<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended: June 30, 2000.
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 August 9, 2000, there were 15,123,518 shares of the registrant's $.01 par
value Common Stock outstanding.
<PAGE> 2
INDEX
<TABLE>
<CAPTION>
PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements Page
<S> <C>
Condensed Consolidated Statement of Operations for
the three months and nine months ended
June 30, 2000 and 1999................................................................. 3
Condensed Consolidated Balance Sheet as of
June 30, 2000 and September 30, 1999................................................... 4
Condensed Consolidated Statement of Cash Flows for
the nine months ended June 30, 2000 and 1999........................................... 5
Notes to Condensed Consolidated Financial
Statements............................................................................. 6
Review Report of Independent Accountants............................................... 11
ITEM 2. Management's Discussion and Analysis of
Results of Operations and Financial Condition.......................................... 12
Forward-looking Statements............................................................. 18
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk............................. 18
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings...................................................................... 19
ITEM 2. Changes in Securities.................................................................. 20
ITEM 3. Defaults Upon Senior Securities........................................................ 20
ITEM 4. Submission of Matters to a Vote of Securities Holders.................................. 20
ITEM 5. Other Information...................................................................... 20
ITEM 6. Exhibits and Reports on Form 8-K....................................................... 21
</TABLE>
2
<PAGE> 3
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
DIGI INTERNATIONAL INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
FOR THE THREE MONTHS AND NINE MONTHS ENDED JUNE 30, 2000 AND 1999
(UNAUDITED)
<TABLE>
<CAPTION>
Three months ended June 30 Nine months ended June 30
-------------------------------- ----------------------------------
2000 1999 2000 1999
------------ ------------ ------------ -------------
<S> <C> <C> <C> <C>
Net sales $ 32,354,163 $ 51,144,524 $ 98,294,133 $ 145,171,035
Cost of sales 15,179,195 23,997,831 46,670,982 73,055,760
------------ ------------ ------------ -------------
Gross margin 17,174,968 27,146,693 51,623,151 72,115,275
Operating expenses:
Sales and marketing 7,929,764 9,323,592 23,853,182 32,270,668
Research and development 5,203,702 6,003,762 17,674,061 18,367,708
General and administrative 3,868,033 5,941,674 14,923,459 19,126,262
Impairment loss - - 18,068,249 -
Restructuring (11,883) (685,397) (150,350) 767,512
------------ ------------ ------------ -------------
Total operating expenses 16,989,616 20,583,631 74,368,601 70,532,150
------------ ------------ ------------ -------------
Operating income (loss) 185,352 6,563,062 (22,745,450) 1,583,125
Other income (expense), net 760,560 64,251 9,911,105 (181,050)
------------ ------------ ------------ -------------
Income (loss) before income taxes 945,912 6,627,313 (12,834,345) 1,402,075
Income tax (benefit) provision (1,567,267) 4,374,028 (3,083,095) 925,370
------------ ------------ ------------ -------------
Net income (loss) $ 2,513,179 $ 2,253,285 $ (9,751,250) $ 476,705
============ ============ ============ =============
Net income (loss) per common share,
basic $ 0.17 $ 0.15 $ (0.65) $ 0.03
============ ============ ============ =============
Net income (loss) per common share,
assuming dilution $ 0.17 $ 0.15 $ (0.65) $ 0.03
============ ============ ============ =============
Weighted average common shares,
basic 15,095,436 14,714,942 15,041,935 14,625,908
============ ============ ============ =============
Weighted average common shares,
assuming dilution 15,100,718 14,772,315 15,041,935 14,767,841
============ ============ ============ =============
</TABLE>
The accompanying notes are an integral part of the condensed consolidated
financial statements.
3
<PAGE> 4
DIGI INTERNATIONAL INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEET
<TABLE>
<CAPTION>
June 30 September 30
ASSETS 2000 1999
------------ -------------
Current assets: (unaudited)
<S> <C> <C>
Cash and cash equivalents $ 19,812,978 $ 20,963,607
Marketable securities 31,928,014 13,714,422
Accounts receivable, net 21,608,733 33,955,669
Inventories, net 22,479,507 22,446,667
Other 5,064,545 5,394,346
------------- -------------
Total current assets 100,893,777 96,474,711
Property, equipment and improvements, net 27,872,900 30,242,877
Intangible assets, net 23,024,663 47,804,611
Other 3,718,371 1,807,829
------------- -------------
Total assets $ 155,509,711 $ 176,330,028
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Borrowings under line of credit agreements $ 4,254,719 $ 4,759,095
Current portion of long-term debt 357,481 330,028
Accounts payable 8,912,214 10,779,998
Income taxes payable 4,519,079 5,274,181
Accrued expenses:
Advertising 1,272,449 2,461,437
Compensation 4,198,612 6,078,230
Other 5,996,831 6,357,348
Restructuring - 488,298
------------- -------------
Total current liabilities 29,511,385 36,528,615
Long-term debt 8,033,083 9,205,918
Net deferred income taxes - 3,431,133
------------- -------------
Total liabilities 37,544,468 49,165,666
Commitments and contingency
Stockholders' equity:
Preferred stock, $.01 par value; 2,000,000 shares
authorized; none outstanding
Common stock, $.01 par value; 60,000,000 shares
authorized; 16,319,214 and 16,192,997 shares issued 163,192 161,930
Additional paid-in capital 72,074,014 71,460,612
Retained earnings 68,483,290 78,234,541
Other cumulative comprehensive income (2,224,522) (1,027,533)
------------- -------------
138,495,975 148,829,550
Unearned stock compensation (134,135) (339,686)
Treasury stock, at cost, 1,217,352 and 1,271,612
common shares (20,396,597) (21,325,502)
------------- -------------
Total stockholders' equity 117,965,243 127,164,362
Total liabilities and stockholders' equity $ 155,509,711 $ 176,330,028
============= =============
</TABLE>
The accompanying notes are an integral part of the condensed consolidated
financial statements.
