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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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

 

26



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,

 

27



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