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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------------
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended
June 30, 2003
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission File Number: 000-28687
DIGITALTHINK, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 94-3244366
(STATE OR OTHER JURISDICTION OF (IRS EMPLOYER IDENTIFICATION
INCORPORATION OR ORGANIZATION) NUMBER)
601 BRANNAN STREET, SAN FRANCISCO, CALIFORNIA, 94107
(Address of principal executive offices)
(415) 625-4000
(Registrant's telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the Registrant is an accelerated filer
(as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
As of August 7, 2003, Registrant had outstanding 44,287,529 Common Stock, $0.001
par value.
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DIGITALTHINK, INC. AND SUBSIDIARIES
TABLE OF CONTENTS
PART I: FINANCIAL INFORMATION
ITEM 1. Financial Statements (Unaudited):
Consolidated Balance Sheets - June 30, 2003 and March 31, 2003
Consolidated Statements of Operations - three months
ended June 30, 2003 and June 30, 2002
Consolidated Statements of Cash Flows - three months
ended June 30, 2003 and June 30, 2002
Notes to Consolidated Financial Statements
ITEM 2. Management's Discussion and Analysis of Financial Condition and
Results of Opertions, including Factors Affecting Future Results
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk
ITEM 4. Controls and Procedures
PART II: OTHER INFORMATION
ITEM 1. Legal Proceedings
ITEM 2. Changes in Securities and Use of Proceeds
ITEM 3. Defaults Upon Senior Securities
ITEM 4. Submission of Matters to a Vote of Security Holders
ITEM 5. Other Matters
ITEM 6. Exhibits and Reports on Form 8-K
Signatures
DIGITALTHINK, INC. AND SUBSIDIARIES
PART I: FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
June 30, March 31,
2003 2003
---------- ----------
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents........................ $ 21,301 $ 22,668
Accounts receivable, net of allowance for doubtful
accounts of $335 and $296, respectively....... 8,621 6,344
Prepaid expenses and other current assets........ 2,614 2,302
---------- ----------
Total current assets..................... 32,536 31,314
Restricted cash and deposits...................... 4,041 4,041
Property and equipment, net....................... 13,694 14,510
Goodwill and other intangible assets.............. 28,597 23,747
---------- ----------
Total assets............................. $ 78,868 $ 73,612
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable................................. $ 3,076 $ 2,213
Accrued liabilities.............................. 3,350 4,140
Borrowings under line of credit and notes payable 7,841 5,266
Deferred revenues................................ 5,376 6,343
---------- ----------
Total current liabilities................ 19,643 17,962
Long-term restructuring charge and
capital lease obligations......................... 6,196 5,892
Stockholders' equity:
Common stock-- $0.001 per share value; 250,000 shares
authorized; issued and outstanding 44,235 at
June 30, 2003 and 41,619 at March 31, 2003....... 274,311 268,718
Deferred stock compensation....................... (168) (224)
Accumulated other comprehensive loss.............. (288) (298)
Accumulated deficit............................... (220,826) (218,438)
---------- ----------
Total stockholders' equity........................ 53,029 49,758
---------- ----------
Total liabilities and stockholders' equity........ $ 78,868 $ 73,612
========== ==========
See accompanying notes to consolidated financial statements.
DIGITALTHINK, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
Three Months Ended June 30,
2003 2002
---------- ----------
Revenues:
Delivered Learning fees.......................... $ 5,623 $ 4,994
Learning Solution services....................... 6,235 4,611
---------- ----------
Total revenues................................ 11,858 9,605
---------- ----------
Costs and expenses:
Cost of Delivered Learning fees.................. 1,035 1,395
Cost of Learning Solution services............... 2,762 1,695
Content research and development................. 1,296 1,486
Technology research and development.............. 1,816 1,953
Selling and marketing............................ 3,630 3,450
General and administrative....................... 1,803 2,167
Depreciation..................................... 1,535 1,695
Amortization of intangibles and warrants......... 371 359
Amortization of stock-based compensation*........ 56 140
Restructuring charge (recovery).................. (36) --
---------- ----------
Total costs and expenses...................... 14,268 14,340
---------- ----------
Loss from operations.............................. (2,410) (4,735)
Interest and other income......................... 22 95
---------- ----------
Net loss before cumulative effect of accounting
principle......................................... (2,388) (4,640)
Cumulative effect of accounting change............ -- (50,189)
---------- ----------
Net loss.......................................... $ (2,388) $ (54,829)
========== ==========
Net loss per share--basic and diluted:
Before cumulative effect of accounting change..... $ (0.05) $ (0.11)
Cumulative effect of accounting change............ -- (1.23)
---------- ----------
Net loss per share--basic and diluted............. $ (0.05) $ (1.34)
========== ==========
Shares used in computing basic and diluted
loss per share.................................... 43,638 40,798
========== ==========
(*) Stock-based compensation:
Cost of Delivered Learning fees.............. $ 1 $ 1
Cost of Learning Solution services........... 5 14
Content research and development............. 1 1
Technology research and development.......... 14 35
Selling and marketing........................ 18 45
General and administrative................... 17 44
---------- ----------
Total.................................... $ 56 $ 140
========== ==========
See accompanying notes to consolidated financial statements.
