<PAGE> 1
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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, 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 May 1, 2000, there were 15,092,695 shares of the registrant's $.01 par value
Common Stock outstanding.
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<PAGE> 2
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, 2000 and 1999................................................................ 3
Condensed Consolidated Balance Sheet as of
March 31, 2000 and September 30, 1999.................................................. 4
Condensed Consolidated Statement of Cash Flows for
the six months ended March 31, 2000 and 1999........................................... 5
Notes to Condensed Consolidated Financial
Statements............................................................................. 6
Report of Independent Accountants...................................................... 11
ITEM 2. Management's Discussion and Analysis of
Results of Operations and Financial Condition.......................................... 12
Forward-looking Statements............................................................. 17
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 THREE MONTHS AND SIX MONTHS ENDED MARCH 31, 2000 AND 1999
(UNAUDITED)
<TABLE>
<CAPTION>
Three months ended March 31 Six months ended March 31
------------------------------ ------------------------------
2000 1999 2000 1999
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Net sales $ 25,799,765 $ 42,631,488 $ 65,939,970 $ 94,026,510
Cost of sales 13,526,558 24,153,615 31,491,787 49,057,929
------------ ------------ ------------ ------------
Gross margin 12,273,207 18,477,873 34,448,183 44,968,581
Operating expenses:
Sales and marketing 7,928,430 10,972,993 15,923,418 22,947,075
Research and development 5,976,235 5,887,729 12,470,359 12,363,946
General and administrative 4,864,484 6,770,104 11,055,425 13,184,589
Impairment loss 18,068,249 - 18,068,249 -
Restructuring (138,467) 1,452,909 (138,467) 1,452,909
------------ ------------ ------------ ------------
Total operating expenses 36,698,931 25,083,735 57,378,984 49,948,519
------------ ------------ ------------ ------------
Operating loss (24,425,724) (6,605,862) (22,930,801) (4,979,938)
Other income (expense) 8,688,720 (35,517) 9,150,545 (245,302)
------------ ------------ ------------ ------------
Loss before income taxes (15,737,004) (6,641,379) (13,780,256) (5,225,240)
Income tax benefit (2,455,067) (4,390,253) (1,515,827) (3,448,658)
------------ ------------ ------------ ------------
Net loss $(13,281,937) $ (2,251,126) $(12,264,429) $ (1,776,582)
============ ============ ============ ============
Net loss per common share, basic and diluted $ (0.88) $ (0.15) $ (0.82) $ (0.12)
============ ============ ============ ============
Weighted average common shares, basic and diluted 15,062,575 14,590,771 15,015,184 14,581,396
============ ============ ============ ============
</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>
March 31 September 30
2000 1999
---------------- ---------------
<S> <C> <C>
ASSETS (unaudited)
Current assets:
Cash and cash equivalents $ 20,632,785 $ 20,963,607
Marketable securities 27,678,595 13,714,422
Accounts receivable, net 20,928,993 33,955,669
Inventories, net 24,886,269 22,446,667
Other 5,236,993 5,394,346
------------- -------------
Total current assets 99,363,635 96,474,711
Property, equipment and improvements, net 28,463,348 30,242,877
Intangible assets, net 24,482,279 47,804,611
Other 3,852,190 1,807,829
------------- -------------
Total assets $ 156,161,452 $ 176,330,028
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Borrowings under line of credit agreements $ 4,377,108 $ 4,759,095
Current portion of long-term debt 336,500 330,028
Accounts payable 9,428,108 10,779,998
Income taxes payable 5,860,498 5,274,181
Accrued expenses:
Advertising 1,564,376 2,461,437
Compensation 3,650,780 6,078,230
Other 7,428,984 6,357,348
Restructuring 11,883 488,298
------------- -------------
Total current liabilities 32,658,237 36,528,615
Long-term debt 8,138,539 9,205,918
Net deferred income taxes - 3,431,133
------------- -------------
Total liabilities 40,796,776 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; 16,309,933 and 16,192,997 issued 163,099 161,930
Additional paid-in capital 72,246,717 71,460,612
Retained earnings 65,970,111 78,234,541
Cumulative foreign currency translation adjustment (2,109,859) (1,027,533)
------------- -------------
136,270,068 148,829,550
Unearned stock compensation (193,240) (339,686)
Treasury stock, at cost, 1,235,989 and 1,271,612 shares (20,712,152) (21,325,502)
