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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------------
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended
December 31, 2002
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission File Number: 000-28687
DIGITALTHINK, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 94-3244366
(STATE OR OTHER JURISDICTION OF (IRS EMPLOYER IDENTIFICATION
INCORPORATION OR ORGANIZATION) NUMBER)
601 BRANNAN STREET, SAN FRANCISCO, CALIFORNIA, 94107
(Address of principal executive offices)
(415) 625-4000
(Registrant's telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
As of February 4, 2003, Registrant had outstanding 41,534,599 Common Stock,
$0.001 par value.
TABLE OF CONTENTS
PART I: FINANCIAL INFORMATION
ITEM 1. Financial Statements (Unaudited):
Condensed Consolidated Balance Sheets - December 31, 2002
and March 31, 2002
Condensed Consolidated Statements of Operations - three and
nine months ended December 31, 2002 and December 31, 2001
Condensed Consolidated Statements of Cash Flows - nine months
ended December 31, 2002 and December 31, 2001
Notes to Condensed Consolidated Financial Statements
ITEM 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations, including Factors Affecting Future Results
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk
ITEM 4. Controls and Procedures
PART II: OTHER INFORMATION
ITEM 1. Legal Proceedings
ITEM 2. Changes in Securities and Use of Proceeds
ITEM 3. Defaults Upon Senior Securities
ITEM 4. Submission of Matters to a Vote of Security Holders
ITEM 5. Other Matters
ITEM 6. Exhibits and Reports on Form 8-K
Signatures
Certifications
DIGITALTHINK, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
December 31, March 31,
2002 2002
-------------- ----------
ASSETS
Current assets:
Cash and cash equivalents $ 22,122 $ 29,470
Marketable securities -- 1,640
Accounts receivable, net of allowance for doubtful
accounts of $300 and $484, respectively 4,472 5,779
Prepaid expenses and other current assets 1,578 1,675
---------- ---------
Total current assets 28,172 38,564
Restricted cash and deposits 4,141 4,083
Property and equipment, net 15,675 18,325
Goodwill and other intangible assets 24,052 75,300
---------- ---------
Total assets $ 72,040 $ 136,272
========== =========
LIABILITIES & STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 2,701 $ 3,569
Accrued liabilities 4,589 7,938
Borrowings under line of credit and notes payable 5,296 2,577
Deferred revenues 3,206 7,043
---------- ---------
Total current liabilities 15,792 21,127
Long-term liabilities 4,948 5,419
Stockholders' equity:
Common stock - $0.001 per share value; shares
authorized: 250,000; shares issued and
outstanding: 41,522 at December 31, 2002
and 40,452 at March 31, 2002 268,653 267,814
Deferred stock compensation (262) (631)
Accumulated other comprehensive losses (303) (264)
Accumulated deficit (216,788) (157,193)
----------- ---------
Total stockholders' equity 51,300 109,726
----------- ---------
Total liabilities and stockholders' equity $ 72,040 $ 136,272
========== =========
See accompanying notes to the condensed consolidated financial statements.
DIGITALTHINK, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
DECEMBER 31, DECEMBER 31,
------------------- -------------------
2002 2001 2002 2001
------------------- -------------------
Revenues:
Delivered Learning fees $ 5,554 $ 7,397 $ 16,415 $ 23,414
Learning Solution services 5,481 6,410 14,248 20,687
------- -------- ------- --------
Total revenues 11,035 13,807 30,663 44,101
Costs and expenses:
Cost of Delivered Learning fees 1,042 1,567 3,657 5,137
Cost of Learning Solution services 1,852 3,023 4,928 9,761
Content research and development 1,346 1,862 4,214 5,163
Technology research and development 1,667 2,603 5,267 9,002
Selling and marketing 3,355 4,676 10,268 17,276
General and administrative 1,510 1,604 5,357 5,152
Depreciation 1,729 1,308 5,253 3,818
Acquisition and other related charges -- -- -- 5,792
Amortization of goodwill and other
intangibles 341 2,114 1,059 5,109
Restructuring charge adjustments (83) -- (83) --
Amortization of warrants 4 2,751 5 8,253
Stock-based compensation * 105 469 368 1,638
------- ------- -------- --------
Total costs and expenses 12,868 21,977 40,293 76,101
------- ------- -------- --------
Loss from operations (1,833) (8,170) (9,630) (32,000)
Interest and other income 60 324 224 1,731
------- ------- -------- --------
Net loss before cumulative
effect of accounting change (1,773) (7,846) (9,406) (30,269)
Cumulative effect of accounting change -- -- (50,189) --
------- -------- -------- --------
Net Loss $ (1,773) $(7,846) $(59,595) $(30,269)
========= ======== ========= =========
Net loss per share--basic and diluted:
Before cumulative effect of
accounting change $ (0.04) $ (0.20) $ (0.23) $ (0.81)
Cumulative effect of accounting change -- -- (1.22) --
-------- -------- --------- ---------
Net loss per share--basic and diluted $ (0.04) $ (0.20) $ (1.45) $ (0.81)
========= ======== ========= =========
Shares used in basic and diluted
loss per common share 41,372 40,212 41,090 37,441
(*) Stock-based compensation:
Cost of Delivered Learning fees $ 1 $ 6 $ 3 $ 23
Cost of Learning Solution services 11 40 37 140
Content research and development 1 5 3 30
Technology research and development 26 116 92 493
Selling and marketing 33 173 117 370
General and administrative 33 129 116 582
-------- ------ ------ -------
Total $ 105 $ 469 $ 368 $ 1,638
======== ====== ======= ========
See accompanying notes to the condensed consolidated financial statements.
DIGITALTHINK, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
NINE MONTHS ENDED DECEMBER 31,
2002 2001
------------ ------------
Cash flows from operating activities:
Net loss $ (59,595) $ (30,269)
Adjustments to reconcile net loss to net
cash used in operating activities:
Depreciation 5,253 3,818
Cumulative effect of accounting change 50,189 --
Amortization of deferred stock compensation 368 1,638
Amortization of warrants 5 8,253
Amortization of goodwill and other intangibles 1,059 5,109
Restructuring charge adjustments (83) --
Loss on disposal of assets 64 --
Acquisition and other related charges -- 5,327
Changes in assets and liabilities:
Restricted cash (58) 254
Accounts receivable 1,308 (825)
Other current assets 96 1,393
Other current liabilities (5,086) (8,118)
Deferred revenue (3,836) (8,199)
Long term liabilities 333 --
--------- ----------
Net cash used in operating activities (9,983) (21,619)
--------- ----------
Cash flows from investing activities:
Purchases of property and equipment (2,759) (8,908)
Sale of fixed assets 92 --
Net cash paid in acquisition -- (954)
Purchases of marketable securities -- (12,859)
Proceeds from maturities of marketable securities 1,640 39,493
-------- ----------
Net cash provided by (used in)
investing activities (1,027) 16,772
-------- ----------
Cash flows from financing activities:
Proceeds from sale of common stock 834 2,476
Principal payments on line of credit and notes -- (3,569)
Borrowings on line of credit 2,855 2,245
------- ----------
Net cash provided by financing
activities 3,689 1,152
------- ----------
Effect of exchange rates on cash and cash
equivalents (27) (181)
Net decrease in cash and cash equivalents (7,348) (3,876)
Cash and equivalents, beginning of the period 29,470 30,512
--------- ----------
Cash and equivalents, end of period $ 22,122 $ 26,636
========= ==========
See accompanying notes to the condensed consolidated financial statements.
Notes to Condensed Consolidated Financial Statements (Unaudited)
1. Basis of Presentation
DigitalThink, Inc. (the "Company") provides custom e-learning solutions designed
to address the strategic business objectives of our customers through training
courseware and the delivery of that courseware on a robust technology platform.
The Company completed the initial development of its delivery technology and
initial content, and began substantial sales and marketing efforts in fiscal
year 1998. In November 1999, the Company reincorporated in Delaware from
California.
The condensed consolidated financial statements included herein have been
prepared by the Company, without audit, pursuant to the rules and regulations of
the Securities and Exchange Commission. Certain information and footnote
disclosures normally included in financial statements prepared in accordance
with generally accepted accounting principles have been condensed or omitted
pursuant to such rules and regulations, although management believes the
disclosures which are made are adequate to make the information presented not
misleading. It is suggested that this document be read in conjunction with the
consolidated financial statements and the notes thereto included in the
Company's Annual Report on Form 10-K, as amended on Form 10-K/A, for the fiscal
year ended March 31, 2002.
The unaudited condensed consolidated financial statements included herein
reflect all adjustments (which include only normal, recurring adjustments) which
are, in the opinion of management, necessary to state fairly the results for the
periods presented. The results for such periods are not necessarily indicative
of the results to be expected for the entire fiscal year ending March 31, 2003.
Certain prior year amounts in the condensed consolidated financial statements
have been reclassified to conform to the current year presentation.
2. Net Loss Per Share
The following table sets forth the computation of net loss per share (in
thousands, except for per share data):
Three Months Ended Nine Months Ended
December 31, December 31,
------------------ ------------------
2002 2001 2002 2001
------- --------- -------- --------
Net loss before cumulative effect of
accounting change $ (1,773) $ (7,846) $ (9,406) $(30,269)
Cumulative effect of accounting
change -- -- (50,189) --
--------- --------- -------- --------
Net loss $ (1,773) $ (7,846) $(59,595) $(30,269)
========= ========= ========= =========
Weighted average common shares
outstanding used in computing
basic and diluted loss per share 41,372 40,212 41,090 37,441
========= ========= ========= =========
Net loss per share:
Before cumulative effect of
accounting change $ (0.04) $ (0.20) $ (0.23) $ (0.81)
Cumulative effect of accounting change -- -- (1.22) --
--------- --------- -------- ---------
Net loss per share--basic and diluted $ (0.04) $ (0.20) $ (1.45) $ (0.81)
========= ========= ======== =========
Basic net loss per share excludes dilution and is computed by dividing loss
attributable to common stockholders by the weighted average number of common
shares outstanding during the period. Diluted loss per common share excludes the
potential dilution that could occur if securities or other contracts to issue
common stock were exercised or converted into common stock, as the effect of
such conversions in loss periods would be anti-dilutive.
