<PAGE>
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 October 31, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from _____________ to _____________
Commission file number 000-26209
Ditech Communications Corporation
(Exact name of registrant as specified in its charter)
Delaware 94-2935531
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
825 East Middlefield Road
Mountain View, California 94043
(650) 623-1300
(Address, including zip code, and telephone number, including area code,
of registrant's executive offices)
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 past 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to the filing requirements for
the past 90 days.
YES [ X ] NO [ ]
As of November 30, 1999, 13,282,222 shares of the Registrant's common stock were
outstanding.
1
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DITECH COMMUNICATIONS CORPORATION
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements
Statements of Operations
THREE MONTHS AND SIX MONTHS ENDED OCTOBER 31, 1999 AND 1998 3
Condensed Balance Sheets
AS OF OCTOBER 31, 1999 AND APRIL 30, 1999 4
Statements of Cash Flows
SIX MONTHS ENDED OCTOBER 31, 1999 AND 1998 5
Notes to Financial Statements 6
ITEM 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 9
ITEM 3 Qualitative and Quantitative Disclosures About Market Risk 26
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings 27
ITEM 2. Changes in Securities and Use of Proceeds 27
ITEM 3. Defaults Upon Senior Securities 27
ITEM 4. Submission of Matters to a Vote of Security Holders 27
ITEM 5. Other Information 28
ITEM 6. Exhibits and Reports on Form 8-K 28
Signatures 28
</TABLE>
2
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PART I. FINANCIAL INFORMATION
ITEM I. Financial Statements
Ditech Communications Corporation
Statements of Operations
(in thousands, except per share data)
(unaudited)
<TABLE>
<CAPTION>
Three months ended Six months ended
Oct. 31, Oct. 31, Oct. 31, Oct. 31,
1999 1998 1999 1998
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Revenues $26,027 $5,814 $35,798 $10,939
Cost of goods sold 7,526 2,704 11,665 5,112
-------- -------- -------- --------
Gross margin 18,501 3,110 24,133 5,827
-------- -------- -------- --------
Operating expenses:
Sales and marketing 2,106 1,307 3,841 2,592
Research and development 1,237 1,016 2,378 1,864
General and administrative 1,150 551 2,007 992
-------- -------- -------- --------
Total operating expenses 4,493 2,874 8,226 5,448
-------- -------- -------- --------
Income from operations 14,008 236 15,907 379
-------- -------- -------- --------
Other income/(expense)
Interest income 152 57 215 105
Interest expense 3 193 175 373
-------- -------- -------- --------
Total other income/(expense) 149 (136) 40 (268)
-------- -------- -------- --------
Income before income taxes 14,157 100 15,947 111
Provision for income taxes 5,941 40 6,692 44
-------- -------- -------- --------
Net income 8,216 60 9,255 67
Accretion of mandatorily redeemable preferred
stock to redemption value - 372 99 734
-------- -------- -------- --------
Net income (loss) attributable to common stockholders $8,216 ($312) $9,156 ($667)
-------- -------- -------- --------
-------- -------- -------- --------
Net income (loss) per share - basic $0.68 ($0.09) $0.90 ($0.20)
-------- -------- -------- --------
-------- -------- -------- --------
Net income (loss) per share - diluted $0.61 ($0.09) $0.74 ($0.20)
-------- -------- -------- --------
-------- -------- -------- --------
Number of shares used in per share calculations:
Basic 12,040 3,411 10,200 3,295
-------- -------- -------- --------
-------- -------- -------- --------
Diluted 13,445 3,411 12,348 3,295
-------- -------- -------- --------
-------- -------- -------- --------
</TABLE>
The accompanying notes are an integral part of these unaudited financial
statements.
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Ditech Communications Corporation
Condensed Balance Sheets
(in thousands)
<TABLE>
<CAPTION>
October 31, April 30,
1999 1999
-------------------- -----------------
<S> <C> <C>
(unaudited)
ASSETS
Current assets
Cash and cash equivalents $59,176 $3,114
Accounts receivable, net of allowance for doubtful
accounts of $250 at October 31, 1999 and
$100 at April 30, 1999 17,118 3,068
Inventories, net 4,038 4,606
Prepaids and other current assets 1,225 663
---------- ----------
Total current assets 81,557 11,451
Property and equipment, net 2,144 1,538
Other assets 3,556 1,341
---------- ----------
Total assets $87,257 $14,330
---------- ----------
---------- ----------
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities
Accounts payable $4,729 $2,559
Accrued expenses 1,842 1,454
Income taxes payable 5,176 417
Deferred revenue 1,065 531
Current portion of long-term obligations 64 1,186
---------- ----------
Total current liabilities 12,876 6,147
Long-term obligations 43 6,264
Deferred income taxes 34 4
---------- ----------
Total liabilities 12,953 12,415
---------- ----------
Redeemable preferred stock - 25,258
Common stock 91,755 3,090
Deferred stock compensation (1,064) (1,229)
Accumulated deficit (16,387) (25,204)
---------- ----------
Total stockholders' equity (deficit) 74,304 (23,343)
---------- ----------
Total liabilities and stockholders' equity (deficit) $87,257 $14,330
---------- ----------
---------- ----------
</TABLE>
The accompanying notes are an integral part of these unaudited financial
statements.
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DITECH COMMUNICATIONS CORPORATION
STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
<TABLE>
<CAPTION>
Six months ended
October 31,
-------------------------
1999 1998
-------- --------
<S> <C> <C>
Cash flows from operating activities:
Net income $9,255 $67
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 762 174
Deferred income taxes (203) (193)
Amortization of deferred stock compensation 165 -
Changes in assets and liabilities:
Accounts receivable (14,051) (382)
Inventories 568 (2,719)
Prepaids and other current assets (328) (235)
Income taxes payable 5,245 237
Accounts payable 2,169 1,375
Accrued expenses 131 (180)
Deferred revenue 535 2,214
-------- --------
Net cash provided by operating activities 4,248 358
-------- --------
Cash flows from investing activities:
Purchase of property and equipment (889) (242)
Other assets (3,114) (109)
-------- --------
Net cash used by investing activities (4,003) (351)
-------- --------
Cash flows from financing activities:
Repurchase of common stock (4) -
Principal payments on notes payable (7,313) (250)
Principal payments on capital leases (30) (35)
Redemption of series A mandatorily redeemable preferred stock (19,655) -
Proceeds from issuance of common stock 82,787 -
Proceeds from exercise of stock options 32 688
-------- --------
Net cash provided by financing activities 55,817 403
-------- --------
Net increase in cash and cash equivalents 56,062 410
Cash and cash equivalents, beginning of period 3,114 3,433
-------- --------
Cash and cash equivalents, end of period $59,176 $3,843
-------- --------
-------- --------
</TABLE>
The accompanying notes are an integral part of these unaudited financial
statements.
5
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DITECH COMMUNICATIONS CORPORATION
NOTES TO FINANCIAL STATEMENTS
1. DESCRIPTION OF BUSINESS
Ditech Communications Corporation ("Ditech" or the "Company") designs,
develops and markets echo cancellation equipment and optical
communications products for use in building and expanding
telecommunications and cable communications networks. The Company has
established a direct sales force that sells its products in the U.S.
and internationally. The Company operates in a single business segment.
