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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended
September 30, 2000
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission File Number: 000-28687
DIGITALTHINK, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 94-3244366
(STATE OR OTHER JURISDICTION OF (IRS EMPLOYER IDENTIFICATION
INCORPORATION OR ORGANIZATION) NUMBER)
1098 HARRISON STREET, SAN FRANCISCO, CALIFORNIA, 94103
(Address of principal executive offices)
(415) 625-4000
(Registrant's telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
As of November 8, 2000, Registrant had outstanding 34,828,529 Common Stock,
$0.001 par value.
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TABLE OF CONTENTS
PART I: FINANCIAL INFORMATION
ITEM 1. Financial Statements (Unaudited):
Condensed Statements of Operations - three months ended September 30,
2000 and September 30, 1999 and year to date September 30, 2000 and
September 30, 1999
Condensed Balance Sheets - September 30, 2000 and March 31, 2000
Condensed Statements of Cash Flows - six months ended September 30,
2000 and September 30, 1999
Notes to Condensed Financial Statements
ITEM 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations, including Factors Affecting Future Results
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk
PART II: OTHER INFORMATION
ITEM 1. Legal Proceedings
ITEM 2. Changes in Securities and Use of Proceeds
ITEM 3. Defaults Upon Senior Securities
ITEM 4. Submission of Matters to a Vote of Security Holders
ITEM 5. Other Information
ITEM 6. Exhibits and Reports on Form 8-K
Signatures
PART I: FINANCIAL INFORMATION
ITEM I: FINANCIAL STATEMENTS
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DIGITALTHINK INC.
BALANCE SHEET
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
September 30, March 31,
2000 2000
------------- ---------
<S> <C> <C>
ASSETS
Current assets:
Cash and equivalents $ 32,038 $ 54,854
Marketable securities 49,119 41,844
Restricted cash 1,817 1,800
Accounts receivable, net of allowance for doubtful
accounts of $300 and $205, respectively 10,885 5,322
Prepaid expenses and other current assets 2,452 792
--------- ---------
Total current assets 96,311 104,612
--------- ---------
Property & equipment, net 9,276 5,564
Goodwill and other intangible assets 18,012 --
--------- ---------
Total assets $ 123,599 $ 110,176
========= =========
LIABILITIES & STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 4,104 $ 2,243
Accrued Liabilities 4,357 3,018
Deferred revenue 14,429 7,035
--------- ---------
Total liabilities 22,890 12,296
--------- ---------
Long-term liabilities 17 --
Stockholders' equity:
Common stock - at $0.001 per share value; shares
authorized: 100,000; shares issued and outstanding:
33,788 in March 2000 and 34,575 in September 2000 181,558 149,160
Stockholders' notes (9) --
Deferred stock compensation (6,299) (7,953)
Accumulated deficit (74,558) (43,327)
--------- ---------
Total stockholders' equity 100,692 97,880
--------- ---------
Total liabilities and stockholders' equity $ 123,599 $ 110,176
========= =========
</TABLE>
<PAGE> 4
DIGITALTHINK INC.
STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
QUARTER ENDED YEAR TO DATE
SEPTEMBER 30, SEPTEMBER 30,
2000 1999 2000 1999
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Revenues:
Delivered Learning fees $ 3,322 $ 992 $ 5,717 $ 1,450
Learning Solution services 5,438 1,144 9,305 1,860
-------- -------- -------- --------
Total revenues 8,760 2,136 15,022 3,310
Costs and expenses:
Cost of Delivered Learning fees 1,331 486 2,343 804
Cost of Learning Solution services 2,932 614 5,213 988
Content research and development 1,125 883 3,945 1,499
Technology research and development 2,778 922 4,920 1,365
Selling and marketing 5,736 2,065 9,657 3,416
General and administrative 1,498 486 2,672 774
Depreciation 771 143 1,333 251
Write-off of in-process research and development 7,118 -- 7,118 --
Amortization of goodwill 1,201 -- 1,201 --
Amortization of warrants 7,629 -- 7,629 --
Stock-based compensation * 1,656 479 3,205 622
-------- -------- -------- --------
Total costs and expenses 33,775 6,078 49,236 9,719
-------- -------- -------- --------
Loss from operations (25,015) (3,942) (34,214) (6,409)
Interest and other income 1,434 68 2,983 160
-------- -------- -------- --------
Net loss $(23,581) $ (3,874) $(31,231) $ (6,249)
======== ======== ======== ========
Basic and diluted loss per common share $ (0.68) $ (1.27) $ (0.91) $ (2.18)
======== ======== ======== ========
Shares used in basic and diluted net loss
per common share 34,542 4,220 34,204 4,180
(*) Stock-based compensation:
Cost of Delivered Learning Fees 34 35 75 50
Cost of Learning Solution services 151 29 310 42
Content research and development 22 13 47 20
Technology research and development 408 37 651 57
Selling and marketing 378 186 807 251
General and administrative 663 179 1,315 202
-------- -------- -------- --------
Total 1,656 479 3,205 622
======== ======== ======== ========
</TABLE>
<PAGE> 5
DIGITALTHINK INC.
STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
SEPTEMBER 30,
2000 1999
-------- -------
<S> <C> <C>
Cash flows from operating activities:
Net loss $(31,231) $(6,249)
Adjustments to reconcile net loss to net cash used
in operating activities:
Depreciation and amortization 1,333 251
Amortization of deferred stock compensation 3,205 622
Amortization of warrants 7,629 --
Amortization of goodwill 1,201 --
Write-off of in-process research and development 7,118 --
Changes in assets and liabilities:
Restricted cash (17) (1,800)
Accounts receivable (5,564) (266)
Other current assets (1,035) (175)
Other current liabilities 1,177 1,186
Long-term liabilities 17 --
Deferred revenue 7,337 1,934
-------- -------
Net cash used in operating activities (8,830) (4,497)
-------- -------
Cash flows from investing activities:
Purchases of property and equipment (4,761) (857)
Other assets 0 (11)
Net cash paid in acquisition (2,626) --
Proceeds received from stockholder 500 --
Purchases of marketable securities (39,425) --
Proceeds from maturities of marketable securities 32,150 --
-------- -------
Net cash used in investing activities (14,162) (868)
-------- -------
Cash flows from financing activities:
Proceeds from sale of preferred stock 0 120
Proceeds from sale of common stock 176 9
-------- -------
Net cash provided by financing activities 176 129
-------- -------
Net decrease in cash and equivalents (22,816) (5,236)
Cash and equivalents, beginning of the period 54,854 9,455
-------- -------
Cash and equivalents, end of period $ 32,038 $ 4,219
======== =======
</TABLE>
Notes to Condensed Financial Statements (Unaudited)
1. Basis of Presentation
The condensed consolidated financial statements included herein have been
prepared by DigitalThink, without audit, pursuant to the rules and
regulations of the Securities and Exchange Commission. Certain information
and footnote disclosures normally included in financial statements
prepared in accordance with generally accepted accounting principles have
been condensed or omitted pursuant to such rules and regulations, although
we believe the disclosures which are made are adequate to make the
information presented not
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misleading. It is suggested that this document be read in conjunction with
the consolidated financial statements and the notes thereto included in
the Company's Annual Report to Stockholders for the fiscal year ended
March 31, 2000.
The unaudited condensed consolidated financial statements included herein
reflect all adjustments (which include only normal, recurring adjustments)
which are, in the opinion of management, necessary to state fairly the
results for the periods presented. The results for such periods are not
necessarily indicative of the results to be expected for the entire fiscal
year ending March 31, 2001.
