DIGI INTERNATIONAL INC – 10-K – MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Edgar Online, Inc.

OVERVIEW

 We are a leading provider of machine to machine (M2M) networking products and solutions that enable the connection, monitoring and control of local or remote physical assets by electronic means. These networking products and solutions connect communication hardware to a physical asset so that information about that asset's status and performance can be sent to a computer system and used to improve or automate one or more processes. Increasingly these products and solutions are deployed via wireless networks. Our hardware products have been the historical foundation of our business. In 2009, we introduced a cloud-based internet platform (iDigi®) which our customers can utilize to monitor and control electronic devices. Our products are deployed by a wide range of businesses and institutions. We have a single operating and reporting segment. Our revenues consist of products that are in non-embedded and embedded product categories. Non-embedded products are connected externally to a device or larger system to provide wired or wireless network connectivity or port expansion, while embedded products are used by a product developer to build an electronic device in which the product provides processing power, wired Ethernet, or wireless network connectivity to that device. The products included in the non-embedded product category include cellular products, wireless communication adapters, console and serial servers, USB connected products and serial cards. The products included in the embedded product category include modules, single-board computers, chips, software and development tools, design services and satellite communication products. We utilize many financial, operational, and other metrics to evaluate both our financial condition and our financial performance. Below we highlight the results of those financial metrics that we feel are most important in these evaluations: 

• Net Sales were approximately $204 Million. Our net sales were

$204.2 million in fiscal 2011, and increased by 11.8% compared to net

sales of approximately $182.5 million in fiscal 2010. Wireless product net

         sales increased by $18.3 million, providing the majority of the          $21.7 million increase in revenue from fiscal 2010 to fiscal 2011.  

• Gross Profit was approximately $107 Million. Gross profit increased by

15.6% in fiscal 2011 to $106.6 million compared to $92.2 million in fiscal

2010. Our gross margin increased as a percentage of net sales to 52.2% in

fiscal 2011 from 50.5% in fiscal 2010. We focused on cost reduction

initiatives that allowed us to reduce the cost of our products and

increase gross profit through purchasing and manufacturing efficiencies

during the fiscal year. Favorable customer and product mix, as well as a

decrease in the amortization of purchased and core technology as certain

intangibles were fully amortized, also contributed to this increase. We

expect to continue to focus on gross margin as we implement our global

strategy of consolidation and production centers to drive more efficiency

improvements and enhance customer service.

• Operating Expenses Decreased as a Percentage of Net Sales in Fiscal 2011

         from Fiscal 2010. Operating expenses were $89.6 million or 43.9% of net          sales in fiscal 2011 versus $82.3 million or 45.0% of net sales in fiscal          2010. The increase in total operating expenses was largely          compensation-related and resulted from a net increase in headcount of 43

people as well as higher non-sales incentive compensation expenses. We

also invested in our iDigi® cloud-based platform during fiscal 2011 as we

worked to evolve our business model. Despite these increases, operating

         expenses as a percentage of net sales decreased during fiscal 2011          compared to fiscal 2010.                                            29 

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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS

           OF OPERATIONS   

OVERVIEW (CONTINUED)

• Net Income in Fiscal 2011 was $11.0 Million. Our net income increased by

$2.1 million to $11.0 million in fiscal 2011, or 23.2%, over net income of

$8.9 million in fiscal 2010. We leveraged the increase in net sales,

combined with cost reduction initiatives and lower operating expenses as a

percent of net sales to improve our profitability.

• Our Balance Sheet and Cash from Operations are Strong. Our current ratio

was 8.3 to 1 in fiscal 2011 compared to 6.7 to 1 in fiscal 2010. Cash from

operations was $21.8 million in fiscal 2011 compared to $16.1 million in

fiscal 2010.

We accomplished a number of key initiatives in fiscal 2011 and also faced significant challenges relative to our business. Accomplishments

    •    We increased revenue and earnings per diluted share in fiscal 2011          compared to the prior fiscal year and maintained a strong balance sheet          and cash flows which we believe provides a solid foundation for growing          our business.  

• We reduced our manufacturing costs for future periods by consolidating our

Breisach, Germany operations with our U.S. production facility.

• We invested significantly in the development of the iDigi® Device Cloud

platform and enhanced our capability to develop customized software

applications that leverage iDigi®, which expands our ability to provide

end-to-end solutions to our customers. We finished fiscal 2011 with over

3,500 companies using the iDigi® Device Cloud.

Challenges

    •    The global economic environment was volatile in fiscal 2011. We monitor          our bookings, backlog and anticipated shipments on a weekly basis which          allows us to stay abreast of rapidly changing economic conditions as we          forecast our revenue.       •    The strengthening of foreign currencies, particularly the Euro and the          British Pound, created net foreign currency losses due to balances held          abroad in non-functional currencies such as the U.S. dollar. We put in

place natural hedging and other strategies to minimize this exposure.

