<PAGE>
- --------------------------------------------------------------------------------
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended: June 30, 1998.
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ____ to ____.
Commission file number: 0-17972
DIGI INTERNATIONAL INC.
--------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Delaware 41-1532464
------------------------------- -------------------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
11001 Bren Road East
Minnetonka, Minnesota 55343
-------------------------------
(Address of principal executive offices) (Zip Code)
(612) 912-3444
-------------------------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
Yes X No
--- ---
On July 28, 1998, there were 13,934,715 shares of the registrant's $.01 par
value Common Stock outstanding.
- --------------------------------------------------------------------------------
<PAGE>
CONTENTS
<TABLE>
<CAPTION>
Page
----
<S> <C> <C>
PART I. FINANCIAL INFORMATION
- ------ ---------------------
ITEM 1. Financial Statements
Condensed Consolidated Statement of Operations
for the three month and nine month periods ended
June 30, 1998 and 1997 .................................... 3
Condensed Consolidated Balance Sheet as of
June 30, 1998 and September 30, 1997 ...................... 4
Condensed Consolidated Statement of Cash Flows
for the nine month periods ended June 30, 1998 and 1997 ... 5
Notes to Condensed Consolidated Financial
Statements ................................................ 6
Review Report of Independent Accountants .................. 9
ITEM 2. Management's Discussion and Analysis of
Results of Operations and Financial Condition ............. 10
Forward-looking Statements ................................ 14
ITEM 3. Quantitative and Qualitative Disclosures About
Market Risk ............................................... 15
PART II. OTHER INFORMATION
- ------ -----------------
ITEM 1. Legal Proceedings ......................................... 15
ITEM 2. Changes in Securities ..................................... 16
ITEM 3. Defaults Upon Senior Securities ........................... 16
ITEM 4. Submission of Matters to a Vote of Securities Holders ..... 16
ITEM 5. Other Information ......................................... 16
ITEM 6. Exhibits and Reports on Form 8-K .......................... 17
</TABLE>
2
<PAGE>
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
DIGI INTERNATIONAL INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
FOR THE THREE MONTHS AND NINE MONTHS ENDED JUNE 30, 1998 AND 1997
(UNAUDITED)
<TABLE>
<CAPTION>
Three months ended June 30 Nine months ended June 30
------------------------------ --------------------------------
1998 1997 1998 1997
------------------------------ --------------------------------
<S> <C> <C> <C> <C>
Net sales $46,449,286 $40,843,298 $134,098,319 $123,472,736
Cost of sales 21,890,041 20,724,950 65,104,699 64,419,895
----------- ------------ ------------- -------------
Gross margin 24,559,245 20,118,348 68,993,620 59,052,841
----------- ------------ ------------- -------------
Operating expenses:
Sales and marketing 9,036,250 9,112,452 26,303,159 29,310,308
Research and development 4,127,946 3,938,589 11,886,956 14,284,202
General and administrative 2,969,649 4,523,797 10,025,425 13,964,227
Restructuring - - - 10,471,482
----------- ------------ ------------- -------------
Total operating expenses 16,133,845 17,574,838 48,215,540 68,030,219
----------- ------------ ------------- -------------
Operating income (loss) 8,425,400 2,543,510 20,778,080 (8,977,378)
Other income, net 659,916 117,221 1,477,270 343,456
AetherWorks Corporation net gain (loss) 1,350,000 (1,525,006) 1,350,000 (4,634,476)
----------- ------------ ------------- -------------
Income (loss) before income taxes 10,435,316 1,135,725 23,605,350 (13,268,398)
Provision (benefit) for income taxes 4,024,409 1,068,455 8,686,768 (1,357,450)
----------- ------------ ------------- -------------
Net income (loss) $ 6,410,907 $ 67,270 $ 14,918,582 $(11,910,948)
----------- ------------ ------------- -------------
----------- ------------ ------------- -------------
Net income (loss) per common share,
basic $ 0.47 $ 0.01 $ 1.10 $ (0.89)
----------- ------------ ------------- -------------
----------- ------------ ------------- -------------
Net income (loss) per common share,
assuming dilution $ 0.45 $ 0.01 $ 1.05 $ (0.89)
----------- ------------ ------------- -------------
----------- ------------ ------------- -------------
Weighted average common shares, basic 13,617,518 13,403,895 13,535,512 13,379,899
----------- ------------ ------------- -------------
----------- ------------ ------------- -------------
Weighted average common shares,
assuming dilution 14,385,012 13,483,826 14,216,915 13,379,899
----------- ------------ ------------- -------------
----------- ------------ ------------- -------------
</TABLE>
The accompanying notes are an integral part of the condensed consolidated
financial statements.
