<PAGE>
- --------------------------------------------------------------------------------
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q/A
AMENDMENT NO. 1 TO 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: December 31, 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 February 2, 1999, there were 14,624,269 shares of the registrant's $.01 par
value Common Stock outstanding.
- --------------------------------------------------------------------------------
<PAGE>
INDEX
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
RESTATEMENT OF FINANCIAL STATEMENTS.........................................3
PART I FINANCIAL INFORMATION
ITEM 1. Financial Statements
Condensed Consolidated Statement of Operations
for the three months ended
December 31, 1998 and 1997.......................................4
Condensed Consolidated Balance Sheet as of
December 31, 1998 and December 30, 1997..........................5
Condensed Consolidated Statement of Cash Flows
for the three months ended December 31, 1998 and 1997............6
Notes to Condensed Consolidated Financial
Statements.......................................................7
Review Report of Independent Accountants........................13
ITEM 2. Management's Discussion and Analysis of
Results of Operations and Financial Condition...................14
Forward-looking Statements......................................19
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings...............................................20
ITEM 6. Exhibits and Reports on Form 8-K................................21
</TABLE>
2
<PAGE>
RESTATEMENT OF FINANCIAL STATEMENTS AND
CHANGES TO CERTAIN INFORMATION
The Registrant previously announced that it would revise the accounting
treatment of its July 1998 acquisitions of ITK International, Inc. and Central
Data Corporation in response to comments received from the Securities and
Exchange Commission. Accordingly, this Quarterly Report on Form 10-Q/A is being
filed as Amendment No. 1 to the Registrant's Quarterly Report on Form 10-Q filed
with the Securities and Exchange Commission on February 16, 1999 for the purpose
of restating financial information and related disclosures for the three month
period ended December 31, 1998. See Note 1 to the Condensed Consolidated
Financial Statements.
3
<PAGE>
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
DIGI INTERNATIONAL INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE MONTHS ENDED DECEMBER 31, 1998 AND 1997
(UNAUDITED)
<TABLE>
<CAPTION>
1998 1997
------------ ------------
(As Restated)
<S> <C> <C>
Net sales $ 51,395,021 $ 42,590,059
Cost of sales 24,904,313 21,221,314
------------ ------------
Gross margin 26,490,708 21,368,745
------------ ------------
Operating expenses:
Sales and marketing 11,974,080 8,259,494
Research and development 6,476,216 3,810,900
General and administrative 6,414,486 3,610,125
------------ ------------
Total operating expenses 24,864,782 15,680,519
------------ ------------
Operating income 1,625,926 5,688,226
Other (expense) income, principally interest (209,786) 268,885
------------ ------------
Income before income taxes 1,416,140 5,957,111
Provision for income taxes 941,595 2,114,775
------------ ------------
Net income $ 474,545 $ 3,842,336
============ ============
Net income per common share, basic $ 0.03 $ 0.28
============ ============
Net income per common share, assuming dilution $ 0.03 $ 0.27
============ ============
Weighted average common shares, basic 14,572,022 13,480,656
============ ============
Weighted average common shares, assuming dilution 14,701,519 14,043,273
============ ============
</TABLE>
4
The accompanying notes are an integral part of the condensed consolidated
financial statements.
<PAGE>
DIGI INTERNATIONAL INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
December 31 September 30
1998 1998
------------- -------------
(As Restated) (As Restated)
(Unaudited)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 4,041,170 $ 10,355,368
Accounts receivable, net 43,100,046 48,549,145
Inventories, net 29,508,100 27,365,924
Other 6,055,093 6,139,941
------------- -------------
Total current assets 82,704,409 92,410,378
Property, equipment and improvements, net 33,098,851 33,990,923
Intangible assets, net 61,333,817 63,602,435
Other 2,595,137 2,978,883
------------- -------------
Total assets $ 179,732,214 $ 192,982,619
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Borrowings under line of credit agreements $ 6,278,303 $ 10,707,000
Current portion of long-term debt 41,748 264,025
Accounts payable 12,234,996 15,255,175
Income taxes payable 4,959,399 3,797,588
Accrued expenses:
Advertising 2,662,924 2,651,742
Compensation 3,948,904 6,776,292
Other 6,657,119 9,808,835
Restructuring accruals 3,566,658 5,254,000
------------- -------------
Total current liabilities 40,350,051 54,514,657
Long-term debt 11,051,206 11,124,446
Net deferred income taxes 5,221,233 5,817,933
Other 308,339 275,000
------------- -------------
Total liabilities 56,930,829 71,732,036
Commitments and contingencies
Stockholders' equity:
Preferred stock, $.01 par value; 2,000,000 shares
authorized; none outstanding
Common stock, $.01 par value; 60,000,000 shares
authorized; 15,837,625 and 15,790,975 shares issued 158,376 157,910
Additional paid-in capital 70,386,446 70,461,123
Retained earnings 75,517,351 75,042,806
Cumulative foreign currency translation adjustment (334,723) (815,809)
------------- -------------
145,727,450 144,846,030
Unearned stock compensation (1,220,077) (1,700,635)
Treasury stock, at cost, 1,236,384 and 1,247,094
shares (21,705,988) (21,894,812)
------------- -------------
Total stockholders' equity 122,801,385 121,250,583
------------- -------------
Total liabilities and stockholders' equity $ 179,732,214 $ 192,982,619
============= =============
</TABLE>
The accompanying notes are an integral part of the condensed consolidated
financial statements.
