<PAGE>
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 July 31, 2000
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 August 31, 2000, 29,371,481 shares of the Registrant's common stock were
outstanding.
1
<PAGE>
DITECH COMMUNICATIONS CORPORATION
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
PART I. FINANCIAL INFORMATION
ITEM 1. Consolidated Financial Statements
Consolidated Statements of Operations
THREE MONTHS ENDED JULY 31, 2000 AND 1999 3
Consolidated Balance Sheets
AS OF JULY 31, 2000 AND APRIL 30, 2000 4
Consolidated Statements of Cash Flows
THREE MONTHS ENDED JULY 31, 2000 AND 1999 5
Notes to the Consolidated 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 21
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings 22
ITEM 2. Changes in Securities and Use of Proceeds 22
ITEM 3. Defaults Upon Senior Securities 22
ITEM 4. Submission of Matters to a Vote of Security Holders 22
ITEM 5. Other Information 22
ITEM 6. Exhibits and Reports on Form 8-K 22
Signatures 23
</TABLE>
2
<PAGE>
PART I. FINANCIAL INFORMATION
ITEM I. Consolidated Financial Statements
Ditech Communications Corporation
Consolidated Statements of Operations
(in thousands, except per share data)
(unaudited)
<TABLE>
<CAPTION>
Three months
ended July, 31
--------------------------------------
2000 1999
------------- -------------
<S> <C> <C>
Revenues $43,529 $9,771
Cost of goods sold 13,043 4,139
------------- -------------
Gross profit 30,486 5,632
------------- -------------
Operating expenses
Sales and marketing 2,630 1,735
Research and development 5,105 1,141
General and administrative 1,549 858
Amortization of goodwill and
purchased technology 2,154 --
------------- -------------
Total operating expenses 11,438 3,734
------------- -------------
Income from operations 19,048 1,898
------------- -------------
Other income/(expense)
Interest income 1,160 63
Interest expense (11) (172)
------------- -------------
Total other income/(expense) 1,149 (109)
------------- -------------
Income before provision for income taxes 20,197 1,789
Provision for income taxes 8,460 750
------------- -------------
Net income 11,737 1,039
Accretion of mandatorily redeemable
preferred stock to redemption value -- 99
------------- -------------
Net income attributable to
common stockholders $11,737 $940
------------- -------------
------------- -------------
Net income attributable to common
stockholders per share
Basic $0.43 $0.06
------------- -------------
------------- -------------
Diluted $0.39 $0.04
------------- -------------
------------- -------------
Number of shares used in per
share calculations
Basic 27,582 16,719
------------- -------------
------------- -------------
Diluted 30,093 22,503
------------- -------------
------------- -------------
</TABLE>
The accompanying notes are an integral part of these unaudited consolidated
financial statements.
3
<PAGE>
Ditech Communications Corporation
Consolidated Balance Sheets
(in thousands)
<TABLE>
<CAPTION>
July 31, April 30,
2000 2000
---------- ----------
(unaudited)
<S> <C> <C>
ASSETS
Current assets
Cash and cash equivalents $121,689 $88,616
Accounts receivable, net 19,978 20,349
Inventories, net 7,443 6,596
Deferred income taxes 2,288 1,839
Other current assets 1,213 352
Income taxes receivable -- 1,412
---------- ----------
Total current assets 152,611 119,164
Property and equipment, net 4,936 2,680
Purchased technology, net 23,323 24,617
Goodwill, net 74,885 10,790
Deferred income taxes 20,106 4,703
Other assets 4,682 3,198
---------- ----------
Total assets $280,543 $165,152
---------- ----------
---------- ----------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
Accounts payable $ 7,263 $5,201
Accrued expenses 15,984 4,228
Deferred revenue 2,260 2,074
Income taxes payable 4,698 --
Note payable, current portion 2,151 --
Obligations under capital lease, current portion 2,099 55
---------- ----------
Total current liabilities 34,455 11,558
---------- ----------
Obligations under capital lease, net of current portion 12 21
---------- ----------
Total liabilities 34,467 11,579
---------- ----------
Common stock 29 28
Deferred stock compensation (22,350) (21,937)
Additional paid in capital 252,297 171,119
Retained earnings 16,100 4,363
---------- ----------
Total stockholders' equity 246,076 153,573
---------- ----------
Total liabilities and stockholders' equity $280,543 $165,152
---------- ----------
---------- ----------
</TABLE>
The accompanying notes are an integral part of these unaudited consolidated
financial statements.
