<PAGE>
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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: March 31, 1999.
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 April 22, 1999, there were 14,604,312 shares of the registrant's $.01 par
value Common Stock outstanding.
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<PAGE>
INDEX
PART I. FINANCIAL INFORMATION
- ------- ---------------------
<TABLE>
<CAPTION>
ITEM 1. Financial Statements Page
----
<S> <C> <C>
Condensed Consolidated Statement of Operations
for the three months and six months ended
March 31, 1999 and 1998.............................................3
Condensed Consolidated Balance Sheet as of
March 31, 1999 and September 30, 1998...............................4
Condensed Consolidated Statement of Cash Flows
for the six months ended March 31, 1999 and 1998....................5
Notes to Condensed Consolidated Financial
Statements..........................................................6
Review Report of Independent Accountants...........................10
ITEM 2. Management's Discussion and Analysis of
Results of Operations and Financial Condition......................11
Forward-looking Statements.........................................16
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk.........16
PART II. OTHER INFORMATION
- -------- -----------------
ITEM 1. Legal Proceedings..................................................17
ITEM 2. Changes in Securities..............................................18
ITEM 3. Defaults Upon Senior Securities....................................18
ITEM 4. Submission of Matters to a Vote of Securities Holders..............18
ITEM 5. Other Information..................................................18
ITEM 6. Exhibits and Reports on Form 8-K...................................19
</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 SIX MONTHS ENDED MARCH 31, 1999 AND 1998
(UNAUDITED)
<TABLE>
<CAPTION>
Three months ended March 31 Six months ended March 31
---------------------------------------- -------------------------------------
1999 1998 1999 1998
-------------------- ------------------- ------------------- -----------------
<S> <C> <C> <C> <C>
Net sales $ 42,631,488 $ 45,058,973 $ 94,026,510 $ 87,649,032
Cost of sales 24,153,615 21,993,344 49,057,929 43,214,657
-------------------- ------------------- ------------------- -----------------
Gross margin 18,477,873 23,065,629 44,968,581 44,434,375
-------------------- ------------------- ------------------- -----------------
Operating expenses:
Sales and marketing 10,972,993 9,007,379 22,947,075 17,266,872
Research and development 5,887,729 3,948,109 12,363,946 7,759,010
General and administrative 5,527,153 3,445,691 10,679,442 7,055,815
Restructuring 1,452,909 - 1,452,909 -
-------------------- ------------------- ------------------- -----------------
Total operating expenses 23,840,784 16,401,179 47,443,372 32,081,697
-------------------- ------------------- ------------------- -----------------
Operating (loss) income (5,362,911) 6,664,450 (2,474,791) 12,352,678
Other (expense) income, principally interest (35,517) 548,470 (245,302) 817,355
-------------------- ------------------- ------------------- -----------------
(Loss) income before income taxes (5,398,428) 7,212,920 (2,720,093) 13,170,033
(Benefit) provision for income taxes (2,890,040) 2,547,584 (1,577,655) 4,662,359
-------------------- ------------------- ------------------- -----------------
Net (loss) income $ (2,508,388) $ 4,665,336 $ (1,142,438) $ 8,507,674
-------------------- ------------------- ------------------- -----------------
-------------------- ------------------- ------------------- -----------------
Net (loss) income per common share,
basic $ (0.17) $ 0.35 $ (0.08) $ 0.63
-------------------- ------------------- ------------------- -----------------
-------------------- ------------------- ------------------- -----------------
Net (loss) income per common share,
assuming dilution $ (0.17) $ 0.33 $ (0.08) $ 0.60
-------------------- ------------------- ------------------- -----------------
-------------------- ------------------- ------------------- -----------------
Weighted average common shares, basic 14,590,771 13,508,084 14,581,396 13,494,509
-------------------- ------------------- ------------------- -----------------
