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 January 31, 2001
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 February 28, 2001, 29,694,257 shares of the Registrant's common stock
were outstanding.
DITECH COMMUNICATIONS CORPORATION
TABLE OF CONTENTS
Page
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PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements (unaudited)
Condensed Consolidated Statements of Operations
THREE MONTHS AND NINE MONTHS ENDED JANUARY 31, 2001 AND 2000 ...................3
Condensed Consolidated Balance Sheets
AS OF JANUARY 31, 2001 AND APRIL 30, 2000 ......................................4
Condensed Consolidated Statements of Cash Flows
NINE MONTHS ENDED JANUARY 31, 2001 AND 2000 ....................................5
Notes to the Condensed Consolidated Financial Statements .......................6
ITEM 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations .....................................................10
ITEM 3 Qualitative and Quantitative Disclosures About Market Risk ....................26
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings .............................................................27
ITEM 2. Changes in Securities and Use of Proceeds .....................................27
ITEM 3. Defaults Upon Senior Securities ...............................................27
ITEM 4. Submission of Matters to a Vote of Security Holders ...........................27
ITEM 5. Other Information .............................................................27
ITEM 6. Exhibits and Reports on Form 8-K ..............................................27
Signatures ...................................................................................28
2
PART I. FINANCIAL INFORMATION
ITEM I. Financial Statements
Ditech Communications Corporation
Condensed Consolidated Statements of Operations
(in thousands, except per share data)
(unaudited)
Three months Nine months
ended January 31, ended January 31,
----------------------------- -------------------------------
2001 2000 2001 2000
------------ ------------- ------------- -------------
Revenues $13,341 $34,382 $101,971 $70,180
Cost of goods sold 5,189 9,952 31,776 21,617
------------ ------------- ------------- -------------
Gross profit 8,152 24,430 70,195 48,563
------------ ------------- ------------- -------------
Operating expenses
Sales and marketing 3,405 2,454 9,192 6,295
Research and development 8,747 1,841 23,485 4,220
General and administrative 1,816 911 4,939 2,917
Amortization of goodwill and other intangible assets 5,936 -- 14,107 --
------------ ------------- ------------- -------------
Total operating expenses 19,904 5,206 51,723 13,432
------------ ------------- ------------- -------------
Income (loss) from operations (11,752) 19,224 18,472 35,131
------------ ------------- ------------- -------------
Other income (expense)
Interest income 1,328 608 3,793 823
Interest expense (1) (3) (83) (177)
------------ ------------- ------------- -------------
Other income, net 1,327 605 3,710 646
------------ ------------- ------------- -------------
Income (loss) before provision for (benefit from) income taxes (10,425) 19,829 22,182 35,777
Provision for (benefit from) income taxes (2,504) 7,959 12,912 14,652
------------ ------------- ------------- -------------
Net income (loss) (7,921) 11,870 9,270 21,125
Accretion of mandatorily redeemable preferred stock to
redemption value -- -- -- 99
------------ ------------- ------------- -------------
Net income (loss) attributable to common stockholders ($7,921) $11,870 $9,270 $21,026
============ ============= ============= =============
Net income(loss) attributable to common stockholders per share
Basic ($0.28) $0.46 $0.33 $0.95
============ ============= ============= =============
Diluted ($0.28) $0.41 $0.31 $0.81
============ ============= ============= =============
Number of shares used in per share calculations
Basic 28,723 25,830 28,299 22,209
============ ============= ============= =============
Diluted 28,723 28,686 29,825 26,026
============ ============= ============= =============
The accompanying notes are an integral part of these unaudited condensed
consolidated financial statements.
