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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 September 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 November 12, 2003, the Registrant had outstanding 49,161,052 shares of
Common Stock, $0.001 par value.
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FORM 10-Q
For the Quarter Ended September 30, 2003
TABLE OF CONTENTS
Page
----
PART I: FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited):
Consolidated Balance Sheets as of September 30, 2003 and
March 31, 2003 3
Consolidated Statements of Operations for the three and
six months ended September 30, 2003 and 2002 4
Consolidated Statements of Cash Flows for the three and
six months ended September 30, 2003 and 2002 5
Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 14
Item 3. Quantitative and Qualitative Disclosures About Market Risk 31
Item 4. Controls and Procedures 31
PART II: OTHER INFORMATION
Item 1. Legal Proceedings 32
Item 2. Changes in Securities and Use of Proceeds 33
Item 3. Defaults Upon Senior Securities 33
Item 4. Submission of Matters to a Vote of Security Holders 33
Item 5. Other Information 34
Item 6. Exhibits and Reports on Form 8-K 34
SIGNATURES 35
PART I: FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
September 30, March 31,
2003 2003
----------- -----------
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents...........................$ 27,401 $ 22,668
Accounts receivable, net of allowance for doubtful
accounts of $282 and $296, respectively........... 9,302 6,344
Prepaid expenses and other current assets........... 2,460 2,302
----------- -----------
Total current assets........................... 39,163 31,314
Restricted cash and deposits........................ 3,710 4,041
Property and equipment, net......................... 13,578 14,510
Goodwill and other intangible assets................ 24,704 23,747
----------- -----------
Total assets...................................$ 81,155 $ 73,612
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable....................................$ 2,594 $ 2,213
Accrued liabilities................................. 6,253 4,140
Borrowings under line of credit and
capital lease obligations......................... 8,527 5,266
Deferred revenues................................... 4,106 6,343
----------- -----------
Total current liabilities...................... 21,480 17,962
Long-term restructuring liability and
capital lease obligations......................... 9,010 5,892
Stockholders' equity:
Common stock-- $0.001 par value per share;
250,000 shares authorized; issued and
outstanding 48,716 at September 30, 2003
and 41,619 at March 31, 2003...................... 284,147 268,718
Deferred stock compensation......................... (112) (224)
Accumulated other comprehensive loss................ (279) (298)
Accumulated deficit................................. (233,091) (218,438)
----------- -----------
Total stockholders' equity..................... 50,665 49,758
----------- -----------
Total liabilities and stockholders' equity.....$ 81,155 $ 73,612
=========== ===========
See accompanying notes to consolidated financial statements.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
Three Months Ended Six Months Ended
September 30, September 30,
-------------------- --------------------
2003 2002 2003 2002
--------- --------- --------- ---------
Revenues:
Delivered Learning fees..............$ 5,774 $ 5,867 $ 11,397 $ 10,861
Learning Solution services........... 5,241 4,156 11,476 8,767
--------- --------- --------- ---------
Total revenues.................... 11,015 10,023 22,873 19,628
Costs and expenses:
Cost of Delivered Learning fees...... 1,014 1,220 2,049 2,615
Cost of Learning Solution services... 2,674 1,381 5,436 3,076
Content research and development..... 1,354 1,382 2,650 2,868
Technology research and development.. 1,713 1,647 3,529 3,600
Selling and marketing................ 3,723 3,463 7,353 6,913
General and administrative........... 2,511 1,680 4,314 3,847
Depreciation......................... 1,430 1,829 2,965 3,524
Amortization of intangibles
and warrants....................... 388 360 759 719
Amortization of stock-based
compensation*...................... 56 123 112 263
Settlement of patent litigation...... 1,450 - 1,450 -
Loss from write-down of intangibles.. 3,507 - 3,507 -
Restructuring charge................. 3,473 - 3,437 -
--------- --------- --------- ---------
Total costs and expenses.......... 23,293 13,085 37,561 27,425
--------- --------- --------- ---------
Loss from operations.................. (12,278) (3,062) (14,688) (7,797)
Interest and other income............. 13 69 35 164
--------- --------- --------- ---------
Net loss before cumulative effect of
accounting change.................. (12,265) (2,993) (14,653) (7,633)
Cumulative effect of accounting change - - - (50,189)
--------- --------- --------- ---------
Net loss..............................$(12,265) $ (2,993) $(14,653) $(57,822)
========= ========= ========= =========
Net loss per share--basic and diluted:
Before cumulative effect of
accounting change..................$ (0.27) $ (0.07) $ (0.33) $ (0.19)
Cumulative effect of accounting change - - - (1.22)
--------- --------- --------- ---------
Net loss per share--basic and diluted.$ (0.27) $ (0.07) $ (0.33) $ (1.41)
========= ========= ========= =========
Shares used in computing basic
and diluted loss per share......... 45,348 41,083 44,498 40,944
========= ========= ========= =========
(*)Stock-based compensation:
Cost of Delivered Learning fees....$ 1 $ 1 $ 2 $ 2
Cost of Learning Solution services. 5 12 10 26
Content research and development... 1 1 2 2
Technology research and development 14 31 28 66
Selling and marketing.............. 18 39 36 84
General and administrative......... 17 39 34 83
--------- --------- --------- ---------
Total..................$ 56 $ 123 $ 112 $ 263
========= ========= ========= =========
See accompanying notes to consolidated financial statements.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
Six Months Ended
September 30,
---------------------------
2003 2002
----------- -----------
Cash flows from operating activities:
Net loss............................................$ (14,653) $ (57,822)
Adjustments to reconcile net loss to net cash
used in operating activities:
Cumulative effect of accounting change............ - 50,189
Provision for doubtful accounts................... (35) 138
Depreciation...................................... 2,965 3,524
(Gain)loss on disposal of property and equipment.. (3) 64
Amortization of intangibles and warrants.......... 759 719
Amortization of stock-based compensation.......... 112 263
Settlement of patent litigation................... 1,450 -
Loss from write-down of intangibles............... 3,507 -
Restructuring charge.............................. 3,437 -
Changes in assets and liabilities:
Accounts receivable............................. (2,659) 937
Prepaid expenses and other current assets....... (89) (657)
Accounts payable................................ 268 (217)
Accrued liabilities............................. 27 (3,905)
Deferred revenues............................... (2,715) (2,120)
----------- -----------
Net cash used in operating activities......... (7,629) (8,887)
----------- -----------
Cash flows from investing activities:
Restricted cash (increase)/decrease................. 331 (58)
Purchases of property and equipment................. (1,988) (2,277)
Proceeds from sales of property and equipment....... 4 54
Cash received in acquisition, net of acquisition costs 188 -
Proceeds from maturities of marketable securities... - 1,640
----------- -----------
Net cash used in investing activities......... (1,465) (641)
----------- -----------
Cash flows from financing activities:
Proceeds from issuance of notes payable............. 16,192 10,200
Repayments of notes payable......................... (12,844) (7,554)
Proceeds from sale of common stock.................. 10,460 457
----------- -----------
Net cash provided by financing activities..... 13,808 3,103
----------- -----------
Effect of exchange rate changes on cash and
cash equivalents.................................... 19 (36)
Net increase (decrease) in cash and cash equivalents. 4,733 (6,461)
Cash and cash equivalents, beginning of period....... 22,668 29,470
----------- -----------
Cash and cash equivalents, end of period.............$ 27,401 $ 23,009
=========== ===========
Supplemental disclosure of noncash investing and
financing activities:
Issuance of common stock for acquisitions...........$ 4,960 $ -
Cash paid for interest..............................$ 28 $ 40
See accompanying notes to consolidated financial statements.
