<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington D.C. 20549
FORM 10-Q
[X] Quarterly report pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934 for the
quarterly period ended October 31, 1999 or
[ ] Transition report pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934 for the
transition period from __________ to __________.
Commission File Number: 0-22703
MCK Communications, Inc.
(Exact name of registrant as specified in its charter)
Delaware 06-1555163
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
313 Washington Street Newton, Massachusetts 02458
(Address of principal executive offices)
Registrant's telephone number, including area code: (617) 454-6100
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 [ ] NO [X]
As of October 31, 1999, there were 17,869,489 shares of registrant's
Common Stock outstanding.
<PAGE> 2
MCK Communications, Inc.
Table of Contents
PART I - FINANCIAL INFORMATION Page
----
Item 1. Condensed Consolidated Financial Statements
Condensed Consolidated Balance Sheets at April 30, 1999 and
October 31, 1999 3
Condensed Consolidated Statements of Operations for the three
and six months ended October 31, 1998 and 1999 4
Condensed Consolidated Statements of Cash Flows for the
six months ended October 31, 1998 and 1999 5
Notes to Condensed Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 9
Item 3. Quantitative and Qualitative Disclosures about Market Risk 13
PART II - OTHER INFORMATION 20
Item 2. Changes in Securities and Use of Proceeds 20
Item 4. Submission of Matters to a Vote of Security Holders 21
Item 6. Exhibits and Reports on Form 8-K 21
Signatures 22
2
<PAGE> 3
Part I. Financial Information
Item 1. Condensed Consolidated Financial Statements
MCK Communications, Inc.
Condensed Consolidated Balance Sheets
(In thousands)
<TABLE>
<CAPTION>
April 30, October 31,
1999 1999
--------- -----------
(Unaudited)
<S> <C> <C>
Assets
Current assets:
Cash and equivalents $ 3,285 $ 26,290
Accounts receivable, net 3,350 4,342
Inventory 1,494 1,850
Prepaids and other current assets 213 497
-------- --------
Total current assets 8,342 32,979
Fixed assets, net 1,054 1,224
Other assets 32 24
-------- --------
Total assets $ 9,428 $ 34,227
======== ========
Liabilities and Stockholders' Equity (deficit)
Current liabilities:
Accounts payable $ 1,666 $ 2,908
Accrued liabilities 693 1,409
Accrued compensation and benefits 404 355
Borrowings under line of credit -- 76
Deferred revenue -- 37
-------- --------
Total current liabilities 2,763 4,785
Long-term debt 2,500 179
Redeemable preferred stock of subsidiary 2,490 --
Redeemable preferred stock 21,011 --
Redeemable convertible preferred stock 4,704 --
Stockholders' equity (deficit):
Common stock, $.001 par value; 25,000,000 authorized: 5 18
Issued and outstanding - 5,300,183 shares at April 30, 1999
and 17,869,489 at October 31, 1999
Additional paid-in capital 1,388 65,795
Accumulated deficit (24,303) (28,072)
Deferred compensation (805) (7,387)
Accumulated other comprehensive loss (166) (245)
Notes receivable from officers (159) (846)
-------- --------
Total common stockholders' equity (deficit) (24,040) 29,263
-------- --------
Total liabilities and stockholders' equity (deficit) $ 9,428 $ 34,227
======== ========
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
3
<PAGE> 4
MCK Communications, Inc.
Condensed Consolidated Statements of Operations
(In thousands, except per share data)
<TABLE>
<CAPTION>
Unaudited Unaudited
Three Months Ended Six Months Ended
October 31, October 31,
------------------------ ------------------------
1998 1999 1998 1999
------- ------- ------- -------
<S> <C> <C> <C> <C>
Revenues $ 3,441 $ 5,521 $ 6,557 $10,043
Cost of goods sold 1,330 2,028 2,518 3,718
------- ------- ------- -------
Gross profit 2,111 3,493 4,039 6,325
Operating expenses:
Research and development 770 1,178 1,521 2,142
Sales and marketing 918 1,625 1,697 2,972
General and administrative 415 599 807 1,092
Amortization of stock based compensation 82 1,300 102 2,414
------- ------- ------- -------
Total operating expenses 2,185 4,702 4,127 8,620
------- ------- ------- -------
Loss from operations (74) (1,209) (88) (2,295)
Other (income) expense:
Interest expense 85 91 236 181
Interest income (49) (27) (65) (51)
Other (income) expense, net 56 (67) 49 (38)
------- ------- ------- -------
Total other (income) expense 92 (3) 220 92
Loss before dividends on redeemable
preferred stock of subsidiary (166) (1,206) (308) (2,387)
Dividends on redeemable preferred stock of
subsidiary 47 46 97 97
------- ------- ------- -------
Net loss (213) (1,252) (405) (2,484)
Dividends on redeemable preferred stock 532 734 926 1,285
------- ------- ------- -------
Loss applicable to common stock $ (745) $(1,986) $(1,331) $(3,769)
======= ======= ======= =======
Basic net loss per share $ (0.19) $ (0.34) $ (0.35) $ (0.74)
======= ======= ======= =======
Shares used in computing basic
net loss per share 3,847 5,846 3,750 5,075
======= ======= ======= =======
Pro-forma basic net loss per share $ (0.06) $ (0.15) $ (0.12) $ (0.28)
======= ======= ======= =======
Shares used in computing pro-forma
basic net loss per share 12,502 13,580 11,345 13,278
======= ======= ======= =======
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
4
<PAGE> 5
MCK Communications, Inc.
Condensed Consolidated Statements of Cash Flows
(In thousands)
<TABLE>
<CAPTION>
Unaudited
Six Months Ended
October 31,
-------------------------
1998 1999
-------- --------
<S> <C> <C>
Cash flows from operating activities:
Net loss $ (405) $(2,484)
Depreciation and amortization 178 303
Stock based compensation 102 2,414
Dividends accrued on subsidiary preferred stock 97 97
Changes in operating assets and liabilities:
Accounts receivable (368) (992)
Inventory (605) (356)
Prepaids and other current assets 112 (284)
Accounts payable 117 1,242
Accrued liabilities (332) 716
Accrued compensation and benefits (71) (49)
Deferred revenue -- 37
-------- -------
Net cash provided by (used in) operating activities (1,175) 644
-------- -------
Cash flows from investing activities:
Purchases of property and equipment (330) (482)
-------- -------
Net cash used in investing activities (330) (482)
-------- -------
Cash flows from financing activities:
Redemption of subordinated debt (2,500) (2,500)
Redemption of Series A redeemable preferred stock (19,070)
Issuance (redemption) of Series C redeemable preferred stock 2,470 (3,147)
Issuance of Series D convertible preferred stock 2,470 --
Redemption of Series E redeemable preferred stock -- (2,587)
Net proceeds from issuance of common stock -- 49,974
Proceeds from option exercises 2 6
Borrowings under line of credit 230
-------- -------
Net cash provided by financing activities 2,442 22,906
-------- -------
Effect of exchange on cash 39 (63)
-------- -------
Net increase (decrease) in cash and equivalents 976 23,005
Cash and equivalents, beginning of period 1,867 3,285
-------- -------
Cash and equivalents, end of period $ 2,843 $26,290
======== =======
Supplemental disclosures of cash flow information:
Cash paid for interest 282 30
Dividends on non-subsidiary preferred 926 1,285
Sale of restricted stock 8 687
Dividends to Manz Development, Inc. 97 97
Issuance of preferred stock in exchange for redemption premium 1,652 --
Conversion of Series B and D redeemable preferred shares to common -- 4,908
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
5
<PAGE> 6
MCK Communications, Inc.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
a. BASIS OF PRESENTATION
The condensed consolidated financial statements have been prepared by MCK
Communications, Inc., pursuant to the rules and regulations of the Securities
and Exchange Commission and include the accounts of MCK Communications, Inc.,
and its wholly-owned subsidiary. Certain information and footnote disclosures,
normally included in financial statements prepared in accordance with generally
accepted accounting principals, have been condensed or omitted pursuant to such
rules and regulations. In the opinion of the Company, the financial statements
reflect all adjustments, consisting of normal recurring adjustments, necessary
for a fair presentation of the financial position at October 31, 1999 and the
operating results and cash flows for the three and six months ended October 31,
1999 and 1998. The condensed balance sheet at April 30, 1999 has been derived
from audited financial statements as of that date. These financial statements
and notes should be read in conjunction with the financial statements and notes
thereto included in the Company's Registration statement on Form S-1 as filed
with the Securities and Exchange Commission.
