UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES /X/ EXCHANGE ACT OF 1934 For the quarterly period ended: December 31, 1995. 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) 6400 Flying Cloud Drive Eden Prairie, Minnesota 55344 (Address of principal executive offices) (Zip Code) (612) 943-9020 (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 January 31, 1996, there were 13,228,442 shares of the registrant's $.01 par value Common Stock outstanding. -1-
INDEX PART I. FINANCIAL INFORMATION ITEM 1. Financial Statements: Consolidated Condensed Statements of Operations for the three months ended December 31, 1995 and 1994. 3 Consolidated Condensed Balance Sheets as of December 31, 1995 and September 30, 1995. 4 Consolidated Condensed Statements of Cash Flows for the three months ended December 31, 1995 and 1994. 5 Notes to Consolidated Condensed Financial Statements. 6 ITEM 2. Management's Discussion and Analysis of Results of Operations and Financial Condition. 8 PART II. OTHER INFORMATION ITEM 1. Legal Proceedings 10 ITEM 2. Changes in Securities 10 ITEM 3. Defaults Upon Senior Securities 10 ITEM 4. Submission of Matters to a Vote of 10 Securities Holders ITEM 5. Other Information 11 ITEM 6. Exhibits and Reports on Form 8-K 11 -2-
DIGI INTERNATIONAL INC. CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS FOR THE THREE MONTHS ENDED DECEMBER 31 (UNAUDITED) <TABLE> <CAPTION> 1995 1994 ------------ ------------ <S> <C> <C> Net sales $43,866,263 $37,878,928 Cost of sales 19,987,202 17,898,419 ------------ ------------ Gross margin 23,879,061 19,980,509 Operating expenses: Sales & marketing 8,820,102 6,735,572 Research & development 4,144,836 2,643,255 General & administrative 3,898,356 3,961,352 ------------ ------------ Total operating expenses 16,863,294 13,340,179 ------------ ------------ Operating income 7,015,767 6,640,330 Other income, principally interest 393,360 339,510 ------------ ------------ Income before income taxes 7,409,127 6,979,840 Provision for income taxes 2,607,899 2,488,515 ------------ ------------ Net income $4,801,228 $4,491,325 ------------ ------------ ------------ ------------ Income per common and common equivalent share: $0.35 $0.32 ------------ ------------ ------------ ------------ Weighted average common and common equivalent shares outstanding 13,902,733 13,961,227 ------------ ------------ ------------ ------------ </TABLE> See accompanying notes to unaudited consolidated condensed financial statements -3-
DIGI INTERNATIONAL INC. CONSOLIDATED CONDENSED BALANCE SHEETS <TABLE> <CAPTION> December 31 September 30 1995 1995 (UNAUDITED) ASSETS -------------- -------------- <S> <C> <C> Current assets: Cash and cash equivalents $1,049,727 $5,103,731 Marketable securities 14,711,797 27,968,775 Accounts receivable, net 33,499,504 31,960,936 Inventories, net 29,579,975 27,019,085 Other 4,532,589 2,225,058 -------------- -------------- Total current assets 83,373,592 94,277,585 Property, equipment and improvements, net 18,724,922 17,716,819 Intangible assets, net 11,518,420 11,633,305 Note receivable and other 5,641,326 2,415,755 -------------- -------------- Total assets $119,258,260 $126,043,464 -------------- -------------- -------------- -------------- LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable $ 8,749,080 $ 12,106,515 Income taxes payable 1,596,895 Accrued expenses: Advertising 3,353,570 2,235,946 Compensation 1,095,714 4,932,987 Other 789,891 941,469 -------------- -------------- Total current liabilities 15,585,150 20,216,917 Commitments Stockholders' equity: Preferred stock, $.01 par value; 2,000,000 shares authorized; none outstanding Common stock, $.01 par value; 60,000,000 shares authorized; 14,576,171 and 14,562,958 shares outstanding 145,762 145,630 Additional paid-in capital 41,522,421 41,306,320 Retained earnings 86,405,754 81,604,526 -------------- -------------- 128,073,937 123,056,476 Less unearned stock compensation (519,946) (598,387) Treasury stock, at cost, 1,347,729 and 1,032,729 shares (23,880,881) (16,631,542) -------------- -------------- Total stockholders' equity 103,673,110 105,826,547 -------------- -------------- Total liabilities and stockholders' equity $119,258,260 $126,043,464 -------------- -------------- -------------- -------------- </TABLE> See accompanying notes to unaudited consolidated condensed financial statements. -4-