2. SUMMARY OF SIGNIFICANT ACCOUNTING PRINCIPLES
Basis of Presentation
The accompanying financial statements at October 31, 1999 and for the
three and six month periods ended October 31, 1999 and 1998, together
with the related notes, are unaudited but include all adjustments
(consisting only of normal recurring adjustments) which, in the opinion
of management, are necessary for a fair presentation, in all material
respects, of the financial position and the operating results and cash
flows for the interim date and periods presented. Results for the
interim period ended October 31, 1999 are not necessarily indicative of
results for the entire fiscal year or future periods. These financial
statements should be read in conjunction with the financial statements
and related notes thereto for the year ended April 30, 1999 included in
the Company's October 5, 1999 Registration Statement on Form S-1 filed
with the Securities and Exchange Commission, file number 333-86691.
Computation of Earnings (Loss) per Share
Basic earnings per share is calculated based on the weighted average
number of shares of common stock outstanding during the period less
shares subject to repurchase, which are considered contingently
issuable shares. Diluted earnings per share is calculated based on the
weighted average number of shares of common stock and common stock
equivalents outstanding, including the dilutive effect of stock
options, using the treasury stock method, common stock subject to
repurchase and the assumed conversion of all outstanding shares of
Series B Mandatorily Redeemable Preferred Stock.
Comprehensive Income
There was no difference between the Company's net income and its total
comprehensive income for the three and six month periods ended October
31, 1999 or 1998.
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3. INVENTORIES
Inventories, net consisted of (in thousands):
<TABLE>
<CAPTION>
Oct. 31, April 30,
1999 1999
-------- ---------
<S> <C> <C>
Raw materials and work-in-progress $2,568 $2,362
Finished goods 1,470 2,244
-------- --------
Total $4,038 $4,606
-------- --------
-------- --------
</TABLE>
4. PUBLIC OFFERINGS
On June 9, 1999, the Company completed its initial public offering of
3,000,000 shares of common stock and subsequently sold an additional
450,000 shares pursuant to the underwriters' over allotment option. As
a result, the Company raised a total of $34.0 million after underwriter
fees and other issuance costs ($400,000 of which was incurred in Fiscal
1999). The Company used the net proceeds from the offering to redeem
all shares of series A mandatorily redeemable preferred stock for $19.7
million, complete the purchase of the Company's core echo cancellation
technology for $3.0 million, and retire the long-term note payable to a
bank for $7.3 million. In addition, all outstanding shares of series B
mandatorily redeemable preferred stock converted into common stock
based on a conversion ratio of 2 shares of common stock for every 3
shares of series B mandatorily redeemable preferred stock.
On October 5, 1999 the Company completed a public offering in which it
sold 1,000,000 shares of its common stock. As a result, the Company
raised a total of $48.4 million after underwriting fees and other
issuance costs.
5. SEGMENT INFORMATION
The Company has adopted the Financial Accounting Standards Board's
Statement of Financial Accounting Standards No. 131 "Disclosures about
Segments of an Enterprise and Related Information" ("SFAS No.131) which
was effective for the Company's fiscal year beginning May 1, 1998. This
statement supercedes Statement of Financial Accounting Standards No. 14
"Financial Reporting for Segments of a Business Enterprise." SFAS No.
131 changes current practice under Statement No. 14 by establishing a
new framework on which to base segment reporting and also requires
interim reporting of segment information.
The Company markets its products primarily to customers in the United
States who are in the telecommunications industry. Management uses one
measurement of profitability and does not disaggregate its business for
internal reporting. The Company's revenues by geographic area are
summarized as follows (in thousands):
<TABLE>
<CAPTION>
Three months ended Six months ended
Oct. 31, Oct. 31, Oct. 31, Oct. 31,
1999 1998 1999 1998
-------- -------- -------- --------
<S> <C> <C> <C> <C>
United States $24,001 $5,809 $32,683 $10,787
Mexico 19 - 390 5
Rest of World 2,007 5 2,725 147
-------- -------- -------- --------
$26,027 $5,814 $35,798 $10,939
-------- -------- -------- --------
-------- -------- -------- --------
</TABLE>
7
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International sales are entirely comprised of export sales.
6. LITIGATION
In June 1999, the Company received a favorable ruling from an
arbitration panel in the matter related to Antec Corporation's alleged
breach of a purchase contract. Subsequent to the favorable ruling, the
Company was notified by Antec's counsel of its intent to contest the
arbitrator's decision. In August 1999, the Company and Antec reached a
final settlement in which the Company received a minor settlement
award. Additionally, the Company and Antec entered into a patent
license agreement. The Company recognized $1.9 million of revenue in
the quarter ended October 31, 1999 associated with the fixed license
fee payable in fiscal 2000.
7. SUBSEQUENT EVENT
On December 9, 1999, the Company announced an agreement to acquire
substantially all the assets of Telinnovation Service Corporation
and Telinnovation Partners (collectively "Telinnovation") of Mountain
View, California in exchange for 600,000 shares of the Company's
common stock. The acquisition, which is valued at approximately
$69 million, will be accounted for using the purchase method. It is
anticipated that the acquisition will close in the fiscal quarter
ending January 31, 2000. The closing of this acquisition is subject
to the Company and Telinnovation meeting certain closing conditions,
including the assignment of Telinnovation customer contracts to the
Company. If any of these conditions are not met, the acquisition may
not close.
8
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
THE FOLLOWING DISCUSSION AND ANALYSIS SHOULD BE READ IN CONJUNCTION WITH OUR
FINANCIAL STATEMENTS AND NOTES THERETO INCLUDED IN OUR REGISTRATION STATEMENT ON
FORM S-1 FILED WITH THE SECURITIES AND EXCHANGE COMMISSION, FILE NUMBER
333-86691. THE DISCUSSION IN THIS QUARTERLY REPORT ON FORM 10-Q CONTAINS
FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES, SUCH AS
STATEMENTS OF OUR PLANS, OBJECTIVES, EXPECTATIONS AND INTENTIONS. OUR ACTUAL
RESULTS COULD DIFFER MATERIALLY FROM THOSE DISCUSSED HERE (SEE "FUTURE GROWTH
AND OPERATING RESULTS SUBJECT TO RISK" BELOW).
OVERVIEW
Ditech designs, develops and markets equipment used in building and expanding
telecommunications and cable communications networks. Our products fall into two
categories, echo cancellation equipment and equipment that enables and
facilitates communications over fiber optic networks. To date, the vast majority
of our revenue has been derived from sales of our echo cancellation products. We
began sales of our fourth generation echo cancellation products in February
1999. We began sales of our first optical communications product in September
1996.
In November 1998, we acquired the echo cancellation technology that we
previously licensed from Telinnovation. We acquired this technology for a total
purchase price of 166,666 shares of our common stock and $2.96 million in
cash.In addition, we paid royalties to Telinnovation on the sales of our
products incorporating this technology until the $2.96 million cash portion of
the purchase price was paid from the proceeds of our initial public offering in
June 1999. The purchased technology will be amortized over a period of five
years.
Revenue is recognized when a product has been shipped, no material vendor
obligations remain outstanding, and collection of the resulting receivable is
probable. In the event that we defer revenue recognition due to uncertainty
about collectibility or the existence of a material vendor obligation such as
installation, we recognize the revenue when the uncertainty is removed or the
obligation is fulfilled. We offer a five year warranty on all of our products.
The warranty generally provides that we will repair or replace any defective
product prior to the passage of five years from the invoice date.
To date, the vast majority of our revenue has been derived from sales of our
echo cancellation products. In fiscal 1997, fiscal 1998, fiscal 1999 and the
first six months of fiscal 2000, we derived approximately 99.5%, 94.1%, 93.7%
and 92.3%, respectively, of our revenue from the sale of our echo cancellation
products. We expect that a substantial majority of our revenue will continue to
come from sales of our echo cancellation products for the foreseeable future.
