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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934 FOR THE FISCAL YEAR ENDED: APRIL 30, 2001
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 -
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 NUMBER)
117 KENDRICK STREET, NEEDHAM, MA 02494
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (617) 454-6100
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: COMMON STOCK, $0.001
PAR VALUE
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 [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
The aggregate market value of voting stock held by non-affiliates of the
registrant as of May 31, 2001, was approximately $28,688,283 based upon the last
sales price reported for such date on The Nasdaq National Market. For purposes
of this disclosure, shares of Common Stock held by persons who hold more than 5%
of the outstanding shares of Common Stock and shares held by officers and
directors of the registrant, have been excluded in that such persons may be
deemed to be affiliates. This determination is not necessarily conclusive.
At May 31, 2001 the registrant had outstanding 20,180,325 shares of Common
Stock.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's definitive Proxy Statement to be filed
pursuant to Regulation 14A for the Registrant's 2001 Annual Meeting of
Stockholders are incorporated by reference into Part III of this Annual Report
on Form 10-K
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TABLE OF CONTENTS
PAGE
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INFORMATION REGARDING FORWARD-LOOKING STATEMENTS........................... 2
PART I..................................................................... 2
ITEM 1. BUSINESS.................................................... 2
ITEM 2. PROPERTIES.................................................. 20
ITEM 3. LEGAL PROCEEDINGS........................................... 21
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS......... 21
PART II.................................................................... 22
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS......................................... 22
ITEM 6. SELECTED HISTORICAL CONDENSED FINANCIAL INFORMATION......... 22
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS................................... 24
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA................. 40
ITEM 9. CHANGES AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE........................................ 40
PART III................................................................... 40
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.......... 40
ITEM 11. EXECUTIVE COMPENSATION...................................... 40
ITEM 12. SECURITY OWNERSHIP OF MANAGEMENT AND CERTAIN BENEFICIAL
OWNERS...................................................... 40
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.............. 40
PART IV.................................................................... 40
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM
8-K......................................................... 40
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS................................. F-1
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INFORMATION REGARDING FORWARD-LOOKING STATEMENTS
This Annual Report on Form 10-K contains certain forward-looking statements
(within the meaning of Section 27A of the Securities Act of 1933, as amended,
and Section 21E of the Securities Exchange Act of 1934, as amended) that involve
risks and uncertainties. Forward-looking statements include, without limitation,
statements containing the words "anticipates," "believes," "expects," "intends,"
"future" and words of similar import which express management's belief,
expectations or intentions regarding the future performance of MCK
Communications, Inc. and its subsidiaries (hereafter, collectively, "we," "us,"
"our," "MCK" or the "Company"). Actual results and the timing of certain events
could differ materially from those projected in the forward-looking statements
as a result of a number of factors. For a discussion of important factors that
could affect the Company's results, please refer to the Business section and to
the financial statement line item discussions and Factors Affecting Future
Operating Results and Stock Price set forth in Management's Discussion and
Analysis of Financial Condition and Results of Operations discussed elsewhere in
this Annual Report on Form 10-K.
PART I
ITEM 1. BUSINESS
OVERVIEW
MCK Communications is a leading provider of products that deliver
distributed voice communications by enabling businesses to extend the
functionality and applications of their business telephone systems from the main
office to outlying offices, remote call centers, teleworkers and mobile
employees over public and private networks. Business telephone systems consist
of private branch exchange ("PBX") systems and key systems ("KTS"). Whereas key
systems are used in medium and small businesses or smaller locations within
larger companies, PBX's are the most commonly used telephone systems in
corporations. PBX's deliver such features as 3- or 4-digit internal dialing,
conferencing, call transfer and call forwarding. PBX's also generally support a
range of telephony applications such as voicemail, automatic call distribution,
auto attendant, call accounting and interactive voice response.
Our EXTender products cost-effectively deliver a unified enterprise-wide
voice network by enabling the voice switch to function as a company-wide voice
server that transmits call function and applications to distributed locations
over the company's existing data networks. This enables a company to provide the
same telephony functionality to all locations while reducing their total cost of
ownership. Savings are achieved by leveraging current investments in voice and
data equipment, flexibility of network choice for lowered communications service
cost and streamlined network administration through the utilization of industry
standard network management techniques.
Our products also provide companies the flexibility of combining the power
of service providers network services such as mobile services to expand the
range of services provided to their workforce. In addition, our products provide
companies flexible choices for managing their path to the future by leveraging
their current infrastructure investments while taking advantage of next
generation "nextgen" telephony systems (i.e., IP switches), applications (i.e.,
unified messaging) and devices (i.e., IP phones) to provide employees enriched
telephony experiences. Our recording gateway products are used within a variety
of telephony-based applications and enable our customers to convert digital PBX
signals into standard analog audio output so that calls can be easily and
cost-effectively recorded for future use.
We market and distribute our products through an international network of
indirect distributors, resellers, equipment providers, system integrators,
service 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 also maintain a sales and marketing office in the
United Kingdom. We outsource our manufacturing to three contract manufacturers.
One manufacturer provides 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
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our customers. Our customer support efforts focus on complementing our
distribution partners' offerings thereby providing end customers with world
class servicing. Our sales force and marketing efforts are primarily directed at
supporting our indirect distribution channels and developing brand awareness.
INDUSTRY BACKGROUND
Most businesses today have deployed separate networks to support voice and
data communications. As they evolve to unite their geographically distributed
locations such as branch or satellite locations and an increasingly virtual
workforce, new demands are being placed on the traditionally localized voice
communications networks. While data networks have evolved to meet this challenge
by offering high-speed remote data access and a high degree of interoperability
among data systems and components, telephony systems and voice networks have
remained largely centralized and proprietary. Consequently, providing
cost-effective, company-wide services and applications to all locations and
employees can be a significant challenge.
Businesses depend on company-wide communication to ensure critical internal
collaboration, provide suitable levels of customer service, and maintain
operational efficiency and productivity by sharing resources throughout the
company. The shift to a more distributed voice environment results from a number
of factors. These include the lowering cost of communications, competitive
advantage of being nearer to key customers, suppliers and partners and the
competition for qualified employees. In order to retain employees and comply
with expanding environmental regulation, many companies are also implementing
large-scale telecommuting programs.
In trying to address these needs, companies are increasingly challenged by
the need to integrate voice and data networks across multiple locations. As the
business environment becomes more competitive, unified voice communications will
become increasingly important. These factors are driving demand for solutions
that deliver an integrated network environment with all the features and
applications found at headquarters distributed to distant locations as well as
to virtual and/or mobile employees.
Enterprise Data Networks
Initially, data networks were built to inter connect mainframe computers
that served a single office location. They were accessible by a limited number
of users and were often too costly for small organizations. Over the past 20
years, advances in open-systems, computer processing and networking technology
have altered this centralized model to deliver cost-effective, high-speed
distributed information processing and communications by using a distributed
client-server architecture. This enables companies to deploy equipment from
multiple vendors that is interoperable across local area network ("LANs"), or
wide area networks ("WANs"), using standard communication protocols,
internetworking technologies, and industry-standard system management platforms.
These same developments have also facilitated widespread data access through the
deployment of remote access equipment capable of extending the reach of data
networks beyond corporate locations over public and private networks.
Historically, branch offices and telecommuters accessed corporate data
networks over a variety of circuit-based networks that were designed for voice
service. These circuit-based networks are dedicated point-to-point connections
that require companies to constantly maintain sufficient bandwidth to meet their
maximum communications requirements. New packet-based networks, deployed over
the past decade, divide all types of data, including voice, into packets that
can be simultaneously transmitted and reassembled into their original form at
their final destination. These packet-based networks are more efficient in their
use of available bandwidth than traditional circuit-based networks, thus
minimizing network capacity constraints and management requirements.
As a result of the growing demand for high-bandwidth applications, such as
Internet and intranet access, service providers are migrating from existing
circuit-based networks to packet-based networks. The ability of packet-based
networks to increase bandwidth availability and network efficiency, lower
operating costs and simplify network administration has led service providers to
make significant investments in packet-based networks in the public
communications infrastructure. These service providers are creating new service
offerings over private managed networks and public networks, such as the
Internet, and are using new
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technologies, such as Quality of Service and firewalls, to ensure speed, quality
and security. Deployment of packet-based networks and widespread access is
enabling companies to realize tremendous productivity gains due to increased
collaboration, internal communication and sharing of resources. Examples of
specific benefits include company-wide e-mail capabilities, company-wide access
to files and applications that run on a corporate server and ease of access for
remote workers.
Enterprise Voice Networks
Enterprise telephony systems are generally based on a circuit-based
architecture and corporate telephone equipment known as private branch
exchanges. Given the mission critical nature of voice communications and related
applications, enterprise voice systems have been architected with numerous
built-in fault tolerant and redundancy features and are designed to deliver
99.999% up-time reliability. In addition to delivering reliable voice service,
PBXs have the capability to serve as the platform for more than 500 critical
voice features and applications, including:
- voicemail systems
- unified messaging systems that create a single interface for accessing
voicemail, e-mail and fax messages
- automatic call distribution systems
- auto-attendant systems
- directories
- call accounting software
- least-cost routing applications
- interactive voice response systems
The PBX is also responsible for delivering features and capabilities such
as:
- phone numbering plans
- 3 or 4 digit internal dialing
- call transferring, conferencing and forwarding
- receptionist call screening
Despite the reliability and functionality of centralized circuit-based
voice networks, the features, applications and inter-connectivity of traditional
PBX systems and their proprietary architectures make it difficult to integrate
them with other systems and applications. Furthermore, they cannot be
cost-effectively networked or extended to outlying and/or smaller offices and
teleworkers. A number of factors have created this deficiency. PBX-based
telephone systems are bandwidth constrained making them poor at networking, not
easily integrated with other traffic types, such as data and video, and the
quality of their voice transmission degrades beyond a limited distance. In
addition, the high cost associated with deploying a PBX system and its supported
voice applications typically makes them prohibitively expensive for smaller
locations. Accordingly, companies seeking to extend voice services to outlying
locations and/or incorporate new applications have traditionally had the
following voice options, all of which have significant limitations:
- Key Systems. Key systems have functionality similar to PBXs but have
been cost-effectively architected to service small office environments.
They lack the full feature set and scalability of more expensive
PBX-based telephone systems. Key systems have limited interoperability
with PBX systems, and consequently function as stand-alone voice systems
with separate voice applications. This creates a less than professional
image due to dissimilar functionalities, inefficiencies and network
management complexities in a multi-office environment.
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- IP PBXs. Recently introduced voice switches from voice and data
networking vendors, such as LAN and Windows NT-server based PBXs, are
based on data standards and tend to be more open. Although providing new
alternatives, they lack the full feature set of the traditional PBXs,
have limited ability to network with the proprietary, circuit-switched
PBXs, limit business reach either to a LAN or nextgen network environment
and provide less than the 99.999% service availability typically expected
by the customer. As a result, they fall far short of business
expectations.
- Centrex. Centrex is a business telephone service that is offered by
local telephone companies from their central offices. While Centrex
offers many of the same features as PBXs, its effectiveness is
constrained by phone companies' capacity, its lack of interoperability
with PBXs, its geographic limitations and its reliance upon the local
phone company for service and support. Adding new services for a Centrex
provider is time consuming, expensive, cumbersome and provisioning
complexity can often prohibit customer acceptance.
- Off-Premises Extension. An Off-Premises Extension is a dedicated
telephone line that originates from a PBX and extends a subset of PBX
features and applications to remote users. These offerings cannot support
digital telephone sets, and require an expensive dedicated leased line or
private network connection.
The inability of these solutions to fully network with the PBX has caused
businesses to deploy separate voice networks for their outlying offices and
telecommuters, limiting the effectiveness of company communications and
increasing the burden on systems administrators. In addition, companies seeking
to extend voice applications to telecommuters presently have no cost-effective,
full-featured solutions.
Enterprise Voice Evolution
As business organizations decentralize, distributed voice networks are
becoming increasingly important. While data networks have evolved to meet this
critical business requirement, there is similar need for a suitable voice
solution that cost-effectively utilizes the company's voice systems and its
features and applications to offer company-wide voice applications to all
employees. This includes employees at smaller outlying offices, telecommuters
and mobile workers. Furthermore, in order to lower costs and simplify network
administration, companies are increasingly demanding that distributed voice and
data services be offered over the same centrally-managed communications
infrastructure. This convergence of voice and data is made possible by
technology that can convert voice transmissions into packets of data and
advances in Quality of Service which enable the transmission of voice over
private managed data networks and public data networks, such as the Internet.
As a result of their reliability, the wide variety of applications
supported and the size of their installed base, proprietary, circuit-switched
PBXs are pervasive in the enterprise arena and are likely to remain entrenched
as the central system delivering enterprise voice on which new applications are
developed and deployed for many years to come. However, businesses are looking
to IP-enable their present systems to support taking advantage of their data
networks and lower communications costs as well as to take advantage of emerging
access networks in support of an increasingly virtual workforce.
To support emerging access networks, a solution needs to packetize both the
voice traffic and PBX signaling information. This signaling information is
proprietary to each type of PBX system and is the language by which the systems
deliver features and applications to the user via the proprietary handset. To
address the sizeable installed base, solutions must support the breadth of
diverse signaling protocols. They must also offer a centrally-managed interface
to the main system and have the capability of packetizing and transmitting voice
and signaling information over both traditional circuit-based data networks and
emerging packet networks.
IP PBX vendors are experiencing introductory success in targeting the KTS
environment and smaller scale-enterprise networks. However, vendors have found a
key barrier to acceptance is the inability to interoperate with legacy
environments. To address this need a solution must enable an enterprise to
leverage
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its existing applications and interoperate with legacy switches and desksets
while incorporating new IP switches. This provides an enterprise flexibility to
manage its migration path.
In taking a closer look at the enterprise telephony application
environment, applications traditionally have sat behind the PBX and are
historically proprietary. Over the last few years, applications have become
"open" and sit behind a LAN or managed Intranet. On a smaller degree, this
openness has allowed some applications to move out of the enterprise and into a
"hosted model". Solutions which support both Customer Premise Equipment ("CPE")
and network based applications provide another example of enabling an enterprise
to have choices for their migration path.
Over the next 5 to 10 years, co-existence, or hybrid solutions, will
prevail. This will allow an enterprise to leverage their existing
infrastructures while having flexible choices for experiencing new solutions.
Resulting solutions will support new platforms inter working with legacy
switches and applications, support legacy and IP voice terminals, support
feature richness through digital line interfaces to preserve the user experience
as well as support CPE and service providers network environments.
MCK ENABLES THE DISTRIBUTED ENTERPRISE
MCK is a player in this enterprise voice transformation because of our
unique physical position in the network. Our systems connect to the PBX,
speaking most legacy protocols, and also connect to the network, speaking
traditional or nextgen IP protocols. MCK is laying a solid foundation for the
future by minimizing the impact of changing technology, bridging the gaps and
allowing enterprises to evolve their voice capabilities via the path of their
choice.
MCK solutions enable end users to access their company's voice system from
anywhere -- outlying offices, telework offices, and while on the road -- while
preserving the experience they have come to expect. This experience includes:
four digit dialing, calling party display, call waiting/forwarding/transfer,
conference calling, etc. over any network and thru any telephony enabled device.
Supporting the broadest range of protocols, networks and devices, MCK
solutions fulfill the market need for widespread interoperability, creating a
more "open" enterprise by enabling business quality voice anytime, anywhere,
over any network. Our solutions support Alcatel, Avaya, Ericsson, Iwatsu, NEC,
Nitsuko, Nortel, and Toshiba, representing over 80% of the U.S. installed PBX
base. They also provide users choices in access networks (e.g., analog, IP,
ISDN, T1...) and devices (e.g., analog, digital, mobile or IP phones). With the
business appeal of an "appearance of one" that is seamlessly connected in a
virtual community, an enterprise becomes a unified company for its employees and
callers.
In addition, our products reduce the total cost of ownership by: allowing
enterprises to utilize their existing investments in voice and data equipment;
allowing enterprises to eliminate voice network charges for traffic between
offices by utilizing data networks in a toll bypass situation; streamlining
network administration through the utilization of industry standard network
management techniques; and providing enterprises the flexibility of choosing
their migration path.
When many companies talk about convergence, they refer to voice and data
and/or voice over IP. At MCK, we're committed to a more "open" enterprise by
delivering convergence along three dimensions. We:
- Extend enterprise voice to distant locations through voice over data
networks
- Bundle with service providers to unite CPE and network services to
deliver new value added services
- Bridge technology gaps between existing and nextgen applications,
switches and services to enable enterprises' managed migration from
legacy to nextgen systems.
Key to enabling this three-fold power of convergence is the ability to preserve
end user interfaces while providing access to the widest array of new
experiences. The following are the key attributes of our solution:
Full-Featured Remote Voice Access. Our solutions provide the features
and applications of enterprise telephone systems to employees at outlying
offices, teleworkers and mobile workers over circuit, packet and wireless
networks. Our solutions allow these distributed workers to utilize voice
switch
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features such as 3 or 4 digit internal dialing, call transferring and
conferencing. They also give employees access to company chosen telephony
applications such as voicemail, unified messaging, auto attendant,
directories and automated call distribution. Extending these voice
applications to outlying employees increases productivity, facilitates
internal collaboration and delivers to external callers transparent access
to all telephone extensions throughout an enterprise.
Digital Line Extension Technology. The features and applications of
the voice switch reside on its digital line or user side. We have developed
proprietary software and hardware interfaces that extract the voice and
voice system signaling information from the user side of the switch. Our
switch-side or gateway products then packetize and transmit this
information to client-side or remote products over existing data networks.
Utilizing this captured information, our remote products mimic the digital
line side of the PBX, thereby transparently connecting the user's digital
telephone set to the main voice system. Based on the protocol expertise and
intellectual property we developed over the past decade, our products
enable companies to deploy effective extended voice solutions without
significant reconfigurations or upgrades to their existing enterprise voice
systems.
Similarly, our products enable employees at satellite or branch
offices, teleworkers and mobile employees to use their digital telephone
sets and existing user interfaces to seamlessly connect with their
company's voice system. Using our digital line extension technology, we are
also working with a number of companies to enable digital telephone sets to
interface with next generation corporate voice systems such as IP-PBXs and
network-based voice systems and applications. This digital line extension
technology also enables us to terminate multiple types of telephone sets,
including a variety of third-party digital telephone sets, analog telephone
sets and IP-based telephone sets, off traditional and/or nextgen voice
systems using MCK gateway products.
