UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE
QUARTERLY PERIOD ENDED JULY 31, 2002 OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE
TRANSITION PERIOD FROM __________ TO __________.
COMMISSION FILE NUMBER: 0-22703
MCK COMMUNICATIONS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
| DELAWARE (STATE OR OTHER JURISDICTION OF INCORPORATION OR ORGANIZATION) |
06-1555163 (I.R.S. EMPLOYER IDENTIFICATION NO.) |
117 KENDRICK STREET NEEDHAM, MASSACHUSETTS 02494
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
REGISTRANT’S TELEPHONE NUMBER, INCLUDING AREA CODE: (617) 454-6100
INDICATE BY CHECK MARK WHETHER THE REGISTRANT (1) HAS FILED ALL REPORTS
REQUIRED to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
YES [X] NO [ ]
As of September 6, 2002, there were 20,396,426 shares of registrant’s Common Stock outstanding.
MCK Communications, Inc.
Table of Contents
| Page | ||||||
| PART I | - - | FINANCIAL INFORMATION | ||||
| Item 1. | Consolidated Financial Statements | |||||
| Consolidated Balance Sheets at April 30, 2002 and July 31, 2002 |
3 | |||||
| Consolidated Statements of Operations for the three months ended July 31, 2001 and 2002 |
4 | |||||
| Consolidated Statements of Cash Flows for the three months ended July 31, 2001 and 2002 |
5 | |||||
| Notes to Consolidated Financial Statements | 6 | |||||
| Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations |
9 | ||||
| Item 3. | Quantitative and Qualitative Disclosures about Market Risk | 13 | ||||
| PART II | - - | OTHER INFORMATION | 13 | |||
| Item 1. | Legal Proceedings | 13 | ||||
| Item 6. | Exhibits and Reports on Form 8-K | 14 | ||||
| Signatures | 15 | |||||
Part I. Financial Information
Item 1. Consolidated Financial Statements
MCK Communications, Inc.
Consolidated Balance Sheets
(In thousands, except per share data)
| Unaudited | ||||||||||
| April 30, | July 31, | |||||||||
| 2002 | 2002 | |||||||||
Assets |
||||||||||
Current assets: |
||||||||||
Cash and equivalents |
$ | 4,554 | $ | 4,263 | ||||||
Restricted securities |
2,000 | 2,000 | ||||||||
Marketable securities |
37,813 | 37,690 | ||||||||
Accounts receivable, net |
3,773 | 2,899 | ||||||||
Inventory |
1,878 | 1,670 | ||||||||
Prepaids and other current assets |
595 | 557 | ||||||||
Total current assets |
50,613 | 49,079 | ||||||||
Fixed assets, net |
1,529 | 1,195 | ||||||||
Other assets |
105 | 105 | ||||||||
Completed technology |
3,978 | 3,659 | ||||||||
Total assets |
$ | 56,225 | $ | 54,038 | ||||||
Liabilities and Stockholders’ Equity |
||||||||||
Current liabilities: |
||||||||||
Accounts payable |
$ | 1,435 | $ | 866 | ||||||
Accrued liabilities |
4,740 | 3,833 | ||||||||
Accrued compensation and benefits |
672 | 663 | ||||||||
Deferred revenue |
422 | 481 | ||||||||
Total current liabilities |
7,269 | 5,843 | ||||||||
Common
stockholders’ equity: |
||||||||||
Common stock, $.001 par value;
authorized 40,000,000 shares
issued and outstanding -
20,421,563 at April 30, 2002 and 20,385,289
at July 31, 2002 |
20 | 20 | ||||||||
Additional paid-in capital |
125,122 | 124,984 | ||||||||
Accumulated deficit |
(75,031 | ) | (75,883 | ) | ||||||
Deferred compensation |
(159 | ) | (88 | ) | ||||||
Accumulated other comprehensive loss |
(464 | ) | (439 | ) | ||||||
Notes receivable from officers |
(532 | ) | (399 | ) | ||||||
Total common stockholders’ equity |
48,956 | 48,195 | ||||||||
Total
liabilities and common stockholders’
equity |
$ | 56,225 | $ | 54,038 | ||||||
The accompanying notes are an integral part of these consolidated financial statements.
3
MCK Communications, Inc.
