UNITED STATES
SECURITIES AND EXCHANGE COMMISSIONWASHINGTON, D.C. 20549

FORM 10-K

FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO SECTIONS 13
OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

|(MARK ONE)                               |                                                                                         
|---------------------------------------- | ----------------------------------------------------------------------------------------
|ý                                        | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934    
|For the Fiscal Year Ended April 30, 2004
|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

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GRAPHIC

DITECH COMMUNICATIONS CORPORATION(Exact Name of Registrant as Specified in its Charter)

DELAWARE(State or Other Jurisdiction of Incorporation or Organization)

94-2935531(I.R.S. Employer Identification No.)

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825 East Middlefield Road
Mountain View, CA 94043
(650) 623-1300(Address, Including Zip Code, of Registrant's Principal Executive Offices and Telephone Number, Including Area Code)

Securities
Registered Pursuant to Section 12(b) of the Act:None

Securities Registered Pursuant to Section 12(g) of the Act:Common Stock, $.001 Par Value

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Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past
90 days. Yes ý No o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be
contained, to the best of the Registrant's knowledge, in definitive proxy or information incorporated by reference to Part III of this Form 10-K or any amendment to this
Form 10-K. o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange
Act) Yes ý No o

The aggregate market value of voting stock held by non-affiliates of the Registrant was approximately $298,431,909 as of October 31, 2003 based
upon the closing price on the Nasdaq National Market reported for such date. Excludes an aggregate of 4,450,470 shares of common stock held by officers and directors and by each person known by the
registrant to own 5% or more of the outstanding common stock. Exclusion of shares held by any such person should not be construed to indicate that a determination has been made that such person
possesses the power, directly or indirectly, to direct or cause the direction of the management or policies of the registrant, or that such person is controlled by or under common control with the
registrant.

The
number of shares outstanding of the Registrant's Common Stock as of July 1, 2004 was 33,702,556 shares.

DOCUMENTS INCORPORATED BY REFERENCE

The information required by Part III of this report, to the extent not set forth herein, is incorporated by reference from the Registrant's definitive proxy
statement relating to the annual meeting of stockholders to be held September 17, 2004, which definitive proxy statement will be filed with the Securities and Exchange Commission within
120 days after the fiscal year to which this Report relates.



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DITECH COMMUNICATIONS CORPORATION
FORM 10-K

INDEX

|                                                                                                                    |  | PAGE
|------------------------------------------------------------------------------------------------------------------- |  | ----
|PART I                                                                                                             
|Item 1Business                                                                                                     |  | 1   
|Item 2Properties                                                                                                   |  | 10  
|Item 3Legal Proceedings                                                                                            |  | 10  
|Item 4Submission of Matters to a Vote of Security Holders                                                          |  | 10  
|PART II                                                                                                            
|Item 5Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities |  | 11  
|Item 6Selected Financial Data                                                                                      |  | 11  
|Item 7Management's Discussion and Analysis of Financial Condition and Results of Operations                        |  | 15  
|Item 7AQuantitative and Qualitative Disclosure About Market Risk                                                   |  | 33  
|Item 8Financial Statements and Supplementary Data                                                                  |  | 35  
|Item 9Changes in and Disagreements with Accountants on Accounting and Financial Disclosure                         |  | 61  
|Item 9AControls and Procedures                                                                                     |  | 61  
|PART III                                                                                                           
|Item 10Directors and Executive Officers of the Registrant                                                          |  | 62  
|Item 11Executive Compensation                                                                                      |  | 62  
|Item 12Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters              |  | 62  
|Item 13Certain Relationships and Related Transactions                                                              |  | 62  
|Item 14Principal Accountant Fees and Services                                                                      |  | 62  
|PART IV                                                                                                            
|Item 15Exhibits, Financial Statement Schedules and Reports on Form 8-K                                             |  | 63  
|SIGNATURES                                                                                                          |  | 67  

Trademarks:

Ditech and the Wave Design logo are registered trademarks of Ditech Communications Corporation. VQA is a trademark of Ditech Communications Corporation. This
Annual Report on Form 10-K also includes trademarks of companies other than Ditech.

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Ditech Communications Corporation

Part I

Item 1Business

General

This Annual Report contains forward-looking statements that relate to future events or future financial performance. In some cases, forward looking statements can
be identified by terminology such as "may", "will", "should", "expects", "plans", "anticipates", "believes", "estimates", "targets", "predicts", "intends", "potential" or "continue" or the negative of
such terms or other comparable terminology. These statements are only predictions. Although we believe that the expectations reflected in the forward looking statements are reasonable, we cannot
guarantee future results, levels of activity, performance or achievements. Actual results could differ materially from those anticipated in these forward-looking statements as a result of various
factors, including the risks outlined under "Item 7Management's Discussion and Analysis of Financial Condition and Results of OperationsFuture Growth and Operating Results
Subject to Risk" and elsewhere in this Annual Report. All forward-looking statements included in this document are based on information available to us on the date hereof. We assume no obligation to
update any such forward-looking statements.

Ditech
Communications Corporation (Ditech) is a global telecommunications equipment supplier for voice networks. Our voice processing products include our echo cancellers, which are used
to effectively eliminate echo, a significant problem in existing and emerging voice networks. Our echo cancellers have been our primary source of revenue to date. Our newest voice processing products
not only provide our customers with our traditional echo cancellation features, but also can be used to provide Voice Quality Assurance (VQA) features, which address issues such as background noise
and other voice quality issues in wireline and wireless communications. Through July 16, 2003, we also developed and marketed optical subsystem communications products through our wholly owned
subsidiary, Altamar Networks, Inc. However, on July 16, 2003, we completed the sale of our optical subsystem communications business and have therefore presented the optical business as
discontinued operations in this Annual Report on Form-10K. Where we use the words "we", "our" or similar expressions, we are referring to Ditech and each of our wholly-owned subsidiaries.
Our fiscal year ends on April 30.

We
market our products domestically through a direct sales force and to a lesser degree original equipment manufacturers (OEMs) and distributors. Internationally, we market our products
through a direct sales force, value-added resellers, system integrators, OEMs and distributors.

Ditech
was originally incorporated as Phone Info., Inc. in July 1983 and subsequently changed its name to Automated Call Processing Corporation, Inc. In
March 1997, Automated Call Processing Corporation sold portions of its business and merged with its wholly owned subsidiary, and the surviving entity was renamed Ditech Corporation. Ditech
Corporation reincorporated in Delaware in April 1999 and changed its name to Ditech Communications Corporation. Through July 16, 2003, Ditech developed and marketed optical subsystem
communications products through its subsidiary, Altamar Networks, which was formed in February 2001. The mailing address for Ditech is 825 East Middlefield Road, Mountain View, California USA
94043. The Ditech general telephone number is 650-623-1300.

Voice Quality Market

In the current deregulated market, voice quality is a key competitive differentiator for telecommunication service providers. One of the primary challenges faced
by service providers in delivering quality voice communication is the elimination of echo. Echo results from signal reflection at the "hybrid," commonly the point where two wires of the local network
meet the four wires of the long

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distance
network. The hybrid is not completely efficient in carrying the electrical energy from the four-wire network to the two-wire network and a certain amount of electrical
energy or voice signal is reflected back from the hybrid towards the speaker. Echo becomes noticeable whenever the one-time delay of a rebounded voice signal exceeds 25 milliseconds. If
the delay exceeds 32 milliseconds, the quality of the voice call begins to degrade creating an echo, which is reflected back to the person speaking and can become an annoyance during the call. When
these echo problems are present, people describe the effect as their voices sounding hollow or like someone talking in a tunnel. Delays, either due to a long transmission path, as in a long distance
telephone call, or due to the complex signal hand-off from one network to another, for instance in digital wireless or satellite voice calls, exacerbate the effect of echo. Therefore, most
long distance, digital wireless and satellite calls require echo cancellation. Delays are also introduced as intelligent processing equipment, such as network switch interconnects, are increasingly
incorporated into voice networks. Digital processing of voice signals requires time to compress and decompress and route signals through networks. As there is a greater shift towards
voice-over-packet, which is a means of packaging voice signals into units of digital data for efficient transmission, these processing delays will continue to increase.

In
addition to dealing with the problem of echo, service providers desire to also address the problems of background noise and high and low voice levels. Background noise is a
particularly acute problem in wireless voice networks, where users are attempting to use their wireless handset in a noisy environment, such as an airport terminal, on a noisy street or in a crowded
restaurant. When voice calls are routed between the networks of different service providers, particularly on international calls, the voice of the speaker is often too high or too low for comfortable
listening.

To
address these voice quality problems, service providers deploy voice quality enhancement and echo cancellation technologies that are designed to quickly analyze all voice channels and
implement counter-measures to solve a variety of voice problems present. When an echo signal is detected, the echo canceller cancels the echo. Voice quality enhancement technology detects and cancels
background noise as well as raises or lowers the voice signal for more comfortable listening.

Service
providers are demanding both smaller and higher capacity equipment as space in service provider facilities and central offices is becoming more crowded. In addition, due to
intense competition, service providers are expanding network services offered to consumers. In order to
compete successfully, they must deliver these services reliably and under the strict time-to-market and cost constraints demanded by consumers. We believe that our echo
cancellation and VQA features, which address these market pressures, are poised to gain share in the market.

Call Traffic Management in Global System for Mobile Communications (GSM) Networks

Mobile networks worldwide currently have in excess of one billion subscribers and recent market research reports indicate that this subscriber base is growing at
a rate where it is likely to exceed two billion in the next four years. GSM is the predominant technology for mobile communications outside the United States and is growing in popularity domestically.
Mobile networks are composed of three distinct areas of equipment: (i) Radio Access Network (Cellular towers, base station with radio equipment, backhaul equipment and lines to carry traffic
back to the switching site and the base station controllers), (ii) Mobile Switching Centers (MSC) with switching equipment, and (iii) Inter MSC network to connect switching sites across
the carrier's geographical coverage area.

As
the number of subscribers increase, operators must either add more radio equipment to base stations in existing cells, providing spectrum is available, or sub-divide
cells, if spectrum is fully utilized, or in the worst case, acquire additional licensed spectrum. The high rate of subscriber growth, coupled with limitations in capital budgets, radio spectrum
licenses and limited ability to spend against low average revenue per user in certain geographical regions of the world, have led wireless service providers to seek alternate means to reduce the cost
of network capacity expansion.

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GSM
networks utilize compression technologies to reduce bandwidth consumption (and therefore radio access equipment cost) on the radio access portion of the network. In GSM, the widely
available voice compression technologies include Full Rate (FR), Half-Rate (HR), Enhanced Full Rate (EFR) and Adaptive Multi-Rate (AMR) voice encoder and decoders (vocoders).
FR and HR vocoders are the most widely available, followed by EFR and AMR, which have recently started deployment. While HR vocoders use half of the bandwidth of FR, EFR and AMR vocoders, mobile
operators prefer to use FR vocoders due to their higher subjective voice quality. Many mobile operators activate the usage of HR vocoders only during peak periods to satisfy high traffic demand,
albeit at lower voice quality.

We
believe that our VQA technology can improve the subjective quality of calls utilizing HR vocoders, such that the calls sound as good as, or better than FR calls that do not use our
VQA technology. Therefore, mobile operators in need of capacity growth can utilize HR vocoders in a greater portion of calls, up to 100% if needed, to increase their overall network capacity without
resorting to the purchase
of additional radio equipment. Depending on the growth rate of the network and range of deployment required, we believe our VQA solution can reduce the total cost of capacity expansion by up to 90%.

Our Voice Processing Solutions

We design, develop and market stand-alone and system-based voice quality enhancement and echo cancellation products for wireline, wireless, satellite, and
voice-over-packet networks throughout the world. Our products use a software architecture coupled with one of the latest commercially available digital signal processors to
cancel echo and enhance the quality of voice communications. In April 2002, we sold our echo cancellation software technology and transferred the majority of the echo cancellation software
development group to Texas Instruments ("TI"). As a result, we are dependent on TI for our echo cancellation software development. We have entered into a license relationship with TI, which provides
that TI will continue to support our echo cancellation software development needs for at least the next two years. We have developed an internal group of software engineers who have been developing
the majority of our non-echo voice quality features. We believe our approach enables us to offer echo cancellation products with some of the highest capacity currently commercially
available.

The
key benefits of our voice processing solutions include:

Time-to-market advantage.Our core technology uses an intelligent software algorithm, which is a
sophisticated process or set of rules for our software to address an array of voice quality problems, running on off-the-shelf electronic integrated circuits and digital signal
processors. Competitive echo cancellation solutions using application specific integrated circuits are more expensive to design, require more development time and are difficult to upgrade. Our
approach leverages rapid technological advances in the commercial integrated circuit and digital signal processor industries. As a result, we believe that we are able to deliver high performance
products to market with shorter product development cycles and lower investments in capital equipment than alternative solutions.

Lower total cost of ownership.Our compact design allows us to offer voice processing products with some of the highest echo
canceling capacities currently available based on a seven-foot industry standard equipment rack located in service providers' central offices or remote facilities. This higher capacity
represents cost and space savings for service providers. Our newer generation products also offer more efficient cabling and network equipment installation, saving service providers even more space
and installation costs. Our products are designed to allow service providers to remotely download and upgrade software via the Internet without interrupting network service or dispatching a technician
to the remote site, which also lowers the cost of ownership.

Remote monitoring and service assurance.Our real-time monitoring technology, known as reflectometry, allows
remote monitoring of real-time performance data. Service providers can use this

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technology
to identify problems remotely and address them proactively. We are also able to assist our customers on-line during this process. As a result, service providers can improve
performance levels and monitor voice quality on a consistent basis.

Voice Quality Assurance technology.Our VQA software integrates voice quality enhancement features with the latest voice
processor technology to improve the sound quality of voice calls in noisy environments. VQA forms the foundation of a wide range of advanced voice enhancement products that we believe will help
service providers optimize the voice quality of their communications networks. VQA's general features include noise reduction, acoustic echo cancellation, level control and noise compensation through
enhanced voice intelligibility.

Our Voice Processing Products

Our newest voice processing products are designed to solve echo and other voice quality issues, such as background noise and voice levels, in wireline, wireless,
satellite and voice-over-packet networks. Our echo cancellation product family includes a mixture of both single and multi-port, stand-alone echo cancellers as well
as several broadband, system-based products. In fiscal 2004, we consolidated many of our previous generation product lines to streamline on-going development, migrate customers to newer,
lower cost and higher performance platforms, and to increase manufacturing volumes on fewer base hardware components. As part of this consolidation process, we announced last-buy periods
for the 18T1, 18E1, Quad I T1, Quad I E1, BBEC, OC-3 and STM-1 echo cancellation systems. We will cease selling these products after both general and certain contractually
mandated last-buy periods end in the first half of fiscal 2005. In fiscal 2004, we announced the availability of two voice processing platform families. Unlike our previous products that
were designed for echo cancellation only, the new voice processing platforms are designed to support a larger variety of voice processing algorithms, such as the features in VQA. These products are
the Quad Voice Processor (QVP), with four T1 or E1 interfaces, and the Broadband Voice Processor-Flex (BVP-Flex) with high capacity interfaces such as DS-3,
STS-1, OC-3 and STM-1. Both platforms can be factory configured to support a wide range of computational power and can be field upgraded to support the purchase of
new software features.

Our
voice processing product family shares several common advantages:

High capacity.Our voice processing platforms are competitive with the capacity of other currently commercially available
competitive products.

Remote software updates.With our products, the latest software updates for bug fixes can be downloaded remotely and
incorporated into our products without taking the products off-line and interrupting service.

International Telecommunications Union ("ITU") standards.Our products are targeted to be compliant with ITU standards. As a
member of the ITU, we actively participate in establishing the evolving global standards.

Warranty.We currently offer a two- to five-year warranty on our voice processing products, depending
on the platform purchased and contractual requirements.

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Our Voice Processing Products

The following table summarizes our current product offerings, exclusive of those products previously identified as being in their last-buy periods.

|Product                                   |  | Description                                                                                                                                                                                                                                                                                                |  |         |  | Functionality                                                                                                                                                                                                    
|----------------------------------------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|SX-24                                     |  | Single port echo canceller for use at T-1 (1.544 Mb/s) transmission rate supporting North American markets                                                                                                                                                                                                 |  |        |  | Basic echo cancellation functionality, plus it supports our voice enhancement software suite of enhancement products previously only available on Quad and higher generation echo cancellers                     
|SX-30                                     |  | Single port echo canceller for use at E1 (2.048 Mb/s) transmission rate supporting international markets and North American gateway applications                                                                                                                                                           |  |        |  | Basic echo cancellation functionality, plus it supports our voice enhancement software suite of enhancement products previously only available on Quad and higher generation echo cancellers                     
|Quad II T1                                |  | Single module including four independent T1 cancellers supporting North American markets                                                                                                                                                                                                                   |  | 
     |  | Hybrid Echo Cancellation and built-in voice enhancement technology
Cancels 480 T1 lines per rack                                                                                                                 
|Quad II E1                                |  | Single module including four independent E1 cancellers supporting international markets and North American gateway applications                                                                                                                                                                            |  | 
     |  | Hybrid Echo Cancellation and built-in voice enhancement technology
Cancels 480 E1 lines per rack                                                                                                                 
|Quad Voice Processor (QVP)T1             |  | Narrowband Voice Processor with four independent T1 voice processing modules that support both hybrid echo cancellation and the extensive suite of VQA software                                                                                                                                            |  |        |  | High capability voice enhancement technology with industry leading algorithms for noise reduction, level control, acoustic echo control and noise compensation through enhanced voice intelligibility            
|                                          |  |                                                                                                                                                                                                                                                                                                            |  |        |  | Processes 480 T1 lines per rack                                                                                                                                                                                  
|Quad Voice Processor (QVP)E1             |  | Narrowband Voice Processor with four independent E1 voice processing modules that support both hybrid echo cancellation and the extensive suite of VQA software                                                                                                                                            |  |        |  | High capability voice enhancement technology with industry leading algorithms for noise reduction, level control, acoustic echo control and noise compensation through enhanced voice intelligibility            
|                                          |  |                                                                                                                                                                                                                                                                                                            |  |        |  | Processes 480 E1 lines per rack                                                                                                                                                                                  
|BVP                                       |  | Broadband Voice Processor System offering the industry's widest range of interface support, targeted at both North American and international network operators                                                                                                                                            |  | 


 |  | Supports up to 2016 channels per system,
Three systems per shelf
Transmux capability for OC-3/STM1/DS-3/STS1
Integrated Voice Quality software                                                                   
|Broadband Voice Processor-Flex (BVP-Flex) |  | Broadband Voice Processor System with flexible resource cards that permit up to six times the computational power of the previous generation BVP platform with continued support for the industry's widest range of interface support, targeted at both
North American and international network operators |  | 


 |  | Supports up to 2016 channels per system,
Three systems per shelf
Transmux capability for OC-3/STM1/DS-3/STS1
Supports both hybrid echo and full VQA features in a variety of hardware and software configurations

Customers

Voice processing customers.Our active voice processing customer base has remained relatively constant at just over 80
customers in fiscal 2004 and 2003. Although we have added several new customers in fiscal 2004, they have basically replaced customers that are no longer in business or that have not bought anything
from us in the past year. Although we continue to do business with the major North American long distance companies, including AT&T, the majority of our domestic echo revenue is currently being
generated by some of the largest domestic wireless carriers including Verizon Wireless and Nextel. Revenues from echo cancellation sales remain highly concentrated. In fiscal 2004,

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our
largest echo cancellation customer, Verizon Wireless, accounted for 37% of our total company revenue and Nextel and AT&T accounted for 23% and 22%, respectively. Our next two largest echo
customers accounted collectively for 4%of our total company revenue.

We
market our products, both domestically and internationally; information by geographic region with respect to revenues from external customers and long-lived assets, is set
forth in Note 12 of the Notes to our Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K. Historically, the majority of our sales have
been to customers in the U.S. These customers accounted for approximately 89%, 84% and 83%, of our revenue in fiscal 2004, 2003 and 2002, respectively. Virtually all of our long-lived
assets are located in the U.S. See "Item 7Management's Discussion and Analysis of Financial Condition and Results of OperationsFuture Growth and Operating Results Subject to
RiskWe May Experience Unforeseen Problems As We Diversify Our International Customer Base, Which Would Impair Our Ability To Grow Our Business" for a discussion of risks associated with
international operations.

Backlog.Our backlog for voice processing products was approximately $16.9 million and $5.0 million as of the
first business day of June 2004 and 2003, respectively. Our backlog includes orders confirmed with a purchase order, for products to be shipped within 120 days to customers with approved
credit status. Backlog also includes shipments classified as deferred revenue, which we expect to recognize as revenue within 120 days. Because of the generally short cycle between order and
shipment, and occasional customer changes in delivery schedules, we do not believe that our backlog as of any particular date is necessarily indicative of actual net sales for any future period.

Research and Development

We have engineering departments dedicated to and focused on designing and developing next generation voice processing products. Our research and development
expenses for fiscal 2004, 2003 and 2002, were approximately $10.7 million, $10.0 million and $14.9 million, respectively. We believe that recruiting and retaining qualified
engineering personnel will be essential to our continued success.

Manufacturing

We operate as a "virtual" manufacturing organization by relying on contract manufacturers to assemble our voice processing products. We perform final test,
configuration and shipping functions for our voice processing products. We are ISO 9001:2000 and ISO 14001:1996 certified and require that our contract manufacturers have ISO 9000:2000 registration as
a condition of qualification. Our raw materials are procured from outside suppliers, primarily through our contract manufacturers. There are several components used in our products which are sole
source. We attempt to closely monitor supplies of parts and vendor lead times in an attempt to mitigate the risk of component availability impacting our ability to deliver product to our customers. In
cases where we believe that a particular sole source component is too critical or expensive to replace and we believe that there may be availability issues, we have and will continue to buy components
in excess of our immediate needs to help mitigate the risk of component shortages in the future. In procuring digital signal processors for our echo cancellation products, we and our contract
manufacturers rely on TI as our sole supplier, as our software license agreement with TI stipulates that we will only use their processors to run the licensed TI software. Our future success will
depend in significant part on our ability to obtain components on time, at competitive prices, and in sufficient quantities to meet demand. Although we believe that there are currently ample supplies
of components, we have experienced part shortages in prior years, which had a direct impact on revenues and results of operations and may experience such shortages again in the future. See "Item
7Management's Discussion and Analysis of Financial Condition and Results of OperationsFuture Growth and Operating Results Subject to Risk" below for a discussion of risks
related to manufacturing our products.