Packet Voice Architecture. Our extensive experience in packetizing
voice, voice signaling information and voice applications enables us to
deliver a complete distributed voice solution over traditional
circuit-based, packet-based and wireless networks. Utilizing our
proprietary Remote Voice Protocol("RVP") software platform and our
standardized hardware architecture, we packetize, compress, encode,
transmit and decode voice over networks such as asynchronous transfer mode,
or ("ATM"), digital subscriber line, or DSL, fiber, frame relay, IP,
integrated services digital network, or ("ISDN"), leased line, T-1,
fractional T-1 and traditional telephone networks. In addition to
supporting RVP, we are adding support for a number of evolving industry
standard voice protocols, including GR-303, H.323, SIP and MGCP, to enable
our products to interface with next generation voice equipment located in
both the enterprise and the network infrastructure of service providers.
Our products packetize voice along with the most diverse range of signaling
protocols and transmit them over the broadest range of circuit, packet and
wireless networks while offering centralized management to simplify network
administration. This enables enterprises and service providers broad
business reach alternatives.
We are evolving this technology to enable enterprises to incorporate
new IP switches which interoperate with legacy switches, desksets and
applications. Our support of the broadest range of signaling protocols
creates a more open enterprise by providing enterprises migration
alternatives.
Lower Cost Solution. Our products provide a cost-effective solution,
lowering costs in the following areas:
- Transmission. Our products lower transmission costs by consolidating
voice and data traffic over a single network, eliminating local loop
service charges through toll bypass and enabling remote users to
utilize volume-based, corporate long distance rates.
- Management. Our products provide telecom managers the ability to
centrally manage our remote devices using Telnet, hypertext mark-up
language("HTML"), and simple network management protocol("SNMP"), with
graphical user interfaces. Our customers can use these remote
monitoring and diagnostic capabilities to solve problems on-line,
thereby reducing the time and cost associated with dispatching a
technician to a remote site.
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- Equipment. Our products enable companies to utilize their existing
capital investment in enterprise voice systems, voice applications and
data networks, thereby eliminating the need to expend significant
additional capital on disparate, incompatible solutions such as key
systems.
- Facilities. Our products allow companies to reduce physical facility
costs and infrastructure investments by enabling employees to work
effectively outside of standard company locations.
Compatibility with Leading voice switch Manufacturers. We have worked
with Alcatel, Avaya, Ericsson, Iwatsu NEC, Nitsuko, Nortel and Toshiba to
develop interfaces between our RVP software platform and their primary
voice communications systems. These manufacturers have tested and validated
in their labs that our RVP platform is interoperable with their primary
switching products, including 4400/4200 (Alcatel), DEFINITY (Avaya),
MD110/BP250 (Ericsson), ADIX (Iwatsu), DEFINITY (Avaya), NEAX
1000/2000/2400 (NEC), 1-Series (Nitsuko), Meridian (Nortel), Norstar
(Nortel) and Strata DK (Toshiba) equipment.
STRATEGY
Our strategy is to create a more "open" enterprise by being the leading
provider of distributed voice solutions that enable businesses to unleash the
power of their enterprise by connecting disparate voice networks. In pursuing
this goal, we follow a three-prong strategy which enables enterprises to
experience greater value from their voice systems. Historically, our
business-quality remote voice solutions allowed corporations to extend the
features and applications of the proprietary, circuit-based PBXs across
distances to branch offices, remote call centers, and teleworkers using circuit
networks. We have evolved this capability to work with the majority of
enterprise voice systems as well as packet-based and wireless networks. By
packetizing the voice and switch signaling, we enable the convergence of voice
and data on a single data network. This enables enterprises to extend their
business reach while providing the same voice functionality at all locations.
The second prong of our strategy is to bundle with service providers to unite
CPE with network services to offer businesses outsourced, value added voice
services. Since our products are architected to support the broadest range of
business voice protocols over the greatest range of networks, they enable
service providers, such as Worldcom, to offer PBX Extension as a value-added
service offering over their full range of packet, wireless and circuit-based
networks. The third prong to our strategy is to provide systems which allow
enterprises ease of evolving their systems from traditional, circuit-based voice
switches and applications to nextgen switch, applications, and devices. Acting
as pure packet processing engines, our products break down the closed system
environment found in today's enterprise voice infrastructure by hooking
protocols together to serve as the "bridge" between legacy voice equipment and
next-generation networks and applications enabling disparate systems to
interoperate. This allows enterprises a managed migration path by incorporating
emerging technologies and nextgen systems without having to throw out existing
infrastructure investments.
As the voice infrastructure evolves over the next five to ten years, we
believe that legacy and nextgen systems will co-exist. However, in time, we
believe that the proprietary, circuit-switched PBX will begin to be replaced
with next-generation IP-based CPE or "network-hosted voice" solutions located on
the network outside of the company's premise. Concurrently, we envision
associated voice applications migrating from a proprietary, customer-owned model
to a standards-based model either managed by the customer or hosted by service
providers.
As MCK's distributed voice solutions continue to enable more "openness" and
push control out to the edge of the network, end-users will gain access to full
business functionality from any edge device by simply dialing into a gateway and
passing authentication. Over time, users will be provided a range of
applications and services from which to choose their own defined experience.
Ultimately we believe in voice communications enabled via an infrastructure
accessible as easily as today's electric power yet tapped into on an
individual's own terms.
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The following are the principle elements of our business strategy to become
the industry-standard bridge for voice networks and applications:
Extend enterprise voice through PBX extension. Corporations continue
to invest in PBX infrastructures. To date, we have been providing remote
voice solutions that deliver seamless voice calls and associated features
and applications such as voice mail, unified messaging, call accounting and
4-digit dialing over either circuit-switched (traditional telephone
network) or packet-switched (data network) environments. For packet-based
networks, our suite of EXTender products has been architected to work with
virtually any network, including T1, xDSL, ATM and cable, using packet
voice and Voice-over-IP protocols, and have been designed to accommodate
the more complex requirements for delivering high-quality enterprise voice
features.
Our Gateway family of products is a corporate site solution that
interfaces with the line side of the PBX. These products packetize and
transcode voice and signaling, and support the transmission of
business-quality voice applications to and from remote client devices. At
the remote site, we offer a line of client products that interface with
with the Gateways over virtually any network type. More than 250,000
EXTender ports are deployed today in many Fortune 5000 companies including
General Electric, United Airlines, Waterhouse Securities and Xerox.
Bundle with wire-line and wireless service providers and application
service providers ("ASPs") to unite CPE and network services to deliver
value-added applications and services. We continue to invest significant
resources into our relationships with service providers, such as Worldcom,
to deliver value-added services for integrated voice and data
communications. We are also in trials with a number of wireless service
providers to deliver PBX extension to mobile workers using their cellular
handset as the client device.
Bridge technology gaps between existing and nextgen switches,
applications, devices and networks to enable enterprises managed
migration. As rich, full-featured voice applications transition from
proprietary, closed networks to open protocols over converged
next-generation networks, whether enterprise or service provider based, our
ability to hook protocols together and bridge between the proprietary, PBX-
based voice infrastructure and these new applications will create the
openness that has been missing in enterprise voice. We recognize the
inherent value in the PBX and its ability to deliver rich applications such
as unified messaging, voice mail, interactive voice response and call
recording, among others. As new and different applications emerge that are
based on standards-based IP protocols, we plan to work to provide
enterprises with an effective migration path to enable the use of these new
applications that are independent of the switch and location, while
preserving their investments in digital telephone sets, the traditional
user interface.
Endorse and drive the adoption of emerging IP-based and
next-generation network protocols by serving as the normalizer for uniting
disparate systems. The adoption of open, standards-based technologies will
facilitate the speed of next-generation network deployment. To address
this, we are working with a number of regional and national organizations
including the National Convergence Alliance, DSL Forum, Softswitch
Consortium, and the appropriate standards bodies. In addition, to address
the need for IP-enabled products that work with any network, we are
architecting our products to support the leading Internet Protocols
including H.323, Media Gateway Control Protocol ("MGCP") and Session
Interface Protocol ("SIP").
Leverage our unique capability of digital line side extension and set
termination. We plan to continue working to provide business users with
ways to access new, feature-rich voice applications such as unified
messaging, interactive voice response and call recording by using the
digital set or IP phone set as the application user interface. By pushing
delivery of the application away from the traditional voice infrastructure,
enterprise customers will be able to take advantage of the latest voice
applications without having to retrain users or replace existing digital
phone set equipment. In addition, enterprise customers will be able to take
advantage of network-based services, which are delivering voice
applications independent of traditional CPE, available at the push of a
button from a digital set.
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Expand distribution, marketing and technology relationships. We
expect to continue establishing distribution, marketing and technology
relationships with OEMs, service providers and distribution channel
partners to further penetrate our target markets and develop our products.
We have development, marketing and distribution relationships with Alcatel,
Avaya, Ericsson, Iwatsu, NEC, Nitsuko and Toshiba and distribution
relationships with Nortel's major channel partners such as Ameritech, Bell
Canada, BellSouth, GTE/Verizon, SBC and Williams Communications. We have
also established a number of other important distribution channel
relationships with companies like Anixter, Sprint North Supply and
Tech-Data. We expect to continue working with our channel partners to focus
on major corporate accounts. In addition, we plan to continue building
additional channels, both in the U.S. and international markets, to expand
the distribution of our products.
Continue to target Fortune 5000 corporations. Our systems presently
are used by corporations such as American Express, Arthur Anderson, Avis,
BancOne, Bank of America, Bear Stearns, Bloomberg, Circuit City, Compaq,
Fidelity Investments, Merrill Lynch, Morgan Stanley, Oracle, Pepsico,
Prudential, Ratheon, United, US Postal Service, Whirlpool, among others. We
intend to continue to focus our distribution strategies on Fortune 5000
corporations. These organizations have made substantial capital investments
in their existing enterprise voice systems and have significant numbers of
locations and desire to support telecommuters. Accordingly, these companies
have the most to gain from an integrated voice network. We are well
positioned to target the Fortune 5000 market because our products interface
with the majority of enterprise systems installed in North America. We will
work with our existing and new partners to increase the market opportunity
for, and drive market acceptance of, our products.
TECHNOLOGY
We have developed expertise in digital line extension and the packetization
of voice for transmission over data networks to address the technology
challenges of extending the features and applications of enterprise voice
systems to distributed locations as well as enable a more "open" enterprise.
Another key component of our technological advantage is the flexible software
and hardware architecture upon which we build our solutions. We will continue to
invest significant resources to maintain and extend our technological advantage.
Digital Line Extension Technology
The rich features and applications of enterprise voice systems are accessed
through the proprietary user or digital line side of the voice switch. These
line-side interfaces enable the delivery of the features and applications of
enterprise voice systems to digital telephone sets. As a result of our years of
experience in working with major PBX voice equipment, we have gained a
significant understanding of these line-side interfaces and have developed
line-side software interfaces to a number of today's enterprise voice systems.
In addition to our software interfaces, we have developed a hardware subsystem
capable of duplicating the electrical interfaces of Alcatel, Avaya, Ericsson,
Iwatsu, NEC, Nitsuko, Nortel and Toshiba systems. These line-side software and
hardware interfaces extract the voice and the signaling information required to
interface with PBX and KTS systems and, using our RVP software platform,
packetize this voice and signaling information for transmission over data
networks to our access products. We have developed messaging software that
transmits this voice and signaling information from our access products to the
digital telephone sets of the manufacturers that we support, thereby
transparently connecting these sets to the PBX or KTS.
Delivery of Packet Voice with Remote Voice Protocol
To deliver voice over data networks, solutions must convert voice into
packet form and then transmit these voice packets alongside data packets.
Despite the advantages of simultaneous transmission of voice and data, there are
also a number of technological challenges to delivering voice over data networks
because audio quality can be distorted by jitter and latency associated with
congestion on the data network.
Our proprietary software platform, RVP, packetizes, compresses and encodes
circuit voice and signaling information for secure transmission over data
networks. We have implemented both industry standard and proprietary voice
prioritization and voice fragmentation techniques that use bandwidth efficiently
while also
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ensuring that delay sensitive voice packets are delivered with the quality
expected from voice. Much of this technology revolves around our core expertise
in developing software that runs on standard digital signal processors, which
are required for encoding voice for transmission over bandwidth constrained
networks. In particular, we have designed and implemented the following software
features in our products to improve the quality of packet voice transmission,
minimize system delay and jitter, and utilize bandwidth efficiently:
- Voice Compression. We integrate a number of industry standard voice
coding algorithms, including G.711, G.726, G.729A and G.723.1, that
compress voice to reduce the total bandwidth required for transmission.
- Echo Cancellation. We deliver echoless voice by integrating industry
standard acoustic echo cancellation technology, known as G.165 and F.168,
to which we have made proprietary enhancements.
- Silence Detection. Our proprietary silence detection technology
eliminates unnecessary transmission of voice packets during the periods
of silence that occur in normal conversation, freeing bandwidth for other
uses.
- Comfort Noise. We incorporate technology that inserts comfort noise
during periods of silence so that users do not inadvertently think that
the phone call is no longer active.
- Jitter Buffering Techniques. Our products adapt to the real-time
irregularities in network transmission and ensure all traffic reaches its
endpoint at the appropriate time by introducing delay that is
unrecognizable to the user.
- Dual Tone Multi-Frequency or ("DTMF") Processing Technology. Dual tone
multi-frequency tones are generated by depressing buttons on digital
telephone sets, enabling the digital telephone set to recognize dialed
numbers used for outbound calls and for applications such as voicemail.
Our proprietary technology improves the transmission of these tones over
packet networks.
We have significant experience in transmitting packet voice over both
low-speed, traditional telephone networks and higher speed, broadband networks.
We have developed network interfaces for the delivery of distributed voice over
traditional telephone and ISDN connections and have incorporated third-party
network devices to support T-1, leased line and frame relay networks. In
addition, to deliver data alongside our packet voice transmission, we have
expertise in terminating dial-up networking connections and bridging standard
data traffic.
In addition to supporting our proprietary protocol, RVP, and its ability to
extract and translate legacy, proprietary signaling, we are incorporating
support for a number of evolving industry standard protocols, such as GR-303,
H.323, SIP and MGCP. This will enable our products to not only interface with
the large and diverse installed base of voice systems but with next generation
enterprise voice systems and applications as well as terminate IP-based
telephone sets. Supporting both legacy and nextgen protocols enable our products
to foster an open enterprise as well as interface with voice equipment and
applications located in the network infrastructure of service providers and
application service providers.
Product Architecture
We develop our products using a combination of proprietary and commercial
hardware and software subsystems. Our product architecture enables these
subsystems to be configured and adapted in order to deliver a broad range of
enterprise voice product solutions, thereby minimizing product development
cycles and maximizing manufacturing efficiency. Our products are fully
compatible with the large installed base of telephone systems from Alcatel,
Avaya, Ericsson, Iwatsu, NEC, Nitsuko, Nortel and Toshiba, and require no design
modifications or upgrades to these systems or their respective digital telephone
sets.
We have designed a standard hardware architecture that serves as a common
platform for our software modules. We use industry standard digital signal
processors and programmable logic devices to build a standard hardware platform
that can be software modified to support different applications or telephone
systems without requiring a hardware change. We have also architected our
products with a variety of standard
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telephony and data network interfaces to ensure that we can transmit packet
voice over the multiple network environments currently available.
All of our products share a common software library of functional modules
that comprise our digital line interface software subsystem and our RVP software
platform. Our digital line interface software subsystem is responsible for the
interface to the proprietary software located on the digital line of the legacy
voice switch. This software subsystem has been designed to emulate a majority of
the business markets' telephone systems without requiring a change to our
hardware architecture. This flexible software architecture also enables us to
easily add software support for new enterprise voice systems. Our RVP software
platform is responsible for packetizing voice and signaling information, as well
as conditioning these voice packets for transmission over data networks. RVP has
been engineered to enable new features to be easily and quickly introduced in
parallel to its existing capabilities.
All the software for our IP EXTender 4000, EXTender 6000 for branch offices
and gateway product lines runs on the VxWorks real-time operating system from
Wind River Systems. This industry standard operating system provides our
engineers with a standard development environment in which to design new
proprietary software applications and easily incorporate third-party software
applications. A standard development environment such as VxWorks allows for the
rapid prototyping and application development necessary for our products that
serve as platforms for future applications.
PRODUCTS
We have worked with Alcatel, Avaya, Ericsson, Iwatsu, NEC, Nitsuko, Nortel
and Toshiba to develop interfaces between the proprietary software of these
leading enterprise voice vendors and our RVP software platform and standard
hardware architecture. We generally enter into contracts with these vendors
which provide us access to their proprietary software and grant us rights to
develop, manufacture and sell products which interface with each vendor's
equipment. As a result of these relationships, we have developed substantial
expertise in understanding and interfacing with their proprietary systems. These
manufacturers have tested and validated in their own labs that our RVP platform
is interoperable with a variety of their equipment. Currently, our EXTender
series of products is compatible with the following PBX systems: 4400/4200
(Alcatel); DEFINITY (Avaya); MD110/BP250 (Ericsson); ADIX (Iwatsu); NEAX
1000/2000/2400 (NEC); 1-Series (Nitsuko); Meridian (Nortel); Norstar (Nortel);
and Strata DK (Toshiba).
The EXTender solution consists of the following component parts:
- Gateways. Devices located near the voice switch, PBX or KTS, that extend
the signaling along with the voice traffic and applications to our
remotely located client devices; and
- Clients. Single or multi-user remotely based, CPE devices that service
outlying offices, teleworkers and mobile workers.
Our EXTender series of products enables companies to provide the
functionality of enterprise voice systems and all of their supported
applications to users who traditionally have not had access to the company's
telephone system and its voice applications because of the limitations of
current systems. Our products enable the main telephone system to act as a
server that distributes features and applications any and all locations over
networks such as ATM, DSL, fiber, frame relay, IP, ISDN, leased line, T-1,
fractional T-1, wireless and traditional telephone connections. Employees can
utilize digital telephone sets identical to the sets deployed at company
headquarters and access the central voice system for applications such as
voicemail, automated call distribution, auto attendant, directories and
interactive voice response, and features such as 3 or 4 digit internal dialing,
conferencing and call forwarding. By enabling all employees, regardless of
location, to have access to a company-wide system, our EXTender solutions create
a single, unified voice network.
PBX Gateway Products
Our PBX gateway products, located at the company's PBX site, interface with
the line side of the switch and create extensions of voice and telephony
applications to our clients or remotes.
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- PBXgateway II. The PBXgateway II supports up to 24 simultaneous users
connected via both our multi-user and single-user client devices.
Depending upon the software version of the product, the PBXgateway II
will transmit voice over a wide variety of data networks including ATM,
DSL, fiber, frame relay, IP, ISDN, leased line, T-1 and fractional T-1
connections. It also has available internal network termination
optionals.
- PBXgateway. The PBXgateway supports our multi-user and IP-based single
user client devices and is available in both 8 and 12 port versions. Like
the PBXgateway II, the PBXgateway will transmit voice over a wide variety
of data networks including ATM, DSL, fiber, frame relay, IP, ISDN, leased
line, T-1 and fractional T-1 connections.