We have established a direct sales force that sells to our customers in the U.S.
and internationally. We also intend to expand the use of sales agents, systems
integrators, original equipment manufacturers and distributors to sell and
market our products
9
<PAGE>
internationally. In addition, we have entered into an agreement with an original
equipment manufacturer for distribution of our optical communications products
and are exploring the possibility of entering into others. We generally expect
that margins will be higher on our newer products than on our more established
products, and that margins on our new products will decline as competition from
competing products becomes more intense. In addition, we expect that gross
margins on products that we sell through original equipment manufacturers will
generally be less than gross margins on direct sales. Gross margins in any one
period may not be indicative of gross margins for future periods.
Historically the majority of our sales have been to customers in the U.S. These
customers accounted for over 91% of our revenue in the first six months of
fiscal 2000, over 86% of our revenue in fiscal 1999 and over 93% in fiscal 1998.
However, sales to some of our customers in the U.S. may result in our products
eventually being deployed internationally, especially in the case of any
original equipment manufacturer that distribute overseas. To date, substantially
all of our international sales have been export sales and denominated in U.S.
dollars.
Our revenue historically has come from a small number of customers. Our five
largest customers accounted for over 75% of our revenue in the first six
months of fiscal 2000, 65% of our revenue in fiscal 1999 and over 75% of our
revenue in fiscal 1998. Qwest accounted for 53% of our revenue in the first
six months of fiscal 2000, and 42% of our revenue in fiscal 1999 and in
fiscal 1998. Our four next largest customers accounted collectively for 25%
of our revenue in the first six months of fiscal 2000, 23% of our revenue in
fiscal 1999 and 38% of our revenue in fiscal 1998. MCI accounted for $7.6
million or more than 50%, of our revenue in fiscal 1997, but only $1.4
million, or approximately 11%, of our revenue in fiscal 1998. This reduction
began shortly before the acquisition of MCI by Worldcom. In the first quarter
of fiscal 2000 we received a substantial unforecasted order from one of our
largest customers for deployment of our Broadband Echo Cancellation System.
We expect this order to result in an incremental $15 million of revenue in
fiscal 2000. In the second quarter of fiscal 2000 we shipped in excess of
half of this order and expect to ship the balance in the third quarter of
fiscal 2000.
We have entered into an agreement to license certain of our optical technology
to Antec Corporation for $1.9 million payable in fiscal 2000, all of which was
recognized as revenue in the second quarter of fiscal 2000, plus per unit
royalties.
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, the components of the
results of operations, as reflected in the Company's statement of operations, as
a percentage of sales.
10
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<TABLE>
<CAPTION>
Three months ended Six months ended
Oct. 31, Oct. 31, Oct. 31, Oct. 31,
1999 1998 1999 1998
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Revenue 100.0% 100.0% 100.0% 100.0%
Cost of goods sold 28.9 46.5 32.6 46.7
-------- -------- -------- --------
Gross margin 71.1 53.5 67.4 53.3
-------- -------- -------- --------
Operating expenses:
Sales and marketing 8.1 22.5 10.7 23.7
Research and development 4.8 17.5 6.7 17.0
General and administrative 4.4 9.5 5.6 9.1
-------- -------- -------- --------
Total operating expenses 17.3 49.5 23.0 49.8
-------- -------- -------- --------
Income from operations 53.8 4.0 44.4 3.5
Other income/(expense), net 0.6 (2.3) 0.1 (2.5)
-------- -------- -------- --------
Income before income taxes 54.4 1.7 44.5 1.0
Provision for income taxes 22.8 0.7 18.7 0.4
-------- -------- -------- --------
Net Income 31.6% 1.0% 25.8% 0.6%
-------- -------- -------- --------
-------- -------- -------- --------
</TABLE>
THREE AND SIX MONTHS ENDED OCTOBER 31, 1999 AND 1998
REVENUE. Revenue increased to $26.0 million in the second quarter of fiscal 2000
from $5.8 million in the second quarter of fiscal 1999. Revenue for the first
half of fiscal 2000 was $35.8 million, compared to $10.9 million in the first
half of fiscal 1999. The primary reason for these increases was continued market
acceptance and sales of our fourth generation echo cancellation products offset
in part by decreased unit sales of our third generation echo cancellation
products. We expect unit sales of our third generation echo cancellation
products to continue to decrease as our customers transition to our fourth
generation echo cancellation products. Revenues for the second quarter of fiscal
2000 were also favorably impacted by the recognition of a one-time license fee
of $1.9 million for our optical amplifier technology and shipment of
approximately half of an unforecasted order received at the end of the first
quarter for our fourth generation echo cancellation systems. Although we expect
to continue rapid sales growth in the near term, we expect long term growth
rates to trend down.
COST OF GOODS SOLD. Cost of goods sold consists of direct material costs,
personnel costs for test and quality assurance, and the cost of licensed
technology incorporated into our products. Cost of goods sold increased to $7.5
million in the second quarter of fiscal 2000 from $2.7 million in the second
quarter of fiscal 1999. Cost of goods sold increased to $11.7 million for the
first half of fiscal 2000, compared to $5.1 million in the first half of fiscal
1999. The primary reason for these increases was costs associated with increased
unit sales of our fourth generation echo cancellation products.
GROSS MARGIN. Gross margin increased to 71.1% in the second quarter of fiscal
2000 from 53.5% in the second quarter of fiscal 1999. Gross margin increased
to 67.4% in the first half of fiscal 2000 from 53.3% in the first half of
fiscal 1999. The primary factors causing these increases were the mix of
products sold and the ability to greatly increase capacity without increasing
manufacturing overhead as a result of our outsourcing of manufacturing. In
addition, margins were favorably impacted by the reduction in product
royalties as a result of completing the acquisition of our core echo
cancellation technology subsequent to our initial public offering in June
1999 and the recognition of $1.9 million of license revenue with minimal
costs.
SALES AND MARKETING. Sales and marketing expenses primarily consist of personnel
costs including commissions and costs associated with customer service, travel,
trade shows and outside consulting services. Sales and marketing expenses
increased to $2.1 million in the second quarter of fiscal 2000 from $1.3 million
in the second quarter of fiscal 1999. Sales and marketing expenses increased to
$3.8 million in the first half of fiscal 2000 from $2.6 million in the first
half of fiscal 1999.
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The primary cause for these increases was increases in personnel and related
costs, including travel, to support expansion of our customer service functions
and marketing efforts of our products both domestically and internationally,
including the formation of new direct and OEM channels partnerships. We plan to
continue to increase our expenditures in sales and marketing in order to broaden
distribution of our products both domestically and internationally.
RESEARCH AND DEVELOPMENT. Research and development expenses primarily consist of
personnel costs, contract consultants, and equipment and supplies used in the
development of echo cancellation and optical communications products. Research
and development expense increased to $1.2 million in the second quarter of
fiscal 2000 from $1.0 million in the second quarter of fiscal 1999. Research and
development expense increased to $2.4 million in the first half of fiscal 2000
from $1.9 million in the first half of fiscal 1999. These increases were
primarily related to increased personnel and related costs and increased
materials and consulting costs associated with both our echo cancellation
products and optical communications products. We expect research and development
expenses to continue to grow in future periods as we enhance current products
and develop new products.
