<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 JANUARY 31, 2000 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 January 31, 2000, there were 18,061,754 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 January 31, 2000 3
Condensed Consolidated Statements of Operations for the
three and nine months ended January 31, 1999 and 2000 4
Condensed Consolidated Statements of Cash Flows for the
nine months ended January 31, 1999 and 2000 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
<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, January 31,
1999 2000
--------- -----------
(Unaudited)
<S> <C> <C>
Assets
Current assets:
Cash and equivalents $ 3,285 $ 8,424
Marketable securities -- 19,423
Accounts receivable, net 3,350 5,203
Inventory 1,494 2,293
Prepaids and other current assets 213 1,240
-------- --------
Total current assets 8,342 36,583
Fixed assets, net 1,054 1,391
Other assets 32 20
-------- --------
Total assets $ 9,428 $ 37,994
======== ========
Liabilities and Stockholders' Equity (deficit)
Current liabilities:
Accounts payable $ 1,666 $ 2,765
Accrued liabilities 693 1,043
Accrued compensation and benefits 404 450
Borrowings under line of credit -- 211
Deferred revenue -- 112
-------- --------
Total current liabilities 2,763 4,581
Long-term debt 2,500 --
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; Authorized 25,000,000 and 40,000,000 5 18
shares at April 30, 1999 and January 31,2000 Issued and
outstanding - 5,300,183 shares at April 30, 1999 and
18,061,754 at January 31, 2000
Additional paid-in capital 1,388 68,785
Accumulated deficit (24,303) (28,604)
Deferred compensation (805) (5,809)
Accumulated other comprehensive loss (166) (225)
Notes receivable from officers (159) (752)
-------- --------
Total common stockholders' equity (deficit) (24,040) 33,413
-------- --------
Total liabilities and stockholders' equity (deficit) $ 9,428 $ 37,994
======== ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
<PAGE> 4
MCK Communications, Inc.
Condensed Consolidated Statements of Operations
(In thousands, except per share data)
<TABLE>
<CAPTION>
Unaudited Unaudited
Three Months Ended Nine Months Ended
January 31, January 31,
------------------------ ------------------------
1999 2000 1999 2000
------- ------- ------- -------
<S> <C> <C> <C> <C>
Revenues $ 3,609 $ 6,719 $ 10,166 $16,763
Cost of goods sold 1,376 2,556 3,894 6,274
------- ------- ------- -------
Gross profit 2,233 4,163 6,272 10,489
Operating expenses:
Research and development 880 1,292 2,401 3,433
Sales and marketing 1,004 2,021 2,702 4,994
General and administrative 347 685 1,153 1,778
Amortization of stock based compensation 146 1,046 248 3,460
------- ------- ------- -------
Total operating expenses 2,377 5,044 6,504 13,665
------- ------- ------- -------
Loss from operations (144) (881) (232) (3,176)
Other (income) expense:
Interest expense 82 9 318 190
Interest income (34) (389) (99) (440)
Other (income) expense, net (40) 30 9 (8)
------- ------- ------- -------
Total other (income) expense 8 (350) 228 (258)
Loss before dividends on redeemable
preferred stock of subsidiary (152) (531) (460) (2,918)
Dividends on redeemable preferred stock of
subsidiary 47 -- 144 97
------- ------- ------- -------
Net loss (199) (531) (604) (3,015)
Dividends on redeemable preferred stock 532 -- 1,458 1,285
------- ------- ------- -------
Loss applicable to common stock $ (731) $ (531) $(2,062) $(4,300)
======= ======= ======= =======
Basic net loss per share $ (0.19) $ (0.03) $ (0.54) $ (0.47)
======= ======= ======= =======
Shares used in computing basic
net loss per share 3,944 17,085 3,815 9,079
======= ======= ======= =======
Pro-forma basic net loss per share $ (0.06) $ (0.03) $ (0.18) $ (0.30)
======= ======= ======= =======
Shares used in computing pro-forma
basic net loss per share 12,605 17,085 11,765 14,547
======= ======= ======= =======
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
<PAGE> 5
MCK Communications, Inc.
