Back to GetFilings.com
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
-------------------
FORM 10-K
-------------------
FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO SECTIONS 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended March 31, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from ____________ to ____________ .
Commission File Number: 333-104650
DIGITALTHINK, INC.
(Exact name of registrant as specified in its charter)
Delaware 94-3244366
(State or other jurisdiction of (I.R.S. Employer
Incorporation or organization) Identification No.)
601 Brannan Street, San Francisco, California 94107
(Address of principal executive offices) (Zip code)
(415) 625-4000
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of Exchange on which registered
None None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.001 par value per share
(Title of Class)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities 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 [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2. Yes [ ] No [ X ]
The aggregate market value of registrant's voting stock held by non-affiliates
of registrant, based upon the closing sale price of the common stock on
September 30, 2002, as reported on the Nasdaq National Market, was approximately
$32.4 million. Shares of common stock held by each officer and director have
been excluded in that such persons may be deemed to be affiliates. This
determination of affiliate status is not necessarily a conclusive determination
for other purposes.
Outstanding shares of registrant's common stock, $.001 par value, as of May 27,
2003: 44,186,732
DOCUMENTS INCORPORATED BY REFERENCE
Parts of certain sections of the Proxy Statement to be filed in connection with
the 2003 Annual Meeting of Stockholders are incorporated by reference into Part
III of this Annual Report on Form 10-K where indicated.
This document contains forward-looking statements that relate to future events
or our future financial performance. In some cases, you can identify
forward-looking statements by terminology such as "may," "should," "expects,"
"plans," "anticipates," "believes," "estimates," "forecasts," "predicts,"
"intends," or "potential" or the negative of such terms or other comparable
terminology. In addition, these forward-looking statements include, but are not
limited to, statements regarding the following: (1) our ability to compete
effectively in the e-learning market, (2) our plans to develop new solutions and
products, (3) our business strategies and plans, and (4) our strategic
relationships with Electronic Data System, Incorporated ("EDS") and others. Many
of the statements we make regarding the future are only predictions. Although we
believe that the expectations reflected in the forward-looking statements are
reasonable based on our current beliefs, we cannot guarantee future results,
levels of activity, performance or achievements. The risks set forth in the
section in Item 1 below entitled "Risk Factors" and elsewhere in this document
could cause our future operating results to differ materially from those
contemplated by our forward-looking statements. In addition, factors that we are
not currently aware of could harm our future operating results.
PART I
Item 1. Business
DigitalThink Overview
We provide custom e-learning solutions designed to address the strategic
business objectives of our customers by helping them to improve workforce
development, sales force effectiveness and customer acquisition and retention.
We can host and centrally manage software and content, significantly reducing
our customers' learning infrastructure costs and enabling us to rapidly update
or customize their courses. Our web-based solutions deliver content to large,
geographically dispersed groups who can access courses from anywhere, at anytime
through a standard web-browser. Our courseware solutions include application
training, new hire and product training, compliance and industry specific
training, to name a few. Our solutions also allow customers to generate revenue
opportunities by offering branded e-learning solutions to their customers. In
addition, we also offer web-based tracking and reporting tools that our
customers use to measure and evaluate participants' progress and the
effectiveness of their learning programs. In the last year we released the L5
Learning Delivery System, a 24/7 available, open, scalable and standards-based
platform. L5 includes a comprehensive learning environment that allows customers
to launch DigitalThink created courseware, client created courseware and
third-party content.
With the acquisition of Horn Interactive in April 2003, a provider of
simulation-based custom e-learning products and services, we are now able to
provide innovative simulation design and development capabilities to our
customers. We believe we have expanded our position as a leader in custom
e-learning courseware by addressing the growing market for simulation-based
learning.
As of March 31, 2003, we had delivered courses on more than 700 subjects to over
525 customers in a variety of industries including technology, retail, financial
services, automotive, healthcare, and telecommunications. Our customers either
pay us to develop custom courses for their specific requirements or select
courses from our catalog, or both. Customers that have purchased solutions from
us over the past fiscal year include Abercrombie & Fitch, the American Bankers'
Association, Automatic Data Processing, BearingPoint (formerly KPMG Consulting),
Charles Schwab, CitiGroup, Circuit City, Cisco Systems, EDS, Lincoln Financial,
Marsh, Percepta, RedHat, Sara Lee, SonicWall and Sun Microsystems.
Industry Background
Today's businesses face rapidly changing environments characterized by
increasing competition, economic globalization and technological change. To
compete effectively, businesses must improve business processes, reduce
operating costs, extend barriers to entry and shorten product development
cycles. The emergence of the Internet as a business platform has accelerated
these trends and presented new opportunities in many industries for leading
companies to create a competitive advantage.
Senior executives at these leading companies realize that a fundamental source
of competitive advantage is the depth, consistency and currency of knowledge
possessed by their employees, distributors, suppliers and customers. Employees
who know more about a company's business are generally able to perform more
effectively. Sales professionals and distributors who understand the benefits of
a company's services achieve better results. Customers who learn the benefits of
a product's features tend to be more loyal, less expensive to support and more
likely to purchase again. Driving knowledge to the extended enterprise
effectively reduces the time-to-market of new products and services, improves
sales channel productivity and reduces customer support costs.
In an attempt to address today's competitive challenges, businesses are spending
large amounts on learning and skills development. Based on annual industry
report by Training Magazine in 2002, businesses spend nearly $54.2 billion
annually on learning programs in the United States. As the Internet and
e-learning continue to demonstrate measurable results for businesses, we believe
-1-
more dollars will be spent on e-learning programs. To date, most dollars spent
on corporate learning has been on in-person, instructor-led training programs.
We have found that these traditional learning methodologies are less effective
than e-learning for certain types of business purposes because they are:
o Difficult to deploy across an organization and its extended enterprise.
Many businesses find it difficult to effectively deliver up-to-date
content in a timely and consistent manner to large,
geographically-dispersed groups. The traditional solution of scheduling
corporate education programs at specific times in single locations
results in logistical challenges and opportunity costs that often lower
participation rates and limit a company's ability to extend knowledge to
its extended enterprise.
o Difficult to customize and update. Instructor-led content is often
prepared in advance to provide for the production and distribution of
printed or videotaped materials, which are then updated at fixed
intervals and delivered using an instructor-led, standardized curriculum
of pre-scheduled meetings in set physical locations. As a result,
print-based content cannot be updated and distributed to learners as
rapidly as web-based content, and instructor-led sessions using these
materials may fail to incorporate the latest information on new
products, strategies and processes for specific uses or customers.
o Difficult to personalize on a large scale. Instructor-led learning
programs are typically designed to address the needs of large groups,
which can impair the effectiveness of the individual learning
experience. If a participant cannot have his or her individual question
answered or cannot access supplemental tutoring after the course
sessions have concluded, learning may not actually occur. The cost of
assembling a large group in a central location is often justified
because of the economics of presenting material to a mass audience.
Actual learning, by contrast, occurs on an individual level. The mass
approach rarely provides sufficient time for individuals to ask
questions, much less to be tutored and critiqued.
o Unable to track and monitor learning effectiveness. Tracking student
performance in traditional corporate classroom programs is avoided as it
typically requires additional expenses for manual test administration,
grading and recording.
o Costly and slow. Traditional learning initiatives require prolonged
absences of valuable employees due to travel to course locations and
attendance at scheduled course meetings, resulting in significant
opportunity costs due to lost work. In addition, course materials must
be printed and delivered using traditional means. As a result,
businesses are unable to continuously educate their extended enterprises
on new products, strategies and processes in a timely manner. With
e-learning, participants can learn at anytime from a computer, without
having to schedule classrooms or meetings, and without having to travel
to a classroom facility.
In response to these limitations, many businesses are seeking more effective
learning solutions. The Internet is transforming the corporate learning
marketplace by offering innovative ways to design and deliver knowledge.
According to International Data Corporation, the corporate e-learning market is
projected to grow from $6.6 billion in 2002 to more than $23.7 billion in 2006.
By leveraging the Internet, businesses can instantly and simultaneously deploy
content to a broad, global audience. This content can be easily and continuously
accessed, modified and refreshed and learning programs can be enhanced as
participants use e-mail and chat rooms to establish interactive relationships
with instructors and peers. Web-based technologies can also offer real-time
tracking of participant performance.
Internal training organizations and external corporate learning providers are
geared to instructor-led training and their set of skills is limited to
classroom scheduling and instruction. To compete effectively in the e-learning
market, these organizations would need to develop a broad range of competencies,
including technology development, content creation, web-hosting and online
community management. Companies are seeking outsourced and integrated e-learning
solutions as a means of more effectively educating their extended enterprise.
The DigitalThink Solution
We enable our customers to change the way their employees and customers learn.
Through a focus on custom content development and delivery, we enable executives
to address critical business initiatives and sustain competitive advantage in
key areas such as new product rollouts, application training, management
development, new-hire training and sales effectiveness.
The key components of our solutions include:
Custom Content Development. With thousands of hours of custom content developed
and millions of learning events around the globe, we are one of the largest and
most proven developers of custom e-learning. Our learning strategists and
instructional designers work with subject matter experts to build award-winning
content that leverages adult learning theory and best practices, creating a
learning experience that drives measurable results against customer-defined
learning objectives.
-2-
We leverage best-practice frameworks developed through experience with hundreds
of customers across thousands of courses. These Expert Course Designs (XCDs),
addressing common business needs such as QuickStart Application Training,
Branded Customer Services, Product Sales Simulation, and Technical
Certification, enable customers to achieve the efficiencies and results of
starting their initiatives with proven instructional strategy, visual design and
interactivities. XCDs enable us to produce high-quality, effective custom
content more quickly than typical custom course development allows.
For optimal learner performance and time-to-competency, our custom content is
personalized based on pre-assessments or in-course performance and includes
exercises for practical application. With the recent acquisition of Horn
Interactive, DigitalThink extends its leadership in the emerging market for
simulation-based learning, offering customers immersive e-learning featuring
complex, realistic simulations for appropriate training contexts such as sales
training and management development.
All our custom courseware is built to be Shareable Content Object Reference
Model ("SCORM") compliant. SCORM is a suite of technical standards that enable
web-based learning systems to find, import, share, reuse and export learning
content in a standardized way. SCORM 1.2 has rapidly emerged as the e-learning
industry standard, and our leadership in supporting and leading the SCORM
standard ensures that customer content investments are portable and reusable.
Custom content we have developed can be deployed to any SCORM-compliant LMS or
delivered through our L5 Learning Delivery System.
Learning Delivery. We are a leader in the e-learning industry, due in part to
the introduction of our L5 Learning Delivery System, designed with over six
years of experience and millions of courses delivered to customers. The L5
Learning Delivery System lowers total costs of e-learning, maximizes learning
impact, and essentially eliminates delivery failures.
o Lower total costs of e- learning. Our L5 Learning Delivery System enables the
separation of learning content from course functionality and branding,
removing the need to hard-code these features into the content. As a
result, we significantly reduce the cost of content maintenance and increase
the reuse of content across business units and channels. The L5 Learning
Delivery System also maximizes content investments across the enterprise
by serving as a central delivery system for all SCORM-compliant content,
replacing the recurring costs of content integration to multiple learning
systems with the efficiencies of a single, standards-based deployment to the
L5 Learning Delivery System for global content delivery. Additionally,
leveraging the L5 Learning Delivery System's hosted web-services approach
eliminates the significant, and often underestimated, capital and human
resource costs associated with scaling e-learning from an initial
pilot program to achieve business impact enterprise-wide.
o Maximize learning impact. Our L5 Learning Delivery System includes a robust
Learning Environment, an asynchronous virtual classroom that improves the
effectiveness of all SCORM-compliant content, whether developed by us or by
our customers or partners. The L5 Learning Environment includes the
following features and learner services, leverageable by all content
delivered from the platform:
o Personalization and dynamic navigation that adjusts course sequence,
allowing learners to see only content that is relevant to them.
o Active collaboration giving learners access to an online community of
peers to discuss course-related topics.
o Built-in notes to let learners capture key information as they
progress through each course, and save or print them for easy
reference at any time.
o Expert tutoring that allows learners to get feedback on their
individual work, answers to specific questions, and personalized
guidance whenever needed.
o Targeted web-searches to enable learners to access the most current
materials available on the Internet or their company's intranet.
o Essentially eliminate delivery failures. Our approximate $50 million
investment in research and development, infrastructure and learner support
ensures high-performance delivery for any number of concurrent learners. The
L5 Learning Delivery System is one of the most scalable web-services in the
industry, with millions of learning events delivered and a system
infrastructure designed to handle many times current traffic levels. We
manage and maintain our delivery architecture to ensure courses are available
24 hours per day, 7 days per week, 365 days per year, and we consistently
lead the industry with uptime exceeding 99.7%. For mobile learners and
low-bandwidth situations, we plan to offer the L5 Desktop Client in the
Summer of 2003, allowing courses to be downloaded from the L5 Learning
Delivery System and taken offline. Completion and performance data are
synchronized when the learner reconnects to the network.
As an open platform, the benefits of the L5 Learning Delivery System extend not
only to content we developed, but to any SCORM content developed by our partners
or our customers. Fully integrated into the L5 Learning Delivery System, the L5
Developer Portal provides tools and training to enable content developers to
successfully author and deploy content to the L5 Learning Delivery System using
any certified SCORM-compliant authoring tool, such as Dreamweaver.
-3-
Management and Integration. The L5 Learning Delivery System provides the option
to leverage the L5 Administration module, providing essential management
functionality that provides customers "instant-on" capabilities to launch and
track their e-learning initiatives quickly and efficiently. For customers with a
third party Learning Management System ("LMS"), the L5 LMS Connector provides
integration for seamless data exchange between systems.
In addition, the L5 Learning Delivery System includes the L5 Reporting &
Analysis module which provides customers with tracking and reporting related to
customer-defined learning objectives, providing more granular and flexible data
analysis than that available through LMS systems alone.
To leverage existing business infrastructure and processes, the L5 Enterprise
Gateway Connector provides customers a standards-based (XML/SOAP) and secure
protocol to reliably integrate the L5 Learning Delivery System with a company's
enterprise business applications, including enterprise resource planning (ERP),
learning management (LMS), human resource management (HRMS), e-commerce, and
customer relationship management (CRM) systems.
Strategy
Our vision is to enable our customers to achieve outstanding business results by
changing the way people learn. We intend to do this through ongoing focus on our
customers requirements, translating them into world-class solutions. Key
elements of our strategy include:
o Develop long-term strategic relationships with our customers. We believe
that e-learning solutions will become increasingly critical to a
business' ability to compete successfully. As a leading provider of
custom e-learning content development and delivery, we become an
increasingly strategic resource for our customers as they address
critical business initiatives through e-learning. We plan to extend our
presence within our customers' enterprises by helping our customers
understand the effectiveness of our solutions in a broad range of
operational initiatives.
o Vertical and horizontal focus. We have increased our focus on providing
solutions to meet requirements specific to the technology, retail,
financial services, automotive, healthcare and telecommunications
sectors. We intend to continue to provide solutions tailored to the
specific business needs in these areas, including trends toward
cost-cutting, customer retention, and new product introduction.
o Leverage development alliances and reseller relationships. We plan to
grow both our direct and indirect sales channels to better service our
existing markets and penetrate new markets. Our technology platform can
be easily adapted to a variety of learning uses and our partners are
building content to be hosted and delivered by us on behalf of their
customer.
Customers
Our customers can use our custom e-learning solutions to compress the learning
cycle, increase knowledge throughout the extended enterprise, enhance brand
equity and customer service and reduce operational costs.
As of March 31, 2003, we have delivered courses to over 525 customers, including
many large corporations. Our customers use our custom e-learning solutions to
address strategic business needs in three broad areas: workforce development,
sales force effectiveness and customer acquisition and retention. A workforce
development customer uses our e-learning solutions to achieve a particular
strategic objective by teaching or reinforcing employee skills. Sales executives
use e-learning to improve the sales performance of their internal or external
sales channels by deploying skills and product education quickly into the field.
Customer retention customers use our products and services to provide e-learning
to their external customers as an attractive new revenue stream or as a source
of goodwill or brand enhancement.
Content and Courses
We currently offer our customers more than 700 subjects from our
custom-developed and e-learning catalog. Depending on topic area, each course
consists of one to several hours of student work, including lessons, quizzes,
interactive applets, simulations, and hands-on participant exercises, some of
which are graded and commented upon by our tutors before being returned via
email to participants. All of our courses have been designed to take advantage
of our e-learning environment and leverage Internet technologies, such as e-mail
and discussion boards, in order to provide participants with an engaging
learning experience and extensive interaction with our tutors. In addition to
pre-developed courses, we develop customized content for our customers. These
customized courses incorporate the significant domain knowledge of our clients
and can be rapidly redesigned for other customers in the same industry. We
typically retain intellectual rights to our content and can reuse elements of
the courses for other customers.
-4-
Products and Technology
Our e-learning environment consists of technologies that we have designed and
created to function as an integrated solution. By employing standard Internet
technologies and a hosted content delivery model, we are able to provide our
customers with a high quality, efficient means to educate their extended
enterprise.
Content Delivery System
We can host the e-learning environments of our customers. In a hosted
environment, the courses and our content delivery system are located on our
servers but can be accessed through the Web or the customer's intranet. By
centralizing all infrastructure and hosting requirements, our customers derive
the following significant benefits:
o customers do not need to install or manage any software;
o content can be updated and infrastructure technology can be improved
continuously without adversely impacting our clients and at a lower
cost to us;
o customers avoid the need to make significant investments in technology
infrastructure such as servers, databases, technical staff or technical
support; and
o participants can access course content at anytime, from anywhere,
through the use of a standard modem and web-browser.