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 did not have a material effect on
the Company's financial position or operating results.
In January 2003, the Financial Accounting Standards Board ("FASB") issued
Interpretation No. 46 ("FIN 46"), Consolidation of Variable Interest Entities.
FIN 46 requires an investor with a majority of the variable interests in a
variable interest entity to consolidate the entity and also requires majority
and significant variable interest investors to provide certain disclosures. A
variable interest entity is an entity in which the equity investors do not have
a controlling interest or the equity investment at risk is insufficient to
finance the entity's activities without receiving additional subordinated
financial support from the other parties. FIN 46 was effective for variable
interest entities created after January 31, 2003. As the Company has not created
or obtained any variable interest entities, the provisions of FIN 46 are not
expected to have an effect on the Company's consolidated financial statements.
In April 2003, the FASB issued Statement of Financial Accounting Standards
("SFAS") No. 149, Amendment of Statement 133 on Derivative Instruments and
Hedging Activities. SFAS No. 149 amends and clarifies accounting for derivative
instruments, including certain derivative instruments embedded in other
contracts and for hedging activities under SFAS No. 133, Accounting for
Derivative Instruments and Hedging Activities. SFAS No. 149 is generally
effective for derivative instruments, including derivative instruments embedded
in certain contracts, entered into or modified after June 30, 2003 and for
hedging relationships designated after June 30, 2003. The adoption of SFAS No.
149 did not have a material impact on the Company's financial position or
results of operations.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - (Continued)
2. Recent Accounting Pronouncements - (Continued)
In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity. SFAS No. 150
changes the accounting for certain financial instruments that, under previous
guidance, issuers could account for as equity and requires that those
instruments be classified as liabilities (or assets in certain circumstances) in
statements of financial position. SFAS No. 150 also requires disclosures about
alternative ways of settling the instruments and the capital structure of
entities all of whose shares are mandatorily redeemable. SFAS No. 150 is
generally effective for all financial instruments entered into or modified after
May 31, 2003, and otherwise is effective at the beginning of the first interim
period beginning after June 15, 2003. The adoption of SFAS No. 150 did not have
a material impact on the Company's financial position or results of operations.
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 Accounting Principles Board ("APB") No. 25, Accounting for
Stock Issued to Employees, 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 SFAS
No. 123, Accounting for Stock-Based Compensation, and SFAS No. 148, Accounting
for Stock-Based Compensation - Transition and Disclosure, 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 Six Months Ended
September 30, September 30,
2003 2002 2003 2002
--------- --------- --------- ---------
Net loss (in thousands):
As reported $(12,265) $ (2,993) $(14,653) $(57,822)
Add: Stock based employee
compensation included
in reported net loss 56 123 112 263
Deduct: Total stock based employee
compensation expense
determined under fair value
based method for awards (773) (2,180) (1,410) (4,048)
--------- --------- --------- ---------
Pro forma $(12,982) $ (5,050) $(15,951) $(61,607)
========= ========= ========= =========
Basic and diluted net loss per share:
As reported $ (0.27) $ (0.07) $ (0.33) $ (1.41)
Pro forma $ (0.29) $ (0.12) $ (0.36) $ (1.50)
The Company calculated the value of stock-based awards on the date of grant
using the Black-Scholes multiple option valuation approach. The following table
illustrates the weighted average assumptions used in the calculations:
Three Months Ended Six Months Ended
September 30, September 30,
2003 2002 2003 2002
--------- --------- --------- ---------
Risk-free interest rates 1.88% 1.72% 1.70% 2.22%
Expected dividend yield -- -- -- --
Expected life after vesting (in years) 1.50 1.50 1.50 1.50
Expected volatility 75% 115% 80% 119%
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - (Continued)
4. Net Loss Per Share
The following table sets forth the computation of net loss per share:
Three Months Ended Six Months Ended
September 30, September 30,
2003 2002 2003 2002
--------- --------- --------- ---------
Net loss (in thousands):
Net loss before cumulative effect of
accounting change $(12,265) $ (2,993) $(14,653) $ (7,633)
Cumulative effect of accounting change - - - (50,189)
--------- --------- --------- ---------
Net loss $(12,265) $ (2,993) $(14,653) $(57,822)
========= ========= ========= =========
Weighted average common shares
outstanding used in computing basic
and diluted loss per share 45,348 41,083 44,498 40,944
========= ========= ========= =========
Net loss per share:
Before cumulative effect of
accounting change $ (0.27) $ (0.07) $ (0.33) $ (0.19)
Cumulative effect of accounting change - - - (1.22)
--------- --------- --------- ---------
Net loss per share--basic and diluted$ (0.27) $ (0.07) $ (0.33) $ (1.41)
========= ========= ========= =========
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.
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.
In accordance with SFAS No. 142, Goodwill and Other Intangibles, goodwill will
be subject to periodic impairment assessment and will not be amortized. 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 table summarizes 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.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - (Continued)
6. Restructuring Charge
During the quarter ended September 30, 2003, the Company recorded a
restructuring charge of $3.5 million, in accordance with the provisions of SFAS
No. 146, Accounting for Costs Associated with Exit or Disposal Activities.
Accordingly, costs associated with the exit activities were measured and
recorded at fair value when the liability was incurred. The following is a
discussion of the components of this charge.
2002 Restructuring
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 its continuing program to create efficiencies within its
operations (the "2002 Restructuring"). At that time, a restructuring charge was
recorded for, among other things, the costs associated with unutilized lease
facilities vacated in conjunction with the strategic initiative. In order to
estimate the future cost of these lease facilities, certain assumptions were
made at that time concerning the sub-lease income to be realized on the
facilities. During the quarter ended September 30, 2003, the Company reviewed
and revised certain of these assumptions with respect to amounts and timing of
expected cash flows to better reflect the current real estate environment. As a
result, an additional restructuring charge of $3.0 million was recorded during
the quarter ended September 30, 2003. The remaining amounts accrued under the
2002 Restructuring (net of anticipated sub-lease proceeds) will be paid over the
respective lease terms through 2016.