3
<PAGE>
DIGI INTERNATIONAL INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEET
<TABLE>
<CAPTION>
June 30 September 30
ASSETS 1998 1997
------------ ------------
<S> <C> <C>
Current assets: (unaudited)
Cash and cash equivalents $ 44,945,413 $ 31,329,666
Accounts receivable, net 34,699,087 25,658,522
Inventories, net 16,403,543 23,683,312
Other 3,902,622 4,147,942
------------ ------------
Total current assets 99,950,665 84,819,442
Property, equipment and improvements, net
22,571,781 23,617,696
Intangible assets, net 7,339,058 6,876,597
Other 8,055,239 2,997,601
------------ ------------
Total assets $137,916,743 $118,311,336
------------ ------------
------------ ------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 8,104,944 $ 10,118,921
Income taxes payable 6,873,073 1,771,986
Accrued expenses:
Advertising 2,694,361 2,847,672
Compensation 3,143,810 2,388,468
Accrued AetherWorks Corporation obligations 3,350,000
Other 2,684,252 2,363,258
------------ ------------
Total current liabilities 23,500,440 22,840,305
Commitments and contingency
Stockholders' equity:
Preferred stock, $.01 par value; 2,000,000 shares
authorized; none outstanding
Common stock, $.01 par value; 60,000,000 shares
authorized; 14,951,203 and 14,727,256 shares issued 149,512 147,273
Additional paid-in capital 47,062,761 44,403,102
Retained earnings 90,032,484 75,113,902
------------ ------------
137,244,757 119,664,277
Unearned stock compensation (974,911) (1,787,658)
Treasury stock, at cost, 1,238,442 and 1,338,894
common shares (21,853,543) (22,405,588)
------------ ------------
Total stockholders' equity 114,416,303 95,471,031
------------ ------------
Total liabilities and stockholders' equity $137,916,743 $118,311,336
------------ ------------
------------ ------------
</TABLE>
The accompanying notes are an integral part of the condensed consolidated
financial statements.
4
<PAGE>
DIGI INTERNATIONAL INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
FOR THE NINE MONTHS ENDED JUNE 30, 1998 AND 1997
(UNAUDITED)
<TABLE>
<CAPTION>
1998 1997
----------- ------------
<S> <C> <C>
Operating activities:
Net income $14,918,582 $(11,910,948)
Adjustments to reconcile net income (loss) to net
cash provided by operating activities:
Restructuring $ - $ 9,601,259
Depreciation and amortization 4,877,165 5,256,247
AetherWorks Corporation net (gain) loss (1,350,000) 4,634,476
Provision for losses on accounts receivable 707,992 1,062,936
Provision for inventory obsolescence 5,354,569 2,256,514
Loss on sale of fixed assets 183,057 172,304
Stock compensation 656,940 105,177
Changes in operating assets and liabilities (3,695,117) 3,621,992
----------- ------------
Total adjustments 1,734,605 26,710,905
----------- ------------
Net cash provided by operating activities 21,653,187 14,799,957
----------- ------------
Investing activities:
Purchase of property, equipment and improvements,
and intangibles (4,407,189) (4,480,397)
Investment in AetherWorks Corporation (2,000,000) (5,000,000)
Advance related to impending acquisition (5,000,000) -
----------- ------------
Net cash used in investing activities (11,407,189) (9,480,397)
----------- ------------
Financing activities:
Stock benefit plan transactions, net 3,369,749 530,069
----------- ------------
Net cash provided by financing activities 3,369,749 530,069
----------- ------------
Net increase in cash and cash equivalents 13,615,747 5,849,629
Cash and cash equivalents, beginning of period 31,329,666 8,943,390
----------- ------------
Cash and cash equivalents, end of period $44,945,413 $ 14,793,019
----------- ------------
----------- ------------
</TABLE>
The accompanying notes are an integral part of the condensed consolidated
financial statements.
5
<PAGE>
DIGI INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION
The interim condensed consolidated financial statements included in this Form
10-Q have been prepared by the Company, without audit, pursuant to the rules
and regulations of the Securities and Exchange Commission. Certain
information and footnote disclosures, normally included in financial
statements prepared in accordance with generally accepted accounting
principles, have been condensed or omitted, pursuant to such rules and
regulations. These condensed consolidated financial statements should be
read in conjunction with the consolidated financial statements and related
notes thereto included in the Company's 1997 Annual Report and Form 10-K.