2. Business Combination
On July 6, 2000 DigitalThink Inc. acquired Arista Knowledge Systems, Inc.
("Arista"), a company providing Internet-based learning management
systems. DigitalThink issued approximately 746,000 shares of DigitalThink
common stock in exchange for outstanding stock, options and warrants of
Arista. The total cost of the acquisition, including transaction costs,
was approximately $24.6 million. The acquisition was accounted for as a
purchase business combination; accordingly the results of operations of
Arista have been included with the Company's results of operations since
July 6, 2000. The purchase price paid for the Arista acquisition was
allocated based on the estimated fair values of the assets acquired as
follows:
<TABLE>
<S> <C>
In-process research and development $ 7,118
Acquired technology, workforce intangible
and goodwill 17,632
Intrinsic value of unvested Arista options
assumed 1,552
Tangible assets acquired 1,832
Liabilities assumed (3,535)
--------
Net assets acquired $ 24,599
========
</TABLE>
The consideration given in acquisition of Arista was as follows:
<TABLE>
<S> <C>
Stock given to Arista stockholders $ 20,523
Stock options assumed 3,976
Transaction costs 100
--------
Total purchase price $ 24,599
========
</TABLE>
Of the purchase price, $7.1 million represents purchased in-process
technology that has not yet reached technological feasibility and has no
alternative future use. Accordingly, this amount was immediately expensed
in the consolidated statement of operations upon consummation of the
acquisition. The value assigned to purchased in-process technology was
based on a valuation prepared by an independent third-party appraiser.
Intangible assets acquired will be amortized over a period of four years.
3. Loss per Common Share
Basic loss per common share excludes dilution and is computed by dividing
loss attributable to common stockholders by the weighted average number of
common shares outstanding during the period. Diluted loss per common share
reflects the potential dilution that could occur if securities or other
contracts to issue common stock were exercised or converted into
<PAGE> 7
common stock. Common share equivalents are excluded from the computation
in loss periods as their effect would be anti-dilutive.
The Company's historical capital structure is not indicative of its
prospective structure due to the automatic conversion of all shares of
redeemable convertible preferred stock into common stock concurrent with
the closing of the Company's initial public offering occurring in February
2000. Accordingly, a pro forma calculation assuming the conversion of all
outstanding shares of redeemable convertible preferred stock into common
stock upon the Company's initial public offering using the if-converted
method from their respective dates of issuance is presented below.
The following table presents the calculation of basic and pro forma basic
net loss per common share (in thousands, except per share data):
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
2000 1999 2000 1999
------------- ------------- ------------- --------------
<S> <C> <C> <C> <C>
Net Loss $(23,581) $ (3,874) $(31,231) $ (6,249)
Basic and diluted:
Weighted average shares of common stock outstanding used
in computing basic and diluted net loss per share 34,542 4,220 34,204 4,182
Basic and diluted net loss per share $ (0.68) $ (1.27) $ (0.91) $ (2.18)
Pro forma basic and diluted:
Net loss $(23,581) $ (3,874) $(31,231) $ (6,249)
Weighted average shares used in computing basic and diluted
net loss per share (from above) 34,542 4,220 34,204 4,182
Adjustment to reflect the effect of the assumed conversion of
preferred stock to common stock from the date of issuance -- 18,798 -- 18,763
Weighted average shares used in computing pro forma basic
and diluted net loss per share 34,542 23,017 34,204 22,946
Pro forma basic and diluted net loss per common share $ (0.68) $ (0.23) $ (0.91) $ (0.40)
</TABLE>
4. Revenue Recognition
Delivered Learning fees allow access to training systems, courses hosted
by the Company, tutor support, and other learning materials for a fixed
period, typically six months. Delivered Learning fees are recognized
ratably over this access period. Revenues for Learning Solution services
(custom course development) are recognized as earned in accordance with
Statement of Position (SOP) 81-1, Accounting for Performance of
Construction/Production-Type Contracts, as development progresses based on
the percentage of completion method. We measure the percentage of
completion based on the ratio of actual custom development costs incurred
to date on each course to total estimated costs to complete the custom
course. Provisions for estimated losses on incomplete contracts will be
made on a contract by contract basis and recognized in the period in which
such losses become probable and can be reasonably estimated. To date,
there have been no such losses. Custom contracts typically call for
non-refundable payments due upon achievement of certain milestones in
<PAGE> 8
production of the courses. Deferred revenues represent customer
prepayments for both Delivered Learning fees and Learning Solution
services.
5. Strategic Alliance with Electronic Data Systems Corporation
On July 11, 2000 the Company entered into an agreement with Electronic
Data Systems Corporation (EDS) pursuant to which EDS has been issued two
separate performance warrants to purchase shares of DigitalThink common
stock. Under the terms of the first warrant, EDS can earn warrants to
purchase up to 862,955 shares of DigitalThink common stock exercisable at
$29 per share. The warrant is earned when EDS delivers third-party
customers from the United States prior to July 31, 2003, which generate a
total of $50 million of contractually committed revenue to DigitalThink
recognizable by July 31, 2005. The warrants must be exercised by October
31, 2003. This warrant contains a significant disincentive for
non-performance. If EDS fails to deliver the full $50 million of
contracted, United States revenue by July 31, 2003, EDS has agreed to pay
DigitalThink $5 million.
Under the terms of the second warrant, EDS can earn warrants for up to
690,364 shares of DigitalThink common stock exercisable at $29 per share.
The warrant is earned when EDS delivers third-party customers from outside
the United States prior to July 31, 2003, which generate a total of $50
million of contractually committed revenue to DigitalThink recognizable by
July 31, 2005. The warrants must be exercised by October 31, 2003. This
warrant contains a significant disincentive for non-performance. If EDS
fails to deliver the full $50 million of contracted, non-United States
revenue by July 31, 2003, EDS has agreed to pay DigitalThink $5 million.
The Company will incur a fixed non-cash charge of $38 millon related to
this transaction, based on the fair value of the warrants issued.
Amortization of the associated warrant expense will occur over the next
three years, in proportion to the amount of revenue generated under the
agreement.
ITEM 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
This Management's Discussion and Analysis of Financial Condition and
Results of Operations and other parts of this Form 10-Q contain forward-looking
statements that involve risks and uncertainties. All forward-looking statements
included in this document are based on information available to the Company on
the date hereof, and the Company assumes no obligation to update any such
forward-looking statements. The Company's actual results could differ materially
from those anticipated in these forward-looking statements as a result of
certain factors, including those set forth in "Factors Affecting Future
Results".
ACQUISITION OF ARISTA KNOWLEDGE SYSTEMS
On July 6, 2000, the Company, through a wholly owned subsidiary, agreed to
purchase all of the issued and outstanding shares of Arista Knowledge Systems,
Inc. (Arista), a Delaware corporation, for a purchase price of approximately
$24.6 million including transaction costs.
The acquisition of Arista was accounted for by the purchase method. Arista's
results of operations have been included in the Company's results of operations
since the date of acquisition. In connection with the acquisition, the Company
recorded a nonrecurring charge of $7.1 million for the write-off of in-process
research and development acquired.
<PAGE> 9
RESULTS OF OPERATIONS - THREE MONTHS ENDED SEPTEMBER 30, 2000 AND 1999
REVENUES
Revenues increased from $2.1 million in the three months ended September 30,
1999 to $8.8 million in the three months ended September 30, 2000. For the three
months ended September 30, 2000, Delivered Learning fees represented 38% of
revenues and Learning Solution services represented 62% of revenues. This is
compared to the three months ended September 30, 1999, during which Delivered
Learning fees represented 46% of revenues and Learning Solution services
represented 54% of revenues.