4
<PAGE>
DITECH COMMUNICATIONS CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
<TABLE>
<CAPTION>
Three months ended
July 31,
-------------------------
2000 1999
---------- ----------
<S> <C> <C>
Cash flows from operating activities:
Net income $11,737 $1,039
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 481 350
Increase in provision for doubtful accounts 200 --
Gain on disposal of property and equipment (2) --
Deferred income taxes (1,559) (121)
Amortization of deferred stock compensation 2,020 82
Amortization of goodwill and other
acquisition related intangible assets 2,151 --
Changes in assets and liabilities:
Accounts receivable 308 (530)
Inventories (544) 57
Other current assets (598) (213)
Income taxes receivable/payable 9,920 721
Accounts payable (419) (253)
Accrued expenses and other (444) (108)
Deferred revenue 186 (115)
---------- ----------
Net cash provided by operating activities 23,437 909
---------- ----------
Cash flows from investing activities:
Purchase of property and equipment (971) (288)
Other assets (108) (3,009)
Net cash received in purchase method
acquisitions 9,153 --
---------- ----------
Net cash provided by (used in)
investing activities 8,074 (3,297)
---------- ----------
Cash flows from financing activities:
Repurchase of common stock -- (3)
Principal payments on notes payable -- (7,313)
Principal payments on capital leases (18) (14)
Redemption of series A mandatorily
redeemable preferred stock -- (19,655)
Proceeds from issuance of common stock -- 34,377
Proceeds from employee stock plan issuances 1,580 8
---------- ----------
Net cash provided by financing activities 1,562 7,400
---------- ----------
Net increase in cash and cash equivalents 33,073 5,012
Cash and cash equivalents, beginning of period 88,616 3,114
---------- ----------
Cash and cash equivalents, end of period $121,689 $8,126
---------- ----------
---------- ----------
</TABLE>
The accompanying notes are an integral part of these unaudited consolidated
financial statements.
5
<PAGE>
DITECH COMMUNICATIONS CORPORATION
NOTES TO CONSOLIDATED 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.
2. SUMMARY OF SIGNIFICANT ACCOUNTING PRINCIPLES
Basis of Presentation
The consolidated financial statements include the accounts of Ditech
Communications Corporation and its subsidiaries. All significant
intercompany accounts and transactions have been eliminated. The
accompanying consolidated financial statements at July 31, 2000 and
for the three month periods ended July 31, 2000 and 1999, 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 July 31, 2000 are not
necessarily indicative of results for the entire fiscal year or
future periods. These consolidated financial statements should be
read in conjunction with the financial statements and related notes
thereto for the year ended April 30, 2000 included in the Company's
Annual Report on Form 10-K, as amended by Amendment No. 1 thereto on
Form 10-K/A filed with the Securities and Exchange Commission on
August 10, 2000, file number 000-26209.
Computation of Earnings 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, and common stock subject to
repurchase.
Comprehensive Income
There was no difference between the Company's net income and its total
comprehensive income for the three month periods ended July 31, 2000 or
1999.
6
<PAGE>
3. ACQUISITIONS
In the last twelve months, the Company has completed two business
acquisitions which were accounted for as purchases. The consolidated
financial statements include the operating results of each business
from the date of acquisition.
On February 1, 2000, the Company completed the acquisition of
substantially all the assets of Telinnovation Service Corporation,
Telinnovation Corporation and Telinnovation Partners (collectively
"Telinnovation") of Mountain View, California in exchange for
1,200,000 shares of the Company's common stock. A portion of these
shares are being held in escrow and will be released upon completion
of certain events.
The total value of the acquisition of approximately $69 million is
being accounted for in three discrete components. The first,
approximately $9 million related to purchased research and
development which was written off in the fourth quarter of fiscal
2000. Next, approximately $37 million related to developed
technology and goodwill which was capitalized and will be amortized
to expense over its estimated life of five years. The remaining $23
million relates to restricted shares, the cost of which was recorded
as deferred stock compensation and will be charged to the statement of
operations over the three year vesting period of the shares.