DIGITALTHINK, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
Three Months Ended June 30,
2003 2002
---------- ----------
Cash flows from operating activities:
Net loss......................................... $ (2,388) $ (54,829)
Adjustments to reconcile net loss to net cash used in
operating activities:
Cumulative effect of accounting change.......... -- 50,189
Provision for doubtful accounts................. 18 5
Depreciation.................................... 1,535 1,695
(Gain) loss on disposal of property and equipment (3) 36
Amortization of intangibles and warrants........ 371 359
Amortization of stock-based compensation........ 56 140
Restructuring charge (recovery)................. (36) --
Changes in assets and liabilities:
Accounts receivable........................... (2,030) (1,049)
Prepaid expenses and other current assets..... (244) (672)
Accounts payable.............................. 750 (28)
Accrued liabilities........................... (680) (2,639)
Deferred revenues............................. (1,445) 77
---------- ----------
Net cash used in operating activities........ (4,096) (6,716)
---------- ----------
Cash flows from investing activities:
Purchases of property and equipment.............. (675) (1,603)
Sales of property and equipment 4 19
Cash received in acquisition (net of acquisition costs) 186 --
Proceeds from maturities of marketable securities -- 31
---------- ----------
Net cash used in investing activities........ (485) (1,553)
---------- ----------
Cash flows from financing activities:
Proceeds from issuance of notes payable
(net of payments)............................... 2,575 2,855
Proceeds from sale of common stock............... 629 353
---------- ----------
Net cash provided by financing activities.... 3,204 3,208
---------- ----------
Effect of exchange rate changes on cash and
cash equivalents.................................. 10 (60)
Net decrease in cash and cash equivalents......... (1,367) (5,121)
Cash and cash equivalents, beginning of period.... 22,668 29,470
---------- ----------
Cash and cash equivalents, end of period.......... $ 21,301 $ 24,349
========== ==========
Supplemental disclosure of cash flow information:
Cash paid for interest $ 13 $ 23
Supplemental disclosure of noncash investing and
financing activities:
Issuance of common stock for acquisitions $ 4,960 $ --
See accompanying notes to consolidated financial statements.
DIGITALTHINK, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
1. Description of Business and Basis of Presentation
DigitalThink, Inc. (the "Company") provides custom e-learning solutions designed
to address the strategic business objectives of its 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.
The consolidated financial statements included herein have been prepared by the
Company, without audit, pursuant to the rules and regulations of the Securities
and Exchange Commission. Certain information and footnote disclosures normally
included in financial statements prepared in accordance with generally accepted
accounting principles have been condensed or omitted pursuant to such rules and
regulations, although management believes the disclosures which are made are
adequate to make the information presented not misleading. It is suggested that
this document be read in conjunction with the consolidated financial statements
and the notes thereto included in the Company's Annual Report on Form 10-K, for
the fiscal year ended March 31, 2003.
The unaudited consolidated financial statements included herein reflect all
adjustments (which include only normal, recurring adjustments) that are, in the
opinion of management, necessary to state fairly the results for the periods
presented. The results for such periods are not necessarily indicative of the
results to be expected for the entire fiscal year ending March 31, 2004.
Certain prior year amounts in the consolidated financial statements have been
reclassified to conform to the current year presentation.
2. Recent Accounting Pronouncements
In November 2002, the Emerging Issues Task Force ("EITF") reached a consensus on
Issue 00-21, Revenue Arrangements with Multiple Deliverables, addressing how to
account for arrangements that involve the delivery or performance of multiple
products, services, and/or rights to use assets. Revenue arrangements with
multiple deliverables are divided into separate units of accounting if the
deliverables in the arrangement meet the following criteria: (1) the delivered
item has value to the customer on a standalone basis; (2) there is objective and
reliable evidence of the fair value of undelivered items; and (3) delivery of
any undelivered item is probable. Arrangement consideration should be allocated
among the separate units of accounting based on their relative fair values, with
the amount allocated to the delivered item being limited to the amount that is
not contingent on the delivery of additional items or meeting other specified
performance conditions. The final consensus will be applicable to agreements
entered into in fiscal periods beginning after June 15, 2003 with early adoption
permitted. The provisions of this consensus are not expected to have a material
effect on the Company's financial position or operating results.
In November 2002, the Financial Accounting Standards Board ("FASB") issued
Interpretation No. 45, Guarantor's Accounting and Disclosure Requirements for
Guarantees, Including Indirect Guarantees of Indebtedness of Others. This
Interpretation elaborates on the disclosures to be made by a guarantor in its
interim and annual financial statements about its obligations under guarantees
issued. The Interpretation also clarifies that a guarantor is required to
recognize, at inception of a guarantee, a liability for the fair value of the
obligation undertaken. These initial recognition and measurement provisions of
the Interpretation are applicable to guarantees issued or modified after
December 31, 2002. The disclosure requirements are effective for financial
statements of interim or annual periods ending after December 15, 2002. The
adoption of this Interpretation did not have a material impact on the Company's
results of operations or financial position.
In December 2002, the FASB issued Statement of Financial Accounting Standard
("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 a voluntary
change to the fair value based method of accounting for stock-based employee
compensation. In addition, SFAS No. 148 amends the disclosure requirements of
Accounting Principles Board ("APB") Opinion No. 28, Interim Financial Reporting,
to require pro forma disclosure in interim financial statements by companies
that elect to account for stock-based compensation using the intrinsic value
method prescribed in APB Opinion No. 25, Accounting for Stock Issued to
Employees. The Company continues to use the intrinsic value method of accounting
for stock-based compensation. As a result, the transition provisions will not
have an effect on the Company's consolidated financial statements. The Company's
interim disclosures are presented in Note 3.
DIGITALTHINK, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - (Continued)
3. Stock Plan Information
The Company's stock option plans provide for grants of incentive or
non-statutory stock options to officers, employees, directors, and consultants.
The Company accounts for stock-based compensation using the intrinsic value
method prescribed in APB No. 25, whereby the options are granted at market
price, and therefore no compensation costs are recognized. The Company has
elected to retain its current method of accounting as described above and has
adopted the SFAS Nos. 123 and 148 disclosure requirements.
