<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, 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.)
117 KENDRICK STREET NEEDHAM, MASSACHUSETTS 02494
(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 [X] NO [ ]
As of November 30, 2000, there were 19,965,932 shares of registrant's
Common Stock outstanding.
<PAGE> 2
MCK Communications, Inc.
Table of Contents
PART I - FINANCIAL INFORMATION Page
Item 1. Financial Statements
Consolidated Balance Sheets at April 30, 2000
and October 31, 2000 3
Consolidated Statements of Operations for the
three and six months ended October 31, 1999 and 2000 4
Consolidated Statements of Cash Flows for the
six months ended October 31, 1999 and 2000 5
Notes to 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 14
PART II - OTHER INFORMATION 23
Item 1. Legal Proceedings 23
Item 4. Submission of Matters to a Vote of Security Holders 23
Item 6. Exhibits and Reports on Form 8-K 23
Signatures 24
<PAGE> 3
Part I. Financial Information
Item 1. Consolidated Financial Statements
MCK Communications, Inc.
Consolidated Balance Sheets
(In thousands)
April 30, October 31,
2000 2000
--------- -----------
(Unaudited)
Assets
Current assets:
Cash and equivalents $ 55,844 $ 9,757
Marketable securities 19,879 50,562
Accounts receivable, net 5,018 8,073
Inventory 2,498 3,961
Prepaids and other current assets 1,297 2,368
--------- ---------
Total current assets 84,536 74,721
Fixed assets, net 2,306 3,227
Goodwill and other assets 352 23,172
--------- ---------
Total assets $ 87,194 $ 101,120
========= =========
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable $ 4,782 $ 5,277
Accrued liabilities 328 654
Accrued compensation and benefits 621 1,251
Taxes payable 413 1,327
Deferred revenue 71 36
--------- ---------
Total current liabilities 6,215 8,545
Deferred taxes 33 33
Stockholders' equity:
Common stock, $.001 par value;
Authorized 40,000,000 shares
Issued and outstanding -
19,357,369 at April 30, 2000 and
19,965,155 at October 31, 2000 19 20
Additional paid-in capital 115,802 128,349
Accumulated deficit (29,213) (31,468)
Deferred compensation (4,624) (3,247)
Accumulated other comprehensive loss (345) (423)
Notes receivable from officers (693) (689)
--------- ---------
Total stockholders' equity 80,946 92,542
--------- ---------
Total liabilities and stockholders'
equity $ 87,194 $ 101,120
========= =========
The accompanying notes are an integral part of these consolidated financial
statements.
<PAGE> 4
MCK Communications, Inc.
Consolidated Statements of Operations
(In thousands, except per share data)
<TABLE>
<CAPTION>
Unaudited Unaudited
Three Months Ended Six Months Ended
October 31, October 31,
---------------------- ----------------------
1999 2000 1999 2000
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Revenues $ 5,521 $ 11,768 $ 10,043 $ 21,811
Cost of goods sold 2,028 4,489 3,718
8,302
-------- -------- -------- --------
Gross profit 3,493 7,279 6,325 13,509
Operating expenses:
Research and development (excluding amortization of
stock based compensation of $474, $208, $928, and
$430 for the three and six month periods ended
October 31, 1999 and 2000, respectively) 1,178 2,318 2,142 4,324
Sales and marketing (excluding amortization of stock
based compensation of $510, $264, $872, and $602
for the three and six month periods ended
October 31, 1999 and 2000, respectively) 1,625 3,292 2,972 6,257
General and administrative (excluding amortization of
stock based compensation of $316, $162, $614, and
$345 for the three and six month periods ended
October 31, 1999 and 2000, respectively) 599 1,040 1,092 1,996
Amortization of stock based compensation 1,300 634 2,414 1,377
Amortization of goodwill and other intangibles -- 1,296 -- 2,629
-------- -------- -------- --------
Total operating expenses 4,702 8,580 8,620 16,583
-------- -------- -------- --------
Loss from operations (1,209) (1,301) (2,295) (3,074)
Other income (expense):
Interest expense (91) -- (181) (9)
Interest income 27 1,033 51 1,999
Other income (expense), net 67 (65) 38 (70)
-------- -------- -------- --------
Total other income (expense) 3 968 (92) 1,920
-------- -------- -------- --------
Loss before provision for income taxes and dividends
on redeemable preferred stock of subsidiary (1,206) (333) (2,387) (1,154)
Provision for income taxes -- 636 -- 1,100
Dividends on redeemable preferred stock of
subsidiary 46 -- 97 --
-------- -------- -------- --------
Net loss (1,252) (969) (2,484) (2,254)
Dividends on redeemable preferred stock 734 -- 1,285 --
-------- -------- -------- --------
Loss applicable to common stock $ (1,986) $ (969) $ (3,769) $ (2,254)
======== ======== ======== ========
Basic net loss per share $ (0.34) $ (0.05) $ (0.74) $ (0.12)
======== ======== ======== ========
Shares used in computing basic
net loss per share 5,846 19,255 5,075 19,041
======== ======== ======== ========
Pro-forma basic net loss per share $ (0.15) $ (0.05) $ (0.28) $ (0.12)
======== ======== ======== ========
Shares used in computing pro-forma
basic net loss per share 13,580 19,255 13,278 19,041
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
<PAGE> 5
MCK Communications, Inc.