GENERAL AND ADMINISTRATIVE. General and administrative expenses primarily
consist of personnel costs for corporate officers and finance personnel, and
legal, accounting and consulting costs. General and administrative expenses
increased to $1.2 million in the second quarter of fiscal 2000 from $551,000 in
the second quarter of fiscal 1999. General and administrative expenses increased
to $2.0 million in the first half of fiscal 2000 from $1.0 million in the first
half of fiscal 1999. These increases were primarily due to amortization of
deferred compensation in connection with stock options previously granted,
personnel costs to support the growth in the business, provisons for bad debt
due to expanded credit risk associated with increasing receivables balances,
insurance premiums for directors and officers insurance obtained as a result of
becoming a public company and increased legal costs incurred to fully resolve an
arbitration matter. We expect general and administrative expenses to increase as
a result of the additional reporting requirements and expenses incurred as a
public company and increased infrastructure costs as we continue to expand our
business.
OTHER INCOME/(EXPENSE). Other income/(expense) consists of interest income on
our invested cash and cash equivalents balances offset by interest expense
attributable to our outstanding debt and capital leases. Other income/(expense)
was $149,000 in the second quarter of fiscal 2000, an improvement from other
expense of ($136,000) in the second quarter of fiscal 1999. Other
income/(expense) was $40,000 in the first half of fiscal 2000, an improvement
from other expense of ($268,000) in the first half of fiscal 1999. The
improvement was primarily attributable to increased interest income on funds
invested from our initial and secondary public offering and a reduction in
interest expense due to the retirement of our outstanding debt.
INCOME TAXES. Income taxes consist of federal and state income taxes. The
effective tax rate in the second quarter and first half of fiscal 2000 was 42%
as compared to 40% in the second quarter and first half of fiscal 1999. The
higher tax rate in fiscal 2000 was due to the existence of certain nondeductible
expenses, primarily amortization of deferred compensation in connection with
stock options previously granted. We expect that our ongoing effective tax rate
should remain at approximately 42%. To the extent that cash reserves are
invested in tax free municipal securities, there could be a reduction in the
effective tax rate.
STOCK-BASED COMPENSATION
With respect to certain stock option grants in fiscal 1999, we have recorded
deferred compensation of $1,320,000 for the fiscal year ended April 30, 1999. We
amortized approximately $82,000 of the deferred compensation in the second
quarter and $165,000 in the first half of fiscal 2000 and will amortize the
remainder over the vesting period of the related stock options.
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LIQUIDITY AND CAPITAL RESOURCES
From the beginning of fiscal 1994 through the date of the recapitalization in
March 1997, we satisfied the majority of our liquidity requirements through cash
flow generated from operations. In connection with our recapitalization in March
1997, we had a net infusion of cash of approximately $4 million after using the
proceeds from issuance of preferred stock and subordinated debt to repurchase
common stock. Following our recapitalization, we satisfied the majority of our
liquidity requirements through cash flow generated from operations and funds
received upon exercises of stock options. In June and October 1999, we completed
our initial and follow-on public offerings as described below.
Operating activities in the first half of fiscal 2000 generated $4.2 million in
cash from operations, primarily due to increased operating profits and to a
lesser extent due to increased income taxes payable, accounts payable and
deferred revenue and a decrease in inventory, partially offset by an increase in
accounts receivable and other current assets.
Investing activities used $4.0 million in the first half of fiscal 2000,
primarily due to purchases of property and equipment to support increased
headcount and development efforts, and the purchase of our echo technology from
Telinnovation in the first quarter of fiscal 2000 for $3.0 million.
Financing activities generated $55.8 million of cash in the first half of fiscal
2000, primarily from the net proceeds from our initial public offering in June
1999 and our follow-on offering in October 1999. These increases in financing
activities were partially offset by the application of the net proceeds of our
initial public offering and principal payments on our capital leases. The
application of the net proceeds from our initial public offering that reduced
cash from financing was as follows:
<TABLE>
<S> <C>
Net proceeds................................................. $34.4 million
Less:
Redemption of series A mandatorily redeemable
preferred stock....................................... 19.7 million
Retirement of long term debt............................ 7.3 million
Remaining after application of net proceeds.................. $ 7.4 million
</TABLE>
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As of October 31, 1999, we had cash and cash equivalents of $59.2 million as
compared to $3.1 million at April 30, 1999, primarily as a result of the receipt
and application of the net proceeds from our initial and follow-on public
offerings. In addition, we have a line of credit with the ability to borrow the
lesser of $3.0 million or 80% of qualified accounts receivable. At October 31,
1999, borrowings of $3.0 million were available and no borrowings were
outstanding. Borrowings under the line bear an interest rate of the lesser of
LIBOR plus 1.25% or the prime rate. The line of credit expires in August of
2000. During the third and fourth quarter of fiscal 1998 and the second quarter
of fiscal 1999, we were in violation of certain minimum cash flow and ratio
covenants related to the credit line. At April 30, 1999, we were in violation of
a quick ratio covenant due primarily to the accrual of costs associated with our
initial public offering. The bank has waived all of these violations. We also
had approximately $350,000 available at October 31, 1999 under a separate
operating lease line of credit.
We have no material commitments other than obligations under operating leases,
particularly our facility lease.
We anticipate significant increases in working capital on a period to period
basis primarily as a result of planned increased product sales and higher
relative levels of inventory and receivables. We will also continue to expend
funds on property and equipment related to the expansion of systems
infrastructure and office equipment to support our growth and lab and test
equipment to support on-going research and development operations.
We believe that we will be able to satisfy our cash requirements for at least
the next twelve months from a combination of existing cash reserves, cash flow
from operations and our bank line of credit.
IMPACT OF EUROPEAN MONETARY CONVERSION
We are aware of the issues associated with the changes in Europe resulting from
the formation of a European economic and monetary union. One change resulting
from this union required EMU member states to irrevocably fix their respective
currencies to a new currency, the euro, as of January 1, 1999, at which date the
euro became a functional legal currency of these countries. During the next
three years, business in the EMU member states will be conducted in both the
existing national currency, such as the French franc or the Deutsche mark, and
the euro. As a result, companies operating or conducting business in EMU member
states will need to ensure that their financial and other software systems are
capable of processing transactions and properly handing these currencies,
including the euro.
Based on our assessment to date, we do not expect the conversion to the euro to
have a material impact on our internal systems or our product sales. To date we
have experienced limited sales activities in the European economies,
substantially all of which have been in U.S. dollars. We will take appropriate
corrective actions based on the results of our assessment.
14
<PAGE>
IMPACT OF THE YEAR 2000 COMPUTER PROBLEM
The Year 2000 computer problem refers to the potential for system and processing
failures of date-related data as a result of computer-controlled systems using
two digits rather than four to define the applicable year. For example, computer
programs that have time-sensitive software may recognize a date represented as
"00" as the year 1900 rather than the year 2000. Additionally, the month of
February will have 29 days in the year 2000. These problems could result in a
system failure or miscalculations causing disruptions of operations, including
among other things, a temporary inability to process transactions, send
invoices, or engage in similar normal business activities.
STATE OF READINESS OF OUR PRODUCTS
We have been testing our existing products for use in the year 2000 and beyond.
Based on the results of these tests, we believe that the following products are
Year 2000 compliant:
<TABLE>
<CAPTION>
Echo Cancellation Products Optical Communications Products
- -------------------------- -------------------------------
<S> <C>
18T1 Optical amplifiers
18E1 DWDM Monitor
Quad T1 Optical telemetry system
Quad E1 Transponder
Broadband Echo Cancellation System WDM Multiplexer/Demultiplexer
4SA
</TABLE>
Certain of our customers may be using older versions of the above products and,
based on our testing, we believe they will not be required to upgrade those
products to become year 2000 compliant. In addition, we have not tested certain
products for year 2000 compliance that we no longer market, some of which might
still be in use.