3
Ditech Communications Corporation
Condensed Consolidated Balance Sheets
(in thousands)
January 31, April 30,
2001 2000
----------------- ----------------
(unaudited)
ASSETS
Current assets
Cash and cash equivalents $121,586 $88,616
Accounts receivable, net 9,046 20,349
Inventories 16,313 6,596
Deferred income taxes 3,191 1,839
Other current assets 1,072 352
Income taxes receivable -- 1,412
----------------- ----------------
Total current assets 151,208 119,164
Property and equipment, net 6,061 2,680
Purchased technology, net 20,731 24,617
Goodwill, net 65,385 10,790
Deferred income taxes 22,358 4,703
Other assets 4,228 3,198
----------------- ----------------
Total assets $269,971 $165,152
================= ================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
Accounts payable $6,714 $5,201
Accrued expenses 6,128 4,228
Deferred revenue 239 2,074
Income taxes payable 3,108 --
Obligations under capital lease, current portion 22 55
----------------- ----------------
Total current liabilities 16,211 11,558
Obligations under capital lease, net of current portion 2 21
----------------- ----------------
Total liabilities 16,213 11,579
----------------- ----------------
Common stock 29 28
Deferred stock compensation (30,798) (21,937)
Additional-paid-in capital 270,894 171,119
Retained earnings 13,633 4,363
----------------- ----------------
Total stockholders' equity 253,758 153,573
----------------- ----------------
Total liabilities and stockholders' equity $269,971 $165,152
================= ================
The accompanying notes are an integral part of these unaudited condensed
consolidated financial statements.
4
Ditech Communications Corporation
Condensed Consolidated Statements of Cash Flows
(in thousands)
(unaudited)
Nine months ended
January 31,
------------------------------------
2001 2000
---------------- ----------------
Cash flows from operating activities:
Net income $9,270 $21,125
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 2,264 1,244
Increase in provision for doubtful accounts 200 225
Gain on disposal of property and equipment (6) --
Tax benefit from exercise of stock options 5,786 1,729
Deferred income taxes (4,714) (780)
Amortization of deferred stock compensation 8,710 247
Amortization of goodwill and other
acquisition related intangible assets 14,107 --
Changes in assets and liabilities:
Accounts receivable 11,637 (9,092)
Inventories (9,882) (456)
Other current assets (463) (470)
Income taxes receivable/payable 4,520 3,368
Accounts payable (893) 1,507
Accrued expenses (1,137) 1,221
Deferred revenue (1,836) 364
---------------- ----------------
Net cash provided by operating activities 37,563 20,232
---------------- ----------------
Cash flows from investing activities:
Purchase of property and equipment (3,363) (1,270)
Other assets (471) (3,162)
Net cash received in purchase acquisitions 564 --
---------------- ----------------
Net cash used in investing activities (3,270) (4,432)
---------------- ----------------
Cash flows from financing activities:
Repurchase of common stock (11) (4)
Principal payments on notes payable (2,118) (7,313)
Principal payments on capital leases (2,267) (45)
Redemption of Series A mandatorily
redeemable preferred stock -- (19,655)
Proceeds from issuance of common stock -- 82,759
Proceeds from employee stock plan issuances 3,073 535
---------------- ----------------
Net cash provided by (used in) financing activities (1,323) 56,277
---------------- ----------------
Net increase in cash and cash equivalents 32,970 72,077
Cash and cash equivalents, beginning of period 88,616 3,114
---------------- ----------------
Cash and cash equivalents, end of period $121,586 $75,191
================ ================
The accompanying notes are an integral part of these unaudited condensed
consolidated financial statements.
5
DITECH COMMUNICATIONS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
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 condensed consolidated financial statements include the accounts of
Ditech and its subsidiaries. All significant intercompany accounts and
transactions have been eliminated. The accompanying condensed
consolidated financial statements at January 31, 2001 and for the three
and nine month periods ended January 31, 2001 and 2000, 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 January 31, 2001 are not necessarily indicative of
results for the entire fiscal year or future periods. These condensed
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 (Loss) per Share
Basic earnings (loss) 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 the dilutive effect of common stock subject to repurchase.
Diluted loss per share is calculated excluding these items as their effect
is anti-dilutive.
Comprehensive Income
There was no difference between the Company's net income and its total
comprehensive income for the three and nine-month periods ended January 31,
2001 or 2000.
6
Reclassifications
Certain reclassifications have been made in the condensed consolidated
statement of cash flows for the nine months ended January 31, 2000 to
conform to classifications used in the current fiscal year. These
reclassifications did not impact the previously reported total cash flows
from operating, investing, or financing activities.