The preparation of the financial statements in conformity with generally
accepted accounting principles 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 revenue and expenses during the reporting
period. Actual results could differ from those estimates and would impact future
results of operations and cash flows.
The results of operations reported for the three and six months ended October
31, 1999 are not necessarily indicative of the results to be achieved for future
quarters or the year ending April 30, 2000.
b. CASH AND EQUIVALENTS
Cash and equivalents are defined as short-term highly liquid investments having
an original maturity of three months or less.
c. REVENUE RECOGNITION
We recognize product revenues upon shipment to the customer. We routinely
analyze and establish, as necessary, reserves at the time of shipment for
product returns and allowances, which amounts to date have not been significant.
Service revenues are recognized as the services are performed. Maintenance
revenues are deferred and recognized over the period of the contract.
d. COMPREHENSIVE INCOME (LOSS)
During the year ended April 30, 1999, the Company adopted SFAS 130, "Reporting
Comprehensive Income", which establishes standards for the reporting and
presentation of comprehensive income and its components in the financial
statements. Comprehensive income includes all changes in equity during a period
except those resulting from investments by and distributions to owners. For the
three and six months ended October 31, 1999, MCK's comprehensive loss was $1.3
million and $2.6 million, respectively, compared to a comprehensive loss of
$182,000 and $383,000 for the three and six months ended October 31, 1998. Other
than the Company's net loss, there are no material components of the reported
comprehensive loss.
e. NET LOSS PER SHARE
Basic net loss per share is computed by dividing net loss by the weighted
average number of shares of common stock outstanding, with no consideration
given for any potentially dilutive securities. The company issued 3,400,000
shares of common stock and converted all of its outstanding convertible
preferred stock to common stock on October 27, 1999, the date of the Company's
initial public offering. The net loss per share calculations have been
appropriately weighted to reflect these activities.
6
<PAGE> 7
No diluted loss per share information has been presented in the accompanying
condensed consolidated statements of operations since potential common shares
from conversion of stock options and restricted stock are antidilutive. The
Company evaluated the requirements of the Securities and Exchange Commission
Staff Accounting Bulletin (SAB)No. 98 and concluded that there are no nominal
issuances of common stock or potential common stock which would be required to
be shown as outstanding for all periods as outlined in SAB No. 98.
Pro forma basic net loss per share has been calculated assuming the conversion
of preferred stock into an equivalent number of common shares as if the shares
had converted on the dates of their issuance.
f. SEGMENTS OF AN ENTERPRISE
In 1997, the Financial Accounting Standards Board issued Statement No. 131,
"Disclosures about Segments of an Enterprise and Related Information" or SFAS
131, which was required to be adopted for fiscal years beginning after December
15, 1997. SFAS 131 superseded SFAS No. 14, "Financial Reporting for Segments of
a Business Enterprise." This statement changes the way public companies report
segment information in annual financial statements. SFAS 131 requires public
companies to report financial and descriptive information about their operating
segments in interim financial reports to shareholders as well. The adoption of
this statement had no impact on the disclosures in the Company's financial
statements as the Company operates in one business segment.
g. RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities". The statement is
effective for the year ended December 31, 2000. SFAS No. 133 establishes
accounting and reporting standards for derivative instruments including certain
derivative instruments embedded in other contracts (collectively referred to as
derivatives) and for hedging activities. The Company does not expect adoption of
this statement to have a material impact on its consolidated financial position
or result of operations.
NOTE 2. INITIAL PUBLIC OFFERING AND SUBSEQUENT EVENT
The Company completed its initial public offering of 3,400,000 shares of common
stock in October 1999 raising approximately $49.5 million, net of offering and
distribution costs. MCK Communications, Inc. is listed on the Nasdaq National
Market under the symbol "MCKC".
In November of 1999, the underwriters of the Initial Public Offering exercised
their over-allotment option and purchased an additional 255,000 shares of the
Company's common stock at the offering price of $16.00. The Company received an
additional $3,794,400, net of underwriting discounts and commissions, in this
transaction. Additionally, certain stockholders sold an additional 255,000
shares of their stock in the Company. The Company did not receive any proceeds
on such sales by its stockholders.
NOTE 3. COMMON STOCK
In October 1999, the Company implemented the following:
1) a 1.53-for-one stock split of the Company's outstanding shares. All share and
per share information included in these condensed consolidated financial
statements have been retroactively adjusted to reflect this stock split.
2) the re-incorporation of the Company in the State of Delaware. Upon re-
incorporation, and following the consummation of the Initial Public Offering,
the Company had 40,000,000 authorized shares of common stock, $.001 par value
and 2,000,000 shares of undesignated preferred stock, $.001 par value.
7
<PAGE> 8
NOTE 4. INVENTORY
Inventory consisted of (in 000's):
April 30, October 31,
1999 1999
--------- -----------
(Unaudited)
Raw materials $ 518 $ 595
Work-in-process 781 1,013
Finished goods 195 242
------ ------
$1,494 $1,850
8
<PAGE> 9
ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
Certain statements in the "Management's Discussion and Analysis of Financial
Condition and Results of Operations" are forward-looking statements that involve
risks and uncertainties. Words such as "anticipates", "expects", "intends",
"plans", "believes", "seeks", "estimates" and similar expressions identify such
forward-looking statements. The forward-looking statements contained herein are
based on current expectations and entail various risks and uncertainties that
could cause actual results to differ materially from these expressed in such
forward-looking statements. Factors that might cause such a difference include,
among other things, those set forth under "overview", "liquidity and Capital
Resources" and "Risk Factors" included in this section and those appearing
elsewhere in this Form 10-Q. Readers are cautioned not to place undue reliance
on these forward-looking statements, which reflect management's analysis only as
of the date hereof. The Company assumes no obligation to update these
forward-looking statements to reflect actual results or changes in factors or
assumptions affecting forward-looking statements.
OVERVIEW
MCK Communications is a leading provider of products that enable corporations to
distribute the full range of features and applications of corporate telephone
systems to branch offices and telecommuters over data networks. We market and
distribute our products through an international network of indirect resellers
and equipment providers and, to a lesser extent, through direct sales. We are
headquartered in Newton, Massachusetts and have a development center in Calgary,
Canada. Our sales force and marketing efforts are primarily directed at
developing brand awareness and supporting our indirect distribution channels.
Product revenues currently consist of sales of our remote voice access products
and, to a lesser degree, our digital-to-analog converter products, installation
services and maintenance. For the foreseeable future, we anticipate that
substantially all of our revenues will be attributable to sales of these
products. We believe that the sales of our multi-user products and next
generation single-user products will represent a substantial and increasing
percentage of our revenues, while the sales of our existing single-user products
and digital-to-analog converters may decline as a percentage of our revenues.
While MCK is developing future products, including remote voice access products
that operate over broadband networks, and is recruiting additional OEM and
channel partners, there can be no assurance that we will be successful in these
efforts.