Consolidated Statements of Cash Flows
(In thousands)
<TABLE>
<CAPTION>
Unaudited
Six Months Ended
October 31,
--------------------
1999 2000
------ ------
<S> <C> <C>
Cash flows from operating activities:
Net loss $ (2,484) $ (2,254)
Depreciation 303 756
Amortization of goodwill and intangibles -- 2,629
Stock based compensation 2,414 1,377
Dividends accrued on subsidiary preferred stock 97 --
Changes in operating assets and liabilities:
Accounts receivable (992) (1,954)
Inventory (356) (865)
Prepaids and other current assets (284) (85)
Other assets -- 170
Accounts payable 1,242 75
Accrued liabilities 716 (224)
Taxes payable -- 914
Accrued compensation and benefits (49) (980)
Deferred revenue 37 (34)
-------- --------
Net cash provided by (used) in operating activities 644 (475)
Cash flows from investing activities:
Purchases of property and equipment (482) (1,343)
Acquisition of business, net of cash acquired -- (12,623)
Purchases of marketable securities -- (30,683)
-------- --------
Net cash used in investing activities (482) (44,649)
Cash flows from financing activities:
Redemption of subordinated debt (2,500) --
Redemption of Series A redeemable preferred stock (19,070) --
Redemption of Series C redeemable preferred stock (3,147) --
Redemption of Series E redeemable preferred stock (2,587) --
Net proceeds from issuance of common stock 49,974 (59)
Proceeds from option exercises 6 111
Increase (decrease) in short term borrowings 230 (866)
-------- --------
Net cash provided by (used) in financing activities 22,906 (814)
Effect of exchange rate change on cash (63) (149)
-------- --------
Net increase (decrease) in cash and equivalents 23,005 (46,087)
Cash and equivalents, beginning of period 3,285 55,844
-------- --------
Cash and equivalents, end of period $ 26,290 $ 9,757
======== ========
Supplemental disclosures of cash flow information:
Cash paid for interest $ 30 $ 9
Common shares issued in acquisition of DTIH -- 12,500
Dividends on non-subsidiary preferred 1,285 --
Sale of restricted stock 687 --
Dividends to Manz Development, Inc. 97 --
Conversion of Series B and D redeemable preferred shares
to common 4,908 --
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
<PAGE> 6
MCK Communications, Inc.
Notes to Consolidated Financial Statements
(Unaudited)
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
a. BASIS OF PRESENTATION
The 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 subsidiaries. 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, 2000 and the operating
results and cash flows for the three and six months ended October 31, 2000 and
1999. The balance sheet at April 30, 2000 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 Annual Report on Form 10-K 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, 2000 are not necessarily indicative of the results to be achieved in future
quarters or the year ending April 30, 2001.
b. CASH AND EQUIVALENTS
Cash and equivalents are defined as highly liquid investments having an original
maturity of three months or less.
c. INVESTMENTS
The Company's investments consist primarily of commercial paper and money market
instruments with maturities of less than one year and are classified as
available-for-sale. Available-for-sale securities are stated at fair value, with
the unrealized losses reported in other comprehensive income. The cost of
securities sold is based on the specific identification method. Interest and
dividends on securities classified as available-for-sale are included in
investment income.