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 was
accounted for in three discrete components. The first, approximately $9
million related to purchased research and development, was written off in
the fourth quarter of fiscal 2000. Next, approximately $37 million related
to developed technology and goodwill was capitalized and is being 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 is being 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 acquisition
costs of approximately $680,000. Atmosphere Networks was an emerging
provider of optical networking products, enabling carriers to combine
various types of traffic (voice, data and video) onto an optical network.
The allocation of the stock and cash purchase price is summarized below (in
thousands):
Net assets acquired $15,830
Established workforce 1,500
Goodwill 64,615
----------
Total purchase price $81,945
==========
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 from market on the date of grant. As
a result, the Company recorded deferred stock compensation of approximately
$17.3 million in August 2000, which was reduced to $15.7
7
million in November 2000, for option cancellations. The deferred stock
compensation is being amortized to expense ratably over the options'
four-year vesting period. The cost allocated to intangible assets for the
acquired workforce and goodwill is being amortized to expense over their
estimated useful lives of four years. Amortization expense for stock
options and intangible assets associated with the Atmosphere acquisition of
approximately $5.4 million was recorded in the third quarter and $11.2
million was recorded in the first nine months of fiscal 2001.
The following unaudited pro forma financial information reflects the
results of operations for the three and nine months ended January 31, 2001
and 2000 as if the acquisitions had occurred on May 1, 1999. The pro forma
results of operations for the three and nine months ended January 31, 2001
include results of operations of Atmosphere Networks, including
amortization of goodwill, other intangibles, and deferred stock
compensation for the periods presented. The pro forma results of operations
for the three and nine months ended January 31, 2000 include results of
operations of Telinnovation, and Atmosphere Networks, including
amortization of goodwill, other intangibles, and deferred stock
compensation and the elimination of intercompany transactions between the
Company and Telinnovation. 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, 1999, and may not be indicative of future operating results (in
thousands, except per share amounts).
Three months ended Nine months ended
January 31, January 31,
--------------------------- --------------------------
2001 2000 2001 2000
----------- ------------ ----------- -----------
(unaudited) (unaudited)
Pro forma financial information
Net Revenues $13,341 $35,076 $103,517 $71,698
----------- ------------ ----------- -----------
Income (loss) from operations (11,752) 5,257 8,929 (2,751)
----------- ------------ ----------- -----------
Net income (loss) attributable to common stockholders $(7,921) $2,044 $1,948 $(6,592)
----------- ------------ ----------- -----------
Net income (loss) per share attributable to common
stockholders:
Basic $(0.28) $0.07 $0.07 $(0.28)
----------- ------------ ----------- -----------
Diluted $(0.28) $0.07 $0.06 $(0.28)
----------- ------------ ----------- -----------
Weighted average shares:
Basic 28,723 27,471 28,692 23,850
----------- ------------ ----------- -----------
Diluted 28,723 30,727 30,255 23,850
----------- ------------ ----------- -----------
4. INVENTORIES
Inventories, consisted of (in thousands, unaudited):
January 31, April 30,
2001 2000
----------------- -----------------
Raw materials $ 5,892 $1,717
Work in progress 4,324 849
Finished goods 6,097 4,030
----------------- -----------------
Total $16,313 $6,596
================= =================
8
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 cancellation
products. The Company's revenues by geographic area are summarized as
follows (in thousands, unaudited):
Three months ended Nine months ended
January 31, January 31,
------------------------------- -------------------------------
2001 2000 2001 2000
-------------- ------------- ------------- --------------
United States $10,924 $28,114 $84,786 $60,797
Mexico 30 608 1,461 998
Brazil 307 -- 3,428 617
China 1,721 2,581 8,091 3,356
Rest of World 359 3,079 4,205 4,412
-------------- ------------- ------------- --------------
$13,341 $34,382 $101,971 $70,180
============== ============= ============= ==============
International sales are entirely composed 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.
