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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, 1997
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.
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(Exact name of registrant as specified in its charter)
Delaware 41-1532464
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
11001 Bren Road East
Minnetonka, Minnesota 55343
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(Address of principal executive offices) (Zip Code)
(612) 912-3444
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(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
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(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
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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 $20.125 per share as reported on the
National Association of Securities Dealers Automated Quotation System-National
Market System on December 12, 1997 was $236,783,746.
Shares of common stock outstanding as of December 12, 1997: 13,485,942
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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, 1997 and Proxy Statement for the
Registrant's Annual Meeting of Stockholders scheduled for January 28, 1998, a
definitive copy of which was filed on December 26, 1997. All such information
set forth below under the heading "Reference" is incorporated herein by
reference.
PART I ITEM IN FORM 10-K REFERENCE
- ------ ----------------- ---------
Item 1. Business Business, pages 4 through 8, this
document; Note 1, Notes to
Consolidated Financial Statements
Annual Report to Stockholders
Item 2. Properties Properties, pages 8 and 9, this
document
Item 3. Legal Proceedings Legal Proceedings, pages 9 and 10,
this document
Item 4. Submission of Matters to a Submission of Matters to a Vote of
Vote of Security Holders Security Holders, page 10, this
document
PART II
- -------
Item 5. Market for Registrant's Common Stock Listing; Dividend Policy,
Equity and Related Stockholder page 35, Annual Report to
Matters Stockholders
Item 6. Selected Financial Data Financial Highlights, and Selected
Financial Information, page 2,
Annual Report to Stockholders
Item 7. Management's Discussion and Management's Discussion and
Analysis of Financial Analysis of Financial Condition and
Condition and Results of Results of Operations, pages 16
Operations through 20, Annual Report to
Stockholders
Item 7A. Quantitative and Qualitative Quantitative and Qualitative
Disclosures About Market Risk Disclosures About Market Risk, page
10, this document
2
Item 8. Financial Statements and Annual Report to Stockholders,
Supplementary Data pages 21 through 33
Item 9. Changes in and Disagreements Changes and Disagreements with
with Accountants on Accounting Accountants on Accounting and
and Financial Disclosure Financial Disclosure, page 10, this
document
PART III ITEM IN FORM 10-K REFERENCE
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Item 10. Directors of the Registrant Election of Directors, Proxy
Statement
Executive Officers of the Executive Officers of the
Registrant Registrant, pages 10 through 11,
this document
Compliance with Section 16(a) Section 16(a) Beneficial Ownership
of the Exchange Act 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
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 Security Ownership of Principal
Beneficial Owners and Stockholders and Management, Proxy
Management Statement
Item 13. Certain Relationships and Certain Relationships and Related
Related Transactions Transactions, Proxy Statement
PART IV
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Item 14. Exhibits, Financial Statement Exhibits, Financial Statement
Schedules and Reports on Schedules and Reports on Form 10-K,
Form 10-K pages 12 through 15, this document
3
PART I
ITEM 1. BUSINESS
Digi International Inc. (the "Company") was formed in 1985 as a
Minnesota corporation and reorganized as a Delaware corporation in
1989. The Company is a leading ISO 9001- compliant provider of data
communications hardware and software that delivers seamless
connectivity solutions for multiuser environments, open systems,
server-based remote access and LAN (Local Area Network) markets.
The two major product areas include: 1) communications interface cards
for multiuser and remote access environments which constituted
approximately 76% of net sales in fiscal 1997, and 2) "physical layer"
and print server products that enhance the data communications
capabilities of a LAN and which constituted 24% of net sales in fiscal
1997. Neither product area is date sensitive and will not require
adaptation to comply with Year 2000 requirements.
Key differentiators of the Company's communications interface cards
include: 1) its embedded high-performance operating system software
(firmware), and 2) the device driver software component which is
optimized to work with a variety of industry-standard operating systems
and allows the operating system (OS) to communicate efficiently and
reliably with peripheral devices.
The Company's communications interface cards provide asynchronous
(transmitting single characters at a time) and synchronous
(transmitting characters in a group) data transmissions for analog
modems, ISDN (Integrated Services Digital Network) X.25, Frame Relay
or T1/E1 connections.
The Company's communications interface card products provide
connections for two primary markets:
1. The core multiport access products provide PC-host-to-terminal
serial I/O (input/output) connections. These products facilitate
data transmission for point-of-sale applications, on-line
transaction processing, factory automation, and data collection and
dissemination, among others. The onboard firmware allows the
products to quickly, accurately and reliably transmit data, thereby
eliminating the information bottlenecks that can result when
multiple users or devices share one processing unit. These
solutions primarily use multiuser, multitasking operating systems
such as UNIX (and its variations), along with standard PC servers
and the communications interface card.
2. Open systems, server-based remote access products. These
communications interface cards address the need for
high-performance, dial-in/dial-out connections which are necessary
for wide area networking, including accessing the Internet. The
Company's remote access products provide the communications ports
which are needed to connect telecommuters, mobile workers and
branch offices to corporate LANs, or branch offices to other
branches, or to make the connections to the Internet. These
solutions primarily
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use open system operating systems such as Novell NetWare or
Microsoft Windows NT RAS (and subsequent upgrades) along with
standard PC servers and the communications interface card.
The Company entered the LAN market with its acquisition of MiLAN
Technology Corporation in November 1993. The MiLAN Technology Division
provides cost-effective and power-efficient Ethernet, Fast Ethernet and
Token Ring networking connectivity products that are installed on a LAN
to increase its productivity.
The Company's LAN products are recognized for their price/performance,
reliability, robust features, and superior technical support.
The Company's MiLAN networking products include these primary groups:
1. The physical layer line of products that allow users to easily
build and expand networks using single and multiport transceivers,
converters, modular microhubs and modular repeaters, as well as the
first comprehensive family of physical layer connectivity solutions
for Fast Ethernet.
2. Print server products based on the FastPort line, which makes print
sharing convenient and affordable. The FastPort line includes the
industry's first multiprotocol network print server providing
access to any printer on an Ethernet or Token Ring network without
the inconvenience and expense of spooling through a workstation or
server.
The Company works closely with customers, PC and server vendors,
operating system companies and other marketing partners to continuously
optimize Digi's WAN and LAN products to interoperate in open systems,
industry-standard environments. This assures customers the ability to
choose the most flexible, cost-effective solution to meet their
individual needs.
The Company markets its products to a broad range of customers,
including major domestic and international distributors, system
integrators, VARs (Value Added Resellers) and OEMs (Original Equipment
Manufacturer).
The Company's products are sold through a network of more than 201
distributors in the United States, Canada and 70 countries worldwide
and through OEM (Original Equipment Manufacturer) contracts.