Deployed Solution
Our deployed delivery option is targeted at companies that need an e-learning
solution that resides within their own technical environment. With this option,
customers can host their own learning management systems and then add our
content from either our catalog or custom courses we design for them, or both.
System Architecture
The architecture of our content delivery system is designed to scale rapidly to
provide large student populations with tutor-supported e-learning content. In
addition, we have developed our content delivery system using standard Internet
technologies such as Java and HTML, facilitating the delivery of our content to
our customers' web-browsers. We utilize a single code base to deliver content.
As a result, any improvement made in our software for one customer automatically
benefits all other customers.
Our content is stored in a database as structured "learning elements." We have
developed a templating system that automatically controls the graphical
presentation, or "look and feel," of a course, as well as course navigation.
This content storage and delivery approach allows us to personalize the content
for individuals in each course and minimizes content or formatting errors. In
addition, this structure enables the rapid customization of course content for
different customers. Our technology was developed internally without deriving
any elements from a legacy application or a previously existing learning
delivery system.
Course Enrollment Options
Our customers can choose several different methods to allow participants to
access our courses. Enrollments can be managed by authorized personnel using our
corporate administration system. Alternatively, participants can self-enroll
using an intranet or Internet e-commerce option. Our system can also be
integrated with third-party enterprise software applications to allow automated
enrollments using a learning management or other data base administration
system.
Tracking and Reporting System
Each participant's learning activities are fully tracked in our database. This
comprehensive tracking ability allows a participant to start a course at work,
and continue at home or while traveling. Regardless of their location, our
system recognizes each participant, tracks their course progress and records
their performance. Using only a standard web-browser, managers can run both
standardized and custom reports on participant enrollments and progress, gaining
visibility into the learning status of their extended enterprise.
-5-
Course Tutoring
Our technology allows us to increase the efficiency and scalability of our
tutoring resources. The ability of tutors worldwide to interact with
participants through standard Internet communication methodologies significantly
increases the pool of tutor candidates we can recruit. In addition, our database
system allows multiple tutors to support the same course as grading and exercise
submissions can be accessed and responded to by any tutor. Duplication of tutor
work is prevented by our message queuing technology.
Collaboration Tools
We host and make available to our customers proprietary and third-party
collaboration tools, which currently include instant messaging software, e-mail
solutions, chat rooms, discussion boards and real-time communications. These
collaboration tools are designed to create a learning environment that fosters
collaboration between peers and a high degree of interaction between
participants and tutors.
Testing and Assessment
Our system offers comprehensive testing and assessment capabilities, which can
be customized for specific learning solutions and customers. Assessment and
testing capabilities include multiple choice, multiple answer quizzes with
randomized question sets, tutor-scored and commented exercises, and interactive
testing applets and simulations.
Full Integration with Corporate Infrastructures
Our custom e-learning solutions can be fully integrated with our customers'
corporate information technology systems, including their web-sites and
intranets. As a result, course participants do not necessarily realize that they
are accessing content hosted from our servers. Our integration layer provides
adapters for learning management systems. We design our course content to be
compatible with our customers' security concerns and bandwidth limitations.
Scalable Architecture
Our system has been designed to scale rapidly and to consistently deliver
content to large numbers of participants. We use load testing to measure our
system capacity and identify potential bottlenecks. Improvements to our system
architecture increase system capacity beyond current demands.
High-Availability Systems
Our systems have been designed to maximize availability, with redundancy in the
areas in which we believe failures are most likely to occur. We have also
implemented redundant network connections to the Internet, a load-balanced
redundant web-server and a highly-redundant storage array to safeguard our
information. In addition, locating our web-servers with Cable and Wireless, a
leading web-hosting firm, provides us with backup power, constant monitoring,
physical security, seismic resistance, fire suppression and climate control
systems. We are vulnerable to certain types of failures, including catastrophic
failure of the Cable and Wireless site due to natural disasters or other events
and simultaneous failure of our primary and redundant systems. We are currently
building a redundant fail-over site in Sacramento, California, to mitigate any
risk with regards to a catastrophic failure at Cable and Wireless. The redundant
fail-over site is expected to be completed by the first half of fiscal 2004.
Sales and Marketing
We sell our custom e-learning solutions primarily through our own direct sales
organization. We also sell indirectly through channel partners and strategic
alliance partners. Our direct sales organization focuses on developing long-term
relationships with large corporate customers. Our channel partners, including
Sun Educational Services, Red Hat and others, leverage their unique distribution
models to reach differentiated industries, international markets and customer
segments. We also have alliance relationships with EDS, BearingPoint (formerly
KPMG Consulting) and others, who work with us to jointly sell our custom
e-learning solutions and resell our courses as components of their e-learning
offerings targeted at specific industries.
Competition
The e-learning market is evolving quickly and is subject to rapid technological
change, shifts in customer demands and evolving learning methodologies. To
succeed, we must continue to upgrade our technology, expand our course offerings
and distinguish our solution. As competition continues to intensify, we expect
the e-learning market to undergo significant price competition and
consolidation. We expect to face price pressures from competitors as our
potential customers demand more value for their education budgets and as our
competitors become mature.
-6-
The e-learning market is highly fragmented with no single competitor accounting
for a dominant market share, and competition is intense. In addition to
competing with other suppliers of technology-based learning solutions, we also
compete with third-party suppliers of instructor-led education and learning and
internal training departments.
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. In
addition, larger companies may enter the e-learning market through the
acquisition of our competitors. We anticipate increased competition as
additional entrants join the e-learning market.
Intellectual Property and Proprietary Rights
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.
Our name and corporate logo are registered trademarks and we own the domain
names digitalthink.com, digitalthink.org, and 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.
We are currently defending two intellectual property actions, both of which are
described under Item 3 of this report. We believe that both of these actions are
without merit and intend to vigorously defend ourselves against both of them.
Although we believe that both of these actions will be resolved in a manner
favorable to DigitalThink, we cannot presently determine the outcome. An adverse
resolution of either of these matters, or protracted litigation, could
significantly negatively impact our financial position and results of operations
and could divert significant management resources.
Employees
As of March 31, 2003, we employed 410 persons. Of these employees, 68 were
employed in course development, 136 were in custom courseware development, 55 in
sales and marketing, 73 in research and development, 28 in web-delivery and
customer support and 50 in general and administration. Of these employees,
approximately 210 were located in the United States and approximately 200 were
located in India.
-7-
RISK FACTORS
You should consider the risks described below before making any investment
decision with respect to our stock. We believe that the risks and uncertainties
described below are the principal material risks facing our company as of the
date of this report. 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 AN ACCUMULATED DEFICIT OF $218.4 MILLION AT
MARCH 31, 2003. 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 March 31, 2003 was $218.4 million. We have never achieved a
profitable quarter and we may continue to incur quarterly losses if our revenue
growth does not meet expectations while 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 develop and acquire new course offerings
with new areas of expertise that may increase operating losses if those expenses
are not immediately offset by new revenues.
DEMAND FOR OUR PRODUCTS AND SERVICES HAVE BEEN AND MAY CONTINUE TO BE AFFECTED
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, and appears to be continuing in 2003. 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
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 future 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 the addition of several new employees to
two organizations we acquired in fiscal 2002. As of March 31, 2003, 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 and
vice versa.
-8-
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 fiscal year ended 2003, we had revenues of
$42.1 million and expenses of $53.4 million, excluding the one-time charge
related to Statement of Financial Accounting Standards ("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.
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 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 THAT 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 REVENUES WE DEPEND ON THE TIMELY ACHIEVEMENT OF VARIOUS
MILESTONES, AND OUR INABILITY TO RECOGNIZE REVENUES 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 47% of our total revenues for the
fiscal year ended March 31, 2003. 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.
-9-
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 or quarterly period.
In the fiscal year ended 2003, our five largest customers accounted for 67% of
our total revenues of $42.1 million compared to 54% of our total revenues of
$43.4 million for the fiscal year ended 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 that 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;
-10-
o different learning styles;
o longer sales and payment cycles;
o difficulties 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 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 most of this new hiring to take place in India.
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. Our success
will depend in large part upon our ability to attract and retain employees. We
face competition in this regard from other companies, but we believe that we
maintain good relations with our employees. None of our employees are members of
organized labor groups.
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 or even their
own in-house development capabilities. 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.
-11-
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 or have introduced 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.
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.
-12-
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 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 a fully redundant 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 are in the process of
developing a fully redundant fail-over site in Sacramento, California, expected
to be operational in the first half of fiscal 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.
-13-
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.
WE ARE SUBJECT TO PENDING LEGAL PROCEEDINGS AND MAY BECOME SUBJECT TO ADDITIONAL
PROCEEDINGS. 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 us and our 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 we have 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
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 we 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 believe that all of these
actions will be resolved in a manner favorable to us, we cannot presently
determine the outcome. An adverse resolution of any of these matters, or
protracted litigation, could significantly negatively impact our financial
position and results of operations and could divert significant management
resources.
We may be from time to time involved in other lawsuits and legal proceedings
that arise in the ordinary course of business. An adverse resolution of these
matters could significantly negatively impact our financial position and results
of operations.
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
-14-
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.
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.
We have put in place a Shareholder Rights Plan that grants existing stockholders
additional rights in the event that a single holder acquires greater than 15% of
our shares. In July 2002, our Board amended the Shareholder Rights Plan to
permit WaldenVC and their affiliated entities and persons to purchase, in the
aggregate, up to 20% of the outstanding shares of DigitalThink. At the same
time, we 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 our
stockholders in each stockholder 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 that prohibits our stockholders from acting by written consent
without a meeting;
o a provision that permits only the board of directors, the president
or the chairman to call special meetings of stockholders; and
o a provision that 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.
WHERE YOU CAN FIND ADDITIONAL INFORMATION
We file annual, quarterly and special reports, proxy statements, and other
information with the SEC. You may read and copy any document we file at the
SEC's public reference room at Room 1024, 450 Fifth Street, N.W., Washington,
D.C. 20549. Please call the SEC at 1-800-SEC-0330 for further information on the
public reference rooms. Our SEC filings are also available to the public at the
SEC's web site at http://www.sec.gov. Additional information about us may be
found on our web site at http://www.digitalthink.com.
-15-
Item 2. Properties
We currently lease a total of approximately 116,000 square feet of office space
in two locations in San Francisco, California and we have subleased
approximately 42,000 square feet of this space to a third party. In addition, we
have approximately 25,000 square feet of leased building space in Minneapolis,
Minnesota, which we have subleased, approximately 4,000 square feet of leased
building space in Troy, Michigan, approximately 3,000 square feet of leased
office space in Chisholm, Minnesota, approximately 3,000 square feet of leased
office space in Chicago, Illinois, approximately 8,000 square feet of leased
building space in the United Kingdom and a total of approximately 30,000 square
feet of leased building space in India in the cities of Kolkata, Bangalore and
Hyderabad. These leases expire at varying dates through 2016 and include
renewals at our option.
In March 2002, we consolidated our sales, administrative and content and
technology development facilities from a total of approximately 244,000 square
feet into approximately 100,000 square feet. As a result, we took a $6.8 million
charge to earnings with respect to leases for excess or closed facilities, which
represents the excess of such remaining lease obligations over estimated market
value, net of anticipated sublease income. Amounts accrued (net of anticipated
sublease proceeds) related to the consolidation of facilities will be paid over
the respective lease terms through 2016. During the fiscal year ended March 31,
2003, four sites have been vacated: Chisholm, Minnesota; Minneapolis, Minnesota;
Troy, Michigan; and our office in the United Kingdom.
Item 3. 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 our officers
and directors, and certain underwriters of our 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. The plaintiffs
seek unspecified monetary damages and other relief.
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 Skillsoft Corporation, Saba Software, Inc. and Docent, Inc. The
plaintiffs seek unspecified monetary damages and other relief.
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. The plaintiffs seek
unspecified monetary damages and other relief.
We believe these lawsuits are without merit and intend to defend against them
vigorously.
Item 4. Submission of Matters to a Vote of Security Holders
We did not submit any matters to a vote of security holders during the fourth
quarter ended March 31, 2003.
-16-
MANAGEMENT
Executive Officers of the Registrant
Michael W. Pope.............. 36 President and Chief Executive Officer
Robert J. Krolik............. 34 Chief Financial Officer and Secretary
Todd A. Clyde................ 38 Vice President, Consulting and Market
Solutions
Linda T. Drumright........... 42 Vice President, Engineering
Michael Schroeder............ 43 Vice President, Human Resources
Umberto Milletti............. 37 Vice President, Solutions Management
J. Jay Tyler................. 48 Executive Vice President, Sales and
Marketing
Michael W. Pope has served as our President and Chief Executive Officer since
April 2002. Prior to that he was Vice President, Chief Financial Officer from
October 1999 to April 2002. From June 1992 to October 1999, Mr. Pope served in
various positions at Dionex Corporation, a manufacturer and marketer of
chromatography systems and related products for chemical analysis, most recently
as Chief Financial Officer from April 1994 to October 1999. Mr. Pope is a
director of Dionex Corporation. Mr. Pope holds a B.A. in Quantitative Economics
from Stanford University and a M.B.A. from the Haas School of Business at the
University of California at Berkeley.
Robert J. Krolik has served as Chief Financial Officer since April 2002 and has
served as Secretary since April 2003. From March 2001 to April 2002 he was
Corporate Controller. Prior to that he was Chief Financial Officer of Karna LLC,
a technology company, from September 1999 to March 2001. From April 1997 to
September 1999 he was Director of Finance of SRI Consulting, a consulting firm.
From July 1991 to March 1997 he held various positions at Arthur Andersen, a
public accounting firm, most recently as manager from July 1996 to March 1997.
Mr. Krolik holds a B.B.A. in Finance from the University of Texas at Austin. He
is also a Certified Public Accountant.
Todd A. Clyde has served as Vice President, Consulting and Market Solutions
since January 2001. Prior to that he was Vice President, Learning Solutions from
March 1998 to December 2000. From October 1986 to March 1998, Mr. Clyde held
several positions with Andersen Consulting (now Accenture), a management
consulting firm, most recently as Senior Manager. Mr. Clyde holds a B.A. in
Management Science from the University of California at San Diego.
Linda T. Drumright has served as Vice President, Engineering since October 1999.
From August 1998 to October 1999, Ms. Drumright served as Vice President,
Budgeting, Planning and Forecasting Application Product Development for Hyperion
Solutions Corporation, a developer of enterprise analytic application software.
Prior to that, from July 1997 to August 1998, she was the Senior Director of the
Tools and Applications Division at Arbor Software Corp., a database software
developer, and from June 1990 to July 1997, she held several technical
positions, including Senior Manager, at Sybase, Inc., an enterprise software
company. Ms. Drumright holds a B.A. in Computer Science from the University of
California at Berkeley.
Michael Schroeder has served as Vice President, Human Resources since April
2003. Prior to that he was Vice President, Human Resources at Alphablox Corp.
from August 2000 to August 2002 . From August 1992 to August 2000, Mr. Schroeder
served in various positions at Synopsys Inc., a manufacturer of high-level
design automation software used in the development of integrated circuits and
systems, most recently as Vice President, Human Resources for Business Group
Operations. Prior to this he worked at Apple Computer as a Senior Employment
Consultant from March 1988 to August 1992. Mr. Schroeder attended the University
of Wisconsin, Milwaukee from 1978-1981 as a Russian Language major.
Umberto Milletti is one of our co-founders and has served as our Vice President,
Solutions Management since April 1996. From March 1993 to March 1996, Mr.
Milletti was Director of Product Development at Knowledge Revolution, a
developer of educational and engineering software. Mr. Milletti holds a B.S. in
Electrical Engineering from Tufts University and a M.S. in Electrical
Engineering and Computer Science from the University of California at Berkeley.
J. Jay Tyler has served as Executive Vice President of Sales and Marketing since
January 2003. Prior to that he was the Senior Vice President of WorldWide Sales
at Clarify, Inc., an enterprise software company, from January 1999 to January
2001. From January 1995 through December 1998 he was a Group Vice President for
Gartner Group a leading provider of I.T. research and advisory services. Prior
to this he worked at Xerox for 18 years, most recently as National Sales Manager
for the Printing Systems Division. Mr. Tyler holds a B.S. in Marketing from
California State University, Chico.
-17-
PART II
Item 5. Market for Registrant's Common Equity and Related Stock Matters
Our common stock is traded on the Nasdaq National Market System under the symbol
DTHK. The following table sets forth, for the period indicated, the low and high
bid prices per share for our common stock as reported by the Nasdaq National
Market.
Fiscal Year ended Fiscal Year ended
March 31, 2003 March 31, 2002
--------------------- -----------------------
Low High Low High
--------- ---------- ---------- ---------
First quarter...............$ 0.85 $ 2.30 $ 5.34 $ 10.38
Second quarter..............$ 0.95 $ 2.10 $ 6.39 $ 15.20
Third quarter...............$ 1.00 $ 2.40 $ 5.87 $ 12.19
Fourth quarter. ............$ 1.54 $ 2.90 $ 2.16 $ 11.65
As of May 27, 2003 there were approximately 5,650 holders of record of
DigitalThink Common Stock.
No dividends have been paid on our common stock since inception. We currently
intend to retain all future earnings, if any, for use in our business and do not
anticipate paying cash dividends in the foreseeable future.