9
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; IF WE ARE UNABLE TO
PROTECT OUR INTELLECTUAL PROPERTY, WE MAY NOT BE ABLE TO COMPETE EFFECTIVELY;
AND WE RECENTLY 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.
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 was accounted for in three discrete
components. The first, approximately $9 million related to purchased research
and development, was written off in the fourth quarter of fiscal 2000. Next,
approximately $37 million related to developed technology and goodwill, was
capitalized and is being 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 is being charged to expense over
the three-year vesting period of the shares.
10
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 acquisition costs of approximately $680,000. The acquisition is
being accounted for as a purchase. The total value of the acquisition of
approximately $82 million comprises approximately $15.8 million in net assets,
$1.5 million associated with the value of the established workforce and $64.6
million of goodwill from the acquisition. The goodwill and established workforce
costs were capitalized and are being amortized over their estimated lives of
four years.
We generally recognize product revenue when persuasive evidence of a definitive
agreement exists, risk of loss and title have passed to the customer, the fee is
fixed or determinable, and collectibility is probable. We offer a five-year
warranty on all of our products. The warranty generally provides that we will
repair or replace any defective product within five years from the invoice date.
We accrue for warranty costs at time of shipment based on our experience.
To date, the vast majority of our revenue has been derived from sales of our
echo cancellation products. We derived approximately 85.3%, 91.8%, 93.7%, and
94.1% of our revenue from the sale of our echo cancellation products in the
first nine months of fiscal 2001, in fiscal 2000, fiscal 1999 and fiscal 1998,
respectively. 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.
In addition, we have 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.
11
Historically the majority of our sales have been to customers in the U.S. In the
first nine months of fiscal 2001, in fiscal 2000, fiscal 1999, and fiscal 1998
we derived approximately 83%, 88%, 86% and 93%, 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 distributes 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 70%, 75%, 65% and 75% of our revenue in the
first nine months of fiscal 2001, in fiscal 2000, fiscal 1999 and fiscal 1998,
respectively. Qwest accounted for 48%, 57%, 42% and 42%, of our revenue in
the first nine months of fiscal 2001, in fiscal 2000, fiscal 1999 and fiscal
1998, respectively.
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.
Three months ended Nine months ended
January 31, January 31,
-------------------------- ---------------------------
2001 2000 2001 2000
----------- ----------- ------------ -----------
Revenue 100.0% 100.0% 100.0% 100.0%
Cost of goods sold 38.9 28.9 31.2 30.8
----------- ----------- ------------ -----------
Gross profit 61.1 71.1 68.8 69.2
----------- ----------- ------------ -----------
Operating expenses
Sales and marketing 25.5 7.1 9.0 9.0
Research and development 65.6 5.4 23.0 6.0
General and administrative 13.6 2.6 4.8 4.2
Amortization of goodwill and other intangibles 44.5 -- 13.8 --
----------- ----------- ------------ -----------
Total operating expenses 149.2 15.1 50.7 19.1
----------- ----------- ------------ -----------
Income (loss)from operations (88.1) 55.9 18.1 50.1
Other income, net 9.9 1.8 3.6 0.9
----------- ----------- ------------ -----------
Income (loss) before provision for (benefit from) income taxes (78.1) 57.7 21.8 51.0
Provision for (benefit from) income taxes (18.8) 23.1 12.7 20.9
----------- ----------- ------------ -----------
Net Income (loss) (59.4)% 34.5% 9.1% 30.1%
=========== =========== ============ ===========
THREE AND NINE MONTHS ENDED JANUARY 31, 2001 AND 2000.
REVENUE. Revenue decreased to $13.3 million in the third quarter of fiscal 2001
from $34.4 million in the third quarter of fiscal 2000. The decline was due to
macroeconomic trends of a slowdown in spending within our industry and delays in
the scheduled shipping of our 5th generation echo cancellation system product,
the OC-3, offset in part by a modest increase in sales of our optical
communications products.