Consolidated Statements of Operations
(In thousands, except per share data)
| Unaudited | ||||||||||
| Three Months Ended | ||||||||||
| July 31, | ||||||||||
| 2001 | 2002 | |||||||||
Revenues |
$ | 3,403 | $ | 4,511 | ||||||
Cost of goods sold |
2,025 | 2,212 | ||||||||
Gross profit |
1,378 | 2,299 | ||||||||
Operating expenses: |
||||||||||
Research and development (excluding amortization of
stock based compensation of $121
and $16 for the three month periods ended
July 31, 2001 and 2002, respectively) |
2,492 | 892 | ||||||||
Sales and marketing (excluding amortization of stock
based compensation of $180 and $(11)
for the three month periods ended
July 31, 2001 and 2002, respectively) |
3,185 | 1,389 | ||||||||
General and administrative (excluding amortization of
stock based compensation of $98 and
$28 for the three month periods ended
July 31, 2001 and 2002, respectively) |
1,077 | 708 | ||||||||
Amortization of stock based compensation |
399 | 33 | ||||||||
Amortization of goodwill and other intangibles |
1,226 | 318 | ||||||||
Impairment of goodwill and other intangibles |
14,063 | — | ||||||||
Restructuring costs |
450 | — | ||||||||
Total operating expenses |
22,892 | 3,340 | ||||||||
Loss from operations |
(21,514 | ) | (1,041 | ) | ||||||
Other income (expense): |
||||||||||
Interest income |
533 | 206 | ||||||||
Other income (expense), net |
(22 | ) | (17 | ) | ||||||
Total other income |
511 | 189 | ||||||||
Loss before provision for income taxes |
(21,003 | ) | (852 | ) | ||||||
Provision for income taxes |
25 | — | ||||||||
Net loss |
$ | (21,028 | ) | $ | (852 | ) | ||||
Basic and diluted net loss per share |
$ | (1.06 | ) | $ | (0.04 | ) | ||||
Shares used in computing basic and diluted
net loss per share |
19,888 | 20,349 | ||||||||
The accompanying notes are an integral part of these consolidated financial statements.
4
MCK Communications, Inc.
Consolidated Statements of Cash Flows
(In thousands)
| Unaudited | |||||||||||
| Three Months Ended | |||||||||||
| July 31, | |||||||||||
| 2001 | 2002 | ||||||||||
Cash flows from operating activities: |
|||||||||||
Net loss |
$ | (21,028 | ) | $ | (852 | ) | |||||
Depreciation |
558 | 360 | |||||||||
Amortization and of goodwill and other intangibles |
1,225 | 318 | |||||||||
Impairment of goodwill and other intangibles |
14,063 | — | |||||||||
Write down of fixed assets |
— | 14 | |||||||||
Stock based compensation |
399 | 33 | |||||||||
Changes in operating assets and liabilities: |
|||||||||||
Accounts receivable |
2,056 | 874 | |||||||||
Inventory |
928 | 208 | |||||||||
Prepaids and other current assets |
1,223 | 38 | |||||||||
Other assets |
(22 | ) | — | ||||||||
Accounts payable |
(2,682 | ) | (569 | ) | |||||||
Accrued liabilities |
(621 | ) | (907 | ) | |||||||
Accrued compensation and benefits |
(207 | ) | (9 | ) | |||||||
Deferred revenue |
179 | 59 | |||||||||
Net cash used in operating activities |
(3,929 | ) | (433 | ) | |||||||
Cash flows from investing activities: |
|||||||||||
Purchases of property and equipment |
(428 | ) | (28 | ) | |||||||
Sales of marketable securities |
6,596 | 123 | |||||||||
Net cash provided by investing activities |
6,168 | 95 | |||||||||
Cash flows from financing activities: |
|||||||||||
Issuance of common stock, net |
186 | 32 | |||||||||
Proceeds from exercise of stock options |
5 | 2 | |||||||||
Net cash provided by financing activities |
191 | 34 | |||||||||
Effect of exchange rate change on cash |
9 | 13 | |||||||||
Net increase (decrease) in cash and equivalents |
2,439 | (291 | ) | ||||||||
Cash and equivalents, beginning of period |
4,035 | 4,554 | |||||||||
Cash and equivalents, end of period |
$ | 6,474 | $ | 4,263 | |||||||
Supplemental disclosures of cash flow information: |
|||||||||||
Cash paid for interest |
$ | 9 | $ | — | |||||||
Common shares issued in acquisition of DTIH |
10,939 | — | |||||||||
The accompanying notes are an integral part of these consolidated financial statements.