Unrealized gains relating to those available-for-sale securities were $1,096 at
October 31, 2000. Realized gains and losses and declines in value judged to be
other-than temporary on available-for-sale securities are included in investment
income
d. REVENUE RECOGNITION
Revenues from product sales to customers are recognized upon shipment. We
routinely analyze and establish, as necessary, reserves at the time of shipment
for product returns and allowances and warranty costs, which amounts to date
have not been significant.
The Company recognizes service revenues as the service is provided. Maintenance
revenues are deferred and recognized ratably over the contract period. Service
and maintenance revenues have not been material.
<PAGE> 7
e. 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, 2000, MCK's comprehensive loss was $1.04
million and $2.33 million, respectively, compared to a comprehensive loss of
$2.02 million and $3.85 million, respectively for three and six months ended
October 31, 1999. Other than the Company's net loss, there are no material
components of the reported comprehensive loss.
f. 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. On April 7, 2000 the Company issued 1,250,000 shares of common
stock in a follow-on offering and on June 14, 2000 issued 364,601 shares of
common stock in connection with the acquisition of DTI Holdings, Inc. The net
loss per share calculations have been appropriately weighted to reflect these
activities, where necessary. No diluted loss per share information has been
presented in the accompanying consolidated statements of operations since
potential common shares from conversion of stock options and restricted stock
are antidilutive
Pro forma basic net loss per share for three and six months ended October 31,
1999 has been calculated assuming the conversion of preferred stock into an
equivalent number of common shares as if the shares had converted at the later
of the beginning of the 1999 fiscal year or on the dates of their issuance.
g. RECENT ACCOUNTING PRONOUNCEMENTS
In December 1999, the Securities and Exchange Commission issued SAB 101, Revenue
Recognition in Financial Statements, which provides guidance on the recognition,
presentation, and disclosure of revenue in financial statements filed with the
Commission. SAB 101 outlines the basic criteria that must be met to recognize
revenue and provides guidance for disclosures related to revenue recognition
policies. We have not assessed the impact, if any, of SAB 101 on our financial
results.
In June 1999, the Financial Accounting Standards Board (FASB) issued SFAS No.
137, Accounting for Derivative Instruments and Hedging Activities - Deferral of
the Effective Date of FASB Statement 133, which postponed the adoption date of
SFAS No. 133. As such, the Company is not required to adopt the statement until
fiscal 2002. Had the Company implemented SFAS No. 133 for the current reporting
period, there would have been no material effect on operational results.
In March 2000, the FASB issued FIN 44, Accounting for Certain Transactions
Involving Stock Compensation. This Interpretation is effective July 1, 2000, but
certain conclusions in this Interpretation cover specific events that occur
after either December 15, 1998, or January 12, 2000. To the extent that this
Interpretation covers events occurring during the period after December 15,
1998, or January 12, 2000, but before the effective date of July 1, 2000, the
effects of applying this Interpretation are recognized on a prospective basis
from July 1, 2000. The Company has adopted FIN 44 and effects of the adoption
are reflected in the financial statements of the Company as of October 31,2000.
<PAGE> 8
NOTE 2. PUBLIC OFFERING OF SECURITIES
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
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 $3.8 million, 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.
On April 7, 2000, the Company completed a follow-on public offering of 1,250,000
shares of common stock, raising approximately $46.7 million, net of offering
expenses. Additionally, certain stockholders sold 1,500,000 shares of their
stock in the Company. The Company did not receive any proceeds on such sales by
its stockholders.
NOTE 3. INVENTORY
Inventory consisted of (in 000's):
April 30, October 31,
2000 2000
--------- -----------
(Unaudited)
Raw materials $ 898 $1,772
Work-in-process 1,309 1,159
Finished goods 291 1,030
------ ------
$2,498 $3,961
NOTE 4. ACQUISITION OF BUSINESS
On June 14, 2000, the Company acquired all of the outstanding stock of DTI
Holdings, Inc. ("DTIH"), its wholly owned subsidiary Digital Techniques, Inc
("DTI") and certain other assets for $12.6 million in cash, including
transaction costs, and 364,601 shares of common stock and assumed stock options
with a fair market value of $12.5 million. The transaction has been accounted
for as a purchase in accordance with Accounting Principals Board ("APB") Opinion
16 - "Business Combinations" and APB 17 - "Intangible Assets". The Company
engaged an independent firm to determine the value of certain tangible and
intangible assets owned by DTIH for the purpose of allocating the total purchase
price. The Company allocated approximately $2.5 million of the purchase price to
tangible assets, $22.2 million to goodwill and related intangibles, and $694,000
to in-process development. Goodwill and associated intangibles resulting from
the acquisition are being amortized over a period not to exceed five years.