3. Restructuring Charge
In March 2002, the Company initiated a strategic initiative, under which the
Company restructured its business in response to the current market environment
and as part of the Company's continuing program to create efficiencies within
its operations. The following table sets forth the activity related to the
restructuring charge in the nine months ended December 31, 2002 (in thousands):
Remaining Amounts
Liability recorded in Remaining Liability
Balances as of Cash Other Net Balances as of
March 31, 2002 Payments Accounts Adjustments December 31, 2002
-------------- -------- --------- ------------- ------------------
Severance $ 210 $ (210) $ -- $ -- $ --
Facilities and
equipment 32 -- (32) -- --
Lease
commitments 7,627 (1,418) (244) (83) 5,882
------- ---------- ------- -------- -------
Total $ 7,869 $ (1,628) $ (276) $ (83) $5,882
======= ========== ======= ======== =======
At March 31, 2002, restructuring charge obligations were recorded as $2.5
million in accrued liabilities and $5.3 million in long-term liabilities. At
December 31, 2002, restructuring charge obligations were recorded as $985,000 in
accrued liabilities and $4.9 million in long-term liabilities. The amounts
recorded in other accounts are balances that have been reclassified into
accounts payable from accrued liabilities as amounts have been invoiced and are
due. The net adjustments of $83,000 were made to the restructuring accrual based
on events occurring during the three months ended December 31, 2002, as a
reversal of previously expensed restructuring costs. This reversal was the
result of the Company subleasing one property earlier than expected resulting in
a reversal of approximately $450,000, offset by estimates of sublease income
associated with another property at a lower rental rate than originally expected
resulting in an additional accrual of approximately $367,000.
4. Revenue Recognition
Delivered Learning fees allow access to training systems, courses hosted by the
Company, tutor support, and other learning materials for a fixed period,
typically six to twelve months. Delivered Learning fees are recognized ratably
over this access period. Revenues for Learning Solution services, including
custom course development or consulting services, are recognized as earned in
accordance with Statement of Position (SOP) 81-1, Accounting for Performance of
Construction/Production-Type Contracts, as development progresses based on the
percentage of completion method. The percentage of completion is based on the
ratio of actual custom development or service costs incurred to date, to total
estimated costs to complete the custom course or service. Provisions for
estimated losses on incomplete contracts will be made on a contract-by-contract
basis and recognized in the period in which such losses become probable and can
be reasonably estimated. To date, there have been no material losses. Custom
contracts typically call for non-refundable payments due upon achievement of
certain milestones in production of the courses or in consulting services.
Deferred revenues represent customer prepayments for both Delivered Learning
fees and Learning Solution services.
5. Change in Accounting for Goodwill and Certain Intangibles
Effective April 1, 2002, the Company adopted Statement of Financial Accounting
Standards (SFAS) No. 141, Business Combinations. SFAS No. 141 requires that the
purchase method of accounting be used for all combinations initiated after June
30, 2001. The adoption of SFAS No. 141 did not have an impact on the results of
operations, financial position or liquidity of the Company.
Effective April 1, 2002, the Company adopted SFAS No. 142, Goodwill and Other
Intangible Assets. SFAS No. 142 addresses the initial recognition and
measurement of intangible assets acquired outside of a business combination and
the accounting for goodwill and other intangible assets subsequent to their
acquisition. SFAS No. 142 provides that intangible assets with finite useful
lives be amortized and that goodwill and intangible assets with indefinite lives
will not be amortized, but will rather be tested at least annually for
impairment. Intangible assets, including goodwill, that are not subject to
amortization will be tested for impairment annually, or more frequently if
events or changes in circumstances indicate that the asset might be impaired,
using a two step impairment assessment. The first step of the impairment test
identifies potential impairment and compares the fair value of the reporting
unit (the Company in this case) with its carrying amount, including goodwill. If
the fair value of the reporting unit exceeds its carrying amount, goodwill of
the reporting unit is not considered impaired, and the second step of the
impairment test is not necessary. If the carrying amount of the reporting unit
exceeds its fair value, the second step of the impairment test shall be
performed to measure the amount of the impairment loss, if any. During the
second quarter ending September 30, 2002, we performed the required impairment
tests of goodwill and indefinite-lived intangible assets as of April 1, 2002. We
incurred a reduction in goodwill of $50.2 million upon the completion of our
analysis, which resulted in a charge to the results of operations from the
cumulative effect of the adoption of a new accounting principle during the nine
months ended December 31, 2002. The impaired goodwill was not deductible for
taxes, and as a result, no tax benefit was recorded in relation to the charge.
The Company performed its annual goodwill impairment analysis on October 31,
2002, using a valuation model based on market capitalization adjusted for
outstanding debt, consistent with the model used as of April 1, 2002. This
analysis indicated that no additional adjustments were required to the remaining
goodwill balance.
The following sets forth a summary of net loss and net loss per share
information for the three and nine months ended December 31, 2002 and 2001
adjusted for the non-amortization provisions of SFAS No. 142 (in thousands,
except per share amounts):
Three Months Ended Nine Months Ended
December 31, December 31,
------------------ -----------------
2002 2001 2002 2001
------- -------- ------- -------
Reported net loss before
cumulative effect of accounting
change $(1,773) $(7,846) $ (9,406) $(30,269)
Reported net loss $(1,773) $(7,846) $(59,595) $(30,269)
Goodwill amortization -- $ 1,491 -- $ 4,183
Adjusted net loss before
cumulative effect of accounting
change $(1,773) $(6,355) $ (9,406) $(26,086)
Adjusted net loss $(1,773) $(6,355) $(59,595) $(26,086)
Weighted average common shares
outstanding used in computing
basic and diluted loss per share 41,372 40,212 41,090 37,441
Basic and diluted net loss per share:
Reported net loss per share
before cumulative effect of
accounting change $ (0.04) $ (0.20) $ (0.23) $ (0.81)
Reported net loss per share $ (0.04) $ (0.20) $ (1.45) $ (0.81)
Goodwill amortization -- $ (0.04) -- $ (0.11)
Adjusted net loss per share--
basic and diluted before
cumulative effect of
accounting change $ (0.04) $ (0.16) $ (0.23) $ (0.70)
Adjusted net loss per share--
basic and diluted $ (0.04) $ (0.16) $ (1.45) $ (0.70)
Changes in the carrying amount of goodwill for the nine months ended December
31, 2002, were as follows (in thousands):
Balance at March 31, 2002 $ 69,818
Cumulative effect of change in accounting principle (50,189)
-----------------
Balance at December 31, 2002 $ 19,629
=================
The gross carrying amount and accumulated amortization of the Company's
intangible assets other than goodwill as of March 31, 2002 and December 31, 2002
are as follows (in thousands):
March 31, 2002 December 31, 2002
--------------------------- --------------------------
Gross Net Gross Net
Carrying Accumulated Book Carrying Accumulated Book
Amount Amortization Value Amount Amortization Value
------- ------------ ----- ------- ------------ -----
Amortized Intangible
Assets:
LearningByte acquired
technology $6,100 $ (762) $5,338 $6,100 $(1,677) $4,423
TCT acquired
technology 215 (71) 144 215 (215) --
------- -------- ------- ------ -------- -------
Total $6,315 $ (833) $5,482 $6,315 $(1,892) $4,423
======= ======== ======= ====== ======== =======
Amortization expense recorded on the intangible assets for the three and nine
months ended December 31, 2002 was $341,000 and $1.1 million, respectively, and
was $623,000 and $926,000 for the three and nine months ended December 31, 2001.
The estimated future amortization expense by fiscal year is as follows: fourth
quarter of fiscal 2003 is $303,000; 2004 is $1.2 million; 2005 is $1.2 million;
2006 is $1.2 million and 2007 is $406,000.
6. Contingencies
In October 2001, a complaint was filed in the United States District Court for
the Southern District of New York against DigitalThink, certain of its officers
and directors, and certain underwriters of the Company's initial public
offering. The complaint was purportedly filed on behalf of a class or certain
persons who purchased DigitalThink's common stock between February 24, 2000 and
December 6, 2000. The complaint alleges violations by DigitalThink and its
officers and directors of the Securities Act of 1933 in connection with certain
alleged compensation arrangements entered into by the underwriters in connection
with the offering. Substantially similar complaints have been filed against over
300 other issuers that have had initial public offerings since 1998.
In August 2002, a complaint was filed in the United States District Court for
the Northern District of California by IP Learn, LLC against DigitalThink and
two of its customers. The complaint alleges that DigitalThink has infringed
certain patents that have been assigned to IP Learn. Substantially similar
complaints have been filed against other companies in the e-learning industry,
including Smartforce, PLC, SkillSoft Corporation, Saba Software, Inc. and
Docent, Inc.
In November 2002, a complaint was filed in the United States District Court for
the Southern District of Texas, Houston Division by IP Innovation LLC v. Thomson
Learning, Inc., Skillsoft Corporation, eCollege.com, DigitalThink, Inc., Docent,
Inc., Blackboard, Inc., Global Knowledge Network, Inc. and The Princeton Review.
The complaint alleges that DigitalThink and the other defendants have infringed
a patent that has been assigned to IP Innovation.
Although no assurances can be given that these matters will be resolved in the
Company's favor, the Company believes the resolution of these lawsuits will not
have a material adverse effect on its financial position, results of operations,
or cash flows.
7. Recent Pronouncements
In October 2001, the Financial Accounting Standards Board (FASB) issued SFAS No.
144, Accounting for the Impairment or Disposal of Long-Lived Assets which
supersedes SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and
for Long-Lived Assets to Be Disposed Of and APB No. 30, Reporting the Results of
Operations--Reporting the Effects of Disposal of a Segment of a Business, and
Extraordinary, Unusual and Infrequently Occurring Events and Transactions. SFAS
No. 144 also amends Accounting Research Bulletin No. 51, Consolidated Financial
Statements. SFAS No. 144 requires that long-lived assets that are to be disposed
of by sale be measured at the lower of book value or fair value less cost to
sell. The statement also significantly changes the criteria required to classify
an asset as held-for-sale. Additionally, SFAS No. 144 expands the scope of
discontinued operations to include all components of an entity with operations
that (1) can be distinguished from the rest of the entity and (2) will be
eliminated from the ongoing operations of the entity in a disposal transaction.
The Company adopted SFAS No. 144 in its quarter ended June 30, 2002, which has
had no impact on the financial statements through the nine months ended December
31, 2002.