-------------------- ------------------- ------------------- -----------------
Weighted average common shares,
assuming dilution 14,590,771 14,265,107 14,581,396 14,149,319
-------------------- ------------------- ------------------- -----------------
-------------------- ------------------- ------------------- -----------------
</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>
March 31 September 30
ASSETS 1999 1998
---------------- ----------------
(unaudited)
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 11,260,148 $ 10,355,368
Accounts receivable, net 32,803,190 48,549,145
Inventories, net 28,474,757 27,365,924
Other 5,563,774 6,139,941
---------------- ----------------
Total current assets 78,101,869 92,410,378
Property, equipment and improvements, net 31,409,183 33,990,923
Intangible assets, net 31,240,847 31,354,483
Other 2,281,518 2,978,883
---------------- ----------------
Total assets $ 143,033,417 $ 160,734,667
---------------- ----------------
---------------- ----------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Borrowings under line of credit agreements $ 4,909,407 $ 10,707,000
Current portion of long-term debt 38,415 264,025
Accounts payable 10,612,010 15,255,175
Income taxes payable 833,194 3,797,588
Accrued expenses:
Advertising 2,282,076 2,651,742
Compensation 4,229,741 6,776,292
Other 7,579,986 9,808,835
Restructuring accruals 4,521,226 5,254,000
---------------- ----------------
Total current liabilities 35,006,055 54,514,657
Long-term debt 9,596,916 11,124,446
---------------- ----------------
Other - 275,000
---------------- ----------------
Total liabilities 44,602,971 65,914,103
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; 15,885,079 and 15,790,975 shares issued 158,851 157,910
Additional paid-in capital 69,882,481 68,695,448
Retained earnings 51,312,593 52,455,031
Cumulative other comprehensive loss (262,314) (815,809)
---------------- ----------------
121,091,611 120,492,580
Unearned stock compensation (493,277) (3,777,204)
Treasury stock, at cost, 1,321,368 and 1,247,094
shares (22,167,888) (21,894,812)
---------------- ----------------
Total stockholders' equity 98,430,446 94,820,564
---------------- ----------------
Total liabilities and stockholders' equity $ 143,033,417 $ 160,734,667
---------------- ----------------
---------------- ----------------
</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 SIX MONTHS ENDED MARCH 31, 1999 AND 1998
(UNAUDITED)
<TABLE>
<CAPTION>
1999 1998
---------------- --------------
<S> <C> <C>
Operating activities:
Net (loss) income $ (1,142,438) $ 8,507,674
Adjustments to reconcile net (loss) income to net
cash provided by operating activities:
Restructuring $ 1,172,672 $ -
Depreciation and amortization 6,381,563 3,380,308
Provision for losses on accounts receivable 285,000 707,992
Provision for inventory obsolescence 2,895,399 3,084,569
(Gain) loss on sale of fixed assets (5,227) 122,421
Stock compensation 459,023 531,827
Changes in operating assets and liabilities (172,915) 340,760
---------------- --------------
Total adjustments 11,015,515 8,167,877
---------------- --------------
Net cash provided by operating activities 9,873,077 16,675,551
---------------- --------------
Investing activities:
Purchase of property, equipment and
improvements, and intangibles (3,052,230) (3,469,771)
Proceeds from the sale of property, equipment and
improvements 857,622 12,713
Investment in AetherWorks Corporation - (2,000,000)
---------------- --------------
Net cash used in investing activities (2,194,608) (5,457,058)
---------------- --------------
Financing activities:
Principal payments on borrowings (5,979,904) -
Treasury stock purchase (815,000) -
Proceeds from exercise of stock options and
employee stock purchases 712,728 563,718
---------------- --------------
Net cash (used in) provided by financing activities (6,082,176) 563,718
---------------- --------------
Effect of exchange rate changes on cash and cash equivalents (691,513) -
Net increase in cash and cash equivalents 904,780 11,782,211
Cash and cash equivalents, beginning of period 10,355,368 31,329,666
---------------- --------------
Cash and cash equivalents, end of period $ 11,260,148 $ 43,111,877
---------------- --------------
---------------- --------------
</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 (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 1998
Annual Report and Form 10-K.