Condensed Consolidated Statements of Cash Flows
(In thousands)
<TABLE>
<CAPTION>
Unaudited
Nine Months Ended
January 31,
-------------------------
1999 2000
-------- --------
<S> <C> <C>
Cash flows from operating activities:
Net loss $ (604) $(3,015)
Depreciation and amortization 299 550
Stock based compensation 248 3,460
Dividends accrued on subsidiary preferred stock 149 97
Changes in operating assets and liabilities:
Accounts receivable (870) (1,853)
Inventory (586) (799)
Prepaids and other current assets 125 (1,027)
Accounts payable 559 1,099
Accrued liabilities (65) 350
Accrued compensation and benefits (2) 45
Deferred revenue -- 112
-------- -------
Net cash used in operating activities (747) (981)
-------- -------
Cash flows from investing activities:
Purchases of property and equipment (470) (890)
Purchases of marketable securities -- (19,423)
-------- -------
Net cash used in investing activities (470) (20,313)
-------- -------
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 -- 53,567
Proceeds from option exercises 3 8
Borrowings under line of credit -- 210
-------- -------
Net cash provided by financing activities 2,443 26,481
-------- -------
Effect of exchange rate change on cash 4 (48)
-------- -------
Net increase in cash and equivalents 1,230 5,139
Cash and equivalents, beginning of period 1,867 3,285
-------- -------
Cash and equivalents, end of period $ 3,097 $ 8,424
======== =======
Supplemental disclosures of cash flow information:
Cash paid for interest $ 587 $ 197
Dividends on non-subsidiary preferred 1,458 1,285
Sale of restricted stock 8 597
Dividends to Manz Development, Inc. 287 193
Issuance of preferred stock in exchange for redemption premium 1,652 --
Conversion of Series B and D redeemable preferred shares to common -- 4,917
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
<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 January 31, 2000 and the
operating results and cash flows for the three and nine months ended January 31,
2000 and 1999. 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 nine months ended January
31, 2000 are not necessarily indicative of the results to be achieved in future
quarters or the year ended 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 nine months ended January 31, 2000, MCK's comprehensive loss was
$511,000 and $3.1 million, respectively, compared to a comprehensive loss of
$224,000 and $607,000 for the three and nine months ended January 31, 1999.
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 22, 1999, the date of the Company's
initial public offering. The company also issued an additional 255,000 shares of
common stock on November 22, 1999 to cover the over-allotment. The net loss per
share calculations have been appropriately weighted to reflect these activities.
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.
<PAGE> 7
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
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
expenses. MCK Communications, Inc. is listed on the NASDAQ National Market under
the symbol "MCKC".
On November 22, 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. The Company received an additional $3,794,400, net of
underwriting discounts and commissions, in this transaction. Additionally,
certain stockholders sold 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 of common
stock. 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.
NOTE 4. INVENTORY
Inventory consisted of (in 000's):
<TABLE>
<CAPTION>
April 30, January 31,
1999 2000
--------- -----------
(Unaudited)
<S> <C> <C>
Raw materials $ 518 $1,002
Work-in-process 781 931
Finished goods 195 360
------ ------
$1,494 $2,293
</TABLE>
<PAGE> 8
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 or that they will have a positive impact on our revenues.