DIGI INTERNATIONAL INC. CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS FOR THE THREE MONTHS ENDED DECEMBER 31 (UNAUDITED) <TABLE> <CAPTION> 1995 1994 --------------- -------------- <S> <C> <C> Operating activities: Net Income $ 4,801,228 $ 4,491,325 Adjustments to reconcile net income to cash (used in) provided by operating activities: Depreciation and amortization 1,251,733 842,297 Provision for losses on accounts receivable 39,280 68,670 Provision for inventory obsolescence 179,012 45,000 Stock compensation 78,441 37,620 Changes in operating assets and liabilities (11,107,061) (1,008,785) --------------- -------------- Total adjustments (9,558,595) (15,198) --------------- -------------- Net cash (used in) provided by operating activities (4,757,367) 4,476,127 --------------- -------------- Investing activities: Purchase of property, equipment and improvements (2,144,951) (717,559) Sale/(purchase) of marketable securities, net 13,256,978 (715,835) Increase in note receivable (3,375,558) -- --------------- -------------- Net cash ( used in) provided by investing activities 7,736,469 (1,433,394) --------------- -------------- Financing activities: Purchase of treasury stock (7,249,339) Stock option transactions, net 216,233 13,433 --------------- -------------- Net cash (used in) provided by financing activities (7,033,106) 13,433 --------------- -------------- Net (decrease) increase in cash and cash equivalents (4,054,004) 3,056,166 Cash and cash equivalents, beginning of period 5,103,731 13,849,017 --------------- -------------- Cash and cash equivalents, end of period $ 1,049,727 $ 16,905,183 --------------- -------------- --------------- -------------- </TABLE> See accompanying notes to unaudited consolidated condensed financial statements. -5-
DIGI INTERNATIONAL INC. NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (UNAUDITED) 1. BASIS OF PRESENTATION The consolidated condensed 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. Certain information and footnote disclosures, normally included in financial statements prepared in accordance with generally accepted accounting principles, have been condensed, or omitted, pursuant to such rules and regulations. These consolidated condensed financial statements should be read in conjunction with the financial statements and related notes thereto included in the Company's 1995 Annual Report and Form 10-K. The consolidated condensed financial statements presented herein, as of December 31, 1995 and for the three months then ended, reflect, in the opinion of management, all adjustments (which consist only of normal recurring adjustments) necessary for a fair presentation of financial position and the results of operations for the periods presented. The results of operations for any interim period are not necessarily indicative of results for the full year. 2. INVENTORIES Inventories are stated at the lower of cost or market, with cost determined on the first-in, first-out method. Inventories at December 31, 1995 and September 30, 1995 consisted of the following: <TABLE> <CAPTION> DECEMBER 31 SEPTEMBER 30 ----------- ------------ <S> <C> <C> Raw materials $16,779,571 $12,476,953 Work in process 7,861,301 7,645,002 Finished goods 4,939,103 6,897,130 ----------- ------------ $29,579,975 $27,019,085 ----------- ------------ ----------- ------------ </TABLE> 3. INCOME PER SHARE Income per common share is computed by dividing net income by the weighted average number of common shares and common equivalent shares outstanding during the period. Common stock equivalents result from dilutive stock options. -6-
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (CONT.) 4. COMMON STOCK During the three months ended December 31, 1995, 13,213 shares of the Company's common stock were issued upon the exercise of outstanding stock options for 13,900 shares. The difference between the shares issued and options exercised results from the stock option plan's provision allowing the employees to elect to pay their withholding obligations through share reduction. Withholding taxes paid by the Company, as a result of the share reduction option, amounted to $19,775. On March 27, 1995, the Company's Board of Directors authorized a one million share repurchase program, which will be funded by available cash balances over an unspecified period of time. During the quarter ended December 31, 1995, $7,249,339 was used for treasury stock purchases. On January 31, 1996, the Company's Board of Directors authorized a separate 500,000 share repurchase program for the purpose of purchasing Common Stock for the Company's Employee Stock Purchase Plan. -7-