The condensed consolidated financial statements presented herein as of March 31,
1999, and for the three months and six months ended March 31, 1999, and 1998,
reflect, in the opinion of management, all adjustments (which, other than the
second quarter 1999 restructuring charges, 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. ACQUISITIONS
In connection with a review of the Company's annual report on Form 10-K for the
year ended September 30, 1998, the staff of the Securities and Exchange
Commission (SEC) has made several inquiries about the Company's accounting for
its acquisitions of ITK International, Inc. (ITK) and Central Data Corporation
(CDC). The most significant of these inquiries relates to the appropriateness of
the amounts of the acquired in-process research and development charges recorded
by the Company in the fourth quarter of fiscal year 1998. Any decrease in the
amount of such charges would result in an increase in the value of identifiable
intangible assets and goodwill as well as an increase in future amortization
expense. The amount of such adjustments, if any, are not known at this time,
although they could be material to the Company's financial position and results
of operations.
6
<PAGE>
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. RESTRUCTURING
In July 1998, the Company's Board of Directors approved a restructuring plan
related to the consolidation of its offices in Germany and the United Kingdom.
The restructuring plan relates to the elimination of existing facilities
rendered redundant by the acquisition of ITK. The charge of $1,020,000 ($647,000
net of tax benefits) recorded in the fourth quarter of fiscal 1998 consisted of
$61,483 of existing commitments for rent, $100,110 of contractual payments for
office equipment, $202,039 of write-offs of leasehold improvements and $656,368
of severance costs associated with the elimination of six positions. As of March
31, 1999, $198,389 of payments have been made relating to this restructuring
charge and two employees have been terminated. The Company expects to complete
these restructuring activities by June 30, 1999.
In connection with the Company's acquisition of ITK in July 1998, the Company
implemented a plan of reorganization and accordingly, recognized a $3,484,000
restructuring liability which the Company included in the liabilities assumed in
the acquisition. Components of this estimated liability included $1,844,000 of
personnel costs and $1,640,000 related to facilities closures. As of March 31,
1999, $1,298,959 of payments have been made relating to personnel costs and
$225,118 of payments have been made related to facilities closure costs. The
Company expects to complete these restructuring activities by June 30, 1999.
In connection with the Company's acquisition of CDC in July 1998, the Company
implemented a plan of reorganization and accordingly, recognized a $750,000
restructuring liability which the Company included in the total liabilities
assumed in the acquisition. Components of this estimated liability included
$675,000 of personnel costs and $75,000 related to a facility closure. As of
March 31, 1999, $152,552 of payments have been made relating to personnel costs.
The CDC facility was sold in January 1999 and cost associated with preparing the
building for sale was netted against proceeds. The Company expects to complete
these restructuring activities by June 30, 1999.
In March 1999, the Company's Board of Directors approved a restructuring plan
related to the reorganization of sales and marketing functions in Germany, the
United Kingdom and the United States, by consolidating worldwide sales and
marketing resources into strategic locations. The related charge of $1,452,909
($610,222 net of tax benefits) consists of $151,038 of existing commitments for
rent on facilities vacated by the Company and $1,301,871 of severance and other
costs associated with the elimination of 44 positions. During the quarter ended
March 31, 1999, $300,343 of payments have been made related to severance of
seven employees. The Company expects to complete these restructuring activities
by December 31, 1999.
As a result of changes of 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.
7
<PAGE>
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
4. INVENTORIES
Inventories, net are stated at the lower of cost or market, with cost determined
on the first-in, first-out method. Inventories at March 31, 1999 and September
30, 1998 consisted of the following:
<TABLE>
<CAPTION>
March 31, 1999 September 30, 1998
--------------- ------------------
<S> <C> <C>
Raw materials $16,722,050 $13,707,999
Work in process 2,804,595 2,922,442
Finished goods 8,948,112 10,735,483
------------- ----------
$28,474,757 $27,365,924
------------- ----------
------------- ----------
</TABLE>
5. COMPREHENSIVE (LOSS) 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 (loss) income and its
components. Comprehensive (loss) 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 (loss) income includes net (loss) income
and foreign currency translation adjustments that are charged or credited to
stockholders' equity.