The condensed consolidated financial statements presented herein as of June
30, 1998 and for the three month and nine month periods ended June 30, 1998
and 1997, reflect, in the opinion of management, all adjustments (which,
other than the restructuring charge recorded in the nine month period ended
June 30, 1997, and the reversal of certain lease obligation accruals recorded
in the three month and nine month periods ended June 30, 1998, consist only
of normal, recurring adjustments) necessary for a fair presentation of the
consolidated financial position and the consolidated results of operations
and cash flows for the periods presented. The consolidated results of
operations for any interim period are not necessarily indicative of results
for the full year.
2. INVESTMENT IN AETHERWORKS CORPORATION
In May 1998, the Company exchanged its previously purchased $13,796,525 of
convertible notes from AetherWorks Corporation, a development stage company
engaged in the development of wireless and dial-up remote access technology,
for a non-interest bearing $8,000,000 non-convertible note. As a part of the
exchange, the Company relinquished its rights to any future technology or
claims on any of AetherWorks' intellectual properties. In exchange, the
Company has been released from all of its guarantees of certain lease
obligations of AetherWorks. As a result, the Company has reversed its
$1,350,000 accrual, established in the fourth quarter of 1997, for the
estimated probable obligation of such lease obligations and has included such
amount in other income for the three month and nine month periods ended June
30, 1998.
Due to the significant uncertainty as to collectibility of the $8,000,000
note, which matures in 2001, the note has been recorded at no value.
The Company continues to lease to AetherWorks $1,325,000 of computer
equipment under a three year direct financing lease, expiring in 2000.
6
<PAGE>
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. INVESTMENT IN AETHERWORKS CORPORATION (CONTINUED)
For the three month and nine month periods ended June 30, 1997, the Company
reported its investment in AetherWorks on the equity method and reported net
losses of $1,525,006 and $4,634,476, respectively. Such losses represented
100% of AetherWorks' net losses for the periods. The percentage of
AetherWorks' net losses included in the Company's financial statements was
based upon the percentage of financial support provided by the Company
(versus other investors) to AetherWorks during such periods. No such losses
were recorded in the three month or nine month periods ended June 30, 1998,
as the Company no longer has any obligation to provide funding for
AetherWorks nor any potential equity interest in or management control over
AetherWorks.
3. INVENTORIES
Inventories, net are stated at the lower of cost or market, with cost
determined on the first-in, first-out method. Inventories at June 30, 1998
and September 30, 1997 consisted of the following:
<TABLE>
<CAPTION>
June 30, 1998 September 30, 1997
------------- ------------------
<S> <C> <C>
Raw materials $8,745,221 $7,967,598
Work in process 2,645,175 8,704,357
Finished goods 5,013,147 7,011,357
</TABLE>
4. NET INCOME (LOSS) PER SHARE
Net income (loss) per share for all periods presented has been calculated
pursuant to the provisions of Statement of Financial Accounting Standards No.
128, which the Company adopted in the first quarter of fiscal 1998. Basic net
income (loss) per share is calculated based on only the weighted average of
common shares outstanding during the period. Net income (loss) per share,
assuming dilution, is computed by dividing net income (loss) by the weighted
average number of common and common equivalent shares outstanding during each
period. The Company's only common stock equivalents are those that result
from dilutive common stock options. Such common stock equivalents were
excluded in determining the weighted average common and common stock
equivalents outstanding for the nine month period ended June 30, 1997,
because their effect was antidilutive.
5. LEGAL PROCEEDINGS
Discussion of legal matters is incorporated by reference from Part II, Item I
of this Form 10-Q "Legal Proceedings" and should be considered an integral
part of these consolidated condensed financial statements and accompanying
notes. The ultimate outcomes of the lawsuits cannot be determined at this
time, and no potential assessment of the probable or possible effects of such
litigation, if any, on the Company's financial position, liquidity or future
operations can be made.
7
<PAGE>
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
6. SHARE RIGHTS PLAN
The Company has adopted a share rights plan. Under the plan, the Company will
distribute as a dividend one right for each share of the Company's common
stock outstanding on June 30, 1998. Each right will entitle its holder to buy
one one-hundredth of a share of a new series of junior participating
preferred stock at an exercise price of $115, subject to adjustment. The
rights will be exercisable only if certain ownership considerations are met.
The Company will be entitled to redeem the rights prior to the rights
becoming exercisable.
7. ACQUISITIONS
On July 1, 1998, the Company announced that it had signed definitive
agreements to purchase privately held ITK International, Inc., for $25
million ($12.5 million in cash and $12.5 million of Digi common stock) and
privately held Central Data Corporation for $18 million ($13.5 million in
cash and $4.5 million of Digi common stock). The Central Data transaction
closed on July 8, 1998 and the ITK transaction closed on July 29, 1998. Both
transactions will be accounted for under the purchase accounting method
whereby the purchase price for each transaction will be allocated to the
assets and liabilities of ITK and Central Data, based upon their relative
fair values. Management estimates that a majority of the purchase price for
the ITK transaction and a substantial portion of the Central Data transaction
will be allocated to acquired, in-process research and development. In
addition, the Company also expects to record a restructuring charge ranging
from $1 million to $2 million in the fourth quarter of 1998, related to the
elimination of duplicate facilities created by the ITK combination.
