1
- --------------------------------------------------------------------------------
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended: June 30, 2001.
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)
(952) 912-3444
------------------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [ ]
On August 10, 2001, there were 15,328,643 shares of the registrant's $.01 par
value Common Stock outstanding.
- --------------------------------------------------------------------------------
2
INDEX
Page
----
PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements
Condensed Consolidated Statement of Operations for the three
months and nine months ended June 30, 2001 and 2000............. 3
Condensed Consolidated Balance Sheet as of June 30, 2001 and
September 30, 2000.............................................. 4
Condensed Consolidated Statement of Cash Flows for the nine
months ended June 30, 2001 and 2000............................. 5
Notes to Condensed Consolidated Financial Statements............ 6
ITEM 2. Management's Discussion and Analysis of Results of Operations
and Financial Condition......................................... 12
Forward-looking Statements...................................... 17
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk...... 19
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings............................................... 20
ITEM 2. Changes in Securities........................................... 21
ITEM 3. Defaults Upon Senior Securities................................. 21
ITEM 4. Submission of Matters to a Vote of Securities Holders........... 21
ITEM 5. Other Information............................................... 21
ITEM 6. Exhibits and Reports on Form 8-K................................ 22
3
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
DIGI INTERNATIONAL INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
FOR THREE MONTHS AND NINE MONTHS ENDED JUNE 30, 2001 AND 2000
(UNAUDITED)
Three months ended June 30 Nine months ended June 30
-------------------------- ---------------------------
2001 2000 2001 2000
----------- ----------- ----------- ------------
Net sales $30,154,901 $32,354,163 $97,635,904 $ 98,294,133
Cost of sales 14,473,872 15,179,195 46,595,914 46,670,982
----------- ----------- ----------- ------------
Gross margin 15,681,029 17,174,968 51,039,990 51,623,151
Operating expenses:
Sales and marketing 7,897,975 8,551,082 23,168,884 25,865,537
Research and development 4,607,979 4,582,384 14,215,911 15,661,706
General and administrative 3,503,212 3,868,033 11,916,326 14,923,459
Impairment loss 18,068,249
Restructuring (298) (11,883) (230,067) (150,350)
----------- ----------- ----------- ------------
Total operating expenses 16,008,868 16,989,616 49,071,054 74,368,601
=========== =========== =========== ============
Operating (loss) income (327,839) 185,352 1,968,936 (22,745,450)
Other income 587,921 760,560 2,068,254 9,911,105
----------- ----------- ----------- ------------
Income (loss) before income taxes 260,082 945,912 4,037,190 (12,834,345)
Income tax provision (benefit) 120,927 (1,567,267) 1,978,253 (3,083,095)
----------- ----------- ----------- ------------
Net income (loss) $ 139,155 $ 2,513,179 $ 2,058,937 $ (9,751,250)
=========== =========== =========== ============
Net income (loss) per common share, basic $ 0.01 $ 0.17 $ 0.14 $ (0.65)
=========== =========== =========== ============
Net income (loss) per common share, assuming dilution $ 0.01 $ 0.17 $ 0.14 $ (0.65)
=========== =========== =========== ============
Weighted average common shares, basic 15,243,716 15,095,436 15,206,085 15,041,935
=========== =========== =========== ============
Weighted average common shares, assuming dilution 15,319,619 15,100,718 15,228,835 15,041,935
=========== =========== =========== ============
The accompanying notes are an integral part of the condensed consolidated
financial statements.
3
4
DIGI INTERNATIONAL INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEET
AS OF JUNE 30, 2001 AND SEPTEMBER 30, 2000
June 30 September 30
2001 2000
------------ ------------
(unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 13,150,077 $ 38,785,936
Marketable securities 37,189,561 20,150,132
Accounts receivable, net 23,636,504 18,175,226
Inventories, net 20,342,309 19,700,010
Other 3,939,756 3,655,511
------------ ------------
Total current assets 98,258,207 100,466,815
Property, equipment and improvements, net 22,808,599 24,408,384
Intangible assets, net 22,320,870 16,397,744
Other 1,615,412 1,649,252
------------ ------------
Total assets $145,003,088 $142,922,195
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Borrowings under line of credit agreements $ 1,727,600 $ 3,147,900
Current portion of long-term debt 194,278 330,305
Accounts payable 6,250,595 6,275,995
Income taxes payable 1,250,906 1,328,481
Accrued expenses:
Advertising 907,648 1,143,565
Compensation 4,550,349 1,862,517
Other 5,778,547 6,760,841
Restructuring reserves 21,309 1,531,992
------------ ------------
Total current liabilities 20,681,232 22,381,596
Long-term debt 6,566,769 7,081,396
Net deferred income taxes 1,101,294
------------ ------------
Total liabilities 28,349,295 29,462,992
Commitments and contingency
Stockholders' equity:
Preferred stock, $.01 par value: 2,000,000 shares
authorized; none outstanding
Common stock, $.01 par value: 60,000,000 shares
authorized; 16,418,123 and 16,322,949 issued 164,181 163,229
Additional paid-in capital 71,780,277 71,851,928
Retained earnings 63,468,798 61,409,861
Accumulated other comprehensive income 92,458 166,750
------------ ------------
135,505,714 133,591,768
Unearned stock compensation (89,618)
Treasury stock, at cost, 1,126,113 and
1,196,463 shares (18,851,921) (20,042,947)
------------ ------------
Total stockholders' equity 116,653,793 113,459,203
------------ ------------
Total liabilities and stockholders' equity $145,003,088 $142,922,195
============ ============
The accompanying notes are an integral part of the condensed consolidated
financial statements.