Revenue for the first nine months of fiscal 2001 was $102.0 million, compared to
$70.2 million in the first nine months of fiscal 2000. This growth was largely
attributable to continued market acceptance of our Quad and Broadband echo
products, primarily in the first two quarters of fiscal 2001, and to a lesser
degree due to growth in our optical product sales. These factors were partially
offset by a decline in echo sales in the third quarter due to the delay in our
12
OC-3 product's availability and the general market slowdown discussed above.
Declining average selling prices of our echo cancellation products, as they
mature and experience increased market competition, also partially offset the
favorable unit sales trend.
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 decreased to $5.2 million in the third quarter of
fiscal 2001 from $10.0 million in the third quarter of fiscal 2000 due to the
decline in sales. Cost of goods sold increased to $31.8 million for the first
nine months of fiscal 2001, compared to $21.6 million for the first nine months
of fiscal 2000. The primary reason for the increase was costs associated with
increased unit sales of our echo cancellation products during the first nine
months of fiscal 2001.
GROSS MARGIN. Gross margin decreased to 61.1% in the third quarter of fiscal
2001 from 71.1% in the third quarter of fiscal 2000. The primary factors
contributing to the decline in gross margin were the relatively fixed
manufacturing overhead costs which represented a larger percent of revenue as
revenue declined. In addition, the revenue mix included a lower percentage of
higher margin echo cancellation products in the third quarter of fiscal 2001
versus the same period in fiscal 2000. Gross margin decreased to 68.8% in the
first nine months of fiscal 2001 from 69.2% in the first nine months of fiscal
2000. The primary factors contributing to this decrease were the higher
percentage of sales of lower margin optical products in fiscal 2001, sales of
lower margin Atmosphere products in the second quarter of fiscal 2001,
reductions in average selling prices on our Quad and DS3 products in the second
quarter of fiscal 2001, and higher overhead costs on a lower revenue base in the
third quarter of fiscal 2001. These unfavorable factors were partially offset by
the elimination of product royalty payments in the first quarter of fiscal 2000
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
improved leverage from our outsourced manufacturing strategy.
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 $3.4 million in the third quarter of fiscal 2001 from $2.5 million
in the third quarter of fiscal 2000. Sales and marketing expenses increased to
$9.2 million in the first nine months of fiscal 2001 from $6.3 million in the
first nine months of fiscal 2000. The primary causes for the increase were
increases in personnel and related costs, including travel, to support expansion
of our customer service functions and marketing efforts for our products both
domestically and internationally, including the formation of new direct and OEM
channel partnerships. Also impacting the increase in the third quarter of fiscal
2001 were marketing expenses for launching of our new fifth generation echo
cancellation system products and optical system products, which more than offset
lower sales commissions on the lower revenue base in the third quarter of fiscal
2001. We plan to continue to increase our expenditures in sales and marketing in
order to launch new products and 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
13
development of echo cancellation and optical communications products as well as
amortization of deferred stock compensation associated with the Telinnovation
and Atmosphere acquisitions. Research and development expense increased to $8.7
million in the third quarter of fiscal 2001 from $1.8 million in the third
quarter of fiscal 2000. Research and development expense increased to $23.5
million in the first nine months of fiscal 2001 from $4.2 million in the first
nine months of fiscal 2000. The increase is related to increased personnel and
related costs as well as increased materials and consulting costs associated
with new product research and development efforts on both our echo cancellation
and optical communications product lines. The number of research and development
employees has continued to increase with our acquisition of Atmosphere in July
2000. Research and development expenses included $3.2 million for the third
quarter of fiscal 2001 and $8.5 million for the first nine months of fiscal 2001
for amortization of deferred stock compensation associated with our acquisitions
of Telinnovation in February 2000 and Atmosphere in July 2000. We expect
research and development expenses to continue to grow in future periods as we
enhance current products and develop new echo cancellation and optical systems
products.