Delivered Learning fees
Delivered Learning fees increased from $992,000 in the three months ended
September 30, 1999 to $3.3 million in the three months ended September 30, 2000
as the number of customers increased from approximately 271 to 315 and the
number of courses increased from 240 to 333. We expect that the number of
courses and customers will continue to increase as we expand our distribution
channels and course offerings.
Learning Solution services
Learning Solution services revenue increased from $1.1 million in the three
months ended September 30, 1999 to $5.4 million in the three months ended
September 30, 2000 as the number of courses under development and the dollar
size of the projects increased. We expect that Delivered Learning fees and
Learning Solution services revenues will continue to account for a similarly
significant portion of our total revenues in the near term.
We market our products primarily through our direct sales channel and our system
integrator resellers in the United States. We also market our products through
resellers, customers, co-developers, and Internet portals. Internationally, we
opened our European operations headquartered in London in May 2000 and have
begun developing relationships with third-party integrators and resellers. To
date, our international revenues have been insignificant.
COSTS AND EXPENSES
Cost of Delivered Learning fees
Cost of Delivered Learning fees includes personnel related costs, maintenance
and facility costs required to operate our Web site and to provide interactive
tutor support to participants in our courses. Cost of Delivered Learning fees
increased from $486,000 in the three months ended September 30, 1999 to $1.3
million in the three months ended September 30, 2000. This increase was
attributable to increased personnel and equipment related expenses required for
a greater number of courses and an increased number of participants. In
addition, a greater number of customers and courses required additional support
from tutors to provide timely online responses to participants. Headcount, which
excludes third-party tutors, related to cost of Delivered Learning fees,
increased from 12 at September 30, 1999 to 25 at September 30, 2000.
<PAGE> 10
Cost of Learning Solution Services
Cost of Learning Solution services consists primarily of personnel related costs
and contractor expenses to develop custom and tailored courses for specific
customers. Cost of Learning Solution services increased from $614,000 in the
three months ended September 30, 1999 to $2.9 million in the three months ended
September 30, 2000. This increase was primarily attributable to the need for
additional headcount to meet demand for the development of custom courses.
Headcount, excluding third-party tutors, related to cost of Learning Solution
services increased from 43 employees at September 30, 1999 to 117 employees at
September 30, 2000.
Content Research and Development
Content research and development expenses represent costs to develop catalog
courses, including personnel related costs, content acquisition costs, royalties
paid to authors and content editing. Content research and development expenses
increased from $883,000 in the three months ended September 30, 1999 to $1.1
million in the three months ended September 30, 2000. This increase was due to
higher content acquisition fees paid for new content and the hiring of
additional personnel to expand the number of courses offered in our catalog.
Headcount in content research and development increased from 34 employees at
September 30, 1999 to 69 employees at September 30, 2000. Management believes
that continued investment in content development and content acquisition is
essential to expand our business. As a result, we expect these expenses to
increase substantially in future periods.
Technology Research and Development
Technology research and development expenses consist primarily of personnel
related costs in connection with product development efforts of underlying
technology. Technology research and development expenses increased from $922,000
in the three months ended September 30, 1999 to $2.8 million in the three months
ended September 30, 2000, partially due to the addition of new engineering
resources from the acquisition of Arista. This increase was primarily
attributable to the hiring of software engineers. Headcount increased from 23
employees at September 30, 1999 to 69 employees at September 30, 2000.
Management believes that continued investment in technology research and
development is essential to our future success and expects these expenses to
increase in future periods.
Selling and Marketing
Selling and marketing expenses consist primarily of personnel related costs,
commissions, advertising and other promotional expenses, and travel and
entertainment expenses. Selling and marketing expenses increased from $2.1
million in the three months ended September 30, 1999 to $5.7 million in the
three months ended September 30, 2000. This increase reflects the costs
associated with the hiring of additional personnel, support of our partner
programs, increased promotional activities, and establishment of foreign
operations. Headcount in selling and marketing increased from 45 at September
30, 1999 to 92 at September 30, 2000. We expect selling and marketing expenses
will continue to increase as we continue to expand our selling and marketing
efforts, establish additional sales territories and increase our promotional
activities.
General and Administrative
General and administrative expenses consist primarily of personnel related
costs, occupancy costs, insurance related costs, and professional services fees.
General and administrative expenses increased from $486,000 in the three months
ended September 30, 1999 to $1.5 million in the three months ended September 30,
2000. This increase was due to an increase in personnel related costs, higher
occupancy costs and fees related to insurance and professional
<PAGE> 11
services. Headcount increased from 10 employees at September 30, 1999 to 34
employees at September 30, 2000. Management expects general and administrative
expenses will continue to increase in the future as we expand our staff and
incur additional costs to support the targeted growth of our business.
Write-off of In-Process Research and Development
Non-recurring expenses related to in-process research and development totaled
$7.1 million in the three months ended September 30, 2000. This write-off
relates to technology acquired as part of the Arista acquisition which had not
reached technological feasibility and had no alternative future use. The
valuation of intangibles was based upon management's estimates of after tax cash
flow. The valuation gave consideration to the following: (i) comprehensive due
diligence concerning all potential intangibles: (ii) the value of developed and
core technology, ensuring that the relative allocations to core technology and
in-process research and development were consistent with the contribution of
final products; (iii) the allocation to in-process research and development was
based upon a calculation that only considered the efforts completed as of the
date of the transaction, and only the cash flows associated with one generation
of products currently in-process; and (iv) it was performed by an independent
valuation group and was deemed reasonable in light of all quantitative and
qualitative information available.
The write-off of in-process research and development related to one significant
project under development to provide a completely outsourced learning management
system. Since the date of acquisition, $358,000 has been incurred in development
costs. The project is scheduled to be completed in stages beginning in the first
quarter of fiscal 2002 and expenses to complete the development are expected to
total $864,000.
There can be no assurances that the Company will be able to complete the
development of the product on a timely basis. Failure to complete the project
could have an adverse impact on the Company's financial condition or results of
operations
Amortization of Goodwill
Expenses related to the amortization of goodwill totaled $1.2 million in the
three months ended September 30, 2000. This goodwill relates to the purchase of
Arista.
Amortization of Warrants
Expenses related to warrants issued to EDS as part of DigitalThink's strategic
alliance totaled $7.6 million in the three months ended September 30, 2000. The
Company expects to incur additional fixed non-cash charges of $30.3 million
through July 2003 related to this transaction.
Stock-Based Compensation
Stock-based compensation expense increased from $479,000 in the three months
ended September 30, 1999 to $1.7 million in the three months ended September 30,
2000.
Net Loss
The net loss increased from $3.9 million in the three months ended September 30,
1999 to $23.6 million in the three months ended September 30, 2000.
<PAGE> 12
RESULTS OF OPERATIONS - SIX MONTHS ENDED SEPTEMBER 30, 2000 AND 1999
REVENUES
Revenues increased from $3.3 million in the six months ended September 30, 1999
to $15.0 million in the six months ended September 30, 2000. For the six months
ended September 30, 2000, Delivered Learning fees represented 38% of revenues
and Learning Solution services represented 62% of revenues. This is compared to
the six months ended September 30, 1999, during which Delivered Learning fees
represented 44% of revenues and Learning Solution services represented 56% of
revenues.
Delivered Learning fees
Delivered Learning fees increased from $1.4 million in the six months ended
September 30, 1999 to $5.7 million in the six months ended September 30, 2000 as
the number of customers and number of courses increased. We expect that the
number of courses and customers will continue to increase as we expand our
distribution channels and course offerings.
