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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark one)
(X) ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended: September 30, 1999
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ____ to ____.
Commission file number: 0-17972
DIGI INTERNATIONAL INC.
(Exact name of registrant as specified in its charter)
Delaware 41-1532464
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
11001 Bren Road East
Minnetonka, Minnesota 55343
(Address of principal executive offices) (Zip Code)
(612) 912-3444
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, $.01 PAR VALUE
(Title of each class)
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, and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
--- ----
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
The aggregate market value of voting stock held by nonaffiliates of the
Registrant, based on a closing price of $10.94 per share as reported on the
National Association of Securities Dealers Automated Quotation System-National
Market System on December 17, 1999 was $147,485,017.
Shares of common stock outstanding as of December 10, 1999: 15,008,190.
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INDEX
DOCUMENTS INCORPORATED BY REFERENCE
The following table shows, except as otherwise noted, the location of
information required in this Form 10-K, in the Registrant's Annual Report to
Stockholders for the year ended September 30, 1999 and Proxy Statement for the
Registrant's Annual Meeting of Stockholders scheduled for January 26, 2000, a
definitive copy of which will be filed on or about December 31, 1999. All such
information set forth below under the heading "Page/Reference" is incorporated
herein by reference, or included in this Form 10-K on the pages indicated.
PART I. ITEM IN FORM 10-K PAGE/REFERENCE
- ------- ----------------- --------------
ITEM 1. Business 4
ITEM 2. Properties 8
ITEM 3. Legal Proceedings 8
ITEM 4. Submission of Matters to a
Vote of Security Holders 9
PART II.
- --------
ITEM 5. Market for Registrant's Common Stock Listing; Dividend
Equity and Related Stockholder Policy, page 9 Annual
Matters Report to Stockholders
ITEM 6. Selected Financial Data:
Financial Highlights Page 1, Annual Report to
Stockholders
Selected Financial Information 10
ITEM 7. Management's Discussion and
Analysis of Financial Condition and
Results of Operations 11
ITEM 7A. Quantitative and Qualitative Disclosures
About Market Risk 24
ITEM 8. Financial Statements and Supplementary Data 25
ITEM 9. Changes in and Disagreements with Accountants
On Accounting and Financial Disclosure 57
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PART III. ITEM IN FORM 10-K PAGE/REFERENCE
- --------- ----------------- --------------
ITEM 10. Directors of the Registrant Election of Directors, Proxy
Statement
Executive Officers of the Registrant 58
Compliance with Section 16(a) of the Section 16(a) Beneficial
Exchange Act Ownership Reporting
Compliance, Proxy Statement.
ITEM 11. Executive Compensation Executive Compensation;
Election of Directors; Summary
Compensation Table; Option
Grants in Last Fiscal Year;
Aggregated Option Exercises in
the Last Fiscal Year and Fiscal
Year-end Option Values;
Employment Contracts;
Severance, Termination of
Employment and Change-in-Control
Arrangements; Performance Evaluation,
Proxy Statement
ITEM 12. Security Ownership of Certain Beneficial Security Ownership of Principal
Stockholders and Management, Stockholders and Management,
Owners and Management Proxy Statement
ITEM 13. Certain Relationships and Related Not Applicable
Transactions Not applicable
PART IV.
- --------
ITEM 14. Exhibits, Financial Statement Schedules and
Reports on Form 8-K 59
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PART I
ITEM 1. BUSINESS
Digi International Inc. ("Digi" or the "Company") was formed in 1985 as a
Minnesota corporation and reorganized as a Delaware corporation in 1989 in
conjunction with its initial public offering. The Company is a worldwide
provider of communications adapters that enable open systems, server-based
applications. In addition, the Company produces local area networking (LAN)
products.
The Company operates exclusively in a single business segment and sells its
products through a global network of distributors, systems integrators, value
added resellers (VARs) and original equipment manufacturers (OEMs). The Company
also sells direct to select accounts and the government.
Digi International Inc. is traded on the Nasdaq National Market under the symbol
DGII. The Company has its worldwide headquarters in Minnetonka, Minnesota, with
regional and sales offices throughout the U.S. and worldwide, including Germany,
Paris, London, Amsterdam, Copenhagen, Singapore, Hong Kong, Sydney, and Tokyo.
PRODUCTS
Digi products enable a virtually unlimited number of users to be connected
locally or remotely to a LAN, the Internet or to multi-user computer systems.
The Company's products provide asynchronous and synchronous data transmissions
for analog modems, ISDN (Integrated Services Digital Network), X.25, Frame Relay
or T1/E1 connections. The application markets where these products are most
prominently used are POS (Point-of-Sales Systems), Industrial Automation,
routing, remote access, and network fax.
The Company's two primary communication adapter product lines are its DataFire
digital and AccelePort multi-port serial communications adapters. These adapters
integrate unique and powerful (Digital Signal Processing) DSP-based technology
that allows them to support a broad array of communications functions
simultaneously. It collaborates with partners to ensure that its boards are
among the industry's most widely supported. This includes working closely with
leading makers of PCs, workstations and other computer hardware, to offer the
highest levels of compatibility. The Company also conforms to the standards
necessary to enable built-in support for its products in many major operating
systems, and writes its own drivers to expand that support where necessary. The
Company also works closely with software application partners, to pre-test and
certify their applications to run on Digi boards.
The Company's server-based communication adapter products constituted
approximately 90%, 80% and 76% of net sales in fiscal 1999, 1998 and 1997,
respectively.
The Company entered the LAN market with its acquisition of MiLAN Technology
Corporation in November 1993. The Company's LAN business, formerly the MiLAN
Technology Division, provides cost-effective and power-efficient Ethernet, Fast
and Giga Ethernet networking connectivity products that are installed on a LAN
to increase its productivity.
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ITEM 1. BUSINESS (CONTINUED)
SERVER-BASED COMMUNICATIONS AND THE MARKET
Server-based communications is based on a open systems where the PC server and
operating system serve as standardized components. The components of a
server-based communications solution include:
A computer hardware platform and operating system, such as a PC or RISC
server running Windows NT, Novell NetWare, UNIX, LINUX or an IBM AS/400
midrange computer;
One or more communications adapters, like Digi's DataFire and
AccelePort products;
Specialized communications application software, available from a wide
range of companies.
Server-based communications solutions are a major growth area. As the middleware
functions of operating systems are improved and enhanced, the Company believes
this market will expand dramatically over the next few years. It has already
begun to grow from something more suitable for small- to medium-sized businesses
to technology with the reliability, performance and scalability to meet the
needs of large enterprises. The Company believes that in the future,
server-based solutions will continue to grow market share against proprietary
boxes for remote access, network fax, and, computer telephony
The Company believes that the key benefits for server-based solutions include
low cost of ownership, increased flexibility and scalability, dependability,
simplified training and support, and the ability for channel partners to add
value and increase profits.
VOICE OVER INTERNET PROTOCOL
The Company entered the Internet telephony market with the acquisition of ITK
International, Inc. ("ITK International" or "ITK") in July of 1998 and its Voice
over Internet Protocol ("VoIP") technology. ITK provides VoIP technology with
the NetBlazer 8500 gateway, a "proof of concept" product that converts voice
signals to TCP/IP packets and routes them over IP networks such as the Internet
and company Intranets. This capability combines voice and data onto one
cost-effective network. Although the VoIP technology acquired from ITK continues
to be under development, the Company believes that this technology will be
successful once a functioning finished product is complete and can be marketed
to "Carrier Class" telephone companies. The current version of the NetBlazer
8500, which includes a sub-set of its ultimate feature set, provided revenues of
$3.0 million during fiscal 1999; total fiscal 1999 net revenue for ITK was $25.7
million. Digi acquired ITK International for approximately $29.6 million in
cash, stock, replacement stock options and the assumption of $39.8 million of
liabilities and restructuring/integration costs.
UNIVERSAL SERIAL BUS AND TERMINAL SERVER
The Company expanded its product lines with its acquisition of Central Data
Corporation ("Central Data" or "CDC") in July 1998. The Company also acquired
in-process research and development from Central Data related to Universal
Serial Bus (USB) technology. This in-process technology will give customers the
ability to maintain existing non-USB peripheral equipment and connect with new
PCs, which contain advanced USB interfaces. The Company introduced USB products
in fiscal 1999, which provided $266,000 of net revenue; total net revenue
contributed by CDC product lines during fiscal 1999 was $16.9 million. The
EtherLite product line, a family of terminal servers used in multiuser and
communications applications, provided 70% of these net revenues. The Company
acquired Central Data for approximately $21.3 million in cash, stock,
replacement stock options and the assumption of $4.4 million of liabilities and
restructuring/integration costs.
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ITEM 1. BUSINESS (CONTINUED)
DISTRIBUTION AND PARTNERSHIPS
The Company sells and markets its products through a global network of
distributors, systems integrators, value added resellers (VARs) and original
equipment manufacturers (OEMs). The Company also sells direct to select accounts
and the government. Internationally, Digi sells and markets its products through
180 distributors in more than 65 countries. More than 300 VARs participate in
the DigiVAR Program.
U.S. distributors include: Ameriquest/Robec, Access Graphics, Anixter,
Avnet/Hallmark, Gates/Arrow Distributing, Graybar, Ingram Micro, Jones Business
Systems, Kent, Merisel, Pinacor, Tech Data Corporation, Westcon and Savior
Technologies. Canadian distributors include Gates/Arrow Electronics, EMJ Data
Systems, Ingram Micro Canada, Merisel Canada and Tech Data Canada.
European distributors include Miel, Arecta, International Computer Products,
Connect Service Riedlbauer, Mitrol, Euroline and Data Solutions. Latin American
and Asia Pacific distributors include Tech Pacific, Sumisho Datacom, Lantech,
Sealcorp Computer Products, Ingram Dicom and Unisel.
Digi maintains strategic partnerships with other industry leaders to develop and
market technology solutions. These include most major communications software
vendors, operating system suppliers and computer hardware manufacturers.
Key Company partners include: Citrix Systems, Compaq, Hewlett-Packard, IBM,
Intel, Lotus, Micron, Microsoft, Motorola, Novell, Red Hat, Santa Cruz Operation
(SCO), Sun Microsystems, and Fundacao CPqD (the Brazilian R&D Center for
Telecommunications).
CUSTOMERS
The Company's customer base includes many of the world's largest companies. IBM
made the Company's adapter boards the first integrated communications offering
for the AS/400 in 1999. Red Hat has made the Company a development partner. The
Company has OEM relationships with leading vendors, allowing them to ship the
Company's boards with their systems. These vendors include NCR, Sun
Microsystems, Silicon Graphics, AT&T, Siemens and many others. Many of the
world's leading telecommunications companies and ISPs also rely on the Company's
products.
During the year ended September 30, 1999, two customers comprised more than 10%
of net sales each: Tech Data at 15.4% and Ingram Micro at 13.4%. During the year
ended September 30, 1998, two customers comprised more than 10% of net sales
each: Ingram Micro at 15.5% and Tech Data at 13.7%. During the year ended
September 30, 1997, two customers comprised more than 10% of net sales each:
Ingram Micro at 15.1%, and Tech Data at 10.5%.
COMPETITIVE CONDITIONS
The computer industry is characterized by rapid technological advances and
evolving industry standards. The market can be significantly affected by new
product introductions and marketing activities of industry participants. The
Company competes for customers on the basis of product performance in relation
to compatibility, support, quality and reliability, product development
capabilities, price and availability. The Company believes that it is the market
leader in serial port boards for server-based communications in the computer
industry. With respect to the LAN business, the Company believes it commands
less than a 5% market share. The Company is currently establishing its position
in the remote access market for the Company's DSP-based RAS product lines. The
Company will enter the Internet telephony market upon full development of its
VoIP technology.
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ITEM 1. BUSINESS (CONTINUED)
Many of the Company's competitors and potential competitors have greater
financial, technological, manufacturing, marketing and personnel resources than
the Company. Present and future competitors may be able to identify new markets
and develop products more quickly and which are superior to those developed by
the Company. They may also adapt new technologies faster, devote greater
resources to research and development, promote products more aggressively and
price products more competitively than the Company. There are no assurances that
competition will not intensify or that the Company will be able to compete
effectively in the markets in which the Company competes.
The major competition for open system server-based communications solutions
offered by the Company are proprietary boxes from companies like Cisco, Ascend,
3Com, Shiva and others. Today, these proprietary boxes represent the majority of
the market for networked communications solutions.
AETHERWORKS CORPORATION
In May 1998, the Company exchanged its previously purchased $13,796,525 of
convertible notes from AetherWorks Corporation, a development stage company
engaged in the development of wireless and dial-up remote access technology, for
a non-interest bearing $8,000,000 non-convertible note. As a part of the
exchange, the Company relinquished its rights to any future technology or claims
on any of AetherWorks' intellectual properties. In exchange, the Company has
been released from all of its guarantees of certain lease obligations of
AetherWorks.
OPERATIONS
The Company's manufacturing operations procure all parts and certain services
involved in the production of products and subcontracts most of its product
manufacturing to outside firms that specialize in such services. The Company
believes that this approach is beneficial because the Company can reduce its
fixed costs, maintain production flexibility and maximize its profit margins.
The Company's products are manufactured to its designs with standard and
semi-custom components. Most of these components are available from multiple
vendors. The Company does have several single-sourced supplier relationships,
either because alternative sources are not available or because the relationship
is advantageous to the Company. If these suppliers are unable to provide timely
and reliable supply of components, the Company could experience manufacturing
delays adversely affecting its results of operations.
During fiscal years 1997, 1998 and 1999, the Company's research and development
expenditures were $18.0, $17.0, and $24.7 million, respectively.
Due to rapidly changing technology in the computer industry, the Company
believes that its success depends primarily upon the engineering, marketing,
manufacturing and support skills of its personnel, rather than upon patent
protection. Although the Company may seek patents where appropriate and has
certain patent applications pending for proprietary technology, the Company's
proprietary technology or products are generally not patented. The Company
relies primarily on the copyright, trademark and trade secret laws to protect
its proprietary rights in its products. The Company has established common law
and registered trademark rights on a family of marks for a number of its
products.
As of September 30, 1999, the Company had backlog orders which management
believed to be firm in the amount of $5.0 million. All of these orders are
expected to be filled in the current fiscal year. Backlog as of September 30,
1998 was $2.9 million.
Total employees at September 30, 1999 were 583.
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ITEM 2. PROPERTIES
The Company's headquarters and research facilities are located in a 130,000
square foot office building in Minnetonka, Minnesota which the Company acquired
in August 1995 and has occupied since March 1996. The Company's primary
manufacturing facility is located in a 58,000 square foot building in Eden
Prairie, Minnesota, which the Company purchased in May 1993 and has occupied
since August 1993. Additional office and research facilities include a 63,000
square foot facility in Dortmund, Germany, a 46,170 square foot facility in
Sunnyvale, California, the lease for which expires in April 2002, and a 5,000
square foot facility in Champaign, Illinois, the lease for which expires in
January 2002.
Management believes that the Company's facilities are suitable and adequate for
current office, research and warehouse requirements, and that its manufacturing
facilities provide sufficient production capacity to meet the Company's
currently anticipated needs.
ITEM 3. 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.
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 intend to oppose the motion. No date has been set for a hearing
on the class certification motion. With the possible exception of additional
depositions of certain lead plaintiffs, discovery in all of the actions has been
completed.