4
<PAGE> 5
DIGI INTERNATIONAL INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
FOR THE NINE MONTHS ENDED JUNE 30, 2000 AND 1999
(UNAUDITED)
<TABLE>
<CAPTION>
2000 1999
------------- ------------
<S> <C> <C>
Operating activities:
Net (loss) income $ (9,751,250) $ 476,705
Adjustments to reconcile net (loss) income to net
cash provided by operating activities:
Asset impairment 18,068,249 -
Restructuring (150,350) 208,266
Depreciation and amortization 10,428,992 11,264,831
Provision for losses on accounts receivable 540,268 420,000
Provision for inventory obsolescence 1,327,537 3,495,399
Loss on sale of fixed assets 9,253 14,215
Stock compensation 131,425 529,738
Changes in operating assets and liabilities (1,767,624) 6,183,006
------------- ------------
Total adjustments 28,587,750 22,115,455
------------- ------------
Net cash provided by operating activities 18,836,500 22,592,160
------------- -------------
Investing activities:
Purchase of short term investments, net (18,213,592) -
Purchase of property, equipment,
intangibles, and improvements (2,211,512) (3,008,585)
------------- -------------
Net cash used in investing activities (20,425,104) (3,008,585)
------------- -------------
Financing activities:
Principal payments on borrowings (134,711) (5,346,233)
Stock benefit plan transactions, net 1,376,904 2,002,977
------------- -------------
Net cash provided by (used in) financing activities 1,242,193 (3,343,256)
------------- -------------
Effect of exchange rate changes on cash and
cash equivalents (804,218) (825,433)
------------- -------------
Net (decrease) increase in cash and cash equivalents (1,150,629) 15,414,886
Cash and cash equivalents, beginning of period 20,963,607 10,355,368
------------- -------------
Cash and cash equivalents, end of period $ 19,812,978 $ 25,770,254
============= ============
</TABLE>
The accompanying notes are an integral part of the condensed consolidated
financial statements.
5
<PAGE> 6
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 accounting principles generally accepted in the United States,
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 1999 Annual Report on Form 10-K.
The condensed consolidated financial statements presented herein as of June 30,
2000, and for the three and nine months ended June 30, 2000 and 1999, reflect,
in the opinion of management, all adjustments (which, other than the second
quarter 2000 impairment loss, 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. IMPAIRMENT LOSS
In March 2000, the Company recorded a charge of $18.1 million reflecting the
write-down of the carrying value of all of the intangible assets associated with
the NetBlazer technology and some of the goodwill acquired in the Company's July
1998 purchase of ITK. The write-down resulted from the Company's March 2000
decision to discontinue development of the NetBlazer technology when the key
technical members of the NetBlazer technology team elected to leave the Company
and the Company concluded that it would not be able to successfully develop a
competitive product from the technology. Accordingly, the Company determined
that future undiscounted cash flows from the acquired ITK assets would be
substantially reduced and, therefore, the carrying value of the acquired ITK
assets would be impaired.
The Company utilized a discounted cash flows valuation method as described in
Statement of Financial Accounting Standards Board No. 121 "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," to
measure the adjustment to the carrying value of the acquired ITK long-lived
assets.
The write-down of the carrying value of the long-lived assets consisted of the
following:
<TABLE>
<CAPTION>
----------------------------------- -----------------------
Impairment
Description Loss
----------------------------------- -----------------------
<S> <C>
Current Technology $10,491,837
Assembled Workforce 252,646
Goodwill 7,323,766
-----------
TOTAL $18,068,249
-----------
</TABLE>
6
<PAGE> 7
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. RESTRUCTURING
In March 1999, the Company's Board of Directors approved a restructuring plan
related to the reorganization of sales and marketing functions in Germany,
England and the United States, by consolidating worldwide sales and marketing
resources into strategic locations. The original related charge of $1,452,909
($581,164 net of tax benefits) consisted of $151,038 of existing commitments for
rent on facilities vacated by the Company in Hamburg, Nurnberg, and Frankfurt,
Germany and $1,301,871 of termination payments associated with the elimination
of 44 positions in Dortmund, Germany; Bagshot, England; Sunnyvale, California;
and Minneapolis, Minnesota.