4
5
DIGI INTERNATIONAL INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
FOR THE NINE MONTHS ENDED JUNE 30 2001 AND 2000
(UNAUDITED)
June 30, 2001 June 30, 2000
------------- -------------
Operating activities:
Net income (loss) $ 2,058,937 $ (9,751,250)
Adjustments to reconcile net income (loss) to net
cash provided by operating activities:
Asset impairment 18,068,249
Restructuring (230,067) (150,350)
Depreciation and amortization 3,242,338 4,199,379
Amortization of goodwill and acquired intangibles 3,920,006 6,229,613
Provision for losses on accounts receivable 524,504 540,268
Provision for inventory obsolescence 340,826 1,327,537
(Gain) loss on sale of fixed assets (30,382) 9,253
Stock compensation 76,849 131,425
Changes in operating assets and liabilities (7,131,209) (1,767,624)
------------ ------------
Total adjustments 712,865 28,587,750
------------ ------------
Net cash provided by operating activities 2,771,802 18,836,500
------------ ------------
Investing activities:
Purchase of marketable securities, net (17,039,429) (18,213,592)
Business acquisitions, net of cash acquired (9,536,422)
Purchase of property, equipment, intangibles and improvements (1,289,808) (2,211,512)
------------ ------------
Net cash used in investing activities (27,865,659) (20,425,104)
------------ ------------
Financing activities:
(Payments) borrowing under lines of credit (1,364,400) 1,653
Principal payments on long-term debt (376,227) (136,364)
Stock benefit plan transactions, net 1,107,243 1,376,904
------------ ------------
Net cash (used in) provided by financing activities (633,384) 1,242,193
------------ ------------
Effect of exchange rate changes on cash and cash equivalents 91,382 (804,218)
Net decrease in cash and cash equivalents (25,635,859) (1,150,629)
Cash and cash equivalents, beginning of period 38,785,936 20,963,607
------------ ------------
Cash and cash equivalents, end of period $ 13,150,077 $ 19,812,978
============ ============
The accompanying notes are an integral part of the condensed consolidated
financial statements.
5
6
DIGI INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION
The interim condensed consolidated financial statements included in this Form
10-Q have been prepared by the Company, without audit, pursuant to the rules and
regulations of the Securities and Exchange Commission (SEC). Certain information
and footnote disclosures, normally included in financial statements prepared in
accordance with accounting principles generally accepted in the United States of
America, have been condensed or omitted, pursuant to such rules and regulations.
These condensed consolidated financial statements should be read in conjunction
with the consolidated financial statements and related notes thereto included in
the Company's 2000 Annual Report on Form 10-K.
The condensed consolidated financial statements presented herein as of June 30,
2001, and for the three and nine months ended June 30, 2001 and 2000, reflect,
in the opinion of management, all adjustments (which, other than the second
quarter 2000 impairment loss, consist only of normal, recurring adjustments)
necessary for a fair presentation of the consolidated financial position and the
consolidated results of operations and cash flows for the periods presented. The
consolidated results of operations for any interim period are not necessarily
indicative of results for the full year.
2. ACQUISITIONS
On June 8, 2001, the Company acquired INXTECH, the parent company of Decision
Europe, a French designer and manufacturer of data communications systems sold
under the Xcell Technology brand. The transaction was accounted for using the
purchase method of accounting. Accordingly, the initial purchase price of
$2,300,000, subject to possible post-closing adjustments based on the final
value of INXTECH net assets, has been allocated to the estimated fair value of
assets acquired and liabilities assumed.
The Company may be required to pay up to $2,500,000 of additional cash
consideration for the purchase subject to Decision Europe achieving certain
future product development milestones and retention of certain key employees.
On October 2, 2000, the Company acquired Inside Out Networks (ION), a developer
of data connections products based in Austin, Texas. The transaction was
accounted for using the purchase method of accounting. Accordingly, the purchase
price of $7,550,844 has been allocated to the estimated fair value of assets
acquired and liabilities assumed.
The Company may be required to pay up to $8,500,000 of additional cash
consideration for the purchase subject to ION achieving specific revenue and
operating income targets during the three years following the acquisition.
6
7
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. ACQUISITIONS (CONTINUED)
The following unaudited pro forma condensed consolidated results of operations
have been prepared as if the acquisition ION had occurred as of the beginning of
the fiscal year ended September 30, 2000. The table below does not include
results of operations of Decision Europe as those amounts are immaterial.
Three months Nine months
ended ended
June 30, 2000 June 30, 2000
------------- -------------
Net sales $33,125,008 $100,883,116
Net income (loss) 2,210,052 (10,282,787)
Net income (loss) per share $ 0.15 $ (0.68)
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 periods presented, nor are they necessarily indicative of
results that will be obtained in the future.