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ITEM 3. LEGAL PROCEEDINGS (CONTINUED)
The Company and its former officers served motions for summary judgment in all
actions on November 19, 1999. Briefing on the motions is scheduled to be
completed by February 4, 2000, and a hearing is expected to be held before the
Court after that date.
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.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to the vote of security holders during the
quarter ended September 30, 1999.
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PART II
ITEM 6. SELECTED FINANCIAL DATA
1999 1998 1997 1996 1995
(As restated (1))
----------------------------------------------------------------------
Net sales $ 193,506 $ 182,932 $ 165,598 $ 193,151 $ 164,978
Percentage increase (decrease) 5.8% 10.5% (14.3)% 17.1% 26.0%
Net income (loss) 3,192 (71) (15,791) 9,300 19,331
Percentage increase (decrease) 4,589.5% 99.6% (269.8)% (51.9)% 15.7%
Net income (loss) per share-basic 0.22 (0.01) (1.18) 0.70 1.42
Percentage increase (decrease) 2,300.0% 99.2% (268.6)% (50.7)% (21.4)%
Net income (loss) per share--
assuming dilution 0.22 (0.01) (1.18) 0.68 1.39
Percentage increase (decrease) 2,300.0% 99.2% (268.6)% (51.1)% 19.8%
Total assets 176,330 191,521 118,311 129,939 126,043
Percentage (decrease) increase (7.9)% 61.9% (8.9)% 3.1% 22.7%
Long-term debt 9,206 11,124
Percentage (decrease) (17.2)%
Stockholders' equity 127,164 121,251 95,471 109,943 105,827
Percentage increase (decrease) 4.9% 27.0% (13.2)% 3.9% 16.1%
(IN THOUSANDS EXCEPT PER SHARE AMOUNTS AND PERCENTAGES)
(1) See Note 2 to the Company's consolidated financial statements
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
This Annual Report 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.
The future operating results and performance trends of the Company may be
affected by a number of factors, including, without limitation, the following:
(i) the highly competitive market in which the Company operates; (ii) the
Company's ability to respond to rapidly developing changes in its marketplace;
(iii) delays in the Company's product development efforts; (iv) the useful life
of products once developed; (v) the Company's ability to integrate its recent
acquisitions and to develop marketable products from the acquired in-process
research and development; (vi) the Company's reliance on distributors; (vii)
declining prices of networking products; (viii) uncertainty in consumer
acceptance of the Company's products; and (ix) changes in the company's level of
revenue or profitability. These and other risks, uncertainties and assumptions
identified from time to time in the Company's filings with the Securities
Exchange Commission, including without limitation, its annual report on Form
10-K and its quarterly report on Form 10-Q, could cause the Company's actual
future results to differ materially from those projected in the forward-looking
statements as a result of the factors set forth in the Company's various filings
with the Securities and Exchange Commission and of changes in general economic
conditions, changes in interest rates and/or exchange rates and changes in the
assumptions used in making such forward-looking statements.
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
The following table sets forth selected information from the Company's
Consolidated Statements of Operations, expressed as a percentage of net sales.
1999 over 1998 over
1999 1998(1) 1997 1998 1997
------ ------- ------ --------- ---------
Net sales 100.0 % 100.0 % 100.0 % 5.8 % 10.5 %
Cost of sales 49.3 48.4 51.6 7.7 3.6
------ ------ ------ -------- ---------
Gross margin 50.7 51.6 48.4 4.0 17.8
Operating expenses:
Sales and marketing 21.2 20.4 22.1 10.0 1.7
Research and development 12.8 9.3 10.9 45.5 (5.6)
General and administrative 12.2 9.3 11.7 39.1 (12.0)
Acquired in-process research and development - 8.8 - (100.0) -
Restructuring 0.3 0.5 6.3 (40.5) (90.3)
------ ------ ------ -------- ---------
46.5 48.3 51.0 1.8 4.6
Operating income (loss) 4.2 3.3 (2.6) 36.2 239.6
Other (expense) income, net (0.1) 1.0 0.1 (114.1) 1,082.2
AetherWorks Corporation net operating loss - - (3.5) - (100.0)
AetherWorks Corporation gain (write-off) - 0.7 (3.5) (100.0) (123.4)
Income (loss) before income taxes 4.1 5.0 (9.5) (13.4) 158.7
Provision for income taxes 2.5 5.0 0.1 (48.4) 10,031.0
------ ------ ------ -------- ---------
Net income (loss) 1.6 % 0.0 % (9.6)% 4,589.5 % (99.6) %
------ ------ ------ -------- ---------
(1) See Note 2 to the Company's consolidated financial statements
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
RESTATEMENT
The Company revised the accounting treatment of its July 1998 acquisitions of
ITK and CDC in response to comments received from the Securities and Exchange
Commission. On August 16, 1999, the Company filed Amendment No. 1 to the
Registrant's 1998 Annual Report on Form 10-K filed with the Securities and
Exchange Commission for the purpose of restating its financial statements for
the year ended September 30, 1998.
NET SALES
The $10.6 million or 5.8% increase in net sales from 1998 to 1999 and the $17.3
million or 10.4% increase in net sales from 1997 to 1998 occurred within the
Company's principal product groups as follows:
Annual Sales
Percent of Annual Net Sales ----------------------
--------------------------- Increase (Decrease)
1999 1998 1997 1999 1998
---- ---- ---- ---- ----
Server Based 89.8% 79.8% 75.7% 18.9% 16.6%
Physical Layer 10.2% 20.1% 23.9% (46.2)% (6.9)%
Other 0.0% 0.0% 0.4% 0.0% (100.0)%
Sales of ISDN and VoIP products added in connection with the July 1998
acquisition of ITK and USB and Etherlite products added in connection with the
July 1998 acquisitions of CDC generated $42.5 million of net sales for the 1999
fiscal year, an increase of $32.8 over the net sales recognized during of the
year ago period, which included ITK and CDC revenue in the fourth quarter of the
fiscal year. These revenue increases were mitigated by a revenue decrease of
$13.3 million for the Company's legacy asynchronous products due to shrinking of
the overall market and a shift in demand to digital technology products. The
Company also experienced a decrease in demand for the Company's physical layer
products due to a decrease in prices and competition resulting in a decrease in
revenues of $17.0 million. Net sales of the Company's new DSP RAS products were
$8.7 million for the 1999 fiscal year, adding $8.1 million over total DSP RAS
product revenue in fiscal 1998. Net sales in fiscal 1998 increased from fiscal
1997 largely because the Company reduced inventory levels in the North American
distribution channel throughout 1997 and into the first quarter of fiscal 1998.
This resulted in a net increase in sales within the distribution channel during
the remainder of 1998.
Net sales to original equipment manufacturers (OEMs) increased 18.6% over 1998
and as a percentage of total net sales, increased to 24.9% versus 22.2% in 1998.
The increase was principally a function of sales added by ITK. Net sales to OEMs
for 1997 were 23.5% of total sales.
Net sales into the distribution channel increased 5.9% over 1998 and as a
percentage of total net sales, remained unchanged at 69.3% in 1999, compared to
1998. International distribution net sales increased by 31.4% over fiscal 1998
primarily due to new product revenues and the expanded distribution channel
added by ITK. Domestic distribution net sales declined by 6.6% due to a decrease
in inventory levels in the distribution channel. Net sales to the distribution
market for 1997 represented 64.1% of total net sales.
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
NET SALES (CONTINUED)
During fiscal years 1999, 1998 and 1997, the Company's net sales to customers
outside the United States, primarily in Europe, were approximately $67.4
million, $46.7 million and $44.5 million, respectively, comprising approximately
34.8%, 25.5% and 26.9% of total net sales.
GROSS MARGIN
Gross margin in 1999 decreased to 50.7%, compared to 51.6% in 1998, primarily
due to the negative impact of sales of lower gross margin ITK products, an
increased percentage of lower margin OEM sales, market-driven erosion of gross
margin on physical layer products, and increases in the Company's inventory
valuation reserves. Gross margin in the fourth quarter of fiscal 1999 improved
to 54.0% when compared to gross margin of 52.0% in the fourth quarter of fiscal
1998, primarily due to improved operating efficiencies in the Company's
production facilities.
Gross margin in 1998 rose to 51.6% compared to 48.4% in 1997 due to cost control
measures and favorable product sales mix. Gross margin also benefited as net
sales of historically lower-margin OEM and physical layer products declined as a
percentage of total net sales. Offsetting the favorable sales mix were increases
in inventory valuation reserves, sales discounts granted, and a higher
proportion of lower margin products sold in the fourth quarter of fiscal 1998
due to the acquisition of CDC and ITK.
OPERATING EXPENSES
Excluding acquired in-process research and development charges of $16,064,933
recorded in 1998, operating expenses in 1999 increased 24.5% from 1998. Sales
and marketing expenses increased by $3.7 million due to $5.6 million of expenses
added by ITK and CDC, $1.8 million expended to promote new DSP RAS products, and
a $3.7 million cost decline primarily due to reduced North American channel
marketing efforts. Research and development expenses increased $7.7 million due
to $4.1 million of additional costs added by ITK and CDC with the remaining
increase of $3.6 million due to new product development costs for the DSP RAS
products. General and administrative expenses increased by $6.6 million
primarily due to increased amortization of acquisition-related goodwill and
other identifiable intangibles of $8.0 million offset by $1.4 million of cost
reductions related reduced information systems implementation costs and other
cost-saving initiatives.
Operating expenses in 1998 declined 3.7% from 1997, excluding acquired
in-process research and development charges of $16,064,933 recorded in 1998 and
the restructuring charges recorded in 1998 and 1997 of $1,020,000 and
$10,471,482 respectively. The operating expense decline reflected reductions in
the workforce, decreased marketing costs and cost savings achieved through the
consolidation of U.S. research and development efforts, offset by CDC and ITK
operating expenses of $3.8 million. General and administrative expenses declined
in 1998 due to workforce reductions and cost-saving initiatives, offset by
increased intangible asset amortization.
The $1.2 million of net restructuring charges recorded in fiscal 1999 were
associated with the board approved plan to reorganize the sales and marketing
functions in Germany, England and the United States, by consolidating worldwide
sales and marketing resources into strategic locations. The charges
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15
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
OPERATING EXPENSES (CONTINUED)
consist principally of existing commitments for rent on facilities vacated by
the Company and termination payments associated with the elimination of 42
positions. These activities are expected to be completed by December 1999. The
Company anticipates annual cost savings of $1.3 million from these
restructurings. (See Note 4 to the Company's consolidated financial statements).
The $1,020,000 restructuring charge recorded in the fiscal 1998 fourth quarter
was associated with a board-approved plan to consolidate existing offices in
Germany with those acquired from ITK. The charge consists principally of rent,
contractual payments on office equipment, write-offs of leasehold improvements
and termination costs associated with the elimination of six positions.
Activities were completed by June 30, 1999. After change in estimate adjustments
of $572,000, the net charge of $448,000 is anticipated to yield annual cost
savings of $425,000. (See Note 4 to the Company's consolidated financial
statements).
The $10,471,482 restructuring charge recorded in the fiscal 1997 second quarter
was related to a board-approved plan to consolidate operations and reduce costs
and expenses. The restructuring charge consisted of $1,259,769 in net cash
expenditures (primarily employee termination costs), all of which had been paid
as of September 30, 1997, and $9,211,713 resulting from the write-down of asset
carrying values. (See Note 4 to the Company's consolidated financial
statements).
OTHER DEVELOPMENTS
On December 16, 1999, the Company announced that it expects revenue for the
fiscal 2000 first quarter ending December 31, 1999 to be in a range of $39
million to $41 million and earnings per diluted share to be in a range of $0.03
to $0.07. The Company attributes the lower than expected revenues and earnings
for the first quarter primarily to two factors associated with Year 2000
concerns. Sales to the Company's OEM customers have been affected by a temporary
change in the purchasing patterns of end users until after January 2000. Sales
into the Company's distribution channel have been impacted similarly by end-user
purchasing behavior and also more significantly by inventory reductions as
channel participants reduce levels due to Year 2000 concerns.
15
16
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
ACQUIRED IN-PROCESS RESEARCH AND DEVELOPMENT
ACQUISITION OF ITK INTERNATIONAL, INC.:
In July 1998, the Company acquired all of the outstanding common stock of ITK.
The transaction was accounted for using the purchase method of accounting.
Accordingly, the purchase price was allocated to the estimated fair value of
assets acquired and liabilities assumed, including estimated restructuring and
integration costs of $3,484,000. (See Note 4 to the Company's consolidated
financial statements).
At the time of the Company's acquisition, ITK described itself as a Remote
Access Server (RAS) product company. Although ITK did offer its own line of ISDN
cards and networking boards, the Company's acquisition was made principally to
acquire the voice over Internet Protocol (VoIP) technology under development by
ITK. This VoIP technology, if successfully developed, would allow users to send
packetized voice signals through the Internet. The Company believes that the
VoIP technology under development at the time of the acquisition could provide
for the development of products which would be a natural extension of the
Company's current product offerings and could position the Company to address
substantially larger markets than the markets served by the Company's current
products.
At the time of the acquisition, ITK had developed a proof of concept prototype
product ("NetBlazer 8500") which demonstrated that the method of voice and data
compression under development by ITK and the method of combining VoIP and remote
access functionality under development by ITK had the potential to be further
developed into a product marketable to "Carrier Class" telephone companies.
However, the NetBlazer 8500 required further development before it could meet
the technical and functional requirements of such customers. Accordingly, the
Company is uncertain whether the VoIP technology being developed will ultimately
meet the technical requirements of Carrier Class telephony customers or whether
it will be commercially viable.
As of the date of the acquisition, the nature of the development efforts related
to the purchased, in-process research and development projects, as well as the
efforts required to complete development of those projects into commercially
viable products, included development projects to address the following: (a)
development of enhanced technical attributes, including enhanced port density,
redundancy, network management capabilities, a higher fault tolerance,
compliance with telephone industry standards such as "SS7" and "NEBS"
compliancy; (b) development of significant hardware and software functions
considered integral to a product with broad appeal to end users and the
telephone companies, including computer-to-phone capabilities, interoperability
with other vendor's gateways, one-stage dialing , local tone simulation and
announcements, end-to-end transparent disconnect cause delivery and real-time
FAX-over capabilities, among others; and (c) re-engineering of the prototype
design to permit cost effective manufacture and commercial use, including
migration from a UNIX operating system to a Windows NT operating system.
It is not certain that development efforts on these projects will allow for
Carrier Class telephone company and end-user specifications to be met. Failure
to achieve these specifications or to achieve market viability will cause the
VoIP projects to fail. If these products are not successfully developed, the
sales and profitability of the Company may be adversely affected in future
periods. Additionally, the value of other identifiable intangible assets and
goodwill acquired may become impaired.
16
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
ACQUIRED IN-PROCESS RESEARCH AND DEVELOPMENT (CONTINUED)
ACQUISITION OF ITK INTERNATIONAL, INC.: (CONTINUED)
Management estimates that $11.3 million of the purchase price represents the
fair value of purchased in-process research and development related to the VoIP
projects referred to above, that had not yet reached technological feasibility
and had no alternative future uses. These amounts were expensed as a
non-recurring, non-tax-deductible charge upon consummation of the acquisition.