As of December 31, 1999, the Company had paid $906,299 of termination costs
relating to the elimination of 33 positions. Restructuring activities were
completed as of December 1999. During the second quarter of fiscal 2000, the
final severance and termination expenses were paid, and the Company adjusted the
remaining restructuring accrual to zero. In fiscal year 2000, severance and
termination costs of $146,767 and rent commitment payments of $7,312 were
charged to the restructuring accrual. Changes in estimate for severance and
termination costs of $124,937 and rent commitments of $13,160 were recorded as a
reduction of the restructuring accrual with a corresponding increase to
operating income.
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 original charge of $1,020,000 ($647,000
net of tax benefits), consisted of $61,483 of noncancellable rent commitments
the Company expected to incur following closure of the Cologne, Germany
facility; $100,110 of contractual payment obligations for office furniture and
other equipment the Company expected 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 1998. As of December 31,
1999, the Company had paid $301,044 of termination costs relating to the
elimination of two positions. Restructuring activities were completed as of June
1999. In the third quarter of fiscal 2000, the Company adjusted the remaining
restructuring accrual to zero, as all obligations have been satisfied. In fiscal
year 2000, rent commitment payments of $12,636 and payments of $27,646 for
write-off of leasehold improvements were charged to the restructuring accrual.
Changes in estimate for rent commitments of $2,573 and write-off of leasehold
improvements of $9,680 were recorded as a reduction of the restructuring accrual
with a corresponding increase to operating income.
In connection with the Company's acquisition of ITK, the Company formulated a
plan of reorganization and, accordingly, recognized a $3,484,000 restructuring
liability which the Company has included as a component of total liabilities
assumed in the acquisition. Components of the original estimated liability
included $1,844,000 of termination payments associated with 10 employees the
Company expected to
7
<PAGE> 8
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. RESTRUCTURING (CONTINUED)
eliminate at the Chelmsford, Massachusetts ITK location and 20 employees the
Company expected to eliminate at the Dortmund, Germany location and $1,640,000
of noncancellable rent obligations for facilities the Company expected to incur
following closure of facilities in Chelmsford, Massachusetts and Bristol and
Newbury, England.
The Company vacated the Chelmsford, Bristol, and Newbury facilities in March
1999, October 1998 and May 1999, respectively. Restructuring activities were
completed as of June 1999. During the second quarter of fiscal 2000, the final
severance, termination and facility closure costs were paid. In fiscal year
2000, severance and termination costs of $5,217 and facility closure costs of
$1,928 were charged against the restructuring accrual. Changes in estimate
relating to severance and termination costs of $17,652 and facilities closures
of $33,469 were recorded as a reduction in the restructuring accrual with
corresponding offsets to goodwill.
In connection with the Company's acquisition of CDC, the Company formulated a
plan of reorganization and, accordingly, 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 included
$675,000 of termination payments, associated with 22 employees the Company
expected to eliminate when it closed the Champaign, Illinois facility in January
1999 and $75,000 related to facility closure costs the Company expected to incur
following closure and sale of the Champaign, Illinois facility. Restructuring
activities were completed as of June 1999. During the second quarter of fiscal
2000, the Company paid the final severance costs of $7,128 associated with this
restructuring and the accrual was adjusted to zero. Total payments against the
restructuring accrual in fiscal year 2000 included severance and termination
costs of $88,661. An additional expense of $3,340 was also recorded related to a
change in estimate in the original restructuring accrual. Adjustments to the
restructuring accrual were reflected as changes to the restructuring accrual
with corresponding offsets to goodwill.
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 June 30, 2000 and September
30, 1999 consisted of the following:
<TABLE>
<CAPTION>
June 30, 2000 September 30, 1999
-------------- ------------------
<S> <C> <C>
Raw materials $13,625,833 $12,948,286
Work in process 1,592,456 2,162,626
Finished goods 7,261,218 7,335,755
----------- -----------
$22,479,507 $22,446,667
=========== ===========
</TABLE>
8
<PAGE> 9
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
5. COMPREHENSIVE INCOME (LOSS)
The components of total comprehensive income (loss) are shown below.
Comprehensive income (loss) includes net income (loss) and foreign currency
translation adjustments that are charged or credited to stockholders' equity.