During the period ended July 31, 2000, the Company recorded a $694,000
in-process research and development charge to fully write off the value
associated with projects that were yet to be completed or released from beta
testing.
The consolidated results of operations for the three months ended October 31,
2000 include DTIH's results for the entire period and the results for the six
months ended October 31, 2000 include DTIH's results from June 14, 2000.
Assuming the acquisition of DTIH occurred On May 1, 1999, on a pro-forma basis,
the company would have reported revenues of $8.3 million and $16.7 million, net
losses of $3.0 million and $5.3 million and basic net loss per share of $0.48
and $0.98 for the three and six months ended October 31, 1999 respectively.
Assuming the acquisition occurred on May 1, 2000, on a pro-forma basis, the
company would have reported revenues of $23.2 million, net losses of $4.6
million and basic net loss per share of $0.24 during the six months ended
October 31, 2000. The unaudited pro-forma financial information is presented for
illustrative purposes and is not necessarily indicative of the combined results
of operations in future periods or the results that actually would have been
realized had MCK and DTIH been a combined company during the specified periods.
<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 for corporate telephone
systems that enable corporations to extend the features and applications of
those systems, which are known as private branch exchanges or PBX's, from the
corporate office to remote branch offices and telecommuters over geographically
dispersed public and private data networks. PBX systems are the most commonly
used corporate telephone systems and deliver features such as three- or
four-digit internal dialing and call forwarding and applications such as
voicemail, automatic call distribution and interactive voice response. Our
EXTender products cost-effectively deliver a unified enterprise-wide voice
network by enabling the PBX to function as a corporate voice server that
transmits voice and PBX applications to remote locations over corporations'
existing data networks. In addition our products reduce the total cost of
ownership by utilizing corporations current investment in voice and data
equipment, and streamline network administration through the utilization of
industry standard network management techniques.
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 Needham, Massachusetts and have
development centers in Allen, Texas and Calgary, Canada. We outsource our
manufacturing to four contract manufacturers. Certain manufacturers provide full
turnkey services including material procurement, final assembly, test, shipment
to our customers, and warranty services. Other manufacturers provide us with
printed circuit assemblies which we then assemble and test prior to shipping to
our customers. Our sales force and marketing efforts are primarily directed at
developing brand awareness and supporting our indirect distribution channels.
On June 14, 2000, we acquired DTI Holdings, Inc ("DTIH") and its wholly owned
subsidiary Digital Techniques, Inc. ("DTI") and certain other assets for $12.6
million in cash, including transaction costs, 364,601 shares of common stock and
assumed stock options. DTI designs, manufactures, distributes and supports a
comprehensive suite of digital to analog recording gateways which complement the
Company's existing products. Based in Allen, Texas, DTI has approximately 50
employees and maintains a 20,000 square foot facility. Consistent with our
current manufacturing model, DTI's performs final assembly and test of its
recording gateway products at its facility and are currently transitioning our
test and assembly operations for our single user products, which are currently
manufactured in Canada, to our Texas facility. We expect this transition to be
complete by no later than February 2001.