5
<PAGE>
DIGI INTERNATIONAL INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THREE MONTHS ENDED DECEMBER 31, 1998 AND 1997
(UNAUDITED)
<TABLE>
<CAPTION>
1998 1997
------------ ------------
(As Restated)
<S> <C> <C>
Operating activities:
Net income $ 474,545 $ 3,842,336
Adjustments to reconcile net income to net cash
(used in) provided by operating activities:
Depreciation and amortization 4,520,089 1,720,414
Provision for losses on accounts receivable 150,000 607,992
Provision for inventory obsolescence 1,175,399 1,397,098
Loss on sale of fixed assets 19,625 70,584
Stock compensation 338,470 113,382
Changes in operating assets and liabilities (7,377,609) (1,645,933)
------------ ------------
Total adjustments (1,174,026) 2,263,537
------------ ------------
Net cash (used in) provided by operating activities (699,481) 6,105,873
------------ ------------
Investing activities:
Purchase of property, equipment, intangibles,
and improvements (1,453,323) (2,084,223)
Investment in AetherWorks Corporation -- (1,000,000)
------------ ------------
Net cash (used in) investing activities (1,453,323) (3,084,223)
------------ ------------
Financing activities:
Principal payments on borrowings (4,521,071) --
Stock benefit plan transactions, net 256,870 363,591
------------ ------------
Net cash (used in) provided by financing activities (4,264,201) 363,591
------------ ------------
Effect of exchange rate changes on cash and
and cash equivalents 102,807 --
Net (decrease) increase in cash and cash equivalents (6,314,198) 3,385,241
Cash and cash equivalents, beginning of period 10,355,368 31,329,666
------------ ------------
Cash and cash equivalents, end of period $ 4,041,170 $ 34,714,907
============ ============
</TABLE>
The accompanying notes are an integral part of the condensed consolidated
financial statements.
6
<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/A have been prepared by the Company, without audit, pursuant to the
rules and regulations of the Securities and Exchange Commission (SEC).
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 Form 10-K/A.
The condensed consolidated financial statements presented herein as of
December 31, 1998, and for the three months ended December 31, 1998, and
1997, reflect, in the opinion of management, all adjustments (which 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.
After discussion with the staff of the Securities and Exchange Commission
(the SEC) the condensed consolidated financial statements as of September 30,
1998, December 31, 1998 and March 31, 1999, and for the year ended September
30, 1998 and the three month period ended December 31, 1998, and the three
and six month periods ended March 31, 1999, have been restated to reflect a
change in the measurement and allocations of the purchase prices related to
the July 1998 acquisitions of ITK and CDC.
The Company allocated amounts to IPR&D and intangible assets in the fourth
quarter of 1998 in a manner consistent with widely recognized appraisal
practices at the date of the acquisitions of ITK and CDC. Subsequent to the
acquisitions, the SEC staff expressed broad views that took issue with
certain appraisal practices generally employed by many public companies in
determining the fair value of IPR&D. As a result of these developments, the
Company has modified its valuation of IPR&D using the alternative income
valuation approach. In addition, in response to questions raised by the SEC
about the Company's measurement of the fair value of common stock and common
stock options issued in the ITK and CDC acquisitions, the Company has
modified its valuation of this portion of the purchase prices.