In July 1991, the Company opened a sales support office in Germany to
increase sales support to the European distribution network. In
October 1993, the Company opened a sales support office in Singapore to
increase sales support for its products to the Pacific Rim distribution
network. In 1996, the Company opened similar offices in Hong Kong,
Sydney and Tokyo and in 1997, the Company opened sales offices in Paris
and London to better serve its non-U.S. markets.
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To serve its worldwide markets, the Company (i) offers products that,
in the opinion of management, provide superior performance relative to
current standards and application requirements, (ii) provides products
that are compatible with a broad array of open system operating systems
and industry-standard PC, server and workstation architectures, and
(iii) provides, in the opinion of management, superior technical
support, including frequent and timely product updates and ready access
to the Company's support staff.
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. Many of the Company's competitors and potential
competitors have greater financial, technological, manufacturing,
marketing and personnel resources than the Company. The Company
believes that it is the market leader in the multiport access and open
system, server-based remote access markets of the computer industry.
With respect to the LAN market, the Company believes it commands less
than a 5% market share.
The Company's manufacturing operations procure all parts and certain
services involved in the production of products. The Company
subcontracts most of its product manufacturing to outside firms that
specialize in providing such services. The Company believes that this
approach to manufacturing is beneficial because it permits the Company
to 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. Virtually all of these components are
available from multiple vendors.
During fiscal years 1995, 1996 and 1997, the Company's research and
development expenditures were $14.8, $21.3 and $18.0 million,
respectively.
Due to the 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.
Through September 30, 1997, the Company purchased $11.8 million in
secured convertible notes from AetherWorks Corporation, a development
stage company engaged in the development of wireless and dial-up remote
access technology. The Company is obligated to purchase up to an
additional $2.0 million secured convertible notes from time to time at
the request of AetherWorks, based on certain conditions. Secured
convertible notes held by the Company were convertible at September 30,
1997 into 60% of AetherWorks' common stock, and the purchase of the $2
million additional principal amount of secured notes would
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increase the Company's ownership portion upon conversion to 62.7%,
based on AetherWorks' present capitalization. On October 14, 1997, the
Company entered into a revised note agreement with AetherWorks, that
clarifies and limits the Company's financial commitment for the
purchase of convertible notes to a maximum of $13.8 million. The
revised note agreement, however, also provides for payments, at the
discretion of AetherWorks, on the outstanding convertible notes of up
to $7.2 million, in exchange for a reduction in the Company's potential
ownership interest, upon conversion, to 19%. The revised note
agreement, among other things, rescinded previous technology transfer
and manufacturing agreements. Also in connection with the financing
arrangement, the Company has also guaranteed $3.1 million of lease
obligations. In addition, the Company has leased to AetherWorks $1.3
million of computer equipment under a three year direct financing lease
agreement. The Company has reported its investment in AetherWorks on
the equity method and has recorded in 1997 a $5.8 million loss which
represents 100% of the AetherWorks' net loss for the year ended
September 30, 1997. The percentage of AetherWorks' losses included in
the Company's results of operations is based upon the percentage of
financial support provided by the Company (versus other investors) to
AetherWorks during fiscal 1997.
Because of the significant uncertainty of the future of AetherWorks
Corporation, as demonstrated by its lack of generating positive cash
flow, obtaining 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 $2.4 million in AetherWorks, and to accrue and expense
its remaining future obligation to purchase additional notes of $2
million. In addition, it has accrued $1.4 million for its probable
obligations resulting from its guarantees of certain AetherWorks lease
obligations.
During the year ended September 30, 1997, two customers comprised more
than 10% of net sales: Ingram Micro at 15.1%, and Tech Data at 10.5%.
For 1996, two customers accounted for more than 10% of net sales: Tech
Data at 13.9% and Ingram Micro at 13.4%. During 1995, two companies
comprised more that 10% of net sales: Ingram Micro accounted for 12.5%
and IBM accounted for 11.7% of net sales.
As of September 30, 1997, the Company had backlog orders which
management believed to be firm in the amount of $14.7 million. All of
these orders are expected to be filled in the current fiscal year.
Backlog at September 30, 1996 was $0.967 million.
During fiscal years 1995, 1996 and 1997, the Company's net sales to
customers outside the United States, primarily in Europe, amounted to
approximately $33 million, $39.9 million and $39.6 million
respectively, comprising approximately 20%, 20% and 23.9% of net sales
for the applicable fiscal year.
On February 13, 1997, the Company's Board of Directors approved a
restructuring plan which resulted in a restructuring charge of
$10,471,482 ($8,283,681, net of tax benefits or $0.62 per share). The
corporate restructuring plan simplified operations, increased
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
7
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 good will 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.
Subsequent to the actions covered by the restructuring charge, the
Company has made additional headcount reductions and has consolidated
other research and development activities into Minneapolis.
During the fourth quarter, the Company consolidated research and
development activities from facilities in Cleveland, Ohio; Redmond,
Washington; and, Huntsville, Alabama to the Company's corporate
headquarters in Minneapolis, Minnesota. Additional headcount reductions
have been made in varying levels throughout the Company, reflecting the
consolidation of duties and responsibilities at the corporate
headquarters.
Actual headcount at September 30, 1997 was 481.
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 currently 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 46,170 square foot
facility in Sunnyvale, California, the lease for which expires in April
2002. Facilities which were closed as part of the Company's
restructuring, announced on February 13, 1997, included a 32,000 square
foot facility in Twinsburg, Ohio, and a 10,525 square foot building in
Torrance, California. Facilities which were closed, subsequent to the
restructuring, and the space subleased included an 8,028 square foot
research facility in Huntsville, Alabama, the sublease for which
expires in February 1999; a 4,886 square foot research facility in
Redmond, Washington the sublease for which expires in December 1998;
and, a 17,146 square foot facility in Nashville, Tennessee, the
sublease for which expires in August 2000.
The Company's sales support office in Germany is located in a 4,535
square foot office in Cologne, Germany, the lease for which expires in
November 1998. The Company's sales support office in Asia is located in
a 1,560 square foot office in Singapore, the lease for which expires in
May 2000. The Company's sales support office in Australia is located
in a 1,000 square foot office in Sydney, the lease for which expires in
March 1998. The Company's sales support office in Hong Kong is located
in a 1,400 square foot office in Causeway Bay, the lease for which
expires in May 1998. The Company's sales support office in London is
located in a 2,000 square foot office, the lease for which expires in
June 2002. The Company's sales support office in Paris is located in a
625 square foot office, the lease for which expires with a 30 day
notice. Management believes that the Company's
8
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
On January 3, 1997, the Company and certain of its previous officers
were named as defendants in a putative securities class action lawsuit
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. Between
January 17, 1997 and March 7, 1997, four similar putative securities
class actions also were commenced. By Memorandum and Order dated April
2, 1997, the District Court consolidated all five of the putative
securities class actions for all purposes including trial, appointed 21
persons to serve as lead plaintiffs in the consolidated class actions,
and allowed the lead plaintiffs to file and serve a consolidated class
action complaint.