Product revenues currently consist of sales of our remote voice access products
and, to a lesser degree, our digital-to-analog gateway 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
<PAGE> 10
represent a substantial portion 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 Six Months Ended
October 31, October 31,
------------------ -------------------
1999 2000 1999 2000
------- ------- ------- -------
<S> <C> <C> <C> <C>
Revenues 100.0 % 100.0 % 100.0 % 100.0 %
Cost of goods sold 36.7 % 38.1 % 37.0 % 38.1 %
------- ------- ------- -------
Gross profit 63.3 % 61.9 % 63.0 % 61.9 %
Operating expenses:
Research and development 21.3 % 19.7 % 21.3 % 19.8 %
Sales and marketing 29.4 % 28.0 % 29.6 % 28.7 %
General and administrative 10.8 % 8.8 % 10.9 % 9.2 %
Amortization of stock based compensation 23.5 % 5.4 % 24.0 % 6.3 %
Amortization of goodwill and other intangibles 0.0 % 11.0 % 0.0 % 12.1 %
------- ------- ------- -------
Total operating expenses 85.2 % 72.9 % 85.8 % 76.1 %
------- ------- ------- -------
Loss from operations (21.9)% (11.0)% (22.9)% (14.2)%
Other income (expense):
Interest expense (1.6)% 0.0 % (1.8)% 0.0 %
Interest income 0.5 % 8.8 % 0.5 % 9.2 %
Other income (expense), net 1.2 % (0.6)% 0.4 % (0.3)%
------- ------- ------- -------
Total other income (expense) 0.1 % 8.2 % (0.9)% 8.9 %
------- ------- ------- -------
Loss before dividends on redeemable
preferred stock of subsidiary (21.8)% (2.8)% (23.8)% (5.3)%
======= ======= ======= =======
</TABLE>
THREE MONTHS ENDED OCTOBER 31, 2000 AND 1999
Revenues. Revenues increased from $5.5 million for the three months ended
October 31, 1999 to $11.8 million for the three months ended October 31, 2000,
an increase of $6.2 million or 113.1%. This increase was primarily due to the
increased sales of our multi-user products, which accounted for approximately
$6.2 million or 53% of revenues during the three months ended October 31, 2000,
compared to $2.6 million or 47% of revenues in the three months ended October
31, 1999. We have historically derived the majority of our revenues from a small
number of customers, most of whom resell our products to end users. Lucent
Technologies, a significant customer that has accounted for more than 40% of our
revenues over the past 2 years, divested its PBX unit into a standalone business
named Avaya. It is unclear what impact this divestiture may have on our revenues
in future quarters.
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 $2.0 million
for the three months ended October 31, 1999 to $4.5 million for the three months
ended October 31, 2000, an increase of $2.5 million or 121.4%. This increase was
primarily related to the increase in volume of units shipped. Gross margin
decreased slightly from 63.3% for the three months ended October 31, 1999 to
61.9% for the three months ended October 31, 2000. The decrease in gross margin
was primarily attributable to increased costs of certain components such as
flash memory, general pricing pressures in the market and, to a lesser extent,
start-up manufacturing costs associated with our 24-port gateway products. We do
not expect the trend of
<PAGE> 11
decreasing margins to continue in future quarters as we expect higher margin
multi-user products and cost saving measures to offset 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 $1.2 million for the three months ended
October 31, 1999 to $2.3 million for the three months ended October 31, 2000, an
increase of $1.1 million or 96.8%. This increase was due primarily to increases
in staffing, the addition of DTI's development team, the manufacturing of
prototype units for our 24-port gateway and, to a lesser extent, related
overhead costs. For the three months ended October 31, 1999 and 2000, research
and development expenses decreased as a percentage of revenues from 21.3% to
19.7% 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 $1.6
million for the three months ended October 31, 1999 to $3.3 million for the
three months ended October 31, 2000, an increase of $1.7 million or 102.6%. This
increase was primarily due to increases in staffing of both sales and marketing
personnel, the addition of DTI's sales force, and, to a lesser extent, increased
marketing activities aimed at driving demand for our products. For the three
months ended October 31, 1999 and 2000, sales and marketing expenses decreased
as a percentage of revenues from 29.4% to 28.0%. 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 $599,000 for the
three months ended October 31, 1999 to $1.0 million for the three months ended
October 31, 2000, an increase of $441,000 or 73.6%. 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, the addition
of DTI staff, and, to a lesser extent, professional service costs. For the three
months ended October 31, 1999 and 2000, general and administrative expenses
decreased as a percentage of revenues from 10.8% to 8.8%. 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 prior to our initial public offering on
October 22, 1999, we recorded deferred compensation expense of $10.2 million. In
January 2000, deferred compensation was reduced by $531,000 in connection with
the cancellation of certain options. 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. We expensed $1.3 million and $634,000 of deferred
stock-based compensation in the three months ended October 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.