In June 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with
Exit or Disposal Activities, which addresses accounting for restructuring and
similar costs. SFAS No. 146 supersedes previous accounting guidance, principally
Emerging Issues Task Force Issue No. 94-3. The Company will adopt the provisions
of SFAS 146 for restructuring activities initiated after December 31, 2002. SFAS
No. 146 requires that the liability for costs associated with an exit or
disposal activity be recognized when the liability is incurred. Under Issue
94-3, a liability for an exit cost was recognized at the date of the Company's
commitment to an exit plan. SFAS No. 146 also establishes that the liability
should initially be measured and recorded at fair value. Accordingly, SFAS No.
146 may affect the timing of recognizing future restructuring costs as well as
the amounts recognized.
ITEM 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
This Management's Discussion and Analysis of Financial Condition and Results of
Operations and other parts of this Form 10-Q contain forward-looking statements
that involve risks and uncertainties. All forward-looking statements included in
this document are based on information available to the Company on the date
hereof, and the Company assumes no obligation to update any such forward-looking
statements. The Company's actual results could differ materially from those
anticipated in these forward-looking statements as a result of certain factors,
including those set forth in "Factors Affecting Future Results".
RESULTS OF OPERATIONS - THREE MONTHS ENDED DECEMBER 31, 2002 AND 2001
REVENUES
We deliver our custom e-learning solutions through a catalog of existing courses
and through customized content tailored to the specific needs of our customers.
We refer to the individuals taking courses as participants. Customized
e-learning courses have accounted for, and we expect will continue to account
for, a significant portion of our total revenues.
We generate revenues by delivering courses included in our course catalog as
well as delivering our customized e-learning courses to participants. Customers
that enter into Delivered Learning contracts provide participants with access to
our online courses and tutor support. Additionally, customers are provided with
access to management systems that allow them to track and monitor participants'
performance. Delivered Learning contracts typically allow for a specific number
of registered participants, based on a per participant fee. These contracts also
typically limit the period of time over which participants can register for and
complete an online course. We begin recognizing these Delivered Learning fees
when a participant registers for a course. These fees are recognized ratably
over the time period a participant has access to the course, which is typically
six to twelve months. Customers typically pay for the courses in advance of the
anticipated timeframe of course registration and do not receive refunds for the
unused portion of the available registrations agreed to in the contract. In
cases where we allow unlimited access to our courses for a specific period of
time, revenue is recognized ratably over the term of the contract.
We also derive revenues from contracts that require development of tailored
e-learning solutions. Typically, these Learning Solution service revenues are
generated from performance consulting services, implementation services, course
content development, instructional plan design, and release of the course for
access by participants and are recognized as earned in accordance with Statement
of Position (SOP) 81-1, Accounting for Performance of Construction
Production-Type Contracts, as development progresses on the percentage of
completion method. We measure the percentage of completion based on the ratio of
actual custom development or service costs incurred to date, to total estimated
costs to complete the custom course or service. Provisions for estimated losses
on incomplete contracts will be made on a contract by contract basis and
recognized in the period in which such losses become probable and can be
reasonably estimated. To date, there have been no such losses. Custom contracts
typically call for non-refundable payments due upon achievement of certain
milestones in the production of courses or in consulting services.
Delivered Learning fees and Learning Solution service revenues are each
recognized only when collection is probable and there is evidence that we have
completed our obligation. If a contract includes both Delivered Learning fees
and Learning Solution services, the revenues are apportioned consistent with the
value associated with each and the term of the contract. In all cases, these
revenues are recognized in accordance with the policies detailed above.
We have entered into revenue sharing agreements with some of our customers and
have certain reseller agreements. Under revenue sharing agreements, we receive
royalties or similar payments based on sales of courses by the customer. Under
reseller agreements, we provide the reseller with courses at a discount from our
list price. The reseller then assumes responsibility for sales, marketing, and
related activities, and we would not expect to incur significant sales and
marketing expenses in connection with reseller sales.
Revenues decreased from $13.8 million in the three months ended December 31,
2001 to $11.0 million in the three months ended December 31, 2002. Revenues
decreased in the quarter ended December 31, 2002 as compared to the same period
last year for delivery due to fewer enrollments. Learning Solution Services
revenues decreased compared to the same period last year as the average dollar
size of our contracts has decreased. For the three months ended December 31,
2002, Delivered Learning fees represented 50% of revenues and Learning Solution
services represented 50% of revenues. This is compared to the three months ended
December 31, 2001, during which Delivered Learning fees represented 54% of
revenues and Learning Solution services represented 46% of revenues.
Delivered Learning Fees
Delivered Learning fees decreased from $7.4 million in the three months ended
December 31, 2001 to $5.5 million in the three months ended December 31, 2002.
The total number of customers increased from 446 to 512 and the total number of
courses developed increased from 720 to 985. Revenue decreased in the quarter
ended December 31, 2002 as compared to the same period last year due to more
courses being delivered to our customers that have unlimited delivery
relationships offset by fewer enrollments with our other customers that pay for
delivery as incurred. We expect that the number of courses and customers will
continue to increase as we expand our distribution channels and course offerings
and as our custom content development projects progress.
Learning Solution Services
Learning Solution services revenue decreased from $6.4 million in the three
months ended December 31, 2001 to $5.5 million in the three months ended
December 31, 2002 as the average dollar size of our contracts decreased.
We market our products primarily through our direct sales channel and our system
integrator resellers in the United States. We also market our products through
resellers, customers, co-developers, and Internet portals. Internationally, we
have begun developing relationships with third-party integrators and resellers.
To date, our international revenues have been less than 5% of total revenues.
COSTS AND EXPENSES
Cost of Delivered Learning Fees
Cost of Delivered Learning fees include personnel-related costs, maintenance and
facility costs required to operate our website and to provide interactive tutor
support to participants in our courses. Cost of Delivered Learning fees
decreased from $1.6 million in the three months ended December 31, 2001 to $1.0
million in the three months ended December 31, 2002. This decrease was
attributable to decreased personnel and decreased tutor support costs. Headcount
related to the cost of Delivered Learning fees, decreased from 63 at December
31, 2001 to 31 employees at December 31, 2002.
Cost of Learning Solution Services
Cost of Learning Solution services consists primarily of personnel-related costs
and contractor expenses to develop custom courses for specific customers. Cost
of Learning Solution services decreased from $3.0 million in the three months
ended December 31, 2001 to $1.9 million in the three months ended December 31,
2002. This decrease was primarily attributable to a decrease in the total number
of employees and the shifting of higher cost headcount in the United States to
lower cost headcount in India with approximately 80 employees now in India.
Headcount related to cost of Learning Solution services decreased from 196
employees at December 31, 2001 to 129 employees at December 31, 2002.
Content Research and Development
Content research and development expenses are expensed as incurred in accordance
with SFAS No. 86, and represent costs to develop catalog courses, including
personnel-related costs, content acquisition costs and content editing. Content
research and development expenses decreased from $1.9 million in the three
months ended December 31, 2001 to $1.3 million in the three months ended
December 31, 2002 mainly due to shifting of higher cost headcount in the United
States to lower cost headcount in India where there are approximately now 57
employees. Headcount in content research and development increased from 60
employees at December 31, 2001 to 70 employees at December 31, 2002.
Technology Research and Development
Technology research and development expenses consist primarily of
personnel-related costs in connection with product development efforts of
underlying technology. Technology research and development expenses decreased
from $2.6 million in the three months ended December 31, 2001 to $1.7 million in
the three months ended December 31, 2002. This decrease was primarily
attributable to a decrease in contractor spending and the shifting of higher
cost headcount in the United States to lower cost headcount in India where there
are approximately 14 employees. Headcount decreased from 64 employees at
December 31, 2001 to 63 employees at December 31, 2002.
Selling and Marketing
Selling and marketing expenses consist primarily of personnel-related costs,
commissions, advertising and other promotional expenses, royalties paid to
authors and travel and entertainment expenses. Selling and marketing expenses
decreased from $4.7 million in the three months ended December 31, 2001 to $3.4
million in the three months ended December 31, 2002 primarily due to less
advertising, and reductions in tradeshow activity and in personnel. Headcount in
selling and marketing decreased from 97 at December 31, 2001 to 62 at December
31, 2002. We expect selling and marketing expenses to remain relatively flat.
General and Administrative
General and administrative expenses consist primarily of personnel-related
costs, occupancy costs, insurance-related costs, and professional services fees.
General and administrative expenses decreased from $1.6 million in the three
months ended December 31, 2001 to $1.5 million in the three months ended
December 31, 2002. This decrease was due to lower occupancy costs offset by
increased fees related to insurance and professional services. Headcount
increased from 43 employees at December 31, 2001 to 49 employees at December 31,
2002 with almost all of the increase in headcount in India.
Amortization of Goodwill and Other Intangibles
Amortization of goodwill and other intangibles totaled $2.1 million in the three
months ended December 31, 2001 associated with the acquisition of LearningByte
International, Inc. ("LBI"). Amortization totaled $341,000 in the three months
ended December 31, 2002 related to amortization of intangibles associated with
the acquisition of LBI.
Amortization of Warrants
Expenses related to warrants issued to EDS as part of a strategic alliance
entered into in July 2000 totaled $2.8 million in the three months ended
December 31, 2001 and zero in the three months ended December 31, 2002 as a
result of the restructuring of the EDS agreement, whereby EDS surrendered its
vested and unvested warrants to purchase shares of the Company's common stock in
March 2002. The Company expensed approximately $4,000 of warrant expense in the
three months ended December 31, 2002 related to warrants issued in connection
with the restructuring of the headquarters facility lease in August 2002.
Stock-Based Compensation
Stock-based compensation expense decreased from $469,000 in the three months
ended December 31, 2001 to $105,000 in the three months ended December 31, 2002.
Net Loss
The net loss decreased from $7.8 million in the three months ended December 31,
2001 to $1.8 million in the three months ended December 31, 2002.