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Sales and Marketing

In fiscal 2004, our overall sales and marketing work force declined from fiscal 2003 levels due to our decision to exit the optical subsystem business in the
first quarter of fiscal 2004. We primarily rely on our direct sales force to sell our voice processing products domestically and to a lesser extent, internationally. We have continued to expand our
network of value-added resellers, distributors, and
sales agents that sell our products internationally, and continued to enhance our web site marketing program, making this an effective marketing and sales tool. In addition, in fiscal 2004 we expanded
our domestic and international trade show participation in a further attempt to strengthen our international presence.

Acquisitions and Dispositions

Our strategy is to increase new product development both through internal staffing and when potential acquisitions provide us with a critical new product and/or a
decided time-to-market advantage, through acquisitions.

On
February 1, 2000, we completed our first acquisition by purchasing substantially all of the assets and hiring all the key employees of Telinnovation Corporation, a leading
developer of voice enhancement and echo cancellation technology. On April 16, 2002, we sold the echo cancellation software intellectual property, which we had purchased from Telinnovation and
all rights to future revenue streams from our existing software licenses to third party network equipment manufacturers to TI in exchange for cash and a license for the echo cancellation software used
in our products. This transaction and license agreement with TI reflects a strategic decision to bolster and focus all of our echo-cancellation resources to compete in the echo
cancellation systems business, where historically we have generated the vast majority of our revenues and profits. Under the terms of the agreement, we received a total of $26.8 million, of
which $18.3 million of cash was received on the closing date of the sale, $5.0 million was paid to us in April 2003 and the final $3.5 million was paid to us in
April 2004. In addition, we secured a long-term license of the echo cancellation software from TI, which is used in our echo cancellation systems. The license has an initial
four-year free royalty period, after which the royalty rate will be set based on a preferred customer pricing formula stipulated in the sale agreement. With this transaction and licensing
agreement with TI, we believe we have maintained the advantage of the echo-cancellation software component of our product, while increasing the funds available to develop new products.

On
May 22, 2003, after careful review, we announced a change to our strategic direction. As of that date we decided to focus all of our assets in continuing to grow our voice
processing business, and resultantly we decided to sell our optical subsystem business. In July 2003, we completed the primary step in our planned exit of our optical communications business
through the sale of a large portion of the assets of the optical communications business to JDS Uniphase Corporation ("JDSU"). The assets sold consisted primarily of inventory, certain specified
optical-related equipment and intellectual property rights, which were sold for an aggregate purchase price of up to approximately $6.5 million in cash, of which (a) approximately
$1.4 million was paid to us at closing, (b) $225,000 will be paid to us one year from the closing (subject to reduction in the event any successful indemnification claims are made
against us), and (c) up to an additional $4.9 million to be paid to us, which is comprised of up to $900,000 based on the level of inventory consumed by JDSU, and up to
$4.0 million based on revenues generated by the optical business acquired by JDSU through June 30, 2005, if any. Additionally, JDSU has indemnification rights for any purchased but
unused inventory at June 30, 2004, up to $2.0 million, and certain costs incurred by JDSU in connection with the performance of certain warranty obligations relating to optical products
that were sold by us prior to the transaction. During fiscal 2004, we recognized $855,000 associated with the level of revenue generated by JDSU since the close of the sale and a tax benefit of
$144,000, which benefit partially offsets the tax provision from continuing operations. However, these incremental proceeds were substantially offset by increased loss accruals

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associated
with exiting our international optical operations and an estimated loss provision associated with our indemnification of the realizable value of the inventory purchased by JDSU. The net
effect of these items was reported as an incremental net loss on disposition of discontinued operations of $1.1 million in the Consolidated Statement of Operations. See Note 4 of Notes
to the Consolidated Financial Statements.

We
will continue to look to acquire companies that meet market attractiveness and strategic fit criteria. Acquisitions involve numerous risks, which are more fully discussed in "Item
7Management's Discussion and Analysis of Financial Condition and Results of OperationsFuture Growth and Operating Results Subject to Risk-Acquisitions and
Investments May Adversely Affect Our Business."

Competition

The markets for our products are intensely competitive, continually evolving and subject to rapid technological change. We believe that rapid product
introductions with price performance advantages are critical competitive factors. We believe our products also face competition in the following areas:



Although
we believe that we currently compete favorably with respect to all of these factors, we may not have the financial resources, technical expertise or marketing, manufacturing,
distribution and support capabilities to compete successfully in the future. We expect that competition will increase in the future.

Our
principal competitors are Natural Microsystems, which purchased Lucent's echo cancellation business in October 2001, and Tellabs. The other competition in the voice processing
market comes from voice switch manufacturers, of which there are at least six companies competing in this space the more formidable of which are Nortel, Lucent, Nokia and Ericsson. These switch
manufacturers do not sell echo cancellation products or compete in the open echo cancellation market, but they integrate echo cancellation functionality within their switches, either as hardware
modules or as software running on chips. A widespread adoption of internal echo cancellation solutions could present a competitive threat to us if the net result was the elimination of demand for our
echo cancellation system products.

Many
of our competitors and potential competitors have substantially greater name recognition and technical, financial, marketing, purchasing and other resources than we do. As a result,
these competitors may be able to respond more quickly to new or emerging technologies or standards and to changes in customer requirements, to devote greater resources to the development, promotion
and sale of products, or to deliver competitive products at a lower price. We may not be able to compete successfully against our current or future competitors.

Existing
and potential customers are also our current and potential competitors. These companies may develop or acquire competitive products or technologies in the future and thereby
reduce or cease their purchases from us. In addition, we believe that the size of suppliers will be an increasingly important part of purchasers' decision-making criteria in the future. We may not be
able to grow rapidly and therefore not compete successfully with our existing or new competitors. In addition, competitive pressures faced by us may result in lower prices for our products, loss of
market share, or reduced gross margins, any of which could materially and adversely affect our business, financial condition and results of operations.

8

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Patents and Intellectual Property Rights

Our future success will depend, in part, on our ability to protect our intellectual property. We rely primarily on nondisclosure agreements as well as copyright,
trademark, trade secret laws, and other methods to protect our proprietary voice processing technologies and processes, and in the future we may utilize patents, where available. Nevertheless, such
measures may not be adequate to safeguard the proprietary technology underlying our voice quality products.

In
connection with the sale of our echo cancellation intellectual property to TI in April 2002, we secured a long-term license of the echo cancellation software from
TI. The license has an initial four-year free royalty period, after which the license can be renewed at a royalty rate to be set based on a preferred customer pricing formula stipulated in
the sales agreement. We are dependent on the license of this technology and continued support from TI, as it is the fundamental technology incorporated in our echo cancellation products.

We
generally enter into confidentiality agreements with our employees and strategic partners, and generally control access to and distribution of our documentation and other proprietary
information. Despite these precautions, it may be possible for a third party to copy or otherwise obtain and use our products or technology without authorization or develop similar technology
independently. In addition, effective patent, copyright, trademark and trade secret protection may be unavailable or limited outside of the U.S., Europe and Japan. We may not be able to obtain any
meaningful intellectual property protection in such countries and territories. Additionally, we may, for a variety of reasons, decide not to file for patent, copyright, or trademark protection outside
of the U.S. Further, we occasionally incorporate the intellectual property of our customers into our designs, and we have certain obligations with respect to the non-use and
non-disclosure of such intellectual property. However, the steps taken by us to prevent misappropriation or infringement of the intellectual property of our company or our customers may
not be successful. Moreover, litigation may be necessary in the future to enforce our intellectual property rights, to protect our trade secrets or to determine the validity and scope of proprietary
rights of others, including our customers. Such litigation could result in substantial costs and diversion of our resources and could have a material adverse effect on our business, financial
condition and results of operations.

The
telecommunications equipment industry is characterized by vigorous protection and pursuit of intellectual property rights. In the future, we may receive notices of claims of
infringement of other parties' proprietary rights. We may not prevail in actions alleging infringement of third-party patents. In addition, in a patent or trade secret action, an injunction could
issue against us, requiring that we withdraw certain products from the market or necessitating that certain products offered for sale or under development be redesigned. We have also entered into
certain indemnification obligations in favor of our customers and strategic partners that could be triggered upon an allegation or finding of our infringement of other parties' proprietary rights.
Irrespective of the validity or successful assertion of such claims, we would likely incur significant costs and diversion of our resources with respect to the defense of such claims, which could also
have a material adverse effect on our business, financial condition and results of operations. To address any potential claims or actions asserted against us, we may seek to obtain a license under a
third party's intellectual property rights. Under such circumstances, a license may not be available on commercially reasonable terms, if at all.

A
few industry participants, such as Lucent, Nortel Networks and certain major universities and research laboratories hold substantial inventories of intellectual property. This
concentration of intellectual property in the hands of a few major entities also poses certain risks to us in seeking to hire qualified personnel. We have on a few occasions recruited such personnel
from such entities. These entities or others may claim the misappropriation or infringement of their intellectual property, particularly when and if employees of these entities leave to work for us.
We may not be able to avoid litigation in the future, particularly if new employees join us after having worked for a competing

9

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company.
Such litigation could be very expensive to defend, regardless of the merits of the claims, and could have a material adverse effect on our business, financial condition and results of
operations.

Employees

As of April 30, 2004, we had 148 employees, 28 of whom were primarily engaged in operations, 51 in research and development, 53 in sales, marketing and
technical support and 16 in finance and administration. Our employees are not represented by any collective bargaining agreement, and we have not experienced a work stoppage. We believe our employee
relations are good.

Available Information

You may obtain a free copy of our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q and current reports on
Form 8-K and any amendments to
those reports, which we make available as soon as reasonably practicable after our filing or furnishing of these reports with or to the SEC, through our website at www.ditechcom.com. Our website address
is provided solely for informational purposes. We do not intend, by this reference, that our website should be
deemed to be part of this Annual Report.

Item 2Properties

Our principal offices and facilities are currently located in two leased buildings totaling approximately 61,000 square feet in Mountain View, California. Of the
space occupied, approximately 64% is used for manufacturing and research and development and the balance is used for office space for sales and marketing and general and administrative functions. The
term of the lease expires on June 30, 2006. We believe that the space under the combined leases is adequate to meet our needs for at least the next twelve months.

Item 3Legal Proceedings

We are subject to legal claims and proceedings that arise in the normal course of our business. While the outcome of these matters is currently not determinable,
we do not expect that the ultimate costs to resolve these matters will have a material adverse effect on our financial position, results of operations or cash flows.

Item 4Submission of Matters to a Vote of Security Holders

Not Applicable.

10

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Part II

Item 5Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Ditech's common stock is quoted on the Nasdaq National Market under the symbol "DITC." The following table shows the high and low sale prices per share of our
common stock as reported on the Nasdaq National Market for the periods indicated:

|               |  | Fiscal 2004 |       | Fiscal 2003
|-------------- |  | ----------- | ----- | -----------
|
|First Quarter  |  | $           | 6.70  |            
|Second Quarter |  | $           | 11.90 |            
|Third Quarter  |  | $           | 24.80 |            
|Fourth Quarter |  | $           | 22.75 |            

We
have never paid any cash dividends on our common stock. Currently, we expect to retain future earnings, if any, for use in the operation and expansion of our business and do not
anticipate paying any cash dividends for the foreseeable future. In addition, our credit facility with a bank restricts the payment of dividends.

According
to the records of our transfer agent, there were 140 stockholders of record of Ditech's common stock at July 1, 2004.

In
the three months ended April 30, 2004, we repurchased 833 shares of common stock from a former employee that were subject to repurchase rights due to their issuance under an
early exercise of stock options, as reflected in the table below. The shares were repurchased at the original issuance price of $7.19 per share per terms of our repurchase rights outlined in our stock
option plans.

|Period   |                                            | TOTAL
NUMBER OF
SHARES
PURCHASED |     | AVERAGE
PRICE PAID
PER SHARE |      | TOTAL NUMBER OF
SHARES PURCHASED
AS PART OF
PUBLICLY ANNOUNCED
PROGRAMS |   | MAXIMUM
DOLLAR VALUE OF
SHARES THAT
MAY YET BE
PURCHASED
UNDER THE
PROGRAMS
|-------- | ------------------------------------------ | -------------------------------- | --- | ---------------------------- | ---- | ----------------------------------------------------------------------- | - | ---------------------------------------------------------------------------
|Month #1 |                                            |                                  |     |                              |      |                                                                         |   |                                                                            
|         | February 1, 2004 through
February 28, 2004 |                                  |    |                              |      |                                                                        |   |                                                                           
|Month #2 |                                            |                                  |     |                              |      |                                                                         |   |                                                                            
|         | March 1, 2004 through
March 31, 2004       |                                  | 833 |                              | $    | 7.19                                                                    |   |                                                                           
|Month #3 |                                            |                                  |     |                              |      |                                                                         |   |                                                                            
|         | April 1, 2004 through
April 30, 2004       |                                  |    |                              |      |                                                                        |   |                                                                           
|         |                                            |                                  |     |                              |      |                                                                         |   |                                                                            
|Total    |                                            | 833                              |     | $                            | 7.19 |                                                                         |  |                                                                            
|         |                                            |                                  |     |                              |      |                                                                         |   |                                                                            

Item 6Selected Financial Data

The consolidated statement of operations data for the years ended April 30, 2004, 2003 and 2002, and the consolidated balance sheet data as of
April 30, 2004 and 2003, have been derived from our audited consolidated financial statements included in Item 8 of this Annual Report on Form 10-K. The consolidated
statement of operations data for the years ended April 30, 2001 and 2000, as adjusted to give effect to the discontinued operations presentation of our optical business, See Note 4 of
the Notes to the Consolidated Financial Statements, and the consolidated balance sheet data as of April 30, 2002,

11

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2001
and 2000, have been derived from our audited consolidated financial statements not included in this Annual Report on Form 10-K. The data set forth below should be read in
conjunction with our consolidated financial statements, including the notes thereto, set forth in "Item 8Financial Statements and Supplementary Data" of this Annual Report on
Form 10-K, and with "Item 7Management's Discussion and Analysis of Financial Condition and Results of Operations" included elsewhere in this
Form 10-K.

12

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|                                                                                                        |                                                                                                                                                                                        | Years Ended April 30,                                                                 
|------------------------------------------------------------------------------------------------------- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | --------------------------------------------------------------------------------------
|
|
|Consolidated Statement of Operations Data:                                                              |                                                                                                                                                                                        |                                                                                       
|Revenue                                                                                                 |                                                                                                                                                                                        | $                                                                                     
|Cost of goods sold                                                                                      |                                                                                                                                                                                        |                                                                                       
|                                                                                                        |                                                                                                                                                                                        |                                                                                       
|                                                                                                        | Gross profit                                                                                                                                                                           |                                                                                       
|                                                                                                        |                                                                                                                                                                                        |                                                                                       
|Operating expenses:                                                                                     |                                                                                                                                                                                        |                                                                                       
|                                                                                                        | Sales and marketing                                                                                                                                                                    |                                                                                       
|                                                                                                        | Research and development                                                                                                                                                               |                                                                                       
|                                                                                                        | General and administrative                                                                                                                                                             |                                                                                       
|                                                                                                        | Restructuring charge                                                                                                                                                                   |                                                                                       
|                                                                                                        | Purchased research and development                                                                                                                                                     |                                                                                       
|                                                                                                        | Amortization of goodwill and other acquisition related intangible assets                                                                                                               |                                                                                       
|                                                                                                        |                                                                                                                                                                                        |                                                                                       
|                                                                                                        |                                                                                                                                                                                        | Total operating expenses                                                              
|                                                                                                        |                                                                                                                                                                                        |                                                                                       
|Income (loss) from continuing operations                                                                |                                                                                                                                                                                        |                                                                                       
|Other income, net                                                                                       |                                                                                                                                                                                        |                                                                                       
|                                                                                                        |                                                                                                                                                                                        |                                                                                       
|Income (loss) from continuing operations before income taxes and cumulative effect of accounting change |                                                                                                                                                                                        |                                                                                       
|Provision for income taxes                                                                              |                                                                                                                                                                                        |                                                                                       
|                                                                                                        |                                                                                                                                                                                        |                                                                                       
|Income (loss) from continuing operations before cumulative effect of accounting change                  |                                                                                                                                                                                        |                                                                                       
|Discontinued operations:                                                                                |                                                                                                                                                                                        |                                                                                       
|                                                                                                        | Income (loss) from discontinued operations net of tax provision (benefit) of $129, $128, $(3,695) and $843 for the fiscal year ended April 30, 2003, 2002, 2001 and 2000, respectively |                                                                                       
|                                                                                                        | Loss on disposition, net of $144 tax benefit for the year ended April 30, 2004                                                                                                         |                                                                                       
|                                                                                                        |                                                                                                                                                                                        |                                                                                       
|Income (loss) from discontinued operations                                                              |                                                                                                                                                                                        |                                                                                       
|                                                                                                        |                                                                                                                                                                                        |                                                                                       
|Cumulative effect of accounting change                                                                  |                                                                                                                                                                                        |                                                                                       
|                                                                                                        |                                                                                                                                                                                        |                                                                                       
|Net income (loss)                                                                                       |                                                                                                                                                                                        |                                                                                       
|                                                                                                        |                                                                                                                                                                                        |                                                                                       
|Accretion of mandatorily redeemable preferred stock to redemption value (a)                             |                                                                                                                                                                                        |                                                                                       
|                                                                                                        |                                                                                                                                                                                        |                                                                                       
|Net income (loss) attributable to common
stockholders (a)                                               |                                                                                                                                                                                        | $                                                                                     
|                                                                                                        |                                                                                                                                                                                        |                                                                                       
|Per share data:                                                                                         |                                                                                                                                                                                        |                                                                                       
|                                                                                                        | Basic                                                                                                                                                                                  |                                                                                       
|                                                                                                        |                                                                                                                                                                                        | Income (loss) from continuing operations before cumulative effect of accounting change
|                                                                                                        |                                                                                                                                                                                        | Discontinued operations                                                               
|                                                                                                        |                                                                                                                                                                                        | Cumulative effect of accounting change                                                
|                                                                                                        |                                                                                                                                                                                        |                                                                                       
|                                                                                                        |                                                                                                                                                                                        | Net income (loss) per share attributable to common stockholders                       
|                                                                                                        |                                                                                                                                                                                        |                                                                                       
|                                                                                                        | Diluted                                                                                                                                                                                |                                                                                       
|                                                                                                        |                                                                                                                                                                                        | Income (loss) from continuing operations before cumulative effect of accounting change
|                                                                                                        |                                                                                                                                                                                        | Discontinued operations                                                               
|                                                                                                        |                                                                                                                                                                                        | Cumulative effect of accounting change                                                
|                                                                                                        |                                                                                                                                                                                        |                                                                                       
|                                                                                                        |                                                                                                                                                                                        | Net income (loss) per share attributable to common stockholders                       
|                                                                                                        |                                                                                                                                                                                        |                                                                                       
|Number of shares used in per share calculations:                                                        |                                                                                                                                                                                        |                                                                                       
|                                                                                                        | Basic                                                                                                                                                                                  |                                                                                       
|                                                                                                        |                                                                                                                                                                                        |                                                                                       
|                                                                                                        | Diluted                                                                                                                                                                                |                                                                                       
|                                                                                                        |                                                                                                                                                                                        |                                                                                       

13

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|                                 |  | April 30,
|-------------------------------- |  | ---------
|
|Consolidated Balance Sheet Data: |  |          
|Cash and cash equivalents        |  | $        
|Short-term investments           |  |          
|Total assets                     |  |          
|Long-term debt                   |  |          
|Total stockholders' equity       |  |          

The selected financial data for the five years ended April 30, 2004 reflects the impacts of our
acquisition and disposition activities over this period of time. The key impacts include the write off of in process research costs in fiscal 2000 upon the acquisition of Telinnovation and the related
amortization of goodwill and other intangibles and deferred stock compensation until the sale of the underlying software technology at the end of fiscal 2002. In September 2002, we discontinued
the development and marketing of our Titanium optical switch product, which resulted in a significant decline in the level of optical losses subsequent to that point in time. In addition, the selected
financial data also reflects the disposition of our optical business in July 2003, which resulted in the financial results from our optical business being reported as a discontinued operation
for all periods presented and contributed to our ability to return to positive net income during fiscal 2004.

---

14

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Item 7Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis should be read in conjunction with "Selected Financial Data" and our Consolidated Financial
Statements and Notes thereto included elsewhere in this Annual Report on Form 10-K. The discussion in this Annual Report on Form 10-K contains forward-looking
statements that involve risks and uncertainties, such as statements of our plans, objectives, expectations and intentions. Our actual results could differ materially from those discussed here. See
"Future Growth and Operating Results Subject to Risk" at the end of this Item 7 for factors that could cause future results to differ materially.

Overview

We design, develop and market equipment used in building, expanding and modernizing telecommunications networks. As a result of announcing our intention to exit
our optical communications business and completion of the sale of a substantial portion of assets used in our optical business in the first quarter of fiscal 2004, our continuing operations are
currently focused solely on our voice processing products, including our long-standing echo cancellation products. Our initial entrance into the voice processing market was focused on echo
cancellation. 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 product introductions have leveraged off the processing capacity of our newer hardware platforms to offer not only echo cancellation but also new VQA features including noise
reduction, acoustic echo cancellation, voice level control and noise compensation through enhanced voice intelligibility. We are currently selling our seventh generation echo cancellation product,
which began production shipments in the third quarter of fiscal 2004.