If compensation expense for the Company's various stock option plans had been
determined based upon the projected fair values at the grant dates for awards
under those plans in accordance with SFAS No. 123, the Company's pro-forma net
earnings, basic and diluted earnings per common share would have been as
follows:
Three Months Ended June 30,
2003 2002
---------- ----------
Net loss (in thousands):
As reported $ (2,388) $ (54,829)
Add: Stock based employee compensation included
in reported net loss 56 140
Deduct: Total stock based employee compensation
expense determined under fair value based
method for awards (559) (1,843)
---------- ----------
Pro forma $ (2,891) $ (56,532)
========== ==========
Basic and diluted net loss per share:
As reported $ (0.05) $ (1.34)
Pro forma $ (0.07) $ (1.39)
The Company calculated the value of stock-based awards on the date of grant
using the Black-Scholes multiple option valuation approach. The following
weighted average assumptions were used: expected life after vesting, 1.5 years
for the three months ended June 30, 2003 and 1.3 years for the three months
ended June 30, 2002; average risk-free interest rate, 1.5% for the three months
ended June 30, 2003 and 2.2% for the three months ended June 30, 2002. The
Company's calculations include volatility assumptions of 87% for the three
months ended June 30, 2003 and 119% for the three months ended June 30, 2002. No
dividends were included in expected terms for either period.
4. Net Loss Per Share
The following table sets forth the computation of net loss per share (in
thousands, except for per share data):
Three Months Ended June 30,
2003 2002
---------- ----------
Net loss before cumulative effect of
accounting change $ (2,388) $ (4,640)
Cumulative effect of accounting change -- (50,189)
---------- ----------
Net loss $ (2,388) $ (54,829)
========== ==========
Weighted average common shares outstanding used in
computing basic and diluted loss per share 43,638 40,798
========== ==========
Net loss per share:
Before cumulative effect of accounting change $ (0.05) $ (0.11)
Cumulative effect of accounting change -- (1.23)
---------- ----------
Net loss per share--basic and diluted $ (0.05) $ (1.34)
========== ==========
Basic net loss per share excludes dilution and is computed by dividing loss
attributable to common stockholders by the weighted average number of common
shares outstanding during the period. Diluted loss per common share excludes the
potential dilution that could occur if securities or other contracts to issue
common stock were exercised or converted into common stock, as the effect of
such conversions in loss periods would be anti-dilutive.
DIGITALTHINK, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - (Continued)
5. Business Combinations
On April 16, 2003, the Company acquired Horn Interactive, Inc. ("Horn"), a
provider of simulation-based custom e-learning courseware, in exchange for 2.0
million shares of DigitalThink common stock, for a total purchase price of $4.8
million. The acquisition of Horn has been accounted for in accordance with SFAS
No. 141, Business Combinations. The cost of the acquisition was allocated to the
assets acquired and liabilities assumed based on estimates of their respective
fair values at the date of acquisition. Intangible assets acquired will be
amortized on a straight-line basis over a weighted average period of 4.3 years.
Goodwill will not be amortized in accordance with SFAS No. 142, Goodwill and
Other Intangibles, and is not expected to be deductible for tax purposes. The
consideration given in the acquisition of Horn was as follows (in thousands):
DigitalThink common stock $ 4,938
Transaction costs 126
Cash received (313)
----------
Total purchase price $ 4,752
==========
The following tables summarize the final purchase price allocation of Horn's
assets acquired and liabilities assumed at the date of acquisition (in
thousands):
Total purchase price $ 4,752
Less: Tangible assets acquired (379)
Plus: Liabilities assumed 843
Less: Acquired technology and other intangibles (1,321)
----------
Goodwill $ 3,895
==========
The Company's consolidated results of operations include Horn's operations from
April 16, 2003, the date of acquisition. Pro forma financial information in
connection with the Horn Interactive acquisition has not been provided, as
results would not have differed materially from actual reported results.
6. Restructuring Charge
In March 2002, the Company initiated a strategic initiative, under which the
Company restructured its business in response to the current market environment
and as part of the Company's continuing program to create efficiencies within
its operations. The following table sets forth the activity related to the
restructuring charge in the three months ended June 30, 2003 (in thousands):
Remaining Amounts Remaining
Liability recorded in Liability
Balance as of Cash Other Net Balance as of
March 31, 2003 Payments Accounts Adjustments June 30, 2003
---------- -------- ---------- ---------- ----------
Lease commitments $ 5,610 (338) -- (36) $ 5,236
At June 30, 2003, restructuring charge obligations were recorded as $0.8 million
in accrued liabilities and $4.4 million in long-term liabilities.
The net adjustments of $36,000 were made to the restructuring accrual based on
events occurring during the three months ended June 30, 2003, as a reversal of
previously expensed restructuring costs. This reversal was the result of an
unanticipated refund of leasehold improvement costs, offset by changes in our
foreign currency exchange rate assumptions and other minor adjustments.
DIGITALTHINK, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - (Continued)
7. Change in Accounting for Goodwill and Certain Intangibles
Effective April 1, 2002, the Company adopted SFAS No. 141. 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. 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 three months ended June 30, 2002. The impaired goodwill was
not deductible for taxes, and as a result, no tax benefit was recorded in
relation to the charge. The Company performed its annual goodwill impairment
analysis on October 31, 2002, using a valuation model based on market
capitalization adjusted for outstanding debt, consistent with the model used as
of April 1, 2002. This analysis indicated that no additional adjustments were
required to the remaining goodwill balance. At June 30, 2003, no events or
circumstances occurred that would necessitate the interim testing of goodwill
impairment.
The gross carrying amount and accumulated amortization of the Company's
intangible assets other than goodwill as of June 30, 2003 and March 31, 2003 are
as follows (in thousands):
June 30, 2003 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 $(2,288) $3,812 $6,100 $(1,982) $4,118
Horn acquired
technology 464 (17) 447 -- -- --
Horn customer
contracts 857 (42) 815 -- -- --
------ ------------ ------ ------- ------------ ------
Total $7,421 $(2,347) $5,074 $6,100 $(1,982) $4,118
Amortization expense recorded on the intangible assets for the three months
ended June 30, 2003 and 2002 was $367,000 and $359,000, respectively. The
estimated future amortization expense by fiscal year is as follows: nine months
ended March 31, 2004 is $1.1 million; 2005 is $1.5 million; 2006 is $1.5
million; 2007 is $0.8 million; 2008 is $0.1 million and 2009 is $4,000.