As a result of valuing IPR&D using the alternative income valuation approach
and adjusting the measurement of the purchase prices, the Company, in
consultation with their independent accountants, has revised its measurement
and allocations of the purchase prices, including the amounts allocated to
IPR&D. The effect of these adjustments was to; reduce the aggregate amount
originally allocated to IPR&D from $39.2 million to $16.1 million; increase
the aggregate amount allocated to current technologies from $15.0 to $29.1
million; increase the amount of net deferred tax liabilities from $0 to $6.3
million; increase goodwill from $8.2 million to $27.4 million; increase
additional paid in-capital from $68.7 million to $70.5 million;
7
<PAGE>
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. BASIS OF PRESENTATION (CONTINUED)
and reduce unearned stock compensation from $3.8 million to $1.7 million.
These adjustments will also result in additional, annual amortization
expense, related to identifiable intangibles and goodwill of approximately
$5.0 million (assuming there are no future adjustments to reflect impairments
of such intangibles and goodwill).
The restatement does not affect previously reported net cash flows for the
periods. The effect of this restatement on previously reported condensed
consolidated financial statements as of and for the three months ended
December 31, 1998 is as follows:
<TABLE>
<CAPTION>
Three Months Ended
December 31, 1998
(Unaudited)
As Previously
Reported As Restated
-------- -----------
<S> <C> <C>
Statements of Operations Data:
General and administrative expenses $5,152,292 $6,414,486
Total operating expenses 23,602,588 24,864,782
Operating income 2,888,120 1,625,926
Income before income taxes 2,678,334 1,416,140
Provision for income taxes 1,312,385 941,595
Net income 1,365,949 474,545
Net income per share, basic $ 0.09 $ 0.03
Net income per share, assuming dilution $ 0.09 $ 0.03
</TABLE>
<TABLE>
<CAPTION>
December 31, 1998 September 30, 1998
(Unaudited)
As Previously As Previously
Reported As Restated Reported As Restated
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Balance Sheet Data
Intangible assets, net $ 34,190,135 $ 61,333,817 $ 31,354,483 $ 63,602,435
Total assets 152,588,532 179,732,214 160,734,667 192,982,619
Income taxes payable 4,733,321 4,959,399 3,797,588 3,797,588
Total current liabilities 40,123,973 40,350,051 54,514,657 54,514,657
Deferred income taxes -- 5,221,233 -- 5,817,933
Total liabilities 51,483,518 56,930,829 65,914,103 71,732,036
Additional paid-in capital 70,386,446 70,386,446 68,695,448 70,461,123
Retained earnings 53,820,980 75,517,351 52,455,031 75,042,806
Unearned stock compensation (1,220,077) (1,220,077) (3,777,204) (1,700,635)
Total stockholders' equity $ 101,105,014 $ 122,801,385 $ 94,820,564 $ 121,250,583
</TABLE>
8
<PAGE>
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. RESTRUCTURING
In July 1998, the Company's Board of Directors approved a restructuring plan
related to the consolidation of its offices in Germany and England. The
restructuring plan relates to the closure of existing leased facilities
rendered redundant by the acquisition of ITK. The charge of $1,020,000
($647,000 net of tax benefits), consisted of $61,483 of noncancellable rent
commitments the Company expects to incur following closure of the Cologne,
Germany facility, $100,100 of contractual payment obligations for office
furniture and other equipment the Company expects to incur following the
closure of the Cologne, Germany facility, $202,039 related to the write-off
of leasehold improvements in connection with the closure of the Cologne,
Germany facility and $656,368 of termination payments associated with the
elimination of six positions in Cologne, Germany and Bagshot, England. The
Company closed the Cologne facility in December of fiscal 1999. As of
December 31, 1998, $165,111 of termination payments have been made relating
to one employee in Bagshot, United Kingdom. Management of the Company expects
that these restructuring activities will be completed by June 1999. A summary
of payments and adjustments are included in the table below.
