuccessful in selling our products or if we are unable to obtain andretain a sufficient number of high-quality channel partners, our operating results could be materially and adversely affected. In addition, our channel partnersmay also market, sell and support products and services that are competitive with ours, and may devote more resources to the marketing, sales and support ofsuch products. They also may have incentives to promote our competitors’ products in lieu of our products, particularly for our competitors with largervolumes of orders, more diverse product offerings and a longer relationship with our distributors and resellers. In these cases, one or more of our importantchannel partners may stop selling our products completely. Our channel partner sales structure also could subject us to lawsuits, potential liability andreputational harm if, for example, any of our channel partners misrepresents the functionality of our products or services to customers, or violates laws or ourcorporate policies. If we fail to manage our existing or future sales channel partners effectively, our business and operating results could be materially andadversely affected.Our gross margins may be subject to decline.Our gross margins may be subject to decline which could decrease our overall profitability and impact our financial performance adversely. Many of thehardware products we sell are approaching the end of their product life cycles. These mature hardware products typically sell at higher gross margins than ourother product and service offerings. In fiscal 2016, sales of mature hardware products represented about 40.9% of our overall revenue. While these productsexperienced increased sales in fiscal 2016, in general, revenues from the sale of these mature hardware products have been declining for several years at a rateof between 1% and 10%, and we expect this trend to continue. In addition, ongoing cost pressures in our industry create downward pressure on the prices atwhich we and other manufacturers can sell hardware products. We also have indicated that we would be willing to realize lower levels of gross margins fromcustomers in return for long-term, binding purchase commitments, a strategy that, if successful, could also put downward pressure on our gross margins. Whilepart of our longer term strategy is to sell software applications and IoT solutions such as Digi Cold Chain which can provide recurring revenues at relativelyhigh gross margin, these types of offerings are at early stages of adoption by customers and their sales growth is not necessarily predictable or assured. Assuch, our gross margins may be subject to decline unless we can implement cost reduction initiatives effectively to offset the impact of these factors.Our revenue may be subject to fluctuations based on the level of significant one time purchases.No single customer has represented more than 10% of our revenue in any of the last three fiscal years. However, many of our customers make significant one-time hardware purchases for large projects that are not repeated. As a result, our revenue may be subject to significant fluctuations based on whether we areable to close significant sales opportunities. Our failure to9Table of Contentscomplete one or a series of significant sales opportunities in a particular fiscal period could have a material adverse effect on our revenue for that period.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,our future prospects depend in part on our ability to acquire or develop and successfully market additional products that address growth markets.Our ability to grow our business is dependent in part on strategic relationships we develop and maintain with third parties as well as our ability 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 our sales depends in part on maintaining and strengthening relationships with parties such as telecommunicationscarriers, systems integrators, enterprise application providers, component providers and other strategic technology companies. Once a relationship isestablished, we likely will dedicate significant time and resources to it in an effort to advance our business interests and there is no assurance any strategicrelationship will generate enough revenue to offset the significant resources we use to advance the relationship. Parties with whom we establish strategicrelationships may also work with companies that compete with us. We also have limited, if any, control as to whether these parties devote adequate resourcesto promoting, selling, and implementing our products. Further, new or emerging technologies, technological trends or changes in customer requirements mayresult in certain companies with whom we maintain strategic relationships de-emphasizing their dealings with us or becoming potential competitors in thefuture. We also have limited, if any, control as to other business activities of these parties and we could experience reputational harm because of ourassociation with such parties if they fail to execute on business initiatives, are accused of breaking the law or otherwise suffer reputational harm for otherreasons. All of these factors could materially and adversely impact our business and results of operations.In some cases we expect the establishment of a strategic relationship with a third party to result in integrations of our products or services with those of otherparties. Identifying appropriate parties for these relationships as well as negotiating and documenting business agreements with them requires significanttime and resources. We expect these agreements typically to be non-exclusive and not to prohibit the other party from working with our competitors oroffering competing services. Once the relationship is established we may also encounter difficulties in combining our products and services in acommercially acceptable manner. We expect this type of dynamic, whereby our ability to realize sales opportunities is dependent on how our products andservices interact with those sold by third parties, may become more common as the marketplace in our industry evolves. There can be no guarantee in anyparticular instance that we will be successful in making our products interact with those of other parties in a commercially acceptable manner and, even if wedo, we cannot guaranty the resulting products and services will be marketed or sold effectively via the relationship.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. In addition, the amount of competition we face in the marketplace maychange and grow as the market for our industry grows and new entrants enter the marketplace. Present and future competitors may be able to identify newmarkets and develop products more quickly, which are superior to those developed by us. They may also adapt new technologies faster, devote greaterresources to research and development, promote products more aggressively, and price products more competitively than us. Competition may also intensifyor we may no longer be able to compete effectively in the markets in which we compete.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 olderproducts or manage transitions from older products effectively could result in inventory obsolescence and also have a material adverse effect on our revenueand profitability.10Table of ContentsAcquisitions 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 issuestock that would dilute our current stockholders’ percentage ownership, incur debt, assume liabilities, or incur large and immediate write-offs.Our operation of any acquired business also involves numerous risks, including but not limited to:•problems combining the purchased operations, technologies, or products;•unanticipated costs;•diversion of management’s attention from our core business;•difficulties integrating businesses in different countries and cultures;•adverse effects on existing business relationships with suppliers and customers;•risks associated with entering markets in which we have no or limited prior experience; and•potential loss of key employees, particularly those of the purchased organization.We cannot assure that we will be able to successfully integrate any businesses, products, technologies, or personnel that we have acquired or that we 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 beexposed to litigation as a result of any consummated or unconsummated acquisition.We are subject to various cybersecurity risks, which are particularly acute in the cloud-based technologies operated by us and other third parties that forma part of our solutions. These risks may increase our costs and could damage our brand and reputation.As we continue to direct a substantial portion of our sales and development efforts toward broader based solutions, such as Digi Cold Chain Solutions and theDevice Cloud, we expect to store, convey and potentially process significant amounts of data produced by devices. This data may include confidential orproprietary information, intellectual property or personally identifiable information of our customers or other third parties with whom they do business. It isimportant for us to maintain solutions and related infrastructure that are perceived by our customers and other parties with whom we do business to provide areasonable level of reliability and security. Despite available security measures and other precautions, the infrastructure and transmission methods used byour products and services may be vulnerable to interception, attack or other disruptive problems. Continued high-profile data breaches at other companiesevidence an external environment that is becoming increasingly hostile to information security. Improper disclosure of data or perception that our datasecurity is insufficient could harm our reputation, give rise to legal proceedings, or subject our company to liability under laws that protect data, any ofwhich could result in increased costs and loss of revenue.If a cyberattack or other security incident were to allow unauthorized access to or modification of our customers’ data or our own data, whether due to afailure with our systems or related systems operated by third parties, we could suffer damage to our brand and reputation. The costs we would incur to addressand fix these incidents could significantly increase our expenses. These types of security incidents could also lead to lawsuits, regulatory investigations andincreased legal liability, including in some cases contractual costs related to customer notification and fraud monitoring. Further, as regulatory focus onprivacy and data security issues continues to increase and worldwide laws and regulations concerning the protection of information become more complex,the potential risks and costs of compliance to our business will intensify.11Table of ContentsDigi Cold Chain Solutions is a new business line for us and is subject to the risks faced by a new business.Digi Cold Chain Solutions was formed through acquisitions of various businesses and represents a new business line for our company. Our management haslimited experience in this marketplace. The operation of Digi Cold Chain Solutions will be subject to significant additional risks that are not necessarilyrelated to our legacy products and services. Additional risks that relate to Digi Cold Chain Solutions, include, but are not limited to:•We have not traditionally sold products or services to restaurants, pharmacies, hospitals and other similar businesses, which are a focus for Digi ColdChain Solutions.•Digi Cold Chain Solutions offerings are deployed to help assure perishable goods are safely preserved. This presents a risk of loss in the event of amalfunction or failure of our offerings.•Although we have retained several key employees with extensive experience in operating companies we have acquired to date, Digi Cold ChainSolutions represents a new line of business in a marketplace that is nascent in its development and has numerous competitors. We cannot provideassurances we will be successful in operating and growing this business.•Our ability to succeed with the Digi Cold Chain Solutions offerings will depend in large part on our ability to provide customers with hardware andsoftware products that are easy to deploy and offer features and functionality that address the needs of particular businesses. We may face challenges anddelays in the development of this business as the marketplace for products and services evolves to meet the needs and desires of customers.In light of these risks and uncertainties, we may not be able to establish or maintain Digi Cold Chain Solutions’ market share, integrate it successfully intoour other operations or take full advantage of businesses we have acquired or may acquire in the future. There can be no assurance that we will recover ourinvestments in this new business, that we will realize a profit from this new business or that diverting our management’s attention to this new business willnot have a material adverse effect on our existing businesses, any of which may have a material adverse effect on our results of operations, financial conditionand prospects.We have identified a material weakness in our internal control over financial reporting. If we are unable to sufficiently mitigate the material weakness or ifwe fail to establish and maintain effective internal control over financial reporting, our ability to accurately report our financial results could be adverselyaffected.In connection with the preparation of our consolidated financial statements as of and for the year ended September 30, 2016, our management conducted anassessment of the effectiveness of our internal control over financial reporting. In connection with that assessment, we concluded there is a material weaknessin our internal control over financial reporting with respect to the design of access control reviews for our financial system and related independent reviews ofmanual journal entry inputs to the system. The Exchange Act Rule 12b-2 and Rule 1-02(p) of Regulation S-X define a material weakness as a deficiency, orcombination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of our annualor interim consolidated financial statements will not be prevented or detected and corrected on a timely basis. The identified material weakness is furtherdescribed in Part II, Item 9A of this Form 10-K.Our remediation efforts with regard to the material weakness are also described in Part II, Item 9A of this Form 10-K. Although we expect to remediate thematerial weakness by the end of our second fiscal quarter of 2017, we cannot be certain whether or when our remediation initiatives will be successful. If ourremedial measures are insufficient to address the material weakness or if additional material weaknesses in our internal control over financial reporting arediscovered or occur in the future, our consolidated financial statements may contain material misstatements and we could be required to restate our financialresults. Further, regardless of how well designed, operated and evaluated it may be, any system of internal control over financial reporting can provide onlyreasonable, not absolute, assurance that its objective will be satisfied. We cannot be certain that, in the future, additional material weaknesses will not exist orotherwise be discovered. If we fail to maintain effective internal control over financial reporting, the accuracy and timing of our financial reporting may beadversely affected by misstatements or restatements of our consolidated financial statements, our business and financial condition could be harmed, investorsmay lose confidence in our reported financial information and the market price of our securities may decline.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 may findit difficult to gain sufficient credit in a timely manner, which could12Table of Contentsresult in an impairment of their ability to place orders with us or to make timely payments to us for previous purchases. If this occurs, our revenue may bereduced, thereby having a negative impact on our results of operations. In addition, we may be forced to increase our allowance for doubtful accounts and ourdays sales outstanding may increase, which would have a negative impact on our cash position, liquidity and financial condition. We cannot predict eitherthe timing or duration of an economic downturn in the economy, should one occur.The long and variable sales cycle for certain of our products makes it more difficult for us to predict our operating results and manage our business.The sale of our products and services can involve a significant technical evaluation and commitment of capital and other resources by potential customersand end users, as well as delays frequently associated with end users’ internal procedures to deploy new technologies within their products and to test andaccept new technologies. For these and other reasons, the sales cycle associated with certain of our products is typically lengthy and is subject to a number ofsignificant risks, such as end users’ internal purchasing reviews, that are beyond our control. Because of the lengthy sales cycle and the large size of certaincustomer orders, if orders forecasted for a specific customer are not realized or delayed, our operating results could be materially adversely affected.We depend on manufacturing relationships and on limited-source suppliers, and any disruptions in these relationships may cause damage to our customerrelationships.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, or force majeure events. For instance, a fire in November2014 disrupted the operations at one of our contract manufacturers in Thailand. If we are required to identify alternative suppliers for any of our requiredcomponents, qualification and pre-production periods could be lengthy and may cause an increase in component costs and delays in providing products tocustomers. Any extended interruption in the supply of any of the key components currently obtained from limited sources could disrupt our operations andhave 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 certificationsand/or approvals by certain governmental bodies. Failure to obtain these approvals, or delays in receiving the approvals, could impact our ability to enterour targeted markets or to compete effectively or at all in these markets and could have an adverse impact on our revenue.We are dependent on wireless communication networks owned and controlled by others.Our revenue could decline if we are unable to deliver continued access to digital cellular wireless carriers that we depend on to provide sufficient 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 and profitability.Certain of our components and other materials used in producing our products are from regions susceptible to natural disasters. If we are unable to 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. For instance, flooding in October 2011 and a fire in November 2014 disrupted the operations at one of ourcontract manufacturers in Thailand. In addition, our customers may not follow their normal purchasing patterns or temporarily cease purchasing from us dueto impacts to their businesses in the region, creating unexpected fluctuations or decreases in our revenue and profitability. Natural disasters in other parts ofthe world on which our operations are reliant also could have material adverse impacts on our business.13Table of ContentsOur use of suppliers in other parts of the world involves risks that could negatively impact us.We purchase a number of components from suppliers in other parts of the world. Product delivery times may be extended due to the distances involved,requiring more lead time in ordering. In addition, ocean freight delays may occur as a result of labor problems, weather delays or expediting and customsissues. Any extended delay in receipt of the component parts could eliminate anticipated cost savings and have a material adverse effect on our customerrelationships and profitability.Our ability to compete could be jeopardized if we are unable to protect our intellectual property rights.Our ability to compete depends in part on our proprietary rights and technology. Our proprietary rights and technology are protected by a combination ofcopyrights, patents, trade secrets and trademarks.We enter into confidentiality agreements with our employees, and sometimes with our customers, potential customers and other third parties, and limit accessto the distribution of our proprietary information. There can be no assurance that the steps taken by us in this regard will be adequate to prevent themisappropriation of our technology. Our pending patent applications may be denied and any patents, once issued, may be circumvented by our competitors.Furthermore, there can be no assurance that others will not develop technologies that are superior to our technologies. Despite our efforts to protect ourproprietary rights, unauthorized parties may attempt to copy aspects of our products or to obtain and use information that we regard as proprietary. Inaddition, the laws of some foreign countries do not protect our proprietary rights as fully as do the laws of the United States. There can be no assurance thatour means of protecting our proprietary rights in the United States or abroad will be adequate or that competing companies will not independently developsimilar technologies. Our failure to adequately protect our proprietary rights could have a material adverse effect on our competitive position and result inloss of revenue.From time to time, we are subject to claims and litigation regarding intellectual property rights or other claims, which could seriously harm us and requireus 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, regardless if they have merit, will not materially adversely affect ourbusiness, operating results or financial condition. In the event of an adverse ruling in any such matter, we may be required to pay substantial damages, ceasethe manufacture, use and sale of infringing products, discontinue the use of certain processes or be required to obtain a license under the intellectual propertyrights of the third party claiming infringement. There can be no assurance that a license would be available on reasonable terms or at all. Any limitations onour ability to market our products, or delays and costs associated with redesigning our products or payments of license fees to third parties, or any failure byus to develop or license a substitute technology on commercially reasonable terms could have a material adverse effect on our business, operating results andfinancial condition.We face risks associated with our international operations and expansion that could impair our ability to grow our revenue abroad as well as our overallfinancial 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 inherentin conducting 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) and the UK Anti-Bribery Act (UKBA) are more commonplace. Although we have implementedpolicies and procedures with the intention of ensuring compliance with these laws and regulations, our employees, contractors and agents, as well as channelpartners involved in our international sales, may take actions in violation of our policies. Many of our vendors and strategic business allies also haveinternational operations and are subject to the risks described above. Even if we are able to successfully manage the risks of international operations, ourbusiness may be adversely affected if one or more of our business partners are not able to successfully manage these risks. There can be no assurance that oneor more of these factors will not have a material adverse effect on our business strategy and financial condition.14Table of ContentsOur 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 UKBA, of all other countries in which we do business, directly or indirectly, including compliance with the anti-briberyprohibitions and the accounting and recordkeeping requirements of this law. Violations of the FCPA or other similar laws could trigger sanctions, includingineligibility for U.S. government insurance and financing, as well as large fines. Failure to comply with the aforementioned regulations could also deter usfrom selling our products in international jurisdictions, which could have a material adverse effect on our revenue and profitability.Foreign currency exchange rates may adversely affect our operating results.We are exposed to a variety of market risks, including the effects of changes in foreign currency exchange rates on transactions that are denominated inforeign currencies. Because our financial statements are denominated in U.S. Dollars and approximately 11% of our revenue is denominated in a currencyother than U.S. Dollars, such as Euros, British Pounds, Yen and Canadian Dollars, our revenues and earnings may be adversely impacted if the U.S. dollarstrengthens significantly against these foreign currencies.The loss of key personnel could prevent us from executing our business strategy.Our business and prospects depend to a significant degree upon the continuing contributions of our executive officers and key technical and other personnel.Competition for such personnel is intense, and there can be no assurance that we will be successful in attracting and retaining qualified personnel. Failure 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 on ourrevenue 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 Unionhas issued 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 placedin the European Union market. The Restrictions of Hazardous Substances Directive (RoHS) bans the use of certain hazardous materials in electric andelectrical equipment which are put on the market in the European Union. In the future, China and other countries including the United States may 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 consolidatedstatement of operations, which could materially adversely impact our consolidated results of operations and financial condition.Unanticipated changes in our tax rates could affect our future results.Our future effective tax rates could be favorably or unfavorably affected by unanticipated changes in the mix of earnings in countries with differing 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 theoutcomes from these examinations will not have an adverse effect on our consolidated operating results and financial condition.15Table of ContentsWe 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.Risks Related to Our Common StockUnsolicited takeover proposals, governance change proposals, proxy contests and resulting litigation may adversely impact our operations, createuncertainty and affect the market price and volatility of our securities.We have received an unsolicited takeover proposal and other companies in our industry have been the target of unsolicited takeover proposals in the past. Inthe event that a third party, such as a competitor, private equity firm or activist investor makes an unsolicited takeover proposal, or proposes to change ourgovernance policies or board of directors, or makes other proposals concerning our ownership structure or operations, our review and consideration of suchproposals may be a significant distraction for our management and employees, and could require us to expend significant time and resources. Such proposalsmay create uncertainty for our employees and this uncertainty may adversely affect our ability to retain key employees, to hire new talent or to completeacquisitions we may desire to make. Similar uncertainty among our customers, suppliers and other business partners could cause them to terminate, or not torenew or enter into, arrangements with us. Certain proposals may result in costly proxy contests or litigation that can disrupt our business operations or resultin an adverse effect on our operating results. Management and employee distraction related to any such proposals also may adversely impact our ability toconduct our business optimally and pursue our strategic objectives. Such proposals, or their withdrawal, could create uncertainty among investors andpotential investors as to our future direction and affect the market price of our common stock without regard to our operational or financial performance.