Comprehensive (loss) income for the three months and six months ended March 31,
1999 and 1998 was as follows:
<TABLE>
<CAPTION>
Three months ended Six months ended
March 31 March 31
------------------------ ----------------------
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net (loss) income $(2,508,388) $4,665,336 $(1,142,438) $8,507,674
Foreign currency
translation adjustments 72,409 - 553,495 -
------ ---- ------- ----
Comprehensive (loss)
income $(2,435,979) $4,665,336 $(588,943) $8,507,674
------------ ---------- ----------- ----------
------------ ---------- ----------- ----------
</TABLE>
8
<PAGE>
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
6. NET (LOSS) INCOME PER SHARE
Basic net (loss) 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. Such common stock equivalents were excluded in determining
the weighted average common and common stock equivalents for the three and six
months ended March 31, 1999, because their effect was anti-dilutive. The
calculation of dilutive earnings per share excludes the 268,311 and 276,223
equivalent shares of the Company for the three months and six months ended March
31, 1999, 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.
9
<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 March 31, 1999, and the
related condensed consolidated statements of operations and cash flows for
the three month and six month periods ended March 31, 1999, and 1998. 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,
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, 1998, 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
April 16, 1999
10
<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 statements of operations expressed as percentages
of sales:
<TABLE>
<CAPTION>
Three months % Six months %
ended Increase ended Increase
March 31 (decrease) March 31 (decrease)
------------------------------ -----------------------------
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C>
Net sales 100.0 100.0 (5.4) 100.0% 100.0% 7.3%
Cost of sales 56.7 48.8 9.8 52.2 49.3 13.5
---- ---- ---- ---- ---- ----
Gross margin 43.3 51.2 (19.9) 47.8 50.7 1.2
---- ---- ---- ---- ---- ----
Operating expenses:
Sales and marketing 25.7 20.0 21.8 24.4 19.7 32.9
Research and development 13.8 8.8 49.1 13.1 8.9 59.3
General and administrative 13.0 7.6 60.4 11.4 8.1 51.4
Restructuring 3.4 0.0 - 1.5 0.0 -
--- --- ----- ---- --- -----
Total operating expenses 55.9 36.4 45.4 50.5 36.6 47.9
---- ---- ---- ---- ---- ----
Operating income (12.6) 14.8 180.5 (2.6) 14.1 120.0
Other (expense) income, net (0.1) 1.2 (106.5) (0.3) 0.9 (130.0)
--- --- ----- --- --- -----
Income before income taxes (12.7) 16.0 (174.8) (2.9) 15.0 (120.7)
Provision for income taxes (6.8) 5.7 (213.4) (1.7) 5.3 (133.8)
--- --- ----- --- --- -----
Net income (5.9) 10.4 (153.8) (1.2)% 9.7% (113.4)%
--- --- ----- --- --- -----
--- --- ----- --- --- -----
</TABLE>
NET SALES
Net sales for the three months ended March 31, 1999, were lower than net sales
for the corresponding three months ended March 31, 1998, by $2,427,485 or a 5.4
% decrease; net sales for the six months ended March 31, 1999 were higher than
net sales for the corresponding six months ended March 31, 1998, by $6,377,478
or a 7.3% increase. The sales of the products added in connection with the
acquisitions of ITK and CDC in July 1998 generated revenues of $9,677,760 and
$23,329,269 for the three months and six months ended March 31, 1999. These
revenue increases were mitigated by a decrease in demand for the Company's
physical layer products resulting in a decrease in related revenues of
$4,364,700 and $10,504,100 for the three and six months ended March 31, 1999
relative to comparable periods of 1998. During second quarter of fiscal 1999,
the Company implemented a channel inventory management program that discontinued
the practice of extending special incentives to its distributors to increase
demand. The result of this change in practice was to reduce revenue and to
reduce days of inventory in the distribution channel.