STATE OF READINESS OF OUR INTERNAL SYSTEMS
We may be affected by year 2000 issues related to non-compliant internal systems
developed by us or by third-party vendors. We have obtained confirmation from
all of our key system vendors that these systems we are using are year 2000
compliant. We completed our assessment of our internal systems in the first
quarter of fiscal 2000 and are not aware of any Year 2000 problem relating to
any of these internal systems. We believe that we do not have any systems
material to our operations that contain embedded chips that are not Year 2000
compliant.
Our internal operations and business are also dependent upon the
computer-controlled systems of third parties such as suppliers, customers and
service providers. We believe that absent a systemic failure outside of our
control, such as a prolonged loss of electrical or telephone service, Year 2000
problems at such third parties will not have a material impact on us.
15
<PAGE>
COST
Based on our assessment to date, we do not anticipate that costs associated with
remediating our non-compliant products or internal systems will be material.
RISKS
Any failure to make our products Year 2000 compliant could result in:
- a decrease in sales of our products;
- an increase in allocation of resources to address Year 2000 problems
of our customers without additional revenue commensurate with such
dedication of resources; and/or
- an increase in litigation costs relating to losses suffered by
our customers due to such Year 2000 problems.
Failures of our internal systems could temporarily prevent us from processing
orders, issuing invoices, and developing products, and could require us to
devote significant resources to correcting such problems. Due to the general
uncertainty inherent in the Year 2000 computer problem, resulting from the
uncertainty of the Year 2000 readiness of third-party suppliers and vendors, we
are unable to determine at this time whether the consequences of Year 2000
failures will have a material impact on our business, results of operations, and
financial condition.
CONTINGENCY PLANS
We have developed and continue to monitor contingency plans relative to our
internal systems, including identifying manual work-arounds and additional
sources of components should our vendors experience unforeseen Year 2000
problems.
FUTURE GROWTH AND OPERATING RESULTS SUBJECT TO RISK
WE DEPEND ON A LIMITED NUMBER OF CUSTOMERS FOR OUR PRODUCTS, THE LOSS OF ANY ONE
OF WHICH COULD CAUSE OUR REVENUE TO DECREASE
Our revenue historically has come from a small number of customers. A customer
may stop buying our products or significantly reduce its orders for our products
for a number of reasons, including the acquisition of a customer by another
company. If this happens, our revenue and business would be materially and
adversely affected. Our five largest customers accounted for over 75% of our
revenue in the first six months of fiscal 2000, over 65% of our revenue in
fiscal 1999 and over 75% of our revenue in fiscal 1998. Qwest accounted for 53%
of our revenue in the six months of fiscal 2000, 42%
16
<PAGE>
of our revenue in fiscal 1999 and in fiscal 1998. Our four next largest
customers accounted collectively for 25% of our revenue in the first six months
of fiscal 2000, 23% of our revenue in fiscal 1999 and 38% of our revenue in
fiscal 1998. MCI accounted for $7.6 million, or more than 50%, of our revenue in
fiscal 1997, but only $1.4 million, or approximately 11%, of our revenue in
fiscal 1998. This reduction began shortly before the acquisition of MCI by
Worldcom.
For example, we received a substantial unforecasted order from one of our
largest customers for deployment of our Broadband Echo Cancellation System.
We expect this order to result in an incremental $15 million of revenue in
fiscal 2000. If all or a portion of the remaining items to be shipped against
this order were cancelled or delayed, our expected operating results for the
next quarter would be adversely affected, which could adversely affect our
stock price.
OUR OPERATING RESULTS HAVE FLUCTUATED SIGNIFICANTLY IN THE PAST, AND WE
ANTICIPATE THAT THEY MAY CONTINUE TO DO SO IN THE FUTURE, WHICH COULD ADVERSELY
AFFECT OUR STOCK PRICE
Our quarterly operating results have fluctuated significantly in the past and
may fluctuate in the future as a result of several factors, some of which are
outside of our control. If revenue declines in a quarter, whether due to a loss
in revenue or a delay in recognizing expected revenue, our operating results
will be adversely affected because many of our expenses are relatively fixed. In
particular, sales and marketing, research and development and general and
administrative expenses do not change significantly with variations in revenue
in a quarter. Adverse changes in our operating results could adversely affect
our stock price.
OUR REVENUE MAY VARY FROM PERIOD TO PERIOD. Factors that could cause our
revenue to fluctuate from period to period include:
- the timing or cancellation of orders from, or shipments to, existing
and new customers;
- the timing of new product and service introductions by us, our
customers, our partners or our competitors;
- competitive pressures;
- variations in the mix of products offered by us; and
- variations in our sales or distribution channels.
In particular, sales of our echo cancellation products, which historically have
accounted for the vast majority of our revenue, have typically come from our
major customers ordering large quantities when they deploy a switching center.
Consequently, we may get one or more large orders in one quarter from a customer
and then no orders the next quarter. As a result, our revenue may vary
significantly from quarter to quarter.
17
<PAGE>
In addition, the sales cycle for our products is typically lengthy. Before
ordering our products our customers perform significant technical evaluations,
which typically last up to 90 days in the case of our echo cancellation products
and up to 180 days in the case of our optical communications products. Once an
order is made, delivery times can vary depending on the product ordered, with
delivery times for optical communications products exceeding those for our echo
cancellation products. As a result, revenue forecasted for a specific customer
for a particular quarter may not occur in that quarter. Because of the potential
large size of our customers' orders, this would adversely affect our revenue for
the quarter.
OUR EXPENSES MAY VARY FROM PERIOD TO PERIOD. Many of our expenses do not vary
with our revenue. Factors that could cause our expenses to fluctuate from
period to period include:
- the extent of marketing and sales efforts necessary to promote and
sell our products;
- the timing and extent of our research and development efforts;
- the availability and cost of key components for our products; and
- the timing of personnel hiring.
If we incur such additional expenses in a quarter in which we do not experience
increased revenue, our profitability would be adversely affected and we may even
incur losses for that quarter.
WE ANTICIPATE THAT AVERAGE SELLING PRICES FOR OUR PRODUCTS WILL DECLINE IN THE
FUTURE, WHICH COULD ADVERSELY AFFECT OUR PROFITABILITY
We expect that the price we can charge our customers for our products will
decline as new technologies become available and as competitors lower prices
either as a result of reduced manufacturing costs or a strategy of cutting
margins to achieve or maintain market share. As a result, we may face reduced
profitability and perhaps losses in future periods. We expect price reductions
to be more pronounced in the market for our echo cancellation products, at least
in the near term, due to more established competition for these products. While
we intend to reduce our manufacturing costs in an attempt to maintain our
margins and to introduce enhanced products with higher selling prices, we may
not execute these programs on schedule. In addition, our competitors may drive
down prices faster or lower than our planned cost reduction programs. Even if we
can reduce our manufacturing costs, many of our operating costs will not decline
immediately if revenue decreases due to price competition.
IF WE DO NOT SUCCESSFULLY DEVELOP AND INTRODUCE OUR NEW PRODUCTS, OUR
PRODUCTS MAY BECOME OBSOLETE
18
<PAGE>
If we do not successfully develop and introduce our new products and our
existing products become obsolete due to product introductions by competitors,
our revenue will decline. Our ability to maintain and increase revenue in the
future will depend primarily on:
- continued acceptance of our new Broadband Echo Cancellation System
and 4SA echo cancellation products;
- our successful introduction and sale of our new optical monitors,
telemetry systems, transponders and four-channel wavelength division
multiplexing products; and
- our successful development and introduction of our sixteen-channel
wavelength division multiplexing products.