EQUITY COMPENSATION PLAN INFORMATION
For information regarding common stock that may be issued upon the exercise of
options, warrants and other rights granted under our existing compensation
plans, see Item 12 of Part III of this Report.
-18-
Item 6. Selected Financial Data
The following selected consolidated financial data should be read in
conjunction with the Consolidated Financial Statements and related notes thereto
and "Management's Discussion and Analysis of Financial Condition and Results of
Operations" appearing elsewhere in this Form 10-K.
Year Ended March 31,
-------------------------------------------
1999 2000 2001 2002 2003
------ ------ ------ ------ ------
(In thousands, except per share data)
Revenues:
Delivered Learning fees (1)...... $ 1,034 $ 4,994 $17,978 $ 20,401 $ 22,518
Learning Solution services (1)... 813 5,821 20,680 22,955 19,609
------ ------- ------ ------- -------
Total revenues............ 1,847 10,815 38,658 43,356 42,127
------ ------- ------ ------- -------
Costs and expenses:
Cost of Delivered Learning fees... 855 2,409 5,509 6,619 4,834
Cost of Learning Solution services 361 3,337 11,211 11,934 6,911
Content research and development.. 1,657 4,082 6,092 7,094 5,747
Technology research and development 1,005 3,687 11,791 11,318 7,166
Selling and marketing.............. 2,970 11,596 23,105 21,208 13,418
General and administrative......... 622 2,342 6,046 7,355 6,853
Depreciation....................... 236 915 3,190 5,274 6,870
Amortization of warrants........... -- -- 13,131 11,003 9
Stock-based compensation *......... 58 3,663 5,432 1,888 349
Amortization of goodwill and other
intangibles................... -- -- 3,602 7,208 1,364
Write-off of in-process research
and development................ -- -- 7,118 -- --
Impairment of goodwill............. -- -- -- 10,437 --
Acquisition-related charges........ -- -- -- 5,792 --
Restructuring charge (recovery).... -- -- -- 9,778 (83)
------ ------- ------ ------- -------
Total costs and expenses.... 7,764 32,031 96,227 116,908 53,438
------ ------- ------ ------- -------
Loss from operations.................(5,917) (21,216) (57,569) (73,552) (11,311)
Penalty income recognized (1)........ -- -- -- 10,000 --
Interest and other income............ 166 1,055 5,344 1,911 255
------ ------- ------ ------- -------
Net loss before cumulative effect of
accounting change..............(5,751) (20,161) (52,225) (61,641) (11,056)
Cumulative effect of accounting
change......................... -- -- -- -- (50,189)
------ ------- ------ ------- -------
Net loss........................... $(5,751)$(20,161)$(52,225)$(61,641)$(61,245)
======== ======= ========= ======= ========
Accretion of redeemable convertible
preferred stock....................$ 3,518 $ 7,593 $ -- $ -- $ --
-------- ------- -------- -------- ---------
Loss attributable to common
shareholders.......................$(9,269)$(27,754)$(52,225)$(61,641)$(61,245)
-------- ------- -------- -------- ---------
Basic and diluted loss per
common share......................$ (2.26)$ (3.87)$ (1.51)$ (1.61)$ (1.49)
-------- ------- -------- -------- ---------
Shares used in basic and diluted
loss per common share............. 4,095 7,164 34,524 38,176 41,203
-------- ------- -------- -------- ---------
Pro forma basic and diluted loss
per common share(2)............... $(0.56) $ (1.09)$ (1.51)$ (1.61)$ (1.49)
======== ======= ========= ======= ========
Shares used in pro forma basic
and diluted net loss per
common share (3).................. 16,687 25,412 34,524 38,176 41,203
======== ======= ========= ======= ========
March 31,
-------------------------------------------
1999 2000 2001 2002 2003
------- ------ ------ ------ -------
Balance sheet data:
Cash and cash equivalents and
marketable securities...... $ 9,455 $ 96,698 $ 64,038 $ 31,110 $ 22,668
Current assets.............. 10,604 102,812 77,183 38,564 31,314
Current liabilities......... 2,251 12,296 22,543 21,127 19,138
Working capital (4)......... 8,353 90,516 54,640 17,437 12,176
Total assets................ 11,330 110,176 111,687 136,272 73,612
Redeemable convertible
preferred stock......... 24,583 -- -- -- --
Long-term restructuring charge
and capital lease
obligations.............. -- -- 17 5,419 4,716
Accumulated deficit......... (15,573) (43,327) (95,552)(157,193) (218,438)
Total stockholders' equity
(deficit)................ $(15,505)$ 97,880 $ 89,127 $109,726 $ 49,758
(*) Stock-based compensation:
Cost of Delivered Learning
fees................. $ 3 $ 143 $ 121 $ 28 $ 3
Cost of Learning Solution
services............. 4 318 500 165 35
Content research and
development.......... 4 72 76 34 3
Technology research and
development.......... 13 473 1,329 555 87
Selling and marketing... 25 1,042 1,391 451 111
General and administrative 9 1,615 2,015 655 110
-------- -------- ------- -------- ---------
Total.................... $ 58 $ 3,663 $ 5,432 $ 1,888 $ 349
======== ======= ========= ======= ==========
-19-
(1) Reflects the forgiveness of the penalty associated with the restructuring of
an agreement with EDS resulting in a reduction of revenues of $8.8 million and
$1.2 million for Delivery Learning fees and Learning Solution services,
respectively, and $10 million of penalty income recognized in the fiscal year
ended March 31, 2002.
(2) Pro forma basic and diluted loss per common share is computed by dividing
net loss by the weighted average number of shares outstanding for the period and
the weighted average number of common shares resulting from the assumed
conversion of outstanding shares of redeemable convertible preferred stock. All
shares of preferred stock were converted to common shares at the initial public
offering dated February 25, 2000.
(3) Shares used in pro forma basic and diluted net loss per common share assumes
the conversion of preferred stock into an equivalent number of shares of common
stock at time of issuance.
(4) Working capital is the difference between current assets and current
liabilities.
-20-
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following Management's Discussion and Analysis of Financial Condition and
Results of Operations contains forward-looking statements based upon current
expectations that involve risks and uncertainties. When used in this document,
the words "intend," "anticipate," "believe," "estimate," "plan," and "expect"
and similar expressions as they relate to us are included to identify
forward-looking statements. Our actual results and the timing of certain events
could differ materially from those anticipated in these forward-looking
statements as a result of certain factors, including those set forth under "Risk
Factors" in this document.
Overview
We provide 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. We completed the
initial development of our delivery technology and initial content and began
significant sales and marketing efforts in fiscal year 1998. In November 1999,
we reincorporated in Delaware from California.
We provide online learning courses and services, which we refer to as custom
e-learning solutions. We were founded in April 1996. In fiscal 1997, we invested
in both course content development and research and development as we built our
course offerings and technology, releasing our first course in the later part of
fiscal 1997. Since fiscal 1998, we have made significant investments in content
research and development, sales and marketing activities, technology research
and development, Web delivery, and customer support. We experienced headcount
fluctuations during this period. We grew from 40 employees on March 31, 1998, to
235 on March 31, 2000, to 441 on March 31, 2001, to 464 employees on March 31,
2002, and decreased to 410 employees at March 31, 2003. Our revenues increased
from $200,000 in fiscal 1998, to $1.8 million in fiscal 1999, to $10.8 million
in fiscal 2000, to $38.7 million in fiscal 2001, and decreased from $43.4
million in fiscal 2002, to $42.1 million in fiscal 2003.
Sources of Revenues and Revenue Recognition Policy
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.
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. Revenues for Learning Solution services include
custom course development and consulting services.
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 course content development, performance consulting services,
implementation services, instructional plan design, and release of the course
for access by participants and are recognized as earned in accordance with AICPA
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
-21-
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.
We have experienced losses in each quarter since our inception and expect that
our quarterly losses will continue at least through the next two quarters. We
expect that these losses will result in large part from our ongoing emphasis on
course development. As of March 31, 2003, we had an accumulated deficit of
$218.4 million. In addition, we derive a significant portion of our revenues
from a limited number of customers and the percentage of our revenues from any
one customer can be material. For example, in fiscal 2003, our largest customer,
EDS, accounted for 37.1% and another customer accounted for 14.4% of our total
revenues of $42.1 million. In fiscal 2002, EDS accounted for 8.8% and another
customer accounted for 15.5% of our total revenues of $43.4 million, or 25.9%
and 12.6%, respectively, when excluding the forgiveness of a $10.0 million
penalty associated with the restructuring of an agreement with EDS. We expect
that EDS and other major customers will continue to account for a significant
portion of our revenues during future fiscal periods. Sales to our largest
customer comprised 10% of our revenues in fiscal 2001.
Stock-Based Compensation
Deferred stock compensation represents the difference between the estimated fair
value of the common stock for accounting purposes and the option exercise price
at the date of grant. We recorded deferred stock compensation of $390,000 in
fiscal 1999, and $11.3 million in fiscal 2000, and $1.6 million in fiscal 2001
in connection with an acquisition. These amounts are being amortized over the
four-year vesting period of the options using the multiple option approach.
Stock-based compensation expense of $3.7 million was recorded in fiscal 2000,
$5.4 million was recorded in fiscal 2001, $1.9 million was recorded in fiscal
2002, and $349,000 was recorded in fiscal 2003. See Note 8 of Notes To
Consolidated Financial Statements.
Net Operating Loss Carryforwards
From inception through March 31, 2003, we incurred net losses for federal and
state income tax purposes and have not recognized any income tax provision or
benefit. As of March 31, 2003, we had approximately $126 million of federal and
$86 million of state net operating loss carryforwards. These net operating loss
carryforwards begin to expire in 2008 and 2005 for federal and state purposes,
respectively. The difference between book accumulated deficit and cumulative tax
net operating losses at March 31, 2003 is due primarily to permanent goodwill
related to our stock acquisitions and warrant expense that are not deductible
for tax purposes. Given our limited operating history and losses incurred to
date, coupled with difficulty in forecasting future results, a full valuation
allowance has been recorded. Furthermore, as a result of changes in our equity
ownership from our preferred stock offerings and initial public offering,
utilization of net operating losses and tax credits may be subject to
substantial annual limitations. This is due to the ownership change limitations
provided by the Internal Revenue Code and similar state provisions. The degree
of any such limitation cannot presently be estimated. To date, we have not
performed an evaluation to determine if such a limitation exists, and we may not
perform such an evaluation until and unless we are profitable in the future. The
annual limitation may result in the expiration of net operating losses and tax
credits before utilization. See Note 7 of Notes To Consolidated Financial
Statements.
Acquisition of Arista Knowledge Systems
On July 6, 2000 we acquired Arista Knowledge Systems, Inc. ("Arista"), a company
providing Internet-based learning management systems. DigitalThink issued
approximately 746,000 shares of DigitalThink common stock in exchange for
outstanding stock, options and warrants of Arista. The total cost of the
acquisition, including transaction costs, was approximately $26.3 million. The
acquisition was accounted for as a purchase; accordingly, the results of
operations of Arista have been included with our results of operations since
July 6, 2000. Of the purchase price, $7.1 million represented purchased
in-process technology that was estimated to be 70% complete in its development
at the time of acquisition. The in-process technology represented a turnkey
solution for education and knowledge distribution systems that had not yet
reached technological feasibility and had no alternative future use.
Accordingly, this amount was immediately expensed upon consummation of the
acquisition. The value of intangibles was based upon management's estimates of
after-tax cash flow. The valuation gave consideration to the following: (i)
comprehensive due diligence concerning all potential intangibles; (ii) the value
of developed and core technology, ensuring that the relative allocations to core
technology and in-process research and development, were consistent with the
contribution of final products; (iii) the allocation to in-process research and
development was based upon a calculation that only considered the efforts
completed as of the date of the transaction, and only cash flows associated with
one generation of products currently in-process; and (iv) it was performed by an
independent valuation group. A discount rate of 28% was used for the in-process
technology. Intangible assets acquired were being amortized on a straight-line
basis over a period of up to four years. As part of our ongoing review of our
-22-
operations and financial performance, we performed an assessment of the carrying
value of long-lived assets to be held for using including goodwill and other
intangible assets recorded in connection with our various acquisitions. The
assessment was performed pursuant to SFAS No. 121, Accounting for the Impairment
of Long-Lived Assets and Long-Lived Assets to Be Disposed Of. The conclusion of
that assessment was that the value of the technology purchased associated with
the Arista acquisition was no longer being used our current product offerings
and was not part of the product roadmap for the future. As a result, we recorded
charges of $10.4 million to write-off the Arista goodwill during the fourth
quarter of fiscal 2002 as it no longer had any recoverable value.
Acquisition of LearningByte International
Effective August 28, 2001, we acquired LearningByte International, Inc. ("LBI"),
a provider of custom e-learning courseware, in exchange for an agreement to
issue approximately 4.7 million shares of DigitalThink common stock and assume
warrants to purchase approximately 500,000 shares of our common stock, for a
total purchase price of approximately $68 million, including transaction costs.
The acquisition of LBI was accounted for as a purchase; accordingly the results
of operations of LBI have been included with our results of operations since
August 28, 2001. The assets acquired and liabilities assumed were recorded at
estimated fair values as determined by management based on information currently
available and on current assumptions as to future operations and based on an
independent appraisal of the fair value of the acquired intangible assets.
Identifiable intangible assets acquired of $6.8 million are being amortized on a
straight-line basis over a weighted average period of 4.6 years. Goodwill will
not be amortized in accordance with SFAS No. 142, Goodwill and Other
Intangibles.
In connection with the LBI acquisition, we recorded a charge of $5.8 million
comprised of approximately $5.3 million for the write-off of internal use
software made obsolete by the acquisition of LBI and $0.5 million for
severance-related costs.
Acquisition of TCT Technical Training Pvt. Ltd.
Effective November 16, 2001, we acquired TCT Technical Training Pvt. Ltd.
("TCT"), of Kolkata, India, a developer of content for custom courseware.
DigitalThink acquired all the outstanding shares of TCT for $500,000 in cash
after we received governmental approval in November 2001. TCT has been acting
exclusively as a contractor to the DigitalThink since April 2001, when the
transaction was first announced. Upon acquisition, $215,000 was recorded as an
intangible that was amortized over one year, and $285,000 represented the net
fair market value of tangible assets acquired and liabilities assumed. The
acquisition of TCT was accounted for as a purchase. TCT's results of operations
have been included in our results of operations since the effective date of the
acquisition.
Acquisition of Horn Interactive
On April 16, 2003, we acquired Horn Interactive, Inc., ("Horn") a provider of
simulation-based learning products and services. DigitalThink acquired all of
the outstanding shares of Horn in exchange for 2,000,000 shares of DigitalThink
stock for a purchase price of approximately $5.0 million. The transaction was
accounted for as a purchase. Accordingly, Horn's results of operations will be
included in our results of operations from and after April 16, 2003.
Strategic Alliance with Electronic Data Systems Corporation
On July 11, 2000, we entered into an agreement with Electronic Data Systems
("EDS") pursuant to which EDS was issued two performance warrants to purchase
shares of DigitalThink common stock. Under the terms of the warrant, EDS could
earn the right to purchase up to 1,553,319 shares of DigitalThink common stock
upon delivery of third-party customers that resulted in a certain aggregate
amount of contractually committed revenues. If EDS failed to meet the specified
aggregate revenue targets, EDS agreed to pay us $5 million pursuant to the terms
of each warrant, for a total potential non-performance penalty of $10 million.
We calculated a fixed non-cash charge of $38 million related to this
transaction, based on the fair value of the warrants issued. A portion of the
warrants vested at the date of the transaction resulting in an immediate charge
of $4.9 million. Amortization of the remaining warrant expense was scheduled to
occur over three years from July 2000 through July 2003, in proportion to the
amount of revenue generated under the agreement, or on a straight-line basis,
whichever was faster. Through March 31, 2002, amortization was recorded on a
straight-line basis totaling $24.1 million.
On March 27, 2002, we restructured the agreement entered into with EDS, whereby
EDS surrendered its vested and unvested warrants to purchase shares of
DigitalThink common stock and we has forgave the $10 million total
non-performance penalty associated with these warrants. As a result, a charge of
approximately $10 million was recorded as a reduction of revenue and a credit of
approximately $10 million was recorded as other income.
-23-
Impairment of Goodwill and Other Long-Lived Assets
As part of our ongoing review of our operations and financial performance, we
performed an assessment of the carrying value of our long-lived assets to be
held for use including goodwill and other intangible assets recorded in
connection with our various acquisitions. The assessment was performed pursuant
to SFAS 121, Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of. The conclusion of that assessment was that
the value of the technology purchased associated with the Arista acquisition was
no longer being utilized in current product offerings and was not part of the
product roadmap for the future. As a result, we recorded charges of $10.4
million to write off the Arista goodwill during the fourth quarter of fiscal
2002 as it no longer had any recoverable value.
Effective April 1, 2002, we adopted 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 our results of operations, financial position or liquidity.
Effective April 1, 2002, we 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 in accordance with SFAS
No. 142. 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 fiscal year ended March 31, 2003. The analysis was prepared
by an independent third-party valuator. 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 at that time.
Restructuring Charge
Since the middle of fiscal 2002, DigitalThink and its industry have experienced
a progressive downturn in business conditions, the primary direct cause of which
has been a decrease in new training initiatives and a decrease in expenditures
by most Fortune 1000 companies. We believe that this decrease is attributable
to, among other things: constrained capital markets and the general economic
slowdown in the United States. The result has been a decrease in the overall
demand for e-learning training. In response, buyers are exhibiting caution when
making significant expenditures. Moreover, as the economic slowdown continues,
some of our current customers have delayed committed e-learning projects to
reduce their spending.