RESULTS OF OPERATIONS
The following table sets forth certain financial data for the periods indicated
as a percentage of revenues:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
January 31, January 31,
------------------ ----------------
1999 2000 1999 2000
----- ----- ----- -----
<S> <C> <C> <C> <C>
Revenues 100.0% 100.0% 100.0% 100.0%
Cost of goods sold 38.1% 38.0% 38.3% 37.4%
----- ----- ----- -----
Gross profit 61.9% 62.0% 61.7% 62.6%
Operating expenses:
Research and development 24.4% 19.2% 23.6% 20.5%
Sales and marketing 27.8% 30.1% 26.6% 29.8%
General and administrative 9.6% 10.2% 11.3% 10.6%
Amortization of stock based compensation 4.0% 15.6% 2.4% 20.6%
----- ----- ----- -----
Total operating expenses 65.9% 75.1% 64.0% 81.5%
----- ----- ----- -----
Loss from operations (4.0)% (13.1)% (2.3)% (19.0)%
Other (income) expense:
Interest expense 2.3% 0.1% 3.1% 1.1%
Interest income (0.9)% (5.8)% (1.0)% (2.6)%
Other (income) expense, net (1.1)% 0.4% 0.1% (0.0)%
----- ----- ----- -----
Total other (income) expense 0.2% (5.2)% 2.2% (1.5)%
----- ----- ----- -----
Loss before dividends on redeemable
preferred stock of subsidiary (4.2)% (7.9)% (4.5)% (17.4)%
===== ===== ===== =====
</TABLE>
<PAGE> 9
THREE MONTHS ENDED JANUARY 31, 2000 AND 1999
Revenues. Revenues increased from $3.6 million for the three months ended
January 31, 1999 to $6.7 million for the three months ended January 31, 2000, an
increase of $3.1 million or 86.2%. This increase was primarily due to the
increased sales of our multi-user remote voice access product, which accounted
for approximately $3.3 million or 48.9% of revenues during the three months
ended January 31, 2000. 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 $1.4 million
for the three months ended January 31, 1999 to $2.6 million for the three months
ended January 31, 2000, an increase of $1.2 million or 85.8%. This increase was
primarily related to the increase in volume of units shipped. Gross margin
increased slightly from 61.9% for the three months ended January 31, 1999 to
62.0% for the three months ended January 31, 2000. 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.
This increased margin contribution of our multi-user product was substantially
offset by start-up manufacturing costs associated with our 12 port product,
which began shipping during the quarter. We do not expect the trend of
increasing margins to continue in future quarters due to rising component costs,
increased pricing pressures, and increased manufacturing overhead costs related
to new product introductions.
Research and development. Research and development expenses include salaries and
related personnel costs, purchased software and prototype expenses related to
the design, development, enhancement and testing of our products. Research and
development expenses increased from $880,000 for the three months ended January
31, 1999 to $1.3 million for the three months ended January 31, 2000, an
increase of $412,000 or 46.8%. This increase was due primarily to increases in
staffing, the manufacturing of prototype units for our 12 Port Branch Office
EXTender and EXTender 6000 product lines and, to a lesser extent, related
overhead costs. For the three months ended January 31, 1999 and 2000, research
and development expenses decreased as a percentage of revenues from 24.4% to
19.2% 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 both in real dollars and as a
percentage of revenue in future periods. We also expect to increase our
expenditures in 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 $1.0
million for the three months ended January 31, 1999 to $2.0 million for the
three months ended January 31, 2000, an increase of $1.0 million or 101.3%. 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 January
31, 1999 and 2000, sales and marketing expenses increased as a percentage of
revenues from 27.8% to 30.1% 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 $347,000 for the
three months ended January 31, 1999 to $685,000 for the three months ended
January 31, 2000, an increase of $338,000 or 97.4%. This increase was primarily
due to increases in staffing in our accounting and human resources groups 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 January 31, 1999 and 2000, general and
administrative expenses increased as a percentage of revenues from 9.6% to
10.2%. 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, MCK
recorded deferred compensation expense of $1.2 million. The company reduced
deferred compensation by $531,000 in connection with the cancellation of certain
options during the three months ended January 31, 2000. The amount recorded
represents 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 or cancellation. Deferred compensation is presented as a reduction of
stockholders' equity and is amortized over the vesting period of the applicable
options, generally four years. MCK expensed $146,000 and $1.0 million of
deferred stock-based compensation in the three months ended January 31, 1999 and
2000, 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 (income) expense, net. Other (income) expense, net consists 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 inter-company transactions. Other (income) expense, net
improved from an expense of $8,000 for the three months ended January 31, 1999
to income of $350,000 for the three months ended January 31, 2000, an
improvement of $358,000. Interest expense, offset by interest income, improved
from an expense of $48,000 for the three months ended January 31,1999 to income
of $380,000 for the three months ended January 31, 2000. This improvement was
primarily related to interest earned on invested cash and the repayment of our
subordinated debt. Foreign exchange gains for the three months ended January 31,
1999 were $40,000 compared to a loss of $30,000 for the three months ended
January 31, 2000. The current period loss was due to a strengthening of the U.S.
dollar against the Canadian dollar.