3. RESTRUCTURING.
In September 2000, the Company's Board of Directors approved a restructuring
plan related to its European operations headquartered in Dortmund, Germany,
which provided for the transition of all product development, technical support
and manufacturing functions to the Company's corporate headquarters located in
Minnetonka, Minnesota. The plan also included the closure of the Company's
office in Bagshot, England. The resulting charge of $1,531,992 consisted of
$1,252,531 for severance and termination costs related to the elimination of 73
positions in Dortmund, Germany and 2 positions in Bagshot, England; $134,227
related to the closure of the Bagshot office for lease cancellation; $100,684 of
cancellation fees related to automobile leases, maintenance contracts, and
office equipment leases, and $44,550 for severance-related legal expenses. Final
facility closure costs and cancellation fees are expected to be paid during the
fourth quarter of fiscal year 2001.
As of June 30, 2001, the Company had paid $1,001,314 of termination costs
relating to the elimination of 67 positions in Dortmund, Germany, and $78,007
relating to the elimination of 2 positions in Bagshot, England. The Company paid
$134,227 of costs related to the Bagshot office closure during the nine months
ended June 30, 2001. The Company paid $67,068 for cancellation fees related to
automobile leases, maintenance contracts, and office equipment leases during the
nine months ended June 30, 2001. The remaining accruals for cancellation fees of
$21,309 relate to expected facility closure costs in Dortmund, Germany. Change
in estimate adjustments related to the severance component of the restructuring
accrual totaling $173,210 were recorded in the second quarter of fiscal year
2001 because the Company made
7
8
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. RESTRUCTURING (CONTINUED)
a decision to retain six employees who had previously been notified that they
would be severed. In addition, change in estimate adjustments totaling $12,307
and $44,550, respectively, were recorded relating to the estimated cancellation
fees and the legal costs components of the accrual. These change in estimate
adjustments were reflected as a reduction in the restructuring accrual and a
corresponding increase to operating income. A summary of payments and
adjustments for the nine months ended June 30, 2001 is included in the table
below.
Balance at Change in
September 30, Estimate Balance at
Description 2000 Payments Adjustments June 30, 2001
- ----------- ------------- ----------- ----------- -------------
Severance and
termination costs $1,252,531 $(1,079,321) $(173,210) $ --
Closure of Bagshot
office 134,227 (134,227) -- --
Cancellation fees 100,684 (67,068) (12,307) 21,309
Severance-related legal
expenses 44,550 -- (44,550) --
---------- ----------- --------- -------
TOTAL $1,531,992 $(1,280,616) $(230,067) $21,309
========== =========== ========= =======
4. INVENTORIES
Inventories are stated at the lower of cost or market, with cost determined on
the first-in, first-out method. Inventories at June 30, 2001 and September 30,
2000 consisted of the following:
June 30, 2001 Sept. 30, 2000
------------- --------------
Raw materials $14,746,294 $14,072,188
Work in process 1,080,655 1,092,654
Finished goods 4,515,360 4,535,168
------------- -------------
$20,342,309 $19,700,010
=========== ===========
8
9
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
5. COMPREHENSIVE INCOME (LOSS)
The components of total comprehensive income (loss) are shown below.
Comprehensive income (loss) includes net income (loss) and foreign currency
translation adjustments that are charged or credited to stockholders' equity.
Comprehensive income (loss) for the three months and nine months ended June 30,
2001 and 2000 was as follows:
Three months ended Nine months ended
June 30 June 30
---------------------- -------------------------
2001 2000 2001 2000
-------- ---------- ---------- ------------
Net income (loss) $139,155 $2,513,179 $2,058,937 $ (9,751,250)
Foreign currency
translation adjustments 278,513 (114,662) (74,292) (1,196,988)
-------- ---------- ---------- ------------
Comprehensive Income (loss) $417,668 $2,398,517 $1,984,645 $(10,948,238)
======== ========== ========== ============
6. NET INCOME (LOSS) PER SHARE
Basic net income (loss) per share is calculated based on 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 equivalent shares are those that result from dilutive
common stock options.
9
10
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
6. NET INCOME (LOSS) PER SHARE (CONTINUED)
The following table is a reconciliation of the numerators and denominators in
the income (loss) per share calculations:
Three months ended June 30 Nine months ended June 30
-------------------------------------- --------------------------------------
Income Shares Per Share Income Shares Per Share
(Numerator) (Denominator) Amount (Numerator) (Denominator) Amount
----------- ------------- --------- ----------- ------------- ---------
2001
BASIC NET INCOME PER SHARE
Net income $ 139,155 15,243,716 $0.01 $ 2,058,937 15,206,085 $ 0.14
EFFECT OF DILUTIVE SECURITIES
Common equivalent shares -- 75,903 -- -- 22,750 --
---------- ---------- ----- ----------- ---------- ------
DILUTED NET INCOME PER SHARE
Net income $ 139,155 15,319,619 $0.01 $ 2,058,937 15,228,835 $ 0.14
2000
BASIC NET INCOME (LOSS) PER SHARE
Net income (loss ) $2,513,179 15,095,436 $0.17 $(9,751,250) 15,041,935 $(0.65)
EFFECT OF DILUTIVE SECURITIES
Common equivalent shares -- 5,282 -- -- -- --
---------- ---------- ----- ----------- ---------- ------
DILUTED NET INCOME (LOSS) PER SHARE
Net income (loss) $2,513,179 15,100,718 $0.17 $(9,751,250) 15,041,935 $(0.65)
Options to purchase 1,684,355 and 2,410,002 shares for the three and nine month
periods ended June 30, 2001, and options to purchase 2,428,577 and 1,457,878
shares for the three and nine month periods ended June 30, 2000, were not
included in the computation of diluted earnings per share because the exercise
prices of these options was greater than the average market price of common
shares and their effect would have been antidilutive.