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------
Balance at Change in Balance at
September 30, Estimates December 31,
Description 1998 Payments Adjustments 1998
- ------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Severance and termination costs $ 656,368 $ (165,111) $ 491,257
Rent commitments 61,483 61,483
Contractual payments for office equipment 100,110 100,110
Write-offs of leasehold improvements 202,039 202,039
--------------------------------------------------------------
TOTAL $ 1,020,000 $ (165,111) $ - $ 854,889
==============================================================
</TABLE>
In connection with the Company's acquisition of ITK, the Company has
formulated a plan of reorganization and accordingly, has recognized a
$3,484,000 restructuring liability which the Company has included as a
component of total liabilities assumed in the acquisition. Components of this
estimated liability include $1,844,000 of termination payments associated
with 10 employees the Company expects to eliminate at the Chelmsford,
Massachusetts ITK location and 20 employees the Company expects to eliminate
at the Dortmund, Germany location and $1,640,000 of noncancellable rent
obligations for facilities the Company expects to incur following closure of
facilities in Chelmsford, Massachusetts and Bristol and Newbury, England. The
Company plans to vacate the Chelmsford, Bristol, and Newbury facilities in
March 1999, October 1998 and May 1999, respectively. As of December 31, 1998,
$1,298,959 of payments have been made relating to termination costs in
Dortmund and $107,598 of payments have been made related to rent commitments
for vacant facilities in Bristol, England. The Company expects to complete
these restructuring activities by June 1999. A summary of payments and
adjustments is included in the table below.
9
<PAGE>
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
<TABLE>
<CAPTION>
2. RESTRUCTURING (CONTINUED)
- ------------------------------------------------------------------------------------------------------
Balance at Change in Balance at
September 30, Estimates December 31,
Description 1998 Payments Adjustments 1998
- ------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Severance and termination costs $ 1,844,000 $ (1,298,959) $ 545,041
Facility closures 1,640,000 (107,598) 1,532,402
----------------------------------------------------------------
TOTAL $ 3,484,000 $ (1,406,557) $ - $ 2,077,443
================================================================
</TABLE>
In connection with the Company's acquisition of CDC, the Company has
formulated a plan of reorganization and accordingly, the Company has
recognized a $750,000 restructuring liability which the Company has included
as a component of total liabilities assumed in the acquisition. Components of
this estimated liability include $675,000 of termination payments, associated
with 22 employees the Company expects to eliminate when it closes the
Champaign, Illinois facility in January 1999 and $75,000 related to facility
closure costs the Company expects to incur following closure and sale of the
Champaign, Illinois facility. As of December 31, 1998, $115,674 of payments
have been made relating to termination costs while the facility had not yet
been closed or sold. The Company expects to complete these restructuring
activities by June 1999. A summary of payments and adjustments are included
in the table below.
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------
Balance at Change in Balance at
September 30, Estimates December 31,
Description 1998 Payments Adjustments 1998
- ------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Severance and termination costs $ 675,000 $ (115,673) $ 559,327
Facility closure 75,000 75,000
----------------------------------------------------------------
TOTAL $ 750,000 $ (115,673) $ - $ 634,327
================================================================
</TABLE>
As a result of changes in management in fiscal 1999, the Company has not
completed the execution of the aforementioned restructuring plans. New
management of the Company is in the process of completing the execution of
these restructuring plans.
10
<PAGE>
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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 December 31,
1998 and September 30, 1998 consisted of the following:
<TABLE>
<CAPTION>
December 31, 1998 September 30, 1998
----------------- ------------------
<S> <C> <C>
Raw materials $14,502,604 $13,707,999
Work in process 4,449,426 2,922,442
Finished goods 10,556,070 10,735,483
----------- -----------
$29,508,100 $27,365,924
=========== ===========
</TABLE>
5. COMPREHENSIVE INCOME
Effective October 1, 1998, the Company adopted Statement of Financial
Accounting Standards No. 130, "Reporting Comprehensive Income." The statement
establishes standards for the reporting and display of comprehensive income
and its components. Comprehensive income is defined as the change in equity
of a business enterprise during a period from transactions and other events
and circumstances from non-owner sources. It includes all changes in equity
during a period except those resulting from investments by owners and
distributions to owners. For the Company, comprehensive income includes net
income and foreign currency translation adjustments that are charged or
credited to stockholders' equity.
Comprehensive income for the three months ended December 30, 1998 and 1997
are as follows:
<TABLE>
<CAPTION>
Three months ended
December 31
--------------------------
1998 1997
--------------------------
<S> <C> <C>
(As Restated)
Net income $474,545 $3,842,336
Foreign currency
translation adjustments 481,086 -
-------- ----------
Comprehensive
income $955,631 $3,842,336
======== ==========
</TABLE>
11
<PAGE>
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
6. NET INCOME PER SHARE
Basic net income per share is calculated based on only the weighted average
of common shares outstanding during the period. Net income per share,
assuming dilution, is computed by dividing net income 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. The calculation of dilutive earnings per share
excludes the 1,123,201 and 168,073 equivalent shares of the Company for the
three month periods ended December 31, 1998 and 1997, respectively,
attributable to the common stock options issued by the Company because their
effect was anti-dilutive.