- Mobility Gateway. The Mobility Gateway allows a cellular handset to act
as a fully functioning digital handset. Using a cellular handset, a user
can send and receive calls through the PBX as well as access all of the
company's voice applications -- even when the user is "on the road". This
enables a user to handle a call just as if they were sitting at their
desk in the office. This includes call hold, transfer, conferencing,
4-digit dialing, auto attendant, directories as well as receiving calls
via the cellular handset. This ability to receive calls is more powerful
than a "findme" capability since the PBX treats the cell phone as if it
were a digital deskset. The Mobility Gateway bridges the call traffic
directly to the cellular handset through the enterprise voice switch. For
instance, if "no answer", the voice mail system responds giving the user
the convenience of one voice mailbox to check. This solution requires no
terminating client device.
When the product is configured to support IP-based networks, the PBXgateway
extends the functionality of the company's PBX to a variety of our multi-user
and single-user IP products, including the EXTender 6000 for branch offices and
the IP EXTender 4000 Clients. The PBXgateway can support up to simultaneous
users across any of these products over multiple network types. All of our
Gateways can be centrally administered over a Telnet connection, an in-band RVP
connection, or with SNMP and HTML interfaces. As part of our strategy, we are
positioning this product as a platform to deliver new applications and services
to our clients, utilizing both new software components.
PBX Client Devices
Our multi-user or branch office products connect remote offices to the
company's telephone system over data networks.
- EXTender 6000 for branch offices. EXTender 6000 for branch offices is a
multi-user product that is available in both 8 and 12 port
configurations. The EXTender 6000 for branch offices located at the
remote office connects to our PBXgateway product located at the company's
PBX site. The product has dual external network interfaces that allow for
multiple connection options over a wide variety of data networks
including ATM, DSL, fiber, frame relay, IP, ISDN, leased line, T-1 and
fractional T-1 connections. It also provides redundancy capability. An
optional analog card is also available, which provides local dialing
capabilities and emergency 911 access. The EXTender 6000 for branch
offices can be centrally administered over a Telnet connection, an
in-band RVP connection, or with SNMP or HTML interfaces. The product's
ability to dynamically allocate bandwidth between multiple users allows
for flexible configurations and bandwidth conservation. The product is
designed using a standard 19-inch, rack-mountable form factor so multiple
units can be deployed in parallel to service larger outlying offices.
Our single-user product line enables teleworkers and geographically
distributed call center agents to connect to the company's main telephone system
and data network via a PBXgateway over public and private networks.
- EXTender 1000. The EXTender 1000 supports both voice and data over a
single POTS telephone line. The product contains a built-in,
industry-standard 56 kilobits per second, or Kbps, modem which enables
the user to access the corporate data network and supports standard
Windows-based, dial-up networking technology. The remote user's personal
computer and full-featured digital telephone set
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plug into the product, which terminates and multiplexes voice and data over a
single telephone line. The EXTender 1000 unit is situated at the remote location
and connects to either another EXTender 1000 unit or a PBXgateway II located at
the company's PBX site.
- EXTender 3000. The EXTender 3000 supports both voice and data over an
integrated services digital network, or ISDN, connection. An integrated
services digital network connection is composed of two 64 Kbps channels
that each can deliver a separate network connection. With its built-in
network interface, the EXTender 3000 enables the remote user to connect a
digital telephone set and a personal computer into the EXTender 3000. The
EXTender 3000 unit situated at the remote location is connected to either
another EXTender 3000 unit or a PBXgateway II located at the company's
PBX site. There are two versions of the EXTender 3000:
- EXTender 3000 S/T. The EXTender 3000S/T utilizes a serial data
connection and offer simultaneous voice and data multiplexed over a
single channel. The second channel is available for analog devices
such as a fax, additional phone or a modem. It incorporates a
standard Windows-based, dial-up networking technology to enable the
user to set up a dial-up network connection to a remote access
server.
- EXTender 3000 E. The EXTender 3000E offers dedicated voice over
one channel and a 64 Kbps Ethernet data connection on the second
channel. The EXTender 3000E uses an Ethernet port and bridging
technology to enable simultaneous voice and data network access
capabilities. In addition, standard hardware compression technology
is utilized to significantly enhance data throughput. When not used
for Ethernet data, the second channel is available as an analog
port, supporting a fax, additional phone or modem.
- EXTender 4000. The EXTender 4000 delivers voice extension over any IP
network. The product sits behind an external network termination device
and delivers IP-based voice over data networks. The IP EXTender 4000
connects to a PBXgateway product located at the corporate site.
Other Products
- Recording Interface. Our Recording Interface converts digital voice from
proprietary PBXs into a standard audio output so that voice calls can be
recorded on any voice logger or recording device. We offer 3
configurations that support from 2 to 48 lines, and are modular in
nature, allowing for easy expansion to accommodate more users. Our
Recording Interface is compatible with the following voice systems:
DEFINITY (Avaya); Meridian (Nortel); Norstar (Nortel); DMS Centrex
(Nortel); CallCenter (Aspect); NEAX (NEC); and HiCom (Siemens).
SALES AND MARKETING
We primarily sell our products through an indirect distribution system that
includes the following channels: OEMs, ILECs, systems integrators and
distributors, telecom and datacom VARs, and service providers. We support our
sales channels with our own internal sales professionals as well as marketing
programs, lead generation, educational programs, field technical support and
telephone technical support. At April 30, 2001, our sales team was composed of a
vice president of worldwide sales, 6 channel sales managers, 19 regional sales
managers, 8 systems engineers, 6 inside sales specialists, and 2 sales
administrators. Our multi-channel strategy enables us to create end-user demand
for our products and services, and access corporate opportunities identified by
our channel partners, while also allowing the enterprise customers to choose the
reseller that is most appropriate for delivering those products and services to
them. Our primary distribution channels include:
OEMs.................................... Alcatel, Ascom, Avaya, Brooktrout,
Comverse, Dictaphone, Ericsson, Iwatsu,
NEC, Nitsuko, Nortel, Toshiba
ILECs................................... Ameritech, Bell Canada, Bellsouth, GTE/
Verizon, PacBell, SBC, Southwestern
Bell,
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Systems Integrators and Distributors.... Anixter, Calayst, Dacon, IBM Global
Services, One Nation Technology,
Solunet, Sprint North Supply, Tech Data,
VodaOne, Williams Communications
Telecom and Datacom VARs................ CDW, Frantel, GBH, IKON, NACR, Northwest
Extension, PB Exchange, Ronco,
TeleCommute Solutions
Service Providers....................... WorldCom
Our channel sales managers work at a corporate level with all of our
largest channel partners in developing sales and marketing plans that are
implemented at the field levels. These channel sales managers are primarily
responsible for driving business through the Alcatel, Avaya, Ericsson, Iwatsu,
NEC, Nortel and Toshiba channels. They also work with our regional territory
managers on large sales opportunities and national accounts. We have channel
managers located in Boston, Dallas, London and Montreal.
Our regional sales managers provide support to all of the channels in their
geographic territory. They work closely with our channel partners, participating
in end-user briefings, proposals, product training sessions, end-user seminars,
trade shows and other demand generating activities. In addition, regional sales
managers are involved in generating and qualifying end-user leads that are
closed in partnership with our indirect channels. We have regional sales
managers located in Atlanta, Boston, Chicago, Dallas, Los Angeles, Nashville,
Phoenix, Seattle, Calgary, Toronto, and London.
Our field-based systems engineers, located in Boston, Denver, Newark,
London and Toronto, provide our channels with technical training and perform
pre- and post-sale technical support for our channels and end-user customers.
All of our systems engineers have in-depth industry experience and product
expertise. They assist our channel partners with proposals, configurations,
requests for quotations and executive briefings, and perform other consultative
duties.
Our distribution channels are responsible for identifying potential
business customers, selling our products as part of complete solutions, and
installing and supporting the equipment at end-user sites. We generally
establish relationships with our most significant distribution channels through
written distribution agreements that provide pricing, discounts, and terms and
conditions under which they may purchase our products for resale. These
agreements are generally non-exclusive, may be terminated at will and do not
prevent our resellers from carrying competing lines or require our resellers to
attain specific sales levels. A number of our distribution channels resell our
products without written agreements, with terms determined on a purchase order
basis. We provide significant sales, marketing, training and technical support
to our channels.
Sales outside of the United States accounted for 15.3% and 18.4% of sales
in fiscal year 2000 and 2001, respectively. We sell globally through Alcatel,
Avaya, NEC and Toshiba. In addition, we have a distribution arrangements with
over 15 other international distributors.
We focus our marketing efforts on awareness generation, lead generation and
sales support activities. Our marketing audience includes existing and
prospective customers, channel partners, trade and business press, industry
analysts and others who are influential in the industry.
We participate in approximately 20 trade shows annually, taking advantage
of joint marketing opportunities with our resellers and channel partners
whenever possible. Trade show efforts include shows in the telecommunications,
teleworking, CTI, networking, call center and service provider industries. We
participate in many seminars with our resellers, as well as all major PBX user
group events and industry-related conferences. We use direct marketing programs
to generate awareness and qualified leads. Many campaigns are executed in
conjunction with our resellers, customized with their messages and contact
information and then mailed to their prospect and customer lists. Additionally,
we dedicate significant marketing resources to public relations activities,
generation of product and partner press releases, speaking opportunities,
by-lined articles, product reviews, customer success stories and editorial
coverage.
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To support our sales channels, we prepare training materials,
presentations, collateral, cost-justification tools, competitive analysis, case
studies, product configurations, fact sheets, product introduction kits and
distributor success guides. Our web site serves as an information source for end
users, prospects and channel partners, as well as a lead generation and
configuration tool as well as customer service resource. Our regional sales
managers and systems engineers regularly visit our reseller offices and conduct
product and technical training. Our marketing database and sales force
automation system currently contains over 17,000 records that can be segmented
and are marketed to regularly.
CUSTOMER SUPPORT
A high level of customer support and service is critical to developing
long-term relationships with our major distribution channels and end-user
customers. The majority of our service and support activities are related to
installation support and initial network configuration issues. In North America,
we also offer a variety of comprehensive and flexible maintenance and support
programs including basic product warranty, installation services, 24 hour a day,
7 day a week remote telephone support and onsite maintenance services. Our
products are architected with support in mind. For example, our branch products
are engineered with remote monitoring, management and diagnostic capabilities so
that problems can be diagnosed on-line, thereby reducing the time and costs
associated with dispatching a technician to a remote site.
A number of our distribution partners support our products. These
distribution partners provide installation, onsite maintenance and telephone
support services to our end users. To complement this service infrastructure, we
have engaged Vital Network Services, an outsourced technical support and
customer services organization, to provide fee-based telephone support,
installation and onsite maintenance services. We sell these services directly
and indirectly to end users. To date, our revenues attributable to customer
service and support services have been immaterial. We provide high-level,
back-up technical support and engineering assistance for both our distribution
partners and Vital Network Services. We have established strict escalation
guidelines with both our distribution channels and Vital Network Services to
ensure that the appropriate technical resources and management attention within
our company are focused on problems that are not solved in a timeframe
commensurate with the problem's priority.
At April 30, 2001, we employed 13 people in customer support. Although we
may augment our Boston, Dallas and Calgary-based support staff, we do not intend
to recruit our own direct field service and support organization.
CUSTOMERS
We sell substantially all of our products through independent channel
partners. The following is a representative list of our indirect channel
partners who have purchased products from us during 12 months ending April 30,
2001:
Alcatel Ericsson Positron
Ameritech Frantel SBC
Anixter GBH Sprint North Supply
Avaya GTE Tech Data
BC Tel IBM Global Services Teleswitch
Bell Canada Nitsuko Toshiba
BellSouth NEC Voda One
Dacon PLC Northwest Extension Williams Communications
Dictaphone PB Exchange WorldCom
For the fiscal year ended April 30, 2001, Avaya (formerly Lucent
Technologies) accounted for 24.1% of our revenues, and our ten largest
customers, including Avaya, accounted for 63.2% of our revenues. For the fiscal
year ended April 30, 2000, Avaya accounted for 45.6% of our revenues, and our 10
largest customers, including Avaya, accounted for 76.1% of our revenues. No
other customer represented over 10% of our revenues in either period.
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RESEARCH AND DEVELOPMENT
To maintain our technology leadership position, we focus our research and
development efforts on improving the functionality and performance of our
existing products and designing new products that address customer needs and
changes in the marketplace. We have assembled a team of experienced hardware and
software engineers with capabilities in both networking and telecommunications.
Our engineering expertise includes significant understanding of:
- the digital line or user side of proprietary enterprise voice systems
- digital audio technology, such as echo cancellation and voice compression
algorithms
- voice enabling signaling
- voice over packet networks including IP telephony
- data network and telephony interfaces
- network diagnostic and management frameworks
At April 30, 2001, we employed 60 people in our engineering organization,
and intend to continue to affordably expand all functional areas of the
engineering organization. We perform research and product development activities
at our principal offices in Needham, Massachusetts, as well as at our Allen,
Texas and Calgary, Alberta development facilities.
Our research and development process is driven by market demand. Product
development begins with a comprehensive functional product specification based
on input from all functional groups and levels within our company. In addition,
we value feedback from our end-user customers and distribution channel partners,
and have incorporated a significant amount of customer-requested functionality
in our products. We are also active in industry bodies and standards committees
and utilize information from these organizations in our product development
process. Finally, we have maintained an ongoing dialogue and established
technology relationships with a number of PBX and KTS manufacturers,
internetworking vendors, broadband equipment suppliers and service providers. We
will continue to focus our efforts with these companies to develop products that
meet specific market requirements in growth sectors.
We intend to continue enhancing the functionality of our existing EXTender
and PBXgateway systems by expanding the range of products and client devices
supported as well as expanding the range of connectivity services by
incorporating trunk side interfaces, including IP network survivability through
failover support to public-switched network, and expanding support of remote
management and provisioning. This will further differentiate our products from
the competition while broadening our addressable market. We will focus our new
products' efforts on bundling with incumbent Service Providers' network services
with emphasis on mobile environments and we will continue to bridge the gap
between legacy and nextgen switches, devices and applications. Specifically for
the later, we will enable IP switch and telephony application providers, whether
CPE or network based, to distribute their systems' functionality to the broadest
installed base of endpoints. This will not only give vendors a stronger solution
equation, but provide enterprises more flexibility to manage their path to
nextgen environments.
PRODUCT VALIDATION LABORATORY
Over the past two years, we have hired the personnel and purchased the
equipment necessary to build and improve our product validation laboratory. Of
the 60 people in our engineering organization, 7 are dedicated full time to our
product validation laboratory. Their efforts are focused on ensuring world class
product quality. At both our Needham, Massachusetts and Calgary, Alberta
development facilities, we have constructed state of the art laboratories with
equipment from such vendors as ADC Kentrox, Alcatel, Ascend, Cisco, Copper
Mountain, CopperCom, Efficient Networks, Ericsson, IBM, Iwatsu, Jetstream,
Avaya, NEC, Netopia, Newbridge, Nitsuko, Nortel Networks, Packeteer, Paradyne,
Sylantro and Toshiba.
Our Calgary, Alberta facility system tests the product line and validates
our product's integration with the major voice switches, applications and
desksets that we support. We conduct extensive product testing to
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ensure that our equipment meets the high standards for voice quality and
reliability associated with mission critical systems such as PBXs. We also
conduct extensive tests on the embedded systems within our product line as well
as on all the features and functions.
Our Needham, Massachusetts facility tests system interoperability. The
ability to deliver traffic within multiple network environments and to
interoperate with equipment from numerous vendors has become a key component to
the success of communications equipment companies. Because no communications
equipment product can be validated independently of the network within which it
operates or independently from the equipment with which it interfaces, this lab
conducts extensive tests of our product line operating within multiple network
environments and interacting with equipment from numerous equipment vendors. We
conduct extensive tests that measure device performance, quality of service and
voice prioritization within multiple network environments and across a range of
network conditions. Our facilities contain extensive telephony and data
equipment and network circuits to conduct these tests.
By combining the capabilities of our two facilities, we have implemented a
product validation procedure that enables us to deliver high quality voice
equipment that works within multiple network environments, is compatible with
most widely deployed network equipment and is capable of adapting to a wide
range of network conditions. Furthermore, the engineers in our product
validation laboratory work continually with validation engineers at other
equipment companies in order to compile feedback and recommendations to improve
our products.
MANUFACTURING
We outsource our manufacturing to three contract manufacturers. Mack
Technologies, located in Westford, Massachusetts, manufactures our Gateway
products as well as our EXTender 6000 for branch offices and EXTender 4000
clients. They are ISO 9002 certified and provide full turnkey services,
including material procurement, final assembly, testing, shipment to our
customers and warranty repair. Electronic Manufacturing Group, located in
Calgary, Alberta, manufactures our EXTender 1000 and 3000 product lines. OEM
Worldwide, located in Watertown, South Dakota, manufactures our recording
interface product line. Both Electronic Manufacturing Group and OEM Worldwide
provide us with printed circuit assemblies. We then complete the final assembly,
testing and inspection of these printed circuit assemblies at our Allen, Texas
facility. We are ISO 9001 certified.
We design and develop the key components, including printed circuit boards
and software, for all of our products. In addition, we determine the components
that are incorporated in our products and select the appropriate suppliers of
these components. We design the tests and specify the testing equipment for the
product testing performed at Mack Technologies and at our facility in Allen,
Texas.
We use a rolling six-month forecast based upon anticipated product orders
to determine our material requirements. Lead times for the materials and
components that we order vary significantly and depend on factors such as
specific supplier, contract terms and demand for a component at a given time.
We, along with our contract manufacturers, may terminate our contracts without
cause at any time. At that time, the terminating party must honor all open
purchases.
COMPETITION
We compete in a new, rapidly evolving and highly competitive and fragmented
industry that is subject to increasing product, market and technology changes
brought about by the introduction of new technologies, the deployment of
broadband networks and changes in the regulatory environment. We believe that
the main competitive factors in our market are the following:
- technology partnerships, particularly with the major PBX manufacturers
and service providers
- system reliability and performance
- sales and distribution capability
- price/performance characteristics
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- access to third-party technology
- conformance to industry standards
- brand name recognition
- ease of deployment and use
- timeliness of product introductions
- product features and breadth
- customer relationships
- technical support and service
- pace of enterprise voice evolution
We believe our success in competing with other manufacturers of
communications products depends primarily on:
- our ability to enter into and maintain key technology, business
development and distribution relationships with third-party
manufacturers, distributors, resellers, system integrators and service
providers in our market segment
- our engineering, marketing and sales skills
- the price, quality and reliability of our products
- our delivery and service capabilities
Our principal competitors include large telecommunications manufacturers
such as Nortel and Avaya. Nortel's 6150 product line competes against our
Gateway and EXTender 6000 products and their Home Office II product competes
against our EXTender 3000 product line. Avaya's R300 product competes against
our Gateway and EXTender 6000 products. It is likely that a number of other
public and private companies are developing next generation network access
products that target the branch office and telecommuting marketplaces. For
example, Intel announced its iPOD product line which will be available later
this year and will provide PBX extension capabilities to branch offices. We
expect competition to intensify in the future and new competitors to emerge.