Learning Solution services
Learning Solution services revenue increased from $1.9 million in the six months
ended September 30, 1999 to $9.3 million in the six months ended September 30,
2000 as the number of courses under development increased. We expect that
Delivered Learning fees and Learning Solution services revenues will continue to
account for a similarly significant portion of our total revenues in the near
term.
COSTS AND EXPENSES
Cost of Delivered Learning fees
Cost of Delivered Learning fees increased from $804,000 in the six months ended
September 30, 1999 to $2.3 million in the six months ended September 30, 2000.
This increase was attributable to increased personnel and equipment related
expenses required to manage our site as we hosted a greater number of courses
and a larger number of participants accessed our courses. In addition, a greater
number of customers and courses required additional support from tutors to
provide timely online responses to participants.
Cost of Learning Solution Services
Cost of Learning Solution services increased from $988,000 in the six months
ended September 30, 1999 to $5.2 million in the six months ended September 30,
2000. This increase was primarily attributable to the need for additional
headcount to meet demand for the development of custom courses.
Content Research and Development
Content research and development expenses increased from $1.5 million in the six
months ended September 30, 1999 to $3.9 million in the six months ended
September 30, 2000. This increase was due to higher content acquisition fees
paid for new content and the hiring of additional personnel to expand the number
of courses offered in our catalog.
Technology Research and Development
Technology research and development expenses increased from $1.4 million in the
six months ended September 30, 1999 to $4.9 million in the six months ended
September 30, 2000. This increase was primarily attributable to the hiring of
software engineers.
<PAGE> 13
Selling and Marketing
Selling and marketing expenses increased from $3.4 million in the six months
ended September 30, 1999 to $9.7 million in the six months ended September 30,
2000. This increase reflects the costs associated with the hiring of additional
personnel, increased promotional activities, support of our partner program, and
the establishment of foreign operations.
General and Administrative
General and administrative expenses increased from $774,000 in the six months
ended September 30, 1999 to $2.7 million in the six months ended September 30,
2000. This increase was due to an increase in personnel related costs, higher
occupancy costs and fees related to insurance and professional services.
Write-off of In-Process Research and Development
Non-recurring expenses related to in-process research and development totaled
$7.1 million in the six months ended September 30, 2000. This write-off relates
to technology acquired as part of the Arista acquisition which had not reached
technological feasibility and had no alternative future use as of July 2000.
Amortization of Goodwill
Expenses related to the amortization of goodwill totaled $1.2 million in the six
months ended September 30, 2000. This goodwill relates to the purchase of Arista
in July 2000.
Amortization of Warrants
Expenses related to warrants issued to EDS as part of DigitalThink's strategic
alliance totaled $7.6 million in the six months ended September 30, 2000. The
Company expects to incur additional fixed non-cash charges of $30.3 million
through July 2003 related to this transaction.
Stock-Based Compensation
Stock-based compensation expense increased from $622,000 in the six months ended
September 30, 1999 to $3.2 million in the six months ended September 30, 2000.
Net Loss
The net loss increased from $6.2 million in the six months ended September 30,
1999 to $31.2 million in the six months ended September 30, 2000.
Liquidity and Capital Resources
Net cash used in operating activities totaled $8.8 million for the six months
ended September 30, 2000 and $4.5 million for the comparable prior year period.
Cash used in operating activities for the current period resulted from net
operating losses and increases in accounts receivable, offset in part by
increases in deferred revenue and current liabilities. Deferred revenue
increased from $7.0 million at March 31, 2000 to $14.4 million at September 30,
2000. Deferred revenue results from customer prepayments of Delivered Learning
fees and Learning Solution services. In both cases, prepayments remain in
deferred revenue until revenue recognition criteria have been met. Other current
liabilities have increased from $5.3 million at March 31, 2000 to $8.5 million
on September 30, 2000. This increase is due to our continuing expansion and
increasing headcount.
<PAGE> 14
Net cash used in investing activities totaled $14.2 million in the six months
ended September 30, 2000 and $868,000 for the comparable prior year period. The
increase resulted from the acquisition of capital assets, including hardware for
our Website, and computer and office related equipment and the purchase ($39.4
million) and sale ($32.2 million) of marketable securities. Net cash paid for
the acquisition of Arista totaled $2.6 million.
Cash provided by financing activities totaled $176,000 in the six months ended
September 30, 2000 and $129,000 in the six months ended September 30, 1999. The
current period amount reflects proceeds generated from the exercise of stock
options.
We believe our existing cash resources are sufficient to finance our presently
anticipated operating expenses and working capital requirement for at least the
next twelve months. Our future liquidity and capital requirements will depend on
numerous factors. The rate of expansion of our operations in response to
potential growth opportunities and competitive pressures will affect our capital
requirements as will funding of continued net losses and substantial negative
cash flows. Additionally, we may need additional capital to fund acquisitions of
complementary businesses, products, and technologies. Our forecast of the period
of time through which our financial resources will be adequate to support
operations is a forward-looking statement that involves risks and uncertainties.
Actual resources sought may differ materially. We may seek to sell additional
equity or debt securities or secure a bank line of credit. Currently, we have no
other immediately available sources of liquidity. The sale of additional equity
or other securities could result in additional dilution to our stockholders.
Arrangement for additional financing may not be available in amounts or on terms
acceptable to us, if at all.
Recent Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standards (SFAS) No. 133, Accounting for Derivative
Instruments and Hedging Activities, which defines derivatives, requires that all
derivatives be carried at fair value, and provides for hedge accounting when
certain conditions are met. SFAS No. 133 is effective for us in fiscal 2002. We
do not believe that the adoption of this statement will have a material impact
on our financial position or results of operations.
In December 1999, the Securities and Exchange Commission issued Staff Accounting
Bulletin (SAB) No. 101, "Revenue Recognition in Financial Statements," which
provides the SEC staff's views on selected revenue recognition issues. The
guidance in SAB 101 must be adopted by the Company's fourth quarter of fiscal
year 2001 and the effects, if any, are required to be recorded through a
retroactive, cumulative-effect adjustment as of the beginning of the fiscal
year, with a restatement of all prior interim quarters in the year. Management
has not completed it's evaluation of the effects, if any, that SAB 101 will have
on the Company's income statement presentation, operating results or financial
position.
<PAGE> 15
FACTORS AFFECTING FUTURE RESULTS.
WE COMMENCED OPERATIONS IN APRIL 1996 AND OUR LIMITED OPERATING HISTORY AND THE
NEW AND EMERGING E-LEARNING MARKET MAKES IT DIFFICULT TO EVALUATE OUR BUSINESS
AND FUTURE PROSPECTS.
We commenced operations in April 1996 and did not begin to generate
significant revenues until fiscal 1999, which ended on March 31, 1999. In fiscal
2000, we had revenues of $10.8 million. We are still in the early stages of our
development, which, when combined with the new and emerging e-learning market,
make it difficult to evaluate our business or our prospects. Because of our
limited operating history, we have a limited and unproven ability to predict the
trends that may emerge in the e-learning market and affect our business. The
uncertainty of our future performance, in general, and the uncertainty regarding
the acceptance of e-learning, in particular, increases the risk that we will be
unable to build a sustainable business and that our stockholder value will
decline.
WE HAVE A HISTORY OF LOSSES AND A LARGE ACCUMULATED DEFICIT OF $74.6 MILLION AT
SEPTEMBER 30, 2000. WE EXPECT FUTURE LOSSES AND WE MAY NOT ACHIEVE OR MAINTAIN
PROFITABILITY.