Comprehensive income (loss) for the three months and nine months ended June 30,
2000 and 1999 was as follows:
<TABLE>
<CAPTION>
Three months ended Nine months ended
June 30 June 30
---------------------------- ---------------------------------
2000 1999 2000 1999
---------- ---------- -------------- -----------
<S> <C> <C> <C> <C>
Net income (loss) $2,513,179 $2,253,285 $ (9,751,250) $ 476,705
Foreign currency
translation adjustments (114,662) 121,496 (1,196,988) 674,991
---------- ---------- ------------ ----------
Comprehensive
income (loss) $2,398,517 $2,374,781 $(10,948,238) $1,151,696
========== ========== ============ ==========
</TABLE>
6. NET INCOME (LOSS) PER SHARE
Basic net income (loss) per share is calculated by dividing net income (loss) by
the weighted average of common shares outstanding during the period. Net income
(loss) per share, assuming dilution, is calculated by dividing net income (loss)
by the weighted average number of common and common equivalent shares
outstanding during each period. The Company's only common stock equivalents are
those that result from dilutive common stock options. The calculation of
dilutive earnings per share excludes 2,428,577 and 1,457,878 equivalent shares
of the Company for the three months and nine months ended June 30, 2000, and
1,683,099 and 1,331,169 equivalent shares of the Company for the three and nine
months ended June 30, 1999, because their effect would be antidilutive.
7. RECENT ACCOUNTING DEVELOPMENTS
In December 1999, the Securities and Exchange Commission (SEC) issued Staff
Accounting Bulletin (SAB) 101 "Revenue Recognition in Financial Statements." The
SAB summarizes certain of the SEC's views regarding revenue recognition. The
provisions of SAB 101, as amended by SAB 101A and SAB 101B, must be adopted by
the fourth quarter of the Company's fiscal year ending September 30, 2001.
However, any effects of the SAB must be reflected retroactively to October 1,
2000 (the first day of fiscal year 2001). The Company has considered the effect
of the guidance outlined in SAB 101 and does not believe that it will impact the
Company's revenue recognition practices or consolidated financial statements.
9
<PAGE> 10
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. 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 Condensed Consolidated Financial Statements.
10
<PAGE> 11
REPORT OF INDEPENDENT ACCOUNTANTS
To the Stockholders and Board of Directors of
Digi International Inc.:
We have reviewed the accompanying condensed consolidated balance sheet of Digi
International Inc. and subsidiaries as of June 30, 2000, and the related
condensed consolidated statements of operations for each of the three month and
nine month periods ended June 30, 2000 and 1999 and the condensed consolidated
statement of cash flows for the nine month periods ended June 30, 2000 and 1999.
These financial statements are the responsibility of the Company's management.
We conducted our review 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 auditing standards generally accepted in the United States, 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 review, we are not aware of any material modifications that should
be made to the accompanying condensed consolidated financial statements for them
to be in conformity with accounting principles generally accepted in the United
States.
We previously audited, in accordance with auditing standards generally accepted
in the United States, the consolidated balance sheet as of September 30, 1999,
and the related consolidated statements of operations and cash flows for the
year then ended (not presented herein); and in our report dated December 15,
1999, 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, 1999, is fairly stated
in all material respects in relation to the consolidated balance sheet from
which it has been derived.
/s/ PricewaterhouseCoopers LLP
Minneapolis, Minnesota
July 14, 2000
11
<PAGE> 12
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 % Nine months %
ended Increase ended Increase
June 30 (decrease) June 30 (decrease)
---------------- ---------- --------------- ----------
2000 1999 2000 1999
------ ----- ---- ----
<S> <C> <C> <C> <C> <C> <C>
Net sales 100.0 100.0 (36.7)% 100.0 100.0 (32.3)%
Cost of sales 46.9 46.9 (36.7) 47.5 50.3 (36.1)
----- ----- -------- ----- ----- --------
Gross margin 53.1 53.1 (36.7) 52.5 49.7 (28.4)
----- ----- -------- ----- ----- --------
Operating expenses:
Sales and marketing 24.5 18.2 (14.9) 24.3 22.2 (26.1)
Research and development 16.0 11.7 (13.3) 18.0 12.7 (3.8)
General and administrative 12.0 11.6 (34.9) 15.2 13.2 (22.0)
Impairment loss - - - 18.4 - -
Restructuring - (1.3) (98.3) (0.2) 0.5 (119.6)
----- ----- -------- ----- ----- --------
Total operating expenses 52.5 40.2 (17.5) 75.7 48.6 5.4
Operating income (loss) 0.6 12.9 (97.2) (23.2) 1.1 (1536.7)
Other income (expense), net 2.3 0.1 1083.7 10.1 (0.1) 5574.2
----- ----- -------- ----- ----- --------
Income (loss) before income taxes 2.9 13.0 (85.7) (13.1) 1.0 (1015.4)
Income tax (benefit) provision (4.8) 8.6 (135.8) (3.2) 0.6 (433.2)
----- ----- -------- ----- ----- --------
Net income 7.7 4.4 11.5% (9.9) 0.4 (2145.6)%
===== ===== ======== ===== ===== ========
</TABLE>
NET SALES
Net sales for the three months ended June 30, 2000, were lower than net sales
for the corresponding three months ended June 30, 1999, by $18.8 million or
36.7%; net sales for the nine months ended June 30, 2000 were also lower than
net sales for the corresponding nine months ended June 30, 1999, by $46.9
million or 32.3%. Net sales of the products added in connection with the July
1998 acquisitions of ITK and CDC generated revenues of $5.9 million and $19.2
million for the three months and nine months ended June 30, 2000, versus $9.3
million and $32.6 million in the comparable periods of 1999. The Company also
experienced a decline in sales of its legacy asynchronous products in the three
and nine month periods ended June 30, 2000, resulting in reduced revenues of
$13.8 million and $33.6 million, respectively, versus the comparable periods of
1999. A decrease in demand for the Company's physical layer products resulted in
reduced revenues of $2.0 million and $5.7 million for the three and nine months
ended June 30, 2000, versus the comparable periods in 1999. Net sales of the
Company's new digital RAS products were $2.9 million and $10.3 million during
the three and nine month periods ended June 30, 2000, as compared to $2.5
million and $4.5 million in the comparable periods of 1999.