<PAGE> 12
Amortization of goodwill and other intangibles. In conjunction with the
acquisition of DTIH, we recorded goodwill and certain intangible assets
resulting from the excess of purchase price over the fair value of the tangible
assets acquired. Goodwill and intangibles will be amortized over a period not to
exceed 5 years and will impact our operating results through fiscal 2005. During
the three months ended October 31, 2000, we amortized $1.3 million of goodwill
and related intangibles.
Other income (expense). Other income (expense), 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
income of $3,000 for the three months ended October 31, 1999 to income of $1.0
million for the three months ended October 31, 2000, an improvement of
approximately $1.0 million. Interest expense, offset by interest income,
improved from an expense of $64,000 for the three months ended October 31,1999
to income of $1.0 million for the three months ended October 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 October 31, 1999 were $67,000 compared to a loss of $65,000 for the three
months ended October 31, 2000. The increased loss was primarily related to a
weakening of the Canadian Dollar against the U.S. Dollar.
SIX MONTHS ENDED OCTOBER 31, 2000 AND 1999
Revenues. Revenues increased from $10.0 million for the six months ended October
31, 1999 to $21.8 million for the six months ended October 31, 2000, an increase
of $11.8 million or 117.2%. This increase was primarily due to the increased
sales of our multi-user remote voice access products, which accounted for
approximately $11.9 million or 54% of revenues during the six months ended
October 31, 2000, compared to $4.3 million or 42% of revenues in the six months
ended October 31, 1999.
Cost of goods sold. Cost of goods sold increased from $3.7 million for the six
months ended October 31, 1999 to $8.3 million for the six months ended October
31, 2000, an increase of $4.6 million or 123.3%. This increase was primarily
related to the increase in volume of units shipped. Gross margin decreased
slightly from 63.0% for the six months ended October 31, 1999 to 61.9% for the
six months ended October 31, 2000. The decrease in gross margin was primarily
attributable to increased costs of certain components such as flash memory,
general pricing pressures in the market and, to a lesser extent, start-up
manufacturing costs associated with our EXTender 3200 for IDSL and 24-port
gateway products.
Research and development. Research and development expenses increased from $2.1
million for the six months ended October 31, 1999 to $4.3 million for the six
months ended October 31, 2000, an increase of $2.2 million or 101.9%. This
increase was due primarily to increases in staffing, the addition of DTI's
development team, the manufacturing of prototype units for our 24-port gateway
and, to a lesser extent, related overhead costs. For the six months ended
October 31, 1999 and 2000, research and development expenses decreased as a
percentage of revenues from 23.2% to 19.8% as a result of increased revenues.
Sales and marketing. Sales and marketing expenses increased from $3.0 million
for the six months ended October 31, 1999 to $6.3 million for the six months
ended October 31, 2000, an increase of $3.3 million or 110.5%. This increase was
primarily due to increases in staffing of both sales and marketing personnel,
the addition of DTI's sales force, and, to a lesser extent, increased marketing
activities aimed at driving demand for our products. For the six months ended
October 31, 1999 and 2000, sales and marketing expenses decreased as a
percentage of revenues from 29.6% to 28.7%.
General and administrative. General and administrative expenses increased from
$1.1 million for the six months ended October 31, 1999 to $2.0 million for the
six months ended October 31, 2000, an increase of $904,000 or 82.8%. 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, the addition of DTI staff, and, to a lesser extent, professional
service costs. For the six months ended October 31, 1999 and 2000, general and
administrative expenses decreased as a percentage of revenues from 10.9% to
9.2%.
<PAGE> 13
Amortization of stock-based compensation. In connection with the grant of
certain stock options to employees prior to our initial public offering on
October 22, 1999, we recorded deferred compensation expense of $10.2 million. In
January 2000, deferred compensation was reduced by $531,000 in connection with
the cancellation of certain options. 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. We expensed $2.4 million and $1.4 million of
deferred stock-based compensation in the six months ended October 31, 1999 and
2000, respectively.
Amortization of goodwill and other intangibles. In conjunction with the
acquisition of DTIH, we recorded goodwill and certain intangible assets
resulting from the excess of purchase price over the fair value of the tangible
assets acquired. Goodwill and intangibles are being amortized over a period not
to exceed 5 years and will impact our operating results through fiscal 2005.