On May 12, 1997, a consolidated amended class action complaint (the
"Consolidated Amended Complaint") was filed in the combined actions,
which are captioned IN RE DIGI INTERNATIONAL INC. SECURITIES
LITIGATION, Master File No. 97-5 (JRT/RLE) (U.S. District Court for the
District of Minnesota). The Consolidated Amended Complaint alleges
that the Company and its previous officers Ervin F. Kamm, Jr., Gerald
A. Wall and Gary L. Deaner violated the federal securities laws by,
among other things, misrepresenting and/or omitting material
information concerning the Company's operations and financial results.
The Consolidated Amended Complaint seeks compensatory damages in an
unspecified amount plus interest against all defendants, jointly and
severally, and an award of attorneys' fees, experts' fees and costs.
On July 3, 1997, defendants served a motion to dismiss the Consolidated
Amended Complaint on the ground, among others, that it fails to plead
claims in accordance with applicable law. The motion to dismiss was
argued before the District Court on October 31, 1997. A ruling has not
yet been received.
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 and entitled LOUISIANA
STATE EMPLOYEES RETIREMENT SYSTEM IN BEHALF OF ITSELF AND IN BEHALF OF
ALL OTHER PARTIES SIMILARLY SITUATED AND CIRCUMSTANCED WHO DESIRE TO
PERSONALLY JOIN IN THIS ACTION AND TO CONTRIBUTE TO THE COSTS AND
EXPENSES THEREOF, PLAINTIFFS, VS. DIGI INTERNATIONAL INC., GARY L.
DEANER, ERVIN F. KAMM, JR., GERALD A. WALL, AND "JOHN DOE AND "RICHARD
ROE", THE NAMES "JOHN DOE" AND "RICHARD ROE" BEING FICTITIOUS, THE
PARTIES INTENDED BEING THOSE PARTIES, PRESENTLY UNKNOWN TO THE
PLAINTIFF, WHO PARTICIPATED IN THE WRONGFUL ACTS SET FORTH HEREIN,
DEFENDANTS, Civil File No. 97-440, Master File No. 97-5 (JRT/RLE) (U.S.
District Court for the District of Minnesota). On June 3, 1997, the
Louisiana State Employees Retirement System filed an Amended Complaint
(the "Louisiana Amended Complaint"). The Louisiana Amended Complaint
alleges that the Company and its previous officers Ervin F. Kamm, Jr.,
Gerald A. Wall and Gary L. Deaner violated
9
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.
The Louisiana Amended Complaint seeks compensatory damages in the
amount of $718,404.70 plus interest against all defendants, jointly and
severally, and an award of attorneys' fees, disbursements and costs.
This action has been consolidated with the consolidated class actions
for pretrial purposes.
On July 17, 1997, defendants served a motion to dismiss the Louisiana
Amended Complaint on the ground, among others, that it fails to plead
claims in accordance with applicable law. The motion to dismiss was
argued before the District Court on October 31, 1997. A ruling has not
yet been received.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of security holders during
the quarter ended September 30, 1996.
PART II
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Not applicable.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
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
---- --- --------
John P. Schinas 60 Chairman of the Board of
Directors
Jerry A. Dusa 50 Director, President and
Chief Executive Officer
10
Jonathon E. Killmer 56 Senior Vice President, Chief
Financial Officer and
Treasurer
Douglas J. Glader 54 Senior Vice President,
Manufacturing Operations
Dino G. Kasdagly 43 Senior Vice President,
Development
Mr. Schinas, founder of the Company, retired as Chief Executive Officer
effective January 27, 1992. He has been a member of the Board of
Directors since the Company's inception in July 1985 and was elected
Chairman of the Board of Directors in July 1991. From July 1985 to July
1991, Mr. Schinas also served the Company as President and Treasurer.
Mr. Dusa has been a member of the Board of Directors and President and
Chief Executive Officer of the Company since March 12, 1997, after
serving the Company as interim acting Chief Executive Officer from
January 3, 1997 to March 12, 1997. Prior to January 3, 1997, Mr. Dusa
had been the owner and principal of Phase One Partners, Inc., an
investment and consulting business, since 1995 and had acted as a
consultant to the Company in this capacity since August 1996. From
1994 to 1995, Mr. Dusa was Vice President of Fujitsu Microelectronics,
Inc., a manufacturer of integrated circuit products. From 1993 to
1994, Mr. Dusa was President of Eagle Technology, a manufacturer of
network connectivity products. From 1992 to 1993, Mr. Dusa was
President of Kalpana, Inc., a manufacturer of network connectivity
products. Prior to 1992, Mr. Dusa held executive management positions
with a number of high technology companies including IBM Corporation,
3Com Corporation and Tandem Computers. Mr. Dusa is a director of Data
Systems Network Corp., a data communications company.
Mr. Killmer joined the Company in October 1996, as Vice President,
Chief Financial Officer and Treasurer. He was named Senior Vice
President in July 1997. Prior to joining the Company, Mr. Killmer had
been a partner in the professional services firm of Coopers & Lybrand
L.L.P., most recently as the Managing Partner of the Minneapolis/St.
Paul office from 1990 until his joining the Company.
Mr. Glader was named Vice President of Operations in February 1995 and
Senior Vice President, Manufacturing Operations, on April 23, 1997.
Before that, he was formerly 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. Kasdagly joined the Company in October 1997, as Senior Vice
President, Development. Prior to joining the Company, Mr. Kasdagly had
been an executive with IBM Corporation
11
since November 1980, most recently as Director, Division Quality and
Business Reengineering for IBM's AS/400 Division.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON
FORM 10-K
(a) Consolidated Financial Statements and Schedules of the Company
and Financial Statements of AetherWorks Corporation
1. Incorporated by reference to pages 21 through 32 of the
Company's 1997 Annual Report to Stockholders:
Consolidated Statement of Operations for the fiscal years
ended September 30, 1997, 1996 and 1995
Consolidated Balance Sheets as of September 30, 1997 and
1996
Consolidated Statement of Cash Flows for the fiscal years
ended September 30, 1997, 1996 and 1995
Consolidated Statement of Stockholders' Equity for the
fiscal years ended September 30, 1997, 1996 and 1995
Notes to Consolidated Financial Statements
Report of Independent Accountants
2. AetherWorks Corporation Financial Statements
Balance Sheets as of September 30, 1997 and 1996
Statement of Operations for the years ended September 30,
1997 and 1996 and period from February 24, 1993
(inception) to September 30, 1997
Statement of Shareholders' Equity (Deficit) for the years
ended September 30, 1997 and 1996 and period from
February 24, 1993 (inception) to September 30, 1997
Statement of Cash Flows for the years ended September 30,
1997 and 1996 and period from February 24, 1993 (inception)
to September 30, 1997
Notes to Financial Statements
Report of Independent Accountants
3. Included in Part II:
Report of Independent Accountants on Financial Statement
Schedule
Schedule II - Valuation and Qualifying - Accounts
12
All other schedules are omitted because they are not
applicable or are not required.