5
MCK Communications, Inc.
Notes to Consolidated Financial Statements
(Unaudited)
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
| a. | BASIS OF PRESENTATION |
The consolidated financial statements have been prepared by MCK Communications, Inc., (the Company) pursuant to the rules and regulations of the Securities and Exchange Commission and include the accounts of MCK Communications, Inc., and its wholly owned subsidiaries. Certain information and footnote disclosures, normally included in financial statements prepared in accordance with generally accepted accounting principals, have been condensed or omitted pursuant to such rules and regulations. In the opinion of the Company, the financial statements reflect all adjustments, consisting of normal recurring adjustments, necessary for the fair presentation of the financial position at July 31, 2002 and the operating results and cash flows for the three months ended July 31, 2001, as restated, and for the three months ended July 31, 2002. The balance sheet at April 30, 2002 has been derived from audited financial statements as of that date. Certain footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted, although the Company believes the disclosures in these financial statements are adequate to make the information not misleading. These financial statements and notes should be read in conjunction with the financial statements and notes thereto included in the Company’s Annual Report on Form 10-K as filed with the Securities and Exchange Commission.
The preparation of the financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates and would impact future results of operations and cash flows.
The results of operations reported for the three months ended July 31, 2002 are not necessarily indicative of the results to be achieved in future quarters or the year ending April 30, 2003.
| b. | CASH AND EQUIVALENTS |
Cash and equivalents are defined as highly liquid investments having an original maturity of three months or less.
| c. | MARKETABLE 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. Realized gains and losses and declines in value judged to be other-than temporary on available-for-sale securities are included in investment 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 interest income. Unrealized losses relating to available-for-sale securities were approximately $14,000 at July 31, 2002.
| d. | REVENUE RECOGNITION |
Revenues from product sales are recognized upon shipment of our products to our customers and the fulfillment of all contractual terms and conditions pursuant to guidance provided by Staff Accounting Bulletin, No. 101, Revenue Recognition in Financial Statements (SAB 101), issued by the Securities and Exchange Commission. Certain distribution partners have rights to return a contractual percentage of sales. For sales to these partners, we defer revenue subject to return until such rights have expired. A significant number of our contractual arrangements contain price protection provisions whereby we are obligated to provide refunds or credits for any decrease in unit prices of product in their inventory. 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 including revenues under non-recurring engineering contracts as the service is provided. Maintenance revenues are deferred and recognized ratably over the contract period. Service and maintenance revenues have not been material.
| e. | COMPREHENSIVE INCOME (LOSS) |
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 translation adjustments and available-for-sale securities valuation adjustments. For the three months ended July 31, 2001 and 2002, the Company’s comprehensive loss was approximately $25 million and $0.9 million, respectively.
| f. | EARNINGS PER SHARE |
Statement of Financial Accounting Standard (SFAS) No. 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 during 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
6
stock. During the three months ended July 31, 2001 and 2002, 3.1 and 1.9 million options, respectively, that could potentially dilute basic EPS in the future were not included in the computation of EPS because to do so would have been antidilutive.
| g. | RECENT ACCOUNTING PRONOUNCEMENTS |
Effective May 1, 2002, the Company adopted the provisions of Statement of Financial Accounting Standard (SFAS) No. 142, “Goodwill and Other Intangible Assets”. This statement affects the Company’s treatment of goodwill and other intangible assets. The statement requires that goodwill existing at the date of adoption be reviewed for possible impairment and that impairment tests be periodically repeated, with impaired assets written down to fair value. Additionally, existing goodwill and intangible assets must be assessed and classified within the statement’s criteria. Intangible assets with finite useful lives will continue to be amortized over those periods. Amortization of goodwill and intangible assets with indeterminable lives will cease.
During the year ended April 30, 2002, the Company wrote off all remaining unamortized goodwill. The existing intangible assets have a finite useful life and will continue to be amortized over those periods.