------------- -------------
Total stockholders' equity 115,364,676 127,164,362
------------- -------------
Total liabilities and stockholders' equity $ 156,161,452 $ 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 SIX MONTHS ENDED MARCH 31, 2000 AND 1999
(UNAUDITED)
<TABLE>
<CAPTION>
2000 1999
------------ ------------
<S> <C> <C>
Operating activities:
Net loss $(12,264,429) $ (1,776,582)
Adjustments to reconcile net loss to net
cash provided by operating activities:
Asset impairment 18,068,249 -
Restructuring (138,467) 1,172,672
Depreciation and amortization 7,679,559 8,886,709
Provision for losses on accounts receivable 326,462 285,000
Provision for inventory obsolescence 1,292,899 2,895,399
Loss (gain) on sale of fixed assets 7,879 (5,227)
Stock compensation 94,164 459,023
Changes in operating assets and liabilities (423,991) (2,043,917)
------------ ------------
Total adjustments 26,906,754 11,649,659
------------ ------------
Net cash provided by operating activities 14,642,325 9,873,077
------------ ------------
Investing activities:
Purchase of short-term investments, net (13,964,173) -
Purchase of property, equipment, intangibles and improvements (1,570,960) (3,052,230)
Proceeds from the sale of fixed assets - 857,622
------------ ------------
Net cash used in investing activities (15,535,133) (2,194,608)
------------ ------------
Financing activities:
Principal payments on borrowings (54,501) (5,979,904)
Purchase of treasury stock - (815,000)
Stock benefit plan transactions 1,213,101 712,728
------------ ------------
Net cash provided by (used in) financing activities 1,158,600 (6,082,176)
------------ ------------
Effect of exchange rate changes on cash and cash equivalents (596,614) (691,513)
------------ ------------
Net (decrease) increase in cash and cash equivalents (330,822) 904,780
Cash and cash equivalents, beginning of period 20,963,607 10,355,368
------------ ------------
Cash and cash equivalents, end of period $ 20,632,785 $ 11,260,148
============ ============
</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 March 31,
2000, and for the three months and six months ended March 31, 2000 and 1999,
reflect, in the opinion of management, all adjustments (which, other than the
second quarter 2000 impairment loss as described in Note 2, 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. Adjustments to the restructuring
accrual were reflected as a reduction in the restructuring accrual and a
corresponding increase to operating income. A summary of payments and
adjustments as of March 31, 2000 is included in the table below.
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------------
Balance at Change in Balance at
September 30, Estimate March 31,
Description 1999 Payments Adjustments 2000
- ----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Severance and termination costs $271,704 $(146,767) $(124,937) $0
Rent commitments 20,472 (7,312) (13,160) 0
---------------------------------------------------------------------------
TOTAL $292,176 $(154,079) $(138,097) $0
---------------------------------------------------------------------------
</TABLE>
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. Restructuring
activities were completed as of June 1999. Adjustments to the restructuring
accrual were reflected as a reduction in the restructuring accrual and a
corresponding increase to operating income. The accrual balance represents
remaining commitments on the Cologne, Germany facility. A summary of payments,
adjustments, and the remaining costs accrued as of March 31, 2000 is included in
the table below.
7
<PAGE> 8
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. RESTRUCTURING (CONTINUED)
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------------
Balance at Change in Balance at
September 30, Estimate March 31,
Description 1999 Payments Adjustments 2000
- ----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Rent commitments $15,209 $(12,636) $(370) $2,203
Write-off of leasehold
improvements 37,326 (27,646) 0 9,680
------------------------------------------------------------------------------
TOTAL $52,535 $(40,282) $(370) $11,883
------------------------------------------------------------------------------
</TABLE>
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 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. Adjustments to the restructuring accrual were
reflected as changes to the restructuring accrual with corresponding offsets to
goodwill. During the second quarter of fiscal 2000, the final severance,
termination and facility closure costs were paid. A summary of payments and
adjustments as of March 31, 2000 is included in the table below.