• Since certain of our components and other materials are purchased from

         regions susceptible to natural disasters as most recently seen in Japan          and Thailand, we faced challenges in procuring certain components and          other materials used in manufacturing. We believe the impact to our

business in fiscal 2011 from the Japan natural disaster was minimal, and

we addressed this primarily through the purchase of additional safety

stock for component parts normally sourced from that region. As previously

announced, the recent flooding in Thailand has affected the operations of

one of our contract manufacturers and this will impact our operations and

         financial results during fiscal 2012.                                            30 

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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS

           OF OPERATIONS   

OVERVIEW (CONTINUED)

• We believe we are approaching the inflection point in the wireless M2M

market, and that we are uniquely positioned for growth as we are able to

provide customers with complete networking solutions. The development of a

cloud-based platform is a critical component of our overall solution and

         go-to-market strategy, and we focused significant human capital and          financial resources on this initiative, while also managing our other          strategic objectives.   In order to continue to improve our financial and operational performance, address the growth of our business and meet our goal of becoming the leading global provider of wireless M2M networking products and end-to-end solutions, we believe we must focus on the following key priorities: 

• Continue delivery of products and solutions to the following four vertical

         markets that we believe promise extensive growth opportunities: energy,          fleet, medical and tank;       •    Enhance our capacity to develop software applications and our iDigi®          cloud-based platform and migrate our sales and marketing efforts towards

end-to-end solutions as opposed to sales of hardware products alone; and

• Further expand our strategic relationships with leading equipment

         manufacturers, application providers and systems integrators.                                            31 

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

CONSOLIDATED RESULTS OF OPERATIONS The following table sets forth selected information from our Consolidated Statements of Operations, expressed as a percentage of net sales and as a percentage of change from year-to-year for the years indicated.

                                                                                                                       % Increase (decrease)                                                                                                                       2011             2010                                                              Year ended September 30,                               compared         compared ($ in thousands)                             2011                      2010                      2009                to 2010          to 2009 Net sales                            $ 204,160       100.0 %   $ 182,548       100.0 %   $ 165,928       100.0 %          11.8 %          10.0 % Cost of sales (exclusive of amortization of purchased and core technology shown separately below)      94,702        46.4        86,266        47.3        80,470        48.5             9.8             7.2 Amortization of purchased and core technology                               2,870         1.4         4,073         2.2         4,193         2.5           (29.5 )          (2.9 )  Gross profit                           106,588        52.2        92,209        50.5        81,265        49.0            15.6            13.5 Operating expenses: Sales and marketing                     39,549        19.4        37,010        20.3        35,304        21.3             6.9             4.8 Research and development                31,642        15.5        27,825        15.2        26,381        15.9            13.7             5.5 General and administrative              18,206         8.9        17,889         9.8        14,557         8.7             1.8            22.9 Restructuring                              154         0.1          (468 )      (0.3 )       1,953         1.2           132.9          (124.0 )  Total operating expenses                89,551        43.9        82,256        45.0        78,195        47.1             8.9             5.2  Operating income                        17,037         8.3         9,953         5.5         3,070         1.9            71.2           224.2

Total other (expense) income, net (522 ) (0.2 ) 566

     0.3         1,212         0.7          (192.2 )         (53.3 )  Income before income taxes              16,515         8.1        10,519         5.8         4,282         2.6            57.0           145.7 Income tax provision                     5,496         2.7         1,578         0.9           199         0.1           248.3           693.0  Net income                           $  11,019         5.4 %   $   8,941         4.9 %   $   4,083         2.5 %          23.2 %         119.0 %    NET SALES Net sales were $204.2 million in fiscal 2011 compared to $182.5 million in fiscal 2010, an increase of $21.7 million or 11.8%, primarily due to a $26.6 million increase in the net sales of modules, cellular products, engineering design services, serial servers, chips and iDigi® services. This was partially offset by a $4.9 million decrease in net sales of serial cards, USB devices, wireless communication adaptors and satellite-related products. The increase in net sales in fiscal 2011 compared to fiscal 2010 is primarily driven by increased unit volume as a result of increased customer sales, many of which were wireless and in our targeted vertical markets. We did not experience a material change in revenue due to pricing during fiscal 2011. Net sales were $182.5 million in fiscal 2010 compared to $165.9 million in fiscal 2009, an increase of $16.6 million or 10.0%, primarily due to an increase of $21.9 million in the net sales of modules, cellular products, serial servers, wireless communication adaptors, USB products, engineering design services and satellite-related products. This was partially offset by a decrease of $5.3 million in net sales due to large sales of a discontinued chip set in fiscal 2009. The increase in net sales in fiscal 2010 compared to fiscal 2009 is primarily driven by increased volume. We did not experience a material change in revenue due to pricing during fiscal 2010. Fluctuation in foreign currency rates compared to the prior year's rates had a favorable impact on net sales of $0.9 million in fiscal 2011 and unfavorable impacts on net sales of $0.3 million and $5.9 million in fiscal 2010 and 2009, respectively.                                           32 

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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS

OF OPERATIONS (CONTINUED)