The Company utilized the alternative income valuation approach to determine the
estimated fair value of the purchased in-process research and development. This
estimate is based on the following assumptions:
o The estimated revenues are based upon projected average annual revenue
growth rates from future products expected to be derived once technological
feasibility is achieved of between 18% and 65% during the period from 2000
through 2005, starting with an estimated growth rate of 65% from 2000 to
2001 with steadily declining rates of estimated revenue growth through
2005. Estimated total revenues expected from products to be developed using
purchased in-process research and development peak in the year 2005 and
decline rapidly in 2006 and 2007 as other new products are expected to
enter the market. These projections are based on estimates made by the
Company's management of market size and growth (which are supported by
independent market data), expected trends in technology and the nature and
expected timing of new product introductions by ITK and its competitors.
o The estimated costs of sales are based upon the historical, stand-alone
costs of ITK without considering any synergies due to the acquisition by
the Company.
o The estimated selling, general and administrative expenses of between 37%
and 32% of revenues from 2000 through 2003 and between 29% and 27% of
revenues between 2004 and 2007, are based upon the estimated expense levels
of ITK as derived from the historical, stand-alone costs of ITK without
considering any synergies due to the acquisition by the Company.
o The discount rate utilized in the alternative income valuation approach is
based on the weighted average cost of capital (WACC). The WACC calculation
produces the average required rate of return of an investment in an
operating enterprise, based on various required rates of return from
investments in various areas of that enterprise. The WACC estimated by an
independent third-party appraiser for the Company, as a corporate business
enterprise is 14%. The discount rate used in the alternative valuation
approach was 30%. This discount rate is higher than the WACC due to the
inherent uncertainties in the estimates described above including
uncertainty surrounding the successful development of purchased research
and development, the estimated useful life of such completed research and
development, the profitability levels of such completed research and
development and the uncertainty of technological advances that are unknown
at this time.
The Company estimated that the purchased in-process research and development
related to VoIP was 83% complete as of the acquisition date. This estimate was
based upon research and development costs
17
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
ACQUIRED IN-PROCESS RESEARCH AND DEVELOPMENT (CONTINUED)
ACQUISITION OF ITK INTERNATIONAL, INC.: (CONTINUED)
incurred to date compared to total estimated development costs. As of the date
of acquisition, the estimated cost to complete the VoIP to a point of
technological feasibility was approximately $2.3 million, expected to be
incurred over a period of approximately 20 months following the acquisition.
This estimate is subject to change, given the uncertainties of the development
process, and no assurance can be given that deviations from these estimates will
not occur.
The identifiable intangible assets of $21,100,000 included in the purchase price
allocation set forth above are comprised of proven technology with an estimated
fair value of $19,700,000 and an assembled workforce with an estimated fair
value of $1,400,000, which have estimated useful lives of five years and six
years, respectively. The remaining unallocated purchase price represents
goodwill of $17,727,086, which is being amortized over seven years. With regard
to the proven technology, the Company intends to further enhance the strengths
of this product range and implement a plan to gain leadership in the ISDN
market. The Company's core asset is the comprehensive set of common application
programming interface (CAPI) and CAPI-enhancing features combined with highly
intelligent ISDN protocol implementation which provide for integration into
server-based communication solutions for the media communication market.
The Company is continuing development of the acquired in-process VoIP technology
and, as of September 30, 1999, believes that its development efforts are on
schedule to meet the product release schedule referred to above with potential
increases in its research and development costs. However, these expectations are
subject to change, given the uncertainties of the development process and
changes in market expectations. Development costs incurred were $1.9 million
during the year ended September 30, 1999. The current version of the NetBlazer
8500, which includes a sub-set of the ultimate feature set, provided revenues of
$3.0 million during fiscal 1999.
ACQUISITION OF CENTRAL DATA CORPORATION:
In July 1998, the Company acquired all of the outstanding common stock of CDC.
The transaction was accounted for using the purchase method of accounting.
Accordingly, the purchase price was allocated to the estimated fair value of
assets acquired and liabilities assumed, including estimated restructuring and
integration costs of $750,000. (See Note 4 to the Company's consolidated
financial statements).
Although CDC did offer its own line of traditional serial port connectivity
products, the Company's acquisition was made principally to acquire the
Universal Serial Bus (USB) technology under development by CDC. This USB
technology, if successfully developed, would broaden the Company's product
offerings to include this new, emerging industry-standard port technology.
Management considers such a product offering integral to its future market share
because the marketplace is migrating from the traditional serial I/O
(input/output) technology (in which the Company has significant market share) to
USB technology. The Company also believes that it can reduce its time to market
by 12 to 18
18
19
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
ACQUIRED IN-PROCESS RESEARCH AND DEVELOPMENT (CONTINUED)
ACQUISITION OF CENTRAL DATA CORPORATION: (CONTINUED)
months by acquiring CDC's in-process research and development rather than
initiating development of its own USB technology.
At the time of acquisition, CDC had developed a prototype of both the 2-port and
4-port USB connectivity technologies that demonstrated the validity of CDC's
product development plan. However, the USB technology development was still in
process, and required significant development work and field testing before it
could meet the technical and functional requirements of customers and achieve
commercial viability. Accordingly, the Company was uncertain whether the
technology being developed could ultimately meet the technical and economic
requirements of the marketplace and become commercially viable.
As of the date of the acquisition, the nature of the development efforts related
to the purchased, in-process research and development projects, as well as the
efforts required to complete development of those projects into commercially
viable products included: (a) development of new hardware designs and software
engineering relating to a complete reengineering of the in-process USB
technology; (b) development of new hardware designs for 8-port USB products; and
(c) development of a new "hub" architecture to support the CDC USB technology.
It is not certain that development efforts on these projects will allow for user
specifications to be met or commercial viability to be achieved. Failure to
achieve these specifications or to achieve market viability will cause the USB
projects to fail. If these products are not successfully developed, the sales
and profitability of the Company may be adversely affected in future periods.
Additionally, the value of other identifiable intangible assets and goodwill
acquired may become impaired.
Management estimates that $4.7 million of the purchase price represents the fair
value of purchased in-process research and development related to the USB
projects referred to above, that had not yet reached technological feasibility
and had no alternative future uses. These amounts were expensed as a
non-recurring, non-tax-deductible charge upon consummation of the acquisition.
The Company utilized the alternative income valuation approach to determine the
estimated fair value of the purchased in-process research and development. These
estimates are based on the following assumptions:
o The estimated revenues are based upon projected average annual revenue
growth rates form future products expected to be derived once technological
feasibility is achieved of between 9% and 52% during the period from 1999
through 2002, starting with an estimated growth rate of 52% from 1999 to
2000 with a declining rate of estimated revenue growth through 2002.
Estimated total revenues expected from products to be developed using
purchased in-process research and development peak in the year 2002 and
decline rapidly in 2003 and 2004 as other new products are expected to
enter the market. These projections are based on estimates made by the
Company's management of market size and growth (which are supported by
independent market data), expected trends in technology and the nature and
expected timing of new product introductions by CDC and its competitors.
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20
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
ACQUIRED IN-PROCESS RESEARCH AND DEVELOPMENT (CONTINUED)
ACQUISITION OF CENTRAL DATA CORPORATION: (CONTINUED)
o The estimated costs of sales are based upon the historical, stand-alone
costs of CDC without considering any synergies due to the acquisition by
the Company.
o The estimated selling, general and administrative expenses of between 35%
and 30% of revenues from 1999 to 2003 and 27% of revenues in 2004, are
based upon the estimated expense levels of CDC as derived from the
historical, stand-alone costs of CDC without considering any synergies due
to the acquisition by the Company.
o The discount rate utilized in the alternative income valuation approach is
based on the weighted average cost of capital (WACC). The WACC calculation
produces the average required rate of return of an investment in an
operating enterprise, based on various required rates of return from
investments in various areas of that enterprise. The WACC estimated by an
independent third-party appraiser for the Company, as a corporate business
enterprise, is 14%. The discount rate used in the alternative valuation
approach was 30%. This discount rate is higher than the WACC due to the
inherent uncertainties in the estimates described above including
uncertainty surrounding the successful development of purchased research
and development, the estimated useful life of such completed research and
development, the profitability levels of such completed research and
development and the uncertainty of technological advances that are unknown
at this time.
The Company estimated that the purchased in-process research and development
related to USB was 87% complete as of the acquisition date. This estimate was
based upon research and development costs incurred to date compared to total
estimated development costs. As of the date of acquisition, the estimated cost
to complete the USB technology to a point of technological feasibility was
approximately $600,000, expected to be incurred over a period of approximately
nine months following the acquisition. This estimate is subject to change, given
the uncertainties of the development process, and no assurance can be given that
deviations from these estimates will not occur.
The identifiable intangible assets of $9,800,000 included in the purchase price
allocation set forth above are comprised of proven technology with an estimated
fair value of $9,400,000, and an assembled workforce with an estimated fair
value of $400,000, which have estimated useful lives of five years and six
years, respectively. The remaining unallocated purchase price represents
goodwill in the amount of $9,711,298, which is being amortized over seven years.
The Company has developed the acquired in-process USB research and development
and released USB products, with initial product revenues generated during
November 1998. Included in revenues for fiscal 1999 is approximately $266,000 of
revenues from the first release of certain USB products. Actual revenues are
below original projections due to delays in the release and marketing of certain
USB products. Research and development expenditures incurred to advance the
acquired in-process USB technology were $500,000 for fiscal 1999.
20
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
OTHER (EXPENSE) INCOME
Other expense of $256,000 in 1999 consisted of $1,015,000 of interest expense on
lines of credit and long term debt, $856,000 of interest income on short term
investments, and $97,000 of miscellaneous other expense. Other income for 1998
included primarily interest income on cash equivalents and a fiscal 1998
third-quarter reversal of a $1.4 million previously accrued obligation related
to lease guarantees for AetherWorks Corporation. As discussed in the next item
below, the obligation is no longer required because the Company is no longer the
primary guarantor for these leases.
AETHERWORKS CORPORATION
NET LOSS AND WRITE-OFF
In connection with the Company's previously purchased $13.8 million of
convertible notes from AetherWorks Corporation, in May 1998 the Company
exchanged such notes for a non-interest bearing $8.0 million non-convertible
note and was released from all of its guarantees of certain lease obligations of
AetherWorks. Due to significant uncertainty as to its collectibility, the $8.0
million note, which matures in 2001, has been recorded by the Company as having
no carrying value. In fiscal 1997 the Company used the equity method to account
for its investment in AetherWorks and record a net loss of $5.8 million, which
represented 100% of AetherWorks' loss for the year. The percentage of
AetherWorks' net losses included in the Company's financial statements was based
upon the percentage of financial support provided by the Company (versus other
investors) during 1997. The Company wrote off its investment in AetherWorks as
of September 30, 1997, and recorded a $5.8 million charge, composed of its $2.4
million remaining investment, its $2.0 million remaining obligation to purchase
additional notes and $1.4 million for the obligation to guarantee certain
AetherWorks leases. The Company no longer has any funding obligations or any
potential equity interest in or management control over AetherWorks.
Consequently, the Company has not included any of AetherWorks' net losses in its
results of operations during fiscal 1999 and fiscal 1998.
INCOME TAXES
The Company recorded a $4.8 million tax provision for 1999 and $9.3 million tax
provision for 1998. These tax provision amounts were required primarily because
of the write-off of acquired in-process research and development and because the
amortization of certain identifiable intangible assets and goodwill acquired in
the purchase of ITK and CDC is not deductible for income tax reporting purposes.
In 1997, the Company recorded a $0.1 million tax provision, while reporting a
pre-tax loss for that year. That provision was necessary due to the
non-deductibility of certain intangible assets written off as part of the
restructuring charge, the AetherWorks net losses and the related investment
write-off.
21
22
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
INFLATION
The Company believes inflation has not had a material effect on its operations
or its financial condition.
LIQUIDITY AND CAPITAL RESOURCES
The Company has financed its operations principally with funds generated from
operations, and, in prior years, with proceeds from earlier public offerings.
The Company's working capital increased from $37.9 million at September 30,
1998, to $59.9 million at September 30, 1999. The Company maintains lines of
credit with various financial institutions providing for borrowings of up to
$15.9 million, depending upon levels of eligible accounts receivable and
inventories. As of September 30, 1999, $4.8 million had been borrowed under
these line of credit agreements.
During 1999, the Company increased cash balances by approximately $10.6 million,
through cash flow from operations, principally due to an increase in cash
generated from operations.
Investing activities consisted of net investments of $13.7 in marketable
securities and purchases of $4.8 million of equipment, capital improvements, and
expansion of the Company's enterprise-wide Enterprise Resource Planning (ERP)
software system into locations outside of the Minnetonka headquarters.
Financing activities consisted of payments on line of credit and debt
obligations totaling $5.9 million and $815,000 for repurchase of shares of the
Company's common stock, which was offset by $3.0 million received from the
exercise of employee stock options and employee stock purchase plan
transactions.
In September 1998, the Board of Directors authorized a program to repurchase up
to one million shares of the Company's common stock for use in the Company's
benefit plans. As of September 30, 1999, 120,000 shares had been repurchased
under this program at a weighted average price of $8.03.
The Company's management believes that current financial resources, cash
generated from operations and the Company's potential capacity for debt and/or
equity financing will be sufficient to fund current and future business
operations.
FOREIGN CURRENCY TRANSLATION
Effective January 1, 1999, eleven countries of the European Union converted to a
common currency called the "Euro." This action will cause some of the Company's
European transactions to be negotiated, invoiced, and paid in "Euros." The
conversion will most likely add currency exchange costs and risks, although such
costs and risks are not quantifiable at this time.
22
23
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
FOREIGN CURRENCY TRANSLATION (CONTINUED)
During 1999, the Company had approximately $67.4 million of net sales related to
foreign customers , of which $44.8 million was in U.S. dollars and $22.6 was in
Deutschemark-denominated sales. During fiscal 1999 the average monthly exchange
rate for the Deutschemark to the U.S. dollar dropped by approximately 12% from
.6103 to .5370 U.S. dollars to the Deutschemark, respectively.
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 READINESS DISCLOSURE
This section contains certain statements that are forward-looking statements
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 Company's
Year 2000 readiness, and the effects of the Year 2000 on the Company may be
differ materially from currently projected. This may be due to, among other
things, delays in the implementation of the Company's Year 2000 Plan, which
includes contingency plans, and the failure of key third parties with whom the
Company transacts business to achieve Year 2000 compliance. The Company faces
risk to the extent that suppliers of products and services purchased by the
Company and others with whom the Company transacts business on a world-wide
basis do not have business products and services that comply with year 2000
requirements. The Company has obtained assurances from most of its key suppliers
that their products and services are year 2000 compliant. In the event any such
third parties cannot, in a timely manner, provide the Company with products and
services that meet the year 2000 requirements, the Company's operating results
could be materially adversely affected.
The Company began a comprehensive project in 1996 to prepare its products and
its enterprise-wide information management system and other internal computer
systems for the year 2000. The Company believes its implementation of a new
enterprise-wide information management system, principally installed to improve
operating efficiency, will address the Company's internal year 2000 compliance
issues. The worldwide rollout of this system was completed on September 30,
1999.
Most of the Company's products are year 2000 compliant because there is very
little or no date processing involved. Certain products, including end-of-life
versions, do require customer action such as a patch or version upgrade to be
compliant. These products have been identified, and the Company has notified
impacted customers. Overall, management believes the year 2000 will not have a
significant impact on operations.
The Company plans to continue with remediation and testing efforts with both its
products and internal systems to further mitigate any risks associated with the
year 2000. Contingency plans have been established in order to transact business
at sufficient levels in the case of adverse events related to the Year 2000 date
change. In addition, the Company will monitor the enterprise computer systems,
LAN/WAN, and the computer room environments for temperature, continuous power
supply, and transaction integrity. Facility personnel will be monitoring owned
and leased buildings for heating and security.