On July 25, 2000, the Company completed the acquisition of
privately-held Atmosphere Networks, Inc. of Campbell, California in
exchange for 841,897 shares of common stock and assumption of
outstanding options, with an aggregate value of $73.4 million and
$7.9 million of cash plus estimated acquisition costs of $400,000.
Atmosphere Networks is an emerging provider of optical networking
products, enabling carriers to combine various types of traffic
(voice, data and video) onto an optical network. The acquisition
has been accounted for as a purchase.
The allocation of the stock and cash purchase price is summarized
below (in thousands):
<TABLE>
<S> <C>
Net assets acquired $15,218
Established workforce 1,500
Goodwill 64,948
-----------
Total purchase price $81,666
===========
</TABLE>
In August 2000, Ditech also granted, to the employees assumed in the
Atmosphere acquisition, non-qualified stock options vesting over a four
year period, for approximately 750,000 shares of Ditech common stock
at a price representing a 50% discount to market on the date of grant.
As a result, the Company will record deferred stock compensation of
approximately $17.3 million in August 2000 which will be recognized as
expense ratably over the options' four-year vesting period. The cost
allocated to intangible assets for the acquired workforce and goodwill
will be amortized to expense over their estimated useful lives of four
years. Amortization expense of approximately $290,000 was recorded in
the quarter ending July 31, 2000.
The following unaudited pro forma financial information reflects the
results of operations for the three months ended July 31, 2000 and
1999 as if the acquisitions had occurred on May 1, 2000 and 1999,
respectively. The pro forma results of operations for the quarter
ended July 31, 2000 include three months' results of Atmosphere
Networks, and three months of amortization of goodwill, other
intangibles, and deferred stock compensation. The pro forma results
of operations for the quarter ended July 31, 1999 include three
months' results of Telinnovation, and Atmosphere Networks, the
elimination of intercompany transactions between the Company and
Telinnovation, and three months of amortization of goodwill, other
intangibles and deferred stock compensation. These pro forma results
have been prepared for comparative purposes only and do not purport
to be indicative of what operating results would have been had the
acquisitions actually taken place on May 1, 2000 and 1999, and may
not be indicative of future operating results (in thousands, except
share and per share amounts).
<TABLE>
<CAPTION>
Three months
ended July, 31
---------------------
2000 1999
--------- ---------
(UNAUDITED)
<S> <C> <C>
Pro forma financial information
Net Revenues $45,075 $10,166
--------- ---------
Income (loss) from operations 9,505 (9,859)
--------- ---------
Net income (loss) attributable to
common stockholders $ 4,414 $(7,760)
--------- ---------
Net income (loss) per share attributable
to common stockholders:
Basic $ 0.16 $ (0.42)
Diluted $ 0.14 $ (0.32)
--------- ---------
Weighted average shares:
Basic 28,367 18,360
--------- ---------
Diluted 30,952 24,544
--------- ---------
</TABLE>
7
<PAGE>
4. INVENTORIES
Inventories, net consisted of (in thousands):
<TABLE>
<CAPTION>
July 31, April 30,
2000 2000
-------- ---------
<S> <C> <C>
Raw materials $2,058 $1,717
Work in progress 661 849
Finished goods 4,724 4,030
-------- --------
Total $7,443 $6,596
-------- --------
-------- --------
</TABLE>
5. SEGMENT INFORMATION
The Company markets its products primarily to customers in the
United States who are in the telecommunications industry.
Substantially all of the Company's sales have been generated from
its echo canceller products. The Company's revenues by geographic
area are summarized as follows (in thousands):
<TABLE>
<CAPTION>
Three months ended July 31
2000 1999
-------- --------
<S> <C> <C>
United States $39,624 $8,682
Mexico 370 370
China 1,699 --
Rest of World 1,836 719
-------- --------
$43,529 $9,771
-------- --------
-------- --------
</TABLE>
International sales are entirely comprised of export sales.