In March of fiscal 2002, we strategically restructured our business in response
to the current market environment and as part of our continuing program to
create efficiencies within our operations. We recorded total restructuring
charges of $9.8 million, which included the following:
o Reducing our workforce by approximately 80 employees, mainly within the
learning services organization, resulting in a $650,000 severance charge.
Approximately $440,000 was paid in March 2002, and approximately $210,000
was paid in the first and second quarters of fiscal 2003.
o Consolidating our sales, administrative and content and technology
development facilities through site closures, from a total of approximately
244,000 square feet into approximately 100,000 square feet. During the
fiscal year ended March 31, 2003, four sites have been vacated:
Chisholm, Minnesota; Minneapolis, Minnesota; Troy, Michigan; and our office
in the United Kingdom. Property and equipment that was disposed or removed
from operations resulted in a charge of $2.3 million and consisted
primarily of leasehold improvements, computer equipment and furniture and
fixtures. In addition, we incurred a charge of $6.8 million associated with
leases related to excess or closed facilities, which represents the excess of
the remaining lease obligations over estimated market value, net of
anticipated sublease income. Amounts accrued (net of anticipated sublease
proceeds) related to the consolidation of facilities will be paid over the
respective lease terms through 2016.
-24-
At December 31, 2002, we recorded a net adjustment of $83,000 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 subleasing one property earlier than expected
resulting in a reversal of approximately $450,000, offset in part 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.
HISTORICAL RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, the percentage
of net revenues represented by certain items in our statements of operations.
Year Ended March 31,
---------------------------------
2001 2002 2003
---------- -------- -------
Revenues:
Delivered Learning fees (1)............ 46.5% 47.1% 53.5%
Learning Solution services (1)......... 53.5 52.9 46.5
------- ------- -------
Total revenues......................... 100.0 100.0 100.0
------- ------- -------
Costs and expenses:
Cost of Delivered Learning fees........ 14.3 15.2 11.5
Cost of Learning Solution services..... 29.0 27.5 16.4
Content research and development....... 15.8 16.4 13.6
Technology research and development.... 30.5 26.1 17.0
Selling and marketing.................. 59.8 48.9 31.9
General and administrative............. 15.6 17.0 16.3
Depreciation........................... 8.3 12.2 16.3
Amortization of warrants............... 34.0 25.4 --
Stock-based compensation .............. 14.1 4.4 0.8
Amortization of goodwill and other
intangibles......................... 9.3 16.6 3.2
Write-off of in-process research and
development......................... 18.4 -- --
Impairment of goodwill................. -- 24.1 --
Acquisition related charges............ -- 13.3 --
Restructuring charge (recovery)........ -- 22.6 (0.2)
------- -------- --------
Total costs and expenses............... 249.1 269.7 126.8
------- ------- --------
Loss from operations................... (149.1) (169.7) (26.8)
Penalty income recognized (1).......... -- 23.1 --
Interest and other income.............. 13.8 4.4 0.6
------- ------- --------
Net loss before cumulative effect of
accounting change................... (135.3) (142.2) (26.2)
Cumulative effect of accounting change. -- -- (119.1)
------- ------- -------
Net loss.............................. (135.3)% (142.2)% (145.3)%
========= ======== ========
(1) Reflects the forgiveness of the penalty associated with the restructuring of
an agreement with EDS resulting in a reduction of revenues of $8.8 million and
$1.2 million for Delivery Learning fees and Learning Solution services,
respectively, and $10 million of penalty income recognized in the fiscal year
ended March 31, 2002.
-25-
Comparison of Fiscal 2002 to Fiscal 2003
Total Revenues
Total revenues decreased from $43.4 million in fiscal 2002 to $42.1 million for
fiscal 2003. For fiscal 2003, Delivered Learning fees represented 53% of
revenues and Learning Solution services represented 47% of revenues. This is
compared to fiscal 2002, during which Delivered Learning fees represented 47% of
revenues and Learning Solution services represented 53% of revenues. Total
revenues for fiscal 2002 were reduced by approximately $10.0 million, which
reflects the forgiveness of a penalty associated with the restructuring of an
agreement with EDS (see Note 13 to the Consolidated Financial Statements). 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. The two components that make up our revenue, Delivered Learning
fees and Learning Solution services fluctuated during the year as noted below.
Delivered Learning Fees
Delivered Learning fees increased from $20.4 million for fiscal 2002 to $22.5
million for fiscal 2003. The fiscal 2002 amount was reduced by approximately
$8.8 million, which reflects the forgiveness of a penalty associated with the
restructuring of an agreement with EDS (see Note 13 to the Consolidated
Financial Statements). Before the forgiveness, revenues for Delivered Learning
fees were $29.2 million for fiscal 2002. Fiscal 2003 revenues decreased from
fiscal 2002 after the $8.8 million adjustment for the EDS forgiveness because of
more courses being delivered to our customers that have contracts with an
unlimited delivery provision offset, in part, by fewer enrollments by customers
that pay for delivery as courses are taken. We expect that the number of courses
and customers will continue to increase as we expand our customer base and
course offerings.
Learning Solution Services
Learning Solution services revenues decreased from $23.0 million for fiscal 2002
to $19.6 million for fiscal 2003. The fiscal 2002 amount was reduced by
approximately $1.2 million, which reflects the forgiveness of a penalty
associated with the restructuring of an agreement with EDS (see Note 13 to the
Consolidated Financial Statements). Before the forgiveness, Learning Solution
Services revenues were $24.2 million for fiscal 2002. The $4.6 million decrease
in revenues is due in large part to the average dollar size of our contracts
decreasing. We expect Learning Solutions services revenues to increase as we
expand our customer base and course offerings.
To date, our international revenues have been less than 5% of total revenue.
Costs and Expenses
Cost of Delivered Learning Fees
Cost of Delivered Learning fees includes 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 $6.6 million for fiscal 2002 to $4.8 million for fiscal 2003.
This decrease was attributable to decreased personnel costs of approximately
$700,000, decreased contactor costs of approximately $700,000, decreased
maintenance and facility costs of approximately $300,000 and decreased tutor
support costs of approximately $170,000. We have shifted resources from our
higher-cost United States locations to our lower-cost India facilities resulting
in an overall reduction of headcount by 5 employees and the resulting $700,000
cost savings year over year. We have also shifted our tutor resources to India
as well. With the restructuring, we have also eliminated a number of our
contractors, which in turn has reduced our costs in these areas. We expect the
cost of Delivered Learning fees to continue to be relative to the revenue
generated from Delivered Learning.
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 $11.9 million for fiscal 2002 to
$6.9 million for fiscal 2003. This decrease was mainly attributable to a
decrease in personnel-related costs of $4.9 million related to a lower number of
employees and the shifting of resources from our higher-cost headcount in the
United States to our lower-cost headcount in India. Total headcount related to
cost of Learning Solution services decreased by 11 employees year over year. We
expect the cost of Learning Solution services to continue to be relative to the
revenue generated from Learning Solutions.
-26-
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 $7.1 million for fiscal 2002 to
$5.7 million for fiscal 2003. This decrease was attributable to a decrease in
personnel-related costs of $1.6 million related to a lower number of employees,
primarily in the higher-cost United States. Total headcount related to content
research and development decreased by 34 employees year over year. We expect
content research and development costs to remain relatively flat.
Technology Research and Development
Technology research and development expenses consist primarily of
personnel-related costs in connection with product development efforts of our
underlying technology. Technology research and development expenses decreased
from $11.3 million for fiscal 2002 to $7.2 million for fiscal 2003. This
decrease was principally attributable to a decrease in contractor spending by
approximately $1.3 million, a decrease of $1.2 million in personnel-related
costs due to the shifting of resources from our higher-cost headcount in the
United States to our lower-cost headcount in India, where there are
approximately 24 employees now. Total headcount related to technology research
and development increased by nine employees year over year with most of the
increase in India. We expect technology research and development costs to remain
relatively flat.
Selling and Marketing
Selling and marketing expenses consist primarily of personnel-related costs,
commissions, advertising and other promotional expenses and royalties paid to
authors. Selling and marketing expenses decreased from $21.2 million for fiscal
2002 to $13.4 million for fiscal 2003. This decrease is due to lower
personnel-related costs and commissions of $4.0 million as well as lower
contractor costs of approximately $800,000. In addition, we incurred fewer
expenses relating to advertising and tradeshow activity which reduced spending
in this area by approximately $1.3 million from fiscal 2002 to fiscal 2003. We
expect selling and marketing expenses may increase slightly in the near future
and commission expense will fluctuate with revenues.
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 $7.4 million for fiscal 2002
to $6.9 million for fiscal 2003. This decrease was due to lower occupancy costs
and lower personnel costs offset by an increase in insurance and professional
services fees. Headcount decreased by approximately five employees year over
year. We expect general and administrative expenses to remain relatively flat
unless there are significant changes in the business.
Amortization of Warrants
Expenses related to warrants issued to EDS as part of a strategic alliance
entered into in July 2000 totaled $11.0 million for fiscal 2002 and zero for
fiscal 2003 as a result of the restructuring of the EDS agreement, whereby EDS
surrendered its vested and unvested warrants to purchase shares of DigitalThink
common stock in March 2002. We expensed approximately $9,000 of warrant expense
for fiscal 2003 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 $1.9 million for fiscal 2002 to
approximately $349,000 for fiscal 2003.
Amortization of Goodwill and Other Intangibles
Expenses related to the amortization of goodwill and other intangibles decreased
from $7.2 million for fiscal 2002 to $1.4 million for fiscal 2003 related to the
acquisition of LBI.
Goodwill Impairment
As part of our ongoing review of the Company's operations and financial
performance, we performed an assessment of the carrying value of the our
long-lived assets to be held for use including goodwill and other intangible
assets recorded in connection with our various acquisitions. The assessment was
performed pursuant to SFAS 121, Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to Be Disposed Of. The conclusion of that
assessment was that the value of the technology purchased associated with the
Arista acquisition was no longer being used in the current product offerings and
was not part of the product roadmap for the future. As a result, we recorded
-27-
charges of $10.4 million to write off the Arista goodwill during the fourth
quarter of fiscal 2002, as it no longer had any recoverable value.
Acquisition and other related charges
Expenses related to the acquisition of LBI and other related charges totaled
$5.8 million for fiscal 2002 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.
Restructuring
In March 2002 we began a strategic initiative to restructure our business in
response to the current market environment and as part of our continuing program
to create efficiencies within our operations. We recorded total restructuring
charges of $9.8 million as part of our strategic initiative, which included the
following:
o Reducing our workforce by approximately 80 employees, mainly within the
learning services organization, resulting in a severance charge of
approximately $650,000. Approximately $440,000 was paid in March 2002, and
approximately $210,000 was paid in the first and second quarters of fiscal
2003.
o Consolidating our sales, administrative and content and technology
development facilities through building and site closures, from a total
of approximately 244,000 square feet into approximately 100,000 square feet.
During the fiscal year ended March 31, 2003, three sites have been vacated:
Chisholm, Minnesota; Troy, Michigan; and our office in the United Kingdom.
Property and equipment that was disposed or removed from operations
resulted in a charge of $2.3 million and consisted primarily of leasehold
improvements, computer equipment and furniture and fixtures. In addition,
we incurred a charge of $6.8 million associated with leases related to
excess or closed facilities, which represents the excess of the remaining
lease obligations over estimated market value, net of anticipated sublease
income. Amounts accrued (net of anticipated sublease proceeds) related to
the consolidation of facilities will be paid over the respective lease terms
through 2016.
At December 31, 2002, the Company recorded a net adjustment of $83,000 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 in part 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.
Penalty Recognized
On March 27, 2002, we restructured the agreement entered into with EDS, whereby
EDS surrendered its vested and unvested warrants to purchase shares of
DigitalThink common stock and we forgave the $10.0 million total non-performance
penalty associated with this agreement. We recorded a charge of approximately
$10.0 million as a reduction of revenue and we recorded a credit of
approximately $10.0 million as other income.
Net Loss Before Cumulative Effect of Accounting Change
The net loss before the cumulative effect of accounting change decreased from
$61.6 million for fiscal 2002 to $11.1 million for fiscal 2003.
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 fiscal 2003. The Company
performed its annual goodwill impairment analysis on October 31, 2002, using a
valuation model based on market capitalization adjusted for outstanding debt,
-28-
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.
Quarterly Results of Operations
The following table sets forth unaudited quarterly consolidated statement of
operations data for each of the eight most recent quarters. In our opinion, this
information has been prepared on the same basis as the audited financial
statements contained in this report and includes all adjustments we consider
necessary for fair presentation in accordance with generally accepted accounting
principles. This information should be read in conjunction with our annual
consolidated financial statements and the related notes appearing elsewhere in
this report. Our operating results for any three-month period are not
necessarily indicative of results for any future period.
June 30, September 30, December 31, March 31,
2001 2001 2001 2002
-------- ------------ ----------- ---------
Revenues:
Delivered Learning fees (1) $ 7,778 $8,239 $ 7,397 $ (3,013)
Learning Solution services (1) 7,232 7,045 6,410 2,268
------- --------- --------- --------
Total revenues............. 15,010 15,284 13,807 (745)
Costs and expenses:
Cost of Delivered Learning
fees....................... 1,795 1,775 1,567 1,482
Cost of Learning Solution
services................... 3,363 3,375 3,023 2,173
Content research and
development................ 1,382 1,919 1,862 1,931
Technology research and
development................ 3,246 3,153 2,603 2,316
Selling and marketing........ 7,210 5,390 4,676 3,932
General and administrative 1,758 1,790 1,604 2,203
Depreciation................. 1,067 1,443 1,308 1,456
Amortization of warrants..... 2,751 2,751 2,751 2,750
Stock-based compensation..... 628 541 469 250
Amortization of goodwill
and other intangibles........ 1,201 1,794 2,114 2,099
Impairment of goodwill....... -- -- -- 10,437
Acquisition and other
related charges.............. -- 5,792 -- --
Restructuring charge (recovery) -- -- -- 9,778
------- ------- -------- --------
Total costs and expenses..... 24,401 29,723 21,977 40,807
------- ------- -------- --------
Interest and other income.... 829 578 324 180
Penalty income recognized(1). -- -- -- 10,000
------- ------- -------- --------
Net loss before cumulative
effect of accounting change.. (8,562) (13,861) (7,846) (31,372)
Cumulative effect of
accounting change (2)........ -- -- -- --
------- ------- ------- --------
Net loss..................... $(8,562) $(13,861) $(7,846) $(31,372)
======= ========= ======== =========
June 30, September 30, December 31, March 31,
2002 2002 2002 2003
-------- ------------ ----------- ---------
Revenues:
Delivered Learning fees (1) $ 4,994 $5,867 $ 5,554 $ 6,103
Learning Solution services (1) 4,611 4,156 5,481 5,361
------- --------- --------- --------
Total revenues............. 9,605 10,023 11,035 11,464
Costs and expenses:
Cost of Delivered Learning
fees....................... 1,395 1,220 1,042 1,177
Cost of Learning Solution
services................... 1,695 1,381 1,852 1,983
Content research and
development................ 1,486 1,382 1,346 1,533
Technology research and
development................ 1,953 1,647 1,667 1,899
Selling and marketing........ 3,450 3,463 3,355 3,150
General and administrative 2,167 1,680 1,510 1,496
Depreciation................. 1,695 1,829 1,729 1,617
Amortization of warrants..... -- 1 4 4
Stock-based compensation..... 140 123 105 (19)
Amortization of goodwill
and other intangibles........ 359 359 341 305
Impairment of goodwill....... -- -- -- --
Acquisition and other
related charges.............. -- -- -- --
Restructuring charge (recovery) -- -- (83) --
------- ------- -------- --------
Total costs and expenses..... 14,340 13,085 12,868 13,145
------- ------- -------- --------
Interest and other income.... 95 69 60 31
Penalty income recognized(1). -- -- -- --
------- ------- -------- --------
Net loss before cumulative
effect of accounting change.. (4,640) (2,993) (1,773) (1,650)
Cumulative effect of
accounting change (2)........ (50,189) -- -- --
------- ------- ------- --------
Net loss.................... $(54,829) $ (2,993) $(1,773) $ (1,650)
======= ========= ======== =========
(1) Reflects the forgiveness of the penalty associated with the restructuring of
an agreement with EDS resulting in a reduction of revenues of $8.8 million and
$1.2 million for Delivery Learning fees and Learning Solution services,
respectively, and $10 million of penalty income recognized in the fiscal year
ended March 31, 2002.
(2) Reflects the cumulative effect of accounting change of $50.2 million related
to the adoption of SFAS142 by the company in fiscal 2003.
Critical Accounting Policies
Management has evaluated the accounting policies used in the preparation of
the consolidated financial statements and related notes contained in this report
and believes those policies to be reasonable and appropriate. The preparation of
financial statements in conformity with generally accepted accounting principles
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities. We believe that the following accounting policies are both
important to the portrayal of the company's financial condition and results and
requires management's most difficult, subjective or complex judgments. For a
more detailed discussion of these policies and significant estimates inherent in
the preparation of our consolidated financial statements, see Note 1 to the
Consolidated Financial Statements.
Revenue Recognition. We have two types of revenues: Delivered Learning fees
and Learning Solution services. 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 months. Delivered Learning fees are
recognized ratably over this access period. Learning Solution services revenues
consist of revenues from fixed-price contracts, which require the accurate
estimation of the value, scope and duration of each course hour. Revenues for
these projects are recognized on percentage of completion, in accordance with
AICPA 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 are made on a contract-by-contract basis and recognized in
the period in which such losses become probable and can be reasonably estimated.
