10-Q 1 a09-6943_110q.htm 10-Q

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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 January 31, 2009

 

OR

 

o

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 Networks, Inc.

(Exact name of registrant as specified in its charter)

 

Delaware

 

94-2935531

(State or other jurisdiction of incorporation or
organization)

 

(I.R.S. Employer 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 principal 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  o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,”  “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act:

 

Large accelerated filer  o

Accelerated filer  o

 

 

Non-accelerated filer  o

Smaller reporting company  x

(Do not check if a smaller reporting company)

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

YES  o     NO  x

 

As of February 28, 2009, 26, 256,917 shares of the Registrant’s common stock were outstanding.

 

 

 



Table of Contents

 

Ditech Networks, Inc.

FORM 10-Q for the Quarter Ended January 31, 2009

 

INDEX

 

 

 

Page

 

 

 

Part I.

Financial Information

 

 

 

 

Item 1.

Financial Statements

 

 

 

 

 

Condensed Consolidated Statements of Operations for the three and nine months ended January 31, 2009 and January 31, 2008

3

 

 

 

 

Condensed Consolidated Balance Sheets at January 31, 2009 and April 30, 2008

4

 

 

 

 

Condensed Consolidated Statements of Cash Flows for the nine months ended January 31, 2009 and January 31, 2008

5

 

 

 

 

Notes to Condensed Consolidated Financial Statements

6

 

 

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

19

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

41

 

 

 

Item 4.

Controls and Procedures

42

 

 

 

Item 4T

Controls and Procedures

42

 

 

 

Part II.

Other Information

 

 

 

 

Item 1.

Legal Proceedings

43

 

 

 

Item 1A.

Risk Factors

43

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

44

 

 

 

Item 3.

Defaults Upon Senior Securities

44

 

 

 

Item 4.

Submission of Matters to a Vote of Security Holders

45

 

 

 

Item 5.

Other Information

45

 

 

 

Item 6.

Exhibits

45

 

 

 

 

Signature

46

 

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PART I. FINANCIAL INFORMATION

 

ITEM I. Financial Statements

 

Ditech Networks, Inc.

Condensed Consolidated Statements of Operations

 

(in thousands, except per share data)

 

(unaudited)

 

 

 

Three months ended
January 31,

 

Nine months ended
January 31,

 

 

 

2009

 

2008

 

2009

 

2008

 

Revenue

 

 

 

 

 

 

 

 

 

Product revenue

 

$

3,864

 

$

5,016

 

$

9,198

 

$

22,730

 

Service revenue

 

1,035

 

1,668

 

4,355

 

4,613

 

Total revenue

 

4,899

 

6,684

 

13,553

 

27,343

 

 

 

 

 

 

 

 

 

 

 

Cost of goods sold

 

 

 

 

 

 

 

 

 

Product revenue

 

2,287

 

2,719

 

6,323

 

11,227

 

Service revenue

 

173

 

247

 

636

 

833

 

Total cost of goods sold(1)

 

2,460

 

2,966

 

6,959

 

12,060

 

 

 

 

 

 

 

 

 

 

 

Gross profit

 

2,439

 

3,718

 

6,594

 

15,283

 

 

 

 

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Sales and marketing (1)

 

2,366

 

3,885

 

8,992

 

14,362

 

Research and development (1)

 

3,004

 

3,769

 

9,853

 

14,214

 

General and administrative (1)

 

1,266

 

1,994

 

5,421

 

7,353

 

Amortization of purchased intangible assets

 

25

 

247

 

73

 

739

 

Impairment of goodwill

 

 

16,423

 

 

16,423

 

 

 

 

 

 

 

 

 

 

 

Total operating expenses

 

6,661

 

26,318

 

24,339

 

53,091

 

 

 

 

 

 

 

 

 

 

 

Loss from operations

 

(4,222

)

(22,600

)

(17,745

)

(37,808

)

Other income, net

 

346

 

933

 

15

 

4,094

 

 

 

 

 

 

 

 

 

 

 

Loss before provision for (benefit from) income taxes

 

(3,876

)

(21,667

)

(17,730

)

(33,714

)

Provision for (benefit from) income taxes

 

(86

)

(1,997

)

50

 

(7,628

)

 

 

 

 

 

 

 

 

 

 

Net loss

 

$

(3,790

)

$

(19,670

)

$

(17,780

)

$

(26,086

)

 

 

 

 

 

 

 

 

 

 

Per share data:

 

 

 

 

 

 

 

 

 

Basic and diluted:

 

 

 

 

 

 

 

 

 

Net loss

 

$

(0.15

)

$

(0.76

)

$

(0.68

)

$

(0.88

)

 

 

 

 

 

 

 

 

 

 

Weighted shares used in per share calculation:

 

 

 

 

 

 

 

 

 

Basic and diluted

 

26,115

 

25,809

 

26,068

 

29,752

 

 


(1) Stock-based compensation expense was allocated by function as follows:

 

Cost of goods sold

 

$

64

 

$

98

 

$

216

 

$

296

 

Sales and marketing

 

45

 

316

 

432

 

1,290

 

Research and development

 

(95

)

199

 

279

 

922

 

General and administrative

 

121

 

322

 

629

 

1,082

 

 

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

 

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Ditech Networks, Inc.

Condensed Consolidated Balance Sheets

 

(in thousands, except per share data)

 

(unaudited)

 

 

 

January 31,
2009

 

April 30,
2008

 

 

 

 

 

 

 

Assets

 

 

 

 

 

Cash and cash equivalents

 

$

40,935

 

$

36,131

 

Short-term investments

 

83

 

14,400

 

Accounts receivable, net of allowance for doubtful accounts of $289 at January 31, 2009 and $315 at April 30, 2008

 

4,168

 

5,294

 

Inventories

 

14,332

 

13,692

 

Other current assets

 

935

 

665

 

 

 

 

 

 

 

Total current assets

 

60,453

 

70,182

 

 

 

 

 

 

 

Long-term investments

 

8,161

 

15,130

 

Property and equipment, net

 

3,989

 

5,493

 

Purchased intangibles, net

 

66

 

139

 

Other assets

 

186

 

186

 

 

 

 

 

 

 

Total assets

 

$

72,855

 

$

91,130

 

 

 

 

 

 

 

Liabilities and Stockholders’ Equity

 

 

 

 

 

Accounts payable

 

$

2,209

 

$

2,130

 

Accrued expenses

 

3,325

 

5,070

 

Deferred revenue

 

605

 

1,274

 

Income taxes payable

 

129

 

229

 

 

 

 

 

 

 

Total current liabilities

 

6,268

 

8,703

 

 

 

 

 

 

 

Long term accrued expenses

 

312

 

377

 

Total liabilities

 

6,580

 

9,080

 

 

 

 

 

 

 

Commitments and contingencies (Note 9)

 

 

 

 

 

 

 

 

 

 

 

Common stock, $0.001 par value: 200,000 shares authorized and 26,257 and 26,090 shares issued and outstanding at January 31, 2009 and April 30, 2008, respectively

 

26

 

26

 

Additional paid-in capital

 

264,983

 

263,254

 

Accumulated deficit

 

(198,429

)

(180,650

)

Accumulated other comprehensive loss

 

(305

)

(580

)

 

 

 

 

 

 

Total stockholders’ equity

 

66,275

 

82,050

 

 

 

 

 

 

 

Total liabilities and stockholders’ equity

 

$

72,855

 

$

91,130

 

 

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

 

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Ditech Networks, Inc.

Condensed Consolidated Statements of Cash Flows

 

(in thousands)

 

(unaudited)

 

 

 

Nine months ended January 31,

 

 

 

2009

 

2008

 

Cash flows from operating activities:

 

 

 

 

 

Net loss

 

$

(17,780

)

$

(26,086

)

Adjustments to reconcile net loss to net cash used in operating activities:

 

 

 

 

 

Depreciation and amortization

 

1,789

 

1,934

 

Impairment loss on investments

 

1,367

 

 

Deferred income taxes

 

 

(7,535

)

(Gain)/loss on disposal of property and equipment

 

18

 

(14

)

Loss on disposal of property and equipment related to restructuring

 

262

 

 

Stock-based compensation expense

 

1,556

 

3,590

 

Amortization of purchased intangibles

 

73

 

739

 

Payment of employee-investor portion of convertible debenture

 

 

(610

)

Amortization of employee-investor portion of convertible debentures

 

 

50

 

Impairment of goodwill

 

 

16,423

 

Changes in assets and liabilities:

 

 

 

 

 

Accounts receivable

 

1,126

 

6,583

 

Inventories

 

(721

)

(5,535

)

Other current assets

 

(270

)

(185

)

Income taxes

 

(100

)

(494

)

Accounts payable

 

79

 

(534

)

Accrued expenses and other

 

(1,809

)

(1,616

)

Deferred revenue

 

(669

)

(2,726

)

 

 

 

 

 

 

Net cash used in operating activities

 

(15,079

)

(16,016

)

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Purchases of property and equipment

 

(486

)

(1,689

)

Purchases of available for sale investments

 

(83

)

(16,586

)

Sales and maturities of available for sale investments

 

20,277

 

61,699

 

Acquisition of Jasomi Networks, Inc., net of cash received

 

 

(3,786

)

Decrease in other assets

 

 

(2

)

 

 

 

 

 

 

Net cash provided by investing activities

 

19,708

 

39,636

 

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

Repurchase of common stock

 

 

(41,006

)

Proceeds from employee stock plan issuances

 

175

 

1,433

 

 

 

 

 

 

 

Net cash provided by (used in) financing activities

 

175

 

(39,573

)

 

 

 

 

 

 

Net increase (decrease) in cash and cash equivalents

 

4,804

 

(15,953

)

Cash and cash equivalents, beginning of period

 

36,131

 

34,074

 

 

 

 

 

 

 

Cash and cash equivalents, end of period

 

$

40,935

 

$

18,121

 

 

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

 

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DITECH NETWORKS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

(unaudited)

 

1.            DESCRIPTION OF BUSINESS

 

Ditech Networks, Inc. (the “Company”) designs, develops and markets telecommunications equipment for use in wireline, wireless, satellite and IP telecommunications networks.  The Company’s products enhance and monitor voice quality and provide security in the delivery of voice services.  The Company has established a direct sales force that sells its products in the U.S. and internationally. In addition, the Company is expanding its use of value added resellers and distributors in an effort to broaden its sales channels, primarily in the Company’s international markets.

 

2.            SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Basis of Presentation

 

The condensed consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All significant intercompany balances and transactions have been eliminated. The accompanying condensed consolidated financial statements as of January 31, 2009, and for the three and nine month periods ended January 31, 2009 and 2008, 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 the fair statement, in all material respects, of the financial position and the operating results and cash flows for the interim date and periods presented. The April 30, 2008 condensed consolidated balance sheet data was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States of America. Results for the interim period ended January 31, 2009 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, 2008, included in the Company’s Annual Report on Form 10-K, filed with the Securities and Exchange Commission on July 10, 2008, file number 000-26209.

 

Computation of Income (Loss) per Share

 

Basic loss per share is calculated based on the weighted average number of shares of common stock outstanding during the three and nine-month periods ended January 31, 2009 and 2008. Diluted loss per share for the three and nine month periods ended January 31, 2009 and 2008 is calculated excluding the effects of all common stock equivalents, as their effect would be anti-dilutive.  For the three and nine-month periods ended January 31, 2009, common stock equivalents, primarily options, totaling approximately 5,492,000 shares and 6,283,000 shares, respectively, were excluded from the calculation of diluted loss per share, as their impact would be anti-dilutive. For the three and nine-month periods ended January 31, 2008, common stock equivalents, primarily options, totaling approximately 7,209,000 shares and 6,468,000 shares, respectively, were excluded from the calculation of diluted earnings per share, as their impact would be anti-dilutive.

 

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A reconciliation of the numerator and denominator used in the calculation of the historical basic and diluted net loss per share follows (in thousands, except per share amounts):

 

 

 

Three months ended
January 31,

 

Nine months ended
January 31,

 

 

 

2009

 

2008

 

2009

 

2008

 

Net loss per share, basic and diluted:

 

 

 

 

 

 

 

 

 

Net loss

 

$

(3,790

)

$

(19,670

)

$

(17,780

)

$

(26,086

)

 

 

 

 

 

 

 

 

 

 

Basic:

 

 

 

 

 

 

 

 

 

Weighted average shares outstanding

 

26,163

 

25,944

 

26,141

 

29,942

 

Less restricted stock included in weighted shares outstanding subject to vesting

 

(49

)

(135

)

(73

)

(190

)

Shares used in calculation of basic loss per share amounts

 

26,115

 

25,809

 

26,068

 

29,752

 

 

 

 

 

 

 

 

 

 

 

Net loss per share

 

$

(0.15

)

$

(0.76

)

$

(0.68

)

$

(0.88

)

 

 

 

 

 

 

 

 

 

 

Diluted:

 

 

 

 

 

 

 

 

 

Shares used in calculation of basic per share amounts

 

26,115

 

25,809

 

26,068

 

29,752

 

Dilutive effect of stock plans

 

 

 

 

 

Shares used in calculation of diluted per share amounts

 

26,115

 

25,809

 

26,068

 

29,752

 

 

 

 

 

 

 

 

 

 

 

Net loss per share

 

$

(0.15

)

$

(0.76

)

$

(0.68

)

$

(0.88

)

 

Comprehensive Income (Loss)

 

For the three and nine months ended January 31, 2009, comprehensive loss was $3.9 million and $17.5 million, respectively, and included the impact of unrealized gains and losses on available for sale investments.  For the three and nine months ended January 31, 2008, comprehensive loss was $19.8 million and $27.0 million, respectively, and included the impact of unrealized gains and losses on available for sale investments, net of tax.

 

Accounting for Stock-Based Compensation

 

Stock-based compensation expense recognized during the period is based on the fair value of the actual awards vested or expected to vest. Stock-based compensation expense recognized in the Company’s condensed consolidated statements of operations for the three and nine months ended January 31, 2009 and 2008 included compensation expense for stock-based payment awards granted prior to, but not yet vested as of, April 30, 2006, the date of adoption of SFAS 123R, based on the grant date fair value estimated in accordance with the provisions of SFAS 123, and compensation expense for the stock-based payment awards granted subsequent to April 30, 2006 based on the grant date fair value estimated in accordance with the provisions of SFAS 123R. In conjunction with the adoption of SFAS 123R, the Company changed its accounting policy of attributing the fair value of stock-based compensation to expense from the accelerated multiple-option approach provided by APB 25, as allowed under SFAS 123, to the straight-line single-option approach.  Compensation expense for all stock-based payment awards expected to vest that were granted on or prior to April 30, 2006 will continue to be recognized using the accelerated attribution method. Compensation expense for all stock-based payment awards expected to vest that were granted or modified subsequent to April 30, 2006 is recognized on a straight-line basis. SFAS 123R requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates.

 

There was no tax benefit from the exercise of stock options related to deductions in excess of compensation cost recognized in the first nine months of each of fiscal 2009 and 2008. Prior to the adoption of SFAS 123R, the Company presented all tax benefits of deductions resulting from the exercise of stock options as an operating cash flow, in accordance with Emerging Issues Task Force (“EITF”) Issue No. 00-15,  Classification in the Statement of Cash Flows of the Income Tax Benefit Received by a Company upon Exercise of a Nonqualified Employee Stock Option.  SFAS 123R requires the Company to reflect the tax savings resulting from tax deductions in excess of expense reflected in its financial statements as a financing cash flow.

 

Investments

 

Investment securities that have maturities of more than three months at the date of purchase but current maturities of less than one year, and auction rate securities which management typically has settled on 7, 28 or 35 day auction cycles, are considered short-term investments. Long-term investment securities include any investments with remaining maturities of one year or more and auction rate securities that have failed to settle since fiscal 2008, for which conditions leading to their failure at auction create uncertainty as to whether they will settle in the near-term. Short- and long-term investments consist of auction rates securities, which have underlying instruments that consist primarily of AMBAC preferred stock, corporate notes and asset backed securities.  Although the AMBAC security is rated Ba1 and the other auction rate security is rated A3 they were both rated AA or higher at the time of purchase. The Company’s investment securities are maintained at two major financial institutions, are classified as

 

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available-for-sale, and are recorded on the Condensed Consolidated Balance Sheets at fair value, with unrealized gains and losses included in accumulated other comprehensive income (loss), a component of stockholders’ equity, net of tax. If the Company sells its investments prior to their maturity, it may record a realized gain or loss in the period the sale took place. In the first nine months of fiscal 2009 and 2008, the Company realized no gains or losses on its investments.

 

The Company evaluates its investments periodically for possible other-than-temporary impairment by reviewing factors such as the length of time and the extent to which the fair value has been below cost-basis, the financial condition of the issuer and the Company’s ability to hold the investment for a period of time, which may be sufficient for anticipated recovery of the market value. To the extent that the historical cost of the available for sale security exceeds the estimated fair market value, and the decline in value is deemed to be other-than-temporary, an impairment charge is recorded in the Condensed Consolidated Statement of Operations. During the nine months ended January 31, 2009, the Company recognized impairment losses of $1.4 million.  There was no impairment loss in the three months ended January 31, 2009 or in the three and nine months ended January 31, 2008.

 

Impairment of Long-lived Assets

 

The Company evaluates the recoverability of its long-lived assets on an annual basis in the fourth quarter, or more frequently if indicators of potential impairment arise.  The Company evaluates the recoverability of its amortizable purchased intangible assets based on an estimate of undiscounted future cash flows resulting from the use of the related asset group and its eventual disposition. The asset group represents the lowest level for which cash flows are largely independent of cash flows of other assets and liabilities. Measurement of an impairment loss for long-lived assets that the Company expects to hold and use is based on the difference between the fair value and carrying value of the asset.  Long-lived assets to be disposed of are reported at the lower of carrying amount or fair value less costs to sell.