6. STOCKHOLDERS' EQUITY AND STOCK SPLIT
In January 2000, the Company's Board of Directors approved a two-for-
one split of the Company's common stock that was applicable to
stockholders of record on February 1, 2000 and effective on February
16, 2000. All references to share and per-share data for all periods
presented have been adjusted to give effect to this two-for-one
stock split.
8
<PAGE>
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 RELATED NOTES THERETO FOR THE YEAR ENDED APRIL 30,
2000 INCLUDED IN FORM 10-K/A FOR THE YEAR ENDED APRIL 30, 2000 FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION ON AUGUST 10, 2000. 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 AS A RESULT OF A NUMBER OF RISKS. THESE RISKS INCLUDE:
WE HAVE A LIMITED NUMBER OF CUSTOMERS, THE LOSS OF ANY ONE OF WHICH COULD
CAUSE OUR REVENUES TO DECREASE MATERIALLY; WE EXPECT OUR REVENUES TO
FLUCTUATE AS A RESULT OF A NUMBER OF FACTORS, WHICH COULD CAUSE OUR STOCK
PRICE TO DROP; WE MAY EXPERIENCE DELAYS IN DEVELOPING NEW PRODUCTS DUE TO
UNFORESEEN TECHNICAL DIFFICULTIES, WHICH WOULD PREVENT US FROM INTRODUCING
NEW PRODUCTS AND GROWING OUR BUSINESS; WE OPERATE IN AN INDUSTRY
CHARACTERIZED BY RAPID TECHNOLOGICAL CHANGE, WHICH MAY RENDER OUR EXISTING
PRODUCTS OBSOLETE; WE RELY HEAVILY ON OUR ABILITY TO PROTECT OUR INTELLECTUAL
PROPERTY IN ORDER TO BE ABLE TO COMPETE EFFECTIVELY; AND WE HAVE JUST
ACQUIRED ATMOSPHERE NETWORKS AND WE MAY NOT BE SUCCESSFUL IN INTEGRATING ITS
PERSONNEL INTO OUR BUSINESS, WHICH WOULD HAMPER OUR ABILITY TO DEVELOP NEW
OPTICAL PRODUCTS. THESE AND OTHER RISK FACTORS ARE MORE FULLY DISCUSSED IN
"FUTURE GROWTH AND OPERATING RESULTS SUBJECT TO RISK" BELOW. IN FEBRUARY
2000, WE EFFECTED A 2-FOR-1 STOCK SPLIT OF OUR COMMON STOCK AND ALL SHARE AND
PER SHARE DATA HAVE BEEN REVISED ACCORDINGLY.
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 in
exchange for 333,332 shares of our common stock, valued at $740,000, and
$2.96 million in cash. In addition, we paid royalties to Telinnovation until
the $2.96 million cash portion of the purchase price was paid in June 1999
from the proceeds of our initial public offering. The purchased technology
is being amortized over a period of five years.
9
<PAGE>
On February 1, 2000, we completed our acquisition of substantially all of the
assets of Telinnovation in exchange for a total of 1,200,000 shares of common
stock. The acquisition is being accounted for as a purchase. The total
value of the acquisition of approximately $69 million is being accounted for
in three discrete components. The first, approximately $9 million related to
purchased research and development which was written off in the fourth
quarter of fiscal 2000. Next, approximately $37 million related to developed
technology and goodwill which was capitalized and will be amortized to
expense over its estimated life of 5 years. The remaining $23 million
relates to restricted shares, the cost of which was recorded as deferred
stock compensation and will be charged to expense over the three year vesting
period of the shares.
On July 25, 2000, we completed our acquisition of Atmosphere Networks Inc. in
exchange for a total of 841,897 shares of common stock and assumption of
outstanding options, with an aggregate value of $73.4 million and $7.9
million of cash plus estimated acquisition costs of $400,000. The
acquisition is being accounted for as a purchase. The total value of the
acquisition of approximately $82 million is comprised of approximately $15.2
million in net assets, $1.5 million associated with the value of the
established workforce and $64.9 million of goodwill from the acquisition.
The goodwill and established workforce costs were capitalized and will
be amortized over their estimated lives of four 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 1998, 1999, 2000 and the first three
months of fiscal 2001, we derived approximately 94.1%, 93.7%, 92.6% and
93.1%, 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 internationally.