Since
becoming a public company in June 1999, our financial success has been primarily predicated on the success of the domestic wire-line and more recently wireless
carriers. During fiscal 2000 and the first half of fiscal 2001, we benefited from the rapid expansion in domestic wire-line infrastructure spending to support increasing demand
expectations due to customer growth and the expectations of increased demand from internet traffic. In the latter half of fiscal 2001, as the promise of the internet's growth waned we, along with
virtually every other telecommunications equipment supplier, experienced a significant decline in revenues due to a dramatic decline in infrastructure spending by domestic carriers. Over the last
three years,
wire-line carriers has experienced a modest recovery in spending while wireless carriers have experienced more rapid growth. We expect that our near term revenues will continue to be
heavily influenced by the buying trends in the domestic wireless market but expect to see increased demand internationally as our newer voice processing platforms, running our VQA software begin to
achieve broader market acceptance.

Exit of Optical Business.In May 2003, we announced a change to our strategic direction. We decided to focus all of
our assets in continuing to grow our voice processing business, including our echo cancellation and new VQA features, and as a result we decided to sell our optical communications business. In
July 2003, we completed the primary step in our planned exit of our optical communications business through the sale of a large portion of the assets of the optical communications business to
JDS Uniphase Corporation ("JDSU"). The assets sold consisted primarily of inventory, certain specified optical-related equipment and intellectual property rights, which were sold for an aggregate
purchase price of up to approximately $6.5 million in cash, of which (a) approximately $1.4 million was paid to us at closing, (b) $225,000 will be paid to us one year
from the closing (subject to reduction in the event any successful indemnification claims are made against us), and (c) up to an additional $4.9 million to be paid to us, which is
comprised of up to $900,000 based on the level of inventory consumed by JDSU, and up to $4.0 million based on revenues generated by the optical business acquired by JDSU through June 30,
2005, if any. Additionally, JDSU has indemnification rights related to any purchased but unused inventory at June 30, 2004, up to $2.0 million, and certain costs incurred by JDSU in
connection with the performance of certain

15

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warranty
obligations relating to optical products that were sold by us prior to the transaction. During fiscal 2004, we recognized $855,000 associated with the level of revenue generated by JDSU since
the close of the sale. However, these incremental proceeds were substantially offset by increased loss accruals associated with exiting our international optical operations and an estimated loss
provision associated with our indemnification of the realizable value of the inventory purchased by JDSU. The net effect of these items was reported as an incremental net loss on disposition of
discontinued operations of $1.1 million in the Consolidated Statement of Operations. See Note 4 of Notes to the Consolidated Financial Statements.

We
have been aggressively pursuing the disposition, through sale, sublease or abandonment, of the optical assets not sold to JDSU and the facility leases for our Australian and United
Kingdom optical research facilities. As of April 30, 2004, we had exited both the United Kingdom facility and Australian facility leases. Additionally, we had sold all of the optical assets at
our two international optical research operations. We are still in the process of disposing of a minor amount of remaining optical assets located in the United States. As a result of exiting the
optical business, our consolidated statements of operations reflect the optical business as a discontinued operation for all periods presented. See Note 4 of Notes to the Consolidated Financial
Statements.

Acquisition History.Since completing our initial public offering in June 1999, we have completed three acquisitions.
At the time we made each of these acquisitions, they were made to bring needed technical skills into our research and development groups to aid in new product introductions. The most recent,
significant acquisition was in July 2000, when we acquired Atmosphere Networks, Inc. to bring needed
technical skills to our optical engineering group. The total value of the acquisition was approximately $82 million, which was accounted for using purchase accounting. In May 2002, we
recorded a transitional impairment of the unamortized goodwill balance associated with this acquisition of $36.8 million, which has been reported as a cumulative effect of accounting change.

Our Customer Base.Historically the majority of our sales have been to customers in the United States. These customers
accounted for approximately 89%, 84% and 83% of our revenue in fiscal 2004, 2003 and 2002, respectively. However, sales to some of our customers in the U.S. 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. We expect that as we expand shipments of our newer voice processing products, which are targeted at GSM networks, international revenue
will begin to become a larger percentage of our overall revenue.

Our
revenue historically has come from a small number of customers. Our five largest customers accounted for approximately 86%, 81% and 74% of our revenue in fiscal 2004, 2003 and 2002,
respectively. Consequently, the loss of any one of these customers, without an offsetting increase in revenue from existing or new customers, would have a negative and substantial effect in our
business.

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. To the extent there are material differences between our ongoing
estimates and the ultimate actual results, our future results of operations will be affected as adjustments to our estimates are required. We believe that the following critical accounting policies

16

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affect
the most significant judgments and estimates used in the preparation of our consolidated financial statements.

Revenue
RecognitionIn applying our revenue recognition and allowance for doubtful accounts policies that are outlined in Note 2 of Notes to the Consolidated Financial
Statements, 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 April 30, 2004, we had deferred $8.3 million of revenue. To the extent that we have received cash for some or
all of a given deferred
revenue transaction, it is reported on the Consolidated Balance Sheet as a deferred revenue liability. However, to the extent that cash has not been collected against the deferred revenue transaction,
the deferred revenue is reflected as a reduction in the corresponding account receivable balance. Of the $8.3 million of revenue deferred as of April 30, 2004, approximately 94% was
associated with deferrals from our largest customers due to contractual terms. 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. At April 30, 2004, the total amount of revenue deferred due to our assessment that collection was not
reasonably assured as of shipment was approximately $515,000.

Inventory
Valuation AllowancesIn conjunction with our ongoing analysis of inventory valuation allowances, we are constantly monitoring projected demand on a product by
product basis. Based on these projections we evaluate the levels of allowances required both for inventory on hand, as well as inventory on order from our contract manufacturers. Although we believe
we have been reasonably successful in identifying allowance requirements in a timely manner, sudden changes in future 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 some larger than anticipated write-downs being recognized, such as the OC-3 write-down recorded in
fiscal 2002. In the case of the OC-3 write-down, the complete pull back from the forecasted demand by the primary customer for this product resulted in a $3.5 million
write-down of the OC-3 inventory. However, in 2003 the addition of a few new major customers helped to utilize a large portion of the inventory, which had been written down
resulting in approximately $2.2 million and $455,000 of previously written down inventory being sold in fiscal 2004 and 2003, respectively.

Cost
of WarrantyAt the time that revenue is recognized, we accrue for the estimated costs of the warranty we offer on our products. We currently offer warranties on our
products ranging from two to five years. The warranty generally provides that we will repair or replace any defective product 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, which would result in a decrease in gross profits. As of April 30,2004, we had recorded $2.0 million of
accruals related to estimated future warranty costs. In general, we have been able to closely estimate the level of warranty exposure on our products, and the level of adjustment required to the
reserve has been relatively insignificant. See Note 3 of the Notes to the Consolidated Financial Statements.

17

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Results of Operations

The following table sets forth certain items from our consolidated statements of operations as a percentage of revenue for the periods indicated:

|                                                                                                                      |                                                                          | Years Ended
April 30,             |      
|--------------------------------------------------------------------------------------------------------------------- | ------------------------------------------------------------------------ | --------------------------------- | -----
|
|Revenue                                                                                                               |                                                                          | 100.0                             | %    
|Cost of goods sold                                                                                                    |                                                                          | 33.6                              |      
|                                                                                                                      |                                                                          |                                   |      
|                                                                                                                      | Gross profit                                                             |                                   | 66.4 
|                                                                                                                      |                                                                          |                                   |      
|Operating expenses:                                                                                                   |                                                                          |                                   |      
|                                                                                                                      | Sales and marketing                                                      |                                   | 18.9 
|                                                                                                                      | Research and development                                                 |                                   | 15.4 
|                                                                                                                      | General and administrative                                               |                                   | 7.6  
|                                                                                                                      | Restructuring charge                                                     |                                   | 0.4  
|                                                                                                                      | Amortization of goodwill and other acquisition related intangible assets |                                   |     
|                                                                                                                      |                                                                          |                                   |      
|                                                                                                                      |                                                                          | Total operating expenses          |      
|                                                                                                                      |                                                                          |                                   |      
|Income (loss) from continuing operations                                                                              |                                                                          | 24.0                              |      
|Other income, net                                                                                                     |                                                                          | 1.9                               |      
|                                                                                                                      |                                                                          |                                   |      
|Income (loss) from continuing operations before provision for income taxes and cumulative effect of accounting change |                                                                          | 25.9                              |      
|Provision for income taxes                                                                                            |                                                                          | 0.4                               |      
|                                                                                                                      |                                                                          |                                   |      
|Income (loss) from continuing operations before cumulative effect of accounting change                                |                                                                          | 25.5                              |      
|Discontinued operations:                                                                                              |                                                                          |                                   |      
|                                                                                                                      | Loss from discontinued operations                                        |                                   | (3.7 
|                                                                                                                      | Loss on disposition, net of tax benefit for the year ended April 30 2004 |                                   | (10.0
|                                                                                                                      |                                                                          |                                   |      
|                                                                                                                      |                                                                          | Loss from discontinued operations |      
|                                                                                                                      |                                                                          |                                   |      
|Cumulative effect of accounting change                                                                                |                                                                          |                                  |      
|                                                                                                                      |                                                                          |                                   |      
|Net income (loss)                                                                                                     |                                                                          | 11.8                              | %    
|                                                                                                                      |                                                                          |                                   |      

Discussion of Fiscal Years ended April 30, 2004, 2003 and 2002

Revenue.

Years ended April 30,2004

2003

2002Revenue

$
69,590

$
35,088

$
27,214


The
primary reason for the increasing trend in revenue has been the gradual recovery of our echo cancellation product sales since fiscal 2002, which marked our lowest level of sales
since becoming a public company. This increase in revenue was largely driven by the addition of several new customers over the past two years and increased sales volumes to existing customers in the
wireless carrier space and to a lesser extent the expansion of our international customer base, primarily in the Asia-Pacific and Europe markets. Revenue in fiscal 2003 was largely driven
by sales of our BBEC and OC-3 system-based products, as well as the initial sales of our new BVP system. We believe that the introduction of new products during this period of time was a
key contributor to acquiring and retaining our key strategic customers, as these new products have provided for ever increasing flexibility for our

18

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customers
and ease of installation. Our latest product, the BVP flex system, accounted for 22% of our revenue in fiscal 2004 despite the fact that it did not begin production shipment until late in
the third quarter of fiscal 2004. Fiscal 2004 also saw the first revenue from our new QVP voice product, which includes our new voice quality features and is primarily targeted to the international
GSM market. The predecessor to the BVP Flex, our BVP system, was the single largest source of revenue for both fiscal 2004 and 2003, representing 58% and 30% of revenue, respectively, and our older
fourth generation products, the Quad and BBEC system were the primary source of revenue in fiscal 2002. With the introduction of our BVP Flex system, sales of the BVP system declined dramatically in
the fourth quarter of fiscal 2004 and are expected to represent a small percentage of future revenue as customers have quickly migrated to our BVP Flex system. We expect that BVP Flex system will
remain the primary source of revenue for the majority of the coming fiscal year.

Geographically,
revenue over the three fiscal years has been generated largely from domestic sales, which represented 89%, 84% and 83% of our fiscal 2004, 2003 and 2002 revenue,
respectively. The slight increase in the percentage of domestic sales over the three years was largely due to the growth in sales of our echo cancellation products to the domestic wireless
telecommunications providers outpacing the growth in our international customer base. Although we have experienced several consecutive quarters of revenue growth, we believe that carrier spending
levels have not fully recovered from the decline experienced in the latter half of fiscal 2001. We believe that our growth for the coming year will continue to be driven by a combination of the
addition of new domestic and international customers, the continued gradual recovery of the telecommunications market as a whole and the successful customer migration to our new BVP Flex and QVP
products, including our new VQA features.

Cost of Goods Sold.

Years ended April 30,2004

2003

2002Cost of goods sold

$
23,413

$
13,543

$
15,009


Cost
of goods sold consists of direct material costs, personnel costs for test and quality assurance, costs of licensed technology incorporated into our products, provisions for
inventory and warranty expenses and other indirect costs. The increase in cost of goods sold in fiscal 2004 as compared to fiscal 2003 and 2002 was in large part driven by increased unit sales of our
echo cancellation products, which contributed to a $6.7 million increase over fiscal 2003 and an $6.5 million increase over fiscal 2002. The other major factors impacting the increase in
costs in 2004 has been the write-off of $1.0 million of materials that were deemed too expensive or impractical to refurbish and an increase of approximately $1.2 million in
the level of installation costs due to increased shipments and an increase in the level of installation support requested by our customers. Our inventory provisions were $3.6 million,
$3.9 million and $3.2 million for fiscal 2004, 2003 and 2002, respectively. We would expect that the trend in cost of goods sold will continue to track fairly closely with the trend in
sales and that we will continue to see increased installation activity as we expand internationally. However, we do not expect to experience the same level of product write-offs in the
coming year.

Gross Margin.

Years ended April 30,2004

2003

2002Gross profit

$
46,177

$
21,545

$
12,205Gross margin %


66.4
%

61.4
%

44.8
%


The
primary cause for the increase in our stand-alone echo cancellation gross margin was the impact of the OC-3 write-down in fiscal 2002 as compared to fiscal
2004 and 2003. In fiscal 2002, we

19

---



recorded
a $3.5 million special provision, including losses on purchase commitments, for potentially excess OC-3 inventory when our largest customer for the product at that time
canceled all planned purchases. Due to the addition of several new OC-3 customers in fiscal 2003, we have been able to sell through the unreserved levels of inventory of this product and
have begun selling previously written-down product, which has resulted in a benefit of over $455,000 in fiscal 2003 and $2.2 million in fiscal 2004. The impact of the
OC-3 reserve in fiscal 2002 and the benefit in fiscal 2004 and 2003 accounts for approximately 74.5% of the 21.6 percentage point increase in voice processing margins in fiscal 2004
and 85% of the 16.6 percentage point increase in echo cancellation margins during fiscal 2003. There were no special inventory provisions in fiscal 2004 or 2003. The other key factor in the
improvement in gross margin is the effect of our relatively fixed manufacturing overhead costs. As these costs have been relatively fixed over the three years while revenue has been steadily
improving, we have seen an improvement in our overall gross margin. Although we expect to continue to see improvement in margins due to the fixed nature of our manufacturing costs, we would expect
that the benefits from the sale of previously written down products will not be as significant in the future. As a result barring any unusual events, we would expect that margins will continue to
approximate the 2004 levels for most of fiscal 2005.

Sales and Marketing.

Years ended April 30,2004

2003

2002Sales and marketing

$
13,168

$
12,051

$
13,277


Sales
and marketing expenses primarily consist of personnel costs, including commissions and costs associated with customer service, travel, trade shows and outside consulting services.
Overall, sales and marketing has remained relatively stable over the last three years with fiscal 2003 showing a modest decline from the 2004 and 2002 levels. Approximately $1.0 million of the
decline from fiscal 2002 was driven by declines in salary and related spending, including travel and conferences, as a result of the reductions in workforce that occurred in January and
September 2002 and tighter control of discretionary spending. However, sales and marketing expenses have begun to trend back up during fiscal 2004 as we have expanded our efforts to introduce
our newer products internationally. We expect that sales and marketing expenses will increase in fiscal 2005 due to continued international expansion efforts and new product introduction costs.

Research and Development.

Years ended April 30,2004

2003

2002Research and development

$
10,719

$
9,952

$
14,888


Research
and development expenses primarily consist of personnel costs, and costs associated with contract consultants, equipment and supplies used in the development of voice processing
products, as well as amortization of deferred stock compensation associated with the Telinnovation acquisition, which ended in the fourth quarter of fiscal 2002 upon the sale of our echo software
technology to TI. The decline in fiscal 2004 and 2003 from the 2002 level of spending is almost entirely due to the cessation of amortization of deferred stock compensation subsequent to the sale of
our echo software technology to TI in April 2002. In fiscal 2002, this amortization amounted to $7.3 million, for which there was no corresponding expense in fiscal 2003 and 2004.
Research and development expenses (other than amortization of deferred stock compensation associated with the Telinnovation acquisition) increased as a result of spending to bring new voice processing
products to market during the past two years. The largest increase was tied to increased headcount and related costs, as our engineering staff grew from 21 employees in fiscal 2002 to 43 and 51
employees in fiscal 2003 and 2004, respectively. In

20

---



addition,
we had increases in depreciation over fiscal 2002 levels of approximately $327,000 and $177,000 in 2004 and 2003, respectively, due to increased levels of lab equipment to support voice
processing product development. We expect to continue to experience increases in our research and development spending due to the planned development of new packet based voice processing products in
fiscal 2005.

General and Administrative.

Years ended April 30,2004

2003

2002General and administrative

$
5,308

$
5,269

$
5,980


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. Overall, general and administrative expense has remained relatively constant over the last three years and virtually flat between fiscal 2004 and 2003. The somewhat lower level of
spending in fiscal 2004 and
2003 as compared to 2002 is due to reductions in professional services spending in fiscal 2004 and 2003 due in large part to: reduced tax compliance and planning spending; a reduction in bad debt
expense from fiscal 2002 levels as several customers filed for bankruptcy in fiscal 2002; reduced printing and graphics costs associated with simplifying our annual financial report; and reduced
levels of charitable contributions and temporary labor spending as we attempted to control costs. These factors resulted in an aggregate savings from the fiscal 2002 levels of approximately $635,000
and $598,000 in fiscal 2004 and 2003, respectively. In addition, we experienced a reduction in amortization of deferred stock compensation related to stock options issued prior to our initial public
offering. See the discussion in under Stock Compensation below for further details. The savings in fiscal 2004 as compared to 2002 were partially offset by increased allocations of facilities costs
due to costs being spread over a smaller employee base which resulted in an increase of $321,000 in general and administrative expenses over fiscal 2002 levels. We expect general and administrative
expenses to increase in fiscal 2005 as we continue to expend greater resources to comply with Sarbanes-Oxley requirements that will become applicable for us and as we experience increased insurance
costs due to higher business volumes and headcount.

Amortization of Goodwill and Other Acquisition Related Intangible Assets.Amortization expense was eliminated in its entirety
beginning in fiscal 2003, resulting in a decline of $7.1 million from fiscal 2002. The elimination was due to the sale of our echo cancellation software technology in April 2002, which
resulted in the elimination of amortization related to the goodwill and intangibles from our acquisition of Telinnovation

Restructuring Charge.The restructuring charge recognized in fiscal 2004 was attributable to the elimination of redundant
general corporate level costs, personnel and facilities, that were impacted as a result of exiting the optical business, but did not qualify for inclusion in discontinued operations. These costs
included $21,000 of severance and related benefits for impacted employees and an original loss provision of $995,000 associated with the abandonment of approximately 11,000 square feet of space in our
Mountain View headquarters. In March 2004, the then unused portion of the loss provision for the building of $741,000 was reversed back through the restructuring charge line. The reversal was
predicated on the significant changes that had occurred in our business since the first quarter of fiscal 2004 when the original decision was made to abandon the space. At the time of the original
provision, we were projecting what we viewed as good (20%) revenue growth during fiscal 2004, based on our client base and the overall state of the telecommunications industry. However with fiscal
2004 revenue growth reaching almost 100% growth over fiscal 2003, almost five times our plan at the beginning of the year, and an expectation that we will see modest growth again in fiscal 2005,
coupled with incremental hiring requirements to begin development of our next generation voice products, the

21

---



headcount
and therefore space demands far exceeded our expectations. As a result, the fiscal year reflects a net loss provision of $275,000 related to our building and employee severance costs. As of
April 2004, we had paid all severance and related costs.

Other Income, Net.

Years ended April 30,2004

2003

2002Other income, net

$
1,294

$
1,702

$
3,701


Other
income, net consists of interest income on our invested cash and cash equivalent and investment balances, offset by a nominal amount of interest and other expense. The decreasing
trend in other income, net was primarily attributable to lower interest rates reducing earnings on our invested balances, and to a lesser extent, a decline in the average invested cash balance
primarily during fiscal 2003 and the first half of fiscal 2004. The other key factor in the decline in other income, net was the lack of a gain on disposal of assets, as experienced in fiscal 2002
when we sold our echo cancellation software technology and related assets to TI for a gain of over $500,000. We would expect to see an increase in other income, net, in part as we benefit from a full
year of earnings being generated by our new investment strategy, which we expect will yield higher average interest rates. In addition, we believe that absent a further deterioration in overall
interest rates, the increase in the average invested balance will contribute to increased interest income levels in fiscal 2005.

Income Taxes.Income taxes consist of federal, state and foreign income taxes. The effective tax rate for fiscal 2004 was a
provision of 1.5%, as compared to 0.3% and 6.4% in fiscal 2003 and 2002, respectively. The income taxes incurred in fiscal 2004 are due to providing alternative minimum taxes on our domestic
operations. The tax provision in fiscal 2003 was primarily related to taxes on our international optical operations. The tax provision in fiscal 2002 was primarily related to providing a valuation
allowance against our deferred tax assets as a result of our growing losses at that time. Assuming that our level of profitability continues at the rates experienced over the last couple of quarters
of fiscal 2004, it is feasible that the valuation allowance on our deferred tax asset could be partially or completely reversed by the end of fiscal 2005. Until that time, we expect to continue to
report minimal income taxes related to our international operations and domestic alternative minimum taxes.

Loss from Discontinued Operations.

Years ended April 30,2004

2003

2002Loss from discontinued operations

$
(2,538
)
$
(34,248
)
$
(54,964
)Loss on disposition


(6,998
)







The
decreasing trend in the loss from operations of our discontinued optical business was due in large part to reductions in spending realized subsequent to September 2002, when
we discontinued our Titanium optical system product development. As a result, there was a significant decline in spending on salaries and materials. In addition, fiscal 2004 also benefited from
reduced spending on optical subsystems marketing and development after our announcement to exit the optical business in May 2003 and the elimination of substantially all optical costs effective
the end of July 2003. As all operations related to our optical business have ceased, we do not expect to have any further losses from this discontinued operation.