We have experienced losses in each quarter since our inception and
expect that our losses will increase in each quarter at least through the end of
fiscal 2001. Our accumulated deficit as of September 30, 2000 was $74.6 million.
We have never achieved a profitable quarter and we expect to continue to incur
increasing quarterly losses as we expand our operations, invest in our
technology, fund the development of new content and support our growth. We plan
to increase our operating expenses to market, sell and support our e-learning
solutions, build infrastructure, add additional features to our product and hire
additional staff. We also plan to invest heavily to develop and acquire new
course offerings with new areas of expertise, which will increase operating
expenses in absolute dollars.
We currently expect our total costs and expenses to be at least $55.0
million in fiscal 2001. As a result, we will need to significantly increase our
quarterly revenues to achieve profitability. If we do not generate sufficient
revenues or become profitable within a timeframe expected by public market
analysts or investors, the market price of our common stock will likely decline.
Even if we do achieve profitability, we may not be able to sustain or increase
profitability on a quarterly or annual basis in the future.
OUR QUARTERLY OPERATING RESULTS ARE SUBJECT TO FLUCTUATIONS WHICH COULD
ADVERSELY AFFECT OUR STOCK PRICE.
Our revenue and operating results are volatile and difficult to
predict and may be susceptible to declines in future periods. Our quarterly
results of operations may fluctuate significantly in the future due to
shortfalls in revenues or orders. We therefore believe that quarter to quarter
comparisons of our operating results may not be a good indication of our future
performance. In the event of a revenue or order shortfall or unanticipated
expenses in some future quarter or quarters, our operating results may be below
the expectations of public market analysts or investors. In such an event, the
price of our common stock may decline significantly. Our current and future
expense estimates are largely fixed and based, to a significant degree, on our
estimates of future revenue. We will likely be unable to, or may elect not to,
reduce spending quickly enough to offset any unexpected revenue shortfall.
Therefore, any significant shortfall in revenue in relation to our expectations
would cause our quarterly results for a particular period to decline.
<PAGE> 16
OUR RECOGNITION OF REVENUE IS DEPENDENT IN PART ON THE PERCENTAGE COMPLETION OF
OUR VARIOUS LEARNING SOLUTIONS PROJECTS, AND OUR INABILITY TO RECOGNIZE REVENUE
IN ACCORDANCE WITH OUR EXPECTATIONS WILL HARM OUR OPERATING RESULTS.
In accordance with our revenue recognition policy, our ability to
record revenues depends upon several factors. These factors include acceptance
by our customers of new courses and the pace of participant registrations in
courses once they are completed and made available on our Web site. All of our
customer contracts provide that at least a portion of our revenues depend on
either course completion or participant registration, or both. Revenues from
custom-tailored courses accounted for approximately 54% of our total revenues
for the fiscal year ended March 31, 2000. Our ability to recognize revenues from
custom-tailored courses depends upon our customers providing us with subject
matter experts and content to be incorporated into the courses as well as our
completion of production and obtaining customer acceptance at each stage of
development. Accordingly, if customers do not provide us with the subject matter
experts or content in a timely manner, we will not be able to recognize the
revenues associated with that project, which would harm our operating results.
In addition, if the expected number of participants do not come to
our Web site to sign up for a course, our ability to recognize revenues will be
delayed, which could also harm our operating results in any quarter. Participant
registration depends in large part on the promotional activities of our
customers. If customers fail to take necessary measures to require employee
enrollment in courses or if they fail to promote the course effectively to
persons outside their organization, our ability to recognize revenues, and
therefore our operating results, could be harmed.
WE HAVE RELIED, AND EXPECT TO CONTINUE TO RELY, ON A LIMITED NUMBER OF CUSTOMERS
FOR THE MAJORITY OF OUR REVENUES, AND ANY DELAY IN RECEIVING REVENUES FROM THESE
CUSTOMERS COULD HARM OUR FINANCIAL PERFORMANCE IN ANY QUARTER.
During fiscal 2000, we derived more than 50% of our revenues from six
customers. As a result, our operating results could suffer if we lost any of
these customers or if revenues from these customers are delayed in any future
fiscal period. For example, in fiscal 2000, KPMG, LLP accounted for 32% of our
total revenues. No other single customer has accounted for more than 10% of our
revenues in fiscal 2000. In fiscal 1999, no customer accounted for more than 10%
of our revenues although our five largest customers accounted for 40% of our
revenues. We expect that we will continue to depend upon a small number of
customers for a significant portion of our revenues. In particular, we expect
that EDS will account for a significant portion of our revenues through fiscal
2003.
OUR FUTURE GROWTH DEPENDS ON SUCCESSFUL HIRING AND RETENTION, INCLUDING HIRING
AND RETENTION OF THIRD-PARTY TUTORS, AND WE MAY BE UNABLE TO HIRE AND RETAIN THE
SKILLED PERSONNEL WE NEED TO SUCCEED.
Our future growth depends on successful hiring and retention, and we
may be unable to hire and retain the skilled personnel we need to succeed. The
growth of our business and revenues will depend in large part upon our ability
to attract and retain sufficient numbers of highly skilled employees,
particularly database engineers, course content developers, Web designers and
technical and sales personnel. Additionally, we primarily rely on individual
third parties to provide the majority of our tutoring and our ability to
adequately support our courses is directly tied to the availability and
competency of these third-party tutors. Qualified personnel are in great demand
throughout education and Internet-related industries and we require personnel
with both educational course design experience as well as experience in Web
design. The number of potential candidates with experience in both these areas
is limited. The demand for qualified personnel is particularly acute in the San
Francisco Bay Area market in which we
<PAGE> 17
compete for a majority of these personnel due to the large number of Internet
companies and the low unemployment rate in the region. We also face
non-geographically based competition for tutors because we can utilize the
services of any individual with the requisite course subject matter knowledge
and e-mail communication skills, as well as reliable Internet access and the
ability to work as a self-managed contractor. Currently, we contract with
individual tutors throughout the United States, as well as in the United
Kingdom, New Zealand and Australia. Our failure to attract and retain sufficient
skilled personnel and tutors may limit the rate at which we can grow, which will
harm our business and financial performance.
OUR BUSINESS WILL SUFFER IF E-LEARNING IS NOT WIDELY ACCEPTED.
The market for e-learning solutions is new and rapidly evolving. We
expect that we will engage in intensive marketing and sales efforts to educate
prospective customers about the benefits of our e-learning solutions. There are
a number of factors that could impact the acceptance of our e-learning
solutions, which are new and largely untested compared to more established
educational methods, including:
- companies that have historically relied on, or invested in,
traditional educational methods may be reluctant or slow to adopt
Web-based e-learning solutions;
- many of our potential customers have allocated only a limited
portion of their education budgets to e-learning; and
- end users may not use online learning solutions effectively.
If the market for e-learning fails to develop or develops more slowly
than we expect, we will not achieve our growth and revenue targets and our stock
price will likely decline.
THE VARIABILITY AND LENGTH OF OUR SALES CYCLE FOR OUR E-LEARNING SOLUTIONS MAY
MAKE OUR OPERATING RESULTS UNPREDICTABLE AND VOLATILE.
The period between our initial contact with a potential customer and
the first purchase of our solution by that customer typically ranges from three
to nine months, and in some cases has extended for close to two years. Because
we rely on large sales for a substantial portion of our revenues, these long
sales cycles can have a particularly significant effect on our financial
performance in any quarter. Factors which may contribute to the variability and
length of our sales cycle include:
- the time required to educate potential customers about the
benefits of our e-learning solutions;
- the time it takes our potential customers to assess the value of
online solutions compared to more traditional educational
solutions;
- the time it takes our potential customers to evaluate competitive
online solutions;
- our potential customers' internal budget and approval processes;
and
- the extended periods most large corporations require to make
purchasing decisions.