   NET SALES (CONTINUED) Net Sales by Product Category The following table presents our revenue by embedded and non-embedded categories:                                       Net Sales                        % of Net Sales         ($ in millions)    2011        2010        2009        2011        2010        2009         Non-embedded      $ 108.5     $ 100.1     $  91.2        53.1 %      54.9 %      55.0 %         Embedded             95.7        82.4        74.7        46.9 %      45.1 %      45.0 %          Total             $ 204.2     $ 182.5     $ 165.9       100.0 %     100.0 %     100.0 %    Non-Embedded Non-embedded products net sales increased $8.4 million, or 8.3%, in fiscal 2011 compared to fiscal 2010 due primarily to increases in cellular products and serial servers. This was partially offset by decreases in sales of serial cards, wireless communication adaptors and USB connected products. USB connected products have decreased due to softening of the retail sector for retail point-of-sale related USB applications in fiscal 2011. Increased sales to customers in the medical and fleet vertical markets contributed to the increase in fiscal 2011 compared to fiscal 2010. Non-embedded products net sales increased $8.9 million, or 9.7%, in fiscal 2010 compared to fiscal 2009. The increase was mostly due to an increase in net sales of cellular products, serial servers, wireless communication adaptors and USB products. Embedded Embedded products net sales increased $13.3 million, or 16.2%, in fiscal 2011 compared to fiscal 2010 due mostly to increases of net sales of modules, engineering design services and chips. Increased sales to customers in the medical vertical market contributed to the increase in fiscal 2011 compared to fiscal 2010. Embedded products net sales increased $7.7 million, or 10.4%, in fiscal 2010 compared to fiscal 2009. The increase was primarily due to a $13.0 million increase in net sales of modules and satellite-related products, partially offset by a decrease of $5.3 million primarily related to large sales of a discontinued chip set in fiscal 2009. Net Sales by Wireless and Wired Categories The following table presents our revenue by wireless and wired categories:                                       Net Sales                        % of Net Sales         ($ in millions)    2011        2010        2009        2011        2010        2009         Wireless          $  84.7     $  66.4     $  56.2        41.5 %      36.3 %      33.9 %         Wired               119.5       116.1       109.7        58.5 %      63.7 %      66.1 %          Total             $ 204.2     $ 182.5     $ 165.9       100.0 %     100.0 %     100.0 %    Wireless products net sales have increased by 27.6% in fiscal 2011 compared to fiscal 2010 and 18.0% in fiscal 2010 compared to fiscal 2009 as a result of our continued investment and focus on wireless M2M products and solutions. As is the trend with respect to the use of telecommunications generally, we anticipate that our sales of wireless products will continue to grow proportionately faster than our sales of wired products.                                           33

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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS

OF OPERATIONS (CONTINUED)

   NET SALES (CONTINUED) Net Sales by Geographic Area Our revenue by geographic location of our customers is as follows:                                              Net Sales                        % of Net Sales   ($ in millions)                 2011        2010        2009        2011        2010        2009   North America                  $ 118.7     $ 107.3     $  90.7       

58.1 % 58.8 % 54.7 %

   Europe, Middle East & Africa      52.1        47.7        56.0        25.5 %      26.2 %      33.7 %   Asian countries                   27.0        22.7        15.6        13.2 %      12.4 %       9.4 %   Latin America                      6.4         4.8         3.6         3.2 %       2.6 %       2.2 %    Total net sales                $ 204.2     $ 182.5     $ 165.9       100.0 %     100.0 %     100.0 %    North America net sales in fiscal 2011 increased $11.4 million due to an increase of $6.3 million of embedded products, of which $2.7 million is related to engineering design services, and $5.1 million of non-embedded products. The North American sales for fiscal 2011 increased over the prior fiscal year primarily as a result of larger customer sales, many of which were wireless and in our targeted vertical markets. Net sales in fiscal 2010 for North America increased $16.6 million due to an increase in embedded products of $4.8 million and non-embedded products of $11.8 million. Europe, Middle East, and Africa ("EMEA") net sales increased $4.4 million in fiscal 2011 over fiscal 2010 mostly due to large customer deals. The strengthening of the Euro and British Pound contributed $0.7 million to the increase in fiscal 2011 compared to fiscal 2010. Net sales in EMEA decreased $8.3 million from fiscal 2009 to fiscal 2010 as fiscal 2009 included large sales of a discontinued chip set and a large sale to a legacy customer. Asian countries revenue increased by $4.3 million in fiscal 2011 compared to fiscal 2010 mostly related to Radio Frequency (RF) modules in the embedded product grouping. Revenue for the Asian countries increased $7.1 million in fiscal 2010 compared to fiscal 2009 due to an increase of $4.1 million for embedded products and $3.0 million for non-embedded products. Also in fiscal 2010, we recorded a full year of net sales related to our acquisition of MobiApps compared to three months of net sales in fiscal 2009. Latin America revenue increased by $1.6 million in fiscal 2011 compared to fiscal 2010 primarily due to non-embedded cellular products. Revenue for Latin America increased $1.2 million in fiscal 2010 compared to fiscal 2009 due to an increase of $0.8 million for embedded products and $0.4 million for non-embedded products. Net Sales by Distribution Channel The following table presents our revenue by distribution channel:                                          Net Sales                        % 

of Net Sales

      ($ in millions)         2011        2010        2009        2011        2010        2009       Direct / OEM channel   $  73.3     $  66.2     $  78.5        35.9 %      36.3 %      47.3 %       Distributors channel     130.9       116.3        87.4        64.1 %      63.7 %      52.7 %        Total company          $ 204.2     $ 182.5     $ 165.9       100.0 %     100.0 %     100.0 %    Net sales in the Direct/OEM channel increased $7.1 million, or 10.8% compared to net sales in fiscal 2010. During fiscal 2011, net sales in the Distributors channel increased by $14.6 million, or 12.4% compared to net sales in fiscal 2010. Increased customer sales in our targeted vertical markets contributed to the increase in both the Distributors channel and the Direct/OEM channel. International sales growth also contributed to the increase in Distributors channel sales.                                           34 

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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS

OF OPERATIONS (CONTINUED)