11
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION (CONTINUED)
CONSOLIDATED RESULTS OF OPERATIONS (CONTINUED)
NET SALES (CONTINUED)
The following table sets forth revenue by principal product group expressed as a
percentage of net sales:
<TABLE>
<CAPTION>
Three months Six months
Ended March 31 Ended March 31
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Server Based 64.8% 69.0% 62.8% 60.9%
Physical Layer 8.4% 11.2% 8.7% 15.6%
OEM 26.8% 19.8% 28.5% 23.5%
Total 100.0% 100.0% 100.0% 100.0%
</TABLE>
GROSS MARGIN
Gross margin for the three months and six months ended March 31, 1999 was 43.3%
and 47.8%, as compared to 51.2% and 50.7% for the three months and six months
ended March 31, 1998. Gross margin for the three months and six months ended
March 31, 1999, was impacted by the increased proportion of sales from lower
gross margin OEM sales. Gross margin was also impacted by reduced margin from
ITK operations which accounted for 15% of total sales for the quarter ended
March 31, 1999 and 16% of total sales for the six-month period ended March 31,
1999. Included in ITK results was the impact of the discontinued sale of Telebit
modem products purchased as part of the ITK acquisition in which remaining
inventory was sold at a deep discount during the quarter. In addition, margins
generated from physical layer LAN products have declined in fiscal 1999 due to
market-driven reductions in selling prices.
OPERATING EXPENSES
Operating expenses for the three months ended March 31, 1999, increased
approximately $6.0 million (excluding second quarter restructuring charges of
$1.5 million) or 36.5% as compared to operating expenses for the three months
ended March 31, 1998. The operations of ITK, which was acquired in the fourth
quarter of fiscal 1998, accounted for approximately $4.6 million or a 28.0% of
the increase in operating expenses. CDC, which was acquired in the fourth
quarter of fiscal 1998, accounted for approximately $930,000 of operating
expense for first quarter and has been fully integrated into the Company's
existing operations during second quarter of fiscal 1999. In addition, during
the three months ended March 31, 1999, the Company recorded a one-time
restructuring charge of $1.5 million due to reorganization of the sales and
marketing functions in Germany, the United Kingdom and the United States.
12
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION (CONTINUED)
CONSOLIDATED RESULTS OF OPERATIONS (CONTINUED)
OPERATING EXPENSES (CONTINUED)
Operating expenses for the six months ended March 31, 1999 increased by
approximately $13.9 million (excluding second quarter restructuring charges) or
43.3% as compared to operating expenses for the six months ended March 31, 1998.
The operations of ITK accounted for approximately $9.5 million. Research and
Development and Sales and Marketing costs have increased for the six months
ended March 31, 1999, due to development of new products and preparation for new
product launch.
ACQUIRED IN-PROCESS RESEARCH AND DEVELOPMENT
In connection with the Company's acquisition of ITK in July 1998, the Company
recorded a $26.0 million non-recurring, non-tax-deductible charge related to the
portion of the purchase price that represented, based upon an independent
appraisal, the fair value of acquired in-process research and development
(IPR&D) upon consummation of the acquisition. The Company is continuing its
efforts to develop the acquired IPR&D into commercially viable products.
In connection with the Company's acquisition of CDC in July 1998, the Company
recorded a $13.2 million non-recurring, non-tax-deductible charge related to the
portion of the purchase price that represented, based upon an independent
appraisal, the fair value of acquired IPR&D upon consummation of the
acquisition. Included in revenues for the first six months of fiscal 1999 is
approximately $173,000 of revenues developed from the first release of certain
products relating to the acquired IPR&D. In addition, the Company is continuing
its efforts to develop other products related to the acquired IPR&D into
commercially viable products.