Although the Company's net sales during both the three and nine month periods
ended June 30, 2000, are lower than the comparable periods a year ago,
management believes that the demand downturn associated with the post year 2000
period is not continuing and stabilization of market demand has occurred. During
the three months ended June 30, 2000, sales of products in all three markets in
which the Company participates, including heritage board, fiber connectivity,
and wide area network, increased over the second quarter of fiscal 2000.
Management also
12
<PAGE> 13
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION (CONTINUED)
CONSOLIDATED RESULTS OF OPERATIONS (CONTINUED)
NET SALES (CONTINUED)
believes that improved sales and marketing execution in the third quarter of
fiscal 2000 contributed to the stabilization of demand for the Company's
products.
The following table sets forth revenue by principal product group expressed as a
percentage of net sales:
<TABLE>
<CAPTION>
Three months Nine months
Ended June 30 Ended June 30
------------- -------------
2000 1999 2000 1999
<S> <C> <C> <C> <C>
Server Based 92.2% 91.8% 91.9% 90.6%
Physical Layer 7.8% 8.2% 8.1% 9.4%
------ ------ ------ ------
Total 100.0% 100.0% 100.0% 100.0%
</TABLE>
GROSS MARGIN
Gross margin for the three and nine months ended June 30, 2000 was 53.1% and
52.5%, as compared to 53.1% and 49.7% for the three and nine months ended June
30, 1999. For the nine months ended June 30, 2000, gross margin was positively
impacted by the increased proportion of sales from higher margin server-based
communication products and a lower proportion of lower margin physical layer LAN
products.
OPERATING EXPENSES
Operating expenses for the three months ended June 30, 2000 decreased $4.3
million, or 20.1%, as compared to operating expenses for the three months ended
June 30, 1999 (excluding the third quarter 1999 restructuring adjustment of $0.7
million). These savings can be attributed to reductions in workforce, decreased
marketing costs and other cost savings achieved through the closing of certain
German sales offices and other restructuring activities which occurred in 1999.
Amortization expenses also were lower for the quarter by $1.1 million as a
result of the impairment and resulting write-off of intangible assets in the
second fiscal quarter of 2000 related to the NetBlazer technology (see Note 2 to
the Condensed Consolidated Financial Statements). Variable operating costs, such
as commissions, cooperative advertising, and other marketing expenses were also
lower primarily due to the reduced revenues for the quarter.
Operating expenses for the nine months ended June 30, 2000 decreased $13.3
million (excluding the impairment charge of $18.1 million in the second quarter
and the adjustment of the restructuring accrual of $0.2 million), or 19.1%, as
compared to operating expenses for the nine months ended June 30, 1999
(excluding the restructuring charge of $0.8 million). Savings realized as a
result of the restructuring plan enacted in 1999 accounted for approximately
$2.2 million of the total decrease in operating expenses. Additional savings at
the Dortmund, Germany location were $4.7 million, a result of the reorganization
in connection with the Company's acquisition of ITK. Savings in the U.S. were
13
<PAGE> 14
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION (CONTINUED)
CONSOLIDATED RESULTS OF OPERATIONS (CONTINUED)
OPERATING EXPENSES (CONTINUED)
$6.4 million, primarily attributable to lower revenues and restructuring
activities that took place during fiscal 1999 as described in Note 3 to the
Condensed Consolidated Financial Statements.