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 approvalis required for certain business combination transactions with interested parties.Our Certificate of Incorporation contains a “fair price” provision requiring majority stockholder approval for certain business combination transactions 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 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.The price of our common stock has been volatile and could continue to fluctuate in the future.The market price of our common stock, like that of many other high-technology companies, has fluctuated significantly and is likely to continue to fluctuatein the future. During fiscal year 2016, the closing price of our common stock on the NASDAQ Global Select Market ranged from $7.88 to $13.00 per share.Our closing sale price on December 9, 2016 was $13.65 per share. Following the announcement of an unsolicited takeover proposal on November 8, 2016,the price of our common stock increased significantly. If this proposal were to be withdrawn, the price of our common stock may move significantly. Further,announcements by us or others regarding the receipt of customer orders, quarterly variations in operating results, departures of key personnel, acquisitions ordivestitures, additional equity or debt financings, results of customer field trials, scientific16Table of Contentsdiscoveries, technological innovations, litigation, product developments, patent or proprietary rights, government regulation and general market conditionsand risks may, for example, have a significant impact on the market price of our common stock.If our stock price declines over a sustained period of time or our profits significantly decrease, we may need to recognize an impairment of our goodwill.The price of our common stock could decline. If such a decline continued over a sustained period of time, we could have an impairment of our goodwill. Ourmarket value is dependent upon certain factors, including continued future growth of our products and solutions. If such growth does not materialize or ourforecasts are not met, our profits could be significantly reduced and our market value may decline, which could result in an impairment of our goodwill.Goodwill is tested for impairment on an annual basis as of June 30, or more frequently if events or circumstances occur which could indicate impairment.ITEM 1B. UNRESOLVED STAFF COMMENTSNone.17Table of ContentsITEM 2. PROPERTIESThe following table contains a listing of our significant property locations as of September 30, 2016: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 Waltham, MAResearch & development, sales and sales support 4,249 October 2020 Rochester, MNEngineering services 3,090 September 2017 Lindon, UTSales, technical support, research & development and administration 11,986 December 2020 Herndon, VASales, marketing and technical support 2,416 October 2017 Hong Kong, ChinaSales, marketing and administration 1,656 April 2016 Beijing, ChinaSales, marketing and administration 1,617 October 2019 Shanghai, ChinaSales, marketing and administration 1,991 May 2017 Ismaning, GermanySales, sales support and administration 6,878 September 2019 Neuilly sur Seine, FranceSales and marketing 2,895 January 2018 Logrono, SpainSales, research & development and administration 3,228 November 2018 Tokyo, JapanSales 1,371 Perpetual SingaporeSales, marketing and administration 3,498 April 2017In addition to the above locations, we perform sales activities in various other locations in Europe and Canada that are not deemed to be principal locationsand are not listed above. In connection with our sale of the Etherios business in October 2015, we no longer maintain operations in Chicago, IL, Dallas, TX orSan Francisco, CA.We have consolidated and relocated office locations due to a fiscal 2016 restructuring (see Note 10 to our Consolidated Financial Statements). We moved ourWireless Design Services team from an office in downtown Minneapolis to our World Headquarters in suburban Minnetonka. Additionally, we closed ouroffice location in Dortmund, Germany and moved the corresponding positions to our existing office in Ismaning just outside of Munich, Germany.ITEM 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 thesematters, 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 effecton our operations in any particular period.ITEM 4. MINE SAFETY DISCLOSURESNone.18Table of ContentsPART II.ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITYSECURITIESStock ListingOur common stock trades under the symbol DGII on the NASDAQ Global Select Market tier of The NASDAQ Stock Market LLC. On December 9, 2016 therewere 129 stockholders of record.The high and low sale prices for our common stock for each quarter during the years ended September 30, 2016 and 2015, as reported by The NASDAQ StockMarket, were:Stock Prices2016 First Second Third FourthHigh $13.53 $12.23 $11.69 $12.49Low $11.14 $7.70 $8.37 $9.79 2015 First Second Third FourthHigh $9.45 $10.78 $10.69 $12.08Low $6.90 $8.23 $8.95 $9.39Dividend 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 April 26, 2016, our Board of Directors authorized a program to repurchase up to $15.0 million of our common stock primarily to return capital toshareholders. This authorization expires on May 1, 2017. Shares repurchased under this program may be made through open market and privately negotiatedtransactions from time to time and in amounts that management deems appropriate. The amount and timing of share repurchases, if any, depends upon marketconditions and other corporate considerations. As of the date of this filing, no shares were repurchased under this program.The following table presents the information with respect to purchases made by or on behalf of Digi International Inc. or any “affiliated purchaser” (asdefined in Rule 10b-18(a)(3) under the Securities Exchange Act of 1934), of our common stock during the fourth quarter of fiscal 2016:Period Total Number ofShares Purchased(1) Average PricePaid per Share Total Number of SharesPurchased as Part of aPublicly AnnouncedProgram Maximum Dollar Valueof Shares that May YetBe Purchased Under theProgramJuly 1, 2016 - July 31, 2016 292 $11.32 — $15,000,000.00August 1, 2016 - August 31, 2016 — — — $15,000,000.00September 1, 2016 - September 30, 2016 — — — $15,000,000.00Total 292 $11.32 — $15,000,000.00(1)All shares reported were forfeited by employees in connection with the satisfaction of tax withholding obligations related to the vesting of restrictedstock units.19Table of ContentsITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITYSECURITIES (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, 2011 to September 30, 2016, the last day of fiscal 2016, with the total cumulative return for the NASDAQ U.S. Benchmark TRIndex (the U.S. Benchmark Index) and the NASDAQ Telecommunications Index (the Peer Index) over the same period. We have determined that our line ofbusiness is mostly comparable to those companies in the Peer Index. The index level for the graph and table was set to $100 on September 30, 2011, for ourCommon Stock, the U.S. Benchmark Index and the Peer Index and assumes the reinvestment of all dividends. FY11 FY12 FY13 FY14 FY15 FY16Digi International Inc. $100.00 $92.36 $90.82 $68.18 $107.18 $103.64NASDAQ U.S. Benchmark TR Index $100.00 $130.13 $158.11 $186.34 $185.02 $213.19NASDAQ Telecommunications Index $100.00 $132.98 $135.24 $153.29 $142.36 $179.4420Table of ContentsITEM 6. SELECTED FINANCIAL DATA(in thousands, except per common share data amounts and number of employees)For Fiscal Years Ended September 30,2016 2015 2014 2013 2012Revenue$203,005 $203,847 $183,173 $184,420 $190,558Gross profit$99,680 $97,121 $90,377 $95,325 $100,337Sales and marketing33,847 37,574 38,751 39,229 39,242Research and development30,955 29,949 28,912 29,082 30,767General and administrative (1)17,026 18,306 18,244 19,417 18,188Restructuring charges, net747 403 81 313 1,259Operating income17,105 10,889 4,389 7,284 10,881Total other (expense) income, net (2)(415) 2,228 672 695 16Income before income taxes16,690 13,117 5,061 7,979 10,897Income tax provision (3)3,212 3,684 568 2,330 3,282Income from continuing operations13,478 9,433 4,493 5,649 7,615Income (loss) from discontinued operations, after income taxes3,230 (2,845) (2,742) 156 —Net income$16,708 $6,588 $1,751 $5,805 $7,615 Basic net income (loss) per common share: Continuing operations$0.52 $0.38 $0.18 $0.22 $0.30Discontinued operations$0.13 $(0.12) $(0.11) $0.01 $—Net income (4)$0.65 $0.27 $0.07 $0.22 $0.30Diluted net income (loss) per common share: Continuing operations$0.51 $0.37 $0.17 $0.22 $0.29Discontinued operations$0.12 $(0.11) $(0.11) $0.01 $—Net income (4)$0.64 $0.26 $0.07 $0.22 $0.29 Balance sheet data as of September 30, Working capital (current assets less current liabilities)$171,837 $136,996 $125,927 $127,672 $155,035Total assets$336,166 $300,360 $290,459 $299,930 $293,403Stockholders' equity$300,029 $274,938 $265,298 $274,243 $270,834Book value per common share (stockholders' equity divided byoutstanding shares)$11.52 $10.98 $10.88 $10.73 $10.45Number of employees as of September 30515 515 571 621 643(1)Included in general and administrative expense in fiscal 2013 is $1.5 million ($1.0 million after tax) related to the patent infringement lawsuitsettlement with U.S. Ethernet Innovations.(2)Included in total other (expense) income, net for fiscal 2015 is a $1.4 million gain from the settlement of a property and casualty insurance claimrelated to the replacement of our capital equipment destroyed in the fire at our subcontract manufacturer's location in Thailand.(3)In fiscal 2016, 2015 and 2014, we recorded net tax benefits of $1.5 million, $0.8 million and $1.5 million, respectively (see Note 11 to ourConsolidated Financial Statements). In fiscal 2013 we recorded net tax benefits of $0.8 related to the January 2, 2013 enactment of the AmericanTaxpayers Relief Act of 2012 extending the research and development tax credit for the last three quarters of fiscal 2012 and the release of incometax reserves due to the expiration of the statute of limitations from various U.S. and foreign tax jurisdictions. In fiscal 2012 we recorded $1.5 millionof additional research and development tax credits pertaining to prior fiscal years and reversed tax reserves for closure of various jurisdictions' taxmatters and tax rate reductions in certain foreign jurisdictions.(4)Earnings per share are calculated by line item and may not add due to the use of rounded amounts.21Table 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, 2016.FORWARD-LOOKING STATEMENTSThis Annual Report contains certain statements that are “forward-looking statements” as that term is defined under the Private Securities Litigation ReformAct of 1995, and within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, 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 the company operates,projections of future performance, perceived marketplace opportunities and statements regarding our mission and vision. Such statements are not guaranteesof future performance and involve certain risks, uncertainties and assumptions, including risks related to the highly competitive market in which ourcompany operates, rapid changes in technologies that may displace products sold by us, declining demand for and prices of networking products, ourreliance on distributors and other third parties to sell our products, delays in product development efforts, uncertainty in user acceptance of our products, theability to integrate our products and services with those of other parties in a commercially accepted manner, potential liabilities that can arise if any of ourproducts have design or manufacturing defects, our ability to defend or settle satisfactorily any litigation, uncertainty in global economic conditions andeconomic conditions within particular regions of the world which could negatively affect product demand and the financial solvency of customers andsuppliers, the impact of natural disasters and other events beyond our control that could negatively impact our supply chain and customers, potentialunintended consequences associated with restructuring or other similar business initiatives that may impact our ability to retain important employees, theability to achieve the anticipated benefits and synergies associated with acquisitions or divestitures, and changes in our level of revenue or profitabilitywhich can fluctuate for many reasons beyond our control.These and other risks, uncertainties and assumptions identified from time to time in our filings with the United States Securities and Exchange Commission,including without limitation, those described in Item 1A, Risk Factors, of this Form 10-K and subsequent quarterly reports of Form 10-Q and other filings,could cause our future results to differ materially from those expressed in any forward-looking statements made by us or on our behalf. Many of such 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.PRESENTATION OF NON-GAAP FINANCIAL MEASURESThis report includes Adjusted EBITDA from continuing operations, which is a non-GAAP financial measure. Non-GAAP financial measures are notsubstitutes for GAAP financial measures, such as net income, for the purpose of analyzing financial performance. The disclosure of these measures does notreflect all charges and gains that were actually recognized by the company. Non-GAAP financial measures are not prepared in accordance with, or analternative for measures prepared in accordance with, generally accepted accounting principles and may be different from non-GAAP financial measures usedby other companies. In addition, non-GAAP financial measures are not based on any comprehensive set of accounting rules or principles. Non-GAAPfinancial measures have limitations in that they do not reflect all of the amounts associated with our results of operations as determined in accordance withGAAP and that these measures should only be used to evaluate our results of operations in conjunction with the corresponding GAAP financial measures.Additionally, we understand that Adjusted EBITDA from continuing operations does not reflect our cash expenditures, the cash requirements for thereplacement of depreciated and amortized assets, or changes in or cash requirements for our working capital needs.We believe that the presentation of Adjusted EBITDA from continuing operations as a percentage of revenue is useful because it provides a reliable andconsistent approach to measuring our performance from year to year and in assessing our performance against that of other companies. We believe thisinformation helps compare operating results and corporate performance exclusive of the impact of our capital structure and the method by which assets wereacquired. EBITDA from continuing operations is used as an internal metric for executive compensation, as well as incentive compensation for the rest of theemployee base, and it is monitored quarterly for these purposes.22Table of ContentsITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)OVERVIEWWe have a single operating and reporting segment. Our revenue consists of hardware product revenue and service revenue. Our hardware product offerings arecomprised of our cellular routers and gateways, radio frequency (“RF”), embedded and network products. Our service offerings include Digi Cold ChainSolutions (formed in October 2015 through our acquisition of Bluenica Corporation), wireless design services, Digi Device Cloud (which includes DigiRemote Manager™) and support services.In October 2015, we sold Etherios as part of a strategy to focus on providing highly reliable machine connectivity solutions for business and mission-criticalapplication environments (see Note 3 to the Consolidated Financial Statements). As a result of the disposition, we have accounted for the Etherios business asa discontinued operation. On November 1, 2016 we completed the acquisition of FreshTemp, LLC to enhance and expand the capabilities and scale of DigiCold Chain Solutions (see Note 19 to our Consolidated Financial Statements).We utilize many financial, operational, and other metrics to evaluate our financial condition and financial performance. Below we highlight the fiscal 2016metrics that we feel are most important in these evaluations:•Revenue was $203.0 Million. Our revenue decreased by $0.8 million, or 0.4%, compared to fiscal 2015. This decrease was due to a decrease inservice revenue of $1.4 million, offset by an increase in product revenue of $0.6 million.•Gross Margin was 49.1%. Our gross margin increased as a percentage of revenue to 49.1% in fiscal 2016 from 47.6% in fiscal 2015. Hardwareproduct gross margin was 49.9% in fiscal 2016, compared to 48.3% in the prior fiscal year. Service gross margin for fiscal 2016 was 26.7% comparedto 33.3% in the prior fiscal year.•Income from Continuing Operations was $13.5 Million and Earnings Per Diluted Share from Continuing Operations were $0.51. Our income fromcontinuing operations increased by $4.0 million, or 42.9%, compared to fiscal 2015. Earnings per diluted share from continuing operations were$0.51 in fiscal 2016, compared to $0.37 in fiscal 2015. Our improved gross margin and our focus on managing our operating expenses allowed us toimprove our income from continuing operations in fiscal 2016.•Adjusted Earnings Before Interest, Taxes, Depreciation and Amortization adjusted for gain from insurance recovery (Adjusted EBITDA) fromContinuing Operations was $21.0 Million. Our Adjusted EBITDA from continuing operations was $21.0 million, or 10.4% of revenue, in fiscal2016, compared to $16.9 million, or 8.3% of revenue, in fiscal 2015. Below is a table reconciling income from continuing operations to AdjustedEBITDA from continuing operations (in thousands): Year ended September 30, 2016 2015 % of totalrevenue % of totalrevenueTotal revenue $203,005 100.0 % $203,847 100.0 %Income from continuing operations $13,478 6.6 % $9,433 4.6 %Gain from insurance recovery — — (1,375) (0.6)Interest income, net (254) (0.1) (214) (0.1)Income tax provision 3,212 1.6 3,684 1.8Depreciation and amortization 4,584 2.3 5,347 2.6Adjusted earnings from continuing operations before interest, taxes, depreciation andamortization adjusted for gain from insurance recovery $21,020 10.4 % $16,875 8.3 %•Our Balance Sheet was Positively Impacted by Investing and Financing Decisions. Our current ratio was 8.2 to 1 at September 30, 2016, comparedto 6.9 to 1 at September 30, 2015. Cash and cash equivalents and marketable securities, including long-term marketable securities, increased $31.9million to $137.7 million at September 30, 2016.We accomplished a number of key initiatives in fiscal 2016 and also faced significant challenges relative to our business.23Table of ContentsITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)Accomplishments•Our total cash and cash equivalents and marketable securities including long-term marketable securities, amounted to $137.7 million at September30, 2016, an increase of $31.9 million from September 30, 2015.•In October 2015, we sold our Etherios CRM consulting business. While we initially acquired Etherios in large part because we believed it wouldhelp drive engagements with companies looking to deploy IoT solutions within their businesses, we were not rewarded in the marketplace as we hadhoped. In turn, we were operating a business that was not fully tied to our core expertise. The divestiture brought more focus to our core business.•During fiscal 2016, we have continued to reduce the number of product stock keeping units (SKUs) we produce, which we believe will havesignificant implications on our ability to manage inventory effectively, improve channel stocking strategies and control costs.•We simplified and scaled our business. We reduced the number of office locations by consolidating our Wireless Design Services team into ourWorld Headquarters and closed our Dortmund, Germany office and relocated to our Munich, Germany office.•In October 2015, we acquired Bluenica Corporation, which formed the basis for Digi Cold Chain Solutions. This company is focused on temperaturemonitoring of perishable goods in the food industry by using wireless sensors and is monitored through our gateway to our application. Theacquisition leverages our existing strength as a provider of IoT hardware and related software while providing us with a recurring revenue stream.•We achieved adjusted EBITDA from continuing operations of 10.4% for fiscal 2016.•Our network products posted better than expected results increasing by 11.5% in fiscal 2016 compared to fiscal 2015. Generally, however, demandfor these products has been declining for several years and we expect revenues for these products will continue to decline in the future.Challenges•Our cellular products and gateways experienced a revenue decline of 17.5% in fiscal 2016 as compared to fiscal 2015. The decline is primarily dueto the loss of large strategic accounts and a delay in certain product introductions.•Our service revenue declined 17.3% during fiscal 2016 vs. fiscal 2015, primarily due to our wireless design services as we struggled to generatesufficient demand while we transitioned this business both from a physical location and senior leadership perspective. Historically, revenue from ourwireless design services has fluctuated from quarter to quarter and we expect that trend to continue.•In June 2016, the United Kingdom’s (U.K.) held a referendum in which voters approved an exit from the European Union (E.U.) widely referred to as“Brexit.” The announcement of Brexit caused significant volatility in global stock markets and currency exchange rate fluctuations that resulted inthe strengthening of the U.S. dollar against the British pound. Brexit could cause disruptions to and create uncertainty surrounding our business,including continued increased volatility in exchange rates, as the future terms of the U.K.’s relationship with the E.U. are determined.24Table of ContentsITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)CONSOLIDATED RESULTS OF OPERATIONSThe following table sets forth selected information derived from our Consolidated Statements of Operations, expressed in dollars and as a percentage ofrevenue and as a percentage of change from year-to-year for the years indicated. Year ended September 30, % Increase (decrease)($ in thousands) 2016 2015 2014 2016compared to2015 2015compared to2014Revenue: Hardware product $196,101 96.6 % $195,497 95.9 % $172,846 94.4 % 0.3 % 13.1 %Service 6,904 3.4 8,350 4.1 10,327 5.6 (17.3) (19.1)Total revenue 203,005 100.0 203,847 100.0 183,173 100.0 (0.4) 11.3Cost of sales: Cost of hardware product 98,265 48.4 101,155 49.6 85,737 46.8 (2.9) 18.0Cost of service 5,060 2.5 5,571 2.8 7,059 3.9 (9.2) (21.1)Total cost of sales 103,325 50.9 106,726 52.492,796 50.7 (3.2) 15.0Gross profit 99,680 49.1 97,121 47.690,377 49.3 2.6 7.5Operating expenses: Sales and marketing 33,847 16.7 37,574 18.4 38,751 21.1 (9.9) (3.0)Research and development 30,955 15.2 29,949 14.7 28,912 15.8 3.4 3.6General and administrative 17,026 8.4 18,306 9.0 18,244 10.0 (7.0) 0.3Restructuring charges, net 747 0.4 403 0.2 81 — 85.4 397.5Total operating expenses 82,575 40.7 86,232 42.385,988 46.9 (4.2) 0.3Operating income 17,105 8.4 10,889 5.34,389 2.4 57.1 148.1Other (expense) income, net (415) (0.2) 2,228 1.1672 0.4 (118.6) 231.5Income from continuing operations, before income taxes 16,690 8.2 13,117 6.45,061 2.8 27.2 159.2Income tax provision 3,212 1.6 3,684 1.8568 0.3 (12.8) 548.6Income from continuing operations 13,478 6.6 9,433 4.64,493 2.5 42.9 109.9Income (loss) from discontinued operations, after income taxes 3,230 1.6 (2,845) (1.4) (2,742) (1.5) 213.5 (3.8)Net income $16,708 8.2 % $6,588 3.2 % $1,751 1.0 % 153.6 % 276.2 %REVENUEOverviewTotal revenue was $203.0 million in fiscal 2016 compared to $203.8 million in fiscal 2015, a decrease of $0.8 million or 0.4%. Service revenue decreased$1.4 million, or 17.3%, partially offset by an increase in product revenue of $0.6 million, or 0.3%. Total revenue was $203.8 million in fiscal 2015 comparedto $183.2 million in fiscal 2014, an increase of $20.6 million or 11.3%. Product revenue increased by $22.7 million, or 13.1%, partially offset by a decreasein service revenue of $2.0 million, or 19.1%. We did not experience a material change in revenue due to pricing during fiscal 2016, 2015 or 2014.Foreign currency rates compared to the prior year's rates had an unfavorable impact on revenue of $1.1 million and $3.4 million for fiscal 2016 and 2015,respectively, and a favorable impact on revenue of $0.8 million in fiscal 2014.Hardware ProductsOur cellular product category includes our cellular routers and all gateways. Our RF product category includes our XBee® modules as well as other RFSolutions. Our Embedded product category includes Digi Connect® and Rabbit® embedded systems on module and single board computers. Our networkproduct category, which has the highest concentration of mature products, includes console and serial servers and USB connected products.25Table of ContentsITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)The following summarizes our product revenue by product categories: Product Revenue % of Product Revenue($ in millions) 2016 2015 2014 2016 2015 2014Cellular routers and gateways $48.4 $58.7 $39.2 24.7% 30.0% 22.7%RF 33.9 34.4 29.1 17.3% 17.6% 16.8%Embedded 56.5 51.0 49.6 28.8% 26.1% 28.7%Network 57.3 51.4 54.9 29.2% 26.3% 31.8%Total product revenue $196.1 $195.5 $172.8 100.0% 100.0% 100.0%2016 Compared to 2015Cellular routers and gateways product revenue decreased $10.3 million, or 17.5%, in fiscal 2016 as compared to fiscal 2015. This decrease primarily was dueto lower purchases by significant customers, across all regions. In addition, there were delays of certain product introductions. Cellular router and gatewayrevenue is substantially driven by large awards-based customer projects and is subject to revenue fluctuations from quarter to quarter, based on when theawarded projects are deployed.RF product revenue decreased $0.5 million in fiscal 2016 as compared to the prior fiscal year due to slower sales to energy-related customers.Embedded product revenue increased $5.5 million, or 10.6%, in fiscal 2016 as compared to fiscal 2015 as significant customers have begun moving newinitiatives to production in