The
loss on disposition in fiscal 2004 reflects the aggregate loss of $6.9 million realized in the first quarter of fiscal 2004 upon the sale of the optical technology, inventory
and certain fixed assets to

22

---



JDSU,
along with other exit costs associated with abandoning that portion of the optical business not acquired by JDSU. Subsequent adjustments have been made to the recognized loss to reflect
incremental sales proceeds associated with the level of revenue generated by JDSU since the close of the sale and estimated tax benefits associated with the year-to-date loss
from disposal, which benefit offset the domestic tax provision recognized from continuing operations, less incremental loss accruals associated with closure of our international optical operations and
likely indemnification obligations pursuant to the sales agreement with JDSU. The net effect of these items resulted in an incremental loss of approximately $100,000 and was included in the total loss
from disposal of our discontinued optical operations of $7.0 million for fiscal 2004 in the Consolidated Statement of Operations. We expect that there will be some additional proceeds from the
sale of our optical business to JDSU associated with the level of revenue that they generate in the coming fiscal year and there could be some additional costs associated with closing down the
international legal entities that were shut down as a result of exiting the optical business. However, we do not expect that the net effect of these items will be material to our financial condition
or results of operations in the coming year.

Cumulative Effect of Accounting Change.The $36.8 million cumulative effect of an accounting change reported in fiscal
2003 represents the transitional impairment loss for previously recorded goodwill associated with our acquisition of Atmosphere, which we recorded in connection with our adoption of SFAS 142
effective May 1, 2002. There were no accounting changes in fiscal 2004 or 2002.

Stock-Based Compensation

We recorded deferred compensation of $1.3 million as of April 30, 1999, as a result of stock options granted in fiscal 1999. We amortized the
deferred compensation over the corresponding vesting period of the stock options. As of the third quarter of fiscal 2003, this component of deferred stock compensation had been fully amortized,
resulting in no amortization expense during fiscal 2004. We amortized approximately $142,000 and $283,000 of the deferred compensation to general and administrative expense in fiscal 2003 and 2002,
respectively.

Associated
with the acquisition of Telinnovation in February 2000, we recorded $23.0 million of deferred compensation related to 400,000 restricted shares granted to the
Telinnovation employees. These restricted shares were tied to the employees' continuing employment with Ditech. The deferred compensation was being amortized as research and development expense over
the three-year vesting period of the restricted shares. As part of the disposition of our echo software technology to TI, TI became the custodian of these restricted shares and will
release them to the Telinnovation employees, who now work for TI, as they are earned. Should a former Telinnovation employee leave their employment prior to earning their restricted shares, the shares
would be forfeited
to TI. Since all former Telinnovation employees have left our employment and are now working for TI, the net deferred stock compensation of $6.1 million remaining on April 15, 2002 was
recognized immediately as part of the sale transaction. Therefore, there was no amortization related to deferred stock compensation associated with our acquisition of Telinnovation in fiscal 2004 and
2003, nor will there be any in the future. We amortized approximately $7.3 million of Telinnovation related deferred compensation in fiscal 2002.

Associated
with the acquisition of Atmosphere on July 25, 2000, we recorded $2.4 million of deferred compensation related to unvested options assumed in the acquisition.
This deferred compensation was amortized to research and development expense over the remaining vesting terms of the assumed options, which became fully vested in the first quarter of fiscal 2003. In
connection with the acquisition of Atmosphere, we issued nonqualified stock options for approximately 750,000 shares of our common stock at a price equal to a 50% discount from the market value of the
stock on its grant date of August 1, 2000. The discount was recorded as deferred compensation of $17.3 million in August 2000. Subsequent to recording this deferred compensation
in August 2000, the gross amount of deferred compensation was reduced from time to time for the impact of option cancellations due to

23

---



employee
terminations. Due to the cancellation of all remaining options, from this August 2000 grant, as part of our option exchange program as described below, the remaining deferred
compensation of $1.2 million was recognized in the fourth quarter of fiscal 2003 and no further amortization of this deferred compensation occurred in fiscal 2004. As this deferred compensation
was solely attributable to optical operations, the amortization expense has been included in the loss from discontinued operations for all years presented. The Atmosphere-related deferred compensation
expense totaled approximately $3.1 million and $4.1 million in fiscal 2003 and 2002, respectively.

In
February 2003, we commenced a voluntary stock option exchange program for our employees, including officers. We implemented this program in order to align employee and
stockholder interests while sustaining high levels of performance during the current stagnant economic period. A large number of our employees' stock option exercise prices were significantly higher
than the current market price of Ditech common stock and, in an effort to motivate and retain our employees, our Board approved this stock option exchange program. Under this program, eligible
employees were offered the opportunity to exchange certain outstanding stock options with exercise prices of $20.00 or more for new replacement options pursuant to the terms of the program. The
original options exchanged were canceled on March 19, 2003. On September 23, 2003, we issued options to purchase a total of 165,730 shares of common stock, representing 25% of the number
of shares originally subject to options exchanged for those individuals still employed by us on September 23, 2003. (See Note 10 of Notes to the Consolidated Financial Statements).

Recent Accounting Pronouncements

In May 2003, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 150,
"Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity" (SFAS 150). SFAS 150 establishes
standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. SFAS 150 is effective for financial instruments entered
into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. Adoption of SFAS 150 did not have any
effect on our financial position, results of operations, or cash flows.

In
December 2003, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 104, "Revenue Recognition"(SAB 104), which supercedes SAB 101, "Revenue Recognition in Financial Statements."The primary purpose of SAB 104 is to rescind accounting guidance
contained in SAB 101 related to multiple element revenue arrangements, which was superceded as a result of the issuance of EITF 00-21, "Accounting for Revenue
Arrangements with Multiple Deliverables." While the wording of SAB 104 has changed to reflect the issuance of EITF 00-21, the revenue recognition principles of SAB
101 remain largely unchanged by the issuance of SAB 104. The adoption of SAB 104 did not have a material impact on our financial statements.

Liquidity and Capital Resources

Since March 1997, we have satisfied the majority of our liquidity requirements through cash flow generated from operations, funds received upon exercise of
stock options and the proceeds from our initial and follow-on public offerings in fiscal 2000.

Cash flows from Operating Activities

Years ended April 30,2004

2003

2002Cash flow from operating activities

$
21,219

$
(12,363
)
$
(13,849
)


24

---



The
improvement in our cash flow from operations reflects the overall improvement in our operating results due in large part to increased product shipments. In addition, our exiting the
optical communications business in the first quarter of fiscal 2004 also favorably impacted our operating results in fiscal 2004 by dramatically reducing the level of spending we had previously
invested in this product line. The combination of these two factors, while controlling growth in our voice quality related operating expenses, has contributed to our return to profitability and
positive cash flows from operating activities in fiscal 2004. During this same period of time, we have also experienced positive cash flow benefits from changes in the mix of our current assets and
liabilities in large part due to favorable revenue linearity and spending control, which helped to reduce the level of accounts receivable while maintaining a consistent level of current liabilities.
Although we expect to see positive cash flows from operations in the coming year, they may not be in the same ratio to earnings, largely due to expected increases in accounts receivable as we enter
new customer markets internationally, which may prolong payment terms somewhat, and as we introduce new products, which may increase inventory levels.

Cash flows from Investing Activities

Years ended April 30,2004

2003

2002Cash flow from investing activities

$
(31,978
)
$
173

$
7,998


The
change in the trend of cash flows from investing activities is due to two key events. First, in fiscal 2004, we changed our investing strategy to include short-term and
long-term investments designed to improve our overall return on invested funds, which accounted for the vast majority of the cash used in fiscal 2004. Partially offsetting this use of cash
in fiscal 2004 and contributing to the positive cash flows from investing activities in fiscal 2003 and 2002 was the collection of proceeds from the sale of our echo cancellation software technology
in fiscal 2002 and collection of the related purchase price installments in fiscal 2003 and 2004 of $5.0 million and $3.5 million, respectively, and to a lesser degree the collection of
sales proceeds from the sale of our optical business in fiscal 2004 of $1.8 million. We expect that investing activities will continue to use cash in the coming year as we continue to utilize
longer term investments to help improve the yield on invested cash, although the level of activity is not likely to mirror that experienced in fiscal 2004 when we first implemented the investment
strategy. We also plan to continue to invest in capital assets related to new product introductions. In addition, the level of offset from the proceeds from sale of our echo software technology and
our optical business should not be as large in fiscal 2005, as we have now collected the full purchase price related to the sale of our echo software technology to TI and have only modest levels of
cash expected to be received from the sale of our optical business to JDSU.

Cash flows from Financing Activities

Years ended April 30,2004

2003

2002Cash flow from financing activities

$
11,049

$
776

$
1,628


The
increase in trend of cash flow from financing activities in fiscal 2004 as compared to the prior two fiscal years is primarily due to funds received upon stock option exercises. The
stock option activity in fiscal 2004 was largely due to option exercises by employees impacted by the restructuring of our optical business prior to the cancellation of those options, as well as
options exercised by existing employees. Although we expect to continue to have positive cash flows from financing activities due to employee stock plan activity, the level of cash flow will vary
depending on market conditions. We further believe that it is unlikely that the cash flows will continue at the pace experienced in fiscal 2004, as the vast majority of cash in flows from former
optical employees has been received.

25

---



As
of April 30, 2004, we had cash and cash equivalents of $94.8 million as compared to $94.5 million at April 30, 2003. Additionally, we had
$30.7 million of short-term investments and $5.0 million of long-term investments as of April 30, 2004, compared to no short-term or
long-term investments as of April 30, 2003.

We
have no material commitments other than obligations under operating leases, particularly our facility leases and normal purchases of inventory, capital equipment and operating
expenses, such as materials for research and development and consulting. We currently occupy approximately 61,000 square feet of space in the two buildings that form our Mountain View, California
headquarters. This facility lease expires in June 2006.

Our
contractual commitments, by year in which they become due, are as follows:

|                     |  | Payments due by period
|-------------------- |  | ----------------------
|
|Operating leases     |  | $                     
|Purchase commitments |  |                       
|                     |  |                       
|Total                |  | $                     
|                     |  |                       

In
addition, as part of the optical sale agreement with JDSU, JDSU has the right to require us to indemnify JDSU for any purchased but unused inventory at June 30, 2004, up to
$2.0 million, and certain costs incurred by JDSU in connection with the performance of certain warranty obligations relating to optical products that we sold prior to July 16, 2003. As
of April 30, 2004, we have recorded an estimated loss provision of $500,000 associated with our indemnification of the purchased but unused inventory, which loss provision was included in the
loss on disposition of our discontinued operations.

We
believe that we will be able to satisfy our cash requirements for at least the next twelve months from our existing cash and short-term investments, and receipt of the
balance of the sale proceeds from the sale of our optical business, as described above. At this time, we are unsure whether we will renew our $2 million line of credit, which expires in
July 2004, as we currently see no immediate need for the facility. The ability to fund our operations beyond the next twelve months will be
dependent on the overall demand of telecommunications providers for new capital equipment. Should our customers' capital spending patterns deteriorate from their current levels, we could need to find
additional sources of cash during fiscal 2006 or be forced to reduce our spending levels to protect our cash reserves.

Future Growth and Operating Results Subject to Risk

Our business and the value of our stock are subject to a number of risks, which are set out below. If any of these risks actually occur, our business, financial
condition or operating results could be materially adversely affected, which would likely have a corresponding impact on the value of our common stock. These risk factors should be carefully reviewed.

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

Our
revenue historically has come from a small number of customers. Our five largest customers accounted for approximately 86%, 81% and 74% of our revenue in fiscal 2004, 2003 and 2002,
respectively. One of these customers accounted for 37% of our revenues in fiscal 2004. A customer may stop buying our products or significantly reduce its orders for our products for a number of
reasons, including the acquisition of a customer by another company or a delay in a scheduled product introduction. If this happens, our revenue could be greatly reduced, which would materially and
adversely affect our business. This occurred in fiscal 2001 when Qwest, then our largest customer,

26

---



substantially
discontinued purchasing our product due to the down turn in the telecommunications industry.

Due
to continuing difficult economic conditions, many operators in the telecommunications industry have experienced financial difficulties, which have dramatically reduced their capital
expenditures and, in some cases, resulted in their filing for bankruptcy or being acquired by other operators. We expect this trend to continue, which may result in our dependence on an even smaller
customer base.

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

We
expect that, at least through fiscal 2005, our sole business will be the design, development and marketing of voice processing products. However, the relatively small size of the
overall echo cancellation portion of the voice market, which is where we have derived the majority of our revenues to date, could limit the rate of growth of our business.

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

Our
quarterly operating results have fluctuated significantly in the past and may fluctuate in the future as a result of several factors, some of which are outside of our control. If
revenue declines in a quarter, as we experienced in the second half of fiscal 2001 and again in the second quarter of fiscal 2002, our operating results will be adversely affected because many of our
expenses are relatively fixed. In particular, sales and marketing, research and development and general and administrative expenses do not change significantly with variations in revenue in a quarter.
Adverse changes in our operating results could adversely affect our stock price.

OUR
REVENUE MAY VARY FROM PERIOD TO PERIOD. Factors that could cause our revenue to fluctuate from period to period include:



In
particular, sales of our echo cancellation products typically come from our major customers ordering large quantities when they deploy a switching center. Consequently, we may get one
or more large orders in one quarter from a customer and then no orders in the next quarter. As a result, our revenue may vary significantly from quarter to quarter.

27

---



Our
customers may delay or rescind orders for our existing products in anticipation of the release of our or our competitors' new products. Further, if our or our competitors' new
products substantially replace the functionality of our existing products, our existing products may become obsolete, which could result in inventory write-downs, and/or we could be forced to sell
them at reduced prices or even at a loss.

In
addition, the sales cycle for our products is typically lengthy. Before ordering our products, our customers perform significant technical evaluations, which typically last up to
90 days or more. Once an order is placed, delivery times can vary depending on the product ordered. As a result, revenue forecasted for a specific customer for a particular quarter may not
occur in that quarter. Because of the potential large size of our customers' orders, this would adversely affect our revenue for the quarter.

OUR
EXPENSES MAY VARY FROM PERIOD TO PERIOD. Many of our expenses do not vary with our revenue. Factors that could cause our expenses to fluctuate from period to period include:



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

IF WE DO NOT SUCCESSFULLY DEVELOP AND INTRODUCE NEW PRODUCTS, OUR PRODUCTS MAY BECOME OBSOLETE.

We
operate in an industry that experiences rapid technological change, and if we do not successfully develop and introduce new products and our existing products become obsolete due to
product introductions by competitors, our revenues will decline. Even if we are successful in developing new products, we may not be able to successfully produce or market our new products in
commercial quantities, or increase our overall sales levels. These risks are of particular concern when a new generation product is introduced. Although we believe we will achieve our product
introduction dates, there is no guarantee that they will not be delayed. The current product introductions, which are of greatest significance, are our new voice quality features, which are being
offered on our new BVP-Flex and QVP voice processing hardware platforms. We are currently experiencing numerous customer evaluations of these features around the world and realized our
first modest levels of revenue from these new products in the fourth quarter of fiscal 2004, and we expect more significant levels of revenue from these new features beginning in fiscal 2005. However,
should the customer evaluation process become protracted or the product not meet the customers' expectations, the timing of our realization of any revenues from these new products could be delayed or
not materialize at all.

We
have in the past experienced, and in the future may experience, unforeseen delays in the development of our new products. For example, in fiscal 2002, sales of our fourth generation
echo cancellers and our broadband system generated the majority of our echo revenue while sales of our fifth generation, OC-3 echo cancellation system fell short of our expectations due to
a sudden decline in projected demand in the third quarter of fiscal 2002 from our primary targeted customer for this product, Qwest. This unexpected drop in demand for the OC-3 product led
to the write down of $3.5 million of excess inventory in the third quarter of fiscal 2002. Although we were eventually able to sell this product after having written it down, there can be no
assurances that we will be able to sell additional written-down units in the future.

28

---



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

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

We
expect that the price we can charge our customers for our products will decline as new technologies become available, as we expand the distribution of products through OEMs,
value-added resellers and distributors internationally and as competitors lower prices either as a result of reduced manufacturing costs or a strategy of cutting margins to achieve or maintain market
share. If this occurs, our operating results will be adversely affected. We expect price reductions to be more pronounced, at least in the near term, due to our planned expansion internationally.
While we intend to reduce our manufacturing costs in an attempt to maintain our margins and to introduce enhanced products with higher selling prices, we may not execute these programs on schedule. In
addition, our competitors may drive down prices faster or lower than our planned cost reduction programs. Even if we can reduce our manufacturing costs, many of our operating costs will not decline
immediately if revenue decreases due to price competition.

In
order to respond to increasing competition and our anticipation that average-selling prices will decrease, we are attempting to reduce manufacturing costs of our new and existing
products. If we do not reduce manufacturing costs and average selling prices decrease, our operating results will be adversely affected. Manufacturing is currently outsourced to a small number of
contract manufacturers. We believe that our current contract manufacturing relationships provide us with competitive manufacturing costs for our products. However, if we or these contract
manufacturers terminate any of these relationships, or if we otherwise establish new relationships, we may encounter problems in the transition of manufacturing to another contract manufacturer, which
could temporarily increase our manufacturing costs and cause production delays.

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

The
markets for our products are intensely competitive, continually evolving and subject to rapid technological change. We may not be able to compete successfully against current or
future competitors, including our customers. Certain of our customers also have the ability to internally produce the equipment that they currently purchase from us. In such cases, we also compete
with their internal product development capabilities. We expect that competition will increase in the future. We may not have the financial resources, technical expertise or marketing, manufacturing,
distribution and support capabilities to compete successfully.

We
face competition from two major direct manufacturers of stand-alone voice processing products, Tellabs and Natural Microsystems. The other competition in these markets comes from
voice switch manufacturers. These manufacturers don't sell voice processing products or compete in the stand-alone voice processing product market, but they integrate voice processing functionality
within their switches, either as hardware modules or as software running on chips. A more widespread adoption of internal voice processing solutions would present an increased competitive threat to
us, if the net result was the elimination of demand for our voice processing system products. With the downturn in spending in the telecommunications industry, service providers appear to be exploring
these alternative sources of voice processing more thoroughly, while they wait for more robust capital spending budgets to return. If our customers decide to design these alternative sources of voice
processing functionality into their future network expansion, it could adversely impact the speed and duration of our sales recovery.

29

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Most
of our competitors and potential competitors have substantially greater name recognition and technical, financial and marketing resources than we do. Such competitors may undertake
more extensive marketing campaigns, adopt more aggressive pricing policies and devote substantially more resources to developing new products than we will.

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

In
April 2002, we sold our echo cancellation software technology and future revenue streams from our licenses of technology acquired from Telinnovation to TI, in return for cash
and a long-term license of the echo cancellation software. Although the licensing agreement has strong guarantees of support for the software used in our products, if TI were to breach
that agreement in some fashion, and not deliver complete and timely support to us, our success in the echo cancellation systems business could be adversely affected.

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

Under
the terms of the sale agreement of our echo cancellation software to TI, TI is precluded from licensing the software to other echo cancellation systems companies for a period of
two years from the date of the sale and to two specified competitors for a period of four years from the date of sale. If TI were to license its echo cancellation software to other echo cancellation
systems companies after two years, this could increase the level of competition and adversely affect our success in our echo cancellation systems business.

WE OPERATE IN AN INDUSTRY EXPERIENCING RAPID TECHNOLOGICAL CHANGE, WHICH MAY MAKE OUR PRODUCTS OBSOLETE.

Our
future success will depend on our ability to develop, introduce and market enhancements to our existing products and to introduce new products in a timely manner to meet our
customers' requirements. The markets we target are characterized by:



WE
MAY NOT BE ABLE TO RESPOND QUICKLY AND EFFECTIVELY TO THESE RAPID CHANGES. The emerging nature of these products and their rapid evolution will require us to continually improve the
performance, features and reliability of our products, particularly in response to competitive product offerings. We may not be able to respond quickly and effectively to these developments. The
introduction or market acceptance of products incorporating superior technologies or the emergence of alternative technologies and new industry standards could render our existing products, as well as
our products currently under development, obsolete and unmarketable. In addition, we may have only a limited amount of time to penetrate certain markets, and we may not be successful in achieving
widespread acceptance of our products before competitors offer products and services similar or superior to our products. We may fail to anticipate or respond on a cost-effective and
timely basis to technological developments, changes in industry standards or end user requirements. We may also experience significant delays in product development or introduction. In addition, we
may fail to release new products or to upgrade or enhance existing products on a timely basis.

30

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WE
MAY NEED TO MODIFY OUR PRODUCTS AS A RESULT OF CHANGES IN INDUSTRY STANDARDS. The emergence of new industry standards, whether through adoption by official standards committees or
widespread use by service providers, could require us to redesign our products. If such standards become widespread, and our products are not in compliance, our current and potential customers may not
purchase our products. The rapid development of new standards increases the risk that our competitors could develop and introduce new products or enhancements directed at new industry standards before
us.

IF INCUMBENT AND EMERGING COMPETITIVE SERVICE PROVIDERS AND THE TELECOMMUNICATIONS INDUSTRY AS A WHOLE EXPERIENCE ANOTHER DOWNTURN OR REDUCTION IN GROWTH RATE,
THE DEMAND FOR OUR PRODUCTS WILL DECREASE, WHICH WILL ADVERSELY AFFECT OUR BUSINESS.