(b) Reports on Form 8-K
Form 8-K dated February 18, 1997, regarding the announcement of the
Company recording a restructuring charge during the second quarter
of fiscal 1997.
(c) Exhibits
Exhibit
Number Description
------ -----------
3(a) Restated Certificate of Incorporation of the Registrant
(4)
3(b) Amended and Restated By-Laws of the Registrant (2)
10(a) Stock Option Plan of the Registrant
10(b) Form of indemnification agreement with directors and
officers of the Registrant (1)
10(c) Amended and Restated Employment Agreement between the
Company and John P.Schinas (5)
10(d) Restated and Amended Note Purchase Agreement between the
Company and AetherWorks Corporation, dated October 14,
1997
10(e) Employment Arrangement between the Registrant and Mike
Kelley, dated February 7, 1996 (8)
10(f) 401(k) Savings and Profit Sharing Plan of Digi
International Inc. (3)
10(h) Consulting Agreement between the Company and Mykola
Moroz (5)
10(i) Employment Arrangement between the Registrant and
Jonathon E. Killmer, dated September 16, 1996 (8)
10(j) Employment Arrangement between the Registrant and David
Rzasa, dated September 30, 1996 (8)
10(k) Separation Agreement between the Company and Gerald A.
Wall, dated December 4, 1996 (8)
10(l) Separation Agreement between the Company and Ervin F.
Kamm, Jr. dated January 3, 1997 (9)
13
10(m) Employment Agreement between the Company and Jerry A.
Dusa, dated March 12, 1997 (10)
10(n) Employment Agreement with Ray D. Wymer, as amended by
Amendment No. 1 to Employment Agreement (7)
10(p) Employment Arrangement between the Registrant and
Douglas Glader (7)
10(p) (i) Amendment to Employment Agreement between the
Company and Douglas Glader (9)
10(q) Employment Agreement between the Registrant and Dana R.
Nelson for fiscal 1995 and 1996 (7)
10(r) Employment Agreement between the Company and Dino G.
Kasdagly, dated October 1, 1997
10(s) Employee Stock Purchase Plan of the Registrant (6)
13 1997 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 Registrant
23.1 Consent of Independent Accountants
23.2 Consent of Independent Accountants
24 Powers of Attorney
27 Financial Data Schedule
(1) Incorporated by reference to the corresponding exhibit number of the
Company's Registration Statement on Form S-1 (File no. 33-30725).
(2) Incorporated by reference to the corresponding exhibit number of the
Company's Registration Statement on Form S-1 (File no. 33-42384).
(3) Incorporated by reference to the corresponding exhibit number of the
Company's Form 10-K for the year ended September 30, 1991 (File no.
0-17972).
(4) Incorporated by reference to the corresponding exhibit number of the
Company's Form 10-K for the year ended September 30, 1993 (File no.
0-17972).
(5) 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).
14
(6) Incorporated by reference to Exhibit B to the Registrant's Proxy
Statement for its Annual Meeting of Stockholders held on January 31,
1996.
(7) Incorporated by reference to the corresponding exhibit number of the
Company's Form 10-K for the year ended September 30, 1995 (File no.
0-17972).
(8) Incorporated by reference to the corresponding exhibit number of the
Company's Form 10-K/A for the year ended September 30, 1996 (File no.
0-17972).
(9) Incorporated by reference to the corresponding exhibit number of the
Company's Form 10-Q for the quarter ended December 31, 1996 (File no.
0-17972).
(10) Incorporated by reference to the corresponding exhibit number of the
Company's Form 10-Q for the quarter ended March 31, 1997 (File no.
0-17972).
15
AetherWorks Corporation
(A Development Stage Company)
Balance Sheets
SEPTEMBER 30
1997 1996
-----------------------
ASSETS
Current assets:
Cash and cash equivalents $ 874,265 $ -
Prepaid expenses 81,430 104,307
-----------------------
Total current assets 955,695 104,307
Property and equipment:
Computer hardware 3,457,408 3,049,813
Computer software 523,387 754,865
Furniture and fixtures 832,471 189,053
-----------------------
4,813,266 3,993,731
Less accumulated depreciation and amortization 739,635 124,485
-----------------------
4,073,631 3,869,246
Other assets:
Deferred financing costs, net of accumulated
amortization of $376,114 in 1997 and
$113,359 in 1996 429,025 321,779
Note receivable from related party 120,536 112,447
-----------------------
Total assets $ 5,578,887 $4,407,779
-----------------------
-----------------------
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable and accrued liabilities $ 602,455 $2,522,138
Accrued interest 3,417 492,690
Current portion of long-term debt and capital
lease obligations 861,964 927,204
-----------------------
Total current liabilities 1,467,836 3,942,032
Long-term debt and capital lease obligations 16,016,747 6,105,467
Shareholders' equity (deficit):
Common Stock, par value $.01 per share:
Authorized shares - 10,000,000
Issued and outstanding shares - 1,200,409 in
1997 and 1,126,700 in 1996 12,004 11,267
Additional paid-in capital 660,775 204,486
Deficit accumulated during the development stage (12,578,475) (5,855,473)
-----------------------
Total shareholders' equity (deficit) (11,905,696) (5,639,720)
-----------------------
Total liabilities and shareholders' equity (deficit) $ 5,578,887 $4,407,779
-----------------------
-----------------------
SEE ACCOMPANYING NOTES.
16
AetherWorks Corporation
(A Development Stage Company)
Statements of Operations
PERIOD FROM
FEBRUARY 24, 1993
YEAR ENDED SEPTEMBER 30 (INCEPTION) TO
SEPTEMBER 30,
1997 1996 1997
-------------------------------------------
Operating expenses:
Research and development $ 3,505,134 $ 2,567,844 $ 7,325,434
General and administrative 2,069,304 999,247 3,858,650
-------------------------------------------
Operating loss (5,574,438) (3,567,091) (11,184,084)
Other income (expense):
Interest income 24,734 56,640 81,374
Interest (expense) (1,173,298) (537,625) (1,783,519)
-------------------------------------------
Net loss for the period $(6,723,002) $(4,048,076) $(12,886,229)
-------------------------------------------
-------------------------------------------
Net loss per share $(5.72) $(3.59) $(13.21)
-------------------------------------------
-------------------------------------------
Weighted average number of shares
outstanding during the period 1,175,570 1,126,700 975,723
-------------------------------------------
-------------------------------------------
SEE ACCOMPANYING NOTES.