See discussion at Note 2 in the Notes to the Condensed Consolidated Financial
Statements of the Company.
OTHER (EXPENSE) INCOME
Other expense, principally interest expense for the three months and six months
ended March 31, 1999, results from debt assumed in the acquisition of ITK, net
of interest earned on cash and cash equivalents. Other income for the three
months and six months ended March 31, 1998 resulted from interest earned on cash
and cash equivalent balances.
13
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF
OPERATIONS AND FINANCIAL CONDITION (CONTINUED)
CONSOLIDATED RESULTS OF OPERATIONS (CONTINUED)
INCOME TAXES
Income taxes have been provided for at an estimated annual effective rate of 58%
for the six months ended March 31, 1999. This effective tax rate exceeds the
U.S. statutory income tax rate and the effective tax rate of 35.4% in the six
months ended March 31, 1998 primarily due to approximately $5.5 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 six months ended March 31, 1999,
consisted primarily of purchases of equipment and capital improvements totaling
approximately $3.1 million. Financing activities for the six months ended March
31, 1999, consisted primarily of payments on line of credit and debt obligations
totaling approximately $6.0 million. At March 31, 1999, the Company had working
capital of approximately $43.1 million. During the quarter, the Company reduced
its unsecured line of credit from $15 million to $5 million. The Company is
negotiating to extend the unsecured line of credit which expires May 31, 1999.
The Company has no borrowings outstanding on this line of credit.
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.
During the quarter ended March 31, 1999, the Company used $815,000 of cash to
purchase 105,000 shares of the Company's stock at an average price of $7.76 per
share for use in the Company's benefit plans.
FOREIGN CURRENCY
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.
14
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF
OPERATIONS AND FINANCIAL CONDITION (CONTINUED)
CONSOLIDATED RESULTS OF OPERATIONS (CONTINUED)
FOREIGN CURRENCY (CONTINUED)
For the six months ended March 31, 1999, the Company had foreign transactions
that were negotiated and invoiced amounting to approximately $31.0 million, of
which $19.5 million were in U.S. dollars and $11.5 million were
Deutschemark-denominated sales through the 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 March 31, 1999.
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 effects of being unable to adequately
process year 2000 dated transactions 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 is 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.
15
<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 - This
expectation may be impacted by presently unanticipated delays or expenses.
THE EXPECTATION THAT RESTRUCTURING ACTIVITIES IN CONNECTION REORGANIZATION OF
THE SALES AND MARKETING FUNCTIONS IN GERMANY, THE UNITED KINGDOM AND THE UNITED
STATES WILL BE COMPLETED ACCORDING TO SCHEDULE - This expectation may be
impacted by presently unanticipated delays or expenses.
THE EXPECTATION THAT THE COMPANY'S 1999 EFFECTIVE TAX RATE WILL BE 58 PERCENT -
This expectation may be impacted by the changes in the Company's level of
profitability or changes in the allocation of the purchase prices made in
connection with the ITK and CDC acquisitions.
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.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company does not have material exposure to market risk from market risk
sensitive instruments.
16
<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.
Plaintiffs in the consolidated putative class actions have moved for class
certification; the Company and its former officers have not yet responded to the
motion but intend to oppose it. No date has been set for a hearing on the class
certification motion. Discovery in the actions is proceeding.
17
<PAGE>
PART II. OTHER INFORMATION (CONTINUED)
LEGAL PROCEEDINGS (CONTINUED)
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.
ITEM 2. CHANGES IN SECURITIES
None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
At the Annual Meeting of Stockholders held on January 27, 1999, the stockholders
voted on the following:
(a) Proposal to elect two directors, Robert S. Moe and John P.
Schinas, for three-year terms. Mr. Moe was elected on a vote of
11,052,266 in favor, with 574,792 shares withholding authority
to vote. Mr. Schinas was elected on a vote of 11,056,396 in
favor, with 570,662 shares withholding authority to vote.