 

Recent Accounting Pronouncements

 

In September 2006, the FASB issued Statement No. 157, Fair Value Measurements (“SFAS 157”). SFAS 157 defines fair value, establishes a framework and guidance regarding the methods for measuring fair value, and expands related disclosures about those measurements. In February 2008, the FASB issued FASB Staff Position (“FSP”) FAS 157-1, Application of FASB Statement No. 157 to FASB Statement No. 13 and Other Accounting Pronouncements That Address Fair Value Measurements for Purposes of Lease Classification or Measurement under Statement 13”, which amends SFAS 157 to exclude accounting pronouncements that address fair value measurements for purposes of lease classification or measurement under SFAS No. 13, “Accounting for Leases”.

 

In February 2008, the FASB issued FSP FAS 157-2, Effective Date of FASB Statement No. 157, which delays the effective date of SFAS No. 157 until the first quarter of fiscal 2010 for all non-financial assets and non-financial liabilities, except for items that are recognized or discounted at fair value in the financial statements on a recurring basis (at least annually). SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. The Company has adopted SFAS 157 for its financial assets effective May 1, 2008, which did not have a material impact on its results of operations, financial position or cash flows (see Note 3). The Company is currently assessing the impact that adoption of SFAS 157 for its non-financial assets and liabilities will have on its results of operations, financial position and cash flows, upon adoption in fiscal 2010.

 

In October 2008, the FASB issued FSP FAS 157-3, Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active,  which provides clarification on the application of SFAS 157 as it relates to financial assets that need to be valued but for which the market has become inactive.  The FSP was effective immediately on the date of its issuance and application of the FSP during the second quarter did not have a material impact on the Company’s results of operations, financial position or cash flows.

 

In February 2007, the FASB issued Statement No. 159, The Fair Value Option for Financial Assets and Financial Liabilities—including an amendment to FAS 115  (“SFAS 159”). SFAS 159 allows entities to choose, at specified election dates, to measure eligible financial assets and liabilities at fair value in situations in which they are not otherwise required to be measured at fair value. If a company elects the fair value option for an eligible item,

 

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changes in that item’s fair value in subsequent reporting periods must be recognized in current earnings. SFAS 159 also establishes presentation and disclosure requirements designed to draw comparison between entities that elect different measurement attributes for similar assets and liabilities. SFAS 159 is effective for fiscal years beginning after November 15, 2007. The Company elected not to apply the fair value option of SFAS 159. As a result, adoption of SFAS 159 did not have a material impact on the Company’s results of operations, financial position and cash flows, upon adoption in fiscal 2009.

 

In December 2007, the FASB issued SFAS 141R, Business Combinations (“SFAS 141R”), replacing SFAS 141, “Business Combinations”. SFAS 141R revises existing accounting guidance for how an acquirer recognizes and measures in its financial statements the identifiable assets, liabilities, any noncontrolling interests, and the goodwill acquired. SFAS 141R is effective for fiscal years beginning after December 15, 2008. SFAS 141R will impact the accounting for business combinations completed by the Company on or after adoption in fiscal 2010.

 

In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements—an amendment of ARB No. 51  (“SFAS 160”). SFAS 160 requires all entities to report noncontrolling (minority) interests in subsidiaries as equity in the consolidated financial statements. Its intention is to eliminate the diversity in practice regarding the accounting for transactions between an entity and noncontrolling interests. This Statement is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008. Earlier adoption is prohibited. Since the Company does not have any subsidiaries with noncontrolling interests, the Company does not expect this statement will have a material impact on its financial condition, results of operations and cash flows upon adoption in fiscal 2010.

 

In May 2008, the FASB issued Staff Position No. APB 14-1, Accounting for Convertible Debt Instruments that May be Settled in Cash Upon Conversion APB 14-1 requires that the liability and equity components of convertible debt instruments that may be settled in cash upon conversion (including partial cash settlement) be separately accounted for in a manner that reflects an issuer’s nonconvertible debt borrowing rate. The resulting debt discount is amortized over the period the convertible debt is expected to be outstanding as additional non-cash interest expense. APB 14-1 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. Retrospective application to all periods presented is required except for instruments that were not outstanding during any of the periods that will be presented in the annual financial statements for the period of adoption but were outstanding during an earlier period. Since the Company does not currently have any convertible debt, it does not expect this statement will have a material impact on its financial condition, results of operations and cash flows upon adoption in fiscal 2010.

 

3.             BALANCE SHEET ACCOUNTS

 

Inventories

 

Inventories comprised (in thousands):

 

 

 

January 31,
2009

 

April 30,
2008

 

 

 

 

 

 

 

Raw materials

 

$

752

 

$

716

 

Work in progress

 

29

 

27

 

Finished goods

 

13,551

 

12,949

 

 

 

 

 

 

 

Total

 

$

14,332

 

$

13,692

 

 

Stock-based compensation included in inventories at January 31, 2009 and April 30, 2008 was $13,000 and $17,000, respectively.

 

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Fair Value Measurements of Financial Assets and Liabilities

 

SFAS No. 157 clarifies that fair value is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability. As a basis for considering such assumptions, SFAS No. 157 establishes a three-tier value hierarchy, which prioritizes the inputs used in measuring fair value as follows: (Level 1) observable inputs such as quoted prices in active markets; (Level 2) inputs other than the quoted prices in active markets that are observable either directly or indirectly; and (Level 3) unobservable inputs in which there is little or no market data, which requires the Company to develop its own assumptions. This hierarchy requires the Company to use observable market data, when available, and to minimize the use of unobservable inputs when determining fair value. On a recurring basis, the Company measures certain financial assets and liabilities at fair value, including its short-term and long-term investments.

 

When available, the Company uses quoted market prices to determine fair value of certain of its cash and cash equivalents including money market funds; such items are classified in Level 1 of the fair value hierarchy. As of January 31, 2009 the Company held auction rate securities with a par value of $14.0 million, which are included in long-term investments. At January 31, 2009, there were no active markets for these auction rate securities or comparable securities due to current market conditions. Therefore, until such a market becomes active, the Company is determining their fair value based on expected discounted cash flows. Such items are classified in Level 3 of the fair value hierarchy.

 

The following table presents for each of the fair value hierarchy levels, the assets and liabilities that are measured at fair value on a recurring basis as of January 31, 2009 (in thousands):

 

 

 

Fair Value

 

Level 1

 

Level 2

 

Level 3

 

 

 

 

 

 

 

 

 

 

 

Assets

 

 

 

 

 

 

 

 

 

Money market funds

 

$

40,201

 

$

40,201

 

$

 

$

 

Certificates of deposit

 

83

 

83

 

 

 

Auction rate securities

 

8,161

 

 

 

8,161

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

48,445

 

$

40,284

 

$

 

$

8,161

 

 

The following table presents the changes in the Level 3 fair value category for the three and nine-month periods ended January 31, 2009 (in thousands):

 

 

 

 

 

Net Realized/Unrealized
Gains (Losses) included in

 

 

 

 

 

 

 

 

 

November 1,
2008

 

Earnings

 

Other
Comprehensive
Loss

 

Purchases, Sales,
Issuances and
(Settlements)

 

Transfers in
and/or (out)
of Level 3

 

January 31,
2009

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Assets

 

 

 

 

 

 

 

 

 

 

 

 

 

Auction rate securities

 

$

13,145

 

 

$

(134

)

$

(4,850

)

 

$

8,161

 

 

 

 

 

 

Net Realized/Unrealized
Gains (Losses) included in

 

 

 

 

 

 

 

 

 

May 1,
2008

 

Earnings

 

Other
Comprehensive
Loss

 

Purchases, Sales,
Issuances and
(Settlements)

 

Transfers in
and/or (out)
of Level 3

 

January 31,
2009

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Assets

 

 

 

 

 

 

 

 

 

 

 

 

 

Auction rate securities

 

$

29,530

 

$

(1,367

)

$

275

 

$

(20,277

)

 

$

8,161

 

 

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Accrued Expenses

 

Accrued expenses comprised (in thousands):

 

 

 

January 31,
2009

 

April 30,
2008

 

 

 

 

 

 

 

Accrued employee related

 

$

1,546

 

$

2,708

 

Accrued warranty

 

511

 

550

 

Accrued professional fees

 

66

 

485

 

Accrued restructuring costs

 

296

 

240

 

Other accrued expenses

 

906

 

1,087

 

 

 

 

 

 

 

Total

 

$

3,325

 

$

5,070

 

 

Warranties. The Company provides for future warranty costs upon shipment of its products. The specific terms and conditions of those warranties may vary depending upon the product sold, the customer and the country in which it does business. However, the Company’s warranties generally start from the shipment date and continue for a period of two to five years for the hardware element of the Company’s products and 90 days to one year for the software element.

 

Because the Company’s products are manufactured to a standardized specification and products are internally tested to these specifications prior to shipment, the Company historically has experienced minimal warranty costs. Factors that affect the Company’s warranty liability include the number of installed units, historical experience and management’s judgment regarding anticipated rates of warranty claims and cost per claim. The Company assesses the adequacy of its recorded warranty liabilities every quarter and makes adjustments to the liability, if necessary.

 

Changes in the warranty liability, which is included as a component of “Accrued expenses” on the Condensed Consolidated Balance

Sheet, during the three and nine-month periods ended January 31, 2009 and 2008 are as follows (in thousands):

 

 

 

Three months ended
January 31,

 

Nine months ended
January 31,

 

 

 

2009

 

2008

 

2009

 

2008

 

 

 

 

 

 

 

 

 

 

 

Balance as of the beginning of the fiscal period

 

$

515

 

$

742

 

$

550

 

$

754

 

Provision for warranties issued during fiscal period

 

55

 

 

275

 

83

 

Warranty costs incurred during fiscal period

 

(28

)

(14

)

(114

)

(53

)

Other adjustments to the liability (including changes in estimates for pre-existing warranties) during fiscal period

 

(31

)

(115

)

(200

)

(171

)

 

 

 

 

 

 

 

 

 

 

Balance as of January 31

 

$

511

 

$

613

 

$

511

 

$

613

 

 

4.             PURCHASED INTANGIBLES

 

On June 30, 2005, the Company acquired Jasomi Networks, (Jasomi”). The carrying value of intangible assets acquired in the Jasomi business combination was as follows (in thousands):

 

 

 

January 31, 2009

 

 

 

Gross
Value

 

Accumulated
Amortization

 

Impairment

 

Net Value

 

Purchased Intangible Assets

 

 

 

 

 

 

 

 

 

Core technology

 

$

2,900

 

$

(2,107

)

$

(763

)

$

30

 

Customer relationships

 

1,100

 

(640

)

(429

)

31

 

Trade name and trademarks

 

200

 

(117

)

(78

)

5

 

Total

 

$

4,200

 

$

(2,864

)

$

(1,270

)

$

66

 

 

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April 30, 2008

 

 

 

Gross
Value

 

Accumulated
Amortization

 

Impairment

 

Net Value

 

Purchased Intangible Assets

 

 

 

 

 

 

 

 

 

Core technology

 

$

2,900

 

$

(2,054

)

$

(763

)

$

83

 

Customer relationships

 

1,100

 

(624

)

(429

)

47

 

Trade name and trademarks

 

200

 

(113

)

(78

)

9

 

Total

 

$

4,200

 

$

(2,791

)

$

(1,270

)

$

139

 

 

In the three months ended January 31, 2009 and 2008, the Company recorded $25,000 and $247,000, respectively, of amortization of Jasomi acquisition-related intangible assets. In the nine months ended January 31, 2009 and 2008, the Company recorded $73,000 and $739,000, respectively, of amortization of Jasomi acquisition-related intangible assets.

 

Estimated future amortization expense of purchased intangible assets as of January 31, 2009 is as follows (in thousands):

 

 

 

Years ended April 30,

 

 

 

 

 

2009 (three months)

 

$

24

 

2010

 

38

 

2011

 

4

 

 

 

$

66

 

 

5.             RESTRUCTURING

 

At the beginning of both the second and third quarters of fiscal 2009, the Company undertook reductions in force in an attempt to reduce its operating expenses. The reduction of force represented approximately 21% of the Company’s workforce as of April 30, 2008.  As a result of the reductions in headcount that have occurred over the last twelve months, the Company determined that it no longer needed approximately 20% of its Mountain View headquarters and has undertaken to sublease that space for some or all of the remainder of the lease term.  In addition, certain fixed assets have been idled due to the reduction in employees.  As there is no current plan to utilize these assets, the Company has decided to sell or scrap the assets.  As a result of these actions, the Company recorded charges in the three and nine months ended January 31, 2009 totaling approximately $0.5 million and $1.4 million, respectively.  The amount recorded in the third quarter of fiscal 2009 was comprised of severance and related benefits totaling $0.2 million, as well as an estimated loss associated with the abandonment of idled fixed assets totaling $0.3 million.  Of the $1.4 million recorded in the first nine months of fiscal 2009, $0.8 million was related to severance and related benefits for the impacted employees and the balance of $0.6 million was related to the estimated $0.3 million loss from subleasing the space vacated in September 2008 and $0.3 million related to the estimated loss on abandonment of idled fixed assets.  All individuals impacted by the reductions in headcount were notified of the termination prior to the end of the period in which their severance costs were recorded. As of January 31, 2009, 94% of the $0.8 million aggregate severance related costs had been paid.  The remaining severance related costs, which primarily relate to outplacement services and COBRA, will be paid over the next twelve months.

 

At the end of the second quarter of fiscal 2008, the Company undertook a restructuring of certain of its operations in an effort to streamline its operations and reduce costs. The restructuring included a reduction in the workforce of approximately 23% and the closure of its research operations in Canada. As a result of these actions the Company recorded a restructuring charge of approximately $1.3 million attributable to severance benefits paid and accrued and costs associated with the closure of the Canadian office, including $250,000 attributable to the loss on abandonment of the Canadian facility lease and losses on assets abandoned at that location.  Of the $1.3 million total restructuring charge, $1.0 million was attributable to severance and related benefits. In the three and nine months ended January 31, 2009, approximately $40,000 and $64,000, respectively, of estimated outplacement benefit accrual related to this reduction in force expired unused and was reversed back to the same financial lines to which it was originally recorded.  All individuals impacted by the reduction in headcount were notified of the termination of their employment as of October 31, 2007.

 

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Reduction in force costs for the three and nine-month periods ended January 31, 2009 and 2008 were as follows (in thousands):

 

 

 

Three months ended
January 31,

 

Nine months ended
January 31,

 

 

 

2009

 

2008

 

2009

 

2008

 

Cost of Sales

 

$

 

$

7

 

$

31

 

$

72

 

Sales and marketing

 

89

 

46

 

323

 

276

 

Research and development

 

371

 

19

 

614

 

913

 

General and administrative

 

25

 

(20

)

399

 

504

 

Total

 

$

485

 

$

52

 

$

1,337

 

$

1,765

 

 

6.            STOCKHOLDERS’ EQUITY

 

Employee Equity Plans

 

The Company utilizes a combination of Employee Stock Purchase, Stock Option and Restricted Stock plans as a means to provide equity ownership in the Company for its employees. In addition, the Company has a Non-employee Directors Stock Option Plan.  In the nine months ended January 31, 2009, 114,452 shares of common stock were issued under the Employee Stock Purchase Plan (“ESPP”) and 209,507 shares remain available for issuance under that plan as of January 31, 2009.

 

Activity under the stock option and restricted stock plans was as follows (in thousands, except life and exercise price amounts):

 

 

 

 

 

Outstanding Options

 

 

 

Shares Available
For Grant(1)

 

Number
of Shares

 

Weighted Average
Exercise Price

 

Balances, April 30, 2008

 

2,180

 

7,060

 

$

7.13

 

Restricted stock and restricted stock units issued

 

(94

)

 

 

 

 

Restricted stock and restricted stock units forfeited

 

55

 

 

 

 

 

Options granted

 

(1,080

)

1,080

 

$

1.43

 

Options exercised

 

 

(10

)

$

0.57

 

Options forfeited

 

363

 

(363

)

$

4.51

 

Options expired

 

2,395

 

(2,395

)

$

7.80

 

Plan shares expired

 

(1,123

)

 

 

 

 

 

 

 

 

 

 

 

 

Balances, January 31, 2009

 

2,696

 

5,372

 

$

5.87

 

 


(1) Shares available for grant include shares from the 2005 New Recruit Stock Plan and the 2006 Equity Incentive Plan that may be issued as either stock options, restricted stock or restricted stock units. Shares issued under the 2006 Equity Incentive Plan as stock bonus awards, stock purchase awards, stock unit awards, or other stock awards in which the issue price is less than the fair market value on the date of grant of the award count as the issuance of 1.3 shares for each share of common stock issued pursuant to these awards for purposes of the share reserve.

 

The aggregate intrinsic value of stock options exercised in the first nine months of fiscal 2009 and 2008 was $16,000 and $526,000, respectively.