However, we may not be able to successfully produce or market our new products
in commercial quantities, complete product development when anticipated, or
increase sales. These risks are of particular concern when a new generation
product is introduced. As a result, while we believe we will achieve our product
introduction dates, they may be delayed. For the year ended April 30, 1999,
sales of our 18T1 and 18E1 echo cancellation products accounted for the vast
majority of our revenue, and for the first six months of fiscal 2000 accounted
for a substantial, albeit smaller, portion of our revenue due to growing
acceptance of our fourth generation echo canceller. Shipments of our optical
amplifiers began in the third quarter of calendar 1996 and accounted for
substantially all of our revenue for optical communications products during
fiscal 1999. In the past, we experienced an unforeseen delay in the development
of one of our products due to the need to design around a part that did not
function as anticipated and also when the first version of one of our optical
communications products did not fully meet customer requirements. We have in the
past experienced, and in the future may experience, similar unforeseen delays in
the development of our new products. We must devote a substantial amount of
resources in order to develop and achieve commercial acceptance of our new echo
cancellation and optical communications products. We may not be able to address
evolving demands in these markets in a timely or effective way. Even if we do,
customers in these markets may purchase or otherwise implement competing
products.
CUSTOMERS MAY DELAY ORDERS FOR OUR EXISTING PRODUCTS IN ANTICIPATION OF
NEW PRODUCTS. Our customers may delay orders for our existing products in
anticipation of the release of our or our competitors' new products. Further,
if our or our competitors' new products substantially replace the
functionality of our existing products, our existing products may become
obsolete, and we could be forced to sell them at reduced prices or even at a
loss.
IF WE ARE NOT ABLE TO DEVELOP SUBSTANTIAL REVENUE FROM SALES OF OUR OPTICAL
COMMUNICATIONS PRODUCTS, OUR ABILITY TO GROW OUR BUSINESS MAY BE SUBSTANTIALLY
IMPAIRED
To date, the vast majority of our revenue has been derived from sales of our
echo cancellation products. If we are not able to develop substantial revenue
from sales of our optical communications products, our ability to grow our
business may be substantially impaired. In fiscal 1997, fiscal 1998, fiscal 1999
and the first half of fiscal 2000,
19
<PAGE>
we derived approximately 99.5%, 94.1%, 93.7% and 92.3%, respectively, of our
revenue from the sale of our echo cancellation products. We expect that a
substantial majority of our revenue will continue to come from sales of our echo
cancellation products for the foreseeable future.
WE FACE INTENSE COMPETITION, WHICH COULD ADVERSELY AFFECT OUR ABILITY TO
MAINTAIN OR INCREASE SALES OF OUR PRODUCTS
The markets for our echo cancellation and optical communications products are
intensely competitive, continually evolving and subject to rapid technological
change. We may not be able to compete successfully against current or future
competitors, including our customers. Certain of our customers also have the
ability to internally produce the equipment that they currently purchase from
us. In such cases, we also compete with their internal product development
capabilities. We expect that competition in each of the echo cancellation and
optical communications markets will increase in the future. We may not have the
financial resources, technical expertise or marketing, manufacturing,
distribution and support capabilities to compete successfully.
One of our competitors, Nortel Networks, has announced that it is developing an
integrated switch, which would have echo cancellation capability built into it
and would therefore eliminate the need for the echo cancellation capability
provided by our products. Announcements such as these, or the commercial
availability of such switches or other competing products, may cause our
customers to delay or cancel orders for our products.
Most of our competitors and potential competitors have substantially greater
name recognition and technical, financial and marketing resources than we do.
Such competitors may undertake more extensive marketing campaigns, adopt more
aggressive pricing policies and devote substantially more resources to
developing new products than we will.
WE DEPEND ON TELINNOVATION FOR TRANSITIONAL SUPPORT OF OUR ECHO CANCELLATION
TECHNOLOGY, THE LOSS OF WHICH COULD DELAY PRODUCT DEVELOPMENT
We acquired our echo cancellation technology from Telinnovation. Prior to this
acquisition we licensed this technology from Telinnovation, which provided
engineering support for our use of this technology. We are currently focused on
increasing our knowledge of this technology so that we will be able to modify
and enhance it ourselves. If Telinnovation does not fulfill its obligations to
assist us during this transitional phase, or if we need to devote more resources
to this technology than we currently expect, our product development plans could
be delayed. In December 1999, we announced an agreement to acquire
Telinnovation, which, upon completion, should substantially mitigate this risk.
IF WE DO NOT REDUCE MANUFACTURING COSTS OF OUR PRODUCTS TO RESPOND TO
ANTICIPATED DECREASING AVERAGE SELLING PRICES, OUR ABILITY TO GENERATE PROFITS
COULD BE ADVERSELY AFFECTED
20
<PAGE>
In order to respond to increasing competition and our anticipation that average
selling prices will decrease, we are attempting to reduce manufacturing costs of
our new and existing products. If we do not reduce manufacturing costs and
average selling prices decrease, our operating results will be adversely
affected. We may not be able to successfully reduce the cost of manufacturing
our products due to a number of factors, including:
WE RELY ON A LIMITED SOURCE OF MANUFACTURING. Manufacturing of our echo
cancellation products and the electronic printed circuit board assemblies for
our optical communications products is currently outsourced to two contract
manufacturers. If we or these contract manufacturers terminate any of these
relationships, or if we otherwise establish new relationships, we may
encounter problems in the transition of manufacturing to another contract
manufacturer, which could temporarily increase our manufacturing costs and
cause product delays.
WE HAVE NO COMMERCIAL MANUFACTURING EXPERIENCE WITH OUR NEW PRODUCTS. To
date we have manufactured our pre-production optical communications products
in our facilities but not in commercial quantities. We will need to outsource
the manufacturing of these products once we begin to commercially manufacture
them. We may experience delays and other problems during the transition to
outsourcing the manufacture of these products.
WE OPERATE IN AN INDUSTRY EXPERIENCING RAPID TECHNOLOGICAL CHANGE, WHICH MAY
MAKE OUR PRODUCTS OBSOLETE
Our future success will depend on our ability to develop, introduce and market
enhancements to our existing products and to introduce new products in a timely
manner to meet our customers' requirements. The echo cancellation and optical
communications markets we target are characterized by:
- rapid technological developments;
- frequent enhancements to existing products and new product
introductions;
- changes in end user requirements; and
- evolving industry standards.
WE MAY NOT BE ABLE TO RESPOND QUICKLY AND EFFECTIVELY TO THESE RAPID
CHANGES. The emerging nature of these products and their rapid evolution will
require us to continually improve the performance, features and reliability
of our products, particularly in response to competitive product offerings.
We may not be able to respond quickly and effectively to these developments.
The introduction or market acceptance of products incorporating superior
technologies or the emergence of alternative technologies and new industry
standards could render our existing products, as well as our products
currently under development, obsolete and unmarketable. In addition, we may
have only a limited amount of time to penetrate certain markets, and we may
not be successful in achieving widespread
21
<PAGE>
acceptance of our products before competitors offer products and services
similar or superior to our products. We may fail to anticipate or respond on a
cost-effective and timely basis to technological developments, changes in
industry standards or end user requirements. We may also experience significant
delays in product development or introduction. In addition, we may fail to
release new products or to upgrade or enhance existing products on a timely
basis.
