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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------------
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended December 31, 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 February 11, 2004, the Registrant had outstanding 49,785,858 shares of
Common Stock, $0.001 par value.
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DIGITALTHINK, INC. AND SUBSIDIARIES
FORM 10-Q
For the Quarter Ended December 31, 2003
TABLE OF CONTENTS
Page
PART I: FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited):
Consolidated Balance Sheets as of December 31, 2003 and
March 31, 2003 3
Consolidated Statements of Operations for the three and
nine months ended December 31, 2003 and 2002 4
Consolidated Statements of Cash Flows for the
nine months ended December 31, 2003 and 2002 5
Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 14
Item 3. Quantitative and Qualitative Disclosures About Market Risk 33
Item 4. Controls and Procedures 33
PART II: OTHER INFORMATION
Item 1. Legal Proceedings 34
Item 2. Changes in Securities and Use of Proceeds 34
Item 3. Defaults Upon Senior Securities 34
Item 4. Submission of Matters to a Vote of Security Holders 34
Item 5. Other Information 34
Item 6. Exhibits and Reports on Form 8-K 35
SIGNATURES 36
DIGITALTHINK, INC. AND SUBSIDIARIES
PART I: FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
December 31, March 31,
2003 2003
------------ ------------
ASSETS
Current assets:
Cash and cash equivalents........................$ 23,373 $ 22,668
Accounts receivable, net of allowance for
doubtful accounts of $278 and $300, respectively 10,097 6,344
Prepaid expenses and other current assets........ 2,032 2,302
------------ ------------
Total current assets.......................... 35,502 31,314
Restricted cash and deposits..................... 3,710 4,041
Property and equipment, net...................... 12,810 14,510
Goodwill and other intangible assets............. 24,628 23,747
------------ ------------
Total assets..................................$ 76,650 $ 73,612
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable.................................$ 1,789 $ 2,213
Accrued liabilities.............................. 4,691 4,140
Borrowings under line of credit and
capital lease obligations....................... 8,373 5,266
Deferred revenues................................ 3,473 6,343
------------ ------------
Total current liabilities..................... 18,326 17,962
Long-term restructuring liability and
capital lease obligations........................ 9,230 5,892
------------ ------------
Total liabilities............................. 27,556 23,854
------------ ------------
Stockholders' equity:
Common stock-- $0.001 par value per share;
250,000 shares authorized; issued and
outstanding 49,698 at December 31, 2003
and 41,619 at March 31, 2003.................... 285,612 268,718
Deferred stock compensation...................... (56) (224)
Accumulated other comprehensive loss............. (285) (298)
Accumulated deficit.............................. (236,177) (218,438)
------------ ------------
Total stockholders' equity.................... 49,094 49,758
------------ ------------
Total liabilities and stockholders' equity....$ 76,650 $ 73,612
============ ============
See accompanying notes to consolidated financial statements.
DIGITALTHINK, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
Three Months Ended Nine Months Ended
December 31, December 31,
------------------- -------------------
2003 2002 2003 2002
--------- --------- --------- ---------
Revenues:
Delivered Learning fees................$ 5,701 $ 5,554 $ 17,098 $ 16,415
Learning Solution services............. 4,892 5,481 16,368 14,248
--------- --------- --------- ---------
Total revenues...................... 10,593 11,035 33,466 30,663
Costs and expenses:
Cost of Delivered Learning fees........ 1,060 1,042 3,109 3,657
Cost of Learning Solution services..... 2,811 1,852 8,247 4,928
Content research and development....... 1,252 1,346 3,902 4,214
Technology research and development.... 1,261 1,667 4,790 5,267
Selling and marketing.................. 3,807 3,355 11,160 10,268
General and administrative............. 2,061 1,510 6,375 5,357
Depreciation........................... 1,368 1,729 4,333 5,253
Amortization of intangibles and warrants 81 345 840 1,064
Amortization of stock-based compensation* 56 105 168 368
Settlement of patent litigation........ - - 1,450 -
Loss from write-down of intangibles.... - - 3,507 -
Restructuring charge (recovery)........ (53) (83) 3,384 (83)
--------- --------- --------- ---------
Total costs and expenses............ 13,704 12,868 51,265 40,293
--------- --------- --------- ---------
Loss from operations.................... (3,111) (1,833) (17,799) (9,630)
Interest and other income............... 25 60 60 224
--------- --------- --------- ---------
Net loss before cumulative effect of
accounting change...................... (3,086) (1,773) (17,739) (9,406)
Cumulative effect of accounting change.. - - - (50,189)
--------- --------- --------- ---------
Net loss................................$ (3,086) $ (1,773) $(17,739) $(59,595)
========= ========= ========= =========
Net loss per share--basic and diluted:
Before cumulative effect of
accounting change......................$ (0.06).$ (0.04) $ (0.39) $ (0.23)
Cumulative effect of accounting change.. - - - (1.22)
--------- --------- --------- ---------
Net loss per share--basic and diluted...$ (0.06) $ (0.04) $ (0.39) $ (1.45)
========= ========= ========= =========
Shares used in computing basic and
diluted loss per share.......... 49,197 41,372 46,070 41,090
========= ========= ========= =========
(*) Stock-based compensation:
Cost of Delivered Learning fees.....$ 1 $ 1 $ 3 $ 3
Cost of Learning Solution services.. 5 11 15 37
Content research and development.... 1 1 3 3
Technology research and development. 14 26 42 92
Selling and marketing............... 18 33 54 117
General and administrative.......... 17 33 51 116
--------- --------- --------- ---------
Total...............................$ 56 $ 105 $ 168 $ 368
========= ========= ========= =========
See accompanying notes to consolidated financial statements.
DIGITALTHINK, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
Nine Months Ended
December 31,
------------------------------
2003 2002
------------ ------------
Cash flows from operating activities:
Net loss.........................................$ (17,739) $ (59,595)
Adjustments to reconcile net loss to net cash
used in operating activities:
Cumulative effect of accounting change.......... - 50,189
Provision for doubtful accounts................. (35) 154
Depreciation.................................... 4,333 5,253
Loss on disposal of property and equipment...... 145 64
Amortization of intangibles and warrants........ 840 1,064
Amortization of stock-based compensation........ 168 368
Settlement of patent litigation................. 1,450 -
Loss from write-down of intangibles............. 3,507 -
Restructuring charge (recovery)................. 3,384 (83)
Changes in assets and liabilities:
Accounts receivable............................ (3,454) 1,154
Prepaid expenses and other current assets...... 339 96
Accounts payable............................... (537) (868)
Accrued liabilities............................ (488) (3,885)
Deferred revenues.............................. (3,348) (3,836)
------------ ------------
Net cash used in operating activities......... (11,435) (9,925)
------------ ------------
Cash flows from investing activities:
Restricted cash (increase) decrease.............. 331 (58)
Purchases of property and equipment.............. (2,737) (2,759)
Proceeds from sales of property and equipment.... 5 92
Cash received in acquisition, net of
acquisition costs............................... 188 -
Proceeds from maturities of marketable securities - 1,640
------------ ------------
Net cash used in investing activities......... (2,213) (1,085)
------------ ------------
Cash flows from financing activities:
Proceeds from issuance of notes payable.......... 24,187 15,300
Repayments of notes payable...................... (21,003) (12,445)
Proceeds from exercises of stock options......... 982 202
Proceeds from sales of common stock.............. 10,175 632
------------ ------------
Net cash provided by financing activities..... 14,341 3,689
------------ ------------
Effect of exchange rate changes on cash and
cash equivalents................................. 12 (27)
Net increase (decrease) in cash and cash equivalents 705 (7,348)
Cash and cash equivalents, beginning of period.... 22,668 29,470
------------ ------------
Cash and cash equivalents, end of period..........$ 23,373 $ 22,122
============ ============
Supplemental disclosure of noncash investing and
financing activities:
Issuance of common stock for acquisitions........$ 4,960 $ -
Issuance of common stock for settlement of
patent litigation...............................$ 734 $ -
Cash paid for interest...........................$ 42 $ 52
See accompanying notes to consolidated financial statements.