As a result of our lengthy sales cycle, we have only a limited
ability to forecast the timing and size of specific sales. This, in turn, makes
it more difficult to predict quarterly financial performance.
THE E-LEARNING MARKET IS HIGHLY COMPETITIVE AND WE MAY NOT HAVE ADEQUATE
RESOURCES TO COMPETE EFFECTIVELY, ACQUIRE AND RETAIN CUSTOMERS AND ATTAIN FUTURE
GROWTH.
The e-learning market is evolving quickly and is subject to rapid
technological change, shifts in customer demands and evolving learning
methodologies. The recent shift in customer demand from CD-ROM delivered
training to the use of the Internet for providing interactive courses is one
example of a technological change that has affected the e-learning market.
Future
<PAGE> 18
evolutions may include such technology innovations as increased bandwidth
connections, the adoption of a standard for receiving voice or video
transmissions over the Internet, and development of new online learning
methodologies that achieve better knowledge results for adult learners. Our
failure to adapt to changes in our industry could cause us to lose existing
customers or fail to gain new customers. Although the e-learning market is
highly fragmented with no single competitor accounting for a dominant market
share, competition is intense. We compete primarily with:
- third-party suppliers of instructor-led education and learning;
- internal education departments; and
- other suppliers of technology-based learning solutions.
Due to the high market fragmentation, we do not often compete
head-to-head with any particular company. On occasion, our customers may
evaluate our end-to-end solution by comparison with point solutions offered by
other e-learning companies. These companies may include click2learn.com, Inc.,
NETg (a unit of Harcourt), SmartForce Corporation and SmartPlanet (a division of
Ziff-Davis, Inc.). We may not provide solutions that compare favorably with
traditional or new instructor-led techniques or other technology-based learning
methodologies. Our competitors vary in size and in the scope and breadth of the
courses and services they offer. Several of our competitors have longer
operating histories and significantly greater financial, technical and marketing
resources. In addition, larger companies may enter the e-learning market through
the acquisition of our competitors. We anticipate that the lack of significant
entry barriers to the e-learning market will allow other competitors to enter
the market, increasing competition. To succeed, we must continue to expand our
course offerings, upgrade our technology and distinguish our solution. We may
not be able to do so successfully. Any failure by us to anticipate or respond
adequately to changes in technology and customer preferences, or any significant
delays in course development or implementation, could impact our ability to
capture market share. As competition continues to intensify, we expect the
e-learning market to undergo significant price competition. We also expect to
face increasing price pressures from customers as they demand more value for
their learning related expenditures. Increased competition or our inability to
compete successfully against current and future competitors could result in
reduced operating margins, as well as loss of market share, thought leadership
and a diminution of our brand.
WE MUST DELIVER COURSES THAT MEET THE NEEDS OF OUR CUSTOMERS OR OUR BUSINESS
WILL SUFFER.
To be competitive, we must develop and introduce on a timely basis
new course offerings which meet the needs of companies seeking to use our
e-learning solutions. Furthermore, the quality of our learning solutions depends
in large part on our ability to frequently update our courses and develop new
content as the underlying subject matter changes. We create courses both by
using subject matter expertise provided by our customers, which we then
incorporate into an educational course format, and through material obtained
from third-party content developers. The quality of our courses depends on our
receiving content and cooperation from the following sources:
- customers, who provide us with specific subject matter experts who
assist our developers in incorporating the customer's content into
our courses; and
- third-party content developers, who provide us with much of the
content for our catalog courses.
If we do not receive materials from the above sources in a timely
manner, we may not be able to develop or deliver specialized courses for our
customers in the time frame they are expecting. Even if we do receive necessary
materials from third parties, if our employees and consultants, upon whom we
rely for instructional and Web design expertise, fail to complete their work in
a timely manner, we will be unable to meet customer expectations. In the past,
we have
<PAGE> 19
experienced delays in obtaining access to our customers' experts, which has
contributed to a longer development cycle and inefficient allocation of our
resources. Any prolonged delays, even when caused by our customers, can damage
our reputation and lead to a failure to satisfy a customer's demands.
OUR PLANS TO EXPAND THE SCOPE OF OUR COURSES TO FIELDS OTHER THAN INFORMATION
TECHNOLOGY WILL DEPEND IN PART ON OUR ABILITY TO ENTER INTO CONTENT DEVELOPMENT
RELATIONSHIPS WITH RECOGNIZED EXPERTS OR SPECIALISTS, AND IF WE ARE UNABLE TO
ATTRACT THE RIGHT EXPERTS, WE MAY NOT BE SUCCESSFUL IN ENTERING NEW FIELDS.
Our strategy involves broadening the fields presently covered by our
courses. In particular, to date we have been primarily focused on courses in the
information technology area, and we are currently planning to develop and
introduce new course offerings in financial services, healthcare, soft skills
and other fields. These new course offerings may encompass areas in which we
have little or no experience or expertise. Therefore, our ability to expand our
courses into these areas will depend in part on our ability to negotiate and
execute content development relationships with recognized experts or leading
corporations in the new fields.. If we are unable to locate these experts, we
may fail to develop the courses that our current and future customers will
demand. Any failure of ours to expand our course offerings to new fields could
constrain our revenue growth and harm our future prospects.
TO REMAIN COMPETITIVE, WE MUST KEEP PACE WITH RAPID TECHNOLOGICAL CHANGES IN OUR
INDUSTRY.
The e-learning market is characterized by rapidly changing
technologies, frequent new service introductions, short development cycles and
evolving standards. We must adapt to rapidly changing technologies by
maintaining and improving the performance features and reliability of our
courses. We may experience technical difficulties that could delay or prevent
the successful development, introduction or marketing of new courses and related
services. For instance, adding capabilities to deliver video over the Internet
to our courses may be desired by some customers, but may nevertheless pose a
serious technical challenge and could have a negative impact on our ability to
develop and deliver courses on a profitable basis. In addition, any new
enhancements to our courses must meet the requirements of our current and
prospective customers and participants. We could incur substantial costs to
modify our services or infrastructure to adapt to rapid technological change.
WE ARE GROWING RAPIDLY AND IF WE FAIL TO MANAGE OUR GROWTH EFFECTIVELY, WE MAY
NOT BE ABLE TO TAKE ADVANTAGE OF MARKET OPPORTUNITIES, WHICH WOULD SEVERELY
IMPACT OUR ABILITY TO COMPETE.
Our recent rapid growth has placed, and future anticipated growth is
likely to continue to place, a considerable strain on our managerial resources.
We have grown from 33 employees on January 1, 1998 to 406 employees on September
30, 2000. We plan to continue to expand our sales and marketing, administration,
content and technology development and tutoring organizations. In order to
manage this growth effectively, we will need to improve our financial and
managerial controls, our reporting systems and procedures. In addition, we will
need to expand, train and manage our work force, which we anticipate will expand
significantly. If we fail to manage our growth effectively, we will not be able
to capitalize on attractive business opportunities and may fail to adequately
support our existing customer base. Should this occur, our reputation and
competitive position could be seriously damaged.
IF WE DO NOT DEVELOP OUR INDIRECT SALES CHANNELS, WE WILL BE LESS LIKELY TO
INCREASE OUR REVENUES.