Sales and marketing expenses for the three months and nine months ended June 30,
2000, were $7.9 million and $23.9 million, versus $9.3 million and $32.3 million
in the comparable periods a year ago. The decrease is due to various
restructuring activities that took place during fiscal 1999. In addition,
variable expenses, such as commissions and cooperative advertising, have been
lower in fiscal 2000 compared to fiscal 1999 primarily as a result of decreased
sales levels. New sales and marketing staff are developing new product roadmaps
and related marketing programs which are expected to increase sales and
marketing expenses in future quarters.
Research and development expenses were $5.2 million, or 16.1% of net sales,
compared to $6.0 million, or 11.7% of net sales, for the three months ended June
30, 2000 and 1999, respectively. For the nine months ended June 30, 2000,
research and development expenses were $17.7 million, or 18.0% of net sales,
compared to $18.4 million, or 12.7% of net sales, for the nine months ended June
30, 1999. The Company continues to increase expenditures domestically on new
product development for digital RAS and product line extensions in the LAN
market, but expenses have decreased at the German location due to the
discontinuance of the NetBlazer technology development.
General and administrative expenses for the three months and nine months ended
June 30, 2000, were $3.9 million and $14.9 million, versus $5.9 million and
$19.1 million in the comparable periods a year ago. Expenses declined in fiscal
2000 as a result of the integration of the CDC and Chelmsford administrative
functions into the Company's corporate headquarters. Amortization expense has
also decreased for the third quarter of fiscal 2000 by $1.1 million as a result
of the impairment charge taken in the second quarter of fiscal 2000 related to
the write-down of the carrying value of the intangible assets associated with
the NetBlazer technology (see Note 2 to the Condensed Consolidated Financial
Statements).
IMPAIRMENT LOSS
As indicated in Note 2 to the Condensed Consolidated Financial Statements, the
Company recorded a charge of $18.1 million reflecting the write-down of the
carrying value of all of the intangible assets associated with the NetBlazer
technology and some of the goodwill acquired in the Company's July 1998 purchase
of ITK. The write-down resulted from the Company's March 2000 decision to
discontinue development of the NetBlazer technology when the key technical
members of the NetBlazer technology team elected to leave the Company and the
Company concluded that it would not be able to successfully develop a
competitive product from the technology. Accordingly, the Company determined
that future undiscounted cash flows from the acquired ITK assets would be
substantially reduced and, therefore, the carrying value of the acquired ITK
assets would be impaired. The Company utilized a discounted cash flows method as
prescribed by Statement of Financial Accounting Standards Board No. 121
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of," to measure the adjustment to the carrying value of the acquired
ITK long-lived assets.
14
<PAGE> 15
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 were
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.
The portion of the purchase price allocated 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).
See the IMPAIRMENT LOSS section of MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION for discussion related to the
discontinuation of the NetBlazer product line, which utilized the acquired VoIP
technology.
The Company has developed the acquired in-process USB research and development
and has developed and released USB products, with initial product revenues
generated during November 1998. Since acquisition, total revenues through June
30, 2000 from the first release of certain USB products are approximately
$648,000 of which $164,000 was generated during the quarter ended June 30, 2000.
Timing of actual USB revenues are behind original expectations due to delays in
the release and marketing of certain USB products. The Company is currently
evaluating its product roadmaps and expects that USB product revenues will
increase in the 2001 and 2002 fiscal years. However, these expectations are
subject to change, given changes in market demands.
OTHER INCOME (EXPENSE)
Other income for the three months and nine months ended June 30, 2000, was $0.8
million and $9.9 million. During the second fiscal quarter of 2000, the Company
received an $8.0 million payment from Nx Networks, the company that acquired
AetherWorks Corporation. This represents payment in full of a non-convertible
note receivable from AetherWorks, previously recorded by the Company as having
no carrying value, due to significant uncertainty as to its collectability.
Other income also includes interest earned on cash and cash equivalents and
short term marketable securities, offset by interest expense on lines of credit
borrowings and long term debt.
Other income (expense) for the three months and nine months ended June 30, 1999,
was $0.1 million and $(0.2) million, resulting from interest on the debt assumed
in the acquisition of ITK, net of interest income earned.
15
<PAGE> 16
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION (CONTINUED)
CONSOLIDATED RESULTS OF OPERATIONS (CONTINUED)
INCOME TAXES
As of March 31, 2000, income taxes were provided for at an estimated annual
effective rate of 11%. As of June 30, 2000, income taxes have been provided for
at an estimated annual effective rate of 24%. The increase in the estimated
annual effective rate during the third quarter of fiscal 2000 is primarily due
to changes in the estimated pre-tax income (loss) for the Company's fiscal year
ending September 30, 2000. The increase in the estimated annual effective tax
rate has resulted in a tax benefit for the three month period ended June 30,
2000. The estimated annual effective rate for fiscal 2000 of 24% is lower than
the statutory income tax rate primarily due to the reversal of certain deferred
tax liabilities associated with ITK intangible assets that were written off in
the second quarter of fiscal 2000 (see Note 2 to the Condensed Consolidated
Financial Statements).