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION RESULTS OF OPERATIONS NET SALES Sales for the quarter ended December 31, 1995 exceeded sales for the corresponding quarter ended December 31, 1994 by $5,987,335, which represents a percentage increase of 15.8%. Sales in all product markets increased over prior year amounts as follows: <TABLE> <CAPTION> PRODUCT MARKET QUARTERLY INCREASE PERCENT OF REVENUE - -------------- ------------------ ------------------ <S> <C> <C> Multi-user 15.6% 66.2% Remote Access 36.0% 16.6% LAN Connect 1.9% 17.2% </TABLE> Sales to original equipment manufacturers (OEM's) across product markets decreased from 24.2% of net sales in the quarter ended December 31, 1994 to 14.1% in 1995. The decrease in OEM business was due primarily to component allocation issues impacting the Company's OEM customers and the industry as a whole. The Company's management expects the OEM portion of the Company's business to increase in the second quarter based on current firm orders and increased availability of components. Sales of the Company's products in international markets increased by 31.4% for the quarter ended December 31, 1995 over the corresponding quarter ended December 31, 1994. The Company believes that the revenues from its Remote Access and LAN Connect markets will continue to grow, while the Multiuser market growth may decline. GROSS MARGINS Gross margins increased from $19,980,509 or 52.8% of net sales for the quarter ended December 31, 1994 to $23,879,061 or 54.4% for the quarter ended December 31, 1995. The increase in gross margin for the quarter is primarily related to the decreased volume in OEM sales and to the smaller contribution made by sales of the Company's LAN Connect products to the Company's sales. Both OEM sales and sales of LAN Connect products have traditionally resulted in lower margins than have non-OEM sales of the Company's Multiuser and Remote Access products. OPERATING EXPENSES Operating expenses increased from $13,340,179 for the quarter ended December 31, 1994 to $16,863,294 for the quarter ended December 31, 1995, an increase of 26.4%. As a percentage of sales, expenses were 38.4% for the quarter ended December 31, 1995 compared to 35.2% for the quarter ended December 31, 1994. The quarterly increase can be attributed primarily to increased research and development and marketing expenditures for new products and markets, principally in the Remote Access and LAN Connect markets, plus increased staffing levels resulting from the Company's increased product development and marketing efforts. OTHER INCOME Interest income increased from $339,510 for the quarter ended December 31, 1994 to $393,360 the quarter ended December 31, 1995. -8-
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (CONT.) This increase resulted from a slight increase in investment yields. INCOME TAXES The Company's effective income tax rate was 35.2% in the current quarter compared to 35.7% in the corresponding quarter of last year. This decrease is due primarily to an increase in the foreign sales corporation benefit due to increased foreign sales. LIQUIDITY AND CAPITAL RESOURCES The Company has financed its operations principally with funds generated from operations and proceeds from public stock offerings. Cash flows from operations for the three months ended December 31, 1995 was negatively impacted by changes in operating assets and liabilities, primarily related to increases in accounts receivable and inventories and to reductions in accounts payable and accrued expenses. Investing activities for the period ended December 31, 1995, primarily include redemption of maturing investments offset by purchases of property, equipment and improvements and an increase in note receivable. The increase in note receivable arose from the Company's purchase of a secured convertible note from a company engaged in the development of remote access technology. If the company developing such technology attains certain development and financial performance milestones, the Company will be obligated to purchase one additional secured convertible note in the principal amount of approximately $1.4 million in the second quarter. On March 27, 1995, the Company's Board of Directors authorized a