Had SFAS No. 142 been adopted for the three months period ending July 31, 2001, the impact on net loss and loss per share would have been as follows:
| Three Months Ended | |||||||||||||||
| July 31, | |||||||||||||||
| (In thousands) | 2002 | 2001 | |||||||||||||
Net loss |
($852 | ) | ($21,028 | ) | |||||||||||
Add back goodwill amortization |
— | 827 | |||||||||||||
Adjusted net loss |
($852 | ) | ($20,201 | ) | |||||||||||
| Three Months Ended | ||||||||||||||||
| July 31, | ||||||||||||||||
| (In thousands) | 2002 | 2001 | ||||||||||||||
Basic and diluted loss per share |
($0.04 | ) | ($1.06 | ) | ||||||||||||
Add back goodwill amortization |
— | 0.04 | ||||||||||||||
Adjusted loss per share |
($0.04 | ) | ($1.02 | ) | ||||||||||||
At July 31, 2002, the components of intangible assets subject to amortization, which consist principally of purchased technology, are as follows (in thousands):
Gross carrying value |
$ | 4,932 | ||
Accumulated amortization |
(1,273 | ) | ||
| $ | 3,659 | |||
Aggregate amortization expense for the three months ended July 31, 2002 was $318,000. The Company anticipates that this intangible asset will be fully amortized by July 31, 2005.
In October 2001, the FASB issued SFAS No. 144, “Accounting for the Impairment or Disposal of Long-lived Assets”. SFAS No. 144 supercedes SFAS No. 121 by requiring one accounting model to be used for long-lived assets to be disposed of by sale, whether previously held and used or newly acquired, and by broadening the presentation of discontinued operations to include more disposal transactions. The adoption of SFAS 144 by the Company as of May 1, 2002 had no impact on its financial position, results of operations, or cash flows.
h. SIGNIFICANT CUSTOMERS
During the quarter ended July 31, 2002, three customers accounted for 15%, 11%, and 10% , respectively of total revenues.
NOTE 2. INVENTORY
Inventory consisted of (in thousand’s):
| April 30, | July 31, | |||||||
| 2002 | 2002 | |||||||
| (Unaudited) | ||||||||
Raw materials |
$ | 1,594 | $ | 1,419 | ||||
Work-in-process |
— | — | ||||||
Finished goods |
284 | 251 | ||||||
| $ | 1,878 | $ | 1,670 | |||||
The Company subcontracts its manufacturing operations to independent third parties. Although it is not obligated to do so, the Company expects that it would purchase any of its inventory that the subcontractor has in stock if the arrangement was terminated. The level of inventory generally ranges between $1.0 and $2.0 million.
NOTE 3. DTI AND IMPAIRMENT
In June 2000, the Company acquired all of the outstanding stock of DTI Holdings, Inc. (“DTIH”), its wholly owned subsidiary Digital Techniques, Inc (together “DTI”) 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 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. Although the Company continues to use the acquired technology, the rapidly changing and competitive environment in which the Company operates has negatively impacted operating results. Two of the Company’s protocol partners have recently introduced their own competitive products, and one has reduced their purchases of the Company’s products. In addition, the Company has determined the market value of the DTI acquisition has declined significantly from the value at the date DTI was acquired. Moreover, during the year ended April 30, 2002, the Company terminated substantially all the DTI staff, which was not contemplated at the date of acquisition. As a result, the Company determined that impairment indicators were evident. In accordance with SFAS No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of”, the Company evaluated the recoverability of its long-lived assets, including intangibles related to the DTI acquisition and determined that the estimated future undiscounted cash flows were below their carrying value at July 31, 2001. Undiscounted cash flows were determined at an enterprise level as the operations and technology of DTI had been integrated with those of the Company. Accordingly, the Company wrote off all remaining unamortized goodwill of $12.4 million and reduced the carrying value of certain identifiable intangibles by $1.7 million to their estimated fair value of $4.9 million. The estimated fair value was based on anticipated future cash flows discounted at a rate of 18%, which is commensurate with the risk involved. The useful lives of the remaining identifiable intangibles were reevaluated and deemed to be appropriate.
7
NOTE 4. RESTRUCTURING
During the year ended April 30, 2001, the Company reorganized various operating functions of its business, re-focusing the business on core competencies and matching staffing needs to strategic initiatives. The reorganization and refocusing resulted in a reduction of the Company’s workforce by approximately 10% or 25 employees. In conjunction with this action we recorded a charge of approximately $597,000 during the three months ended April 30, 2001 for the costs of severance, related benefits and outplacement services.