Many of our competitors are substantially larger than we are and have
significantly greater financial, sales and marketing, technical, manufacturing
and other resources, more established distribution channels and stronger
relationships with service providers. These competitors may be able to respond
more rapidly to new or emerging technologies and changes in customer
requirements or devote greater resources to the development, promotion and sale
of their products than we can. Furthermore, we believe some of our competitors
may offer aggressive sales terms, including financing alternatives, which we may
not be able to match. These competitors may enter our existing or future markets
with solutions that may be less expensive, provide higher performance or
additional features or be introduced earlier than our solutions. Given the
market opportunity, we expect that other companies may enter our market with
better products and technologies. If any technology that is competing with ours
is more reliable, has better quality, is less expensive or has other advantages
over our technology, the demand for our products could decrease.
We expect our competitors to continue to improve the performance of their
current products and introduce new products or new technologies. Successful new
product introductions or enhancements by our competitors could reduce the sales
or market acceptance of our products, perpetuate intense price competition or
make our products obsolete. To be competitive, we must continue to invest
significant resources in research and development, sales and marketing and
customer support. We cannot be sure that we will have sufficient resources to
make these investments or that we will be able to make the technological
advances necessary to remain competitive.
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Increased competition is likely to result in price reductions, reduced
gross margins and loss of market share. Our failure to compete successfully
against current or future competitors could seriously harm our business,
financial condition and results of operations.
INTELLECTUAL PROPERTY
Our success and ability to compete is dependent in part upon our
proprietary technology. We rely on a combination of copyright, trademark, trade
secret and other intellectual property law, nondisclosure agreements and other
protective measures to protect our proprietary rights. We also utilize
unpatented proprietary knowledge and trade secrets, and employ various methods
to protect our trade secrets and knowledge. We presently have no patents. We
have one provisional patent application pending on a system for and method of
extending a PBX phone port to an external phone device.
We believe our intellectual property rights are significant and that the
loss of all or a substantial portion of such rights could have a material
adverse effect on our business, financial condition and results of operations.
There can be no assurance that our intellectual property protection measures
will be sufficient to prevent misappropriation of our technology. 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. In addition, we cannot be certain
that others will not independently develop substantially equivalent intellectual
property, gain access to our trade secrets or intellectual property, or disclose
our intellectual property or trade secrets. Furthermore, the laws of many
foreign countries do not protect our intellectual property to the same extent as
the laws of the United States. From time to time, we may desire or be required
to renew or to obtain licenses from others in order to develop and market
commercially viable products effectively. There can be no assurances that any
necessary licenses will be available on reasonable terms, if at all.
The communications industry is characterized by the existence of a large
number of patents and frequent claims and related litigation regarding patent
and other intellectual property rights. In particular, leading companies in the
communications markets have extensive patent portfolios. From time to time,
third parties may assert exclusive patent, copyright, trademark and other
intellectual property rights to technologies and related standards that are
important to us. We expect that we may increasingly be subject to infringement
claims as the number of products and competitors in the market for our
technology grows and the functionality of products overlaps. Although we have
not been a party to any litigation asserting claims that allege infringement of
intellectual property rights, we may be a party to litigation in the future. In
addition, third parties may assert claims or initiate litigation against us or
our manufacturers, suppliers, OEMs, technology partners or customers alleging
infringement of their proprietary rights with respect to our existing or future
products.
We may in the future initiate claims or litigation against third parties
for infringement of our proprietary rights to determine the scope and validity
of our proprietary rights. Any such claims, with or without merit, could be
time-consuming, result in costly litigation and diversion of technical and
management personnel or require us to develop non-infringing technology or enter
into royalty or licensing agreements. Such royalty or licensing agreements, if
required, may not be available on acceptable terms, if at all.
EMPLOYEES
At April 30, 2001, we had a total of 186 employees, of which 60 were in
research and development, 80 were in sales, marketing, business development and
customer support, 19 were in manufacturing and operations, and 27 were in
finance and administration. None of our employees is represented by a labor
union. We have not experienced any work stoppages and consider relations with
our employees to be good.
ITEM 2. PROPERTIES
We currently lease approximately 48,000 square feet of space at our
headquarters in Needham, Massachusetts under a lease that expires in March 2007.
We have concurrently sub-let 15,000 square feet of
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this space for a term of 3 years to an unrelated third party and believe the
additional space will not impact our operating results until we occupy the
space. We also lease approximately 12,500 square feet at our development center
in Calgary, Alberta under a lease that expires in October 2005 and 16,700 square
feet at our applications business unit in Allen, Texas that expires in August
2004.
ITEM 3. 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.
In the complaint, captioned 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 agreement and a certain restricted stock
agreement executed by and between the Company and Ms. Lockhart. Ms. Lockhart
seeks approximately $30,000 in severance pay as well as approximately $1,000,000
in damages. On June 5, 2000, the Company filed its answer denying the material
allegations of Ms. Lockhart's complaint. The trial of this action is scheduled
for July 23, 2001. 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
None.
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PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
MARKET PRICE FOR COMMON STOCK. The following table sets forth for the
periods indicated the high and low closing prices for the Common Stock, as
reported by NASDAQ:
FISCAL QUARTER ENDED HIGH LOW
- -------------------- ------- --------
July 31, 2000............................................... $36.625 $18.0625
October 31, 2000............................................ 38.125 14.0625
January 31, 2001............................................ 21.25 4.3906
April 30, 2001.............................................. 6.8125 1.75
HOLDERS OF RECORD. As of May 31, 2001, there were approximately 125
holders of record of our common stock and 20,180,325 shares of Common Stock
outstanding.
DIVIDEND POLICY. To date, the Company has not paid any cash dividends on
its Common Stock. The Company currently anticipates that it will retain any
available funds to finance the growth and operation of its business and does not
anticipate paying any cash dividends in the foreseeable future.
ITEM 6. SELECTED HISTORICAL CONDENSED FINANCIAL INFORMATION
The following selected financial data should be read in conjunction with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," and are qualified by reference to the Consolidated Financial
Statements and Notes thereto appearing elsewhere in this Report. The statement
of operations data set forth below for the years ended April 30, 1999, 2000 and
2001, and the balance sheet data at April 30, 2000, 2001, are derived from, and
are qualified by reference to, the audited Consolidated Financial Statements of
MCK Communications, Inc. included elsewhere herein. The statement of operations
data set forth below for the years ended April 30, 1997 and 1998 and the balance
sheet data at April 30, 1997, 1998 and 1999 are derived from audited
Consolidated Financial Statements of MCK Communications, Inc. not included
herein.
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YEARS ENDED APRIL 30,
----------------------------------------------------------------
1997 1998 1999 2000 2001
---------- ---------- ---------- ----------- -----------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
OPERATIONS DATA:
Revenues..................................... $ 5,921 $ 7,876 $ 14,270 $ 25,082 $ 38,220
Cost of goods sold........................... 2,313 2,800 5,390 9,455 15,287
---------- ---------- ---------- ----------- -----------
Gross profit................................. 3,608 5,076 8,880 15,627 22,933
Operating expenses:
Research and development (excluding
amortization of stock based compensation
of $0, $0, $175, $1,558 and $830 in 1997,
1998, 1999, 2000 and 2001,
respectively)............................ 815 1,758 3,349 4,876 9,232
Sales and marketing (excluding amortization
of stock based compensation of $0, $0,
$110, $1,853 and $1,005 in 1997, 1998,
1999, 2000 and 2001, respectively........ 1,145 2,191 3,888 7,817 13,820
General and administrative (excluding
amortization of stock based compensation
of $0, $0, $120, $1,234 and $1,067 in
1997, 1998, 1999, 2000 and 2001,
respectively)............................ 607 1,485 1,617 2,475 4,646
Amortization of stock based compensation... -- -- 406 4,645 2,902
Amortization of goodwill and other
intangibles(1)........................... -- -- -- -- 4,588
Write-off of in-process research and
development(2)........................... -- -- -- -- 3,694
Restructuring.............................. -- -- -- -- 597
Transaction-related charge................. 493 -- -- -- --
---------- ---------- ---------- ----------- -----------
Total operating expenses............ 3,060 5,434 9,260 19,813 39,479
---------- ---------- ---------- ----------- -----------
Income (loss) from operations................ 548 (358) (380) (4,186) (16,546)
Other income (expense)....................... (343) (595) (207) 758 3,617
---------- ---------- ---------- ----------- -----------
Income (loss) before income tax provision
(benefit) and dividends on redeemable
preferred stock of subsidiary.............. 205 (953) (587) (3,428) (12,929)
Income tax provision (benefit)............... 302 -- -- 100 (1,130)
Dividends on redeemable preferred stock of
subsidiary................................. 133 160 197 97 --
---------- ---------- ---------- ----------- -----------
Net loss..................................... (230) (1,113) (784) (3,625) (11,799)
Dividends on redeemable preferred stock...... 1,011 1,220 1,966 1,285 --
---------- ---------- ---------- ----------- -----------
Net loss applicable to common shares......... $ (1,241) $ (2,333) $ (2,750) $ (4,910) $ (11,799)
========== ========== ========== =========== ===========
Basic and diluted net loss per common
share...................................... $ (0.39) $ (0.67) $ (0.71) $ (0.44) $ (0.61)
Shares used in computing basic and diluted
net loss per common share.................. 3,188,152 3,476,282 3,881,526 11,144,565 19,213,239
Pro forma basic and diluted loss per common
share...................................... (0.31)
Shares used in computing pro forma basic and
diluted loss per common share.............. 15,268,368
CONSOLIDATED BALANCE SHEET DATA:
Cash and equivalents(1)(2)................. 3,228 1,867 3,285 75,724 54,802
Working capital(1)(2)...................... 4,965 3,545 5,578 78,288 58,444
Total assets(1)(2)......................... 6,517 5,665 9,428 87,194 90,397
Long term debt............................. 5,000 5,000 2,500 -- --
Redeemable preferred stock................. 18,069 19,449 28,205 -- --
Total stockholders' equity
(deficit)(1)(2).......................... (17,568) (20,050) (24,040) 80,946 82,860
- ---------------
(1) See footnote 16 on page F-17
(2) See footnote 17 on page F-18
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion should be read in conjunction with our
consolidated financial statements and the related notes included elsewhere in
this prospectus.
OVERVIEW
MCK Communications is a leading provider of products that enable businesses
to unleash the power of their voice communications systems by:
- extending the functionality and applications of their business telephone
systems from the main office to outlying offices, remote call centers,
teleworkers and mobile employees over public and private networks
- bundling with service providers to unite customer premise equipment
("CPE") and network services to deliver new outsourced, value added
services
- bridging technology gaps between existing and next generation ("nextgen")
applications (i.e., unified messaging), IP switches and devices (i.e., IP
telephones) to enable enterprises ease of technology migration.
This combination enables a more open enterprise. 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, have development centers in Allen, Texas and Calgary,
Canada, and maintain a sales and marketing office in the United Kingdom.
From our inception in 1989 through 1993, we were a small company based in
Calgary, Canada that designed and marketed a number of niche, voice products
targeted at the oil industry. Commencing in 1993, we altered our business focus
and began developing remote voice access products for enterprise telephone
systems by using the technology derived from this initial business. These
efforts led to the development of our EXTender product line. During the period
from 1993 through 1995, our operating activities related primarily to
establishing a research and development organization, developing and testing
prototype designs, and developing OEM relationships. We shipped our first remote
voice access product, the EXTender 1000, in 1995. Since then we focused our
research and development efforts on developing additional remote voice access
products and product enhancements, and more recently creating technologies to
enable a more "open" enterprise. In addition, we established a product
validation laboratory, built international indirect sales channels, developed
additional technology relationships, and established our sales, marketing and
customer support organizations.
Through the fiscal year ended April 30, 1999, our revenues consisted
primarily of product sales of our single-user remote voice access products and,
to a lesser degree, our recording interface gateways products. In April 1999, we
released our first multi-user remote voice access products, the EXTender 6000
for branch offices and the PBXgateway, and we are presently developing
additional products that operate over broadband and wireless networks. For the
foreseeable future, we anticipate that substantially all of our revenues will be
attributable to sales of our access and gateway products, with sales of
recording interface gateways representing a decreasing percentage of our
revenues. Among our access and gateway products, we believe that the 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 may decline as a percentage of our revenues. To date we
have generated minimal service and maintenance revenues. We do not expect
maintenance or service revenues to be a significant portion of our revenues.
Periodically, we have received non-recurring engineering fees, although such
fees have not been material to date.
For the fiscal years ended April 30, 2000 and 2001, Avaya (formerly Lucent
Technologies) accounted for approximately 45.6% and 24.1%, respectively of our
revenues. However, during the last six months of our fiscal year ended April 30,
2001, sales to Avaya fell to $2.1 million or 12.8% of our business compared to
$7.1 million or 32.5% of our business in the previous six month period. The
revenue shortfall from Avaya was
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not offset by revenue contributions from other channels and had an adverse
effect on our business. We believe the reduction in revenues from Avaya is
related to a change in their inventory carrying policy, a slow down in their
overall business and their release of internally developed competitive products.
Additionally, a weak economy has lead to a slow down in capital spending which
has also had a negative impact on our business. We expect the trend of lower
Avaya revenues to continue until the implementation of their new inventory
carrying policy is complete and their business recovers. However, there can be
assurance that revenue from Avaya will return to previous levels. We cannot
currently predict when capital spending will rebound to previous levels.
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.
Our cost of goods sold consists primarily of purchased finished products
from Mack Technologies and purchased subassemblies from EMG and OEM Worldwide.
We incur additional costs to test and assemble these subassemblies for shipment
to our customers. Cost of goods sold also includes certain manufacturing
overhead costs, primarily facilities and related depreciation. Additionally, our
cost of goods sold includes costs related to maintenance and support services
provided to our distribution channels and end users through Vital Network
Services, a third-party support provider.
Research and development expenses consist primarily of salaries and related
personnel costs and contract engineering, purchased software and prototype
expenses related to the design, development, enhancement and testing of our
products. As of April 30, 2001, all research and development costs have been
expensed as incurred. We will continue to enhance existing products and fund new
product development initiatives targeted at the growing service provider and
next generation equipment manufacturer market segments. We expect research and
development expenses to increase in both real dollars and as a percentage of
revenue in future periods. We also expect to increase our expenditures on our
product validation laboratories that test the interoperability of our products
with enterprise voice systems and other products. This competency continues to
be critical to our business as we develop additional products that function over
circuit, packet and wireless networks in conjunction with third-party data
equipment.
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. We primarily sell our products through an indirect distribution system
that includes the following channels: OEMs and private label partners, ILECs,
systems integrators and distributors, telecom and datacom VARs and service
providers. Our sales force and marketing efforts are primarily directed at
developing brand awareness and supporting our indirect distribution channels. We
intend to pursue sales and marketing campaigns to deepen penetration with
existing partners and selectively expand to new distribution channels. As
revenues increase, we expect sales and marketing headcount and associated
expenses to increase accordingly.
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. We expect
that general and administrative expenses will remain relatively constant during
fiscal year 2002.
Stock based compensation expenses resulted from the granting of restricted
stock and stock options to employees and directors with exercise prices per
share determined to be below the deemed fair values per share for financial
reporting purposes of our common stock at dates of grant. The deferred
compensation is being amortized to expense over the vesting period of the
individual options, generally four years. At April 30, 2001, deferred
compensation to be amortized in future periods amounted to $1.6 million. The
amortization of existing deferred stock-based compensation is expected to impact
our reported results of operations through the July 2003 quarter.
Amortization of goodwill and other intangibles. In June 2000, we acquired
all of the outstanding stock of Digital Techniques Incorporated Holding "DTIH"
and its subsidiary Digital Techniques, Inc. "DTI" and
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certain other assets for $12.7 million in cash and stock valued at $10.9
million. The acquisition provided us with technologies to expand our current
line of distributed voice products, development rights to additional protocols
and an expanded customer base. In conjunction with the acquisition, 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 of 5 years and will impact our
operating results through fiscal year 2005.
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
intercompany transactions.
RESULTS OF OPERATIONS
The following table sets forth certain financial data for the periods
indicated as a percentage of revenues.
YEARS ENDED APRIL 30,
-----------------------
1999 2000 2001
----- ----- -----
Revenues.................................................... 100.0% 100.0% 100.0%
Cost of goods sold.......................................... 37.8 37.7 40.0
----- ----- -----
Gross profit................................................ 62.2 62.3 60.0
Operating expenses:
Research and development.................................. 23.5 19.4 24.2
Sales and marketing....................................... 27.3 31.2 36.1
General and administrative................................ 11.3 9.9 12.2
Amortization of stock based compensation.................. 2.8 18.5 7.6
Amortization of goodwill and other intangibles............ -- -- 12.0
Write-off of in-process research and development.......... -- -- 9.7
Restructuring............................................. -- -- 1.5
----- ----- -----
Total operating expenses.......................... 64.9 79.0 103.3
----- ----- -----
Loss from operations........................................ 2.7 16.7 43.3
Other (income) expense, net................................. 1.5 (3.0) (9.5)
----- ----- -----
Loss before income tax provision (benefit) and dividends on
redeemable preferred stock of subsidiary.................. 4.1 13.7 33.8
Income tax provision (benefit).............................. -- 0.4 (2.9)
----- ----- -----
Net loss before dividends on subsidiary redeemable preferred
stock..................................................... 4.1% 14.1% 30.9%
===== ===== =====
Fiscal years ended April 30, 2000 and 2001
Revenues. Revenues increased from $25.1 million for the fiscal year ended
April 30, 2000 to $38.2 million for the fiscal year ended April 30, 2001, an
increase of $13.1 million or 52.4%. This increase was primarily due to the
increased sales of our remote voice access products, and our multi-user remote
voice products in particular. The multi-user remote voice products accounted for
approximately $19.6 million or 51.4% of revenues during the year ended April 30,
2001, compared to $12.1 million or 48.3% of revenues in the year ended April 30,
2000. Secondarily, revenues for fiscal 2001 increased by approximately $7.4
million due to our acquisition of DTI in June of 2000. Lucent Technologies, a
significant customer that has accounted for more than 40% of our revenues over
the past two years, divested its PBX unit into a standalone business named
Avaya. Revenue from Avaya declined from $7.1 million during the first six months
of fiscal 2001 to $2.1 million during the last six months of fiscal 2001. This
decrease in revenue had an adverse affect on our operating results. We believe
the reduction in revenues from Avaya is directly related to a slow down of
Avaya's overall business. We expect the trend of lower Avaya revenues to
continue until we have seen the completion of their inventory model transition
and a strengthening of their core business. We also believe that the recent slow
down in the economy has had a negative impact on capital spending, which has had
an adverse
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effect on our business. Additionally, both Avaya and Nortel introduced
competitive products during fiscal 2001, which could further reduce our market
share and revenue in future periods. We will continue leveraging our
distribution channels to drive revenue. However, our revenues and gross profit
could be harmed if we need to reduce our prices to remain competitive.