 

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Table of Contents

 

The summary of options vested, exercisable and expected to vest at January 31, 2009 comprised (in thousands, except term and exercise price):

 

 

 

Number of 
Shares

 

Weighted
Average
Exercise Price

 

Aggregate
Intrinsic
Value

 

Weighted
Average
Remaining
Contractual
Term

 

Fully vested and expected to vest options

 

5,006

 

$

6.10

 

$

85

 

6.00

 

Options exercisable

 

3,260

 

$

7.70

 

$

29

 

4.40

 

 

The summary of unvested restricted stock awards for the first nine months of fiscal 2009 comprised (in thousands, except life):

 

 

 

Number of
Shares

 

Weighted Average
Grant Date Fair
Value

 

Nonvested restricted stock, April 30, 2008

 

124

 

$

6.98

 

Restricted stock issued

 

72

 

$

2.30

 

Restricted stock vested

 

(34

)

$

7.08

 

Restricted stock forfeited

 

(42

)

$

6.24

 

 

 

 

 

 

 

Nonvested restricted stock, January 31, 2009

 

120

 

$

4.41

 

 

The aggregate intrinsic value of vested and expected to vest restricted stock units, which had a weighted average remaining contractual term of 1.1 years, was $6,000 at January 31, 2009. For the nine months ended January 31, 2009 and 2008, the total fair value of restricted shares that vested was $0.2 million and $0.3 million, respectively.

 

As of January 31, 2009, there was approximately $3.4 million of total unrecognized compensation cost related to stock options and restricted stock/RSUs that is expected to be recognized over a weighted-average period of 2.4 years for options and 1.8 years for restricted stock and restricted stock units.

 

The key assumptions used in the fair value model and the resulting estimates of weighted-average fair value per share used to record stock-based compensation in the three and nine-month periods ended January 31, 2009 and 2008 under SFAS 123R for options granted and for employee stock purchases under the ESPP, during these periods are as follows:

 

 

 

Three months ended
January 31,

 

Nine months ended
January 31,

 

 

 

2009

 

2008

 

2009

 

2008

 

 

 

 

 

 

 

 

 

 

 

Stock options:

 

 

 

 

 

 

 

 

 

Dividend yield(1)

 

 

 

 

 

Volatility factor(2)

 

0.68

 

0.64

 

0.65

 

0.64

 

Risk-free interest rate(3)

 

1.6

%

3.5

%

2.5

%

3.8

%

Expected life (years)(4)

 

4.6

 

4.8

 

4.6

 

4.8

 

Weighted average fair value of options granted during the period

 

$

0.46

 

$

1.91

 

$

0.76

 

$

2.33

 

 

 

 

 

 

 

 

 

 

 

Employee stock purchase plan:(5)

 

 

 

 

 

 

 

 

 

Dividend yield(1)

 

 

 

 

 

Volatility factor(2)

 

0.93

 

0.54

 

0.84

 

0.53

 

Risk-free interest rate(3)

 

0.4

%

3.3

%

0.8

%

3.3

%

Expected life (years)(4)

 

1.0

 

1.0

 

0.8

 

1.0

 

Weighted average fair value of employee stock purchases during the period

 

$

0.45

 

$

1.20

 

$

0.59

 

$

1.25

 

 

 

 

 

 

 

 

 

 

 

Restricted stock and restricted stock units:

 

 

 

 

 

 

 

 

 

Weighted average fair value of restricted stock and RSUs granted during the period

 

$

 

$

3.37

 

$

2.30

 

$

6.42

 

 


(1) The Company has no history or expectation of paying dividends on its common stock.

 

(2) The Company estimates the volatility of its common stock at the date of grant based on the historic volatility of its common stock for a term consistent with the expected life of the awards affected at the time of grant.

 

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(3) The risk-free interest rate is based on the U.S. Treasury yield for a term consistent with the expected life of the awards in affect at the time of grant.

 

(4) The expected life of stock options granted under the Stock Option Plans is based on historical exercise patterns, which the Company believes are representative of future behavior. The expected life of grants under the ESPP represents the amount of time remaining in the 12-month offering window.

 

(5) Assumptions for the Purchase Plan relate to the most recent enrollment period. Enrollment is currently permitted in May and November of each year.

 

7.            BORROWING AGREEMENT

 

In the first quarter of fiscal 2009, the Company renewed its $2.0 million operating line of credit with its bank.  The renewed line of credit, which expires on July 31, 2009, carries the same basic terms and financial covenants related to minimum effective tangible net worth and cash and cash equivalent and short-term investment balances as the original line of credit.  As of January 31, 2009, the Company had no borrowings outstanding under the line of credit but was not in compliance with the loan covenant related to minimum tangible net worth.  In February 2009, the Company completed a modification of the line of credit which included the establishment of new financial covenants and a waiver of the covenant violation as of January 31, 2009.

 

8.            INCOME TAXES

 

Effective May 1, 2007, the Company adopted Financial Accounting Standards Board (“FASB”) Interpretation No. 48,  Accounting for Uncertainties in Income Taxes — An Interpretation of FASB Statement No. 109  (“FIN 48”). FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The liability for uncertain tax positions, if recognized, will decrease the Company’s tax expense. The Company does not anticipate that the amount of liability for uncertain tax positions existing at January 31, 2009 will change significantly within the next 12 months.  Interest and penalties related to the liability for uncertain tax positions are included in provision for income taxes.

 

The Company files income tax returns in the U.S. and various state and foreign jurisdictions. The tax years since fiscal 1998 are subject to examination by the Internal Revenue Service and certain state tax authorities due to the Company’s net operating loss and/or tax credit carry forwards generated in those years. The Company is currently under audit by one state jurisdiction in which it operates for its fiscal 2005 filing but is not under examination by any other tax jurisdictions.

 

The Company recorded a tax provision (benefit) of $(86,000) and $50,000, respectively, for the three and nine months ended January 31, 2009 resulting in an effective tax rate of approximately (2%) and less than 1%, respectively.  The effective tax rate for the three and nine months ended January 31, 2009 reflected the effects of a full valuation allowance against the Company’s net deferred tax assets principally from the federal and state net operating loss and tax credit carry forwards created in fiscal 2009 because of uncertainty as to the recoverability of those items due to the Company’s continuing operating losses. The tax provision for the three and nine months ended January 31, 2009 is attributable to certain state and foreign jurisdictions in which the Company operates.

 

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The Company recorded a tax benefit of $2.0 million and $7.6 million, respectively, for the three and nine months ended January 31, 2008 resulting in an effective tax rate of (9)% and (23)%, respectively. The effective tax rate for the three and nine months ended January 31, 2008 reflected the favorable impact associated with federal and California operating losses and research credits partially offset by the Company’s inability to deduct for tax purposes: (1) stock-based compensation expense associated with (i) most non-U.S. employees and (ii) incentive stock option grants; (2) amortization of debentures associated with the Jasomi acquisition that are payable to employee-investors; and (3) the non-deductible nature of the impairment charge for goodwill recorded in the third quarter of fiscal 2008.

 

9.            COMMITMENTS AND CONTINGENCIES

 

Legal Proceedings

 

Beginning on June 14, 2005, several purported class action lawsuits were filed in the United States District Court for the Northern District of California, purportedly on behalf of a class of investors who purchased Ditech’s stock between August 25, 2004 and May 26, 2005. The complaints allege claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 against Ditech and its Chief Executive Officer and Chief Financial Officer in connection with alleged misrepresentations concerning Voice Quality Assurance product orders (VQA orders) and the potential effect on Ditech of the merger between Sprint and Nextel, seeking monetary damages. All of the lawsuits were consolidated into a single action entitled In re Ditech Communications Corp. Securities Litigation,  No. C 05-02406-JSW, and a consolidated amended complaint was filed on February 2, 2006. The defendants moved to dismiss the complaint, and by order dated August 10, 2006, the court granted the defendants’ motion and dismissed the complaint with leave to amend. The plaintiffs filed their Second Amended Complaint on September 11, 2006. The defendants again moved to dismiss, and by order dated March 22, 2007, the court dismissed the Second Amended Complaint with leave to amend. The plaintiffs filed their Third Amended Complaint on April 23, 2007. On May 14, 2007, the defendants again moved to dismiss. By order dated October 11, 2007, the court dismissed the third amended complaint with prejudice. On November 8, 2007, the plaintiffs filed a notice of appeal to the Ninth U.S. Circuit Court of Appeals. The appeal has been fully briefed. Oral argument of the appeal has been set for April14, 2009.

 

On August 23, 2006, August 25, 2006, and November 3, 2006, three actions were filed in United States District Court for the Northern District of California (Case Nos. C06-05157, C06-05242, and C06-6877) purportedly as derivative actions on behalf of the Company against certain of the Company’s current and former officers and directors alleging that between 1999 and 2001 certain stock option grants were backdated; that these options were not properly accounted for; and that as a result false and misleading financial statements were filed. These three actions have been consolidated under case number C06-05157. On December 1, 2006, a fourth derivative complaint making similar allegations against many of the same defendants was filed in California Superior Court for the County of Santa Clara (Case No.106-CV-075695). On April 19, 2007, the California Superior Court granted the Company’s motion to stay the state court action pending the outcome of the federal consolidated actions.

 

The defendants named in the derivative actions are Timothy Montgomery, Gregory Avis, Edwin Harper, William Hasler, Andrei Manoliu, David Sugishita, William Tamblyn, Caglan Aras, Toni Bellin, Robert DeVincenzi, James Grady, Lee House, Serge Stepanoff, Gary Testa, Lowell Trangsrud, Kenneth Jones, Pong Lim, Glenda Dubsky, Ian Wright, and Peter Chung. These derivative complaints raise claims under Section 10(b) and 10b-5 of the Securities Exchange Act, Section 14(a) of the Securities Act, and California Corporations Code Section 25403, as well as common law claims for breach of fiduciary duty, unjust enrichment, waste of corporate assets, gross mismanagement, constructive fraud, and abuse of control. The plaintiffs seek remedies including money damages, disgorgement of profits, accounting, rescission, and punitive damages. With respect to the consolidated federal actions, the plaintiffs filed an amended consolidated complaint on March 2, 2007, adding new allegations regarding another stock option grant. On April 2, 2007, the Company moved to dismiss the amended complaint based on plaintiffs’ failure to make a demand on the board before bringing suit. On the same day, the individual defendants moved to dismiss the amended complaint for failure to state a claim. On July 16, 2007, the Court granted the individual defendants’ motion to dismiss without prejudice.  Plaintiffs filed a second amended complaint on September 21, 2007.  On November 30, 2007, defendants moved to dismiss plaintiffs’ second amended complaint for failure to make a demand on the board and for failure to state a claim.  On March 26, 2008, the Court granted the individual defendants’ motion to dismiss without prejudice, requiring that plaintiffs file any amended complaint by April 25, 2008.  Plaintiffs did not file an amended complaint.  As a result, on May 12, 2008,

 

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defendants moved to dismiss plaintiffs’ action with prejudice.  The parties agreed to postpone the hearing on defendants’ motion so that they could engage in mediation.  These actions are in their preliminary stages; no discovery has taken place and no trial date has been set.

 

The Company cannot predict the outcome of the lawsuits at this time and has made no provisions for potential losses from these lawsuits.

 

Lease Commitments

 

At January 31, 2009, future minimum payments under the Company’s current operating leases are as follows (in thousands):

 

 

 

Years ended April 30,

 

 

 

 

 

2009 (three months)

 

$

258

 

2010

 

1,058

 

2011

 

1,094

 

2012

 

276

 

 

 

 

 

 

 

$

2,686

 

 

Guarantees and Indemnifications. As is customary in the Company’s industry and as required by law in the U.S. and certain other jurisdictions, certain of the Company’s contracts provide remedies to its customers, such as defense, settlement, or payment of judgment for intellectual property claims related to the use of the Company’s products. From time to time, the Company indemnifies customers against combinations of losses, expenses, or liabilities arising from various trigger events related to the sale and the use of the Company’s products and services. In addition, from time to time the Company also provides protection to customers against claims related to undiscovered liabilities, additional product liability or environmental obligations. In the Company’s experience, claims made under such indemnifications are rare.

 

As permitted or required under Delaware law and to the maximum extent allowable under that law, the Company has certain obligations to indemnify its current and former officers and directors for certain events or occurrences while the officer or director is, or was serving at the Company’s request in such capacity. These indemnification obligations are valid as long as the director or officer acted in good faith and in a manner that a person reasonably believed to be in or not opposed to the best interests of the Company, and, with respect to any criminal action or proceeding, had no reasonable cause to believe his or her conduct was unlawful. The maximum potential amount of future payments the Company could be required to make under these indemnification obligations is unlimited; however, the Company has a director and officer insurance policy that limits the Company’s exposure and enables the Company to recover a portion of any future amounts paid. As a result of the Company’s insurance policy coverage, the Company believes the estimated fair value of these indemnification obligations is minimal.

 

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10.         REPORTABLE SEGMENTS AND GEOGRAPHIC INFORMATION

 

The Company currently operates in a single segment - voice processing products.

 

The Company’s revenue from external customers by geographic region, based on shipment destination, was as follows (in thousands):

 

 

 

Three months ended January 31,

 

Nine months ended January 31,

 

 

 

2009

 

2008

 

2009

 

2008

 

 

 

 

 

 

 

 

 

 

 

USA

 

$

1,463

 

$

3,023

 

$

6,509

 

$

17,607

 

Middle East/Africa

 

659

 

1,189

 

1,978

 

3,526

 

Canada

 

368

 

681

 

843

 

2,428

 

Far East

 

2,380

 

1,048

 

3,677

 

2,515

 

Other

 

29

 

743

 

546

 

1,267

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

4,899

 

$

6,684

 

$

13,553

 

$

27,343

 

 

Sales for the three months ended January 31, 2009 included three customers that represented greater than 10% of total revenue (45%, 15 and 13%).  Sales for the nine months ended January 31, 2009 included two customers that represented greater than 10% of total revenue (24% and 16%).  Sales for the three months ended January 31, 2008 included two customers that represented greater than 10% of total revenue (30% and 17%).   Sales for the nine months ended January 31, 2008 included three customers that represented greater than 10% of total revenue (40%, 15% and 13%).  As of January 31, 2009, the Company had three customers that represented greater than 10% of accounts receivable (53%, 20% and 14%).  At April 30, 2008, three customers represented greater than 10% of accounts receivable (46%, 16% and 13%).

 

The Company maintained substantially all of its property and equipment in the United States at January 31, 2009 and April 30, 2008.

 

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ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

The following discussion and analysis should be read in conjunction with our Consolidated Financial Statements and Notes thereto for the year ended April 30, 2008, included in our Annual Report on Form 10-K, filed with the Securities and Exchange Commission on July 10, 2008. The discussion in this Report on Form 10-Q contains forward-looking statements that involve risks and uncertainties, such as statements of our future financial operating results, plans, objectives, expectations and intentions. Our actual results could differ materially from those discussed here. See “Future Growth and Operating Results Subject to Risk” at the end of this Item 2 for factors that could cause future results to differ materially.

 

Overview

 

We design, develop and market telecommunications equipment for use in enhancing voice quality and canceling echo in voice calls over wireline, wireless and internet protocol (IP) telecommunications networks. Our products monitor and enhance voice quality and provide transcoding in the delivery of voice services. Since entering the voice processing market, we have continued to refine our echo cancellation products to meet the needs of the ever-changing telecommunications marketplace. Our more recent TDM-based product introductions have leveraged the processing capacity of our newer hardware platforms to offer not only echo cancellation but also enhanced Voice Quality Assurance (“VQA”) features including noise reduction, acoustic echo cancellation, voice level control and noise compensation through enhanced voice intelligibility.  Our most recent product introduction offers all the voice capabilities of our TDM-based products along with codec transcoding to meet the new challenges faced by carriers deploying VoIP technologies.

 

Since becoming a public company in June 1999, our financial success has been primarily predicated on the macroeconomic environment of U.S. wireline and, more recently, wireless carriers as well as our success in selling to the larger carriers. Since the beginning of calendar year 2004, large North American telecommunications service providers have been engaged in merger and acquisition activity. This activity largely drove a decline in our fiscal 2006 revenue as one of our two largest fiscal 2005 U.S. customers was and continues to be involved in post-merger integration and, consequently, orders from that customer since the first quarter of fiscal 2006 have been nominal. Over the last several quarters, not only have we continued to see changing strategies related to voice quality impacting the timing and amount of potential domestic and international customer demand, but we have also experienced delays in purchasing decisions due to the interplay of budget constraints with the strategic nature of their voice quality deployment and their transition to third generation cellular technology (“3G”) networks.

 

We believe that the current market conditions around the world could create further delays in purchasing decisions both as carriers tighten their capital investment activity due to internal budget constraints and as tighter credit hampers their ability to borrow to facilitate network expansion and/or upgrades.

 

Despite the previously mentioned delays due to budget and uncertainty around network architecture, we continue to believe that in the United States our continued focus on voice quality in the competitive wireless services landscape and the continued expansion of wireless networks will be key factors in adding new customers and driving opportunities for revenue growth. The development of our VQA feature set, which was originally targeted at the international Global System for Mobile Communications (“GSM”) market, has seen growing importance in the domestic market as well. We continue to focus sales and marketing efforts on international and domestic mobile carriers who might best apply our VQA solution. We have continued to invest in customer trials domestically and internationally in an attempt to better avail ourselves of these opportunities as they arise. Despite these efforts, we have experienced mixed results as we remain dependant on the buying patterns of a small, yet more diverse, group of carriers.

 

We expect additional long-term opportunities for growth will occur in voice over internet protocol, or “VoIP,” based network deployments as there appears to be a growing trend of service providers transitioning from traditional circuit-switched network infrastructure to VoIP. As such, since the beginning of fiscal 2005 we have directed the majority of our R&D spending towards the development of our Packet Voice Processor (PVP), a platform targeting VoIP-based network deployments.  The Packet Voice Processor introduces cost-effective voice format transcoding capabilities combined with our VQA technology to improve call quality and clarity by eliminating acoustic echo and

 

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voice level imbalances and reducing packet loss, delay and jitter. Although fiscal 2008 marked the first period in which revenue from the Packet Voice Processor exceeded 10% of total revenue, ordering patterns are still volatile leading to spikes in the timing and amount of revenue from this product.