7. RECENT ACCOUNTING DEVELOPMENTS
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 SEC's views regarding revenue
recognition. The provisions of SAB 101, as amended by SAB 101A and SAB 101B,
must be adopted by the fourth quarter of the Company's fiscal year ending
September 30, 2001. However, any effects of the SAB must be reflected
retroactively to October 1, 2000 (the first day of fiscal year 2001). The
Company is reviewing the guidance outlined in SAB 101 and does not believe that
the effect of adoption of SAB 101 will have a material impact on the Company's
revenue recognition practices or its fiscal 2001 consolidated financial
statements.
In June 2001, the Financial Accounting Standards Board issued Statements of
Financial Accounting Standards (SFAS) No. 141, "Business Combinations", and No.
142, "Goodwill and Other Intangible Assets." The most significant changes made
by SFAS No. 141 are: 1) requiring that the purchase method of accounting be used
for all business combinations initiated after
10
11
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
7. RECENT ACCOUNTING DEVELOPMENTS (CONTINUED)
June 30, 2001, and 2) establishing specific criteria for the recognition of
intangible assets separately from goodwill. SFAS No. 142 primarily addresses the
accounting for acquired goodwill and intangible assets (i.e., the
post-acquisition accounting). The provisions of SFAS No. 142 will be effective
for fiscal years beginning after December 15, 2001. The most significant changes
made by SFAS No. 142 are: 1) goodwill and indefinite-lived intangible assets
will no longer be amortized; 2) goodwill and indefinite-lived intangible assets
will be tested for impairment at least annually; and 3) the amortization period
of intangible assets with finite lives will no longer be limited to forty years.
Goodwill and intangible assets acquired after June 30, 2001, will be subject
immediately to the nonamortization and amortization provisions of this
statement. These standards only permit prospective application of the new
accounting; accordingly, adoption of these standards will not affect previously
reported financial information of the Company. The principal effect of SFAS No.
142 will be the Company ceasing the amortization of goodwill. Goodwill
amortization was approximately $3,030,000 for the year ended September 30,
2000, and approximately $1,655,000 for the first nine months ended June 30,
2001.
8. LEGAL PROCEEDINGS
Discussion of legal matters is incorporated by reference from Part II, Item I of
this Form 10-Q "Legal Proceedings" and should be considered an integral part of
these Condensed Consolidated Financial Statements.
11
12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION
CONSOLIDATED RESULTS OF OPERATIONS
The following table sets forth selected information derived from the Company's
interim condensed consolidated statements of operations expressed as percentages
of sales:
Cost of sales 48.0 46.9 (4.6) 47.7 47.5 (0.2)
---- ---- ------ ---- ----- ------
Gross margin 52.0 53.1 (8.7) 52.3 52.5 (1.1)
---- ---- ------ ---- ----- ------
Operating expenses:
Sales and marketing 26.2 26.4 (7.6) 23.7 26.3 (10.4)
Research and development 15.3 14.1 0.6 14.6 15.9 (9.2)
General and administrative 11.6 12.0 (9.4) 12.2 15.2 (20.2)
Impairment loss -- -- -- -- 18.4 (100.0)
Restructuring -- -- (97.5) (0.2) (0.2) 53.0
---- ---- ------ ---- ----- ------
Total operating expenses 53.1 52.5 (5.8) 50.3 75.6 (34.0)
---- ---- ------ ---- ----- ------
Operating (loss) income (1.1) 0.6 (276.9) 2.0 (23.1) (108.7)
Other income, net 2.0 2.3 (22.7) 2.1 10.1 (79.1)
---- ---- ------ ---- ----- ------
Income (loss) before income taxes 0.9 2.9 (72.5) 4.1 (13.0) (131.5)
Income tax provision (benefit) 0.4 (4.9) (107.7) 2.0 (3.1) (164.2)
---- ---- ------ ---- ----- ------
Net income (loss) 0.5 7.8 (94.5)% 2.1 (9.9) (121.1)%
==== ==== ====== ==== ===== ======
NET SALES
Net sales for the three and nine months ended June 30, 2001 were lower than net
sales for the corresponding three and nine months ended June 30, 2000, by $2.2
million or 6.8%, and $0.7 million or 0.7%, respectively. Net sales of the
Company's legacy board products, including sales of acquired ION products and
Decision Europe products, generated revenues of $20.7 million for the third
quarter of fiscal 2001 versus $22.4 million for the comparable quarter last
year, and $65.5 million for the first nine months of fiscal 2001, compared to
$66.8 million for the first nine months of fiscal 2000. Physical layer local
area network (LAN) products sales were $5.6 million and $18.1 million for the
three and nine months ended June 30, 2001, reflecting increased revenues of $2.4
million and $9.3 million, respectively. Net sales of the Company's wide area
network (WAN) products declined $2.9 million and $8.7 million for the three and
nine-month periods ended June 30, 2001, versus the comparable periods a year
ago.