DIGITALTHINK, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
1. Description of Business and Basis of Presentation
DigitalThink, Inc. (the "Company") provides custom e-learning solutions designed
to address the strategic business objectives of its customers through training
courseware and the delivery of that courseware on a robust technology platform.
The Company completed the initial development of its delivery technology and
initial content, and began significant sales and marketing efforts in fiscal
year 1998. In November 1999, the Company reincorporated in Delaware from
California.
The consolidated financial statements included herein have been prepared by the
Company, without audit, pursuant to the rules and regulations of the Securities
and Exchange Commission. Certain information and footnote disclosures normally
included in financial statements prepared in accordance with generally accepted
accounting principles have been condensed or omitted pursuant to such rules and
regulations, although management believes the disclosures which are made are
adequate to make the information presented not misleading. It is suggested that
this document be read in conjunction with the consolidated financial statements
and the notes thereto included in the Company's Annual Report on Form 10-K for
the fiscal year ended March 31, 2003.
The unaudited consolidated financial statements included herein reflect all
adjustments (which include only normal, recurring adjustments) that are, in the
opinion of management, necessary to state fairly the results for the periods
presented. The results for such periods are not necessarily indicative of the
results to be expected for the entire fiscal year ending March 31, 2004.
Certain prior year amounts in the consolidated financial statements have been
reclassified to conform to the current year presentation.
2. Recent Accounting Pronouncements
In November 2002, the Emerging Issues Task Force ("EITF") reached a consensus on
Issue 00-21, Revenue Arrangements with Multiple Deliverables, addressing how to
account for arrangements that involve the delivery or performance of multiple
products, services, and/or rights to use assets. Revenue arrangements with
multiple deliverables are divided into separate units of accounting if the
deliverables in the arrangement meet the following criteria: (1) the delivered
item has value to the customer on a standalone basis; (2) there is objective and
reliable evidence of the fair value of undelivered items; and (3) delivery of
any undelivered item is probable. Arrangement consideration should be allocated
among the separate units of accounting based on their relative fair values, with
the amount allocated to the delivered item being limited to the amount that is
not contingent on the delivery of additional items or meeting other specified
performance conditions. The final consensus will be applicable to agreements
entered into in fiscal periods beginning after June 15, 2003 with early adoption
permitted. The provisions of this consensus did not have an effect on the
Company's financial position or operating results.
In December 2003, the Financial Accounting Standards Board ("FASB") issued a
revised Statement of Financial Accounting Standards ("SFAS") No. 132, Employers'
Disclosures about Pensions and Other Postretirement Benefits - An Amendment of
FASB Statements No. 87, 88, and 106. SFAS No. 132, as revised, increases the
existing disclosure requirements pertaining to pension and benefit plans in both
annual and interim filings. The provisions of SFAS No. 132 are applicable for
annual periods ending after December 15, 2003 and interim periods beginning
after December 15, 2003. The adoption of SFAS No. 149 will not have an effect 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 the
disclosure requirements of SFAS No. 123, Accounting for Stock-Based
Compensation, and SFAS No. 148, Accounting for Stock-Based Compensation -
Transition and Disclosure.
DIGITALTHINK, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - (Continued)
3. Stock Plan Information - (Continued)
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 Nine Months Ended
December 31, December 31,
2003 2002 2003 2002
--------- --------- --------- ---------
Net loss (in thousands):
As reported............................$ (3,086) $ (1,773) $(17,739) $(59,595)
Add: Stock based employee compensation
included in reported net loss......... 56 105 168 368
Deduct: Total stock-based employee
compensation expense determined under
fair value based method for awards.... (1,186) (160) (2,597) (4,205)
--------- --------- --------- ---------
Pro forma $ (4,216) $ (1,828) $(20,168) $(63,432)
========= ========= ========= =========
Basic and diluted net loss per share:
As reported............................$ (0.06) $ (0.04) $ (0.39) $ (1.45)
Pro forma..............................$ (0.09) $ (0.04) $ (0.44) $ (1.54)
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 Nine Months Ended
December 31, December 31,
2003 2002 2003 2002
--------- --------- --------- ---------
Risk-free interest rates 1.77% 1.75% 1.71% 2.21%
Expected dividend yield -- -- -- --
Expected life after vesting (in years) 1.50 1.50 1.50 1.50
Expected volatility 67% 117% 79% 119%
4. Net Loss Per Share
The following table sets forth the computation of net loss per share:
Three Months Ended Nine Months Ended
December 31, December 31,
2003 2002 2003 2002
--------- --------- --------- ---------
Net loss (in thousands):
Net loss before cumulative effect of
accounting change $ (3,086) $ (1,773) $(17,739) $ (9,406)
Cumulative effect of accounting change - - - (50,189)
--------- --------- --------- ---------
Net loss $ (3,086) $ (1,773) $(17,739) $(59,595)
========= ========= ========= =========
Weighted average common shares
outstanding used in computing basic and
diluted loss per share 49,197 41,372 46,070 41,090
========= ========= ========= =========
Net loss per share:
Before cumulative effect of
accounting change $ (0.06) $ (0.04) $ (0.39) $ (0.23)
Cumulative effect of accounting change - - - (1.22)
--------- --------- --------- ---------
Net loss per share--basic and diluted $ (0.06) $ (0.04) $ (0.39) $ (1.45)
========= ========= ========= =========
Basic net loss per share excludes dilution and is computed by dividing loss
attributable to common stockholders by the weighted average number of common
shares outstanding during the period. Diluted loss per common share excludes the
potential dilution that could occur if securities or other contracts to issue
common stock were exercised or converted into common stock, as the effect of
such conversions in loss periods would be anti-dilutive.
DIGITALTHINK, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - (Continued)
5. Business Combinations
On April 16, 2003, the Company acquired Horn Interactive, Inc. ("Horn"), a
provider of simulation-based custom e-learning courseware, in exchange for 2.0
million shares of DigitalThink common stock, for a total purchase price of $4.8
million. The acquisition of Horn has been accounted for in accordance with SFAS
No. 141, Business Combinations. The cost of the acquisition was allocated to the
assets acquired and liabilities assumed based on estimates of their respective
fair values at the date of acquisition. Intangible assets acquired will be
amortized on a straight-line basis over a weighted average period of 4.3 years.
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 $ 4,940
Transaction costs 125
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.