 

In addition to the PVP development efforts, we have begun developing other product offerings that leverage off our expertise in voice technology including but not limited to the creation of licensed versions of our core technology for use in other elements within communications networks, such as Bluetooth headsets and the recent announcement of our new mStage product, which is currently in development.  While the Bluetooth opportunities are focused on moving our expertise in voice quality to the communication interface devices at the fringe of the voice networks, mStage will enable mobile subscribers to use their voice as well as their thumbs to interact with web applications like social networking and IM on-demand, even during a phone call.  We are undertaking these new opportunities in an effort to not only diversify our product offerings but also our customer base.  We believe that these products could help generate a more predictable revenue base, which we believe is less susceptible to our customer’s decisions on the timing and nature of the network expansions than our legacy product offerings have experienced on a stand alone basis.

 

Acquisition History.    Although we regularly evaluate whether there are acquisition candidates that have technologies that would compliment our products and core strengths, in the last five fiscal years, we have completed only one acquisition. In June 2005, we acquired Jasomi, which developed and sold session border controllers that enable VoIP calls to traverse the network address translation, or “NAT,” and protect networks from external attacks by admitting only authorized sessions, ensuring that reliable VoIP service can be provided to them. Consideration for the acquisition totaled approximately $21.8 million.  We additionally issued shares of Ditech restricted stock to new employees hired as part of the acquisition.

 

Our Customer Base.    Historically, the majority of our sales have been to customers in the United States. Although these customers have traditionally accounted for well over 50% of our revenue in a given period, they are becoming a smaller percentage due to the growing interest in our VQA technology in several key international markets.  Domestic customers accounted for approximately 48% of our revenue in the first nine months of fiscal 2009 and 63% and 71% of our revenue in fiscal 2008 and 2007, respectively. However, sales to some of our U.S. customers may result in our products purchased by these customers eventually being deployed internationally, especially in the case of any original equipment manufacturer that distributes overseas. To date, the vast majority of our international sales have been export sales and denominated in U.S. dollars. Growth in international revenue, as a percentage of total review, has been largely driven by demand from customers in South East Asia, the Middle East and Latin America.  We expect our international demand to continue to be heavily influenced these markets as they are experiencing the highest level of growth and commonly have the most need for cost effective solutions to address voice quality in their growing networks.

 

Our revenue historically has come from a small number of customers. Our largest customer accounted for approximately 24% of our revenue in the first nine months of fiscal 2009 and 35% of our total revenue in fiscal 2008. Our five largest customers accounted for approximately 64% of our revenue in the first nine months of fiscal 2009 and 68% and 88% of our revenue in fiscal 2008 and 2007, respectively. Consequently, the loss of any one of our largest customers, without an offsetting increase in revenue from existing or new customers, would have a negative and substantial effect on our business. This customer concentration risk was evidenced in fiscal 2006 and again over the last eighteen months as sudden delays and/or declines in purchases by our large customers resulted in significant declines in our overall revenues and ultimately resulted in net losses for those periods.

 

Critical Accounting Policies and Estimates.  The preparation of our financial statements requires us to make certain estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses and related disclosures. We evaluate these estimates on an ongoing basis, including those related to our revenues, allowance for bad debts, provisions for inventories, warranties and recovery of deferred income taxes receivable. Estimates are based on our historical experience and other assumptions that we consider reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual future results may differ from these estimates in the event that facts and circumstances vary from our expectations. If and when adjustments are required to reflect material differences arising between our ongoing estimates and the ultimate actual results, our future results of operations will be affected. We believe that the following critical accounting policies affect the most significant judgments and estimates used in the preparation of our consolidated financial statements.

 

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Revenue Recognition—In applying our revenue recognition and allowance for doubtful accounts policies that are described in our Annual Report on Form 10-K filed on July 10, 2008, the level of judgment is generally relatively limited, as the vast majority of our revenue has been generated by a handful of relatively long-standing customer relationships. These customers are some of the largest wire-line and wireless carriers in the United States and our relationships with them are documented in contracts, which clearly highlight potential revenue recognition issues, such as passage of title and risk of loss. As of January 31, 2009, we had deferred $3.5 million of revenue.  However, only to the extent that we have received cash for a given deferred revenue transaction is the deferred revenue recorded on the Condensed Consolidated Balance Sheet.  Of the $3.5 million of revenue deferred as of January 31, 2009, approximately $2.7 million was associated with installations and other product related deferrals and $0.8 million was associated with maintenance contracts.  In dealing with the remaining smaller customers, we closely evaluate the credit risk of these customers. In those cases where credit risk is deemed to be high, we either mitigate the risk by having the customer post a letter of credit, which we can draw against on a specified date, to effectively provide reasonable assurance of collection, or we defer the revenue until customer payment is received.

 

Investments— We consider investment securities that have maturities of more than three months at the date of purchase but remaining maturities of less than one year, and auction rate securities, which we have historically settled on 7, 28 or 35 day auction cycles, as short-term investments. However, when auction rate securities fail to settle at auction, which occurred in fiscal 2008, and conditions leading to their failure to auction create uncertainty as to whether they will settle in the near-term, we classify them as long-term consistent with the contractual term of the underlying security. Long-term investment securities include any investments with remaining maturities of one year or more and auction rate securities for which we are unable to estimate when they will settle. Short-term and long-term investments consist primarily of corporate notes and asset backed securities. We have classified our investments as available-for-sale securities in the accompanying consolidated financial statements. We carry available-for-sale securities at fair value, and report unrealized gains and losses as a separate component of stockholders’ equity. Realized gains and losses and declines in value judged to be other-than-temporary on available-for-sale securities, if any, are included in other income, net based on specific identification. We include interest on securities classified as available-for-sale in total other income. See also the discussion in “Liquidity and Capital Resources” and Item 3 for additional information on auction rate securities.

 

Inventory Valuation Allowances— In conjunction with our ongoing analysis of inventory valuation, we constantly monitor projected demand on a product by product basis. Based on these projections we evaluate the levels of write-downs required for inventory on hand and inventory on order from our contract manufacturers. Although we believe we have been reasonably successful in identifying write-downs in a timely manner, sudden changes in buying patterns from our customers, either due to a shift in product interest and/or a complete pull back from their expected order levels has resulted in the recognition of larger than anticipated write-downs. For example, we recorded an inventory write-down for excess levels of inventory of $5.1 million in fiscal 2008. There were no sales of previously written-down inventory during the three and nine-month periods ended January 31, 2009 and 2008.

 

Cost of Warranty— At the time that we recognize revenue, we accrue for the estimated costs of the warranty we offer on our products. We currently offer warranties on the hardware elements of our products ranging from one to five years and warranties on the software elements of our products ranging from 90 days to one year.    The warranty generally provides that we will repair or replace any defective product and provide software bug fixes within the term of the warranty. Our accrual for the estimated warranty is based on our historical experience and expectations of future conditions. To the extent we experience increased warranty claim activity or increased costs associated with servicing those claims, we may revise our estimated warranty accrual to reflect these additional exposures.  This would result in a decrease in gross profits. As of January 31, 2009, we had $0.5 million accrued related to estimated future warranty costs.  See Note 3 of the Notes to the Condensed Consolidated Financial Statements.

 

Impairment of Long-lived Assets— We continually monitor events and changes in circumstances that could indicate that carrying amounts of long-lived assets, including intangible assets, may not be recoverable. When such events or changes in circumstances arise, we assess the recoverability of our long-lived assets by determining whether the carrying value of such assets will be recovered through undiscounted expected future cash flows. If the total of the undiscounted future cash flows is less than the carry amount of the assets in question, we recognize an impairment loss based on the excess of the carrying amount over the fair value of the assets. We evaluate the recoverability of our amortizable purchased intangible assets based on an estimate of the undiscounted cash flows resulting from the use of the related asset group and its eventual disposition. The asset group represents the lowest level for which cash flows are largely independent of cash flows of other assets and liabilities. We report long-lived assets to be disposed of at the lower of carrying amount or fair value less costs to sell.

 

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Accounting for Stock-based Compensation —Stock-based compensation cost is estimated at the grant date based on the award’s fair value as calculated by the Black-Scholes-Merton (“Black-Scholes”) option-pricing model and is recognized as expense, net of estimated forfeitures, ratably over the requisite service period.  Given our employee stock options have certain characteristics that are significantly different from traded options and, because changes in the subjective assumptions can materially affect the estimated value, in our opinion the existing valuation models may not provide an accurate measure of the fair value of our employee stock options.  Although we determine the fair value of employee stock options in accordance with SFAS 123R and SAB 107 using the Black-Scholes option-pricing model, that value may not be indicative of the fair value observed between a willing buyer and a willing seller in a market transaction.

 

The Black-Scholes model requires various highly judgmental assumptions including expected option life and volatility. If any of the assumptions used in the Black-Scholes model or the estimated forfeiture rate changes significantly, stock-based compensation expense may differ materially in the future from that recorded in the current period.

 

Accounting for Income Taxes — Amounts recorded for income taxes, both current and deferred, are based on estimates of the tax consequences of our operations in the various tax jurisdictions in which we operate. Our deferred taxes are the result of temporary differences resulting from differing treatment of items such as valuation allowances for bad debts and inventory, for tax and accounting purposes. As part of our ongoing assessment of the recoverability of our deferred tax assets, on a quarterly basis we review the expiration dates of our net operating loss and research credit carry forwards. In addition, we complete a study on the impact of Section 382 of the Internal Revenue Code on at least a semi-annual basis to determine whether a change in ownership may limit the value of our net operating loss carry forwards. We determined that a full valuation allowance against all of our deferred tax assets beginning as of April 30, 2008 was required. We have considered all evidence, positive and negative, pursuant to SFAS 109,  Accounting for Income Taxes , and believe that based on our recent operating losses and uncertainty about the magnitude and timing of future operating profits, it is no longer more likely than not that our deferred tax assets will be realized.

 

Effective May 1, 2007, we adopted Financial Accounting Standards Board (“FASB”) Interpretation No. 48, Accounting for Uncertainties in Income Taxes—An Interpretation of FASB Statement No. 109  (“FIN 48”). FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition of tax benefits, classification on the balance sheet, interest and penalties, accounting in interim periods, disclosure, and transition. We have classified interest and penalties as a component of tax expense. As a result of the implementation of FIN 48 effective May 1, 2007, we recognized a $0.4 million decrease in the liability for unrecognized tax benefits, which was accounted for as a decrease in the May 1, 2007 balance of accumulated deficit. We do not expect a significant change to the liability for uncertain tax positions over the next 12 months.

 

The effective tax rate was approximately (2)% and (9)% for the three months ended January 31, 2009 and 2008, respectively. The effective tax rate for the nine months ended January 31, 2009 and 2008 was less than 1% and approximately (23)%, respectively.  In general, our effective tax rates differ from the statutory rate primarily due to stock-based compensation, research and experimentation tax credits, state taxes and the tax impact of foreign operations. However beginning with the fourth quarter of fiscal 2008, the effective tax rate was also significantly impacted by the establishment of a valuation allowance against our net deferred tax asset position.  As a result, the effective tax rate reflects the tax consequences of certain of the smaller state and foreign jurisdictions in which we report limited profits.

 

We have begun an audit by one of the state jurisdictions in which we do business for our fiscal 2005 filing. Other than this one state, we are currently not under audit for any other years or in any other jurisdictions. We regularly assess the likelihood of adverse outcomes resulting from these examinations to determine the adequacy of our provision for income taxes.

 

Recent Accounting Pronouncements  In September 2006, the FASB issued Statement No. 157, Fair Value Measurements (“SFAS 157”). SFAS 157 defines fair value, establishes a framework and guidance regarding the methods for measuring fair value, and expands related disclosures about those measurements. In February 2008, the

 

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FASB issued FASB Staff Position (“FSP”) FAS 157-1, Application of FASB Statement No. 157 to FASB Statement No. 13 and Other Accounting Pronouncements That Address Fair Value Measurements for Purposes of Lease Classification or Measurement under Statement 13”, which amends SFAS 157 to exclude accounting pronouncements that address fair value measurements for purposes of lease classification or measurement under SFAS No. 13, “Accounting for Leases”.

 

In February 2008, the FASB also issued FSP FAS 157-2, Effective Date of FASB Statement No. 157, which delays the effective date of SFAS No. 157 until the first quarter of fiscal 2010 for all non-financial assets and non-financial liabilities, except for items that are recognized or discounted at fair value in the financial statements on a recurring basis (at least annually). SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. There was no material impact from our adoption of SFAS No. 157 relative to our financial assets and liabilities effective May 1, 2008.  We are currently assessing the impact that SFAS 157 will have on our non-financial assets and liabilities, on our results of operations, financial position and cash flows, upon adoption beginning in fiscal 2010.

 

In October 2008, the FASB issued FSP FAS 157-3, Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active,  which provides clarification on the application of SFAS 157 as it relates to financial assets that need to be valued but for which the market has become inactive.  The FSP was effective immediately on the date of its issuance and application of the FSP during the second quarter did not have a material impact on our results of operations, financial position or cash flows.

 

In February 2007, the FASB issued Statement No. 159,The Fair Value Option for Financial Assets and Financial Liabilities—including an amendment to FAS 115  (“SFAS 159”). SFAS 159 allows entities to choose, at specified election dates, to measure eligible financial assets and liabilities at fair value in situations in which they are not otherwise required to be measured at fair value. If a company elects the fair value option for an eligible item, changes in that item’s fair value in subsequent reporting periods must be recognized in current earnings. SFAS 159 also establishes presentation and disclosure requirements designed to draw comparison between entities that elect different measurement attributes for similar assets and liabilities. SFAS 159 is effective for fiscal years beginning after November 15, 2007. We did not elect to apply the fair value option under SFAS 159 upon adoption on May 1, 2008.  As such, the application of the standard did not have a material impact on our results of operations, financial position and cash flows.

 

In December 2007, the FASB issued SFAS 141R, Business Combinations (“SFAS 141R”), replacing SFAS 141, “Business Combinations”. SFAS 141R revises existing accounting guidance for how an acquirer recognizes and measures in its financial statements the identifiable assets, liabilities, any noncontrolling interests, and the goodwill acquired. SFAS 141R is effective for fiscal years beginning after December 15, 2008. The adoption of SFAS 141R will impact the accounting for business combinations completed by us on or after adoption in fiscal 2010.

 

In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements—an amendment of ARB No. 51. SFAS No. 160 requires all entities to report noncontrolling (minority) interests in subsidiaries as equity in the consolidated financial statements. Its intention is to eliminate the diversity in practice regarding the accounting for transactions between an entity and noncontrolling interests. This Statement is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008. Earlier adoption is prohibited. Since we do not have any subsidiaries with noncontrolling interests, we do not expect this statement will have a material impact on our financial condition, results of operations and cash flows upon adoption in fiscal 2010.

 

In May 2008, the FASB issued Staff Position No. APB 14-1, Accounting for Convertible Debt Instruments that May be Settled in Cash Upon Conversion. APB 14-1 requires that the liability and equity components of convertible debt instruments that may be settled in cash upon conversion (including partial cash settlement) be separately accounted for in a manner that reflects an issuer’s nonconvertible debt borrowing rate. The resulting debt discount is amortized over the period the convertible debt is expected to be outstanding as additional non-cash interest expense. APB 14-1 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. Retrospective application to all periods presented is required except for instruments that were not outstanding during any of the periods that will be presented in the annual financial statements for the period of adoption but were outstanding during an earlier period. Since we do not currently have any convertible debt, we do not expect this statement will have a material impact on our financial condition, results of operations and cash flows upon adoption in fiscal 2010.

 

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RESULTS OF OPERATIONS

 

The following table sets forth, for the periods indicated, the components of the results of operations, as reflected in our statements of operations, as a percentage of sales.

 

 

 

Three months ended January 31,

 

Nine months ended January 31,

 

 

 

2009

 

2008

 

2009

 

2008

 

Revenue

 

100.0

%

100.0

%

100.0

%

100.0

%

Cost of goods sold

 

50.2

 

44.4

 

51.3

 

44.1

 

Gross Profit

 

49.8

 

55.6

 

48.7

 

55.9

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Sales and marketing

 

48.3

 

58.1

 

66.4

 

52.5

 

Research and development

 

61.3

 

56.4

 

72.7

 

52.0

 

General and administrative

 

25.8

 

29.8

 

40.0

 

26.9

 

Amortization of purchased intangibles

 

0.5

 

3.7

 

0.5

 

2.7

 

Impairment of goodwill

 

 

245.7

 

 

60.1

 

Total operating expenses

 

136.0

 

393.7

 

179.6

 

194.2

 

Loss from operations

 

(86.2

)

(338.1

)

(130.9

)

(138.3

)

Other income, net

 

7.1

 

13.9

 

0.1

 

15.0

 

Loss before provision for (benefit from) income taxes

 

(79.1

)

(324.2

)

(130.8

)

(123.3

)

Provision for (benefit from) income taxes

 

(1.8

)

(29.9

)

0.4

 

(27.9

)

Net loss

 

(77.3

)%

(294.3

)%

(131.2

)%

(95.4

)%

 

THREE AND NINE MONTHS ENDED JANUARY 31, 2009 AND 2008.

 

Revenue.