8. Contingencies
In October 2001, DigitalThink and certain of our officers and directors were
named as defendants in a class action shareholder complaint filed in the United
States District Court for the Southern District of New York. In the complaint,
the plaintiffs allege that DigitalThink, certain of our officers and directors,
and the underwriters of our initial public offering ("IPO") violated section 11
of the Securities Act of 1933 based on allegations that our registration
statement and prospectus failed to disclose material facts regarding the
compensation to be received by, and the stock allocation practices of, the IPO
underwriters. The complaint also contains a claim for violation of section 10(b)
of the Securities Exchange Act of 1934 based on allegations that this omission
constituted a deceit on investors. Similar complaints were filed in the same
Court against hundreds of other public companies ("Issuers") that conducted IPOs
of their common stock in the late 1990s (the "IPO Lawsuits"). In October 2002,
the Court entered an order dismissing our named officers and directors from the
IPO Lawsuits without prejudice. In February 2003, the Court issued a decision
denying the motion to dismiss the Section 10(b) claim against us, but granting
the motion to dismiss the Section 11
DIGITALTHINK, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - (Continued)
8. Contingencies - (continued)
claim without leave to amend. In June 2003, Issuers and Plaintiffs reached a
tentative settlement agreement that would, among other things, result in the
dismissal with prejudice of all claims against the Issuers and their officers
and directors in the IPO Lawsuits. In addition, the tentative settlement
guarantees that, in the event that the Plaintiffs recover less than $1 billion
in settlement or judgment against the Underwriter defendants in the IPO
Lawsuits, the Plaintiffs will be entitled to recover the difference between the
actual recovery and $1 billion from the insurers for the Issuers. Although our
Board has approved this settlement proposal in principle, it remains subject to
a number of procedural conditions, as well as formal approval by the Court. If
the settlement does not occur, and litigation against us continues, we believe
we have meritorious defenses and intend to defend the case vigorously.
Securities class action litigation could result in substantial costs and divert
our management's attention and resources. Although no assurance can be given
that this matter will be resolved in our favor, we believe that the resolution
of this lawsuit will not have a material adverse effect on our financial
position, results of operations or cash flows.
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. Substantially similar complaints have been filed against
other companies in the e-learning industry, including Skillsoft Corporation,
Saba Software, Inc. and Docent, Inc. The complaint, amended in November 2002,
alleges infringement of five patents and seeks damages and injunctive relief. We
have filed an answer to the amended complaint asserting a number of affirmative
defenses. In addition, we have filed counterclaims against IP Learn seeking
declaratory relief that we do not infringe the patents-in-suit and that each of
the patents-in-suit are invalid.
In May 2002, a complaint was filed in the United States District Court for the
Southern District of Texas, Houston Division by IP Innovation LLC against
Thomson Learning, Inc., Skillsoft Corporation, eCollege.com, DigitalThink, Inc.,
Docent, Inc., Blackboard, Inc., Global Knowledge Network, Inc. and The Princeton
Review. The complaint, amended in November 2002, alleges infringement of one of
the plaintiff's patents, and seeks damages and injunctive relief. We have filed
an answer to the complaint asserting a number of affirmative defenses. In
addition, we have filed counterclaims against IP Innovation seeking declaratory
relief that we do not infringe the patents-in-suit and that each of the
patents-in-suit are invalid.
We believe the IP Learn and IP Innovation lawsuits are without merit and intend
to defend against them vigorously. Although no assurances can be given that
these matters will be resolved in the Company's favor, the Company believes the
resolution of these lawsuits will not have a material adverse effect on its
financial position, results of operations, or cash flows.
ITEM 2. 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.
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
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 June 30, 2003, we had an accumulated deficit of $220.8
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. We expect that EDS and other major customers will
continue to account for a significant portion of our revenues during future
fiscal periods.
Revenues increased from $9.6 million in the three months ended June 30, 2002 to
$11.9 million in the three months ended June 30, 2003. Revenues increased in the
quarter ended June 30, 2003 as compared to the same period last year due to
increased sales, an increase in recurring revenues due to a growing customer
base, and the addition of new revenue through the acquisition of Horn
Interactive. In addition, Learning Solution Services revenues increased compared
to the same period last year due to the addition of a significant, new customer
contract and other smaller contracts. For the three months ended June 30, 2003,
Delivered Learning fees represented 47% of revenues and Learning Solution
services represented 53% of revenues. This is compared to the three months ended
June 30, 2002, during which Delivered Learning fees represented 52% of revenues
and Learning Solution services represented 48% of revenues.
Acquisition of Horn Interactive
On April 16, 2003, we acquired Horn Interactive, Inc., ("Horn") a provider of
simulation-based learning products and services. We acquired all of the
outstanding shares of Horn in exchange for 2,000,000 shares of our common stock
for a purchase price of approximately $4.8 million, including transaction costs.
The acquisition of Horn was accounted for as a purchase; accordingly, the
results of operations of Horn have been included with our results of operations
since April 16, 2003. 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.
Identifiable intangible assets acquired of $1.3 million are being amortized on a
straight-line basis over a weighted average life of 4.3 years. Goodwill will not
be amortized in accordance with SFAS No. 142, Goodwill and Other Intangibles.
RESULTS OF OPERATIONS - THREE MONTHS ENDED JUNE 30, 2003 AND 2002
REVENUES
Delivered Learning Fees
Delivered Learning fees increased from $5.0 million in the three months ended
June 30, 2002 to $5.6 million in the three months ended June 30, 2003. The total
number of customers increased from 475 to 552 and the total number of courses
developed increased from 843 to 1,107. Revenue increased in the quarter ended
June 30, 2003 as compared to the same period last year due to a larger customer
base with an increasing shift toward renewal revenues. We expect that the number
of courses and customers will continue to increase as we expand our course
offerings and as our custom content development projects progress.