6. Restructuring Charge (Recovery)
During the three months ended December 31, 2003, the Company recognized a
restructuring recovery of $53,000 reflecting the adjustment of certain
restructuring expenses previously recorded. During the quarter, the Company
successfully sublet one of its leased facilities earlier than had previously
been expected and on terms more favorable to the Company. This event, along with
minor adjustments to the amounts due under the other leases included in the 2002
Restructuring (discussed below), resulted in a net recovery to the Company of
$246,000. This recovery was partially offset by expense resulting from an
unfavorable change in foreign currency translation assumptions of $161,000 and
additional expenses of $32,000 recognized in conjunction with the 2003
Restructuring (discussed below). During the nine months ended December 31, 2003,
the Company recognized a restructuring charge of $3.4 million which was
comprised of the $3.5 million restructuring charge recognized during the quarter
ended September 30, 2003 offset by a $36,000 restructuring recovery recognized
during the three months ended June 30, 2003 and the $53,000 restructuring
recovery recognized during the three months ended December 31, 2003. During the
three and nine months ended December 31, 2002, the Company recognized a
restructuring recovery of $83,000 reflecting the reversal of certain
restructuring expenses previously accrued as a result of a change in certain
lease assumptions.
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 and the subsequent adjustments to
the restructuring liability.
DIGITALTHINK, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - (Continued)
6. Restructuring Charge (Recovery) - (Continued)
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. During the three months ended December 31,
2003, the Company paid net lease-related cash payments of $356,000 related to
this component of the restructuring liability. Additionally, the Company
recognized a non-cash adjustment of $20,000 to write-off amounts accrued in the
2002 Restructuring for purchase accounting adjustments made to one of the leases
acquired as a result of the LearningByte International, Inc. acquisition. The
Company recognized a net recovery of $85,000 related to this component of the
restructuring liability as a result of the favorable sub-lease event and
unfavorable foreign currency translation assumptions discussed above. The
remaining accrued liability (net of anticipated sub-lease proceeds) of $7.5
million 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 reduction in development activities in the
United States. These reductions resulted in severance charges of $268,000.
During the three months ended December 31, 2003, the Company paid $50,000
in termination payments and recognized an additional restructuring expense
of $1,000 related to this component of the restructuring liability. The
remaining accrued liability of $4,000 will be paid during the three months
ending March 31, 2004.
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. During the three months ended December 31, 2003,
the Company paid facilities-related cash payments of $96,000 and recognized
an additional restructuring expense of $35,000 as a result of additional
unanticipated costs. The remaining accrued liability of $20,000 is expected
to be paid during the three months ending March 31, 2003.
o Asset Disposal Costs - In conjunction with the closure of the India
facility, the Company disposed of, or removed 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. During the three months ended December 31, 2003, the
Company recognized a non-cash adjustment of $137,000 related to the
disposal of this equipment and a restructuring recovery of $4,000 as a
result of more favorable disposal terms than expected. The remaining costs
to remove the leasehold improvements are estimated to be $19,000 and are
expected to be paid during the three months ending March 31, 2003.
DIGITALTHINK, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - (Continued)
6. Restructuring Charge (Recovery) - (Continued)
The following table sets forth the activity related to the restructuring
liabilities during the three months ended December 31, 2003 (in thousands):
2002
Restructuring
----------
Facility-
Related
Costs
----------
Restructuring liability at 9/30/03 $ 7,924
Restructuring expense (recovery) (85)
Net cash payments (356)
Non-cash adjustments 20
----------
Restructuring liability at 12/31/03 $ 7,503
==========
2003 Restructuring
--------------------------------------------
Total
2003
Employee Facility- Asset Restruc-
Termination Related Disposal turing
Costs Costs Costs Costs
---------- ---------- ----------- ----------
Restructuring liability at 9/30/03 $ 53 $ 81 $ 160 $ 294
Restructuring expense (recovery) 1 35 (4) 32
Net cash payments (50) (96) - (146)
Non-cash adjustments - - (137) (137)
---------- ---------- ----------- ----------
Restructuring liability at 12/31/03 $ 4 $ 20 $ 19 $ 43
========== ========== =========== ==========
Total
Restructuring
Costs
----------
Restructuring liability at 9/30/03 $ 8,218
Restructuring expense (recovery) (53)
Net cash payments (502)
Non-cash adjustments (117)
----------
Restructuring liability at 12/31/03 $ 7,546
==========
At December 31, 2003, the restructuring liability was recorded as $1.1 million
in accrued liabilities and $6.4 million in long-term restructuring liability and
capital lease obligations on the Consolidated Balance Sheets.
7. Accounts Receivable, Net
Accounts receivable presented on the Consolidated Balance Sheets includes the
following components:
December 31, 2003 March 31, 2003
----------------- -----------------
Accounts receivable $ 7,024 $ 3,040
Unbilled revenues 3,264 3,544
Other receivables 87 60
Allowance for doubtful accounts (278) (300)
--------- ---------
Total accounts receivable, net $10,097 $ 6,344
========= =========
Unbilled revenues represent revenue recognized for work that was completed, but
was not yet billable under the terms of the contractual agreement. These amounts
are recoverable over the life of the contractual agreement as the specific
billing milestones are reached.
DIGITALTHINK, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - (Continued)
8. 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, 2003, 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.
During the quarter ended December 31, 2003, no events or circumstances occurred
that would necessitate the interim testing of goodwill impairment.
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 December 31, 2003 and March 31, 2003
are as follows (in thousands):
December 31, 2003
-------------------------------------------
Gross
Carrying Accumulated Net Book
Amount Amortization Value
------------- ------------- -------------
Amortized Intangible Assets:
LBI acquired technology -- -- --
Horn acquired technology $ 464 $ (66) $ 398
Horn customer contracts 857 (151) 706
------------- ------------- -------------
Total $ 1,321 $ (217) $ 1,104
============= ============= =============
March 31, 2003
-------------------------------------------
Gross
Carrying Accumulated Net Book
Amount Amortization Value
------------- ------------- -------------
Amortized Intangible Assets:
LBI acquired technology $ 6,100 $ (1,982) $ 4,118
Horn acquired technology -- -- --
Horn customer contracts -- -- --
------------- ------------- -------------
Total $ 6,100 $ (1,982) $ 4,118
============= ============= =============
Amortization expense recorded on intangible assets for the three and nine months
ended December 31, 2003 was $77,000 and $827,000, respectively. For the three
and nine months ended December 31, 2002, the amortization expense recorded was
$341,000 and $1.1 million respectively. The estimated future amortization
expense by fiscal year is as follows: three months ended March 31, 2004 is
$77,000; 2005-2007 is $307,000 per year; 2008 is $102,000 and 2009 is $4,000.
DIGITALTHINK, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - (Continued)
9. 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.
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.
Customer Contracts
The Company recently received a letter from Electronic Data Systems Corporation
("EDS") alleging that the Company is in material default under the agreement
between the two companies. While the Company believes that all alleged instances
of default are either wholly without merit or completely cured, EDS maintains
that it has the ability to terminate the agreement and has informed the Company
that it may do so. The Company believes that EDS does not have the ability to
terminate the agreement. If the Company and EDS are unable to reach a mutually
agreeable business resolution regarding this matter, and EDS refuses to comply
with its payment and other obligations under the contract, the Company intends
to pursue all breach of contract and other claims that the Company has against
EDS. If EDS were to purport to terminate its agreement with the Company, the
Company could experience a material adverse effect on its financial position,
results of operations, and cash flows. As a result of this dispute, the Company
is instituting a plan that would require significant expense reductions
including headcount reductions and an attempt to renegotiate the Company's real
property leases or terminate them altogether. The lease terminations have yet to
be negotiated and cannot be assured.
DIGITALTHINK, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - (Continued)
9. Contingencies - (Continued)
Through December 31, 2003, the amount of EDS contract revenues that were
recognized by the Company in excess of amounts collected totaled $3.2 million,
which amount is reflected as accounts receivable on the consolidated balance
sheet as of that date. Notwithstanding EDS's allegations discussed above, the
Company believes the reflection of such amount as accounts receivable is
reasonable because this amount is reasonably assured of being collectible under
the contract. The Company continues to serve catalog courses and develop custom
courses for EDS. If the Company were unsuccessful in collecting this amount,
this receivable could be subject to write-off in a future accounting period. As
of February 13, 2004, this balance was due and payable but had not yet been paid
by EDS.