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24
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
YEAR 2000 READINESS DISCLOSURE (CONTINUED)
The costs associated with the year 2000 project have been minimal and are not
incremental to the Company, but include temporary reallocation of existing
resources. However, there can be no assurances that various factors relating to
the Year 2000 compliance issues, including litigation, will not have a material
adverse effect on the Company's business, operating results, or financial
position.
While the Company believes it is prepared for Year 2000 issues and has an
effective program in place to resolve the impact of a Year 2000 issue in a
timely manner, there can be no assurance that the failure of the Company or of
the third parties with whom the Company transacts business to adequately address
their respective Year 2000 issues, will not have a material adverse effect on
the Company's business, financial condition, cash flows and results of
operations.
NEW ACCOUNTING STANDARDS
See Note 1 to the Company's consolidated financial statements.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
25
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
CONSOLIDATED STATEMENTS OF OPERATIONS
For the fiscal years ended September 30 1999 1998 1997
As Restated-See Note 2
-----------------------------------------------------------
Net sales $ 193,506,059 $ 182,931,670 $ 165,597,937
Cost of sales 95,313,636 88,539,156 85,482,536
------------- ------------- -------------
Gross Margin 98,192,423 94,392,514 80,115,401
Operating expenses:
Sales and marketing 41,002,559 37,288,027 36,671,271
Research and development 24,689,228 16,963,410 17,978,135
General and administrative 23,657,586 17,011,504 19,324,777
Acquired in-process research and development - 16,064,933 -
Restructuring 607,398 1,020,000 10,471,482
------------- ------------- -------------
Total operating expenses 89,956,771 88,347,874 84,445,665
------------- ------------- -------------
Operating income (loss) 8,235,652 6,044,640 (4,330,264)
Other (expense) income, net (256,320) 1,818,286 153,809
AetherWorks Corporation net operating loss - - (5,764,201)
AetherWorks Corporation gain (write-off) - 1,350,000 (5,758,548)
------------- ------------- -------------
Income (loss) before income taxes 7,979,332 9,212,926 (15,699,204)
Provision for income taxes 4,787,599 9,284,020 91,640
------------- ------------- -------------
Net income (loss) $ 3,191,733 $ (71,094) $ (15,790,844)
===========================================================
Net income (loss) per common share,
basic $ 0.22 $ (0.01) $ (1.18)
===========================================================
Net income (loss) per common share,
assuming dilution $ 0.22 $ (0.01) $ (1.18)
===========================================================
Weighted average common shares, basic 14,696,057 13,729,765 13,393,408
===========================================================
Weighted average common shares,
assuming dilution 14,831,242 13,729,765 13,393,408
===========================================================
The accompanying notes are an integral part of the consolidated financial
statements
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26
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA (CONTINUED)
CONSOLIDATED BALANCE SHEETS
At September 30,
1999 1998
-------------- ---------------
As Restated-See
Note 2
ASSETS
Current assets:
Cash and cash equivalents $ 20,963,607 $ 10,355,368
Marketable securities 13,714,422 -
Accounts receivable, net 33,955,669 47,087,978
Inventories, net 22,446,667 27,365,924
Other 5,394,346 6,139,941
------------ ------------
Total current assets 96,474,711 90,949,211
Property, equipment and improvements, net 30,242,877 33,990,923
Intangible assets, net 47,804,611 63,602,435
Other 1,807,829 2,978,883
------------ ------------
Total assets $176,330,028 $191,521,452
============ ============
LIABILITES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Borrowings under line of credit agreements $ 4,759,095 $ 10,707,000
Current portion of long-term debt 330,028 264,025
Accounts payable 10,779,998 15,255,173
Income taxes payable 5,274,181 3,797,588
Accrued expenses:
Advertising 2,461,437 2,651,742
Compensation 6,078,230 6,776,292
Other 6,357,348 8,347,668
Restructuring reserves 488,298 5,254,000
------------ ------------
Total current liabilities 36,528,615 53,053,488
------------ ------------
Long-term debt 9,205,918 11,124,446
Net deferred income taxes 3,431,133 5,817,933
Other - 275,000
------------ ------------
Total liabilities 49,165,666 70,270,867
------------ ------------
Commitments and contingencies
Stockholders' equity:
Preferred stock, $.01 par value: 2,000,000 shares
authorized; none outstanding
Common stock, $.01 par value; 60,000,000 shares
authorized; 16,192,997 and 15,790,975 shares issued 161,930 157,910
Additional paid-in capital 71,460,612 70,461,123
Retained earnings 78,234,541 75,042,808
Cumulative foreign currency translation adjustment (1,027,533) (815,809)
------------ ------------
148,829,550 144,846,032
Unearned stock compensation (339,686) (1,700,635)
Treasury stock, at cost, 1,271,612 and 1,247,094 shares (21,325,502) (21,894,812)
------------ ------------
Total stockholders' equity 127,164,362 121,250,585
------------ ------------
Total liabilities and stockholders' equity $176,330,028 $ 191,521,452
============ ============
The accompanying notes are an integral part of the consolidated financial
statements
26
27
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA (CONTINUED)
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the fiscal years ended September 30,
1999 1998 1997
---- ---- ----
As Restated-See
Note 2
Operating activities:
Net income (loss) $ 3,191,733 $ (71,094) $(15,790,844)
Adjustments to reconcile net income (loss) to
cash provided by operating activities:
Acquired in-process research and development 16,064,933
Restructuring (672,167) 1,020,000 9,211,713
Depreciation of property and equipment 5,988,640 5,174,725 5,587,132
Amortization of intangibles 12,807,568 3,665,879 1,114,023
AetherWorks Corporation net loss 5,764,201
AetherWorks Corporation (gain) write-off (1,350,000) 5,758,548
Loss on sale of fixed assets 243,524 159,498 760,555
Provision for losses on accounts receivable 179,366 708,992 1,933,251
Provision for inventory obsolescence 6,218,261 3,414,270 2,910,988
Deferred income taxes (2,119,056) (1,251,611) (1,787,933)
Stock compensation 582,981 895,401 244,569
Changes in operating assets and liabilities:
Accounts receivable 12,359,264 (17,687,833) 15,283,125
Inventories (1,618,415) (569,839) 3,780,241
Income taxes payable 1,761,296 883,900 3,447,612
Other assets 2,228,897 (3,227,695) 713,772
Accounts payable (3,822,046) 279,236 (2,430,817)
Accrued expenses and other liabilities (4,025,827) 2,280,156 153,448
------------ ------------ ------------
Total adjustments 30,112,286 10,460,012 52,444,428
------------ ------------ ------------
Net cash provided by operating activities 33,304,019 10,388,918 36,653,584
------------ ------------ ------------
Investing activities:
Purchase of property and equipment and certain other
intangible assets (4,759,893) (5,816,163) (8,841,473)
Proceeds from sale of fixed assets 843,995
Purchase of held-to-maturity marketable securities (20,633,113)
Proceeds form sale of held-to-maturity marketable securities 7,000,000
Business acquisitions, net of cash acquired (27,356,560)
Investment in AetherWorks Corporation - (2,000,000) (6,500,000)
------------ ------------ ------------
Net cash used in by investing activities (17,549,011) (35,172,723) (15,341,473)
------------ ------------ ------------
Financing activities:
Payments on long-term debt (5,915,843) (73,000)
Proceeds from the issuance of long-term debt 2,064,865
Purchase of treasury stock (815,000) (153,750)
Stock option transactions, net 2,381,422 2,310,572 539,838
Employee stock purchase plan transactions, net 586,324 471,629 534,327
------------ ------------ ------------
Net cash (used in) provided by financing activities (3,763,097) 4,620,316 1,074,165
------------ ------------ ------------
Effect of exchange rates changes on cash and cash equivalents (1,383,672) (810,809)
Net increase (decrease) in cash and cash equivalents 10,608,239 (20,974,298) 22,386,276
Cash and cash equivalents, beginning of period $ 10,355,368 $ 31,329,666 $ 8,943,390
------------ ------------ ------------
Cash and cash equivalents, end of period $ 20,963,607 $ 10,355,368 $ 31,329,666
============ ============ ============
Supplemental Cash Flows Information:
Interest paid $ 937,306 $ 224,730 $ 208,000
Income taxes paid $ 3,742,898 $ 7,463,578 $ 238,439
The accompanying notes are an integral part of the consolidated financial
statements
27
28
pp
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA (CONTINUED)
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY AND COMPREHENSIVE INCOME
Consolidated Statements of Stockholders' Equity
For the years ended September 30, 1999, 1998 and 1997
Common Stock Treasury Stock Additional
Shares Par Value Shares Value Paid-in-Capital
---------- --------- --------- ----------- ---------------
Balances, September 30, 1996 14,677,150 $146,772 1,338,894 $(23,679,979) $42,866,758
Employee Stock Purchase issuances (69,402) 1,274,391 (740,064)
Issuance of stock options at below
market prices 1,892,015
Stock compensation
Issuance of stock upon exercise of
stock options, net of withholding 50,106 501 379,720
Tax benefit realized upon exercise
of stock options 159,617
Forfeiture of stock (154,944)
options
Net loss
- ---------------------------------------------------------------------------------------------------------------------------
Balances, September 30, 1997 14,727,256 147,273 1,269,492 (22,405,588) 44,403,102
Issuance of stock for acquisitions 775,837 7,758 21,829,797
Purchase of treasury stock, at cost 15,000 (153,750)
Employee Stock Purchase issuances (37,398) 664,526 (192,897)
Issuance of stock options at below
market prices 977,697
Stock compensation
Issuance of stock upon exercise of
stock options, net of withholding 287,882 2,879 2,307,742
Tax benefit realized upon exercise
of stock options 1,305,001
Forfeiture of stock options (169,319)
Foreign currency translation adjustment
Net loss
- ---------------------------------------------------------------------------------------------------------------------------
Balances, September 30, 1998 (As Restated-See Note 2) 15,790,975 157,910 1,247,094 (21,894,812) 70,461,123
Purchase of treasury stock, at cost 105,000 (815,000)
Employee Stock Purchase issuances (80,482) 1,384,310 (797,986)
Stock compensation
Issuance of stock upon exercise of
stock options, net of withholding 402,022 4,020 2,377,402
Tax benefit realized upon exercise
of stock options 198,041
Forfeiture of stock options (777,968)
Foreign currency translation adjustment
Net income
- ---------------------------------------------------------------------------------------------------------------------------
Balances, September 30, 1999 16,192,997 $161,930 1,271,612 $(21,325,502) $71,460,612
===========================================================================================================================
The accompanying notes are an integral part of the consolidated
financial statements
Continued Next Page
28
29
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA (CONTINUED)
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY AND COMPREHENSIVE INCOME
(CONTINUED)
Consolidated Statements of Stockholders' Equity
For the years ended September 30, 1999, 1998 and 1997
Unearned Total
Retained Stock Cumulative Stockholders' Comprehensive
Earnings Compensation Translation Equity (Loss) Income
------------- --------------- ------------ ------------- -------------
Balances, September 30, 1996 $ 90,904,746 $ (295,156) $ 109,943,141
Employee Stock Purchase issuances 534,327
Issuance of stock options at below
market prices (1,892,015)
Stock compensation 244,569 244,569
Issuance of stock upon exercise of
stock options, net of withholding 380,221
Tax benefit realized upon exercise
of stock options 159,617
Forfeiture of stock options 154,944
Net loss (15,790,844) (15,790,844) $ (15,790,844)
- -------------------------------------------------------------------------------------------------------------- -------------
Balances, September 30, 1997 75,113,902 (1,787,658) 95,471,031 $ (15,790,844)
=============
Issuance of stock for acquisitions 21,837,555
Purchase of treasury stock, at cost (153,750)
Employee Stock Purchase issuances 471,629
Issuance of stock options at below
market prices (977,697)
Stock compensation 895,401 895,401
Issuance of stock upon exercise of
stock options, net of withholding 2,310,621
Tax benefit realized upon exercise
of stock options 1,305,001
Forfeiture of stock options 169,319
Foreign currency translation adjustment $ (815,809) (815,809) (815,809)
Net loss (71,094) (71,094) (71,094)
- -------------------------------------------------------------------------------------------------------------- ------------
Balances, September 30, 1998
(As Restated-See Note 2) 75,042,808 (1,700,635) (815,809) 121,250,585 $ (886,903)
=============
Purchase of treasury stock, at cost (815,000)
Employee Stock Purchase issuances 586,324
Stock compensation 582,981 582,981
Issuance of stock upon exercise of
stock options, net of withholding 2,381,422
Tax benefit realized upon exercise
of stock options 198,041
Forfeiture of stock options 777,968
Foreign currency translation adjustment (211,724) (211,724) (211,724)
Net income 3,191,733 3,191,733 3,191,733
- -------------------------------------------------------------------------------------------------------------- ------------
Balances, September 30, 1999 $ 78,234,541 $ (339,686) $ (1,027,533) $ 127,164,362 $ 2,980,009
============================================================================================================== =============
The accompanying notes are an integral part of the consolidated financial
statements
29
30
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BUSINESS DESCRIPTION
Digi International is a leading worldwide provider of data communications
products for open systems, server-based communications, Internet telephony, and
local area network (LAN) applications. Digi's communications products support a
broad range of server platforms and network operating systems that enable people
to access information.
Digi's products are marketed through a global network of distributors, system
integrators, original equipment manufacturers (OEMs), as well as thousands of
value-added resellers (VARs).
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company and
its wholly-owned subsidiaries. All significant intercompany accounts and
transactions have been eliminated in consolidation.
CASH EQUIVALENTS AND MARKETABLE SECURITIES
The Company considers all highly liquid investments purchased with an original
maturity of three months or less to be cash equivalents. Those having original
maturities in excess of three months are classified as marketable securities.
Marketable Securities consist of high-grade commercial paper and have maturies
of less than one year. Marketable securities classified as held to maturity are
carried at amortized cost. Gross unrealized holding gains and losses were
$10,561 and $5,383 as of September 30, 1999. The Company had no marketable
securities as of September 30, 1998.
REVENUE RECOGNITION
Revenue is recognized at the date of shipment. Estimated warranty costs and
customer returns are recorded at the time of sale.
The Company offers rebates to authorized domestic and international distributors
and authorized resellers. The rebates are incurred based on the level of sales
to the respective distributors and resellers, and are charged to operations in
the same period as the corresponding sales.
INVENTORIES
Inventories are stated at the lower of cost or fair market value, with cost
determined on the first-in, first-out method. Fair market value for raw
materials is based on replacement cost and for other inventory classifications
based on net realizable value. Appropriate consideration is given to
deterioration, obsolescence and other factors in evaluating net realizable
value.
30
31
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
PROPERTY, EQUIPMENT AND IMPROVEMENTS
Property, equipment and improvements are carried at cost. Depreciation is
provided by charges to operations using the straight-line method based on
estimated useful lives, ranging from three to 39 years.
Expenditures for maintenance and repairs are charged to operations as incurred,
while major renewals and betterments are capitalized. The assets and related
accumulated depreciation accounts are adjusted for asset retirements and
disposals with the resulting gain or loss included in operations.
The Company's cost of business process reengineering activities, whether done
internally or by third parties, is expensed as incurred.