7. 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.
12
<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 December 31, 1998, and the
related condensed consolidated statements of operations and cash flows for
the three months ended December 31, 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, 1998, and the
related consolidated statements of operations and cash flows for the year
then ended (not presented herein); and in our report dated December 11, 1998,
except as to Notes 2 and 3, for which the date is July 23, 1999, we expressed
an unqualified opinion on those consolidated financial statements. Such
financial statements have been restated as described in the following
paragraph. In our opinion, the information set forth in the accompanying
condensed consolidated balance sheet as of September 30, 1998, is fairly
stated in all material respects in relation to the consolidated balance sheet
from which it has been derived.
As more fully described in Note 1 to the accompanying condensed consolidated
financial statements and Note 2 of the Company's consolidated financial
statements as of and for the year ended September 30, 1998, the Company and
the staff of the Securities and Exchange Commission have had discussions
regarding the accounting treatment related to the July 1998 acquisitions of
ITK International, Inc. and Central Data Corporation. As a result of these
discussions, the Company has changed the method used to allocate the purchase
price to in-process technologies. In connection with this modification, the
Company has adjusted the measurement and allocations of the purchase prices
recorded for the aforementioned acquisitions. Accordingly, the consolidated
financial statements as of and for the year ended September 30, 1998 and as
of and for the three months ended December 31, 1998, have been restated.
/s/ PricewaterhouseCoopers LLP
Minneapolis, Minnesota
January 22, 1999, except for the information in Note 1 as to which the date
is July 23, 1999
13
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF
OPERATIONS AND FINANCIAL CONDITION
OVERVIEW
The Company previously announced it would revise the accounting treatment of its
July 1998 acquisitions of ITK and CDC in response to comments received from the
Securities and Exchange Commission. The following discussion includes all
changes that have been made related to the restatement. See Note 1 to the
Condensed Consolidated Financial Statements.
CONSOLIDATED RESULTS OF OPERATIONS
The following table sets forth selected information derived from the Company's
interim condensed consolidated statements of operations expressed as percentages
of sales:
<TABLE>
<CAPTION>
Three months %
ended Increase
December 31 (decrease)
-------------------------------------
1998 1997
------------------------
(As Restated)
------------------------
<S> <C> <C> <C>
Net sales 100.0% 100.0% 20.7%
Cost of sales 48.5 49.8 17.4
---- ---- ----
Gross margin 51.5 50.2 24.0
---- ---- ----
Operating expenses:
Sales and marketing 23.3 19.4 45.0
Research and development 12.6 8.9 69.9
General and administrative 12.5 8.5 77.7
---- ---- ----
Total operating expenses 48.4 36.8 58.6
---- ---- ----
Operating income 3.1 13.4 (49.2)
Other (expense) income, net (0.4) 0.6 (178.0)
---- ---- -----
Income before income taxes 2.7 14.0 (76.2)
Provision for income taxes 1.8 5.0 (55.5)
---- ---- -----
Net income 0.9 9.0% (87.6)%
==== ==== =====
</TABLE>
NET SALES
Net sales for the three month period ended December 31, 1998, were higher
than net sales for the corresponding three month period ended December
31,1997 by $8,804,962 or 20.7 %. The acquisitions of ITK and CDC contributed
$13,651,509 in increased revenue for the three month period ended December
31, 1998. Offsetting this revenue growth were reduced sales in physical layer
products versus the comparable period in 1997 due to decreased product
demand. In addition, also offsetting this revenue growth were reduced sales
to the distribution markets. The decline in distribution sales is primarily
due to increased sales to distributors during the third and fourth quarter of
fiscal 1998, as the Company gave incentives to distributors to increase their
purchases.
14
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION (CONTINUED)
CONSOLIDATED RESULTS OF OPERATIONS (CONTINUED)
GROSS MARGIN
Gross margin for the three month period ended December 31, 1998 increased to
51.5%, as compared to 50.2% for the three month period ended December 31,
1997. Such increase was principally due to increased sales of higher margin
server-based products to the distribution channel. In particular, gross
margins for the three month period ended December 31, 1998, were enhanced by
a favorable product mix, resulting in higher sales of higher margin products.
Offsetting the increase in margins were ITK and CDC products sold during the
three month period ended December 31, 1998, which had margins of 47.2%.