8
<PAGE>
REVIEW REPORT OF INDEPENDENT ACCOUNTANTS
----------------------------------------
To the Stockholders and Board of Directors of
Digi International Inc.:
We have reviewed the accompanying condensed consolidated balance sheet of
Digi International Inc. and subsidiaries as of June 30, 1998, and the related
condensed consolidated statements of operations for the three month and nine
month periods ended June 30, 1998 and 1997, and cash flows for the nine month
periods ended June 30, 1998 and 1997. These condensed consolidated financial
statements are the responsibility of the Company's management.
We conducted our reviews in accordance with standards established by the
American Institute of Certified Public Accountants. A review of interim
financial information consists principally of applying analytical procedures
to financial data and making inquiries of persons responsible for financial
and accounting matters. It is substantially less in scope than an audit
conducted in accordance with generally accepted auditing standards, the
objective of which is the expression of an opinion regarding the financial
statements taken as a whole. Accordingly, we do not express such an opinion.
Based on our reviews, we are not aware of any material modifications that
should be made to the condensed consolidated financial statements referred to
above for them to be in conformity with generally accepted accounting
principles.
We have previously audited, in accordance with generally accepted auditing
standards, the consolidated balance sheet as of September 30, 1997, and the
related consolidated statements of operations and cash flows for the year
then ended (not presented herein); and in our report dated December 15, 1997,
we expressed an unqualified opinion on those consolidated financial
statements. In our opinion, the information set forth in the accompanying
condensed consolidated balance sheet as of September 30, 1997, is fairly
stated in all material respects in relation to the consolidated balance sheet
from which it has been derived.
/s/ PricewaterhouseCoopers LLP
Minneapolis, Minnesota
July 20, 1998
9
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION
CONSOLIDATED RESULTS OF OPERATIONS
The following table sets forth selected information derived from the
Company's interim condensed consolidated statement of operations expressed as
percentages of sales:
<TABLE>
<CAPTION>
Three months % Nine Months %
ended Increase ended Increase
June 30 (decrease) June 30 (Increase)
------------------------------ ------------------------------
1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C>
Net sales 100.0% 100.0% 14% 100.0% 100.0% 9%
Cost of sales 47.1 50.7 6 48.5 52.2 1
----- ----- --- ----- ----- ---
Gross margin 59.2 49.3 22 51.4 47.8 17
----- ----- --- ----- ----- ---
Operating expenses:
Sales and marketing 19.5 22.3 (1) 19.7 23.7 (10)
Research and development 8.9 9.6 5 8.9 11.6 (17)
General and administrative 6.4 11.1 (34) 7.5 11.3 (28)
Restructuring 0.0 0.0 0 0.0 8.5 (100)
----- ----- --- ----- ----- ---
Total operating expenses 34.7 43.0 (8) 36.0 55.1 (29)
----- ----- --- ----- ----- ---
Operating income (loss) 18.1 6.2 231 15.5 (7.3) 331
Other income, net 1.4 0.3 463 1.1 0.3 330
AetherWorks Corporation gain (loss) 2.9 (3.7) 100 1.0 (3.8) 100
----- ----- --- ----- ----- ---
Income (loss) before income taxes 22.5 2.8 819 17.6 (10.7) 278
Provision (benefit) for income taxes 8.7 2.6 277 6.4 (1.1) 740
----- ----- --- ----- ----- ---
Net income (loss) 13.8% 0.2% *% 11.1% (9.6%) 225%
----- ----- --- ----- ----- ---
----- ----- --- ----- ----- ---
</TABLE>
*Not meaningful
NET SALES
Net sales for the three month and nine month periods ended June 30,1998 were
higher than net sales for the corresponding periods ended June 30, 1997 by
approximately $5.6 million and $10.6 million or 13.7% and 8.6% respectively.
The majority of the increase was due to the Company completing its effort to
reduce inventory levels in the distribution channel through the first fiscal
quarter of 1998, resulting in a net increase in sales into the distribution
channel during the second quarter of fiscal 1998. In addition, net sales for
the three and nine month periods ended June 30, 1998 contain minor amounts
related to royalties and the sale of trademarks.