INTANGIBLE ASSETS
Purchased proven technology, license agreements, covenants not to compete and
other intangible assets are recorded at cost. Goodwill represents the excess of
cost over the fair value of identifiable assets acquired and is being amortized
on a straight-line basis over estimated useful life periods ranging from five to
15 years. Purchased in process research and development costs (IPR&D) are
expensed upon consummation of the purchase. All other intangible assets are
amortized on a straight-line basis over their estimated useful lives of one to
seven years.
The Company periodically, at least quarterly, analyzes intangible assets for
potential impairment, assessing the appropriateness of lives and recoverability
of unamortized balances through measurement of undiscounted operating cash flows
on a basis consistent with generally accepted accounting principles.
RESEARCH AND DEVELOPMENT
Research and development costs are expensed when incurred. Software development
costs are expensed as incurred. Such costs are required to be expensed until the
point that technological feasibility and proven marketability of the product are
established. Costs otherwise capitalized after such point also are expensed
because they are insignificant.
INCOME TAXES
Deferred income taxes are recognized for the tax consequences in future years of
differences between the tax bases of assets and liabilities and their financial
reporting amounts at each year end based on enacted tax laws and statutory tax
rates applicable to the periods in which the differences are expected to affect
taxable income. Income tax expense is the tax payable for the period and the
change during the period in deferred tax assets and liabilities.
31
32
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
INCOME TAXES (CONTINUED)
Tax credits are accounted for under the flow-through method, which recognizes
the benefit in the year in which the credit is utilized.
INCOME (LOSS) PER COMMON SHARE
Basic net income (loss) per share is calculated based on only the weighted
average of common shares outstanding during the period. Net income (loss) per
share, assuming dilution, is computed by dividing net income (loss) by the
weighted average number of common and common equivalent shares outstanding. The
Company's only common stock equivalents are those that result from dilutive
common stock options. The calculation of diluted earnings per common share for
1999 includes 135,185 of such common stock equivalents. The calculation of
diluted loss per common share for 1998 and 1997 excludes 835,670 and 236,165
equivalent shares, respectively, of the Company's common stock attributable to
common stock options because their effect would be antidilutive.
FOREIGN CURRENCY TRANSLATION
Financial position and results of operations of the Company's international
subsidiaries are measured using local currencies as the functional currency.
Assets and liabilities of these operations are translated at the exchange rates
in effect at each fiscal year-end. Statements of operations accounts are
translated at the average rates of exchange prevailing during the year.
Translation adjustments arising from the use of differing exchange rates from
period to period are included in the cumulative translation account in
stockholders' equity.
USE OF ESTIMATES
The preparation of consolidated financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
32
33
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
COMPREHENSIVE INCOME
During the first quarter of fiscal 1999, the Company adopted Statement of
Financial Accounting Standards No. 130 (FAS 130), "Reporting Comprehensive
Income". FAS 130 requires the Company to report in the consolidated financial
statements, in addition to net income, comprehensive income and its components
including foreign currency items and unrealized gains and losses of certain
investments in debt and equity securities. Comprehensive income is defined as
"the change in equity (net assets) of a business enterprise during a period from
transactions and other events and circumstances from non-owner sources." It
includes all changes in equity during a period except those resulting from
investment by owners and distributions to owners.
SEGMENT REPORTING
For the year ended September 30, 1999, the Company adopted Statement of
Financial Accounting Standards No. 131 (FAS 131), "Disclosures about Segments of
an Enterprise and Related Information". This statement establishes standards for
reporting information about operating segments in annual financial statements
and requires selected information about operating segments in interim financial
reports issued to stockholders. It also establishes standards for related
disclosures about products and services, geographic areas and major customers.
Under FAS 131, operating segments are to be determined consistent with the way
that management organizes and evaluates financial information internally, makes
operating decisions, and assesses performance.
RECLASSIFICATION OF CERTAIN ITEMS
Accrued sales discounts and allowances of $1,461,167, which previously were
included in accrued expenses, have been reclassified into net accounts
receivable for the year ended September 30, 1998. This reclassification had no
impact on previously reported operating income, or net income.
Costs of $2,647,207 relating to systems support and communications costs, which
previously were included in general and administrative expenses, have been
reclassified into sales and marketing and research and development expenses for
the year ended September 30, 1997. This reclassification had no impact on
previously reported operating income, or net income.
NEW ACCOUNTING STANDARDS
In June 1998, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities." Statement No. 133 will be effective for the
Company beginning with the Company's fiscal year ending September 30, 2000. In
July 1999, the FASB issued Statement of Financial Accounting Standards No. 137,
"Accounting for Derivative Instruments and Hedging Activities - Deferral of the
Effective Date of FASB Statement No. 133" which defers the effective date of
FASB 133 to the Company's fiscal year ending September 30, 2001. As the Company
presently has no derivative instruments and is not involved in hedging activity,
the Company does not expect the adoption of FASB Statement No. 133 and FASB
Statement No. 137 to have an impact on the results of operations or the
financial position of the Company.
33
34
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
NEW ACCOUNTING STANDARDS (CONTINUED)
In January 1999, the American Institute of Certified Public Accountants issued
Statement of Position No. 98-9 (SOP 98-9), "Modification of SOP 97-2, Software
Revenue Recognition, with Respect to Certain Transactions." This SOP retains the
limitations of SOP 97-2 on what constitutes vendor-specific objective evidence
of fair value. SOP 98-9 will become effective for the Company's fiscal year
ending September 30, 2000. The adoption of SOP 98-9 is not expected to have a
significant impact on the results of operations or financial position of the
Company.
In November 1999, the Staff of the Securities and Exchange Commission issued
Staff Accounting Bulletin No. 100 (SAB 100) - Restructuring and Impairment
Charges. This SAB expresses the views of the Staff regarding the accounting for
and disclosure of certain expenses commonly reported in connection with exit
activities and business combinations. Although it has not made a definite
determination of its impact, the Company does not expect the adoption of SAB 100
to have a materially adverse effect on its financial position or results of
operation.
In December 1999, the Staff of the Securities and Exchange Commission issued
Staff Accounting Bulletin No. 101 (SAB 101) - Revenue Recognition in Financial
Statements. This SAB summarizes certain of the Staff's views in applying
generally accepted accounting principals to revenue recognition in financial
statements. Although it has not made a definite determination of its impact, the
Company does not expect the adoption of SAB 101 to have a materially adverse
effect on its financial position or results of operation.
2. RESTATEMENT
After discussion with the staff of the Securities and Exchange Commission (the
SEC) the consolidated financial statements as of September 30, 1998 and for the
year ended September 30, 1998 have been restated to reflect a change in the
measurement and allocations of the purchase prices related to the July 1998
acquisitions of ITK and CDC.
The Company allocated amounts to IPR&D and intangible assets in the fourth
quarter of 1998 in a manner consistent with widely recognized appraisal
practices at the date of the acquisitions of ITK and CDC. Subsequent to the
acquisitions, the SEC staff expressed broad views that took issue with certain
appraisal practices generally employed by many public companies in determining
the fair value of IPR&D. As a result of these developments, the Company has
modified its valuation of IPR&D using the alternative income valuation approach.
In addition, in response to questions raised by the SEC Staff about the
Company's measurement of the fair value of common stock and common stock options
issued in the ITK and CDC acquisitions, the Company has revised its valuation of
this portion of the purchase prices.
As a result of valuing IPR&D using the alternative income valuation approach and
adjusting the measurement of the purchase prices, the Company, in consultation
with their independent accountants, has revised its measurement and allocations
of the purchase prices, including the amounts allocated to IPR&D. The effect of
these adjustments was to: reduce the aggregate amount originally allocated to
IPR&D from $39.2 million to $16.1 million; increase the aggregate amount
allocated to current
34
35
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. RESTATEMENT (CONTINUED)
technologies from $15.0 to $29.1 million; increase the amount of net deferred
tax liabilities from $0 to $6.3 million; increase goodwill from $8.2 million to
$27.4 million; increase additional paid in-capital from $68.7 million to $70.5
million; and reduce unearned stock compensation from $3.8 million to $1.7
million. These adjustments will also result in additional annual amortization
expense related to identifiable intangibles and goodwill of approximately $5.0
million (assuming there are no future adjustments to reflect impairments of such
intangibles and goodwill). The revised purchase accounting for the ITK and CDC
acquisitions is described in detail in Note 3.
The restatement does not affect previously reported net cash flows for the
periods. The effect of this reallocation on previously reported consolidated
financial statements as of and for the year ended September 30, 1998 is as
follows:
As of and for the year ended
September 30, 1998
-------------------------------------
As previously
reported As restated
------------- -------------
Statement of Operations Data:
General and administrative expenses $ 16,003,146 $ 17,011,504
Acquired in-process research and development 39,200,000 16,064,933
Total operating expenses 110,474,583 88,347,874
Operating (loss) income (16,082,069) 6,044,640
Loss before income taxes (12,913,783) 9,212,926
Provision for income taxes 9,745,088 9,284,020
Net loss $ (22,658,871) $ (71,094)
Net loss per common share, basic $ (1.65) $ (0.01)
Net loss per common share, assuming dilution $ (1.65) $ (0.01)
Balance Sheet Data:
Intangible assets, net $ 31,354,483 $ 63,602,435
Total assets 160,734,667 192,982,619
Net deferred income taxes 5,817,933
Total liabilities 65,914,103 71,732,034
Additional paid-in capital 68,695,448 70,461,123
Retained earnings 52,455,031 75,042,808
Unearned stock compensation (3,777,204) (1,700,635)
Total stockholders' equity $ 94,820,564 $ 121,250,585
35
36
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. ACQUISITIONS
In July 1998, the Company acquired all of the outstanding common stock of ITK
International, Inc. (ITK). The transaction was accounted for using the purchase
method of accounting. Accordingly, the purchase price was allocated to the
estimated fair value of assets acquired and liabilities assumed, including
estimated restructuring and integration costs of $3,484,000 (see Note 4).
Components of the purchase consideration, including related transaction costs,
consist of $14,767,154 in cash, the Company's common stock with a market value
of $12,501,183 and $2,316,415 of replacement stock options issued by the Company
to ITK option holders. The cash and the Company's common stock were issued in
exchange for outstanding shares of ITK's common stock and the Company's stock
options were issued in exchange for the outstanding ITK common stock options.
The value of the Company's common stock issued was based on a per share value of
approximately $21.69, calculated as the average market price of the Company's
common stock during the two business days immediately preceding and subsequent
to the date the parties reached agreement on terms and announced the
transaction. The value of the Company's common stock options is based on the
estimated fair value of these options, as of the date the transaction was
consummated, using the Black-Scholes valuation model.
The table below is an analysis of the purchase price allocation.
Cash and fair value of Company's common
stock and common stock options issued $ 28,146,369
Direct acquisition costs 1,438,383
ITK liabilities assumed, including estimated
Restructuring and integration costs of $3,484,000 39,784,248
------------
Total purchase price $ 69,369,000
============
Estimated fair value of tangible assets acquired, including
$5,772,000 of deferred taxes 27,440,814
Estimated fair value of:
IPR&D 11,330,100
Identifiable intangible assets 21,100,000
Goodwill 17,727,086
Deferred tax liabilities related to identifiable
intangibles (8,229,000)
------------
$ 69,369,000
============
The Company utilized the alternative income valuation approach to determine the
estimated fair value of the purchased in-process research and development.
Management estimates that $11.3 million of the purchase price represents the
fair value of purchased in-process research and development related to the VoIP
projects referred to above, that had not yet reached technological feasibility
and had no alternative future uses. These amounts were expensed as a
non-recurring, non-tax-deductible charge upon consummation of the acquisition.
It is not certain that development efforts on these projects will allow for
carrier class telephone company and end-user specifications to be met. Failure
to achieve these specifications or to achieve market viability will cause the
in-process Voice over Internet Protocol technology (VoIP) projects to fail. If
these products are not successfully developed, the sales and
36
37
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. ACQUISITIONS (CONTINUED)
profitability of the combined Company may be adversely affected in future
periods. Additionally, the value of other identifiable intangible assets and
goodwill acquired may become impaired.
The identifiable intangible assets of $21,100,000 included in the purchase price
allocation set forth above are comprised of proven technology with an estimated
fair value of $19,700,000 and an assembled workforce with an estimated fair
value of $1,400,000, which have estimated useful lives of five years and six
years, respectively. The remaining unallocated purchase price represents
goodwill, which is being amortized over seven years.
In July 1998, the Company acquired all of the outstanding common stock of
Central Data Corporation (CDC). The transaction was accounted for using the
purchase method of accounting. Accordingly, the purchase price was allocated to
the estimated fair value of assets acquired and liabilities assumed, including
estimated restructuring and integration costs of $750,000 (see Note 4).
Components of the purchase consideration, including related transaction costs,
consist of $14,261,965 in cash, the Company's common stock with a market value
of $4,326,721 and $2,693,236 of replacement stock options issued by the Company
to CDC option holders. The cash and the Company's common stock were issued in
exchange for outstanding shares of CDC's common stock and the Company's stock
options were issued in exchange for the outstanding CDC common stock options.
The value of the Company's common stock issued was based on a per share value of
approximately $21.69, calculated as the average market price of the Company's
common stock during the two business days immediately preceding and subsequent
to the date the parties reached agreement on terms and announced the
transaction. The value of the Company's common stock options is based on the
estimated fair value of these options, as of the date the transaction was
consummated, using the Black-Scholes valuation model.
The table below is an analysis of the purchase price allocation.
Cash and fair value of Company's common
stock and common stock options issued $ 20,980,482
Direct acquisition costs 301,440
CDC liabilities assumed, including estimated
restructuring and integration costs of $750,000 4,394,617
------------
Total purchase price $ 25,676,539
============
Estimated fair value of tangible assets acquired 5,252,408
Estimated fair value of:
IPR&D 4,734,833
Identifiable intangible assets 9,800,000
Goodwill 9,711,298
Deferred tax liabilities related to identifiable
intangibles (3,822,000)
------------
$ 25,676,539
============
37
38
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. ACQUISITIONS (CONTINUED)
The Company utilized the alternative income valuation approach to determine the
estimated fair value of the purchased in-process research and development.
Management estimates that $4.7 million of the purchase price represents the fair
value of purchased in-process research and development related to the USB
projects referred to above, that had not yet reached technological feasibility
and had no alternative future uses. These amounts were expensed as a
non-recurring, non-tax-deductible charge upon consummation of the acquisition.
It is not certain that development efforts on these projects will allow for user
specifications to be met or commercial viability to be achieved. Failure to
achieve these specifications or to achieve market viability will cause the
Universal Serial Bus (USB) projects to fail. If these products are not
successfully developed, the sales and profitability of the combined Company may
be adversely affected in future periods. Additionally, the value of other
identifiable intangible assets and goodwill acquired may become impaired.
The identifiable intangible assets of $9,800,000 included in the purchase price
allocation set forth above are comprised of proven technology with an estimated
fair value of $9,400,000, and an assembled workforce with an estimated fair
value of $400,000, which have estimated useful lives of five years and six
years, respectively. The remaining unallocated purchase price represents
goodwill, which is being amortized over seven years.
The following unaudited pro forma condensed consolidated results of operations
have been prepared as if the acquisitions of ITK and CDC had occurred as of the
beginning of fiscal 1998 and 1997:
1998 1997
- --------------------------------------------------------------
Net sales $220,271,670 $194,605,937
Net loss ($20,206,426) ($76,316,007)
Net loss per share ($1.36) ($5.39)
The unaudited pro forma condensed consolidated results of operations are not
necessarily indicative of results that would have occurred had the acquisitions
been in effect for the years presented, nor are they necessarily indicative of
the results that will be obtained in the future.