RESULTS OF OPERATIONS - NINE MONTHS ENDED DECEMBER 31, 2002 AND 2001
REVENUES
Revenues decreased from $44.1 million in the nine months ended December 31, 2001
to $30.7 million in the nine months ended December 31, 2002. Revenues decreased
in the nine months ended December 31, 2002 as compared to the same period last
year for delivery due to fewer enrollments. Learning Solution Services revenues
decreased compared to the same period last year as the average dollar size of
our contracts has decreased. For the nine months ended December 31, 2002,
Delivered Learning fees represented 54% of revenues and Learning Solution
services represented 46% of revenues. This is compared to the nine months ended
December 31, 2001, during which Delivered Learning fees represented 53% of
revenues and Learning Solution services represented 47% of revenues.
Delivered Learning Fees
Delivered Learning fees decreased from $23.4 million in the nine months ended
December 31, 2001 to $16.4 million in the nine months ended December 31, 2002
even though the number of customers and courses increased. Revenue decreased in
the nine months ended December 31, 2002 as compared to the same period last year
due to more courses being delivered to our customers that have unlimited
delivery relationships offset by fewer enrollments with our customers that pay
for delivery as incurred. We expect that the number of courses and customers
will continue to increase as we expand our distribution channels and course
offerings.
Learning Solution Services
Learning Solution services revenue decreased from $20.7 million in the nine
months ended December 31, 2001 to $14.2 million in the nine months ended
December 31, 2002 as the average dollar size of the contracts decreased. We
expect that Delivered Learning fees and Learning Solution services revenues will
continue to account for a similarly significant portion of our total revenues in
the near term.
COSTS AND EXPENSES
Cost of Delivered Learning Fees
Cost of Delivered Learning fees include personnel-related costs, maintenance and
facility costs required to operate our website and to provide interactive tutor
support to participants in our courses. Cost of Delivered Learning fees
decreased from $5.1 million in the nine months ended December 31, 2001 to $3.7
million in the nine months ended December 31, 2002. This decrease was
attributable to decreased personnel and decreased tutor support costs. Headcount
related to cost of Delivered Learning fees, decreased from 63 at December 31,
2001 to 31 employees at December 31, 2002.
Cost of Learning Solution Services
Cost of Learning Solution services consists primarily of personnel-related costs
and contractor expenses to develop custom courses for specific customers. Cost
of Learning Solution services decreased from $9.8 million in the nine months
ended December 31, 2001 to $4.9 million in the nine months ended December 31,
2002. This decrease was primarily attributable to a decrease in the total number
of employees and the shifting of higher cost headcount in the United States to
lower cost headcount in India with approximately 80 employees now in India.
Headcount related to cost of Learning Solution services decreased from 196
employees at December 31, 2001 to 129 employees at December 31, 2002.
Content Research and Development
Content research and development expenses are expensed as incurred in accordance
with SFAS No. 86, and represent costs to develop catalog courses, including
personnel-related costs, content acquisition costs and content editing. Content
research and development expenses decreased from $5.2 million in the nine months
ended December 31, 2001 to $4.2 million in the nine months ended December 31,
2002. This decrease was due to slightly lower personnel costs due to the shift
of higher cost United States employees to lower cost India where there are
approximately 57 employees. Headcount in content research and development
increased from 60 employees at December 31, 2001 to 70 employees at December 31,
2002.
Technology Research and Development
Technology research and development expenses consist primarily of
personnel-related costs in connection with product development efforts of
underlying technology. Technology research and development expenses decreased
from $9.0 million in the nine months ended December 31, 2001 to $5.3 million in
the nine months ended December 31, 2002. This decrease was primarily
attributable to a decrease in contractor spending and the shifting of higher
cost headcount in the United States to lower cost headcount in India where there
are approximately 14 employees. Headcount decreased from 64 employees at
December 31, 2001 to 63 employees at December 31, 2002.
Selling and Marketing
Selling and marketing expenses consist primarily of personnel-related costs,
commissions, advertising and other promotional expenses, royalties paid to
authors and travel and entertainment expenses. Selling and marketing expenses
decreased from $17.3 million in the nine months ended December 31, 2001 to $10.3
million in the nine months ended December 31, 2002. This decrease is primarily
due to less advertising and reductions in tradeshow activity and in personnel.
Headcount in selling and marketing decreased from 97 at December 31, 2001 to 62
at December 31, 2002. We expect selling and marketing expenses will remain
relatively flat.
General and Administrative
General and administrative expenses consist primarily of personnel-related
costs, occupancy costs, insurance-related costs, and professional services fees.
General and administrative expenses increased from $5.2 million in the nine
months ended December 31, 2001 to $5.4 million in the nine months ended December
31, 2002. This increase was due to fees related to insurance and professional
services offset by lower occupancy costs. Headcount increased from 43 employees
at December 31, 2001 to 49 employees at December 31, 2002 with almost all of the
increase in headcount in India.
Acquisition and other related charges
Expenses related to the acquisition of LBI and other related charges totaled
$5.8 million in the nine months ended December 31, 2001 and were comprised of
approximately $5.3 million for the write-off of internal use software made
obsolete by the acquisition, and approximately $500,000 for severance-related
costs for redundancies. The write-off of internal use software related to one
significant project that was put into service during fiscal 2002 to better
enable content development by the Company and customers, but was determined to
be obsolete given LBI's technology.
Amortization of Goodwill and Other Intangibles
Expenses related to the amortization of goodwill and other intangibles decreased
from $5.1 million in the nine months December 31, 2001 to $1.1 million in the
nine months ended December 31, 2002 related to LBI.
Amortization of Warrants
Expenses related to warrants issued to EDS as part of a strategic alliance
entered into in July 2000 totaled $8.3 million in the nine months ended December
31, 2001 and zero in the nine months ended December 31, 2002 as a result of the
restructuring of the EDS agreement, whereby EDS surrendered its vested and
unvested warrants to purchase shares of the Company's common stock in March
2002. The Company expensed approximately $5,000 of warrant expense in the nine
months ended December 31, 2002 related to warrants issued in connection with the
restructuring of the headquarters facility lease in August 2002.
Stock-Based Compensation
Stock-based compensation expense decreased from $1.6 million in the nine months
ended December 31, 2001 to $368,000 in the nine months ended December 31, 2002.
Net Loss Before Cumulative Effect of Accounting Change
The net loss decreased from $30.3 million in the nine months ended December 31,
2001 to $9.4 million in the nine months ended December 31, 2002.
Cumulative Effect of Accounting Change
Effective April 1, 2002, the Company adopted SFAS No. 142, "Goodwill and Other
Intangible Assets." SFAS No. 142 requires, among other things, the
discontinuance of amortization related to goodwill and indefinite lived
intangible assets. These assets will then be subject to an impairment test at
least annually. In addition, the statement includes provisions upon adoption for
the reclassification of certain existing recognized intangibles to goodwill, the
identification of reporting units for the purpose of assessing potential future
impairments of goodwill, the reassessment of the useful lives of existing
recognized intangibles and the reclassification of certain intangibles out of
previously reported goodwill. Upon the adoption of SFAS No. 142, the Company
recognized a goodwill impairment loss of $50.2 million as of April 1, 2002,
which was recorded as the cumulative effect of an accounting change in the
Company's consolidated statements of operations for the nine months ended
December 31, 2002. The Company performed its annual goodwill impairment analysis
on October 31, 2002, using a valuation model based on market capitalization
adjusted for outstanding debt, consistent with the model used as of April 1,
2002. This analysis indicated that no additional adjustments were required to
the remaining goodwill balance. Any further impairment losses recorded in the
future could have a material adverse impact on our financial conditions and
results of operations.
Critical Accounting Policies
There have been no significant changes to the Company's critical accounting
policies as disclosed in the Company's Annual Report on Form 10-K, as amended on
Form 10-K/A, for the year ended March 31, 2002.
Liquidity and Capital Resources
Net cash used in operating activities totaled $10.0 million for the nine months
ended December 31, 2002 and $21.6 million for the comparable prior year period.
Cash used in operating activities for the current period resulted from net
operating losses, decreases in current liabilities and deferred revenues offset
by increases in accounts receivable. Deferred revenue decreased from $7.0
million at March 31, 2002 to $3.2 million at December 31, 2002. Deferred revenue
results from customer advance billings and prepayments of Delivered Learning
fees and Learning Solution services. In both cases, prepayments remain in
deferred revenue until revenue recognition criteria have been met. Accrued
liabilities have decreased from $7.9 million at March 31, 2002 to $4.6 million
on December 31, 2002 and long-term liabilities have decreased from $5.4 million
at March 31, 2002 to $4.9 million at December 31, 2002 resulting from a
reduction of expenses and the payment of invoices in the nine month period.
Net cash used in investing activities totaled $1.0 million in the nine months
ended December 31, 2002 and net cash provided by investing activities totaled
$16.8 million for the comparable prior year period. The change resulted from the
acquisition of capital assets, including leasehold improvements, hardware for
our website, and computer and office related equipment, offset in part by the
maturity of marketable securities.
Cash provided by financing activities totaled $3.7 million in the nine months
ended December 31, 2002 and $1.2 million in the nine months ended December 31,
2001. The increase reflects the exercise of stock options and stock purchases in
the employee stock purchase program and borrowings on the Company's line of
credit.
In December 2001, we entered into a $5.0 million line of credit agreement and
had available $2.8 million from this line of credit as of March 31, 2002.
Subsequent to March 31, 2002, the balance of $2.2 million on the line of credit
was repaid. In June 2002, we amended the line of credit agreement to increase
the line to $8.0 million and renewed the line of credit in December 2002 to
expire in December 2003. We had available $2.9 million from this line of credit
as of December 31, 2002. Subsequent to December 31, 2002, the balance of $5.1
million on the line of credit was repaid.
We believe our existing cash resources, anticipated revenues and available
borrowings are sufficient to finance our presently anticipated operating
expenses and working capital requirements for at least the next twelve months.
Our future liquidity and capital requirements will depend on numerous factors.
The rate of expansion of our operations in response to potential growth
opportunities and competitive pressures, as well as the macroeconomic
environment, will affect our capital requirements as will funding of net losses
and possible negative cash flows. Additionally, we may need additional capital
to fund acquisitions of complementary businesses, products, and technologies.
Our forecast of the period of time through which our financial resources will be
adequate to support operations is a forward-looking statement that involves
risks and uncertainties. Actual resources sought may differ materially. We may
seek to sell additional equity or debt securities or secure a larger bank line
of credit. The sale of additional equity or debt securities could result in
additional dilution to our stockholders. Currently, we have no other immediately
available sources of liquidity. Additional financing may not be available in
amounts or on terms acceptable to us, if at all.