10
<PAGE>
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. In
fiscal 1998, 1999, 2000 and the first three months of fiscal 2001, we derived
approximately 93%, 86%, 88% and 91%, respectively, of our revenue from U.S.
customers. 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%, 65%, 75% and 80% of our revenue in
fiscal 1998, 1999, 2000 and the first three months of fiscal 2001,
respectively. Qwest/LCI accounted for 42%, 42%, 57%, and 69% of our revenue
in fiscal 1998, 1999, 2000 and the first three months of fiscal 2001,
respectively.
11
<PAGE>
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, the components of
the results of operations, as reflected in our statement of operations, as a
percentage of sales.
<TABLE>
<CAPTION>
Three months ended
July 31,
-------------------
2000 1999
-------- --------
<S> <C> <C>
Revenue 100.0% 100.0%
Cost of goods sold 30.0 42.4
-------- --------
Gross profit 70.0 57.6
-------- --------
Operating expenses
Sales and marketing 6.0 17.7
Research and development 11.7 11.7
General and administrative 3.6 8.8
Amortization of goodwill and
purchased technology 4.9 --
-------- --------
Total operating expenses 26.2 38.2
-------- --------
Income from operations 43.8 19.4
Other income/(expense), net 2.6 (1.1)
-------- --------
Income before provision for income taxes 46.4 18.3
Provision for income taxes 19.4 7.7
-------- --------
Net Income 27.0% 10.6%
-------- --------
-------- --------
</TABLE>
THREE MONTHS ENDED JULY 31, 2000 AND 1999
REVENUE. Revenue increased to $43.5 million in the first three months of
fiscal 2001 from $9.8 million in the first three months of fiscal 2000. This
growth was largely attributable to continued market acceptance of Quad and
Broadband products.
COST OF GOODS SOLD. Cost of goods sold consists of direct material costs,
personnel costs for test and quality assurance, provisions for inventory and
warranty expenses and the cost of licensed technology incorporated into our
products. Cost of goods sold increased to $13.0 million in the first three
months of fiscal 2001 from $4.1 million in the first three months of fiscal
2000. The primary reason for the increase was costs associated with increased
unit sales of our echo cancellation products.
GROSS MARGIN. Gross margin increased to 70.0% in the first three months of
fiscal 2001 from 57.6% in the first three months of fiscal 2000. The primary
factors contributing to this increase were the elimination of product royalty
payments as a result of completing the acquisition of our core echo
cancellation technology subsequent to our initial public offering in June
1999, the change in mix of echo cancellation products to our newer quad and
broadband products and our improved leverage of our virtual manufacturing
environment.
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 $2.6 million in the first three months of
fiscal 2001 from $1.7 million in the first three months of fiscal 2000.
12
<PAGE>
The primary cause for the increase 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 $5.1 million in the first three
months of fiscal 2001 from $1.1 million in the first three months of fiscal
2000. The increase is primarily related to increased personnel and related
costs and increased materials and consulting costs associated with new
product research and development efforts on both our echo cancellation and
optical communications product lines. In addition, research and development
expenses for the first three months of fiscal 2001 included $1.9 million in
amortization of deferred stock compensation associated with our acquisition
of Telinnovation which was completed on February 1, 2000. 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 $1.5 million in the first three months of fiscal 2001 from
$858,000 in the first three months of fiscal 2000. The increase was primarily
due to increased personnel costs associated with infrastructure growth to
support business expansion and the demands of being a publicly traded
company, higher bad debt provisions due to greater collection risks
associated with international sales growth and increased insurance premiums
due to the growth in our business. 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.
AMORTIZATION OF GOODWILL AND PURCHASED TECHNOLOGY. In the first three months
of fiscal 2001, we amortized a total of $2.2 million for goodwill and
purchased technology. $1.9 million of this amortization is associated with
the acquisition of Telinnovation, which was completed on February 1, 2000.
The Atmosphere acquisition contributed approximately $300,000 of amortization
in the quarter due to the purchase closing at the end of the quarter.
However, future quarters will include approximately $4.1 million of
amortization related to Atmosphere. The cost of goodwill and purchased
technology are being amortized to expense over their estimated useful lives
of up to five years.