Net sales to the distribution markets, as a percentage of total net sales,
increased to 75.8% and 70.7% for the three month and nine month periods ended
June 30, 1998, as compared to 61.5% and 63.7% for the comparable periods of
1997. Sequentially, net sales to the distribution markets for the three
month period ended June 30, 1998 increased 3.4%, compared to the three month
period ended March 31, 1998.
10
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION (CONTINUED)
CONSOLIDATED RESULTS OF OPERATIONS (CONTINUED)
NET SALES (CONTINUED)
Net sales to original equipment manufacturers (OEM's), as a percentage of
total net sales, were 18.1% and 21.6% for the respective three and nine month
periods ended June 30, 1998, as compared to 26.1% and 23.6% for the
comparable periods in 1997, reflecting a continuing reduction of OEM sales.
Such reduction was caused, in part, by the inability to ship all orders
through June 30, 1998. The company expects the percentage of OEM sales to
increase to levels near or at historical levels in terms of percentage of
total net sales in the fourth quarter of fiscal 1998.
GROSS MARGIN
Gross margin for the three and nine month periods ended June 30, 1998 was
52.9% and 51.5%, respectively, as compared to 49.3% and 47.8% for the
comparable periods in 1997. Such increases versus 1997 were due primarily to
a decrease of historically lower margin OEM and certain physical layer
product net sales as a percentage of total net sales for the three and nine
months ended June 30, 1998. In particular, gross margins for the three month
period ended June 30, 1998, were enhanced by a favorable product mix,
resulting in higher sales of higher margin products, in spite of increased
provisions for inventory obsolescence. The Company expects the gross margin
percentage for the fourth quarter of fiscal 1998 to revert to the levels
achieved in the second quarter of fiscal 1998.
OPERATING EXPENSES
Operating expenses for the three month period ended June 30, 1998 decreased
8.2% versus operating expenses for the corresponding period ended June 30,
1997 and decreased as a percentage of net sales to 34.7% for the three month
period ended June 30, 1998 from 43.0% for the three month period ended June
30, 1997. Operating expenses for the nine month period ended June 30, 1998
decreased by 16.2% versus operating expenses (excluding restructuring
charges) for the nine month period ended June 30, 1997. As a percentage of
net sales, operating expenses declined to 36.0% for the nine month period
ended June 30, 1998, from 46.6% (excluding restructuring charges) for the
corresponding period in 1997.
Such declines were due to reductions in the workforce, decreased marketing
costs and cost savings achieved through consolidation of research and
development functions.
The Company expects that operating expenses for the fourth quarter of fiscal
1998 will be higher than the $16.1 million incurred in the three months ended
June 30, 1998, due to costs related to new product roll-out, the previously
announced acquisitions of ITK International, Inc. and Central Data
Corporation and the increased marketing expenses for products of the acquired
companies.
11
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION (CONTINUED)
CONSOLIDATED RESULTS OF OPERATIONS (CONTINUED)
OTHER INCOME
The increase in other income for the three month and nine month periods ended
June 30, 1998 was a result of additional interest income earned on increased
cash and cash equivalent balances, and the $1,350,000 reversal of the
previously accrued probable obligation related to lease guarantees of
AetherWorks Corporation, which is no longer required (see Note 2 to the
Company's Condensed Consolidated Financial Statements).
AETHERWORKS CORPORATION NET LOSS
In connection with the Company's previously purchased $13.8 million of
convertible notes from AetherWorks Corporation, in May 1998, the Company
exchanged such notes for a non-interest bearing $8.0 million non-convertible
note and was released from all of its guarantees of certain lease obligations
of AetherWorks. Due to the significant uncertainty as to collectibility, the
$8.0 million note, which matures in 2001, has been recorded at no value (see
Note 2 to the Company's Condensed Consolidated Financial Statements). In
fiscal 1997, the Company recorded its investment in AetherWorks on the equity
method and recorded net losses of $1,525,006 and $4,634,476 for the three
month and nine month periods ended June 30, 1997, respectively. These net
losses represent 100% of AetherWorks' net losses for such periods. The
percentage of AetherWorks' net losses included in the Company's financial
statements was based upon the percentage of financial support provided by the
Company (versus other investors) during such periods. The Company wrote off
its investment in AetherWorks as of September 30, 1997. As the Company no
longer has any funding obligations nor any potential equity interest in or
management control over AetherWorks, the Company has not reported any of
AetherWorks' net losses in the three month or nine month periods ended
June 30, 1998.
INCOME TAXES
Income taxes have been accrued at an overall effective rate of 38.6% and
36.8% for the respective three and nine month periods ended June 30, 1998.