Learning Solution Services
Learning Solution services revenue increased from $4.6 million in the three
months ended June 30, 2002 to $6.2 million in the three months ended June 30,
2003 due to the addition of a significant new customer contract combined with
new revenue from contracts assumed in the Horn acquisition and other smaller
contracts. 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 revenues.
COSTS AND EXPENSES
Cost of Delivered Learning Fees
Cost of Delivered Learning fees include personnel-related costs, maintenance and
facility costs required to operate our website and to provide interactive tutor
support to participants in our courses. Cost of Delivered Learning fees
decreased from $1.4 million in the three months ended June 30, 2002 to $1.0
million in the three months ended June 30, 2003. This decrease was attributable
to the fact
that we shifted tutor support services from the United States to our lower cost
India operation. Headcount remained relatively flat over the two periods with
headcount of 27 at June 30, 2002 compared to headcount of 28 at June 30, 2003.
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 increased from $1.7 million in the three months
ended June 30, 2002 to $2.8 million in the three months ended June 30, 2003.
This increase was primarily attributable to direct contractor costs associated
with a significant new customer contract for which the associated revenue was
also recognized. Additionally, net headcount increased by 85, growing from 114
employees at June 30, 2002 to 199 employees at June 30, 2003, including the
addition of personnel as a result of the Horn acquisition. We expect the cost of
Learning Solutions services to continue to be relative to the revenue generated
from Learning Solutions.
Content Research and Development
Content research and development is expensed as incurred in accordance with SFAS
No. 86, and represents costs to develop catalog courses, including
personnel-related costs, content acquisition costs and content editing. Content
research and development expenses decreased from $1.5 million in the three
months ended June 30, 2002 to $1.3 million in the three months ended June 30,
2003 mainly due to shifting of higher cost headcount in the United States to
lower cost headcount in India. Headcount in content research and development
remained stable at 55 employees at both June 30, 2003 and 2002. 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
underlying technology. Technology research and development expenses decreased
from $2.0 million in the three months ended June 30, 2002 to $1.8 million in the
three months ended June 30, 2003. This decrease was primarily attributable to an
overall decrease of 39 employees, from 96 employees at June 30, 2002 to 57
employees at June 30, 2003, primarily recognized in our lower cost India-based
workforce. 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, royalties paid to
authors and travel and entertainment expenses. Selling and marketing expenses
increased from $3.5 million in the three months ended June 30, 2002 to $3.6
million in the three months ended June 30, 2003, primarily due to an increase in
headcount from 52 at June 30, 2002 to 62 at June 30, 2003. We expect selling and
marketing expenses may increase in the near future as commission expense
fluctuates 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 $2.2 million in the three
months ended June 30, 2002 to $1.8 million in the three months ended June 30,
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 from 63 employees at June 30, 2002 to 55 employees at June 30, 2003,
with all of the decrease in headcount recognized in our lower-cost India-based
personnel. We expect general and administrative expenses to remain relatively
flat unless there are significant changes in the business.
Amortization of Intangibles
Amortization of intangibles totaled $367,000 in the three months ended June 30,
2003 associated with the acquisition of LearningByte International, Inc. ("LBI")
and Horn. Amortization totaled $359,000 in the three months ended June 30, 2002
related to amortization of intangibles associated with the acquisition of LBI.
Amortization of Warrants
The Company expensed approximately $4,000 of warrant expense in the three months
ended June 30, 2003 related to warrants issued in connection with the
restructuring of the corporate headquarters facility lease in August 2002. No
such expense was recognized for the three months ended June 30, 2002.
Stock-Based Compensation
Stock-based compensation expense decreased from $140,000 in the three months
ended June 30, 2002 to $56,000 in the three months ended June 30, 2003.
Net Loss Before Cumulative Effect of Accounting Change
The net loss decreased from $4.6 million in the three months ended June 30, 2002
to $2.4 million in the three months ended June 30, 2003.
Cumulative Effect of Accounting Change
Effective April 1, 2002, we adopted Statement of Financial Accounting Standards
("SFAS") No. 141, Business Combinations. SFAS No. 141 requires that the purchase
method of accounting be used for all combinations initiated after June 30, 2001.
The adoption of SFAS No. 141 did not have an impact on 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. 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 three months ended June 30,
2002. The impaired goodwill was not deductible for taxes, and as a result, no
tax benefit was recorded in relation to the charge. 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. At June 30, 2003,
no events or circumstances occurred that would necessitate the interim testing
of goodwill impairment.
Net Loss
The net loss decreased from $54.8 million in the three months ended June 30,
2002 to $2.4 million in the three months ended June 30, 2003. The net loss for
the three months ended June 30, 2002 includes $50.2 million in expense related
to the goodwill impairment charge discussed above.
Critical Accounting Policies
There have been no significant changes to our critical accounting policies as
disclosed in our Annual Report on Form 10-K for the year ended March 31, 2003.
Liquidity and Capital Resources
Net cash used in operating activities totaled $4.1 million for the three months
ended June 30, 2003 and $6.7 million for the three months ended June 30, 2002.
Cash used in operating activities for the current period resulted from net
operating losses and increases in accounts receivable and decreases in deferred
revenue offset by increases in accounts payable. Deferred revenue decreased from
$6.3 million at March 31, 2003 to $5.4 million at June 30, 2003. Deferred
revenue results from customer advance billings and prepayments of Delivered
Learning fees and Learning Solution services. In both cases, prepayments remain
in deferred revenue until revenue recognition criteria have been met. Accrued
liabilities decreased from $4.1 million at March 31, 2003 to $3.4 million on
June 30, 2003 reflecting the on-going payment of lease-related liabilities.
Long-term liabilities increased from $5.9 million at March 31, 2003 to $6.2
million at June 30, 2003, reflecting the increase to deferred rent associated
with one of our lease obligations.
Net cash used in investing activities totaled $485,000 in the three months ended
June 30, 2003 as compared to $1.6 million for the three months ended June 30,
2002. The net decrease reflects a reduction in capital expenditures during the
three months ended June 30, 2003 combined with net cash received of $186,000 as
a result of the Horn acquisition.