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
increased to $1.1 million in the first three months of fiscal 2001, an
improvement from other expense of $109,000 in the first three months of
fiscal 2000. The increase was primarily attributable to increased interest
income on funds invested from our initial and follow-on public offerings
completed in fiscal 2000 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 first three months of fiscal 2001 was 41.5% and 42%
in the first three months of fiscal 2000. We expect that our ongoing
effective tax rate should remain at approximately 41.5%.
STOCK-BASED COMPENSATION
We recorded deferred compensation of $1,320,000 as of April 30, 1999 as a
result of stock options granted in Fiscal 1999. We are amortizing the
deferred compensation over the corresponding vesting period of the stock
options. We amortized approximately $82,000 of the deferred compensation in
both of the first three months of fiscal 2001 and fiscal 2000.
Associated with the acquisition of Telinnovation in February 2000, we
recorded $22.9 million of deferred compensation related to 400,000 restricted
shares granted to the Telinnovation employees. These restricted shares are
tied to the employees' continuing employment with Ditech. The deferred
compensation is being amortized over the three year vesting period of the
restricted shares. We amortized approximately $1.9 million the first three
months of fiscal 2001.
Associated with the acquisition of Atmosphere on July 25, 2000, we recorded
$2.4 million of deferred compensation related to unvested options assumed by
us in the acquisition. This deferred compensation will be amortized to
compensation expense over the remaining two year vesting period of the
options. In connection with the acquisition of Atmosphere we issued
nonqualified stock options for approximately 750,000 shares of our common
stock at a price equal to a 50% discount from the market value of the stock
on its grant date of August 1, 2000. The discount has been recorded as
deferred compensation of $17.3 million in August 2000 and will be amortized
to compensation expense over the four year vesting period of the options.
LIQUIDITY AND CAPITAL RESOURCES
Since March 1997, we satisfied the majority of our liquidity requirements
through cash flow generated from operations, funds received upon exercise of
stock options and the proceeds from our initial and follow-on public
offerings in fiscal 2000.
In the first three months of fiscal 2001 we generated $23.4 million in cash
from operations, primarily due to increased operating profits, after
including the impact of non cash items, and to a lesser extent due to
increased income taxes payable and deferred revenue and a reduction in
accounts receivable, partially offset by an increase in inventory and other
current assets and reductions in accounts payable and accrued expenses.
Operating activities generated $909,000 in cash in the first three months of
fiscal 2000, mostly due to increased operating profits and to a lesser
extent due to increased income taxes payable, partially offset by increases
in accounts receivable and other current assets and reductions in accounts
payable and deferred revenue.
In the first three months of fiscal 2001 we generated $8.1 million in cash
from investing activities, mostly from cash assumed in the Atmosphere
acquisition, prior to payment of the cash portion of the acquisition of $7.9
million, which was paid in August 2000. Investing activities used $3.3
million in cash in the first three months of fiscal 2000 due mostly to
purchases of property and equipment and the purchase of our echo technology
from Telinnovation for $3.0 million.
In the first three months of fiscal 2001 we generated $1.6 million in cash
from financing activities, primarily due to proceeds from issuances of stock
under our stock option plan and funding related to semiannual employee stock
purchase plans. Financing activities generated $7.4 million in cash in the
first three months of fiscal 2000, mostly from the net proceeds from our
initial public offering in June 1999, partially offset by the application of
the net proceeds of that offering and principal payments on our capital
leases.
13
<PAGE>
As of July 31, 2000, we had cash and cash equivalents of $121.7 million as
compared to $88.6 million at April 30, 2000. 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 July 31, 2000, borrowings of $3.0 million
were available and no borrowings were outstanding. In August 2000, we
negotiated an increase in the line of credit to the lesser of $4.0 million or
80% of qualified accounts receivable and extended its expiration date to
August 2001.
We have no material commitments other than obligations under operating
leases, particularly our facility lease. We currently occupy approximately
49,000 square feet in the two facilities that form our Mountain View
headquarters and we anticipate taking over the remaining 11,000 square feet
in the second building in the last quarter of calendar year 2000. This
facility lease has a term of 5 years.
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 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 action based on the results of our assessment.