   NET SALES (CONTINUED) During fiscal 2010, net sales in the Distributors channel increased by $28.9 million, or 33% compared to net sales in fiscal 2009. Net sales in fiscal 2010 in the Direct / OEM channel decreased by $12.3 million, or 15.7% compared to the prior fiscal year. The increase in net sales in the Distributors channel compared to the Direct / OEM channel primarily is due to fulfillment of customer orders for wireless products. Our distribution channel strategy is evolving to support the vertical markets on which we're focused as well as to support distribution of our wireless products. GROSS PROFIT 2011 Compared to 2010 Gross profit was $106.6 million and $92.2 million in fiscal 2011 and 2010, respectively, an increase of $14.4 million, or 15.6%. The gross margin for fiscal 2011 was 52.2% compared to 50.5% in fiscal 2010. Gross margin increased 1.7 percentage points primarily due to product cost reduction initiatives that allowed us to reduce the cost of our products and increase gross profit through purchasing and manufacturing efficiencies during the fiscal year. Favorable customer and product mix, as well as a decrease in the amortization of purchased and core technology as certain intangibles were fully amortized, also contributed to the increase in gross profit during fiscal 2011. Amortization of purchased and core technology was $2.9 million or 1.4% of net sales in fiscal 2011 as compared to $4.1 million or 2.2% of net sales in fiscal 2010. 2010 compared to 2009 Gross profit was $92.2 million and $81.3 million in fiscal 2010 and 2009, respectively, an increase of $10.9 million, or 13.5%. The gross margin for fiscal 2010 was 50.5% compared to 49.0% in fiscal 2009. Gross margin increased 2.1 percentage points primarily due to a reduction of costs as a result of the business restructuring in fiscal 2009 and other cost reduction initiatives and also increased 0.3 percentage points related to a reduction in amortization of purchased and core technology as some technology is fully amortized. This was partially offset by a 0.9 percentage points decrease in gross margin due to unfavorable product mix primarily related to cellular and certain embedded products. Amortization of purchased and core technology was $4.1 million or 2.2% of net sales in fiscal 2010 as compared to $4.2 million or 2.5% of net sales in fiscal 2009. OPERATING EXPENSES 2011 Compared to 2010 Operating expenses were $89.6 million in fiscal 2011, an increase of $7.3 million or 8.9%, compared to $82.3 million in fiscal 2010 mostly due to increased compensation-related expenses of $5.9 million, including salaries and incentive compensation, as we fully reinstated our non-sales incentive program for fiscal 2011 and increased headcount by 43 employees, primarily in sales, marketing and research and development. We also invested in our iDigi® platform during fiscal 2011 as we worked to evolve our business to include cloud-based solutions. Sales and marketing expenses were $39.6 million in fiscal 2011, an increase of $2.6 million or 6.9%, compared to $37.0 million in fiscal 2010. Sales and marketing expenses increased by $2.0 million for compensation- related expenses due to increased headcount and full reinstatement of our non-sales incentive program and $0.6 million for outside services, travel and entertainment and miscellaneous other sales and marketing expenses.                                           35

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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS

OF OPERATIONS (CONTINUED)

   OPERATING EXPENSES (CONTINUED) Research and development expenses were $31.6 million in fiscal 2011, an increase of $3.8 million or 13.7%, compared to $27.8 million in fiscal 2010. Research and development expenses increased by $2.6 million for compensation-related expenses due to increased headcount and full reinstatement of our non-sales incentive program, $0.8 million for other research and development expenses mostly related to the investment in our iDigi® cloud-based platform and $0.4 million for professional services and contract labor. General and administrative expenses were $18.2 million in fiscal 2011, an increase of $0.3 million or 1.8%, compared to $17.9 million in fiscal 2010. The increase in general and administrative expenses was due to increases of $1.3 million for compensation-related expenses mostly related to a full reinstatement of our non-sales incentive program and $0.2 million related to a litigation settlement discussed in Notes 16 and 18 to our consolidated financial statements. This partially was offset by a reduction of $1.2 million in professional fees related to internal investigation and remediation actions we took related to the U.S. Foreign Corrupt Practices Act incurred in fiscal 2010. 2010 Compared to 2009 Operating expenses were $82.3 million in fiscal 2010, an increase of $4.1 million or 5.2%, compared to $78.2 million in fiscal 2009. Compensation-related expenses, including salaries, incentive compensation, commissions and stock-based compensation increased $1.8 million as we fully restored the sales commission program and partially reinstated our non-sales incentive compensation program for fiscal 2010. We also incurred professional fees of $1.4 million related to the internal investigation and remediation actions we took related to the U.S. Foreign Corrupt Practices Act as well as incremental ongoing expenses related to the fiscal 2009 MobiApps acquisition of $1.6 million. Sales and marketing expenses were $37.0 million in fiscal 2010, an increase of $1.7 million or 4.8%, compared to $35.3 million in fiscal 2009. The increase was due to an increase of $1.0 million in commission expense, $0.4 million in incremental expenses for MobiApps and $0.3 million of other various sales and marketing expenses. Research and development expenses were $27.8 million in fiscal 2010, an increase of $1.4 million or 5.5%, compared to $26.4 million in fiscal 2009. The increase was due to an increase of $0.9 million in professional services, contract labor and certification testing, $0.7 million in incremental expenses for MobiApps, and $0.4 million of compensation-related expenses, offset by a net reduction of $0.6 million of expense primarily related to a development project that was completed in fiscal 2009. General and administrative expenses were $17.9 million in fiscal 2010, an increase of $3.4 million or 22.9%, compared to $14.5 million in fiscal 2009. General and administrative expenses increased by $2.0 million due to increased professional fees which includes $1.4 million of investigation and remediation fees. In addition, the incremental expenses for MobiApps increased general and administrative expenses by $0.5 million, compensation-related expenses increased by $0.3 million and other miscellaneous general and administrative expenses increased by $0.6 million.                                           36 