12
13
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION (CONTINUED)
NET SALES (CONTINUED)
The following table sets forth revenue by principal product group expressed as a
percentage of net sales:
Three months Nine months
ended June 30 ended June 30
--------------- ---------------
2001 2000 2001 2000
----- ----- ----- -----
Server based 81.2% 90.1% 81.4% 91.1%
Physical layer 18.8 9.9 18.6 8.9
----- ----- ----- -----
Total 100.0% 100.0% 100.0% 100.0%
GROSS MARGIN
Gross margin for the three and nine months ended June 30, 2001 was 52.0% and
52.3%, compared to 53.1% and 52.5% for the three and nine months ended June 30,
2000. The decrease in gross margin for the three and nine months ended June 30,
2001 compared to the comparable prior year periods ended June 30, 2000, is
primarily due to unabsorbed fixed costs as a result of lower revenues. In
addition, product mix changes had a negative impact on margins due to the impact
of the increased proportion of sales of lower margin physical layer LAN products
and the lower proportion of higher margin server-based communication products.
The decrease in gross margin for the nine months ended June 30, 2001 compared to
the comparable prior year period was not significant.
OPERATING EXPENSES
Operating expenses, excluding restructuring and asset impairment charges, for
the three months ended June 30, 2001 decreased $1.0 million, or 5.8%, compared
to operating expenses for the three months ended June 30, 2000. Operating
expenses for European operations decreased by $1.3 million in the third quarter
of fiscal 2001, which is primarily attributable to the restructuring which the
Company executed in the fourth quarter of fiscal 2000. Operating expenses at the
Company's Sunnyvale location increased by $800,000 for the quarter ended June
30, 2001, compared to operating expenses for the three months ended June 30,
2000, primarily due to additional sales and marketing personnel and related
expenses to support the $2.4 million, or 75.0% increase in revenue for LAN
products. The impact of incremental operating expenses of $1.0 million related
to the operations of ION, acquired in October 2000, and incremental operating
expenses of $.2 million related to Decision Europe, acquired in June 2001, were
offset by the impact of cost containment measures at other locations resulting
in expense reductions of $1.7 million relative to the comparable quarter last
year. Operating expenses, excluding restructuring and asset impairment charges,
for the nine months ended June 30, 2001, decreased $7.1 million, or
13
14
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION (CONTINUED)
OPERATING EXPENSES (CONTINUED)
12.7%, as compared to operating expenses for the nine months ended June 30,
2000. The fiscal 2000 European restructuring plan accounted for approximately
$7.3 million of the total decrease in operating expenses. Operating expenses
increased by $2.4 million in Sunnyvale primarily to support the $9.3 million, or
105.7% increase in LAN product sales for the first nine months of fiscal 2001 as
compared to the first nine months of fiscal 2000. In other locations additional
savings of $2.2 million were realized, due to a decrease in expenses of $5.4
million as a result of cost containment measures across the Company that
included a decrease in employee headcount of approximately 50 people from June
30, 2000 to June 30, 2001. The decrease in expenses due to the overall emphasis
on cost containment was partially offset by the impact of incremental operating
expenses of $3.0 million and $.2 million related to the operations of ION and
Decision Europe, respectively, in the first nine months of fiscal 2001.
Sales and marketing expenses for the three and nine months ended June 30, 2001,
were $7.9 million and $23.2 million, versus $8.6 million and $25.9 million in
the comparable periods a year ago. The fiscal 2000 European restructuring
resulted in expense reductions of $0.4 million and $2.1 million for the three
and nine-month periods ended June 30, 2001, respectively. Additional expense
reductions were achieved in travel and entertainment and cooperative advertising
for the three and nine months ended June 30, 2001 compared to the same periods
in the prior year. Incremental sales and marketing expenses related to the
operations of ION for the three and nine-month periods ended June 30, 2001, were
$0.3 and $0.7 million, respectively. Sales and marketing expenses at other
locations decreased $0.6 million and $1.3 million for the three month and
nine-month periods ended June 30, 2001, versus the comparable three and
nine-month periods in the prior year, as a result of expense control measures
taken in fiscal 2001.
Research and development expenses were $4.6 million for each of the three-month
periods ended June 30, 2001, and June 30, 2000. For the nine months ended June
30, 2001, research and development expenses were $14.2 million, a decrease of
$1.4 million, or 9.2%, from the nine-month period ended June 30, 2000. The
fiscal 2000 European restructuring resulted in expense reductions of $0.5
million and $1.5 million for the three and nine months ended June 30, 2001,
respectively. Incremental research and development expenses related to the
operations of ION for the three and nine-month periods ended June 30, 2001, were
$0.3 and $0.7 million, respectively. Incremental research and development
expenses related to the operations of Decision Europe for each of the three and
nine-month periods ended June 30, 2001, were $0.1 million. Compensation and
other employee related expenses decreased by $0.7 million for the nine-month
period ended June 30, 2001, as a result of a reduction in engineering staffing.
Expenses related to LAN product development in Sunnyvale increased $0.1 million
in each of the three and nine month periods ended June 30, 2001 over the
comparable prior year periods due to a transition in product development to a
newer group of products with a fiber connectivity focus.