If we do not accurately estimate the resources required or the scope of work to
be performed, or do not manage its projects properly within the planned periods
of time or satisfy our obligations under the contracts, then future learning
services margins may be significantly and negatively affected or losses on
existing contracts may need to be recognized. Any such resulting reductions in
margins or contract losses could be material to our results of operations. To
date, there have been no material losses.
-29-
Allowance for Doubtful Accounts. We maintain an allowance for doubtful
accounts for estimated losses resulting from the inability of our customers to
make required payments. We review, with assistance from our sales team, the
ability of our customers to make any obligatory payments. We provide an
allowance for doubtful accounts for all specific receivables that we judge to be
unlikely of collection. In addition, we record an estimated reserve based on the
size and age of all receivable balances against which we have not established
specific reserves. These estimated allowances are periodically reviewed,
analyzing the customer's payment history and information regarding customer's
credit worthiness known to us. If the financial condition of our customers were
to deteriorate, resulting in an impairment of their ability to make payments,
additional allowances may be required. For fiscal 2002 and fiscal 2003, the
Allowance for Doubtful Accounts was approximately $484,000 and approximately
$296,000, respectively. While losses depend to a large degree on future economic
conditions, we do not anticipate significant adverse credit development in
fiscal 2004.
Goodwill and Other Acquired Intangibles. Our business acquisitions
typically result in goodwill and other intangible assets, which affect the
amount of future period amortization expense and possible impairment expense
that we will incur. The determination of the value of such intangible assets
requires management to make estimates and assumptions that affect our
consolidated financial statements. In assessing the recoverability of our
goodwill and other intangibles, we must make assumptions regarding estimated
future cash flows and other factors to determine the fair value of the
respective assets. If these estimates or their related assumptions change in the
future, we may be required to record impairment charges for these assets not
previously recorded.
As noted above, on April 1, 2002, we 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. As a result of the adoption of SFAS No. 142 during the quarter
ending September 30, 2002, we incurred a reduction in goodwill of $50.2 million
that resulted in a charge to our results of operations from the cumulative
effect of the adoption of a new accounting principle during the fiscal year
ended March 31, 2003. The impaired goodwill was not deductible for taxes, and as
a result, no tax benefit was recorded in relation to the charge. In addition, we
performed our 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.
Operating Leases. We have many operating lease agreements related to our
office buildings throughout the United States, the United Kingdom and India. The
agreements qualify for operating lease accounting treatment under SFAS No. 13,
Accounting for Leases, and, as such, the assets are not included on our balance
sheet. We believe we will be able to meet our obligations under the agreements,
but if we default on our commitments and are unable to remedy the default
quickly enough, the lessors may terminate all remaining commitments and demand
payment equal to the lessor's net present value of all future lease payments. If
we default on the leases and are required to make payment, this will decrease
our cash available for working capital and could require us to find alternate
facilities on terms that may not be as favorable as the current arrangement. As
of March 31, 2003, we were in compliance with all covenants. For further
information on these leases, please refer to the section below entitled
"Liquidity and Capital Resources" and Note 12 of Notes to Consolidated Financial
Statements.
Accounting for Employee Stock Options. At March 31, 2003, the Company has
two stock-based employee compensation plans, which are described more fully in
Note 8. We account for stock-based awards to employees using the intrinsic value
method in accordance with Accounting Principles Board (APB) No. 25, Accounting
for Stock Issued to Employees (APB 25). We account for stock based awards to
non-employees in accordance with SFAS No. 123, Accounting for Stock-Based
Compensation. Approximately $349,000 of stock-based compensation was reflected
in the net loss for fiscal 2003 as options granted prior to our initial public
offering had an exercise price below the fair market value of the underlying
common stock on the date of grant. These options have been accounted for as
deferred stock compensation and the related expense has been recognized in
fiscal 2000 to fiscal 2003. Information about the impact on our operating
results of using APB Opinion No. 25 is included in Note 1 of our Notes to
Consolidated Financial Statements.
-30-
Liquidity and Capital Resources
Since inception, we have satisfied our cash requirements primarily through
sales of equity securities and to a lesser extent, revenues. As of March 31,
2003, our principal sources of liquidity included cash and cash equivalents
aggregating $22.7 million, and funds from operations. This compares to cash and
cash equivalents of $29.5 million on March 31, 2002 and investments in
marketable securities of $1.6 million at March 31, 2002.
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.
Borrowings under the line of credit bear interest at prime plus 1/2%. 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
March 31, 2003. Subsequent to March 31, 2003, the balance of $5.1 million on the
line of credit was repaid.
Our operating activities used cash of $9.1 million in fiscal 2003, $19.0
million in fiscal 2002 and $18.2 million in fiscal 2001. The improvement in cash
generation from operations was primarily driven by an improvement in operating
losses offset by a usage of cash in operating assets and liabilities. We had a
use of cash from accounts receivable and deferred revenue in fiscal 2002 of $2.2
million and a use of cash of approximately $1.3 million in fiscal 2003. We were
able to collect our receivables quicker in fiscal 2003 as compared to fiscal
2002 on lower revenues. We had a use of cash of $1.0 million from current
liabilities (which includes accounts payable and accrued liabilities) in fiscal
2002 compared to a use of cash of $4.8 million in fiscal 2003 resulting from a
reduction of expenses and the payment of invoices over fiscal 2003. To date, we
have met our operating expense requirements primarily from the proceeds of our
equity offerings. Beginning in the second half of fiscal 2004, we plan to meet
our operating expense requirements from cash flow from operating activities.
Our investing activities used $1.4 million in fiscal 2003 and $7.9 million
in fiscal 2001 and provided cash of $17.1 million in fiscal 2002. The source of
cash in fiscal 2002 resulted from the sales of marketable securities offset by
the acquisition of capital assets, including hardware for our web-site, computer
and office equipment, and platform development costs, and purchases of
marketable securities. The use of cash in fiscal 2003 of approximately $3.2
million resulted from the acquisition of capital assets, including leasehold
improvements, hardware for our web-site, and computer and office related
equipment, offset in part by maturity of marketable securities of $1.6 million.
We plan to continue to invest in capital assets as our business grows.
Our financing activities sourced cash of $3.8 million in fiscal 2003, $1.2
million in fiscal 2002 and $1.7 million in fiscal 2001. The source in fiscal
2001 were the proceeds received from issuance of common stock through the
exercise of options and the employee stock purchase plan. The source in fiscal
2002 were the proceeds received from issuance of common stock through the
exercise of options and the employee stock purchase plan of $2.6 million offset
by $1.4 million of payments on notes payable. The sources in fiscal 2003 reflect
the exercise of stock options and stock purchases in the employee stock purchase
plan program of approximately $951,000 and net borrowings on the company's line
of credit of approximately $2.9 million.
We lease our facilities and certain equipment and furniture under operating
lease agreements that expire at various dates through fiscal 2008 and
thereafter. Future lease payments under the operating lease agreements are
approximately as follows:
Fiscal Year Ending March 31, (in thousands)
2004..................................... $4,870
2005...................................... 5,037
2006...................................... 5,492
2007...................................... 5,793
2008...................................... 6,448
Thereafter............................... 31,220
------
Total................................. $58,860
=======
We believe that our principal sources of liquidity, which include cash and
cash equivalents of $22.7 million at March 31, 2003 and funds expected from
operations will satisfy our currently anticipated working capital and capital
expenditure 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 financial resources to support ongoing operations may differ materially
from estimates. 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,
-31-
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 adopted SFAS No.
144 in our quarter ended June 30, 2002. Such adoption has had no impact on the
financial statements through March 31, 2003.
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. We 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 our 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.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation-Transition and Disclosure". SFAS No. 148 amends SFAS No. 123,
"Accounting for Stock-Based Compensation" to provide alternative methods of
transition for an entity that voluntarily changes to the fair value based method
of accounting for stock-based employee compensation. SFAS No. 148 also amends
the disclosure requirements of SFAS No. 123, "Accounting for Sock-Based
Compensation" to require more prominent disclosures about the method of
accounting for stock-based employee compensation and the effect of the method
used on reported results in both annual and interim financial statements. We
adopted the disclosure provisions of SFAS No. 148 for our annual period ended
March 31, 2003.
-32-
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
The following discusses our exposure to market risk related to changes in
interest rates and foreign currency exchange rates. This discussion contains
forward-looking statements that are subject to risks and uncertainties. Actual
results could vary materially as a result of a number of factors.
Interest Rate Risk
As of March 31, 2003, we had cash and cash equivalents of $22.7 million,
consisting of cash and highly liquid short-term investments with original
maturities of three months or less at the date of purchase. Additionally the
Company had no marketable securities, classified as available for sale, with
maturities greater than three months. These investments may be subject to
interest rate risk and will decrease in value if market rates increase. A
hypothetical increase or decrease in market interest rates of 10% from the
market rates in effect at March 31, 2003 would cause the fair value of these
investments to change by an immaterial amount. Declines in interest rates over
time would result in lower interest income.
Foreign Currency and Exchange Rate Risk
Almost all of our revenues recognized to date have been denominated in U.S.
dollars and are primarily from the United States. However, a portion of our
future revenue may be derived from international customers. Revenues from these
customers may be denominated in the local currency of the applicable countries.
As a result, our operating results could become subject to significant foreign
currency fluctuations based upon changes in exchange rates in relation to the
U.S. dollar.
Furthermore, as we engage in business outside the United States, changes in
exchange rates relative to the U.S. dollar could make us less competitive in
international markets. Although we will continue to monitor our foreign currency
exposure, and may use financial instruments to limit this exposure, there can be
no assurance that exchange rate fluctuations will not have a materially negative
impact on our business.
-33-
Item 8. Consolidated Financial Statements and Supplementary Data
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
----------
Independent Auditors' Report......................................... 35
Consolidated Balance Sheets as of March 31, 2002 and 2003............ 36
Consolidated Statements of Operations for the years ended
March 31, 2001, 2002 and 2003..................................... 37
Consolidated Statement of Stockholders' Equity (Deficit)
for the years ended March 31, 2001, 2002 and 2003................. 38
Consolidated Statements of Cash Flows for the years ended
March 31, 2001, 2002 and 2003.................................... 39
Notes to Consolidated Financial Statements........................... 40
-34-
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
DigitalThink, Inc.
We have audited the accompanying consolidated balance sheets of
DigitalThink, Inc. and subsidiaries as of March 31, 2002 and 2003, and the
related consolidated statements of operations, stockholders' equity (deficit),
and cash flows for each of the three years in the period ended March 31, 2003.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements based
on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in
all material respects, the financial position of DigitalThink, Inc. and
subsidiaries at March 31, 2002 and 2003, and the results of their operations and
their cash flows for each of the three years in the period ended March 31, 2003
in conformity with accounting principles generally accepted in the United States
of America.
As discussed in Note 4 to the accompanying consolidated financial
statements, effective April 1, 2002, the Company changed its method of
accounting for goodwill in accordance with Statement of Financial Accounting
Standards No. 142, "Goodwill and Other Intangible Assets."
DELOITTE & TOUCHE LLP
San Francisco, California
April 18, 2003
-35-
DIGITALTHINK, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except per share data)
ASSETS
As of March 31,
------------------------
2002 2003
------------ ----------
Current assets:
Cash and cash equivalents...................... $ 29,470 $ 22,668
Marketable securities.......................... 1,640 --
Accounts receivable, net of allowance for doubtful
accounts of $484 and $296, respectively..... 5,779 6,344
Prepaid expenses and other current assets...... 1,675 2,302
---------- ----------
Total current assets....................... 38,564 31,314
Restricted cash and deposits................... 4,083 4,041
Property and equipment, net.................... 18,325 14,510
Goodwill and other intangible assets........... 75,300 23,747
---------- ----------
Total assets............................... $ 136,272 $ 73,612
========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable............................... $ 3,569 $ 2,213
Accrued liabilities............................ 7,938 5,316
Borrowings under line of credit and notes payable 2,577 5,266
Deferred revenues............................... 7,043 6,343
----------- ------------
Total current liabilities................... 21,127 19,138
Long-term restructuring charge and capital lease
obligations................................... 5,419 4,716
Commitments and contingencies (Note 12)
Stockholders' equity:
Common stock -- $0.001 per share value;
250,000 shares authorized;
issued and outstanding 40,452 in 2002
and 41,619 in 2003........................... 267,814 268,718
Deferred stock compensation..................... (631) (224)
Accumulated other comprehensive loss............ (264) (298)
Accumulated deficit............................. (157,193) (218,438)
---------- ---------
Total stockholders' equity.................. 109,726 49,758
---------- ----------
Total liabilities and stockholders' equity... $ 136,272 $ 73,612
========== ==========
See accompanying notes to consolidated financial statements.
-36-
DIGITALTHINK, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
Year Ended March 31,
------------------------------------
2001 2002 2003
---------- ----------- --------
Revenues:
Delivered Learning fees............. $ 17,978 $ 20,401 $ 22,518
Learning Solution services.......... 20,680 22,955 19,609
---------- ----------- ----------
Total revenues.................... 38,658 43,356 42,127
---------- ----------- ----------
Costs and expenses:
Cost of Delivered Learning fees..... 5,509 6,619 4,834
Cost of Learning Solution services.. 11,211 11,934 6,911
Content research and development.... 6,092 7,094 5,747
Technology research and development. 11,791 11,318 7,166
Selling and marketing............... 23,105 21,208 13,418
General and administrative.......... 6,046 7,355 6,853
Depreciation........................ 3,190 5,274 6,870
Amortization of warrants............ 13,131 11,003 9
Stock-based compensation*........... 5,432 1,888 349
Amortization of goodwill and other
intangibles...................... 3,602 7,208 1,364
Write-off of in-process research and
development...................... 7,118 -- --
Impairment of goodwill.............. -- 10,437 --
Acquisition related charges......... -- 5,792 --
Restructuring charge (recovery)..... -- 9,778 (83)
---------- ----------- ----------
Total costs and expenses......... 96,227 116,908 53,438
---------- ----------- ----------
Loss from operations............. (57,569) (73,552) (11,311)
Penalty income recognized (Note 13) -- 10,000 --
Interest and other income........ 5,344 1,911 255
---------- ----------- ----------
Net loss before cumulative effect of
accounting principle.......... (52,225) (61,641) (11,056)
Cumulative effect of accounting change -- -- (50,189)
---------- ----------- ----------
Net loss......................... $ (52,225) $ (61,641) $ (61,245)
========== =========== ==========
Net loss per share--basic and diluted:
Before cumulative effect of accounting
change......................... $ (1.51) $ (1.61) $ (0.27)
Cumulative effect of accounting change -- -- (1.22)
---------- ----------- ----------
Net loss per share--basic and diluted $ (1.51) $ (1.61) $ (1.49)
========== =========== ==========
Shares used in computing basic and
diluted loss per share........ 34,524 38,176 41,203
========== =========== ==========
(*) Stock-based compensation:
Cost of Delivered Learning fees..... $ 121 $ 28 $ 3
Cost of Learning Solution services.. 500 165 35
Content research and development.... 76 34 3
Technology research and development. 1,329 555 87
Selling and marketing............... 1,391 451 111
General and administrative.......... 2,015 655 110
---------- ----------- ----------
Total............................... $ 5,432 $ 1,888 $ 349
========== =========== ==========
See accompanying notes to consolidated financial statements.