<PAGE> 10
NINE MONTHS ENDED JANUARY 31, 2000 AND 1999.
Revenues. Revenues increased from $10.2 million for the nine months ended
January 31, 1999 to $16.8 million for the nine months ended January 31, 2000, an
increase of $6.6 million or 64.9%. This increase was primarily due to the
release of our first multi-user remote voice access product in April 1999, which
accounted for approximately $7.6 million or 45.2% of revenues.
Cost of goods sold. Our cost of goods sold increased from $3.9 million for the
nine months ended January 31, 1999 to $6.3 million for the nine months ended
January 31, 2000, an increase of $2.4 million or 61.1%. This increase was
primarily related to the increase in volume of units shipped. Gross margin
increased from 61.7% for the nine months ended January 31, 1999 to 62.6% for the
nine months ended January 31, 2000. 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 $2.4
million for the nine months ended January 31, 1999 to $3.4 million for the nine
months ended January 31, 2000, an increase of $1.0 million or 43.0%. This
increase was due primarily to increases in staffing, the manufacturing of
proto-type units for our EXTender 3200 for IDSL, EXTender 4000, 12 port Branch
Office EXTender and EXTender 6000 product lines. For the nine months ended
January 31, 1999 and 2000, research and development expenses decreased as a
percentage of revenues from 23.6% to 20.5% as a result of increased revenues.
Sales and marketing. Sales and marketing expenses increased from $2.7 million
for the nine months ended January 31, 1999 to $5.0 million for the nine months
ended January 31, 2000, an increase of $2.3 million or 84.8%. 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 nine
months ended January 31, 1999 and 2000, sales and marketing expenses increased
as a percentage of revenues from 26.6% to 29.8% as newly hired sales personnel
generally do not achieve full productivity during their first two quarters with
us.
General and administrative. General and administrative expenses increased from
$1.2 million for the nine months ended January 31, 1999 to $1.8 million for the
nine months ended January 31, 2000, an increase of $625,000 or 54.2%. This
increase was primarily due to increases in staffing in our accounting and human
resources groups 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 nine months ended January 31, 1999 and 2000,
general and administrative expenses decreased as a percentage of revenues from
11.3% to 10.6% as a result of increased revenues.
Amortization of stock based compensation. Stock-based compensation expense was
$248,000 and $3.5 million in the nine months ended January 31, 1999 and 2000,
respectively.
Other (income) expense, net. Other (income) expense, net improved from an
expense of $228,000 for the nine months ended January 31, 1999 to income of
$258,000 for the nine months ended January 31, 2000, an improvement of $486,000.
Interest expense, offset by interest income, improved from an expense of
$219,000 for the nine months ended January 31, 1999 to income of $250,000 for
the nine months ended January 31, 2000. This improvement was due to income
earned on invested cash and the repayment of our subordinated debt. Foreign
exchange losses for the nine months ended January 31, 1999 were $9,000 compared
to a gain of $8,000 for the nine months ended January 31, 2000.
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 common stock from the Company 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 January 31, 2000, our principal sources of liquidity consisted of cash and
equivalents of $8.4 million, short-term investments of $19.4 million, this
represents an increase of $24.6 million compared to April 30, 1999. We also have
a credit facility against accounts receivable which provides for borrowings of
up to $2.0 million and are 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, commercial paper, and
government and non-government debt securities. These investments are designed to
provide current income to the Company without exposing the principal to
significant risk.
Net cash used in operations was $981,000 for the nine months ended January 31,
2000. Cash used by operations was primarily related to an increase in accounts
receivable of $1.9 million, an increase in prepaids and other current assets of
$1.0 million, and an increase in inventory of $799,000 and was partially offset
by an increase in accounts payable and accrued expenses of $1.4 million. Net
cash provided by financing activities was $26.5 million for the nine months
ended January, 31, 2000. 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 and an additional $3.8 million
from the over allotment. 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.
<PAGE> 11
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 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 involves different
combinations of third-party products and MCK cannot evaluate whether all of the
third party products are year 2000 compliant. We have not experienced nor do we
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 and have modified, upgraded or replaced these systems to
minimize the possibility of a material disruption to our business. We believe
that any other systems requiring replacement are not mission-critical and can be
replaced or modified 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 and marketable securities that primarily
consist of commercial paper, corporate bonds and overnight money market
accounts. A 100 basis point shift in interest rates would not result in a
material change in cash flows or the fair value of the cash and marketable
securities.