Cash provided by financing activities totaled $3.2 million in both the three
months ended June 30, 2003 and June 30, 2002. The cash from financing activities
reflects the exercise of stock options and stock purchases in the employee stock
purchase program and borrowings on the Company's line of credit.
At both June 30, 2003 and March 31, 2003 we had an $8 million line of credit in
place that expires in December 2003. We had available from this line of credit
$300,000 at June 30, 2003 and $2.9 million at March 31, 2003. Subsequent to June
30, 2003, the balance of $7.7 million on the line of credit was repaid.
Borrowings under this line of credit are secured by certain of our assets.
We believe our existing capital resources will be sufficient to meet our capital
requirements for the next twelve months; however, if our capital requirements
increase materially from those currently planned or if revenues fall below our
expectations, as a result of the loss of key customers, material delays in the
receipt of payments from customers or otherwise, we may require additional
financing sooner than anticipated. Additional financing may not be available in
amounts or on terms acceptable to us, if at all. 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 significant dilution to our
stockholders. Currently, we have no other immediately available sources of
liquidity. Our future liquidity and capital requirements will depend on numerous
factors.
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. 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.
Recent Accounting Pronouncements
In November 2002, the Emerging Issues Task Force ("EITF") reached a consensus on
Issue 00-21, Revenue Arrangements with Multiple Deliverables, addressing how to
account for arrangements that involve the delivery or performance of multiple
products, services, and/or rights to use assets. Revenue arrangements with
multiple deliverables are divided into separate units of accounting if the
deliverables in the arrangement meet the following criteria: (1) the delivered
item has value to the customer on a standalone basis; (2) there is objective and
reliable evidence of the fair value of undelivered items; and (3) delivery of
any undelivered item is probable. Arrangement consideration should be allocated
among the separate units of accounting based on their relative fair values, with
the amount allocated to the delivered item being limited to the amount that is
not contingent on the delivery of additional items or meeting other specified
performance conditions. The final consensus will be applicable to agreements
entered into in fiscal periods beginning after June 15, 2003 with early adoption
permitted. The provisions of this consensus are not expected to have a material
effect on the Company's financial position or operating results.
In November 2002, the Financial Accounting Standards Board ("FASB") issued
Interpretation No. 45, Guarantor's Accounting and Disclosure Requirements for
Guarantees, Including Indirect Guarantees of Indebtedness of Others. This
Interpretation elaborates on the disclosures to be made by a guarantor in its
interim and annual financial statements about its obligations under guarantees
issued. The Interpretation also clarifies that a guarantor is required to
recognize, at inception of a guarantee, a liability for the fair value of the
obligation undertaken. These initial recognition and measurement provisions of
the Interpretation are applicable to guarantees issued or modified after
December 31, 2002. The disclosure requirements are effective for financial
statements of interim or annual periods
ending after December 15, 2002. The adoption of this Interpretation did not have
a material impact on the Company's results of operations or financial position.
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 a voluntary change to the fair value based method of accounting
for stock-based employee compensation. In addition, SFAS No. 148 amends the
disclosure requirements of Accounting Principles Board ("APB") Opinion No. 28,
Interim Financial Reporting, to require pro forma disclosure in interim
financial statements by companies that elect to account for stock-based
compensation using the intrinsic value method prescribed in APB Opinion No. 25,
Accounting for Stock Issued to Employees. The Company continues to use the
intrinsic value method of accounting for stock-based compensation.
Special Note Regarding Forward-Looking Statements and Risk Factors
Certain statements in this Quarterly Report on Form 10-Q contain
"forward-looking statements." Forward-looking statements are any statements
other than statements of historical fact. Examples of forward-looking statements
include projections of earnings, revenues or other financial items, statements
of the plans and objectives of management for future operations, and statements
concerning proposed new products and services, and any statements of assumptions
underlying any of the foregoing. In some cases, you can identify forward-looking
statements by the use of words such as "may", "will", "expects", "should",
"believes", "plans", "anticipates", "estimates", "predicts", "potential", or
"continue", and any other words of similar meaning.
Statements regarding our future financial performance or results of operations,
including expected revenue growth, EBITDA growth, future expenses, future
operating margins and other future or expected performance are subject to the
following risks: that cost-reduction initiatives began last year will not be
achieved due to implementation difficulties or contractual spending commitments
that can't be reduced; that demand for our products and services could be
affected by adverse economic conditions affecting the technology industry; the
acquisition of businesses or the launch of new lines of business, which could
increase operating expense and dilute operating margins; the inability to
attract new customers; increased competition, which could lead to negative
pressure on our pricing and the need for increased marketing; the inability to
maintain, establish or renew relationships with customers, whether due to
competition or other factors; costs associated with our continued
standardization of our technology platforms or our failure to successfully
complete upgrades; and to the general risks associated with our businesses.
The following additional factors could also impact our financial results and
cause our forward-looking statements to be inaccurate:
Accounting rules regarding the accounting for goodwill have recently been
changed by the FASB. The changes in these rules have had a significant impact on
our reported financial results. In June 2001, the FASB issued SFAS No. 141,
Business Combinations and SFAS No. 142, Goodwill and Other Intangible Assets.
These statements continue to require recognition of goodwill as an asset but do
not permit amortization of goodwill as was required by Accounting Principles
Board (APB) Opinion No. 17, Intangible Assets. Under the SFAS No. 142, goodwill
is to be separately tested for impairment using a fair-value-based approach when
an event occurs indicating the potential for impairment. Any required goodwill
impairment charges are presented as a separate line item within the operating
section of the income statement. The change from an amortization approach to an
impairment approach applies to previously recorded goodwill, as well as goodwill
arising from acquisitions completed after the application of the new standard.
When we adopted these statements, our goodwill amortization charges ceased.