the North America and EMEA regions.Network product revenue increased $5.9 million, or 11.5%, in fiscal 2016 as compared to fiscal 2015 primarily related to large terminal server sales tosignificant customers. Most of our network products are in the mature phase of their product life cycle. We expect that revenue from these products willgenerally decrease in the future.2015 Compared to 2014Cellular routers and gateway product revenue increased $19.5 million, or 49.6%, in fiscal 2015 as compared to fiscal 2014. These increases primarily weredue to a growing market performance and expanding market share with large sales to certain customers of our cellular routers and gateway products. Webelieve sales of these products in fiscal 2015 significantly outpaced the industry growth rate.RF product revenue increased $5.3 million, or 18.1%, in fiscal 2015 as compared to fiscal 2014 primarily due to larger sales to certain customers of modulesand wireless communication adapters. All of our RF products are included in the growth product category.Embedded product revenue increased by $1.4 million, or 2.8%, in fiscal 2015 as compared to fiscal 2014 primarily related to our embedded modules andchips, partially offset by a decrease in the sales of Rabbit® modules, which are in the mature portion of their product life cycle.Network product revenue decreased $3.5 million, or 6.3%, in fiscal 2015 as compared to fiscal 2014. The decrease was mostly due to a decrease in sales ofserial cards which are in the mature portion of their product life cycle. There was also a decrease in USB connected products, device servers and satelliteproducts (which have been discontinued), partially offset by an increase in revenue from terminal servers. All of our network products are included in themature product category.Service2016 Compared to 2015Service revenue for fiscal 2016 was $6.9 million compared to $8.3 in the prior fiscal year, a decrease of $1.4 million, or 17.3%. The decrease was primarilydue to a $1.5 million decline in revenue for our wireless design services as we struggled to generate sufficient demand while we were transitioning thisbusiness to our World Headquarters location as well as identifying new senior leadership. Revenue from the Digi Device Cloud™ platform and supportservices decreased by $0.6 million. We received incremental revenue from Digi Cold Chain Solutions of $0.7 million which was acquired during the firstquarter of26Table of ContentsITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)fiscal 2016. We expect that revenue from Digi Cold Chain Solutions will continue to increase as we focus on expanding this business, which includes acomponent of recurring revenue.2015 Compared to 2014Our service offerings in fiscal 2015 included wireless design services, revenue generated from the Digi Device Cloud™ platform and our support services.The significant majority of our service revenue was generated from wireless design services.Service revenue for fiscal 2015 was $8.3 million compared to $10.3 million in the prior fiscal year, a decrease of $2.0 million, or 19.1%. The decrease wasprimarily due to a decline in revenue from our wireless design services.Revenue by Geographic LocationOur revenue by geographic location of our customers was as follows: Revenue % of Revenue($ in millions) 2016 2015 2014 2016 2015 2014North America, primarily United States $131.5 $127.6 $106.9 64.8% 62.6% 58.4%Europe, Middle East & Africa 44.9 47.5 47.7 22.1% 23.3% 26.0%Asia 20.4 22.9 22.8 10.0% 11.2% 12.4%Latin America 6.2 5.8 5.8 3.1% 2.9% 3.2%Total revenue $203.0 $203.8 $183.2 100.0% 100.0% 100.0%2016 Compared to 2015North America revenue in fiscal 2016 increased $3.9 million, or 3.0%, compared to fiscal 2015. This was primarily due to a $5.3 million increase in productrevenue mostly related to higher sales of network and embedded products. This was partially offset by a decrease in cellular gateway products and a decreasein service revenue mostly related to wireless design services.EMEA revenue decreased $2.6 million, or 5.5%, in fiscal 2016 from fiscal 2015. The British Pound and Euro weakened compared to the U.S. Dollar duringfiscal 2016, which contributed to the decrease in revenue. In addition revenue decreased for cellular-related and RF products, partially offset by an increase inrevenue from embedded products compared to the same periods in the prior year.Revenue in Asian countries decreased by $2.5 million, or 11.0%, in fiscal 2016 compared to fiscal 2015 mostly related to decreased volume of networkproducts.Latin America revenue increased by $0.4 million, or 6.9%, in fiscal 2016 from fiscal 2015, primarily due to increased RF product sales in fiscal 2016.2015 Compared to 2014North America revenue in fiscal 2015 increased $20.7 million, or 19.4%, compared to fiscal 2014, as certain customers made large purchases of our cellularproducts. There was also an increase in revenue from our RF and embedded modules and serial servers, partially offset by a decline of $2.0 million in servicerevenue.EMEA revenue decreased $0.2 million, or 0.4%, in fiscal 2015 as compared to fiscal 2014. The decrease primarily was due to fluctuations of foreign currencyrates, which had an unfavorable impact on total revenue of $3.2 million for fiscal 2015 as compared to fiscal 2014 due to the weakening of the Euro andBritish Pound compared to the U.S. Dollar. This was mostly offset by increased revenue from cellular products and embedded products compared to the priorfiscal year.Asian countries revenue increased $0.1 million, or 0.6%, in fiscal 2015 as compared to fiscal 2014.Latin America revenue remained flat in fiscal 2015 as compared to fiscal 2014.27Table of ContentsITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)Revenue by Distribution ChannelThe following table presents our revenue by distribution channel: Revenue % of Revenue($ in millions) 2016 2015 2014 2016 2015 2014Direct/OEM channel $68.8 $77.9 $67.7 33.9% 38.2% 37.0%Distributors channel 134.2 125.9 115.5 66.1% 61.8% 63.0%Total revenue $203.0 $203.8 $183.2 100.0% 100.0% 100.0%2016 Compared to 2015Revenue in fiscal 2016 in our Direct/OEM channel decreased by $9.1 million, or 11.7%, compared to the prior fiscal year primarily resulting from lower salesof cellular and RF products and from our service offerings. During fiscal 2016, revenue from our distributors increased by $8.3 million, or 6.6%, compared tofiscal 2015, as we continued to advance our efforts to expand our relationships with certain distributors that have global scale in fiscal 2016.2015 Compared to 2014During fiscal 2015, revenue in our Direct/OEM channel increased $10.2 million, or 15.1%, compared to revenue in fiscal 2014 due to large sales to certaincustomers. Revenue in fiscal 2015 for our distributors increased by $10.4 million, or 9.0%, compared to revenue in fiscal 2014. We have been taking steps toexpand our relationship with certain distributors who have a global reach.GROSS PROFIT2016 Compared to 2015Gross profit was $99.7 million and $97.1 million in fiscal 2016 and 2015, respectively, an increase of $2.6 million, or 2.6%. The gross margin for fiscal 2016was 49.1% compared to 47.6% in fiscal 2015.Hardware product gross profit was $97.8 million and $94.3 million in fiscal 2016 and 2015, respectively, an increase of $3.5 million, or 3.7%. The hardwareproduct gross margin for fiscal 2016 was 49.9% compared to 48.3% in fiscal 2015. The increase was driven primarily by strong revenue performance in ournetwork category which traditionally has higher margin products. In addition, we realized manufacturing cost reductions across many of our product lines infiscal 2016.Service gross profit was $1.8 million and $2.8 million in fiscal 2016 and 2015, respectively, a decrease of $0.9 million, or 33.6%. The service gross marginfor fiscal 2016 was 26.7% compared to 33.3% in fiscal 2015. This primarily was a result of amortization costs for purchased and core technology associatedwith our Cold Chain Solutions acquisition in the first quarter of fiscal 2016 and lower revenue from wireless design services. We expect our service grossmargin to vary from quarter to quarter for the foreseeable future as our wireless product design and development services margins are dependent on theutilization rates of our personnel.2015 Compared to 2014Gross profit was $97.1 million and $90.4 million in fiscal 2015 and 2014, respectively, an increase of $6.7 million, or 7.5%. The gross margin for fiscal 2015was 47.6% compared to 49.3% in fiscal 2014.Hardware product gross profit was $94.3 million and $87.1 million in fiscal 2015 and 2014, respectively, an increase of $7.2 million, or 8.3%. The hardwareproduct gross margin for fiscal 2015 was 48.3% compared to 50.4% in fiscal 2014. The decrease in gross margin primarily was due to the mix of our hardwareproducts since we sold proportionately more growth hardware products in fiscal 2015 that generally have a lower gross margin compared to mature hardwareproducts. In the future we expect to focus more on securing larger and longer-term opportunities that may impact our gross margins negatively. Additionally,for fiscal 2015, we incurred additional manufacturing expenses to recover from the impact of the Thailand fire that also reduced gross margin.28Table of ContentsITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)Service gross profit was $2.8 million and $3.3 million in fiscal 2015 and 2014, respectively, a decrease of $0.5 million, or 15.0%. The service gross marginfor fiscal 2015 was 33.3% compared to 31.6% in fiscal 2014. The increase in gross margin is a direct result of improved utilization of consulting labor inconnection with our restructuring (see Note 10 to our Consolidated Financial Statements).OPERATING EXPENSES2016 Compared to 2015Operating expenses were $82.6 million in fiscal 2016, a decrease of $3.6 million, or 4.2%, compared to $86.2 million in fiscal 2015. Below is a summary ofour operating expenses by function:Sales and marketing expenses were $33.8 million and $37.6 million in fiscal 2016 and 2015, respectively, a decrease of $3.8 million or 9.9%. This decreasewas due primarily to decreased compensation and employee-related expenses of $3.0 million as a result of reduced headcount. Travel and entertainmentexpenses also decreased by $0.3 million.Research and development expenses were $30.9 million and $29.9 million in fiscal 2016 and 2015, respectively, an increase of $1.0 million or 3.4%.Compensation and employee-related expenses increased by $1.5 million as a result of underutilization of billable research and development resources as wellas increased contract labor costs. Outside services for testing and certifications increased by $0.3 million. This was partially offset by decreases of $0.8million in travel and entertainment, occupancy and other miscellaneous research and development costs.General and administrative expenses were $17.0 million and $18.3 million in fiscal 2016 and 2015, respectively, a decrease of $1.3 million or 7.0%. Thedecrease is primarily related to compensation-related expenses of $0.7 million, as fiscal 2015 included Chief Financial Officer transition expenses. Inaddition there was a decrease in expenses of $0.7 million as we reduced the fair value of the contingent consideration associated with our acquisition ofBluenica (see Note 2 to our Consolidated Financial Statements).Restructuring expenses were $0.7 million in fiscal 2016 and $0.4 million in fiscal 2015. For further information on restructurings, see Note 10 to ourConsolidated Financial Statements.2015 Compared to 2014Operating expenses were $86.2 million in fiscal 2015, an increase of $0.2 million, or 0.3%, compared to $86.0 million in fiscal 2014. Below is a summary ofour operating expenses by function:Sales and marketing expenses were $37.6 million and $38.8 million in fiscal 2015 and 2014, respectively, a decrease of $1.2 million or 3.0%. The decreasewas primarily due to a reduction in travel expenses of $0.6 million and $1.0 million of facility, outside services and other sales and marketing expenses. Thiswas partially offset by an increase in compensation-related expenses of $0.4 million.Research and development expenses were $29.9 million and $28.9 million in fiscal 2015 and 2014, respectively, an increase of $1.0 million or 3.6%.Compensation and employee-related expenses increased by $2.0 million primarily due to underutilization of billable research and development and usingthose employees for completing internal products. In addition, incentive compensation expenses increased due to improved company performance in fiscal2015. This was partially offset by a decrease of $1.0 million in other miscellaneous research and development costs and professional services.General and administrative expenses were $18.3 million and $18.2 million in fiscal 2015 and 2014, respectively, an increase of $0.1 million or 0.3%. Thiswas primarily due to an increase in professional fees of $0.5 million and compensation and employee-related expenses of $1.3 million mostly related toincreased incentive compensation expenses due to improved company performance in fiscal 2015. In addition, we realized a net decrease of $0.7 million inexpenses due to CEO transition expenses incurred in fiscal 2014 which were only partially offset by CFO transition expenses in fiscal 2015. General andadministrative expenses also decreased $1.0 million in fiscal 2015 compared to the prior fiscal year due to occupancy expenses, miscellaneous general andadministrative expenses, depreciation and amortization as certain intangibles were fully amortized.Restructuring expenses were $0.4 million and $0.1 million in fiscal 2015 and fiscal 2014, respectively, an increase of $0.3 million. For further information onrestructuring, see Note 10 to our Consolidated Financial Statements.29Table of ContentsITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)OTHER (EXPENSE) INCOME, NET2016 Compared to 2015Total other (expense) income, net was comprised of other expense, net of $0.4 million in fiscal 2016 compared to other income, net of $2.2 million in fiscal2015. In fiscal 2016, we recorded $0.7 million of foreign currency net transaction losses compared to fiscal 2015 in which we recorded $0.6 million of foreigncurrency net transaction gains and a $1.4 million of gain from the settlement of a property and casualty insurance claim related to the replacement of ourcapital equipment destroyed in the fire at our subcontract manufacturer's location. Our interest income on marketable securities and cash and cash equivalentsincreased from fiscal 2015 to fiscal 2016 as our average investment balance increased from $74.0 million in fiscal 2015 to $102.3 million in fiscal 2016. Weearned an average interest rate of 0.4% and 0.3% in fiscal 2016 and 2015, respectively.2015 Compared to 2014We recorded other income, net of $2.2 million in fiscal 2015 compared to $0.7 million in fiscal 2014. In fiscal 2015, we recorded $1.4 million of gain fromthe settlement of a property and casualty insurance claim related to the replacement of our capital equipment destroyed in the fire at our subcontractmanufacturer's location. We also recorded $0.6 million of foreign currency net transaction gains in fiscal 2015 as compared to $0.4 million of foreigncurrency net transaction gains in fiscal 2014. Our interest income remained mostly the same. Our average investment balance was $74.0 million in fiscal 2015and $74.1 million in fiscal 2014. We earned an average interest rate of 0.3% in both fiscal 2015 and fiscal 2014.INCOME TAXESOur effective income tax rates were 19.2%, 28.1% and 11.2% for fiscal years 2016, 2015 and 2014, 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 (see Note 11 to our Consolidated Financial Statements).During fiscal 2016, we recorded net tax benefits of $1.5 million, primarily from the reinstatement of the federal research and development tax credit forcalendar year 2015 and the reversal of tax reserves due to the expiration of statutes of limitation from U.S. and foreign tax jurisdictions. In addition, we filedamended income tax returns resulting in an additional domestic refund related to qualified manufacturing activities.During fiscal 2015, we recorded net tax benefits of $0.8 million, resulting from the reinstatement of the research and development tax credit for calendar year2014, reversal of tax reserves due to the expiration of statute of limitations from U.S. and foreign tax jurisdictions and reversal of tax reserves due to theresolution of tax audits.During fiscal 2014, we recorded net tax benefits of $1.5 million related to the re-measurement and reversal of certain income tax reserves as a result of afederal income tax audit of fiscal 2012, the reassessment of state research and development tax credits and the release of income tax reserves due to theexpiration of statute of limitations from U.S. and foreign tax jurisdictions.INFLATIONManagement believes that during fiscal years 2016, 2015 and 2014, inflation has not had a material effect on our consolidated statement of operations orfinancial position.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$134.1 million, $92.2 million and $80.4 million at September 30, 2016, 2015 and 2014, respectively. Our working capital was $171.8 million, $137.0million and $125.9 million at September 30, 2016, 2015 and 2014, respectively. The increase of cash, cash equivalents and short-term marketable securitiesand working capital during fiscal 2016 was attributable primarily to increased net income and less investment in non-current marketable securities than infiscal 2015. As a result of adopting ASU 2015-17 prospectively in the first quarter of fiscal 2016, all deferred tax assets and liabilities are classified on ajurisdictional basis as non-current in our condensed consolidated balance sheets, which is a change from our historical presentation whereby certain of ourdeferred tax assets and liabilities were classified as current and the remainder was classified as non-current.30Table of ContentsITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)In November 2016, we spent $1.7 million on the acquisition of FreshTemp, LLC (see Note 19 to the Consolidated Financial Statements).Consolidated Statements of Cash Flows Highlights: Year ended September 30,($ in thousands) 2016 2015 2014Operating activities $27,089 $14,074 $1,809Investing activities (3,780) (19,454) 16,579Financing activities 7,749 5,145 (10,960)Effect of exchange rate changes on cash and cash equivalents (349) (2,237) (1,258)Net increase (decrease) in cash and cash equivalents $30,709 $(2,472) $6,1702016 Compared to 2015Net cash provided by operating activities was $27.1 million during fiscal 2016 compared to $14.1 million during fiscal 2015, a net increase of $13.0 million.This net increase is due to an increase of $8.4 million in net income adjusted for non-cash items and a net increase in cash flows resulting from operatingassets and liabilities of $4.6 million. The increase in cash flows related to changes in operating assets and liabilities was primarily due to an increase $5.9million resulting from a reduction in inventory, an increase in accounts payable of $5.4 million, and an increase of $1.0 million resulting from a reduction ofaccounts receivable, prepaids and other assets. This was partially offset by a reduction of accrued liabilities of $5.7 million and a reduction of $2.0 million oftaxes payable.Net cash used by investing activities was $3.8 million in fiscal 2016 compared to $19.5 million in fiscal 2015, a net decrease of $15.7 million. We purchased$15.3 million fewer marketable securities in fiscal 2016 as compared to fiscal 2015. We received $2.8 million in proceeds from the sale of Etherios, net ofcash acquired, in fiscal 2016 and spent $1.8 million less for capital expenditures in fiscal 2016 compared to fiscal 2015. This was partially offset by cash usedfor the acquisition of Bluenica of $2.9 million and proceeds from an insurance settlement in fiscal 2015 of $1.4 million.Net cash provided by financing activities was $7.7 million in fiscal 2016 compared to $5.1 million in fiscal 2015, an increase of $2.6 million. Werepurchased $1.8 million less of our common stock in fiscal 2016 compared to fiscal 2015, and received $0.8 million of additional proceeds related toexercises of stock options and employee stock purchase plan transactions.2015 Compared to 2014Net cash provided by operating activities was $14.1 million during fiscal 2015 compared to $1.8 million in fiscal 2014, a net increase of $12.3 million. Thisnet increase was primarily due to an increase of $7.6 million of net income adjusted for non-cash items and a net increase in cash flows resulting from changesin operating assets and liabilities of $4.6 million. The net increase in cash flows resulting from changes in operating assets and liabilities of $4.6 million wasprimarily due to a $4.8 million increase in accrued liabilities resulting from larger incentive compensation accruals on improved company performance infiscal 2015. We also had an increase in cash flows as we spent $4.0 million less on inventory in fiscal 2015 compared to fiscal 2014. In addition, we had a$0.9 million increase in cash flows as our accounts receivable increased by a smaller amount in fiscal 2015 compared to fiscal 2014. This was partially offsetby a $4.7 million decrease in cash flows related to accounts payable and a $0.4 million decrease related to income taxes payable.Net cash used in investing activities was $19.5 million in fiscal 2015 compared to net cash provided of $16.6 million in fiscal 2014, a decrease of $36.1million. There were net purchases of marketable securities in fiscal 2015 compared to net maturities of marketable securities in fiscal 2014 which accountedfor $36.4 million of the decrease along with $1.1 million of additional purchases of capital expenditures. This was partially offset by an increase of $1.4million related to the gain from insurance recovery.Net cash provided by financing activities was $5.1 million in fiscal 2015 compared to net cash used by financing activities of $11.0 million in fiscal 2014.We had $13.4 million fewer repurchases of common stock in fiscal 2015 compared to fiscal 2014. We also had $2.7 million of additional proceeds fromexercises of stock options and employee stock purchase plan transactions in fiscal 2015 compared to fiscal 2014.31Table of ContentsITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)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 and capital expenditures for the nexttwelve months and beyond.At September 30, 2016, our total cash and cash equivalents and marketable securities balance, including long-term marketable securities was $137.7 million.Approximately $28.4 million of cash and cash equivalents was being held by our controlled foreign subsidiaries at September 30, 2016. At September 30,2016, we had $31.5 million of accumulated undistributed foreign earnings that are indefinitely reinvested in non-U.S. subsidiaries, resulting in slightly morethan half of our cash and cash equivalents being held by non-U.S. subsidiaries. Although we have no current need or intention to repatriate historicalearnings in the form of cash in the United States, if we change our assertion from indefinitely reinvesting undistributed foreign earnings, we would have toaccrue applicable taxes. The amount of any taxes and the application of any tax credits would be determined based on the income tax laws at the time of suchrepatriation. Under current tax laws, we estimate the unrecognized deferred tax liability to be up to $0.6 million.The following summarizes our contractual obligations at September 30, 2016: Payments due by fiscal period($ in thousands) Total Less than 1 year 1-3 years 3-5 years ThereafterOperating leases $3,922 $1,706 $1,758 $458 $—The operating lease agreements included above primarily relate to office space. The table above does not include possible payments for uncertain taxpositions. Our reserve for uncertain tax positions, including accrued interest and penalties, was $1.9 million as of September 30, 2016. Due to the nature ofthe underlying liabilities and the extended time often needed to resolve income tax uncertainties, we cannot make reliable estimates of the amount or timingof future cash payments that may be required to settle these liabilities.The above table also does not include those obligations for royalties under license agreements as these royalties are calculated based on future sales oflicensed products and we cannot make reliable estimates of the amount of cash payments.FOREIGN CURRENCYWe are exposed to foreign currency transaction risk associated with certain sales being denominated in Euros, British Pounds, Japanese Yen and CanadianDollar 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 2016, we had approximately $71.5 million of revenue related to foreign customers including export sales, of which $22.9 million was denominated inforeign currency, predominantly the Euro and British Pound. During fiscal 2015 and 2014, we had approximately $76.2 million and $76.3 million,respectively of revenue to foreign customers including export sales, of which $21.3 million and $23.3 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.In June 2016, the U.K. held a referendum in which voters approved Brexit. The announcement of Brexit caused significant volatility in global stock marketsand currency exchange rate fluctuations that resulted in the strengthening of the U.S. dollar against the British pound. Brexit could cause disruptions to andcreate uncertainty surrounding our business, including continued increased volatility in exchange rates, as the future terms of the U.K.’s relationship with theE.U. are determined.RECENT ACCOUNTING DEVELOPMENTSFor information on new accounting pronouncement, see Note 1 to our Consolidated Financial Statements.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 affect32Table of ContentsITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)the reported amounts of assets, liabilities, revenue and expenses, the disclosure of contingent assets and liabilities and the values of purchased assets andassumed liabilities in acquisitions. We base our estimates on historical experience and various other assumptions that are believed to be reasonable under thecircumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent fromother 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 consolidatedfinancial statements.