17
AetherWorks Corporation
(A Development Stage Company)
Statement of Shareholders' Equity (Deficit)
DEFICIT
ACCUMULATED
COMMON STOCK ADDITIONAL DURING THE
------------------------- PAID-IN DEVELOPMENT
SHARES AMOUNT CAPITAL STAGE TOTAL
-----------------------------------------------------------------------------
Balance at February 24, 1993 (inception) - $ - $ - $ - $ -
Sale of Common Stock at $.01 per share
to the founder in June 1993 600,000 6,000 507 - 6,507
Sale of Common Stock at $.71 per share
between March 1993 and March 1994 105,000 1,050 73,950 - 75,000
Sale of Common Stock at $.93 per share in
January 1994 7,500 75 6,925 - 7,000
Sale of Common Stock at $.43 per share in
January 1994 23,333 233 9,767 - 10,000
Sale of Common Stock at $.80 per share in
March 1994 37,500 375 29,625 - 30,000
Sale of Common Stock at $1.11 per share in
March 1994 126,000 1,260 138,740 - 140,000
Sale of Common Stock at $.19 per share in
March 1994 30,000 300 5,250 - 5,550
Net loss for the period - - - (180,764) (180,764)
-----------------------------------------------------------------------------
Balance at March 31, 1994 929,333 9,293 264,764 (180,764) 93,293
Sale of Common Stock at $1.11 per share in
April 1994 28,286 283 31,146 - 31,429
Sale of Common Stock at $.43 per share in
May 1994 81,667 817 34,183 - 35,000
Sale of Common Stock at $1.11 per share in
May 1994 70,714 707 77,864 - 78,571
Value of warrants granted to consultants
for services in May 1994 - - 2,250 - 2,250
Sale of Common Stock at $6.00 per share in
June 1994 15,033 150 90,050 - 90,200
Note payable converted to Common Stock
at $6.00 per share in January 1995 1,667 17 9,983 - 10,000
Recapitalization resulting from election of
C Corporation status - - (307,754) 307,754 -
Net loss for the period - - - (1,934,387) (1,934,387)
-----------------------------------------------------------------------------
Balance at September 30, 1995 1,126,700 11,267 202,486 (1,807,397) (1,593,644)
Value of warrants issued in connection
with note payable in October 1995 - - 2,000 - 2,000
Net loss for the year - - - (4,048,076) (4,048,076)
-----------------------------------------------------------------------------
Balance at September 30, 1996 1,126,700 11,267 204,486 (5,855,473) (5,639,720)
Value of warrants granted for services
in June 1997 - - 14,772 - 14,772
Notes payable converted to Common Stock
at $6.00 per share in January 1997 73,209 732 438,522 - 439,254
Sale of Common Stock at $6.00 per share
in January 1997 500 5 2,995 - 3,000
Net loss for the year - - - (6,723,002) (6,723,002)
-----------------------------------------------------------------------------
Balance at September 30, 1997 1,200,409 $12,004 $660,775 $(12,578,475) $(11,905,696)
-----------------------------------------------------------------------------
-----------------------------------------------------------------------------
SEE ACCOMPANYING NOTES.
18
AetherWorks Corporation
(A Development Stage Company)
Statements of Cash Flows
PERIOD FROM
FEBRUARY 24,
1993 (INCEPTION)
YEAR ENDED SEPTEMBER 30 TO SEPTEMBER 30,
1997 1996 1997
-----------------------------------------------
OPERATING ACTIVITIES
Net loss for the period $(6,723,002) $(4,048,076) $(12,886,229)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization 877,904 247,268 1,132,416
Value of warrants granted in connection with note payable - 2,000 2,000
Value of warrants granted for services 14,772 - 17,022
Changes in operating assets and liabilities:
Prepaid expenses and other assets 14,788 (93,391) (79,180)
Accounts payable and accrued liabilities 1,213,128 77,109 2,106,930
-----------------------------------------------
Net cash used in operating activities (4,602,410) (3,815,090) (9,707,041)
INVESTING ACTIVITIES
Purchases of property and equipment (431,075) (358,132) (811,597)
Issuance of notes receivable from related party - (110,000) (110,000)
-----------------------------------------------
Net cash used in investing activities (431,075) (468,132) (921,597)
FINANCING ACTIVITIES
Net proceeds from issuance of notes payable 6,580,000 4,861,386 12,255,533
Payments of debt and capital leases (675,250) (589,637) (1,264,887)
Proceeds from sale of common stock 3,000 - 512,257
-----------------------------------------------
Net cash provided by financing activities 5,907,750 4,271,749 11,502,903
-----------------------------------------------
Increase (decrease) in cash and cash equivalents 874,265 (11,473) 874,265
Cash and cash equivalents at beginning of period - 11,473 -
-----------------------------------------------
Cash and cash equivalents at end of period $ 874,265 $ - $ 874,265
-----------------------------------------------
-----------------------------------------------
SUPPLEMENTAL SCHEDULE OF NONCASH FINANCING ACTIVITIES
Conversion of note payable for common stock $ 439,254 $ - $ 439,254
Property and equipment acquired through financing agreements (388,460) (3,613,209) (4,001,669)
Note payable for capital lease guarantee 370,000 - 370,000
SUPPLEMENTAL SCHEDULE OF CASH FLOW INFORMATION
Cash paid for interest 203,395 103,543 318,926
SEE ACCOMPANYING NOTES.
19
AetherWorks Corporation
(A Development Stage Company)
Notes to Financial Statements
September 30, 1997
1. DESCRIPTION OF BUSINESS
AetherWorks Corporation (the "Company") was formed on February 24, 1993 and is a
development stage company engaged in the design and development of software
which will integrate telephone, wireless electronic mail, facsimile, paging and
internet access on to one hardware platform and software that provides a
computer telephony framework on which software applications can operate in the
telephony environment.
2. SUMMARY OF ACCOUNTING POLICIES
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid investments with a maturity of three
months or less when purchased to be cash equivalents. Cash equivalents are
carried at cost which approximates market value.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. Depreciation is provided using the
straight-line method over the estimated useful lives of the assets of five
years.
DEFERRED FINANCING COSTS
Deferred financing costs consist of costs associated with issuing the 1995 Note
Purchase Agreement (see Note 3) and are being amortized over 36 months.
INCOME TAXES
Income taxes are accounted for under the liability method. Deferred income taxes
are provided for temporary differences between the financial reporting tax bases
of assets and liabilities.