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

RESTRUCTURING

 2011 Restructuring On July 21, 2011, we announced a restructuring of our manufacturing operations in Breisach, Germany. The restructuring reduced our manufacturing footprint by consolidating prototype and production functions and centralizing outsourced production control in our Eden Prairie, Minnesota production facility. The consolidation was driven by our strategy of driving efficiency improvements and enhancing customer service globally through more centralized operations. We will continue to maintain sales and research and development activities at the leased facility in Breisach, Germany. As a result of these initiatives, we expect the total charge to be $0.6 million on a pre-tax basis, which consists of $0.5 million for employee termination costs for 25 employees and $0.1 million for asset write-downs. We recorded a charge of $0.2 million in the fourth quarter of fiscal 2011, and expect to record charges of $0.3 million in the first quarter of fiscal 2012 and $0.1 million in the second quarter of fiscal 2012. The payments are expected to be completed in the second quarter of fiscal 2012. We expect to cease manufacturing in Breisach by the end of December 2011 and the majority of the manufacturing positions will be vacated by the end of December 2011. 2009 Restructuring On April 23, 2009 we announced a business restructuring to increase our focus on wireless products and solutions that include hardware, software and services. The restructuring included the closing of an engineering facility in Long Beach, California, and the relocation and consolidation of the manufacturing facility in Davis, California to our Minnetonka, Minnesota headquarters. We paid a lease cancellation fee for one of the leased facilities in Davis and had vacated the facility as of September 30, 2009. We continue to maintain non-manufacturing activities at the remaining leased facility in Davis, California. As a result of these initiatives, during the third quarter of fiscal 2009 we recorded a $2.0 million charge, which consisted of $1.8 million for employee termination costs for 86 positions and $0.2 million for contract termination fees and other relocation costs. All 86 positions were vacated as of September 30, 2009. The employee termination costs included severance and the associated costs of continued medical benefits and outplacement services. The other restructuring expenses included contract termination fees for non-renewal of lease terms relating to one of the facilities in Davis, California and relocation expenses for employees. During fiscal 2010, we recorded an additional $0.1 million for an additional six months of continued medical benefits as a result of new healthcare legislation passed in December 2009</chron> related to the aforementioned restructuring. Also during fiscal 2010 we reversed $0.5 million of the restructuring accrual since costs associated with continued medical benefits and relocation were lower than expected. During fiscal 2011, we paid a small amount of employee termination costs and reversed the remaining restructuring accrual. OTHER (EXPENSE) INCOME, NET 2011 Compared to 2010 Other (expense) income, net was $0.5 million of expense in fiscal 2011, a decrease of $1.1 million compared to $0.6 million of income in fiscal 2010. The majority of this was due to $0.7 million of foreign currency net transaction losses in fiscal 2011 compared to foreign currency net transaction gains of $0.3 million in fiscal 2010. We realized interest income on marketable securities and cash and cash equivalents of $0.3 million in fiscal 2011 compared to $0.4 million in fiscal 2010. Our average investment balance increased from $69.0 million in fiscal 2010 to $85.9 million in fiscal 2011, but our interest income was less than in the prior fiscal year since we earned an average interest rate of 0.3% in fiscal 2011 compared to 0.5% in fiscal 2010.                                           37

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 ITEM 7.   MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS           OF OPERATIONS (CONTINUED)   OTHER (EXPENSE) INCOME, NET (CONTINUED) 2010 Compared to 2009 Total other income, net was $0.6 million in fiscal 2010, a decrease of $0.6 million compared to $1.2 million in fiscal 2009. We realized interest income on marketable securities and cash and cash equivalents of $0.4 million in fiscal 2010 compared to $1.4 million in fiscal 2009. Although our average investment balance during fiscal 2010 was $69.0 million compared to $57.6 million in fiscal 2009, the decrease in interest income was primarily due to a lower than average interest rate as we earned an average interest rate of 0.5% during fiscal 2010 compared to 2.4% during fiscal 2009. Interest expense was $0.1 million in fiscal 2010 as compared to $0.3 million in fiscal 2009 as we made one of the deferred payments during fiscal 2010 for the Spectrum acquisition. Other income, net also increased $0.3 million related to a net increase in foreign currency transaction gains in fiscal 2010 compared to fiscal 2009. INCOME TAXES Our effective income tax rate was 33.3%, 15.0% and 4.6% for fiscal years 2011, 2010 and 2009, respectively. Our effective tax rate will vary based on a variety of factors, including overall profitability, the geographical mix of income before taxes and related statutory tax rate in each jurisdiction, and discrete events, such as settlements of audits. During fiscal 2011, we recorded a tax benefit of $0.7 million primarily related to the release of income tax reserves due to the expiration of the statutes of limitations from various jurisdictions, primarily foreign. The enactment of the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 provided for the extension of the research and development tax credit that allowed us to record a benefit for tax credits earned during the last three quarters of fiscal 2010 in the first quarter of fiscal 2011. The aforementioned income tax benefits resulting from the reversal of income tax reserves and other discrete tax benefits reduced our effective tax rate by 4 percentage points in fiscal 2011. During fiscal 2010, we reversed $2.3 million in income tax reserves associated primarily with the closing of prior tax years through statute expiration and the conclusion of a federal tax audit. While the statutes of limitations have not expired, U.S. federal income tax returns for the periods ended September 30, 2007 and September 30, 2008 have been audited by and settled with the Internal Revenue Service. The aforementioned income tax benefits resulting from the reversal of income tax reserves and other discrete tax benefits reduced the effective tax rate by 22 percentage points in fiscal 2010. During fiscal 2009, we reversed $0.6 million in income tax reserves primarily associated with the statutory closing of a prior U.S. federal and state tax year and settlement of prior liabilities under amnesty programs. We recorded an additional current discrete tax benefit of $0.5 million resulting from the enactment on October 3, 2008 of the retroactive extension of the research and development tax credit for activity from January 1, 2008 to September 30, 2008. We also recorded adjustments to actual for items reported on the tax returns filed for fiscal 2007 and 2008. The aforementioned income tax benefits resulting from the reversal of income tax reserves and other discrete tax benefits reduced the effective tax rate by 27 percentage points in fiscal 2009.                                           38