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 isreasonably assured and there are no post-delivery obligations, other than warranty. Under these criteria, product revenue generally is recognized uponshipment of product to customers. Sales to authorized domestic distributors and Direct / OEMs are made with certain rights of return and price adjustmentprovisions. Estimated reserves for future returns and pricing adjustments are established by us based on an analysis of historical patterns of returns and priceadjustments as well as an analysis of authorized returns compared to received returns and distribution sales for the current period. Estimated reserves forfuture returns and price adjustments are charged against revenue in the same period as the corresponding sales are recorded. Material differences between thehistorical trends used to determine estimated reserves and actual returns and pricing adjustments could result in a material change to our consolidated resultsof operations or financial position. We have applied consistent methodologies for estimating reserves for future returns and pricing adjustments for all yearspresented. The reserve for future returns and pricing adjustments was $2.0 million at September 30, 2016 and $1.8 million at September 30, 2015.Revenue recognized for service revenue as a percentage of total revenue represented 3.4%, 4.1% and 5.6% in fiscal 2016, 2015 and 2014, respectively. Ourservice revenue is derived primarily from our wireless design services and our Digi Cold Chain Solutions. We also have some service revenue that is derivedfrom our Digi Device Cloud™, which is a platform-as-a-service (PaaS) offering in which customers pay for services consumed in terms of devices beingmanaged and monitored, or as a monthly service fee for access to information. In addition, we have small amounts of revenue from our support services. Werecognize service revenue from our wireless design services, Digi Cold Chain Solutions and Device Cloud based upon performance, including final productdelivery and customer acceptance. In addition, we recognize small amounts of revenue from support services which is recognized over the life of thecontract, and training as the services are performed.MARKETABLE SECURITIESWe regularly monitor and evaluate the realizable value of our marketable securities. When assessing marketable securities for other-than-temporary declinesin value, we consider several factors. These factors include: how significant the decline in value is as a percentage of the original cost, how long the marketvalue of the investment has been less than its original cost, the underlying factors contributing to a decline in the prices of securities in a single asset class,the performance of the issuer’s stock price in relation to the stock price of its competitors within the industry, expected market volatility, analystrecommendations, the views of external investment managers, any news or financial information that has been released specific to the investee and theoutlook for the overall industry in which the issuer operates. If events and circumstances indicate that a decline in the value of these securities has occurredand is other-than-temporary, we would record a charge to other (expense) income.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 accountswas $0.2 million at September 30, 2016 and $0.3 million at September 30, 2015.33Table of ContentsITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)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 operationsor financial 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. In a business combination, goodwill is capitalized at the acquisitiondate. It is measured at fair value, which is the excess of the acquisition price for shares in a company over the acquired net assets. The net assets include thefair values of the acquired identifiable assets less the assumed liabilities and contingent liabilities.Goodwill is tested for impairment on an annual basis as of June 30, or more frequently if events or circumstances occur which could indicate impairment. AtJune 30, 2016, our market capitalization was $278.6 million compared to our carrying value of $294.9 million. Our market capitalization plus our estimatedcontrol premium of 35% resulted in a fair value in excess of our carrying value by a margin of 27%. As a result, no impairment was indicated and we were notrequired to complete the second step of the goodwill impairment analysis. No goodwill impairment charges were recorded. The control premium used in ourannual goodwill assessment at June 30, 2016 was based on a control premium study as of June 2014, resulting in a range of control premium of 30% to 40%.We reviewed the data and concluded that a 35% control premium best represented the amount an investor would likely pay, over and above marketcapitalization, in order to obtain a controlling interest given the economic conditions at that time.During the third quarter of fiscal 2016, we reviewed recent control premium data for transactions that occurred during fiscal 2016 in the industries mostcomparable to our business (see Footnote 1 to our Consolidated Financial Statements). The data indicated that our current 35% control premium continues tobe indicative of the amount that an investor would pay to obtain a controlling interest based on current macroeconomic and industry data.During the fourth quarter of fiscal 2016, we assessed various qualitative factors to determine whether or not an additional goodwill impairment assessmentwas required as of September 30, 2016. We concluded that no additional goodwill impairment assessment was required. We continue to monitor our stockprice on a daily basis. If the stock price remained below certain thresholds for a significant period of time, we would complete an interim impairmentassessment. We also monitor other events or circumstances that could have a significant impact on our operations. If one of these events or circumstanceswere to occur, we would evaluate whether an interim goodwill impairment assessment should be completed.CONTINGENT CONSIDERATIONWe measure our contingent consideration liabilities recognized in connection with business combinations at fair value on a recurring basis using significantunobservable inputs classified within Level 3 of the fair value hierarchy as defined in ASC 320 “Investments - Debt and Equity Securities”. We used aprobability-weighted discounted cash flow approach as a valuation technique to determine the fair value of the contingent consideration on the acquisitiondate. At each subsequent reporting period, the fair value is remeasured with the change in fair value recognized in general and administrative expense andinterest expense in our Condensed Consolidated Statements of Operations. Amounts, if any, paid to the seller in excess of the amount recorded on theacquisition date will be classified as cash flows used in operating activities. Payments to the seller not exceeding the acquisition-date fair value of thecontingent consideration will be classified as cash flows used in financing activities. At September 30, 2016, the fair value of our contingent considerationwas $10.0 million. There was no contingent consideration at September 30, 2015.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 extended34Table of ContentsITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)period of time to resolve and could result in adjustments to our income tax balances that are material to our consolidated financial position and results ofoperations and could result in potential cash outflows.We have unrecognized tax benefits of $1.7 million at September 30, 2016. We expect that it is reasonably possible that the total amounts of unrecognized taxbenefits will decrease approximately $0.7 million over the next 12 months due to the expiration of various statutes of limitations. The total amount ofunrecognized tax benefits that if recognized would affect our effective tax rate is $1.6 million. We recognize interest and penalties related to income taxmatters 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 warrantycosts are accrued in the period that the related revenue is recognized based upon an estimated average per unit repair or replacement cost applied to theestimated number of units under warranty. These estimates are based upon historical warranty incidents and are evaluated on an ongoing basis to ensure theadequacy of the warranty accrual. The product warranty accrual was $1.0 million at both September 30, 2016 and 2015.ITEM 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 raterisk.FOREIGN CURRENCY RISKWe are exposed to foreign currency transaction risk associated with certain sales being denominated in Euros, British Pounds, Japanese Yen or CanadianDollar 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 non-functional currency accounts, primarily the U.S. dollar accounts in our foreignlocations to reduce our foreign currency risk. We have not implemented a formal hedging strategy.The table below compares the average monthly exchange rates of the Euro, British Pound, Japanese Yen and Canadian Dollar: Fiscal year endedSeptember 30, % increase 2016 2015 (decrease)Euro1.1112 1.1499 (3.4)%British Pound1.4261 1.5462 (7.8)%Japanese Yen0.0090 0.0084 7.1 %Canadian Dollar0.7552 NA NAA 10.0% change from the 2016 average exchange rate for the Euro, British Pound, Yen and Canadian Dollar to the U.S. Dollar would have resulted in a 2.3%increase or decrease in fiscal 2016 annual revenue and a 2.3% increase or decrease in stockholders' equity at September 30, 2016. The above analysis doesnot take into consideration any pricing adjustments 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 ofcustomer financial status, credit limits and collaboration with sales management on customer contacts to facilitate payment.Investments are made in accordance with our investment policy and consist of certificates of deposit, money market funds, corporate bonds and 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.35Table 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 (loss),stockholders’ equity and cash flows present fairly, in all material respects, the financial position of Digi International Inc. and its subsidiaries at September30, 2016 and 2015, and the results of their operations and their cash flows for each of the three years in the period ended September 30, 2016 in conformitywith accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in theindex appearing under Item 15(a)(2) presents fairly, in all material respects, the information set forth therein when read in conjunction with the relatedconsolidated financial statements. Also in our opinion, the Company did not maintain, in all material respects, effective internal control over financialreporting as of September 30, 2016, based on criteria established in Internal Control - Integrated Framework 2013 issued by the Committee of SponsoringOrganizations of the Treadway Commission (COSO) because a material weakness in internal control over financial reporting related to inadequatesegregation of duties for an individual who had access to create and post journal entries at a material subsidiary of the Company existed as of that date. Amaterial weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility thata material misstatement of the annual or interim financial statements will not be prevented or detected on a timely basis. The material weakness referred toabove is described in Management's Report on Internal Control Over Financial Reporting appearing under Item 9A. We considered this material weakness indetermining the nature, timing, and extent of audit tests applied in our audit of the 2016 consolidated financial statements, and our opinion regarding theeffectiveness of the Company’s internal control over financial reporting does not affect our opinion on those consolidated financial statements. TheCompany's management is responsible for these financial statements and financial statement schedule, for maintaining effective internal control overfinancial reporting and for its assessment of the effectiveness of internal control over financial reporting included in management's report referred to above.Our responsibility is to express opinions on these financial statements, on the financial statement schedule, and on the Company's internal control overfinancial reporting based on our audits which were integrated audits in 2016 and 2015. We conducted our audits in accordance with the standards of thePublic Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assuranceabout whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in allmaterial respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financialstatements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statementpresentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessingthe risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Ouraudits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basisfor our opinionsA company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reportingand the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal controlover financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairlyreflect the 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, MinnesotaDecember 13, 201636Table of ContentsITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA (CONTINUED)DIGI INTERNATIONAL INC.CONSOLIDATED STATEMENTS OF OPERATIONS Fiscal years ended September 30, 2016 2015 2014 (in thousands, except per common share data)Revenue: Hardware product$196,101 $195,497 $172,846Service6,904 8,350 10,327Total revenue203,005 203,847 183,173Cost of sales: Cost of hardware product98,265 101,155 85,737Cost of service5,060 5,571 7,059Total cost of sales103,325 106,726 92,796Gross profit99,680 97,121 90,377Operating expenses: Sales and marketing33,847 37,574 38,751Research and development30,955 29,949 28,912General and administrative17,026 18,306 18,244Restructuring charges, net747 403 81Total operating expenses82,575 86,232 85,988Operating income17,105 10,889 4,389Other (expense) income, net: Interest income545 218 176Interest expense(291) (4) (5)Other (expense) income, net(669) 2,014 501Total other (expense) income, net(415) 2,228 672Income from continuing operations, before income taxes16,690 13,117 5,061Income tax provision3,212 3,684 568Income from continuing operations13,478 9,433 4,493Income (loss) from discontinued operations, after income taxes3,230 (2,845) (2,742)Net income$16,708 $6,588 $1,751 Basic net income (loss) per common share: Continuing operations$0.52 $0.38 $0.18Discontinued operations$0.13 $(0.12) $(0.11)Net income (1)$0.65 $0.27 $0.07Diluted net income (loss) per common share: Continuing operations$0.51 $0.37 $0.17Discontinued operations$0.12 $(0.11) $(0.11)Net income (1)$0.64 $0.26 $0.07Weighted average common shares: Basic25,760 24,645 25,345Diluted26,311 25,227 25,730(1) Earnings per share presented are calculated by line item and may not add due to the use of rounded amounts.The accompanying notes are an integral part of the consolidated financial statements.37Table of ContentsITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA (CONTINUED)DIGI INTERNATIONAL INC.CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) Fiscal years ended September 30, 2016 2015 2014 (in thousands)Net income$16,708 $6,588 $1,751Other comprehensive loss, net of tax: Foreign currency translation adjustment(2,107) (4,323) (2,713)Change in net unrealized gain (loss) on investments53 (21) 43Less income tax (provision) benefit(20) 7 (17)Reclassification of realized (gain) loss on investments included in net income (1)(7) 1 —Less income tax benefit (2)3 — —Other comprehensive loss, net of tax(2,078) (4,336) (2,687)Comprehensive income (loss)$14,630 $2,252 $(936)(1)Recorded in Other (expense) income, 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.38Table of ContentsITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA (CONTINUED)DIGI INTERNATIONAL INC.CONSOLIDATED BALANCE SHEETS As of September 30, 2016 2015 (in thousands, except share data)ASSETS Current assets: Cash and cash equivalents$75,727 $45,018Marketable securities58,382 47,191Accounts receivable, net28,685 27,788Inventories26,276 31,877Deferred tax assets— 3,252Receivable from sale of business2,997 —Other3,578 3,435Current assets of discontinued operations— 1,624Total current assets195,645 160,185Marketable securities, long-term3,541 13,626Property, equipment and improvements, net14,041 14,339Identifiable intangible assets, net4,041 2,648Goodwill109,448 100,183Deferred tax assets7,295 6,255Receivable from sale of business1,959 —Other196 250Non-current assets of discontinued operations— 2,874Total assets$336,166 $300,360LIABILITIES AND STOCKHOLDERS’ EQUITY Current liabilities: Accounts payable$8,569 $6,673Income taxes payable167 828Accrued compensation10,787 10,156Accrued warranty1,033 1,014Contingent consideration on acquired business513 —Other2,739 3,037Current liabilities of discontinued operations— 1,481Total current liabilities23,808 23,189Income taxes payable1,490 1,546Deferred tax liabilities616 135Contingent consideration on acquired business9,447 —Other non-current liabilities776 457Non-current liabilities of discontinued operations— 95Total liabilities36,137 25,422Commitments and Contingencies (see Notes 16 & 17) Stockholders’ equity: Preferred stock, $.01 par value; 2,000,000 shares authorized; none issued and outstanding— —Common stock, $.01 par value; 60,000,000 shares authorized; 32,471,175 and 31,534,198 shares issued325 315Additional paid-in capital237,492 227,367Retained earnings141,112 124,404Accumulated other comprehensive loss(24,691) (22,613)Treasury stock, at cost, 6,430,797 and 6,487,248 shares(54,209) (54,535)Total stockholders’ equity300,029 274,938Total liabilities and stockholders’ equity$336,166 $300,360The accompanying notes are an integral part of the consolidated financial statements.39Table of ContentsITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA (CONTINUED)DIGI INTERNATIONAL INC.CONSOLIDATED STATEMENTS OF CASH FLOWS Fiscal years ended September 30, 2016 2015 2014Operating activities: (in thousands)Net income $16,708 $6,588 $1,751Adjustments to reconcile net income to net cash provided by operating activities: Depreciation of property, equipment and improvements 2,742 2,949 3,557Amortization of identifiable intangible assets 1,872 2,910 3,589Stock-based compensation 3,654 4,301 4,330Excess tax benefits from stock-based compensation (212) — (44)Deferred income tax provision (benefit) 1,115 (769) (2,783)Gain on insurance settlement related to property and equipment — (1,375) —Gain on sale of business (2,870) — —Change in fair value of contingent consideration (441) — —Bad debt/product return provision 168 357 98Inventory obsolescence 1,734 1,284 860Restructuring charges, net 747 509 81Other 66 87 3Changes in operating assets and liabilities (net of acquisition): Accounts receivable (1,188) (1,794) (2,730)Inventories 3,993 (1,913) (5,966)Other assets 597 241 210Income taxes (1,589) 387 (1,408)Accounts payable 1,612 (3,769) 970Accrued expenses (1,619) 4,081 (709)Net cash provided by operating activities 27,089 14,074 1,809Investing activities: Purchase of marketable securities (74,759) (54,427) (27,420)Proceeds from maturities of marketable securities 73,706 38,028 47,420Proceeds from sale of business 2,849 — —Acquisition of businesses, net of cash acquired (2,860) — —Proceeds from insurance settlement related to property and equipment — 1,400 —Proceeds from sale of property and equipment — 45 —Proceeds from sale of investment 13 — —Purchase of property, equipment, improvements and certain other intangible assets (2,729) (4,500) (3,421)Net cash (used in) provided by in investing activities (3,780) (19,454) 16,579Financing activities: Excess tax benefits from stock-based compensation 212 — 44Proceeds from stock option plan transactions 7,191 6,559 3,689Proceeds from employee stock purchase plan transactions 896 925 1,009Purchase of common stock (550) (2,339) (15,702)Net cash provided by (used in) financing activities 7,749 5,145 (10,960)Effect of exchange rate changes on cash and cash equivalents (349) (2,237) (1,258)Net increase (decrease) in cash and cash equivalents 30,709 (2,472) 6,170Cash and cash equivalents, beginning of period 45,018 47,490 41,320Cash and cash equivalents, end of period $75,727 $45,018 $47,490 Supplemental disclosures of cash flow information: Interest paid $9 $4 $5Income taxes paid, net $3,029 $1,296 $3,197Supplemental schedule of non-cash investing and financing activities: Accrual for capitalized intangible asset $(183) $(17) $—Receivable related to sale of business $4,956 $— $—Liability related to acquisition of business $(10,550) $— $—Accrual for purchase of common stock $— $— $(100)The accompanying notes are an integral part of the consolidated financial statements.40Table of ContentsITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA (CONTINUED)DIGI INTERNATIONAL INC.CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITYFor fiscal years ended September 30, 2016, 2015 and 2014 Accumulated Additional Other Total Common Stock Treasury Stock Paid-In Retained Comprehensive Stockholders’ Shares Par Value Shares Value Capital Earnings Loss EquityBalances, September 30, 2013 30,264 $303 4,709 $(38,517) $211,982 $116,065 $(15,590) $274,243Net income 1,751 1,751Other comprehensive loss (2,687) (2,687)Employee stock purchase issuances (129) 1,082 (73) 1,009Repurchase of common stock 1,734 (15,802) (15,802)Issuance of stock upon exercise of stockoptions 440 4 3,685 3,689Tax impact from equity awards (1,235) (1,235)Stock-based compensation expense 4,330 4,330Balances, September 30, 2014 30,704 $307 6,314 $(53,237) $218,689 $117,816 $(18,277) $265,298Net income 6,588 6,588Other comprehensive loss (4,336) (4,336)Employee stock purchase issuances (124) 1,041 (116) 925Repurchase of common stock 297 (2,339) (2,339)Issuance of stock under stock award plans 830 8 6,551 6,559Tax impact from equity awards (2,058) (2,058)Stock-based compensation expense 4,301 4,301Balances, September 30, 2015 31,534 $315 6,487 $(54,535) $227,367 $124,404 $(22,613) $274,938Net income 16,708 16,708Other comprehensive loss (2,078) (2,078)Employee stock purchase issuances (104) 876 20 896Repurchase of common stock 48 (550) (550)Issuance of stock under stock award plans 937 10 7,181 7,191Tax impact from equity awards (914) (914)Accelerating vesting of Etherios stock awardplans 184 184Stock-based compensation expense 3,654 3,654Balances, September 30, 2016 32,471 $325 6,431 $(54,209) $237,492 $141,112 $(24,691) $300,029The accompanying notes are an integral part of the consolidated financial statements.41Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIESBusiness DescriptionWe are a leading provider of Internet of Things (IoT) networking hardware products and solutions. We provide Machine-to-Machine (M2M) and IoTconnections to solve business and mission-critical machine communication challenges for our customers that are reliable, secure, scalable and managed. Wecreate secure, easy to implement embedded solutions and services to help customers build IoT connectivity. In addition, we deploy ready to use, completebox solutions to connect remote machinery. We also manage cloud services, offer professional services and complete IoT solutions. Our solutions aredeployed by a wide range of businesses and institutions. Any business that utilizes a significant number of devices, whose operations could benefit fromremote monitoring or control, may realize benefits from IoT networking.Discontinued OperationsOn October 23, 2015, we sold all of the outstanding stock of our wholly owned subsidiary, Etherios Inc. (“Etherios”) to West Monroe Partners, LLC. Becausethe sale of Etherios represented a strategic shift that will have a major effect on our operations and financial results, we have classified our Etherios businessas discontinued operations, which requires retrospective application to financial information for all periods presented. Since the cost of segregating theconsolidated statement of cash flows outweighed the benefits, we elected not to segregate our consolidated statement of cash flows as the material items inthe operating and investing sections are disclosed in Note 3 to our Consolidated Financial Statements.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.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 quotedmarket prices and trading activity for each security where available. We obtain relevant information from our investment advisor and, if warranted, also mayreview the 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,we consider several factors. These factors include: how significant the decline in value is as a percentage of the original cost, how long the market value ofthe 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 theoutlook for the overall industry in which the issuer operates. If events and circumstances indicate that a decline in the value of a security has occurred and isother-than-temporary, we would record a charge to other (expense) income.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 used42Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)reasonable collection efforts are written off through a charge to the allowance for doubtful accounts and a credit to accounts receivable.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 five years.Building improvements and buildings are depreciated over ten and thirty-nine years, respectively.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 acquiredin a business acquisition, or at cost when not purchased in a business acquisition. All other identifiable intangible assets are amortized on either a straight-line basis over their estimated useful lives of three to thirteen years or based on the pattern in which the asset is consumed. Useful lives for identifiableintangible assets are estimated at the time of acquisition based on the periods of time from which we expect to derive benefits from the identifiable intangibleassets. Amortization of purchased and core technology is included in cost of sales in the Consolidated Statements of Operations. Amortization of all otheracquired identifiable intangible 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 cashflows are not sufficient to recover the carrying value amount. We measure impairment loss by utilizing an undiscounted cash flow valuation technique usingfair values indicated by the income approach. Impairment losses, if any, would be recorded in the period the impairment is identified. There were no materialimpairments identified in fiscal 2016, 2015 or 2014.