-37-
DIGITALTHINK, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
Years ended March 31, 2001, 2002 and 2003
(in thousands)
Common stock Stockholders'
---------------- Deferred Stock Notes
Shares Amount Compensation Receivable
-------- --------- --------------- -------------
Balances, March 31, 2000...... 33,788 $ 149,160 $ (7,953) $ --
Components of comprehensive
income:
Net loss..................... -- -- -- --
Change in unrealized gain on
available-for-sale
investments................ -- -- -- --
Translation adjustment....... -- -- -- --
Total comprehensive income
Exercise of stock options..... 525 480 -- --
Employee stock purchase plan.. 100 1,187 -- --
Stockholders' notes receivable -- -- -- (9)
Forfeited and unvested options -- (974) 974 --
Amortization of deferred stock
compensation................ -- -- 5,432 --
Amortization of warrants...... -- 13,131 -- --
Issuance of common stock and
assumption of stock options
in connection with
acquisition................. 586 24,599 (1,552) --
-------- -------- --------- ---------
Balances, March 31, 2001....... 34,999 187,583 (3,099) (9)
Components of comprehensive
income:
Net loss..................... -- -- -- --
Change in unrealized gain on
available-for-sale
investments................. -- -- -- --
Translation adjustment....... -- -- -- --
Total comprehensive income
Exercise of stock options
and warrants............... 516 993 -- --
Employee stock purchase plan. 228 1,629 -- --
Repayment of stockholders'
notes receivable............ -- -- -- 9
Forfeited and unvested options -- (580) 580 --
Amortization of deferred stock
compensation................ -- -- 1,888 --
Amortization of warrants..... -- 11,003 -- --
Issuance of common stock and
assumption of warrants in
connection with acquisition 4,709 67,186 -- --
-------- -------- --------- ---------
Balances, March 31, 2002...... 40,452 267,814 (631) --
Components of comprehensive
income:
Net loss.................... -- -- -- --
Change in unrealized gain on
available-for-sale
investments................ -- -- -- --
Translation adjustment...... -- -- -- --
Total comprehensive income
Exercise of stock options and
warrants................... 477 309 -- --
Employee stock purchase plan. 582 505 -- --
Forfeited and unvested options -- (67) 67 --
Amortization of deferred stock
compensation................ -- -- 349 --
Amortization of warrants..... -- 9 (9) --
Issuance of common stock for
services rendered........... 8 9 -- --
Issuance of common stock..... 100 111 -- --
Issuance of stock options for
services.................... -- 9 -- --
Issuance of stock options for
cash....................... -- 19 -- --
-------- -------- ---------- ---------
Balances, March 31, 2003........ 41,619 $268,718 $ (224) $ --
======== ======== ========== =========
Accumulated
Other
Comprehensive Accumulated
Loss Deficit Total
----------------- ------------- ------------
Balances, March 31, 2000...... $ -- $ (43,327) $ 97,880
Components of comprehensive
income:
Net loss..................... -- (52,225) (52,225)
Change in unrealized gain on
available-for-sale
investments................ 177 -- 177
Translation adjustment....... 27 -- 27
--------
Total comprehensive income (52,021)
--------
Exercise of stock options..... -- -- 480
Employee stock purchase plan.. -- -- 1,187
Stockholders' notes receivable -- -- (9)
Forfeited and unvested options -- -- --
Amortization of deferred stock
compensation................ -- -- 5,432
Amortization of warrants...... -- -- 13,131
Issuance of common stock and
assumption of stock options
in connection with
acquisition................. -- -- 23,047
---------- --------- ---------
Balances, March 31, 2001....... 204 (95,552) 89,127
Components of comprehensive
income:
Net loss..................... -- (61,641) (61,641)
Change in unrealized gain on
available-for-sale
investments................. (165) -- (165)
Translation adjustment....... (303) -- (303)
--------
Total comprehensive income -- -- (62,109)
--------
Exercise of stock options
and warrants............... -- -- 993
Employee stock purchase plan. -- -- 1,629
Repayment of stockholders'
notes receivable............ -- -- 9
Forfeited and unvested options -- -- --
Amortization of deferred stock
compensation................ -- -- 1,888
Amortization of warrants..... -- -- 11,003
Issuance of common stock and
assumption of warrants in
connection with acquisition -- -- 67,186
---------- --------- ---------
Balances, March 31, 2002...... (264) (157,193) 109,726
Components of comprehensive
income:
Net loss.................... -- (61,245) (61,245)
Change in unrealized gain on
available-for-sale
investments................ (12) -- (12)
Translation adjustment...... (22) -- (22)
---------
Total comprehensive income (61,279)
---------
Exercise of stock options and
warrants................... -- -- 309
Employee stock purchase plan. -- -- 505
Forfeited and unvested options -- -- --
Amortization of deferred stock
compensation................ -- -- 349
Amortization of warrants..... -- -- --
Issuance of common stock for
services rendered........... -- -- 9
Issuance of common stock..... -- -- 111
Issuance of stock options for
services.................... -- -- 9
Issuance of stock options for
cash....................... -- -- 19
---------- --------- ---------
Balances, March 31, 2003........ $ (298) $(218,438) $ 49,758
========== =========== =========
See accompanying notes to consolidated financial statements.
-38-
DIGITALTHINK, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Year Ended March 31,
-------------------------------------
2001 2002 2003
---------- ------------ ---------
Cash flows from operating activities:
Net loss...............................$ (52,225) $ (61,641) $ (61,245)
Adjustments to reconcile net loss to
net cash used in
operating activities:
Depreciation......................... 3,190 5,274 6,870
Cumulative effect of accounting change -- -- 50,189
Amortization of deferred stock
compensation....................... 5,432 1,888 349
Amortization of stock options issued
for services....................... -- -- 9
Amortization of warrants............. 13,131 11,003 9
Amortization of goodwill and other
intangibles........................ 3,602 7,208 1,364
Impairment of goodwill............... -- 10,437 --
Restructuring charges (recovery)..... -- 2,333 (83)
Acquisition related charges.......... -- 5,328 --
Loss on disposal of property and equipment -- -- 69
Write-off of in-process research and
development........................ 7,118 -- --
Changes in assets and liabilities:
Accounts receivable................ (3,705) 4,078 (565)
Prepaid expenses and other current
assets........................... (1,705) 2,427 (627)
Accounts payable................... 1,868 (2,433) (1,356)
Accrued liabilities................ 652 1,397 (3,419)
Deferred revenues.................. 4,456 (6,294) (700)
-------- ---------- -----------
Net cash used in operating activities (18,186) (18,995) (9,136)
-------- ---------- -----------
Cash flows from investing activities:
Restricted cash (increase)/decrease.. (2,033) (250) 42
Purchases of property and equipment.. (12,404) (14,402) (3,246)
Sales of property and equipment -- -- 123
Net cash paid in acquisition......... (1,732) (169) --
Purchases of marketable securities... (52,799) (17,300) --
Proceeds from maturities of marketable
securities......................... 61,117 49,186 1,640
Other assets......................... -- 9 --
-------- ---------- ----------
Net cash (used in) provided by
investing activities............... (7,851) 17,074 (1,441)
-------- ---------- ----------
Cash flows from financing activities:
Payments and proceeds from notes
payable.......................... -- (1,440) 2,855
Proceeds from sale of common stock.. 1,668 2,622 942
-------- ---------- ----------
Net cash provided by financing
activities...................... 1,668 1,182 3,797
-------- ---------- ----------
Effect of exchange rate changes on cash
and cash equivalents.................. 27 (303) (22)
Net decrease in cash and cash equivalents (24,342) (1,042) (6,802)
Cash and cash equivalents, beginning
of year.............................. 54,854 30,512 29,470
-------- ---------- ----------
Cash and cash equivalents, end of year.. $ 30,512 $ 29,470 $ 22,668
========== =========== ==========
Supplemental disclosure of cash flow information:
Cash paid for interest............... $ -- $ 41 $ 63
Supplemental disclosure of noncash
investing and financing activities:
Unrealized gain/(loss) on marketable
securities......................... $ 177 $ (165) $ --
Issuance of common stock for
acquisitions....................... $ 24,599 $ 67,186 $ --
See accompanying notes to consolidated financial statements.
-39-
DIGITALTHINK, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Summary of Significant Accounting Policies
Organization
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 significant sales and marketing
efforts in fiscal year 1998. In November 1999, the Company reincorporated in
Delaware from California.
Principles of Consolidation
The consolidated financial statements include the accounts of DigitalThink
Inc., and its wholly-owned subsidiaries. All significant intercompany balances
and transactions have been eliminated in consolidation.
Estimates
The preparation of consolidated financial statements in conformity with
generally accepted accounting principles accepted in the United States of
America requires management to make estimates and assumptions that affect
reported amounts of assets, liabilities, revenues and expenses as of the dates
and for the periods presented. Actual results could differ from those estimates.
Significant estimates used in the preparation of consolidated financial
statements include:
Accruals associated with restructuring. In March 2002 we initiated a
strategic initiative, under which we restructured our business in response to
the current market environment and as part of our continuing program to create
efficiencies within our operations. This resulted in the Company recording total
restructuring charges of $9.8 million as part of our strategic initiative. All
of these actions required estimates, which are periodically reviewed and
adjusted, if appropriate, based on current circumstances.
Revenue Recognition and Percentage of Completion. Revenues for Learning
Solution services, including custom course development or consulting services,
are recognized as earned in accordance with 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.
Cash and Cash Equivalents
The Company considers all highly liquid debt instruments purchased with a
remaining maturity of three months or less to be cash equivalents.
Marketable Securities
At March 31, 2003, the Company did not have any short-term marketable
securities.
At March 31, 2002 all short-term marketable securities were due in one year
or less and consisted of the following (in thousands):
Gross Gross Estimated
Cost Unrealized Gains Unrealized Losses Fair Value
--------- ---------------- ----------------- ----------
Short-Term Investments
Government agencies $ 1,652 $ -- $ (12) $ 1,640
The Company classifies these investments as available for sale. Unrealized
gains or losses are included in a separate component of stockholders' equity.
Realized gains and losses are computed based on the specific determination
method and were not material during any of the periods presented.
-40-
DIGITALTHINK, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
1. Summary of Significant Accounting Policies - (Continued)
Restricted Cash and Deposits
Restricted cash and deposits represent deposits held as collateral relating
to operating leases and letters of credit.
Concentration of Credit Risk
Financial instruments potentially subjecting the Company to concentrations
of credit risk consist primarily of cash, cash equivalents, short term
investments and accounts receivable. The Company invests its excess cash in
deposits with major banks, in U.S. Treasury and U.S. agency obligations and in
debt securities of corporations with strong credit ratings. No losses have been
experienced on such investments.
Accounts receivable are unsecured, and the Company is at risk to the extent
that such amounts become uncollectible. The Company closely monitors its
outstanding receivable balances on an on-going basis. At March 31, 2002, one
account represented 23% of gross accounts receivable, although less than 30 days
outstanding. At March 31, 2003, one account represented 15% of gross accounts
receivable, although less than 30 days outstanding.
In fiscal 2001, one customer accounted for 10% of total revenues. In fiscal
2002, our largest customer, EDS, accounted for 8.8% and another customer
accounted for 15.5% of our total revenues of $43.4 million, or 25.9% and 12.6%,
respectively, when excluding the forgiveness of a $10.0 million penalty
associated with the restructuring of an agreement with EDS. In fiscal 2003, our
largest customer, EDS, accounted for 37.1% of total revenues and two other
customers accounted for 14.4% and 10.8% of total revenues, respectively.
Property and Equipment
Property and equipment is stated at cost. Depreciation is computed using
the straight-line method over estimated useful lives of three to four years.
Leasehold improvements are amortized using the straight-line method over the
shorter of the estimated useful lives or the remaining lease terms.
Long-Lived Assets
The Company reviews long-lived assets for impairment whenever events or
changes in circumstances indicate that the carrying amount of that asset may not
be recoverable. An impairment loss would be recognized when the sum of the
undiscounted future net cash flows expected to result from the use of the asset
and its eventual disposition is less than its carrying amount.
Goodwill
Goodwill is recorded when the consideration paid for acquisitions exceeds
the estimated fair value of identifiable net tangible and intangible assets
acquired. Goodwill related to acquisitions occurring prior to July 1, 2001 and
other acquisition-related intangibles are amortized on a straight-line basis up
to four years. Goodwill and other acquisition-related intangibles are reviewed
for recoverability periodically or whenever events or changes in circumstances
indicate that the carrying amount may not be recoverable.
As part of our ongoing review of the Company's operations and financial
performance, we performed an assessment of the carrying value of the our
long-lived assets to be held for use including goodwill and other intangible
assets recorded in connection with our various acquisitions. The assessment was
performed pursuant to SFAS 121, Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to Be Disposed Of. The conclusion of that
assessment was that the value of the technology purchased associated with the
Arista acquisition was no longer being used in the current product offerings and
was not part of the product roadmap for the future. As a result, we recorded
charges of $10.4 million to write off the Arista goodwill during the fourth
quarter of fiscal 2002 as it no longer had any recoverable value.
See Note 4 to the Consolidated Financial Statements.
-41-
DIGITALTHINK, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
1. Summary of Significant Accounting Policies - (Continued)
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 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.
Content research and development
Expenses charged to operations as incurred include course development
personnel related costs. Course development expenses and subject matter expert
payments to course authors are expensed as incurred, in accordance with SFAS No.
86, as the recoverability of such costs against future revenues is uncertain.
Technology research and development
Expenses are charged to operations as incurred. Such expenses include
web-site development costs. Web-site development costs which meet the
capitalization criteria of SOP 98-1, Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use are capitalized and amortized
over the useful economic life.
Income Taxes
The Company accounts for income taxes using an asset and liability
approach. Deferred tax liabilities are recognized for future taxable amounts and
deferred tax assets are recognized for future deductions and operating loss
carryforwards, net of a valuation allowance to reduce net deferred tax assets to
amounts that are more likely than not to be realized.
Translation of Foreign Currency
The Company's foreign operations are measured using local currencies as the
functional currency. Assets and liabilities are translated into U.S. dollars at
year-end rates of exchange, and results of operations are translated at average
rates for the year.
Loss per Common Share
Basic loss per common share excludes dilution and is computed by dividing
net loss by the weighted average number of common shares outstanding during the
period. Diluted loss per common share reflects the potential dilution that could
occur if securities or other contracts to issue common stock were exercised or
converted into common stock. Common share equivalents are excluded from the
computation in loss periods as their effect would be anti-dilutive.
-42-
DIGITALTHINK, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
1. Summary of Significant Accounting Policies - (Continued)
Recently Issued Accounting Standards
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. The Company adopted
SFAS No. 144 in its quarter ended June 30, 2002 and there was no impact to the
financial statements upon adoption.
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.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation-Transition and Disclosure". SFAS No. 148 amends SFAS No. 123,
"Accounting for Stock-Based Compensation" to provide alternative methods of
transition for an entity that voluntarily changes to the fair value based method
of accounting for stock-based employee compensation. SFAS No. 148 also amends
the disclosure requirements of SFAS No. 123, "Accounting for Sock-Based
Compensation" to require more prominent disclosures about the method of
accounting for stock-based employee compensation and the effect of the method
used on reported results in both annual and interim financial statements. We
adopted the disclosure provisions of SFAS No. 148 for our annual period ended
March 31, 2003.
Stock-Based Compensation
At March 31, 2003, the Company has two stock-based employee compensation
plans, which are described more fully in Note 8. The Company accounts for
stock-based awards to employees using the intrinsic value method in accordance
with Accounting Principles Board (APB) No. 25, Accounting for Stock Issued to
Employees (APB 25). The Company accounts for stock based awards to non-employees
in accordance with SFAS No. 123, Accounting for Stock-Based Compensation.
Approximately $349,000 of stock-based compensation was reflected in the net loss
for fiscal 2003 as options granted prior to the Company's initial public
offering had an exercise price below the fair market value of the underlying
common stock on the date of grant. These options have been accounted for as
deferred stock compensation and the related expense has been recognized in
fiscal 2000 to fiscal 2003. The following table illustrates the effect on net
loss and earnings per share if the Company had applied the fair value
recognition provisions of FASB Statement No. 123, "Accounting for Stock-Based
Compensation", to stock-based employee compensation. Refer to Note 8 for the
assumptions used in calculating the estimated fair value of the stock options.
Years Ended March 31,
----------------------------------------
2001 2002 2003
---------- ----------- ----------
Net loss (in thousands):
As reported....................... $ (52,225) $ (61,641) $ (61,245)
Add: Stock-based employee
compensation included in
reported net loss............... 5,432 1,888 349
Deduct: Total-stock based employee
compensation expense determined
under fair value based method for
all awards (21,348) (17,182) (5,403)
-------- ------------- ----------
Pro forma......................... $ (68,141) $ (76,935) $ (66,299)
========== =========== ===========
Basic and diluted net loss per share:
As reported..................... $ (1.51) $ (1.61) $ (1.49)
Pro forma....................... $ (1.97) $ (2.02) $ (1.61)
-43-
DIGITALTHINK, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
1. Summary of Significant Accounting Policies - (Continued)
Comprehensive Income
The Company is required to report comprehensive income in the financial
statements, in addition to net income. The primary differences between net
income and comprehensive income are foreign currency translation adjustments and
net unrealized gains or losses on securities available for sale.
Reclassification
Certain prior year amounts in the consolidated financial statements and
notes thereto have been reclassified to conform to the current year
presentation.
2. Business Combinations
On July 6, 2000 DigitalThink, Inc. acquired Arista Knowledge Systems, Inc.
("Arista"), a company providing Internet-based learning management systems.
DigitalThink issued approximately 746,000 shares of DigitalThink common stock in
exchange for outstanding stock, options and warrants of Arista. The total cost
of the acquisition, including transaction costs, was approximately $26.3
million. The acquisition was accounted for as a purchase business combination;
accordingly the results of operations of Arista have been included with the
Company's results of operations since July 6, 2000. The purchase price paid for
the Arista acquisition was allocated based on the estimated fair values of the
net assets acquired as follows (in thousands):
In-process research and development $ 7,118
Acquired technology, workforce intangible and goodwill 19,212
Intrinsic value of unvested Arista options assumed 1,552
Tangible assets acquired 1,718
Liabilities assumed (3,269)
---------
Net assets acquired $ 26,331
=========
The consideration given in the acquisition of Arista was as follows:
DigitalThink common stock $ 20,523
Stock options assumed 3,976
Net cash paid 1,732
Transaction costs 100
-------
Total purchase price $ 26,331
========
Of the purchase price, $7.1 million represents purchased in-process
technology that had not yet reached technological feasibility and had no
alternative future use. Accordingly, this amount was immediately expensed in the
consolidated statement of operations upon consummation of the acquisition. The
value assigned to purchased in-process technology was based on a valuation
prepared by an independent third-party appraiser. Intangible assets acquired
will be amortized on a straight-line basis over a period of four years.