10. Settlement of Patent Litigation
In August 2002, a complaint was filed in the United States District Court for
the Northern District of California by IpLearn, LLC ("IpLearn") 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 IpLearn seeking declaratory relief that the Company did
not infringe the patents-in-suit and that each of the patents-in-suit was
invalid. On November 24, 2003, the Company reached a settlement with IpLearn to
settle the patent litigation. Under the terms of the settlement, IpLearn agreed
to release all claims covered by the lawsuit and grant the Company irrevocable
licenses for the patents covered by the lawsuit. Under the terms of the
settlement, there was no admission of liability by either party. In exchange,
the Company agreed to pay approximately $700,000 in cash to IpLearn, to issue
287,784 shares of common stock to IpLearn and to release all counterclaims
covered by the lawsuit. The cash payment will be made over two years. The stock
was issued on November 25, 2003. While this settlement agreement was reached
after September 30, 2003, the litigation that gave rise to the settlement
agreement existed at the balance sheet date of September 30, 2003. Accordingly,
the Company recognized expense of $1.6 million during the quarter ended
September 30, 2003, and for the nine months ended December 31, 2003,
representing the settlement amount of approximately $1.5 million and legal fees
of approximately $0.1 million.
11. Credit Facility
In December 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. In December 2003, this Loan Agreement was
renewed to extend the term to December 17, 2004. 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 December 31, 2003, the Company borrowed $8.0 million under this line of
credit. This entire loan balance was subsequently repaid on January 2, 2004. At
December 31, 2003, the Company was in compliance with all specified loan
covenants.
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 e-learning solutions designed to address the
strategic business objectives of our customers through catalog and custom
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 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. Customers typically pay for the courses in advance of course
registration and do not receive refunds for the unused portion of the available
registrations agreed to in the contract. We recognize revenues on these
Delivered Learning contracts ratably over the time period a participant has
access to the course, which is typically six to twelve months. 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 the development of
customized e-learning solutions, or "Learning Solution" services. Typically,
these Learning Solution service revenues are generated from custom 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, if required. 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.
In some cases, we enter into contracts that include the delivery of both
Delivered Learning and Learning Solutions services. Typically, these
multiple-element arrangements provide for a combination of services such as
design and development of an e-learning solution along with an ongoing
obligation to provide access to the courseware via a hosting arrangement. Such
contracts are divided into separate units of accounting and the total
arrangement fee is allocated to each unit based on its relative fair value.
Revenue is then recognized separately for each element of the arrangement in
accordance the applicable revenue recognition policy. Delivered Learning fees
and Learning Solution service revenues are each recognized only when the
following criteria have been met: i) persuasive evidence of an arrangement
exists, ii) the contract value is fixed or determinable, iii) the services have
been rendered and there is evidence that we have completed our obligation, and
iv) collection is probable.
We have entered into revenue sharing agreements with some of our customers and
have some 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. For both the three and
nine months ended December 31, 2003, our revenues from revenue sharing
agreements and resellers were less than 5% of total revenues.
We have experienced losses in each quarter since our inception and expect that
our quarterly losses will continue at least for the foreseeable future. We
expect that these losses will result, in large part, from the challenging
enterprise software sales environment. As of December 31, 2003, we had an
accumulated deficit of $236.2 million.
We derive a significant portion of our revenues from a limited number of
customers and the percentage of our revenues from any one customer is material.
For example, in the fiscal year ended March 31, 2003, our largest customer,
Electronic Data Systems Corporation ("EDS"), accounted for 37.1% and Circuit
City accounted for 14.4% of our total revenues of $42.1 million. For the three
months ended December 31, 2003, EDS accounted for 41.2% and Circuit City
accounted for 10.2% of our total revenues of $10.6 million. For the nine months
ended December 31, 2003, EDS accounted for 40.2% and Circuit City accounted for
11.6% of our total revenues of $33.5 million. We expect that EDS, should it
honor its contract with us, Circuit City, and other major customers will
continue to account for a significant portion of our revenues during all fiscal
periods in the foreseeable future. See "Customer Contracts" below for more
information regarding our dispute with EDS.
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.
Customer Contracts
We recently received a letter from EDS alleging that we are in material default
under the agreement between the two companies. While we believe that all alleged
instances of default are either wholly without merit or completely cured, EDS
maintains that it has the ability to terminate the agreement and has informed us
that it may do so. We believe that EDS does not have the ability to terminate
the agreement. If we are unable to reach a mutually agreeable business
resolution regarding this matter, and EDS refuses to comply with its payment and
other obligations under the contract, we intend to pursue all breach of contract
and other claims that we have against EDS. If EDS were to purport to terminate
its agreement with us, we could experience a material adverse effect on our
financial position, results of operations, and cash flows. We are instituting a
plan that would require significant expense reductions including headcount
reductions and an attempt to renegotiate our real property leases or terminate
them altogether. The lease terminations have yet to be negotiated and cannot be
assured.
Through December 31, 2003, the amount of EDS contract revenues that we
recognized in excess of amounts collected totaled $3.2 million, which amount is
reflected as accounts receivable on the consolidated balance sheet as of that
date. Notwithstanding EDS's allegations discussed above, we believe the
reflection of such amount as accounts receivable is reasonable because this
amount is reasonably assured of being collectible under the contract. We
continue to serve catalog courses and develop custom courses for EDS. If we were
unsuccessful in collecting this amount, this receivable could be subject to
write-off in a future accounting period. As of February 13, 2004, this balance
was due and payable but had not yet been paid by EDS.
RESULTS OF OPERATIONS - THREE AND NINE MONTHS ENDED DECEMBER 31, 2003 AND 2002
REVENUES
Delivered Learning Fees
Delivered Learning fees increased by 3% to $5.7 million in the three months
ended December 31, 2003 from $5.6 million in the three months ended December 31,
2002. This increase is partially attributable to an increase in enrollments in
custom courses as a result of an overall increase in number of customers and
courses developed. The total number of customers increased by 15% as we added 76
new customers from December 31, 2002 to December 31, 2003. The total number of
courses developed increased from 985 to 1,255 for the same periods. This
increase in enrollments drove a 7% increase in Delivered Learning fees.
Additionally, under the terms of one of our large, multi-year contracts, the
revenues assigned to the Delivered Learning component of the contract increased
in fiscal year 2004, resulting in a 3% increase in Delivered Learning fees
compared to the same quarter in fiscal 2003. These increases were partially
offset by a reduction in catalog delivery revenues due to the decline in catalog
enrollments. Additionally, two customer contracts expired during the three
months ended December 31, 2002. Upon expiration, the unused contract amount,
representing 3% of Delivered Learning fees, was recognized into revenue, as the
unused portion of the contract is not refunded to the customer. No such
expirations occurred during the three months ended December 31, 2003.