4. 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 September 30, 1999, the Company paid $836,953 of termination costs
relating to the elimination of 33 positions. During the third quarter of fiscal
1999, management of the Company determined that $33,100 of severance costs in
Dortmund would not be payable due to a decision to retain two employees
previously notified that they would be terminated. In addition, the Company
reduced its estimated
38
39
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
4. RESTRUCTURING (CONTINUED)
remaining rent commitment by $80,106 as it successfully sublet the vacated
office space in Nurnberg, Germany. During the fourth quarter of fiscal 1999,
management of the Company determined that $160,114 of severance costs in
Minneapolis would not be payable due to a decision to retain two additional
employees previously notified that they would be terminated. Adjustments to the
restructuring accrual are reflected as a reduction in the restructuring accrual
and a corresponding increase to operating income. Management of the Company
expects that these restructuring activities will be completed by December 1999.
A summary of payments and adjustments is included in the table below.
- ---------------------------------------------------------------------------------------------------------------
Change in Balance at
Beginning Estimate September 30,
Description Balance Payments Adjustments 1999
- ---------------------------------------------------------------------------------------------------------------
Severance and termination
costs $ 1,301,871 $ (836,953) $ (193,214) $ 271,704
Rent commitments 151,038 (50,460) (80,106) 20,472
----------- ----------- ----------- ----------
TOTAL $ 1,452,909 $ (887,413) $ (273,320) $ 292,176
----------- ----------- ----------- ----------
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 during December 1998. As of September
30, 1999, the company paid $301,044 of termination costs relating to the
elimination of two positions. During the third quarter of 1999, the Company
reduced the restructuring accrual by $572,191 due to management's decision
during the quarter to retain four employees previously notified that they would
be terminated, a final settlement negotiated by the Company which reduced the
remaining contractual rent commitments for office space and equipment in
Cologne, Germany which was previously vacated and abandoned by the Company, and
a decision by current management to utilize certain equipment which prior
management had planned to abandon. Adjustments to the restructuring accrual are
reflected as a reduction in the restructuring accrual and a corresponding
increase to operating income. Restructuring activities have been completed as of
June 1999. A summary of payments and adjustments is included in the table below.
39
40
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
4. RESTRUCTURING (CONTINUED)
- ---------------------------------------------------------------------------------------------------------------
Balance at Change in Balance at
September 30, Estimate September 30,
Description 1998 Payments Adjustments 1999
- ---------------------------------------------------------------------------------------------------------------
Severance and termination
costs $ 656,368 $ (301,044) $ (355,324) $ -
Rent commitments 61,483 (29,900) (16,374) 15,209
Contractual payments for
office equipment 100,110 (49,972) (50,138) -
Write-offs of leasehold
improvements 202,039 (14,358) (150,355) 37,326
----------- ---------- ---------- ---------
TOTAL $ 1,020,000 $ (395,274) $ (572,191) $ 52,535
----------- ---------- ---------- ---------
In connection with the Company's acquisition of ITK, the Company formulated a
plan of reorganization and accordingly, has recognized a $3,484,000
restructuring liability which the Company has included as a component of total
liabilities assumed in the acquisition. Components of 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. During the third quarter of
fiscal 1999, the Company reduced the restructuring accrual by $1,451,882 as
management determined during the quarter that the number of positions to be
terminated was 26 rather than 30 due to unanticipated employee turnover and
other changes in management of the Company during fiscal 1999. In addition,
during the third quarter of 1999, the Company and the lessor of the Newbury
facility reached a final, negotiated settlement which significantly reduced the
Company's remaining contractual rent obligation. Adjustments to the
restructuring accrual are reflected as a reduction in the restructuring accrual
and a corresponding decrease in goodwill. Restructuring activities have been
completed as of June 1999. A summary of payments and adjustments is included in
the table below.
- ---------------------------------------------------------------------------------------------------------
Balance at Change in Balance at
September 30, Estimate September 30,
Description 1998 Payments Adjustments 1999
- ---------------------------------------------------------------------------------------------------------
Severance and termination
costs $ 1,844,000 $ (1,442,339) $ (378,792) $ 22,869
Facility closures 1,640,000 (531,513) (1,073,090) 35,397
----------- ------------ ------------ ----------
TOTAL $ 3,484,000 $ (1,973,852) $ (1,451,882) $ 58,266
----------- ------------ ------------ ----------
40
41
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
4. RESTRUCTURING (CONTINUED)
In connection with the Company's acquisition of CDC, the Company formulated a
plan of reorganization and accordingly, the Company has recognized a $750,000
restructuring liability which the Company has included as a component of total
liabilities assumed in the acquisition. Components of this estimated liability
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.
During the third quarter of fiscal 1999, the Company reduced the restructuring
accrual by $222,513 due to management's decision during the quarter to reduce
the number of employees to be terminated from 22 to 20 due to unanticipated
employee turnover and other changes in management. In addition, during the third
quarter, management determined that it would not incur significant additional
closure costs from the sale of the Champaign, Illinois facility. Adjustments to
the restructuring accrual are reflected as a reduction in the restructuring
accrual and a corresponding decrease in goodwill. Restructuring activities have
been completed as of June 1999. A summary of payments and adjustments is
included in the table below.
- ----------------------------------------------------------------------------------------------------------
Balance at Change in Balance at
September 30, Estimate September 30,
Description 1998 Payments Adjustments 1999
- ----------------------------------------------------------------------------------------------------------
Severance and termination
costs $ 675,000 $ (442,166) $ (147,513) $ 85,321
Facility closure 75,000 - (75,000) -
----------- ------------ ------------ ----------
TOTAL $ 750,000 $ (442,166) $ (222,513) $ 85,321
----------- ------------ ------------ ----------
In February 1997, the Company's Board of Directors approved a restructuring plan
that resulted in a restructuring charge of $10,471,482 ($8,283,681, net of tax
benefits). The corporate restructuring plan resulted in consolidation and
reduced costs and expenses. It included the closing of the Cleveland
manufacturing facility, the reduction of selected product lines and the
consolidation and closing of the Torrance, California and Nashville, Tennessee
research and development facilities. These costs included: (i) write downs of
the carrying values of fixed assets related to the closed manufacturing and
research and development facilities, (ii) write downs of the carrying values of
goodwill and identifiable intangible assets (primarily licensing agreements
related to the discontinued product lines) and related inventories, and (iii)
severance costs associated with the elimination of 105 positions. These
restructuring activities were completed in fiscal year 1997.
The restructuring charge consisted of $1,259,769 in net cash expenditures
(primarily severance), of which all had been paid as of September 30, 1997, and
$9,211,713 resulting from the write-down of asset carrying values.
41
42
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
5. SEGMENT INFORMATION AND MAJOR CUSTOMERS
The Company operates in one reportable segment as defined in FAS 131. The
operations of the Company are primarily conducted in the Unites States, the
Company's country of domicile. Geographic data, determined by references to the
location of the Company's operations for the years ended September 30, are as
follows:
Revenue by geographic area:
Year Ended September 30,
1999 1998 1997
---- ---- ----
Unites States $164,329,109 $171,385,998 $159,262,803
Europe 26,948,248 9,573,107 5,093,731
Asia 1,249,157 1,205,606 845,453
Australia 979,545 766,959 395,950
------------ ------------ ------------
$193,506,059 $182,931,670 $165,597,937
============ ============ ============
Long-lived assets by geographic area:
Year Ended September 30,
1999 1998 1997
---- ---- ----
United States $40,921,789 $48,218,876 $30,154,985
Foreign 37,125,699 49,374,482 339,308
----------- ----------- -----------
Total long-lived assets $78,047,488 $97,593,358 $30,494,293
=========== =========== ===========
The Company's foreign export sales, primarily to Europe, comprised 34.8%, 25.5%,
and 26.9% of net sales for the years ended September 30, 1999, 1998 and 1997,
respectively.
During 1999, one customer accounted for 15.4% of net sales and 8.7% of the trade
accounts receivable as of September 30, 1999, while another accounted for 13.4%
of net sales and 22.5% of the trade accounts receivable as of September 30,
1999.
During 1998, one customer accounted for 15.5% of net sales and 26% of the trade
accounts receivable as of September 30, 1998, while another accounted for 13.7%
of net sales and 10% of the trade accounts receivable as of September 30, 1998.
During 1997, one customer accounted for 15.1% of net sales while another
accounted for 10.5% of net sales. In addition, one customer accounted for 28% of
the trade accounts receivable outstanding as of September 30, 1997.
6. INVESTMENT IN AETHERWORKS CORPORATION
In May 1998, the Company exchanged its previously purchased $13,796,525 of
convertible notes from AetherWorks Corporation, a development stage company
engaged in the development of wireless and dial-up remote access technology, for
a non-interest bearing $8,000,000 non-convertible note. As a part of the
exchange, the Company relinquished its rights to any future technology or claims
on any of AetherWorks' intellectual properties. In exchange, the Company has
been released from all of its
42
43
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
6. INVESTMENT IN AETHERWORKS CORPORATION (CONTINUED)
guarantees of certain lease obligations of AetherWorks. As a result, the Company
has reversed its $1,350,000 accrual established in the fourth quarter of 1997,
for the estimated cost related to its guarantee of such lease obligations and
has included such amount in AetherWorks Corporation gain for the year ended
September 30, 1998.
Due to the significant uncertainty as to its collectibility, the $8,000,000
note, which matures in 2001, has been recorded by the Company as having no
carrying value.
The Company continues to lease to AetherWorks $1,325,000 of computer equipment
under a three-year direct financing lease, expiring in 2000.
For fiscal 1997, the Company reported its investment in AetherWorks on the
equity method and reported net losses of $5,764,201. This loss, which excludes
$5,758,548 of additional charges accrued as of September 30, 1997 as described
below, represented 100% of AetherWorks net loss for the year. The percentage of
AetherWorks net losses included in the Company's Statement of Operations was
based upon the percentage of financial support provided by the Company (versus
other investors) to AetherWorks that year.
Because of the significant uncertainty of the future of AetherWorks Corporation,
as demonstrated by its lack of ability to generate positive cash flow, obtain
other sources of equity financing and its continued uncertainty in developing
commercially marketable products, the Company decided, as of September 30, 1997,
to write off its remaining investment of $2,408,548 in AetherWorks, and to
accrue and expense its remaining obligation to purchase $2,000,000 of additional
notes. In addition, the Company also accrued $1,350,000 for its obligation
resulting from its guarantees of certain AetherWorks' lease obligations as of
September 30, 1997.
The following represents condensed financial information from the audited
statements of AetherWorks for the year ended September 30, 1997:
OPERATING DATA FOR THE YEAR ENDED SEPTEMBER 30, 1997
Operating expenses:
Research and development $ 3,505,134
General and administrative 2,069,304
Other 1,169,345
Eliminations (979,582)
-------------
Net loss $ (5,764,201)
=============
The "eliminations line" item represents interest expense payable to the Company
for interest due on the notes issued by AetherWorks to the Company. This amount
is excluded from the AetherWorks loss as the Company has eliminated the
corresponding interest income from its Consolidated Statements of Operations.
43
44
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
7. SELECTED BALANCE SHEET DATA
1999 1998
-------------- ---------------
As Restated-See
Note 2
-------------- ---------------
Accounts receivable, net:
Trade accounts receivable $42,720,227 $53,618,657
Less reserve for returns and doubtful
accounts and sales allowances 8,764,558 6,530,679
----------- -----------
$33,955,669 $47,087,978
=========== ===========
Inventories, net:
Raw materials $17,487,552 $16,814,657
Work in process 2,162,626 2,922,442
Finished goods 7,335,755 10,735,483
----------- -----------
26,985,933 30,472,582
Less reserve for obsolescence 4,539,266 3,106,658
----------- -----------
$22,446,667 $27,365,924
=========== ===========
Property, equipment and improvements:
Land $ 2,533,666 $ 2,774,300
Building 19,338,618 19,912,614
Improvements 580,286 554,932
Equipment 22,991,088 20,859,857
Purchased software 8,872,121 6,968,127
Furniture & fixtures 1,462,338 929,890
----------- -----------
55,778,117 51,999,720
Less accumulated depreciation 25,535,240 18,008,797
----------- -----------
$30,242,877 $33,990,923
=========== ===========
Intangible assets:
Purchased technology $30,010,858 $30,010,858
License agreements 2,559,067 3,476,400
Assembled workforce 1,800,000 1,800,000
Other 1,228,225 1,483,835
Goodwill 29,826,194 33,802,679
----------- -----------
65,424,344 70,573,772
Less accumulated amortization 17,619,733 6,971,337
----------- -----------
$47,804,611 $63,602,435
=========== ===========
44
45
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. BORROWING UNDER LINE OF CREDIT AGREEMENTS
The Company maintains lines of credit with various financial institutions which
provide for borrowings of up to $15,856,600. As of September 30, 1999 and 1998,
$4,759,095 and $10,707,000 has been borrowed under these line of credit
agreements. These line of credit agreements are uncollateralized and provide for
interest rates ranging from 4.5% to 10.6% as of September 30, 1999 and 1998.
9. LONG-TERM DEBT
Long-term debt consists of the following at September 30,
1999 1998
---- ----
5.5% fixed rate long-term collateralized note $1,688,260 $ 1,854,490
5.2% fixed rate long-term collateralized note 1,143,660 1,256,240
6.3% fixed rate long-term collateralized note 4,356,800 4,784,959
6.0% fixed rate long-term uncollateralized note 1,960,560 1,555,010
5.0% to 10.6% subsidized long-term notes 386,666 525,851
6.0% fixed rate long-term collateralized note - 538,450
Variable rate long-term collateralized note - 250,000
Long-term collateralized mortgage note - 623,471
---------- -----------
$9,535,946 $11,388,471
Less current portion 330,028 264,025
---------- -----------
$9,205,918 $11,124,446
The 5.5% fixed rate long-term note is payable in semi-annual installments
beginning September 2000. The 5.2% fixed rate long-term note is payable in
semi-annual installments beginning June 2001. The 6.3% fixed rate long-term note
is payable in semi-annual installments beginning March 2000. Interest on the
notes is payable on a quarterly basis. These notes are collateralized by land,
buildings and equipment with a book value of $9,228,990. The 6.0% fixed rate
long-term uncollateralized note is due in full on November 30, 2001. Interest is
payable annually.
45
46
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
9. LONG-TERM DEBT (CONTINUED)
The subsidized long-term notes bear interest rates ranging from 5% to 10.6% and
are due at various dates through 2006. All borrowings under these notes are
uncollateralized.
The 6.0% fixed rate long-term collateralized note, the variable rate long-term
collateralized note, and the long-term collateralized mortgage note were paid in
full during fiscal 1999.