2003 Restructuring
During the quarter ended September 30, 2003, the Company continued to evaluate
the market environment, along with the Company's organizational structure and
its expectations regarding future revenue levels. Based on this evaluation, the
Company determined that it would initiate a further restructuring of its U.S and
India operating structure (the "2003 Restructuring"). This restructuring plan
included the closure of one India facility and a reduction of the U.S. workforce
associated with certain research and development activities. The total charge
recorded for the 2003 Restructuring was $512,000, which included the following:
o Employee Termination Costs - The Company reduced its workforce by 56
employees - 38 employees as a result of the India facility closure and 18
employees as a result of a shift in U.S. research and development
activities. These reductions resulted in severance charges of $268,000.
Most of the severance charges were paid during the quarter ended September
30, 2003 except $53,000 of which that will be paid during the quarter
ending December 31, 2003.
o Facility-Related Costs - Despite the closure of the India facility, the
Company will continue to incur certain costs associated with the lease and
maintenance of the vacated premises until such time as the associated
contracts may be legally terminated. As these continuing obligations have
no future value to the organization, the Company recorded a charge of
$84,000 for the excess of the cost of the remaining obligations over their
estimated market value. All of this amount will be paid during the quarter
ending December 31, 2003.
o Asset Disposal Costs - In conjunction with the closure of the India
facility, the Company will dispose of, or remove from operations, certain
equipment and leasehold improvements located in the facility. As a result,
the Company recorded a restructuring charge of $160,000 representing the
write-down of the excess of the cost of the assets to their estimated net
realizable values. The asset disposals should be completed during the
quarter ending December 31, 2003.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - (Continued)
6. Restructuring Charge - (Continued)
The following table sets forth the activity related to the restructuring charge
during the three months ended September 30, 2003 (in thousands):
Total
Employee Facility- Asset Restruc-
Termination Related Disposal turing
Costs Costs Costs Costs
--------- --------- --------- ---------
Restructuring liability at 6/30/03 - $ 5,236 - $ 5,236
Add: 2002 restructuring charge increase - 2,961 - 2,961
Add: 2003 restructuring charge $ 268 84 $ 160 512
--------- --------- --------- ---------
Total restructuring charge 268 3,045 160 3,473
Less:Cash payments (215) (276) - (491)
--------- --------- --------- ---------
Restructuring liability at 9/30/03 $ 53 $ 8,005 $ 160 $ 8,218
========= ========= ========= =========
Restructuring liability, short-term $ 53 $ 1,391 $ 160 $ 1,604
Restructuring liability, long-term - 6,614 - 6,614
--------- --------- --------- ---------
Total restructuring liability
at 9/30/03 $ 53 $ 8,005 $ 160 $ 8,218
========= ========= ========= =========
At September 30, 2003, restructuring charge obligations were recorded as $1.6
million in accrued liabilities and $6.6 million in long-term restructuring
liability and capital lease obligations on the Consolidated Balance Sheets.
7. Goodwill and Intangibles
Effective April 1, 2002, the Company adopted SFAS No. 141, Business
Combinations. SFAS No. 141 requires that the purchase method of accounting be
used for all combinations initiated after June 30, 2001. The adoption of SFAS
No. 141 did not have an impact on the results of operations, financial position
or liquidity of the Company.
Effective April 1, 2002, the Company adopted SFAS No. 142, Goodwill and Other
Intangible Assets. SFAS No. 142 addresses the initial recognition and
measurement of intangible assets acquired outside of a business combination and
the accounting for goodwill and other intangible assets subsequent to their
acquisition. SFAS No. 142 provides that intangible assets with finite useful
lives will 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
quarter ended 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 quarter 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
September 30, 2003, no events or circumstances occurred that would necessitate
the interim testing of goodwill impairment.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - (Continued)
7. Goodwill and Intangibles - (Continued)
At September 30, 2003, the Company determined that the technology acquired
through the August 28, 2001 LearningByte International, Inc. ("LBI") acquisition
was no longer utilized in Company operations as a result of the release of the
L5 Desktop Client in July 2003. As such, it was established that the remaining
cost of the associated intangible asset was not recoverable and that no residual
value or sales value existed for the asset. Accordingly, the Company recognized
an impairment loss of $3.5 million at September 30, 2003, representing the
write-down of the LBI intangible to zero.
The gross carrying amount and accumulated amortization of the Company's
intangible assets other than goodwill as of September 30, 2003 and March 31,
2003 are as follows (in thousands):
September 30, 2003 March 31, 2003
--------------------------- --------------------------
Gross Net Gross Net
Carrying Accumulated Book Carrying Accumulated Book
Amount Amortization Value Amount Amortization Value
------ ------------ ------- ------ ------------ ------
Amortized Intangible Assets:
LBI acquired
technology - - - $6,100 $(1,982) $4,118
Horn acquired
technology $ 464 $ (42) $ 422 - - -
Horn customer
contracts 857 (98) 759 - - -
------ ------------ ------- ------ ------------ ------
Total $1,321 $ (140) $1,181 $6,100 $(1,982) $4,118
====== ============ ======= ====== ============ ======
Amortization expense recorded on the intangible assets for the three and six
months ended September 30, 2003 was $384,000 and $751,000, respectively. For the
three and six months ended September 30, 2002, the amortization expense recorded
was $359,000 and $718,000 respectively. The estimated future amortization
expense by fiscal year is as follows: six months ended March 31, 2004 is
$154,000; 2005-2007 is $307,000 per year; 2008 is $102,000 and 2009 is $4,000.
8. Contingencies
Legal Proceedings
In October 2001, the Company and certain of its 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 the Company, certain of its officers and directors,
and the underwriters of the Company's initial public offering ("IPO") violated
Section 11 of the Securities Act of 1933 based on allegations that the
registration statement and prospectus pertaining to the IPO 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 the Company's officers and directors named in the lawsuit 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 the Company, but
granting the motion to dismiss the Section 11 claim without leave to amend. In
June 2003, Issuers and the 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 the Company's board of directors has approved
this settlement proposal in principle, the actual settlement 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 the Company continues, the
Company believes it has meritorious defenses and intends to defend the case
vigorously. Securities class action litigation could result in substantial costs
and divert management's attention and resources. Although no assurance can be
given that this matter will be resolved in the Company's favor, the Company
believes that the resolution of the IPO Lawsuits will not have a material
adverse effect on its financial position, results of operations or cash flows.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - (Continued)
8. Contingencies - (Continued)
In August 2002, a complaint was filed in the United States District Court
for the Northern District of California by IP Learn, LLC against the Company and
two of its customers. Substantially similar complaints were filed against other
companies in the e-learning industry, including Skillsoft Corporation, Saba
Software, Inc. and Docent, Inc. The complaint, amended in November 2002, alleged
infringement of five patents and sought damages and injunctive relief. The
Company filed an answer to the amended complaint asserting a number of
affirmative defenses. In addition, the Company filed counterclaims against IP
Learn seeking declaratory relief that the Company did not infringe the
patents-in-suit and that each of the patents-in-suit was invalid. In early
November 2003, the Company reached a tentative settlement with IP Learn to
license IP Learn's technology and to settle the patent litigation. Under the
terms of the tentative settlement, IP Learn would agree to release all claims
covered by the lawsuit. In addition, IP Learn would grant the Company
irrevocable licenses for the patents covered by the lawsuit. In exchange, the
Company would agree to pay approximately $1.5 million to IP Learn in the form of
approximately half in cash and half in stock and to release all counterclaims
covered by the lawsuit. IP Learn and the Company would agree that the amicable
resolution of this litigation would not constitute an admission or concession of
liability or fault by either party. While this tentative settlement agreement
was reached after September 30, 2003, the litigation that gave rise to the
tentative settlement agreement existed at the balance sheet date of September
30, 2003. Accordingly, the Company recognized expenses of $1.6 million during
the quarter ended September 30, 2003 representing the tentative settlement
amount of approximately $1.5 million and legal fees of approximately $0.1
million.