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 ITEM 7.   MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS           OF OPERATIONS (CONTINUED)   SUBSEQUENT EVENT On October 26, 2011, we announced that the flooding in Thailand has impacted the operations of our contract manufacturer located near Bangkok, Thailand. The main manufacturing facility is currently closed, although efforts are underway to restore operations at the contract manufacturer's back-up facility, which has not currently been impacted by flooding and is also located in Bangkok. In addition, we are working on reallocating production normally done in Thailand to our U.S. manufacturing facility, as well as other contract manufacturers we currently use. We presently anticipate that the Thailand flooding and the resulting impact on our subcontract manufacturer in Thailand will decrease revenue in a range of approximately $2 million to $6 million for the first fiscal quarter of 2012, and gross margin will decrease by approximately two percentage points in the first fiscal quarter of 2012. We expect that the impact of the Thailand flooding for the full fiscal year 2012 will have a minimal impact on revenue, and the impact to gross margin will be approximately one percentage point. We expect that earnings per diluted share for fiscal 2012 will be reduced by approximately $0.07 due to the revenue and gross margin impact previously described. INFLATION Management believes that during fiscal years 2011, 2010 and 2009, inflation has not had a material effect on our operations or on our consolidated financial position. LIQUIDITY AND CAPITAL RESOURCES We have financed our operations principally with funds generated from operations. We held cash, cash equivalents and short-term marketable securities of $106.2 million, $87.6 million and $70.7 million at September 30, 2011, 2010 and 2009, respectively. Our working capital was $142.7 million, $122.1 million and $106.1 million at September 30, 2011, 2010 and 2009, respectively. Absent a disruption in our business, we expect our working capital to continue to increase. Consolidated Statement of Cash Flow Highlights (in thousands)                                                           Year ended September 30,                                                     2011           2010           2009 Operating activities                              $  21,839      $  16,095      $  15,686 Investing activities                                (22,399 )      (15,167 )       25,286 Financing activities                                  4,639          2,604         (5,427 ) Effect of exchange rate changes on cash and cash equivalents                                       (338 )       (1,023 

) (1,287 )

Net increase in cash and cash equivalents $ 3,741$ 2,509

$ 34,258

    Net cash provided by operating activities was $21.8 million during fiscal 2011 compared to $16.1 million in fiscal 2010, a net increase of $5.7 million. This net increase was due to an increase in net income of $2.1 million, deferred income taxes of $2.4 million, inventory obsolescence of $1.1 million, net increases in working capital of $1.0 million and other non-cash items of $0.4 million. This was offset by net decreases in amortization expense of $1.3 million. Changes in working capital increased cash flows by $1.0 million due to a $3.8 million increase in accounts receivable as the increase in accounts receivable in fiscal 2011 was less than the increase in fiscal 2010 and a $1.5 million increase in inventories as inventories have declined in fiscal 2011. This was offset by a $2.7 million net decrease in accounts payable and $1.6 million in other assets and accrued expenses.                                           39

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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS

OF OPERATIONS (CONTINUED)

   LIQUIDITY AND CAPITAL RESOURCES (CONTINUED) Net cash provided by operating activities was $16.1 million during fiscal 2010 compared to $15.7 million during fiscal 2009, a net increase of $0.4 million. This net increase is due to an increase in net income of $4.9 million and a net increase of $0.2 million of other non-cash items, offset by a decrease of $1.0 million for changes in deferred income tax benefits and a $3.7 million decrease due to changes in working capital. Changes in working capital decreased cash flows by $3.7 million primarily due to an $11.9 million decrease in accounts receivable as the receivables balance increased due to higher revenue in September 2010 than in September 2009. Inventory levels were approximately the same at September 30, 2010 and 2009, however inventories decreased $3.6 million at September 30, 2009 compared to 2008. This was offset by a net increase of $6.0 million related to changes in accounts payable and a net increase of $5.8 million related to changes in other assets and accrued expenses. Net cash used in investing activities was $22.4 million in fiscal 2011 as compared to $15.2 million in fiscal 2010, a net increase of $7.2 million. We used an additional $7.4 million of cash for net purchases of marketable securities in fiscal 2011 compared to fiscal 2010, offset by $0.2 million fewer capital expenditures in fiscal 2011 as compared to fiscal 2010. Net cash used by investing activities was $15.2 million in fiscal 2010 as compared to net cash provided by investing activities of $25.3 million during fiscal 2009, a net decrease of $40.5 million. Net purchases of marketable securities in fiscal 2010 offset by net settlements of marketable securities in fiscal 2009 resulted in a net decrease of $41.3 million. We used cash of $3.0 million for a deferred payment related to the Spectrum acquisition in fiscal 2010. In fiscal 2009 we spent $3.0 million related to the acquisition of the assets of MobiApps and reduced our capital expenditures by $0.8 million. Net cash provided by financing activities was $4.6 million in fiscal 2011 as compared to $2.6 million in fiscal 2010, an increase of $2.0 million, resulting from additional exercises of stock options and employee stock purchase plan transactions. Net cash provided by financing activities was $2.6 million in fiscal 2010 as compared to net cash used in financing activities of $5.4 million in fiscal 2009, a net increase of $8.0 million. We spent $6.6 million related to treasury stock repurchases in fiscal 2009. In fiscal 2010 compared to fiscal 2009, we received an additional $1.1 million in proceeds from the exercise of stock options and employee stock purchase plan transactions and spent $0.3 million less in capital lease payments. We expect positive cash flows from operations and believe that our current cash, cash equivalents and marketable securities balances, cash generated from operations and our ability to secure debt and/or equity financing will be sufficient to fund our business operations and capital expenditures for the next twelve months and beyond. The following summarizes our contractual obligations at September 30, 2012:                                             Payments due by fiscal period                                    Less than    (in thousands)      Total        1 year         1-3 years       3-5 years       Thereafter     Operating leases   $ 7,563     $     2,759     $     3,209     $     1,453     $        142                                             40 