Aggregate maturities of long-term debt are as follows:
Fiscal Year
2000 $ 330,028
2001 397,013
2002 1,838,570
2003 675,304
2004 422,610
Thereafter 5,872,421
----------
$9,535,946
==========
10. INCOME TAXES
The components of the provision for income taxes for the years ended September
30, 1999, 1998, and 1997 are as follows:
1999 1998 1997
---- ---- ----
Currently payable:
Federal $ 6,201,277 $ 9,768,927 $ 1,737,116
State 705,378 766,704 142,457
Deferred (2,119,056) (1,251,611) (1,787,933)
----------- ----------- -----------
$ 4,787,599 $ 9,284,020 $ 91,640
=========== =========== ===========
The net deferred tax asset (liability) at September 30, 1999 and 1998 consists
of the following:
1999 1998
---- ----
Valuation reserves $ 2,904,412 $ 2,673,443
Inventory valuation 228,442 430,501
Compensation costs 600,991 1,007,367
Net operating loss carryforwards 5,772,000 5,772,000
Intangible asset basis difference (9,203,133) (11,589,933)
Other 154,854 102,133
----------- -----------
Net deferred tax asset (liability) $ 457,566 $(1,604,489)
=========== ===========
46
47
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10. INCOME TAXES (CONTINUED)
As of September 30, 1999 and 1998, the net deferred tax asset (liability)
consists of current deferred tax assets of $3,888,699 and $4,213,444,
respectively and net non-current deferred tax liabilities of $3,431,133 and
$5,817,933, respectively. As of September 30, 1999 and 1998, the Company has
recorded $9,203,133 and $11,589,933 of deferred tax liabilities related to the
identifiable intangible assets that were acquired as part of the ITK and CDC
acquisitions. These deferred tax liabilities are being amortized over the
estimated useful lives of the related identifiable intangible assets acquired.
As of September 30, 1999 and 1998, the Company had federal net operating loss
carryforwards of approximately $14,800,000 available to offset future taxable
income, which expire at various dates through 2011. Utilization of such net
operating loss carryforwards is presently limited to offset taxable income, if
any, generated by ITK.
The reconciliation of the statutory federal income tax rate with the effective
income tax rate for the years ended September 30, 1999, 1998, and 1997 is as
follows:
1999 1998 1997
-------- -------- --------
Statutory income tax rate 35.0% 35.0% (34.0) %
Increase (reduction) resulting from:
Utilization of research and development tax credits (0.9)
Utilization of low income housing credits (5.0) (3.9) 1.7
State taxes, net of federal benefits 5.7 5.4
AetherWorks Corporation net operating loss 12.5
AetherWorks Corporation write-off 9.6
Acquired in-process research and development 61.0
Restructuring charges 9.3
Tax contingencies 4.7
Nondeductible intangible asset amortization 15.3 2.7 1.3
Foreign operations 2.9 5.4 (0.2)
Other 6.1 (4.8) (3.9)
- ------------------------------------------------------------------------------------------------------
60.0% 100.8% 0.1 %
47
48
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
11. STOCK OPTIONS AND EMPLOYEE STOCK PURCHASE PLAN
The Company's stock option plan (the Stock Option Plan) provides for the
issuance of nonstatutory stock options and incentive stock options (ISOs) to key
employees and nonemployee board members holding less than 5% of the outstanding
shares of the Company's common stock. The Company's Non-Officer Stock Option
Plan (the Non-Officer Plan and, together with the Stock Option Plan, the Plans),
provides for the issuance of nonstatutory stock options to key employees who are
not officers or directors of the Company.
The option price for ISOs and non-employee directors options granted under the
Stock Option Plan is set at the fair market value of the Company's common stock
on the date of grant. The option price for nonstatutory options granted under
the Plans is set by the Compensation Committee of the Board of Directors. The
authority to grant options under the Plans and set other terms and conditions
rests with the Compensation Committee. The Stock Option Plan terminates in 2006.
The Non-Officer Plan does not have a designated termination date.
During the years ended September 30, 1999, 1998, and 1997, 402,022, 287,882, and
50,106 shares of the Company's Common Stock, respectively, were issued upon the
exercise of options for 402,022, 289,353, and 50,167 shares, respectively. The
difference between shares issued and options exercised results from the
provision in the Plans allowing employees to elect to pay their withholding
obligation through share reduction. Withholding taxes paid by the Company as a
result of the share withholding provision amounted to $28,871 and $5,171 during
the years ended September 30, 1998 and 1997, respectively. No employees elected
to pay tax withhold obligations through share reduction during fiscal 1999.
During the year ended September 30, 1998 the Board of Directors authorized the
issuance of incentive stock options for the purchase of 486,631 shares. In
addition, the Board of Directors authorized the issuance of nonstatutory stock
options for the purchase of 543,461 shares, at prices below the market value of
the stock on the grant dates.
During the year ended September 30, 1997 the Board of Directors authorized the
cancellation and reissue of nonstatutory stock options to certain employees for
the purchase of 823,326 shares, at an exercise price below the market value of
the stock. Under this authorization, the original option issues were canceled
and new options were issued with a new four-year vesting schedule.
The difference between the option price and market value at the date of grant
for the above option arrangements has been recorded as additional paid-in
capital with an offsetting debit within stockholders' equity to unearned stock
compensation. The compensation expense related to these option grants is
amortized to operations over the contractual vesting period in which employees
perform services and amounted to $582,981 in 1999, $895,401 in 1998, and
$244,569 in 1997.
48
49
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
11. STOCK OPTIONS AND EMPLOYEE STOCK PURCHASE PLAN (CONTINUED)
Stock options and common shares reserved for grant under the Plans are as
follows:
Available For Options Weighted
Grant Outstanding Average
Price Per
Share
------------- ------------ ---------
Balances, September 30, 1996 354,514 2,336,660 $ 18.14
Additional shares approved for grant 500,000
Granted (1,509,701) 1,509,701 8.62
Exercised (50,617) 7.71
Cancelled 1,879,636 (1,879,636) 19.01
----------- -----------
Balances, September 30, 1997 1,224,449 1,916,108 $ 10.01
Additional shares approved for grant 750,000
Granted (1,254,525) 1,254,525 15.96
Exercised (289,353) 8.56
Cancelled 150,013 (150,013) 12.79
----------- -----------
Balances, September 30, 1998 869,937 2,731,267 $ 12.75
Granted (1,019,100) 1,019,100 9.32
Exercised (402,022) $ 5.95
Cancelled 1,244,635 (1,244,635) $ 14.26
----------- -----------
Balances, September 30, 1999 1,095,472 2,103,710 $ 11.50
=========== ===========
49
50
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
11. STOCK OPTIONS AND EMPLOYEE STOCK PURCHASE PLAN (CONTINUED)
Commencing April 1996, the Company has sponsored an Employee Stock Purchase Plan
(the Purchase Plan) which covers all domestic employees with at least 90 days of
service. The Purchase Plan allows eligible participants the right to purchase
common stock on a quarterly basis at the lower of 85% of the market price at the
beginning or end of each three-month offering period. Employee contributions to
the plan were $586,324 in 1999, $658,118 in 1998, and $534,327 in 1997. Pursuant
to the Purchase Plan, 80,482, 37,398, and 69,402 shares were issued to employees
during the fiscal years ended 1999, 1998 and 1997, respectively. As of September
30, 1999, 303,883 shares are available for future issuances under the Purchase
Plan.
12. STOCK-BASED COMPENSATION
In accordance with Statement of Financial Accounting Standards No. 123,
"Accounting for Stock-Based Compensation" (SFAS 123), the Company has chosen to
continue to account for stock-based compensation using the intrinsic value
method prescribed in Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees," and related interpretations. Accordingly,
compensation costs for stock options granted to employees are measured as the
excess, if any, of the fair value of the Company's stock at the date of the
grant over the amount an employee must pay to acquire the stock. Such
compensation costs, if any, are amortized on a straight-line basis over the
option vesting schedule.
Had the Company used the fair-value-based method of accounting for its stock
options granted in 1999, 1998 and 1997, and charged operations over the option
vesting periods based on the fair value of options at the date of grant, net
income (loss) and net income (loss) per common share would have been changed to
the following pro forma amounts:
1999 1998 1997
---- ---- ----
Net income (loss):
As reported $ 3,191,733 $ (71,094) $ (15,790,844)
Pro forma $ 281,852 $ (3,244,655) $ (17,449,611)
Net income (loss) per share - basic:
As reported $ 0.22 $ (0.01) $ (1.18)
Pro forma $ 0.02 $ (0.24) $ (1.30)
Net income (loss) per share - assuming dilution:
As reported $ 0.22 $ (0.01) $ (1.18)
Pro forma $ 0.02 $ (0.24) $ (1.30)
50
51
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
12. STOCK-BASED COMPENSATION (CONTINUED)
The weighted average fair value of options granted in fiscal years 1999, 1998
and 1997 was $11.50 $12.29, and $12.47, respectively. The weighted average fair
value was determined based upon the fair value of each option on the grant date,
utilizing the Black-Scholes option-pricing model and the following assumptions:
ASSUMPTIONS: 1999 1998 1997
- ------------ ---- ---- ----
Risk free interest rate 5.75% 5.49% 6.02%
Expected option holding period 4 years 4 years 4 years
Expected volatility 50% 60% 40%
Expected dividend yield 0 0 0
At September 30, 1999, the weighted average exercise price and remaining life of
the stock options are as follows:
RANGE OF EXERCISE PRICES $2.36-3.19 $5.91-8.88 $9.40-14.00 $14.31-20.88 $21.50-29.25 Total
---------- ---------- ----------- ------------ ------------ -----
Total options outstanding 49,009 1,087,279 515,769 217,715 233,938 2,103,710
Weighted average remaining
contractual life (years) 4.91 8.13 8.14 6.66 6.70 7.75
Weighted average exercise price $2.70 $7.66 $11.97 $17.71 $24.35 $11.50
Options exercisable 39,134 386,927 177,539 117,182 172,592 893,374
Weighted average price of exercisable options $2.79 $7.99 $12.06 $17.29 $23.77 $12.84
13. SHARE RIGHTS PLAN
The Company has adopted a share rights plan. Under the plan, the Company
distributed as a dividend one right for each share of the Company's common stock
outstanding on June 30, 1998. Each right entitles its holder to buy one
one-hundredth of a share of a new series of junior participating preferred stock
at an exercise price of $115, subject to adjustment. The rights are exercisable
only if certain ownership considerations are met. The Company will be entitled
to redeem the rights prior to the rights becoming exercisable.
51
52
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
14. COMMITMENTS
The Company has entered into various operating lease agreements, the last of
which expires in fiscal 2013. Below is a schedule of future minimum commitments
under noncancellable operating leases:
FISCAL
YEAR AMOUNT
------ ------
2000 $ 1,224,904
2001 864,496
2002 411,944
2003 72,371
2004 72,371
Thereafter $ 663,399
Total rental expense for all operating leases for the years ended September 30,
1999, 1998 and 1997 was $1,838,242, $1,786,715, and $1,405,582 respectively.
15. EMPLOYEE BENEFIT PLAN
The Company has a savings and profit sharing plan pursuant to Section 401(k) of
the Internal Revenue Code ("the Code"), whereby eligible employees may
contribute up to 15% of their pre-tax earnings, not to exceed amounts allowed
under the Code. In addition, the Company may make contributions to the plan at
the discretion of the Board of Directors. The Company accrued $350,000 as a
matching contribution for 1999. The Company provided a matching contribution of
$240,000 in 1998 and no Company contribution was made in 1997.
52
53
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
16. CONTINGENCIES
During fiscal 1997, the Company and certain of its previous officers were named
as defendants in a series of putative securities class action lawsuits in the
United States District Court for the District of Minnesota on behalf of an
alleged class of purchasers of its common stock during the period January 25,
1996 through December 23, 1996, inclusive, which were consolidated, through a
Consolidated Amended Complaint filed in May 1997. Also in 1997, a similar but
separate action was filed by the Louisiana State Employees Retirement System.
The Consolidated Amended Complaint and the Louisiana Amended Complaint allege
the Company and certain of its previous officers violated federal securities
laws by, among other things, misrepresenting and/or omitting material
information concerning the Company's operations and financial results. The
Louisiana Amended Complaint also alleges misrepresentations in violation of
state common law.
In a decision issued on May 22, 1998, the District Court granted in part and
denied in part the motions of the Company and its three former officers to
dismiss the Consolidated Amended Complaint and the Louisiana Amended Complaint.
The Court dismissed without leave to replead all claims asserted in both cases,
except for certain federal securities law claims based upon alleged
misrepresentations and/or omissions relating to the accounting treatment applied
to the Company's AetherWorks investment. 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. These claims remain
pending against the Company and two of its former officers, Ervin F. Kamm, Jr.
and Gerald A. Wall. Discovery in the actions is proceeding.
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 intend to oppose the motion. No date has been set for a hearing
on the class certification motion. With the possible exception of additional
depositions of certain lead plaintiffs, discovery in all of the actions has been
completed.
The Company and its former officers served motions for summary judgment in all
actions on November 19, 1999. Briefing on the motions is scheduled to be
completed by February 4, 2000, and a hearing is expected to be held before the
Court after that date.
The ultimate outcomes of these actions cannot be determined at this time, and no
potential assessment of the probable or possible effects of such litigation if
any, on the Company's financial position, liquidity or future operations can be
made.
In the normal course of business, the Company is subject to various claims and
litigation. Management of the Company expects that these various litigation
items will not have a material adverse effect on the results of operations or
financial condition of the Company.
53
54
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
17. FOURTH QUARTER FISCAL 1998 INFORMATION (UNAUDITED)
During the third quarter of fiscal year 1998, management of the Company
established $3 million of inventory valuation reserves including $1 million
which related to an estimated overstatement of inventories resulting from
certain system difficulties encountered in connection with the implementation of
a new enterprise-wide computer system during the third quarter, and $2 million
which related to estimated adjustments to the value of certain remote access
server products which the Company believed were approaching technological
obsolescence, primarily due to the expected introduction of the Company's new
remote access server products in the fourth quarter of fiscal year 1998.
During the fourth quarter the Company was advised by a third-party vendor that
it would delay delivery of a new modem which was integral to the Company's
planned introduction of its new remote access server products. When the Company
became aware of this delay, management reassessed the estimated timing and
effect of technological obsolescence on the value of its old remote access
product inventories, which resulted in a $900,000 reduction in the management's
estimate of the required obsolescence provision in the fourth quarter.
In addition, in connection with its normal year-end closing procedures, the
Company conducted a physical inventory count of its inventories as of September
30, 1998. This physical inventory count indicated that any previous inventory
record discrepancies that had resulted from the system implementation were no
longer impacting the Company's reported inventory balances as of September 30,
1998. Accordingly, the Company determined, during the fourth quarter, that the
system difficulties encountered in the third quarter had been corrected and,
therefore eliminated the related $1 million provision during the fourth quarter.
54
55
REPORT OF MANAGEMENT
TO THE STOCKHOLDERS OF DIGI INTERNATIONAL INC.
The Company's management is responsible for the integrity, objectivity and
consistency of the financial information presented in this Annual Report on Form
10-K and the Company's 1999 Annual Report to Shareholders. The consolidated
financial statements contained herein were prepared in accordance with generally
accepted accounting principles and were based on informed judgments and
management's best estimates as required. Financial information elsewhere in this
annual report is consistent with that contained in the consolidated financial
statements.
The Company maintains a system of internal controls designed to provide
reasonable assurance that assets are safeguarded, transactions are properly
executed in accordance with management's authorization, and accounting records
may be relied upon for the preparation of financial statements and other
financial information. The system is monitored by direct management review.
Limitations exist in any system of internal control, based upon the recognition
that the cost of the system should not exceed the benefits derived.
The Company's consolidated financial statements have been audited by
PricewaterhouseCoopers LLP, independent certified public accountants. Their
audit was conducted in accordance with generally accepted auditing standards. As
part of their audits of the Company's consolidated financial statements, these
independent accountants considered the Company's internal controls to the extent
they deemed necessary to determine the nature, timing and extent of their audit
tests.