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, the Company,
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. The Company
has filed an answer to the complaint asserting a number of affirmative defenses.
In addition, the Company has filed counterclaims against IP Innovation seeking
declaratory relief that it does not infringe the patents-in-suit and that each
of the patents-in-suit is invalid. We believe the IP Innovation lawsuit is
without merit and intend to defend against it vigorously. Although no assurance
can be given that this matter will be resolved in the Company's favor, the
Company believes the resolution of this lawsuit will not have a material adverse
effect on its financial position, results of operations, or cash flows.
9. Private Placement
On September 8, 2003, the Company issued 4,166,667 shares of its common stock
and warrants to purchase 1,458,333 shares of its common stock, resulting in
$10,000,000 of gross proceeds to the Company. Under the terms of the private
placement, the Company sold the shares of common stock for a price of $2.40 per
share plus a warrant to purchase 0.35 of a share of common stock. The warrants
bear an exercise price of $3.45 per share. The exercise price and the number of
shares to be issued upon exercise of the warrants are subject to future
adjustments in the event of certain issuances of the Company's equity securities
for a common-equivalent per share price of less than the exercise price, with
certain exclusions. The terms of the private placement also provide for an
additional issuance of up to 2,083,334 shares of common stock and warrants to
purchase up to 729,167 shares of common stock under the same terms and
conditions as the original issuance. The investors in the original issuance have
up to 120 days from the effective date of the registration statement to elect to
purchase the additional shares. The Company incurred approximately $500,000 in
issuance costs related to this private placement, which was accounted for as a
reduction to the proceeds from the offering.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - (Continued)
10.Credit Facility
On December 20, 2001, the Company entered into a Loan and Security Agreement
("Loan Agreement") with a financial institution to borrow up to $8.0 million
under a one-year, revolving line of credit. On December 19, 2002, this Loan
Agreement was amended to extend the term to December 18, 2003. As collateral
under the Loan Agreement, the Company granted a security interest in all of the
Company's assets, excluding intellectual property. Under the provisions of the
Loan Agreement, certain covenants must be met in order to remain in compliance
with the lending arrangement.
On September 30, 2003, the Company borrowed $8.0 million under this line of
credit. This entire loan balance was subsequently repaid on October 1, 2003. At
September 30, 2003, one of the financial covenants specified in the Loan
Agreement was not met. To address this violation, in October 2003, the Company
obtained an amendment to the Loan Agreement, effective September 30, 2003, that
adjusted the financial covenant in order to bring the Company into compliance.
As the Company obtained the qualified amendment, no default provisions were
triggered and the Company remains eligible to borrow under the credit facility.
11.Subsequent Event
In early November 2003, the Company reached a tentative settlement with IP
Learn to license IP Learn's technology and to settle the patent litigation as
discussed in "Note 8 - Contingencies". While this tentative settlement agreement
was reached after September 30, 2003, the litigation that gave rise to the
tentative settlement agreement existed at the balance sheet date of September
30, 2003. Accordingly, the Company recognized expenses of $1.6 million during
the quarter ended September 30, 2003 representing the tentative settlement
amount of approximately $1.5 million and legal fees of approximately $0.1
million.
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
DigitalThink, Inc. provides custom e-learning solutions designed to address the
strategic business objectives of our customers through training courseware and
the delivery of that courseware on a robust technology platform. 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.
We generate revenues by delivering courses included in our course catalog as
well as delivering our customized e-learning courses to participants. We refer
to these services as "Delivered Learning". 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, or "Learning Solution" services. 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 service revenues, 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 well as
due to the challenging sales environment. As of September 30, 2003, we had an
accumulated deficit of $233.1 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 the fiscal
year ended March 31, 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 $10.0 million in the three months ended September 30,
2002 to $11.0 million in the three months ended September 30, 2003. Revenues
increased in the quarter ended September 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, Inc. 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 September 30, 2003, Delivered Learning fees represented 52% of
revenues and Learning Solution services represented 48% of revenues. This is
compared to the three months ended September 30, 2002, during which Delivered
Learning fees represented 59% of revenues and Learning Solution services
represented 41% of revenues. This shift represents our continued focus on custom
development services as a core element of our product offering.
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. In accordance
with SFAS No. 142, Goodwill and Other Intangibles, goodwill will be subject to
periodic impairment assessment and will not be amortized.
RESULTS OF OPERATIONS - THREE AND SIX MONTHS ENDED SEPTEMBER 30, 2003 AND 2002
REVENUES
Delivered Learning Fees
Delivered Learning fees decreased to $5.8 million in the three months ended
September 30, 2003 from $5.9 million in the three months ended September 30,
2002. The total number of customers increased from 492 at September 30, 2002 to
566 at September 30, 2003. The total number of courses developed increased from
925 to 1,192 for the same periods. Delivered Learning fees from recurring new
and recurring contracts increased in the three months ended September 30, 2003
as compared to the same period last year due to a larger customer base with an
increasing shift toward renewal revenues. This increase was offset by the fact
that two revenue contracts expired during the three months ended September 30,
2002 with a deferred revenue balance of approximately $350,000. Upon
termination, the remaining deferred revenue balance was recognized into revenue.
No such terminations occurred during the quarter ended September 30, 2003.
For the six months ended September 30, 2003, Delivered Learning fees increased
to $11.4 million from $10.9 million for the six months ended September 30, 2002.
Revenue increased in the six months ended September 30, 2003 as compared to the
same period last year due to a larger customer base with an increasing shift
toward renewal revenues, offset in part by the decrease in revenue from the six
months ended September 30, 2002 due to the one-time termination of revenue
contracts during that period as discussed above. 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. While
increases in the number of courses and customers may drive revenue growth, the
average order size and ability to continue to derive revenue from existing
customers will also determine our ability to grow revenues.
Learning Solution Services
Learning Solution services revenues increased to $5.2 million for the three
months ended September 30, 2003 from $4.2 million for the three months ended
September 30, 2002. Learning Solution services revenues increased 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.
For the six months ended September 30, 2003, Learning Solution services revenues
increased to $11.5 million from $8.8 million for the six months ended September
30, 2002. Revenues increased during this period due to the same factors
discussed above. The significant new customer contract was added in late fiscal
year 2003, and we added Horn contracts that were assumed as part of the April
2003 acquisition. As we recognize revenue for Learning Solutions services based
upon the percentage completion of each revenue contract, we expect Learning
Solutions services revenues to be relative to the progress made in completing
our custom development projects.