 

 

 

 

 

 

 

Change From Prior Year

 

 

 

Three months ended January 31,

 

Nine months ended January 31,

 

3 Month

 

9 Month

 

$s in thousands

 

2009

 

2008

 

2009

 

2008

 

Period

 

Period

 

Revenue

 

$

4,899

 

$

6,684

 

$

13,553

 

$

27,343

 

$

(1,785

)

$

(13,790

)

 

The decrease in revenue during the three and nine months ended January 31, 2009 compared to the same periods in fiscal 2008 was largely due to a decrease in revenue from our largest domestic customer, Verizon, as well as declines in the overall purchases from the next four largest customers in fiscal 2008, without an increase in other domestic and international business to offset these declines.  In the aggregate, our top five customers in fiscal 2009 accounted for $4.3 million and $8.6 million, respectively, of revenue in the three and nine months ended January 31, 2009 as opposed to the top five customers in the same periods of fiscal 2008, which accounted for $4.6 million and $20.9 million, respectively.

 

Our largest customer in both fiscal 2009 and 2008, Verizon, accounted for approximately $0.7 million and $3.2 million, respectively, of our revenue during the three and nine months ended January 31, 2009 as compared to $2.0 million and $10.9 million, respectively, during the corresponding periods of fiscal 2008.  This decline in revenue, both in real terms and as a percentage of revenue, appears to be largely due to Verizon shifting focus away from their traditional wireless network deployments, where our product has historically been installed, to newer 3G networks. The mix of customers that represent our next four largest customers has changed year over year but is reflective of a growing trend of our international business becoming a larger percentage of our revenue base mostly due to the decline in our domestic revenues exceeding the rate of decline we have experienced internationally and our VoIP product offering beginning to take hold, primarily domestically.  Two customers, other than Verizon, accounted for over 10% of our revenue for the three month periods ended January 31, 2009 and 2008.  For the nine months ended January 31, 2009 and 2008, one customer and two customers, respectively, accounted for more that 10% of revenue.

 

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Table of Contents

 

Although we have experienced a consistent number of customers representing greater than 10% of our revenues during the first nine months of fiscal 2009 and 2008, the overall dollar magnitude of the revenue from these customers continues to trend down as buying decisions continue to be slow to materialize and are generally for more conservative amounts than buying patterns experienced in fiscal 2006 and 2007.  We believe that this protracted buying process and the smaller ordering levels are a function of tighter capital spending budgets and tighter credit markets, as well as uncertainty in the technical direction that companies are looking to take.  This indecision around future network design appears to have made carriers leery to invest heavily in legacy circuit switched technology due to the risk of stranding investments upon conversion to VoIP.  However, on the VoIP side we are experiencing carriers moving into the VoIP space in a more conservative manner than was expected by industry analysts, resulting in deployments at a fraction of the size which we are accustomed to seeing for circuit switched network deployments.  Although our initial VoIP product was designed for large scale deployments and therefore was not easily adaptable to meet the smaller scale deployments that most carriers wanted to undertake, we have recently completed development of a smaller scale version of PVP product, which we hope will more closely meet current market demands.

 

Geographically, our domestic revenue for the three months ended January 31, 2009 totaled 30% of total worldwide revenue as compared to 45% realized for the corresponding period in fiscal 2008.  Our domestic revenue for the nine months ended January 31, 2009 was 48% of worldwide revenue as compared to 64% for the comparable period in fiscal 2008.  The decrease in the domestic portion of our revenue both in real terms and as a percentage of total revenue was primarily driven by the decline in Verizon purchasing activity.  Our international revenue has primarily been dependent on our success in selling VQA. Although we continue to believe that there are meaningful domestic and international revenue opportunities, we continue to experience slower than anticipated purchasing cycles from our existing and prospective customers, which has resulted in volatility in the level of revenue from quarter to quarter.  We plan to continue to invest in customer trials to attempt to capture the world-wide revenue opportunities that exist for us.  We expect that sales of our TDM-based BVP-Flex and QVP products will continue to represent the majority of our revenue in the foreseeable future, as carriers continue to be cautious in their deployment strategies of VoIP based communications networks.  We expect revenue in the fourth quarter of fiscal 2009 to be flat to up by as much as 15% as compared to our third quarter of fiscal 2009 revenue level.

 

Cost of Goods Sold and Gross Profit.

 

 

 

 

 

 

 

Change From Prior Year

 

 

 

Three months ended January 31,

 

Nine months ended January 31,

 

3 Month

 

9 Month

 

$s in thousands

 

2009

 

2008

 

2009

 

2008

 

Period

 

Period

 

Cost of goods sold

 

$

2,460

 

$

2,966

 

$

6,959

 

$

12,060

 

$

(506

)

$

(5,101

)

Gross profit

 

2,439

 

3,718

 

6,594

 

15,283

 

(1,279

)

(8,689

)

Gross margin%

 

49.8

%

55.6

%

48.7

%

55.9

%

(5.8

)%pts

(7.2

)%pts

 

Cost of goods sold consists of direct material costs, personnel costs for test, configuration and quality assurance, costs of licensed technology incorporated into our products, post-sales installation costs, provisions for inventory and warranty expenses and other indirect costs. The decrease in cost of goods sold was primarily driven by the decrease in business volume during the three and nine months ended January 31, 2009 as compared to the three and nine months ended January 31, 2008.  Our analysis of gross margin below discusses the other factors driving changes in cost of goods sold.

 

Our gross margin percentage decreased during the three months ended January 31, 2009, as compared to the same period in fiscal 2008, primarily as a result of a change in customer and product mix between the two periods.   The most notable change in this mix was a decline in maintenance revenue as a percentage of the overall revenue, due in large part to a decline the level of maintenance support purchased by our largest maintenance customer.  As maintenance revenue has historically had a higher margin than our product revenue, this decline in maintenance revenue resulted in a decline in our overall margins.

 

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Table of Contents

 

Our gross margin percentage decreased during the nine months ended January 31, 2009, as compared to the comparable period in fiscal 2008, largely due to our under absorbed manufacturing overhead costs during the first half of the year representing a larger percentage of our revenues and increased provisions for excess inventory and warranty costs during the first nine of fiscal 2009. The change in product and customer mix in the third quarter, discussed above, also contributed to the decline in year-to-date margin, but to a lesser degree.  These factors that lead to declines in our gross margin percentage were only partially offset by the reductions in manufacturing and service allocations to cost of sales as a result of reduced spending in the manufacturing and service organizations due to the reductions in force.

 

All other things being equal, we expect that if our revenue levels increase, gross margin percentages should increase slightly from the current levels as the continued under absorption of manufacturing overheads will become a smaller percentage of a larger revenue base, resulting in improved margins.  However, we could experience further pricing pressures as we expand the distribution of our products internationally through value-added resellers and distributors, which could cause our gross margins to decrease.

 

Sales and Marketing.

 

 

 

 

 

 

 

Change From Prior Year

 

 

 

Three months ended January 31,

 

Nine months ended January 31,

 

3 Month

 

9 Month

 

$s in thousands

 

2009

 

2008

 

2009

 

2008

 

Period

 

Period

 

Sales & Marketing

 

$

2,366

 

$

3,885

 

$

8,992

 

$

14,362

 

$

(1,519

)

$

(5,370

)

% of Revenue

 

48.3

%

58.1

%

66.4

%

52.5

%

(9.8

)%pts

13.9

%pts

 

Sales and marketing expenses primarily consist of personnel costs, including commissions and costs associated with customer service, travel, trade shows and outside consulting services.  The decrease in sales and marketing expense in the three and nine month periods ending January 31, 2009, as compared to the corresponding periods in fiscal 2008 was largely due to the impacts of the reductions in force that have occurred since the end of second quarter of fiscal 2008 and subsequent attrition in the sale and marketing organizations.  The resulting reduction in headcount had a direct impact on both base pay and variable compensation, which experienced a combined reduction of $0.9 million and $3.6 million during the three and nine months periods, respectively.  The reduction in headcount also impacted travel and related expenses which experienced a $0.2 million and $0.8 million decrease during the three and nine month periods, respectively and also resulted in a reduction in stock compensation for the three and nine months ended January 31, 2009 of approximately $0.2 million and $0.8 million, respectively.  We also experienced a decline in the three months ended January 31, 2009 of $0.3 million due to reductions in outside service spending again tied to our focus on tighter cost control.  Lastly, sales and marketing spending declined by $0.3 million during the nine months periods due to tighter cost control through the adoption of a more focused marketing communications program.  We expect sales and marketing expenses to decrease slightly in the fourth quarter of fiscal 2009 as we realize the full benefits from the reductions in force that was completed in the second and third quarters of fiscal 2009.

 

Research and Development.

 

 

 

 

 

 

 

Change From Prior Year

 

 

 

Three months ended January 31,

 

Nine months ended January 31,

 

3 Month

 

9 Month

 

$s in thousands

 

2009

 

2008

 

2009

 

2008

 

Period

 

Period

 

Research & Development

 

$

3,004

 

$

3,769

 

$

9,853

 

$

14,214

 

$

(765

)

$

(4,361

)

% of Revenue

 

61.3

%

56.4

%

72.7

%

52.0

%

4.9

%pts

20.7

%pts

 

Research and development expenses primarily consist of personnel costs, contract consultants, materials and supplies used in the development of voice processing products. The decrease in expense during the three and nine month periods ended January 31, 2009 as compared to the corresponding periods in fiscal 2008 was largely driven by the reductions in force that have occurred since the end of the second quarter of fiscal 2008 and subsequent attrition.  As a result of these reductions in force and the related closure of our Canadian research operations in fiscal 2008, we experienced a decline in payroll and related expenses totaling $0.5 million and $3.0 million during the

 

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Table of Contents

 

three and nine months ended January 31, 2009, respectively.  We also experienced a $0.3 million and $0.7 million decline in stock-based compensation attributable to employees in the research and development organization during the three and nine months ended January 31, 2009, respectively.  See the discussion in the Stock-based Compensation section below.   Lastly, in the nine months ended January 31, 2009 we also experienced a $0.5 million decline in spending related to travel and corporate overhead costs allocated to engineering due to the reduction in headcount and space needs.  We expect research and development expenses to decrease in the fourth quarter of fiscal 2009 as we realize the full benefits from the reduction in force that was completed in the third quarter of fiscal 2009, partially offset by increasing investment in our new development projects such as licensing our voice quality software for inclusion in Bluetooth devises and our new mStage voice interface device.

 

General and Administrative.

 

 

 

 

 

 

 

Change From Prior Year

 

 

 

Three months ended January 31,

 

Nine months ended January 31,

 

3 Month

 

9 Month

 

$s in thousands

 

2009

 

2008

 

2009

 

2008

 

Period

 

Period

 

General & Administrative

 

$

1,266

 

$

1,994

 

$

5,421

 

$

7,353

 

$

(728

)

$

(1,932

)

% of Revenue

 

25.8

%

29.8

%

40.0

%

26.9

%

(4.0

)%pts

13.1

%pts

 

 General and administrative expenses primarily consist of personnel costs for corporate officers, finance and human resources personnel, as well as insurance, legal, accounting and consulting costs.  The decline in spending was impacted by a decline in spending on professional services of $0.2 million and $0.4 million for the three and nine months ended January 31, 2009, respectively, due largely to the incremental costs incurred in the first quarter of fiscal 2008 associated with the adoption of FIN 48 and reduced outside legal costs associated with our ongoing legal proceedings, as discussed in Note 9 of our condensed consolidated financial statements included in Item 1, Part I of this report.  Fiscal 2009 general and administrative spending also experienced a decline in stock compensation due to the departure of the former CEO and due to the reductions in force since the second quarter of fiscal 2008 of $0.2 million and $0.4 million for the three and nine months ending January 31, 2009, respectively.  In addition, the three months ended January 31, 2009 experienced a decline in spending for travel and related costs, as well as several miscellaneous cost categories totaling $0.2 million as part of tighter cost control efforts.  General and administrative spending also declined during the three and nine months ended January 31, 2009 by approximately $0.1 million and $0.3 million, respectively, due to reduced payroll and related costs associated with the reductions in force that have occurred since the second quarter of fiscal 2008.  The decrease in general and administrative expense during the nine months ended January 31, 2009 was also due to a decrease in special charges attributable to the separation package for the departing CEO in fiscal 2008 and the search for his replacement.  As a result, general and administrative spending declined by $0.7 million for the nine months ended January 31, 2009. We expect general and administrative expenses to increase modestly in the fourth quarter of fiscal 2009 due to the seasonal nature of our spending on audit and tax services.

 

Stock-based Compensation.

 

Stock-based compensation expense recognized under SFAS 123R in fiscal 2009 and 2008 was as follows:

 

 

 

Three months ended
January 31,

 

Nine months ended
January 31,

 

$s in thousands

 

2009

 

2008

 

2009

 

2008

 

Cost of Sales

 

$

64

 

$

98

 

$

216

 

$

296

 

Sales and marketing

 

45

 

316

 

432

 

1,290

 

Research and development

 

(95

)

199

 

279

 

922

 

General and administrative

 

121

 

322

 

629

 

1,082

 

Total

 

$

135

 

$

935

 

$

1,556

 

$

3,590

 

 

The decline in stock based compensation for the three and nine months ended January 31, 2009 is due to two key factors.  First and foremost is the reduction in options outstanding and therefore stock compensation linked to the reductions in force that occurred since the end of the second quarter of fiscal 2008.  The second key element of the decline is linked to the timing of option grants that are subject to accounting under SFAS 123R. As compensation related to older options, which were granted at higher fair values per share due to the stock price at the time of grant,

 

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Table of Contents

 

become fully amortized, they are being replaced by newer option grants which are being issued at lower fair values due largely to the decline in our stock price.   We expect to continue to experience a declining level of expense related to stock compensation.

 

Impairment of Goodwill

 

In the fiscal 2008, we have experienced the start of a protracted decline in our stock price and therefore our market capitalization, due in large part to the decline in our operating results. As a result of our stock price’s depressed state and uncertainty as to when our stock price would return to levels sufficient to justify the recovery of our recorded goodwill, we undertook an interim impairment review in the third quarter of fiscal 2008. As a result of the review, we determined that the entire goodwill balance of $16.4 million was impaired and therefore recorded an impairment loss in the third quarter fiscal 2008.  There was no similar charge in fiscal 2009.

 

Amortization of purchased intangible assets.

 

 

 

Three months

 

Nine months

 

Change From Prior Year

 

 

 

ended January 31,

 

ended January 31,

 

3 Month

 

9 Month

 

$s in thousands

 

2009

 

2008

 

2009

 

2008

 

Period

 

Period

 

Amortization of purchased intangible assets

 

$

25

 

$

247

 

$

73

 

$

739

 

$

(222

)

$

(666

)

% of Revenue

 

0.5

%

3.7

%

0.5

%

2.7

%

(3.2

)%pts

(2.2

)%pts

 

Purchased intangible assets relate to our acquisition of Jasomi in fiscal 2006 and are being amortized to operating expense over their estimated useful lives which range from four to five years.  The decline in amortization is largely due to the $1.3 million impairment charge that was recognized at the end of fiscal 2008.  See Note 4 of our condensed consolidated financial statements included in Item 1, Part I of this report.

 

Reduction in Force and Related Charges.

 

 

 

Three months ended
January 31,

 

Nine months ended
January 31,

 

$s in thousands

 

2009

 

2008

 

2009

 

2008

 

Cost of Sales

 

$

 

$

7

 

$

31

 

$

72

 

Sales and marketing

 

89

 

46

 

323

 

276

 

Research and development

 

371

 

19

 

614

 

913

 

General and administrative

 

25

 

(20

)

399

 

504

 

Total

 

$

485

 

$

52

 

$

1,337

 

$

1,765

 

 

In the third quarter of fiscal 2009, we incurred a charge of $0.5 million related to the reduction in force and related charges undertaken in an effort to reduce spending levels to coincide with the more recent declines we had experienced in our revenue.  This reduction in force along with that in the second quarter of fiscal 2009 has resulted in a 21% reduction in headcount during fiscal 2009 and a charge for the nine months ended January 31, 2009 of $1.4 million.  As a result of the cumulative reductions in force since the second quarter of fiscal 2008, the charges for the three and nine months ended January 31, 2009 included the estimated costs to vacate approximately 20% of the space in our Mountain View headquarters and the cost associated with abandoning certain idled fixed assets, resulting in charges of $0.3 million and $0.6 million, respectively. The space vacated is currently being marketed for sublease.  During the three and nine months ended January 31, 2009, approximately $40,000 and $64,000, respectively, related to accrued outplacement services lapsed without being used and was therefore reversed to the same financial lines to which it was originally recorded in the second quarter of fiscal 2008.  All other costs associated with the fiscal 2008 reduction in force have been incurred.  All severance payments associated with the fiscal 2009 reductions in force have been paid as of January 31, 2009.  The only costs remaining to be paid as of January 31, 2009 are estimated outplacement costs for the reductions in force totaling less than $0.1 million and the balance of the loss on sublease of the vacated space in the Mountain View headquarter of $0.2 million.

 

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Table of Contents

 

In addition to the fiscal 2008 restructuring costs, in the second quarter of fiscal 2008 we also incurred other one time benefit costs associated with the retirement package for our departing CEO in August 2007, which totaled approximately $0.4 million and was included in general and administrative expense.

 

Other Income, Net.

 

 

 

Three months

 

Nine months

 

Increase (Decrease)
From Prior Year,

 

 

 

ended January 31,

 

ended January 31,

 

3 Month

 

9 Month

 

$s in thousands

 

2009

 

2008

 

2009

 

2008

 

Period

 

Period

 

Other income, net

 

$

346

 

$

933

 

$

15

 

$

4,094

 

$

(587

)

$

(4,079

)

% of Revenue

 

7.1

%

14.0

%

0.1

%

15.0

%

(6.9

)%pts

(14.9

)%pts

 

Other income, net consists of interest income on our invested cash and cash equivalent balances, foreign currency activities, and a nominal amount of interest expense. The decreases in other income, net for both the three and nine months ended January 31, 2009 were primarily attributable to lower average cash balances, due in large part to the $41 million stock repurchase which was completed in the latter half of second quarter of fiscal 2008, as well as lower average returns on our invested cash due to the shift in our investment portfolio from auction rate securities to more liquid money funds.  The reduction also reflects impairment charges associated with certain of our investments in auction rate securities during the nine months ended January 31, 2009 of $1.4 million.