We
have experienced, and continue to experience, as have other companies in our sector, a slowdown in infrastructure spending by our customers. This trend of lower capital spending in
the telecommunications industry contributed to the decline in our revenues, beginning in the second half of fiscal 2001, and although we have experienced some level of recovery in sales to these
customers, sales have not fully recovered to the levels we saw prior to the decline in fiscal 2001. Our success will depend in large part on development, expansion and/or upgrade of voice and
communications networks. We are subject to risks of growth constraints due to our current and planned dependence on domestic and international telecommunications service providers. These potential
customers may be constrained for a number of reasons, including their limited capital resources, economic conditions, changes in regulation and consolidation.

SOME OF THE KEY COMPONENTS USED IN OUR PRODUCTS ARE CURRENTLY AVAILABLE ONLY FROM SOLE SOURCES, THE LOSS OF WHICH COULD DELAY PRODUCT
SHIPMENTS.

We
rely on certain vendors as the sole source of certain key components that we use in our products. For example, we rely on TI as the sole source vendor for the digital signal
processors used in our echo cancellation and voice enhancement products. We have no guaranteed supply arrangements with our vendors. Any extended interruption in the supply of these components would
affect our ability to meet scheduled deliveries of our products to customers. If we are unable to obtain a sufficient supply of these components, we could experience difficulties in obtaining
alternative sources or in altering product designs to use alternative components. Resulting delays or reductions in product shipments could damage customer relationships, and we could lose customers
and orders. Additionally, because these vendors are the sole source of these components, we are at risk that adverse changes in prices of these components could have negative impacts on the cost of
our products or require us to alter product designs to use alternative, less expensive components.

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

Although
we believe there are currently ample supplies of components for our products, it is possible that in the near-term component manufacturers may reduce their inventory
levels and require firm orders before they manufacture components. This reduction in stocking levels could lead to extended lead times in the future. If we are unable to procure our planned quantities
of materials from all prospective suppliers, and if we cannot use alternative components, we could experience revenue delays or reductions and potential harm to customer relationships. An example of
this risk occurred in the third quarter of fiscal 2001 as two vendors supplying us with components used in our OC-3 product did not meet our total demand. As a result, the schedule
shipment of our OC-3 product was delayed, which contributed to our revenue shortfall in that quarter.

31

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WE MAY EXPERIENCE UNFORESEEN PROBLEMS AS WE DIVERSIFY OUR INTERNATIONAL CUSTOMER BASE, WHICH WOULD IMPAIR OUR ABILITY TO GROW OUR
BUSINESS.

Historically,
we have sold mostly to customers in North America. We are continuing to execute on our plans to expand our international presence through the establishment of new
relationships with established international OEMs, value-added resellers and distributors. However, we may still be required to hire additional personnel for the overseas market and incur other
unforeseen expenditures. Our planned expansion overseas may not be successful. As we expand our sales focus further into
international markets, we will face new and complex issues that we may not have faced before, such as expanded risk to currency fluctuations, longer payment cycles, manufacturing overseas, political
or economic instability, potential adverse tax consequences and broadened import/export controls, which will put additional strain on our management personnel. In the past, the vast majority of our
international sales have been denominated in U.S. dollars; however, in the future, we may be forced to denominate a greater amount of international sales in foreign currencies. Additionally, the
number of installations we will be responsible for is likely to increase as a result of our continued international expansion. In the past, we have experienced difficulties installing one of our echo
cancellation products overseas. In addition, we may not be able to establish more relationships with international OEMs, value-added resellers and distributors. If we do not, our ability to increase
sales could be materially impaired.

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

We
depend heavily on Timothy K. Montgomery, our Chairman, President and Chief Executive Officer, and on other key management and technical personnel, for the conduct and development of
our business and the development of our products. We have attempted to mitigate some of this risk through some key hires over the past couple of years. However, there is no guarantee that if we lost
the services of one or more of these people for any reason, that it would not adversely affect our ability to conduct and expand our business and to develop new products. We believe that our future
success will depend in large part upon our continued ability to attract, retain and motivate highly skilled employees. However, we may not be able to do so.

OUR ABILITY TO COMPETE SUCCESSFULLY WILL DEPEND, IN PART, ON OUR ABILITY TO PROTECT OUR INTELLECTUAL PROPERTY RIGHTS, WHICH WE MAY NOT BE ABLE TO
PROTECT.

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

32

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OUR PRODUCTS EMPLOY TECHNOLOGY THAT MAY INFRINGE ON THE PROPRIETARY RIGHTS OF THIRD PARTIES, WHICH MAY EXPOSE US TO LITIGATION.

Although
we do not believe that our products infringe the proprietary rights of any third parties, third parties may still assert infringement or invalidity claims (or claims for
indemnification resulting from infringement claims) against us. Such assertions could materially adversely affect our business, financial condition and results of operations. In addition, irrespective
of the validity or the successful assertion of such claims, we could incur significant costs in defending against such claims.

ACQUISITIONS AND INVESTMENTS MAY ADVERSELY AFFECT OUR BUSINESS.

From
time to time, we review acquisition and investment prospects that would complement our existing product offerings, augment our market coverage, secure supplies of critical materials
or enhance our technological capabilities. Acquisitions or investments could result in a number of financial consequences, including:



Furthermore,
acquisitions involve numerous operational risks, including:



Item 7AQuantitative and Qualitative Disclosures About Market Risk

Our exposure to market risk due to changes in the general level of United States interest rates relates primarily to our cash equivalents and
short-term and long-term investment portfolios. Our cash, cash equivalents, and short-term and long-term investments are primarily maintained at three
major financial institutions in the United States. As of April 30, 2004, we did not hold any derivative instruments. The primary objective of our investment activities is the preservation of
principal while maximizing investment income and minimizing risk, and we attempt to achieve this by diversifying our portfolio in a variety of highly rated investment securities that have limited
terms to maturity. We do not hold any instruments for trading purposes.

Investment
securities that have maturities of more than three months at the date of purchase but current maturities of less than one year are considered short-term
investments. Investment securities with remaining maturities of one year or more are considered long-term investments. Our short-term and long-term investments
consist primarily of U.S. Government securities and corporate bonds, as well as, commercial paper, asset backed securities and certificates of deposit. Short-term and long-term

33

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investments
are maintained at one major financial institution, are classified as available-for-sale, and are recorded on the accompanying Consolidated Balance Sheets at fair
value.

The
following table presents the hypothetical changes in fair values of our investments as of April 30, 2004, based on a discounted cash flow calculation over the remaining term
of each investment, that are sensitive to changes in interest rates. (dollars in thousands):

|                  |  | Valuation of Securities Given
an Interest Rate Decrease of
X Basis Points |        |  |   | Valuation of Securities Given
an Interest Rate Increase of
X Basis Points
|----------------- |  | ------------------------------------------------------------------------- | ------ |  | - | -------------------------------------------------------------------------
|
|
|Total investments |  | $                                                                         | 36,020 |  | $ | 35,920                                                                   

These
instruments are not leveraged. The modeling technique used measures the change in fair values arising from selected potential changes in interest rates. Market changes reflect
immediate hypothetical parallel shifts in the yield curve of plus or minus 50 basis points (BPS), 100 BPS, and 150 BPS over the remaining life of the investments, which shifts are representative of
the historical movements in the Federal Funds Rate.

The
following table presents our cash equivalents and short-term and long-term investments subject to interest rate risk and their related weighted average
interest rates as of April 30, 2004 (in thousands). Carrying value approximates fair value.

Carrying
Value

Average
Interest RateCash and cash equivalents

$
94,785

0.95
%Short-term investments


30,724

1.32Long-term investments


4,996

1.75Total

$
130,505

1.05
%


As
of April 30, 2003, we did not hold any short-term or long-term investments, and our cash and cash equivalents as of April 30, 2003 were
$94.5 million, all of which had maturities of 30 days or less and bore an average interest rate of 1.30%. Due to the short-term nature of these securities, we do not believe
that they presented a material risk to shifts in interest rates.

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

34

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Item 8Financial Statements and Supplementary Data

DITECH COMMUNICATIONS CORPORATION  INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

|                                                |  | Page
|----------------------------------------------- |  | ----
|Report of Independent Auditors                  |  | 36  
|Consolidated Balance Sheets                     |  | 37  
|Consolidated Statements of Operations           |  | 38  
|Consolidated Statements of Stockholders' Equity |  | 39  
|Consolidated Statements of Cash Flows           |  | 40  
|Notes to Consolidated Financial Statements      |  | 41  
|Supplementary Financial Data (unaudited)        |  | 60  

35

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Report of Independent Registered Public Accounting Firm

To the Board of Directors and Stockholders of
Ditech Communications Corporation:

In
our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations, stockholders' equity and cash flows present fairly, in all material
respects, the financial position of Ditech Communications Corporation and its subsidiaries at April 30, 2004 and 2003, and the results of their operations and their cash flows for each of the
three years in the period ended April 30, 2004, in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with the standards of
the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and
significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

/s/PRICEWATERHOUSECOOPERS LLP

May 25,
2004
San Jose, California

36

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DITECH COMMUNICATIONS CORPORATION        CONSOLIDATED BALANCE SHEETS        (in thousands)

|                                                                                                                                                       |                                                                                                                       | April 30,                  |         
|------------------------------------------------------------------------------------------------------------------------------------------------------ | --------------------------------------------------------------------------------------------------------------------- | -------------------------- | --------
|
|ASSETS                                                                                                                                                 |                                                                                                                       |                            |         
|Current assets:                                                                                                                                        |                                                                                                                       |                            |         
|                                                                                                                                                       | Cash and cash equivalents                                                                                             |                            | $       
|                                                                                                                                                       | Short-term investments                                                                                                |                            |         
|                                                                                                                                                       | Accounts receivable, net of allowance for doubtful accounts of $404 and $811 at April 30, 2004 and 2003, respectively |                            |         
|                                                                                                                                                       | Inventories                                                                                                           |                            |         
|                                                                                                                                                       | Other current assets                                                                                                  |                            |         
|                                                                                                                                                       |                                                                                                                       |                            |         
|                                                                                                                                                       |                                                                                                                       | Total current assets       |         
|Long-term investments                                                                                                                                  |                                                                                                                       |                            | 4,996   
|Property and equipment, net                                                                                                                            |                                                                                                                       |                            | 3,603   
|Other assets                                                                                                                                           |                                                                                                                       |                            | 1,773   
|                                                                                                                                                       |                                                                                                                       |                            |         
|                                                                                                                                                       |                                                                                                                       | Total assets               |         
|                                                                                                                                                       |                                                                                                                       |                            |         
|LIABILITIES                                                                                                                                            |                                                                                                                       |                            |         
|Current liabilities:                                                                                                                                   |                                                                                                                       |                            |         
|                                                                                                                                                       | Accounts payable                                                                                                      |                            | $       
|                                                                                                                                                       | Accrued expenses                                                                                                      |                            |         
|                                                                                                                                                       | Deferred revenue                                                                                                      |                            |         
|                                                                                                                                                       | Income taxes payable                                                                                                  |                            |         
|                                                                                                                                                       |                                                                                                                       |                            |         
|                                                                                                                                                       |                                                                                                                       | Total liabilities          |         
|                                                                                                                                                       |                                                                                                                       |                            |         
|Commitments and contingencies (Note 7)                                                                                                                 |                                                                                                                       |                            |         
|STOCKHOLDERS' EQUITY                                                                                                                                   |                                                                                                                       |                            |         
|Common stock, $0.001 par value: 200,000 shares authorized and 32,915 and 30,480 shares issued and outstanding at April 30, 2004 and 2003, respectively |                                                                                                                       |                            | 33      
|Additional paid-in capital                                                                                                                             |                                                                                                                       |                            | 281,190 
|Accumulated deficit                                                                                                                                    |                                                                                                                       |                            | (145,785
|Other comprehensive income (loss)                                                                                                                      |                                                                                                                       |                            | (38     
|                                                                                                                                                       |                                                                                                                       |                            |         
|                                                                                                                                                       |                                                                                                                       | Total stockholders' equity |         
|                                                                                                                                                       |                                                                                                                       |                            |         
|                                                                                                                                                       | Total liabilities and stockholders' equity                                                                            |                            | $       
|                                                                                                                                                       |                                                                                                                       |                            |         

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

37

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DITECH COMMUNICATIONS CORPORATION        CONSOLIDATED STATEMENTS OF OPERATIONS        (in thousands, except per share data)

|                                                                                                        |                                                                                                                                  | Years ended April 30,                                                                      |                         
|------------------------------------------------------------------------------------------------------- | -------------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------------------------------------------------------ | ------------------------
|
|Revenue                                                                                                 |                                                                                                                                  | $                                                                                          | 69,590                  
|Cost of goods sold                                                                                      |                                                                                                                                  |                                                                                            | 23,413                  
|                                                                                                        |                                                                                                                                  |                                                                                            |                         
|                                                                                                        | Gross profit                                                                                                                     |                                                                                            |                         
|                                                                                                        |                                                                                                                                  |                                                                                            |                         
|Operating expenses:                                                                                     |                                                                                                                                  |                                                                                            |                         
|                                                                                                        | Sales and marketing                                                                                                              |                                                                                            |                         
|                                                                                                        | Research and development                                                                                                         |                                                                                            |                         
|                                                                                                        | General and administrative                                                                                                       |                                                                                            |                         
|                                                                                                        | Restructuring charge                                                                                                             |                                                                                            |                         
|                                                                                                        | Amortization of goodwill                                                                                                         |                                                                                            |                         
|                                                                                                        | Amortization of other acquisition related intangible assets                                                                      |                                                                                            |                         
|                                                                                                        |                                                                                                                                  |                                                                                            |                         
|                                                                                                        |                                                                                                                                  |                                                                                            | Total operating expenses
|                                                                                                        |                                                                                                                                  |                                                                                            |                         
|Income (loss) from continuing operations                                                                |                                                                                                                                  |                                                                                            | 16,707                  
|                                                                                                        |                                                                                                                                  |                                                                                            |                         
|Other income (expense):                                                                                 |                                                                                                                                  |                                                                                            |                         
|                                                                                                        | Interest income                                                                                                                  |                                                                                            |                         
|                                                                                                        | Gain on sale of echo software technology and related assets                                                                      |                                                                                            |                         
|                                                                                                        | Other income (expense), net                                                                                                      |                                                                                            |                         
|                                                                                                        |                                                                                                                                  |                                                                                            |                         
|                                                                                                        |                                                                                                                                  | Total other income                                                                         |                         
|                                                                                                        |                                                                                                                                  |                                                                                            |                         
|Income (loss) from continuing operations before income taxes and cumulative effect of accounting change |                                                                                                                                  |                                                                                            | 18,001                  
|Provision for income taxes                                                                              |                                                                                                                                  |                                                                                            | 270                     
|                                                                                                        |                                                                                                                                  |                                                                                            |                         
|Income (loss) from continuing operations before cumulative effect of accounting change                  |                                                                                                                                  |                                                                                            | 17,731                  
|Discontinued operations:                                                                                |                                                                                                                                  |                                                                                            |                         
|                                                                                                        | Loss from discontinued operations net of tax provision of $129 and $128 for the year ended April 30, 2003 and 2002, respectively |                                                                                            |                         
|                                                                                                        | Loss on disposition, net of $144 tax benefit for the year ended April 30, 2004                                                   |                                                                                            |                         
|                                                                                                        |                                                                                                                                  |                                                                                            |                         
|                                                                                                        |                                                                                                                                  | Loss from discontinued operations                                                          |                         
|Cumulative effect of accounting change                                                                  |                                                                                                                                  |                                                                                            |                        
|                                                                                                        |                                                                                                                                  |                                                                                            |                         
|Net income (loss)                                                                                       |                                                                                                                                  | $                                                                                          | 8,195                   
|                                                                                                        |                                                                                                                                  |                                                                                            |                         
|Per share data:                                                                                         |                                                                                                                                  |                                                                                            |                         
|                                                                                                        | Basic:                                                                                                                           |                                                                                            |                         
|                                                                                                        |                                                                                                                                  | Net income (loss) from continuing operations before cumulative effect of accounting change |                         
|                                                                                                        |                                                                                                                                  | Loss from discontinued operations                                                          |                         
|                                                                                                        |                                                                                                                                  | Cumulative effect of accounting change                                                     |                         
|                                                                                                        |                                                                                                                                  |                                                                                            |                         
|                                                                                                        |                                                                                                                                  |                                                                                            | Net income (loss)       
|                                                                                                        |                                                                                                                                  |                                                                                            |                         
|                                                                                                        | Diluted:                                                                                                                         |                                                                                            |                         
|                                                                                                        |                                                                                                                                  | Net income (loss) from continuing operations before cumulative effect of accounting change |                         
|                                                                                                        |                                                                                                                                  | Loss from discontinued operations                                                          |                         
|                                                                                                        |                                                                                                                                  | Cumulative effect of accounting change                                                     |                         
|                                                                                                        |                                                                                                                                  |                                                                                            |                         
|                                                                                                        |                                                                                                                                  |                                                                                            | Net income (loss)       
|                                                                                                        |                                                                                                                                  |                                                                                            |                         
|Number of shares used in per share calculations:                                                        |                                                                                                                                  |                                                                                            |                         
|                                                                                                        | Basic                                                                                                                            |                                                                                            |                         
|                                                                                                        |                                                                                                                                  |                                                                                            |                         
|                                                                                                        | Diluted                                                                                                                          |                                                                                            |                         
|                                                                                                        |                                                                                                                                  |                                                                                            |                         

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

38

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DITECH COMMUNICATIONS CORPORATION        CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY        (in thousands)

|                                                                                            |                                                             | Common Stock               |   |   |    |   |   |         |   |   |          |         |  
|------------------------------------------------------------------------------------------- | ----------------------------------------------------------- | -------------------------- | - | - | -- | - | - | ------- | - | - | -------- | ------- | -
|
|
|Balances, May 1, 2001                                                                       |                                                             | 29,725                     |   | $ | 30 |   | $ | 270,683 |   | $ | 6,459    |         | $
|Issuance of stock under employee stock plans                                                |                                                             | 406                        |   |   |   |   |   | 1,676   |   |   |         |         |  
|Repurchase of common stock                                                                  |                                                             | (13                        | ) |   |   |   |   | (26     | ) |   |         |         |  
|Adjustment to deferred compensation for stock option cancellations                          |                                                             |                           |   |   |   |   |   | (2,346  | ) |   |         |         |  
|Deferred compensation on issuance of stock options                                          |                                                             |                           |   |   |   |   |   | 104     |   |   |         |         |  
|Tax benefit of employee stock transactions                                                  |                                                             |                           |   |   |   |   |   | 2,045   |   |   |         |         |  
|Elimination of deferred compensation in sale of echo software technology and related assets |                                                             |                           |   |   |   |   |   |        |   |   |         |         |  
|Amortization of deferred stock compensation                                                 |                                                             |                           |   |   |   |   |   |        |   |   |         |         |  
|Net loss                                                                                    |                                                             |                           |   |   |   |   |   |        |   |   | (85,329  | )       |  
|                                                                                            |                                                             |                            |   |   |    |   |   |         |   |   |          |         |  
|Balances, April 30, 2002                                                                    |                                                             | 30,118                     |   |   | 30 |   |   | 272,136 |   |   | (78,870  | )       |  
|Issuance of stock under employee stock plans                                                |                                                             | 362                        |   |   |   |   |   | 776     |   |   |         |         |  
|Adjustment to deferred compensation for stock option cancellations                          |                                                             |                           |   |   |   |   |   | (2,904  | ) |   |          |         |  
|Amortization of deferred stock compensation                                                 |                                                             |                           |   |   |   |   |   |        |   |   |         |         |  
|Other comprehensive income (loss)                                                          |                                                             |                            |   |   |    |   |   |         |   |   |          |         |  
|                                                                                            | Translation gain on international operations                |                            |  |   |    |  |   |         |  |   |          |        |  
|                                                                                            | Net loss                                                    |                            |  |   |    |  |   |         |  |   |          | (75,110 | )
|                                                                                            |                                                             |                            |   |   |    |   |   |         |   |   |          |         |  
|                                                                                            |                                                             | Total comprehensive loss   |   |   |    |   |   |         |   |   |          |         |  
|                                                                                            |                                                             |                            |   |   |    |   |   |         |   |   |          |         |  
|Balances, April 30, 2003                                                                    |                                                             | 30,480                     |   |   | 30 |   |   | 270,008 |   |   | (153,980 | )       |  
|Issuance of stock under employee stock plans                                                |                                                             | 2,435                      |   |   | 3  |   |   | 11,052  |   |   |          |         |  
|Repurchase of common stock                                                                  |                                                             |                            |   |   |    |   |   | (6      | ) |   |          |         |  
|Stock compensation on modification of options to employees hired by JDSU                    |                                                             |                            |   |   |    |   |   | 136     |   |   |          |         |  
|Other comprehensive income (loss):                                                          |                                                             |                            |   |   |    |   |   |         |   |   |          |         |  
|                                                                                            | Translation loss on international operations                |                            |   |   |    |   |   |         |   |   |          |         |  
|                                                                                            | Unrealized loss on available for sale investment securities |                            |   |   |    |   |   |         |   |   |          |         |  
|                                                                                            | Net income                                                  |                            |   |   |    |   |   |         |   |   |          | 8,195   |  
|                                                                                            |                                                             | Total comprehensive income |   |   |    |   |   |         |   |   |          |         |  
|                                                                                            |                                                             |                            |   |   |    |   |   |         |   |   |          |         |  
|Balances, April 30, 2004                                                                    |                                                             | 32,915                     |   | $ | 33 |   | $ | 281,190 |   | $ | (145,785 | )       | $
|                                                                                            |                                                             |                            |   |   |    |   |   |         |   |   |          |         |  