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,or more frequently if events or circumstances occur which could indicate impairment. The calculation of goodwill impairment requires us to makeassumptions about the fair value of our one reporting unit, which historically has been approximated by using our market capitalization plus a controlpremium. Control premium assumptions require judgment and actual results may differ from assumed or estimated amounts.Our test for potential goodwill impairment is a two-step approach. We estimate the fair value for our one reporting unit by comparing its fair value (marketcapitalization plus control premium) to our carrying value. If the carrying value of the reporting unit exceeds its estimated fair value, the second step of thegoodwill impairment analysis requires us to measure the amount of the impairment loss. An impairment loss is calculated by comparing the implied fair valueof the goodwill to its carrying amount. To calculate the implied fair value of goodwill, the fair value of the reporting unit's assets and liabilities, excludinggoodwill, is estimated. The excess of the fair value of the reporting unit over the amount assigned to its assets and liabilities, excluding goodwill, is theimplied fair value of the reporting unit's goodwill.In June 2014, we performed a control premium study to determine the appropriate control premium to include in the calculation of fair value. We used 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, thefollowing three methodologies were used: (1) analysis of individual transactions within our industry; (2) analysis of industry-wide data, and (3) analysis ofglobal transaction data. Individual43Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)transactions in the Communication Equipment or Technology Hardware, Storage and Peripherals industries were used to find transactions of targetcompanies that operated in similar markets and shared similar operating characteristics with us. Transaction screening criteria included selection of transactions 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),•Target company had publicly traded stock outstanding at the transaction date, and•Transactions announced between June 30, 2009 and the valuation date.In analyzing industry-wide data, transactions in the following three industries were identified that encompassed the products offered by us: Office Equipmentand Computer 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 40%. We reviewed the data and concluded that a35% 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.During the third quarter of fiscal 2016, we reviewed recent control premium data for transactions that occurred during fiscal 2016 in the industries previouslydescribed. The data indicated that our 35% control premium continued to be indicative of the amount that an investor would pay to obtain a controllinginterest based on current macroeconomic and industry data.At June 30, 2016, our market capitalization was $278.6 million compared to our carrying value of $294.9 million. Our market capitalization plus ourestimated control premium of 35% resulted in a fair value in excess of our carrying value by a margin of 27%. We concluded that no impairment wasindicated and we were not required to complete the second step of the goodwill impairment analysis. No goodwill impairment charges were recorded. Duringthe fourth quarter of fiscal 2016, we assessed various qualitative factors to determine whether or not an additional goodwill impairment assessment wasrequired as of September 30, 2016, and we concluded that no additional impairment assessment was required.We continue to monitor our stock price on a daily basis. If the stock price remained below certain thresholds for a significant period of time, we wouldcomplete an interim impairment assessment. We also monitor other events or circumstances that could have a significant impact on our operations. If one ofthese events or circumstances were to occur, we would evaluate whether an interim goodwill impairment assessment should be completed.If our stock price or control premium declines, the first step of our goodwill impairment analysis may fail. We have identified factors that could result inadditional interim goodwill impairment testing. For example, we would perform the second step of the impairment testing if our stock price fell below certainthresholds for a significant period of time, or if our control premium significantly decreased. Events or circumstances may occur that could negatively impactour stock price, including changes in our anticipated revenues and profits and our ability to execute on our strategies. In addition, our control premium coulddecline due to changes in economic conditions in the technology industry or more generally in the financial markets. An impairment could have a materialeffect on our consolidated balance sheet and results of operations. We have had no goodwill impairment losses since the adoption of Accounting StandardsCodification (ASC) 350, Intangibles-Goodwill and Others, in fiscal 2003.Contingent ConsiderationWe measure our contingent consideration liabilities recognized in connection with business combinations at fair value on a recurring basis using significantunobservable inputs classified within Level 3 of the fair value hierarchy as defined in ASC 320 “Investments - Debt and Equity Securities”. We used aprobability-weighted discounted cash flow approach as a valuation technique to determine the fair value of the contingent consideration on the acquisitiondate. At each subsequent reporting period, the fair value is remeasured with the change in fair value recognized in general and administrative expense andinterest expense in our Condensed Consolidated Statements of Operations. Amounts, if any, paid to the seller in excess of the amount recorded on theacquisition date will be classified as cash flows used in operating activities. Payments to the seller not exceeding the acquisition-date fair value of thecontingent consideration will be classified as cash flows used in financing activities.44Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)WarrantiesIn 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.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 96.6%, 95.9% and 94.4% in fiscal 2016, 2015 and 2014, respectively. We recognize hardwareproduct revenue when persuasive evidence of an arrangement exists, delivery has occurred, the sales price is fixed or determinable, collectability isreasonably assured and there are no post-delivery obligations, other than warranty. Under these criteria, product revenue generally is recognized uponshipment of product to customers.Sales to authorized domestic and foreign 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 well asan analysis of authorized returns compared to received returns and distribution sales for the current period. Estimated reserves for future returns and priceadjustments are charged against revenue in the same period as the corresponding revenue is recorded.Service revenue as a percentage of total revenue represented 3.4%, 4.1% and 5.6% in fiscal 2016, 2015 and 2014, respectively. Our service revenue is derivedprimarily from our wireless design services and our Digi Cold Chain Solutions. We also have some service revenue that is derived from our Digi DeviceCloud™, which is a platform-as-a-service (PaaS) offering in which customers pay for services consumed in terms of devices being managed and monitored, oras a monthly service fee for access to information. In addition, we have small amounts of revenue from our support services. We recognize service revenuefrom our wireless design services, Digi Cold Chain Solutions and Device Cloud based upon performance, including final product delivery and customeracceptance. In addition, we recognize small amounts of revenue from our support services which is recognized over the life of the contract, and training asthe services are 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 technologicalfeasibility and proven marketability of the product are established. To date, the time period between the establishment of technological feasibility andcompletion of software development has been short, and no significant development costs have been incurred during that period. Accordingly, we have notcapitalized any software 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.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).45Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)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 functional currency. Assets and liabilities of these operations are translated at the exchange rates in effectat the end of each reporting period. For our larger international subsidiaries, statements of operations accounts are translated at the daily rate. For all otherinternational subsidiaries, our statements of operations accounts are translated at the weighted average rates of exchange prevailing during each reportingperiod. Translation adjustments arising from the use of differing currency exchange rates from period to period are included in accumulated othercomprehensive 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 2016, 2015 and 2014, therewere net transaction (losses) gains of $(0.7) million, $0.6 million and $0.5 million, respectively, that were recorded in other (expense) income, net. Wemanage our net asset or net liability position for U.S. dollar accounts in our foreign locations to reduce our foreign currency risk. We have not implemented aformal hedging strategy.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 netincome per common share is computed by dividing net income by the weighted average number of common and potentially dilutive common sharesoutstanding during the period. Potentially dilutive common shares of our stock result from dilutive common stock options and restricted stock units. We usethe treasury stock method to calculate the weighted-average shares used in the diluted earnings per share computation. Under the treasury stock method, theproceeds from exercise of an option, the amount of compensation cost, if any, for future service that we have not yet recognized, and the amount of estimatedtax benefits that would 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 percommon share data): Fiscal years ended September 30, 2016 2015 2014Numerator: Income from continuing operations$13,478 $9,433 $4,493Income (loss) from discontinued operations, after income taxes$3,230 $(2,845) $(2,742)Net income$16,708 $6,588 $1,751Denominator: Denominator for basic net income per common share — weighted average shares outstanding25,760 24,645 25,345Effect of dilutive securities: Stock options and restricted stock units551 582 385Denominator for diluted net income per common share — adjusted weighted average shares26,311 25,227 25,730 Basic net income (loss) per common share: Continuing operations$0.52 $0.38 $0.18Discontinued operations$0.13 $(0.12) $(0.11)Net income (1)$0.65 $0.27 $0.07Diluted net income (loss) per common share: Continuing operations$0.51 $0.37 $0.17Discontinued operations$0.12 $(0.11) $(0.11)Net income (1)$0.64 $0.26 $0.07(1) Earnings per share presented are calculated by line item and may not add due to the use of rounded amounts.46Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)Because their effect would be anti-dilutive at period end, certain potentially dilutive shares related to stock options to purchase common shares wereexcluded in the above computation of diluted earnings per share because the options’ exercise prices were greater than the average market price of ourcommon shares. At September 30, 2016, 2015 and 2014, such excluded stock options were 1,519,691, 3,016,911 and 3,284,993, respectively.Use of Estimates and Risks and UncertaintiesThe preparation of consolidated financial statements in conformity with generally accepted accounting principles in the United States requires managementto make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date ofthe financial statements and the reported amount of revenue and expenses during the reporting period. Actual results could differ from those estimates.Estimates that could significantly affect our results of operations or financial condition involve the assignment of fair values upon acquisition of goodwilland other intangible assets and testing for impairment; the determination of our allowance for doubtful accounts and reserve for future returns and pricingadjustments; 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 loss account in stockholders’ equity.Recent Accounting DevelopmentsAdoptedIn November 2015, the Financial Accounting Standards Board (“FASB”) issued ASU 2015-17, “Income Taxes (Topic 740): Balance Sheet Classification ofDeferred Taxes.” ASU 2015-17 simplified the presentation of deferred income taxes by requiring that deferred tax assets and liabilities be classified as non-current in the balance sheet. The amendments in this Update are effective for financial statements issued for annual periods beginning after December 15,2016, and interim periods within those annual periods and may be applied either prospectively to all deferred tax assets and liabilities or retrospectively toall periods presented. Early adoption is permitted. We elected to early adopt ASU 2015-17 beginning in the fiscal quarter ending December 31, 2015. Otherthan the revised balance sheet presentation of deferred tax assets and liabilities from current to non-current, the adoption of this standard did not have amaterial impact to our consolidated financial statements.In September 2015, FASB issued ASU 2015-16, “Simplifying the Accounting for Measurement-Period Adjustments.” To simplify the accounting foradjustments made to provisional amounts recognized in a business combination, the amendments in this update eliminate the requirement to retrospectivelyaccount for those adjustments. The amendments in this update are effective for fiscal years beginning after December 15, 2015, including interim periodswithin those years, which for us will be the first fiscal quarter ending December 31, 2016. Earlier application is permitted for financial statements that havenot been issued. We elected to early adopt ASU 2015-16 beginning the fiscal quarter ending December 31, 2015. The adoption of this standard did not havea material impact to our consolidated financial statements.Not Yet AdoptedIn August 2016, FASB issued ASU 2016-15, “Statement of Cash Flows (Topic 230), Classification of Certain Cash Receipts and Cash Payments.” Theamendments in this update provided guidance on eight specific cash flow issues. This update is to provide specific guidance on each of the eight issues,thereby reducing the diversity in practice in how certain transaction are classified in the statement of cash flows. This ASU is effective for annual periods andinterim periods for those annual periods beginning after December 15, 2017, which for us is the first quarter ended December 31, 2018. Early adoption ispermitted. We are currently evaluating the impact of the adoption of ASU 2016-15 on our consolidated financial statements.In June 2016, the Financial Accounting Standards Board (“FASB”) issued ASU 2016-13, “Financial Instruments - Credit Losses (Topic 326), Measurement ofCredit Losses on Financial Instruments.” The amendments in this update replace the incurred loss impairment methodology in current GAAP with amethodology that reflects expected credit losses. This update is intended to provide financial statement users with more decision-useful information aboutthe expected credit losses. This ASU is effective for annual periods and interim periods for those annual periods beginning after December 15, 2019, whichfor us is47Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)the first quarter ended December 31, 2020. Entities may early adopt beginning after December 15, 2018. We are currently evaluating the impact of theadoption of ASU 2016-13 on our consolidated financial statements.In March 2016, FASB issued ASU 2016-09, “Improvements to Employee Share-Based Payment Accounting.” This update includes provisions intended tosimplify various aspects related to how share-based payments are accounted for and presented in the financial statements. This ASU is effective for annualperiods and interim periods within those annual periods beginning after December 15, 2016, which for us is the first fiscal quarter ending December 31, 2017.Early adoption is permitted. We will adopt ASU 2016-09 beginning October 1, 2017. We are currently evaluating the impact of the adoption of ASU 2016-09on our consolidated financial statements. Prospectively, beginning October 1, 2017, excess tax benefits and tax deficiencies will be reflected as income taxbenefit or expense in our Consolidated Statement of Operations and could result in a material impact. The extent of the excess tax benefits or tax deficienciesare subject to variation in our stock price and the timing of RSU vestings and employee stock option exercises.In February, 2016, FASB issued ASU 2016-02, “Leases (Topic 842)”, which amends the existing guidance to require lessees to recognize lease assets andlease liabilities from operating leases on the balance sheet. This ASU is effective using the modified retrospective approach for annual periods and interimperiods within those annual periods beginning after December 15, 2018, which for us is the first fiscal quarter ending December 31, 2019. Early adoption ispermitted. We are currently evaluating the impact of the adoption of ASU 2016-02 on our consolidated financial statements.In January 2016, FASB issued ASU 2016-01, “Financial Instruments-Overall: Recognition and Measurement of Financial Assets and Financial Liabilities.”ASU 2016-01 will require equity investments in unconsolidated entities (other than those accounted for using the equity method of accounting) to bemeasured at fair value with changes in fair value recognized in net income. The amendments in this update will also simplify the impairment assessment ofequity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment, eliminate the requirement forpublic business entities to disclose the method and significant assumptions used to estimate the fair value that is required to be disclosed for financialinstruments measured at amortized cost on the balance sheet and require these entities to use the exit price notion when measuring fair value of financialinstruments for disclosure purposes. This ASU would also change the presentation and disclosure requirements for financial instruments. In addition, thisASU clarifies the guidance related to valuation allowance assessment when recognizing deferred tax assets resulting from unrealized losses on available-for-sale debt securities. The amendments in this ASU are effective for fiscal years beginning after December 15, 2017, including interim periods within thosefiscal years, which for us is the first fiscal quarter ending December 31, 2018. Early adoption is permitted for financial statements of fiscal years and interimperiods that have not been issued. We are currently evaluating the impact of the adoption of ASU 2016-01.In July 2015, FASB issued ASU 2015-11, “Simplifying the Measurement of Inventory.” This provision would require inventory that was previously recordedusing first-in, first-out (“FIFO”) to be recorded at lower of cost or net realizable value. Net realizable value is the estimated selling price in the ordinary courseof business, less reasonably predictable costs of completion, disposal, and transportation. This guidance is effective for fiscal years beginning after December15, 2016 and interim periods within those years, which for us will be the first fiscal quarter ending December 31, 2017. The amendments in this guidanceshould be applied prospectively with earlier application permitted as of the beginning of an interim or annual period. We are currently evaluating the impactof the adoption of ASU 2015-11 and whether it would have a material impact on our consolidated financial statements.In April 2015, FASB issued ASU 2015-05, “Intangibles-Goodwill and Other-Internal-Use Software (Subtopic 350-40) - Customer’s Accounting for Fees Paidin a Cloud Computing Arrangement.” The new standard provides guidance to customers about whether a cloud computing arrangement includes a softwarelicense. If the arrangement does include a software license, the software license element of the arrangement should be accounted for in the same manner as theacquisition of other software licenses. This guidance is effective for fiscal years, and interim periods within those years, beginning after December 15, 2015,with early adoption permitted. We expect to adopt this guidance beginning with our fiscal quarter ending December 31, 2016. We do not expect thisguidance to have a material impact on our consolidated financial statements.In August 2014, FASB issued ASU 2014-15, “Presentation of Financial Statements - Going Concern.” This guidance requires management to evaluatewhether there is substantial doubt about a company’s ability to continue as a going concern and to provide related footnote disclosures. These amendmentsare effective for the annual period ending after December 15, 2016, and for annual periods and interim periods thereafter, which for us, will be our annualperiod ended September 30, 2017. Early adoption is permitted. While we are evaluating the impact of the adoption of ASU 2014-15, we do not expect it tohave an impact on our consolidated financial statements.48Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)In May 2014, FASB issued ASU 2014-09, “Revenue from Contracts with Customers.” This guidance provides a five-step analysis in determining when andhow revenue is recognized so that an entity will recognize revenue when it transfers promised goods or services to customers in an amount that reflects whatit expects in exchange for the goods and services. It also requires more detailed disclosures to enable users of financial statements to understand the nature,amount, timing and uncertainty of revenue and cash flows arising from contracts with customers. In August 2015, the FASB issued ASU 2015-14 “Revenuefrom Contracts with Customers (Topic 606): Deferral of the Effective Date” which approved a one-year deferral of the effective date of ASU 2014-09. As aresult of this deferral, ASU 2014-09 is effective for our fiscal 2019, including interim periods within that reporting period. The FASB also agreed to allow usto choose to adopt the standard effective for our fiscal 2018. In addition, the FASB issued ASU 2016-08, ASU 2016-10 and ASU 2016-12 in March 2016,April 2016 and May 2016, respectively, to provide interpretive clarifications on the new guidance in ASC Topic 606. We are currently working through anadoption plan and have identified our revenue streams and completed a preliminary analysis of how we currently account for revenue transactions comparedto the revenue accounting required under the new standard. We intend to complete our adoption plan in fiscal 2017. This plan includes a review oftransactions supporting each revenue stream to determine the impact of accounting treatment under ASC 606, evaluation of the method of adoption, andcompleting a rollout plan for implementation of the new standard with affected functions in our organization. Because of the nature of the work that remains,at this time we are unable to reasonably estimate the impact of adoption on our consolidated financial statements. We plan to adopt the new guidancebeginning October 1, 2018.2. ACQUISITIONAcquisition of Bluenica CorporationOn October 5, 2015 we purchased all of the outstanding stock of Bluenica Corporation (“Bluenica”), a company focused on temperature monitoring ofperishable goods in the food industry by using wireless sensors which are installed in grocery and convenience stores, restaurants, and in products duringshipment and storage to ensure that quality, freshness and public health requirements are met. This acquisition forms the basis for our Digi Cold ChainSolutions.The terms of the acquisition included an upfront cash payment together with earn-out payments. Cash of $2.9 million was paid at time of closing. The earn-out payments are scheduled to be paid in installments over a four-year period based on revenue achievement of the acquired business. Each of the earn-outpayments will be calculated based on the revenue performance of Digi Cold Chain Solutions for each respective earn-out period. The cumulative amount ofthese earn-out payments will not exceed $11.6 million. An additional payment, not to exceed $3.5 million, may also be due depending on revenueperformance. The fair value of this contingent consideration was $10.4 million at the date of acquisition (see Note 8 to the Consolidated FinancialStatements). We have determined that the earn-out will be considered as part of the purchase price consideration as there are no continuing employmentrequirements associated with the earn-out. Costs directly related to the acquisition, including legal, accounting and valuation fees, of approximately $0.1million have been charged directly to operations and are included in general and administrative expense in our Condensed Consolidated Statements ofOperations in fiscal 2016.The purchase price was allocated to the estimated fair value of assets acquired and liabilities assumed. The purchase price allocation resulted in therecognition of $11.0 million of goodwill. We believe that the acquisition resulted in the recognition of goodwill because this is a complementary acquisitionfor us and will provide a source of recurring revenue in a new vertical market.Operating results for Bluenica, now known as Digi Cold Chain Solutions, are included in our Consolidated Statements of Operations from October 6, 2015.The Consolidated Balance Sheet as of September 30, 2016 reflects the final allocation of the purchase price to the assets acquired and liabilities assumedbased on their estimated fair values at the date of acquisition.The Bluenica acquisition has been accounted for using the acquisition method of accounting, which requires, among other things, that assets acquired andliabilities assumed pursuant to the stock purchase agreement be recognized at fair value as of the acquisition date. During the third quarter of fiscal 2016, wefinalized the purchase price allocation by recording adjustments to our deferred tax liabilities account as a result of the completion and filing of the lastannual tax return for Bluenica.49Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS2. ACQUISITION (CONTINUED)The following table summarizes the values of Bluenica assets acquired and liabilities assumed as of the acquisition date (in thousands):Cash$2,888Purchase price payable upon completion of diligence matters115Fair value of contingent consideration on acquired business10,400Total purchase price consideration$13,403 Fair value of net tangible assets acquired$129Fair value of identifiable intangible assets acquired: Purchased and core technology2,000Customer relationships900Goodwill10,985Deferred tax liabilities, net(611)Total$13,403The weighted average useful life for all the identifiable intangibles listed above is 5.6 years. For purposes of determining fair value, the purchased and coretechnology identified above is assumed to have a useful life of five years and the customer relationships are assumed to have useful lives of seven years.Useful lives for identifiable intangible assets are estimated at the time of acquisition based on the periods of time from which we expect to derive benefitsfrom the identifiable intangible assets.The following unaudited pro forma condensed consolidated results of operations for fiscal 2015 have been prepared as if the acquisition of Bluenica hadoccurred at the beginning of fiscal 2015. Pro forma adjustments include amortization of identifiable intangible assets. Year ended(in thousands, except per share data) September 30, 2015Total revenues $203,972Income from continuing operations $8,505Loss from discontinued operations, after income taxes $(2,845)Net income $5,660Basic net income (loss) per common share: Continuing operations $0.35Discontinued operations $(0.12)Net income $0.23Diluted net income (loss) per common share: Continuing operations $0.34Discontinued operations $(0.11)Net income (1) $0.22(1) Earnings per share presented are calculated by line item and may not add due to the use of rounded amounts.Since the acquisition of Bluenica occurred close to the beginning of our fiscal 2016, we believe that the proforma amounts would be not be materiallydifferent from actual amounts. Revenue for fiscal 2016 related to the Bluenica acquisition was $0.7 million. As our operating costs related to the Bluenicaacquisition are now integrated, operating income and related earnings per