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 to $1.0 million for the three months ended September 30, 2003 from
$1.2 million for the three months ended September 30, 2002. This decrease is
attributable to the fact that we completed the shift of tutor support services
from the United States to our lower cost India operation. Additionally, we
reduced Delivered Learning headcount by 8% from September 30, 2002.
For the six months ended September 30, 2003, cost of Delivered Learning fees
decreased to $2.0 million from $2.6 million for the six months ended September
30, 2002. This decrease was a result of the shift in tutor support services and
the headcount reductions discussed above. We expect the cost of Delivered
Learning fees as a proportion of the revenues derived from Delivered Learning to
remain relatively constant.
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 to $2.7 million for the three months
ended September 30, 2003 from $1.4 million for the three months ended September
30, 2002. This increase was primarily attributable to an increase in direct
contractor costs associated with a significant new customer contract for which
the associated revenues were also recognized. Additionally, net Learning
Solutions services headcount increased by 17% from September 30, 2002 to
September 30, 2003, including the addition of personnel as a result of the Horn
acquisition.
For the six months ended September 30, 2003, cost of Learning Solution services
increased to $5.4 million from $3.1 million for the six months ended September
30, 2002. Costs increased during this period due to the same factors discussed
above. The significant new customer contract was added in late fiscal year 2003,
resulting in a corresponding increase in direct contractor costs. Additionally,
the acquisition of Horn in April 2003 resulted in an increase in
personnel-related expenses from the corresponding period last year. We expect
the cost of Learning Solutions services as a proportion of the revenues derived
from Learning Solutions service to remain relatively constant.
Content Research and Development
Content research and development expenses are expensed as incurred in accordance
with SFAS No. 86, Accounting for the Costs of Computer Software to be Sold,
Leased, or Otherwise Marketed, and represent costs to develop catalog courses,
including personnel-related costs, content acquisition costs and content
editing. Content research and development expenses remained flat at $1.4 million
for both the three months ended September 30, 2003 and 2002. Headcount in
content research and development remained unchanged from September 30, 2002 to
September 30, 2003.
For the six months ended September 30, 2003, content research and development
expenses decreased slightly to $2.7 million from $2.9 million for the six months
ended September 30, 2002. This decrease is mainly due to the shifting of higher
cost headcount in the
United States to lower cost headcount in India. We expect content research and
development costs to decrease as we shift our resources toward custom
development services.
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 increased
slightly to $1.7 million in the three months ended September 30, 2003 from $1.6
million in the three months ended September 30, 2002. Headcount in technology
research and development decreased by 15% from September 30, 2002 to September
30, 2003, primarily recognized in our lower cost India-based workforce. The
expense savings from these headcount reductions was offset by the temporary
shift of personnel expenses in the Learning Solution services organization to
technology research and development projects as a result of excess capacity in
the Learning Solutions organization.
For the six months ended September 30, 2003, technology research and development
expenses decreased slightly to $3.5 million from $3.6 million for the six months
ended September 30, 2002. This decrease was primarily attributable to the
overall decrease in headcount expenses as a result of the 15% reduction in
headcount, mostly recognized in our India-based workforce, from September 30,
2002 to September 30, 2003. In general, we expect technology research and
development expenses 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 to $3.7 million in the three months ended September 30, 2003 from $3.5
million in the three months ended September 30, 2002. This increase was
primarily due to a more than 10% increase in headcount from September 30, 2002
to September 30, 2003, offset by a decrease in royalty expense as a result of
our continued shift toward custom courseware development over the catalog
offering.
For the six months ended September 30, 2003, selling and marketing expenses
increased to $7.4 million from $6.9 million for the six months ended September
30, 2002. This increase was attributable to the 10% increase in headcount,
partially offset by decreased royalty expenses discussed above. We expect
selling and marketing expenses to increase to the extent that commission expense
fluctuates with revenues.
General and Administrative
General and administrative expenses consist primarily of personnel-related
costs, occupancy costs, insurance-related costs, professional services fees, and
business taxes. General and administrative expenses increased to $2.5 million in
the three months ended September 30, 2003 from $1.7 million in the three months
ended September 30, 2002. This increase was due to higher legal fees as a result
of continued litigation activities, an increase in local business taxes due to
the elimination of previously available tax credits and an increase in insurance
expenses. These increases were partially offset by lower occupancy costs and
lower personnel costs as a result of a 10% reduction in headcount.
For the six months ended September 30, 2003, general and administrative expenses
increased to $4.3 million from $3.8 million for the six months ended September
30, 2002. This increase was due to the increases in legal fees, business taxes,
and insurance costs discussed above, partially offset by lower occupancy costs
and lower personnel costs as a result of the 10% reduction in headcount,
primarily realized in our India-based workforce. We expect general and
administrative expenses to remain relatively flat.
Amortization of Intangibles and Warrants
Amortization of Intangibles and Warrants expense consists of the amortization of
intangible assets acquired through the LBI and Horn acquisitions and
amortization of warrants issued in connection with the restructuring of the
corporate headquarters facility lease. Amortization of intangibles and warrants
increased to $388,000 in the three months ended September 30, 2003 from $360,000
in the three months ended September 30, 2002. For the six months ended September
30, 2003, amortization of intangibles and warrants increased to $759,000 from
$719,000 for the six months ended September 30, 2002. The increases for both
periods were due to an increase in intangible assets as a result of the Horn
acquisition completed in April 2003. As result of the write down of the
remaining LBI intangible asset at September 30, 2003 (discussed below), we
expect amortization of intangibles and warrants expense to decrease by
approximately $300,000 on a quarterly basis to $77,000 per quarter.
Amortization of Stock-Based Compensation
Amortization of stock-based compensation decreased to $56,000 in the three
months ended September 30, 2003 from $123,000 in the three months ended
September 30, 2002. For the six months ended September 30, 2003, amortization of
stock-based compensation decreased to $112,000 from $263,000 for the six months
ended September 30, 2002. We expect amortization of stock-based compensation to
remain flat for the remainder of fiscal 2004 as the remaining balance of
deferred compensation is amortized.
Settlement of Patent Litigation
In August 2002, a complaint was filed against us by IP Learn, LLC. The complaint
alleged infringement of five patents and sought damages and injunctive relief.
We filed an answer to the complaint asserting a number of affirmative defenses.
In addition, we filed counterclaims against IP Learn seeking declaratory relief
that we did not infringe the patents-in-suit and that each of the
patents-in-suit was invalid. In early November 2003, we reached a tentative
settlement with IP Learn to license IP Learn's technology and to settle the
patent litigation. Under the terms of the tentative settlement, IP Learn would
agree to release all claims covered by the lawsuit. In addition, IP Learn would
grant to us irrevocable licenses for the patents covered by the lawsuit. In
exchange, we would agree to pay $1.45 million to IP Learn in the form of
approximately half in cash and half in stock and to release all counterclaims
covered by the lawsuit. While this tentative settlement occurred after September
30, 2003, the litigation that gave rise to the tentative settlement existed at
the balance sheet date of September 30, 2003. Accordingly, we recognized an
expense of $1.45 million during the quarter ended September 30, 2003 for the
tentative settlement amount. No such tentative settlement occurred during the
three and six months ended September 30, 2002.