OPERATING EXPENSES
Operating expenses for the three month period ended December 31, 1998,
increased approximately $9.2 million or 58.6 % as compared to operating
expenses for the three month period ended December 31, 1997. The operations
of ITK and CDC, which were acquired in the fourth quarter of the 1998 fiscal
year, accounted for approximately $7.1 million or a 45% increase in operating
expenses. In addition, the Company increased its sales and marketing efforts
related to new product introductions. The Company also increased its research
and development efforts for new products. General and administrative expenses
also increased due to the approximately $2.5 million increase in amortization
expense resulting from identifiable intangible assets and goodwill acquired
in the ITK and CDC transactions.
The Company anticipated annual cost savings of approximately $3.7 million
relating to restructuring plans implemented by the Company (see Footnote 2 of
the condensed consolidated financial statements). These cost savings will
principally reduce future selling, general and administrative expenses and
were expected to begin during first quarter of fiscal 1999. As a result of
changes in management during fiscal 1999, the execution of restructuring
plans was delayed. The Company expects to begin to realize the full effect of
the aforementioned cost savings by December of 1999.
15
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF
OPERATIONS AND FINANCIAL CONDITION (CONTINUED)
CONSOLIDATED RESULTS OF OPERATIONS (CONTINUED)
ACQUIRED IN-PROCESS RESEARCH AND DEVELOPMENT
During July, 1998 the Company acquired ITK and CDC. These transactions was
accounted for using the purchase method of accounting. The purchase prices
were allocated to the net assets acquired based on their estimated fair
market values at the date of acquisitions.
After discussion with the staff of the Securities and Exchange Commission
(the SEC) the condensed consolidated financial statements as of September 30,
1998 and December 31, 1998 and for the three month period ended December 31,
1998 have been restated to reflect a change in the measurement and
allocations of the purchase prices related to the July 1998 acquisitions of
ITK and CDC.
The Company allocated amounts to IPR&D and intangible assets in the fourth
quarter of 1998 in a manner consistent with widely recognized appraisal
practices at the date of the acquisitions of ITK and CDC. Subsequent to the
acquisitions, the SEC staff expressed broad views that took issue with
certain appraisal practices generally employed by many public companies in
determining the fair value of IPR&D. As a result of these developments, the
Company has modified its valuation of IPR&D using the alternative income
valuation approach.
As a result of valuing IPR&D using the alternative income valuation approach
and adjusting the measurement of the purchase prices, the Company, in
consultation with their independent accountants, has revised its measurement
and allocations of the purchase prices, including the amounts allocated to
IPR&D. The effect of these adjustments was to; reduce the aggregate amount
originally allocated to IPR&D from $39.2 million to $16.1 million; increase
the aggregate amount allocated to current technologies from $15.0 to $29.1
million; increase the amount of net deferred tax liabilities from $0 to $6.3
million; increase goodwill from $8.2 million to $27.4 million; increase
additional paid in-capital from $68.7 million to $70.5 million; and reduce
unearned stock compensation from $3.8 million to $1.7 million.
The value assigned to purchased in-process technology was related to research
projects for which technological feasibility had not been established,
Internet Protocol (VoIP) technology ($11.3 million) and Universal Serial Bus
(USB) technology ($4.8 million).
The Company is continuing development of the acquired in-process VoIP
technology and, as of June 30, 1999 believes that its development efforts are
on schedule to meet the product release schedule referred to in the Company's
Annual Report on Form 10-K/A without any significant changes in its research
and development costs. However, these expectations are subject to change,
given the uncertainties of the development process and changes in market
expectations.
The Company is continuing development of the acquired in-process USB research
and development and has developed and released USB products, with initial
product revenues generated during November 1998. Completion of the in-process
USB research and development was achieved without any significant changes in
the estimated research and development costs.
16
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF
OPERATIONS AND FINANCIAL CONDITION (CONTINUED)
CONSOLIDATED RESULTS OF OPERATIONS (CONTINUED)
OTHER INCOME
Other expense, principally interest for the three month period ended December
31, 1998, results from debt assumed in the acquisition of ITK. Other income
for the three month period ended December 31, 1997 resulted from interest
earned on cash and cash equivalent balances.
INCOME TAXES
Income taxes have been provided for at an estimated annual effective rate of
66.5% for the three month period ended December 31, 1998. This effective tax
rate exceeds the U.S. statutory income tax rate and the effective tax rate of
35.5% in the three month period ended December 31, 1997 primarily due to the
additional $10.0 million of annual amortization expense related to the
Company's acquisitions of ITK and CDC which is not deductible for income tax
reporting purposes.