 

Income Taxes.

 

 

 

Three months

 

Nine months

 

Decrease From
Prior Year,

 

 

 

ended January 31,

 

ended January 31,

 

3 Month

 

9 Month

 

$s in thousands

 

2009

 

2008

 

2009

 

2008

 

Period

 

Period

 

Provision for (benefit from) income taxes

 

$

(86

)

$

(1,997

)

$

50

 

$

(7,628

)

$

1,911

 

$

7,678

 

% of Revenue

 

(1.8

)%

(29.9

)%

0.4

%

(27.9

)%

28.1

%pts

28.3

%pts

 

Income taxes consist of federal, state and foreign income taxes. The effective tax rate in the third quarter of fiscal 2009 was approximately (2)% compared to (9)%  in the third quarter of fiscal 2008.  The effective tax rate for the nine months ended January 31, 2009 was less than 1% compared to (23)%  for the nine months ended January 31, 2008.  The effective tax rate for the three and nine months ended January 31, 2009 reflected our establishment of a full valuation allowance against our deferred tax assets, including our net operating loss carry forwards.  As a result of this valuation allowance, our tax expense for the three and nine months ended January 31, 2009 is limited to certain state and foreign tax jurisdictions where we report limited profits.  The effective tax rate for the three and nine months ended January 31, 2008 reflected our inability to deduct for tax purposes (1) stock-based compensation expense associated with (i) most non-U.S. employees and (ii) incentive stock option grants, (2) amortization of debentures associated with the Jasomi acquisition that are payable to employee-investors and (3) the non-deductible nature of the impairment charge for goodwill.  These items were partially offset by favorable levels of R&D credit due to continued expanded spending on product development.

 

LIQUIDITY AND CAPITAL RESOURCES

 

As of January 31, 2009, we had cash and cash equivalents of $40.9 million as compared to $36.1 million at April 30, 2008.  In addition, we had short-term investments of $0.1 million as compared to $14.4 million at April 30, 2008. As of January 31, 2009, we also had long-term investments of $8.2 million as compared to $15.1 million at April 30, 2008. These long-term investments are tied to auction rate securities that failed to settle at auction.  Although these securities would normally be classified as short-term, as they typically settle every 7, 28 or 35 days, because they failed to settle at auction they have been reclassified to long-term pending them settling at auction (see Note 3 of our condensed consolidated financial statements included in Item 1, Part I of this report). The decline in our aggregate cash and investment balances in fiscal 2009 is in large part due to the $15.1 million of cash used by operations primarily due to our operating losses during the first nine months of fiscal 2009.  We have a $2 million line of credit facility with our bank, which expires in July 2009.  There are no amounts outstanding as of January 31, 2009 under the line of credit.  As of January 31, 2009, we were not in compliance with the loan covenant related to minimum tangible net worth.  In February 2009, we completed a modification of the line of credit which included the establishment of new financial covenants and a waiver of the covenant violation as of January 31, 2009.

 

We believe that the steps we have taken over the last 12 to 15 months to reduce our operating expenses and to drive our legacy business to be at or near cash flow break even will begin to be more evident in our financial results in the coming quarters.  However, we do expect to continue to invest in our newer product offerings, which we believe will help diversify our customer base and hopefully add more predictability to our revenue streams. We expect that the investments in our new products will result in continued negative cash flows from operations until such time that we experience a resurgence of demand for our legacy products closer to their historical levels or our new products gain traction in the market and begin to generate meaningful revenue streams.

 

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Table of Contents

 

Since March 1997, we have satisfied our liquidity requirements through cash flow generated from operations, funds received from stock issued under our various stock plans and the proceeds from our initial and follow-on public offerings in fiscal 2000.

 

 

 

Nine months ended
January 31,

 

 

 

2009

 

2008

 

Cash flow from operating activities

 

$

(15,079

)

$

(16,016

)

 

The use of cash for the first nine months of fiscal 2009 was largely due to our continued operating losses.   The other operating factor that impacted cash flows from operations was a decline in accrued expenses of $1.8 million primarily due to declines in employee related accruals as a result of the pay-down of certain accrued liabilities during the first nine months of fiscal 2009.  Partially offsetting these operating uses of cash were cash inflows due to a $1.1 million reduction in our outstanding accounts receivable balance due to collection of prior sales and the reduced level of current year sales.

 

Our accounts receivable days sales outstanding at January 31, 2009 was approximately 77 days compared to 62 days at April 30, 2008.

 

We expect to see continued modest levels of negative cash flows from operations in the coming quarter based on continued softness in revenue resulting in operating losses.

 

 

 

Nine months ended
January 31,

 

 

 

2009

 

2008

 

Cash flow from investing activities

 

$

19,708

 

$

39,636

 

 

We generated $19.7 million in cash from our investing activities in the first nine months of fiscal 2009 primarily as a result of liquidating $20.3 million of investments, the proceeds from which were invested in cash and cash equivalents.  Additionally impacting cash flows from investing activities was the purchase of $0.5 million of equipment, primarily to support our product development efforts.  We plan to continue to invest in capital assets related to new product features and to support our efforts to sell our VoIP products.

 

 

 

Nine months ended
January 31,

 

 

 

2009

 

2008

 

Cash flow from financing activities

 

$

175

 

$

(39,573

)

 

We generated $0.2 million of cash in financing activities in the first nine months of fiscal 2009 due to funds received from the employee stock purchase plan and stock option exercises.  Although we expect to continue to have positive cash flows from financing activities due to employee stock plan activity, the level of cash flow will vary depending on market conditions.

 

We have no material commitments other than obligations under operating leases, particularly our facility leases, and normal purchases of inventory, capital equipment and operating expenses, such as materials for research and development and consulting.  We currently occupy approximately 61,000 square feet of space in the two buildings that form our Mountain View, California headquarters.  In September 2005, we renegotiated our Mountain View, California lease, which extended the lease term through July 31, 2011 and reduced the rent cost.  We have engaged a leasing company to sublease approximately 11,200 square feet of our Mountain View headquarters which we have vacated due to reduced space needs as a result of the cumulative affect of the reductions in force that we have completed since the second quarter of fiscal 2008.

 

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Table of Contents

 

The following table sets forth our contractual commitments as of January 31, 2009:

 

 

 

Payments due by period

 

Contractual Obligations

 

Total

 

Less than
1 year

 

2 to 3
years

 

4 to 5
years

 

Over 5
years

 

Operating leases

 

$

2,686

 

$

258

 

$

2,152

 

$

276

 

$

 

Purchase commitments

 

2,684

 

2,684

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

5,370

 

$

2,942

 

$

2,152

 

$

276

 

$

 

 

We believe that we will be able to satisfy our cash requirements for at least the next eighteen months from our existing cash, short-term and long-term investments.  The ability to fund our operations beyond the next eighteen months will be dependent on the overall demand of telecommunications providers for new capital equipment. Should we continue to experience significantly reduced levels of customer demand for our products compared to historical levels of purchases, we may need to find additional sources of cash during the latter part of fiscal 2010 or be forced to further reduce our spending levels to protect our cash reserves.

 

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 the value of our common stock. These risk factors should be carefully reviewed.

 

WE DEPEND ON A LIMITED NUMBER OF CUSTOMERS, THE LOSS OF ANY ONE OF WHICH COULD CAUSE OUR REVENUE TO DECREASE.

 

Our revenue historically has come from a small number of customers. Our five largest customers accounted for approximately 64% of our revenue in the first nine months of fiscal 2009 and 68% and 88% of our revenue in fiscal 2008 and 2007, respectively. Our largest customer accounted for approximately 24% of our revenue in the nine months of fiscal 2009 and 35% and 64% of our revenue in fiscal 2008 and 2007, respectively. 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, a delay in a scheduled product introduction, completion of a network expansion or upgrade, or a change in technology or network architecture. If this happens, our revenue could be greatly reduced, which would materially and adversely affect our business, including but not limited to exposing us to excess inventory levels due to declines in anticipated sales levels. In addition, our customer concentration exposes us to credit risk as, for example, 89% of our accounts receivable balance at January 31, 2009 was from four customers.

 

Since the beginning of calendar year 2004, North American telecommunication service providers have been involved in a series of merger and acquisition activities and some affected telecommunication service providers are still assessing the network technology and deployment plans. In any merger, product purchases for network deployment may be reviewed, postponed or canceled based on revised plans for technology or network expansion for the merged entity. We believe this is what happened at Nextel when, in December 2004, they announced a plan to merge with Sprint. Consequently, our fiscal 2006 revenue from Nextel was nominal compared to 37% of our total worldwide revenue, or $34.9 million, in fiscal 2005. More recently, we have also experienced changes in buying patterns due to carrier transitions from their legacy TDM/networks to VoIP networks and the impact of the world-wide economic and credit crisis.  These more recent factors have directly impacted the timing and magnitude of carrier’s buying patterns, as they are closely watching their capital spending and are looking to minimize their investment in their legacy network configurations but have been slow to deploy large scale VoIP networks.  Until carrier transition strategies from their legacy TDM/networks to VoIP networks get clarified and the economic and credit markets return to a more normal state, our revenue could be more volatile due to timing issues around large customer purchases.

 

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Recent worldwide market turmoil may adversely affect our customers which directly impacts our business and results of operations.

 

Our operations and performance depend on our customers having adequate resources to purchase our products and services. The unprecedented turmoil in the global markets and the global economic downturn generally continues to adversely impact our customers and potential customers. These market and economic conditions have continued to deteriorate despite government intervention globally, and may remain volatile and uncertain for the foreseeable future. Customers have altered and may continue to alter their purchasing and payment activities in response to deterioration in their businesses, lack of credit, economic uncertainty and concern about the stability of markets in general, and these customers may reduce, delay or terminate purchases of, and payment for, our products and services. If we are unable to adequately respond to changes in demand resulting from deteriorating market and economic conditions, our financial condition and operating results may be materially and adversely affected.

 

IN PERIODS OF WORSENING ECONOMIC CONDITIONS, OUR EXPOSURE TO CREDIT RISK AND PAYMENT DELINQUENCIES ON OUR ACCOUNTS RECEIVABLE SIGNIFICANTLY INCREASES.

 

A substantial majority of our outstanding accounts receivables are not secured. In addition, our standard terms and conditions permit payment within a specified number of days following the receipt of our product. While we have procedures to monitor and limit exposure to credit risk on our receivables, there can be no assurance such procedures will effectively limit our credit risk and avoid losses. As economic conditions deteriorate, certain of our customers have faced and may face liquidity concerns and have delayed and may delay or may be unable to satisfy their payment obligations, which would have a material adverse effect on our financial condition and operating results.

 

OUR CASH AND CASH EQUIVALENTS AND OUR SHORT AND LONG-TERM INVESTMENTS COULD BE ADVERSELY AFFECTED IF THE FINANCIAL INSTITUTIONS IN WHICH WE HOLD THESE FUNDS FAIL.

 

We maintain the cash and cash equivalents and our short and long-term investments with reputable major financial institutions. Deposits with these banks exceed the Federal Deposit Insurance Corporation (“FDIC”) insurance limits. While we monitor daily the cash balances in the operating accounts and adjust the balances as appropriate, these balances could be impacted if one or more of the financial institutions with which we deposit fails or is subject to other adverse conditions in the financial or credit markets. To date we have experienced no loss or lack of access to our invested cash or cash equivalents (other than our auction rate securities which are classified as long-term investments); however, we can provide no assurance that access to our invested balances will not be impacted by adverse conditions in the financial and credit markets.

 

WE ARE RELIANT PRIMARILY ON OUR VOICE QUALITY BUSINESS TO GENERATE REVENUE GROWTH AND PROFITABILITY, WHICH COULD LIMIT OUR RATE OF FUTURE REVENUE GROWTH.

 

We expect that, at least through fiscal 2009, our primary business will be the design, development and marketing of voice processing products. However, the relatively small size of the overall echo cancellation portion of the voice market, which is where we have derived the majority of our revenue to date, could limit the rate of growth of our business. In addition, certain telecommunication service providers may utilize different technologies, such as VoIP, which would further limit demand for products we sold in the last few fiscal years, which are deployed in mobile and wireline networks. Although fiscal 2008 was the first year in which revenue from our Packet Voice Processor (PVP) targeted at the VoIP market was greater than 10% of our total revenue, due to the slower than anticipated market transition to VoIP networks and the protracted nature of customer evaluation of our VoIP platform, sales of our PVP product have been volatile from quarter to quarter.  As such, there is no guarantee that revenue from our PVP product in any given quarter will continue to exceed 10% of our total revenue or that we will continue to be successful in selling the PVP in volume into those VoIP networks.

 

IF WE DO NOT SUCCESSFULLY DEVELOP AND INTRODUCE NEW PRODUCTS, OUR PRODUCTS MAY BECOME OBSOLETE WHICH COULD CAUSE OUR SALES TO DECLINE.

 

We operate in an industry that experiences rapid technological change, and if we do not successfully develop and introduce new products and our existing products become obsolete, our revenues will decline. Even if we are successful in developing new products, we may not be able to successfully produce or market our new products in

 

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commercial quantities, or increase our overall sales levels. These risks are of particular concern when a new generation product is introduced. Although we believe we will meet our product introduction timetables, there is no guarantee that delays will not occur. For example, we realized our first modest levels of revenue from our new voice quality features, which are offered on our BVP-Flex and Quad Voice Processor (QVP) voice processing hardware platforms, in the fourth quarter of fiscal 2004 and are continuing to experience numerous customer evaluations of the latest versions of these features around the world. These evaluations have typically taken longer than we anticipated. Although we have experienced substantial revenue from our VQA products over the last two fiscal years, there is no guarantee that our VQA products will continue to meet the expectations of new potential customers or that customers will continue to invest heavily in traditional TDM/wireline network infrastructure. As such, the timing of our realization of any additional revenues from the VQA platforms could be delayed or not materialize at all.

 

The PVP, which has only experienced modest levels of production shipments to date, provides voice processing functionality to enable the deployment of end-to-end VoIP services. This is the first packet-based product developed by us. The product may not achieve broad market acceptance due to feature or capabilities mismatches with customer requirements, product pricing, or limitations of our sales and marketing organizations to properly interact with customers to communicate the benefits of the product.

 

We must devote a substantial amount of resources in order to develop and achieve commercial acceptance of our new products, most recently our PVP and our voice quality features offered on our BVP-Flex and QVP hardware platforms. Our new and/or existing products may not be able to address evolving demands in the telecommunications market in a timely or effective way. Even if they do, customers in these markets may purchase or otherwise implement competing products.

 

AS WE MODIFY OUR CORE ALGORITHMS FOR USE IN OTHER ELEMENTS OF COMMUNICATIONS NETWORKS, THERE IS NO GUARANTEE THAT WE WILL BE SUCCESSFUL IN CAPTURING MARKET SHARE OR THAT IT WILL NOT ADVERSELY IMPACT THE SALE OF OUR EXISTING PRODUCTS.

 

We have begun to work with equipment providers for other elements of communications networks, most notably Bluetooth headset providers, to license our voice algorithms for use in their devices.  Although we believe that porting our algorithms to these new devices will not be a material undertaking, there is no guarantee that we will be successful in the porting efforts or that we will gain market acceptance.  In addition, as the barriers to entry related to technology embedded in Bluetooth devices are low, there is no guarantee that our competitors, who may have more resources and/or market presence, will not enhance their offerings to compete directly with our technology.  Further, there is no guarantee that if and when our algorithms become adopted in other portions of the communications network that they will not reduce the demand for our existing voice processing platforms, which could adversely impact our revenues and increase the risk for excess or obsolete inventory in our existing platforms.

 

THERE IS NO GUARANTEE THAT OUR DEVELOPMENT EFFORTS ON OUR NEW MSTAGE PRODUCT WILL BE COMPLETED IN THE DESIRED TIME FRAME OR THAT WE WILL EXPERIENCE THE DESIRED CUSTOMER DEMAND AND DIVERSIFICATION.

 

Although we have received positive feed back from the market related to our recent product announcements related to our mStage product, there is no guarantee that we will be successful in our development efforts or that they will be completed in a timely enough manner to generate meaningful levels of revenue and capture market share before our competitors attempt to introduce competing technology.  In addition, there is no guarantee that the market will embrace the use of a voice interface to interact with web applications like social networking and IM on-demand, during a phone call, which also could lead to actual revenue from this new product not achieving our expectations. If we fail to generate meaningful revenue from our new products in development, we may not be able to recoup our investment in these products and, further, our ability to become profitable may be adversely impacted.

 

OUR OPERATING RESULTS HAVE FLUCTUATED SIGNIFICANTLY IN THE PAST, AND WE ANTICIPATE THAT THEY MAY CONTINUE TO DO SO IN THE FUTURE, WHICH COULD ADVERSELY AFFECT OUR STOCK PRICE.

 

Our quarterly operating results have fluctuated significantly in the past and may fluctuate in the future as a result of several factors, some of which are outside of our control. If revenue significantly declines, as we experienced in fiscal 2008 and the first nine months of fiscal 2009, 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. For example, we have experienced delays in customers finalizing contracts and/or issuing purchase orders, which have resulted in revenues slipping out of the quarter in which we had expected to recognize them. This resulted in revenue shortfalls from investor expectations during several quarters over the last 24 months and ultimately resulted in us experiencing declines in our stock price following the announcement of these revenue shortfalls.