Recent Accounting Pronouncements
In October 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets which supersedes SFAS No. 121, Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of and
APB No. 30, Reporting the Results of Operations--Reporting the Effects of
Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently
Occurring Events and Transactions. SFAS No. 144 also amends Accounting Research
Bulletin No. 51, Consolidated Financial Statements. SFAS No. 144 requires that
long-lived assets that are to be disposed of by sale be measured at the lower of
book value or fair value less cost to sell. The statement also significantly
changes the criteria required to classify an asset as held-for-sale.
Additionally, SFAS No. 144 expands the scope of discontinued operations to
include all components of an entity with operations that (1) can be
distinguished from the rest of the entity and (2) will be eliminated from the
ongoing operations of the entity in a disposal transaction. We are required to
adopt SFAS No. 144 for our fiscal year beginning April 1, 2002. The Company has
adopted SFAS No. 144 in its quarter ended June 30, 2002, which had no impact on
the financial statements through the nine months ended December 31, 2002.
In June 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with
Exit or Disposal Activities, which addresses accounting for restructuring and
similar costs. SFAS No. 146 supersedes previous accounting guidance, principally
Emerging Issues Task Force Issue No. 94-3. The Company will adopt the provisions
of SFAS 146 for restructuring activities initiated after December 31, 2002. SFAS
No. 146 requires that the liability for costs associated with an exit or
disposal activity be recognized when the liability is incurred. Under Issue
94-3, a liability for an exit cost was recognized at the date of the Company's
commitment to an exit plan. SFAS No. 146 also establishes that the liability
should initially be measured and recorded at fair value. Accordingly, SFAS No.
146 may affect the timing of recognizing future restructuring costs as well as
the amounts recognized.
Special Note Regarding Forward-Looking Statements and Risk Factors
Certain statements in this Quarterly Report on Form 10-Q contain "forward-
looking statements." Forward-looking statements are any statements other than
statements of historical fact. Examples of forward-looking statements include
projections of earnings, revenues or other financial items, statements of the
plans and objectives of management for future operations, and statements
concerning proposed new products and services, and any statements of assumptions
underlying any of the foregoing. In some cases, you can identify forward-looking
statements by the use of words such as "may", "will", "expects", "should",
"believes", "plans", "anticipates", "estimates", "predicts", "potential", or
"continue", and any other words of similar meaning.
Statements regarding the Company's future financial performance or results of
operations, including expected revenue growth, EBITDA growth, future expenses,
future operating margins and other future or expected performance are subject to
the following risks: that cost-reduction initiatives began last year will not be
achieved due to implementation difficulties or contractual spending commitments
that can't be reduced; that demand for our products and services could be
affected by adverse economic conditions affecting the technology industry; the
acquisition of businesses or the launch of new lines of business, which could
increase operating expense and dilute operating margins; the inability to
attract new customers; increased competition, which could lead to negative
pressure on the Company's pricing and the need for increased marketing; the
inability to maintain, establish or renew relationships with customers, whether
due to competition or other factors; costs associated with the Company's
continued standardization of its technology platforms or the failure of the
Company to successfully complete upgrades; and to the general risks associated
with the Company's businesses.
The following additional factors could also impact our financial results and
cause our forward-looking statements to be inaccurate:
Accounting rules regarding the accounting for goodwill have recently been
changed by the FASB. The changes in these rules have had a significant impact on
our reported financial results. In June 2001, the FASB issued Statement of
Financial Accounting Standard SFAS No. 141, Business Combinations and SFAS No.
142, Goodwill and Other Intangible Assets. These statements continue to require
recognition of goodwill as an asset but do not permit amortization of goodwill
as was required by Accounting Principles Board (APB) Opinion No. 17, Intangible
Assets. Under the SFAS No. 142, goodwill is to be separately tested for
impairment using a fair-value-based approach when an event occurs indicating the
potential for impairment. Any required goodwill impairment charges are presented
as a separate line item within the operating section of the income statement.
The change from an amortization approach to an impairment approach applies to
previously recorded goodwill, as well as goodwill arising from acquisitions
completed after the application of the new standard. When these statements were
adopted by the Company, our goodwill amortization charges ceased. However, it is
possible that in the future, we would incur less frequent, but larger,
impairment charges related to the goodwill already recorded as well as any
goodwill arising out of future acquisitions. As these statements (SFAS 141 and
SFAS 142) have just been issued and adopted, it is difficult to predict whether
our future earnings may be subject to significant volatility, particularly on a
period-to-period basis.
Any shortfall in revenue or earnings compared to analysts' or investors'
expectations could cause, an immediate and significant decline in the trading
price of our common stock. In addition, we may not learn of such shortfalls or
delays until late in the fiscal quarter, which could result in an even more
immediate and greater decline in the trading price of our common stock.
FACTORS AFFECTING FUTURE RESULTS
You should consider the risks described below before making an investment
decision. We believe that the risks and uncertainties described below are the
principal material risks facing our company as of the date of this Form 10-Q. In
the future, we may become subject to additional risks that are not currently
known to us. Our business, financial condition or results of operations could be
materially adversely affected by any of the following risks. The trading price
of our common stock could decline due to any of the following risks.
WE HAVE A HISTORY OF LOSSES AND A LARGE ACCUMULATED DEFICIT OF $216.8 MILLION AT
DECEMBER 31, 2002. WE EXPECT FUTURE LOSSES OVER THE NEXT TWO QUARTERS AND WE MAY
NOT ACHIEVE PROFITABILITY WITHIN THE TIMEFRAMES PUBLIC STOCKHOLDERS ANTICIPATE.
We have experienced losses in each quarter since our inception. Our accumulated
deficit as of December 31, 2002 was $216.8 million. We have never achieved a
profitable quarter and we may continue to incur quarterly losses if our revenue
growth does not meet expectations and our current expense structure remains in
place. If we do achieve profitability, we will need to continue to generate
revenues greater than expenses on a quarterly or annual basis in the future to
continue being profitable. We plan to invest to develop and acquire new course
offerings with new areas of expertise, which may increase operating expenses if
those expenses are not immediately offset by new revenues.
DEMAND FOR OUR PRODUCTS AND SERVICES HAS BEEN AND MAY CONTINUE TO BE EFFECTED BY
ADVERSE ECONOMIC CONDITIONS AFFECTING THE INFORMATION TECHNOLOGY INDUSTRY.
The information technology industry has been in a period of economic decline
during 2001 and 2002, attributable in part to general weakness in the overall
economy. As a result, there has been a reduced level of investment by businesses
in information technology products and systems. When businesses are reducing
investment in technologies or slowing the rate of adoption of new technologies
and systems, they have a reduced need for training of their employees, customers
and others in the use of these systems. In addition, many of our current and
potential customers have experienced adverse changes in their financial
performance, whether as a result of the general weakening of the economy or
other factors. Some companies may delay training initiatives or, if these
companies continue to experience disappointing operating results, whether as a
result of adverse economic conditions, competitive issues or other factors, they
may decrease or forego education and training expenditures overall before
limiting other expenditures. As a result of these factors, and possibly also due
to the aftermath of the September 11, 2001 terrorist attacks, our new contract
signings in the second half of fiscal 2002 were materially and adversely
affected, this in turn has impacted our revenues in fiscal 2003. Continuation of
the economic downturn in the United States, as well as continuation of the
current adverse economic conditions in the information technology industry, may
harm our results of operations.
WE HAVE A SIGNIFICANT BUSINESS PRESENCE IN INDIA, AND RISKS ASSOCIATED WITH
DOING BUSINESS THERE COULD DISRUPT OR HARM OUR BUSINESS.
In order to reduce costs associated with course development, we have established
a significant presence in India through two acquisitions in the 2001 fiscal
year. As of December 31, 2002, we had approximately 200 employees in three
separate locations in India. Difficulties that we could encounter with our
Indian operations or with other international operations that we may establish
in the future include the following:
o difficulties in staffing and managing international operations;
o multiple, conflicting and changing governmental laws and regulations;
o fluctuations in currency exchange rates;
o political and economic instability, including the potential for more
terrorist acts;
o developments between the nations of India and Pakistan regarding the
threat of war;
o adverse tax consequences;
o difficulties in protecting our intellectual property rights;
o increases in tariffs, duties, price controls or other restrictions on
foreign currencies; and
o trade barriers imposed by foreign countries.
In particular, continuing tensions between India and Pakistan could have a
direct impact on our operations. Recently, due to heightened concerns in the
region, the United States State Department has issued an advisory against travel
to India. However, the Company continues to conduct normal operations in India
along with the associated travel of United States employees visiting India.
If we encounter these problems in connection with our operations in India, our
revenues could fall below expectations, which would harm our business and
operating results. In this event, our stock price could decline.
OUR LIMITED OPERATING HISTORY AND THE NEW AND EMERGING E-LEARNING MARKET MAKES
IT DIFFICULT TO EVALUATE OUR BUSINESS AND FUTURE PROSPECTS.
We commenced operations in April 1996 and did not begin to generate significant
revenues until fiscal 1999. In the first nine months of fiscal 2003, we had
revenues of $30.7 million and expenses of $40.3 million, excluding the one-time
charge related to SFAS No. 142 of $50.2 million. We are still in the early
stages of our development, which, when combined with the new and emerging
e-learning market, and general economic factors affecting the technology sector,
make it difficult to evaluate our business or our prospects. Because of our
limited operating history, we have a limited and unproven ability to forecast
sales and predict the trends in the e-learning market and in our business. The
uncertainty of our future performance, in particular, and the uncertainty
regarding the acceptance of e-learning, in general, increases the risk that we
will be unable to build a sustainable business and that our stockholder value
will decline.
WE MAY NOT BE ABLE TO SECURE NECESSARY FUNDING IN THE FUTURE; ADDITIONAL FUNDING
MAY RESULT IN DILUTION TO OUR STOCKHOLDERS.
We require substantial working capital to fund our business. We have had
significant operating losses and negative cash flow from operations since
inception. We expect to use our available cash resources and anticipated
revenues to fund continued operations, build courseware and possibly make future
acquisitions. We believe that our existing capital resources will be sufficient
to meet our capital requirements at least for the next twelve months. However,
if our capital requirements increase materially from those currently planned or
if revenues fall below our expectations, we may require additional financing
sooner than anticipated. If additional funds are raised through the issuance of
equity securities, the percentage ownership of our stockholders will be reduced,
stockholders may experience dilution, or such equity securities may have rights,
preferences or privileges senior to those of the holders of our common stock.