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

39

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DITECH COMMUNICATIONS CORPORATION        CONSOLIDATED STATEMENTS OF CASH FLOWS        (in thousands)

|                                                     |                                                                                                    | Years ended April 30,                                                    |                           
|---------------------------------------------------- | -------------------------------------------------------------------------------------------------- | ------------------------------------------------------------------------ | --------------------------
|
|Cash flows from operating activities:                |                                                                                                    |                                                                          |                           
|                                                     | Net income (loss)                                                                                  |                                                                          | $                         
|                                                     | Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: |                                                                          |                           
|                                                     |                                                                                                    | Loss from discontinued operations                                        |                           
|                                                     |                                                                                                    | Depreciation and amortization                                            |                           
|                                                     |                                                                                                    | Increase (decrease) in provision for doubtful accounts                   |                           
|                                                     |                                                                                                    | Loss (gain) on disposal of property and equipment                        |                           
|                                                     |                                                                                                    | Tax benefit of employee stock transactions                               |                           
|                                                     |                                                                                                    | Deferred income taxes                                                    |                           
|                                                     |                                                                                                    | Gain on sale of echo software technology and related assets              |                           
|                                                     |                                                                                                    | Amortization of deferred stock compensation                              |                           
|                                                     |                                                                                                    | Amortization of goodwill and other acquisition related intangible assets |                           
|                                                     |                                                                                                    | Impairment of goodwill                                                   |                           
|                                                     |                                                                                                    | Restructuring costs and other special charges                            |                           
|                                                     |                                                                                                    | Other                                                                    |                           
|                                                     |                                                                                                    | Changes in assets and liabilities:                                       |                           
|                                                     |                                                                                                    |                                                                          | Accounts receivable       
|                                                     |                                                                                                    |                                                                          | Inventories               
|                                                     |                                                                                                    |                                                                          | Other current assets      
|                                                     |                                                                                                    |                                                                          | Income taxes              
|                                                     |                                                                                                    |                                                                          | Accounts payable          
|                                                     |                                                                                                    |                                                                          | Accrued expenses and other
|                                                     |                                                                                                    |                                                                          | Deferred revenue          
|                                                     |                                                                                                    |                                                                          |                           
|                                                     |                                                                                                    |                                                                          |                           
|                                                     |                                                                                                    |                                                                          |                           
|Cash flows from investing activities:                |                                                                                                    |                                                                          |                           
|                                                     |                                                                                                    | Purchases of property and equipment                                      |                           
|                                                     |                                                                                                    | Purchase of available for sale investments                               |                           
|                                                     |                                                                                                    | Sales and maturities of available for sales investments                  |                           
|                                                     |                                                                                                    | Proceeds from sale of echo software technology and related assets        |                           
|                                                     |                                                                                                    | Collection of note receivable and related interest                       |                           
|                                                     |                                                                                                    | Proceeds from sale of discontinued optical business                      |                           
|                                                     |                                                                                                    | Additions to other assets                                                |                           
|                                                     |                                                                                                    |                                                                          |                           
|                                                     |                                                                                                    |                                                                          |                           
|                                                     |                                                                                                    |                                                                          |                           
|Cash flows from financing activities:                |                                                                                                    |                                                                          |                           
|                                                     |                                                                                                    | Repurchase of common stock                                               |                           
|                                                     |                                                                                                    | Principal payments under capital lease obligations                       |                           
|                                                     |                                                                                                    | Proceeds from employee stock plan issuances                              |                           
|                                                     |                                                                                                    |                                                                          |                           
|                                                     |                                                                                                    |                                                                          |                           
|                                                     |                                                                                                    |                                                                          |                           
|Net increase (decrease) in cash and cash equivalents |                                                                                                    |                                                                          | 290                       
|Cash and cash equivalents, beginning of year         |                                                                                                    |                                                                          | 94,495                    
|                                                     |                                                                                                    |                                                                          |                           
|Cash and cash equivalents, end of year               |                                                                                                    | $                                                                        | 94,785                    
|                                                     |                                                                                                    |                                                                          |                           

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

40

---





DITECH COMMUNICATIONS CORPORATION        NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1.     ORGANIZATION AND NATURE OF BUSINESS

Ditech Communications Corporation (formerly Automated Call Processing Corporation) (the "Company") is a Delaware corporation that reincorporated from a California
corporation in April 1999. The Company designs, develops and markets telecommunications equipment used to improve the voice quality of long-distance and wireless telephone
communications. The Company has established a direct sales force that sells its products in the U.S. and internationally and to a lesser extent utilizes value added resellers (VARs), original
equipment manufacturers (OEMs) and distributors, primarily internationally.

2.     SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES



The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All significant intercompany balances and
transactions have been eliminated.

In
May 2003, the Company announced its intention to exit the optical communications portion of its business. In July 2003, the Company executed a sale of a substantial
portion of the assets used in the optical business. As a result, the optical business has been presented as a discontinued operation in the Consolidated Statements of Operations for all periods
presented. See Note 4 for a further discussion of the discontinued operations.



Certain items in prior years' consolidated financial statements have been reclassified to conform to classifications used in the current year.



The preparation of financial statements in conformity with generally accepted accounting principles in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.



The Company generally recognizes product revenue, including shipping charges, when: persuasive evidence of a definitive agreement exists; shipment to the customer
has occurred; title and all risks and rewards of ownership have passed to the customer; acceptance terms, if any have been fulfilled; no significant contractual obligations remain outstanding; the fee
is fixed or determinable; and collection is reasonably assured.



The Company maintains its allowance for doubtful accounts for estimated losses resulting from the inability of its customers to make required payments. In
maintaining the allowance for doubtful accounts, the Company evaluates the trends in customers' payment patterns as well as looking to external communications available about customers to estimate the
level of allowance that is needed to address potential losses that the Company may incur due to the customer's inability to pay.

41

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The Company currently offers warranty on all of its products with terms ranging from two to five years. The warranty generally provides that the Company will
repair or replace any defective product within two to five years from the invoice date. A provision for the estimated future cost of warranty is made at the time product revenue is recognized, based
on the Company's experience and expectations of future conditions.



Research and development costs include salaries and related, outside consulting, facilities, consumable materials and allocated corporate costs, which are
expensed as incurred.



The Company considers all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents. Management believes that
the financial institutions in which it maintains such deposits are financially sound and, accordingly, minimal credit risk exists with respect to
these deposits. Substantially all of the Company's cash and cash equivalents are held by three major U.S. financial institutions.



During fiscal 2004, in an effort to improve the return on invested funds, the Company began to invest in securities with maturities of greater than three months
but less than two years. Investment securities that have maturities of more than three months at the date of purchase but current maturities of less than one year are considered short-term
investments. Investment securities with remaining maturities of one year or more are considered long-term investments. Short-term and long-term investments consist
primarily of U.S. Government securities and corporate bonds, as well as, commercial paper, asset backed securities and certificates of deposit. Short-term and long-term
investments are currently maintained at one major financial institution, are classified as available-for-sale, and are recorded on the accompanying Consolidated Balance Sheets
at fair value. Unrealized holding gains and losses are included as a separate component of other comprehensive income on the accompanying Consolidated Balance Sheets, net of any related tax effect.
Realized gains and losses are calculated based on the specific identification method and are included in other income, net on the Consolidated Statements of Operations.



Carrying amounts of certain of the Company's financial instruments, including cash and cash equivalents, accounts receivable, and accounts payable are considered
to approximate fair value based upon comparable market information available at the respective balance sheet dates.



Inventories are stated at the lower of standard cost or market. Standard cost approximates cost as determined by using the first-in,
first-out (FIFO) method. Appropriate consideration is given to obsolescence, excessive levels, deterioration and other factors in evaluating net realizable value.



Property and equipment are stated at cost and are depreciated using the straight-line method over their estimated useful lives ranging from two to
five years or, in the case of leasehold improvements, the lease period, if shorter. Upon disposal, the assets and related accumulated depreciation are

42

---



removed
from the Company's accounts, and the resulting gains or losses are reflected in the statements of operations.



The excess of the cost over the fair value of net assets of purchased businesses was recorded as goodwill and prior to adoption of SFAS 142 was amortized
on a straight-line basis over its estimated useful life, generally five years or less. The cost of other acquired intangibles was amortized on a straight-line basis over their
estimated useful lives, generally five years or less. Effective May 1, 2002, the Company adopted the provisions of SFAS 142, which required the Company to cease amortization of goodwill
and perform a transitional impairment analysis of its goodwill and other acquisition related intangible assets as of the date of adoption. See Note 6 for a detailed discussion of the
consequences of adoption of this new standard.

Amortization
expense for purchased technology associated with the Telinnovation acquisition was $5.0 million in fiscal 2002. Due to the sale of the Company's echo software
technology in April 2002, there was no amortization recorded related to these assets in fiscal 2004 and 2003. Amortization expense for goodwill associated with Telinnovation and goodwill and
other acquisition related intangible assets associated with the Atmosphere Networks acquisition was $19.6 million in fiscal 2002. Due to the sale of our echo software technology and the
adoption of SFAS 142 in May 2002, there was no amortization for these goodwill and other acquisition related intangible costs in fiscal 2004 or 2003. Amortization associated with the
Atmosphere related intangible assets has been reflected in the loss from discontinued operations in fiscal 2002 as it was solely attributable to our optical operations.



The Company periodically evaluates the recoverability of its long-lived assets based upon expected undiscounted cash flows and recognizes impairment
from the carrying value of long-lived assets, if any, based on the fair value of such assets.



The Company's products are concentrated in the telecommunications equipment industry, which is highly competitive and rapidly changing. Revenues for the Company's
products are concentrated with a relatively limited number of customers. Three customers accounted for 37%, 23% and 22% of net revenues during fiscal 2004. Two customers accounted for 53% and 12% of
net revenues for fiscal 2003. Two customers accounted for 41% and 13% of net revenues in fiscal 2002. Net revenues from customers outside the United States, which were primarily denominated in U.S.
dollars, were 11%, 16% and 13% in fiscal 2004, 2003 and 2002, respectively. The Company's gross accounts receivable were concentrated with two customers at April 30, 2004, (representing 77% and
11% of receivables) and three customers at April 30, 2003 (representing 34%, 18% and 15% of receivables). The Company performs ongoing credit evaluations of its customers' financial condition
and generally requires no collateral from its customers. The Company maintains an allowance for doubtful accounts receivable based upon the expected collectibility of accounts receivable.

A
significant component of one of the Company's products is purchased from a sole vendor. If the Company were unable to obtain the component at prices reasonable to the Company, it would
experience delays in redesigning the product to function with a component from an alternative supplier. The Company relies on three manufacturers for the assembly of the majority of the Company's
products. The Company may experience delays if it were to shift production to an alternative vendor.

43

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Income taxes are accounted for under the liability method. Under this method, deferred income taxes are recognized for temporary differences by applying enacted
statutory rates applicable to future years to differences between the financial statement carrying amounts and the tax basis of existing assets and liabilities. The effect on deferred taxes of a
change in tax rates is recognized in income in the period that includes the enactment date. The Company establishes valuation allowances on its deferred tax assets when it believes that it is more
likely than not that the deferred tax assets will not be recovered.



Assets and liabilities of non-U.S. subsidiaries that operate in a local currency environment are translated to U.S. dollars at exchange rates in
effect at the balance sheet date with the resulting translation adjustments recorded directly as a separate component of accumulated other comprehensive income. Income and expense accounts are
translated at the average rates during the year. Due to the closure of the Company's international optical research offices in the first quarter of fiscal 2004, the cumulative translation adjustment
associated with those subsidiaries was realized as part of the discontinued operations in fiscal 2004.



The comprehensive income (loss) for fiscal 2004 and 2003 was $8,077,000 and $(75,030,000) and included the impact of foreign currency translation adjustments
related to the Company's international operations and unrealized gains and losses on available for sale investment securities, net of tax. There was no material difference between the Company's net
income and its total comprehensive income for fiscal 2002.



Basic earnings per share is calculated based on the weighted average number of shares of common stock outstanding during the period less shares subject to
repurchase, which are considered contingently issuable shares. Diluted earnings per share is calculated based on the weighted average number of
shares of common stock and common stock equivalents outstanding, including the dilutive effect of stock options, using the treasury stock method and common stock subject to repurchase. Diluted loss
per share for fiscal 2003 and 2002 is calculated excluding the effects of all common stock equivalents, as their effect would be anti-dilutive.

44

---



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

|                                                           |                                                                                        | Years Ended April 30, |      
|---------------------------------------------------------- | -------------------------------------------------------------------------------------- | --------------------- | -----
|
|Historical net income (loss) per share, basic and diluted: |                                                                                        |                       |      
|                                                           | Income (loss) from continuing operations before cumulative effect of accounting change |                       | $    
|                                                           | Loss from discontinued operations                                                      |                       |      
|                                                           | Cumulative effect of accounting change                                                 |                       |      
|                                                           |                                                                                        |                       |      
|Net income (loss)                                          |                                                                                        | $                     | 8,195
|                                                           |                                                                                        |                       |      
|Basic:                                                     |                                                                                        |                       |      
|                                                           | Weighted average shares of common stock outstanding                                    |                       |      
|                                                           | Less stock subject to repurchase                                                       |                       |      
|                                                           |                                                                                        |                       |      
|                                                           | Shares used in calculation of basic per share numbers                                  |                       |      
|                                                           |                                                                                        |                       |      
|                                                           | Income (loss) from continuing operations before cumulative effect of accounting change |                       | $    
|                                                           | Loss from discontinued operations                                                      |                       |      
|                                                           | Cumulative effect of accounting change                                                 |                       |      
|                                                           |                                                                                        |                       |      
|                                                           | Net income (loss) per share                                                            |                       | $    
|                                                           |                                                                                        |                       |      
|Diluted:                                                   |                                                                                        |                       |      
|                                                           | Shares used in calculation of basic per share numbers                                  |                       |      
|                                                           | Shares subject to repurchase                                                           |                       |      
|                                                           | Dilutive effect of stock plans                                                         |                       |      
|                                                           |                                                                                        |                       |      
|                                                           | Shares used in calculation of diluted per share numbers                                |                       |      
|                                                           |                                                                                        |                       |      
|                                                           | Income (loss) from continuing operations before cumulative effect of accounting change |                       | $    
|                                                           | Loss from discontinued operations                                                      |                       |      
|                                                           | Cumulative effect of accounting change                                                 |                       |      
|                                                           |                                                                                        |                       |      
|                                                           | Net income (loss) per share                                                            |                       | $    
|                                                           |                                                                                        |                       |      

The computation of diluted net income (loss) per share excluded the following number of options, as their effect was anti-dilutive:
325,000 shares in fiscal 2004, 6,576,000 in fiscal 2003 and 6,450,000 in fiscal 2002.



Statement of Financial Accounting Standards No. 123, "Accounting for Stock-based Compensation," ("SFAS 123"), encourages, but does not require,
companies to record compensation cost for stock-based compensation plans at fair value. The Company accounts for grants of equity instruments to employees using the intrinsic value method described in
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" and complies with the disclosure provisions of SFAS 123. Accordingly, compensation cost for stock
options is measured as the excess, if any, of the quoted market price of the Company's stock at the date of the grant over the amount an employee must pay to acquire the stock and is recognized over
the vesting period of the related shares.

The
Company recorded deferred stock compensation associated with its acquisitions of Telinnovation and Atmosphere in fiscal 2000 and 2001. Prior to the sale of the echo cancellation

45

---



software
technology (see Note 8), the deferred stock compensation associated with the Telinnovation acquisition was amortized to research and development expense over the vesting period of the
options. As the deferred stock compensation related to the Atmosphere acquisition was solely attributable to our optical business, it has been reflected in the loss from discontinued operations for
fiscal 2003 and 2002. There was no amortization expense for either of these acquisitions in fiscal 2004, as the deferred amounts had been fully amortized during fiscal 2003 and 2002. Amortization
expense totaled $3.1 million and $11.4 million in fiscal 2003 and 2002, respectively.

The
Company applies Accounting Principles Board Opinion No. 25 and related Interpretations in accounting for its stock option plans. If compensation cost for the Company's stock
option plan had been determined based on the fair value at the grant dates for awards under those plans consistent with the method of SFAS 123, the Company's net income (loss) for the years
ended April 30, 2004, 2003 and 2002 would have been adjusted to the pro forma amounts indicated in the following table (in thousands, except per share amounts):

April 30,2004

2003

2002Net income (loss) as reported

$
8,195

$
(75,110
)
$
(85,329
)Add: Stock-based compensation expense included in reported net income (loss), net of applicable tax effects





3,230


4,393Deduct: Stock-based compensation determined under the fair value method for all stock awards, net of applicable taxes


(9,362
)

(13,308
)

(33,831
)Pro forma net loss

$
(1,167
)
$
(85,188
)
$
(114,767
)Diluted net income (loss) attributable to common stockholders per share:As reported

$
0.24

$
(2.47
)
$
(2.90
)Pro forma

$
(0.03
)
$
(2.80
)
$
(3.91
)




In May 2003, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 150,
"Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity" (SFAS 150). SFAS 150 establishes
standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. SFAS 150 is effective for financial instruments entered
into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. The Company's adoption of SFAS 150 did
not have any effect on the Company's financial position, results of operations, or cash flows.

In
December 2003, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 104, "Revenue Recognition"(SAB 104), which supercedes SAB 101, "Revenue Recognition in Financial Statements."The primary purpose of SAB 104 is to rescind
accounting guidance contained in SAB 101 related to multiple element revenue arrangements, which was superceded as a result of the issuance of EITF 00-21,
"Accounting for Revenue Arrangements with Multiple Deliverables." While the wording of SAB 104 has changed to reflect the issuance of EITF
00-21, the revenue recognition principles of SAB 101 remain largely unchanged by the issuance of SAB 104. The adoption of SAB 104 did not have a material impact on the
Company's financial statements.

46

---



3.     BALANCE SHEET ACCOUNTS

Inventories: Inventories comprised (in thousands):

April 30,2004

2003Raw materials

$
1,527

$
4,316Work in progress


46


185Finished goods


4,382


3,966Total

$
5,955

$
8,467


During the third quarter of fiscal 2002, the Company recorded an inventory write-down, including purchase commitments, totaling $3.5 million
related to additional excess inventory for one of its echo cancellation products. This write-down was due to a sudden and significant decline in the forecasted demand from the Company's
primary customer for the product during that quarter, and was calculated in accordance with the Company's policy. Due to stronger than anticipated
demand for this echo cancellation product in the latter part of fiscal 2003, the Company benefited from the sale of previously written-down echo cancellers with an original cost of
$2.2 million in fiscal 2004 and $455,000 in fiscal 2003 but no carrying value.

The
following tables summarize the Company's investments as of April 30, 2004 (in thousands):

Cost

Gross Unrealized Gains

Gross Unrealized Losses

Fair ValueU.S. government obligations

$
10,806

$
2

$
(12
)
$
10,796Corporate notes


12,836





(26
)

12,810Asset backed securities


4,850


1


(3
)

4,848Commercial paper


2,997








2,997Certificates of deposit


4,269








4,269Total

$
35,758

$
3

$
(41
)
$
35,720


These investments were reported as:

Short-term investments

$
30,724Long-term investments


4,996Total

$
35,720


For the year ended April, 2004, no gains or loss had been realized on the sale of short-term and long-term investments. As of
April 30, 2004, net unrealized holding losses of $38,000 were included in other comprehensive income in the accompanying Consolidated Balance Sheets, net of any related tax effect.

The
following table summarizes the maturities of the Company's investments as of April, 2004 (in thousands):

Cost

Fair ValueLess than one year

$
30,752

$
30,724Due in 1-2 years


5,006


4,996Total

$
35,758

$
35,720


The Company did not have any short-term or long-term investments at April 30, 2003.

47

---



Property
and Equipment: Property and equipment comprised (in thousands):

April 30,2004

2003Furniture and fixtures

$
1,600

$
1,654Equipment


8,076


15,945Leasehold improvements


1,061


1,035Computer software


2,788


3,41613,525


22,050Less: accumulated depreciation and amortization


(9,922
)

(13,157
)Total

$
3,603

$
8,893


Acquired amortized intangible assets, which are included as a component of Other Assets, comprised (in thousands):

April 30, 2004Gross Carrying Value

Accumulated AmortizationSoftware licenses

$
3,199

$
(1,621
)April 30, 2003Gross Carrying Value

Accumulated AmortizationSoftware licenses

$
3,094

$
(860
)Other


602


(351
)Total

$
3,696

$
(1,211
)


The decline in other amortizable assets is related to the discontinuation of our optical business in fiscal 2004 and the resulting impairment of this optical
intangible asset. The net book value as of July 2003 of $217,000 was recorded as a loss on disposal in the Consolidated Statement of Operations.

Amortization
expense related to these assets was $865,000 in fiscal 2004 and $1.0 million in fiscal 2003. The decline in amortization expense is primarily related to the
impairment of the optical intangible, as previously discussed.

Estimated
amortization future amortization expense is as follows:

Years ended April 30,2005

$
8452006


7332007


2008


2009 and thereafter


$
1,578


48

---



Accrued Expenses: Accrued expenses comprised (in thousands):

April 30,2004

2003Accrued employee related

$
3,883

$
2,878Accrued warranty


1,980


1,588Accrued restructuring charges


1,064


29Accrued professional services


217


243Other accrued expenses


1,791


1,288Total

$
8,885

$
6,026


WarrantiesThe 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. As part of the sale of the Company's optical business to JDS Uniphase ("JDSU"), see Note 4, the Company has agreed to indemnify JDSU for warranty costs that JDSU
incurs for optical products sold by the Company prior to July 16, 2003.
Pursuant to the terms of the agreement with JDSU, JDSU will perform warranty repairs on these products and then bill the Company for the cost of those services at rates stipulated in the agreement.

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 Consolidated Balance Sheet, during the are as follows (in thousands):

Year ended April 30,2004

2003Balance as of the beginning of the fiscal period

$
1,588

$
1,178Provision for warranties issued during fiscal period


898


940Warranty costs incurred during fiscal period


(526
)

(648
)Other adjustments to the liability (including changes in estimates for pre-existing warranties) during fiscal period


20


118Balance as of the end of the fiscal period

$
1,980

$
1,588


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.