GENERAL AND ADMINISTRATIVE. General and administrative expenses primarily
consist of personnel costs for corporate officers and finance personnel, and
insurance, legal, accounting and consulting costs. General and administrative
expenses increased to $1.8 million in the third quarter of fiscal 2001 from $0.9
million in the third quarter of fiscal 2000. General and administrative expenses
increased to $4.9 million in the first nine months of fiscal 2001 from $2.9
million in the first nine 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 OTHER INTANGIBLES ASSETS. In the third quarter of
fiscal 2001, we amortized a total of $5.9 million for goodwill, purchased
technology and other acquisition related assets. Amortization for the quarter
included $1.9 million associated with the acquisition of Telinnovation, which
was completed on February 1, 2000 and $4.0 million associated with the
acquisition of Atmosphere, which was completed on July 25, 2000. Amortization
for the first nine months of fiscal 2001 totaled $14.1 million, which included
$5.6 million associated with the Telinnovation acquisition and approximately
$8.5 million associated with the Atmosphere acquisition. Goodwill and other
intangible assets 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 $1.3 million in the third quarter of fiscal 2001 from $605,000 in the third
quarter of fiscal 2000. Other income increased to $3.7 million in the first nine
months of fiscal 2001 from $646,000 in the first nine 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
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2000, cash from operations 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 third quarter of fiscal 2001 was a benefit of 24.0%
and was a provision of 40.1% in the third quarter of fiscal 2000. The low
effective tax benefit rate is due to certain non-deductible costs associated
with the acquisition of Atmosphere,including goodwill and purchased technology
amortization. Excluding these non-deductible costs, the effective tax rate was
approximately 41.25%. We expect that our ongoing effective tax provision
(benefit) rate excluding these non-deductible expenses should remain at
approximately 41% to 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 $78,000 of the deferred compensation in the third
quarter of fiscal 2001 and $83,000 in the third quarter of fiscal 2000 and
approximately $243,000 in the first nine months of fiscal 2001 and $248,000 in
the first nine months of 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 in the third quarter, and $5.7 million in
the first nine 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. Adjustments were recorded in the second and third quarter of
fiscal 2001, due to option cancellations, which reduced that amount to
approximately $1.9 million. This deferred compensation is being amortized to
compensation expense over the remaining term of the original twenty four month
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 was recorded as deferred
compensation of $17.3 million in August 2000 and adjustments recorded in the
second and third quarter of fiscal 2001, due to options cancellations, reduced
that amount to approximately $15.7 million. This deferred compensation is being
amortized to compensation expense over the remaining term of the original forty
eight month vesting period of the options. Amortization of the
Atmosphere-related deferred compensation totaled approximately $1.3 million in
the third quarter, and $2.7 million in the first nine months, of fiscal 2001.
LIQUIDITY AND CAPITAL RESOURCES
Since March 1997, we have satisfied the majority of our liquidity requirements
through cash flow generated from operations, funds received upon exercise of
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stock options and the proceeds from our initial and follow-on public offerings
in fiscal 2000.
In the first nine months of fiscal 2001 we generated $37.6 million in cash from
operations, primarily due to operating profits, after including the impact of
non cash items, and to a lesser extent due to a reduction in accounts receivable
and an increase in income taxes payable. These net sources of cash were offset
in part by a use of cash for an increase in inventory. Operating activities
generated $20.2 million in cash in the first nine months of fiscal 2000, mostly
due to operating profits and to a lesser extent due to increased income taxes
payable, accounts payable, accrued expenses and deferred revenue, partially
offset by an increase in accounts receivable.
In the first nine months of fiscal 2001 we used $3.3 million in cash for
investing activities, mostly from purchases of property and equipment, offset in
part by the completion of the Atmosphere acquisition, which was a net source of
cash provided from investing activities of approximately $564,000. Investing
activities used $4.4 million in cash in the first nine months of fiscal 2000 due
mostly to the purchase of our echo technology from Telinnovation for $3.0
million and purchases of property and equipment.
In the first nine months of fiscal 2001 we used $1.3 million in cash in
financing activities, primarily due to the retirement, in the second quarter of
fiscal 2001, of approximately $4.4 million in short term notes and capital lease
obligations assumed in the Atmosphere purchase, partially offset by proceeds of
approximately $3.1 million from issuances of stock under our stock option plans
and funding related to semiannual employee stock purchase plans. Financing
activities generated $56.3 million in cash in the first nine months of fiscal
2000, mostly from the net proceeds from our initial public offering in June 1999
and our follow-on offering in October 1999, partially offset by the application
of the net proceeds of our initial public offering to redeem all our outstanding
preferred stock and for paying off our note payable obligations in the first
quarter of fiscal 2000.