The Audit Committee of the Board of Directors is composed entirely of
non-employee directors and is responsible for monitoring and overseeing the
quality of the Company's accounting and reporting policies, internal controls
and other matters deemed appropriate. The independent certified public
accountants have free access to the Audit Committee without management present.
/s/ John P. Schinas
John P. Schinas
Chairman
/s/ Subramanian Krishnan
Subramanian Krishnan
Senior Vice President and Chief Financial Officer
December 28, 1999
55
56
REPORT OF INDEPENDENT ACCOUNTANTS
TO THE STOCKHOLDERS AND BOARD OF DIRECTORS OF DIGI INTERNATIONAL INC.
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, cash flows and stockholders' equity
present fairly, in all material respects, the financial position of Digi
International Inc. and subsidiaries (the Company) at September 30, 1999 and
1998, and the results of their operations and their cash flows for each of the
three years in the period ended September 30, 1999, in conformity with generally
accepted accounting principles. These financial statements are the
responsibility of the Company's management; our responsibility is to express an
opinion on these financial statements based on our audits. We conducted our
audits of these statements in accordance with generally accepted auditing
standards which require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.
As discussed more fully in Note 2, the Company and the staff of the Securities
and Exchange Commission have had discussions regarding the accounting treatment
related to the July 1998 acquisitions of ITK International, Inc. and Central
Data Corporation. As a result of these discussions, the Company has changed the
method used to allocate the purchase price to in-process technologies. In
connection with this modification, the Company has adjusted the measurement and
allocations of the purchase prices recorded for the aforementioned acquisitions.
Accordingly, the consolidated financial statements as of and for the year ended
September 30, 1998 have been restated.
As discussed in Note 6, the Company has recorded its investment in AetherWorks
Corporation (AetherWorks) on the equity method; the 1997 consolidated statement
of operations include AetherWorks' net operating loss for the year ended
September 30, 1997 of $5,764,201. We did not audit the financial statements of
AetherWorks, which statements were audited by other auditors whose report has
been furnished to us, and our opinion, insofar as it relates to the amounts
included for AetherWorks' net operating loss, is based solely on the report of
other auditors.
/s/ PricewaterhouseCoopers LLP
Minneapolis, Minnesota
December 15, 1999
56
57
QUARTERLY FINANCIAL DATA (UNAUDITED)
In thousands except per share amounts Quarter ended
Dec. 31 Mar. 31 June 30 Sept. 30
1999
Net sales $51,395 $42,631 $51,145 $48,335
Gross margin 26,491 18,478 27,147 26,076
Restructuring 1,453 (685) (161)
Net income (loss) 475 (2,251) 2,253 2,715
Net income (loss) per share - basic 0.03 -0.15 0.15 0.18
Net income (loss) per share - assuming dilution 0.03 -0.15 0.15 0.18
1998 (a)
Net sales $42,590 $45,059 $46,449 $48,833
Gross margin 21,369 23,066 24,559 (b) 25,399 (b)
Acquired in-process research and development 16,065
Restructuring 1,020
AetherWorks Corporation gain 1,350
Net income (loss) 3,842 4,665 6,411 (14,989)
Net income (loss) per share - basic 0.28 0.35 0.47 (1.05)
Net income (loss) per share - assuming dilution 0.27 0.33 0.45 (1.05)
1997
Net sales $42,236 $40,393 $40,843 $42,125
Gross margin 19,640 19,294 20,118 21,063
Restructuring 10,471
AetherWorks Corporation net loss (1,520) (1,590) (1,525) (1,130)
AetherWorks Corporation write-off (5,759)
Net (loss) income (2,578) (9,400) 67 (2,431)
Net (loss) income per share - basic (0.19) (0.70) 0.01 (0.29)
Net (loss) income per share - assuming dilution (0.19) (0.70) 0.01 (0.29)
The summation of quarterly net income per share may not equate to the year-end
calculation as quarterly calculations are performed on a discrete basis.
(a) see Note 2 to the Company's consolidated financial statements.
(b) see Note 17 to the Company's consolidated financial statements.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
57
58
PART III
ITEM 10. EXECUTIVE OFFICERS OF THE REGISTRANT
As of the date of filing this Form 10-K, the following individuals were
executive officers of the Registrant:
Name Age Position
Joseph T. Dunsmore 41 President and
Chief Executive Officer
Douglas J. Glader 56 Executive Vice President and
Chief Operating Officer
Subramanian Krishnan 45 Senior Vice President and
Chief Financial Officer
Mr. Dunsmore joined the Company on October 24, 1999, as President and Chief
Executive Officer and as a member of the Board of Directors. Prior to joining
Digi International, Mr. Dunsmore had been Vice President of Access for Lucent
Microelectronics, a telecommunications company, since July 1999. From October
1998 to June 1999, he acted as an independent consultant to various high
technology companies. From February 1998 to October 1998, Mr. Dunsmore was Chief
Executive Officer of NetFax, Inc., a telecommunications company. From October
1995 to February 1998, he held executive management positions at US Robotics and
then at 3COM after 3COM acquired US Robotics in June 1997. Prior to that, Mr.
Dunsmore held various marketing management positions at AT&T Paradyne
Corporation since May 1983.
Mr. Glader was named Executive Vice President and Chief Operating Officer on
April 19, 1999, Vice President of Operations in February 1995 and Senior Vice
President, Manufacturing Operations, on April 23, 1997. Before that, he was
Director of Manufacturing and Operations for MiLAN Technology Corporation, which
the Company acquired in November 1993. He began his career with Memorex
Corporation and also worked for Measurex Corporation, Altus Corporation and
Direct Incorporated. He founded and was Vice President of Operations for
Greyhawk Systems, Inc., a manufacturer of electronic imaging hardware and
software.
Mr. Krishnan was named Senior Vice President and Chief Financial Officer on
February 1, 1999. Prior to joining the Company, he served as a principal with
LAWCO Financial, an investment banking firm in Minneapolis, MN from January 1997
to January 1999. Prior to LAWCO, he served for 13 years with the Valspar
Corporation as the Director of Corporate Financial Planning and Reporting and
Taxes and was primarily responsible for mergers, acquisitions and joint
ventures.
58
59
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON
FORM 8-K
(a) Consolidated Financial Statements and Schedules of the Company
and Report of Independent Auditors for AetherWorks Corporation
1. Consolidated Statements of Operations for the fiscal years
ended September 30, 1999, 1998 and 1997
Consolidated Balance Sheets as of September 30, 1999 and
1998
Consolidated Statements of Cash Flows for the fiscal years
ended September 30, 1999, 1998 and 1997
Consolidated Statements of Stockholders' Equity for the
fiscal years ended September 30, 1999, 1998 and 1997
Notes to Consolidated Financial Statements
Report of Independent Accountants
2. All financial statement schedules are omitted because they
are not applicable or are not required.
3. Report of Ernst & Young LLP, Independent Auditors for
AetherWorks Corporation
(b) Reports on Form 8-K
Form 8-K/A dated August 18, 1999, regarding the Company's
acquisition of ITK International, Inc. on July 29, 1998.
59
60
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON
FORM 8-K (CONTINUED)
(c) Exhibits
Exhibit
Number Description
------- -----------
3(a) Restated Certificate of Incorporation of the Company (1)
3(b) Amended and Restated By-Laws of the Company (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, 1999, to Share Rights Agreement,
dated as of June 10, 1998 between Digi International Inc. and
Norwest Bank Minnesota, National Association, as Rights
Agent (4)
10(a) Stock Option Plan of the Company (5)
10(b) Form of indemnification agreement with directors and
officers of the Company (6)
10(c) Amended and Restated Employment Agreement between the
Company and John P. Schinas (7)
10(d) Restated and Amended Note Purchase Agreement between the
Company and AetherWorks Corporation, dated May 12,
1998
60
61
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON
FORM 8-K (CONTINUED)
(c) Exhibits (Continued)
Exhibit
Number Description
------- -----------
10(e) Employment Arrangement between the Company and Jonathon E.
Killmer, dated September 16, 1996 *(8)
10(f) Employment Agreement between the Company and Jerry A.
Dusa, dated March 12, 1997 *(9)
10(g) Employment Arrangement between the Company and Douglas
Glader *(10)
10(g)(i) Amendment to Employment Agreement between the Company
and Douglas Glader, dated September 24, 1999
10(h) Employment Agreement between the Company and Dino G.
Kasdagly, dated October 1, 1997 *(11)
10(i) Agreement between the Company and Subramanian Krishnan dated
March 26, 1999 *(12)
10(i)(i) Amendment to Agreement between the Company and Subramanian
Krishnan dated September 24, 1999 *
10(j) Employment Agreement between the Company and Joseph T.
Dunsmore dated October 24, 1999 *
10(k) Employee Stock Purchase Plan of the Company (13)
13 1999 Annual Report to Stockholders (only those portions
specifically incorporated by reference herein shall be
deemed filed with the Securities and Exchange Commission)
21 Subsidiaries of the Company
23.1 Consent of Independent Accountants
23.2 Consent of Independent Accountants
24 Powers of Attorney
27 Financial Data Schedule
- -----------------
*Management contract or compensatory plan or arrangement required to be filed as
an exhibit to this Form 10-K.
61
62
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON
FORM 8-K (CONTINUED)
(1) Incorporated by reference to Exhibit 3(a) to the Company's Form 10-K for
the year ended September 30, 1993 (File no. 0-17972).
(2) Incorporated by reference to Exhibit 3(b) to the Company's Registration
Statement on Form S-1 (File no. 33-42384).
(3) Incorporated by reference of 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).
(5) Incorporated by reference to the corresponding exhibit number to the
Company's Form 10-K for the year ended September 30, 1998 (File no.
0-17972).
(6) Incorporated by reference to Exhibit 10(b) to the Company's Registration
Statement on Form S-1 (File no. 33-30725).
(7) Incorporated by reference to Exhibit 10(c) to the Company's Form 10-K for
the year ended September 30, 1994 (File no. 0-17972).
(8) Incorporated by reference to Exhibit 10(k) to the Company's Form 10-K/A for
the year ended September 30, 1996 (File no. 0-17972).
(9) Incorporated by reference to Exhibit 10(m) to the Company's Form 10-Q for
the quarter ended March 31, 1997 (File no. 0-17972).
(10) Incorporated by reference to Exhibit 10(q) to the Company's Form 10-K for
the year ended September 30, 1995 (File no. 0-17972).
(11) Incorporated by reference to Exhibit 10(r) to the Company's Form 10-K for
the year ended September 30, 1997 (File no. 0-17972).
(12) Incorporated by reference to Exhibit 10(k) to the Company's Form 10-Q for
the quarter ended March 31, 1999 (File no. 0-17972).
(13) Incorporated by reference to Exhibit B to the Company's Proxy Statement for
its Annual Meeting of Stockholders held on January 31, 1996.
62
63
REPORT OF INDEPENDENT AUDITORS
BOARD OF DIRECTORS AND SHAREHOLDERS
AETHERWORKS CORPORATION
We have audited the balance sheets of AetherWorks Corporation (a development
stage company) as of September 30, 1997 and 1996, and the related statements of
operations, shareholders' equity (deficit) and cash flows for the years then
ended and the period from February 24, 1993 (inception) to September 30, 1997.
These financial statements, not separately presented herein, are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of AetherWorks Corporation (a
development stage company) at September 30, 1997 and 1996, and the results of
its operations and its cash flows for the years then ended and the period from
February 24, 1993 (inception) to September 30, 1997, in conformity with
generally accepted accounting principles.
The financial statements referred to above have been prepared assuming the
Company will continue as a going concern. As discussed in Note 11 to the
financial statements, the Company's deficit accumulated during the development
stage raises substantial doubt about its ability to continue as a going concern.
The Company intends to obtain additional financing to permit it to continue its
operations. The financial statements do not include any adjustments that might
result from the outcome of this uncertainty.
/s/ Ernst & Young LLP
Minneapolis, MN
October 28, 1997
63
64
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
December 28, 1999 By: /s/ Joseph T. Dunsmore
-----------------------
Joseph T. Dunsmore
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the Registrant and
in the capacities and on the dates indicated.
December 28, 1999 /s/ Joseph T. Dunsmore
-----------------------
Joseph T. Dunsmore
President and Chief Executive Officer
(Principal Executive Officer)
December 28, 1999 /s/ Subramanian Krishnan
------------------------
Subramanian Krishnan
Sr. Vice President & Chief Financial Officer
(Principal Financial and Accounting Officer)
JOHN P. SCHINAS
WILLIS K. DRAKE
RICHARD E. EICHHORN
MYKOLA MOROZ A majority of the Board of Directors*
DAVID STANLEY
ROBERT S. MOE
KENNETH E. MILLARD
JOSEPH T. DUNSMORE
Subramanian Krishnan, by signing his name hereto, does hereby sign this document
on behalf of each of the above named directors of the Registrant pursuant to
Powers of Attorney duly executed by such persons.
December 28, 1999 /s/ Subramanian Krishnan
------------------------
Subramanian Krishnan
Attorney-in-fact
64
65
EXHIBIT INDEX
Exhibit Description Page
- ------- ----------- ----
3(a) Restated Certificate of Incorporation of the Incorporated by
Registrant, as amended Reference
3(b) Amended and Restated By-Laws of the Registrant Incorporated by
Reference
4(a) Form of Rights Agreement, dated as of June 10, 1998 Incorporated by
between Digi International Inc. and Norwest Bank Reference
Minnesota, National Association, as Rights Agent
4(b) Amendment dated January 26, 1999, to Shares Rights Incorporated by
greement, dated as of June 10, 1998 between Digi Reference
International Inc. and Norwest Bank Minnesota,
National Association, as Rights Agent
10(a) Stock Option Plan of the Registrant Incorporated by
Reference
10(b) Form of indemnification agreement with directors Incorporated by
and officers of the Registrant Reference
10(c) Amended and Restated Employment Agreement between Incorporated by
the Registrant and John P. Schinas Reference
10(d) Restated and Amended Note Purchase Agreement Filed
between the Registrant and AetherWorks Electronically
Corporation, dated May 12, 1998
10(e) Employment Arrangement between the Registrant and Incorporated by
Jonathon E. Killmer, dated September 16, 1996 Reference
10(f) Employment Agreement between the Registrant and Incorporated by
Jerry A. Dusa, dated March 12, 1997 Reference
10(g) Employment Arrangement between the Registrant and Incorporated by
Douglas Glader Reference
10(g)(i) Amendment to Employment Agreement between the Filed
Registrant and Douglas Glader, dated September 24, 1999 Electronically
10(h) Employment Agreement between the Registrant and Incorporated by
Dino G. Kasdagly, dated October 1, 1997 Reference
10(i) Agreement between the Company and Subramanian Krishnan Incorporated by
dated March 26, 1999. Reference
10(i)(i) Amendment to the agreement between the Company and Filed
Subramanian Krishnan dated September 24, 1999. Electronically
10(j) Employment Agreement between the Company and Filed
Joseph T. Dunsmore, dated October 24, 1999 Electronically
10(k) Employee Stock Purchase Plan of the Registrant Incorporated by
Reference
13 1999 Annual Report to Stockholders Filed
Electronically
21 Subsidiaries of the Company Filed
Electronically
23.1 Consent of Independent Accountants Filed
Electronically
23.2 Consent of Independent Accountants Filed
Electronically
24 Powers of Attorney Filed
Electronically
27 Financial Data Schedule Filed
Electronically
65