share for Bluenica are not determinable for fiscal 2016.3. DISCONTINUED OPERATIONSOn October 23, 2015, we sold all the outstanding stock of our wholly owned subsidiary, Etherios to West Monroe Partners, LLC. We sold Etherios as part of astrategy to focus on providing highly reliable machine connectivity solutions for business and mission-critical application environments. Etherios wasincluded in our single operating segment.50Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS3. DISCONTINUED OPERATIONS (CONTINUED)Below is a summary of the gain on sale (in thousands):Gross proceeds $4,096Less: Employee related liabilities (1,134)Working capital adjustment (113) Net cash proceeds 2,849Present value of receivable due on October 23, 2016 2,941Present value of receivable due on October 23, 2017 1,922Total fair value of consideration received 7,712Less: Net assets of Etherios (3,383)Facility abandonment costs (725)Transaction costs, primarily professional fees (734)Gain on sale of discontinued operations, before income taxes $2,870The terms of the sale agreement provide that West Monroe Partners LLC will pay us $3.0 million on October 23, 2016 and $2.0 million on October 23, 2017.The present value of these amounts is included within the total fair value of consideration received. These receivable amounts are unsecured and non-interestbearing. The carrying value of these receivables presented on our Consolidated Balance Sheet at September 30, 2016 approximated their fair values, whichwere determined using level 3 cash flow fair value measurement techniques. We received the first payment of $3.0 million on October 21, 2016.Goodwill has been included in the net assets of Etherios based on the relative fair value of Etherios compared to the fair value of the Company, as theCompany consists of a single reporting unit for goodwill impairment testing purposes.As a condition to the sale agreement, we retained the operating leases in the Dallas and Chicago locations. Digi is no longer using these facilities and hassublet the Dallas location to West Monroe Partners, LLC through December 31, 2017. Also in connection with the sale, we assigned our San Francisco leaseto West Monroe Partners, LLC. A remaining potential obligation exists in the event of a default under the assigned lease. However, we believe the likelihoodof a liability related to this lease is remote. As of September 30, 2016, the future minimum lease payments for the San Francisco lease are approximately $0.1million.Income (loss) from discontinued operations, after income taxes, as presented in the Consolidated Statements of Operations for the twelve months endedSeptember 30, 2016, 2015 and 2014 is as follows (in thousands): Twelve months ended September 30, 2016 2015 2014Service revenue$891 $9,011 $9,528Cost of service713 8,101 9,421Gross profit178 910 107Operating expenses: Sales and marketing148 1,970 1,825Research and development103 2,098 877General and administrative43 1,208 1,669Restructuring— 106 —Total operating expenses294 5,382 4,371Loss from discontinued operations, before income taxes(116) (4,472) (4,264)Gain on sale of discontinued operations, before income taxes2,870 — —Income (loss) from discontinued operations, before income taxes2,754 (4,472) (4,264)Income tax benefit on discontinued operations(476) (1,627) (1,522)Income (loss) from discontinued operations, after income taxes$3,230 $(2,845) $(2,742)51Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS3. DISCONTINUED OPERATIONS (CONTINUED)Income tax benefit on discontinued operations for the twelve months ended September 30, 2016 was $0.5 million and primarily represented income taxbenefits for deductible transaction costs, partially offset by a tax expense for equity awards for which we will not receive a tax deduction. For tax purposes,this transaction resulted in a capital loss of $13.7 million, as the tax basis of the Etherios stock was higher than the book basis of the assets that were sold.Since we do not expect to be able to utilize this capital loss in the five year carryforward period, a deferred tax asset offset by a full valuation allowance of$5.1 million was recorded in the third quarter of fiscal 2016 upon completion of the capital loss calculation.At September 30, 2015, the carrying amounts of major classes of assets and liabilities of discontinued operations included in the Consolidated Balance Sheetwas as follows (in thousands): September 30, 2015Current assets: Accounts receivable, net$1,417Deferred tax assets127Other current assets80Total current assets1,624Property, equipment and improvements, net18Identifiable intangible assets, net1,531Goodwill1,914Deferred tax assets (1)(589)Total assets of discontinued operations$4,498 Current liabilities: Accounts payable$50Accrued compensation1,346Other current liabilities85Total current liabilities1,481Other non-current liabilities95Total liabilities of discontinued operations$1,576(1) As of September 30, 2015, we had a consolidated net deferred income tax asset related to the United States federal jurisdiction. That net deferred income tax asset positionincluded a deferred income tax liability of $589 thousand related to Etherios which was entirely in the United States federal tax jurisdiction.The following table presents amortization, depreciation and purchases of property, equipment, improvements and certain other intangible assets of thediscontinued operations related to Etherios (in thousands): Twelve months ended September 30, 2016 2015 2014Amortization of identifiable intangible assets$30 $483 $513Depreciation of property, equipment and improvements$— $29 $21Purchases of property, equipment, improvements and certain other intangible assets$— $(11) $(144)52Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS4. GOODWILL AND OTHER IDENTIFIABLE INTANGIBLE ASSETS, NETIdentifiable Intangible Assets, NetAmortizable identifiable intangible assets, net as of September 30, 2016 and 2015 were comprised of the following (in thousands): September 30, 2016 September 30, 2015 Grosscarryingamount Accum.amort. Net Grosscarryingamount Accum.amort. NetPurchased and core technology$46,594 $(44,999) $1,595 $45,449 $(45,424) $25License agreements18 (10) 8 18 (4) 14Patents and trademarks11,619 (10,871) 748 11,377 (10,385) 992Customer relationships17,463 (15,773) 1,690 17,090 (15,473) 1,617Total$75,694 $(71,653) $4,041 $73,934 $(71,286) $2,648Amortization expense for fiscal years 2016, 2015 and 2014 was as follows (in thousands):Fiscal yearTotal2016$1,8422015$2,4272014$3,076Estimated amortization expense for the next five years is as follows (in thousands):Fiscal yearTotal2017$1,3502018$9502019$7232020$6652021$129GoodwillThe changes in the carrying amount of goodwill were (in thousands): Fiscal years ended September 30, 2016 2015Beginning balance, October 1$100,183 $101,484Acquisition of Bluenica Corporation10,985 —Foreign currency translation adjustment(1,720) (1,301)Ending balance, September 30$109,448 $100,1835. SEGMENT INFORMATION AND MAJOR CUSTOMERSWe operate under a single operating and reporting segment. Our revenue consists of hardware product revenue and service revenue. In an effort to providefurther transparency of our financial information, beginning the first quarter of fiscal 2016, we transitioned away from reporting revenue in terms of growthand mature hardware products and now report four product categories: Cellular routers and gateways, Radio Frequency (RF), Embedded and Network. Webelieve this is a more meaningful presentation and reflects how we are monitoring our revenue.Our cellular product category includes cellular routers and all gateways, and the RF product category includes XBee® modules as well as other RF solutions.The embedded product category includes Digi Connect® and Rabbit® embedded systems on53Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS5. SEGMENT INFORMATION AND MAJOR CUSTOMERS (CONTINUED)module and single board computers. The network product category, which has the highest concentration of mature products, includes console and serialservers and USB connected devices.Our service offerings include Cold Chain Solutions, wireless product design and development services, our PaaS recurring revenue generated from DeviceCloud platform, and technical support services.The following table presents our revenue for each product category (in thousands): Fiscal years ended September 30, 2016 2015 2014Cellular routers and gateways$48,373 $58,666 $39,215RF33,924 34,373 29,094Embedded56,489 51,063 49,681Network57,315 51,395 54,856Total product revenue196,101 195,497 172,846Service6,904 8,350 10,327Total revenue$203,005 $203,847 $183,173The information in the following table provides revenue by the geographic location of the customer (in thousands): Fiscal years ended September 30, 2016 2015 2014North America, primarily United States$131,457 $127,592 $106,893Europe, Middle East & Africa44,932 47,523 47,729Asia20,390 22,907 22,762Latin America6,226 5,825 5,789Total revenue$203,005 $203,847 $183,173Net property, equipment and improvements by geographic location were as follows (in thousands): Fiscal years ended September 30, 2016 2015 2014United States$13,861 $14,085 $12,691International, primarily Europe180 254 418Total net property, equipment and improvements$14,041 $14,339 $13,109Our U.S. export sales represented 38.7%, 39.4% and 40.6% of revenue for the fiscal years ended September 30, 2016, 2015 and 2014. No single customerexceeded 10% of revenue for any of the periods presented. No single customer exceeded 10% of total accounts receivable at September 30, 2016. AtSeptember 30, 2015, we had two customers, whose accounts receivable balance represented 10.7% and 11.6% of total accounts receivable. No singlecustomer exceeded 10% of total accounts receivable at September 30, 2014.54Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS6. SELECTED BALANCE SHEET DATA(in thousands) As of September 30, 2016 2015Accounts receivable, net: Accounts receivable$30,885 $29,890Less allowance for doubtful accounts209 285Less reserve for future returns and pricing adjustments1,991 1,817Total accounts receivable, net$28,685 $27,788 Inventories: Raw materials$21,116 $26,037Work in process802 598Finished goods4,358 5,242Total inventories$26,276 $31,877 Property, equipment and improvements, net: Land$1,800 $1,800Buildings10,522 10,522Improvements3,239 3,328Equipment15,778 15,691Purchased software3,377 3,458Furniture and fixtures2,803 2,720Total property, equipment and improvements, gross37,519 37,519Less accumulated depreciation and amortization23,478 23,180Total property, equipment and improvements, net$14,041 $14,3397. 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 atemporary loss 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 willbe required to sell the security before its anticipated recovery, or (c) permanent impairment due to bankruptcy or insolvency.In order to estimate the fair value for each security in our investment portfolio, we obtain quoted market prices and trading activity for each security whereavailable. We obtain relevant information from our investment advisor and, if warranted, also may review the financial solvency of certain security issuers. Asof September 30, 2016, 18 of our 48 securities that we held were trading below our amortized cost basis. We determined each decline in value to be temporarybased upon the above described factors. We expect to realize the fair value of these securities, plus accrued interest, either at the time of maturity or when thesecurity is sold. All of our current holdings are classified as available-for-sale marketable securities and are recorded at fair value on our consolidated balancesheet with the unrealized gains and losses recorded in accumulated other comprehensive loss. All of our current marketable securities are scheduled to maturein less than one year and our non-current marketable securities are scheduled to mature in less than two years. We received proceeds from the sale of ouravailable-for-sale marketable securities of $73.7 million, $38.0 million and $47.4 million for fiscal 2016, 2015 and 2014, respectively.55Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS7. MARKETABLE SECURITIES (CONTINUED)At September 30, 2016 our marketable securities consisted of (in thousands): AmortizedCost (1) UnrealizedGains UnrealizedLosses Fair Value (1)Current marketable securities: Corporate bonds$28,801 $— $(34) $28,767Commercial paper23,963 — (20) 23,943Certificates of deposit3,755 13 — 3,768Government municipal bonds1,904 — — 1,904Current marketable securities58,423 13 (54) 58,382Non-current marketable securities: Certificates of deposit3,505 36 — 3,541Total marketable securities$61,928 $49 $(54) $61,923(1)Included in amortized cost and fair value is purchased and accrued interest of $271.At September 30, 2015 our marketable securities consisted of (in thousands): AmortizedCost (1) UnrealizedGains UnrealizedLosses Fair Value (1)Current marketable securities: Corporate bonds$31,753 $— $(39) $31,714Commercial paper7,986 — (1) 7,985Certificates of deposit6,253 8 — 6,261Government municipal bonds1,232 — (1) 1,231Current marketable securities47,224 8 (41) 47,191Non-current marketable securities: Corporate bonds4,138 — (12) 4,126Certificates of deposit7,511 2 (6) 7,507Government municipal bonds1,996 — (3) 1,993Non-current marketable securities13,645 2 (21) 13,626Total marketable securities$60,869 $10 $(62) $60,817(1)Included in amortized cost and fair value is purchased and accrued interest of $252.The following tables show the fair values and gross unrealized losses of our available-for-sale securities that have been in a continuous unrealized lossposition deemed to be temporary, aggregated by investment category (in thousands): September 30, 2016 Less than 12 Months More than 12 Months Fair Value Unrealized Losses Fair Value Unrealized LossesCorporate bonds$24,454 $(33) $4,102 $(1)Commercial paper23,943 (20) — —Total$48,397 $(53) $4,102 $(1)56Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS7. MARKETABLE SECURITIES (CONTINUED) September 30, 2015 Less than 12 Months More than 12 Months Fair Value Unrealized Losses Fair Value Unrealized LossesCorporate bonds$33,664 $(52) $— $—Commercial paper5,987 (1) — —Certificates of deposit4,244 (6) 499 (1)Government municipal bonds3,159 (3) — —Total$47,054 $(62) $499 $(1)8. 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 participantsas of 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 to the fair valuemeasurement. The hierarchy is broken down into three levels. Level 1 inputs are quoted prices in active markets for identical assets or liabilities. Level 2inputs include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are notactive, and inputs (other than quoted prices) that are observable for the asset or liability, either directly or indirectly. Level 3 inputs are unobservable for theasset or liability and their fair values are determined using pricing models, discounted cash flow methodologies or similar techniques and at least onesignificant model assumption or input is unobservable. Level 3 may also include certain investment securities for which there is limited market activity or adecrease in the observability of market pricing for the investments, such that the determination of fair value requires significant judgment or estimation.Fair value is applied to financial assets such as our marketable securities, which are classified and accounted for as available-for-sale and to financialliabilities for contingent consideration. These items are stated at fair value at each reporting period using the above guidance. The following tables provideinformation by level for financial assets and liabilities that are measured at fair value on a recurring basis (in thousands): Fair Value Measurements at September 30, 2016 using: Total carryingvalue atSeptember 30, 2016 Quoted price inactive markets(Level 1) Significant otherobservable inputs(Level 2) Significantunobservable inputs(Level 3)Assets: Money market$44,319 $44,319 $— $—Corporate bonds28,767 — 28,767 —Commercial paper23,943 — 23,943 —Certificates of deposit7,309 — 7,309 —Government municipal bonds1,904 — 1,904 —Total assets measured at fair value$106,242 $44,319 $61,923 $—Liabilities: Contingent consideration on acquired business9,960 — — 9,960Total liabilities measured at fair value$9,960 $— $— $9,96057Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS8. FAIR VALUE MEASUREMENTS (CONTINUED) Fair Value Measurements at September 30, 2015 using: Total carryingvalue atSeptember 30, 2015 Quoted price inactive markets(Level 1) Significant otherobservable inputs(Level 2) Significantunobservable inputs(Level 3)Assets: Money market$14,436 $14,436 $— $—Corporate bonds35,840 — 35,840 —Commercial paper7,985 — 7,985 —Certificates of deposit13,768 — 13,768 —Government municipal bonds3,224 — 3,224 —Total assets measured at fair value$75,253 $14,436 $60,817 $—Our money market funds, which have been determined to be cash equivalents, are measured at fair value using quoted market prices in active markets foridentical assets and are therefore classified as Level 1 assets. We value our Level 2 assets using inputs that are based on market indices of similar assets withinan active market. There were no transfers into or out of our Level 2 financial assets during the twelve months ended September 30, 2016.The use of different assumptions, applying different judgment to matters that are inherently subjective and changes in future market conditions could resultin different estimates of fair value of our securities or contingent consideration, currently and in the future. If market conditions deteriorate, we may incurimpairment charges for securities in our investment portfolio. We may also incur changes to our contingent consideration liability as discussed below.In connection with the Bluenica acquisition discussed in Note 2, we are required to make contingent payments over a period of up to four years, subject toDigi Cold Chain Solutions achieving specified revenue thresholds. The fair value of the liability for contingent payments recognized upon acquisition was$10.4 million, and was estimated by discounting to present value the probability-weighted contingent payments expected to be made. Assumptions used inthis calculation included the discount rate and various probability factors. This liability is considered to be a Level 3 financial liability that is re-measuredeach reporting period.The following table presents a reconciliation of the liability measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for thetwelve months ended September 30, 2016 (in thousands): Twelve months endedSeptember 30, 2016Fair value at beginning of period $—Purchase price contingent consideration 10,400Change in fair value of contingent consideration (440)Fair value at end of period $9,960The change in fair value of contingent consideration for the acquisition of Bluenica is included in general and administrative and interest expense on ourCondensed Consolidated Statements of Operations and reflects our estimate of the probability of achieving the relevant targets and is discounted based onour estimated discount rate. We have estimated the fair value of the contingent consideration based on the probability of achieving the specified revenuethresholds at 75.8% to 98.0%. A significant increase (decrease) in our estimates of achieving the relevant targets could materially increase (decrease) the fairvalue of the contingent consideration liability.58Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS9. PRODUCT WARRANTY OBLIGATIONThe 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 302016$1,014 $771 $(752) $1,0332015$862 $967 $(815) $1,0142014$1,063 $627 $(828) $862We are not responsible for, and do not warrant that, custom software versions, created by original equipment manufacturer (OEM) customers based upon oursoftware source code, will function in a particular way, will conform to any specifications or are fit for any particular purpose. Further, we do not indemnifythese customers from any third-party liability as it relates to or arises from any customization or modifications made by the OEM customer.10. RESTRUCTURINGBelow is a summary of the restructuring charges and other activity within the restructuring accrual (in thousands): 2016 Restructuring 2015Restructuring 2014Restructuring 2013Restructuring EmployeeTerminationCosts Other EmployeeTerminationCosts EmployeeTerminationCosts EmployeeTerminationCosts TotalBalance at September 30, 2013$— $— $— $— $350 $350Restructuring charge— — — 152 — 152Payments— — — (152) (279) (431)Reversals— — — — (71) (71)Balance at September 30, 2014— — — — — —Restructuring charge— — 412 — — 412Payments— — (403) — — (403)Reversals— — (9) — — (9)Balance at September 30, 2015— — — — — —Restructuring charge558 195 — — — 753Payments(559) (195) — — — (754)Reversals(6) — — — — (6)Foreign currency fluctuation7 — — — — 7Balance at September 30, 2016$— $— $— $— $— $—2016 RestructuringOn January 19, 2016, we approved a restructuring plan for our wireless design services group. This plan resulted in an elimination of 5 positions. We recordeda restructuring charge of $0.1 million related to severance during the second quarter of fiscal 2016 and paid the majority of the severance during that samequarter.On November 19, 2015, we approved a restructuring plan impacting our corporate staff. The plan closed our Dortmund, Germany office and relocated certainemployees to our Munich office. We also recorded a contract termination charge as we relocated employees in our Minneapolis, Minnesota office to ourWorld Headquarters in Minnetonka, Minnesota in December 2015. We recorded a restructuring charge of $0.7 million that included $0.5 million ofseverance and $0.2 million of contract termination costs during the first quarter of fiscal 2016. This restructuring resulted in an elimination of 10 positions.The payments associated with these charges were completed in the third quarter of fiscal 2016.59Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS10. RESTRUCTURING (CONTINUED)2015 RestructuringOn January 22, 2015, we announced the closure of our India location. The March closure resulted in the elimination of approximately 38 employees fromengineering, sales and administration. We recorded a restructuring charge of $0.4 million related to severance during the second quarter of fiscal 2015. Thepayments associated with this charge were completed during the third quarter of fiscal 2015.2014 RestructuringOn 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 recorded a restructuring charge of$0.2 million related to severance during the first quarter of fiscal 2014. The payments associated with these charges and all the actions associated with therestructuring were completed during the third quarter of fiscal 2014.2013 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 along with a reversal of $0.1million were completed during the first quarter of fiscal 2014.11. INCOME TAXESThe components of income from continuing operations, before income taxes are as follows (in thousands): Fiscal years ended September 30, 2016 2015 2014United States$9,841 $6,934 $(833)International6,849 6,183 5,894Income from continuing operations, before income taxes$16,690 $13,117 $5,061The components of the income tax provision are as follows (in thousands): Fiscal years ended September 30, 2016 2015 2014Current: Federal$(141) $1,452 $1,007State139 453 (58)Foreign2,099 2,279 2,196Deferred: U.S.1,260 (297) (2,417)Foreign(145) (203) (160)Income tax provision$3,212 $3,684 $56860Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS11. INCOME TAXES (CONTINUED)The net deferred tax asset consists of the following (in thousands): As of September 30, 2016 2015Current deferred tax asset$— $3,252Non-current deferred tax asset7,295 6,255Current deferred tax liability— (36)Non-current deferred tax liability(616) (135)Net deferred tax asset$6,679 $9,336 Uncollectible accounts and other reserves$915 $966Depreciation and amortization421 206Inventories683 999Compensation costs4,925 7,130Tax carryforwards6,263 1,185Valuation allowance(5,970) (862)Identifiable intangible assets(558) (288)Net deferred tax asset$6,679 $9,336As of September 30, 2016, we have estimated carryforwards for tax purposes as follows: We have $0.9 million of carryforwards mostly related to state researchand development tax credits and carryforwards consisting of a U.S. capital loss of $5.1 million and non-U.S. net operating losses of $0.3 million. The majorityof the state research and development tax credits and non-U.S. net operating losses have an unlimited carryforward period. Our non-U.S. tax creditcarryforwards will expire in 2028. Our U.S. capital loss carryforward will expire in 2020.Our valuation allowance for certain U.S. and foreign locations increased to $6.0 million at September 30, 2016 from $0.9 million at September 30, 2015,primarily due to the capital loss realized on the sale of Etherios. We are not expecting to generate sufficient capital gains within the carryforward period tofully utilize the capital loss. The amount of the deferred tax assets realized could vary if there are differences in the timing or amount of future reversals ofexisting deferred tax liabilities or changes in the amounts of future taxable income. If our future taxable income projections are not realized, an additionalvaluation allowance may be required, and would be reflected as income tax expense at the time that any such change in future taxable income is determined.The reconciliation of the statutory federal income tax amount to our income tax provision is as follows (in thousands): Fiscal years ended September 30, 2016 2015 2014Statutory income tax amount$5,548 $4,491 $1,721Increase (decrease) resulting from: State taxes, net of federal benefits204 (190) (251)Utilization of tax credits(1,116) (250) (76)Manufacturing deduction(450) (285) (92)Discrete tax benefits(1,461) (818) (1,475)Foreign operations276 181 316Valuation reserve(43) 297 11Adjustment of tax contingency reserves202 71 168Meals and entertainment55 64 93Employee stock purchase plan83 76 85Contingent consideration(154) — —Other, net68 47 68Income tax provision$3,212 $3,684 $56861Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS11. INCOME TAXES (CONTINUED)During fiscal 2016, we recorded net tax benefits of $1.5 million, primarily from the reinstatement of the federal research and development tax credit forcalendar year 2015 and the reversal of tax reserves due to the expiration of statutes of limitation from U.S. and foreign tax jurisdictions. In addition, we filedamended income tax returns resulting in an additional domestic refund related to qualified manufacturing activities. These benefits are included within thediscrete tax benefits in the above table.During fiscal 2015, we recorded net tax benefits of $0.8 million, resulting from the reinstatement of the research and development tax credit for calendar year2014, reversal of tax reserves due to the expiration of statute of limitations from U.S. and foreign tax jurisdictions and reversal of tax reserves due to theresolution of tax audits. These benefits are included within the discrete tax benefits in the above table.During fiscal 2014, we recorded net tax benefits of $1.5 million related to the re-measurement and reversal of certain income tax reserves