RESULTS OF OPERATIONS
The following table sets forth certain financial data for the periods indicated
as a percentage of revenues:
9
<PAGE> 10
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
October 31, October 31,
------------------ ----------------
1998 1999 1998 1999
----- ----- ----- -----
<S> <C> <C> <C> <C>
Revenues 100.0% 100.0% 100.0% 100.0%
Cost of goods sold 38.7% 36.7% 38.4% 37.0%
----- ----- ----- -----
Gross profit 61.3% 63.3% 61.6% 63.0%
Operating expenses:
Research and development 22.4% 21.3% 23.2% 21.3%
Sales and marketing 26.7% 29.4% 25.9% 29.6%
General and administrative 12.1% 10.8% 12.3% 10.9%
Amortization of stock based compensation 2.4% 23.5% 1.6% 24.0%
----- ----- ----- -----
Total operating expenses 63.5% 85.2% 62.9% 85.8%
----- ----- ----- -----
Loss from operations (2.2)% (21.9)% (1.3)% 22.9%
Other (income) expense:
Interest expense 2.5% 1.6% 3.6% 1.8%
Interest income (1.4)% (0.5)% (1.0)% (0.5)%
Other (income) expense, net 1.6% (1.2)% 0.7% (0.4)%
----- ----- ----- -----
Total other (income) expense 2.7% (0.1)% 3.4% 0.9%
----- ----- ----- -----
Loss before dividends on redeemable
preferred stock of subsidiary (4.8)% (21.8)% (4.7)% (23.8)%
===== ===== ===== =====
</TABLE>
THREE MONTHS ENDED OCTOBER 31, 1999 AND 1998
Revenues. Revenues increased from $3.4 million for the three months ended
October 31, 1998 to $5.5 million for the three months ended October 31, 1999, an
increase of $2.1 million or 60.4%. This increase was primarily due to the
release of our first multi-user remote voice access product in April 1999, which
accounted for approximately $2.6 million or 46.7% of revenues. We expect
revenues from our current single-user products to decrease as a percentage of
revenues as we grow our sales of our multi-user products and our next generation
single-user products.
Cost of goods sold. Cost of goods sold includes the cost of finished product and
subassemblies purchased from contract manufacturers, overhead, and customer
service and support costs. Our cost of goods sold increased from $1.3 million
for the three months ended October 31, 1998 to $2.0 million for the three months
ended October 31, 1999, an increase of $698,000 or 52.5%. This increase was
primarily related to the increase in volume of units shipped. Gross margin
increased from 61.3% for the three months ended October 31, 1998 to 63.3% for
the three months ended October 31, 1999. The increase in gross margin was
primarily attributable to the introduction of our first multi-user remote voice
access product, which has a higher gross margin than our other products. We do
not expect this trend to continue in future quarters due to increased pricing
pressures and rising component costs.
Research and development. Research and development expenses include salaries and
related personnel costs, purchased software and proto-type expenses related to
the design, development, enhancement and testing of our products. Research and
development expenses increased from $770,000 for the three months ended October
31, 1998 to $1.2 million for the three months ended October 31, 1999, an
increase of $408,000 or 53.0%. This increase was due primarily to increases in
staffing, the manufacturing of proto-type units for our EXTender 3200 for IDSL,
EXTender 4000 and PBXgateway product lines and, to a lesser extent, related
overhead costs. For the three months ended October 31, 1998 and 1999, research
and development expenses decreased as a percentage of revenues from 22.4% to
21.3% as a result of increased revenues. Because we will continue to enhance
existing products and fund new product development initiatives, we expect
research and development expenses to increase in future periods. We also expect
to increase our expenditures on our product validation laboratory to test the
interoperability of our products with corporate telephone systems and other
products. This competency is becoming increasingly critical to our business as
we develop additional products that function over data networks in conjunction
with third-party data equipment.
Sales and marketing. Sales and marketing expenses consist primarily of salaries,
commissions and related personnel expenses for those engaged in the sales,
marketing and support of products as well as related trade show, promotional and
public relations expenses. Sales and marketing expenses increased from $918,000
for the three months ended
10
<PAGE> 11
October 31, 1998 to $1.6 million for the three months ended October 31, 1999,
an increase of $707,000 or 77.0%. This increase was primarily due to increases
in staffing of both sales and marketing personnel and, to a lesser extent,
increased marketing activities related to the introduction of our first
multi-user product. For the three months ended October 31, 1998 and 1999, sales
and marketing expenses increased as a percentage of revenues from 26.7% to 29.4%
as newly hired sales personnel generally do not achieve full productivity during
their first two quarters with us. We intend to pursue sales and marketing
campaigns aggressively and increase our sales force headcount and, therefore,
expect these expenses to increase in the future.
General and administrative. General and administrative expenses consist
primarily of salaries and related personnel expenses for executive, accounting
and administrative personnel, professional fees and other general corporate
expenses. General and administrative expenses increased from $415,000 for the
three months ended October 31, 1998 to $599,000 for the three months ended
October 31, 1999, an increase of $184,000 or 44.3%. This increase was primarily
due to increases in staffing in our accounting group to support our growth and
reporting requirements as a public company, consulting costs relating to an
upgrade of our enterprise resource planning system to ensure its Year 2000
compliance and, to a lesser extent, professional service costs. For the three
months ended October 31, 1998 and 1999,general and administrative expenses
decreased as a percentage of revenues from 12.1% to 10.8% as a result of
increased revenues. As we add personnel and incur additional costs related to
the growth of our business, we expect that general and administrative expenses
will also increase.
Amortization of stock-based compensation. In connection with the grant of
certain stock options to employees in the fiscal year ended April 30, 1999 and
the three months ended October 31, 1999, MCK recorded deferred compensation
expense of $1.2 million and $1.5 million, respectively, representing the
difference between the deemed fair value of the common stock for financial
reporting purposes and the exercise price of these options at the date of grant.
Deferred compensation is presented as a reduction of stockholders' equity and is
amortized on an accelerated basis over the vesting period of the applicable
options, generally four years. MCK expensed $82,000 and $1.3 million of deferred
stock-based compensation in the three months ended October 31, 1998 and 1999,
respectively. The amortization of existing deferred stock-based compensation is
expected to impact our reported results of operations through the quarter ended
July 2003.
Other expense, net. Other expense, net consisted primarily of interest expense
related to our subordinated debt, offset by interest income, and foreign
exchange gains or losses related to the effects of the Canadian/U.S. exchange
rate on intra-company transactions. Other expense, net improved from an expense
$92,000 for the three months ended October 31, 1998 to an income of $3,000 for
the three months ended October 31, 1999, an increase of $95,000. Interest
expense, offset by interest income, increased from $36,000 for the three months
ended October 31,1998 to $64,000 for the three months ended October 31, 1999.
This increase was primarily due to a lower average cash balance during the
October 1999 quarter as compared to the comparable quarter of 1998. Foreign
exchange losses for the three months ended October 31, 1998 were $56,000
compared to a gain of $67,000 for the three months ended October 31, 1999. The
decreased loss was due to a weakening of the U.S. dollar against the Canadian
dollar.
SIX MONTHS ENDED OCTOBER 31, 1999 AND 1998.
Revenues. Revenues increased from $6.6 million for the six months ended October
31, 1998 to $10.0 million for the six months ended October 31, 1999, an increase
of $3.5 million or 53.2%. This increase was primarily due to the release of our
first multi-user remote voice access product in April 1999, which accounted for
approximately $4.3 million or 42.4% of revenues.
Cost of goods sold. Our cost of goods sold increased from $2.5 million for the
six months ended October 31, 1998 to $3.7 million for the six months ended
October 31, 1999, an increase of $1.2 million or 47.7%. This increase was
primarily related to the increase in volume of units shipped. Gross margin
increased from 61.6% for the six months ended October 31, 1998 to 63.0% for the
six months ended October 31, 1999. The increase in gross margin was primarily
attributable to the introduction of our first multi-user remote voice access
product, which has a higher gross margin than our other products.
Research and development. Research and development expenses increased from $1.5
million for the six months ended October 31, 1998 to $2.1 million for the six
months ended October 31, 1999, an increase of $621,000 or 40.8%. This increase
was due primarily to increases in staffing, the manufacturing of proto-type
units for our EXTender 3200 for IDSL, EXTender 4000 and PBXgateway product
lines. For the six months ended October
11
<PAGE> 12
31, 1998 and 1999, research and development expenses decreased as a percentage
of revenues from 23.2% to 21.3% as a result of increased revenues.