The higher effective rate reflected in the third quarter reflects an increase
in the expected tax rate for the nine month period ended June 30, 1998. Due
to the net losses incurred in nine month period ended June 30, 1997, the
Company had recorded an income tax benefit of $1,357,450. During the three
month period ended June 30, 1997, the Company had taxable income and,
accordingly, recorded an income tax provision of $1,068,455. The effective
rate for the three month period ended June 30, 1997 was higher than normal
due to the non-deductibility of the AetherWorks net losses.
FINANCIAL CONDITION
LIQUIDITY AND CAPITAL RESOURCES
The Company has financed its operations principally with funds generated from
operations. Investing activities for the three month and nine month periods
ended June 30, 1998 consisted
12
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION (CONTINUED)
LIQUIDITY AND CAPITAL RESOURCES (CONTINUED)
primarily of purchases of equipment and capital improvements, including a new
enterprise wide computer system. The nine month period ended June 30, 1998
also included the final payments for AetherWorks Corporation convertible
notes. Equipment, system and other purchases totaled $4,407,189 during the
nine month period ended June 30, 1998. The final convertible note payments
to AetherWorks amounted to $2 million for the nine month period ended June
30, 1998. The Company has no further financial obligations under its
agreements with AetherWorks Corporation.
On July 1, 1998, the Company announced the acquisitions of Central Data
Corporation and ITK International, Inc. The purchase price for the
acquisitions totaled $43 million, and will include the issuance of $17
million of common stock and cash payments of $26 million (see Note 6 to the
Company's Condensed Consolidated Financial Statements). In addition,
approximately $5 million to $7 million of operating cash may be required to
provide working capital to the acquired companies.
As a result of the acquisitions, the Company will record approximately $10
million in debt in the fourth quarter of 1998, as a result of outstanding
debt of Central Data and ITK.
At June 30, 1998, the Company had working capital of approximately $76.4
million and no debt. The Company has negotiated a $10 million unsecured line
of credit with its bank, but has not utilized such line. The Company's
management believes that current financial resources, cash generated from
operations and the Company's potential capacity for debt and/or equity
financing will be sufficient to fund current and future business operations.
FOREIGN CURRENCY TRANSLATION
Substantially all of the Company's foreign transactions are negotiated,
invoiced and paid in U.S. dollars. In future periods, sales made through the
Company's newly acquired subsidiary, ITK, will be substantially all in
deutsche marks.
Effective January 1, 1999, eleven states of the European Union will convert
to a common currency, the "euro." This action will most likely cause the
majority of the Company's European transactions to be negotiated, invoiced
and paid in "euros." The conversion will most likely add currency exchange
costs and risks, although such costs and risks are not quantifiable at this
time.
INFLATION
Management believes inflation has not had a material effect on the Company's
operations or on its financial position.
13
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION (CONTINUED)
NEW ACCOUNTING STANDARDS
As described in Note 4 to the Condensed Consolidated Financial Statements,
the Company, in the first fiscal quarter of 1998, adopted Statement of
Financial Accounting Standards No. 128, "Earnings Per Share."
In addition, during the first fiscal quarter of 1998, the Emerging Issues
Task Force of the Financial Accounting Standards Board released Issue No.
97-13, "Accounting for Costs Incurred in Connection with a Consulting
Contract or an Internal Project That Combines Business Process Reengineering
and Information Technology Transformation" (EITF 97-13). The Task Force
reached a consensus that the cost of business process reengineering
activities, whether done internally or by third parties, is to be expenses as
incurred. This consensus did not have a significant impact on the Company's
quarterly results through June 30, 1998. The Company, however, incurred
costs in connection with the completion of its enterprise-wide information
systems implementation project that were required to be expensed pursuant to
EITF 97-13. Such amounts were approximately $600,000.
FORWARD LOOKING STATEMENTS
Certain statements made above, which are summarized below, are
forward-looking statements that involve risks and uncertainties, and actual
results may be materially different. Factors that could cause actual results
to differ include those identified as follows:
THE EXPECTATION THAT THE COMPANY ESTIMATES THAT A MAJORITY OF THE PURCHASE
PRICE FOR THE ITK TRANSACTION AND A SUBSTANTIAL PORTION OF THE CENTRAL DATA
TRANSACTION WILL BE ALLOCATED TO ACQUIRED, IN-PROCESS RESEARCH AND
DEVELOPMENT - This expectation may be impacted by the final report of the
third-party appraiser engaged to appraise the fair value of the assets and
liabilities acquired.
THE EXPECTATION THAT THE COMPANY WILL RECORD RESTRUCTURING CHARGES RANGING
FROM $1 MILLION TO $2 MILLION IN THE FOURTH QUARTER OF 1998 - This
expectation could be impacted by the Company's ultimate integration and
operating plans for ITK.