FINANCIAL CONDITION
LIQUIDITY AND CAPITAL RESOURCES
The Company has financed its operations principally with funds generated from
operations. Investing activities for the three months ended December 31,
1998, consisted primarily of purchases of equipment and capital improvements
totaling approximately $1.5 million. Financing activities for the three
months ended December 31, 1998, consisted primarily of payments on line of
credit and debt obligations totaling approximately $4.5 million. At December
31, 1998, the Company had working capital of approximately $42.4 million. The
Company is currently negotiating to extend a $15 million unsecured line of
credit, which expires February 28, 1999. The Company 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
Effective January 1, 1999, eleven countries of the European Union converted
to a common currency called the "Euro." This action will cause some 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.
For the three month period ended December 31, 1998, the Company had foreign
transactions that were negotiated, invoiced and paid amounting to
approximately $15.6 million, of which $8.9 million were in U.S. dollars and
$6.7 million were Deutschemark-dominated sales through the
17
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF
OPERATIONS AND FINANCIAL CONDITION (CONTINUED)
CONSOLIDATED RESULTS OF OPERATIONS (CONTINUED)
FOREIGN CURRENCY TRANSLATION (CONTINUED)
newly acquired subsidiary ITK. In future periods, a significant portion of
sales made through ITK will be made in Deutschemarks until full integration
of the "Euro" is achieved. The Company has not implemented a hedging strategy
to reduce the risk of foreign currency translation exposures, which
management does not believe to be significant based on the scope of the
Company's foreign operations as of December 31, 1998.
YEAR 2000 ISSUES
The Company began a comprehensive project in 1996 to prepare its products and
its internal computer systems for the year 2000. Most of the Company's
products are year 2000 compliant because there is very little or no date
processing involved. Certain products, including end-of-life versions, do
require customer action such as a patch or version upgrade to be compliant.
These products are being identified, and the Company is in the process of
notifying impacted customers.
The Company believes its implementation of a new enterprise-wide information
management system, principally installed to improve operating efficiency,
will address the Company's internal year 2000 compliance issues. Because of
the acquisitions of ITK and CDC, the worldwide rollout of this system will
not be completed until the late summer of calendar 1999. If necessary
conversions are not completed on a timely basis, the year 2000 could have a
material adverse effect on the Company's operations. Overall, management
believes the year 2000 will not have a significant impact on operations. The
Company plans to continue with remediation and testing efforts with both its
products and internal systems to further mitigate any risks associated with
the year 2000.
The costs associated with the year 2000 project are minimal and are not
incremental to the Company, but include temporary reallocation of existing
resources. Although the Company believes that the remaining cost of year 2000
modifications for both internal-use systems and the Company's products are
not material, there can be no assurances that various factors relating to the
year 2000 compliance issues, including litigation, will not have a material
adverse effect on the Company's business, operating results, or financial
position.
INFLATION
Management believes inflation has not had a material effect on the Company's
operations or on its financial position.
18
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF
OPERATIONS AND FINANCIAL CONDITION (CONTINUED)
CONSOLIDATED RESULTS OF OPERATIONS (CONTINUED)
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 below:
THE EXPECTATION THAT VARIOUS RESTRUCTURING ACTIVITIES IN CONNECTION WITH THE
ACQUISITIONS OF ITK AND CDC WILL BE COMPLETED ACCORDING TO SCHEDULE AND WILL
RESULT IN EXPECTED BENEFITS - This expectation may be impacted by presently
unanticipated delays or expenses.
THE EXPECTATION THAT THE COMPANY'S 1999 EFFECTIVE TAX RATE WILL BE 66.5
PERCENT - This expectation may be impacted by the changes in the Company's
level of profitability.
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.
THE BELIEF THAT IMPLEMENTATION OF A NEW ENTERPRISE-WIDE INFORMATION
MANAGEMENT SYSTEM WILL ADDRESS THE COMPANY'S INTERNAL YEAR 2000 COMPLIANCE
ISSUES AND THE BELIEF THAT THE YEAR 2000 WILL NOT HAVE A SIGNIFICANT IMPACT
ON OPERATIONS - These beliefs may be impacted by presently unanticipated
delays in assessment or remediation, unanticipated increases in costs or
non-compliance by third parties.