Sales and marketing. Sales and marketing expenses increased from $1.7 million
for the six months ended October 31, 1998 to $3.0 million for the six months
ended October 31, 1999, an increase of $1.3 million or 75.1%. This increase was
primarily due to increases in staffing of both sales and marketing personnel
and, to a lesser extent, increased marketing activities related to the
introduction of our first multi-user remote voice access product. For the six
months ended October 31, 1998 and 1999, sales and marketing expenses increased
as a percentage of revenues from 25.9% to 29.6% as newly hired sales personnel
generally do not achieve during their first two quarters with us.
General and administrative. General and administrative expenses increased from
$807,000 for the six months ended October 31, 1998 to $1.1 million for the six
months ended October 31, 1999, an increase of $285,000 or 35.3%. This increase
was primarily due to increases in staffing in our accounting group to support
our growth and reporting requirements as a public company, consulting costs
relating to an upgrade of our enterprise resource planning system to ensure its
Year 2000 compliance and, to a lesser extent, professional service costs. For
the six months ended October 31, 1998 and 1999,general and administrative
expenses decreased as a percentage of revenues from 12.3% to 10.9% as a result
of increased revenues.
Amortization of stock based compensation. Stock-based compensation expense was
$102,000 and $2.4 million in the six months ended October 31, 1998 and 1999,
respectively.
Other expense, net. Other expense, net decreased from $220,000 for the six
months ended October 31, 1998 to $92,000 for the six months ended October 31,
1999, a decrease of $128,000 or 58.1%. Interest expense, offset by interest
income, decreased from $171,000 for the six months ended October 31,1998 to
$130,000 for the six months ended October 31, 1999. This decrease was due to a
reduction in the subordinated debt on our balance sheet from $5.0 million to
$2.5 million relating to the July 1998 financing. Foreign exchange losses for
the six months ended October 31, 1998 were $49,000 compared to a gain of $38,000
for the six months ended October 31, 1999. The decreased loss was due to a
weakening of the U.S. dollar against the Canadian dollar.
LIQUIDITY AND CAPITAL RESOURCES
Prior to our initial public offering, we financed our operations primarily from
the sale of preferred stock and other financing arrangements, such as a bank
line of credit, a subordinated debt offering and a capital equipment financing.
On October 22, 1999, the Company completed its initial public offering of common
stock, in which we sold 3,400,000 shares of common stock at a price of $16.00
per share. Proceeds from the offering, after offering expenses, were
approximately $49.5 million. In November 1999, the underwriters of the Initial
Public Offering exercised their over-allotment option and purchased an
additional 255,000 shares of the Company's common stock at the offering price of
$16.00. The Company received an additional $3,794,400, net of underwriting
discounts and commissions, in this transaction.
As of October 31, 1999, our principal sources of liquidity consisted of cash and
equivalents of $26.3 million and a credit facility against accounts receivable
which provides for borrowings of up to $2.0 million. We are currently in
negotiations with our lender to increase the amount available under the
borrowing base to $5.0 million. The Company regularly invests excess funds in
short-term money market funds. In the future we expect to invest excess cash in
short-term money market funds, commercial paper, and government and
non-government debt securities.
Net cash provided by operations was $644,000 for the six months ended October
31, 1999. Cash provided by operations was primarily related to an increase in
accounts payable of $1.2 million and an increase in accrued expenses of $716,000
and was partially offset by an increase in accounts receivable of $992,000 and
an increase in inventory of $356,000. Net cash provided by financing activities
was $22.9 million for the six months ended October, 31, 1999. Cash provided by
financing activities was primarily due to the proceeds from the issuance of
common stock, including net proceeds of $49.5 million from the initial public
offering. This was partially offset by mandatory redemption payments to the
holders of redeemable preferred stock of $24.8 million and a reduction in
subordinated debt of $2.5 million.
We expect to devote substantial capital resources to continue our research and
development efforts, to hire and expand the sales, support, marketing and
product development organizations, to expand marketing programs and for other
general corporate activities. In addition, we may utilize cash resources to fund
acquisitions or investments in complementary businesses, technologies or
products. We believe that the net proceeds from this offering, together with our
current cash and equivalents, cash generated from operations and available
borrowings under our line of
12
<PAGE> 13
credit, will be sufficient to meet our anticipated cash requirements for working
capital and capital expenditures for at least the next 12 months.
YEAR 2000 COMPLIANCE
Some computers, software, and other equipment include computer code in which
calendar year data is abbreviated to only two digits. As a result of this design
decision, some of these systems could fail to operate or fail to produce correct
results if "00" is interpreted to mean 1900, rather than 2000. These problems
are widely expected to increase in frequency and severity as the Year 2000
approaches, and are commonly referred to as the "Year 2000 problem."
The majority of MCK's products do not have time keeping capabilities and are
therefore, by default, Year 2000 compliant. Only our Branch Office EXTender 6000
and PBXgateway products have internal clocks, and we believe such product lines
are Year 2000 compliant. However, our products are generally integrated into
networks involving sophisticated hardware and software products provided by
other vendors. Each of MCK's customers' solutions involve different combinations
of third-party products and MCK cannot evaluate whether all of the third party
products are year 2000 compliant. We currently do not expect any significant
Year 2000 problems to arise with our products. We have generally represented to
our indirect channel partners and end users that our products are Year 2000
compliant, and if that turns out to be untrue, these parties may make claims
against us which may result in litigation or contract terminations.
We believe that we have identified mission-critical computers, servers,
applications, business systems and related equipment used in connection with our
internal operations that will need to be evaluated to determine if they must be
modified, upgraded or replaced to minimize the possibility of a material
disruption to our business. We have also identified critical facilities
equipment, such as fax machines, telephone switches, security systems and other
common devices, may be affected by the Year 2000 problem. We have begun the
process of modifying, upgrading and replacing major systems that have been
assessed as adversely affected, and expect to complete his process before the
occurrence of any material disruption of our business.
ITEM 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest Rate Risk. We have cash equivalents that primarily consist of overnight
money market accounts. A 100 basis point shift in interest rates would not
result in a material change in interest expense, cash flows or the fair value of
the cash equivalents.
Foreign Currency Exchange Rate Risk. We primarily sell our products in U.S.
dollars and therefore we are not generally exposed to foreign currency exchange
risk. However, our Canadian subsidiary sells products to Canadian customers that
it invoices in Canadian dollars. For the three months and six months ended
October 31, 1999, revenue from our Canadian subsidiary accounted for 5.9% and
7.1% of revenues, respectively. Transactions with our Canadian subsidiary, whose
functional currency is the Canadian dollar, present us with foreign currency
exchange risk. The principal transactions are buying and selling of inventory.
The intercompany balance is denominated in U.S. dollars and changes in the
foreign currency exchange rate result in foreign currency gains and losses.
Using the intercompany balance at October 31, 1999, a 10% strengthening of the
U.S.dollar against the Canadian dollar would result in a foreign currency
transaction loss of $152,000
RISK FACTORS
WE DERIVE ALMOST ALL OF OUR REVENUES FROM A SMALL NUMBER OF CUSTOMERS AND
OUR REVENUES MAY DECLINE SIGNIFICANTLY IF ANY MAJOR CUSTOMER CANCELS OR DELAYS
A PURCHASE OF OUR PRODUCTS
We have historically derived the majority of our revenues from a small number of
customers, most of whom resell our products to end users. Our failure to
generate as much revenue as expected from these customers or the failure of
these customers, particularly Lucent, to purchase our products would seriously
harm our business. For the three and six months ended October 31, 1999, Lucent
accounted for 42.5% and 44.2% of our revenues, respectively, and our ten largest
customers, including Lucent, accounted for 84.1% and 77.7% of our revenues,
respectively. None of these large customers is obligated to purchase additional
products or services. Accordingly, present and future customers may terminate
their purchasing arrangements with us or significantly reduce or delay their
orders. Any
13
<PAGE> 14
termination, change, reduction or delay in orders could seriously harm our
business, financial condition and results of operations. Accordingly, unless and
until we diversify and expand our customer base, our future success will
significantly depend upon the timing and size of future purchases by our largest
customers and, in particular: - the product requirements of these customers; -
the financial and operational success of these customers; and - the success of
the underlying products and services that our products support. The loss of any
one of our major customers or the delay of significant orders from such
customers, even if only temporary, could reduce or delay our recognition of
revenues, harm our reputation in the industry and reduce our ability to
accurately predict cash flow, and, as a consequence, could seriously harm our
business, financial condition and results of operations.