The following unaudited pro forma results of operations for the year ended
March 31, 2001 give effect to the acquisition as if it had occurred at the
beginning of fiscal 2001. The pro forma results of operations exclude the $7.1
million of nonrecurring charges that were recorded in conjunction with the
acquisition (in thousands, except per share amounts):
Year Ended March 31, 2001
-------------------------
Net revenues $ 38,658
Loss from operations $ 62,061
Net loss $(58,353)
Basic and diluted loss per share attributable
to common shareholders $ (1.69)
-42-
DIGITALTHINK, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
2. Business Combinations - (Continued)
Effective August 28, 2001, the Company acquired LearningByte International,
Inc. ("LBI"), a provider of custom e-learning courseware, in exchange for
approximately 4.7 million shares of DigitalThink common stock and assume
approximately 500,000 warrants outstanding, for a total purchase price of
approximately $68.0 million, including transaction costs, as follow (in
thousands):
DigitalThink common stock $ 63,656
Warrants assumed at fair value 3,530
Transaction costs 800
---------
Total purchase price $ 67,986
=========
The acquisition of LBI was accounted for by the purchase method. LBI's
results of operations have been included in the Company's results of operations
since the effective date of the acquisition. The assets acquired and liabilities
assumed were recorded at estimated fair values as determined by the Company's
management. The Company obtained an independent appraisal of the fair value of
the acquired tangible and identified intangible assets, and their remaining
useful lives. Intangible assets acquired will be amortized on a straight-line
basis over a weighted average period of 4.6 years. Goodwill will not be
amortized in accordance with SFAS 141. A summary of the assets acquired and
liabilities assumed in the acquisition follows (in thousands):
Acquired technology and customer list $ 6,800
Goodwill 70,040
Net fair value of tangible assets
acquired and liabilities assumed (8,854)
--------
Net assets acquired $ 67,986
=========
The following table reflects the results of operations on a pro forma basis
as if the acquisition had been completed on April 1, 2000 and 2001, and does not
consider the effects of synergies and cost reduction initiatives directly
related to all acquisitions. Therefore, the pro forma financial information is
as follows (in thousands, except per share amounts):
Years Ended March 31,
------------------------------------
2001 2002
------------ -----------
Net revenues $ 32,216 $ 46,387
Loss from operations $ (58,781) $ (70,513)
Net loss $ (54,476) $ (70,162)
Basic and diluted loss per share $ (1.39) $ (1.75)
In connection with the LBI acquisition, the Company recorded a charge of
$5.8 million comprised of approximately $5.3 million for the write-off of
internal use software made obsolete by the acquisition of LBI and $0.5 million
for severance-related costs.
Effective November 16, 2001, the Company acquired TCT Technical Training
Pvt. Ltd. ("TCT"), of Kolkata, India, a content developer of custom courseware.
DigitalThink acquired all the outstanding shares of TCT for $500,000 after we
received governmental approval in November 2001. TCT has been acting exclusively
as a contractor to the Company since April 2001, when the transaction was first
announced. Upon acquisition, $215,000 was recorded as an intangible to be
amortized over one year and $285,000 was the net fair value of tangible assets
acquired and liabilities assumed. The acquisition of TCT was accounted for by
the purchase method. TCT's results of operations have been included in the
Company's results of operations since the effective date of the acquisition. Pro
forma financial information in connection with the TCT acquisition has not been
provided, as results would not have differed materially from actual reported
results.
-45-
DIGITALTHINK, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
3. Restructuring Charge
Remaining Amounts
Liability Recorded Remaining Liability
Balances as of Cash in Other Net Balances as of
March 31, 2002 Payments Accounts Adjustments March 31, 2003
-------------- -------- -------- ----------- -----------------
(in thousands)
Severance $ 210 $ (210) $ -- $ -- $ --
Facilities and
equipment 32 (32) -- -- --
Lease commitments 7,627 (1,867) (67) (83) 5,610
--------- -------- -------- ------- ----------
Total $ 7,869 $(2,109) $ (67) $ (83) $ 5,610
========= ======== ======== ======= ==========
In March 2002 we initiated a strategic initiative, under which we
restructured our business in response to the current market environment and as
part of our continuing program to create efficiencies within our operations. We
recorded total restructuring charges of $9.8 million as part of our strategic
initiative, which included the following:
o Reducing our workforce by approximately 80 employees, mainly within
the learning services organization, resulting in a severance charge
of approximately $650 thousand severance charge. Approximately $440
thousand was paid in March 2002, and approximately $210 thousand
was paid in the first and second quarters of fiscal 2003.
o Consolidating our sales, administrative and content and technology
development facilities through building and site closures, from a total
of approximately 244,000 square feet into approximately 100,000 square
feet. During the fiscal year ended March 31, 2002, four sites have been
vacated: Chisholm, Minnesota; Minneapolis, Minnesota; Troy, Michigan;
and our office in the United Kingdom. Property and equipment that was
disposed or removed from operations resulted in a charge of $2.3 million
and consisted primarily of leasehold improvements, computer equipment
and furniture and fixtures. In addition, we incurred a charge of $6.8
million associated with leases related to excess or closed facilities,
which represents the excess of the remaining lease obligations over
estimated market value, net of anticipated sublease income. Amounts
accrued (net of anticipated sublease proceeds) related to the
consolidation of facilities will be paid over the respective lease terms
through 2016.
The Company has been recording deferred rent for those leased facilities
that met the criteria in accordance with SFAS No. 13, Accounting for Leases.
Nine leased facilities were included in the restructuring costs and for two of
those facilities; the Company had recorded deferred rent of approximately
$864,000. This amount of deferred rent was a liability as of March 2002 and
noted as part of the restructuring liability.
At March 31, 2003, restructuring charge obligations were recorded as $1.0
million in accrued liabilities and $4.6 million in long-term liabilities. The
"Amounts Recorded in Other Accounts" are balances that have been reclassified to
accounts payable from accrued liabilities as the amounts have been invoiced and
become 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.
-46-
DIGITALTHINK, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
4. Change in Accounting for Goodwill and Certain Intangibles
Effective April 1, 2002, the Company adopted 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 year
ended March 31, 2003. 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 years ended December 31, 2002 and 2001 adjusted for the
non-amortization provisions of SFAS No. 142 (in thousands, except per share
amounts):
Years Ended March 31,
-----------------------------------
2001 2002 2003
-------- ---------- -----------
Reported net loss before cumulative effect
of accounting change $(52,225) $(61,641) $ (11,056)
Reported net loss $(52,225) $(61,641) $ (61,245)
Goodwill amortization $ 3,602 $ 5,674 $ --
Adjusted net loss before cumulative
effect of accounting change $(48,623) $(55,967) $ (11,056)
Adjusted net loss $(48,623) $(55,967) $ (61,245)
Weighted average common shares outstanding
used in computing basic and diluted loss
per share 34,524 38,176 41,203
Basic and diluted net loss per share:
Reported net loss per share before
cumulative effect of accounting change $ (1.51) $ (1.61) $ (0.27)
Reported net loss per share $ (1.51) $ (1.61) $ (1.49)
Goodwill amortization $ 0.10 $ 0.15 $ --
Adjusted net loss per share--basic and
diluted before cumulative effect of
accounting change $ (1.41) $ (1.46) $ (0.27)
Adjusted net loss per share--basic and
diluted $ (1.41) $ (1.46) $ (1.49)
-47-
DIGITALTHINK, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
4. Change in Accounting for Goodwill and Certain Intangibles - (Continued)
Changes in the carrying amount of goodwill for the fiscal year ended March
31, 2003 were as follows (in thousands):
Balance at March 31, 2002 $ 69,818
Cumulative effect of change in accounting principle (50,189)
-----------------
Balance at March 31, 2003 $ 19,629
=================
The gross carrying amount and accumulated amortization of the Company's
intangible assets other than goodwill as of March 31, 2003 and March 31, 2002
were as follows (in thousands):
March 31, 2002 March 31, 2003
-------------------------- --------------------------
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 $ (1,982) $4,118
TCT acquired
technology 215 (71) 144 215 (215) --
------ --------- ------ ------ --------- -------
Total $6,315 $ (833) $5,482 $6,315 $ (2,197) $4,118
====== ========= ====== ====== ========= =======
Amortization expense recorded on the intangible assets for the fiscal years
ended March 31, 2002 and 2003 was $1.5 million and $1.4 million, respectively.
The estimated future amortization expense by fiscal year is as follows: 2004 is
$1.2 million; 2005 is $1.2 million; 2006 is $1.2 million and 2007 is
approximately $500,000.
5. Property and Equipment
Property and equipment consist of the following (in thousands):
March 31,
------------------------
2002 2003
---------- ---------
Furniture and fixtures.......................... $ 737 $ 942
Computer hardware and software.................. 18,812 20,259
Leasehold improvements.......................... 8,337 9,117
Accumulated depreciation........................ (9,561) (15,808)
--------- ---------
Property and equipment, net................. $18,325 $ 14,510
========= ========
6. Accrued Liabilities (in thousands):
March 31,
----------------------
2002 2003
-------- --------
Payroll and related expenses........................$ 1,464 $ 1,396
Deferred rent....................................... 103 1,176
Restructuring charge................................ 2,569 1,038
Other............................................... 3,802 1,706
------- --------
Total accrued liabilities..................... $ 7,938 $ 5,316
======= ========
-48-
DIGITALTHINK, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
7. Income Taxes:
No income taxes were provided for any of the periods presented due to the
Company's net losses. Deferred tax assets are comprised of the following (in
thousands):
March 31,
----------------------
2002 2003
-------- ----------
Deferred tax assets:
Accruals and reserves................................. $ 539 $ 892
Net operating losses and tax credits carried forward.. 31,755 49,838
Basis difference in fixed assets...................... 392 1,428
------- --------
Total gross deferred tax asset before valuation
allowance...................................... 32,686 52,128
Valuation allowance................................... (32,686) (52,158)
-------- --------
Net deferred tax asset................................ $ -- $ --
======== ========
At March 31, 2003, the Company had available federal and California state
net operating loss carryforwards of approximately $126 million and $86 million,
respectively, to offset future taxable income. These net operating loss
carryforwards begin to expire in 2008 and 2005 for federal and state purposes,
respectively. The Company has federal and California state research and
development credit carryforwards of $878,000 and $441,000 respectively. The
Company also has California state enterprise zone credit carryforwards of
$613,000. At March 31, 2003, the Company's wholly owned foreign subsidiaries in
the United Kingdom and India had foreign net operation loss carryforwards of
approximately $3 million to offset future foreign taxable income. At March 31,
2002 and 2003, the net deferred tax assets have been fully reserved due to the
uncertainty surrounding the realization of such benefits. The difference between
book accumulated deficit and cumulative tax net operating losses at March 31,
2003 is due primarily to permanent goodwill related to DigitalThink stock
acquisitions and warrant expense that are not deductible for tax purposes.
Internal Revenue Code Section 382 places a limitation (the "Section 382
Limitation") on the amount of taxable income which can be offset by net
operating loss ("NOL") carryforwards after a change in control (generally
greater than 50% change in ownership) of a loss corporation. California has
similar rules. Generally, after a control change, a loss corporation cannot
deduct NOL carryforwards in excess of the Section 382 Limitation. Due to these
"change in ownership" provisions, utilization of the NOL carryforwards may be
subject to an annual limitation regarding their utilization against taxable
income in future periods.
-49-
DIGITALTHINK, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
8. Stockholders' Equity (Deficit)
Stock Option Plan
The Company's stock option plans provide for grants of incentive or
nonstatutory stock options to officers, employees, directors and consultants.
Options vest over four years and expire over terms up to ten years. One of the
Company's stock option plans provides for annual increases in the number of
shares available for issuance equal to the lesser of 2 million shares, 5% of the
outstanding shares on the date of the annual increase, or a lesser amount as may
be determined by the board of directors.
The Company had 1,941,409 shares available for future grant at March 31,
2003.
A summary of the activity under the Company's stock option plans is as
follows:
Weighted
Average
Number Exercise
of Shares Price
----------- ----------
Balances, March 31, 2000 (487,576 exercisable
at a weighted average exercise price of
$4.18 per share).................................... 4,879,264 $ 3.13
Granted (weighted average fair value of
$14.47)............................................ 4,627,554 17.12
Options assumed in acquisition........................ 159,704 17.44
Canceled.............................................. (1,012,929) 15.77
Exercised............................................. (524,698) 0.90
------------ -------
Balances, March 31, 2001 (1,407,436 exercisable
at a weighted average exercise price of
$3.14 per share) ................................... 8,128,895 9.89
Granted (weighted average fair value of $7.99)........ 1,629,519 9.63
Canceled.............................................. (2,277,736) 14.44
Exercised............................................. (505,066) 1.96
------------ -------
Balances, March 31, 2002 (2,849,597 exercisable
at a weighted average exercise price of
$7.53 per share)................................... 6,975,612 8.89
Granted (weighted average fair value of $0.79)........ 5,747,351 1.19
Canceled.............................................. (3,215,774) 8.21
Exercised............................................. (476,870) 0.65
------------- --------
Balances, March 31, 2003............................. 9,030,319 $ 4.19
============= ========
The following table summarizes information as of March 31, 2003 concerning
options outstanding:
Options Outstanding Vested Options
---------------------------------------- ------------------
Weighted Average Weighted Weighted
Range of Remaining Average Average
Exercise Number Contractual Life Exercise Number Exercise
Prices Outstanding (Years) Price Vested Price
--------- ------------ ---------------- ---------- -------- ---------
$0.05 - $1.00 587,045 5.17 $ 0.23 535,247 $ 0.16
1.02 - 1.14 4,105,142 8.84 1.14 1,872,917 1.13
1.17 - 1.83 1,479,690 7.89 1.51 816,517 1.50
2.04 - 8.00 1,121,992 8.17 7.36 514,226 7.76
8.06 - 11.00 1,119,041 7.65 9.36 665,870 9.37
11.19 - 34.25 401,050 7.73 17.83 228,814 18.76
34.63 - 56.00 216,359 3.98 22.52 141,385 41.78
---------- ---- ------- --------- --------
Total 9,030,319 8.05 $ 4.19 4,774,976 $ 5.00
========== ==== ======= ========= ========
Additional Stock Plan Information
As discussed in Note 1, the Company accounts for its stock-based awards
using the intrinsic value method in accordance with Accounting Principles Board
Opinion No. 25, Accounting for Stock Issued to Employees, and its related
interpretations.
-50-
DIGITALTHINK, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
8. Stockholders' Equity (Deficit) - (Continued)
Statement of Financial Accounting Standards No. 123, Accounting for
Stock-Based Compensation (SFAS 123), requires the disclosure of pro forma net
income (loss) had the Company adopted the fair value method (see Note 1). Under
SFAS 123, the fair value of stock-based awards to employees is calculated
through the use of option pricing models, even though such models were developed
to estimate the fair value of freely tradable, fully transferable options
without vesting restrictions, which significantly differ from the Company's
stock option awards. These models also require subjective assumptions, including
expected time to exercise, which greatly affect the calculated values. The
following weighted average assumptions were used: expected life after vesting,
0.5 years in fiscal 2000, 3 years in fiscal 2001, 2.5 years in fiscal 2002 and
1.5 years in fiscal 2003; average risk-free interest rate, 6.0% in fiscal 2000,
5.3% in fiscal 2001, 4.5% in fiscal 2002 and 2.15% in fiscal 2003. The Company's
calculations include volatility of 100% in the period following the public
offering through March 31, 2000, 115% in fiscal 2001, 120% in fiscal 2002 and
110% in fiscal 2003 and no dividends during the expected term. The Company's
calculations are based on a multiple option valuation approach, and forfeitures
are recognized as they occur.
Stock-Based Compensation
During fiscal 2001, the Company assumed 159,704 unvested common stock
options at a weighted average price of $17.44 per share, which was less than the
fair value of $35 per share, related to the Arista acquisition. Accordingly, the
Company recorded $1.6 million as the value of such options. Stock-based
compensation of $5.4 million was amortized to expense in the year ended March
31, 2001. In addition, the Company recorded a $974,000 decrease in deferred
stock compensation in fiscal 2001 due to unvested options of terminated
employees.
At March 31, 2002, the Company had $631,000 in deferred stock compensation
related to options, which will be amortized to expense through fiscal 2004.
At March 31, 2003, the Company had $224,000 in deferred stock compensation
related to options, which will be amortized to expense through fiscal 2004.
9. Net Loss Per Share
For fiscal 2001, 2002 and 2003, the Company had stock options outstanding
of 8,128,895, 6,975,612, and 9,030,319 respectively, which could potentially
dilute basic earnings per share in the future, but were excluded in the
computation of diluted net loss per share in the periods presented, as their
effect would have been antidilutive.
10. Related Party Transactions
During fiscal 2001, the Company generated revenues of approximately $4.0
million, $3.0 million, $831,000, $827,000, and $199,000 from 5 customers who are
investors in the Company. Additionally, the Company generated revenues of $2.5
million from one customer of which one of the Company's directors is a director.
Receivables at fiscal year-end relating to these six customers totaled $752,000.
During fiscal 2002, the Company generated revenues of approximately $4.0
million, $1.5 million, $335,000, and $10,000 from 4 customers who are investors
in the Company. Additionally, the Company generated revenues of $3.9 million
from one customer of which one of the Company's directors is an executive
officer. Receivables at fiscal year-end relating to these six customers totaled
$486,000.
During fiscal 2003, the Company generated revenues of approximately $40,000
and $33,000 from two customers who are investors in the Company. Additionally,
the Company generated revenues of $4.5 million from one customer of which one of
the Company's directors serves as a board member. Receivables at fiscal year-end
relating to these three customers totaled approximately $922,000.
-51-
DIGITALTHINK, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
11. Employee Benefit Plans
401(k) Plan
The Company has a 401(k) retirement plan (the Plan) that covers
substantially all employees of the Company. The Plan provides for voluntary
salary reduction contributions of up to 20% of eligible participants' annual
compensation. The Company has not provided matching contributions for any of the
periods presented.
Employee Stock Purchase Plan
The Company has a Qualified Employee Stock Purchase Plan (ESPP) under which
200,000 shares of common stock were originally reserved for issuance. The ESPP
allows for annual increases equal to the lesser of 1% of the outstanding shares
of common stock on the first day of the fiscal year, 400,000 shares, or such
lesser amount as may be determined by the board. Under the ESPP, eligible
employees may purchase shares of the Company's common stock through payroll
deductions of up to 10% of the participant's compensation.