During the six months ended October 31, 2000, we amortized $1.9 million of
goodwill and wrote off $694,000 of in-process research and development costs.
Other income (expense). Other income (expense), net improved from an expense of
$92,000 for the six months ended October 31, 1999 to income of $1.9 million for
the six months ended October 31, 2000, an improvement of $2.0 million. Interest
expense, offset by interest income, improved from an expense of $130,000 for the
six months ended October 31,1999 to income of $2.0 million for the six months
ended October 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 six months ended October 31, 1999 were $38,000 compared
to a loss of $70,000 for the six months ended October 31, 2000. The increased
loss was primarily related to a weakening of the Canadian Dollar against the
U.S. Dollar.
LIQUIDITY AND CAPITAL RESOURCES
As of October 31, 2000, our principal sources of liquidity consisted of cash and
equivalents of $9.8 million, short-term investments of $50.6 million, and a $5.0
million credit facility against accounts receivable. This represents a decrease
in cash and equivalents and short-term investments of $15.4 million compared to
April 30, 2000. We regularly invest 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 $475,000 for the six months ended October 31,
2000. Cash used by operations was primarily related to an increase in accounts
receivable of $2.0 million, an increase in inventory of $865,000, and a decrease
in accrued compensation of $1.0 million. This was partially offset by net income
adjusted to exclude non cash stock based compensation charges and depreciation
and amortization of $2.5 million and an increase in taxes payable of $914,000.
Net cash used in investing activities was $44.6 million. We used $30.7 million
to purchase short-term investments and $12.6 million in cash to purchase DTIH
and certain other assets. Net cash used in financing activities was $814,000 for
the six months ended October, 31, 2000. Cash used in financing activities was
primarily related to a reduction in DTI's short-term debt of $866,000.
We expect to devote substantial capital resources to continue our research and
development efforts, to hire and expand our 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 our current cash and equivalents, short-term
investments and cash generated from operations will be sufficient to meet our
anticipated cash requirements for working capital and capital expenditures for
at least the next 12 months.
<PAGE> 14
ITEM 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest Rate Risk. The Company's cash equivalents and marketable securities
primarily consist of interest sensitive securities with weighted average
maturities of less than six months. A 100 basis point decrease in interest rates
would not result in a material change in the fair value of these investments due
mainly to the short-term nature of these investments. However, a 100 basis point
decrease in interest rates would increase our net loss by approximately
$600,000.
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. In the fiscal year ended April 30, 2000, this
revenue accounted for 11.5% of revenues. 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, 2000, a 10%
strengthening of the U.S. dollar against the Canadian dollar would result in a
foreign currency transaction loss of approximately $100,000.
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. Lucent divested its PBX unit into a standalone business named
Avaya. It is unclear what impact this may have on our relationship with Lucent
or Avaya and could have an adverse effect on our revenues derived from both
companies. For the fiscal year ended April 30, 1999, Lucent accounted for 46.7%
of our revenues, and our ten largest customers, including Lucent, accounted for
78.7% of our revenues. For the fiscal year ended April 30, 2000, Lucent
accounted for 45.6% of our revenues, and our 10 largest customers, including
Lucent, accounted for 76.1% of our revenues. 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:
- 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.
<PAGE> 15
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 like Lucent Technologies, Nortel, NEC, Toshiba, among others
and their channel distribution partners. The systems sold by these vendors
account for approximately 70% of the U.S. market for corporate PBX equipment
sales, and approximately 99% of our revenues for the fiscal year ended April 30,
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
<PAGE> 16
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 thirteen fiscal quarters, our net
results of operations have ranged from a net loss of $443,000 to a net loss of
$2.0 million. 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
<PAGE> 17
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 four independent manufacturers, Celestica, Electronic
Manufacturing Group, Mack Technologies, and OEM Worldwide 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
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 substantially all 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
<PAGE> 18
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, we expect our multi-user products, next generation single
user products and our recently announced gateway products will account for a
substantial portion of our revenues in 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, resellers and distributors,
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 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, AND MAY CONTINUE TO BE, VOLATILE AND YOU MAY NOT BE
ABLE TO RESELL SHARES AT OR ABOVE YOUR PURCHASE PRICE
The trading price of our common stock has been, and may continue to be, subject
to wide fluctuations in response to factors such as:
- changes in general market conditions;
- 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 financial estimates by securities analysts;
- announcements of significant acquisitions, strategic partnerships,
<PAGE> 19
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 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. 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 IN
INTERNATIONAL OPERATIONS
International sales represented 15.3% of our revenues for the fiscal year ended
April 30, 2000, and 18.3% of our revenues for the year ended April 30, 1999.