 

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OUR REVENUE MAY VARY FROM PERIOD TO PERIOD.

 

Factors that could cause our revenue to fluctuate from period to period include:

 

·      changes in capital spending in the telecommunications industry and larger macroeconomic trends, including but not limited to the impacts of the current world-wide economic crisis;

 

·       the timing or cancellation of orders from, or shipments to, existing and new customers;

 

·       the loss of, or a significant decline in orders from, a customer;

 

·       delays outside of our control in obtaining necessary components from our suppliers;

 

·       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;

 

·       delays in timing of revenue recognition, due to new contractual terms with customers;

 

·       competitive pricing pressures;

 

·       variations in the mix of products offered by us; and

 

·       variations in our sales or distribution channels.

 

Sales of our products 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.

 

Our customers may delay or rescind orders for our existing products in anticipation of the release of our or our competitors’ new products, due to merger and acquisition activity or if they are unable to secure sufficient credit to enable their purchases. Further, if our or our competitors’ new products substantially replace the functionality of our existing products, our existing products may become obsolete, which could result in inventory write-downs, and/or we could be forced to sell them at reduced prices or even at a loss.

 

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 or more for our base echo cancellation systems and up to 180 days or more for our newer VQA and PVP product offerings. Once an order is placed, delivery times can vary depending on the product ordered and the timing of installations or product acceptance may be delayed by our customers. As a result, revenue forecasted for a specific customer for a particular quarter may not occur in that quarter. Further, in a fiscal quarter for which we enter the quarter with a small backlog relative to our revenue target, we are at heightened risk for the factors noted above as we are more dependent on the generation of new orders within the quarter to meet the revenue targets. Because of the potentially 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.

 

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If we incur these additional expenses in a quarter in which we do not experience increased revenue, our operating results would be adversely affected.

 

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 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 RAPID TECHNOLOGICAL CHANGES IN OUR INDUSTRY.    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 these standards become widespread, and our products are not in compliance with these standards, 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.

 

ACQUISITIONS AND INVESTMENTS MAY ADVERSELY AFFECT OUR BUSINESS.

 

From time to time, we 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. For example, in June 2005 we acquired Jasomi. 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;

 

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·       the incurrence of debt and contingent liabilities; and

 

·       amortization expenses related to acquisition related intangible assets and impairment of goodwill.

 

Furthermore, acquisitions involve numerous operational risks, including:

 

·       difficulties in the integration of operations, personnel, technologies, products and the information systems of the acquired companies;

 

·       diversion of management’s attention from other business concerns;

 

·       diversion of resources from our existing businesses, products or technologies;

 

·       risks of entering geographic and business markets in which we have no or limited prior experience; and

 

·       potential loss of key employees of acquired organizations.

 

WE ANTICIPATE THAT AVERAGE SELLING PRICES FOR OUR PRODUCTS WILL DECLINE IN THE FUTURE, WHICH COULD ADVERSELY AFFECT OUR ABILITY TO BE PROFITABLE.

 

We expect that the price we can charge our customers for our products will decline as new technologies become available, as we expand the distribution of products through value-added resellers and distributors internationally 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. If this occurs, our operating results will be adversely affected. We expect price reductions to be more pronounced due to our planned expansion internationally. 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.

 

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 USE PRIMARILY TWO CONTRACT MANUFACTURERS TO MANUFACTURE OUR PRODUCTS, AND IF WE LOSE THE SERVICES OF THESE MANUFACTURERS THEN WE COULD EXPERIENCE INCREASED MANUFACTURING COSTS AND PRODUCTION DELAYS

 

Manufacturing is currently outsourced to primarily two contract manufacturers. We believe that our current contract manufacturing relationships provide us with competitive manufacturing costs for our products. However, if we or these contract manufacturers terminate our 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.

 

IF WE LOSE THE SERVICES OF ANY OF OUR KEY MANAGEMENT OR KEY TECHNICAL PERSONNEL, OR ARE UNABLE TO RETAIN OR ATTRACT ADDITIONAL TECHNICAL PERSONNEL, OUR ABILITY TO CONDUCT AND EXPAND OUR BUSINESS COULD BE IMPAIRED.

 

We depend heavily on key management and technical personnel for the conduct and development of our business and the development of our products. However, there is no guarantee that if we lost the services of one or more of these people for any reason, that it would not 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 technical employees. However, we may not be able to do so.

 

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WE FACE INTENSE COMPETITION, WHICH COULD ADVERSELY AFFECT OUR ABILITY TO MAINTAIN OR INCREASE SALES OF OUR PRODUCTS.

 

The markets for our 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. Certain of our customers also have the ability to internally produce the equipment that they currently purchase from us. In these cases, we also compete with their internal product development capabilities. We expect that competition will increase in the future. We may not have the financial resources, technical expertise or marketing, manufacturing, distribution and support capabilities to compete successfully.

 

We face competition from two direct manufacturers of stand-alone voice processing products, Tellabs and Natural Microsystems. The other competition in these markets comes from voice switch manufacturers. These switch manufacturers do not sell voice processing products or compete in the stand-alone voice processing product market, but they integrate voice processing functionality within their switches, either as hardware modules or as software running on chips. A more widespread adoption of internal voice processing solutions would present an increased competitive threat to us, if the net result was the elimination of demand for our voice processing system products.

 

Many of our competitors and potential competitors have long-standing relationships with our existing and potential customers, and have substantially greater name recognition and technical, financial and marketing resources than we do. These competitors may undertake more extensive marketing campaigns, adopt more aggressive pricing policies and devote substantially more resources to developing new products than we will.

 

WE DO NOT HAVE THE RESOURCES TO ACT AS A SYSTEMS INTEGRATOR, WHICH MAY BE REQUIRED TO WIN DEALS WITH SOME LARGE U.S. AND INTERNATIONAL TELECOMMUNICATIONS SERVICES COMPANIES.

 

When implementing significant technology upgrades, large U.S. and international telecommunications services companies often require one major equipment supplier to act as a “systems integrator” to ensure interoperability of all the network elements. Normally the system integrator would provide the most crucial network elements and also take responsibility for the interoperation of their own equipment with the equipment provided by other suppliers. We are not in a position to take such a lead system integrator position and therefore we may have to partner with a system integrator (other, much larger, telecommunication equipment supplier) to have a chance to win business with certain customers. As a result, we may experience delays in revenue because it could take a long time to agree to terms with the necessary system integrator and the terms may reduce our profitability for that transaction. Moreover, there is no guarantee that we will reach agreement with a system integrator.

 

IF INCUMBENT AND 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 continue to depend in large part on development, expansion and/or upgrade of voice and communications networks. We are subject to risks of growth constraints due to our current and planned dependence on U.S. and international telecommunications service providers. These potential customers may be constrained for a number of reasons, including their limited capital resources, economic conditions, changes in regulation and mergers or consolidations which we have seen in North America since calendar year 2004. New service providers (e.g., Skype, Google and Yahoo) are beginning to compete against our traditional customers with new business models that are substantially reducing the prices charged to end users. This competition may force network operators to reduce capital expenditures, which could reduce our revenue.

 

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 continuing to execute on our plans to expand our international presence through the establishment of new relationships with established international value-added resellers and distributors. However, we may still be required to hire additional personnel for the overseas market, may invest in markets that ultimately generate little or no revenue, and may incur other unforeseen expenditures related to our international expansion. Despite these efforts, to date our expansion overseas has met with success in only a few markets and there is no guarantee of future success.

 

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As we expand our sales focus farther into international markets, we will face new and complex issues that we may not have faced before, such as expanded risk to currency fluctuations, longer payment cycles, manufacturing overseas, political or economic instability, potential adverse tax consequences and broadened import/export controls, which will put additional strain on our management personnel. In the past, the vast majority 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, which may expose us to greater exchange rate risk.

 

The number of installations we will be responsible for may increase as a result of our continued international expansion and recognition of revenue may be dependent on product acceptances that are tied to completion of the installations. In addition, we may not be able to establish more relationships with international value-added resellers and distributors. If we do not, our ability to increase sales could be materially impaired.

 

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 suppliers as the sole source of certain key components that we use in our products. For example, we rely on Texas Instruments as the sole source supplier for the digital signal processors used in our echo cancellation and voice enhancement products. We have no guaranteed supply arrangements with our suppliers. Any extended interruption in the supply of these components would affect our ability to meet scheduled deliveries of our 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. Additionally, because these suppliers are the sole source of these components, we are at risk that adverse increases in the price of these components could have negative impacts on the cost of our products or require us to find alternative, less expensive components, which would have to be designed into our products in an effort to avoid erosion in our product margin.

 

WE NOW LICENSE OUR ECHO CANCELLATION SOFTWARE FROM TEXAS INSTRUMENTS, AND IF WE DO NOT RECEIVE THE LEVEL OF SUPPORT WE EXPECT FROM TEXAS INSTRUMENTS, IT COULD ADVERSELY AFFECT OUR ECHO CANCELLATION SYSTEMS BUSINESS.

 

In April 2002, we sold our echo cancellation software technology and future revenue streams from our licenses of acquired technology to Texas Instruments, in return for cash and a long-term license of the echo cancellation software. The license had an initial four-year royalty-free period after which, in March 2006, we (1) extended the royalty-free period through December 31, 2007 for certain legacy DSPs purchased from TI primarily to support our remaining warranty obligation for our end-of-life products and (2) negotiated new pricing based on the purchase of DSPs bundled with the echo software for our current products. Although the licensing agreement has strong guarantees of support for the software used in our products, if Texas Instruments were to not deliver complete and timely support to us, our success in the echo cancellation systems business could be adversely affected.

 

IF TEXAS INSTRUMENTS LICENSES ITS ECHO CANCELLATION SOFTWARE TO OTHER ECHO CANCELLATION SYSTEMS COMPANIES, THIS COULD INCREASE THE COMPETITIVE PRESSURES ON OUR ECHO CANCELLATION SYSTEMS BUSINESS.

 

If Texas Instruments licenses its echo cancellation software, that it acquired from us in April 2002, to other echo cancellation systems companies, it could increase the level of competition we face. By providing those companies with similar technological advantages to our product offering those companies might be able to compete on a more direct basis with us, which could adversely affect our success in our echo cancellation systems business.

 

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SOME SUPPLIERS OF KEY COMPONENTS MAY REDUCE THEIR INVENTORY LEVELS WHICH COULD RESULT IN LONGER LEAD TIMES FOR FUTURE COMPONENT PURCHASES AND ANY DELAYS IN FILLING OUR DEMAND MAY REDUCE OR DELAY OUR EXPECTED PRODUCT SHIPMENTS AND REVENUES.

 

Although we believe there are currently ample supplies of components for our products, it is possible that in the near-term component manufacturers may reduce their inventory levels and require firm orders before they manufacture components. This reduction in stocking levels could lead to extended lead times in the future. If we are unable to procure our planned quantities of materials from all prospective suppliers, and if we cannot use alternative components, we could experience revenue delays or reductions and potential harm to customer relationships.

 

IF WE ARE UNSUCCESSFUL IN MANUFACTURING PRODUCTS THAT COMPLY WITH ENVIRONMENTAL REQUIREMENTS, IT MAY LIMIT OUR ABILITY TO SELL IN REGIONS ADOPTING THESE REQUIREMENTS.

 

As part of our ISO 14001-certified management system and our overall commitment to the environment we are investigating the requirements set forth by the RoHS directive. Based on some independent industry benchmarking, and guidance offered by the UK’s Department of Trade and Industry, we believe that our product, telecommunication network infrastructure equipment, qualifies for the lead-in-solder exemption of the RoHS Directive. Consequently, we have obtained what is commonly called “5 of 6” compliance. We will continue to monitor the evolution of the EC/95 and related industry activities and will take appropriate action for those products that we sell into EU countries and territories. Moreover, we will continue to monitor the evolution of the EC/96 and related industry activities elsewhere in the world and will take appropriate action for those products that we sell into regions adopting new environmental standards. There is no guarantee that we will be successful in complying with these evolving environmental requirements or that the costs involved with compliance might be prohibitive. In either case, if we are unsuccessful in complying with these environmental requirements, it would limit our ability to sell into territories adopting new environmental requirements, which could impact our total revenue and overall results of operations.

 

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 may 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, these measures may not be adequate to safeguard the technology underlying our products. In addition, employees, consultants and others who participate in the development of our products may breach their agreements with us regarding our intellectual property, and we may not have adequate remedies for any such breach. In addition, we may not be able to effectively protect our intellectual property rights in certain countries. We may, for a variety of reasons, decide not to file for patent, copyright or trademark protection outside of the United States. We also realize that our trade secrets may become known through other means not currently foreseen by us. Notwithstanding our efforts to protect our intellectual property, our competitors may be able to develop products that are equal or superior to our products without infringing on any of our intellectual property rights.

 

WE CURRENTLY ARE, AND IN THE FUTURE MAY BE, SUBJECT TO SECURITIES CLASS ACTION LAWSUITS DUE TO DECREASES IN OUR STOCK PRICE.

 

We are at risk of being subject to securities class action lawsuits if our stock price declines substantially, as has happened recently. Securities class action litigation has often been brought against a company following a decline in the market price of its securities. For example, in May 2005, we announced that we expected our first quarter fiscal 2006 revenue to be approximately one half of our last quarter fiscal 2005 revenue, and our stock price declined dramatically. On June 14, 2005, a lawsuit entitled Richard E. Jaffe v. Ditech Communications Corp., Timothy K. Montgomery and William J. Tamblyn,    Case No. C 05 02406 was filed in the United States District Court for the Northern District of California, purportedly on behalf of a class of investors who purchased Ditech’s stock between August 25, 2004 and May 26, 2005. The complaint alleges claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 against Ditech, our Chief Financial Officer and our former Chief Executive Officer. Several similar lawsuits were filed and all of the cases were consolidated into a single action. Although the court has dismissed this action with prejudice, the plaintiffs in this action have appealed the dismissal.

 

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We cannot predict the outcome of the lawsuits. As a result of the recent substantial decline in our stock price, or if our stock price declines substantially in the future, we may be the target of similar litigation. The current, and any future, securities litigation could result in substantial costs and divert management’s attention and resources, and could seriously harm our business.

 

WE CURRENTLY ARE, AND IN THE FUTURE MAY BE, SUBJECT TO ADDITIONAL SECURITIES LAWSUITS.

 

We are at risk of being subject to other lawsuits as a result of being a public company. Four actions have been filed purportedly as derivative actions on behalf of Ditech Networks against certain of our current and former officers and directors. The complaints allege that between 1999 and 2001 a number of stock option grants were backdated, and that as a result the defendants breached their fiduciary duties to Ditech Networks and violated provisions of federal securities laws and California statutory and common law. The complaints also allege that some of our officers and former officers were unjustly enriched. These lawsuits could result in substantial costs and divert management’s attention and resources, and thus could seriously harm our business.

 

OUR STOCK REPURCHASE SIGNIFICANTLY DECREASED OUR CASH RESOURCES AND MAY IMPAIR OUR ABILITY TO ACQUIRE OR DEVELOP ADDITIONAL TECHNOLOGIES.

 

In the second quarter of fiscal 2008, we completed the repurchase of over seven million shares of our common stock for a total cost of $41 million. As a result, we have significantly less cash resources, which may inhibit our ability to acquire companies or technologies, or develop new technologies, that we believe would be beneficial to our company and our stockholders. Further, if we experience a continued downturn in our business, we may need to rely on our cash reserves to fund our business during the period of the downturn which, if prolonged and severe, we may not be able to do.

 

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. If made, these assertions could materially adversely affect our business, financial condition and results of operations. In addition, irrespective of the validity or the successful assertion of these claims, we could incur significant costs in defending against these claims.

 

THERE IS RISK THAT OUR AUCTION RATE SECURTIES WILL NOT SETTLE AT AUCTION AND WE MAY EXPERIENCE ADDITIONAL OTHER THAN TEMPORARY DECLINES IN VALUE, WHICH WOULD CAUSE ADDITIONAL CHARGES TO BE REALIZED ON OUR STATEMENT OF OPERATIONS.

 

As of January 31, 2009, we held one A3 rated auction rate security (A3 rated ARS) and one Ba1 rated auction rate security (Ba1 rated ARS), totaling $14.0 million of par value, both of which failed to settle at auctions. The A3 rated ARS only began to fail to auction in the fourth quarter of fiscal 2008, while the Ba1 rated ARS with a par value of $10.0 million has failed to settle since the second quarter of fiscal 2008. Due to the prolonged nature of the decline in value of the Ba1 rated auction rate security that has failed to settle since the second quarter of fiscal 2008, the severity of the decline and no clear indication of when it might settle, we determined that the unrealized loss was no longer temporary. Therefore, we have recognized a total of $5.5 million of impairment charges in the condensed consolidated statement of operations since the beginning of the fourth quarter of fiscal 2008 ($1.4 million in fiscal 2009). We believe that the $0.3 million decline in value that we have experienced in the A3 rated ARS as of January 31, 2009 is a temporary event and we have accounted for this decline as an unrealized loss in accumulated other comprehensive loss within stockholders’ equity in the condensed consolidated balance sheets. It is possible that we will incur further declines in value in these two securities during the remainder of fiscal due to changing facts related to the underlying collateral, changes in the amount and timing of cash flow streams being generated by the securities, which play a key role in the overall valuation model, as well as changes in the overall market. In addition, in the future should we determine that these declines in value are other than temporary, we would recognize a further impairment charge on our condensed consolidated statement of operations, which could be material. As of February 28, 2009, we continued to hold auction rate securities with a par value of $13.7 million. See Item 3. below for a further discussion of our auction rate securities.