For the nine months ended December 31, 2003, Delivered Learning fees increased
by 4% to $17.1 million from $16.4 million for the nine months ended December 31,
2002. This increase is partially attributable to the increase in enrollments in
custom courses as discussed above, resulting in a 6% increase in Delivered
Learning fees. Additionally, the recognition of increased revenues on the
Delivered Learning component of one of our large, multi-year contracts resulted
in a 6% increase in Delivered Learning revenue over the nine-month period. These
increases were partially offset by the reduction in catalog delivery revenues
due to the decline in catalog enrollments. Additionally, expirations of revenue
contracts during the nine-month period ended December 31, 2002 with unused
contract amounts resulted in a 3% decrease in Delivered Learning fees, as there
were no similar contract expirations during the nine months ended December 31,
2003. We expect that the number of courses delivered will continue to increase
as we expand our course offerings. While increases in the number of courses and
number of enrollments may drive revenue growth, it is dependent on the price we
obtain from these new enrollments as to whether Delivered Learning fees will
grow. However, if our dispute with EDS is not resolved amicably, our Delivered
Learning fees would be materially adversely impacted.
Learning Solution Services
Learning Solution services revenues decreased by 11% to $4.9 million for the
three months ended December 31, 2003 from $5.5 million for the three months
ended December 31, 2002. Learning Solution services revenues decreased primarily
because, during the three months ended December 31, 2002, we completed a larger
number of courses including high value design work, data migration and catalog
localization for one of our newly added customers. Some of these projects did
not occur in the three months ended December 31, 2003, resulting in a 7%
decrease in revenues for the three months ended December 31, 2003. In general,
while our orders during the quarter ended September 30, 2003 were higher than
the previous quarter, some of the orders did not translate into revenue during
the quarter ended December 31, 2003 as some of our customers chose to defer
initiation of the projects until the fourth quarter of fiscal 2004.
For the nine months ended December 31, 2003, Learning Solution services revenues
increased by 15% to $16.4 million from $14.2 million for the nine months ended
December 31, 2002. Revenues increased during this period due to the addition of
a significant multi-year customer contract in mid-fiscal year 2003, resulting in
a 16% increase in Learning Solutions services revenues during the nine months
ended December 31, 2003. This was slightly offset by less one-off projects such
as data migration and design work discussed above. Because we recognize revenues
for Learning Solutions services based upon the percentage completion of each
revenue contract, we expect the level of our Learning Solutions services
revenues to be proportional to the progress made in completing our custom
development projects. However, if our dispute with EDS is not resolved amicably,
our Learning Solution services revenues would be materially adversely impacted.
During both the three and nine months ended December 31, 2003, our international
revenues constituted less than 5% of total revenues.
COSTS AND EXPENSES
Cost of Delivered Learning Fees
Cost of Delivered Learning fees include personnel-related costs, catalog costs,
and 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 increased by 2% to $1.1 million for the three months
ended December 31, 2003 from $1.0 million for the three months ended December
31, 2002. The increase was a result of hosting 3rd party catalog courses for a
customer, offset by a decrease in tutor support and personnel costs as a result
of the shift of our tutor support services and other related functions from the
United States to our lower cost India operation.
For the nine months ended December 31, 2003, cost of Delivered Learning fees
decreased by 15% to $3.1 million from $3.7 million for the nine months ended
December 31, 2002. This decrease was attributable to the shift in tutor support
services and other personnel to our lower cost India operation as discussed
above, offset by an increase in costs as a result of hosting 3rd party catalog
courses for a customer. In general, the majority of the Delivered Learning costs
are fixed. As we expect our Delivered Learning revenues to grow in relation to
the number of customers and enrollments we add, we would expect the cost of
Delivered Learning fees to remain relatively flat.
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 by 52% to $2.8 million for the three
months ended December 31, 2003 from $1.9 million for the three months ended
December 31, 2002. From December 31, 2002 to December 31, 2003, net Learning
Solutions services headcount increased by over 100%, primarily due to the
addition of personnel as a result of the Horn acquisition. Additionally, direct
contractor costs associated with two significant new customer contracts, for
which the associated revenue was also recognized, increased by $560,000 from the
same quarter last year, representing 30% of the total increase. These increases
were partially offset by the allocation of approximately $300,000 of personnel
expenses in the Learning Solutions organization to the technology research and
development organization during the three months ended December 31, 2003
representing the costs associated with Learning Solutions personnel deployed on
internal company projects such as tool development and process reengineering,
resulting in a 17% reduction in cost of Learning Solution services. This
allocation is consistent with past practices.
For the nine months ended December 31, 2003, cost of Learning Solution services
increased by 67% to $8.2 million from $4.9 million for the nine months ended
December 31, 2002. Costs increased during this period due to the same factors
discussed above. The increase in personnel from December 31, 2002 to December
31, 2003, primarily due to the April 2003 Horn acquisition, resulted in a 65%
increase in the cost of Learning Solutions services. Additionally, direct
contractor costs associated with the two significant new customer contracts
increased by approximately $2.0 million from the same quarter last year,
representing 40% of the total increase. These increases were partially offset by
the allocation of approximately $1.2 million of personnel expenses in the
Learning Solutions organization to the technology research and development
organization during the nine months ended December 31, 2003 representing the
costs associated with Learning Solutions personnel deployed on internal company
projects such as tool development and process reengineering, resulting in a 24%
reduction in cost of Learning Solution services over the same 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
or decrease. However, given our dispute with EDS, the Company is making
contingency plans to significantly reduce costs within our Learning Solutions
services organization, which would include personnel reductions and an attempt
to renegotiate or terminate our real property leases.
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 $1.3 million
for both the three months ended December 31, 2003 and 2002.
For the nine months ended December 31, 2003, content research and development
expenses decreased by 7% to $4.2 million from $3.9 million for the nine months
ended December 31, 2002. This decrease is mainly due to the shifting of higher
cost headcount in the United States to lower cost headcount in India and our
overall migration toward custom development. We expect content research and
development costs to decrease as we shift our resources toward more 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 the
underlying technology. Technology research and development expenses decreased by
24% to $1.3 million in the three months ended December 31, 2003 from $1.7
million in the three months ended December 31, 2002. This decrease was partially
due to the shift of a portion of our United States based personnel to our lower
cost India operation, resulting in a 26% reduction in expenses. Additionally, we
capitalized additional software development costs during the three months ended
December 31, 2003, in conjunction with the development of software to be sold
and or used for internal purposes, resulting in a 17% decrease in expenses.
These cost decreases were offset by a 19% increase in expenses as a result of
the increased allocation of personnel expenses in the Learning Solution services
organization to the technology research and development organization
representing the costs associated with Learning Solutions personnel deployed on
internal company projects such as tool development and process reengineering, a
practice consistent with prior period.
For the nine months ended December 31, 2003, technology research and development
expenses decreased by 9% to $4.8 million from $5.3 million for the nine months
ended December 31, 2002. This decrease was partially due to the shift of
personnel to our lower cost India operation as discussed above, resulting in a
16% reduction in expenses. Additionally, we capitalized additional software
development costs resulting in a 16% decrease in expenses during the nine months
ended December 31, 2003, also discussed above. These cost decreases were offset
by a 23% increase in expenses as a result of the increased allocation of
personnel expenses in the Learning Solution services organization to the
technology research and development organization representing the costs
associated with Learning Solutions personnel deployed on internal company
projects, a practice consistent with prior periods. In general, we expect
technology research and development expenses to remain relatively flat in the
near term.
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 by 13% to $3.8 million in the three months ended December 31, 2003
from $3.4 million in the three months ended December 31, 2002. This increase was
partially due to marketing events and recruiting costs incurred during the three
months ended December 31, 2003, as well as on-going expenses for sales
generation and incentives, resulting in a 6% increase in selling and marketing
expenses during the quarter. Additionally, while headcount decreased slightly
from December 31, 2002 to December 31, 2003, the average compensation in the
sales organization increased as a result of the overall quality upgrade of the
sales workforce enacted in late fiscal year 2003 and early fiscal year 2004 in
connection with the addition of senior sales executives. This compensation shift
resulted in a 5% increase in selling and marketing expenses for the quarter.