In
connection with the sale of the Company's echo cancellation software technology to Texas Instruments (TI) in April 2002 and the sale of the Company's optical business to JDSU
in July 2003,

49

---



the
Company indemnified TI and JDSU for various matters. In April 2004, the indemnifications to TI lapsed without a material cost to the Company. As part of the Company's indemnification to
JDSU, it has accrued a loss provision of $500,000 related to probable indemnifications of the realizability of inventory purchased by JDSU.

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.

4.     DISCONTINUED OPERATIONS

On July 16, 2003, the Company completed the primary step in the planned exit of its optical communications business through the sale of a large portion of
the assets of its optical communications business to JDSU, pursuant to an Asset Purchase Agreement (the "Purchase Agreement"). The assets sold consisted primarily of inventory, certain specified
optical-related equipment and intellectual property rights, which were sold for an aggregate purchase price of up to approximately $6.5 million in cash, of which (i) approximately
$1.4 million was paid to the Company at closing, (ii) $225,000 will be paid to the Company one year from the closing (subject to reduction in the event any successful indemnification
claims are made against the Company), and (iii) up to an additional $4.9 million to be paid to the Company, which is comprised of up to $900,000 based on the level of inventory consumed
by JDSU, and up to $4.0 million based on revenues generated by the optical business acquired by JDSU through June 30, 2005, if any. Additionally, JDSU has the right to require the
Company to reimburse JDSU for any purchased but unused inventory at June 30, 2004, up to $2.0 million, and certain costs incurred by JDSU in connection with the performance of certain
warranty obligations relating to optical products that were sold by the Company prior to July 16, 2003. During the last half of fiscal 2004, the Company recognized $855,000 associated with the
level of revenue generated by JDSU since
the close of the sale and a $144,000 tax benefit associated with the year-to-date loss from disposal, which benefit offset the domestic tax provision recognized from continuing
operations. The incremental sales proceeds and the tax benefit were offset by incremental loss accruals associated with closure of the Company's international optical operations and an estimated loss
provision associated with its indemnification of inventory purchased by JDSU which aggregated $1.1 million. The net effect of these items was reported as an incremental net loss on disposal of
discontinued operations in the Consolidated Statement of Operations.

The
Company has been aggressively pursuing the disposition, through sale, sublease or abandonment, of assets not included in the Purchase Agreement and facility leases for the Company's
Australian and United Kingdom optical research facilities. As of April 30, 2004, the Company had exited the Australian and United Kingdom facility leases and had sold substantially all of the
assets at these two international research operations. The Company is still in the process of disposing an insignificant amount of the remaining optical assets located in the United States. As a
result of exiting the optical business, the Company's Consolidated Statements of Operations reflect the optical business as a discontinued operation for all periods presented.

50

---



Certain information with respect to the discontinued optical communications business' operations is summarized below (in thousands):

Year ended April 30,2004

2003Revenue

$
1,656

$
12,286Gross profit (loss)


269


(180
)Operating expenses


2,807


33,939Operating loss


(2,538
)

(34,119
)Income tax provision





129Net loss from discontinued operations


(2,538
)

(34,248
)


The results of the optical business for the year ended April 30, 2003 include a restructuring charge and loss associated with impaired assets of
$6.8 million related to the discontinuation of the Company's Titanium optical system level product. This charge was included in the optical business' operating expenses. In addition, the
Company recognized an inventory write-down of $4.2 million related to the Titanium product, which write-down was included in cost of goods sold and resulted in a
negative gross margin in fiscal 2003.

The
following table shows the components of the gain (loss) from the disposal of the Company's discontinued operations for the year ended April 30, 2004 (in thousands):

Year ended April 30, 2004Proceeds from sale

$
2,926Less: Net book value of assets sold


4,671Transaction costs


221Loss on sale


(1,966
)Less: Costs to exit remainder of optical business


5,176Plus: Benefit for income taxes


144Net loss on disposition

$
(6,998
)


Due to the Company's net operating loss carry forward position and related full valuation allowance, no federal or state tax benefit was recorded associated with
the loss on the disposal of the optical business prior to the third quarter of fiscal 2004. Since the third quarter of fiscal 2004, a tax benefit from the disposition of $144,000 was recognized, which
offset the tax provision from continuing operations. The costs of exiting the optical business included severance and related costs for optical employees not hired by JDSU of $1.6 million, of
which $1.4 million had been paid as of April 30, 2004, impairment of optical assets not acquired by JDSU of $2.6 million, other exit costs associated with closure of international
optical subsidiaries of $530,000 and losses associated with abandonment of facility leases related to the Company's UK and Australian optical development operations of $497,000. Associated with the
closure of our international optical operations we have identified approximately $300,000 of potential additional closure costs, which may need to be paid to fully dissolve our international
operations. We are currently negotiating to mitigate these costs; as a result a probable and estimable loss has not been incurred. At such time that a loss becomes probable and estimable related to
this matter, we will record such loss provision as an additional adjustment to the loss from exiting the optical business.

5.     RESTRUCTURING AND OTHER SPECIAL CHARGES

As a result of the Company's decision to exit the optical communications business in the first quarter of fiscal 2004, the Company incurred certain restructuring
charges associated with general costs that did not qualify for discontinued operations treatment. The restructuring was designed to reduce

51

---



the
level of certain general costs that were deemed excess as a result of the Company's decision to exit its optical business and included a loss reserve for excess leased space in the Company's
Mountain View, California headquarters and severance of certain corporate level employees.

As
a result of this restructuring, the Company recorded restructuring charges of $275,000, which have been classified as operating expenses. The following paragraphs provide detailed
information on each of the components of the restructuring charges, which were recorded in the first quarter of fiscal 2004.

Workforce Reduction.The restructuring resulted in the termination of two employees whose focus was primarily corporate in
nature. The workforce reductions were substantially completed in the first quarter of fiscal 2004. The Company recorded a workforce reduction charge of approximately $21,000 relating to severance pay
and continuation of certain fringe benefits for the impacted employees.

Lease Loss Provision.The Company initially recorded a $995,000 restructuring charge associated with the abandonment of
excess leased space in its Mountain View headquarters. The charge was based on the monthly rental and related costs on the abandoned space of approximately 11,000 square feet less the anticipated
sublease income that the Company hoped to derive from the space based on current market conditions in the Mountain View area and impairment of leasehold improvements associated with the abandoned
space. In March 2004, the then remaining portion of the loss provision for the building of $741,000 was reversed back through the restructuring charge line, when the Company made the decision
to begin using the space again. The reversal was predicated on the significant changes that had occurred in the Company's business since the first quarter of fiscal 2004 when the original decision was
made to abandon the space. At the time of the original provision, the Company was projecting what it viewed as good (20%) revenue growth during fiscal 2004, based on the Company's client base and the
overall state of the telecommunications industry. However with fiscal 2004 revenue growth approximating almost 100% growth over fiscal 2003, almost five times the Company's plan at the beginning of
the year and an expectation that the Company would see modest growth again in fiscal 2005, coupled with incremental hiring requirements to begin development of the Company's next generation voice
products the headcount and therefore space demands far exceeded the Company's expectations. As a result, the fiscal year reflects a net loss provision of $254,000 related to our facility lease,

As
of the end of April 2004, virtually all of the costs associated with the severances and related benefits and the lease costs while the facility was abandoned had been paid.

6.     ACCOUNTING FOR GOODWILL

The changes in the carrying amount of goodwill for the year ended April, 2003 are as follows (in thousands):

Balance as of May 1, 2002

$
35,998Reclassification of acquisition related intangible asset


839Cumulative effect of accounting change


(36,837
)Balance as of April 30, 2003

$



The reclassification of the acquisition related intangible asset primarily relates to the net book value of the workforce intangible, as it no longer met the
definition of a discrete intangible asset under the provisions of SFAS 142. This reclassification was made as part of the Company's adoption of SFAS 142.

The
Company performed a transitional impairment test of its goodwill and intangible assets as of May 1, 2002. Due to the continuing soft telecommunications market and the
depressed values of

52

---



telecommunications
equipment provider stocks, the Company recorded a transitional goodwill impairment loss of $36.8 million which was recorded as a cumulative effect of an accounting change in
the Company's Consolidated Statement of Operations for the first quarter of fiscal 2003. The fair value of the optical reporting unit giving rise to the transitional impairment loss was estimated
using a combination of the expected present value of future cash flows and a market value approach.

Due
to the adoption of SFAS 142, the Company ceased amortizing goodwill effective May 1, 2002. Had SFAS 142 been adopted for the year ended April 30, 2002,
the Company would not have recorded goodwill amortization expense of $19.6 million. The following table summarizes (in thousands, except per share amounts) the Company's net loss adjusted to
exclude goodwill amortization expense and the related tax effect, as if amortization had ceased effective May 1, 2000. The net loss for the year ended April 30, 2003 includes the
transitional impairment loss of $36.8 million related to adoption of SFAS 142.

Year ended April 302003

2002Reported net loss

$
(75,110
)
$
(85,329
)Goodwill amortization, net of tax





19,617Adjusted net loss

$
(75,110
)
$
(65,712
)Basic loss per share:As reported

$
(2.47
)
$
(2.90
)Adjusted

$
(2.47
)
$
(2.24
)Diluted loss per share:As reported

$
(2.47
)
$
(2.90
)Adjusted

$
(2.47
)
$
(2.24
)


7.     COMMITMENTS AND CONTINGENCIES



The Company leases its principal office facilities in Mountain View, California under a non-cancelable operating lease expiring in June 2006.
The Company is responsible for taxes, insurance and maintenance expenses related to the leased facilities. Presently, there is no option for renewal of the lease on our Mountain View facilities. The
Company also has operating leases on certain office equipment.

At
April 30, 2004, future minimum payments under the leases are as follows (in thousands):

Years ended April 30,2005

$
1,9282006


1,9852007


3772008


382009 and thereafter


$
4,328


Rent expense under all leases for the years ended April 30, 2004, 2003 and 2002, was $2,311,000, $2,752,000 and $2,742,000, respectively. Included in these
rent amounts was $71,000, $255,000, and $205,000 in fiscal 2004, 2003 and 2002, respectively, which was related to rent at the Company's

53

---



international
optical operations and has been reflected in discontinued operations and $254,000 in fiscal 2004 which is included in the restructuring charge.



Effective August 28, 2003, the Company renewed its $2.0 million operating line of credit agreement with its bank. The renewed line of credit expires
on July 31, 2004. Advances under the line bear interest at the rate of prime plus 0.25%. The credit facility is collateralized by substantially all of the Company's current and future assets.
The credit facility provides for certain financial covenants, including but not limited to: minimum tangible net worth of $75 million plus 50% of all proceeds from the sale of subordinated debt
or equity securities subsequent to August 7, 2002; and minimum unrestricted cash of at least $20 million. The facility also restricts the payment of dividends and limits the Company's
ability to dispose of all or substantially all of its assets or to merge with another company. As of April, 2004, the Company had no borrowings outstanding under the line of credit.

8.     SALE OF ECHO CANCELLATION TECHNOLOGY

On April 16, 2002, the Company sold its echo cancellation and voice enhancement software technology, the associated product licenses and all of the related
assets to Texas Instruments ("TI") for an aggregate price of $26.8 million. Of the total price, $18.3 million was paid in cash on the closing, $5 million was received in
April 2003 on the first anniversary of the closing date and the balance of $3.5 million was collected in April 2004. Concurrent with the closing of the sale, all of the
individuals employed in the echo cancellation software group, including those individuals assumed as part of the Telinnovation acquisition in February 2000, were hired by TI. Additionally, in
connection with the sale, Ditech received, at no cost, a license from TI and Telogy Networks, Inc., a wholly owned subsidiary of TI, to use the existing echo cancellation and voice enhancement
software and any enhancements in Ditech's products for a period of four years. A value of $3.0 million was assigned to this four year license period, which value is being amortized to cost of
goods sold over the four year term. After this initial four year period expires, Ditech can license the software technology on a per unit royalty formula based on the most favorable rates offered by
TI to other customers.

The
sale resulted in a net gain of $583,000, which was reported as part of other income, net in fiscal 2002. The gain was calculated as follows (in thousands):

Proceeds from sale

$
26,800Less:Goodwill


6,341Purchased technology


11,469Deferred stock compensation


6,056Property and equipment


18Existing license


1,354Transaction costs


979Net gain on sale

$
583


9.     PREFERRED STOCK

Ditech is authorized to issue, from time to time, in one or more series, 5,000,000 shares of preferred stock at a $0.001 par value. The Board of Directors may
determine the rights, preferences, privileges and restrictions granted or imposed upon any series of preferred stock. As of April 30, 2004, no preferred stock was outstanding.

54

---



In
March 2001, the Company's Board of Directors adopted a Preferred Share Purchase Rights Plan designed to enable Ditech stockholders to realize the full value of their investment
and to provide for fair and equal treatment for all Ditech stockholders in the event that an unsolicited attempt is made to acquire Ditech. Under the Plan, stockholders will receive one right to
purchase one-thousandth of a share of newly designated Series A Junior Participating Preferred Stock of Ditech at an initial exercise price of $75.00 for each outstanding share of
Ditech common stock held at the close of business on April 16, 2001. The rights expire on March 25, 2011.

10.   STOCKHOLDERS' EQUITY



In March and April 1999, the Board adopted, and the stockholders approved, the Company's 1999 Employee Stock Purchase Plan (the "Purchase Plan") under
which an aggregate of 1,416,666 shares of common stock has been reserved as of April 30, 2004. Employees who participate in an offering period can have up to 10% of their earnings
withheld pursuant to the Purchase Plan. The amount withheld will then be used to purchase shares of the common stock on specified dates determined by the Board. The price of common stock purchased
under the Purchase Plan will be equal to 85% of the lower of the fair market value of the common stock on the commencement date of each offering period or on the specified purchase date. In fiscal
2004, 2003 and 2002, shares purchased under the plan totaled 175,310, 332,048 and 284,067 shares, respectively. As of April 30, 2004, 424,985 shares remain available for issuance under
the Purchase Plan.



The Company's 1997 Stock Option Plan serves as the successor equity incentive program to the Company's 1987 Stock Option Plan and the Supplemental Stock Option
Plan (the "Predecessor Plans"). All outstanding stock options under the Predecessor Plans continue to be governed by the terms and conditions of the 1997 Stock Option Plan. The Company reserved
4,000,000 shares of common stock for issuance under the 1997 Stock Option Plan. Under the 1997 Stock Option Plan, the Board of Directors could grant incentive or non-statutory stock
options at a price not less than 100% or 85%, respectively, of fair market value of common stock, as determined by the Board of Directors, at grant date. In November 1998, the Company adopted
its 1998 Stock Option Plan and determined not to grant any further options under its 1997 Stock Option Plan. The Company has reserved a total of 3,856,082 shares of common stock for issuance
under the 1998 Stock Option Plan, under terms similar to those of the 1997 Stock Option Plan. During fiscal 2000, the Company adopted two non-statutory stock option plans under which a
total of 1,350,000 shares were reserved for issuance. The terms of non-statutory options granted under these plans are substantially consistent with non-statutory
options granted under the 1997 and 1998 plans.

On
July 25, 2000, the Company purchased the net assets of Atmosphere Networks, and assumed all outstanding stock options that had been granted under the Atmosphere Networks 1997
Stock Plan (the "Atmosphere Plan"). The option shares under the Atmosphere Plan were converted into 122,236
options to purchase Ditech common stock. The calculation of the conversion of option shares was determined using the approximate fair market values of the Atmosphere Networks and Ditech common stock
prices within a one-week period up to the date of the acquisition. After July 25, 2000, no new options are permitted to be granted under the Atmosphere Plan. The options granted
under this plan are substantially consistent with the terms of options granted under Ditech's stock option plans.

In
August 2000, the Board of Directors adopted the 2000 Non-Qualified Stock Plan. A total of 5,000,000 shares have been reserved under this stock option plan as
of April 30, 2004. The terms of non-statutory options granted under this plan are substantially consistent with non-statutory options granted under the 1997 and 1998
plans.

55

---



All
options under all option plans described above are immediately exercisable and have a ten-year term. Shares issued through early option exercises are subject to the
Company's right of repurchase at the original exercise price. The number of shares subject to repurchase generally decreases by 25% of the option shares one year after the grant date, and thereafter,
ratably over 36 months. As of April 30, 2004, 1,776 shares were subject to repurchase.

In
March 1999, the Company adopted the 1999 Non-Employee Directors' Stock Option Plan. Under this stock option plan an aggregate of 650,000 shares are reserved
as of April 30, 2004. Options granted under the plan have a 5-year term. One-time initial automatic grants of 50,000 shares each are made upon a director's
initial appointment and are subject to annual vesting over a four-year period. Annual automatic grants of 10,000 shares each are made on the date of each annual meeting of
stockholders to each incumbent director (provided they have served as a director for at least six months) and are fully vested at the grant date.

In
February 2003, the Company commenced a stock option exchange program, which allowed its employees with outstanding options under certain specified stock option plans with an
exercise price of $20.00 or more per share, to exchange, pursuant to the terms of the exchange program, their qualifying outstanding options, for replacement options to be issued on
September 23, 2003. The exchange was conducted on a one-for-four (1:4) basis; thus a participating employee would receive replacement options covering 25% of the number
of shares subject to the original options surrendered for cancellation. On March 19, 2003, employees surrendered for cancellation options to purchase a total of 1,193,719 shares.

On
September 23, 2003, the Company granted options for the purchase of 165,730 shares of its common stock pursuant to the option exchange program at an exercise price equal to the
market value of the Company's stock on that day of $10.35 per share. The decline in the number of shares granted under the option exchange program from that originally eligible was due to employee
terminations that
occurred primarily in the first quarter of fiscal 2004 as a result of exiting the optical communications business and the related restructuring.

Activity
under the stock option plans referenced above was as follows (in thousands, except per share amounts):

|                         |                       |       |        | Outstanding Options
|------------------------ | --------------------- | ----- | ------ | -------------------
|
|Balances, May 1, 2001    |                       | 763   |        | 5,958              
|                         | Reservation of shares |       | 1,500  |                    
|                         | Options granted       |       | (1,381 | )                  
|                         | Options exercised     |       |       |                    
|                         | Options canceled      |       | 754    |                    
|                         |                       |       |        |                    
|Balances, April 30, 2002 |                       | 1,636 |        | 6,450              
|                         | Reservation of shares |       | 2,100  |                    
|                         | Options granted       |       | (2,984 | )                  
|                         | Options exercised     |       |       |                    
|                         | Options canceled      |       | 2,443  |                    
|                         |                       |       |        |                    
|Balances, April 30, 2003 |                       | 3,195 |        | 6,576              
|                         | Reservation of shares |       | 250    |                    
|                         | Options granted       |       | (2,400 | )                  
|                         | Options exercised     |       |       |                    
|                         | Options canceled      |       | 975    |                    
|                         |                       |       |        |                    
|Balances, April 30, 2004 |                       | 2,020 |        | 5,724              
|                         |                       |       |        |                    

56

---



Options outstanding and exercisable at April 30, 2004 (in thousands, except life and per share amounts):

|               |  | Options Outstanding |  |   |       | Options Exercisable
|-------------- |  | ------------------- |  | - | ----- | -------------------
|
|
|$0.41 - $2.85  |  | 880                 |  | $ | 2.42  |                    
|$2.92 - $7.12  |  | 948                 |  | $ | 4.19  |                    
|$7.18 - $8.41  |  | 919                 |  | $ | 7.23  |                    
|$8.56 - $8.76  |  | 1,977               |  | $ | 8.76  |                    
|$8.82 - $79.50 |  | 1,000               |  | $ | 12.38 |                    
|               |  |                     |  |   |       |                    
|$0.41 - $79.50 |  | 5,724               |  | $ | 7.42  |                    
|               |  |                     |  |   |       |                    

The estimated weighted average fair value of options granted during fiscal years 2004, 2003 and 2002 was $5.52, $1.93 and $4.38 per share,
respectively. The estimated weighted average fair value of shares granted under the Employee Stock Purchase Plan was $0.58, $0.76 and $2.27 in fiscal 2004, 2003 and 2002, respectively.

The
fair value of options granted under the Company's stock option plans during fiscal 2004, 2003 and 2002 was estimated on the date of grant using the Black-Scholes option pricing
model. The model utilized the multiple option approach with the following weighted average assumptions used: no dividend yield, expected volatility of 91%, 107% and 123% in fiscal 2004, 2003 and 2002,
respectively, risk-free interest rates of 2.38%, 3.08% and 4.01% in fiscal 2004, 2003 and 2002, respectively, and expected life of four years for the option plans. The Employee Stock
Purchase Plan used the following weighted average assumptions: no dividend yield, expected volatility of 58%, 77% and 71% in fiscal 2004, 2003 and 2002, respectively, risk-free interest
rates of 1.63%, 1.77% and 2.80% in fiscal 2004, 2003 and 2002, respectively, and expected life of six months. Forfeitures are recognized as they occur.

During
fiscal 1999, the Company granted options to certain employees under the 1997 Stock Plan and 1998 Stock Option Plan with exercise prices below the deemed fair market value of the
Company's common stock at the date of grant. In accordance with the requirements of APB 25, the Company has recorded deferred compensation for the difference between the exercise price of the stock
options and the fair market value of the Company's shares at the date of grant. This deferred compensation has been amortized to expense over the period during which the options become exercisable,
generally four years. At April 30, 1999, the Company had recorded deferred compensation related to these options in the total amount of $1.3 million, of which $142,000 and $283,000 had
been amortized to general and administrative expense during 2003 and 2002, respectively. The deferred compensation was fully amortized during fiscal 2003, and no further amortization will occur for
this item. The gross amount of deferred compensation was reduced from time to time for option cancellations due to employee terminations and was fully amortized during fiscal 2003.