OUR INABILITY TO DEVELOP AND MAINTAIN RELATIONSHIPS WITH KEY PBX VENDORS WOULD
HARM OUR ABILITY TO SUSTAIN AND GROW OUR BUSINESS
Our success will depend to a significant degree upon our relationships with
leading PBX vendors, including those with Alcatel, Lucent, NEC, Nortel Networks
and Toshiba. The systems sold by these vendors account for approximately 65% of
the U.S. market for corporate PBX equipment sales, and approximately 99% of our
revenues for fiscal year 1999 were attributable to products which interoperate
with corporate telephone systems offered by these vendors. We may not have
access in the future to the proprietary protocols for the major corporate
telephone systems marketed by those vendors, which access may be essential to
ensure the continued interoperability of our products. Moreover, we may not be
able to develop products that interoperate with the corporate telephone systems
offered by other vendors. Additionally, the standards for telephony equipment
and data networks are evolving and our products may not be compatible with any
new technology standards that may emerge. If we are unable to provide our
customers with interoperable solutions, they may make purchases from vendors who
provide the requisite product interoperability. This could seriously harm our
business, financial condition and results of operations. In addition, we
currently have varying distribution, marketing and development arrangements with
the PBX vendors noted above. These relationships are not exclusive and there is
no assurance that we will continue to enjoy the support and cooperation that we
have historically experienced from these parties or their distribution channels.
Moreover, it is possible that the PBX vendors may seek to offer broader product
lines and solutions that are competitive with our products.
UNLESS WE ARE ABLE TO KEEP PACE WITH THE RAPIDLY CHANGING PRODUCT REQUIREMENTS
OF OUR CUSTOMERS, WE WILL NOT BE ABLE TO SUSTAIN OR GROW OUR BUSINESS
The telecommunications market is characterized by rapid technological advances,
evolving industry standards, changes in end-user requirements, frequent new
product introductions and evolving offerings by telecommunications service
providers. We believe our future success will largely depend on our ability to
anticipate or adapt to such changes and to offer, on a timely basis, products
that meet customer demands. Our customers could purchase competitive products
from other suppliers if we fail to produce technologically competitive products
in a cost-effective manner or on a timely basis. This may cause us to be unable
to sustain or grow our business.
INTENSE COMPETITION IN THE MARKET FOR REMOTE VOICE SOLUTIONS COULD PREVENT US
FROM INCREASING OR SUSTAINING REVENUE AND PREVENT US FROM ACHIEVING OR
SUSTAINING PROFITABILITY
The market for remote voice solutions is highly competitive. Our inability to
compete effectively in this market would materially adversely affect our
revenues and future profitability. Many of our current and potential competitors
have significantly greater sales and marketing, technical, manufacturing,
financial and other resources, more established distribution channels and
stronger relationships with service providers. For instance, in June 1999 Nortel
Networks announced its intention to develop new products which will compete
directly with our products. Moreover, our competitors may foresee the course of
market developments more accurately than we do and could in the future develop
new technologies that compete with our products or even render our products
obsolete. Realizing and maintaining technological advantages over our
competitors will require a continued high level of investment in research and
development, sales and marketing and customer support. Due to the opportunities
in and the rapidly evolving nature of the market in which we compete, additional
competitors with significant market presence and financial resources, including
large communications equipment manufacturers, may enter our market, thereby
further intensifying competition. We may not have sufficient resources to
continue to make the investments or achieve the technological advances necessary
to compete successfully with existing competitors or new competitors. Increased
competition is likely to result in price reductions, reduced gross margins,
longer sales cycles and loss of market
14
<PAGE> 15
share, any of which would seriously harm our business and results of operations.
We may not be able to compete successfully against current or future competitors
and these competitive pressures may seriously harm our business.
FUTURE CONSOLIDATION IN THE COMMUNICATIONS EQUIPMENT INDUSTRY MAY
INCREASE COMPETITION THAT COULD HARM OUR BUSINESS
The markets in which we compete are characterized by increasing consolidation
both within the communications sector and by companies combining or acquiring
communications assets. This consolidation creates uncertainty as to the nature
of our future competition. For instance, a relatively small competitor which is
acquired by a large telecommunications company would likely have access to
greater resources than us and would accordingly be a greater competitive threat.
We may not be able to compete successfully in an increasingly consolidated
industry. Increased competition and consolidation in our industry could require
that we reduce the prices of our products and may result in our loss of market
share, which would materially adversely affect our business, financial condition
and results of operations. Additionally, because we are now, and may in the
future be, dependent on strategic relationships with third parties in our
industry, such as Lucent, any consolidation involving these parties could reduce
the demand for our products and otherwise harm our business prospects.
FLUCTUATIONS IN OUR QUARTERLY RESULTS COULD CAUSE THE MARKET PRICE OF OUR COMMON
STOCK TO FALL
Our quarterly operating results have varied in the past and are likely to vary
in the future. For example, over the ten most recent fiscal quarters, our net
results of operations have ranged from a net loss before dividends on subsidiary
redeemable preferred stock of $95,000 to net loss of $1,206,000. It is possible
that our revenues and operating results may be below the expectations of
securities analysts and investors in future quarters. If we fail to meet or
surpass the expectations of securities analysts or investors, the market price
of our common stock will most likely fall. A number of factors could cause our
quarterly results to fluctuate, including, but not limited to: the timing and
amount of, or cancellation or rescheduling of, orders for our products,
particularly large orders from our key customers; our ability to develop,
introduce, ship and support new products and product enhancements, and manage
product transitions; new product introductions and announcements, and reductions
in the prices of products offered by our competitors; our ability to sustain our
technology relationships, particularly with the major PBX manufacturers and
service providers; availability and changes in the prices of components provided
by third parties; our ability to attain and maintain production volumes and
quality levels for our products; the mix of products sold and the mix of
distribution channels through which they are sold; fluctuations in demand for
our products; costs relating to possible acquisitions and integration of
technologies or businesses; telecommunications market conditions and economic
conditions generally; our ability to hire, train, integrate and retain new
personnel; and changes in the level of our operating expenses. Given that any
one or more of these or other factors could have an adverse effect on our
business, the prediction of future quarterly results is difficult and uncertain.
In addition, some of our operating expenses are relatively fixed in advance of
any particular quarter. As a result, we may not be able to reduce our operating
costs in response to unanticipated reductions in our revenues or the demand for
our products.
OUR DEPENDENCE ON INDEPENDENT MANUFACTURERS AND SUPPLIERS COULD RESULT IN
PRODUCT DELIVERY DELAYS
We currently use two independent manufacturers, Celestica and Electronic
Manufacturing Group, to manufacture all of our products. We are also
contemplating using an additional manufacturer to manufacture our multi-user
remote voice access products. Our reliance on independent manufacturers involves
a number of risks, including the absence of adequate capacity, the
unavailability of or interruptions in access to necessary manufacturing
processes and reduced control over delivery schedules. If our manufacturers are
unable or unwilling to continue manufacturing our products and components in
required volumes, we will have to identify acceptable alternative manufacturers,
which could take in excess of six months. Furthermore, the use of a new
manufacturer may cause significant interruptions in supply if the new
manufacturer has difficulty manufacturing products to our specifications.
Further, the introduction of a new manufacturer may increase the variance in the
quality of our products. In addition, we rely upon third-party suppliers of
specialty components and intellectual property used in our products. It is
possible that a component needed to complete the manufacture of our products may
not be available to us at acceptable prices or on a timely basis, if at all.
Inadequate supplies of components, or the loss of intellectual property rights,
could affect our ability to deliver products to our customers. Any significant
interruption in the supply of our products would result in the reduction of
product sales to customers, which in turn could permanently harm our reputation
in the industry.