The estimated annual effective tax rate of 66% used in 1999 was primarily due to
the 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. The Company's working capital increased from $59.9 million at
September 30, 1999, to $71.4 million at June 30, 2000.
Net cash provided by operating activities for the nine months ended June 30,
2000, was $18.8 million, compared to net cash provided by operations of $22.6
million for the nine months ended June 30, 1999. The impairment loss incurred in
the second fiscal quarter ended March 31, 2000, discussed in Note 2 of the
Condensed Consolidated Financial Statements, is a non-cash charge that reduced
operating and net income, but did not affect the Company's cash flow. Additional
cash provided by operating activities of $11.8 million related to a reduction in
accounts receivable is offset by a reduction in liabilities and accrued
expenses. Both the reduced accounts receivable and the reduced liabilities
relate to the decreased revenues during the first nine months of fiscal year
2000 versus the comparable period in 1999.
Net cash used in investing activities for the nine months ended June 30, 2000,
included net purchases of marketable securities of $18.2 million. An additional
$2.2 million was used for purchase of equipment and other capital expenditures.
For the nine months ended June 30, 1999, $3.0 million was used for purchases of
equipment and other capital expenditures.
Net cash provided by financing activities for the nine month period ended June
30, 2000, was $1.2 million, mostly resulting from employee stock benefit plan
transactions. For the nine months ended June 30, 1999, $5.3 million in payments
were made on line of credit and debt obligations. The Company also received $2.0
million as a result of employee stock benefit plan transactions during the nine
months ended June 30, 1999.
16
<PAGE> 17
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION (CONTINUED)
CONSOLIDATED RESULTS OF OPERATIONS (CONTINUED)
LIQUIDITY AND CAPITAL RESOURCES (CONTINUED)
The Company's management believes that current financial resources, cash
generated from operations and the Company's potential capacity for additional
debt and/or equity financing will be sufficient to fund current and future
capital requirements.
FOREIGN CURRENCY
Effective January 1, 1999, eleven countries of the European Union converted to a
common currency called the "Euro." All invoicing activity within the European
Union is required to be transacted in Euros, effective January 1, 2002. This
action will cause some of the Company's European transactions to be negotiated,
invoiced, and paid in Euros. Additional currency risk may exist when sales from
the United States into the European Union are transacted in Euros rather than
U.S. dollars. Such costs and risks are not quantifiable at this time.
For the three months and nine months ended June 30, 2000, the Company had
approximately $10.7 million and $37.1 million of net sales to customers outside
of the United States. For the three month period ended June 30, 2000, $9.7
million of these sales were denominated in U.S. dollars and $1.0 million were
denominated in Deutschemarks. For the nine month period ended June 30, 2000,
$32.9 million of these sales were denominated in U.S. dollars and $4.2 million
were denominated in Deutschemarks. In future periods, a significant portion of
sales 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.
YEAR 2000 ISSUES
The Company experienced no adverse systems effects of the Year 2000 issue. While
market stabilization has occurred in the third quarter of fiscal 2000, the
Company experienced some adverse operational effects from the Year 2000 issue as
a result of the industry wide slowdown in sales in the first and second quarters
of fiscal 2000. While the Company has not been able to quantify the effects of
the Year 2000 sales impact versus other market factors, management believes that
there will be no further material adverse effects on sales from the Year 2000
issue.
The Company has tested its enterprise-wide information management system and
other internal computer systems for any adverse effects that may be experienced
during the change over to the year 2001. The Company considers the possibility
of adverse effects on the business due to year 2001 issues with its internal
enterprise-wide information management system and other internal computer
systems to be remote.
INFLATION
Management believes inflation has not had a material effect on the Company's
operations or on its financial position.
17
<PAGE> 18
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION (CONTINUED)
CONSOLIDATED RESULTS OF OPERATIONS (CONTINUED)
SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
This Form 10-Q contains certain statements that are "forward-looking statements"
as that term is defined under the Private Securities Litigation Reform Act of
1995, and within the meaning of Section 27A of the Securities Act of 1933, as
amended, and Section 21E of the Securities Exchange Act of 1934, as amended. The
words "believe," "expect," "anticipate," "intend," "estimate," "target," "may,"
"will," "plan," "project," "should," "continue," or the negative thereof or
other expressions, which are predictions of or indicate future events and trends
and which do not relate to historical matters, identify forward-looking
statements. Such statements are based on information available to management as
of the time of such statements and relate to, among other things, expectations
of the business environment in which the Company operates, projections of future
performance, perceived opportunities in the market and statements regarding the
Company's mission and vision. Forward-looking statements involve known and
unknown risks, uncertainties and other factors, which may cause the actual
results, performance or achievements of the Company to differ materially from
anticipated future results, performance or achievements expressed or implied by
such forward-looking statements. The Company undertakes no obligation to
publicly update or revise any forward-looking statement, whether as a result of
new information, future events or otherwise.