Loss From Write-Down of Intangibles
At September 30, 2003, we determined that the technology acquired through the
August 28, 2001 LBI acquisition was no longer utilized in our operations. As
such, it was established that the remaining cost of the associated intangible
asset was not recoverable and that no residual value or sales value existed for
the asset. Accordingly, we recognized an impairment loss of $3.5 million at
September 30, 2003, representing the write-down of the LearningByte intangible
to zero. No such loss occurred during the three and six months ended September
30, 2002.
Restructuring Charge
During the three and six months ended September 30, 2003, we recorded a
restructuring charge of $3.5 million and $3.4 million, respectively, in
accordance with the provisions of SFAS No. 146. Accordingly, costs associated
with the exit activities were measured and recorded at fair value when the
liability was incurred. The following is a discussion of the components of this
charge.
2002 Restructuring
In March 2002, we initiated a strategic initiative, under which we restructured
our business in response to the current market environment and as part of our
continuing program to create efficiencies within our operations (the "2002
Restructuring"). At that time, a restructuring charge was recorded for, among
other things, the costs associated with unutilized lease facilities vacated in
conjunction with the strategic initiative. In order to estimate the future cost
of these lease facilities, certain assumptions were made at that time concerning
the sub-lease income to be realized on the facilities. During the quarter ended
September 30, 2003, we reviewed and revised certain of these assumptions with
respect to amounts and timing of expected cash flows to better reflect the
current real estate environment. As a result, an additional restructuring charge
of $3.0 million was recorded during the quarter ended September 30, 2003. The
remaining amounts accrued under the 2002 Restructuring (net of anticipated
sub-lease proceeds) will be paid over the respective lease terms through 2016.
2003 Restructuring
During the quarter ended September 30, 2003, we continued to evaluate the market
environment, along with our organizational structure and our expectations
regarding future revenue levels. Based on this evaluation, we determined that we
would initiate a further restructuring of our U.S. and India operating structure
(the "2003 Restructuring"). This restructuring plan included the closure of one
India facility and a reduction of the U.S. workforce associated with certain
research and development activities. The total charge recorded for the 2003
Restructuring was $512,000, which included the following:
o Employee Termination Costs - We reduced our workforce by 56 employees - 38
employees as a result of the India facility closure and 18 employees as a
result of a shift in U.S. research and development activities. These
reductions resulted in severance charges
of $268,000. Most of the severance charges were paid during the quarter
ended September 30, 2003 except $53,000 of which that will be paid
during the quarter ending December 31, 2003.
o Facility-Related Costs - Despite the closure of the India facility, we will
continue to incur certain costs associated with the lease and maintenance
of the vacated premises until such time as the associated contracts may be
legally terminated. As these continuing obligations have no future value to
the organization, we recorded a charge of $84,000 for the excess of the
cost of the remaining obligations over their estimated market value. All of
this amount will be paid during the quarter ending December 31, 2003.
o Asset Disposal Costs - In conjunction with the closure of the India
facility, we will dispose of, or remove from operations, certain equipment
and leasehold improvements located in the facility. As a result, we
recorded a restructuring charge of $160,000 representing the write-down of
the excess of the cost of the assets to their estimated net realizable
values. The asset disposals should be completed during the quarter ending
December 31, 2003.
No such charges were recognized during the three and six months ended September
30, 2002.
Net Loss Before Cumulative Effect of Accounting Change
Net loss before cumulative effect of accounting change increased to $12.3
million in the three months ended September 30, 2003 from $3.0 million in the
three months ended September 30, 2002. For the six months ended September 30,
2003, net loss before cumulative effect of accounting change increased to $14.7
million from $7.6 million for the six months ended September 30, 2002. The net
loss before cumulative effect of accounting change for both the three and six
months ended September 30, 2003 includes $3.5 million in expense related to the
loss from the write-down of intangibles discussed above, $3.4 million in expense
related to the restructuring charge discussed above and $1.45 million in expense
related to the settlement of patent litigation discussed above.
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 will 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 quarter ended 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 quarter 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 September 30, 2003, no events or
circumstances occurred that would necessitate the interim testing of goodwill
impairment.
Net Loss
Net loss increased to $12.3 million in the three months ended September 30, 2003
from $3.0 million in the three months ended September 30, 2003. For the six
months ended September 30, 2003, net loss decreased to $14.7 million from $57.8
million for the six months ended September 30, 2002. The net loss for the six
months ended September 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 $7.6 million for the six months
ended September 30, 2003 and $8.9 million for the six months ended September 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
revenues offset by non-cash expense items including depreciation, amortization
and loss from the write-down of intangibles. The increase in accounts receivable
from $6.3 million at March 31, 2003 to $9.3 million at September 30, 2003 was
due primarily to a change in the billing terms of one of our significant
contracts. Deferred revenues decreased from $6.3 million at March 31, 2003 to
$4.1 million at September 30, 2003. Deferred revenues result from customer
advance billings and prepayments of Delivered Learning fees and Learning
Solution services. In both cases, prepayments remain in deferred revenues until
revenue recognition criteria have been met.
Net cash used in investing activities totaled $1.5 million in the six months
ended September 30, 2003 as compared to $0.6 million for the six months ended
September 30, 2002. The net increase reflects a decrease in proceeds from
maturities of marketable securities during the six months ended September 30,
2003 offset by a decrease in restricted cash requirements.
Cash provided by financing activities totaled $13.8 million in the six months
ended September 30, 2003 and $3.1 million in the six months ended September 30,
2002. The increase in cash from financing activities reflects the private
placement of stock for net proceeds of $9.5 million, an increase in exercises of
stock options and stock purchases in the employee stock purchase program and
increased borrowings on our line of credit.
At both September 30, 2003 and March 31, 2003, we had an $8 million revolving
line of credit in place that expires in December 2003. As collateral for the
line of credit, we have granted a security interest in all of our assets,
excluding intellectual property. Under the provisions of the line of credit,
certain covenants must be met in order to remain in compliance with the lending
arrangement.
On September 30, 2003, we borrowed $8.0 million under this line of credit. This
entire loan balance was subsequently repaid on October 1, 2003. At September 30,
2003, one of the financial covenants specified in the line of credit was not
met. To address this violation, we obtained an amendment to the line of credit
agreement, effective September 30, 2003, that adjusted the financial covenant in
order to bring us into compliance. As we obtained the qualified amendment, no
default provisions were triggered and we remain eligible to borrow under the
credit facility.