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 nine months ended
January 31, 2000, revenue from our Canadian subsidiary accounted for 9.4% and
8.0% 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 inter-company balance is denominated in U.S. dollars and changes in the
foreign currency exchange rate result in foreign currency gains and losses.
Using the inter-company balance at January 31, 2000, a 10% strengthening of the
U.S. dollar against the Canadian dollar would result in a foreign currency
transaction loss of $193,000
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 who 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. Furthermore, Lucent announced in March 20000, that it plans to
divest its PBX unit into a standalone business. It is unclear what impact this
may have on our relationship with Lucent or the new entity. For the three and
nine months ended January 31, 2000, Lucent accounted for 47.9% and 45.7% of our
revenues, respectively, and our ten largest customers, including Lucent,
accounted for 77.1% and 76.8% 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 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: 1) the product requirements of these customers; 2) the financial and
operational success of these customers; and 3) 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.
OUR INABILITY TO DEVELOP AND MAINTAIN RELATIONSHIPS WITH KEY PBX VENDORS WOULD
HARM OUR ABILITY TO SUSTAIN AND GROW OUR BUSINESS
<PAGE> 12
Our success will depend to a significant degree upon our relationships with
leading PBX vendors, and their channel distribution partners. 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 the nine months
ended January 31, 2000 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 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 last eleven fiscal quarters, our net
results of operations have ranged from a net loss of $442,849 to a net loss of
$1,986,154. 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
<PAGE> 13
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 three independent manufacturers, Celestica, Mack Technologies
and Electronic Manufacturing Group, to manufacture all of our 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. For example, the demand for flash memory chips is
particularly strong and may lead to shortages for these components of our
products. 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.
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 and increasing 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, develop and maintain our
relationships with large PBX vendors, telecommunications service providers, and
application 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
<PAGE> 14
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 HAS BEEN VOLATILE AND YOU MAY NOT BE ABLE TO RESELL SHARES AT OR
ABOVE THE OFFERING PRICE
The price of our common stock has been and may continue to be volatile 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 14.1% and 12.2% of our revenues for the three
and nine months ended January 31, 2000. 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: 1) changes in
foreign government regulations and communications standards; 2) export license
requirements; 3) currency fluctuations, tariffs and taxes; 4) other trade
barriers; 5) difficulty in collecting accounts receivable; 6) difficulty in
managing foreign operations; and 7) 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 and 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 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
<PAGE> 15
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 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 January 31, 2000, we employed 107 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, our senior management
team has been with us for less than three 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
<PAGE> 16
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. While we
have not experienced any visibly significant problems arising from the year 2000
problem, we continue to evaluate our risk in five primary 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 continue to evaluate our
exposure in all of these areas. We have conducted a comprehensive inventory and
evaluation of the information systems used to run our business and have upgraded
or replaced systems that were identified as non-compliant. The cost of
remediation for the Year 2000 non-compliance issues identified to date were not
material to our operating results and we believe any other costs will be
immaterial to our 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 continue to work with our critical suppliers and contract
manufacturers to ensure that 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
acquirer 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
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
ITEM 5. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON Form 8-K
(a) Exhibits
Exhibit 27.1 - Financial Data Schedule
<PAGE> 17
(b) Reports on Form 8-K
None.
<PAGE> 18
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: March 9, 2000
MCK COMMUNICATIONS, INC.
/S/ Steven J. Benson
-----------------------------------
Steven J. Benson
President and CEO
/S/ Paul K. Zurlo
-----------------------------------
Paul K. Zurlo
Chief Financial Officer
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS FINANCIAL INFORMATION EXTRACTED FROM THE CONSOLIDATED
BALANCE SHEET AND STATEMENT OF OPERATIONS FOR THE NINE MONTHS ENDED JANUARY 31,
2000 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FORM 10-Q
</LEGEND>
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<NAME> MCK COMMUNICATIONS, INC.
<MULTIPLIER> 1,000
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