Additional financing may not be available when needed on terms favorable to us
or at all. If adequate funds are not available or are not available on
acceptable terms, we may be unable to develop or enhance our products and
services, take advantage of future opportunities or respond to competitive
pressures.
OUR QUARTERLY OPERATING RESULTS ARE SUBJECT TO FLUCTUATIONS WHICH COULD CAUSE
OUR STOCK PRICE TO DECLINE.
Our revenue and operating results are volatile and difficult to predict and may
be susceptible to declines in future periods. Our quarterly results of
operations may fluctuate significantly in the future due to the delays in the
progress of ongoing work, shortfalls in orders or the timing of when the orders
are booked in the quarter. We therefore believe that quarter-to-quarter
comparisons of our operating results may not be an accurate indication of our
future performance. In the event of a revenue or order shortfall or
unanticipated expenses in some future quarter or quarters, our operating results
may be below the expectations of public market analysts or investors. In such an
event, the price of our common stock may decline significantly. Our operating
expenses are largely fixed in the short term and based, to a significant degree,
on our estimates of future revenue. We will likely be unable to, or may elect
not to, reduce spending quickly enough to offset any unexpected revenue
shortfall. Therefore, any significant shortfall in revenue in relation to our
expectations would cause our quarterly results for a particular period to
decline.
IN RECOGNIZING REVENUE WE DEPEND ON THE TIMELY ACHIEVEMENT OF VARIOUS
MILESTONES, AND OUR INABILITY TO RECOGNIZE REVENUE IN ACCORDANCE WITH OUR
EXPECTATIONS WILL HARM OUR OPERATING RESULTS.
In accordance with our revenue recognition policy, our ability to record
revenues depends upon several factors. These factors include acceptance by our
customers of new courses and the pace of participant registrations in courses
once they are completed and made available for access. Most of our customer
contracts provide that at least a portion of our revenues depend on either
course completion or participant registration, or both. Revenues from custom
course development accounted for approximately 46% of our total revenues for the
nine months ended December 31, 2002. Our ability to recognize revenues from
custom courses depends upon our customers providing us with subject matter
experts, content and prompt acceptance of our work through each stage of
development. Accordingly, if customers do not meet all project deadlines in a
timely manner, we will not be able to recognize the revenues associated with
that project, which would harm our operating results.
In addition, if the expected number of participants do not sign up for a course,
our ability to recognize revenues will be delayed, which could also harm our
operating results in any quarter. Participant registration depends in large part
on the promotional activities of our customers. If customers fail to take
necessary measures to require employee enrollment in courses or if they fail to
promote the course effectively to persons outside their organization, our
ability to recognize revenues and our operating results, could be harmed.
WE ARE LIKELY TO BE DEPENDENT UPON A SMALL GROUP OF MAJOR CUSTOMERS FOR A
SIGNIFICANT PORTION OF OUR REVENUES, AND CHANGES IN SALES TO THESE CUSTOMERS
COULD HARM OUR PERFORMANCE.
We expect that we will continue to depend upon a small number of customers for a
significant portion of our revenues. As a result, our operating results could
suffer if we lost any of these customers or if these customers slowed or
cancelled purchases or delayed payment in any future fiscal period. In the first
nine months of fiscal quarter of 2003, our five largest customers accounted for
68% of our total revenues of $30.7 million compared to 56% or $44.1 million for
the first nine months of fiscal 2002. We expect that our major customers will
continue to account for a significant portion of our revenues during future
fiscal periods until we are able to increase the number of new or existing
long-term, large customers. Accordingly, changes in these customers' businesses
and in their views regarding the value of e-learning in general and our products
and services in particular could harm our financial performance.
THE LENGTH AND VARIABILITY OF OUR SALES CYCLE MAY MAKE OUR OPERATING RESULTS
UNPREDICTABLE AND VOLATILE.
The period between our initial contact with a potential customer and the first
purchase of our solution by that customer typically ranges from three to nine
months. In some cases the cycle has extended for close to two years. Because we
rely on relatively few large sales for a substantial portion of our revenues,
these long sales cycles can adversely affect our financial performance in any
quarter. Factors which may contribute to the variability and length of our sales
cycle include the time periods required for:
o our education of potential customers about the benefits of our e-learning
solutions;
o our potential customers' assessment of the value of online solutions compared
to traditional educational solutions;
o our potential customers' evaluation of competitive online solutions; and
o our potential customers' internal budget and approval processes.
Our lengthy sales cycle limits our ability to forecast the timing and size of
specific sales. This, in turn, makes it difficult to predict quarterly financial
performance.
IF WE RELEASE UPDATED FUNCTIONALITY OR NEW PRODUCTS CONTAINING DEFECTS, WE MAY
NEED TO RECONFIGURE AND RE-RELEASE AND OUR BUSINESS AND REPUTATION WOULD BE
HARMED.
Products as complex as ours often contain unknown and undetected errors or
performance problems. Many serious defects are frequently found during the
period immediately following introduction and initial deployment of new products
or enhancements to existing products. Although we attempt to resolve all serious
errors before we release products to them, our products are not error-free.
These errors or performance problems could result in lost revenues or delays in
customer acceptance and would be detrimental to our business and reputation. As
is typical in the industry, with each release we have discovered errors in our
products after introduction. We will not be able to detect and correct all
errors before releasing our products commercially and these undetected errors
could be significant. We cannot assure that these undetected errors or
performance problems in our existing or future products will not be discovered
in the future or that known errors considered minor by us will not be considered
serious by our customers, resulting in a decrease in our revenues.
OUR INTERNATIONAL PRESENCE COULD SUBJECT US TO NEW RISKS BECAUSE OF CURRENCY AND
POLITICAL CHANGES, LEGAL AND CULTURAL DIFFERENCES OR ECONOMIC INSTABILITY.
Our strategy includes international sales. Our current plans include continued
sales overseas, which began during fiscal 2001, as well as the creation of a
partner-based support infrastructure for customers around the world. In addition
to our operations in India, we could be affected by political and monetary
changes, including instability in the Middle East and Central Asia, and changes
required by the European Union.
This international presence will require significant management attention and
financial resources and could harm our financial performance by increasing our
costs. We have very limited experience in marketing, selling and distributing
courses internationally. We could become subject to additional risks as we grow
internationally, including:
o difficulties in staffing and managing international operations;
o inability to develop content localized for international jurisdictions;
o protectionist laws and business practices that favor local competition;
o multiple, conflicting and changing governmental laws and regulations;
o slower adoption of e-learning solutions; odifferent learning styles;
o longer sales and payment cycles; odifficulties in collecting accounts
receivable;
o fluctuations in currency exchange rates;
o political and economic instability;
o adverse tax consequences;
o little or no protection of our intellectual property rights in certain
foreign countries;
o increases in tariffs, duties, price controls or other restrictions on foreign
currencies; and
o trade barriers imposed by foreign countries.
If we encounter these problems in connection with our current and future sales
growth internationally, our revenues could fall below expectations, which would
harm our business and operating results. In this event, our stock price could
decline.
OUR GROWTH DEPENDS ON HIRING AND RETAINING QUALIFIED PERSONNEL IN A HIGHLY
COMPETITIVE EMPLOYMENT MARKET.
The growth of our business and revenues will depend in large part upon our
ability to attract and retain sufficient numbers of highly skilled employees,
particularly database engineers, course content developers, web designers and
sales personnel. We plan for much of this new hiring to take place in India,
which makes recruiting a greater challenge. Education and Internet related
industries create high demand for qualified personnel and candidates experienced
in both areas are limited. Our failure to attract and retain sufficient skilled
personnel may limit the rate at which we can grow, which will harm our business
and financial performance.
THE GROWTH OF OUR BUSINESS REQUIRES WIDE ACCEPTANCE OF E-LEARNING SOLUTIONS.
The market for e-learning solutions is new and rapidly evolving. A number of
factors could impact the acceptance of our e-learning solutions, including:
o historic reliance on traditional education methods;
o limited allocation of our customers' and prospective customers' education
budgets to e-learning; and
o ineffective use of online learning solutions.
Our e-learning solutions are new, largely untested and less familiar to
prospective customers than more established education methods. If the market for
e-learning fails to develop or develops more slowly than we expect, we will not
achieve our growth and revenue targets and our stock price will likely decline.
WE MAY NOT HAVE ADEQUATE RESOURCES TO COMPETE EFFECTIVELY, ACQUIRE AND RETAIN
CUSTOMERS AND ATTAIN FUTURE GROWTH IN THE HIGHLY COMPETITIVE E-LEARNING MARKET.
The e-learning market is evolving quickly and is subject to rapid technological
change, shifts in customer demands and evolving learning methodologies. As a
result, customers and potential customers have more choices. This challenges us
to distinguish our offerings. If we fail to adapt to changes and competition in
our industry, we may lose existing customers or fail to gain new customers. No
single competitor accounts for a dominant market share, yet competition is
intense. We compete primarily with:
o third-party suppliers of instructor-led education and learning;
o internal education departments; and
o other suppliers of technology-based learning solutions.
Due to the high market fragmentation, we do not often compete head-to-head with
any particular company. On occasion, our customers may evaluate our solution by
comparison with solutions offered by other e-learning companies. These companies
may include publicly-held companies and other regional web development
organizations. We may not provide solutions that compare favorably with
traditional or new instructor-led techniques or other technology-based learning
methodologies. Our competitors vary in size and in the scope and breadth of the
courses and services they offer. Several of our competitors have longer
operating histories and significantly greater financial, technical and marketing
resources. Larger companies may enter the e-learning market through the
acquisition of our competitors. We anticipate that the lack of significant entry
barriers to the e-learning market will allow other competitors to enter the
market, increasing competition.
To succeed, we must continue to expand our course offerings, upgrade our
technology and distinguish our solution. We may not be able to do so
successfully. Any failure by us to anticipate or respond adequately to changes
in technology and customer preferences, or any significant delays in course
development or implementation, could impact our ability to capture market share.
