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
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.
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
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
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.
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
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.
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
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.
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
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
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
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
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,
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)
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).
(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).
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.
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.
AetherWorks Corporation (A Development Stage Company)
Statement of Shareholders' Equity (Deficit)
SEE ACCOMPANYING NOTES.
AetherWorks Corporation (A Development Stage Company)
Statements of Cash Flows
SEE ACCOMPANYING NOTES.
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.
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.
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
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
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.
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
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.
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:
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.
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.
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
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
Digi International Inc. Schedule II Valuation and Qualifying Accounts
(1) Uncollectible accounts charged against allowance.
(2) Scrapped inventory charged against allowance.
(3) Charged to restructuring.
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
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) . . . . . . . . . . .
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. . . . . . . . . . . . . . . . . . . .
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART III
ITEM 10.
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
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
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
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
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,
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)
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).
(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).
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.
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.
AetherWorks Corporation (A Development Stage Company)
Statement of Shareholders' Equity (Deficit)
SEE ACCOMPANYING NOTES.
AetherWorks Corporation (A Development Stage Company)
Statements of Cash Flows
SEE ACCOMPANYING NOTES.
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.
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.
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
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
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.
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
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.
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:
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.
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.
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
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
Digi International Inc. Schedule II Valuation and Qualifying Accounts
(1) Uncollectible accounts charged against allowance.
(2) Scrapped inventory charged against allowance.
(3) Charged to restructuring.
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
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) . . . . . . . . . . .
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. . . . . . . . . . . . . . . . . . . .
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
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
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,
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)
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).
(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).
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.
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.
AetherWorks Corporation (A Development Stage Company)
Statement of Shareholders' Equity (Deficit)
SEE ACCOMPANYING NOTES.
AetherWorks Corporation (A Development Stage Company)
Statements of Cash Flows
SEE ACCOMPANYING NOTES.
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.
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.
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
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
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.
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
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.
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:
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.
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.
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
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
Digi International Inc. Schedule II Valuation and Qualifying Accounts
(1) Uncollectible accounts charged against allowance.
(2) Scrapped inventory charged against allowance.
(3) Charged to restructuring.
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
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) . . . . . . . . . . .
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. . . . . . . . . . . . . . . . . . . .