However, it is possible that in the future, we would incur less frequent, but
larger, impairment charges related to the goodwill already recorded as well as
any goodwill arising out of future acquisitions. Therefore, it is difficult to
predict whether our future earnings may be subject to significant volatility,
particularly on a period-to-period basis.
Any shortfall in revenue or earnings compared to analysts' or investors'
expectations could cause, an immediate and significant decline in the trading
price of our common stock. In addition, we may not learn of such shortfalls or
delays until late in the fiscal quarter, which could result in an even more
immediate and greater decline in the trading price of our common stock.
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 $220.8 MILLION AT JUNE
30, 2003. WE EXPECT 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 June 30, 2003 was $220.8 million. We have never achieved a
profitable quarter and we may continue to incur quarterly losses if our revenue
growth does not meet expectations 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.
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 our existing
capital resources will be sufficient to meet our capital requirements for the
next twelve months; however, if our capital requirements increase materially
from those currently planned or if revenues fall below our expectations, as a
result of the loss of key customers, material delays in the receipt of payments
from customers or otherwise, we may require additional financing sooner than
anticipated. In order to finance our presently anticipated capital requirements,
we may seek to sell additional equity or debt securities or secure a larger bank
line of credit. Additional financing may not be available in amounts or on terms
acceptable to us, if at all. The sale of additional equity or debt securities
could result in significant dilution to our stockholders and such securities may
have rights, preferences or privileges senior to those of the holders of our
common stock. If adequate funds are not available or are not available on
acceptable terms, we may be unable to operate our business, develop or enhance
our products and services, take advantage of future opportunities or respond to
competitive pressures.
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
since 2001. 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, which 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 June 30, 2003, we had
approximately 173 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. However, the Company continues to conduct
normal operations in India along with the associated travel of United States
employees visiting India and vice versa.
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.
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 first fiscal quarter of 2004, our five largest customers accounted for
75.7% of our total revenues of $11.9 million. 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.
IN ANY QUARTER, A DELAY IN RECEIVING PAYMENT FROM A KEY CUSTOMER COULD HARM OUR
PERFORMANCE.
We expect that in the next twelve months, 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 any of these customers delayed payment in any future fiscal period. For
example, in fiscal 2003, our largest customer accounted for 37.1% and another
customer accounted for 14.4% of our total revenues of $42.1 million.
OUR LIMITED OPERATING HISTORY AND THE NEW AND EMERGING E-LEARNING MARKET MAKES
IT DIFFICULT TO EVALUATE OUR BUSINESS AND FUTURE PROSPECTS.
We commenced operations in April 1996 and did not begin to generate significant
revenues until fiscal 1999. In the first quarter of fiscal 2004, we had revenues
of $11.8 million and expenses of $14.3 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.
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 53% of our total revenues for the
three months ended June 30, 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.
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;
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.
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.
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.
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, DigitalThink and certain of our officers and directors were
named as defendants in a class action shareholder complaint filed in the United
States District Court for the Southern District of New York. In the complaint,
the plaintiffs allege that DigitalThink, certain of our officers and directors,
and the underwriters of our initial public offering ("IPO") violated section 11
of the Securities Act of 1933 based on allegations that our registration
statement and prospectus failed to disclose material facts regarding the
compensation to be received by, and the stock allocation practices of, the IPO
underwriters. The complaint also contains a claim for violation of section 10(b)
of the Securities Exchange Act of 1934 based on allegations that this omission
constituted a deceit on investors. Similar complaints were filed in the same
Court against hundreds of other public companies ("Issuers") that conducted IPOs
of their common stock in the late 1990s (the "IPO Lawsuits"). In October 2002,
the Court entered an order dismissing our named officers and directors from the
IPO Lawsuits without prejudice. In February 2003, the Court issued a decision
denying the motion to dismiss the Section 10(b) claim against us, but granting
the motion to dismiss the Section 11 claim without leave to amend. In June 2003,
Issuers and Plaintiffs reached a tentative settlement agreement that would,
among other things, result in the dismissal with prejudice of all claims against
the Issuers and their officers and directors in the IPO Lawsuits. In addition,
the tentative settlement guarantees that, in the event that the Plaintiffs
recover less than $1 billion in settlement or judgment against the Underwriter
defendants in the IPO Lawsuits, the Plaintiffs will be entitled to recover the
difference between the actual recovery and $1 billion from the insurers for the
Issuers. Although our Board has approved this settlement proposal in principle,
it remains subject to a number of procedural conditions, as well as formal
approval by the Court. If the settlement does not occur, and litigation against
us continues, we believe we have meritorious defenses and intend to defend the
case vigorously. Securities class action litigation could result in substantial
costs and divert our management's attention and resources. Although no assurance
can be given that this matter will be resolved in our favor, we believe that the
resolution of this lawsuit will not have a material adverse effect on our
financial position, results of operations or cash flows.
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. Substantially similar complaints have been filed against
other companies in the e-learning industry, including Skillsoft Corporation,
Saba Software, Inc. and Docent, Inc. The complaint, amended in November 2002,
alleges infringement of five patents and seeks damages and injunctive relief. We
have filed an answer to the amended complaint asserting a number of affirmative
defenses. In addition, we have filed counterclaims against IP Learn seeking
declaratory relief that we do not infringe the patents-in-suit and that each of
the patents-in-suit are invalid.
In May 2002, a complaint was filed in the United States District Court for the
Southern District of Texas, Houston Division by IP Innovation LLC against
Thomson Learning, Inc., Skillsoft Corporation, eCollege.com, DigitalThink, Inc.,
Docent, Inc., Blackboard, Inc., Global Knowledge Network, Inc. and The Princeton
Review. The complaint, amended in November 2002, alleges infringement of one of
the plaintiff's patents, and seeks damages and injunctive relief. We have filed
an answer to the complaint asserting a number of affirmative defenses. In
addition, we have filed counterclaims against IP Innovation seeking declaratory
relief that we do not infringe the patents-in-suit and that each of the
patents-in-suit are invalid.