<PAGE> 20
If we do not develop our indirect sales channels, we will be less
likely to increase our revenues. To date, more than 90% of our sales have been
made through direct sales efforts. We believe that we will need to diversify our
sales efforts if we are to be successful. If we do not develop indirect sales
channels, we may miss sales opportunities that might be available through these
other channels. We are currently investing in personnel and marketing activities
to develop indirect sales channels including instructor-led training companies
that are seeking to provide an e-learning product offering, e-commerce Web sites
that sell Web-based learning, and other market participants such as software
producers and systems integrators who provide learning as an additional service
to their clients.
Although we are currently investing to develop these indirect sales
channels, we may not succeed in establishing a channel that can effectively
market our e-learning solutions on a profitable basis. In addition, our direct
sales force may compete with these resellers, and we may not be able to manage
conflicts across our direct and indirect sales channels. Our focus on increasing
sales through our indirect channel may divert management resources and attention
from direct sales. Conflicts across sales channels could cause us to encounter
pricing pressures and lose revenue opportunities, which could harm our business
and cause our operating results to decline.
IN ORDER TO ADDRESS THE EXPECTED GROWTH IN OUR BUSINESS WE MUST CONTINUE TO
IMPROVE THE CAPACITY OF OUR TECHNOLOGY INFRASTRUCTURE; ANY FAILURE OF OUR
INFRASTRUCTURE WOULD DIRECTLY IMPACT OUR ABILITY TO DELIVER COURSES AND WOULD
LIKELY LEAD TO SIGNIFICANT LOSSES AND CUSTOMER DISSATISFACTION.
In order to address the expected growth in our business we must
continue to improve the capacity of our technology infrastructure. The
continuing and uninterrupted performance of our internal computer network and
Internet course servers is critical to our success. Any system failure that
causes interruptions or delays in our ability to make our courses accessible to
customers could reduce customer satisfaction and, if sustained or repeated,
could reduce the attractiveness of our courses and services and result in
significant revenue losses. We are particularly vulnerable to network failures
during periods of rapid growth when our roster of courses and participants can
outpace our network capacity. The continued viability of our business requires
us to support multiple participants concurrently and deliver fast response times
with minimal network delays. We are continuing to add system capacity, but we
may not be able to adequately address network capacity, especially during
periods of rapid growth. Any failure to meet these capacity requirements could
lead to additional expenditures, lost business opportunities and damage to our
reputation and competitive position.
ANY FAILURE OF, OR CAPACITY CONSTRAINTS IN, THE SYSTEMS OF THIRD PARTIES ON
WHICH WE RELY COULD ADVERSELY AFFECT OUR BUSINESS.
Our communications hardware and some of our other computer hardware
operations are located at the facilities of Exodus Communications, Inc. in Santa
Clara, California. Unexpected events such as natural disasters, power losses and
vandalism could damage our systems. Telecommunications failures, computer
viruses, electronic break-ins, earthquakes, fires, floods, other natural
disasters or other similar disruptive problems could adversely affect the
operation of our systems. Despite precautions we have taken, unanticipated
problems affecting our systems in the future could cause interruptions or delays
in the delivery of our courses.
The failure of our telecommunications provider or Exodus, which
together provide us with our Internet connection, to provide sufficient and
timely data communications capacity and network infrastructure could cause
service interruptions or slower response times, and reduce customer demand for
our courses and services. Our insurance policies may not adequately compensate
us for any losses that may occur due to any damages or interruptions in our
systems. Accordingly, we could be required to make capital expenditures in the
event of damage.
<PAGE> 21
We do not currently have fully redundant systems or a formal disaster
recovery plan. Our Web site must accommodate a high volume of traffic and
deliver courses and other information in a timely manner. Our Web site has
experienced in the past, and may experience in the future, slow response times
and periods of unavailability for a variety of reasons. We periodically
experience unscheduled system downtime, which results in our Web site being
inaccessible to participants. Since September 1, 1999, we have experienced 22
instances of unscheduled system downtime which on average have resulted in our
Web site being entirely inaccessible to course participants for approximately
1.5 hours. Although we have not suffered material losses during these downtimes,
if we experience extended downtime in the future, customers and our course
participants could lose confidence in our services.
WE CURRENTLY INTEND TO EXPAND INTERNATIONALLY AND, AS A RESULT, WE COULD BECOME
SUBJECT TO NEW RISKS.
Our strategy includes international expansion of our business. Our
current plans include expansion into the United Kingdom, which began during the
first quarter of fiscal 2001, and creating a partner-based support
infrastructure for customers around the world. In the United Kingdom, we could
be affected by political and monetary changes, including European unification
and introduction of the Euro. This international expansion will require
significant management attention and financial resources and could harm our
financial performance by increasing our costs. We have very limited experience
in marketing, selling and distributing courses internationally. We currently
have 5 employees located outside of the United States. We could become subject
to additional risks as we expand internationally, including:
- difficulties in staffing and managing international operations;
- our inability to develop content localized for international
jurisdictions;
- protectionist laws and business practices that favor local
competition;
- multiple, conflicting and changing governmental laws and
regulations;
- slower adoption of e-learning solutions;
- different learning styles;
- longer sales and payment cycles;
- greater difficulties in collecting accounts receivable;
- fluctuations in currency exchange rates;
- political and economic instability;
- potentially adverse tax consequences;
- little or no protection of our intellectual property rights in
some foreign countries, particularly less developed countries; and
- increases in tariffs, duties, price controls or other restrictions
on foreign currencies or trade barriers imposed by foreign
countries.
If we encounter these factors in connection with our current and
future expansions internationally, our revenues could fall below expectations,
which would harm our business and operating results. In this event, our stock
price could decline.
OUR INABILITY TO PROTECT OUR INTELLECTUAL PROPERTY AND PROPRIETARY RIGHTS AND
OUR INTERNET DOMAIN NAME COULD LEAD TO UNAUTHORIZED USE OF OUR COURSES OR
RESTRICT OUR ABILITY TO MARKET OUR COURSES.
Our success depends, in part, on our ability to protect our
proprietary rights and technology. We rely on a combination of copyrights,
trademarks, service marks, trade secret laws and employee and third-party
nondisclosure agreements to protect our proprietary rights. Despite our efforts
to protect these rights, unauthorized parties may attempt to duplicate or copy
our courses or our delivery technology or obtain and use information that we
regard as proprietary. In addition, the laws of many countries do not protect
our proprietary rights to as great an extent as do the laws of the United
States. As a consequence, effective trademark, service mark, copyright
<PAGE> 22
and trade secret protection may not be available in every country in which our
courses and services are made available. We have registered the trademark
DigitalThink and we own the domain name digitalthink.com. It is possible,
however, that third parties could acquire trademarks or domain names that are
substantially similar or conceptually similar to our trademarks or domain names.
This could decrease the value of our trademarks or domain names and could hurt
our business. The regulation of domain names in the United States and in foreign
countries is subject to change. The relationship between regulations governing
domain names and laws protecting trademarks and similar proprietary rights is
unclear. As a result, we may not acquire or maintain exclusive rights to our
domain names in the United States or in other countries in which we conduct
business. We may from time to time encounter disputes over rights and
obligations concerning intellectual property. We obtain the content for many of
our courses from our customers and it is possible that the use of this content
may subject us to the intellectual property claims of third parties. Although we
generally seek indemnification from our customers to protect us from these types
of claims, we may not be fully protected from extensive damage claims or claims
for injunctive relief. In addition, our customers may assert that some of the
courses we develop for our general catalog or under contract with other
customers may improperly use their proprietary content. Our involvement in any
litigation to resolve intellectual property ownership matters would require us
to incur substantial costs and divert management's attention and resources. In
addition, we cannot predict the effect of a failure to prevail in any litigation
of this kind.