RECENT ACCOUNTING DEVELOPMENTS
In December 1999, the Securities and Exchange Commission (SEC) issued Staff
Accounting Bulletin (SAB) 101 "Revenue Recognition in Financial Statements." The
SAB summarizes certain of the SEC's views regarding revenue recognition. The
provisions of SAB 101, as amended by SAB 101A and SAB 101B, must be adopted by
the fourth quarter of the Company's fiscal year ending September 30, 2001.
However, any effects of the SAB must be reflected retroactively to October 1,
2000 (the first day of fiscal year 2001). The Company has considered the effect
of the guidance outlined in SAB 101, and does not believe that it will impact
the Company's revenue recognition practices or consolidated financial
statements.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company does not have material exposure to market risk from market risk
sensitive financial instruments other than the currency risk associated with
certain transactions being denominated in Deutschemarks.
18
<PAGE> 19
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 putative securities class action
lawsuits filed in the United States District Court for the District of Minnesota
by 21 lead plaintiffs on behalf of an alleged class of purchasers of the
Company's common stock during the period January 25, 1996 through December 23,
1996. The putative class actions were thereafter consolidated (Master File No.
97-5 DWF/RLE). The Consolidated Amended Class Action Complaint ("Consolidated
Amended Complaint") alleges that the Company and certain of its previous
officers violated the federal securities laws by, among other things,
misrepresenting and/or omitting material information concerning the Company's
operations and financial results.
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 (Civil File No. 97-440, Master File No. 97-5 DWF/RLE) (the "Louisiana
Amended Complaint"). The Louisiana Amended Complaint alleges that the Company
and certain of its previous officers violated the 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.
In a decision issued on May 22, 1998, 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 and seeks an
award of attorneys' fees, disbursements and costs. The Consolidated Amended
Complaint seeks compensatory damages of approximately $43.1 million, plus
interest, against all defendants, jointly and severally, and an award of
attorneys' fees, experts' fees and costs. 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 all of the actions has been completed.
The 21 lead plaintiffs have moved for class certification with respect to the
claims asserted in the Consolidated Amended Complaint. The Company and its
former officers have opposed the motion and have also filed a motion to remove
the lead plaintiffs for failure to conduct themselves properly as lead
plaintiffs. Both the class certification motion and the motion to remove the
lead plaintiffs were heard by the Court on June 8, 2000, and taken under
advisement.
The Company and its former officers served motions for summary judgment in all
actions on November 19, 1999. A hearing on the motions was held before the Court
on April 28, 2000, at which time the motions were taken under advisement by the
Court.
The ultimate outcomes of these actions 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.
19
<PAGE> 20
PART II. OTHER INFORMATION (CONTINUED)
ITEM 2. CHANGES IN SECURITIES
None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
ITEM 5. OTHER INFORMATION
None
20
<PAGE> 21
PART II. OTHER INFORMATION (CONTINUED)
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit Number Document Description Form of Filing
-------------- -------------------- --------------
<S> <C> <C>
3(a) Restated Certificate of Incorporation
of the Registrant, as Amended (incorporated
by reference to the corresponding exhibit
number to the Company's Form 10-K for
the year ended September 30, 1993
(File No. 0-17972)........................................... Incorporated by Reference
3(b) Amended and Restated By-Laws of the
Registrant (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
4(a) Form of Rights Agreement, dated as of
June 10, 1998 between Digi International, Inc.
and Wells Fargo Bank Minnesota, National
Association (formerly known as Norwest Bank
Minnesota, National Association), as Rights
Agent (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
4(b) Amendment dated January 26, 1998, to Share
Rights Agreement, dated as of June 10, 1998
between Digi International Inc. and Wells Fargo
Bank Minnesota, National Association (formerly
known as Norwest Bank Minnesota, National
Association), as Rights Agent (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
15 Letter Re: Unaudited Interim Financial
Information.................................................. Electronic Transmission
27 Financial Data Schedule...................................... Electronic Transmission
</TABLE>
21
<PAGE> 22
PART II. OTHER INFORMATION (CONTINUED)
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
<TABLE>
<CAPTION>
(a) Exhibits:
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 Wells Fargo Bank Minnesota, National Association (formerly known as 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 Wells Fargo Bank Minnesota, National Association
(formerly known as Norwest Bank Minnesota, National Association), as Rights Agent
15 Letter Re: Unaudited Interim Financial Information
27 Financial Data Schedule
(b) Reports on Form 8-K:
</TABLE>
No reports on Form 8-K were filed during the quarterly period
ended June 30, 2000.
22
<PAGE> 23
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 11, 2000 By:
----------------------------
S. Krishnan
Chief Financial Officer
(duly authorized officer and
Principal Financial Officer)
23