We believe the IP Learn and IP Innovation lawsuits are without merit and intend
to defend against them vigorously. Although no assurances can be given that
these matters will be resolved in the Company's favor, the Company believes the
resolution of these lawsuits will not have a material adverse effect on its
financial position, results of operations, or cash flows. 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
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 persons to purchase, in the aggregate, up
to 20% of our outstanding shares. 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 stoock 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.
ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
There have been no significant changes to our exposure to market risk as
disclosed in our Annual Report on Form 10-K for the year ended March 31, 2003.
ITEM 4: CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
Based on their evaluation of our disclosure controls and procedures (as defined
in the rules promulgated under the Securities Exchange Act of 1934), our chief
executive officer and our chief financial officer concluded that our disclosure
controls and procedures were effective as of the end of the period covered by
this report.
We believe that a controls system, no matter how well designed and operated,
cannot provide absolute assurance that the objectives of the controls system are
met, and no evaluation of controls can provide absolute assurance that all
control issues and instances of fraud, if any, within a company have been
detected. Our disclosure controls and procedures are designed to provide
reasonable assurance of achieving their objectives, and the Chief Executive
Officer and the Chief Financial Officer have concluded that these controls and
procedures are effective at the "reasonable assurance" level.
Changes in Internal Controls
There were no significant changes in our internal control over financial
reporting during the period covered by this report that have materially
affected, or are reasonably likely to materially affect, our internal control
over financial reporting.
PART II: OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
In October 2001, DigitalThink and certain of our officers and directors were
named as defendants in a class action shareholder complaint filed in the United
States District Court for the Southern District of New York. In the complaint,
the plaintiffs allege that DigitalThink, certain of our officers and directors,
and the underwriters of our initial public offering ("IPO") violated section 11
of the Securities Act of 1933 based on allegations that our registration
statement and prospectus failed to disclose material facts regarding the
compensation to be received by, and the stock allocation practices of, the IPO
underwriters. The complaint also contains a claim for violation of section 10(b)
of the Securities Exchange Act of 1934 based on allegations that this omission
constituted a deceit on investors. Similar complaints were filed in the same
Court against hundreds of other public companies ("Issuers") that conducted IPOs
of their common stock in the late 1990s (the "IPO Lawsuits"). In October 2002,
the Court entered an order dismissing our named officers and directors from the
IPO Lawsuits without prejudice. In February 2003, the Court issued a decision
denying the motion to dismiss the Section 10(b) claim against us, but granting
the motion to dismiss the Section 11 claim without leave to amend. In June 2003,
Issuers and Plaintiffs reached a tentative settlement agreement that would,
among other things, result in the dismissal with prejudice of all claims against
the Issuers and their officers and directors in the IPO Lawsuits. In addition,
the tentative settlement guarantees that, in the event that the Plaintiffs
recover less than $1 billion in settlement or judgment against the Underwriter
defendants in the IPO Lawsuits, the Plaintiffs will be entitled to recover the
difference between the actual recovery and $1 billion from the insurers for the
Issuers. Although our Board has approved this settlement proposal in principle,
it remains subject to a number of procedural conditions, as well as formal
approval by the Court. If the settlement does not occur, and litigation against
us continues, we believe we have meritorious defenses and intend to defend the
case vigorously. Securities class action litigation could result in substantial
costs and divert our management's attention and resources. Although no assurance
can be given that this matter will be resolved in our favor, we believe that the
resolution of this lawsuit will not have a material adverse effect on our
financial position, results of operations or cash flows.
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. Substantially similar complaints have been filed against
other companies in the e-learning industry, including Skillsoft Corporation,
Saba Software, Inc. and Docent, Inc. The complaint, amended in November 2002,
alleges infringement of five patents and seeks damages and injunctive relief. We
have filed an answer to the amended complaint asserting a number of affirmative
defenses. In addition, we have filed counterclaims against IP Learn seeking
declaratory relief that we do not infringe the patents-in-suit and that each of
the patents-in-suit are invalid.
In May 2002, a complaint was filed in the United States District Court for the
Southern District of Texas, Houston Division by IP Innovation LLC against
Thomson Learning, Inc., Skillsoft Corporation, eCollege.com, DigitalThink, Inc.,
Docent, Inc., Blackboard, Inc., Global Knowledge Network, Inc. and The Princeton
Review. The complaint, amended in November 2002, alleges infringement of one of
the plaintiff's patents, and seeks damages and injunctive relief. We have filed
an answer to the complaint asserting a number of affirmative defenses. In
addition, we have filed counterclaims against IP Innovation seeking declaratory
relief that we do not infringe the patents-in-suit and that each of the
patents-in-suit are invalid.
We believe the IP Learn and IP Innovation lawsuits are without merit and intend
to defend against them vigorously. Although no assurances can be given that
these matters will be resolved in the Company's favor, the Company believes the
resolution of these lawsuits will not have a material adverse effect on its
financial position, results of operations, or cash flows.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER MATTERS
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
31.1 Certification by Chief Executive Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification by Chief Financial Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
32.1 Certification by Chief Executive Officer pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
32.2 Certification by Chief Financial Officer pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K:
We filed a Current Report on Form 8-K dated April 16, 2003 to report
the completion of our acquisition of Horn Interactive, Inc.
We filed a Current Report on Form 8-K dated April 18, 2003 to furnish a
press release dated April 18, 2003 in which we announced our financial
results for the fourth quarter ended March 31, 2003 and for the fiscal
year ended March 31, 2003.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
DIGITALTHINK, INC.
(Registrant)
Date: August 8, 2003 /s/ MICHAEL W. POPE
------------------------------------
Michael W. Pope
Chief Executive Officer, President and Director
(Principal Executive Officer)
Date: August 8, 2003 /s/ ROBERT J. KROLIK
------------------------------------
Robert J. Krolik
Chief Financial Officer
(Principal Financial and Accounting Officer)