19
<PAGE>
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Between January 3, 1997 and March 7, 1997, the Company and certain of its
previous officers were named as defendants in five putative securities class
action lawsuits filed in the United States District Court for the District of
Minnesota on behalf of an alleged class of purchasers for its common stock
during the period January 25, 1996, through December 23, 1996. The five
putative class actions were thereafter consolidated, and on May 12, 1997, a
consolidated amended class action complaint (the "Consolidated Amended
Complaint") was filed in the actions, which are captioned IN RE DIGI
INTERNATIONAL INC. SECURITIES LITIGATION (Master File No. 97-5 DWF/RLE). 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.
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, which is captioned LOUISIANA STATE EMPLOYEES RETIREMENT
SYSTEM V. DIGI INTERNATIONAL INC., GARY L. DEANER, ERVIN F. KAMM, JR., GERALD
A. WALL AND "JOHN DOE" AND "RICHARD ROE", DEFENDANTS (Civil File No. 97-440,
Master File No. 97-5 DWF/RLE). 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.
In a decision issued on May 22, 1998, the United States District Court for
the District of Minnesota granted in part and denied in part defendants'
motions 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. The
Court also limited the claims asserted in the Louisiana Amended Complaint to
the 11,000 shares of the Company's stock held subsequent to November 14,
1996, for which the Louisiana Amended Complaint claims damages of
$184,276.40. The claims in the two actions remain pending against the Company
and its former officers Ervin F. Kamm, Jr. and Gerald A. Wall. Discovery in
the actions is proceeding.
Because the lawsuits are in preliminary stages, the ultimate outcomes cannot
be determined at this time, and no potential assessment of their effect, if
any, on the Company's financial position, liquidity or future operations can
be made.
20
<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**
4(a) Form of Rights Agreement, dated as of June 10, 1998 between
Digi International Inc. and Norwest Bank Minnesota, National
Association, as Rights Agent***
4(b) Amendment dated January 26, 1998, to Share Rights Agreement,
dated as of June 10, 1998 between Digi International Inc. and
Norwest Bank Minnesota, National Association, as Rights
Agent****
10(h)(i) Amendment to Employment Agreement between the Company and
Douglas J. Glader dated February 1, 1999
15 Letter Re: Unaudited Interim Financial Information
27 Financial Data Schedule
(b) Reports on Form 8-K:
None.
</TABLE>
- ------------------------------------------------
*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)
***Incorporated by reference to Exhibit 1 to the Company's Registration
Statement on Form 8-A dated June 24, 1998 (File No. 0-17972)
****Incorporated by reference to Exhibit 1 to Amendment No. 1 to the Company's
Registration Statement on Form 8-A dated February 5, 1999 (File No. 0-17972)
21
<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 16, 1999 By: /s/ S. Krishnan
--------------------------------
S. Krishnan
Chief Financial Officer
(duly authorized officer and
Principal Financial Officer)
22
<PAGE>
EXHIBIT 15
UNAUDITED INTERIM FINANCIAL INFORMATION LETTER
<PAGE>
EXHIBIT 15
Securities and Exchange Commission
450 Fifth Street N.W.
Washington, D.C. 20549
Commissioners:
We are aware that our report dated January 22, 1999, except for the
information in Note 1 as to which the date is July 23, 1999, on our reviews
of interim condensed consolidated financial information of Digi International
Inc. and subsidiaries (the Company) for the three month period ended December
31, 1998 and 1997, and included in the Company's Form 10-Q/A for the quarter
ended December 31, 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).
PRICEWATERHOUSECOOPERS LLP
Minneapolis, Minnesota
August 16, 1999
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<RESTATED>
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> SEP-30-1999
<PERIOD-START> OCT-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 4,041,170
<SECURITIES> 0
<RECEIVABLES> 43,100,046
<ALLOWANCES> 0
<INVENTORY> 29,508,100
<CURRENT-ASSETS> 82,704,409
<PP&E> 33,098,851
<DEPRECIATION> 0
<TOTAL-ASSETS> 179,732,214
<CURRENT-LIABILITIES> 40,350,051
<BONDS> 0
0
0
<COMMON> 158,736
<OTHER-SE> 122,643,009
<TOTAL-LIABILITY-AND-EQUITY> 179,732,214
<SALES> 0
<TOTAL-REVENUES> 51,395,021
<CGS> 24,904,313
<TOTAL-COSTS> 24,864,782
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 1,416,140
<INCOME-TAX> 941,595
<INCOME-CONTINUING> 474,545
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 474,545
<EPS-BASIC> .03
<EPS-DILUTED> .03
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