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------------
Balance at Change in Balance at
September 30, Estimate March 31,
Description 1999 Payments Adjustments 2000
- ----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Severance and termination
costs $22,869 $(5,217) $(17,652) $0
Facility closures 35,397 (1,928) (33,469) 0
------------------------------------------------------------------------------
TOTAL $58,266 $(7,145) $(51,121) $0
------------------------------------------------------------------------------
</TABLE>
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.
8
<PAGE> 9
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. RESTRUCTURING (CONTINUED)
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.
Adjustments to the restructuring accrual were reflected as changes to the
restructuring accrual with corresponding offsets to goodwill. A summary of
payments and adjustments as of March 31, 2000 is included in the table below.
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------------
Balance at Change in Balance at
September 30, Estimate March 31,
Description 1999 Payments Adjustments 2000
- ----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Severance and termination
costs $85,321 $(88,661) $3,340 $0
------------------------------------------------------------------------------
TOTAL $85,321 $(88,661) $3,340 $0
------------------------------------------------------------------------------
</TABLE>
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, 2000 and September
30, 1999 consisted of the following:
<TABLE>
<CAPTION>
March 31, 2000 September 30, 1999
-------------- ------------------
<S> <C> <C>
Raw materials $13,072,065 $12,948,286
Work in process 2,691,246 2,162,626
Finished goods 9,122,958 7,335,755
------------- -------------
$24,886,269 $22,446,667
=========== ===========
</TABLE>
5. COMPREHENSIVE LOSS
The components of total comprehensive loss are shown below. Comprehensive loss
includes net loss and foreign currency translation adjustments that are charged
or credited to stockholders' equity.
Comprehensive loss for the three months and six months ended March 31, 2000 and
1999 was as follows:
<TABLE>
<CAPTION>
Three months ended Six months ended
March 31 March 31
------------------------------ ------------------------------
2000 1999 2000 1999
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Net loss $(13,281,937) $ (2,251,126) $(12,264,429) $ (1,776,582)
Foreign currency
translation adjustments (40,763) 72,409 (1,082,326) 553,495
------------ ------------ ------------ ------------
Comprehensive
loss $(13,322,700) $ (2,178,717) $(13,346,755) $ (1,223,087)
============ ============ ============ ============
</TABLE>
9
<PAGE> 10
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
6. NET LOSS PER SHARE
Basic net loss per share is calculated by dividing net loss by the weighted
average of common shares outstanding during the period. Net loss per share,
assuming dilution, is calculated by dividing net 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 diluted loss per share for the three
months and six months ended March 31, 2000 and 1999 excluded such equivalent
shares because their effect would be antidilutive. These equivalent shares were
1,155,230 and 767,273 for the three and six month periods ended March 31, 2000,
and 268,311 and 276,223 for the three and six month periods ended March 31,
1999. Shares used in the computations for the three months and six months ended
March 31, 2000 and 1999 are as follows:
<TABLE>
<CAPTION>
Three months ended Six months ended
March 31 March 31
------------------------------ ------------------------------
2000 1999 2000 1999
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Weighted average shares,
basic and diluted 15,062,575 14,590,771 15,015,184 14,581,396
</TABLE>
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 No. 101A, are effective for the quarter
ended December 31, 2000. The Company has analyzed the effect of the guidance
outlined in SAB Nos. 101 and 101A, and does not believe that it will impact the
Company's revenue recognition practices or consolidated financial statements.
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 its subsidiaries as of March 31, 2000, and the related
condensed consolidated statements of operations for each of the three month and
six month periods ended March 31, 2000 and 1999 and the condensed consolidated
statement of cash flows for the six month periods ended March 31, 2000 and 1999.