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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS

OF OPERATIONS (CONTINUED)

   LIQUIDITY AND CAPITAL RESOURCES (CONTINUED) The operating lease agreements included above primarily relate to office space. The table above does not include possible payments for uncertain tax positions. Our reserve for uncertain tax positions, including accrued interest and penalties, was $2.6 million as of September 30, 2011. Due to the nature of the underlying liabilities and the extended time often needed to resolve income tax uncertainties, we cannot make reliable estimates of the amount or timing of future cash payments that may be required to settle these liabilities. The above table also does not include our obligation for royalties under a license agreement that we entered into September 30, 2011 as a result of the patent litigation settlement with MOSAID Technologies Incorporated. The royalties are calculated based on future sales of licensed products identified in the settlement agreement and we cannot make reliable estimates of the amount of cash payments. FOREIGN CURRENCY We are exposed to foreign currency risk associated with certain sales transactions being denominated in Euros, British Pounds, Japanese Yen and Indian Rupees and foreign currency translation risk as the financial position and operating results of our foreign subsidiaries are translated into U.S. Dollars for consolidation. We have not implemented a formal hedging strategy to reduce foreign currency risk. During 2011, we had approximately $85.5 million of net sales related to foreign customers including export sales, of which $28.8 million was denominated in foreign currency, predominantly the Euro and British Pound. During both 2010 and 2009, we had approximately $75.2 million of net sales to foreign customers including export sales, of which $27.6 million and $33.4 million, respectively, were denominated in foreign currency, predominantly the Euro and British Pound. In future periods, we expect a significant portion of sales will continue to be made in Euros and British Pounds. RECENT ACCOUNTING DEVELOPMENTS In September 2011, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update No. 2011-08, "Intangibles-Goodwill and Other (Topic 350) Testing Goodwill for Impairment". This guidance provides an update on how an entity tests goodwill for impairment. This revised guidance allows companies an option to make a qualitative evaluation about the likelihood of goodwill impairment. Under the revised guidance, a company is permitted to first assess qualitative factors to determine whether goodwill impairment exists prior to performing analyses comparing the fair value of a reporting unit to its carrying amount. If, based on the qualitative assessment, a company concludes it is more likely than not that the fair value of the reporting unit exceeds its carrying value, quantitative testing for impairment is not necessary. This guidance is effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. Early adoption is permitted. We have elected to early adopt this update to be effective for our fiscal year beginning October 1, 2011 and we do not expect that the adoption of this update will have a material impact on our consolidated financial statements. In June 2011, the FASB issued Accounting Standards Update No. 2011-05, "Comprehensive Income (Topic 220): Presentation of Comprehensive Income". This guidance eliminates the option to report other comprehensive income and its components in the consolidated statement of stockholders' equity. Rather it requires that all non-owner changes in stockholders' equity be presented in either a single continuous statement of comprehensive income or in two separate but consecutive statements. This guidance also requires us to present on the face of the financial statements any reclassification adjustments for items that are reclassified from other comprehensive income to net income. The guidance is effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. We will adopt this guidance beginning with our fiscal quarter ending December 31, 2012. The adoption of this guidance will have no effect on our consolidated financial position or results of operations, as it will only impact how certain information related to other comprehensive income is presented in our consolidated financial statements.                                           41

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 ITEM 7.   MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS           OF OPERATIONS (CONTINUED)   RECENT ACCOUNTING DEVELOPMENTS (CONTINUED) In May 2011, the FASB issued Accounting Standards Update No. 2011-04, "Fair Value Measurements (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs". This guidance changes the wording used to describe many of the requirements in U.S. GAAP for measuring fair value and for disclosing information about fair value measurements to ensure consistency between U.S. GAAP and International Financial Reporting Standards ("IFRS"). This guidance is to be applied prospectively and is effective during interim and annual periods beginning after December 15, 2011. We will adopt this guidance beginning with our fiscal quarter ending March 31, 2012. We do not expect this guidance to have a material impact on our consolidated financial statements. CRITICAL ACCOUNTING POLICIES AND ESTIMATES Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, the disclosure of contingent assets and liabilities and the values of purchased assets and assumed liabilities in acquisitions. We base our estimates on historical experience and various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates. We believe the following critical accounting policies impact our more significant judgments and estimates used in the preparation of our consolidated financial statements. REVENUE RECOGNITION Our revenues are derived primarily from the sale of embedded and non-embedded products to our distributors and Direct (end-user) / OEM customers, and to a small extent from the sale of professional and engineering services, fees associated with technical support, training, software licenses and royalties. We recognize product revenue when persuasive evidence of an arrangement exists, delivery has occurred, the sales price is fixed or determinable, collectability is reasonably assured and there are no post-delivery obligations other than warranty. Under these criteria, product revenue is generally is recognized upon shipment of product to customers, including Direct (end-user)/OEM and distributors. Sales to authorized domestic distributors and Direct / OEMs are made with certain rights of return and price adjustment provisions. Estimated reserves for future returns and pricing adjustments are established by us based on an analysis of historical patterns of returns and price adjustments as well as an analysis of authorized returns compared to received returns, current on-hand inventory at distributors, and distribution sales for the current period. Estimated reserves for future returns and price adjustments are charged against revenues in the same period as the corresponding sales are recorded. Material differences between the historical trends used to determine estimated reserves and actual returns and pricing adjustments could result in a material change to our consolidated results of operations or financial position. We have applied consistent methodologies for estimating reserves for future returns and pricing adjustments for all years presented. The reserve for future returns and pricing adjustments was $1.3 million at September 30, 2011 and $1.1 million at September 30, 2010.                                           42 