14
15
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION (CONTINUED)
OPERATING EXPENSES (CONTINUED)
General and administrative expenses for the three months and nine months ended
June 30, 2001, were $3.5 million and $11.9 million, versus $3.9 million and
$14.9 million in the comparable periods a year ago. Included in the $3.0 million
decrease in general and administrative expenses for the nine months ended June
30, 2001 compared to the nine months ended June 30, 2000 is a $2.3 million
decrease in amortization of acquired intangibles. The decrease in amortization
is due to the write off of certain ITK intangible assets in the second quarter
of fiscal 2000 resulting in a reduction in amortization of $3.4 million,
partially offset by additional amortization of ION acquired intangibles of $1.1
million. General and administrative expenses declined by $0.4 million and $3.6
million related to the fiscal 2000 European restructuring for the three and
nine-month periods ended June 30, 2001, respectively. Incremental general and
administrative expenses related to the operations of ION for the three and
nine-month periods ended June 30, 2001, were $0.5 million and $1.6 million,
respectively, of which $0.4 million and $1.1 million, respectively, resulted
from amortization of acquired intangible assets. General and administrative
expense reductions at other locations of $0.5 million and $1.0 million for the
three and nine-month periods ended June 30, 2001, were realized due to expense
control measures taken in fiscal 2001.
OTHER INCOME (EXPENSE)
Other income for the three and nine months ended June 30, 2001 was $0.6 million
and $2.1 million. The Company realized interest income on short-term marketable
securities and cash and cash equivalents of $0.7 million and $2.5 million,
respectively, for the three and nine months ended June 30, 2001. Interest
expense on lines of credit and long term debt was $0.1 million and $0.5 million,
respectively, for the three and nine-month periods ended June 30, 2001.
Other income for the three months and nine months ended June 30, 2000 was $0.8
million and $9.9 million. During the second fiscal quarter of 2000, the Company
received an $8.0 million payment from Nx Networks, the company which acquired
AetherWorks Corporation. This represented payment in full of a non-convertible
note receivable from AetherWorks (assumed by Nx Networks), previously recorded
by the Company as having no carrying value, due to significant uncertainty as to
its collectability. Other income also includes interest earned on cash and cash
equivalents, partially offset by interest expense on line of credit borrowings
and long-term debt.
INCOME TAXES
Income taxes have been provided for at an estimated annual effective rate of 49%
for the nine months ended June 30, 2001. This effective tax rate exceeds the
U.S. statutory income tax
15
16
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION (CONTINUED)
INCOME TAXES (CONTINUED)
rate primarily due to the annual amortization expense relating to the goodwill
acquired in the Central Data Corporation (CDC), Inside Out Networks, and
Decision Europe acquisitions which is not deductible for income tax reporting
purposes. For the nine months ended June 30, 2000, income taxes were provided
for at an effective rate of 24% which was less than the U.S. statutory income
tax rate primarily due to the reversal of certain deferred tax liabilities
associated with ITK intangible assets that were written off in the second
quarter of fiscal 2000.
FINANCIAL CONDITION
LIQUIDITY AND CAPITAL RESOURCES
The Company has financed its operations principally with funds generated from
operations. The Company's working capital decreased from $78.1 million at
September 30, 2000, to $77.6 million at June 30, 2001.
Net cash provided by operating activities was $2.8 million for the nine months
ended June 30, 2001, compared to net cash provided by operating activities of
$18.8 million for the nine months ended June 30, 2000. In March 2000, the
Company received a one-time $8.0 million payment on a note receivable from
AetherWorks which had previously been recorded as uncollectable. There was also
an additional $5.4 million outflow of cash resulting from changes in operating
assets and liabilities in the first nine months of fiscal 2001 compared to the
first nine months of fiscal 2000. The net cash outflow of $7.1 million relating
to the change in operating assets and liabilities in the first nine months of
fiscal 2001 relates primarily to a $6.5 million increase in accounts receivable.
The net cash outflow of $1.8 million relating to the change in operating assets
and liabilities in the first nine months of fiscal 2000 is primarily due to a
decline of $9.8 million in accounts receivable, offset by an increase in
inventory of $1.5 million and a decrease in accounts payable and accrued
expenses of $10.1 million.
Net cash used in investing activities for the nine months ended June 30, 2001,
consisted of net purchases of marketable securities of $17.0 million and $1.3
million of purchases of equipment and other capital improvements. In October
2000, the Company acquired Inside Out Networks, resulting in a $7.2 million use
of cash. In June 2001, the Company used $2.3 million to acquire Decision Europe.
For the nine months ended June 30, 2000, the Company had net purchases of
marketable securities of $18.2 million and used $2.2 million for the purchase of
equipment and capital improvements.
Net cash used for financing activities for the nine months ended June 30, 2001
consisted of $1.1 million received from employee stock purchase plan
transactions. The Company also made payments of $1.7 million related to line of
credit and debt obligations. For the nine months ended June 30, 2000, $1.4
million was received as a result of employee stock benefit plan transactions,
and $135,000 was paid on line of credit and debt obligations.
16
17
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION (CONTINUED)
FINANCIAL CONDITION (CONTINUED)
LIQUIDITY AND CAPITAL RESOURCES (CONTINUED)
The Company's management believes that current financial resources, cash
generated from operations and the Company's potential capacity for additional
debt and/or equity financing will be sufficient to fund current and future
capital requirements.