These 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 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 reviews, we are not aware of any material modifications that should
be made to the accompanying condensed consolidated interim 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
April 17, 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 % Six months %
ended Increase ended Increase
March 31 (decrease) March 31 (decrease)
---------------- ----------- ----------------- ----------
2000 1999 2000 1999
---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C>
Net sales 100.0 100.0 (39.5)% 100.0 100.0 (29.9)%
Cost of sales 52.4 56.7 (44.0) 47.8 52.2 (35.8)
------ ------ ------ ------ ------ -------
Gross margin 47.6 43.3 (33.6) 52.2 47.8 (23.4)
------ ------ ------ ------ ------ -------
Operating expenses:
Sales and marketing 30.7 25.7 (27.7) 24.1 24.4 (30.6)
Research and development 23.2 13.8 1.5 18.9 13.1 0.9
General and administrative 18.9 15.9 (28.1) 16.8 14.0 (16.1)
Impairment loss 70.0 - - 27.4 - -
Restructuring (0.5) 3.4 109.5 (0.2) 1.5 109.5
------ ------ ------ ------ ------ -------
Total operating expenses 142.3 58.8 46.3 87.0 53.1 14.9
------ ------ ------ ------ ------ -------
Operating loss (94.7) (15.5) (269.8) (34.8) (5.3) (360.5)
Other income (expense) 33.7 (0.1) - 13.9 (0.3) 3,830.3
------ ------ ------ ------ -------
Loss before income taxes (61.0) (15.6) (137.0) (20.9) (5.6) (163.7)
Income tax benefit (9.5) (10.3) (44.1) (2.3) (3.7) (56.0)
------ ------ ------ ------ ------ -------
Net loss (51.5) (5.3) (490.0)% (18.6) (1.9) (590.3)%
====== ====== ====== ====== ====== =======
</TABLE>
NET SALES
Net sales for the three months ended March 31, 2000, were lower than net sales
for the corresponding three months ended March 31, 1999, by $16.8 million or
39.5%; net sales for the six months ended March 31, 2000 were lower than net
sales for the corresponding six months ended March 31, 1999, by $28.1 million or
29.9%. Net sales of the products added in connection with the July 1998
acquisitions of ITK and CDC generated revenues of $6.4 million and $13.4 million
for the three months and six months ended March 31, 2000, respectively, versus
$9.6 million and $23.3 million in the comparable periods of 1999. The Company
also experienced a decline in sales of its legacy asynchronous products in the
three and six month periods ended March 31, 2000, resulting in reduced revenues
of $14.8 million and $19.8 million, respectively. A decrease in demand for the
Company's physical layer products resulted in reduced revenues of $0.5 million
and $3.7 million for the three and six months ended March 31, 2000, versus the
comparable periods in 1999. Net sales of the Company's new digital RAS products
were $2.6 million and $7.4 million during the three and six month periods ended
March 31, 2000, as compared to $0.8 million and $2.0 million in the comparable
year ago periods.
The Company's reduction in net sales during both the three and six month periods
ending March 31, 2000, is attributed to an industry-wide slowdown in purchasing
patterns as a result of concerns relating to the Year 2000 changeover, as well
as an apparent erosion of the asynchronous serial port market. Management
believes that the sales slowdown due to Year 2000 concerns will not be a
material factor in the future. The Company has begun an initiative to focus its
investment in
12
<PAGE> 13
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION (CONTINUED)
NET SALES (CONTINUED)
the growth markets of the heritage board product lines, specifically terminal
server and USB, in an effort to mitigate the effect that the decline in the
asynchronous products has had on net sales. In addition, the Company will also
strategically focus on the fiber connectivity market in the MiLAN business and
the convergence gateway markets in the wide area network arena. The Company
believes that the new strategy of focus and execution in these emerging markets
will drive future revenue growth.
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
-------------- --------------
2000 1999 2000 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
Server Based 88.3% 91.6% 91.6% 90.2%
Physical Layer 11.7% 8.4% 8.4% 9.8%
------- ------- ------- -------
Total 100.0% 100.0% 100.0% 100.0%
</TABLE>
GROSS MARGIN
Gross margin for the three and six months ended March 31, 2000 was 47.6% and
52.2%, as compared to 43.3% and 47.8% for the three and six months ended March
31, 1999. For the three months ended March 31, 2000, gross margin as a percent
of net sales exceeded the prior year percent, largely due to nonrecurring
charges in the German location in March 1999 to write down obsolete inventories
and to dispose of remaining Telebit modem products at discounted prices. For the
six months ended March 31, 2000, gross margin was positively impacted by the
increased proportion of sales from higher margin server-based communication
products and decreased sales of lower margin physical layer LAN products.
OPERATING EXPENSES
Operating expenses for the three months ended March 31, 2000 decreased $4.9
million (excluding the impairment charge of $18.1 million and the restructuring
adjustment of $0.1 million recorded in the second quarter of fiscal 2000) or
20.6% as compared to operating expenses for the three months ended March 31,
1999 (excluding the second quarter of fiscal 1999 restructuring charge of $1.5
million). These expense decreases 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. Variable
operating costs, such as commissions, coop advertising, and other marketing
expenses were also lower given the reduced revenues for the quarter.