Also, sales commission expense increased as a result of the timing of sales
achievements, contributing to a 4% increase in expenses. These increases were
partially offset by a reduction in royalty expenses as a result of lower catalog
registrations, resulting in a 2% decrease in selling and marketing expenses.
For the nine months ended December 31, 2003, selling and marketing expenses
increased by 9% to $11.2 million from $10.3 million for the nine months ended
December 31, 2002. This increase was partially due to marketing events and
recruiting costs incurred during the nine months ended December 31, 2003, as
well as on-going expenses for sales generation and incentives. These marketing
expenses resulted in a 4% increase in selling and marketing expenses during the
nine-month period ended December 31, 2003. Additionally, in connection with the
quality upgrade of the sales workforce discussed above, the related increase in
compensation resulted in a 5% increase in selling and marketing expenses. Also,
sales commission expense increased as a result of the timing of sales
achievements, contributing to a 2% increase in expenses. These increases were
partially offset by a reduction in royalty expenses, resulting in a 2% decrease
in selling and marketing expenses. 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 by 36% to $2.1
million in the three months ended December 31, 2003 from $1.5 million in the
three months ended December 31, 2002. This increase was partially due to higher
local business taxes attributable to the elimination of previously available tax
credits, higher accounting fees and increases in medical and workers
compensation insurance costs in line with the local and national trends. These
expenses combined resulted in a 13% increase in general and administrative
expenses during the quarter. Also, general and administrative expenses increased
by 8% as a result of the costs added through the Horn acquisition in April 2003.
Legal fees contributed 7% of the net increase in expenses as a result of
continued litigation activities during the quarter.
For the nine months ended December 31, 2003, general and administrative expenses
increased by 19% to $6.4 million from $5.4 million for the nine months ended
December 31, 2002. This increase was partially due to the higher local business
taxes, accounting fees and insurance costs discussed above. These expenses
combined resulted in a 7% increase in general and administrative expenses during
the nine-month period. Additionally, general and administrative expenses
increased by 6% as a result of the costs added through the Horn acquisition.
Also, legal fees contributed 9% of the net increase in expenses as a result of
litigation activities during the quarter. Finally, increased rent expense as a
result of lease renewals completed in September 2002 contributed 4% of the net
increase in expenses. These cost increases were partially offset by a reduction
in the United States based personnel, resulting in an 8% decrease in
personnel-related general and administrative expenses. We expect general and
administrative expenses to remain relatively flat in the near term. However,
given our dispute with EDS, the Company is making contingency plans to
significantly reduce general and administrative costs, which would include
personnel reductions and an attempt to renegotiate or terminate our real
property leases.
Amortization of Intangibles and Warrants
Amortization of intangibles and warrants expense consists of the amortization of
intangible assets acquired through the LearningByte International, Inc. ("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 decreased to $81,000 in the three months ended December
31, 2003 from $345,000 in the three months ended December 31, 2002. For the nine
months ended December 31, 2003, amortization of intangibles and warrants
decreased to $840,000 from $1.1 million for the nine months ended December 31,
2002. The decreases for both periods were due to the decrease in amortization
expense as a result of the write-down of the LBI intangible asset at September
30, 2003 as discussed below. This decrease was partially offset by an increase
in intangible assets as a result of the Horn acquisition completed in April
2003. We expect amortization of intangibles and warrants expense to remain flat
over the next year.
Amortization of Stock-Based Compensation
Amortization of stock-based compensation decreased to $56,000 in the three
months ended December 31, 2003 from $105,000 in the three months ended December
31, 2002. For the nine months ended December 31, 2003, amortization of
stock-based compensation decreased to $168,000 from $368,000 for the nine months
ended December 31, 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 in the United States District Court for
the Northern District of California by IpLearn, LLC ("IpLearn") against us and
two of our 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 IpLearn seeking declaratory relief
that we did not infringe the patents-in-suit and that each of the
patents-in-suit was invalid. On November 24, 2003, we reached a settlement with
IpLearn to settle the patent litigation. Under the terms of the settlement,
IpLearn agreed to release all claims covered by the lawsuit and to grant us
irrevocable licenses for the patents covered by the lawsuit. Under the terms of
the settlement, there was no admission of liability by either party. In
exchange, we agreed to pay approximately $700,000 in cash to IpLearn, to issue
287,784 shares of common stock to IpLearn and to release all counterclaims
covered by the lawsuit. The cash payment will be made over two years. The stock
was issued on November 25, 2003. While this settlement agreement was reached
after September 30, 2003, the litigation that gave rise to the settlement
agreement existed at the balance sheet date of September 30, 2003. Accordingly,
we recognized expense of $1.6 million during the quarter ended September 30,
2003, and for the nine months ended December 31, 2003, representing the
settlement amount of approximately $1.5 million and legal fees of approximately
$0.1 million. No such settlement occurred during the three and nine months ended
December 31, 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 during
the quarter ended September 30, 2003, and for the nine months ended December 31,
2003, representing the write-down of the LearningByte intangible to zero. No
such loss occurred during the three and nine months ended December 31, 2002.
Restructuring Charge (Recovery)
During the three months ended December 31, 2003, we recognized a restructuring
recovery of $53,000 reflecting the adjustment of certain restructuring expenses
previously recorded. During the quarter, we successfully sublet one of our
leased facilities earlier than had previously been expected and on terms more
favorable to us. This event, along with minor adjustments to the amounts due
under the other leases included in the 2002 Restructuring (discussed below),
resulted in a net recovery of $246,000. This recovery was partially offset by
expense resulting from an unfavorable change in foreign currency translation
assumptions of $161,000 and additional expenses of $32,000 recognized in
conjunction with the 2003 Restructuring (discussed below). During the nine
months ended December 31, 2003, we recognized a restructuring charge of $3.4
million which was comprised of the $3.5 million restructuring charge recognized
during the quarter ended September 30, 2003 offset by a $36,000 restructuring
recovery recognized during the three months ended June 30, 2003 and the $53,000
restructuring recovery recognized during the three months ended December 31,
2003. During the three and nine months ended December 31, 2002, we recognized a
restructuring recovery of $83,000 reflecting the reversal of certain
restructuring expenses previously accrued as a result of a change in certain
lease assumptions.
During the quarter ended September 30, 2003, we 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 and the subsequent adjustments to the restructuring liability.
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. During
the three months ended December 31, 2003, we paid net lease-related cash
payments of $356,000 related to this component of the restructuring liability.
Additionally, we recognized a non-cash adjustment of $20,000 to write-off
amounts accrued in the 2002 Restructuring for purchase accounting adjustments
made to one of the leases acquired as a result of the LearningByte
International, Inc. acquisition. We recognized a net recovery of $85,000 related
to this component of the restructuring liability as a result of the favorable
sub-lease event and unfavorable foreign currency translation assumptions
discussed above. The remaining accrued liability (net of anticipated sub-lease
proceeds) of $7.5 million 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 reduction in development activities in the United States. These
reductions resulted in severance charges of $268,000. During the three
months ended December 31, 2003, we paid $50,000 in termination payments and
recognized an additional restructuring expense of $1,000 related to this
component of the restructuring liability. The remaining accrued liability
of $4,000 will be paid during the three months ending March 31, 2004.