NET LOSS PER SHARE
Net loss per share is computed by dividing the net loss for the period by the
weighted average number of shares of common stock outstanding during the period
presented. Common equivalent shares outstanding from stock options and warrants
are excluded from the computation as their effect is antidilutive.
20
2. SUMMARY OF ACCOUNTING POLICIES (CONTINUED)
RESEARCH AND DEVELOPMENT
All research and development costs are charged to operations as incurred.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts reported in the financial statements and accompanying notes.
Actual results could differ from those estimates.
STOCK-BASED COMPENSATION
The Company follows Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees" (APB 25), and related interpretations in accounting
for its stock options. Under APB 25, no compensation expense is recognized when
the exercise price of stock options equals the market price of the underlying
stock on the date of grant.
In October 1995, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" (Statement No. 123). Beginning October 1, 1996, the Company is
subject to the pro forma disclosure requirements of net income and earnings per
share as if Statement No. 123 had been used.
IMPAIRMENT OF LONG-LIVED ASSETS
The Company will record impairment losses on long-lived assets used in
operations when indicators of impairment are present and the undiscounted cash
flows estimated to be generated by those assets are less than the assets'
carrying amount.
RECLASSIFICATIONS
Certain amounts presented for fiscal 1996 have been reclassified to conform to
the 1997 presentations.
21
3. LONG-TERM DEBT AND CAPITAL LEASE OBLIGATIONS
Long-term debt, including capital leases, is:
SEPTEMBER 30
1997 1996
--------------------------
Notes payable under Note Purchase Agreement:
(see description of Note A below) $11,796,525 $5,296,525
(see description of Note B below) 1,772,895 -
Note payable to the City of St. Paul 80,000 -
8.8% notes payable to vendor - 280,710
Notes payable at interest rates from 8% to 9.75% - 366,664
Capitalized leases 3,229,291 1,088,772
--------------------------
16,878,711 7,032,671
Less current portion 861,964 927,204
--------------------------
$16,016,747 $6,105,467
--------------------------
--------------------------
In August 1994 through June 1995, the Company entered into various note payable
agreements ("Notes") which accrue interest ranging from 8.0% to 9.75% per annum.
The unsecured Notes were due on various dates between October 1995 and March
1996. The outstanding principal balance on the Notes was $366,664 as of
September 30, 1996. The Notes include amounts due from certain shareholders of
$47,000 as of September 30, 1996. As of September 30, 1996, some of the Notes
were beyond their maturity dates. The Notes were convertible at the holders'
option into shares of the Company's common stock at $6.00 per share and warrants
to purchase, at $7.20 per share, additional shares of common stock of the
Company equal to ten percent of the number of shares acquired by the holders
through conversion of the Notes. In January 1997 all of the note holders
converted their notes to $6.00 per share common stock as part of a Private
Placement Memorandum dated January 31, 1997. This conversion relieved the
Company of $366,664 notes due in addition to accrued interest of $72,590.
In October 1995, the Company entered into a 1995 Note Purchase Agreement
("the Agreement") with a data communications company ("Creditor"). Upon the
closing of the Agreement, the Company issued a convertible note for $3,363,235.
The Creditor
22
3. LONG-TERM DEBT AND CAPITAL LEASE OBLIGATIONS (CONTINUED)
committed to provide additional funding in the event that certain milestones
were attained, but had no obligation to provide continued funding in the event
two or more milestones were missed.
In June 1996, the Company restated and amended the 1995 Note Purchase Agreement,
principally to eliminate milestones set forth in the Agreement as well as to
obtain additional financing to acquire and develop new technology and to modify
the Creditor's option to convert all, but not less than all, of the aggregate
outstanding principal and interest of the Note into between 51% and 62.7% of the
common stock of the Company, depending on the amount of the Company's borrowings
from the Creditor. Upon the closing of the 1996 Restated and Amended Note
Purchase Agreement (the "1996 Note Purchase Agreement"), the Company issued an
additional note to the Creditor in the amount of $1,433,290. The 1996 Note
Purchase Agreement also gives the Company the option to issue additional notes
to the Creditor, provided that the aggregate amount of the additional notes does
not exceed $9 million. The Company had issued additional notes for $500,000 as
of September 30, 1996. In 1997, the Company issued additional notes for
$6,500,000 which brought the total amount of notes outstanding at September 30,
1997 to $11,796,525. The notes bear interest at prime plus 3% (11.50% at
September 30, 1997) with principal and interest payable on December 31, 1998.
In October 1997, the Company restated and amended the 1996 Note Purchase
Agreement, principally to provide the Company the ability to pay back a portion
of convertible notes. Upon the closing of the 1997 Note Purchase Agreement ("the
1997 Agreement"), the Company exchanged all outstanding convertible notes for a
new convertible note ("Note A") to the Creditor in the amount of $11,796,525.
The 1997 Agreement also gives the Company the option to obtain additional
advances from the Creditor, provided that the aggregate amount of the additional
advances does not exceed $2,000,000. Funds advanced to the Company will be added
to Note A, which bears interest at prime plus 3%. The unpaid principal is
payable on December 31, 1998. The note is convertible into common stock of the
Company at varying rates based upon the amount of the outstanding debt.
If the Company does not pay the balance of Note A by December 31, 1998, the
Agreement provides for the mandatory conversion of the entire balance due into
shares of common stock. An optional conversion also exists if the Company
undergoes an initial
23
3. LONG-TERM DEBT AND CAPITAL LEASE OBLIGATIONS (CONTINUED)
public offering prior to the due date or in the event of a majority sale of
Company assets, a merger or consolidation, or the sale of 80% or more of the
Company's outstanding capital stock to a party other than the Creditor or to any
person who is a shareholder of the Company.
The Company also issued a second non-convertible note ("Note B") under the 1997
Agreement in the amount of $1,802,626 to the Creditor. This amount consists of
$1,402,895 for all of the outstanding aggregate accrued interest at September
30, 1997 on the previously outstanding notes, $29,731 for accrued interest to
the date of the 1997 Agreement, and $370,000 as consideration for certain lease
guarantees provided by the Creditor. The outstanding balance of Note B will
increase by the amount of interest that accrues on Note A. Note B bears interest
at prime plus 3%. The unpaid principal and interest balance is payable on
December 31, 2000.
On November 27, 1996, the Company entered into a promissory note (the "Note")
for $80,000 with the Housing and Redevelopment Authority of the City of Saint
Paul. The Note bears interest at 10.25% per annum and is payable semi-annually
through its maturity date of November 27, 2001. The Note was issued under the
provisions of an accompanying loan agreement which allows for all or a portion
of the Note to be forgiven based on defined employment levels and events of
default which may accelerate the due date. The Company received the proceeds
from this Note in June 1997 and has accrued $3,417 in interest at September 30,
1997.