As competition continues to intensify, we expect the e-learning market to
undergo significant price competition. We also expect to face increasing price
pressure from customers, as they demand more value for their learning-related
expenditures. Increased competition, or our inability to compete successfully
against current and future competitors, could reduce operating margins, loss of
market share and thought leadership resulting in a diminution of our brand.
WE RELY ON COOPERATION FROM OUR CUSTOMERS AND THIRD PARTIES TO DEVELOP AND
DELIVER COURSES AND OUR BUSINESS WILL SUFFER IF SUCH COOPERATION OCCURS IN AN
UNTIMELY OR INEFFICIENT MANNER.
To be competitive, we must develop and introduce on a timely basis new course
offerings, which meet the needs of companies seeking to use our e-learning
solutions. The quality of our learning solutions depends in large part on our
ability to frequently update our courses and develop new content as the
underlying subject matter changes. We create courses by incorporating subject
matter expertise provided by our customers and third party content developers
into an e-learning delivery platform. The quality of our courses depends on
receiving content and cooperation from our customers, subject matter experts
provided by our customers, and third-party content developers. If we do not
receive materials from these sources in a timely manner, we may not be able to
develop or deliver specialized courses to our customers in the expected time
frame. Even if we do receive necessary materials from third parties, our
employees and consultants must complete their work in a timely manner or we will
not meet customer or revenue expectations. In the past, we have experienced
delays in obtaining access to our customers' experts, which has contributed to a
longer development cycle and inefficient allocation of our resources. Any
prolonged delays, even when caused by our customers, can result in failure to
satisfy a customer's demands, damage our reputation and our inability to achieve
our revenue goals.
OUR PLANS TO EXPAND THE SCOPE OF OUR COURSES TO FIELDS OTHER THAN INFORMATION
TECHNOLOGY DEPENDS ON OUR ABILITY TO DEVELOP RELATIONSHIPS WITH EXPERTS, AND IF
WE ARE UNABLE TO ATTRACT THE RIGHT EXPERTS, WE MAY NOT BE SUCCESSFUL IN ENTERING
NEW FIELDS.
Our strategy involves broadening the fields presently covered by our courses. In
particular, to date we have been primarily focused on courses in the information
technology area. We are currently planning to develop and introduce new course
offerings including global business skills, financial services, retail and other
fields. These new course offerings may encompass areas in which we have little
or no experience or expertise. Therefore, our ability to expand our courses into
these areas will depend in part on our ability to negotiate and execute content
development relationships with recognized experts or leading corporations in the
new fields. If we cannot locate these experts, we may fail to develop the
courses that our current and future customers will demand. The failure to expand
our course offerings to new fields could constrain our revenue growth and harm
our future prospects.
TO REMAIN COMPETITIVE, WE MUST KEEP PACE WITH RAPID TECHNOLOGICAL CHANGES IN OUR
INDUSTRY.
Rapidly changing technologies, frequent new service introductions, short
development cycles and evolving standards characterize the e-learning market. We
must adapt to rapidly changing technologies by maintaining and improving the
performance features and reliability of our courses. We may experience technical
difficulties that could delay or prevent the successful development,
introduction or marketing of new courses and related services. For instance,
adding capabilities to deliver video over the Internet to our courses may be
desired by some customers, but may nevertheless pose a serious technical
challenge and could have a negative impact on our ability to develop and deliver
courses on a profitable basis. In addition, any new enhancements to our courses
must meet the requirements of our current and prospective customers and
participants. We could incur substantial costs to modify our services or
infrastructure to adapt to rapid technological change.
WE COULD INHIBIT INCREASES IN OUR REVENUES IF WE DO NOT DEVELOP INDIRECT SALES
CHANNELS.
To date, more than 90% of our sales have been made through direct sales efforts.
We believe that we will need to diversify our sales efforts to be successful. If
we do not develop indirect sales channels, we may miss sales opportunities. We
are currently investing in personnel and marketing activities to develop
indirect sales channels, particularly through our relationships with EDS and
BearingPoint (formerly KPMG Consulting), who provide learning as an additional
service to their clients.
Although we are currently investing to develop these indirect sales channels, we
may not succeed in establishing a channel that can effectively market our
e-learning solutions on a profitable basis. Our direct sales force may compete
with these resellers, and we may not be able to manage conflicts across our
direct and indirect sales channels. Our focus on increasing sales through our
indirect channel may divert management resources and attention from direct
sales. Conflicts across sales channels could cause us to encounter pricing
pressures and lose revenue opportunities, which could harm our business and
cause our operating results to decline.
THE EXPECTED GROWTH IN OUR BUSINESS REQUIRES CONTINUOUS IMPROVEMENT TO OUR
TECHNOLOGY INFRASTRUCTURE AND A FAILURE TO MAKE SUCH IMPROVEMENTS COULD LEAD TO
CUSTOMER DISSATISFACTION AND REVENUE LOSSES.
In order meet existing and anticipated demand, we must continue to improve the
capacity of our technology infrastructure. Our success requires the continuing
and uninterrupted performance of our internal computer network and Internet
course servers. Any system failure that causes interruptions or delays in our
ability to make our courses accessible to customers could reduce customer
satisfaction. If sustained or repeated, a system failure could reduce the
attractiveness of our courses and services, resulting in significant revenue
losses. We are particularly vulnerable to network failures during periods of
rapid growth when our roster of courses and participants can outpace our network
capacity. The continued viability of our business requires us to support
multiple participants concurrently and deliver fast response times with minimal
network delays. Any failure to meet these capacity requirements could lead to
additional expenditures, lost business opportunities and damage to our
reputation and competitive position.
ANY FAILURE OF, OR CAPACITY CONSTRAINTS IN, THE SYSTEMS OF THIRD PARTIES ON
WHICH WE RELY COULD ADVERSELY AFFECT OUR BUSINESS.
Our success is highly dependent on the consistent performance of our Internet
and communications infrastructure. Our communications hardware and some of our
other computer hardware operations are located at the facilities of Cable &
Wireless (formerly Exodus), in Santa Clara, California with a back-up facility
(fail-over site) in Sacramento, California. Unexpected events such as natural
disasters, power losses and vandalism could damage our systems.
Telecommunications failures, computer viruses, electronic break-ins,
earthquakes, fires, floods, other natural disasters or other similar disruptive
problems could adversely affect the operation of our systems. Despite
precautions we have taken, unanticipated problems affecting our systems in the
future could cause interruptions or delays in the delivery of our courses.
Our telecommunications vendor and our co-location facilities together provide us
with our Internet connection. Their failure to provide sufficient and timely
data communications capacity and network infrastructure could cause service
interruptions or slower response times, resulting in reduced customer demand for
our courses and services. Our insurance policies may not adequately compensate
us for any losses that may occur due to any damages or interruptions in our
systems. We could be required to make capital expenditures in the event of
damage. Any system failures could adversely affect customer usage in any future
quarters, which could adversely affect our revenues and operating results and
harm our reputation with corporate customers, subscribers and commerce partners.
We do not currently have fail-over site or a formal disaster recovery plan. Our
Web site must accommodate a high volume of traffic and deliver courses and other
information in a timely manner. If our Web site fails for any reason or if we
experience periods of unscheduled downtimes, even for a short period of time,
our business and reputation would be materially harmed. We cannot accurately
project the rate or timing of any increases in traffic to our Web site and the
failure to expand and upgrade the Web site or any system error, failure or
extended downtime could materially harm our business, reputation, financial
condition or results of operations. We have recently contracted with a third
party to provide a fail-over site to our live site outside the San Francisco Bay
area. We are in the process of developing the fail-over site, expected to be
operational in the first half of 2004.
WE MAY BECOME SUBJECT TO GOVERNMENT REGULATION AND LEGAL UNCERTAINTIES THAT
COULD REDUCE DEMAND FOR OUR PRODUCTS AND SERVICES OR INCREASE THE COST OF DOING
BUSINESS, THEREBY ADVERSELY AFFECTING OUR FINANCIAL RESULTS.
We are not currently subject to direct regulation by any domestic or foreign
governmental agency, other than regulations applicable to businesses generally,
export control laws and laws or regulations directly applicable to Internet
commerce. However, due to the increasing popularity and use of the Internet, it
is possible that a number of laws and regulations may become applicable to us or
may be adopted in the future with respect to the Internet covering issues such
as:
o user privacy;
o taxation;
o content;
o right to access personal data;
o copyrights;
o distribution; and
o characteristics and quality of services.
The applicability of existing laws governing issues such as property ownership,
copyrights, and other intellectual property issues, encryption, taxation, libel,
export or import matters and personal privacy to the Internet is uncertain. The
vast majority of these laws were adopted prior to the broad commercial use of
the Internet and related technologies. As a result, they do not contemplate or
address the unique issues of the Internet and related technologies. Changes to
these laws, including some recently proposed changes, could create uncertainty
in the Internet marketplace. Such uncertainty could reduce demand for our
services or increase the cost of doing business due to increased costs of
litigation or increased service delivery costs.
OUR INABILITY TO PROTECT OUR INTELLECTUAL PROPERTY AND PROPRIETARY RIGHTS AND
OUR INTERNET DOMAIN NAME COULD LEAD TO UNAUTHORIZED USE OF OUR COURSES OR
RESTRICT OUR ABILITY TO MARKET OUR COURSES.
Our success depends on our ability to protect our proprietary rights and
technology. We rely on a combination of copyrights, trademarks, service marks,
trade secret laws and employee and third-party nondisclosure agreements to
protect our proprietary rights. Despite our efforts, unauthorized parties may
attempt to duplicate or copy our courses or our delivery technology or obtain
and use information that we regard as proprietary and third parties may assert
that our technology and intellectual property infringes patents, trademarks,
copyrights and trade secrets. The laws of many countries do not protect our
proprietary rights to the same extent as the laws of the United States.
Effective trademark, service mark, copyright and trade secret protection may not
be available in every country in which we provide our courses and services.
We have registered the trademark DigitalThink and we own the domain names
digitalthink.com, digitalthink.org, digitalthink.net. It is possible, however,
that third parties could acquire trademarks or domain names that are
substantially similar or conceptually similar to our trademarks or domain names.
This could decrease the value of our trademarks or domain names and could hurt
our business. The regulation of domain names in the United States and in foreign
countries could change. The relationship between regulations governing domain
names and laws protecting trademarks and similar proprietary rights is unclear.
As a result, we may not acquire or maintain exclusive rights to our domain names
in the United States or in other countries in which we conduct business.