WE MAY NEED TO MODIFY OUR PRODUCTS AS A RESULT OF CHANGES IN INDUSTRY
STANDARDS. The emergence of new industry standards, whether through adoption
by official standards committees or widespread use by service providers,
could require us to redesign our products. If such standards become
widespread, and our products are not in compliance, our current and potential
customers may not purchase our products. The rapid development of new
standards increases the risk that our competitors could develop and introduce
new products or enhancements directed at new industry standards before us.
IF EMERGING COMPETITIVE SERVICE PROVIDERS AND THE TELECOMMUNICATIONS INDUSTRY AS
A WHOLE EXPERIENCE A DOWNTURN OR REDUCTION IN GROWTH RATE, THE DEMAND FOR OUR
PRODUCTS WILL DECREASE, WHICH WILL ADVERSELY AFFECT OUR BUSINESS
Our success will depend in large part on continued development and expansion of
voice and data communications networks. Development of communications networks
is driven in part by the growth of competitive service providers that emerged as
a result of the Telecommunications Act of 1996 and privatization of the
telecommunications industry on a global scale. We are subject to risks of growth
constraints due to our current and planned dependence on emerging competitive
and privatized overseas service providers. These potential customers may be
constrained for a number of reasons, including their limited capital resources,
changes in regulation and consolidation.
WE DEPEND ON TEXAS INSTRUMENTS AS THE SOLE SOURCE OF A COMPONENT USED IN OUR
PRODUCTS, THE LOSS OF WHICH COULD DELAY PRODUCT SHIPMENTS
We rely on Texas Instruments as the sole source of the digital signal processors
that we use in our echo cancellation products. We have no guaranteed supply
arrangements with Texas Instruments. Any extended interruption in the supply of
digital signal processors from Texas Instruments would affect our ability to
meet scheduled deliveries of our echo cancellation products to customers. If we
are unable to obtain a sufficient supply of digital signal processors from Texas
Instruments, we could experience difficulties in obtaining alternative sources
or in altering product designs to use alternative components. Resulting delays
or reductions in product shipments could damage customer relationships, and we
could lose customers and orders.
OUR BUSINESS IS GROWING, WHICH IS DIVERTING OUR MANAGEMENT'S ATTENTION FROM THE
DAY TO DAY OPERATIONS OF OUR BUSINESS AND MAY REDUCE OUR ABILITY TO FOCUS ON
FUTURE BUSINESS OPPORTUNITIES
22
<PAGE>
We anticipate significantly expanding our business capacity to address potential
growth in our customer base and market opportunities. Expansion of our business
may strain our management personnel, operations and resources. Growth in our
customer base may require us to improve our predictions of what customers are
likely to need and when they will need it, which may also further strain our
sales and marketing personnel. Continued growth will require us to hire more
engineering, sales, marketing, operations, customer support and services, and
administrative personnel and scale our research and development capability,
which we may not be able to do. We may also experience problems in integrating
new personnel into our corporate culture. In addition, new hires may not be
productive during the time that they are being integrated into our business.
WE MAY EXPERIENCE UNFORESEEN PROBLEMS AS WE DIVERSIFY OUR INTERNATIONAL CUSTOMER
BASE, WHICH WOULD IMPAIR OUR ABILITY TO GROW OUR BUSINESS
Historically, we have sold mostly to customers in North America. We currently
are contemplating the expansion of our international presence, which will
require additional hiring of personnel for the overseas market and other
expenditures. Our planned expansion overseas may not be successful. As we expand
our sales focus further into international markets, we will face additional and
complex issues that we may not have faced before, such as addressing currency
fluctuations, manufacturing overseas and import/export controls, which will put
additional strain on our management personnel. In the past, substantially all of
our international sales have been denominated in U.S. dollars, however, in the
future, we may be forced to denominate a greater amount of international sales
in foreign currencies. The number of installations we will be responsible for is
likely to increase as a result of our continued international expansion. In the
past, we have experienced difficulties installing one of our echo cancellation
products overseas. In addition, we may not be able to establish more
relationships with original equipment manufacturers. If we do not, our ability
to increase sales could be materially impaired.
IF WE LOSE THE SERVICES OF ANY MEMBER OF OUR SENIOR MANAGEMENT OR KEY TECHNICAL
PERSONNEL, OR ARE UNABLE TO RETAIN OR ATTRACT ADDITIONAL TECHNICAL PERSONNEL,
OUR ABILITY TO CONDUCT AND EXPAND OUR BUSINESS WILL BE IMPAIRED
We depend heavily on Tim Montgomery, our President and Chief Executive
Officer, and on other key management and technical personnel, for the conduct
and development of our business and the development of our products. If we
lose the services of any one of these people for any reason, this could
adversely affect our ability to conduct and expand our business and to
develop new products. We do not have employment contracts with any of our
executive officers other than Mr. Montgomery, Ms. Toni Bellin, our Vice
President of Operations, and Marc Schwager, our Vice President of Marketing.
We believe that our future success will depend in large part upon our
continued ability to attract, retain and motivate highly skilled employees,
who are in great demand. However, we may not be able to do so.
A SMALL GROUP OF ENTITIES OWN OR CONTROL A SUBSTANTIAL AMOUNT OF OUR STOCK AND
MAY, THEREFORE, INFLUENCE OUR AFFAIRS
23
<PAGE>
A small group of entities own or control a substantial amount of our stock and
may, therefore, influence our affairs. As a result, these stockholders as a
group will be able to substantially influence the management and affairs of
Ditech and, if acting together, would be able to influence most matters
requiring the approval by our stockholders, including the election of directors,
any merger, consolidation or sale of all or substantially all of our assets and
any other significant corporate transactions. The concentration of ownership may
also delay or prevent a change of control of Ditech at a premium price if these
stockholders oppose it.
OUR ABILITY TO COMPETE SUCCESSFULLY WILL DEPEND, IN PART, ON OUR ABILITY TO
PROTECT OUR INTELLECTUAL PROPERTY RIGHTS, WHICH WE MAY NOT BE ABLE TO PROTECT
We rely on a combination of patents, trade secrets, copyright and trademark
laws, nondisclosure agreements and other contractual provisions and technical
measures to protect our intellectual property rights. Nevertheless, such
measures may not be adequate to safeguard the technology underlying our echo
cancellation and optical communications products. Employees, consultants and
others who participate in the development of our products may also breach their
agreements with us regarding our intellectual property, and we may not have
adequate remedies for any such breach. In addition, we may not be able to
effectively protect our intellectual property rights in certain countries. We
may, for a variety of reasons, decide not to file for patent, copyright or
trademark protection outside of the United States. We also realize that our
trade secrets may become known through other means not currently foreseen by us.
Notwithstanding our efforts to protect our intellectual property, our
competitors may be able to develop products that are equal or superior to our
products without infringing on any of our intellectual property rights.
OUR PRODUCTS EMPLOY TECHNOLOGY THAT MAY INFRINGE ON THE PROPRIETARY RIGHTS OF
THIRD PARTIES, WHICH MAY EXPOSE US TO LITIGATION
Although we do not believe that our products infringe the proprietary rights of
any third parties, third parties may still assert infringement or invalidity
claims (or claims for indemnification resulting from infringement claims)
against us. Such assertions could materially adversely affect our business,
financial condition and results of operations. In addition, irrespective of the
validity or the successful assertion of such claims, we could incur significant
costs in defending against such claims.