PROVISIONS OF OUR CHARTER DOCUMENTS AND DELAWARE LAW MAY HAVE ANTI-TAKEOVER
EFFECTS THAT COULD PREVENT A CHANGE IN OUR CONTROL, EVEN IF THIS WOULD BE
BENEFICIAL TO STOCKHOLDERS.
Provisions of our amended and restated certificate of incorporation,
bylaws and Delaware law could make it more difficult for a third party to
acquire us, even if doing so would be beneficial to our stockholders. These
provisions include:
- A Shareholder Rights Plan that grants existing stockholders
additional rights in the event a single holder acquires greater
than 15% of our shares;
- a classified board of directors, in which our board is divided
into three classes with three year terms with only one class
elected at each annual meeting of stockholders, which means that a
holder of a majority of our common stock will need two annual
meetings of stockholders to gain control of the board;
- a provision which prohibits our stockholders from acting by
written consent without a meeting;
- a provision which permits only the board of directors, the
president or the chairman to call special meetings of
stockholders; and
- a provision which requires advance notice of items of business to
be brought before stockholders meetings. In addition, amending any
of the above provisions will require the vote of the holders of 66
2/3% of our outstanding common stock.
DIRECTORS, EXECUTIVE OFFICERS AND THEIR AFFILIATED ENTITIES HOLD A SUBSTANTIAL
AMOUNT OF OUR STOCK AND ARE ABLE TO CONTROL MATTERS REQUIRING STOCKHOLDER
APPROVAL.
As of September 30, 2000, our directors, executive officers and their affiliated
entities own approximately 49.3% of our outstanding capital stock. As a result,
these stockholders, acting together, are able to control all matters requiring
approval by the stockholders, including the election of all directors and
approval of significant corporate transactions.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk
<PAGE> 23
The following discusses our exposure to market risk related to
changes in interest rates, foreign currency exchange rates, and equity prices.
This discussion contains forward-looking statements that are subject to risks
and uncertainties. Actual results could vary materially as a result of a number
of factors.
Interest rate risk
As of September 30, 2000, we had cash and cash equivalents of $32.0
million, consisting of cash and highly liquid short-term investments with
original maturities of three months or less at the date of purchase.
Additionally, the Company had marketable securities, classified as available for
sale, with maturities greater than three months totaling $49.1 million. These
investments may be subject to interest rate risk and will decrease in value if
market rates increase. A hypothetical increase in market interest rates of 10%
from the market rates in effect at September 30, 2000 would cause the fair value
of the these investments to decrease by an immaterial amount. Declines in
interest rates over time will result in lower interest income.
Foreign Currency and Exchange Rate Risk
All of our revenues recognized to date have been denominated in U.S.
dollars and are primarily from the United States. However, an increasing portion
of our future revenue may be derived from international customers. Revenues from
these customers may be denominated in the local currency of the applicable
countries. As a result, our operating results could become subject to
significant foreign currency fluctuations based upon changes in exchange rates
in relation the U.S. dollar.
Furthermore, if we engage in business outside the United States,
changes in exchange rates relative to the U.S dollar could make us less
competitive in international markets. Although we will continue to monitor our
foreign currency exposure, and may use financial instruments to limit this
exposure, there can be no assurance that exchange rate fluctuations will not
have a materially negative impact on our business.
Equity Price Risk
We do not own any equity investments.
PART II: OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
On September 15, 2000, the Company's Board of Directors adopted a Shareholder
Rights Plan under which the Company declared a dividend of one Right for each
share of Common Stock outstanding. Prior to the Distribution Date referred to
below, the Rights will be evidenced by and trade with the certificates for the
Common Stock. After the Distribution Date, the Company will mail Rights
certificates to the stockholders and the Rights will become transferable apart
from the Common Stock.
Rights will separate from the Common Stock and become exercisable following (a)
the tenth business day (or such later date as may be determined by a majority of
the Directors) after a person or group acquires beneficial ownership of 15% or
more of the Company's Common Stock or (b) the tenth business day (or such later
date as may be determined by a majority of the Directors) after a person or
group announces a tender or exchange offer, the consummation of
<PAGE> 24
which would result in ownership by a person or group of 15% or more of
DigitalThink's Common Stock.
After the Distribution Date, each Right will entitle the holder to purchase for
$ 250.00 a fraction of a share of the Company's Preferred Stock with economic
terms similar to that of one share of the Company's Common Stock.
Report of Use of Proceeds from Initial Public Offering date February 24, 2000
On February 24, 2000, we completed our initial public offering, in
which we sold 5,060,000 shares of common stock at $14 per share. The total
aggregate gross proceeds amounted to $65.2 million. Underwriters' discounts and
other related costs were approximately $5.5 million, resulting in net proceeds
of approximately $59.7 million, plus additional $14 million from a private
placement of common stock the Company completed concurrently with the initial
public offering. From March 1, 2000 to September 30, 2000, the Company estimates
that it has used a portion of the net proceeds of the two offerings as follows:
(I) investments in cash and cash equivalents of $60.5 million; and (ii) working
capital and general corporate purposes of $12.5 million.
The Company has used these proceeds for working capital and general corporate
purposes, for the following:
- the acquisition of Arista Knowledge Systems, Inc.;
- increased learning solutions capacity and capability;
- creation of a platform partner program;
- expanded technology and engineering headcount; and
- investment in content and course development tools and resources
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company's Annual Meeting of Stockholders was held on July 28, 2000 in San
Francisco, California. Proxies for the meeting were solicited pursuant to
Regulation 14A. At the Company's Annual Meeting, the stockholders approved the
following resolutions:
Election of the following persons as directors:
<TABLE>
<S> <C> <C> <C> <C>
Steven L. Eskenazi - For: 23,476,416 Withheld: 215,644
Samuel D. Kingsland - For: 23,528,740 Withheld: 163,320
</TABLE>
Ratification and appointment of Deloitte & Touche LLP as independent accountants
<TABLE>
<S> <C>
For: 23,671,411
Against 4,153
Abstain 16,496
Broker non-vote 0
</TABLE>
ITEM 5. OTHER MATTERS
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
<PAGE> 25
(a) Exhibits
27.1 Financial Data Schedule
(b) Reports on Forms 8-K
(i) On July 21, 2000, the Company filed Form 8-K with the
Securities and Exchange Commission to report the purchase of
Arista Knowledge Systems, Inc. On September 15, 2000 an
amendment to this filing was submitted to the Securities and
Exchange Commission. The amendment included pro forma
statements of income and comprehensive income for the year
ended March 31, 2000 as well as a pro forma consolidated
balance sheet dated June 30, 2000. Additionally, the amendment
reported Arista Knowledge Systems' 1998, 1999 and June 30,
2000 financial statements, footnotes and independent auditor's
report.
(ii) The Company filed a report on Form 8-K on September 18, 2000
with respect to the adoption of a Shareholder Rights Plan.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
DIGITALTHINK, INC.
(Registrant)
Date: November 10, 2000
/s/ Peter J. Goettner
---------------------------------
Peter J. Goettner
Chairman of the Board
Chief Executive Officer
(Principle Executive Officer)
November 10, 2000 /s/ Michael W. Pope
---------------------------------
Michael W. Pope
Vice President,
Chief Financial Officer
(Principle Financial and Accounting Officer)
<PAGE> 26
EXHIBIT INDEX
Exhibits
--------
27.1 Financial Data Schedule