as a result of afederal income tax audit of fiscal 2012, the reassessment of state research and development tax credits and the release of income tax reserves due to theexpiration of statute of limitations from U.S. and foreign tax jurisdictions. These benefits are included within the discrete tax benefits in the above table.A reconciliation of the beginning and ending amount of unrecognized tax benefits is (in thousands): Fiscal years ended September 30, 2016 2015 2014Unrecognized tax benefits at beginning of fiscal year$1,618 $2,301 $3,332Increases related to: Prior year income tax positions107 110 181Current year income tax positions240 144 148Decreases related to: Prior year income tax positions(71) (255) (1,105)Settlements(30) (74) (95)Expiration of statute of limitations(156) (608) (160)Unrecognized tax benefits at end of fiscal year$1,708 $1,618 $2,301The total amount of unrecognized tax benefits at September 30, 2016 that, if recognized, would affect our effective tax rate is $1.6 million. We expect that itis reasonably possible that the total amounts of unrecognized tax benefits will decrease approximately $0.7 million over the next 12 months due to theexpiration of various statutes of limitations.Of the $1.7 million of unrecognized tax benefits, $1.3 million is included in non-current income taxes payable and $0.4 million is included with non-currentdeferred tax assets on the consolidated balance sheet at September 30, 2016.We recognize interest and penalties related to income tax matters in income tax expense. During fiscal 2016 and 2015, there were insignificant amounts ofinterest and penalties related to income tax matters in income tax expense. We had accrued interest and penalties related to unrecognized tax benefits of $0.2million at September 30, 2016 and $0.3 million at September 30, 2015. These accrued interest and penalties are included in our non-current income taxespayable on our consolidated balance sheets.We operate in multiple tax jurisdictions both in the U.S. and outside of the U.S and face audits from various tax authorities regarding transfer pricing, taxcredits, and other matters. Accordingly, we must determine the appropriate allocation of income to each of these jurisdictions. This determination requires usto make several estimates and assumptions. Tax audits associated with the allocation of this income, and other complex issues, may require an extendedperiod of time to resolve and may result in adjustments to our income tax balances in those years that are material to our consolidated balance sheet andresults of operations. With a few exceptions, we are no longer subject to income tax examination for tax years prior to fiscal 2013. For state tax authorities,most notably in California and Texas, generally we are no longer subject to income tax examination for tax years before fiscal 2012, and for Minnesota fortax years prior to fiscal 2014. We do not anticipate significant changes to our unrecognized tax benefits as a result of these examinations.62Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS11. INCOME TAXES (CONTINUED)At September 30, 2016, we had approximately $31.5 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 torepatriate historical earnings in the form of cash to the United States, if we change our assertion from indefinitely reinvesting undistributed foreign earnings,we would have to accrue applicable taxes. The amount of any taxes and the application of any tax credits would be determined based on the income tax lawsat the time of such repatriation. Under current tax laws, we estimate the unrecognized deferred tax liability to be up to $0.6 million.12. STOCK-BASED COMPENSATIONDuring fiscal 2016, stock-based awards were granted under our 2016 Omnibus Incentive Plan (the “2016 Plan”), as well as our 2014 Omnibus Incentive Plan(the “2014 Plan”). Grants under the 2014 Plan ceased upon stockholder approval of the 2016 Plan during the second quarter of fiscal 2016. The authority togrant options under the 2016 Plan and set other terms and conditions rests with the Compensation Committee of the Board of Directors. We also have awardsoutstanding under our 2013 Omnibus Incentive Plan (the “2013 Plan”), 2000 Omnibus Stock Plan, as amended and restated as of December 4, 2009 (the“2000 Plan”), and the Stock Option Plan, as amended and restated as of November 27, 2006 (the “Stock Option Plan”) and our Non-Officer Stock Option Planas amended and restated as of November 27, 2006 (the “Non-Officer Plan”).The 2016 Plan initially authorized the issuance of up to 1,500,000 common shares in connection with awards of stock options, stock appreciation rights,restricted stock, restricted stock units, performance-based full value awards or other stock-based awards. Eligible participants include our employees, ouraffiliates, non-employee directors of our Company and any consultant or advisor who is a natural person and provides services to us or our affiliates. Optionsthat have been granted under the 2016 Plan typically vest over a four-year period and will expire if unexercised after seven years from the date of grant.Restricted stock unit awards (“RSUs”) that have been granted to directors typically vest in one year. RSUs that have been granted to executives andemployees typically vest in November over a four-year period. Awards may be granted under the 2016 Plan until January 31, 2026. Options under the 2016Plan can be granted as either incentive stock options (“ISOs”) or non-statutory stock options (“NSOs”). The exercise price of options and the grant date priceof restricted stock is determined by our Compensation Committee but may not be less than the fair market value of our common stock based on the closingprice on the date of grant. Upon exercise, we issue new shares of stock. As of September 30, 2016, there were approximately 1,450,982 shares available forfuture grants under the 2016 Plan.The 2014 Plan initially authorized the issuance of up to 2,250,000 common shares in connection with awards of stock options, stock appreciation rights,restricted stock, restricted stock units, performance-based full value awards or other stock-based awards. Eligible participants included our employees, ouraffiliates, non-employee directors of our Company and any consultant or advisor who is a natural person and provides services to us or our affiliates. Optionsgranted under this plan generally vested over a four year service period and expired if unexercised after eight years from the date of grant. Restricted stockawards (RSU's) that were granted to Directors typically vested in one year. RSU's that were granted to executives and employees typically vested inNovember over a four-year period. Options under the 2014 Plan were granted as either incentive stock options (ISOs) or non-statutory stock options (NSOs).Awards may no longer be granted under the 2014 Plan as the plan was terminated effective February 1, 2016 at the Annual Meeting of Stockholders. Theexercise price of options and the grant date price of restricted stock was determined by our Compensation Committee but could not be less than the fairmarket value of our common stock based on the closing price on the date of grant.The 2013 Plan initially authorized 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 included our employees, non-employeedirectors, consultants and advisors. Options granted under this plan generally vested over a four year service period and expired if unexercised after eightyears from the date of grant. RSU's that were granted to Directors typically vested in one year. Awards may no longer be granted under the Incentive Plan asthe plan was terminated effective January 27, 2014 at the Annual Meeting of Stockholders. Options under the 2013 Plan were granted as either ISOs or NSOs.The exercise price was determined by our Compensation Committee but could not be less than the fair market value of our common stock based on theclosing price on the date of grant.The 2000 Plan initially 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 included our employees, non-employee directors, consultants and advisors. Anauthorization to issue an additional 2,500,000 common shares was ratified on January 25, 2010 at the Annual Meeting of Stockholders. Awards may nolonger be granted under the 2000 Plan as63Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS12. STOCK-BASED COMPENSATION (CONTINUED)the plan was terminated as to future awards on January 28, 2013 at the Annual Meeting of Stockholders. Options under the 2000 Plan were granted as eitherISOs or non-statutory stock options NSOs. The exercise price was determined by our Compensation Committee but could not be less than the fair marketvalue of our common stock based on the closing price on the date of grant.Awards outstanding under the Stock Option Plan and the Non-Officer Plan included NSOs. In addition, the Stock Option Plan also included ISOs toemployees and others who provided services to us, including consultants, advisers and directors. Options granted under these plans generally vested over afour year service period and will expire if unexercised after ten years from the date of grant. The exercise price for ISOs and non-employee director optionsgranted under the Stock Option Plan was set at the fair market value of our common stock based on the closing price on the date of grant. The exercise pricefor NSOs granted under the Stock Option Plan or the Non-Officer Plan was set by the Compensation Committee of the Board of Directors and was set to theexercise price based on the closing price on the date of grant.Our equity plans and corresponding forms of award agreements generally have provisions allowing employees to elect to satisfy tax withholding obligationsthrough the delivery of shares, having us retain a portion of shares issuable under the award or paying cash to us for the withholding. During fiscal 2016 and2015, our employees forfeited 47,464 shares and 9,371 shares, respectively in order to satisfy $0.6 million and $0.1 million, respectively, of withholding taxobligations related to stock-based compensation, pursuant to terms of awards under our board and shareholder-approved compensation plans. No shares wereforfeited to satisfy withholding obligations during fiscal 2014.We recorded cash received from the exercise of stock options of $7.2 million, $6.6 million and $3.7 million during fiscal years 2016, 2015 and 2014,respectively. During fiscal 2016, there were $0.2 million of excess tax benefits from stock-based compensation. The were no excess tax benefits from stock-based compensation during fiscal 2015 and excess tax benefits were minimal during fiscal year 2014.We sponsor an Employee Stock Purchase Plan, as amended and restated as of October 29, 2013, December 4, 2009 and November 27, 2006 (the “PurchasePlan”), covering all domestic employees with at least 90 days of continuous service and who are customarily employed at least 20 hours per week. ThePurchase Plan allows eligible participants the right to purchase common stock on a quarterly basis at the lower of 85% of the market price at the beginning orend of each three-month offering period. The most recent amendments to the Purchase Plan, ratified by our stockholders on January 27, 2014, increased thetotal number of shares to 2,800,000 that may be purchased under the plan. Employee contributions to the Purchase Plan were $0.9 million in both fiscal 2016and 2015, and $1.0 million in fiscal 2014. Pursuant to the Purchase Plan, 103,915, 123,847, and 129,449 shares of common stock were issued to employeesduring fiscal 2016, 2015 and 2014, respectively. Shares are issued under the Purchase Plan from treasury stock. As of September 30, 2016, 513,616 shares ofcommon stock were available for future issuances under the Purchase Plan.Stock-based compensation cost capitalized as part of inventory was immaterial as of September 30, 2016, 2015 and 2014.Stock-based compensation expense is included in the consolidated results of operations as follows (in thousands): Fiscal years ended September 30, 2016 2015 2014Cost of sales$215 $221 $207Sales and marketing921 1,158 1,171Research and development590 561 636General and administrative1,923 1,941 1,933Stock-based compensation before income taxes3,649 3,881 3,947Income tax benefit(1,185) (1,343) (1,361)Stock-based compensation after income taxes$2,464 $2,538 $2,58664Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS12. STOCK-BASED COMPENSATION (CONTINUED)The following table summarizes our stock option activity (in thousands, except per common share amounts): OptionsOutstanding Weighted AverageExercised Price Weighted AverageContractual Term (inyears) AggregateIntrinsic Value(1)Balance at September 30, 2015 4,800 $10.21 Granted 553 11.46 Exercised (772) 9.65 Forfeited / Canceled (618) 11.06 Balance at September 30, 2016 3,963 $10.36 4.5 $6,078 Exercisable at September 30, 2016 2,857 $10.49 3.7 $4,158(1) The aggregate intrinsic value represents the total pre-tax intrinsic value, based on our closing stock price of $11.40 as of September 30, 2016, whichwould have been received by the option holders had all option holders exercised their options as of that date.The intrinsic value of an option is the amount by which the fair value of the underlying stock exceeds its exercise price. The total intrinsic value of alloptions exercised during each of the twelve months ended September 30, 2016, 2015 and 2014 was $1.9 million, $0.9 million and $0.5 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, 2016 2015 2014Weighted average per option grant date fair value$3.90 $2.98 $4.35Assumptions used for option grants: Risk free interest rate1.22% - 1.85% 1.57% - 1.85% 1.76% - 2.02%Expected term6.00 years 6.00 years 6.00 yearsExpected volatility32% - 33% 32% - 36% 38% - 40%Weighted average volatility32% 35% 40%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 optionexercise and employee termination information within the valuation model. The expected term of options granted is derived from the vesting period andhistorical information and represents the period of time that options granted are expected to be outstanding. The risk-free rate used is the zero-coupon U.S.Treasury bond rate in effect at the time of the grant whose maturity equals the expected term of the option.We use historical data to estimate pre-vesting forfeiture rates. The pre-vesting forfeiture rate used in fiscal 2016 was 10.0%. As of September 30, 2016, thetotal unrecognized compensation cost related to non-vested stock-based compensation arrangements, net of expected forfeitures, was $2.9 million and therelated weighted average period over which it is expected to be recognized was approximately 3.0 years.65Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS12. STOCK-BASED COMPENSATION (CONTINUED)At September 30, 2016, 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$7.40 - $8.03 611 4.35 $7.74 460 $7.85$8.04 - $9.03 627 5.49 $8.52 234 $8.42$9.04 - $9.68 685 5.00 $9.53 662 $9.53$9.69 - $10.81 830 5.24 $10.57 664 $10.58$10.82 - $12.63 724 5.13 $12.10 351 $11.73$12.64 - $14.75 268 0.39 $13.47 268 $13.47$14.76 - $15.23 218 1.16 $15.23 218 $15.23$7.40 - $15.23 3,963 4.53 $10.36 2,857 $10.49The total grant date fair value of shares vested was $2.9 million in both fiscal 2016 and 2015 and $0.8 million in fiscal 2014.A summary of our non-vested restricted stock units as of September 30, 2016 and changes during the twelve months then ended is presented below (inthousands, except per common share amounts): Number of Awards Weighted AverageGrant Date Fair ValueNonvested at September 30, 2015543 $8.41Granted251 $10.92Vested(185) $8.55Canceled(104) $8.13Nonvested at September 30, 2016505 $9.67As of September 30, 2016, the total unrecognized compensation cost related to non-vested restricted stock units was $3.0 million and the related weightedaverage period over which it is expected to be recognized was approximately 1.3 years.13. COMMON STOCK REPURCHASECommon Stock Repurchase ProgramOn October 29, 2013, 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. During the first quarter of fiscal 2015, we repurchased 287,787 shares for $2.2 million under thisplan which expired on October 31, 2014.On October 28, 2014, our Board of Directors authorized a program to repurchase up to $15.0 million of our common stock primarily to return capital toshareholders and to support our employee stock purchase program. This authorization began on November 1, 2014 and expired on October 31, 2015. Therewere no shares repurchased under this program.On April 26, 2016, our Board of Directors authorized a program to repurchase up to $15.0 million of our common stock primarily to return capital toshareholders. This authorization expires on May 1, 2017. Shares repurchased under this program may be made through open market and privately negotiatedtransactions from time to time and in amounts that management deems appropriate. The amount and timing of share repurchases, if any, depends upon marketconditions and other corporate considerations. There were no shares repurchased under this program as of September 30, 2016.66Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS14. 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 Rightswill expire on June 30, 2018, unless extended or earlier redeemed or exchanged by us as defined in the Share Rights Agreement.15. 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 2016, $1.7 million for fiscal 2015 and $1.6 million for fiscal 2014.16. COMMITMENTSWe have entered into various operating lease agreements for office facilities and equipment, the last of which expires in fiscal 2020. 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 ona straight-line basis over the term of the lease.The following schedule reflects future minimum rental commitments under noncancelable operating leases (in thousands):Fiscal year Amount2017 $1,7062018 9582019 8002020 3882021 70Thereafter —Total minimum payments required $3,922The 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, 2016 2015 2014Rentals$1,613 $2,076 $2,606Less: sublease rentals(46) (56) (24)Total rental expense$1,567 $2,020 $2,58217. CONTINGENCIESPatent Infringement LawsuitsIn 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 thesematters, 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 effecton our operations in any particular period.67Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS18. QUARTERLY FINANCIAL DATA (UNAUDITED)(in thousands, except per common share data) Quarter ended Dec. 31 March 31 June 30 Sept. 30Fiscal 2016 Revenue$50,259 $50,162 $52,130 $50,454Gross profit24,357 24,742 25,977 24,604Income from continuing operations (1)(2)3,131 2,226 4,277 3,844Income (loss) from discontinued operations, after income taxes3,319 (89) — —Net income (1)(2)6,450 2,137 4,277 3,844Basic net income per common share: Continuing operations0.12 0.09 0.17 0.15Discontinued operations0.13 — — —Net income (4)0.25 0.08 0.17 0.15Diluted net income per common share: Continuing operations0.12 0.09 0.16 0.14Discontinued operations0.13 — — —Net income (4)0.25 0.08 0.16 0.14 Fiscal 2015 Revenue$47,218 $50,401 $52,055 $54,173Gross profit22,557 23,235 25,024 26,305Income from continuing operations (1)(2)(3)1,018 1,662 3,085 3,668Loss from discontinued operations, after income taxes(1,357) (216) (589) (683)Net (loss) income (1)(2)(3)(339) 1,446 2,496 2,985Basic net income (loss) per common share: Continuing operations0.04 0.07 0.12 0.15Discontinued operations(0.06) (0.01) (0.02) (0.03)Net (loss) income (4)(0.01) 0.06 0.10 0.12Diluted net income (loss) per common share: Continuing operations0.04 0.07 0.12 0.14Discontinued operations(0.06) (0.01) (0.02) (0.03)Net (loss) income (4)(0.01) 0.06 0.10 0.12(1)During fiscal 2016 and 2015, we recorded net tax benefits of $1.5 million and $0.8 million, respectively. We recorded a benefit of $0.7 million in thefirst quarter of fiscal 2016 resulting from the reinstatement of the research and development tax credit for calendar year 2015, reversal of income taxreserves due to the expiration of the statute of limitations from various U.S. and foreign tax jurisdictions and reversal of tax reserves due to theresolution of tax audits. In the third quarter of fiscal 2016, we recorded a tax benefit of $0.5 million primarily due to the filing of an amended incometax return resulting in a domestic refund related to qualified manufacturing activities. In the fourth quarter of fiscal 2016, we recorded a net tax benefitof $0.2 million, primarily due to the filing of an additional amended income tax return resulting in an additional domestic refund related to qualifiedmanufacturing activities, partially offset by an adjustment of the state rate on net deferred tax assets. We recorded net tax benefits of $0.5 million in thefirst quarter of fiscal 2015 resulting from the reinstatement of the research and development tax credit for calendar year 2014, reversal of income taxreserves due to the expiration of the statute of limitations from various U.S. and foreign tax jurisdictions and reversal of tax reserves due to theresolution of tax audits. In the third quarter of fiscal 2015, we recorded a tax benefit of $0.4 million primarily due to the reversal of reserves for stateresearch and development tax credits and transfer pricing, partially offset by an adjustment of the state rate on net deferred tax assets.68Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS18. QUARTERLY FINANCIAL DATA (UNAUDITED)(CONTINUED)(2)For continuing operations, we recorded business restructuring charges of $0.7 million ($0.4 million after tax) in the first quarter of fiscal 2016, $0.1million ($0.1 million after tax) in the second quarter of fiscal 2016 and $0.4 million ($0.3 million after tax) in the second quarter of fiscal 2015.(3)During fiscal 2015, we recorded a gain of $1.4 million from the settlement of a property and casualty insurance claim related to the replacement of ourcapital equipment destroyed in the fire at our subcontract manufacturer's location. We recorded $1.0 million ($0.6 million after tax) during the secondquarter of fiscal 2015 and $0.4 million ($0.3 million after tax) during the third quarter of fiscal 2015.(4)Earnings per share are calculated by line item and may not add due to the use of rounded amounts.19. SUBSEQUENT EVENTAcquisition of FreshTemp, LLCOn November 1, 2016, we purchased all of the outstanding stock of FreshTemp, LLC, a Pittsburgh-based provider of temperature monitoring and taskmanagement solutions for the food industry. We believe this is a complementary acquisition for us as the acquired technology will continue to be supportedto create an advanced portfolio of products for the Digi Cold Chain Solution's market.The terms of the acquisition included an upfront cash payment together with future earn-out payments and a holdback amount. Cash of $1.7 million was paidat time of closing. The earn-out payments are scheduled to be paid after June 30, 2017 which is the end of the earn-out period. The cumulative amount ofthese earn-out payments will not exceed $2.3 million. A preliminary purchase price allocation, estimated acquisition costs and proforma financialinformation are not available due to the timing of the acquisition.69Table of ContentsITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURENone.ITEM 9A. CONTROLS AND PROCEDURESThis Annual Report on Form 10-K includes the certifications attached as Exhibits 31.1 and 31.2 of our Chief Executive Officer and Chief Financial Officerrequired by Rule 13a-14 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). This Item 9A includes information concerning thecontrols and control evaluations referred to in those certifications.Evaluation of Disclosure Controls and ProceduresWe maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act that are designed to providereasonable assurance that information required to be disclosed in our reports filed or submitted under the Exchange Act) is recorded, processed, summarizedand reported within the time periods specified in the SEC’s rules and forms and that such information is accumulated and communicated to management ofthe Company, including our Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosure.Management, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the design and operationof our disclosure controls and procedures as of September 30, 2016. Based on their evaluation, the Chief Executive Officer and Chief Financial Officerconcluded that, as of September 30, 2016, our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d - 15(e) under the Security ExchangeAct of 1934, as amended) were not effective because of the material weakness in internal control over financial reporting described below.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). Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability offinancial reporting and the preparation of our consolidated financial statements for external purposes in accordance with generally accepted accountingprinciples. Management, with the participation of our Chief Executive Officer and Chief Financial Officer, assessed the effectiveness of our internal controlover financial reporting as of September 30, 2016.In making this assessment, management used the framework set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) inInternal Control - Integrated Framework (2013). A material weakness is a deficiency, or combination of deficiencies, in internal control over financialreporting, such that there is a reasonable possibility that a material misstatement of our interim or annual financial statements will not be prevented ordetected on a timely basis.We did not design effective controls to identify and maintain segregation of duties between the ability to create and post manual journal entries to thegeneral ledger system for a key accounting individual as we moved locations at one of our subsidiaries, impacting the accuracy and completeness of all keyaccounts and disclosures at our German subsidiary. Specifically, the individual was assigned system access to both prepare and post journal entries, whileholding responsibility for review of certain monthly account reconciliations, without his entries being subject to an independent review.The material weakness resulting from this deficiency did not result in any adjustments to the consolidated financial statements for the fiscal year endedSeptember 30, 2016. However, this deficiency could result in misstatements to all key accounts and disclosures at our German subsidiary that would result ina material misstatement to our consolidated financial statements that would not be prevented or detected on a timely basis. Because of this material weakness,management concluded that the Company did not maintain effective internal control over financial reporting as of September 30, 2016, based on criteria inInternal Control - Integrated Framework (2013) issued by COSO.The effectiveness of our internal control over financial reporting as of September 30, 2016 has been audited by PricewaterhouseCoopers LLP, an independentregistered public accounting firm, as stated in their report, which appears in Item 8 of this Annual Report on Form 10-K.Remediation Efforts on the Material Weakness in Internal Control Over Financial ReportingWe are in the process of improving our internal controls to remediate the material weakness that existed as of September 30, 2016, as described above inManagement’s Report on Internal Control Over Financial Reporting. We removed access to create and post journal entries from the member of the accountingteam with incompatible duties as of September 30, 2016. In70Table of Contentsaddition, a thorough review of all journal entries made by the individual revealed no irregularities or errors. Although this was an isolated case, we intend toenhance our access review controls for our financial system to include a review of all employee status changes. We are also reviewing our procedures aroundthe completeness of journal entry review to ensure that all manual journal entries are subject to independent review. The actions we take are subject toongoing review by senior members of management, as well as audit committee oversight. We expect to remediate the identified material weakness by the endof our second fiscal quarter of 2017.Changes in Internal Control Over Financial ReportingThere have been no changes in our internal control over financial reporting during the quarterly period ended September 30, 2016 that have materiallyaffected, or are reasonably likely to materially affect, our internal control over financial reporting.ITEM 9B. OTHER INFORMATIONNone71Table 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 2017 Annual Meeting of Stockholders we intend to 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 PositionRonald E. Konezny 48 President and Chief Executive OfficerMichael C. Goergen 49 Senior Vice President, Chief Financial Officer and TreasurerJon A. Nyland 53 Vice President Manufacturing OperationsKevin C. Riley 55 Chief Operating OfficerTracy L. Roberts 54 Vice President of Technology ServicesDavid H. Sampsell 48 Vice President of Corporate Development, General Counsel and Corporate SecretaryJoel K. Young 52 Senior Vice President of Research and Development and Chief Technical OfficerRonald E. Konezny has served as President and Chief Executive Officer and as a member of our Board of Directors since December 2014. He previouslyserved as Vice President, Global Transportation and Logistics at Trimble Navigation Limited, a global provider of navigation and range-finding equipmentand related solutions, from September 2013 to December 2014. From August 2011 to September 2013, he served as General Manager of Trimble’s GlobalTransportation and Logistics division. From 2007 to September 2013, he served as Chief Executive Officer of PeopleNet, Inc., a provider of telematicssolutions for the transportation industry, which was acquired by Trimble in 2011. Mr. Konezny founded PeopleNet in 1996 and served in various other roles,including Chief Technology Officer, Chief Financial Officer and Chief Operating Officer, before serving as its Chief Executive Officer. Mr. Konezny serveson the board of directors of I.D. Systems, Inc.Michael C. Goergen has served as Senior Vice President, Chief Financial Officer and Treasurer since April 2015. He previously served as Senior VicePresident - Finance of the Transport - Logistics division of Trimble Navigation Limited from April 2013 to March, 2015. From June 2007 to April, 2013, Mr.Goergen served as Chief Financial Officer of PeopleNet Communications, which was acquired by Trimble in 2011. He had served in various financial roles atPeopleNet since 1997.Jon A. Nyland has served as Vice President of Manufacturing Operations since April 1999. He joined our company in 1993 as Manager of Manufacturing andTest Engineering and served in roles of increasing responsibility until reaching his current position. Prior to joining us, from 1985 to 1993, Mr. Nyland heldengineering and consulting positions with ITT Corporation, Minnesota Technology, and Turtle Mountain Corporation.Kevin C. Riley has served as Senior Vice President and Chief Operating Officer since January 2016 and previously served as Senior Vice President of GlobalSales between January 2013 and January 2016. Prior to joining us, Mr. Riley served as Senior Vice President - Global Markets for Infor Global Solutions, anenterprise software solutions company, where he led four global business units to profitable growth from January 2010 to November 2011. He served as VicePresident and General Manager at Oracle, an enterprise software company, from 2008 to 2010, and President of Global Knowledge Software from 2002 untilGlobal Knowledge Software's acquisition by Oracle in 2008. He also served as President and Chief Operating Officer for Learn2 Corporation from 1999 to2002.Tracy L. Roberts has served as Vice President of Information Technology since March 2005 and Vice President of Technology Services since July 2013. Shealso previously served as Vice President of Human Resources from March 2005 until May 2016. Prior to joining us, Ms. Roberts served as Director of HumanResources at Novartis Nutrition Corporation where she was responsible for the medical nutritional business unit. Ms. Roberts held various human resourceand marketing positions at Cray Research (now known as Silicon Graphics) from 1983 to 1996.72Table of ContentsITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE (CONTINUED)David H. Sampsell has served as Vice President of Corporate Development, General Counsel and Corporate Secretary since January 2015. He had previouslyserved as Vice President, General Counsel and Corporate Secretary since April 2011. Prior to joining us, Mr. Sampsell worked as corporate counsel at ADCTelecommunications, 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 Counsel overseeing corporate transactions andsecurities law compliance. Prior to joining ADC, Mr. Sampsell was an attorney in private practice with Leonard, Street and Deinard, P.A. from 1996 to 1999and Moore & Van Allen, PLLC from 1993 to 1996.Joel K. Young has served as Senior Vice President of Research and Development and Chief Technical Officer since 2006. He joined us in 2000 and served asVice President of Engineering until 2005 when he served as Vice President of Research and Development and Chief Technical Officer until 2006. 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 Ethics/Code of ConductWe 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 financial code of ethics is available on our website(www.digi.com) under the “Company - Investor Relations - Corporate Governance” caption. We intend to satisfy our disclosure obligations regarding anyamendment to, or a waiver from, a provision of this code of ethics by posting such information on the same website. We also have a “code of conduct” thatapplies to all directors, officers and employees, a copy of which is available through our website (www.digi.com) under the “Company - 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 STOCKHOLDER MATTERSIncorporated 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” andthe information 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. 4 - Ratification of Independent Registered Public Accounting Firm” in ourProxy Statement.73Table of ContentsPART IV.ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULESUnless otherwise indicated, all documents incorporated into this Annual Report on Form 10-K by reference to a document filed with the SEC are locatedunder SEC file number 1-34033.(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, 2016, 2015 and 2014 Consolidated Statements of Comprehensive Income (Loss) for fiscal years ended September 30, 2016, 2015 and 2014 Consolidated Balance Sheets as of September 30, 2016 and 2015 Consolidated Statements of Cash Flows for fiscal years ended September 30, 2016, 2015 and 2014 Consolidated Statements of Stockholders’ Equity for fiscal years ended September 30, 2016, 2015 and 2014 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 2 Stock Purchase Agreement with West Monroe Partners, LLC dated as of October 23, 2015* (1) 3(a) Restated Certificate of Incorporation of the Company, as amended (2) 3(b) Amended and Restated By-Laws of the Company (3) 4(a) Share Rights Agreement, dated as of April 22, 2008, between the Company and Wells Fargo Bank, N.A., as Rights Agent(4) 4(b) Form of Amended and Restated Certificate of Powers, Designations, Preferences and Rights of Series A Junior ParticipatingPreferred Shares (5) 10(a) Digi International Inc. Stock Option Plan as Amended and Restated as of November 27, 2006** (6) 10(a)(i) Form of Notice of Grant of Stock Options and Option Agreement (for grants under Digi International Inc. Stock OptionPlan)** (7) 10(b) Digi International Inc. Non-Officer Stock Option Plan, as Amended and Restated as of November 27, 2006 (8) 10(c) Digi International Inc. Employee Stock Purchase Plan as amended and restated as of October 29, 2013** (9) 10(d) Digi International Inc. 2000 Omnibus Stock Plan, as amended and restated as of December 4, 2009** (10) 10(d)(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(d)(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(e) Digi International Inc. 2013 Omnibus Incentive Plan** (13) 10(e)(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(e)(ii) Form of (Director) Restricted Stock Unit Award Agreement (for awards under Digi International Inc. 2013 OmnibusIncentive Plan)** (15)74Table of ContentsITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES (CONTINUED) 10(f) Digi International Inc. 2014 Omnibus Incentive Plan** (16) 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. 2014 Omnibus Incentive Plan)** (17) 10(f)(ii) Form of (Director) Restricted Stock Unit Award Agreement (for awards under Digi International Inc. 2014 OmnibusIncentive Plan)** (18) 10(f)(iii) Form of (Executive) Restricted Stock Unit Award Agreement (for awards under Digi International Inc. 2014 OmnibusIncentive Plan)** (19) 10(g) Digi International Inc. 2016 Omnibus Incentive Plan* (20) 10(g)(i) Form of (Director) Restricted Stock Unit Award Agreement (for awards under Digi International Inc. 2016 OmnibusIncentive Plan)* (21) 10(g)(ii) Form of (Executive) Restricted Stock Unit Award Agreement (for awards under Digi International Inc. 2016 OmnibusIncentive Plan)* (22) 10(g)(iii) Form of (Employee) Restricted Stock Unit Award Agreement (for awards under Digi International Inc. 2016 OmnibusIncentive Plan)* (23) 10(g)(iv) Form of Notice of Grant of Stock Options and Option Agreement (for grants under Digi International Inc. 2016 OmnibusIncentive Plan)* (24) 10(h) Form of indemnification agreement with directors and officers of the Company** (25) 10(i) Employment Agreement between the Company and Ronald E. Konezny dated November 26, 2014** (26) 10(j) Agreement between the Company and Joel K. Young dated July 30, 2007** (27) 10(k) Offer Letter Agreement, dated as of October 28, 2010 between the Company and Steven E. Snyder** (28) 10(l) Agreement between the Company and Jon A. Nyland dated September 17, 2013** (29) 10(m) Offer Letter Agreement, dated as of April 8, 2011 between the Company and David H. Sampsell** (30) 10(n) Transition Agreement between the Company and Steven E. Snyder dated March 25, 2015** (31) 10(o) Offer letter between the Company and Michael C. Goergen dated March 6, 2015** (32) 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____________________________75Table of ContentsITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES (CONTINUED)*Certain schedules and exhibits have been omitted in accordance with Item 601(b)(2) of Regulation S-K. A copy of any omitted schedule and/or exhibitwill be furnished to the Securities and Exchange Commission upon request.**Management compensatory contract or arrangement required to be included as an exhibit to this Annual Report on Form 10-K.(1)Incorporated by reference to Exhibit 2.1 to the Company's Form 8-K filed October 29, 2015.(2)Incorporated by reference to Exhibit 3(a) to the Company’s Form 10‑K for the year ended September 30, 1993 (File no. 0‑17972).(3)Incorporated by reference to Exhibit 3 to the Company's Form 8-K dated January 18, 2011 (File no. 1‑34033).(4)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).(5)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).(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 99 to the Company’s Registration Statement on Form S-8 filed on March 12, 2014 (File no. 333‑194522).(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 99 to the Company’s Registration Statement on Form S-8 filed on March 12, 2014 (File no. 333‑194518).(17)Incorporated by reference to Exhibit 10(b)(i) to the Company’s Form 10-Q for the quarter ended March 31, 2014 (File no. 1-34033).(18)Incorporated by reference to Exhibit 10(b)(ii) to the Company’s Form 10-Q for the quarter ended March 31, 2014 (File no. 1-34033).(19)Incorporated by reference to Exhibit 10(a) to the Company’s Form 10-Q for the quarter ended June 30, 2014 (File no. 1-34033).(20)Incorporated by reference to Appendix A to the Company’s definitive proxy statement on Schedule 14A filed December 11, 2015 (File No. 1-34033)(21)Incorporated by reference to Exhibit 10(a)(i) to the Company’s Form 10-Q for the quarter ended March 31, 2016 (File no. 1-34033).(22)Incorporated by reference to Exhibit 10(a)(ii) to the Company’s Form 10-Q for the quarter ended March 31, 2016 (File no. 1-34033).(23)Incorporated by reference to Exhibit 10(a)(iii) to the Company’s Form 10-Q for the quarter ended March 31, 2016 (File no. 1-34033).(24)Incorporated by reference to Exhibit 10(a)(iv) to the Company’s Form 10-Q for the quarter ended March 31, 2016 (File no. 1-34033). (25)Incorporated by reference to Exhibit 10 to the Company’s Form 10‑Q for the quarter ended June 30, 2010 (File no. 1‑34033).(26)Incorporated by reference to Exhibit 10.1 to the Company's Form 8-K dated December 3, 2014 (File no. 1-34033).(27)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).76Table of ContentsITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES (CONTINUED)(28)Incorporated by reference to Exhibit 10 to the Company’s Form 10‑Q for the quarter ended December 31, 2010 (File no. 1‑34033).(29)Incorporated by reference to Exhibit 10(l) to the Company's Form 10-K for the year ended September 30, 2013 (File no. 1‑34033).(30)Incorporated by reference to Exhibit 10(m) to the Company's Form 10-K for the year ended September 30, 2013 (File no. 1‑34033).(31)Incorporated by reference to Exhibit 10.1 to the Company's Form 8-K filed March 26, 2015.(32)Incorporated by reference to Exhibit 10.2 to the Company's Form 8-K filed March 26, 2015.77Table 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 December 13, 2016. DIGI INTERNATIONAL INC. By: /s/ Ronald E. Konezny Ronald E. KoneznyPresident, 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 Registrantand in the capacities indicated on December 13, 2016. By: /s/ Ronald E. Konezny Ronald E. KoneznyPresident, Chief Executive Officer and Director(Principal Executive Officer) By: /s/ Michael C. Goergen Michael C. GoergenSenior Vice President, Chief Financial Officer and Treasurer(Principal Financial Officer and Principal Accounting Officer) By:* William N. PriesmeyerDirector By:* Satbir KhanujaDirector By:* Ahmed NawazDirector By:* Girish RishiDirector By:* Spiro LazarakisDirector*Ronald E. Konezny, 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/ Ronald E. Konezny Ronald E. KoneznyAttorney-in-fact78Table of ContentsSCHEDULE II - VALUATION AND QUALIFYING ACCOUNTSDIGI INTERNATIONAL INC.(in thousands)Description Balance atbeginning ofperiod Increase to costsand expenses Deductions Balance at endof periodValuation allowance - deferred tax assets September 30, 2016 $862 $5,260 $208 $5,914September 30, 2015 $572 $316 $26 $862September 30, 2014 $807 $174 $409 $572 Valuation account - doubtful accounts September 30, 2016 $285 $10 $86(1) $209September 30, 2015 $367 $4 $86(1) $285September 30, 2014 $313 $209 $155(1) $367 Reserve for future returns and pricing adjustments September 30, 2016 $1,817 $9,946 $9,772 $1,991September 30, 2015 $1,662 $7,002 $6,847 $1,817September 30, 2014 $1,770 $6,526 $6,634 $1,662(1)Uncollectible accounts charged against allowance, net of recoveries79Table of ContentsExhibit Number DescriptionMethod of Filing2 Stock Purchase Agreement with West Monroe Partners, LLC dated as of October 23, 2015Incorporation byReference 3(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) Digi International Inc. Stock Option Plan as Amended and Restated as of November 27, 2006Incorporation byReference 10(a)(i) Form of Notice of Grant of Stock Options and Option AgreementIncorporation byReference 10(b) Digi International Inc. Non-Officer Stock Option Plan, as Amended and Restated as of November 27, 2006Incorporation byReference 10(c) Digi International Inc. Employee Stock Purchase Plan as amended and restated as of October 29, 2013Incorporation byReference 10(d) Digi International Inc. 2000 Omnibus Stock Plan, as amended and restated as of December 4, 2009Incorporation byReference 10(d)(i) Form of Notice of Grant of Stock Options and Option AgreementIncorporation byReference 10(d)(ii) Form of Notice of Grant of Stock Options and Option AgreementIncorporation byReference 10(e) Digi International Inc. 2013 Omnibus Incentive PlanIncorporation byReference 10(e)(i) Form of Notice of Grant of Stock Options and Option Agreement including Addendums to OptionAgreement that may apply to certain grantsIncorporation byReference 10(e)(ii) Form of (Director) Restricted Stock Unit Award AgreementIncorporation byReference 10(f) Digi International Inc. 2014 Omnibus Incentive PlanIncorporation byReference 10(f)(i) Form of Notice of Grant of Stock Options and Option Agreement including Addendums to OptionAgreement that may apply to certain grants (for grants under Digi International Inc. 2014 OmnibusIncentive Plan)Incorporation byReference 10(f)(ii) Form of (Director) Restricted Stock Unit Award Agreement (for awards under Digi International Inc. 2014Omnibus Incentive Plan)Incorporation byReference 10(f)(iii) Form of (Executive) Restricted Stock Unit Award Agreement (for awards under Digi International Inc. 2014Omnibus Incentive Plan)Incorporation byReference 10(g) Digi International Inc. 2016 Omnibus Incentive PlanIncorporation byReference 10(g)(i) Form of (Director) Restricted Stock Unit Award Agreement (for awards under Digi International Inc. 2016Omnibus Incentive Plan)Incorporation byReference 10(g)(ii) Form of (Executive) Restricted Stock Unit Award Agreement (for awards under Digi International Inc. 2016Omnibus Incentive Plan)Incorporation byReference 10(g)(iii) Form of (Employee) Restricted Stock Unit Award Agreement (for awards under Digi International Inc. 2016Omnibus Incentive Plan)Incorporation byReference 80Table of ContentsExhibit Number DescriptionMethod of Filing10(g)(iv) Form of Notice of Grant of Stock Options and Option Agreement (for grants under Digi International Inc.2016 Omnibus Incentive Plan)Incorporation byReference 10(h) Form of indemnification agreement with directors and officers of the CompanyIncorporation byReference 10(i) Employment Agreement between the Company and Ronald E. Konezny dated November 26, 2014Incorporation 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, 2013Incorporation byReference 10(m) Offer Letter Agreement, dated as of April 8, 2011 between the Company and David H. SampsellIncorporation byReference 10(n) Transition Agreement between the Company and Steven E. Snyder dated March 25 ,2015Incorporation byReference 10(o) Offer Letter between the Company and Michael C. Goergen dated March 6, 2015Incorporation byReference 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 DocumentElectronically81EXHIBIT 21Subsidiaries of the CompanyName JurisdictionFreshTemp, LLC Pennsylvania, United StatesBluenica Corporation Ontario, CanadaDigi International GmbH GermanyDigi International (HK) Ltd. Hong KongDigi International Kabushikikaisha JapanDigi International Limited United KingdomDigi International SARL FranceDigi International Spain S.A. SpainDigi International Wireless Design Services Inc. Minnesota, United StatesDigi m2m Solutions India Pvt. Ltd. IndiaDigi Wireless Singapore Pte. Ltd. SingaporeITK International Inc. Delaware, United States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, 333-169428, 333-194518, 333-194522, and 333-209958) of Digi International Inc. of our report dated December 13, 2016 relatingto the financial statements, financial statement schedule and the effectiveness of internal control over financial reporting, which appears in this Form 10‑K./s/PricewaterhouseCoopers LLPMinneapolis, MinnesotaDecember 13, 2016EXHIBIT 24DIGI INTERNATIONAL INC.Power of AttorneyThe undersigned director of Digi International Inc., a Delaware corporation, does hereby make, constitute and appoint Ronald E. Konezny and MichaelC. Goergen, and either of them, the undersigned’s true and lawful attorney-in-fact and agent, 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 for the fiscal year ended September 30, 2016, and all amendments thereto, to be filed by said corporation with the U.S. Securities andExchange Commission, Washington, D.C. (the “SEC”), and to file the same with all exhibits thereto and other supporting documents in connection therewithwith the SEC, 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 tothe performance and execution of the powers herein expressly granted.IN WITNESS WHEREOF, the undersigned has hereunto set the undersigned’s hand this 20th day of November, 2016. /s/ Satbir Khanuja Satbir Khanuja DIGI INTERNATIONAL INC.Power of AttorneyThe undersigned director of Digi International Inc., a Delaware corporation, does hereby make, constitute and appoint Michael C. Goergen and David H.Sampsell, and either of them, the undersigned’s true and lawful attorney-in-fact and agent, 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 for the fiscal year ended September 30, 2016, and all amendments thereto, to be filed by said corporation with the U.S. Securities andExchange Commission, Washington, D.C. (the “SEC”), and to file the same with all exhibits thereto and other supporting documents in connection therewithwith the SEC, 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 tothe performance and execution of the powers herein expressly granted.IN WITNESS WHEREOF, the undersigned has hereunto set the undersigned’s hand this 18th day of November, 2016. /s/ Ronald E. Konezny Ronald E. Konezny DIGI INTERNATIONAL INC.Power of AttorneyThe undersigned director of Digi International Inc., a Delaware corporation, does hereby make, constitute and appoint Ronald E. Konezny and MichaelC. Goergen, and either of them, the undersigned’s true and lawful attorney-in-fact and agent, 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 for the fiscal year ended September 30, 2016, and all amendments thereto, to be filed by said corporation with the U.S. Securities andExchange Commission, Washington, D.C. (the “SEC”), and to file the same with all exhibits thereto and other supporting documents in connection therewithwith the SEC, 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 tothe performance and execution of the powers herein expressly granted.IN WITNESS WHEREOF, the undersigned has hereunto set the undersigned’s hand this 18th day of November, 2016. /s/ Spiro C. Lazarakis Spiro C. Lazarakis DIGI INTERNATIONAL INC.Power of AttorneyThe undersigned director of Digi International Inc., a Delaware corporation, does hereby make, constitute and appoint Ronald E. Konezny and MichaelC. Goergen, and either of them, the undersigned’s true and lawful attorney-in-fact and agent, 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 for the fiscal year ended September 30, 2016, and all amendments thereto, to be filed by said corporation with the U.S. Securities andExchange Commission, Washington, D.C. (the “SEC”), and to file the same with all exhibits thereto and other supporting documents in connection therewithwith the SEC, 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 tothe performance and execution of the powers herein expressly granted.IN WITNESS WHEREOF, the undersigned has hereunto set the undersigned’s hand this 18th day of November, 2016. /s/ Ahmed Nawaz Ahmed Nawaz DIGI INTERNATIONAL INC.Power of AttorneyThe undersigned director of Digi International Inc., a Delaware corporation, does hereby make, constitute and appoint Ronald E. Konezny and MichaelC. Goergen, and either of them, the undersigned’s true and lawful attorney-in-fact and agent, 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 for the fiscal year ended September 30, 2016, and all amendments thereto, to be filed by said corporation with the U.S. Securities andExchange Commission, Washington, D.C. (the “SEC”), and to file the same with all exhibits thereto and other supporting documents in connection therewithwith the SEC, 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 tothe performance and execution of the powers herein expressly granted.IN WITNESS WHEREOF, the undersigned has hereunto set the undersigned’s hand this 21st day of November, 2016. /s/ William N. Priesmeyer William N. Priesmeyer DIGI INTERNATIONAL INC.Power of AttorneyThe undersigned director of Digi International Inc., a Delaware corporation, does hereby make, constitute and appoint Ronald E. Konezny and MichaelC. Goergen, and either of them, the undersigned’s true and lawful attorney-in-fact and agent, 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 for the fiscal year ended September 30, 2016, and all amendments thereto, to be filed by said corporation with the U.S. Securities andExchange Commission, Washington, D.C. (the “SEC”), and to file the same with all exhibits thereto and other supporting documents in connection therewithwith the SEC, 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 tothe 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, 2016. /s/ Girish Rishi Girish Rishi Exhibit No. 31(a)CERTIFICATION PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002I, Ronald E. Konezny, 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 thestatements made, 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 theRegistrant and 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, particularlyduring the 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 accordancewith generally 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 ofthe disclosure 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. December 13, 2016/s/ Ronald E. Konezny Ronald E. Konezny President, Chief Executive Officer and Director Exhibit No. 31(b)CERTIFICATION PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002I, Michael C. Goergen, 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 thestatements made, 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 theRegistrant and 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, particularlyduring the 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 accordancewith generally 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 ofthe disclosure 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. December 13, 2016/s/ Michael C. Goergen Michael C. Goergen 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, 2016 (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. December 13, 2016 /s/ Ronald E. Konezny Ronald E. Konezny President, Chief Executive Officer and Director December 13, 2016 /s/ Michael C. Goergen Michael C. Goergen Senior Vice President, Chief Financial Officer and Treasurer 

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