Cost of goods sold. Cost of goods sold increased from $9.5 million for the
fiscal year ended April 30, 2000 to $15.3 million for the fiscal year ended
April 30, 2001, an increase of $5.8 million or 61.7%. This increase was
primarily related to the increase in volume of units shipped. Gross profit
decreased from 62.3% for the year ended April 30, 2000 to 60.0% for the year
ended April 30, 2001. The decrease in gross profit was primarily attributable to
a $500,000 write down of inventory related to the discontinuance of certain non-
strategic products as well as 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 and cost
reduced EXTender 4000 products. We expect our gross profit will continue to be
under pressure due to an overall weakness in the economy, increased competition,
and rising costs of certain components.
Research and development. Research and development expenses increased from
$4.9 million for the fiscal year ended April 30, 2000 to $9.2 million for the
fiscal year ended April 30, 2001, an increase of $4.4 million or 89.3%. 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 cost reduced EXTender 4000 products, and, to a lesser extent, related
overhead costs. For the year ended April 30, 2000 and 2001, research and
development expenses increased as a percentage of revenues from 19.4% to 24.2%
as a result of increased spending and lower than expected revenues in the second
half of the year.
Sales and marketing. Sales and marketing expenses increased from $7.8
million for the fiscal year April 30, 2000 to $13.8 million for the fiscal year
ended April 30, 2001, an increase of $6.0 million or 76.8%. This increase was
primarily due to increases in staffing of both sales and marketing personnel,
the addition of DTI's sales force, the write-off of $500,000 of accounts
receivable due to the bankruptcy of a reseller, and, to a lesser extent,
increased marketing activities in support of more diversified distribution. For
the year ended April 30, 2000 and 2001, sales and marketing expenses increased
as a percentage of revenues from 31.2% to 36.1% as a result of increased
spending and lower than expected revenues in the second half of the year.
General and administrative. General and administrative expenses increased
from $2.5 million for the fiscal year ended April 30, 2000 to $4.6 million for
the fiscal year ended April 30, 2001, an increase of $2.2 million or 87.7%. 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, fees associated with the recruiting and
hiring of our new Chief Executive Officer, and, to a lesser extent, professional
service costs. For the year ended April 30, 2000 and 2001, general and
administrative expenses increased as a percentage of revenues from 9.9% to 12.2%
as a result of increased spending and lower than expected revenues in the second
half of the year.
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 $9.7 million, net
of cancellations 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 recorded $4.6 million and $2.9 million of
stock-based compensation expense in the fiscal years ended April 30, 2000 and
2001, 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 of 5
years and will impact our operating results through fiscal 2005. During the year
ended April 30, 2001, we recorded $4.6 million of amortization expense related
to goodwill and intangibles.
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Write-off of in-process research and development. During fiscal 2001 we
allocated $694,000 of the $23.6 million purchase price for the DTIH acquistion
and 100% of the Entrata acquisition price to in-process research and
development. We did not incur any such charges in fiscal 2000. In-process
research and development represents ongoing acquired research and development
projects which have yet to reach technological feasibility and would have no
probable alternative future use. We used independent professional valuation
consultants to assess and allocate values for the DTIH acquisition. With regard
to Entrata, it was estimated that the non-exclusive license we purchased was
less than 50% complete and would require approximately $2.0 million of
additional funding to integrate with our technology. No assurance can be given,
however, that the underlying assumptions used in the valuation of these projects
will be realized. Additionally, the development of our technology has inherent
risks in the design of its hardware and software components, the manufacture of
the product, and the development of a marketplace to sell the product. If we
experience problems or delays in designing or manufacturing the product or
should the market not develop for our products it could affect or prevent us
from achieving commercial success.
Restructuring. During March 2001 we reorganized various operating
functions of our business, re-focused our business on our core competencies and
matched staffing needs to our strategic initiatives. The reorganization and
refocusing resulted in a reduction of our workforce by approximately 10% or 25
employees. In conjunction with this action we recorded a charge of approximately
$597,000 for the costs of severance, related benefits and outplacement services.
The restructuring was completed in fiscal 2001 and we do not anticipate any
impact on future results.
Other income (expense). Other income (expense) improved from income of
$758,000 for the fiscal year ended April 30, 2000 to $3.6 million for the fiscal
year ended April 30, 2001, an improvement of $2.9 million. Interest expense,
offset by interest income, improved from income of $794,000 for the fiscal year
ended April 30, 2000 to income of $3.7 million for the fiscal year ended April
30, 2001. This improvement was primarily related to interest earned on invested
cash and the repayment of our subordinated debt. Foreign exchange losses for the
fiscal year ended April 30, 2000 were $20,000 compared to a loss of $34,000 for
the fiscal year ended April 30, 2001. Losses were primarily related to a
weakening of the Canadian Dollar against the U.S. Dollar.
Income Tax Provision (Benefit) The Company recorded a income tax benefit
of $1.1 million for the fiscal year ended April 30, 2001 compared to a provision
of $100,000 for the fiscal year ended April 30, 2000. The benefit primarily
resulted from a reduction of the deferred tax asset valuation allowance, which
resulted from the deferred tax liabilities recognized as part of the DTIH
acquisition.
Fiscal years ended April 30, 1999 and 2000
Revenues. Revenues increased from $14.3 million for the fiscal year ended
April 30, 1999 to $25.1 million for the fiscal year ended April 30, 2000, an
increase of $10.8 million or 75.8%. This increase was primarily due to the
release of our first multi-user remote voice access product in April 1999, which
accounted for approximately $1.3 million or 9.1% of revenues in fiscal year 1999
and approximately $12.1 million or 48.3% in fiscal year 2000.
Cost of goods sold. Our cost of goods sold increased from $5.4 million for
the fiscal year ended April 30, 1999 to $9.5 million for the fiscal year ended
April 30, 2000, an increase of $4.1 million or 75.4%. This increase was
primarily related to the increase in volume of units shipped. Gross profit
increased from 62.2% for the fiscal year ended April 30, 1999 to 62.3% for the
fiscal year ended April 30, 2000. The slight increase in gross profit was
primarily attributable to the higher mix in revenues of our multi-user remote
voice access products, which have higher gross profit than our other products.
This was partially offset by increases in certain component costs such as flash
memory and pricing pressure in the market.
Research and development. Research and development expenses increased from
$3.3 million for the fiscal year ended April 30, 1999 to $4.9 million for the
fiscal year ended April 30, 2000, an increase of $1.5 million or 45.6%. This
increase was due primarily to increases in staffing, the development of
proto-type units for our EXTender 3200 for IDSL, IP EXTender 4000, 12-port
EXTender 6000, and 24-port Gateway product
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lines. For the fiscal year ended April 30, 2000, research and development
expenses decreased as a percentage of revenues from 23.5% to 19.4% as a result
of increased revenues.
Sales and marketing. Sales and marketing expenses increased from $3.9
million for the fiscal year ended April 30, 1999 to $7.8 million for the fiscal
year ended April 30, 2000, an increase of $3.9 million or 101.0%. This increase
was primarily due to increases in staffing of both sales and marketing personnel
and, to a lesser extent, increased marketing activities related to the
introduction of our first multi-user remote voice access product. For the fiscal
year ended April 30, 2000, sales and marketing expenses increased as a
percentage of revenues from 27.3% to 31.2% as newly hired sales personnel
generally do not achieve full productivity during their first two quarters with
us and as we have hired personnel to develop a broadband service provider
channel which, do date, has not generated meaningful revenue.
General and administrative. General and administrative expenses increased
from $1.6 million for the fiscal year ended April 30, 1999 to $2.5 million for
the fiscal year ended April 30, 2000, an increase of $858,000 or 53.1%. 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 fiscal years ended April 30, 2000, general
and administrative expenses decreased as a percentage of revenues from 11.3% to
9.9% as a result of increased revenues.
Amortization of stock based compensation. In connection with the grant of
certain stock options to employees in the fiscal year ended April 30, 2000, we
recorded deferred compensation expense of $8.5 million. 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. 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 $4.6 million and $406,000 of deferred
stock-based compensation in the years ended April 30, 2000 and 1999,
respectively. The amortization of existing deferred stock-based compensation is
expected to impact our reported results of operations through the quarter ended
July 2003.
Other income (expense), net. Other income (expense), net improved from an
expense of $207,000 for the fiscal year ended April 30, 1999 to income of
$758,000 for the fiscal year ended April 30, 2000, an improvement of $965,000.
Interest expense, offset by interest income, improved from an expense of
$268,000 for the fiscal year ended April 30, 1999 to income of $794,000 for the
fiscal year ended April 30, 2000. This improvement was due to income earned on
invested cash and the repayment of our subordinated debt. Foreign exchange gains
for the fiscal year ended April 30, 1999 were $60,000 compared to a loss of
$20,000 for the fiscal year ended April 30, 2000.
LIQUIDITY AND CAPITAL RESOURCES
As of April 30, 2001, our principal sources of liquidity consisted of cash
and equivalents of $4.0 million and short-term investments of $50.8 million.
This represents a decrease in cash and equivalents and short-term investments of
$20.9 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.
On June 14, 2000 we acquired all of the outstanding stock of DTIH and it's
wholly-owned subsidiary DTI for $12.7 million in cash, 364,601 shares of our
common stock and assumed stock options. The transaction was accounted for as a
purchase. Additionally, we used $3.1 million to purchase capital assets
including a new information system to support sales, marketing and customer
support, continued development of our validation lab, and other equipment
required to grow our business. We used $2.0 million to acquire a royalty free
license from Entrata which we expect to integrate into certain MCK products and
solutions in the future. We also used cash to fund our operating losses during
the year.
We expect to devote our capital resources to continue our research and
development efforts to enhance our existing products and fund new product
development initiatives targeted at the growing service provider
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and next generation equipment manufacturer markets, to hire and expand our
sales, support, marketing and product management 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. For instance, the licensing agreement we
signed with Entrata requires us to pay $1.0 million to Entrata over the next 12
months and we expect to invest an additional $1.0 million on this platform in an
effort to bring products to market. 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.
RECENT ACCOUNTING PRONOUNCEMENTS
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101 (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. The Company
adopted SAB 101 as required in the fourth quarter of fiscal year 2001 which had
no impact on our consolidated results of operations and financial position.
In June 1998, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standard (SFAS) No. 133, "Accounting for
Derivative Instruments and Hedging Activities," as amended by SFAS Nos. 137 and
138, which establishes standards for the recognition, measurement and reporting
of derivatives and hedging activities and is effective, as amended, for all
quarters in fiscal years beginning after June 15, 2000. The Company anticipates
that the adoption of this new accounting standard will not have a material
impact on its consolidated financial statements.
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 $550,000.
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, 2001, this revenue accounted for 11.2% 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 April 30, 2001, a
10% strengthening of the U.S. dollar against the Canadian dollar would result in
a foreign currency transaction loss of approximately $154,000 to date foreign
exchange gains and losses have not been significant. Transactions with our
United Kingdom office, whose functional currency is the British Pound have not
been significant and have not had a material impact on our operations. All sales
outside of North America are denominated in U.S. dollars an are not generally
exposed to foreign currency exchange risk.
At April 30, 2001 we did not own any equity investments. Therefore, we did
not have any direct equity price risk.
FACTORS AFFECTING FUTURE OPERATING RESULTS AND STOCK PRICE
WE ARE EXPOSED TO GENERAL ECONOMIC CONDITIONS
As a result of unfavorable economic conditions, reduced capital spending by
our enterprise end-users, and the need of our indirect channel partners to hold
less inventory to satisfy customer demand, our sales declined significantly in
our fourth quarter of fiscal 2001. This economic downtown has resulted in longer
selling cycles
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for new equipment purchases. We believe that our business and results of
operations will be seriously harmed if current economic conditions do not
improve. Additionally, the slow down may impact our customers ability to pay for
products previously shipped which would require us to write-off the associated
receivables against earnings.
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 Avaya (formerly the enterprise business unit of
Lucent), to purchase our products would seriously harm our business. For
example, during the six month period ended April 30, 2001 Avaya accounted for
approximately $2.1 million or 12.8% of our revenues compared to $7.1 million or
32.5% of our revenues in the six months ended October 31, 2000. This revenue
shortfall was not offset by revenue contributions of other channels and had a
material adverse effect on our operating results during this period. While we
believe that some of the decline in sales to Avaya is due to a slow down in
their business and a weakening of the economy, we recognize that Avaya has
introduced competitive products into the market. As a result, there can be no
assurance that sales to Avaya will not continue to decline.
For the fiscal year ended April 30, 2001, Avaya accounted for 24.1% of our
revenues, and our 10 largest customers, including Avaya, accounted for 63.2% 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:
- market strategies of these customers
- the product requirements of these customers
- the financial and operational success of these customers
- the success of the underlying products and services that our products
support.
The loss of any one of our major customers or the delay of significant
orders from such customers, even if only temporary, could reduce or delay our
recognition of revenues, harm our reputation in the industry and reduce our
ability to accurately predict cash flow, and, as a consequence, could seriously
harm our business, financial condition and results of operations.
OUR INABILITY TO DEVELOP AND MAINTAIN RELATIONSHIPS WITH KEY PBX VENDORS WOULD
HARM OUR ABILITY TO SUSTAIN AND GROW OUR BUSINESS
Our success depends to a significant degree upon our relationships with
leading enterprise voice vendors like Alcatel, Avaya, Ericsson, Iwatsu, Nitsuko,
Nortel, NEC, and Toshiba, among others and their channel distribution partners.
The systems sold by these vendors account for approximately 80% of the U.S.
market for voice equipment sales, and substantially all of our revenues for the
fiscal year ended April 30, 2001 were attributable to products which
interoperate with enterprise voice systems offered by these vendors. We may not
have access in the future to the proprietary protocols for the major 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 voice 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.
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In addition, we currently have varying distribution, marketing and
development arrangements with the 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 these vendors may
seek to offer broader product lines and solutions that are competitive with our
products.
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 affordably 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.
BECAUSE WE SELL THROUGH INDIRECT DISTRIBUTION CHANNELS, OUR VISIBILITY INTO END
USER DEMAND IS LIMITED
Our product distribution strategy is focused primarily on selling to
indirect distribution channels rather than selling directly to end users. We do
not typically have the primary relationship with the end users who ultimately
purchase our products from our distribution partners. We interface with our
channel partners and rely on them for information. The information we receive
from our channel partners related to future demand for our products is limited.
While some provide us with forecasts, pipelines and other key end user account
information, it is often incomplete and cannot always be relied upon for its
accuracy. As a result, it is difficult for us to clearly understand our sales
pipeline and therefore our results may vary significantly from our internal
targets.
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 business communications 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 in growing segments. 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.
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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 traditional PBX and KTS technology
- delayed market acceptance of Nextgen switches and applications
- the performance, price and total cost of ownership of our products
- the availability, functionality and price of competing products and
technologies
- 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 the majority of our revenues from our product family of
distributed voice 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, 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
- technological change and customer acceptance.
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, both Nortel
Networks and Avaya have released products which compete directly with our
products and Intel has announced a competitive product that will be released
later this year. 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 and may result in charges,
write-offs, etc. as we transition our product line and offer products to address
the needs of service providers and next generation equipment manufacturers. 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
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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 that 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 Avaya, any consolidation involving these
parties could reduce the demand for our products and otherwise harm our business
prospects.
OUR DEPENDENCE ON INDEPENDENT MANUFACTURERS AND SUPPLIERS COULD RESULT IN
PRODUCT DELIVERY DELAYS
We currently use three independent manufacturers, Electronic Manufacturing
Group (EMG), 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.
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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 eight fiscal quarters, our net
results of operations have ranged from a net loss of $531,000 to a net loss of
$6.6 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 volume levels for our
products
- our ability to sustain world class product and customer support quality
- 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
- 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 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
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- 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 or the perception that such sales could occur
- 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 18.4% of our revenues for the fiscal year
ended April 30, 2001, and 15.3% of our revenues for the year ended April 30,
2000. 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
- 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.
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
36
38
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. 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
37
39
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 circuit switched and IP PBXs, application servers, telephony sets and
private and public networks. 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 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 April 30, 2001, we employed 186 employees. This number may
increase significantly in the future as the economy and our business recover.
Further expansion will likely be necessary to address potential growth in our
customer base and market opportunities. In addition, we hired a new chief
executive officer in January 2001 and much of our senior management team has
been with us for less than a year. 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
- 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 distributed voice 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 that may absorb significant management
attention. For example, during the third quarter of fiscal 2001 we discontinued
several non-strategic products in an effort to focus our business on our core
technologies. In conjunction with this action we recorded a charge of $500,000
to cover the write-off of stranded assets, primarily inventory.
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, 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 the recently completed acquisition or any future acquisition
fails to meet our expectations or if we change the strategic
38
40
focus of the company, we may decide to sell, close, or otherwise significantly
reduce our investment in the acquired technologies which could have an adverse
effect on our operating results.
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.
Within the last year we have experienced significant changes to the management
team including the appointment of a new chief executive officer and several new
vice presidents. 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 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.
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, 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.
39
41
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information required by this item is incorporated by reference to the
Consolidated Financial Statements set forth on pages F-1 through F-18 hereof.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this Item 10 concerning our directors and
officers is incorporated by reference to the information under the heading,
"Election of Directors -- Information Regarding the Nominees and Executive
Officers" in our 2001 Proxy Statement.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item 11 is incorporated by reference to
the information under the heading, "Compensation of Directors and Executive
Officers" in our 2001 Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF MANAGEMENT AND CERTAIN BENEFICIAL OWNERS
The information required by this Item 12 is incorporated by reference to
the information under the heading, "Security Ownership of Management and Certain
Beneficial Owners" in our 2001 Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item 13 is incorporated by reference to
the information under the heading, "Certain Relationships and Related
Transactions" in our 2001 Proxy Statement.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a)(1) Financial Statements
1. Report of Ernst & Young LLP, independent auditors (see page F-2 hereof).
2. Consolidated Balance Sheets as of April 30, 2000 and 2001 (see page F-3
hereof).
3. Consolidated Statements of Operations for the years ended April 30,
1999, 2000 and 2001 (see page F-4 hereof).
4. Consolidated Statements of Common Stockholders' (Deficit) Equity for the
years ended April 30, 1999, 2000 and 2001 (see page F-5 hereof).
5. Consolidated Statements of Cash Flows for the years ended April 30,
1999, 2000 and 2001 (see page F-6 hereof).
6. Notes to Consolidated Financial Statements (see pages F-7 through F-18
hereof).
(a)(2) Financial Statement Schedules.