FUTURE GROWTH AND OPERATING RESULTS SUBJECT TO RISK
Our business and the value of our stock are subject to a number of risks,
which are set out below. If any of these risks actually occur, our business,
financial condition or operating results could be materially adversely
affected, which would likely have a corresponding impact on our common stock.
These risk factors should be carefully reviewed.
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 80%, 75%, 65% and 75% of our revenue in the first three months of fiscal
2001, and in the twelve months of fiscal years 2000, 1999, and 1998
respectively. Qwest/LCI accounted for 69%, 57%, 42% and 42%, of our revenue
in the first three months of fiscal 2001, and in the twelve months of fiscal
years 2000, 1999, and 1998 respectively. Our four next largest customers
accounted collectively for 14%, 20%, 23% and 38% of our revenue in the first
three months of fiscal 2001, and in the twelve months of fiscal years 2000,
1999, and 1998 respectively. As an example of this risk, 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.
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.
14
<PAGE>
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;
- delays outside of our control in the installation of product for our
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.
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.
15
<PAGE>
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.
We operate in an industry that experiences rapid technological
change, and if we do not successfully develop and introduce our new products
and our existing products become obsolete due to product introductions by
competitors, our revenues will decline. Our ability to maintain and increase
revenue in the future will depend primarily on:
- continued acceptance of our Broadband Echo Cancellation System;
- our successful introduction of a next generation echo cancellation
system; and
- our successful introduction and sale of our new optical amplifiers.
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. 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 WHICH WOULD DECREASE OUR REVENUES. 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.
16
<PAGE>
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 1998,
1999, 2000, and the first three months of fiscal 2001 we derived
approximately 94.1%, 93.7%, 92.6%, and 93.1% 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.
To date, the vast majority of our optical revenue has come from a
few customers, one of whom is located in the Far East. Due to our dependence
on such a small number of optical customers at this time and the political
and economic volatility in certain parts of the Far East, our optical revenue
could be subject to abrupt and unanticipated changes in demand. Until we can
diversify our optical revenue stream, both in terms of customer and
geographic mix, we may experience unexpected adverse swings in optical
revenue from quarter to quarter.
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.
IF WE DO NOT RETAIN KEY PERSONNEL FROM ACQUISITIONS, WE MAY NOT BE
ABLE TO REALIZE THE BENEFITS WE EXPECT FROM OUR ACQUISITIONS.
During the last twelve months, we completed the acquisitions of
Telinnovation and Atmosphere. We believe these acquisitions provide us with
expanded opportunities in the newly developing voice over the internet and in
packet based markets where echo cancellation will be an important issue and
in the rapidly growing optical communications market. However, our ability to
successfully execute in these new markets is greatly dependent on our ability
to retain the key personnel from Telinnovation and Atmosphere. Although we
believe that we have provided significant incentives directly linked to
continued employment over the next twelve to fifteen months, there is no
guarantee that these key employees will remain in our employment until after
we have successfully penetrated these markets, if at all.
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.
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
17
<PAGE>
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
three contract manufacturers. Until we are able to establish additional
manufacturing relationships, we may not be able to successfully reduce
manufacturing costs. In addition, 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 production delays.
WE HAVE NO COMMERCIAL MANUFACTURING EXPERIENCE WITH OUR NEW
PRODUCTS. To date we have manufactured our newer 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 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.
18
<PAGE>
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.
SOME OF THE KEY COMPONENTS USED IN OUR PRODUCTS ARE CURRENTLY
AVAILABLE ONLY FROM SOLE SOURCES, THE LOSS OF WHICH COULD DELAY PRODUCT
SHIPMENTS.
We rely on certain vendors as the sole source of certain key
components that we use in our echo cancellation products. We have no
guaranteed supply arrangements with these vendors. Any extended interruption
in the supply of these components 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 these components, 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.
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
are currently implementing our plans to expand 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
19
<PAGE>
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 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.
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. In addition,
employees, consultants and others who participate in the development of our
products may 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.