Under this plan, eligible employees may purchase shares of the Company's
common stock at 85% of fair market value at specific, predetermined dates. In
fiscal 2001, approximately 100,000 shares were purchased at an average price of
$11.87. In fiscal 2002, approximately 228,000 shares were purchased at an
average price of $7.18. In fiscal 2003, approximately 582,000 shares were
purchased at an average price of $0.87. At March 31, 2003, approximately 42,000
shares were available for purchase under the ESPP.
12. Lease Commitments
The Company leases its principal office facilities under operating leases.
As of March 31, 2003, future minimum payments under facilities operating leases
are as follows (in thousands):
Fiscal Year Ending
March 31,
-------------------
2004............................. $ 4,870
2005............................. 5,037
2006............................. 5,492
2007............................. 5,793
2008............................. 6,448
Thereafter....................... 31,220
---------
Total........................... $ 58,860
=========
Rent expense under operating leases was $2.7 million, $4.4 million, and
$3.8 million for the years ended March 31, 2001, 2002 and 2003, respectively.
-52-
DIGITALTHINK, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
13. Strategic Alliance with Electronic Data Systems Corporation
On July 11, 2000 the Company entered into an agreement with EDS pursuant to
which EDS was issued two separate performance warrants to purchase shares of
DigitalThink common stock. Under the terms of the first warrant, EDS could earn
warrants to purchase up to 862,955 shares of DigitalThink common stock
exercisable at $29 per share. The warrant could have been earned when EDS
delivered third-party customers from the United States prior to July 31, 2003,
which generated a total of $50 million of contractually committed revenue to
DigitalThink recognizable by July 31, 2005. The warrants expired October 31,
2003. This warrant contained a significant disincentive for non-performance. If
EDS failed to deliver the full $50 million of contracted, United States revenue
by July 31, 2003, EDS agreed to pay DigitalThink $5 million.
Under the terms of the second warrant, EDS could earn warrants for up to
690,364 shares of DigitalThink common stock exercisable at $29 per share. The
warrant could have been earned when EDS delivered third-party customers from
outside the United States prior to July 31, 2003, which generated a total of $50
million of contractually committed revenue to DigitalThink recognizable by July
31, 2005. The warrants expired October 31, 2003. This warrant contained a
significant disincentive for non-performance. If EDS failed to deliver the full
$50 million of contracted, non-United States revenue by July 31, 2003, EDS
agreed to pay DigitalThink $5 million.
The Company calculated a fixed non-cash charge of $38 million related to
this transaction, based on the fair value of the warrants issued. A portion of
the warrant vested at the date of the transaction resulting in an immediate
charge of $4.9 million. Amortization of the remaining warrant expense would
occur over three years from July 2000 through July 2003, in proportion to the
amount of revenue generated under the agreement, or on a straight-line basis,
whichever is faster. Through March 31, 2002, amortization was recorded on a
straight-line basis totaling $24.1 million.
On March 27, 2002, DigitalThink restructured the agreement entered into
with EDS, whereby EDS has surrendered its vested and unvested warrants to
purchase shares of DigitalThink common stock and DigitalThink has forgiven the
$10.0 million total non-performance penalty associated with these warrants.
Therefore, during the fiscal year ended 2002 a charge of approximately $10.0
million was recorded as a reduction of revenue and a credit of approximately
$10.0 million was recorded as other income.
14. Subsequent Event
On April 16, 2003, the Company acquired privately held Horn Interactive,
Inc., ("Horn") a provider of simulation-based custom e-learning. The Company
issued approximately 2 million shares of DigitalThink common stock in exchange
for all the outstanding shares of Horn and Horn has become a wholly-owned
subsidiary of the Company. The total cost of the acquisition, including
transaction costs, was approximately $5.0 million. The acquisition was accounted
for as a purchase business combination; accordingly the results of operations of
Horn will be included in the Company's results of operations from April 17, 2003
forward.
* * * * *
-53-
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
Not applicable
PART III
Item 10. Directors and Executive Officers of the Registrant
The information required by this item with respect to executive officers is
contained in Part I of this report. The information required by this item with
respect to directors is hereby incorporated by reference from the information
under the caption "Election of Directors" to be contained in DigitalThink's
proxy statement, to be filed with the Securities and Exchange Commission no
later than 120 days from the end of our last fiscal year in connection with the
solicitation of proxies for our 2003 Annual Meeting of Stockholders (the "Proxy
Statement"). The information required by this item with respect to compliance
within Section 16(a) of the Securities Exchange Act is incorporated by reference
to the information under the caption "Compliance with Section 16(a) of the
Securities Exchange Act of 1934" in the Proxy Statement.
Item 11. Executive Compensation
The information required by this item is incorporated by reference to the
information under the caption "Executive Officer Compensation" in the Proxy
Statement.
Item 12. Security Ownership of Certain Beneficial Owners and Management
The information required by this item is incorporated by reference from the
information under the caption "Security Ownership of Certain Beneficial Owners
and Management" and "Equity Compensation Plan Information" in the Proxy
Statement.
Item 13. Certain Relationships and Related Transactions
The information required by this item is incorporated by reference from the
information under the caption "Certain Relationships and Related Transactions"
in the Proxy Statement.
Item 14: 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 our
"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 90 days before the filing date of this annual report
on Form 10-K. 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.
-54-
PART IV
Item 15. Exhibits, Financial Statement Schedule, and Reports on Form 8-K
(a)1. Consolidated Financial Statements
The following Consolidated Financial Statements of DigitalThink, Inc.
and Report of Deloitte & Touche LLP have been filed under Item 8 of this Form
10-K.
Index to Consolidated Financial Statements
Independent Auditors' Report
Consolidated Balance Sheets as of March 31, 2002 and 2003
Consolidated Statements of Operations for the years ended March 31, 2001,
2002 and 2003
Consolidated Statement of Stockholders' Equity (Deficit) for the years
ended March 31, 2001, 2002 and 2003
Consolidated Statements of Cash Flows for the years ended March 31, 2001,
2002 and 2003
Notes to Consolidated Financial Statements
(a)2. Financial Statement Schedule
The following financial statement schedule of DigitalThink, Inc. for the
fiscal years ended March 31, 2001, 2002, and 2003 is filed with this Report and
should be read in conjunction with the Consolidated Financial Statements of
DigitalThink included under Item 8.
Schedule II - Valuation and Qualifying Accounts
Schedules not listed above have been omitted because they are not
applicable or are not required or the information required to be set forth
therein is included in the Consolidated Financial Statements or Note thereto.
(a)3. Exhibits
Refer to (C) below.
(b) Reports on Form 8-K
On January 28, 2003, we filed a current report on Form 8-K announcing the
addition of J. Jay Tyler as our Executive Vice President of Sales and Marketing.
-55-
(c) Exhibits
Exhibit
Number Description of Document
- -------- -------------------------------------
2.1 Agreement and Plan of Reorganization among and between DigitalThink,
LearningByte International and Merger Sub, dated August 14, 2001 (1)
2.2 Agreement and Plan of Merger and Reorganization dated April 16,
2003, by and among DigitalThink, Inc., Buffalo Bill Acquisition
Corp., Horn Interactive, Inc. and the shareholders of Horn
Interactive, Inc. (2)
3.1 Bylaws of DigitalThink, Inc. (3)
3.2 Bylaws of DigitalThink, Inc. (4)
3.3 Bylaws of DigitalThink, Inc.
4.2 Preferred Stock Rights Agreement, dated as of March 31, 2003 between
DigitalThink, Inc. and Mellon Investor Services, LLC, including the
Certificate of Designation, the form of Rights Certificate and the
Summary of Rights attached thereto as Exhibits A, B and C,
respectively. (9)
10.1 Restated Investors Rights Agreement dated November 10, 1999 (5)
10.2 1996 Stock Plan and forms of agreements thereunder (5)
10.3 1999 Employee Stock Purchase Plan (5)
10.4 Form of Director and Executive Officer Indemnification Agreement (5)
10.16 Change of Control Severance Agreement between DigitalThink and Jon
C. Madonna dated September 14, 2001 (3)
10.17 Change of Control Severance Agreement between DigitalThink and
Michael W. Pope dated September 14, 2001 (3)
10.19 Restated 1996 ISO Stock Plan (6)
10.20 Standard Industrial/Commercial Single Tenant Lease Amendment
dated September 4, 2002 between Thomas A. Price and Gwendolyn L.
Price, as trustees of the Price Trust UTD October 5, 1984 and
DigitalThink, for office space located at 601 Brannan Street, San
Francisco, California (6)
10.21 Warrant Agreement dated August 21, 2002 between Thomas A. Price and
Gwendolyn L. Price, as trustees of the Price Trust UTD October 5,
1984 and DigitalThink (6)
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 (7)
10.23 Stock and Option Purchase Agreement between DigitalThink and Roger
Goddu, dated September 20, 2002. (8)
10.24 Employment Agreement between DigitalThink and J. Jay Tyler dated
January 27, 2003
21.1 DigitalThink subsidiaries
23.1 Independent Auditors' Consent
24.1 Power of Attorney (see signature page)
99.1 Certification of Chief Executive Officer pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002
99.2 Certification of Chief Financial Officer pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002
- ----------
(1) Incorporated by reference to exhibit 99.1 filed with our Current Report on
Form 8-K dated August 22, 2001.
(2) Incorporated by reference to our Current
Report on Form 8-K dated April 16, 2003.
(3) Incorporated by reference to our Annual Report on Form 10-K for the fiscal
year ended March 31, 2002.
(4) Incorporated by reference to exhibit 4.2(b) filed with our Registration
Statement on From S-1 (File No. 333-92429), as amended.
(5) Incorporated by reference to our Registration Statement on From S-1 (File
No. 333-92429), as amended.
(6) Incorporated by reference to our Quarterly Report on Form 10-Q for the
quarter ended September 30, 2002.
(7) Incorporated by reference to our Quarterly Report on Form 10-Q for the
quarter ended December 31, 2002.
(8) Incorporated by reference to exhibit 99.1 filed with our Current Report on
Form 8-K dated October 7, 2002.
(9) Incorporated by reference to our Form 8-A/A dated March 31, 2003.
-56-
SIGNATURES
Pursuant to the requirements of the Securities Act, the registrant has duly
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
DIGITALTHINK, INC.
(Registrant)
June 10, 2003
By: /s/ MICHAEL W. POPE
-------------------------------------
Michael W. Pope
President and Chief Executive Officer
June 10, 2003
By: /s/ ROBERT J. KROLIK
--------------------------------------
Robert J. Krolik
Chief Financial Officer
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints Michael W. Pope and Robert J. Krolik, and each of
them, each with the power of substitution, his attorney-in-fact, to sign any
amendments to this Annual Report on Form 10-K (including post-effective
amendments), and to file the same, with exhibits thereto and other documents in
connection therewith, with the Securities and Exchange Commission, hereby
ratifying and confirming all that each of said attorneys-in-fact, or his
substitute or substitutes, may do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
Signature Title Date
BY: /s/ JON C. MADONNA Chairman of the Board June 10, 2003
--------------------------
Jon C. Madonna
By: /s/ MICHAEL W. POPE Chief Executive Officer,
-------------------------- President and Director June 10, 2003
Michael W. Pope (Principal Executive Officer)
By: /s/ ROBERT J. KROLIK Chief Financial Officer June 10, 2003
--------------------------
Robert J. Krolik (Principal Financial and Accounting Officer)
By: /s/ STEVE L. ESKENAZI Director June 10, 2003
--------------------------
Steve L. Eskenazi
By: /s/ PETER J. GOETTNER Director June 10, 2003
--------------------------
Peter J. Goettner
By: /s/ SAMUEL D. KINGSLAND Director June 10, 2003
--------------------------
Samuel D. Kingsland
By: /s/ WILLIAM H. LANE, III Director June 10, 2003
--------------------------
William H. Lane, III
By: /s/ ROGER V. GODDU Director June 10, 2003
--------------------------
Roger V. Goddu
By: /s/ RODERICK C. MCGEARY Director June 10, 2003
--------------------------
Roderick C. McGeary
-57-
CERTIFICATIONS
I, Michael W. Pope, certify that:
1. I have reviewed this annual report on Form 10-K of DigitalThink, Inc.;
2. Based on my knowledge, this annual 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 annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual 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 annual 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 annual 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 annual
report (the "Evaluation Date"); and
c) presented in this annual 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
functions):
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
annual 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: June 10, 2003
/s/ MICHAEL W. POPE
- ----------------------------------------------------------
Michael W. Pope
Chief Executive Officer, President and Director
-58-
I, Robert J. Krolik, certify that:
1. I have reviewed this annual report on Form 10-K of DigitalThink, Inc.;
2. Based on my knowledge, this annual 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 annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual 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 annual 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 annual 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 annual
report (the "Evaluation Date"); and
c) presented in this annual 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
functions):
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
annual 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: June 10, 2003
/s/ ROBERT J. KROLIK
- ----------------------------------------------------------
Robert J. Krolik
Chief Financial Officer
-59-
Schedule II
DigitalThink, Inc. and Subsidiaries
Valuation and Qualifying Accounts
For the Years Ended March 31, 2001, 2002, 2003
Balance at Charges to Charged Balance at
Beginning Costs and To Other End of
of Period Expenses Deductions Accounts(1) Period
---------- ---------- ---------- ---------- ---------
Year ended March 31, 2001:
Allowance for doubtful
accounts............... $205,000 $170,000 $(128,000) $ - $247,000
Year ended March 31, 2002:
Allowance for doubtful
accounts............... $247,000 $ 96,000 $(342,000) $483,000 $484,000
Year ended March 31, 2003:
Allowance for doubtful
accounts............... $484,000 $150,000 $(338,000) $ - $296,000
- ---------------------------------------------------------
(1) Recorded on the books of acquired company
-60-
EXHIBIT LIST
Exhibit
Number Description of Document
- --------- --------------------------------------------------------------
2.1 Agreement and Plan of Reorganization among and between
DigitalThink, LearningByte International and Merger Sub, dated
August 14, 2001 (1)
2.2 Agreement and Plan of Merger and Reorganization dated April 16,
2003, by and among DigitalThink, Inc., Buffalo Bill Acquisition
Corp., Horn Interactive, Inc. and the shareholders of Horn
Interactive, Inc. (2)
3.1 Bylaws of DigitalThink, Inc. (3)
3.2 Bylaws of DigitalThink, Inc. (4)
3.3 Bylaws of DigitalThink, Inc.
4.2 Preferred Stock Rights Agreement, dated as of March 31, 2003
between DigitalThink, Inc. and Mellon Investor Services, LLC,
including the Certificate of Designation, the form of Rights
Certificate and the Summary of Rights attached thereto as Exhibits
A, B and C, respectively. (9)
10.1 Restated Investors Rights Agreement dated November 10, 1999 (5)
10.2 1996 Stock Plan and forms of agreements thereunder (5)
10.3 1999 Employee Stock Purchase Plan (5)
10.4 Form of Director and Executive Officer Indemnification Agreement
(5)
10.16 Change of Control Severance Agreement between DigitalThink and
Jon C. Madonna dated September 14, 2001 (3)
10.17 Change of Control Severance Agreement between DigitalThink and
Michael W. Pope dated September 14, 2001 (3)
10.19 Restated 1996 ISO Stock Plan (6)
10.20 Standard Industrial/Commercial Single Tenant Lease Amendment
dated September 4, 2002 between Thomas A. Price and Gwendolyn L.
Price, as trustees of the Price Trust UTD October 5, 1984 and
DigitalThink, for office space located at 601 Brannan Street, San
Francisco, California (6)
10.21 Warrant Agreement dated August 21, 2002 between Thomas A.
Price and Gwendolyn L. Price, as trustees of the Price Trust
UTD October 5, 1984 and DigitalThink (6)
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 (7)
10.23 Stock and Option Purchase Agreement between DigitalThink and Roger
Goddu, dated September 20, 2002. (8)
10.24 Employment Agreement between DigitalThink and J. Jay Tyler dated
January 27, 2003
21.1 DigitalThink subsidiaries
23.1 Independent Auditors' Consent
24.1 Power of Attorney (see signature page)
99.1 Certification of Chief Executive Officer pursuant to Section 906
of the Sarbanes-Oxley Act of 2002
99.2 Certification of Chief Financial Officer pursuant to Section 906
of the Sarbanes-Oxley Act of 2002
- ----------
(1) Incorporated by reference to exhibit 99.1 filed with our Current Report on
Form 8-K dated August 22, 2001.
(2) Incorporated by reference to our Current Report on Form 8-K dated April 16,
2003.
(3) Incorporated by reference to our Annual Report on Form 10-K for the fiscal
year ended March 31, 2002.
(4) Incorporated by reference to exhibit 4.2(b) filed with our Registration
Statement on From S-1 (File No. 333-92429), as amended.
(5) Incorporated by reference to our Registration Statement on From S-1 (File
No. 333-92429), as amended.
(6) Incorporated by reference to our Quarterly Report on Form 10-Q for the
quarter ended September 30, 2002.
(7) Incorporated by reference to our Quarterly Report on Form 10-Q for the
quarter ended December 31, 2002.
(8) Incorporated by reference to exhibit 99.1 filed with our Current Report on
Form 8-K dated October 7, 2002.
(9) Incorporated by reference to our Form 8-A/A dated March 31, 2003.