As of January 31, 2001, we had cash and cash equivalents of $121.6 million as
compared to $88.6 million at April 30, 2000. In addition, we have a line of
credit with the ability to borrow $4.0 million. This line of credit expires in
August 2001. At January 31, 2001, borrowings of $4.0 million were available and
no borrowings were outstanding under this line of credit. Due to the net loss
experienced in the third quarter of fiscal 2001, we were in default of a
covenant associated with the line of credit which requires positive quarterly
net income, exclusive of the impact of purchase accounting related costs. We
have received a waiver of this default from the bank.
We have no material commitments other than obligations under operating leases,
particularly our facility lease. We currently occupy approximately 60,000 square
feet in the two buildings that form our Mountain View headquarters. This
facility lease has an initial term of 5 years, which expires in June 2006.
We anticipate 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, 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
16
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, or EMU. 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 two years, business in the EMU member states will be conducted
in both the existing national currency, such as the French franc or the Deutsche
mark, and the euro. As a result, companies operating or conducting business in
EMU member states will need to ensure that their financial and other software
systems are capable of processing transactions and properly handing these
currencies, including the euro.
Based on our assessment to date, we do not expect the conversion to the euro to
have a material impact on our internal systems or our product sales. To date we
have experienced limited sales activities in the European economies,
substantially all of which have been in U.S. dollars. We will take appropriate
corrective action based on the results of our ongoing 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 or a delay in a scheduled product introduction. If this
happens, our revenue could be greatly reduced, which would materially and
adversely affect our business. Our five largest customers accounted for over
70%, 75%, 65% and 75% of our revenue in the first nine months of fiscal 2001,
in fiscal 2000, fiscal 1999 and fiscal 1998, respectively. Qwest accounted
for 48%, 57%, 42% and 42%, of our revenue in the first nine months of fiscal
2001, in fiscal 2000, fiscal 1999 and fiscal 1998, respectively. Our four
next largest customers accounted collectively for 24%, 18%, 23% and 33% of
our revenue in the first nine months of fiscal 2001, and in fiscal 2000,
fiscal 1999, and fiscal 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. More
recently, in the third quarter of fiscal 2001, delays in scheduled shipments
of the recently announced OC-3 echo cancellation products to Qwest resulted
in Qwest revenues declining to 12% of total revenue in the quarter versus
their recent purchase history that averaged over 40% of total revenue in the
last three years.
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
17
AFFECT OUR STOCK PRICE.
Our quarterly operating results have fluctuated significantly in the past
and may fluctuate in the future as a result of several factors, some of which
are outside of our control. If revenue declines in a quarter, whether due to a
loss in revenue or a delay in recognizing expected revenue, our operating
results will be adversely affected because many of our expenses are relatively
fixed. In particular, sales and marketing, research and development and general
and administrative expenses do not change significantly with variations in
revenue in a quarter. Adverse changes in our operating results could adversely
affect our stock price.
OUR REVENUE MAY VARY FROM PERIOD TO PERIOD. Factors that could cause our
revenue to fluctuate from period to period include:
- the timing or cancellation of orders from, or shipments to, existing and
new customers;
- delays outside of our control in the installation of products 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 in the next quarter. As a result, our revenue may
vary significantly from quarter to quarter.
Revenue can vary period to period if planned dates of new product
introductions are missed and the product release occurs in a later quarter. As
an example of this risk, in October 2000, we announced our OC-3 and STM-1 echo
cancellation systems, which were expected to be available for commercial
shipment in the third and fourth quarters, respectively, of fiscal 2001. In the
third quarter of fiscal 2001, we experienced delays in the scheduled shipping of
the OC-3 product, contributing to a revenue shortfall in that quarter. A further
delay in the availability of these key new products could result in a continued
depression in our revenues and net income. Currently we estimate that the OC-3
and the STM-1 system products will be available for first customer shipments in
the fourth quarter of fiscal 2001 and the first quarter of fiscal 2002,
respectively.