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;
20
<PAGE>
- 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.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We do not engage in any foreign currency hedging transactions, and
therefore do not believe we are subject to exchange rate risk. Our exposure
to market risk for changes in interest rates relates primarily to our cash
and cash equivalents. We maintain our invested cash and cash equivalent
portfolio holdings in various short-term securities. Because of the
short-term duration of the financial instruments held, we do not believe that
our financial instruments are materially sensitive to changes in interest
rates. Our cash and cash equivalents as of July 31, 2000 of $121.7 million
all have maturities of 35 days or less and bear an average interest rate of
4.4%. The estimated fair value of our cash and cash equivalents approximates
the principal amounts reflected above based on the short maturities of these
instruments.
21
<PAGE>
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
On July 25, 2000, Ditech issued an aggregate of 841,897 shares of its common
stock to the holders of preferred stock of Atmosphere Networks, Inc. in
connection with Ditech's acquisition of Atmosphere Networks. These shares
issued in the acquisition had a value of approximately $68.0 million in the
aggregate based on the weighted average closing price of our common stock for
the five business days preceding the completion of the acquisition on July
25, 2000. The shares were issued in reliance on Regulation D promulgated
under the Securities Act of 1933, as amended, in that they were issued
without a general solicitation and all of the preferred shareholders of
Atmosphere Networks represented that they were "accredited investors" as
defined in Regulation D. In connection with the acquisition, Ditech also
assumed the obligation of Atmosphere Networks under its outstanding options,
and these options became options to purchase Ditech common stock.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not Applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not Applicable.
ITEM 5. OTHER INFORMATION
Not Applicable.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibit
2.1(1) Agreement and Plan of Merger and Reorganization, dated as
of June 21, 2000, by and among Ditech, Oxygen Acquisition
Corporation, a Delaware corporation, and Atmosphere
Networks, Inc., a Delaware corporation.
2.2(2) Amendment to Agreement and Plan of Merger and Reorganization,
dated as of July 25, 2000, by and among Ditech, Oxygen
Acquisition Corporation, a Delaware corporation, and
Atmosphere Networks, Inc., a Delaware corporation.
3.1(3) Amended and Restated Certificate of Incorporation of Ditech.
3.2(3) Bylaws of Ditech
27.1 Financial Data Schedule
(1) Incorporated by reference to the correspondingly numbered
exhibit to Ditech's Annual Report on Form 10-K, File No. 000-26209,
for the year ending April 30, 2000, filed with the Securities and
Exchange Commission on July 31, 2000.
(2) Incorporated by reference to the correspondingly numbered
exhibit to Ditech's Current Report on Form 8-K, File No. 000-26209,
filed with the Securities and Exchange Commission on August 8, 2000.
(3) Incorporated by reference from the exhibits with corresponding
numbers from Ditech's Registration Statement (No. 333-86691), filed
September 8, 1999.
(b) Reports on Form 8-K
No reports on form 8-K were filed during the quarter ended July 31,
2000.
22
<PAGE>
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: September 14, 2000 By: /s/ William J. Tamblyn
-----------------------------
William J. Tamblyn
Vice President Finance and Chief
Financial Officer (Principal
Financial and Accounting Officer)
23
<PAGE>
INDEX TO EXHIBITS
(a) Exhibit
2.1(1) Agreement and Plan of Merger and Reorganization, dated as
of June 21, 2000, by and among Ditech, Oxygen Acquisition
Corporation, a Delaware corporation, and Atmosphere Networks,
Inc., a Delaware corporation.
2.2(2) Amendment to Agreement and Plan of Merger and Reorganization,
dated as of July 25, 2000, by and among Ditech, Oxygen
Acquisition Corporation, a Delaware corporation, and
Atmosphere Networks, Inc., a Delaware corporation.
3.1(3) Amended and Restated Certificate of Incorporation of Ditech.
3.2(3) Bylaws of Ditech
27.1 Financial Data Schedule
(1) Incorporated by reference to the correspondingly numbered
exhibit to Ditech's Annual Report on Form 10-K, File No. 000-26209,
for the year ending April 30, 2000, filed with the Securities and
Exchange Commission on July 31, 2000.
(2) Incorporated by reference to the correspondingly numbered
exhibit to Ditech's Current Report on Form 8-K, File No. 000-26209,
filed with the Securities and Exchange Commission on August 8,
2000.
(3) Incorporated by reference from the exhibits with corresponding
numbers from Ditech's Registration Statement (No. 333-86691),
filed September 8, 1999.
24