Operating expenses for the six months ended March 31, 2000 decreased $9.0
million (excluding the impairment charge of $18.1 million and the restructuring
adjustment of $0.1 million recorded in the second quarter of fiscal 2000) or
18.7% as compared
13
<PAGE> 14
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION (CONTINUED)
OPERATING EXPENSES (CONTINUED)
to operating expenses for the six months ended March 31, 1999 (excluding the
second quarter of fiscal 1999 restructuring charge of $1.5 million). Expense
decreases 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 expense decreases at the Dortmund, Germany location were
$2.3 million, a result of the reorganization in connection with the Company's
acquisition of ITK. Savings in the U.S. were $4.5 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 six months ended March 31,
2000, were $7.9 million and $15.9 million, versus $11.0 million and $22.9
million in the comparable periods a year ago. The decrease is due to various
restructuring activities that took place during fiscal 1999. In addition,
revenue related expenses, such as commissions and coop advertising, are lower
than they were in fiscal 1999 due to the shortfall in sales in fiscal 2000
compared to the year ago period. Compensation costs have also been lower than
1999 due to unfilled sales and marketing positions. Management anticipates an
increase in absolute dollars of these expenses as personnel are hired in the
second half of fiscal 2000.
Research and development expenses were $6.0 million for the three months ended
March 31, 2000, an increase of $0.1 million over the comparable period in the
prior year. For the six months ended March 31, 2000, research and development
expenses were $12.5 million, as compared to $12.4 million for the six months
ended March 31, 1999. The Company continues to invest in developing new digital
RAS products, as well as new product line extensions in the LAN market.
General and administrative expenses for the three months and six months ended
March 31, 2000, were $4.9 million and $11.1 million, versus $6.8 million and
$13.2 million in the comparable periods a year ago. Expenses declined in fiscal
2000 as a result of restructuring activities such as the integration of the CDC
and Chelmsford administrative functions into the Company's corporate
headquarters.
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 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.
14
<PAGE> 15
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION (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 the 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, including Voice-over 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 March
31, 2000 from the first release of certain USB products are approximately
$484,000 of which $73,000 was generated during the quarter ended March 31, 2000.
Actual total USB revenues are below original projections due to delays in the
release and marketing of certain USB products. The Company believes that these
delays will not materially reduce expected revenues to be generated from USB
products. However, these expectations are subject to change, depending upon
changes in market conditions.
OTHER INCOME (EXPENSE)
Other income for the three months and six months ended March 31, 2000, was $8.7
million and $9.2 million. During the second fiscal quarter of 2000, the Company
received an $8.0 million payment from Nx Networks, the company which acquired
AetherWorks Corporation. This represents payment in full of a non-convertible
note receivable from AetherWorks (assumed by Nx Networks), 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, partially offset by interest expense on line of credit borrowings
and long-term debt.
Other expense for the three months and six months ended March 31, 1999, was
$0.04 million and $0.2 million, representing interest on the debt assumed in the
acquisition of ITK, offset by earnings on cash and cash equivalents.
INCOME TAXES
Income taxes have been provided for at an estimated annual effective rate of 11%
for the six months ended March 31, 2000, compared to an estimated annual
effective rate of 66% for the six months ended March 31, 1999. The lower
estimate effective tax rate in 2000 is primarily due to the accounting treatment
of deferred tax liabilities related to the ITK intangible asset impairment loss
(see Note 2 to the Condensed Consolidated Financial Statements).
15
<PAGE> 16
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION (CONTINUED)
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 $66.7 million at March 31, 2000.
Net cash provided by operating activities for the six months ended March 31,
2000, was $14.6 million, compared to net cash provided by operations of $9.9
million for the six months ended March 31, 1999. The impairment loss incurred in
the second fiscal quarter ended March 31, 2000, as discussed in Note 2 of the
Condensed Consolidated Financial Statements, and other non-cash charges, reduced
operating and net income, but did not affect the Company's cash flow.