While we expect sales to international markets to increase as a percentage of
revenues in the future. 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 downturns 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.
<PAGE> 20
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 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
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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 October 31, 2000, we employed 205 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.
DIFFICULTIES AND FINANCIAL BURDENS ASSOCIATED WITH ACQUISITIONS COULD HARM OUR
BUSINESS AND FINANCIAL RESULTS
On June 14, 2000, we acquired all of the outstanding stock of DTI Holdings, Inc.
and its wholly owned subsidiary Digital Techniques, Inc. Our product range and
customer base have increased in the recent past due in part to this acquisition.
This acquisition provided us with technologies to expand our current line of
remote voice access products. There can be no assurance that the integration of
all of the acquired technologies will be successful or will not result in
unforeseen difficulties which may absorb significant management attention.
In the future, we may acquire additional businesses or product lines. The
recently completed acquisition, or any future acquisition, may not produce the
revenue, earnings or business synergies that we anticipated, and an acquired
product, service or technology might not perform as expected. Prior to
completing an acquisition,
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however, it is difficult to determine if such benefits can actually be realized.
The process of integrating acquired companies into our business may also result
in unforeseen difficulties. Unforeseen operating difficulties may absorb
significant management attention, which we might otherwise devote to our
existing business. Also, the process may require significant financial resources
that we might otherwise allocate to other activities, including the ongoing
development or expansion of our existing operations.
If we pursue a future acquisition, our management could spend a significant
amount of time and effort identifying and completing the acquisition. To pay for
a future acquisition, we might use capital stock or cash. Alternatively, we
might borrow money from a bank or other lender. If we use capital stock, our
stockholders would experience dilution of their ownership interests. If we use
cash or debt financing, our financial liquidity will be reduced.
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.
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 the outstanding shares of 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,
<PAGE> 23
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
On May 3, 2000, Joan Lockhart, the Company's former Vice President of Marketing,
filed a complaint in Massachusetts State Court against the Company (the
"Complaint"). In the Complaint, entitled Joan Lockhart v. MCK Communications,
Inc., (Middlesex Superior Court), Ms. Lockhart asserts a claim for breach of
contract against the Company based on her allegations that the Company failed to
comply with the terms of her employment and certain restricted stock and stock
option agreements executed by and between the Company and Ms. Lockhart. Ms.
Lockhart seeks certain damages of approximately $30,000 in severance pay as well
as declaratory and injunctive relief, including the right to purchase 33,309
shares of restricted stock and exercise certain stock options. On June 5, 2000,
the Company filed its answer denying the material allegations of Ms. Lockhart's
complaint. We are unable at this time to estimate the probability of a favorable
or unfavorable outcome or to estimate the amount of any losses in the event of
an unfavorable outcome.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
We held our annual meeting on October 17, 2000. The following actions were voted
on at the meeting:
a. The Election of two Class I Directors for a three-year term
For Against Abstain
Steven J. Benson 16,687,544 195,415 --
Calvin K. Manz 16,687,544 195,415 --
b. Approval and adoption of the Company's 2000 Employee Stock Purchase Plan
For Against Abstain
13,148,926 396,094 14,621
c. Approval and adoption of the Company's 2000 Director Stock Option Plan
For Against Abstain
8,810,463 4,734,194 14,984
ITEM 6. EXHIBITS AND REPORTS ON Form 8-K
(a) Exhibits
Exhibit 27.1 - Financial Data Schedule
(b) Reports on Form 8-K
On August 28, 2000 we filed an amendment to Form 8-K, which Form
8-K was filed to report the acquisition of DTIH on June 14, 2000. The amendment
includes historical financial information for DTIH as required.
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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, 2000
MCK COMMUNICATIONS, INC.
/s/ Steven J. Benson
-----------------------------------
Steven J. Benson
President and CEO
/s/ Paul K. Zurlo
-----------------------------------
Paul K. Zurlo
Chief Financial Officer