15
<PAGE> 16
OUR ABILITY TO SUSTAIN OR GROW OUR BUSINESS MAY BE HARMED IF WE ARE UNABLE TO
PROVIDE ADEQUATE CUSTOMER SUPPORT
Our ability to continue to grow and to retain current and future customers
depends in part upon the quality of our customer support operations. We have
recently entered into an arrangement with a third-party customer support firm to
provide some of our customer support functions. Failure to offer adequate
customer support, either directly or through third parties, or failure to
properly integrate third-party services into our customer support framework
could materially and adversely affect our reputation and cause demand for our
products to decline.
IF OUR PRODUCTS ARE NOT ACCEPTED BY THE MARKET, OUR REVENUES WILL DECREASE
Market acceptance of our products is critical to our future success. Factors
that may affect the market acceptance of our products include: continued market
acceptance of PBX technology; the performance, price and total cost of ownership
of our products; the availability and price of competing products and
technologies; and the efforts and success of our indirect distribution channels.
Many of these factors are beyond our control. We may experience failure or
delays in market acceptance of our products. Failure of our existing or future
products to maintain and achieve meaningful levels of market acceptance would
reduce the amount of revenue we receive from the sale of our products.
BECAUSE SUBSTANTIALLY ALL OF OUR REVENUES ARE DERIVED FROM SALES OF A SMALL
NUMBER OF PRODUCTS, OUR FUTURE OPERATING RESULTS WILL BE DEPENDENT ON SALES
OF THESE PRODUCTS
We currently derive a substantial part of our revenues from our product family
of remote voice access equipment, and we expect that this concentration will
continue in the foreseeable future. The market may not continue to demand our
products, and we may not be successful in marketing any new or enhanced
products. Any reduction in the demand for our products or our failure to
successfully develop or market new or enhanced products could reduce the amount
of revenue we receive from the sale of our products and cause the price of our
common stock to decline. In addition, our branch office products have only
recently been introduced to the market, and we are expecting that these products
will account for a substantial portion of our revenues for the foreseeable
future. Factors that could affect sales of our products include: the demand for
remote access voice solutions; the successful development, introduction and
market acceptance of new and enhanced products that address customer
requirements; product introductions or announcements by our competitors; price
competition in our industry; and technological change.
IF WE FAIL TO DEVELOP AND EXPAND OUR INDIRECT DISTRIBUTION CHANNELS, OUR
BUSINESS COULD SUFFER
Our product distribution strategy focuses primarily on continuing to develop and
expand our indirect distribution channels, maintain our relationships with large
PBX vendors and telecommunications service providers, and expand our field sales
organization. If we fail to develop and cultivate relationships with significant
indirect distribution channels, or if these distribution channels are not
successful in their sales efforts, our product sales may decrease and our
operating results may suffer. Many of our indirect distribution channels also
sell products that compete with our products, and none of our strategic or
reseller arrangements are exclusive. In addition, our operating results will
likely fluctuate significantly depending on the timing and amount of orders from
our indirect distribution channels. Our indirect distribution channels may not
market our products effectively or may cease to devote the resources necessary
to provide us with effective sales, marketing and technical support. In order to
support and develop leads for our indirect distribution channels, we plan to
significantly expand our field sales staff. This internal expansion may not be
successfully completed. In addition, the cost of this expansion may exceed the
revenues generated and our expanded sales and support staff may not be able to
compete successfully against the significantly more extensive and well-funded
sales and marketing operations of many of our current or potential competitors.
Our inability to effectively develop and expand our distribution channels or
manage the expansion of our sales and support staff would adversely affect our
ability to grow and increase revenues.
OUR STOCK PRICE MAY BE VOLATILE AND YOU MAY NOT BE ABLE TO RESELL SHARES AT OR
ABOVE THE OFFERING PRICE
16
<PAGE> 17
There has previously not been a public market for our common stock. It is
uncertain whether and to what extent a trading market will develop for our
common stock or how liquid that market might become. The trading price of our
common stock could be subject to wide fluctuations in response to factors such
as: actual or anticipated variations in quarterly operating results;
announcements of technological innovations; general technology or economic
trends; revenues and operating results failing to meet or surpass the
expectations of securities analysts or investors in any quarter; changes in
general market conditions; changes in financial estimates by securities
analysts; announcements of significant acquisitions, strategic partnerships,
joint ventures or capital commitments by us or our competitors; additions or
departures of key personnel; the demand for our common stock; the number of
market makers for our common stock; sales of a large number of shares of our
common stock in the public market after this offering or the perception that
such sales could occur; and other events or factors, many of which are beyond
our control. In addition, the stock market in general, and the NASDAQ National
Market and technology companies in particular, have experienced extreme price
and volume fluctuations that have often been unrelated or disproportionate to
the operating performance of such companies. The trading prices of many
technology companies' stocks are at or near historical highs and these trading
prices are substantially above historical levels. These trading prices may not
be sustained. These broad market and industry factors may materially adversely
affect the market price of our common stock, regardless of our actual operating
performance. In the past, following periods of volatility in the market price of
a company's securities, securities class-action litigation has often been
instituted against such companies. Such litigation, if instituted, could result
in substantial costs and a diversion of management's attention and resources,
which would reduce the amount of resources and management time focused on
growing our business and improving operating results.
SALES TO CUSTOMERS BASED OUTSIDE THE UNITED STATES HAVE HISTORICALLY ACCOUNTED
FOR A SIGNIFICANT PORTION OF OUR REVENUES, WHICH EXPOSES US TO RISKS INHERENT
INTERNATIONAL OPERATIONS
International sales represented 8.9% and 11.0% of our revenues for the three and
six months ended October 31, 1999. We expect sales to international markets to
increase as a percentage of revenues in the future and have opened a direct
sales office in the United Kingdom to both support and manage this growth.
International sales are subject to a number of risks, including: - changes in
foreign government regulations and communications standards; - export license
requirements; - currency fluctuations, tariffs and taxes; - other trade
barriers; - difficulty in collecting accounts receivable; - difficulty in
managing foreign operations; and political and economic instability. If the
relative value of the U.S. dollar in comparison to the currency of our foreign
customers should increase, the resulting effective price increase of our
products to these foreign customers could result in decreased sales. In
addition, to the extent that general economic down turns impact our customers,
the ability of these customers to purchase our products could be adversely
affected. Payment cycles for international customers are typically longer than
those for customers in the United States. In addition, the foreign markets for
our products may develop more slowly than currently anticipated. We anticipate
that our non-Canadian, foreign sales will generally be invoiced in U.S. dollars,
and we do not currently plan to engage in foreign currency hedging transactions.
As we expand our international operations, however, we may allow payment in
foreign currencies, and exposure to losses in foreign currency transactions may
increase. We may choose to limit any currency exposure through the purchase of
forward foreign exchange contracts or other hedging strategies. Our future
currency hedging strategies may not be successful.
OUR LIMITED ABILITY TO PROTECT OUR INTELLECTUAL PROPERTY MAY ADVERSELY AFFECT
OUR ABILITY TO COMPETE
Our success and ability to compete is dependent in part upon our proprietary
technology. Any infringement of our proprietary rights could result in
significant litigation costs, and any failure to adequately protect our
proprietary rights could result in our competitors offering similar products,
potentially resulting in loss of a competitive advantage and decreased revenues.
We rely on a combination of copyright, trademark, trade secret and other
intellectual property laws, as well as confidentiality agreements and licensing
arrangements, to establish and protect our proprietary rights. We presently have
no patents. Despite our efforts to protect our proprietary rights, existing
copyright, trademark and trade secret laws afford only limited protection. In
addition, the laws of some foreign countries do not protect our proprietary
rights to the same extent as do the laws of the United States. Attempts may be
made to copy or reverse engineer aspects of our products or to obtain and use
information that we regard as proprietary. Accordingly, we may not be able to
protect our proprietary rights against unauthorized third-party
17
<PAGE> 18
copying or use. Furthermore, policing the unauthorized use of our products is
difficult. Some of our contractual arrangements provide third parties with
access to our source code and other intellectual property upon the occurrence of
specified events. Such access could enable these third parties to use our
intellectual property and source code to develop and manufacture competing
products, which would adversely affect our performance and ability to compete.