We may from time to time encounter disputes over rights and obligations
concerning intellectual property. We obtain the content for many of our courses
from our customers and it is possible that the use of this content may subject
us to the intellectual property claims of third parties. Although we generally
seek indemnification from our customers to protect us from these types of
claims, we may not be fully protected from extensive damage claims or claims for
injunctive relief. Our customers may assert that some of the courses we develop
for our general catalog or under contract with other customers may improperly
use their proprietary content. Our involvement in any litigation to resolve
intellectual property ownership matters would require us to incur substantial
costs and divert management's attention and resources. We cannot predict the
effect of a failure to prevail in any litigation of this kind.
THE PRICE OF OUR COMMON STOCK HAS FLUCTUATED SIGNIFICANTLY IN THE PAST AND MAY
CONTINUE TO DO SO.
Our common stock price has fluctuated significantly since our initial public
offering in February 2000. While much of the fluctuation in our common stock
price may be due to our business and financial performance, we believe that
these fluctuations are also due to fluctuations in the stock market in general
based on factors not directly related to our performance, such as general
economic conditions or prevailing interest rates. As a result of these
fluctuations in the price of our common stock, it is difficult to predict what
the price of our common stock will be at any point in the future, and you may
not be able to sell your common stock at or above the price that you paid for
it.
WE ARE SUBJECT TO A PENDING LEGAL PROCEEDING AND MAY BECOME SUBJECT TO
ADDITIONAL PROCEEDINGS AND ADVERSE DETERMINATIONS IN THESE PROCEEDINGS COULD
HARM OUR BUSINESS.
In October 2001, a complaint was filed in the United States District Court for
the Southern District of New York against the Company, certain of its officers
and directors, and certain underwriters of the Company's initial public
offering. The complaint was purportedly filed on behalf of a class or certain
persons who purchased DigitalThink's common stock between February 24, 2000 and
December 6, 2000. The complaint alleges violations by DigitalThink and its
officers and directors of the Securities Act of 1933 in connection with certain
alleged compensation arrangements entered into by the underwriters in connection
with the offering. Substantially similar complaints have been filed against over
300 other issuers that have had initial public offerings since 1998.
In August 2002, a complaint was filed in the United States District Court for
the Northern District of California by IP Learn, LLC against DigitalThink and
two of its customers. The complaint alleges that DigitalThink has infringed
certain patents that have been assigned to IP Learn. Substantially similar
complaints have been filed against other companies in the e-learning industry,
including Smartforce, PLC, SkillSoft Corporation, Saba Software, Inc. and
Docent, Inc.
In November 2002, a complaint was filed in the United States District Court for
the Southern District of Texas, Houston Division by IP Innovation LLC v. Thomson
Learning, Inc., Skillsoft Corporation, eCollege.com, DigitalThink, Inc., Docent,
Inc., Blackboard, Inc., Global Knowledge Network, Inc. and The Princeton Review.
The complaint alleges that DigitalThink and the other defendants have infringed
a patent that has been assigned to IP Innovation.
We believe that all of these actions are without merit and intend to vigorously
defend ourselves against all of them. Although we cannot presently determine the
outcome of this action, an adverse resolution of this matter could significantly
negatively impact our financial position and results of operations.
We may be from time to time involved in various lawsuits and legal proceedings,
which arise in the ordinary course of business. An adverse resolution of these
matters could significantly negatively impact our financial position and results
of operations.
PROVISIONS OF OUR CHARTER DOCUMENTS AND DELAWARE LAW MAY HAVE ANTI-TAKEOVER
EFFECTS THAT COULD PREVENT A CHANGE IN OUR CONTROL, EVEN IF THIS WOULD BE
BENEFICIAL TO STOCKHOLDERS.
DigitalThink has put in place a Shareholder Rights Plan that grants existing
shareholders additional rights in the event that a single holder acquires
greater than 15% of our shares. In July 2002, the DigitalThink Board of
Directors amended the Shareholder Rights Plan to permit WaldenVC and their
affiliated persons to purchase, in the aggregate, up to 20% of the outstanding
shares of DigitalThink. At the same time, DigitalThink also entered into an
agreement with WaldenVC, in which WaldenVC agreed to vote their shares in direct
proportion to the votes cast by all of DigitalThink's shareholders in each
shareholder election.
Provisions of our amended and restated certificate of incorporation, bylaws and
Delaware law could make it more difficult for a third party to acquire us, even
if doing so would be beneficial to our stockholders. These provisions include:
o a classified board of directors, in which our board is divided
into three classes with three year terms with only one class
elected at each annual meeting of stockholders, which means
that a holder of a majority of our common stock will need two
annual meetings of stockholders to gain control of the board;
o a provision which prohibits our stockholders from acting by written consent
without a meeting;
o a provision which permits only the board of directors, the president or
the chairman to call special meetings of stockholders; and
o a provision which requires advance notice of items of business to be
brought before stockholders meetings.
Amending any of the above provisions will require the vote of the holders of 66
2/3% of our outstanding common stock.
ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
There have been no significant changes to the Company's exposure to market risk
as disclosed in the Company's Annual Report on Form 10-K, as amended on Form
10-K/A, for the year ended March 31, 2002.
ITEM 4: CONTROLS AND PROCEDURES
Evaluation of disclosure controls and procedures
DigitalThink's management, under the supervision and with the participation of
the Chief Executive Officer ("CEO") and Chief Financial Officer ("CFO"),
performed an evaluation of the effectiveness of the design and operation of the
DigitalThink's "disclosure controls and procedures" (as defined in Securities
Exchange Act of 1934 (the "Exchange Act") Rules 13a-14(c) and 15-d-14(c)) as of
a date (the "Evaluation date") within ninety (90) days before the filing date of
this Quarterly Report on Form 10-Q. Based on that evaluation, the CEO and CFO,
concluded that, as of the Evaluation Date, DigitalThink's disclosure controls
and procedures were effective to ensure that information DigitalThink is
required to disclose in filings or submissions under the Exchange Act is
recorded, processed, summarized and reported accurately and timely within the
time periods specified by the Securities and Exchange Commission.
Changes in internal controls
Subsequent to the Evaluation Date, there were no significant changes in
DigitalThink's internal controls or in other factors that could significantly
affect DigitalThink's disclosure controls and procedures, nor were there any
significant deficiencies or material weaknesses in DigitalThink's internal
controls. As a result, no corrective actions were required or undertaken.
PART II: OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
In October 2001, a complaint was filed in the United States District Court for
the Southern District of New York against DigitalThink, certain of its officers
and directors, and certain underwriters of the Company's initial public
offering. The complaint was purportedly filed on behalf of a class or certain
persons who purchased DigitalThink's common stock between February 24, 2000 and
December 6, 2000. The complaint alleges violations by DigitalThink and its
officers and directors of the Securities Act of 1933 in connection with certain
alleged compensation arrangements entered into by the underwriters in connection
with the offering. Substantially similar complaints have been filed against over
300 other issuers that have had initial public offerings since 1998.
In August 2002, a complaint was filed in the United States District Court for
the Northern District of California by IP Learn, LLC against DigitalThink and
two of its customers. The complaint alleges that DigitalThink has infringed
certain patents that have been assigned to IP Learn. Substantially similar
complaints have been filed against other companies in the e-learning industry,
including Smartforce, PLC, SkillSoft Corporation, Saba Software, Inc. and
Docent, Inc.
In November 2002, a complaint was filed in the United States District Court for
the Southern District of Texas, Houston Division by IP Innovation LLC v. Thomson
Learning, Inc., Skillsoft Corporation, eCollege.com, DigitalThink, Inc., Docent,
Inc., Blackboard, Inc., Global Knowledge Network, Inc. and The Princeton Review.
The complaint alleges that DigitalThink and the other defendants have infringed
a patent that has been assigned to IP Innovation.
Although no assurances can be given that these matters will be resolved in the
Company's favor, the Company believes the resolution of these lawsuits will not
have a material adverse effect on its financial position, results of operations,
or cash flows.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
On September 30, 2002, DigitalThink entered into an agreement to sell 100,000
shares of DigitalThink common stock and 15-month option to purchase an
additional 100,000 shares to Roger Goddu, a member of the DigitalThink board of
directors. DigitalThink relied on the exemption provided in Rule 506 promulgated
under Section 4(2) of the Securities Act of 1933, as amended, for sales to a
single accredited investor. The aggregate purchase price of the shares and
option was $130,000 and the aggregate exercise price of the option was $111,000.
The transaction closed on November 13, 2002.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER MATTERS
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
Exhibit 10.22 Agreement of Sublease dated November 5, 2002
between San Francisco Unified School District and
DigitalThink, for office space located at 1064 and 1098
Harrison Street, San Francisco, California
Exhibit 99.1 Certification Pursuant to 18 U.S.C. Section 1350, as
Adopted Pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002
Exhibit 99.2 Certification Pursuant to 18 U.S.C. Section 1350, as
Adopted Pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002
(b) Reports on Forms 8-K:
On October 8, 2002, the Company filed Form 8-K with the Securities and
Exchange Commission to report a press release dated October 7, 2002 announcing
the addition of retail veteran Roger Goddu to its board of directors.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
DIGITALTHINK, INC.
(Registrant)
Date: February 10, 2003
/s/ MICHAEL W. POPE
-----------------------------------
Michael W. Pope
Chief Executive Officer, President
and Director
(Principal Executive Officer)
Date: February 10, 2003 /s/ ROBERT J. KROLIK
------------------------------------
Robert J. Krolik
Chief Financial Officer
(Principal Financial and Accounting
Officer)
CERTIFICATIONS
I, Michael W. Pope, certify that:
1. I have reviewed this quarterly report on Form 10-Q of DigitalThink, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the effectiveness of
the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal controls
which could adversely affect the registrant's ability to record, process,
summarize and report financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: February 10, 2003
/s/ MICHAEL W. POPE
- ----------------------------------------------------------
Michael W. Pope
Chief Executive Officer, President and Director
I, Robert J. Krolik, certify that:
1. I have reviewed this quarterly report on Form 10-Q of DigitalThink, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the effectiveness of
the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal controls
which could adversely affect the registrant's ability to record, process,
summarize and report financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: February 10, 2003
/s/ Robert J. Krolik
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Robert J. Krolik
Chief Financial Officer