In
connection with the acquisition of Atmosphere Networks, the Company issued nonqualified stock options for approximately 750,000 shares of our common stock at a price equal to a
50% discount from the market value of the stock on its grant date of August 1, 2000. The discount was recorded as initial deferred compensation of $17.3 million in August 2000.
The gross amount of deferred compensation has been reduced from time to time for option cancellations due to employee terminations. As part to the stock option exchange program undertaken in the
fourth quarter of fiscal 2003, discussed above, all remaining shares under option from this option grant were canceled. As such, all remaining deferred compensation that existed as of the closing date
of the tender period was recognized as expense in the fourth quarter of fiscal 2003 and no further amortization will occur for this item. In fiscal 2003 and 2002, $3.1 million and
$3.4 million, respectively, of this deferred compensation was amortized and included in the loss form discontinued operations as it was solely attributable to our optical operations.

57

---



11.   INCOME TAXES

The provisions for income taxes reflected in the statements of operations for the years ended April 30 consist of (in thousands):

2004

2003

2002Current:Federal

$
76




$
(17,505
)State








2Foreign


50

$
129


128Total current

$
126


129


(17,375
)Deferred:Federal








19,291State








3,194Total deferred








22,485Total

$
126

$
129

$
5,110


The deferred tax provisions for fiscal 2004, 2003 and 2002 reflect the tax effects of changes in the amounts of temporary differences during each year, offset by
the establishment of a full valuation allowance against the net deferred tax asset position, due to uncertainty surrounding the realization of the benefit of such assets. Management periodically
evaluates the recoverability of the deferred tax assets and will recognize the tax benefit only as reassessment demonstrates they are realizable. At such time, if it is determined that it is more
likely than not that the deferred tax assets are realizable, the valuation allowance will be reduced. The income tax benefit associated with nonqualified stock options and disqualifying dispositions
of incentive stock options and employee stock purchase plan stock is recorded as an increase to additional paid in capital.

The
components of the Company's deferred tax assets and liabilities at April 30 consisted of (in thousands):

2004

2003Deferred tax assets (liabilities):Uniform capitalization

$
677

$
618Depreciation


267


267Inventory reserves


4,691


5,618Other reserves and accruals


2,203


1,315Purchased technology, goodwill and other intangibles


868


999Tax credits


7,545


6,684Net operating losses


35,978


32,008Total deferred tax assets


52,229


47,509Less valuation allowance


(52,229
)

(47,509
)Net deferred tax assets

$


$



The Company has federal and state tax net operating loss carryforwards of approximately $90.2 million and $107.7 million, respectively, available to
offset future taxable income. The Company has federal and state tax credit carryforwards of approximately $5.4 million and $3.1 million, respectively. The net operating loss and tax
credit carryforwards expire between 2005 and 2024 if not utilized. The Company's tax net operating loss and tax credit carryforwards include federal and state net operating loss carryforwards of
approximately $27.2 million and $17.6 million, respectively,

58

---



generated
by Atmosphere Networks prior to its acquisition, and are subject to annual limitations which could reduce or defer the utilization of those losses and credits.

The
Company's effective tax rate differs from the U.S. federal statutory income tax rate for the years ended April 30, principally due to the following:

2004

2003

2002Tax provision (benefit) at federal statutory rate

35.0
%
(35.0
)%
(35.0
)%State taxes, net of federal benefit

5.7

(5.7
)
(5.9
)Non-deductible goodwill and other intangible amortization

3.8

3.2

7.5Tax-exempt interest income





(0.1
)Valuation allowance

(39.8
)
37.4

41.3Other, including non-deductible expenses

(3.2
)
0.4

(1.4
)Effective tax rate

1.5
%
0.3
%
6.4
%


12.   REPORTABLE SEGMENTS AND GEOGRAPHIC INFORMATION

As a result of the Company exiting the optical communications business in the first quarter of fiscal 2004, that segment is now being reported as a discontinued
operation in the consolidated statements of operations for all periods presented. As such, the Company currently operates in a single segment, voice quality products, and segment data will no longer
be reported.

The
Company's revenues from external customers by geographic region, based on ship to destination, were as follows (in thousands):

Years ended April 30,2004

2003

2002USA

$
61,916

$
29,305

$
22,528Asia Pacific


1,348


1,382


544Canada


1,914


1,926


2,424Latin America


547


572


1,715Europe


3,865


1,903


3Total

$
69,590

$
35,088

$
27,214


The Company's long lived assets by geographic region were as follows (in thousands):

As of April 30,2004

2003USA

$
3,552

$
7,358United Kingdom


51


803Australia





732Total

$
3,603

$
8,893


The decline in long-lived assets during fiscal 2004 is due to the sale and/or impairment of optical long-lived assets due to exiting the
optical business. As the Company's international operations in the United Kingdom and Australia were primarily dedicated to optical research, substantially all of their assets have been sold or
impaired.

13.   PROFIT SHARING PLAN

The Company maintains a 401(k) profit sharing plan for all eligible employees. Employees may contribute to the Plan based on statutory limits. Any Company
contributions are at the discretion of

59

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the
Board of Directors. The Company made contributions to the Plan during fiscal 2004, 2003 and 2002 of $45,000, $70,000 and $55,000, respectively.

14.   RELATED PARTY TRANSACTION

In October 2001, the Company advanced its Vice President of Optical Sales $750,000 under a secured note receivable agreement. The note, which was
classified as other long-term assets on the balance sheet, was due with interest at the rate of 4.59% on November 1, 2004. The note was full recourse and secured by an investment
account owned by the Vice President of Optical Sales, which has in excess of $750,000 of debt and equity instruments. The note and all accrued interest was repaid by the Vice President in the first
quarter of fiscal 2004.

15.   SUPPLEMENTAL CASH FLOW INFORMATION

(in thousands)

Years ended April 30,2004

2003

2002Operating:Interest paid

$
11

$
11

$
31Income taxes paid


64


50


11Non-cash financing and investing activities:Deferred stock compensation





(2,904
)

(2,346
)Deferred compensation associated with stock options issued to consultants








104


SUPPLEMENTARY FINANCIAL DATA (unaudited)

The following quarterly data reflects the treatment of the Company's optical business, which was sold in July 2003, as a discontinued operation. See
Note 4 of the Notes to the Consolidated Financial Statements (in thousands, except per share data).

|                                                                                       |                                                                                        | Fiscal 2004 |        | Fiscal 2003 |  
|-------------------------------------------------------------------------------------- | -------------------------------------------------------------------------------------- | ----------- | ------ | ----------- | -
|
|Revenue                                                                                |                                                                                        | $           | 10,717 |             | $
|Gross profit                                                                           |                                                                                        | $           | 6,963  |             | $
|Income (loss) from continuing operations before cumulative effect of accounting change |                                                                                        | $           | (516   | )           | $
|Net income (loss)                                                                      |                                                                                        | $           | (9,925 | )           | $
|Basic per share data                                                                   |                                                                                        |             |        |             |  
|                                                                                       | Income (loss) from continuing operations before cumulative effect of accounting change |             | $      | (0.02       | )
|                                                                                       | Net income (loss)                                                                      |             | $      | (0.32       | )
|Diluted per share data                                                                 |                                                                                        |             |        |             |  
|                                                                                       | Income (loss) from continuing operations before cumulative effect of accounting change |             | $      | (0.02       | )
|                                                                                       | Net income (loss)                                                                      |             | $      | (0.32       | )

60

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Item 9Changes in and Disagreements with Accountants on  Accounting and Financial Disclosure

Not Applicable.

Item 9AControls and Procedures

We carried out an evaluation, under the supervision and with the participation of Timothy Montgomery, our principal executive officer, and William Tamblyn, our
principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Securities Exchange Act Rules 13a-15(e) and
15d-15(e)) as of April 30, 2004. Based on this evaluation, Messrs. Montgomery and Tamblyn concluded that our disclosure controls and procedures were effective as of
April 30, 2004 to provide a reasonable assurance that the information required to be disclosed by us in this Annual Report on Form 10-K was recorded, processed, summarized
and reported within the time periods specified by the Securities and Exchange Commission's rules and Form 10-K. It should be noted that a control system, no matter how well
conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. For example, controls can be circumvented by a person's individual acts,
by collusion of two or more people or by management override of the control. Because a cost-effective control system can only provide reasonable assurance that the objectives of the
control system are met, misstatements due to error or fraud may occur and not be detected.

In
addition, we reviewed our internal controls, and there were no changes in our internal control over financial reporting during the quarter ended April 30, 2004, that have
materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

61

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Part III

Item 10Directors and Executive Officers of the Registrant

Directors.Information concerning our Directors is incorporated by reference to the section entitled "Proposal
1Election of Directors" contained in our definitive Proxy Statement with respect to our Annual Meeting of Stockholders to be filed with the Securities and Exchange Commission not later
than August 29, 2004 in connection with the solicitation of proxies for the Company's Annual Meeting of Stockholders to be held September 17, 2004 (the "Proxy Statement").

Executive Officers.Information concerning our Executive Officers is set forth under the section entitled "Executive Officers
of Ditech" in the Proxy Statement and is incorporated herein by reference.

Section 16(a) Beneficial Ownership Reporting Compliance.Information concerning compliance with Section 16(a)
of the Securities Act of 1934 is set forth in the section entitled "Section 16(a) Beneficial Ownership Reporting Compliance" contained in our Proxy Statement and is incorporated herein by
reference

Code of Business Conduct and Ethics.The information required by this Item with respect to our code of conduct and ethics is
incorporated herein by reference from the section captioned "Proposal 1Election of Directors-Code of Business Conduct and Ethics" contained in the Proxy Statement.

Item 11Executive Compensation

The information required by this Item is set forth in the Proxy Statement under the captions "Compensation of Executive Officers" and "Compensation Committee
Interlocks and Insider Participation." Such information is incorporated herein by reference.

Item 12Security Ownership of Certain Beneficial Owners and Management  and Related Stockholder Matters

The information required by this Item with respect to security ownership of beneficial owners and management is set forth in the Proxy Statement under the
caption, "Security Ownership of Certain Beneficial Owners and Management." Such information is incorporated herein by reference.

The
information required by this Item with respect to securities authorized for issuance under our equity compensation plans is set forth in the Proxy Statement under the caption "Equity
Compensation Plan Information." Such information is incorporated herein by reference.

Item 13Certain Relationships and Related Transactions

The information required by this Item is set forth in the Proxy Statement under the heading "Certain Relationships and Related Transactions." Such information is
incorporated herein by reference.

Item 14Principal Accountant Fees and Services

The information required by this Item is set forth in the Proxy Statement under the heading "Proposal 2Ratification of Selection of Independent
Auditors." Such information is incorporated herein by reference.

62

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Part IV

Item 15Exhibits, Financial Statement Schedules and Reports on Form 8-K



Schedule II
Valuation and Qualifying Accounts
(in thousands)

|                          |                                                | Balance at Beginning of Year |   | Additions |  | Deductions |       | Balance at End of Year
|------------------------- | ---------------------------------------------- | ---------------------------- | - | --------- |  | ---------- | ----- | ----------------------
|Year ended April 30, 2002 |                                                |                              |   |           |  |            |       |                       
|                          | Allowance for doubtful accounts(1)             |                              | $ | 597       |  | $          | 231   |                       
|                          | Provision for excess and obsolete inventory(2) |                              | $ | 2,802     |  | $          | 3,382 |                       
|Year ended April 30, 2003 |                                                |                              |   |           |  |            |       |                       
|                          | Allowance for doubtful accounts(1)             |                              | $ | 740       |  | $          | 100   |                       
|                          | Provision for excess and obsolete inventory(2) |                              | $ | 5,357     |  | $          | 8,328 |                       
|Year ended April 30, 2004 |                                                |                              |   |           |  |            |       |                       
|                          | Allowance for doubtful accounts(1)             |                              | $ | 811       |  | $          |      |                       
|                          | Provision for excess and obsolete inventory(2) |                              | $ | 11,292    |  | $          | 3,648 |                       

---

63

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Report of Independent Registered Public Accounting Firm on Financial Statement Schedules

To
the Board of Directors and Stockholders of Ditech Communications Corporation:

Our
audits of the consolidated financial statements referred to in our report dated May 25, 2004, appearing on page 36 of this Annual Report to Shareholders on
Form 10-K of Ditech Communications Corporation also included an audit of the financial statement schedule listed in Item 15(a)(2) of this Form 10-K. In our
opinion, this financial statement schedule presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements.

/s/PRICEWATERHOUSECOOPERS LLP

San
Jose, California
May 25, 2004



|Exhibit      |  | Description of document                                                                                                  
|------------ |  | -------------------------------------------------------------------------------------------------------------------------
|2.1(1)       |  | Asset Purchase Agreement, dated as of April 16, 2002, by and between Ditech and Texas Instruments                        
|2.2(2)       |  | Asset Purchase Agreement, dated as of July 16, 2003, by and between Ditech and JDSU.                                     
|3.1(4)       |  | Restated Certificate of Incorporation of Ditech                                                                          
|3.2(5)       |  | Bylaws of Ditech, as amended and restated on March 28, 2002                                                              
|3.3(6)       |  | Certificate of Designation of Series A Junior Participating Preferred Stock                                              
|4.1          |  | Reference is made to Exhibits 3.1, 3.2 and 3.3                                                                           
|4.2(7)       |  | Specimen Stock Certificate                                                                                               
|4.3(6)       |  | Rights Agreement, dated as of March 26, 2001 among Ditech Communications Corporation and Wells Fargo Bank Minnesota, N.A.
|4.4(6)       |  | Form of Rights Certificate                                                                                               
|10.1(7)      |  | Lease Agreement, dated August 18, 1998, between Ditech and Lincoln-Whitehall Pacific, LLC, as amended January 25, 1999   
|10.2(7)(8)   |  | 1997 Stock Option Plan                                                                                                   
|10.3(8)(12)  |  | 1998 Amended and Restated Stock Option Plan                                                                              
|10.4(8)(15)  |  | 1999 Employee Stock Purchase Plan                                                                                        
|10.5(8)(15)  |  | 1999 Non-Employee Directors' Stock Option Plan                                                                           
|10.6(7)(8)   |  | Employment Agreement, dated October 3, 1997, as amended September 15, 1998, between Ditech and Timothy Montgomery        
|10.7(8)(14)  |  | 1999 Non-Officer Equity Incentive Plan                                                                                   
|10.8(5)(8)   |  | Employment Offer, dated June 19, 2001, between Ditech and Lowell Trangsrud                                               
|10.9(8)(11)  |  | Employment Offer, dated as of April 30, 2002, between Ditech and Sandeep Pombra                                          
|10.10(12)    |  | Loan and Security Agreement, dated August 7, 2002, by and between Ditech and Comerica Bank-California                    
|10.12(8)(13) |  | Employment Letter, dated April 25, 2002 between Ditech and Lee House                                                     
|10.16(7)(8)  |  | Form of Indemnity Agreement to be entered between Ditech and each of its current executive officers and directors        
|10.18(7)     |  | Stock Purchase Agreement, dated as of September 15, 1997 between Ditech and William Hasler                               
|10.19(7)(8)  |  | Form of option agreement under the 1997 Stock Option Plan                                                                
|             |  |                                                                                                                          

64

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|10.20(7)(8)  |  | Form of option agreement under the 1998 Stock Option Plan                                                                                  
|------------ |  | -------------------------------------------------------------------------------------------------------------------------------------------
|10.21(9)(10) |  | Patent License Agreement, dated as of August 13, 1999, between Ditech and Antec Corporation                                                
|10.26(3)     |  | Second Lease Amendment, dated February 15, 2000, between Ditech and Middlefield-Bernardo Associates LLC                                    
|10.28(8)(12) |  | 2000 Non-Qualified Stock Option Plan                                                                                                       
|10.31(1)(9)  |  | Software License Agreement, dated as of April 16, 2002, by and between Ditech and Telogy                                                   
|10.32(9)(16) |  | Amendment No. 1 to Telogy Software License between Ditech Communications Corporation and Texas Instruments Incorporated, dated May 21, 2003
|10.33(17)    |  | First Amendment to Loan and Security Agreement dated August 28, 2003 between Ditech Communications Corporation and Comerica BankCalifornia
|10.34(8)(17) |  | Employment Agreement, dated September 16, 2003, between Ditech Communications Corporation and Jim H. Grady                                 
|21.1         |  | Subsidiaries of Ditech Communications Corporation                                                                                          
|23.1         |  | Consent of PricewaterhouseCoopers LLP                                                                                                      
|31.1         |  | Certification by Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                                         
|31.2         |  | Certification by Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                                         
|32.1         |  | Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                                                                    

---

65

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66

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.

|              | DITECH COMMUNICATIONS CORPORATION
|------------- | ---------------------------------
|July 13, 2004 | By:                              

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in
the capacities and on the dates indicated.

|Signatures                                      |  | Title                                                                                                   |  | Date         
|----------------------------------------------- |  | ------------------------------------------------------------------------------------------------------- |  | -------------
|                                                |  |                                                                                                         |  |              
|/s/TIMOTHY K. MONTGOMERYTimothy K. Montgomery   |  | President, Chief Executive Officer and Chairman of the Board of Directors (principal executive officer) |  | July 13, 2004
|/s/WILLIAM J. TAMBLYNWilliam J. Tamblyn         |  | Executive Vice President and Chief Financial Officer (principal financial and accounting officer)       |  | July 13, 2004
|/s/GREGORY M. AVISGregory M. Avis               |  | Director                                                                                                |  | July 13, 2004
|/s/EDWIN L. HARPEREdwin L. Harper               |  | Director                                                                                                |  | July 13, 2004
|/s/WILLIAM A. HASLERWilliam A. Hasler           |  | Director                                                                                                |  | July 13, 2004
|/s/ANDREI M. MANOLIU, PHDAndrei M. Manoliu, Phd |  | Director                                                                                                |  | July 13, 2004
|/s/DAVID M. SUGISHITADavid M. Sugishita         |  | Director                                                                                                |  | July 13, 2004

67

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Exhibit Index

|Exhibit      |  | Description of document                                                                                                                    
|------------ |  | -------------------------------------------------------------------------------------------------------------------------------------------
|2.1(1)       |  | Asset Purchase Agreement, dated as of April 16, 2002, by and between Ditech and Texas Instruments                                          
|2.2(2)       |  | Asset Purchase Agreement, dated as of July 16, 2003, by and between Ditech and JDSU.                                                       
|3.1(4)       |  | Restated Certificate of Incorporation of Ditech                                                                                            
|3.2(5)       |  | Bylaws of Ditech, as amended and restated on March 28, 2002                                                                                
|3.3(6)       |  | Certificate of Designation of Series A Junior Participating Preferred Stock                                                                
|4.1          |  | Reference is made to Exhibits 3.1, 3.2 and 3.3                                                                                             
|4.2(7)       |  | Specimen Stock Certificate                                                                                                                 
|4.3(6)       |  | Rights Agreement, dated as of March 26, 2001 among Ditech Communications Corporation and Wells Fargo Bank Minnesota, N.A.                  
|4.4(6)       |  | Form of Rights Certificate                                                                                                                 
|10.1(7)      |  | Lease Agreement, dated August 18, 1998, between Ditech and Lincoln-Whitehall Pacific, LLC, as amended January 25, 1999                     
|10.2(7)(8)   |  | 1997 Stock Option Plan                                                                                                                     
|10.3(8)(12)  |  | 1998 Amended and Restated Stock Option Plan                                                                                                
|10.4(8)(15)  |  | 1999 Employee Stock Purchase Plan                                                                                                          
|10.5(8)(15)  |  | 1999 Non-Employee Directors' Stock Option Plan                                                                                             
|10.6(7)(8)   |  | Employment Agreement, dated October 3, 1997, as amended September 15, 1998, between Ditech and Timothy Montgomery                          
|10.7(8)(14)  |  | 1999 Non-Officer Equity Incentive Plan                                                                                                     
|10.8(5)(8)   |  | Employment Offer, dated June 19, 2001, between Ditech and Lowell Trangsrud                                                                 
|10.9(8)(11)  |  | Employment Offer, dated as of April 30, 2002, between Ditech and Sandeep Pombra                                                            
|10.10(12)    |  | Loan and Security Agreement, dated August 7, 2002, by and between Ditech and Comerica Bank-California                                      
|10.12(8)(13) |  | Employment Letter, dated April 25, 2002 between Ditech and Lee House                                                                       
|10.16(7)(8)  |  | Form of Indemnity Agreement to be entered between Ditech and each of its current executive officers and directors                          
|10.18(7)     |  | Stock Purchase Agreement, dated as of September 15, 1997 between Ditech and William Hasler                                                 
|10.19(7)(8)  |  | Form of option agreement under the 1997 Stock Option Plan                                                                                  
|10.20(7)(8)  |  | Form of option agreement under the 1998 Stock Option Plan                                                                                  
|10.21(9)(10) |  | Patent License Agreement, dated as of August 13, 1999, between Ditech and Antec Corporation                                                
|10.26(3)     |  | Second Lease Amendment, dated February 15, 2000, between Ditech and Middlefield-Bernardo Associates LLC                                    
|10.28(8)(12) |  | 2000 Non-Qualified Stock Option Plan                                                                                                       
|10.31(1)(9)  |  | Software License Agreement, dated as of April 16, 2002, by and between Ditech and Telogy                                                   
|10.32(9)(16) |  | Amendment No. 1 to Telogy Software License between Ditech Communications Corporation and Texas Instruments Incorporated, dated May 21, 2003
|10.33(17)    |  | First Amendment to Loan and Security Agreement dated August 28, 2003 between Ditech Communications Corporation and Comerica BankCalifornia
|10.34(8)(17) |  | Employment Agreement, dated September 16, 2003, between Ditech Communications Corporation and Jim H. Grady                                 
|21.1         |  | Subsidiaries of Ditech Communications Corporation                                                                                          
|23.1         |  | Consent of PricewaterhouseCoopers LLP                                                                                                      
|             |  |                                                                                                                                            

68

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|31.1 |  | Certification by Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
|---- |  | --------------------------------------------------------------------------------------------------
|31.2 |  | Certification by Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
|32.1 |  | Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                           

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69

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