 

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Item 3—Quantitative and Qualitative Disclosures About Market Risk

 

Our exposure to market risk due to changes in the general level of United States interest rates relates primarily to our cash equivalents and short-term and long-term investment portfolios. Our cash, cash equivalents and short-term and long-term investments are primarily maintained at four major financial institutions in the United States. As of January 31 2009 and April 30, 2008, we did not hold any derivative instruments. The primary objective of our investment activities is the preservation of principal while maximizing investment income and minimizing risk, and we attempted to achieve this by diversifying our portfolio in a variety of highly rated investment securities that have limited terms to maturity. We do not hold any instruments for trading purposes.

 

Investment securities that have maturities of more than three months at the date of purchase but current maturities of less than one year and auction rate securities which prior to the fourth quarter of fiscal 2008 management has been able to liquidate on 7, 28 or 35 day auction cycles, are considered short-term investments. Those securities with maturities of greater than one year, including auction rate securities that failed to settle and which based on their nature do not appear likely to settle in the near term, are classified as long-term investments. Short and long-term investments consist primarily of auction rate securities in AMBAC preferred stock, asset backed securities and corporate notes. Our investment securities are maintained at two major financial institutions, are classified as available-for-sale, and are recorded on the accompanying Condensed Consolidated Balance Sheets at fair value. If we sell our investments prior to their maturity, we may incur a charge to operations in the period the sale took place. In the first nine months of fiscal 2009 and during fiscal 2008, we realized no gains or losses on our investments, but we did recognize impairment charges of $1.4 million in the first nine months of fiscal 2009 and $4.1 million in fiscal 2008 on certain of our auction rate securities that failed to settle and have recorded a cumulative unrealized loss of $0.3 million on the remaining auction rate securities as a component of accumulated other comprehensive loss.

 

Auction rate securities are variable rate debt instruments with interest rates that, unless they fail to settle, are reset approximately every 7, 28 or 35 days. The underlying securities have contractual maturities which are generally greater than ten years. The auction rate securities are classified as available for sale and are recorded at fair value. Typically, the carrying value of auction rate securities approximates fair value due to the frequent resetting of the interest rates. As of January 31, 2009 and April 30, 2008, we held one auction rate security totaling $10.0 million of par value, which had an original rating at the time we purchased them of AA but is currently rated Ba1 (Ba1 rated ARS) and has failed to settle at auctions since the second quarter of fiscal 2008.  As of January 31, 2009, we held one additional auction rate security with a par value of $4.0 million (eight additional auction rate securities with a par value of $24.3 million as of April 30, 2008) which continue to be rated A3 (A3 rated ARS) but failed to settle since the fourth quarter of fiscal 2008. While we continue to earn interest on these investments at the maximum contractual rate, the fair value of these auction rate securities no longer approximates par value. Accordingly, we have recorded these investments at a fair value of $8.2 million as of January 31, 2009 ($29.5 million as of April 30, 2008). Due to the prolonged nature and the severity of the decline in the value of the Ba1 rated ARS that have failed to settle since the second quarter of fiscal 2008 and no clear indication of when it might settle, we determined that the unrealized loss was no longer temporary. Therefore, we have recognized $1.4 million and a $4.1 million of impairment charges in the first nine months of fiscal 2009 and the fourth quarter of fiscal 2008, respectively, on this auction rate security. We believe that the $0.3 million decline in value that we have experienced in the A3 rated ARS as of January 31, 2009, is a temporary event and has been accounted for as an unrealized loss in accumulated other comprehensive loss. We have concluded that no other-than-temporary impairment losses occurred for the A3 rated ARS that began to fail to settle in fourth quarter of fiscal 2008 because we believe that the decline in fair value is due to general market conditions, this investment is of high credit quality, and we have the intent and ability to hold this investment until the anticipated recovery in fair value occurs. We will continue to analyze our auction rate securities each reporting period for impairment and may be required to recognize an impairment charge in the statement of operations if the decline in fair value is determined to be other than temporary. The fair value of these securities has been estimated by management based on assumptions that market participants would use in pricing the asset in a current transaction, which could change significantly based on market conditions.

 

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Our investment securities are not leveraged. Due to the short-term nature of our investments, they are not subject to significant fluctuations in their fair value due to changes in interest rates. As such, the recorded fair value of the investments at January 31, 2009 and April 30, 2008 approximates the fair value after assuming a hypothetical shift in the yield curve of plus or minus 50 basis points (BPS), 100 BPS, and 150 BPS over the remaining life of the investments, which shifts are representative of the historical movements in the Federal Funds Rate. 100 BPS equals 1%.

 

The following table presents our cash equivalents and short-term and long-term investments subject to interest rate risk and their related weighted average interest rates as of January 31, 2009 and April 30, 2008 (dollars in thousands). Carrying value approximates fair value.

 

 

 

January 31, 2009

 

April 30, 2008

 

 

 

Carrying
Value

 

Average
Interest Rate

 

Carrying
Value

 

Average
Interest Rate

 

Cash and cash equivalents

 

$

40,935

 

1.52

%

$

36,131

 

2.61

%

Short-term investments

 

83

 

3.58

%

14,400

 

4.15

%

Long-term investments

 

8,161

 

2.62

%

15,130

 

4.50

%

 

 

 

 

 

 

 

 

 

 

Total

 

$

49,096

 

1.71

%

$

65,661

 

3.38

%

 

To date, the vast majority of our sales have been denominated in U.S. dollars. As only a small amount of foreign invoices are paid in currencies other than the U.S. dollar, we consider our foreign exchange risk immaterial to our consolidated financial position, results of operations and cash flows.

 

Item 4—Controls and Procedures

 

Limitations of Disclosure Controls and Procedures and Internal Control Over Financial Reporting

 

It should be noted that a control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. For example, controls can be circumvented by a person’s individual acts, by collusion of two or more people or by management override of the control. Because a cost-effective control system can only provide reasonable assurance that the objectives of the control system are met, misstatements due to error or fraud may occur and not be detected.

 

Disclosure Controls and Procedures

 

Ditech Networks, Inc. maintains disclosure controls and procedures, as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), that are designed to ensure that information required to be disclosed in the reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), as appropriate, to allow timely decisions regarding required financial disclosure. In connection with the preparation of this Quarterly Report on Form 10-Q, we carried out an evaluation under the supervision and with the participation of our management, including our CEO and CFO, as of January 31, 2009 of the effectiveness of the design and operation of our disclosure controls and procedures. Based upon this evaluation, our CEO and CFO concluded that as of January 31, 2009, our disclosure controls and procedures were effective.

 

Change in Internal Control over Financial Reporting

 

There has been no change in internal control over financial reporting in the quarter ended January 31, 2009 that has materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

Item 4T — Controls and Procedures

 

Not Applicable

 

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Part II. OTHER INFORMATION

 

ITEM 1.    LEGAL PROCEEDINGS

 

Beginning on June 14, 2005, several purported class action lawsuits were filed in the United States District Court for the Northern District of California, purportedly on behalf of a class of investors who purchased Ditech’s stock between August 25, 2004 and May 26, 2005. The complaints allege claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 against Ditech and its Chief Executive Officer and Chief Financial Officer in connection with alleged misrepresentations concerning VQA orders and the potential effect on Ditech of the merger between Sprint and Nextel, seeking monetary damages. All of the lawsuits were consolidated into a single action entitled In re Ditech Communications Corp. Securities Litigation,  No. C 05-02406-JSW, and a consolidated amended complaint was filed on February 2, 2006. The defendants moved to dismiss the complaint, and by order dated August 10, 2006, the court granted the defendants’ motion and dismissed the complaint with leave to amend. The plaintiffs filed their Second Amended Complaint on September 11, 2006. The defendants again moved to dismiss, and by order dated March 22, 2007, the court dismissed the Second Amended Complaint with leave to amend. The plaintiffs filed their Third Amended Complaint on April 23, 2007. On May 14, 2007, the defendants again moved to dismiss. By order dated October 11, 2007, the court dismissed the third amended complaint with prejudice. On November 8, 2007, the plaintiffs filed a notice of appeal to the Ninth U.S. Circuit Court of Appeals. The appeal has been fully briefed. Oral argument of the appeal has been set for April 14, 2009.

 

On August 23, 2006, August 25, 2006, and November 3, 2006, three actions were filed in United States District Court for the Northern District of California (Case Nos. C06-05157, C06-05242, and C06-6877) purportedly as derivative actions on behalf of the Company against certain of the Company’s current and former officers and directors alleging that between 1999 and2001 certain stock option grants were backdated; that these options were not properly accounted for; and that as a result false and misleading financial statements were filed. These three actions have been consolidated under case number C06-05157. On December 1, 2006, a fourth derivative complaint making similar allegations against many of the same defendants was filed in California Superior Court for the County of Santa Clara (Case No.106-CV-075695). On April 19, 2007, the California Superior Court granted the Company’s motion to stay the state court action pending the outcome of the federal consolidated actions.

 

The defendants named in the derivative actions are Timothy Montgomery, Gregory Avis, Edwin Harper, William Hasler, Andrei Manoliu, David Sugishita, William Tamblyn, Caglan Aras, Toni Bellin, Robert DeVincenzi, James Grady, Lee House, Serge Stepanoff, Gary Testa, Lowell Trangsrud, Kenneth Jones, Pong Lim, Glenda Dubsky, Ian Wright, and Peter Chung. These derivative complaints raise claims under Section 10(b) and 10b-5 of the Securities Exchange Act, Section 14(a) of the Securities Act, and California Corporations Code Section 25403, as well as common law claims for breach of fiduciary duty, unjust enrichment, waste of corporate assets, gross mismanagement, constructive fraud, and abuse of control. The plaintiffs seek remedies including money damages, disgorgement of profits, accounting, rescission, and punitive damages. With respect to the consolidated federal actions, the plaintiffs filed an amended consolidated complaint on March 2, 2007, adding new allegations regarding another stock option grant. On April 2, 2007, the Company moved to dismiss the amended complaint based on plaintiffs’ failure to make a demand on the board before bringing suit. On the same day, the individual defendants moved to dismiss the amended complaint for failure to state a claim. On July 16, 2007, the Court granted the individual defendants’ motion to dismiss without prejudice.  Plaintiffs filed a second amended complaint on September 21, 2007.  On November 30, 2007, defendants moved to dismiss plaintiffs’ second amended complaint for failure to make a demand on the board and for failure to state a claim.  On March 26, 2008, the Court granted the individual defendants’ motion to dismiss without prejudice, requiring that plaintiffs file any amended complaint by April 25, 2008.  Plaintiffs did not file an amended complaint.  As a result, on May 12, 2008, defendants moved to dismiss plaintiffs’ action with prejudice.  The parties agreed to postpone the hearing on defendants’ motion so that they could engage in mediation.  These actions are in their preliminary stages; no discovery has taken place and no trial date has been set.

 

ITEM 1A.               RISK FACTORS

 

We include in Part I, Item 2. “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Future Growth and Operating Results Subject to Risk” a description of risk factors related to our business in order to enable readers to assess, and be appropriately apprised of, many of the risks and uncertainties applicable to the forward-looking statements made in this Quarterly Report on Form 10-Q. We do not claim that the risks and uncertainties set forth in that section are all of the risks and uncertainties facing our business, but do believe that they reflect the more important ones.

 

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The risk factors set forth in Part I, Item 1A of our Annual Report on Form 10-K for the year ended April 30, 2008, as filed with the SEC on July 10, 2008, have not substantively changed, except for the following risk factors:

 

1. The risk factor “We Depend On A Limited Number Of Customers, The Loss Of Any One Of Which Could Cause Our Revenue To Decrease,” was revised to include first nine months of fiscal 2009 financial information and to include credit risk associated with our customer concentration, as well as to include the risk of changing buying patterns of our customers and the current world-wide economic crisis.

 

2. The risk factor “We Are Reliant Primarily On Our Voice Quality Business To Generate Revenue Growth And Profitability, Which Could Limit Our Rate Of Future Revenue Growth,” was revised to update information for our first nine months of fiscal 2009.

 

3. The risk factor “If We Do Not Successfully Develop And Introduce New Products, Our Products May Become Obsolete Which Could Cause Our Sales to Decline,” was revised to include the risk that our customers may not continue to invest heavily in traditional TDM/network infrastructure.

 

4.  We have added the following risk factor:  “As We Modify Our Core Algorithms For Use In Other Elements Of Communications Networks, There Is No Guarantee That We Will Be Successful In Capturing Market Share Or That It Will Not Adversely Impact The Sale Of Our Existing Products.”

 

5. The risk factor “Our Operating Results Have Fluctuated Significantly In the Past, And We Anticipate That They May Continue To Do So In The Future, Which Could Adversely Affect Our Stock Price.” was revised to include first nine months of fiscal 2009 financial information.

 

6.  The risk factor “Our Revenue May Vary From Period to Period.” was revised to reference the current world-wide economic crisis.

 

7.  The risk factor “There Is Risk That Our Auction Rate Securities Will Not Settle At Auction And We May Experience Additional Other Than Temporary Declines In Value, Which Could Cause Additional Charges To Be Realized On Our Statement Of Operations” has been revised to include first nine months of fiscal 2009 financial information.

 

8.     The risk factor “Recent Worldwide Market Turmoil May Adversely Affect Our Customers Which Directly Impacts Our Business And Results Of Operations” was added to address the impacts of current world-wide economic crisis on our business.

 

9.     The risk factor “In Periods Of Worsening Economic Conditions, Our Exposure To Credit Risk And Payment Delinquencies On Our Accounts Receivable Significantly Increases” was added to address the impacts of current world-wide economic crisis on collection risks.

 

10.   The risk factor “Our Cash And Cash Equivalents And Short and Long-term Investments Could Be Adversely Affected If The Financial Institutions In Which We Hold Our Cash And Cash Equivalents Fail” was added to address the risk of the current world-wide economic crisis on our ability to access our invested cash.

 

11.   The risk factor “There Is No Guarantee That Our Development Efforts On Our New mStage Product Will Be Completed In The Desired Time Frame Or That We Will Experience The Desired Customer Demand And Diversification” was added to address certain risks associated with our new products.

 

ITEM 2.  UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

 

None.

 

ITEM 3.  DEFAULTS ON SENIOR SECURITIES

 

None.

 

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ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

 

None.

 

ITEM 5.  OTHER INFORMATION

 

None.

 

ITEM 6.  EXHIBITS

 

See the Exhibit Index which follows the signature page of this Quarterly Report on Form 10-Q, which is incorporated herein by reference.

 

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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 Networks, Inc.

 

 

 

 

Date: March 9, 2009

By:

/s/  WILLIAM J. TAMBLYN

 

 

William J. Tamblyn

 

 

Executive Vice President and Chief Financial Officer (Principal Financial and Chief Accounting Officer)

 

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EXHIBIT INDEX

 

Exhibit

 

Description of document

2.1(1)

 

Asset Purchase Agreement, dated as of April 16, 2002, by and between Ditech and Texas Instruments

2.2(2)

 

Asset Purchase Agreement, dated as of July 16, 2003, by and between Ditech Communications Corporation and JDS Uniphase Corporation

2.3(3)

 

Agreement and Plan of Merger, dated as of June 6, 2005, among Ditech, Spitfire Acquisition Corp., Jasomi Networks, Inc., Jasomi Networks (Canada), Inc., Daniel Freedman, Cullen Jennings and Todd Simpson.

3.1(4)

 

Restated Certificate of Incorporation of Ditech Networks, Inc.

3.2(5)

 

Bylaws of Ditech Networks, Inc., as amended and restated

4.1

 

Reference is made to Exhibits 3.1 and 3.2

4.2(7)

 

Specimen Stock Certificate

4.3(6)

 

Rights Agreement, dated as of March 26, 2001 among Ditech Communications Corporation and Wells Fargo Bank Minnesota, N.A.

4.4(6)

 

Form of Rights Certificate

10.1(8)(9)

 

Amendment to Letter Agreement dated December 15, 2008 between Ditech Networks, Inc. and Todd Simpson

10.2(8)(9)

 

Amended and Restated Change In Control Severance Benefit Plan

31.1

 

Certification by Principal Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

31.2

 

Certification by Principal Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

32

 

Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 


(1)

Incorporated by reference from the exhibit with the corresponding description from Ditech’s Current Report on Form 8-K (File No. 000-26209), filed April 30, 2002.

 

 

(2)

Incorporated by reference from the exhibit with the corresponding description from Ditech’s Current Report on Form 8-K (File No. 000-26209) filed July 30, 2003.

 

 

(3)

Incorporated by reference from the exhibit with the corresponding number from Ditech’s Annual Report on Form 10-K for the fiscal year ended April 30, 2005 (File No. 000-26209), filed July 14, 2005.

 

 

(4)

Incorporated by reference from Exhibit 3.2 to Ditech’s Current Report on Form 8-K (File No. 000-26209), filed May 22, 2006.

 

 

(5)

Incorporated by reference from Exhibit 3.1 to Ditech’s Current Report on Form 8-K (File No. 000-26209), filed August 15, 2007.

 

 

(6)

Incorporated by reference from Exhibit 99.2 to Ditech’s Current Report on Form 8-K (File No. 000-26209), filed March 30, 2001.

 

 

(7)

Incorporated by reference from the exhibit with the corresponding description from Ditech’s Registration Statement (No. 333-75063), declared effective on June 9, 1999.

 

 

(8)

Management contract or compensatory plan or arrangement.

 

 

(9)

Filed herewith.

 

47