THE EXPECTATION THAT THE ORIGINAL EQUIPMENT MANUFACTURER (OEM) PORTION OF THE
COMPANY'S BUSINESS WILL RETURN TO LEVELS NEAR OR AT HISTORICAL LEVELS IN
TERMS OF PERCENTAGE OF TOTAL NET SALES IN THE FOURTH FISCAL QUARTER - This
expectation may be impacted by unanticipated revenue opportunities or changes
in ordering levels that may reduce expected levels of net sales to OEMs.
THE EXPECTATION THAT GROSS MARGIN PERCENTAGES FOR THE FOURTH QUARTER OF
FISCAL 1998 WILL BE LOWER THAN THOSE ACHIEVED IN THE THIRD QUARTER OF FISCAL
1998 - This expectation may be impacted by presently unanticipated favorable
product sales mix compared to normal selling patterns or may be unfavorably
impacted by unanticipated costs due to unforeseen price increases or
shortages of components.
14
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION (CONTINUED)
FORWARD LOOKING STATEMENTS (CONTINUED)
THE EXPECTATION THAT OPERATING EXPENSES IN THE FOURTH QUARTER OF FISCAL 1998
WILL BE HIGHER THAN THOSE INCURRED IN THE THIRD FISCAL QUARTER OF 1998 - This
expectation may be impacted by presently unanticipated revenue opportunities
or by unanticipated expenses or presently unforeseen cost savings.
THE BELIEF THAT THE COMPANY'S CURRENT FINANCIAL RESOURCES, CASH GENERATED
FROM OPERATIONS AND THE COMPANY'S POTENTIAL CAPACITY FOR DEBT AND/OR EQUITY
FINANCING WILL BE SUFFICIENT TO FUND CURRENT AND ANTICIPATED BUSINESS
OPERATIONS - Changes in anticipated operating results, credit availability
and equity market conditions may further enhance or inhibit the Company's
ability to maintain or raise appropriate levels of cash.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On January 3, 1997, the Company and certain of its previous officers were
named as defendants in a putative securities class action lawsuit in the
United States District Court for the District of Minnesota on behalf of an
alleged class of purchasers of its common stock during the period January 25,
1996, through December 23, 1996. Between January 17, 1997 and March 7, 1997,
four similar putative securities class actions also were commenced. By
Memorandum and Order dated April 2, 1997, the District Court consolidated all
five of the putative securities class actions for all purposes including
trial, appointed 21 persons to serve as lead plaintiffs in the consolidated
class actions, and allowed the lead plaintiffs to file and serve a
consolidated class action complaint.
On May 12, 1997, a consolidated amended class action complaint (the
"Consolidated Amended Complaint") was filed in the combined actions, which
are captioned IN RE DIGI INTERNATIONAL INC. SECURITIES LITIGATION, Master
File No. 97-5 (JRT/RLE) (U.S. District Court for the District of Minnesota).
The Consolidated Amended Complaint alleges that the Company and its previous
officers Ervin F. Kamm, Jr., Gerald A. Wall and Gary L. Deaner violated the
federal securities laws by, among other things, misrepresenting and/or
omitting material information concerning the Company's operations and
financial results. The Consolidated Amended Complaint seeks compensatory
damages in an unspecified amount plus interest against all defendants,
jointly and severally, and an award of attorneys' fees, experts' fees and
costs.
15
<PAGE>
PART II. OTHER INFORMATION (CONTINUED)
ITEM 1. LEGAL PROCEEDINGS (CONTINUED)
On February 25, 1997, the Company and certain of its previous officers also
were named as defendants in a securities lawsuit filed in the United States
District Court for the District of Minnesota by the Louisiana State Employees
Retirement System and entitled LOUISIANA STATE EMPLOYEES RETIREMENT SYSTEM IN
BEHALF OF ITSELF AND IN BEHALF OF ALL OTHER PARTIES SIMILARLY SITUATED AND
CIRCUMSTANCED WHO DESIRE TO PERSONALLY JOIN IN THIS ACTION AND TO CONTRIBUTE
TO THE COSTS AND EXPENSES THEREOF, PLAINTIFFS, VS. DIGI INTERNATIONAL INC.,
GARY L. DEANER, ERVIN F. KAMM, JR., GERALD A. WALL, AND "JOHN DOE AND
"RICHARD ROE", THE NAMES "JOHN DOE" AND "RICHARD ROE" BEING FICTITIOUS, THE
PARTIES INTENDED BEING THOSE PARTIES, PRESENTLY UNKNOWN TO THE PLAINTIFF, WHO
PARTICIPATED IN THE WRONGFUL ACTS SET FORTH HEREIN, DEFENDANTS, Civil File
No. 97-440, Master File No. 97-5 (JRT/RLE) (U.S. District Court for the
District of Minnesota). On June 3, 1997, the Louisiana State Employees
Retirement System filed an Amended Complaint (the "Louisiana Amended
Complaint"). The Louisiana Amended Complaint alleges that the Company and
its previous officers Ervin F. Kamm, Jr., Gerald A. Wall and Gary L. Deaner
violated federal securities laws and state common law by, among other things,
misrepresenting and/or omitting material information concerning the Company's
operations and financial results. The Louisiana Amended Complaint seeks
compensatory damages in the amount of $718,404.70 plus interest against all
defendants, jointly and severally, and an award of attorneys' fees,
disbursements and costs. This action has been consolidated with the
consolidated class actions for pretrial purposes.