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. During
the three months ended December 31, 2003, we paid facilities-related cash
payments of $96,000 and recognized an additional restructuring expense of
$35,000 as a result of additional unanticipated costs. The remaining
accrued liability of $20,000 is expected to be paid during the three months
ending March 31, 2003.
o Asset Disposal Costs - In conjunction with the closure of the India
facility, we disposed of, or removed 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. During
the three months ended December 31, 2003, we recognized a non-cash
adjustment of $137,000 related to the disposal of this equipment and a
restructuring recovery of $4,000 as a result of more favorable disposal
terms than expected. The remaining costs to remove the leasehold
improvements are estimated to be $19,000 and are expected to be paid during
the three months ending March 31, 2003.
Net Loss Before Cumulative Effect of Accounting Change
Net loss before cumulative effect of accounting change increased by 74% to $3.1
million in the three months ended December 31, 2003 from $1.8 million in the
three months ended December 31, 2002. For the nine months ended December 31,
2003, net loss before cumulative effect of accounting change increased by 89% to
$17.7 million from $9.4 million for the nine months ended December 31, 2002. The
net loss before cumulative effect of accounting change for the nine months ended
December 31, 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, 2003, 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. During the nine-month period ended
December 31, 2003, no events or circumstances occurred that would necessitate
the interim testing of goodwill impairment.
Net Loss
Net loss increased by 74% to $3.1 million in the three months ended December 31,
2003 from $1.8 million in the three months ended December 31, 2002. For the nine
months ended December 31, 2003, net loss decreased by 70% to $17.8 million from
$59.6 million for the nine months ended December 31, 2002. The net loss for the
nine months ended December 31, 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 $11.4 million for the nine months
ended December 31, 2003 and $9.9 million for the nine months ended December 31,
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 $10.1 million at December 31, 2003 was
due primarily to a change in the billing terms of one of our significant
customers. Deferred revenues decreased from $6.3 million at March 31, 2003 to
$3.5 million at December 31, 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 $2.2 million in the nine months
ended December 31, 2003 as compared to $1.1 million for the nine months ended
December 31, 2002. The net increase reflects a decrease in proceeds from
maturities of marketable securities during the nine months ended December 31,
2003 offset by a decrease in restricted cash requirements.
Cash provided by financing activities totaled $14.3 million in the nine months
ended December 31, 2003 and $3.7 million in the nine months ended December 31,
2002. The increase in cash from financing activities reflects the private
placement of stock in September 2003 resulting in 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.
In December 2001, we 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. In December 2003, this Loan Agreement was
renewed to extend the term to December 17, 2004. As collateral under the Loan
Agreement, we granted a security interest in all of our 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 December 31, 2003, we borrowed approximately $8.0 million under this line of
credit. This entire loan balance was subsequently repaid on January 2, 2004. At
December 31, 2003, we were in compliance with all specified loan covenants.
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 to the investors the option to
purchase up to 2,083,334 additional shares of common stock and warrants to
purchase up to 729,167 additional shares of common stock under the same terms
and conditions as the original issuance. The investors in the original issuance
had until January 29, 2004 to elect to purchase the additional shares and
warrants. We granted the investors an extension of such option to February 27,
2004. 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 we are unable to reach a
satisfactory resolution of our dispute with EDS and EDS refuses to honor its
obligations under its contract with us, 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, and we are unable to achieve
similar reductions in our operating expenses, we may require additional
financing in the near future in order to continue operations. 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. Other than the existing line
of credit, 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 an effect on our
financial position or operating results.
In December 2003, the Financial Accounting Standards Board ("FASB") issued a
revised Statement of Financial Accounting Standards ("SFAS") No. 132, Employers'
Disclosures about Pensions and Other Postretirement Benefits - An Amendment of
FASB Statements No. 87, 88, and 106. SFAS No. 132, as revised, increases the
existing disclosure requirements pertaining to pension and benefit plans in both
annual and interim filings. The provisions of SFAS No. 132 are applicable for
annual periods ending after December 15, 2003 and interim periods beginning
after December 15, 2003. The adoption of SFAS No. 149 will not have an effect on
our 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 $236.1 MILLION AT
DECEMBER 31, 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. For the nine
months ended December 31, 2003, we had a net loss of $17.7 million and our
accumulated deficit as of December 31, 2003 was $236.1 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 HAS 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 third fiscal quarter of 2004, EDS accounted for 41.2% and Circuit City
accounted 10.2% of our total revenues of $10.6 million; our five largest
customers accounted for 67.5% of our total revenues during that same period. 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.
We recently received a letter from EDS alleging that we are in material default
under the agreement between the two companies that is the source of all of our
revenues from EDS. While we believe that all alleged instances of default are
either wholly without merit or completely cured, EDS maintains that it has the
ability to terminate the agreement and has informed us that it may do so. We
believe that EDS does not have the ability to terminate the agreement. If we are
unable to reach a mutually agreeable business resolution regarding this matter,
and EDS refuses to comply with its payment and other obligations under the
contract, we intend to pursue all breach of contract and other claims that we
have against EDS. If EDS were to purport to terminate its agreement with us, we
could experience a material adverse effect on our financial position, results of
operations, and cash flows. As a result of the dispute, we are instituting a
plan that would require significant expense reductions including headcount
reductions and an attempt to renegotiate our real property leases or terminate
them altogether. The lease terminations have yet to be negotiated and cannot be
assured.
IN ANY QUARTER, A DELAY IN RECEIVING PAYMENT FROM A KEY CUSTOMER COULD HARM OUR
PERFORMANCE.
In the third fiscal quarter of 2004, our five largest customers accounted for
67.5% of our total revenue of $10.6 million. We expect that for the foreseeable
future, 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 lose any of these customers or if any of these customers delay any
future payments.
In particular, we rely on significant quarterly payments from EDS. If we are
unable to reach a mutually agreeable business resolution regarding our dispute
with EDS and EDS refuses to comply with its payment and other obligations under
the contract, we may experience a material adverse effect on our business,
financial condition and results of operations.
WE HAVE A SIGNIFICANT BUSINESS PRESENCE IN INDIA AND RISKS ASSOCIATED WITH DOING
BUSINESS THERE COULD DISRUPT OR HARM OUR BUSINESS.
In order to reduce costs associated with course development, we have established
a significant presence in India through the addition of several new employees
from two organizations we acquired in fiscal 2002. As of December 31, 2003, we
had 166 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, we continue 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.
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. 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 49% of our total revenues for the
nine months ended December 31, 2003. Our ability to recognize revenues from
custom courses depends upon our customers providing us with subject matter
experts, content and prompt acceptance of our work through each stage of
development. Accordingly, if customers do not meet all project deadlines in a
timely manner, we will not be able to recognize the revenues associated with
that project, which would harm our operating results.
In addition, if the expected number of participants do not sign up for a course,
our ability to recognize revenues will be delayed, which could also harm our
operating results in any quarter. Participant registration depends in large part
on the promotional activities of our customers. If customers fail to take
necessary measures to require employee enrollment in courses or if they fail to
promote the course effectively to persons outside their organization, our
ability to recognize revenues and our operating results, could be harmed.
THE NEW AND EMERGING E-LEARNING MARKET MAKES IT DIFFICULT TO EVALUATE OUR
BUSINESS AND FUTURE PROSPECTS.
We commenced operations in April 1996 and did not begin to generate significant
revenues until fiscal 1999. In the first nine months of fiscal 2004, we had
revenues of $33.4 million and expenses of $51.3 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.