one million share repurchase program, which will be funded by available cash balances over an unspecified period of time. During the quarter ended December 31, 1995, $7,249,339 was used for treasury stock purchases. On January 31, 1996, the Company's Board of Directors authorized a separate 500,000 share repurchase program for the purpose of purchasing Common Stock for the Company's Employee Stock Purchase Plan. At December 31, 1995, the Company had working capital of $71.2 million, no debt and no established lines of credit. Management believes current financial resources, cash generated by operations and the Company's potential capacity for debt and/or equity financing will be sufficient to fund current business operations and any anticipated business expansion. The Financial Accounting Standards Board (FASB) has issued Statement No. 123, "Accounting for Stock-Based Compensation." The Company plans to adopt this Statement in fiscal year 1997. Although it has not made a definite determination of its impact, the Company does not expect the adoption of Statement No. 123 to have a materially adverse effect on its financial position of results of operations. -9-
PART II OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS None ITEM 2. CHANGES IN SECURITIES None ITEM 3. DEFAULTS UPON SENIOR SECURITIES None ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS At the annual meeting of stockholders held on January 31, 1996, the stockholders approved the following: (a) Proposal to elect three directors, each to a three year term. Mr. John P. Schinas was elected on a vote of 10,024,028 in favor, with 74,367 shares withholding authority to vote. Mr. Richard E. Offerdahl was elected on a vote of 9,960,828 in favor, with 137,967 shares withholding authority to vote. Dr. Jagdish N. Sheth was elected on a vote of 10,018,455 in favor, with 79,940 shares withholding authority to vote. (b) Proposal to amend provisions of the Digi International Inc. Stock Option Plan that provide for the granting of stock options to non-employee directors. The proposal passed on a vote of 7,511,152 in favor, 2,227,119 against, 113,440 abstentions, and 246,684 broker non-votes. (c) Proposal to approve the Digi International Inc. Employee Stock Purchase Plan, which provides eligible employees of the Company the opportunity to purchase Common Stock. The proposal passed on a vote of 9,405,966 in favor, 268,046 against, 121,032 abstentions, and 303,351 broker non-votes. (d) Proposal to ratify the appointment of Coopers & Lybrand L.L.P. as independent public accountants of the Company for fiscal year 1996. The proposal passed on a vote of 10,005,952 in favor, 43,945 against, 48,498 abstentions, and no broker non-votes. -10-
ITEM 5. OTHER INFORMATION None ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits: EXHIBIT NUMBER DESCRIPTION -------------- ----------- 3(a) RESTATED CERTIFICATE OF INCORPORATION OF THE REGISTRANT* 3(b) AMENDED AND RESTATED BY-LAWS OF THE REGISTRANT** 10(a) STOCK OPTION PLAN OF THE REGISTRANT**** 10(c) AMENDED AND RESTATED EMPLOYMENT AGREEMENT BETWEEN THE COMPANY AND JOHN P. SCHINAS*** 10(h) CONSULTING AGREEMENT BETWEEN THE COMPANY AND MYKOLA MOROZ*** 10(r) EMPLOYMENT ARRANGEMENT BETWEEN THE COMPANY AND JAMES R. BAKER FOR FISCAL 1996 10(s) EMPLOYEE STOCK PURCHASE PLAN OF THE REGISTRANT***** 27 FINANCIAL DATA SCHEDULE * INCORPORATED BY REFERENCE TO THE CORRESPONDING EXHIBIT NUMBER OF THE COMPANY'S FORM 10-K FOR THE YEAR ENDED SEPTEMBER 30, 1992 (FILE NO.0- 17972). ** INCORPORATED BY REFERENCE TO THE CORRESPONDING EXHIBIT NUMBER OF THE COMPANY'S REGISTRATION STATEMENT ON FORM S-1 (FILE NO.33-42384). *** INCORPORATED BY REFERENCE TO THE CORRESPONDING EXHIBIT NUMBER OF THE COMPANY'S FORM 10-K FOR THE YEAR ENDED SEPTEMBER 30, 1994 (FILE NO.0-17972). **** INCORPORATED BY REFERENCE TO EXHIBIT A TO THE REGISTRANT'S PROXY STATEMENT FOR ITS ANNUAL MEETING OF STOCKHOLDERS HELD ON JANUARY 31, 1996 (FILE NO.0-17972). ***** INCORPORATED BY REFERENCE TO EXHIBIT B TO THE REGISTRANT'S PROXY STATEMENT FOR ITS ANNUAL MEETING OF STOCKHOLDERS HELD ON JANUARY 31, 1996. (b) Reports on Form 8-K: There were no reports filed on form 8-K during the quarter ended December 31, 1995. -11-
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: February 14, 1996 By: /s/Gerald A. Wall ----------------------- Gerald A. Wall Chief Financial Officer (duly authorized officer and Principal Financial Officer) -12-