IF WE VIOLATE OUR BANK DEBT COVENANTS, WE MAY NOT BE ABLE TO UTILIZE OUR BANK
LINE OF CREDIT
In the past we were in violation of certain minimum cash and ratio covenants of
a line of credit. If operating results do not meet certain thresholds, we may be
in violation of these covenants in the future. If we are in violation of these
covenants, we may not be able to utilize our bank line of credit.
24
<PAGE>
ACQUISITIONS AND INVESTMENTS MAY ADVERSELY AFFECT OUR BUSINESS
We regularly review acquisition and investment prospects that would complement
our existing product offerings, augment our market coverage, secure supplies of
critical materials or enhance our technological capabilities. Acquisitions or
investments could result in a number of financial consequences, including:
- potentially dilutive issuances of equity securities;
- large one-time write-offs;
- reduced cash balances and related interest income;
- higher fixed expenses which require a higher level of revenues to
maintain gross margins;
- the incurrence of debt and contingent liabilities; and
- amortization expenses related to goodwill and other intangible
assets.
Furthermore, acquisitions involve numerous operational risks, including:
- difficulties in the integration of operations, personnel,
technologies, products and the information systems of the acquired
companies;
- diversion of management's attention from other business concerns;
- diversion of resources from our existing businesses, products or
technologies;
- risks of entering geographic and business markets in which we have
no or limited prior experience; and
- potential loss of key employees of acquired organizations.
OUR OR THIRD PARTIES' COMPUTER SYSTEMS MAY FAIL IN THE YEAR 2000, WHICH WOULD
DELAY OUR PRODUCT DEVELOPMENT AND THE MANUFACTURING OF OUR PRODUCTS
Failure of our computer systems could adversely affect our product development
processes and/or our ability to cost-effectively manage Ditech during the time
required to fix such problems. In addition, computer failures could cause the
manufacturer of our products to incur delays in manufacturing, or our customers
to postpone or cancel orders for our products. Although our analysis to date has
not detected any significant risks with our internal systems, nor those of third
parties we rely upon,
25
<PAGE>
unforeseen problems in our own computers and embedded systems and from
customers, our manufacturers, suppliers and other organizations with which we
conduct transactions worldwide may arise. These statements constitute year 2000
disclosures under federal law. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations - Impact of the Year 2000 Computer
Problem" for more information on the status of our preparation relating to this
issue.
ITEM 3. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK
We maintain investment portfolio holdings of various short-term securities.
Because of the short-term duration of the financial instruments held by us, we
do not believe that our financial instruments are materially sensitive to
changes in interest rates.
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<PAGE>
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None.
ITEM 2. CHANGES IN SECURTIES AND USE OF PROCEEDS
In June 1999, the Company issued an aggregate of 3,450,000 shares of its common
stock as part of its initial public offering completed on June 9, 1999. The
shares were registered on a Registration Statement on Form S-1, registration
number 333-75063, declared effective on June 9, 1999. The Company's initial
public offering generated net proceeds to the Company, after underwriter fees
and other offering expenses, of $34.0 million which the Company used for the
following purposes (in millions):
<TABLE>
<S> <C>
Retirement of series A mandatorily redeemable
preferred stock $19.7
Retirement of notes payable 7.3
Purchase of echo technology 3.0
</TABLE>
The balance of the offering proceeds were used to fund operating expenses and
fixed asset additions in the first and second quarters of fiscal 2000.
Stock options aggregating 20,000 shares were exercised by an executive officer
of the Company in August, 1999 for $16,500 in cash. The shares issued were not
registered under the Securities Act of 1933, as amended, in reliance on Section
4(2).
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not Applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company held its annual meeting of shareholders on October 7, 1999. The
following actions were voted upon at such meeting:
<TABLE>
<CAPTION>
Affirmative Negative Votes
Votes Votes Withheld
----------- ---------- ----------
<S> <C> <C> <C>
Re-election of two directors to hold office until 2002:
Gregory M. Avis 9,055,609 1,500
George J. Turner 9,055,609 1,500
Ratifcation of PricewaterhouseCoopers as the Company's independent accountants
for the fiscal year ending April, 30, 2000:
9,042,879 11,030 3,200
</TABLE>
27
<PAGE>
ITEM 5. OTHER INFORMATION
Not Applicable.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibit
10.11.1* Third Amendment to Credit Agreement, dated August 13,
1999 between Ditech and BankBoston, N.A.
10.21*+ Patent License Agreement, dated as of August 13,
1999, between Ditech and Antec Corporation
27 Financial data schedule for the period ended October
31, 1999
* Incorporated by reference from the exhibits with
corresponding numbers from the Registrant's Registration
Statement (No. 333-86691), filed on September 8, 1999.
+ Confidential treatment has been requested for a portion
of this exhibit. The agreement has been filed seperately
with the Commission.
(b) Reports on Form 8-K
No reports on form 8-K were filed during the quarter ended October 31, 1999.
SIGNATURE
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.
Ditech Communications Corporation
Date: December 14, 1999 By: /s/ William J. Tamblyn
-------------------------
William J. Tamblyn
Vice President Finance and Chief
Financial Officer (Principal
Financial and Accounting Officer)
28
<PAGE>
INDEX TO EXHIBITS
(a) Exhibit
10.11.1* Third Amendment to Credit Agreement, dated August 13,
1999 between Ditech and BankBoston, N.A.
10.21*+ Patent License Agreement, dated as of August 13,
1999, between Ditech and Antec Corporation
27 Financial data schedule for the period ended October
31, 1999
* Incorporated by reference from the exhibits with
corresponding numbers from the Registrant's
Registration Statement (No. 333-86691), filed on
September 8, 1999.
+ Confidential treatment has been requested for a portion
of this exhibit. The agreement has been filed seperately
with the Commission.
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE BALANCE
SHEET AS OF OCTOBER 31, 1999 AND THE STATEMENTS OF OPERATIONS FOR THE THREE AND
SIX MONTH PERIODS ENDED OCTOBER 31, 1999 AND IS QUALIFIED IN ITS ENTIRETY BY
REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C> <C>
<PERIOD-TYPE> 3-MOS 6-MOS
<FISCAL-YEAR-END> APR-30-2000 APR-30-2000
<PERIOD-START> AUG-01-1999 MAY-01-1999
<PERIOD-END> OCT-31-1999 OCT-31-1999
<CASH> 59,176 0
<SECURITIES> 0 0
<RECEIVABLES> 17,368 0
<ALLOWANCES> 250 0
<INVENTORY> 4,038 0
<CURRENT-ASSETS> 81,557 0
<PP&E> 2,144<F1> 0
<DEPRECIATION> 0 0
<TOTAL-ASSETS> 87,257 0
<CURRENT-LIABILITIES> 12,876 0
<BONDS> 0 0
0 0
0 0
<COMMON> 90,691 0
<OTHER-SE> (16,387) 0
<TOTAL-LIABILITY-AND-EQUITY> 87,257 0
<SALES> 24,167 33,938
<TOTAL-REVENUES> 26,027 35,798
<CGS> 7,526 11,665
<TOTAL-COSTS> 7,526 11,665
<OTHER-EXPENSES> 4,343 8,076
<LOSS-PROVISION> 150 150
<INTEREST-EXPENSE> 3 175
<INCOME-PRETAX> 14,157 15,947
<INCOME-TAX> 5,941 6,692
<INCOME-CONTINUING> 8,216 9,255
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> 8,216 9,255
<EPS-BASIC> 0.68 0.90
<EPS-DILUTED> 0.61 0.74
<FN>
<F1>Represents net plant and equipment.
</FN>
</TABLE>