FOREIGN CURRENCY
Effective January 1, 1999, eleven countries of the European Union converted to a
common currency called the "Euro." All invoicing activity within the European
Union is required to be transacted in Euros, effective January 1, 2002. This
action will cause some of the Company's European transactions to be negotiated,
invoiced, and paid in Euros. Additional currency risk may exist when sales from
the United States into the European Union are transacted in Euros rather than US
dollars. Such costs and risks are not quantifiable at this time.
The Company continues to hold long-term debt denominated in Deutschemarks at its
Dortmund, Germany (ITK) location, related to the facility in Dortmund. This debt
balance is subject to fluctuations as a result of Deutschemark exchange rate
changes.
For the three and nine months ended June 30, 2001, the Company had approximately
$8.7 million and $28.7 million of net sales to foreign customers, respectively.
For the three month period ended June 30, 2001, $6.8 million was denominated in
U.S. dollars and $1.9 million was denominated in Deutschemarks. For the nine
month period ended June 30, 2001, $23.8 million was denominated in U.S. dollars
and $4.9 million was denominated in Deutschemarks.
In future periods, a significant portion of sales will be made in Deutschemarks
until full integration of the Euro is achieved. The Company has not implemented
a hedging strategy to reduce the risk of foreign currency translation exposures.
INFLATION
Management believes inflation has not had a material effect on the Company's
operations or on its financial position.
SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
This Form 10-Q contains certain statements that are "forward-looking statements"
as that term is defined under the Private Securities Litigation Reform Act of
1995, and within the meaning of Section 27A of the Securities Act of 1933, as
amended, and Section 21E of the Securities
17
18
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION (CONTINUED)
SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
(CONTINUED)
Exchange Act of 1934, as amended. The words "believe," "expect," "anticipate,"
"intend," "estimate," "target," "may," "will," "plan," "project," "should,"
"continue," or the negative thereof or other expressions, which are predictions
of or indicate future events and trends and which do not relate to historical
matters, identify forward-looking statements. Such statements are based on
information available to management as of the time of such statements and relate
to, among other things, expectations of the business environment in which the
Company operates, projections of future performance, perceived opportunities in
the market and statements regarding the Company's mission and vision.
Forward-looking statements involve known and unknown risks, uncertainties and
other factors, which may cause the actual results, performance or achievements
of the Company to differ materially from anticipated future results, performance
or achievements expressed or implied by such forward-looking statements. The
Company undertakes no obligation to publicly update or revise any
forward-looking statement, whether as a result of new information, future events
or otherwise.
RECENT ACCOUNTING DEVELOPMENTS
In December 1999, the Securities and Exchange Commission (SEC) issued Staff
Accounting Bulletin (SAB) 101, "Revenue Recognition in Financial Statements."
The SAB summarizes certain of the SEC's views regarding revenue recognition. The
provisions of SAB 101, as amended by SAB 101A and SAB 101B, must be adopted by
the fourth quarter of the Company's fiscal year ending September 30, 2001.
However, any effects of the SAB must be reflected retroactively to October 1,
2000 (the first day of fiscal year 2001). The Company is reviewing the guidance
outlined in SAB 101 and does not believe the effect of adoption of SAB 101 will
have a material impact on the Company's revenue recognition practices or
its fiscal 2001 consolidated financial statements.
Effective October 1, 2000, the Company adopted Statement of Financial Accounting
Standards No. 133, "Accounting for Derivative Instruments and Hedging
Activities" (FASB 133). The adoption of FASB 133 did not have an impact on the
Company's consolidated financial position or results of operations as the
Company does not have any derivative instruments nor does the Company
participate in any hedging activities.
In June 2001, the Financial Accounting Standards Board issued Statements of
Financial Accounting Standards (SFAS) No. 141, "Business Combinations", and No.
142, "Goodwill and Other Intangible Assets." The most significant changes made
by SFAS No. 141 are: 1) requiring that the purchase method of accounting be used
for all business combinations initiated after June 30, 2001, and 2) establishing
specific criteria for the recognition of intangible assets separately from
goodwill. SFAS No. 142 primarily addresses the accounting for acquired goodwill
and intangible assets (i.e., the post-acquisition accounting). The provisions of
SFAS No. 142 will be effective for fiscal years beginning after December 15,
2001. The most significant changes made by SFAS No. 142 are: 1) goodwill and
indefinite-lived intangible assets will no longer be amortized; 2) goodwill and
indefinite-lived intangible assets will be
18
19
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION (CONTINUED)
RECENT ACCOUNTING DEVELOPMENTS (CONTINUED)
tested for impairment at least annually; and 3) the amortization period of
intangible assets with finite lives will no longer be limited to forty years.
Goodwill and intangible assets acquired after June 30, 2001, will be subject
immediately to the nonamortization and amortization provisions of this
statement. These standards only permit prospective application of the new
accounting; accordingly, adoption of these standards will not affect previously
reported financial information of the Company. The principal effect of SFAS No.
142 will be the Company's ceasing the amortization of goodwill. Goodwill
amortization, was approximately $3,030,000 for the year ended September 30,
2000, and approximately $1,655,000 for the first nine months ended June 30,
2001.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company does not have material exposure to market risk from market risk
sensitive financial instruments other than the currency risk associated with
certain transactions being denominated in Deutschemarks.