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 ITEM 7.   MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS           OF OPERATIONS (CONTINUED)   Our non-product revenue represented 4.5%, 3.3% and 3.0% of net sales in fiscal 2011, 2010 and 2009, respectively. The majority of the non-product revenue was from professional and engineering services and represented 4.2%, 2.9% and 2.7% of net sales in fiscal 2011, 2010 and 2009, respectively. We also had revenue from cloud-based services, post-contract customer support, fees associated with technical support, training, royalties and the sale of software licenses. Our software development tools and development boards often include multiple elements, including hardware, software licenses, post-contract customer support, limited training and basic hardware design review. Our customers purchase these products and services during their product development process in which they use the tools to build network connectivity into the devices they are manufacturing. Revenue for professional and engineering services and training is recognized upon performance. Revenue from software licenses is recognized when earned. Revenues from contracts with multiple element arrangements are recognized as each element is earned based on the relative fair value of each element provided the delivered elements have value to customers on a standalone basis. Amounts allocated to each element are based on its vendor specific objective evidence, such as the sales price for the product or service when it is sold separately. Revenue from cloud-based services is earned in two ways: a) web-based management fees are considered to be earned on a monthly basis consistent with a monthly contractual commitment, and b) transaction fees that are billed to the customer at the larger of the minimum price or the number of transactions times the stated fee and are considered earned as the transactions occur. CASH EQUIVALENTS AND MARKETABLE SECURITIES We regularly monitor and evaluate the realizable value of our marketable securities. When assessing marketable securities for other-than-temporary declines in value, we consider several factors. These factors include: how significant the decline in value is as a percentage of the original cost, how long the market value of the investment has been less than its original cost, the underlying factors contributing to a decline in the prices of securities in a single asset class, the performance of the issuer's stock price in relation to the stock price of its competitors within the industry, expected market volatility, analyst recommendations, the views of external investment managers, any news or financial information that has been released specific to the investee and the outlook for the overall industry in which the issuer operates. If events and circumstances indicate that a decline in the value of these securities has occurred and is other-than-temporary, we would record a charge to other income (expense). ACCOUNTS RECEIVABLE AND ALLOWANCE FOR DOUBTFUL ACCOUNTS We maintain an allowance for doubtful accounts, which reflects the estimate of losses that may result from the inability of some of our customers to make required payments. The estimate for the allowance for doubtful accounts is based on known circumstances regarding collectability of customer accounts and historical collections experience. If the financial condition of one or more of our customers were to deteriorate, resulting in an inability to make payments, additional allowances may be required. Material differences between the historical trends used to estimate the allowance for doubtful accounts and actual collection experience could result in a material change to our consolidated results of operations or financial position. The allowance for doubtful accounts was $0.3 million at September 30, 2011 and $0.5 million at September 30, 2010.                                           43 

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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS

OF OPERATIONS (CONTINUED)

   CRITICAL ACCOUNTING POLICIES AND ESTIMATES (CONTINUED) INVENTORIES Inventories are stated at the lower of cost or fair market value, with cost determined using the first-in, first-out method. We reduce the carrying value of our inventories for estimated excess and obsolete inventories equal to the difference between the cost of inventory and its estimated realizable value based upon assumptions about future product demand and market conditions. Once the new cost basis is established, the value is not increased with any changes in circumstances that would indicate an increase in value after the remeasurement. If actual product demand or market conditions are less favorable than those projected by management, additional inventory write-downs may be required that could result in a material change to our consolidated results of operations or financial position. We have applied consistent methodologies for the net realizable value of inventories. GOODWILL Goodwill represents the excess of cost over the fair value of identifiable assets acquired. Goodwill is tested for impairment on an annual basis as of June 30, or more frequently if events or circumstances occur which could indicate impairment. At June 30, 2011, our market capitalization exceeded the carrying value of our reporting unit by 28.6%; therefore, there was no indication of goodwill impairment. There were no triggering events to indicate goodwill impairment at September 30, 2011. INCOME TAXES We operate in multiple tax jurisdictions both in the U.S. and outside of the U.S. Accordingly, we must determine the appropriate allocation of income to each of these jurisdictions. This determination requires us to make several estimates and assumptions. Tax audits associated with the allocation of this income, and other complex issues, may require an extended period of time to resolve and could result in adjustments to our income tax balances that are material to our consolidated financial position and results of operations. We have unrecognized tax benefits of $2.6 million classified as a long-term liability as we do not expect significant payments to occur over the next 12 months. The total amount of unrecognized tax benefits that if recognized would affect our effective tax rate is $2.0 million. We recognize interest and penalties related to income tax matters in income tax expense. WARRANTIES In general, we warrant our products to be free from defects in material and workmanship under normal use and service. The warranty periods range from one to five years from the date of receipt. We have the option to repair or replace products we deem defective due to material or workmanship. Estimated warranty costs are accrued in the period that the related revenue is recognized based upon an estimated average per unit repair or replacement cost applied to the estimated number of units under warranty. These estimates are based upon historical warranty incidents and are evaluated on an ongoing basis to ensure the adequacy of the warranty accrual. The product warranty accrual was $0.9 million at both September 30, 2011 and September 30, 2010.                                           44

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