The carrying amounts of the Company's debt instruments in the balance sheets at
September 30, 1997 and 1996 approximate fair value.
In connection with the financing agreements, the Company has incurred cumulative
financing costs of $805,139, including $370,000 payable to the Creditor as
compensation for their guarantee of certain lease agreements. This amount is
being amortized over the respective terms of the related instruments through
September 2002.
During fiscal 1996 and 1997, the Company leased certain equipment, computer
hardware and computer software under several long-term lease agreements which
are classified as capital leases. The Creditor of the Restated and Amended Note
Purchase Agreement guaranteed the majority of the Company's lease agreements.
24
3. LONG-TERM DEBT AND CAPITAL LEASE OBLIGATIONS (CONTINUED)
Leased assets included in the accompanying balance sheet as of September 30,
1997 consist of:
Property and equipment:
Computer hardware $2,992,073
Computer software 109,775
Furniture and fixtures 698,791
----------
3,800,639
Less accumulated amortization 561,310
----------
Net assets under capital leases $3,239,329
----------
----------
Future minimum lease payments under capital leases and principal maturities of
long-term debt consist of the following:
CAPITAL LONG-TERM
LEASES DEBT TOTAL
---------------------------------------
Year ending September 30:
1998 $1,148,933 $ 20,847 $ 1,169,780
1999 997,802 11,793,647 12,791,449
2000 969,427 1,793,740 2,763,167
2001 542,750 20,847 563,597
2002 266,896 20,339 287,235
---------------------------------------
Total minimum payments 3,925,808 13,649,420 17,575,228
Less amount representing interest 696,517 - 696,517
---------------------------------------
Present value of net minimum
payments 3,229,291 13,649,420 16,878,711
Less current portion 848,993 12,971 861,964
---------------------------------------
Long-term debt and capital lease
obligations $2,380,298 $13,636,449 $16,016,747
---------------------------------------
---------------------------------------
4. OPERATING LEASES
The Company leases various property and equipment under operating leases that
expire on various dates through fiscal 1999. On August 13, 1996, the Company
entered into an operating lease for its office facility in St. Paul, Minnesota
and its technical facility in Santa Clara, California, on May 15, 1996, which
expire in fiscal 2002 and 1999, respectively. Operating expenses including
maintenance, certain utilities and insurance
25
4. OPERATING LEASES (CONTINUED)
are paid by the Company. The Company used office space of the Creditor per the
1995 Note Purchase Agreement (see Note 3) on a rent-free basis for the period
from November 1, 1995 to September 30, 1996. Total rent expense under non-
cancelable operating leases was $352,951 and $95,727 for the years ended
September 30, 1997 and 1996, respectively.
Future minimum lease rental payments required under non-cancelable operating
leases in excess of one year as of September 30, 1997 are as follows:
1998 $356,898
1999 280,895
2000 130,310
2001 136,298
2002 71,143
--------
$975,544
--------
--------
5. INCOME TAXES
Upon inception, the Company operated as an S Corporation whereby taxable income
or loss is passed through to the shareholders. The Subchapter S election was
terminated on May 31, 1994 and, as a result, the Company became subject to
federal and state income taxes. Also, as of that date, the Company's accumulated
deficit of $307,754 incurred while the Company was an S Corporation was
reclassified as additional paid-in capital.
At September 30, 1997 the Company had net operating loss carryforwards of
approximately $12,500,000 which are available to offset future taxable income
and begin to expire in the year 2010 and are subject to limitations if
significant ownership changes occur.
The deferred tax assets resulting from net operating loss carryforwards and
other temporary differences are fully offset by a valuation allowance.
26
6. STOCK OPTIONS AND WARRANTS
The Company has a stock option plan (the 1997 Stock Option Plan) which provides
for the granting of 300,267 incentive stock options to employees and
nonqualified stock options to employees, directors, and consultants. The
incentive stock options granted to employees vest according to a two-phase
schedule. In phase one no options shall vest until the sooner of the following
dates: (1) January 2, 1999, or (2) 90 days after the Company's initial public
offering. Upon the occurrence of the sooner of the dates in phase one, options
shall vest according to optionee's years of service with the Company, measured
retroactively from the date of first employment with the Company and extending
over a subsequent period of no longer than six years, beginning with 20% vesting
on the first anniversary date of employment and increasing in 20% increments
each year thereafter. The non-qualified stock options granted during fiscal year
end September 30, 1997 vested immediately.
Stock options and warrants outstanding are summarized as follows:
SHARES PLAN OPTIONS
AVAILABLE OUTSTANDING WEIGHTED
FOR GRANT ------------------------- AVERAGE
UNDER THE NON- EXERCISE
PLAN INCENTIVE QUALIFIED WARRANTS PRICE
--------------------------------------------------------------
Balance at September 30, 1995 - 30,833 $6.32
Warrants granted - 1,667 7.20
------------------------------------------------
Balance at September 30, 1996 - 32,500 6.37
Warrants granted - 12,364 7.20
Establishment of plan 300,267 - - - -
Options granted (180,053) 155,043 25,010 - 7.20
Options canceled 22,685 (22,685) - - 7.20
------------------------------------------------
Balance at September 30, 1997 142,899 132,358 25,010 44,864 $7.06
------------------------------------------------
------------------------------------------------
Options and warrants exercisable
at September 30, 1997 - 25,010 43,530 $6.80
-------------------------------------
-------------------------------------
Options and warrants exercisable
at September 30, 1996 - - 30,833 $6.32
-------------------------------------
-------------------------------------
FASB Statement No. 123 requires that the fair value of options granted during
1997 and 1996 and the pro forma impact on earnings be discussed when material.
The impact was not material for 1997 and 1996.
27
7. LICENSE AGREEMENT
On June 28, 1996, the Company entered into a license agreement with an entity to
acquire certain rights and documentation relating to speech input-output
software. The Company paid a non-refundable engineering fee of $125,010 and a
royalty payment of $10,000 upon the execution of the agreement. Subsequent to
entering into the license agreement, the Company determined that the entity
could not provide them with the product they had expected. Consequently the
contract was canceled and the royalty and engineering fees were redeemed.
8. RELATED PARTY TRANSACTION
In June 1996, the Company loaned the President and Chief Executive Officer of
the Company $110,000 under a promissory note. The note, which bears interest at
7.25% per annum, is due on or before June 10, 2001.
9. BENEFIT PLAN
In May 1996, the Company established a defined contribution retirement plan
covering substantially all employees under Section 401(k) of the Internal
Revenue Code. The Company recorded an expense of $51,196 and $9,685 for
contributions to the Plan for the years ended September 30, 1997 and 1996,
respectively.