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
the proprietary rights of others. Such litigation could result in substantial
costs and diversion of resources and could seriously harm our future operating
results.
CLAIMS ALLEGING INFRINGEMENT OF A THIRD PARTY'S INTELLECTUAL PROPERTY COULD
RESULT IN SIGNIFICANT EXPENSE TO US AND RESULT IN OUR LOSS OF SIGNIFICANT RIGHTS
The telecommunications industry is characterized by the existence of a large
number of patents and frequent litigation based on allegations of patent
infringement. From time to time, third parties may assert patent, copyright,
trademark and other intellectual property rights to technologies that are
important to our business, and this risk may increase as the number of entrants
in our market increases and the functionality of our products is enhanced and
overlaps with the products of other companies. Any claims against us or any
purchaser or user of our products asserting that our products infringe or may
infringe proprietary rights of third parties, if determined adversely to us,
could have a material adverse effect on our business, financial condition or
results of operations. Any claims, with or without merit, could be
time-consuming, result in costly litigation, divert the efforts of our technical
and management personnel, cause product shipment delays, disrupt our
relationships with our customers or require us to enter into royalty or
licensing agreements, any of which could have a material adverse effect upon our
operating results. Such royalty or licensing agreements, if required, may not be
available on terms acceptable to us, if at all. Legal action claiming patent
infringement may be commenced against us and we may not prevail in such
litigation given the complex technical issues and inherent uncertainties in
patent litigation. In the event a claim against us is successful and we cannot
obtain a license to the relevant technology on acceptable terms, license a
substitute technology or redesign our products to avoid infringement, our
business, financial condition and results of operations would be materially
adversely affected.
IF OUR PRODUCTS CONTAIN DEFECTS, WE MAY BE SUBJECT TO SIGNIFICANT LIABILITY
CLAIMS FROM OUR CUSTOMERS AND THE END USERS OF OUR PRODUCTS AND INCUR
SIGNIFICANT UNEXPECTED EXPENSES AND LOST SALES
Our products have in the past contained, and may in the future contain,
undetected or unresolved errors when first introduced or as new versions are
released. Despite extensive testing, errors, defects or failures may be found in
our current or future products or enhancements after commencement of commercial
shipments. If this happens, we may experience delay in or loss of market
acceptance and sales, certain product returns, diversion of development
resources, injury to our reputation or increased service and warranty costs, any
of which could seriously harm our business, financial condition and results of
operations. For example, minor software defects in our EXTender 3000E product
caused us to cease shipments of that product for approximately six weeks to
enable us to correct the defects. Moreover, because our products are designed to
provide critical communications services, we may receive significant liability
claims. Our agreements with customers typically contain provisions intended to
limit our exposure to liability claims. These limitations may not, however,
preclude all potential claims resulting from a defect in one of our products.
Although we maintain product liability insurance covering damages arising from
the implementation and use of our products, the terms of our insurance limit the
amount and types of damages that are covered and may not cover any claims sought
against us. Liability claims could require us to spend significant time and
money in litigation or to pay significant damages. As a result, any such claims,
whether or not successful, could seriously damage our reputation and our
business.
WE MAY HAVE DIFFICULTY IDENTIFYING THE SOURCE OF THE PROBLEM WHEN THERE IS A
PROBLEM IN A NETWORK WHICH MAY ADVERSELY AFFECT THE MARKET ACCEPTANCE OF OUR
PRODUCTS
Our products must successfully integrate with products from other vendors, such
as traditional telephone systems. As a result, when problems occur in a network,
it may be difficult to identify the source of the problem. The occurrence of
hardware and software errors, whether caused by our products or another vendor's
products, may result in the delay or loss of market acceptance of our products
and any necessary revisions may force us to incur significant
18
<PAGE> 19
expenses. The occurrence of some of these types of problems may seriously harm
our business, financial condition and results of operations.
WE CONTINUE TO SIGNIFICANTLY EXPAND OUR OPERATIONS AND OUR FAILURE TO MANAGE
GROWTH COULD HARM OUR BUSINESS AND ADVERSELY AFFECT OUR RESULTS OF OPERATIONS
AND FINANCIAL CONDITION
We have significantly expanded our operations, including the number of our
employees, the breadth of our product offerings and the geographic scope of our
activities. At October 31, 1999, we employed 105 employees and we expect the
number of our employees to increase significantly in the future. Further
significant expansion will likely be necessary to address potential growth in
our customer base and market opportunities. In addition, substantially all of
our senior management have been with us for approximately two years. Any failure
to manage growth effectively could harm our business and adversely affect our
financial condition and operating results. We cannot assure you that we will be
able to do any of the following activities, which we believe are essential to
successfully manage the anticipated growth of our operations: improve our
existing and implement new operations, financial and management information
controls, reporting systems and procedures; hire, train and manage additional
qualified personnel; expand and upgrade our core technologies; and effectively
manage multiple relationships with our customers, suppliers and other third
parties.
IF WE LOSE KEY PERSONNEL, WE MAY NOT BE ABLE TO SUCCESSFULLY OPERATE OUR
BUSINESS
Our success depends to a significant degree upon the continued contributions of
our senior sales, engineering and management personnel, many of whom perform
important management functions and would be difficult to replace. Specifically,
we believe that our future success is highly dependent on Steven J. Benson and
other senior management personnel. Within the last year, we have introduced
several new products, and we have additional new products currently in
pre-release testing. The loss of the services of any key personnel, particularly
senior management and engineers, could seriously harm our business, financial
condition and results of operations, including our success in selling our
recently introduced products and introducing new products.
IF WE ARE UNABLE TO RETAIN AND HIRE ADDITIONAL QUALIFIED PERSONNEL AS NECESSARY,
WE MAY NOT BE ABLE TO SUCCESSFULLY ACHIEVE OUR OBJECTIVES
We have experienced growth in revenues and expansion of our operations, which
has placed significant demands on our management, engineering staff and
facilities. Continued growth will also require us to hire more engineering,
sales and administrative personnel. We may not be able to attract and retain the
necessary personnel to accomplish our business objectives and we may experience
constraints that will adversely affect our ability to satisfy customer demand in
a timely fashion or to support our customers and operations. We have at times
experienced, and continue to experience, difficulty in recruiting qualified
personnel. Recruiting qualified personnel is an intensely competitive and
time-consuming process. New sales personnel and marketing personnel will require
training and take time to achieve full productivity. In addition, the design and
installation of telephony solutions can be complex. Accordingly, we need highly
trained professional services and customer support personnel. We cannot be
certain that we will successfully attract and retain additional qualified
personnel. In addition, our key person life insurance policy, covering some of
our key employees, may be insufficient to cover the costs associated with the
loss of one of these employees.
IF WE OR OUR KEY SUPPLIERS OR CUSTOMERS FAIL TO BE YEAR 2000 COMPLIANT, OUR
BUSINESS MAY BE SEVERELY DISRUPTED AND OUR RESULTS OF OPERATIONS MAY BE
MATERIALLY ADVERSELY AFFECTED
The Year 2000 problem creates a risk for us. Although most of our products do
not incorporate internal clocks, if our remaining products or our internal
computer systems do not correctly recognize date information when the year
changes to 2000, there could be an adverse impact on our operations. The risk
exists primarily in five areas: potential warranty or other claims from our
customers, which may result in significant expense to us; failures of systems we
use to run our business, which could disrupt our business operations; failures
of systems used by our suppliers and contract manufacturers, which could delay
or affect the quality of our products; customers may delay purchasing decisions
until the impact of Year 2000 is more clearly understood, which could negatively
impact our revenues; and the potential for failures of our products,
particularly our central office-based systems, due to Year 2000 problems
associated with products manufactured by other equipment vendors used in
conjunction with our products, which may require that we incur significant
unexpected expenses. We are currently evaluating our exposure in all of these
areas. We are in the
19
<PAGE> 20
process of conducting a comprehensive inventory and evaluation of the
information systems used to run our business. We intend to upgrade or replace
systems which are identified as non-compliant. For the Year 2000 non-compliance
issues identified to date, we do not expect the cost of remediation to be
material to our operating results. If implementation of replacement systems is
delayed, however, or if significant new non-compliance issues are identified,
our business, financial condition or results of operations could be materially
adversely affected. We intend to contact our critical suppliers and contract
manufacturers to determine whether their operations and the products and
services they provide are Year 2000 compliant. Where practicable, we will
attempt to mitigate our risks with respect to the failure of our suppliers and
contract manufacturers to be prepared for any Year 2000 problems. However,
failures remain a possibility and could have a material adverse effect on our
business, financial condition or results of operations. In addition, litigation
regarding Year 2000 compliance issues is expected to escalate. For these
reasons, the impact of customer claims could have a material adverse effect on
our business, financial condition or results of operations.