During the year ended April 30, 2002, due to the continued downturn in the economic environment and to accelerate the Company’s return to profitability, the Company instituted a number of actions to streamline operations. These actions included closing the Company’s Texas operations and personnel reductions at the Company’s Needham and Calgary locations. In connection with these actions, the Company recorded aggregate charges of approximately $1.5 million related to the costs of severance, related benefits and outplacement services. The consolidation and reorganization resulted in aggregate reductions of our workforce by approximately 126 employees, or 66% of our workforce. The employee termination costs will be paid out through December 2002. In addition, the Company recorded a provision of approximately $250,000 related to remaining lease obligations for its Texas operations and recorded a charge of approximately $200,000 related to fixed assets previously used at those facilities and abandoned. The Texas facility lease obligations expire in August 2004. The Company recorded a charge of approximately $1.5 million in connection with a sublease of part of its space at the Needham location through the remaining lease term. In addition, the Company recorded a charge of approximately $800,000 related to fixed assets and leasehold improvements at that facility. The Needham facility lease obligation expires in February 2007.
The following table summarizes the restructuring activity for the three months ended July 31, 2002 (in thousands):
| Employee | Facility | |||||||
| Termination Costs | Exit Costs | |||||||
Balance, April 30, 2002 |
$ | 475 | $ | 1,757 | ||||
Non-cash charges |
— | — | ||||||
Paid to date |
(318 | ) | (294 | ) | ||||
Balance July 31, 2002 |
$ | 157 | $ | 1,463 | ||||
NOTE 5. LEGAL MATTERS
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. On December 6, 2001, the Massachusetts Superior Court, Middlesex County, entered judgment against the Company and in favor of Ms. Lockhart in the amount of approximately $1,160,000, including interest. The Company believes it has meritorious grounds for appeal of this judgment and intends to pursue vigorously an appeal of the same. Provision has been made in the Company’s financial statements for the year ended April 30, 2002 for the judgment entered in the event the appeal is not successful. The Company has also expensed the legal fees incurred in this provision.
In December 2001, a complaint was filed in the Southern District of New York seeking an unspecified amount of damages on behalf of an alleged class of persons who purchased shares of the Company’s common stock between the date of its initial public offering and December 6, 2000. The complainants name as defendants the Company and certain of its officers and other parties as underwriters of its initial public offering. The plaintiffs allege, among other things, that the Company’s prospectus, contained in the Registration Statement on Form S-1 filed with the Securities and Exchange Commission, was materially false and misleading because it failed to disclose that the investment banks which underwrote the Company’s initial public offering of securities and others received undisclosed and excessive brokerage commissions, and required investors to agree to buy shares of securities after the initial public offering was completed at predetermined prices as a precondition to obtaining initial public offering allocations. The plaintiffs further allege that these actions artificially inflated the price of the Company’s common stock after the initial public offering. This case is one of many with substantially similar allegations known as the “Laddering Cases” filed before the Southern District of New York against a variety of unrelated issuers and investment bankers and have been consolidated for pre-trial purposes before one judge to assist with administration. The Company believes that the claims against it are without merit and that it intends to defend the actions. No provision has been recorded for this matter.
8
The Company has been named a defendant in a lawsuit filed in Norfolk County, Massachusetts by Entrata Communications, Inc. (“Entrata”). Entrata Communications, Inc. v. Superwire.com. Inc. and MCK Communications, Inc. arises out of a dispute between Entrata and one of its largest shareholders, Superwire.com, Inc. (“Superwire”). Pursuant to a contract with Entrata, the Company was obligated to pay Entrata $750,000 in early 2002. In order to take advantage of a $100,000 discount offered for early payment, the Company paid Entrata $650,000 in November 2001, in full satisfaction of its contractual obligations. Entrata contends that it never received the funds from the Company and that the funds were diverted to Superwire. Through the lawsuit, Entrata seeks to recover from both the Company and Superwire the full $750,000 that the Company would have owed in 2002. The Company has asserted counterclaims against Entrata for and cross-claims against Superwire for fraud and breach of contract. As discovery has not yet commenced, it is too soon to assess the Company’s likelihood of success in this litigation. Management intends to defend the claims against the Company and prosecute its counterclaims and cross-claims vigorously.
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Certain statements in the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” are forward-looking statements regarding future events and are subject to risks and uncertainties. The forward-looking statements contained herein are based on current expectations. Factors that might cause such a difference include, among other things, those set forth under