Schedules are not provided because of the absence of conditions under which
they are required or because the required information is shown in the financial
statements or notes thereto.
(a)(3) Exhibits.
The following is a complete list of exhibits filed as part of this Form
10-K. Documents identified by footnotes are being filed herewith and, pursuant
to Rule 12b-32 of the General Rules and Regulations
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42
promulgated by the Commission under the Securities Exchange Act of 1934
reference is made to such documents as previously filed as exhibits with the
Commission.
EXHIBIT NO. DESCRIPTION
- ----------- -----------
2.1 (1) Agreement and Plan of Merger, dated June 14, 2000, by and
among the Registrant, Omni Acquisition Corporation, Troy
Holdings International, Inc., DTI Holdings, Inc., Digital
Techniques, Inc. and certain shareholders of DTI Holdings,
Inc.
3.1 (2) Second Amended and Restated Certificate of Incorporation of
the Registrant (Exhibit No. 3.3 of Registration Statement on
Form S-1 (File No. 333-85821)).
3.2 (2) First Amended and Restated By-laws of the Registrant
(Exhibit No. 3.5 of Registration Statement on Form S-1 (File
No. 333-85821)).
4.1 (2) Specimen certificate for shares of common stock, $.001 par
value, of the Registrant.
10.1 (2) Amended and Restated Registration Rights Agreement, dated
July 16, 1998, among the Registrant and the stockholders
named therein. (Exhibit No. 10.2 of Registration Statement
on Form S-1 (File No. 333-85821)).
10.2 (2) Amended and Restated 1996 Stock Option Plan of the
Registrant. (Exhibit No. 10.3 of Registration Statement on
Form S-1 (File No. 333-85821)).
10.3 (3) 1999 Stock Option and Grant Plan of the Registrant.
10.4 (2) Form of Stock Restriction Agreement for sale of restricted
stock to executive officers (Exhibit No. 10.9 of
Registration Statement on Form S-1 (File No. 333-85821)).
10.5 (2) Form of Promissory Note for purchase of restricted stock by
executive officers (Exhibit No. 10.10 of Registration
Statement on Form S-1 (File No. 333-85821)).
10.6 (2) Form of Pledge Agreement (Exhibit No. 10.11 of Registration
Statement on Form S-1 (File No. 333-85821)).
10.7 (2) Form of Promissory Note (Exhibit No. 10.12 of Registration
Statement on Form S-1 (File No. 333-85821)).
10.8 (2)+ Agreement between the Registrant and Lucent Technologies,
Inc. effective as of April 30, 1999 (Exhibit No. 10.15 of
Registration Statement on Form S-1 (File No. 333-85821)).
10.9 (2)+ Master Support Agreement between the Registrant and Vital
Networks, Inc. dated June 28, 1999 (Exhibit No. 10.16 of
Registration Statement on Form S-1 (File No. 333-85821)).
10.10 (2) Lease Agreement by and between the Registrant and
Wellsford/Whitehall Holdings, L.L.C. dated January 10, 2000.
10.10.1 (5) First Amendment to Lease Agreement between the registrant
and Wellsford/Whitehall Holdings, LLC dated May 25, 2000.
(Exhibit No. 10.13.1 of Annual Report on Form 10-K (File No.
0-22703)).
10.10.2 (5) Second Amendment to Lease Agreement between the registrant
and Wellsford/Whitehall Holdings, LLC dated May 31, 2000.
(Exhibit No. 10.13.1 of Annual Report on Form 10-K (File No.
0-22703)).
10.11 (5) Lease Agreement by and between the Digital Techniques, Inc.
and Armet Bethany Limited Partnership dated July 7, 1993, as
amended April 21, 1995 and further amended December 14,
1998. (Exhibit No. 10.14 of Annual Report on Form 10-K (File
No. 0-22703)).
10.12 (6) 2000 Director Stock Option Plan of the Registrant.
10.13 (7) 2000 Employee Stock Purchase Plan of the Registrant.
10.14 Offer letter dated January 11, 2001, between the Registrant
and Glenda Davis.
10.15 Restricted Stock Purchase Agreement, dated March 13, 2001,
between the Registrant and Glenda Davis.
10.16 Non-qualified Stock Option Agreement, dated March 13, 2001,
between the Registrant and Glenda Davis.
21.1 Subsidiaries of the Registrant.
23.1 Consent of Ernst & Young LLP.
41
43
- ---------------
+ Confidential treatment obtained as to portions of this exhibit. The
confidential information has been filed separately with the Securities and
Exchange Commission.
(1) Incorporated by reference to Exhibit 2.1 filed with the Registrant's Report
on Form 8-K dated June 28, 2000.
(2) Incorporated by reference to identically numbered exhibits (unless otherwise
indicated) filed in response to Item 16(a), "Exhibits," of the Registrant's
Registration Statement on Form S-1, as amended (File No. 333-85821), which
was declared effective on October 21, 1999.
(3) Incorporated by reference to Exhibit 10.4 filed with the Registrant's
Registration Statement on Form S-8 dated February 4, 2000.
(4) Incorporated by reference to Exhibit No. 10.18 of the Registrant's
Registration Statement on Form S-1, as amended (File No. 333-96235), which
was declared effective on April 4, 2000.
(5) Incorporated by reference to identically numbered exhibits (unless otherwise
indicated) filed with the Registrant's Annual Report on Form 10-K for the
fiscal year ended April 30, 2000, as filed with the SEC on July 31, 2000.
(6) Incorporated by reference to Exhibit 99.1 filed with the Registrant's
Registration Statement on Form S-8 dated November 14, 2000.
(7) Incorporated by reference to Exhibit 99.1 filed with the Registrant's
Registration Statement on Form S-8 dated December 4, 2000.
(b) Reports on Form 8-K.
On May 4, 2001 the registrant filed a current report on Form 8-K/A. The
filing was completed in response to a request by the staff of the Securities
and Exchange Commission and revised the auditors letter previously filed.
42
44
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1933, as amended, the registrant has duly caused this Report to
be signed on its behalf by the undersigned, thereunto duly authorized, in the
town of Needham, State of Massachusetts on the 2nd day of July, 2001.
MCK COMMUNICATIONS, INC.
By: /s/ GLENDA DAVIS
--------------------------------------
Glenda Davis
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE
--------- ----- ----
/s/ STEVEN J. BENSON Chairman of the Board June 29, 2001
- ---------------------------------------------------
Steven J. Benson
/s/ GLENDA N. DAVIS President, Chief Executive Officer July 2, 2001
- --------------------------------------------------- and Director (Principal Executive
Glenda N. Davis Officer)
/s/ PAUL K. ZURLO Chief Financial Officer (Principal July 2, 2001
- --------------------------------------------------- Financial Officer and Principal
Paul K. Zurlo Accounting Officer)
/s/ CALVIN K. MANZ Director June 29, 2001
- ---------------------------------------------------
Calvin K. Manz
/s/ JOHN B. LANDRY Director June 29, 2001
- ---------------------------------------------------
John B. Landry
/s/ GREGORY M. AVIS Director June 29, 2001
- ---------------------------------------------------
Gregory M. Avis
/s/ MICHAEL H. BALMUTH Director June 29, 2001
- ---------------------------------------------------
Michael H. Balmuth
/s/ PAUL SEVERINO Director June 29, 2001
- ---------------------------------------------------
Paul Severino
43
45
MCK COMMUNICATIONS, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE
----
Report of Ernst & Young LLP, Independent Auditors........... F-2
Consolidated Balance Sheets................................. F-3
Consolidated Statements of Operations....................... F-4
Consolidated Statements of Common Stockholders' (Deficit)
Equity.................................................... F-5
Consolidated Statements of Cash Flows....................... F-6
Notes to Consolidated Financial Statements.................. F-7
F-1
46
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
Board of Directors and Stockholders
MCK Communications, Inc.
We have audited the accompanying consolidated balance sheets of MCK
Communications, Inc. (the Company) as of April 30, 2001 and 2000, and the
related consolidated statements of operations, common stockholders' (deficit)
equity and cash flows for each of the three years in the period ended April 30,
2001. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
the Company as of April 30, 2001 and 2000 and the consolidated results of its
operations and its cash flows for each of the three years in the period ended
April 30, 2001, in conformity with accounting principles generally accepted in
the United States.
/s/ ERNST & YOUNG LLP
Boston, Massachusetts
June 1, 2001
F-2
47
MCK COMMUNICATIONS, INC.
CONSOLIDATED BALANCE SHEETS
APRIL 30,
----------------------------
2000 2001
------------ ------------
ASSETS
Current assets:
Cash and equivalents...................................... $ 55,844,365 $ 4,035,317
Marketable debt securities................................ 19,879,364 50,766,252
Accounts receivable (net of allowances of $154,064 and
$596,225 at April 30, 2000 and 2001, respectively)..... 5,018,173 5,150,289
Inventory................................................. 2,497,802 4,336,746
Prepaids and other current assets......................... 1,296,574 1,691,383
------------ ------------
Total current assets.............................. 84,536,278 65,979,987
Fixed assets, net........................................... 2,306,182 4,093,420
Goodwill, intangibles and other long term assets............ 351,878 13,754,306
Completed technology........................................ -- 6,568,866
------------ ------------
Total assets................................................ $ 87,194,338 $ 90,396,579
============ ============
LIABILITIES AND COMMON STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable.......................................... $ 4,782,681 $ 3,484,151
Accrued liabilities....................................... 774,614 2,863,914
Accrued compensation and benefits......................... 620,710 1,179,128
Deferred revenue.......................................... 70,659 8,854
------------ ------------
Total current liabilities......................... 6,248,664 7,536,047
Common stockholders' (deficit) equity:
Common stock, $.001 par value; authorized -- 40,000,000
issued and outstanding 19,357,339 shares at April 30, 2000
and 20,115,078 shares at April 30, 2001................... 19,357 20,115
Additional paid-in capital.................................. 115,801,560 126,851,376
Accumulated deficit......................................... (29,213,397) (41,012,462)
Deferred compensation....................................... (4,623,999) (1,615,469)
Accumulated other comprehensive loss........................ (344,720) (546,668)
Notes receivable from officers.............................. (693,127) (836,360)
------------ ------------
Total common stockholders' equity........................... 80,945,674 82,860,532
------------ ------------
Total liabilities and common stockholders' equity........... $ 87,194,338 $ 90,396,579
============ ============
See accompanying notes to consolidated financial statements.
F-3
48
MCK COMMUNICATIONS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED APRIL 30,
-----------------------------------------
1999 2000 2001
----------- ----------- -----------
Revenues............................................ $14,269,603 $25,082,402 $38,219,724
Cost of goods sold.................................. 5,389,557 9,455,140 15,287,086
----------- ----------- -----------
Gross profit........................................ 8,880,046 15,627,262 22,932,638
Operating expenses:
Research and development (excluding amortization
of stock based compensation of $175,418,
$1,557,925 and $829,892 in 1999, 2000 and 2001,
respectively).................................. 3,348,608 4,876,183 9,232,038
Sales and marketing (excluding amortization of
stock based compensation of $110,405,
$1,852,866 and $1,004,885 in 1999, 2000 and
2001, respectively)............................ 3,888,537 7,817,048 13,820,168
General and administrative (excluding amortization
of stock based compensation of $120,177,
$1,234,375 and $1,067,604 in 1999, 2000 and
2001, respectively)............................ 1,616,620 2,474,699 4,645,677
Amortization of stock based compensation.......... 406,000 4,645,166 2,902,381
Amortization of goodwill and other intangibles.... -- -- 4,587,596
Write-off of in-process research and
development.................................... -- -- 3,694,000
Restructuring..................................... -- -- 597,000
----------- ----------- -----------
Total operating expenses.................. 9,259,765 19,813,096 39,478,860
----------- ----------- -----------
Loss from operations................................ 379,719 4,185,834 16,546,222
Other (income) expense:
Interest expense.................................. 397,969 183,101 36,388
Interest income................................... (130,339) (976,929) (3,696,497)
Other (income) expense, net....................... (60,267) 35,980 43,075
----------- ----------- -----------
Total other (income) expense.............. 207,363 (757,848) (3,617,034)
----------- ----------- -----------
Loss before provision for income taxes and dividends
on redeemable preferred stock of subsidiary....... 587,082 3,427,986 12,929,188
Income tax provision (benefit)...................... -- 100,000 (1,130,123)
Dividends on redeemable preferred stock of
subsidiary........................................ 196,947 96,563 --
----------- ----------- -----------
Net loss............................................ 784,029 3,624,549 11,799,065
Dividends on redeemable preferred stock............. 1,965,921 1,285,338 --
----------- ----------- -----------
Loss applicable to common stock..................... $ 2,749,950 $ 4,909,887 $11,799,065
=========== =========== ===========
Basic and diluted net loss per common share......... $ (0.71) $ (0.44) $ (0.61)
----------- ----------- -----------
Shares used in computing basic and diluted net loss
per common share.................................. 3,881,526 11,144,565 19,213,239
----------- ----------- -----------
Pro forma basic and diluted loss per common share... $ (0.31)
Shares used in computing pro forma basic and diluted
loss per common share............................. 15,268,368
See accompanying notes to consolidated financial statements.
F-4
49
MCK COMMUNICATIONS, INC.
CONSOLIDATED STATEMENTS OF COMMON STOCKHOLDERS' (DEFICIT) EQUITY
ACCUMULATED
SHARES OF COMMON ADDITIONAL OTHER
COMPREHENSIVE COMMON STOCK AT PAID-IN ACCUMULATED DEFERRED COMPREHENSIVE
LOSS STOCK PAR VALUE CAPITAL DEFICIT COMPENSATION LOSS
-------------- ----------- --------- ------------ ------------ ------------ -------------
Balance at April 30,
1998.................... $ 4,978,570 $ 4,979 $ 152,352 $(19,901,160) -- $(155,290)
Stock options
exercised............... 241,288 241 16,203 -- -- --
Sale of restricted
stock................... 114,750 115 11,135 -- -- --
Cancellation of
restricted stock........ (34,425) (35) (3,340) -- -- --
Foreign currency
translation
adjustment.............. $ (10,453) -- -- -- -- -- (10,453)
Deferred compensation.... -- -- 1,211,652 -- (1,211,652) --
Amortization of deferred
compensation............ -- -- -- -- 406,000 --
Dividends on preferred
stock................... -- -- -- (1,965,921) -- --
Issuance of preferred
stock in exchange for
redemption premium...... -- -- -- (1,652,400) -- --
Net loss................. (784,029) -- -- -- (784,029) -- --
------------ ----------- -------- ------------ ------------ ----------- ---------
Total comprehensive
income (loss)........... $ (794,482) -- -- -- -- -- --
============
Balance at April 30,
1999.................... 5,300,183 5,300 1,388,002 (24,303,510) (805,652) (165,743)
Foreign currency
translation
adjustment.............. $ (150,905) -- -- -- -- -- (150,905)
Unrealized loss on
marketable securities... (28,072) -- -- -- -- -- (28,072)
Deferred compensation.... -- -- 8,463,513 -- (8,463,513) --
Amortization of deferred
compensation............ -- -- -- -- 4,645,166 --
Sale of restricted
stock................... 397,800 398 687,102 -- -- --
Dividends on preferred
stock................... -- -- -- (1,285,338) -- --
Sale of common stock..... 4,935,600 4,936 100,408,413 -- -- --
Stock options
exercised............... 133,435 133 37,271 -- -- --
Conversion of Series B
and D Preferred Stock... 8,677,210 8,677 4,907,938 -- -- --
Cancellation of
restricted stock........ (86,859) (87) (90,679) -- -- --
Payment on notes
receivable.............. -- -- -- -- -- --
Net loss................. (3,624,549) -- -- -- (3,624,549) -- --
------------ ----------- -------- ------------ ------------ ----------- ---------
Total comprehensive
income (loss)........... $ (3,803,526) -- -- -- -- -- --
============
Balance at April 30,
2000.................... 19,357,369 19,357 115,801,560 (29,213,397) (4,623,999) (344,720)
Foreign currency
translation
adjustment.............. $ (240,780) -- -- -- -- -- (240,780)
Unrealized gain on
marketable securities... 38,832 -- -- -- -- -- 38,832
Amortization of deferred
compensation............ -- -- -- -- 2,612,220 --
Stock options exercised
net of cancellations.... 357,801 358 69,129 -- 73,262 --
Sale of restricted stock
net of cancellations.... 35,307 35 41,228 -- 323,048 --
Acquisition of DTI....... 364,601 365 10,939,459 -- -- --
Payment on notes
receivable.............. -- -- -- -- -- --
Net loss................. (11,799,065) -- -- -- (11,799,065) -- --
------------ ----------- -------- ------------ ------------ ----------- ---------
Total comprehensive
income (loss)........... $(12,001,013) -- -- -- -- -- --
============
Balance at April 30,
2001.................... 20,115,078 $ 20,115 $126,851,376 $(41,012,462) $(1,615,469) $(546,668)
=========== ======== ============ ============ =========== =========
TOTAL
NOTES COMMON
RECEIVABLE STOCKHOLDERS'
FROM (DEFICIT)
OFFICERS EQUITY
---------- -------------
Balance at April 30,
1998.................... $(150,802) $(20,049,921)
Stock options
exercised............... -- 16,444
Sale of restricted
stock................... (11,250) --
Cancellation of
restricted stock........ 3,375 --
Foreign currency
translation
adjustment.............. -- (10,453)
Deferred compensation.... -- --
Amortization of deferred
compensation............ -- 406,000
Dividends on preferred
stock................... -- (1,965,921)
Issuance of preferred
stock in exchange for
redemption premium...... -- (1,652,400)
Net loss................. -- (784,029)
--------- ------------
Total comprehensive
income (loss)........... -- --
Balance at April 30,
1999.................... (158,677) (24,040,280)
Foreign currency
translation
adjustment.............. -- (150,905)
Unrealized loss on
marketable securities... -- (28,072)
Deferred compensation.... -- --
Amortization of deferred
compensation............ -- 4,645,166
Sale of restricted
stock................... (687,500) --
Dividends on preferred
stock................... -- (1,285,338)
Sale of common stock..... -- 100,413,349
Stock options
exercised............... -- 37,404
Conversion of Series B
and D Preferred Stock... -- 4,916,615
Cancellation of
restricted stock........ 90,766 --
Payment on notes
receivable.............. 62,284 62,284
Net loss................. -- (3,624,549)
--------- ------------
Total comprehensive
income (loss)........... -- --
Balance at April 30,
2000.................... (693,127) 80,945,674
Foreign currency
translation
adjustment.............. -- (240,780)
Unrealized gain on
marketable securities... -- 38,832
Amortization of deferred
compensation............ -- 2,612,220
Stock options exercised
net of cancellations.... -- 142,749
Sale of restricted stock
net of cancellations.... (147,412) 216,899
Acquisition of DTI....... -- 10,939,824
Payment on notes
receivable.............. 4,179 4,179
Net loss................. -- (11,799,065)
--------- ------------
Total comprehensive
income (loss)........... -- --
Balance at April 30,
2001.................... $(836,360) $ 82,860,532
========= ============
See accompanying notes to consolidated financial statements.