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
18
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, as we experienced in the third
quarter of fiscal 2001.
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:
- our successful introduction of our OC-3 and STM-1 echo cancellation
systems; and
- our successful introduction and sale of our new optical amplifiers and
optical systems products.
However, we may not be able to successfully produce or market our new
19
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 should
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. In the future we 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.
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. We derived approximately
85.3%, 91.8%, 93.7%, and 94.1% of our revenue from the sale of our echo
cancellation products in the first nine months of fiscal 2001, in fiscal 2000,
fiscal 1999 and fiscal 1998, respectively. 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
20
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 begun sales of an integrated
switch, which has echo cancellation capability built into it and could therefore
eliminate the need for the echo cancellation capability provided by our
products. To date, we believe we have not experienced any material changes in
customer orders as a result of the introduction of this product. However, new
technologies such as these 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 fourteen months, we completed the acquisitions of
Telinnovation and Atmosphere. We believe the Telinnovation acquisition provides
us with expanded opportunities in the newly developing voice over the Internet
and packet-based markets where echo cancellation will be an important issue. We
believe the Atmosphere acquisition provides us with expanded opportunities 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 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
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 and our
21
OC-3 echo cancellation system 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.
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.
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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. Ditech has
experienced recently, as have other companies in our sector, an unexpected
slowdown in infrastructure spending by its customers. This recent trend of lower
capital spending in the telecommunications industry contributed to the decline
in our revenues in the third quarter of fiscal 2001.
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.
SOME OF THE KEY COMPONENTS USED IN OUR PRODUCTS MAY HAVE INSUFFICIENT
SUPPLY TO MEET THE TOTAL MARKET DEMAND AND ANY UNFULFILLED DEMAND WE EXPERIENCE
MAY REDUCE OR DELAY OUR EXPECTED PRODUCT SHIPMENTS AND REVENUES.
Certain key components used in our products are in short supply relative to
the worldwide market demand. We may not be as successful as some of the larger
manufacturers we compete with in securing our desired purchase quantities of
these scarce components. If we are unable to procure our planned quantities of
material from all prospective suppliers, and if we can not use alternative
components, we could experience revenue delays or reductions and potential harm
to customer relationships. An example of this risk occurred in the third quarter
of fiscal 2001 as two vendors supplying us with components used in our OC-3
product did not meet our total demand which contributed to our revenue shortfall
in that quarter.
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.
Despite the revenue decline we experienced in the third quarter of fiscal
2001, our revenue for the nine months ended January 31, 2001 is 45% higher than
the revenue in the equivalent period of fiscal 2000. 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
23
will need it, which may also place further strain on 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 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 Chairman, 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
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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;
- 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 experiences; and
- potential loss of key employees of acquired organizations.
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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, the majority of which
are tax exempt. 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 January 31, 2001 of $121.6 million all have maturities of
35 days or less and bear an average interest rate of 4.1%. The estimated fair
value of our cash and cash equivalents approximates the principal amounts
reflected above based on the short maturities of these instruments.
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PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
None.
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
3.1 (1) Restated Certificate of Incorporation of Ditech
3.2 Bylaws of Ditech, as amended
(1) Incorporated by reference from the exhibit with corresponding number
from Ditech's Quarterly Report on From 10-Q, filed December 13,
2000.
(b) Reports on Form 8-K
Ditech filed no reports on form 8-K during the quarter ended
January 31, 2001.
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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: March 13, 2001 By: /s/ William J. Tamblyn
------------------ -----------------------------------
William J. Tamblyn
Vice President Finance and Chief
Financial Officer (Principal
Financial and Accounting Officer)
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INDEX TO EXHIBITS
Exhibits
3.1 (1) Restated Certificate of Incorporation of Ditech
3.2 Bylaws of Ditech, as amended
(1) Incorporated by reference from the exhibit with corresponding number
from Ditech's Quarterly Report on From 10-Q, filed December 13,
2000.