Net cash used in investing activities for the six months ended March 31, 2000,
consisted of net purchases of marketable securities of $14.0 million and $1.6
million was used for purchase of equipment and capital improvements. For the six
months ended March 31, 1999, $3.1 million was used for purchases of equipment
and capital improvements, and the Company received proceeds of $0.9 million from
the sale of fixed assets.
Net cash provided by financing activities for the six month period ended March
31, 2000, was $1.2 million, mostly resulting from employee stock benefit plan
transactions. For the six months ended March 31, 1999, $6.0 million in payments
were made on line of credit and debt obligations. During the quarter ended March
31, 1999, the Company used $0.8 million 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 and the Company received $0.7 million from employee
stock plan transactions.
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 six months ended March 31, 2000, the Company had
approximately $11.7 million and $26.4 million of net sales related to foreign
customers, respectively. For the three month period ended March 31, 2000, $10.3
million was denominated in U.S. dollars and $1.4 million was denominated in
Deutschemarks. For the six month period ended March 31, 2000, $23.2 million was
denominated in U.S. dollars and $3.2 million was denominated in Deutschemarks.
In future periods, a significant portion of sales will be made in Deutschemarks
16
<PAGE> 17
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION (CONTINUED)
FINANCIAL CONDITION (CONTINUED)
FOREIGN CURRENCY (CONTINUED)
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.
However, the Company has experienced some adverse operational effects from the
Year 2000 issue as a result of the industry wide slowdown in sales, as discussed
in the Net Sales section of Management's Discussion and Analysis, Consolidated
Results of Operations. 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.
INFLATION
Management believes inflation has not had a material effect on the Company's
operations or on its financial position.
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.
17
<PAGE> 18
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION (CONTINUED)
FINANCIAL CONDITION (CONTINUED)
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 No. 101A, are effective for the quarter
ended December 31, 2000. The Company has analyzed the effect of the guidance
outlined in SAB Nos. 101 and 101A , and does not believe that it will impact the
Company's revenue recognition practices or 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 are scheduled to be heard by the Court on June 8, 2000.
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
At the Annual Meeting of Shareholders held on January 26, 2000, the stockholders
voted on the following:
(a) Proposal to elect one director, Joseph T. Dunsmore, to a two-year term and
to elect two directors, Kenneth E. Millard and David Stanley, for three-year
terms. Mr. Dunsmore was elected on a vote of 13,716,218 in favor, with 103,365
shares withholding authority to vote. Mr. Millard was elected on a vote of
13,711,341 in favor, with 108,242 shares withholding authority to vote. Mr.
Stanley was elected on a vote of 13,667,876 in favor, with 151,707 shares
withholding authority to vote. There were no broker non-votes.
ITEM 5. OTHER INFORMATION
None
20
<PAGE> 21
PART II. OTHER INFORMATION (CONTINUED)
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
Exhibit No. Description
3(a) Restated Certificate of Incorporation of the Registrant, as
Amended (1)
3(b) Amended and Restated By-Laws of the Registrant (2)
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 (3)
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
(4)
15 Letter Re: Unaudited Interim Financial Information
27 Financial Data Schedule
(b) Reports on Form 8-K:
No reports on Form 8-K were filed during the quarterly period
ended March 31, 2000.
- ------------------------------------------------
(1) 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)
(2) Incorporated by reference to the corresponding exhibit number to the
Company's Registration Statement on Form S-1 (File No. 33-42384)
(3) Incorporated by reference to Exhibit 1 to the Company's Registration
Statement on Form 8-A dated June 24, 1998 (File No. 0-17972)
(4) Incorporated by reference to Exhibit 1 to Amendment No. 1 to the Company's
Registration Statement on Form 8-A dated February 5, 1999 (File No.
0-17972)
21
<PAGE> 22
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 15, 2000 By:
--------------------------------
S. Krishnan
Chief Financial Officer
(duly authorized officer and
Principal Financial Officer)
22
<PAGE> 1
EXHIBIT 15
UNAUDITED INTERIM FINANCIAL INFORMATION LETTER
EXHIBIT 15
Securities and Exchange Commission
450 Fifth Street N.W.
Washington, D.C. 20549
Commissioners:
We are aware that our report dated April 17, 2000 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, 2000 and 1999, and included in the Company's Form 10-Q for the quarter ended
March 31, 2000, 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 15, 2000
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