F-5
50
MCK COMMUNICATIONS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED APRIL 30,
-------------------------------------------
1999 2000 2001
----------- ------------ ------------
Cash flow from operating activities:
Net loss........................................ $ (784,029) $ (3,624,549) $(11,799,065)
Depreciation.................................... 378,977 821,528 1,664,208
Amortization of goodwill and other
intangibles.................................. 15,000 15,000 4,587,596
Stock based compensation........................ 406,000 4,645,166 2,902,381
In-process research and development............. -- -- 694,000
Deferred income taxes........................... -- 33,133 (1,501,940)
Dividends accrued on redeemable preferred stock
of subsidiary................................ 196,947 96,563 --
Change in operating assets and liabilities:
Accounts receivable.......................... (1,457,353) (1,667,784) 969,059
Inventory.................................... (736,895) (1,004,161) (1,239,834)
Prepaids and other current assets............ 81,420 (1,083,549) 664,624
Accounts payable............................. 1,181,424 3,116,243 (1,717,688)
Accrued liabilities.......................... 138,058 128,476 1,573,144
Accrued compensation and benefits............ 178,404 136,220 (1,051,887)
Deferred revenue............................. -- 70,659 (61,805)
Other long-term assets....................... -- (335,035) 226,878
----------- ------------ ------------
Net cash (used) provided by operating
activities.............................. (402,047) 1,347,910 (4,090,329)
Cash flows from investing activities:
Purchase of fixed assets........................ (675,650) (1,964,736) (3,099,560)
Purchase of marketable securities............... -- (19,907,436) (30,886,888)
Acquisition of business, net of cash acquired... -- -- (12,650,141)
----------- ------------ ------------
Net cash used by investing activities...... (675,650) (21,872,172) (46,636,589)
Cash flows from financing activities:
Proceeds from issuance of preferred stock, net
of issuance costs............................ 4,940,323 -- --
Repayment of subordinated debt.................. (2,500,000) (2,500,000) --
Redemption of preferred stock................... -- (24,804,444) --
Decrease in short-term borrowings............... -- -- (866,147)
Issuance of common stock, net................... -- 100,610,001 4,179
Proceeds from exercise of stock options......... 16,444 37,404 69,487
----------- ------------ ------------
Net cash provided (used) by financing
activities.............................. 2,456,767 73,342,961 (792,481)
Effect of exchange rate changes on cash........... 38,701 (259,318) (289,649)
----------- ------------ ------------
Net increase (decrease) in cash................... 1,417,771 52,559,381 (51,809,048)
Cash and equivalents at beginning of period....... 1,867,213 3,284,984 55,844,365
----------- ------------ ------------
Cash and equivalents at end of period............. $ 3,284,984 $ 55,844,365 $ 4,035,317
=========== ============ ============
Non-cash transactions:
Dividends on non-subsidiary preferred stock..... $ 1,782,309 $ 1,285,338 --
Sale of restricted stock, net of
cancellations................................ 7,875 596,734 $ 147,412
Dividends to Manz Development, Inc.............. 380,559 193,025 --
Issuance of preferred stock in exchange for
redemption premium........................... 1,652,400 -- --
Conversion of Series B and D redeemable
preferred stock to common stock.............. -- 4,916,615 --
Issuance of common stock in acquisition......... -- -- 10,939,824
See accompanying notes to consolidated financial statements.
F-6
51
MCK COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FISCAL YEARS ENDED APRIL 30, 1999, 2000 AND 2001
1. NATURE OF OPERATIONS
MCK Communications, Inc. (MCK or the Company) develops and markets products
that enable businesses to unleash the power of their voice communications by
- extending the functionality and applications of their business telephone
systems from the main office to outlying offices, remote call centers,
teleworkers and mobile employees over public and private networks;
- bundling with service providers to unite CPE and network services to
deliver new outsourced, value added services
- bridging technology gaps between existing and nextgen applications,
switches and devices to enable enterprises ease of technology migration.
This combination strengthens our commitment to enabling a more open enterprise.
Sales are made to OEMs and private label partners, ILECs, systems integrators
and distributors, telecom and datacom VARs, and broadband service providers. The
Company operates in one business segment. In the fiscal years ended 1999, 2000
and 2001, sales to one customer represented 47%, 46% and 24%, respectively, of
consolidated revenues.
2. SIGNIFICANT ACCOUNTING POLICIES
(a) Principles of Consolidation
The consolidated financial statements include the accounts of MCK
Communications, Inc. and its wholly-owned subsidiaries. All significant
intercompany accounts and transactions are eliminated.
(b) Cash Equivalents
Cash equivalents are defined as short-term, highly-liquid investments
having an original maturity of three months or less.
(c) Inventory
Inventory is valued at the lower of cost (first-in, first-out) or market.
(d) Fixed Assets
Fixed assets are stated at cost and depreciated on a straight-line basis
over the following estimated useful lives:
Equipment............................ 3 years
Furniture and fixtures............... 3 years
Purchased software................... 2 years
Leasehold improvements............... The lesser of seven years or term of
lease
(e) Fair Value of Financial Instruments
The Company's cash, cash equivalents, marketable debt securities, accounts
receivable, accounts payable and accrued liabilities are carried at cost, which
approximates fair value due to their relative short term to maturity.
F-7
52
MCK COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(f) 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. To date these amounts
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.
The Company has adopted the provisions of Staff Accounting Bulletin No. 101
"Revenue Recognition," which did not have a material effect on the Company's
financial position or results of operations.
(g) Earnings per Share and Pro Forma Earnings per Share
SFAS 128 requires entities to present both basic earnings per share ("EPS")
and diluted EPS. Basic EPS excludes dilution and is computed by dividing income
(loss) available to common stockholders by the weighted-average number of common
shares outstanding of the period. Diluted EPS reflects the potential dilution
that could occur if securities or other contracts to issue common stock were
exercised or converted into common stock or resulted in the issuance of common
stock.
Pro forma earnings per share is computed using the weighted average number
of common shares outstanding and assumes the conversion of the redeemable
convertible preferred stock at the later of May 1, 1998 or at the date of
issuance.
(h) Use of Estimates
The preparation of 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 revenues and expenses during the
reporting period. Significant estimates include the collectibility of accounts
receivable and the carrying value of inventory. Actual results could differ from
those estimates.
(i) Translation of Foreign Currencies
All assets and liabilities of the Company's foreign subsidiaries are
translated into U.S. dollars using the rate of exchange in effect at the balance
sheet date. Revenue and expense accounts are translated into U.S. Dollars using
the weighted-average exchange rate during the period. The gains or losses
resulting from such translation are reported in a separate component of
stockholders' equity, which also includes exchange gains and losses on certain
intercompany balances of a long-term investment nature. Gains or losses
resulting from foreign currency transactions, which are included in results of
operations, were a gain of approximately $56,000 in 1999, a loss of $51,000 in
2000 and a loss of $34,000 in 2001. The Company's foreign subsidiaries
represented approximately $2.0 million of total assets at April 30, 2001.
(j) Income Taxes
The Company provides deferred taxes to recognize temporary differences
between the financial and tax bases of assets and liabilities. Valuation
allowances are established when necessary to reduce deferred tax assets to the
amounts expected to be realized.
(k) Comprehensive Income
Comprehensive income includes all changes in equity during a period except
those resulting from investments by and distributions to owners. Other
comprehensive income is comprised of net income, currency
F-8
53
MCK COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
translation adjustments and available-for-sale securities valuation adjustments.
For the fiscal years ended April 30, 1999, 2000 and 2001, MCK's comprehensive
loss was $794,000, $3.8 million and $12.0 million, respectively.
(l) Concentration of Credit Risk
Financial instruments that potentially subject the Company to concentration
of credit risk consist primarily of cash equivalents, marketable debt securities
and trade accounts receivable. The Company invests its cash equivalents in
deposits with financial institutions with strong credit ratings and or in
marketable debt securities. The Company sells its products to customers in the
telecommunications industry, primarily in the United States and Canada. The
Company performs periodic credit evaluations of its' customers financial
condition and collateral is generally not required. The Company maintains
reserves for potential credit losses and such losses have been within
management's expectations. Trade accounts receivable at April 30, 2000 included
approximately $1.4 million from one customer.
(m) Marketable Debt Securities
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 gains and 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 available-for-sale securities were $10,759 at
April 30, 2001. Realized gains and losses and declines in value judged to be
other-than temporary on available-for-sale securities are included in investment
income.
(n) Stock-Based Compensation
The Company has elected to follow Accounting Principles Board Opinion No.
25, Accounting for Stock Issued to Employees ("APB 25"), and related
interpretations in accounting for its employee stock options. Under APB 25, no
compensation expense is recorded when the exercise price of the options granted
equals the market price of the underlying stock on the date of grant. The
Company has adopted the disclosure-only provisions of SFAS No. 123, Accounting
for Stock-Based Compensation. In those instances where stock options were
granted with exercise prices less than the fair value of the common stock at the
date of grant, expense is being recognized over the vesting period. Because the
stock options vest on a pro-rata basis the Company follows the guidance included
in Financial Accounting Standards Board interpretation No. 28 to determine
compensation expense for the period.
(o) Accounting for Impairment of Long-Lived Assets
The Company reviews for impairment losses on long-lived assets and goodwill
when impairment indications are present. In the event that undiscounted cash
flows are not sufficient to recover the associated asset, the Company would
adjust the carrying amount to fair value determined by using a discounted cash
flow methodology. Also, on an on-going basis, the Company reviews the periods of
depreciation and amortization for continued appropriateness.
(p) Research and Development Costs
Research and development costs are charged to expense as incurred.
F-9
54
MCK COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
3. INVENTORY
Inventory consisted of:
APRIL 30,
------------------------
2000 2001
---------- ----------
Raw materials............................................... $ 897,680 $2,268,429
Work-in-process............................................. 1,309,150 418,652
Finished goods.............................................. 290,972 1,649,665
---------- ----------
$2,497,802 $4,336,746
========== ==========
4. FIXED ASSETS
Fixed assets consisted of:
APRIL 30,
--------------------------
2000 2001
----------- -----------
Equipment................................................. $ 2,179,913 $ 4,410,255
Purchased software........................................ 688,298 1,979,427
Leasehold improvements.................................... 662,815 761,482
Furniture and fixtures.................................... 399,996 742,019
----------- -----------
3,931,022 7,893,183
Accumulated depreciation.................................. (1,624,840) (3,799,763)
----------- -----------
$ 2,306,182 $ 4,093,420
=========== ===========
5. CREDIT AGREEMENTS
Revolving Credit Agreement. During the fiscal year ended April 30, 2000,
the Company maintained a revolving credit agreement that provided for borrowings
up to the lesser of $2 million or 80% of qualifying accounts receivable. During
the fiscal year ended April 30, 2001, the line revolving credit agreement
provided for borrowings up to the lesser of $5 million or 80% of qualifying
receivables. No amounts were outstanding under this agreement during the year
ended April 30, 2000 or 2001. The agreement charged interest at the bank's base
rate and the debt was collateralized by substantially all assets of the Company.
The agreement expired in February 2001.
The Company paid interest of approximately $663,000, $196,568 and $36,000
for the years ended April 30, 1999, 2000 and 2001, respectively.
6. INCOME TAXES
Pre-tax income (loss) is summarized by country as follows:
APRIL 30,
----------------------------------------
1999 2000 2001
--------- ----------- ------------
Canada...................................... $(195,394) $ 1,190,099 $ 24,048
United States............................... (391,688) (4,618,085) (12,953,236)
--------- ----------- ------------
Total............................. $(587,082) $(3,427,986) $(12,929,188)
========= =========== ============
F-10
55
MCK COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The provision (benefit) for income taxes consisted of:
APRIL 30,
-------------------------------
1999 2000 2001
---- -------- -----------
Current:
Canada............................................... $-- $ -- $ 253,736
United States........................................ -- 66,867 118,081
-- -------- -----------
-- 66,867 371,817
Deferred:
Canada............................................... -- 33,133 (33,133)
United States........................................ -- -- (1,468,807)
-- -------- -----------
-- 33,133 (1,501,940)
-- -------- -----------
Total...................................... $-- $100,000 $(1,130,123)
== ======== ===========
The provision (benefit) for income taxes differed from the amount computed
by applying the U.S. federal statutory rate as follows:
APRIL 30,
---------------------------------------
1999 2000 2001
--------- ----------- -----------
Income tax provision (benefit) at statutory
rate....................................... $(205,479) $(1,204,638) $(4,525,215)
Tax loss with no current benefit............. 187,943 68,440 1,523,783
Utilization of foreign net operating
losses..................................... -- (136,087) --
Foreign tax differential..................... (12,214) 114,487 2,313
Non-deductible expenses...................... 29,750 1,549,562 1,877,717
Tax credits.................................. -- (331,386) --
State taxes, net of federal benefit.......... -- 14,494 (332,169)
Other, net................................... -- 25,128 323,448
--------- ----------- -----------
Total.............................. $ -- $ 100,000 $(1,130,123)
========= =========== ===========
The components of the Company's deferred tax assets and liabilities are as
follows:
APRIL 30,
------------------------
2000 2001
--------- -----------
Deferred tax assets:
Reserves and accruals...................................... $ 232,593 $ 1,333,759
Depreciation............................................... 54,746 1,078,451
Tax credits................................................ 155,006 155,006
Net operating loss carryforward............................ 173,457 1,311,319
--------- -----------
Total deferred tax assets........................ 615,802 3,878,535
Deferred tax liabilities:
Intangible asset........................................... -- (2,354,752)
Other...................................................... (157,395) --
--------- -----------
Total deferred tax liabilities................... (157,395) (2,354,752)
Valuation allowance........................................ (491,540) (1,523,783)
--------- -----------
Net deferred tax liabilities............................... $ (33,133) $ --
========= ===========
F-11
56
MCK COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The Company has incurred cumulative losses for the three year period ended
April 30, 2001. Consequently, the Company does not have an objective and
verifiable basis for concluding that it is more likely than not the Company will
generate taxable income in the foreseeable future. Accordingly, the Company has
provided a valuation allowance covering its net deferred tax asset. At April 30,
2000 and 2001, the Company had $19,249 of Canadian investment tax credits earned
as a result of government incentive programs which expire in 2010. At April 30,
2001 the Company has $135,757 of United States research credits which begin to
expire in 2018 and net operating loss carryforwards of $3,278,299 which begin to
expire in 2019. The Company paid income taxes of $912, $874 and $206,903 in
1999, 2000 and 2001, respectively.
7. STOCK PLANS
In June 1996, the Company adopted the 1996 Stock Option Plan (the "1996
Plan"), which provides for the issuance of up to 1,959,081 shares of common
stock of the Company as either incentive stock options or non-qualified stock
options. The 1996 Plan is administered by the Compensation Committee of the
Board of Directors. Both incentive stock options and non-qualified stock options
are generally granted at the fair market value, although as disclosed herein,
certain options were granted below fair market value. Options granted under the
1996 Plan generally vest as to 25% of the underlying shares on the first
anniversary of the date of grant and ratably over the remaining thirty-six
months and expire five and ten years from date of grant for incentive stock
options and non-qualified stock options, respectively. At April 30, 2001,
193,987 shares were available for future grant. At April 30, 1999, 2000 and
2001, there were 146,628, 374,991 and 334,493 options exercisable under the 1996
Plan, at a weighted average exercise price of $0.046, $0.152 and $0.42 per
share, respectively.
In August 1999, the Company adopted the 1999 Stock Option and Grant Plan
(the "1999 Plan"). The 1999 Plan provides for the issuance of up to 3,060,000
shares of common stock of the Company as either incentive stock options or
non-qualified stock options. The 1999 Plan is administered by the Compensation
Committee of the Board of Directors. Options granted under the 1999 Plan
generally vest as to 25% of the underlying shares on the first anniversary of
the date of grant and ratably over the remaining twelve quarters and expire ten
years from the date of grant. At April 30, 2001, 355,949 shares were available
for future grant. At April 30, 2000 and 2001 there were 28,450 and 445,507
options exercisable under the 1999 Plan at a weighted average exercise price of
$6.81 and $13.44 per share, respectively.
On August 15, 2000 the Board of Directors of the Company adopted the 2000
Director Stock Option Plan (The "Director Plan"). The Director Plan provides for
the issuance of up to 500,000 shares of common stock of the Company as
non-qualified stock options. The Director Plan is administrated by a committee
of the Board of Directors. Initial options granted under the Director Plan
generally vest ratably over 12 quarters and are exercisable at any time after
the date of grant unless otherwise provided in an option agreement or determined
by the board. Annual options granted are fully vested and are immediately
exercisable at the date of grant. All options granted under the Director Plan
expire upon the termination date of the participant. At April 30, 2001, 406,255
shares were available for future grant and 15,624 options were exercisable at a
weighted average exercise price of $16.50 per share.
F-12
57
MCK COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following table summarizes option activity over the life of the 1996
Plan, the 1999 Plan and the Director Plan:
OPTIONS WEIGHTED AVERAGE
OUTSTANDING EXERCISE PRICE
----------- ----------------
Outstanding at April 30, 1998............................ 470,571 0.07
Granted................................................ 762,768 0.12
Exercised.............................................. (241,286) 0.07
Canceled............................................... (20,411) 0.10
--------- ------
Outstanding at April 30, 1999............................ 971,642 0.11
Granted................................................ 1,406,882 13.42
Exercised.............................................. (133,435) 0.28
Canceled............................................... (120,922) 7.62
--------- ------
Outstanding at April 30, 2000............................ 2,124,167 $ 8.57
Granted................................................ 3,127,779 10.21
Exercised.............................................. (357,801) 0.19
Canceled............................................... (895,798) 16.76
--------- ------
Outstanding at April 30, 2001............................ 3,998,347 $ 9.02
========= ======
The following table presents certain information about options outstanding
as of April 30, 2001:
WEIGHTED
AVERAGE
WEIGHTED AVERAGE NUMBER OF EXERCISE PRICE
NUMBER OF REMAINING CONTRACTUAL OPTIONS OF OPTIONS
EXERCISE PRICE OPTIONS LIFE (YRS.) EXERCISABLE EXERCISABLE
-------------- --------- --------------------- ----------- --------------
$0.001 101,916 9.11 101,916 $0.001
$0.098039 409,432 2.14 238,204 0.098
$0.196 - $2.0313 401,260 4.84 122,741 1.142
$2.125 - $3.8125 80,750 9.85 -- --
$4.375 810,250 9.72 -- --
$4.375 - $5.375 172,500 9.65 -- --
$5.8125 433,067 9.38 3,750 5.8125
$8.17 - $11.3125 398,507 8.97 74,057 8.174
$12.75 - $20.125 571,114 8.99 108,945 13.342
$20.625 - $33.938 619,551 8.99 85,584 26.142
------- ------
---------
735,197 $6.096
3,998,347
The weighted-average exercise price of stock options granted are as
follows:
1999 2000 2001
----- ------ ------
Exercise price less than fair value of common stock......... $0.12 $ 6.43 $ --
Exercise price equals fair value of common stock............ -- $23.25 $10.22
The Company recorded deferred compensation charges of $1,211,652 and
$8,463,514 related to stock options and restricted stock granted below market
exercise prices during the fiscal year ended April 30, 1999 and 2000,
respectively. The deferred compensation is being amortized to expense over the
vesting period of the individual options, generally four years. SFAS No. 123
requires the Company to disclose, on a pro forma basis, the effect on net income
(loss) as if the Company had recorded compensation expense for its stock-based
compensation plans based on the fair value of the awards. On a pro forma basis,
loss applicable to common
F-13
58
MCK COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
stock for 1999, 2000 and 2001 would have been approximately $2,799,000,
$5,619,000 and $15,063,000, respectively. Loss per common share would have been
approximately $0.72, $0.50, and $0.78, for the years ended April 30, 1999, 2000
and 2001, respectively.