(b) Proposal to amend the Digi International Inc. Stock Option Plan
(the Plan) to reserve 700,000 additional shares of Common Stock
for future awards and to extend the expiration date of the Plan
from December 1, 2006 to November 24, 2008. This proposal was
defeated on a vote of 3,476,400 in favor, 4,863,561 against,
145,302 abstentions and 3,141,795 broker non-votes.
ITEM 5. OTHER INFORMATION
None
18
<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*****
10(k) Severance Agreement between the Company and Subramanian Krishnan
dated March 26, 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 to 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 to 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)
*****Incorporated by reference to the corresponding exhibit number to the
Company's Form 10-Q for the quarter ended December 31, 1998 (File No. 0-17972)
19
<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: May 17, 1999 By: /s/ S. Krishnan
-----------------------------------------
S. Krishnan
Chief Financial Officer
(duly authorized officer and
Principal Financial Officer)
20
<PAGE>
EXHIBIT 10(K)
SEVERANCE AGREEMENT BETWEEN
THE COMPANY AND SUBRAMANIAN KRISHNAN
DATED MARCH 26, 1999
<PAGE>
March 26, 1999
PERSONAL AND CONFIDENTIAL
Mr. Subramanian Krishnan
Digi International Inc.
11001 Bren Road East
Minnetonka, MN 55343
Dear Kris:
This letter confirms the terms of your agreement with the Company
regarding severance compensation.
If you are terminated by the Company without "cause" on or before
September 30, 1999, you would be entitled to severance equal to one year's base
salary and a bonus (if earned) to the extent that such bonus is not guaranteed),
based on your cash bonus target that would be pro-rated for the portion of the
fiscal year through the termination date. The definition of "cause" for purposes
of this letter agreement shall be the definition contained in the terms and
conditions of your Nonstatutory Stock Option Agreement with the Company dated
February 24, 1999.
The letter agreement constitutes the entire agreement between you and
the Company regarding the subject matter contained herein and supersedes all
prior agreements and understandings relating thereto.
If the terms outlined above are acceptable, please confirm by signing
the enclosed copy below and returning it to me.
Very truly yours, DIGI
DIGINTERNATIONAL INC.
/s/ John P. Schinas
By John P. Schinas
Chairman of the Board
ACCEPTED:
/s/ SUBRAMANIAN KRISHNAN
----------------------------------
Subramanian Krishnan
<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 April 16, 1999 on our reviews of interim
condensed consolidated financial information of Digi International Inc. and
subsidiaries (the Company) for the three month and six month periods ended March
31, 1999 and 1998, and included in the Company's Form 10-Q for the quarter ended
March 31, 1999, 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
May 14, 1999
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> SEP-30-1999
<PERIOD-START> OCT-01-1998
<PERIOD-END> MAR-31-1999
<CASH> 11,260,148
<SECURITIES> 0
<RECEIVABLES> 32,803,190
<ALLOWANCES> 0
<INVENTORY> 28,474,757
<CURRENT-ASSETS> 78,101,869
<PP&E> 31,409,183
<DEPRECIATION> 0
<TOTAL-ASSETS> 143,033,417
<CURRENT-LIABILITIES> 35,006,051
<BONDS> 0
0
0
<COMMON> 158,848
<OTHER-SE> 98,271,692
<TOTAL-LIABILITY-AND-EQUITY> 143,033,417
<SALES> 94,026,510
<TOTAL-REVENUES> 94,026,510
<CGS> 49,057,929
<TOTAL-COSTS> 47,443,372
<OTHER-EXPENSES> 245,302
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (2,720,094)
<INCOME-TAX> (1,577,655)
<INCOME-CONTINUING> (1,142,439)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (1,142,439)
<EPS-PRIMARY> (.08)
<EPS-DILUTED> (.08)
</TABLE>