CONTROL BY EXISTING STOCKHOLDERS MAY LIMIT YOUR ABILITY TO INFLUENCE THE OUTCOME
OF DIRECTOR ELECTIONS AND OTHER MATTERS REQUIRING STOCKHOLDER APPROVAL
Our executive officers, directors and principal stockholders and their
affiliates own a significant percentage of our outstanding common stock. These
stockholders, if acting together, would be able to significantly influence all
matters requiring approval by our stockholders, including the election of
directors and the approval of mergers or other business combination
transactions. This concentration of ownership could have the effect of delaying
or preventing a change in our control or otherwise discouraging a potential
acquiror from attempting to obtain control of us, which in turn could have a
material adverse effect on the market price of the common stock or prevent our
stockholders from realizing a premium over the market prices for their shares of
common stock.
PROVISIONS OF DELAWARE LAW AND OF OUR CHARTER AND BY-LAWS MAY MAKE A TAKEOVER
MORE DIFFICULT
Provisions in our certificate of incorporation and by-laws and in Delaware
corporate law may make it difficult and expensive for a third party to pursue a
tender offer, change in control or takeover attempt that is opposed by our
management. Public stockholders who might desire to participate in such a
transaction may not have an opportunity to do so, and the ability of public
stockholders to change our management could be substantially impeded by these
anti-takeover provisions. For example, we have a staggered board of directors
and the right under our charter documents to issue preferred stock without
further stockholder approval, which provisions could adversely affect the
holders of our common stock.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
(c) For the three months ended October 31, 1999, the Company issued 63,696
shares of common stock pursuant to the exercise of stock options at exercise
prices ranging from $0.098 to $0.196. All of these stock options were granted
prior to the Company's initial public offering under one of the Company's
employee stock option plans. We also sold 30,600 shares of common stock to one
of our directors, as disclosed on page 58 of our Registration Statement on Form
S-1 filed with the Securities and Exchange Commission. No underwriters were used
in connection with these sales and issuances. The sales and issuances of these
securities were exempt from registration under the Securities Act pursuant to
Rule 701 promulgated thereunder on the basis that these securities were offered
and sold either pursuant to a written compensatory benefit plan or pursuant to
written contracts relating to compensation, as provided by Rule 701, or pursuant
to Section 4(2) of the Securities Act on the basis that the transactions did not
involve a public offering.
(d) In connection with its initial public offering in October 1999, the Company
filed a Registration Statement on Form S-1, SEC File No. 333-85821 (the
"Registration Statement"), which was declared effective by the Commission on
October 21, 1999. Pursuant to the Registration Statement, the Company registered
3,400,000 shares of its Common Stock, $.001 par value per share for its own
account. The initial public offering resulted in gross proceeds of $54.4
million, $3,808,000 of which was applied toward the underwriting discount and
commissions. Other expenses related to the offering are estimated to have been
$1.1 million and have been paid or are payable to unaffiliated parties. The net
proceeds to the Company were approximately $49,492,000. The Company used a
portion of the net proceeds to make the following mandatory payments:
20
<PAGE> 21
- - Made a redemption payment of $19,070,164 to our Series A Redeemable
Preferred stockholders, which represents a redemption payment of
$14,985,733 plus accrued dividends of $4,084,431.
- - Made a redemption payment of $3,147,487 to our Series C Redeemable
Preferred stockholders, which represents a redemption payment of
$2,500,000 plus accrued dividends and liquidation premiums of $647,487.
- - Made a redemption payment of $2,586,793 to our Series E Redeemable
Preferred stockholders, which represents a redemption payment of
$2,500,000 plus accrued dividends of $586,793.
- - Made a redemption payment of $2,522,107 to the holders of our subordinated
debt obligations, which represents a redeption payment of $2,500,000 plus
accrued interest of $22,107.
We currently expect to use the net proceeds primarily for working capital and
general corporate purposes, including increased research and development
expenditures, increased sales and marketing expenditures, and capital
expenditures made in the ordinary course of of business. In addition, we may use
a portion of the net proceeds to fund acquisitions or investments in
complementary businesses, technologies or products. However, we have no present
commitments or agreements with respect to such acquistions. Pending such uses,
we will invest the net proceeds in short-term, investment-grade, interest
bearing securities.
In November 1999, the Underwriters exercised their over-allotment options and
purchased 255,000 shares of common stock at the issuance price of $16.00 per
share. The Company received $3,794,400 net of commissions and costs. We intend
to use these proceeds in a manner similar to that described above.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
By written consent dated as of September 30, 1999 a majority of the
Company's stockholders approved the following proposals:
- A proposal to approve the Company's reincorporation in the
State of Delaware;
By written consent dated as of October 19, 1999 a majority of the
Company's stockholders approved the following proposals:
- A proposal to approve amendment of the Company's
Certificate of Incorporation to, among other things,
increase the number of authorized shares of Common Stock
of the Company to 40,000,000, to create a staggered board
of directors and to eliminate the ability of stockholders
to act by written consent to be effective upon
consummation of the initial public offering;
- A proposal to approve amendment of the Company's
Certificate of Incorporation to, among other things,
eliminate the Company's authorized Redeemable Convertible
Preferred Stock and Convertible Preferred Stock to be
effective upon the closing of the initial public offering;
- A proposal to approve the adoption of the 1999 Stock
Option and Grant Plan; and
- A proposal to elect Steven J. Benson and Calvin C. Manz as
Class I Directors, Michael Balmuth and John Landry as
Class II Directors, and Gregory M. Avis and Paul Severino
as Class III Directors.
ITEM 5. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON Form 8-K
(a) Exhibits
Exhibit 27.1 - Financial Data Schedule
(b) Reports on Form 8-K
None.
21
<PAGE> 22
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
Dated: December 15, 1999
MCK COMMUNICATIONS, INC.
/S/ Steven J. Benson
-----------------------------------
Steven J. Benson
President and CEO
22
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM OUR
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES AND EXCHANGE
ACT OF 1934 FOR THE PERIOD ENDED OCTOBER 31, 1999.
</LEGEND>
<MULTIPLIER> 1,000
<CURRENCY> DOLLARS
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> APR-30-2000
<PERIOD-START> MAY-01-1999
<PERIOD-END> OCT-31-1999
<EXCHANGE-RATE> 1
<CASH> 26,290
<SECURITIES> 0
<RECEIVABLES> 4,539
<ALLOWANCES> (197)
<INVENTORY> 1,850
<CURRENT-ASSETS> 32,979
<PP&E> 2,448
<DEPRECIATION> 1,224
<TOTAL-ASSETS> 34,227
<CURRENT-LIABILITIES> 4,785
<BONDS> 0
0
0
<COMMON> 18
<OTHER-SE> 29,245
<TOTAL-LIABILITY-AND-EQUITY> 34,227
<SALES> 10,043
<TOTAL-REVENUES> 10,043
<CGS> 3,718
<TOTAL-COSTS> 3,718
<OTHER-EXPENSES> 8,620
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 181
<INCOME-PRETAX> (2,387)
<INCOME-TAX> 0
<INCOME-CONTINUING> (2,484)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (3,769)
<EPS-BASIC> (0.74)
<EPS-DILUTED> 0
</TABLE>