In a decision issued on May 22, 1998, the District Court granted in part and
denied in part the motions of the Company and its three former officers to
dismiss the Consolidated Amended Complaint and the Louisiana Amended
Complaint. The Court dismissed without leave to replead all claims asserted
in both cases, except for certain federal securities law claims based upon
alleged misrepresentations and/or omissions relating to the accounting
treatment applied to the Company's AetherWorks investment. These claims
remain pending against the Company and its former officers Ervin F. Kamm, Jr.
and Gerald A. Wall. Discovery in the actions has recently commenced.
ITEM 2. CHANGES IN SECURITIES
None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
ITEM 5. OTHER INFORMATION
None
16
<PAGE>
PART II. OTHER INFORMATION (CONTINUED)
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
<TABLE>
<CAPTION>
Exhibit No. Description
- ----------- -----------
<S> <C>
3(a) Restated Certificate of Incorporation of the Registrant,
As Amended*
3(b) Amended and Restated By-Laws of the Registrant**
15 Letter Re: Unaudited Interim Financial Information
27 Financial Data Schedule
</TABLE>
(b) Reports on Form 8-K:
Current Report on Form 8-K dated June 24, 1998 reporting the adoption of a
Share Rights Plan.
- -------------------------
*Incorporated by reference to the corresponding exhibit number of the
Company's Form 10-K for the year ended September 30, 1992 (File No. 0-17972)
**Incorporated by reference to the corresponding exhibit number of the
Company's Registration Statement on Form S-1 (File No. 33-42384)
17
<PAGE>
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this Report to be signed on its behalf by the
undersigned thereunto duly authorized.
DIGI INTERNATIONAL INC.
Date: August 10, 1998 By: /s/ Jonathon E. Killmer
--------------------------------
Jonathon E. Killmer
Chief Financial Officer
(duly authorized officer and
Principal Financial Officer)
18
<PAGE>
EXHIBIT 15
UNAUDITED INTERIM FINANCIAL INFORMATION LETTER
<PAGE>
EXHIBIT 15
Securities and Exchange Commission
450 Fifth Street N.W.
Washington, D.C. 20549
We are aware that our report dated July 20, 1998 on our reviews of interim
condensed consolidated financial information of Digi International Inc. and
Subsidiaries (the Company) for the three month and nine month periods ended
June 30, 1998 and 1997, and included in the Company's Form 10-Q for the
quarter ended June 30, 1998, is incorporated by reference in the Company's
registration statements on Form S-8 (Registration Nos. 33-32956, 33-38898,
333-99, 333-1821, 333-23857 and 333-57869). Pursuant to Rule 436(c), under
the Securities Act of 1933, this report should not be considered a part of
the registration statements prepared or certified by us within the meaning of
Sections 7 and 11 of that Act.
PRICEWATERHOUSECOOPERS L.L.P.
Minneapolis, Minnesota
August 5, 1998
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> SEP-30-1998
<PERIOD-START> OCT-01-1997
<PERIOD-END> JUN-30-1998
<CASH> 44,945,413
<SECURITIES> 0
<RECEIVABLES> 34,699,087
<ALLOWANCES> 0
<INVENTORY> 16,403,543
<CURRENT-ASSETS> 99,950,665
<PP&E> 22,571,781
<DEPRECIATION> 0
<TOTAL-ASSETS> 137,916,743
<CURRENT-LIABILITIES> 23,500,440
<BONDS> 0
0
0
<COMMON> 149,512
<OTHER-SE> 114,266,791
<TOTAL-LIABILITY-AND-EQUITY> 137,916,743
<SALES> 134,098,319
<TOTAL-REVENUES> 134,098,319
<CGS> 65,104,699
<TOTAL-COSTS> 48,215,540
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 23,605,350
<INCOME-TAX> 8,686,768
<INCOME-CONTINUING> 14,918,582
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 14,918,582
<EPS-PRIMARY> 1.10
<EPS-DILUTED> 1.05
</TABLE>