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 up 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 12 months; however, if we are unable to reach a satisfactory resolution of
our dispute with EDS and EDS refuses to honor its obligations under its contract
with us, 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, and we are unable to achieve similar reductions in our operating
expenses, we may require additional financing in the near future in order to
continue operations. 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.
The terms of the private placement completed on September 8, 2003 provide to the
investors the option to purchase up to 2,083,334 additional shares of common
stock and warrants to purchase up to 729,167 additional shares of common stock
under the same terms and conditions as the original issuance. The investors in
the original issuance had until January 29, 2004 to elect to purchase the
additional shares and warrants. We granted the investors an extension of such
option to February 27, 2004. The sale of additional equity could result in
dilution to our stockholders.
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. 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 may not be able to detect and correct all errors
before releasing our products commercially and these undetected errors could be
significant. If these undetected errors or performance problems in our existing
or future products are discovered in the future or if known errors considered
minor by us are considered serious by our customers, we may experience a
decrease in 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. We face
competition in this regard from other companies, but we believe that we maintain
good relations with our employees, and none of our employees are members of
organized labor groups. Our failure to
attract and retain sufficient skilled personnel may limit the rate at which we
can grow, which will harm our business and financial performance.
THE GROWTH OF OUR BUSINESS REQUIRES WIDE ACCEPTANCE OF E-LEARNING SOLUTIONS.
The market for e-learning solutions is new and rapidly evolving. A number of
factors could impact the acceptance of our e-learning solutions, including:
o historic reliance on traditional education methods;
o limited allocation of our customers' and prospective customers' education
budgets to e-learning; and
o ineffective use of online learning solutions.
Our e-learning solutions are new, largely untested and less familiar to
prospective customers than more established education methods. If the market for
e-learning fails to develop or develops more slowly than we expect, we will not
achieve our growth and revenue targets and our stock price will likely decline.
WE MAY NOT HAVE ADEQUATE RESOURCES TO COMPETE EFFECTIVELY, ACQUIRE AND RETAIN
CUSTOMERS AND ATTAIN FUTURE GROWTH IN THE HIGHLY COMPETITIVE E-LEARNING MARKET.
The e-learning market is evolving quickly and is subject to rapid technological
change, shifts in customer demands and evolving learning methodologies. As a
result, customers and potential customers have more choices. This challenges us
to distinguish our offerings. If we fail to adapt to changes and competition in
our industry, we may lose existing customers or fail to gain new customers. No
single competitor accounts for a dominant market share, yet competition is
intense. We compete primarily with:
o third-party suppliers of instructor-led education and learning;
o internal education departments; and
o other suppliers of technology-based learning solutions.
Due to the high 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 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.
In addition to the legal proceedings discussed above, 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 any of these matters could
significantly negatively impact our financial position and results of operations
and could divert significant management resources.
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. 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 December 31, 2003, we had cash and cash equivalents of $23.4 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 December 31, 2003 would cause the fair value of these
investments to change by an immaterial amount. Declines in interest rates over
time would result in lower interest income.
Foreign Currency and Exchange Rate Risk
Almost all of our revenues recognized to date have been denominated in U.S.
dollars and are primarily from the United States. However, a portion of our
future revenue may be derived from international customers. Revenues from these
customers may be denominated in the local currency of the applicable countries.
As a result, our operating results could become subject to significant foreign
currency fluctuations based upon changes in exchange rates in relation to the
U.S. dollar.
Furthermore, as we engage in business outside the United States, changes in
exchange rates relative to the U.S. dollar could make us less competitive in
international markets. Although we will continue to monitor our foreign currency
exposure, and may use financial instruments to limit this exposure, there can be
no assurance that exchange rate fluctuations will not have a materially negative
impact on our business.
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 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 November 25, 2003, we issued a total of 287,784 shares of common stock to
IpLearn and IpLearn's attorney in conjunction with the settlement of patent
litigation. DigitalThink did not receive any proceeds for this issuance. 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
None.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
Exhibit
Number Description
2.1 Agreement and Plan of Reorganization among and between DigitalThink,
LearningByte International and Merger Sub, dated August 14, 2001 (1)
2.2 Agreement and Plan of Merger and Reorganization dated April 16, 2003, by
and among DigitalThink, Inc., Buffalo Bill Acquisition Corp., Horn
Interactive, Inc. and the shareholders of Horn Interactive, Inc. (2)
3.1 Amended and Restated Certificate of Incorporation (3)
3.2 Bylaws of DigitalThink, Inc. (4)
4.1 Preferred Stock Rights Agreement, dated as of March 31, 2003 between
DigitalThink, Inc. and Mellon Investor Services, LLC, including the
Certificate of Designation, the form of Rights Certificate and the Summary
of Rights attached thereto as Exhibits A, B and C, respectively. (5)
4.2 Securities Purchase Agreement dated as of September 8, 2003 (6)
4.3 Registration Rights Agreement dated as of September 8, 2003 (7)
4.4 Form of Warrant to Purchase Common Stock (8)
10.1 Amended and Restated Loan and Security Agreement dated December 17, 2003
between Silicon Valley Bank and DigitalThink, Inc.
10.2 Settlement and License Agreement dated November 24, 2003 between IpLearn,
LLC and DigitalThink, Inc.
10.3 Share Allotment Agreement dated November 24, 2003 between IpLearn, LLC,
Daniel S. Mount and DigitalThink, Inc.
10.4 Employment Agreement between DigitalThink, Inc and Lawrence D. Blair dated
September 23, 2003
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 of Chief Executive Officer pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
32.2 Certification of Chief Financial Officer pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
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(1) Incorporated by reference to exhibit 99.1 filed with our Current Report on
Form 8-K dated August 22, 2001.
(2) Incorporated by reference to our Current Report on Form 8-K dated April 16,
2003.
(3) Incorporated by reference to exhibit 3.1 filed with our Annual Report on
Form 10-K for the fiscal year ended March 31, 2002.
(4) Incorporated by reference to exhibit 3.3 filed with our Annual Report on
Form 10-K for the fiscal year ended March 31, 2003.
(5) Incorporated by reference to our Form 8-A/A dated March 31, 2003.
(6) Incorporated by reference to exhibit 4.1 filed with our Registration
Statement filed on Form S-3 (File No. 333-108939).
(7) Incorporated by reference to exhibit 4.2 filed with our Registration
Statement filed on Form S-3 (File No. 333-108939).
(8) Incorporated by reference to exhibit 4.3 filed with our Registration
Statement filed on Form S-3 (File No. 333-108939).
(b) Reports on Form 8-K:
1) We filed a Current Report on Form 8-K dated October 22, 2003 reporting
under Items 7 and 12 to furnish a press release dated October 22, 2003 in
which we announced our financial results for the second quarter ended
September 30, 2003.
2) We filed a Current Report on Form 8-K dated November 14, 2003 reporting
under Item 5 to report the tentative settlement with IpLearn to license
IpLearn's technology and settle patent litigation.
3) We filed a Current Report on Form 8-K dated November 26, 2003 reporting
under Item 5 to report the final settlement with IpLearn to license
IpLearn's technology and settle patent litigation.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
DIGITALTHINK, INC.
(Registrant)
Date: February 17, 2004 /s/ MICHAEL W. POPE
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Michael W. Pope
Chief Executive Officer, President and Director
(Principal Executive Officer)
Date: February 17, 2004 /s/ ROBERT J. KROLIK
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Robert J. Krolik
Chief Financial Officer
(Principal Financial and Accounting Officer)