The pro forma effect in 1999, 2000 and 2001 of expensing the estimated fair
value of stock options is not necessarily representative of the effects on
reported net income for future years due to such factors as the vesting period
of the stock options and the potential for issuance of additional stock options
in future years.
The fair market value for these options was estimated at the date of grant
using the minimum value method prior to our Initial Public Offering on October
22, 1999 and the Black-Scholes model thereafter using the following
weighted-average assumptions for options granted in 1999, 2000 and 2001:
risk-free interest rate of 5.0%, 6.5% and 5.6%; a weighted-average expected life
of the option of between five and six years; expected volatility of 1.2 in 1999
and 2000 (Black-Scholes only) and 1.5 in 2001; and no dividends.
The weighted-average fair value of stock options granted are as follows:
1999 2000 2001
----- ----- -----
Fair value of stock options where exercise price less than
fair value of common stock................................ $0.45 $9.64 $ --
Fair value of stock options where exercise price equals fair
value of common stock..................................... -- 19.91 9.98
The weighted average remaining contractual life for all stock options
outstanding at April 30, 2001 was 8.13 years.
The Company issued 100,000 shares of restricted common stock having a fair
value of $2.5312 per share in March 2001, 22,950 shares of restricted common
stock at $3.27 per share which was less than the fair value at September 1999,
374,850 shares of restricted common stock at $1.63 per share which was less than
fair value at July 1999, 114,750 shares of restricted common stock having a fair
value of $0.098 per share in June 1998 and 1,538,178 shares of restricted common
stock having a fair value of $0.098 per share in January 1998 to certain
executives and a member of the Board of Directors in exchange for promissory
notes totaling $1,102,672. The promissory notes are non-interest bearing to
employees insofar as the Company is required to reimburse the employees for any
interest on the promissory notes that is payable to the Company. The face value
of the promissory notes approximate their fair market value. Upon termination
for any reason other than for cause or in the event of the merger, consolidation
or sale of substantially all of the Company's assets or voting securities, the
Company must repurchase all the non-vested restricted stock of the executives at
the original issue price. If an executive is terminated for cause, the Company
must repurchase such executive's vested and non-vested restricted stock.
The Company has a right of first refusal prior to any transfer of
restricted stock. The restricted stock generally vests over four years and the
promissory notes have a five-year maturity. The outstanding balance of the
promissory notes at April 30, 2000 and 2001 is $693,127 and $836,360,
respectively.
At April 30, 2001, the Company had reserved 4,954,538 shares of common
stock for issuance under the 1996 and 1999 Stock Option plans and the Director
Plan.
8. EMPLOYEE STOCK PURCHASE PLAN
The Company has an employee stock purchase plan (the "Stock Purchase Plan")
under which eligible employees may purchase common stock at a price per share
equal to 85% of the lower of the fair market value of the common stock at the
beginning or end of each offering period. Participation in the offering is
limited to 10% of an employee's compensation (not to exceed amounts allowed
under section 423 of the Internal Revenue Code), may be terminated at any time
by the employee and automatically ends on termination of
F-14
59
MCK COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
employment with the Company. A total of 250,000 shares of common stock have been
reserved under the Stock Purchase Plan.
9. EMPLOYEE SAVINGS PLANS
The Company maintains a retirement savings plan under section 401(k) of the
Internal Revenue Code. The plan covers substantially all U.S. employees and
allows participants to defer a portion of their annual compensation on a pre-tax
basis. The Company also maintains a Registered Retirement Savings Plan for its
Canadian employees which allows participants to defer a portion of their annual
compensation on a pre-tax basis. The Company made no contributions to either
plan during 1999, 2000 or 2001.
10. COMMITMENTS AND CONTINGENCIES
The Company leases office space in the United States, Canada, and the
United Kingdom under non-cancelable operating leases. The Company's former
Canadian facility was leased from Manz Developments, Inc., a related party. Rent
expense under this arrangement was approximately $99,000, $105,000, and $66,207
in 1999, 2000 and 2001 respectively. In January 2001 the Company moved its
Canadian offices and no longer leases space from Manz Developments, Inc. Total
rent expense under all operating leases for 1999, 2000 and 2001 was
approximately $333,000, $478,000 and $1,331,000, respectively. At April 30,
2001, future minimum lease commitments were approximately $1,774,446 in 2002,
$1,725,165 in 2003, $1,689,777 in 2004, $1,545,000 in 2005, $1,499,000 in 2006
and $1,238,000 thereafter. Future minimum lease payments have not been reduced
by future minimum sublease rentals of $486,000, $486,000 and $162,110 in 2002,
2003 and 2004, respectively.
11. EARNINGS PER SHARE AND PRO FORMA EARNINGS PER SHARE
The calculations of earnings per share are as follows:
PRO FORMA
YEAR ENDED
APRIL 30,
YEARS ENDED APRIL 30, (UNAUDITED)
------------------------------------------ -----------
1999 2000 2001 2000
----------- ----------- ------------ -----------
Numerator:
Net loss........................... $ (784,029) $(3,624,549) $(11,799,065) $(3,624,549)
Dividends on preferred stock....... 1,965,921 1,285,338 -- 1,102,313(1)
----------- ----------- ------------ -----------
Numerator for basic and diluted
earnings per share-income
available to common
stockholders.................... $(2,749,950) $(4,909,887) $(11,799,065) $(4,726,862)
=========== =========== ============ ===========
Denominator:
Denominator for basic and diluted
earnings per share -- weighted-
average shares.................. 3,881,526 11,144,565 19,213,239 15,268,368(2)
=========== =========== ============ ===========
Basic and diluted loss per share..... $ (0.71) $ (0.44) $ (0.61) $ (0.31)
=========== =========== ============ ===========
- ---------------
(1) Excludes dividends on redeemable convertible preferred stock.
(2) Includes common shares issued upon conversion of redeemable convertible
preferred stock.
F-15
60
MCK COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following potential common shares have been excluded from the
computation of diluted net loss per share for all periods presented because the
effect would have been anti-dilutive (in thousands):
YEAR ENDED APRIL 30,
------------------------
1999 2000 2001
------ ----- -----
Shares issuable under stock options........................ 972 2,124 3,998
====== ===== =====
Shares of nonvested restricted stock....................... 1,119 873 381
====== ===== =====
Shares potentially issuable upon conversion of Series B and
D preferred stock........................................ 14,413 -- --
====== ===== =====
12. VALUATION AND QUALIFYING ACCOUNTS
Accounts Receivable Reserves and Allowances:
ADDITIONS
BALANCE AT BALANCE CHARGED TO DEDUCTIONS BALANCE AT
BEGINNING OF ACQUIRED IN INCOME (PRINCIPALLY END OF
PERIOD YEAR ACQUISITION STATEMENT WRITE-OFFS) YEAR
- ------ ------------ ----------- ---------- ------------ ----------
Year ended April 30,
1999.................... $150,000 -- $112,418 $ (82,858) $179,560
Year ended April 30,
2000.................... $179,560 -- $ 80,838 $(106,334) $154,064
Year ended April 30,
2001.................... $154,064 $151,777 $807,706 $(517,322) $596,225
13. INITIAL PUBLIC OFFERING AND FOLLOW ON 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 distribution costs. MCK Communications, Inc. is listed on the
NASDAQ National Market under the symbol "MCKC."
Upon completion of the Initial Public Offering, the Company redeemed
14,985,733, 28,505, and 20,000 shares of Series A, Series C and Series E
Redeemable Preferred Stock, respectively. The aggregate redemption price for the
Series A, Series C and Series E preferred stock was $19,070,164, $3,147,487 and
$2,586,793, respectively. In addition, 3,968,384 shares of Series B Redeemable
Preferred Stock were converted into 6,102,195 shares of the Company's common
stock and 1,672,354 shares of Series D Redeemable Preferred Stock were converted
into 2,575,015 shares of the Company's common stock.
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 at the offering price of $16.00. The Company
received an additional $3,794,400, net of underwriting discounts and
commissions, in this transaction. Additionally, certain stockholders sold
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
2,750,000 shares of common stock, 1,250,000 of which were sold by the Company
and 1,500,000 of which were sold by certain stockholders. The Company received
approximately $47.1 million, net of offering and distribution costs. The Company
did not receive any proceeds on the sale of shares by its stockholders.
14. 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.
In the complaint, captioned 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
F-16
61
MCK COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
employment agreement and a certain restricted stock agreement executed by and
between the Company and Ms. Lockhart. Ms. Lockhart seeks approximately $30,000
in severance pay as well as approximately $1,000,000 in damages. On June 5,
2000, the Company filed its answer denying the material allegations of Ms.
Lockhart's complaint. The trial of this action is scheduled for July 23, 2001.
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.
15. SEGMENTS
Information about the Company's revenue and long-lived assets by geographic
area is as follows:
APRIL 30,
-----------------------------------------
1999 2000 2001
----------- ----------- -----------
Revenues from external customers:
United States............................... $11,653,200 $21,257,032 $31,199,724
Canada...................................... 1,664,715 2,892,278 4,026,977
Rest of world............................... 951,688 933,092 2,993,023
----------- ----------- -----------
Total............................. $14,269,603 $25,082,402 $38,219,724
----------- ----------- -----------
APRIL 30,
-------------------------
2000 2001
---------- -----------
Long-lived assets:
United States.............................................. $2,017,744 $16,686,666
Canada..................................................... 640,316 671,447
Rest of world.............................................. -- 3,598
---------- -----------
Total............................................ $2,658,060 $17,361,711
========== ===========
16. ACQUISITION OF DTI
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 $12.7 million in cash, including
transaction costs, and 364,601 shares of common stock and 101,916 stock options
with a fair market value of $10.9 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 $1.6 million of the purchase price to
tangible liabilities, $16.8 million to goodwill and other intangibles, $8.0
million to completed technology, and $694,000 to in-process development.
Goodwill and associated intangibles resulting from the acquisition are being
amortized over a period of five years. Other intangibles include items such as
DTI's customer lists and in-place trained workforce. Goodwill, completed
technology and other intangibles are evaluated for impairment based on the
related undiscounted cash flows. The balances shown at April 30, 2001 are net of
accumulated amortization of $4.6 million. 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 year ended April 30, 2001
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 $36.9 million and $39.6 million, net losses of $11.3 million and
$14.2 million and basic net loss per common share of $0.72 and $0.74 for the
years ended April 30, 2000 and 2001 respectively. The unaudited pro-forma
financial information is presented for illustrative purposes and is
F-17
62
MCK COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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.
17. ENTRATA LICENSE AGREEMENT
The Company entered into an agreement with Entrata providing MCK with a
royalty free, non-exclusive, perpetual, worldwide license to use, install, and
modify Entrata's LoopBuilder 50 and 100 series integrated access device
technology. This technology will be integrated into certain MCK products and
solutions and resold or sublicensed under MCK's name and trademarks. In
consideration for the license and related training, MCK agreed to pay $3.0
million, of which $2.0 million was advanced to Entrata prior to April 30, 2001.
The remaining amounts are payable by May 31, 2002. The source code, and all
deliverables were received by the Company in February 2001. Training was
completed during the Company's fourth quarter of fiscal 2001. The entire $3.0
million was expensed during the fourth quarter of fiscal 2001 as in-process
research and development.
18. RESTRUCTURING
During March 2001, we reorganized various operating functions of our
business, re-focused our business on our core competencies and matched staffing
needs to our strategic initiatives. The reorganization and refocusing resulted
in a reduction of our workforce by approximately 10% or 25 employees. In
conjunction with this action we recorded a charge of approximately $597,000 for
the costs of severance, related benefits and outplacement services. As of April
30, 2001, we had an accrual of $380,000 related to employee severance and
outplacement services that will be paid during our quarter ending July 31, 2001.
19. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
QUARTER
-------------------------------------------
2001 FIRST(2) SECOND THIRD FOURTH(1)
- ---- -------- ------- ------- ---------
(IN THOUSANDS EXCEPT PER SHARE DATA)
Revenues..................................... $10,042 $11,768 $10,355 $6,054
Gross profit................................. 6,230 7,279 5,877 3,547
Net loss..................................... 1,286 969 2,921 6,623
Loss per common share:
Basic earnings per share..................... $ 0.07 $ 0.05 $ 0.15 $ 0.34
- ---------------
(1) Includes $3.0 million of expense related to the Entrata license
agreement (see note 17) and $597,000 of expense related to a corporate
restructuring (see note 18).
(2) Includes the results of DTIH subsequent to June 14, 2000 (see note 16).
F-18
63
EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION
- ----------- -----------
2.1 (1) Agreement and Plan of Merger, dated June 14, 2000, by and
among the Registrant, Omni Acquisition Corporation, Troy
Holdings International, Inc., DTI Holdings, Inc., Digital
Techniques, Inc. and certain shareholders of DTI Holdings,
Inc.
3.1 (2) Second Amended and Restated Certificate of Incorporation of
the Registrant (Exhibit No. 3.3 of Registration Statement on
Form S-1 (File No. 333-85821)).
3.2 (2) First Amended and Restated By-laws of the Registrant
(Exhibit No. 3.5 of Registration Statement on Form S-1 (File
No. 333-85821)).
4.1 (2) Specimen certificate for shares of common stock, $.001 par
value, of the Registrant.
10.1 (2) Amended and Restated Registration Rights Agreement, dated
July 16, 1998, among the Registrant and the stockholders
named therein. (Exhibit No. 10.2 of Registration Statement
on Form S-1 (File No. 333-85821)).
10.2 (2) Amended and Restated 1996 Stock Option Plan of the
Registrant. (Exhibit No. 10.3 of Registration Statement on
Form S-1 (File No. 333-85821)).
10.3 (3) 1999 Stock Option and Grant Plan of the Registrant.
10.4 (2) Form of Stock Restriction Agreement for sale of restricted
stock to executive officers (Exhibit No. 10.9 of
Registration Statement on Form S-1 (File No. 333-85821)).
10.5 (2) Form of Promissory Note for purchase of restricted stock by
executive officers (Exhibit No. 10.10 of Registration
Statement on Form S-1 (File No. 333-85821)).
10.6 (2) Form of Pledge Agreement (Exhibit No. 10.11 of Registration
Statement on Form S-1 (File No. 333-85821)).
10.7 (2) Form of Promissory Note (Exhibit No. 10.12 of Registration
Statement on Form S-1 (File No. 333-85821)).
10.8 (2)+ Agreement between the Registrant and Lucent Technologies,
Inc. effective as of April 30, 1999 (Exhibit No. 10.15 of
Registration Statement on Form S-1 (File No. 333-85821)).
10.9 (2)+ Master Support Agreement between the Registrant and Vital
Networks, Inc. dated June 28, 1999 (Exhibit No. 10.16 of
Registration Statement on Form S-1 (File No. 333-85821)).
10.10 (2) Lease Agreement by and between the Registrant and
Wellsford/Whitehall Holdings, L.L.C. dated January 10, 2000.
10.10.1 (5) First Amendment to Lease Agreement between the registrant
and Wellsford/Whitehall Holdings, LLC dated May 25, 2000.
(Exhibit No. 10.13.1 of Annual Report on Form 10-K (File No.
0-22703)).
10.10.2 (5) Second Amendment to Lease Agreement between the registrant
and Wellsford/Whitehall Holdings, LLC dated May 31, 2000.
(Exhibit No. 10.13.1 of Annual Report on Form 10-K (File No.
0-22703)).
10.11 (5) Lease Agreement by and between the Digital Techniques, Inc.
and Armet Bethany Limited Partnership dated July 7, 1993, as
amended April 21, 1995 and further amended December 14,
1998. (Exhibit No. 10.14 of Annual Report on Form 10-K (File
No. 0-22703)).
10.12 (6) 2000 Director Stock Option Plan of the Registrant.
10.13 (7) 2000 Employee Stock Purchase Plan of the Registrant.
10.14 Offer letter dated January 11, 2001, between the Registrant
and Glenda Davis.
10.15 Restricted Stock Purchase Agreement, dated March 13, 2001,
between the Registrant and Glenda Davis.
10.16 Non-qualified Stock Option Agreement, dated March 13, 2001,
between the Registrant and Glenda Davis.
64
EXHIBIT NO. DESCRIPTION
- ----------- -----------
21.1 Subsidiaries of the Registrant.
23.1 Consent of Ernst & Young LLP.
- ---------------
+ Confidential treatment obtained as to portions of this exhibit. The
confidential information has been filed separately with the Securities and
Exchange Commission.
(1) Incorporated by reference to Exhibit 2.1 filed with the Registrant's Report
on Form 8-K dated June 28, 2000.
(2) Incorporated by reference to identically numbered exhibits (unless otherwise
indicated) filed in response to Item 16(a), "Exhibits," of the Registrant's
Registration Statement on Form S-1, as amended (File No. 333-85821), which
was declared effective on October 21, 1999.
(3) Incorporated by reference to Exhibit 10.4 filed with the Registrant's
Registration Statement on Form S-8 dated February 4, 2000.
(4) Incorporated by reference to Exhibit No. 10.18 of the Registrant's
Registration Statement on Form S-1, as amended (File No. 333-96235), which
was declared effective on April 4, 2000.
(5) Incorporated by reference to identically numbered exhibits (unless otherwise
indicated) filed with the Registrant's Annual Report on Form 10-K for the
fiscal year ended April 30, 2000, as filed with the SEC on July 31, 2000.
(6) Incorporated by reference to Exhibit 99.1 filed with the Registrant's
Registration Statement on Form S-8 dated November 14, 2000.
(7) Incorporated by reference to Exhibit 99.1 filed with the Registrant's
Registration Statement on Form S-8 dated December 4, 2000.