10. GOING CONCERN
As reflected in the accompanying financial statements, the Company has
accumulated a deficit during its development stage. The Company may be unable to
maintain solvency unless it continues to obtain additional financing to continue
as a going concern. The Company intends to obtain additional debt or equity
financing in fiscal 1998 to fund operations.
Because of uncertainties regarding the achievability of management's plans, no
assurances can be given as to the Company's ability to continue in existence.
The financial statements do not include any adjustments to reflect the possible
future effects on the recoverability and classification of assets or the amount
and classification of liabilities that may result from the possible inability of
the Company to continue as a going concern.
28
Report of Independent Auditors
Board of Directors and Shareholders
AetherWorks Corporation
We have audited the accompanying 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 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 accompanying financial statements have been prepared assuming the Company
will continue as a going concern. As discussed in Note 10 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
29
REPORT OF INDEPENDENT ACCOUNTANTS
To the Stockholders and Board of Directors of
Digi International Inc.
Our report on the consolidated financial statements of Digi International
Inc. has been incorporated by reference in this Form 10-K from page 32 of the
1997 Annual Report to Stockholders of Digi International Inc. In connection
with our audits of such financial statements, we have also audited the related
financial statement schedule listed in Item 14(a)3 on page 12 of this Form 10-K.
In our opinion, the financial statement schedule referred to above, when
considered in relation to the basic financial statements taken as a whole,
presents fairly, in all material respects, the information required to be
included therein.
COOPERS & LYBRAND L.L.P.
Minneapolis, Minnesota
December 15, 1997
30
Digi International Inc.
Schedule II
Valuation and Qualifying Accounts
Balance at Charged to Deductions
Beginning Charged to Other from Balance at
of Year Expense Accounts Allowance End of Year
----------- ----------- ----------- ----------- -----------
Deducted from Accounts Receivable-
Allowance for Doubtful Accounts:
Year ended September 30: 1995 $641,500 $243,895 $228,895(1) $656,500
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
1996 $656,500 $262,164 $183,222(1) $735,442
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
1997 $735,442 $1,533,251 $1,488,940(1) $1,179,753
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
Deducted from Inventory-Allowance
for Inventory Obsolesence:
Year ended September 30: 1995 $682,000 $716,300 $586,300(2) $812,000
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
1996 $812,000 $1,455,895 $1,099,735(2) $1,168,176
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
1997 $1,168,176 $2,910,988 $2,936,967(3) $4,823,351(2) $2,192,780
----------- ----------- ----------- ----------- -----------
----------- ----------- ----------- ----------- -----------
(1) Uncollectible accounts charged against allowance.
(2) Scrapped inventory charged against allowance.
(3) Charged to restructuring.
31
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 26, 1997 By: /s/ Jonathon E. Killmer
- ----------------------------------- -------------------------------
Date Jonathon E. Killmer
Senior Vice President & Chief
Financial 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 26, 1997 /s/ Jerry A. Dusa
- ----------------------------------- -----------------------------------
Date Jerry A. Dusa
President & Chief Executive Officer
December 26, 1997 /s/ Jonathon E. Killmer
- ----------------------------------- -----------------------------------
Date Jonathon E. Killmer
Senior Vice President & Chief
Financial Officer
JOHN P. SCHINAS
WILLIS K. DRAKE
JERRY A. DUSA
RICHARD E. EICHHORN
MYKOLA MOROZ A majority of the Board of Directors*
DAVID STANLEY
ROBERT S. MOE
*Jonathon E. Killmer, by signing his name hereto, does hereby sign this document
on behalf of each of the above named directors of the Registrant pursuant to
Power of Attorney duly executed by such persons.
/s/ Jonathon E. Killmer
------------------------------
Jonathon E. Killmer,
Attorney-in-fact
32
INDEX TO EXHIBITS
Exhibit
Number Description Page
- ------ ----------- ----
3(a) Restated Certificate of Incorporation of the Registrant (4). .
3(b) Amended and Restated By-Laws of the Registrant (2) . . . . . .
10(a) Stock Option Plan of the Registrant. . . . . . . . . . . . . .
10(b) Form of indemnification agreement with directors
and officers of the Registrant (1) . . . . . . . . . . . . . .
10(c) Amended and Restated Employment Agreement
between the Company and John P. Schinas (5). . . . . . . . . .
10(d) Restated and Amended Note Purchase Agreement
between the Company and AetherWorks Corporation,
dated October 14, 1997 . . . . . . . . . . . . . . . . . . . .
10(e) Employment Arrangement between the Registrant
and Mike Kelley, dated February 7, 1996 (8). . . . . . . . . .
10(f) 401(k) Savings and Profit Sharing Plan of
Digi International Inc. (3). . . . . . . . . . . . . . . . . .
10(h) Consulting Agreement between the Company
and Mykola Moroz (5) . . . . . . . . . . . . . . . . . . . . .
10(i) Employment Arrangement between the Registrant
and Jonathon E. Killmer, dated September 16, 1996 (8). . . . .
10(j) Employment Arrangement between the Registrant
and David Rzasa, dated September 30, 1996 (8). . . . . . . . .
10(k) Separation Agreement between the Company
and Gerald A. Wall, dated December 4, 1996 (8) . . . . . . . .
10(l) Separation Agreement between the Company and
Ervin F. Kamm, Jr. dated January 3, 1997 (9) . . . . . . . . .
10(m) Employment Agreement between the Company and
Jerry A. Dusa, dated March 12, 1997 (10) . . . . . . . . . . .
33
INDEX TO EXHIBITS
(continued)
Exhibit
Number Description Page
- ------ ----------- ----
10(n) Employment Agreement with Ray D. Wymer, as
amended by Amendment No. 1 to Employment
Agreement (7). . . . . . . . . . . . . . . . . . . . . . . . .
10(p) Employment Arrangement between the Registrant
and Douglas Glader (7) . . . . . . . . . . . . . . . . . . . .
10(p)(i) Amendment to Employment Agreement between
the company and Douglas Glader (9) . . . . . . . . . . . . . .
10(q) Employment Arrangement between the Registrant
and Dana R. Nelson for fiscal 1995 and 1996 (7). . . . . . . .
10(r) Employment Agreement between the Company and
Dino Kasdagly, dated October 1, 1997 . . . . . . . . . . . . .
10(s) Employee Stock Purchase Plan of the Registrant (6) . . . . . .
13 1997 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 Registrant . . . . . . . . . . . . . . . .
23.1 Consent of Independent Accountants . . . . . . . . . . . . . .
23.2 Consent of Independent Accountants . . . . . . . . . . . . . .
24 Powers of Attorney . . . . . . . . . . . . . . . . . . . . . .
27 Financial Data Schedule. . . . . . . . . . . . . . . . . . . .
34