19
20
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Between January 3, 1997 and March 7, 1997, the Company and certain of its
previous officers were named as defendants in putative securities class action
lawsuits filed in the United States District Court for the District of Minnesota
by 21 lead plaintiffs on behalf of an alleged class of purchasers of the
Company's common stock during the period January 25, 1996 through December 23,
1996. The putative class actions were thereafter consolidated (Master File No.
97-5 DWF/RLE). The Consolidated Amended Class Action Complaint ("Consolidated
Amended Complaint") alleges that the Company and certain of its previous
officers violated the federal securities laws by, among other things,
misrepresenting and/or omitting material information concerning the Company's
operations and financial results.
On February 25, 1997, the Company and certain of its previous officers also were
named as defendants in a securities lawsuit filed in the United States District
Court for the District of Minnesota by the Louisiana State Employees Retirement
System (Civil File No. 97-440, Master File No. 97-5 DWF/RLE) (the "Louisiana
Amended Complaint"). The Louisiana Amended Complaint alleges that the Company
and certain of its previous officers violated the federal securities laws and
state common law by, among other things, misrepresenting and/or omitting
material information concerning the Company's operations and financial results.
In a decision issued on May 22, 1998, the District Court dismissed without leave
to replead all claims asserted in both cases, including all claims asserted
against defendant Gary L. Deaner, 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
District 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 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.
On August 17, 2000, the District Court granted defendants' motions for summary
judgment and dismissed with prejudice the Consolidated Amended Complaint and the
Louisiana Amended Complaint. Although the 21 lead plaintiffs in the consolidated
putative class actions had previously moved for class certification, the
District Court dismissed the actions before ruling on that motion. Both the
Louisiana State Employees Retirement System and the 21 lead plaintiffs in the
consolidated putative class actions filed appeals from the decisions of the
District Court.
On July 5, 2001, the United States Court of Appeals for the Eighth Circuit
affirmed the decisions of the District Court and ordered that judgment be
entered in favor of defendants on the claims alleged in the Consolidated Amended
Complaint and the Louisiana Amended Complaint. On July 19, 2001, the 21 lead
plaintiffs in the consolidated putative class actions filed a petition for
rehearing en banc with the Court of Appeals. No decision has yet been received
on the petition.
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.
20
21
PART II. OTHER INFORMATION (CONTINUED)
ITEM 2. CHANGES IN SECURITIES
None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
ITEM 5. OTHER INFORMATION
None
21
22
PART II. OTHER INFORMATION (CONTINUED)
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
Exhibit No. Description
----------- -----------
3(a) Restated Certificate of Incorporation of the Registrant, as
Amended (1)
3(b) Amended and Restated By-Laws of the Registrant (2)
4(a) Form of Rights Agreement, dated as of June 10, 1998
between Digi International Inc. and Wells Fargo Bank
Minnesota, National Association (formerly known as 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 Wells Fargo Bank Minnesota,
National Association (formerly known as Norwest Bank
Minnesota, National Association), as Rights Agent (4)
(b) Reports on Form 8-K:
There were no reports on Form 8-K for the quarterly period ended June 30,
2001.
- --------
(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 to Exhibit 1 to the Company's Registration
Statement on Form 8-A dated June 24, 1998 (File No. 0-17972)
(4) Incorporated by reference to Exhibit 1 to Amendment 1 to the Company's
Registration Statement on Form 8-A dated February 5, 1999 (File No.
0-17972)
22
23
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this Report to be signed on its behalf by the
undersigned thereunto duly authorized.
DIGI INTERNATIONAL INC.
Date: August 14, 2001 By: /s/ S. Krishnan
------------------------------------
S. Krishnan
Chief Financial Officer
(duly authorized officer and
Principal Financial Officer)
23
24
EXHIBIT INDEX
Exhibit Number Document Description Form of Filing
- -------------- -------------------- --------------
3(a) Restated Certificate of Incorporation of the Registrant, as
Amended (incorporated by reference to the corresponding
exhibit number to the Company's Form 10-K for the year
ended September 30, 1993 (File No. 0-17972)................ Incorporated by Reference
3(b) Amended and Restated By-Laws of the Registrant
(incorporated by reference to the corresponding exhibit
number to the Company's Registration Statement on
Form S-1 (File No. 33-42384)............................... Incorporated by Reference
4(a) Form of Rights Agreement, dated as of June 10, 1998 between
Digi International Inc. and Wells Fargo Bank Minnesota,
National Association (formerly known as Norwest Bank
Minnesota, National Association), as Rights Agent
(incorporated by reference to Exhibit 1 to the Company's
Registration Statement on Form 8-A dated June 24, 1998
(File No. 0-17972)......................................... Incorporated by Reference
4(b) Amendment dated January 26, 1999, to Share Rights
Agreement, dated June 10, 1998 between Digi International
Inc. and Wells Fargo Bank Minnesota, National Association
(formerly known as Norwest Bank Minnesota, National
Association), as Rights Agent (incorporated by reference
to Exhibit 1 to Amendment No. 1 to the Company's
Registration Statement on Form 8-A dated February 5, 1999
(File No. 0-17972))........................................ Incorporated by Reference
24