On September 8, 2003, we issued 4,166,667 shares of our common stock and
warrants to purchase 1,458,333 shares of our common stock, resulting in
$10,000,000 of gross proceeds to DigitalThink. Under the terms of the private
placement, we sold the shares of common stock for a price of $2.40 per share
plus a warrant to purchase 0.35 of a share of common stock. The warrants bear an
exercise price of $3.45 per share. The exercise price and the number of shares
to be issued upon exercise of the warrants are subject to future adjustments in
the event of certain issuances of our equity securities for a common-equivalent
per share price of less than the exercise price, with certain exclusions. The
terms of the private placement also provide for an additional issuance of up to
2,083,334 shares of common stock and warrants to purchase up to 729,167 shares
of common stock under the same terms and conditions as the original issuance.
The investors in the original issuance have up to 120 days from the effective
date of the registration statement to elect to purchase the additional shares.
We incurred approximately $500,000 in issuance costs related to this private
placement, which was accounted for as a reduction to the proceeds from the
offering.
We believe our existing capital resources will be sufficient to meet our capital
requirements for the next 12 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 during 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 did not have a material effect on
the Company's financial position or operating results.
In January 2003, the Financial Accounting Standards Board ("FASB") issued
Interpretation No. 46 ("FIN 46"), Consolidation of Variable Interest Entities.
FIN 46 requires an investor with a majority of the variable interests in a
variable interest entity to consolidate the entity and also requires majority
and significant variable interest investors to provide certain disclosures. A
variable interest entity is an entity in which the equity investors do not have
a controlling interest or the equity investment at risk is insufficient to
finance the entity's activities without receiving additional subordinated
financial support from the other parties. FIN 46 was effective for variable
interest entities created after January 31, 2003. As the Company has not created
or obtained any variable interest entities, the provisions of FIN 46 are not
expected to have an effect on the Company's consolidated financial statements.
In April 2003, the FASB issued Statement of Financial Accounting Standards
("SFAS") No. 149, Amendment of Statement 133 on Derivative Instruments and
Hedging Activities. SFAS No. 149 amends and clarifies accounting for derivative
instruments, including certain derivative instruments embedded in other
contracts and for hedging activities under SFAS No. 133, Accounting for
Derivative Instruments and Hedging Activities. SFAS No. 149 is generally
effective for derivative instruments, including derivative instruments embedded
in certain contracts, entered into or modified after June 30, 2003 and for
hedging relationships designated after June 30, 2003. The adoption of SFAS No.
149 did not have a material impact on the Company's financial position or
results of operations.
In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity. SFAS No. 150
changes the accounting for certain financial instruments that, under previous
guidance, issuers could account for as equity and requires that those
instruments be classified as liabilities (or assets in certain circumstances) in
statements of financial position. SFAS No. 150 also requires disclosures about
alternative ways of settling the instruments and the capital structure of
entities all of whose shares are mandatorily redeemable. SFAS No. 150 is
generally effective for all financial instruments entered into or modified after
May 31, 2003, and otherwise is effective at the beginning of the first interim
period beginning after June 15, 2003. The adoption of SFAS No. 150 did not have
a material impact on the Company's financial position or results of operations.
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, future expenses, and other future or expected
performance are subject to risks and uncertainties, including those described
below under the heading "Risk Factors" and in the section above entitled
"Management's Discussion and Analysis of Financial Condition and Results of
Operations".
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 $233.1 MILLION AT
SEPTEMBER 30, 2003. WE EXPECT LOSSES OVER AT LEAST 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 September 30, 2003 was $233.1 million. We have never achieved a
profitable quarter and we may continue to incur quarterly losses if our revenue
growth does not meet expectations while our current expense structure remains in
place. If we do achieve profitability, we will need to continue to generate
revenues greater than expenses on a quarterly or annual basis in the future to
continue being profitable. We plan to develop and acquire new course offerings
with new areas of expertise that may increase operating losses if those expenses
are not immediately offset by new revenues.
DEMAND FOR OUR PRODUCTS AND SERVICES HAVE BEEN AND MAY CONTINUE TO BE AFFECTED
BY ADVERSE ECONOMIC CONDITIONS AFFECTING THE INFORMATION TECHNOLOGY INDUSTRY.
The information technology industry has been in a period of economic decline
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 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 second fiscal quarter of 2004, our five largest customers accounted for
68.6% of our total revenues of $11.0 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 the second quarter of fiscal 2004, our largest customer accounted
for 41.2% and another customer accounted for 12.5% of our total revenues of
$11.0 million.
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 September 30, 2003, we had
157 employees in two 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.
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 second quarter of fiscal 2004, we had
revenues of $11.0 million and expenses of $23.3 million. 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, forecast sales or
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 revenues 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 48% of our total revenues for the
three months ended September 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.
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.
IF WE RELEASE UPDATED OR NEW PRODUCTS CONTAINING DEFECTS, WE MAY NEED TO
RECONFIGURE AND RE-RELEASE THOSE PRODUCTS, 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 level of 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 LOSS OF REVENUES.
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 have developed a fully redundant fail-over site to address the high volume of
traffic and course delivery needs required of our site. If our Web site fails
for any reason and the fail-over site does not operate as planned, 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 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 pertaining to the IPO 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 officers and directors
named in the lawsuit 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 the 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 of directors has approved this settlement proposal in principle, the
actual settlement agreement 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 the IPO
Lawsuits 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 were filed against
other companies in the e-learning industry, including Skillsoft Corporation,
Saba Software, Inc. and Docent, Inc. The complaint, amended in November 2002,
alleged infringement of five patents and sought damages and injunctive relief.
We filed an answer to the amended complaint asserting a number of affirmative
defenses. In addition, we filed counterclaims against IP Learn seeking
declaratory relief that we did infringe the patents-in-suit and that each of the
patents-in-suit was invalid. In early November 2003, we reached a tentative
settlement with IP Learn to license IP Learn's technology and to settle the
patent litigation. Under the terms of the tentative settlement, IP Learn would
agree to release all claims covered by the lawsuit. In addition, IP Learn would
grant to us irrevocable licenses for the patents covered by the lawsuit. In
exchange, we would agree to pay approximately $1.5 million to IP Learn in the
form of approximately half in cash and half in stock and to release all
counterclaims covered by the lawsuit. While this tentative settlement agreement
was reached after September 30, 2003, the litigation that gave rise to the
tentative settlement agreement existed at the balance sheet date of September
30, 2003. Accordingly, we recognized expenses of $1.6 million during the quarter
ended September 30, 2003 representing the tentative settlement amount of
approximately $1.5 million and legal fees of approximately $0.1 million.
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 Innovation lawsuit is without
merit and intend to defend against it vigorously. Although no assurance can be
given that this matter will be resolved in the Company's favor, the Company
believes the resolution of this lawsuit 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. 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. 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 stock will need two annual meetings of
stockholders to gain control of the board;
o a provision that prohibits our stockholders from acting by written
consent without a meeting;
o a provision that permits only the board of directors, the
president or the chairman to call special meetings of
stockholders; and
o a provision that requires advance notice of items of business to be
brought before stockholders meetings.
Amending any of the above provisions will require the vote of the holders of 66
2/3% of our outstanding common stock.
ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The following discusses our exposure to market risk related to changes in
interest rates and foreign currency exchange rates. This discussion contains
forward-looking statements that are subject to risks and uncertainties. Actual
results could vary materially as a result of a number of factors.
Interest Rate Risk
As of September 30, 2003, we had cash and cash equivalents of $27.4 million,
consisting of cash and highly liquid short-term investments with original
maturities of three months or less at the date of purchase. Additionally the
Company had no marketable securities, classified as available for sale, with
maturities greater than three months. These investments may be subject to
interest rate risk and will decrease in value if market rates increase. A
hypothetical increase or decrease in market interest rates of 10% from the
market rates in effect at September 30, 2003 would cause the fair value of these
investments to change by an immaterial amount. Declines in interest rates over
time would result in lower interest income.
Foreign Currency and Exchange Rate Risk
Almost all of our revenues recognized to date have been denominated in U.S.
dollars and are primarily from the United States. However, a portion of our
future revenue may be derived from international customers. Revenues from these
customers may be denominated in the local currency of the applicable countries.
As a result, our operating results could become subject to significant foreign
currency fluctuations based upon changes in exchange rates in relation to the
U.S. dollar.
Furthermore, as we engage in business outside the United States, changes in
exchange rates relative to the U.S. dollar could make us less competitive in
international markets. Although we will continue to monitor our foreign currency
exposure, and may use financial instruments to limit this exposure, there can be
no assurance that exchange rate fluctuations will not have a materially negative
impact on our business.
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 Control over Financial Reporting
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 pertaining to the IPO 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 officers and directors
named in the lawsuit 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 the 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 of directors has approved this settlement proposal in principle, the
actual settlement agreement 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 the IPO
Lawsuits 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 were filed against
other companies in the e-learning industry, including Skillsoft Corporation,
Saba Software, Inc. and Docent, Inc. The complaint, amended in November 2002,
alleged infringement of five patents and sought damages and injunctive relief.
We filed an answer to the amended complaint asserting a number of affirmative
defenses. In addition, we filed counterclaims against IP Learn seeking
declaratory relief that we did infringe the patents-in-suit and that each of the
patents-in-suit was invalid. In early November 2003, we reached a tentative
settlement with IP Learn to license IP Learn's technology and to settle the
patent litigation. Under the terms of the tentative settlement, IP Learn would
agree to release all claims covered by the lawsuit. In addition, IP Learn would
grant to us irrevocable licenses for the patents covered by the lawsuit. In
exchange, we would agree to pay approximately $1.5 million to IP Learn in the
form of approximately half in cash and half in stock and to release all
counterclaims covered by the lawsuit. While this tentative settlement agreement
was reached after September 30, 2003, the litigation that gave rise to the
tentative settlement agreement existed at the balance sheet date of September
30, 2003. Accordingly, we recognized expenses of $1.6 million during the quarter
ended September 30, 2003 representing the tentative settlement amount of
approximately $1.5 million and legal fees of approximately $0.1 million.
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 Innovation lawsuit is without
merit and intend to defend against it vigorously. Although no assurance can be
given that this matter will be resolved in the Company's favor, the Company
believes the resolution of this lawsuit will not have a material adverse effect
on its financial position, results of operations, or cash flows.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
On September 8, 2003, we issued 4,166,667 shares of our common stock and
warrants to purchase 1,458,333 shares of our common stock, resulting in
$10,000,000 of gross proceeds to DigitalThink. Under the terms of the private
placement, we sold the shares of common stock for a price of $2.40 per share
plus a warrant to purchase 0.35 of a share of common stock. The warrants bear an
exercise price of $3.45 per share. The exercise price and the number of shares
to be issued upon exercise of the warrants are subject to future adjustments in
the event of certain issuances of our equity securities for a common-equivalent
per share price of less than the exercise price, with certain exclusions. The
terms of the private placement also provide for an additional issuance of up to
2,083,334 shares of common stock and warrants to purchase up to 729,167 shares
of common stock under the same terms and conditions as the original issuance.
The investors in the original issuance have up to 120 days from the effective
date of the registration statement to elect to purchase the additional shares.
We incurred approximately $500,000 in issuance costs related to this private
placement, which was accounted for as a reduction to the proceeds from the
offering. The issuances to date were exempt from registration under Regulation D
promulgated under Section 4(2) of the Securities Act of 1933.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On July 30, 2003, the Company held its 2003 Annual Meeting of Stockholders. At
the annual meeting, the Company's stockholders were asked to vote upon the
following proposals: 1) to elect two Class I directors to hold office until the
2006 annual meeting of stockholders; 2) to ratify the selection of Deloitte &
Touche LLP as independent auditors of the Company for the fiscal year ending
March 31, 2004; and 3) to approve the 1999 Employee Stock Purchase Plan, as
amended to increase the number of shares reserved thereunder by 700,000 shares.
The results of the voting were as follows:
Proposal 1 - Election of Directors:
Votes
--------------------------
Nominee For Withheld
------- ---------- ---------
Steven L. Eskenazi 35,494,701 819,838
Samuel D. Kingsland 35,239,927 1,074,612
The following directors' terms of office continue after the meeting:
Michael W. Pope
Roger V. Goddu
William H. Lane, III
Peter J. Goettner
Jon C. Madonna
Roderick C. McGeary
Proposal 2 - Ratification of Deloitte & Touche LLP:
Votes
-------------------------------------------
For Against Abstain
---------- ------- -------
35,898,765 392,730 23,044
Proposal 3 - Approval of increase to the number of shares authorized for
issuance under the 1999 Employee Stock Purchase Plan:
Votes
-------------------------------------------
For Against Abstain
---------- ------- -------
34,528,216 1,750,693 35,630
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
4.1 Securities Purchase Agreement dated as of September 8, 2003 (incorporated
herein by reference to Exhibit 4.1 of the Company's Registration Statement
filed on Form S-3 (No. 333-108939))
4.2 Registration Rights Agreement dated as of September 8, 2003 (incorporated
herein by reference to Exhibit 4.2 of the Company's Registration Statement
filed on Form S-3 (No. 333-108939)
4.3 Form of Warrant to Purchase Common Stock (incorporated herein by reference
to Exhibit 4.3 of the Company's Registration Statement filed on Form S-3
(No. 333-108939)
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:
1) We filed a Current Report on Form 8-K dated July 16, 2003 reporting under
Items 7 and 9 to furnish a press release dated July 16, 2003 in which we
announced our financial results for the first quarter ended June 30, 2003.
2) We filed a Current Report on Form 8-K dated September 9, 2003 reporting
under Items 5 and 7 to report the completion of a private placement of
stock and warrants.
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: November 14, 2003 /s/ MICHAEL W. POPE
-----------------------------------------------
Michael W. Pope
Chief Executive Officer, President and Director
(Principal Executive Officer)
Date: November 14, 2003 /s/ ROBERT J. KROLIK
-----------------------------------------------
Robert J. Krolik
Chief Financial Officer
(Principal Financial and Accounting Officer)