MSU DEVICES INC (MUCP.OB) Quarterly Report (SEC form 10-Q)
Item 2 - Management's Discussion and Analysis of Financial Condition and
Results of Operations
Overview of Business Operations
Forward Looking Statements
This quarterly report on Form 10-Q includes "forward-looking statements" within
the meaning of Section 27A of the Securities Act of 1933, as amended (the
"Act"), and Section 21E of the Securities Exchange Act of 1934, as amended,
which can be identified by the use of forward-looking terminology such as,
"may," "expect," "could," "plan," "seek," "anticipate," "estimate," or
"continue" or the negative thereof or other variations thereon or comparable
terminology.
These forward-looking statements are subject to various risks and uncertainties
that could cause actual results to differ materially from those referred to in
the forward-looking statements and are made pursuant to the "safe-harbor"
provisions of the Private Securites Litigation Reform Act of 1995. These
statements are made based on management's current expectations or beliefs as
well as assumptions made by, and information currently available to, management.
Although the Company believes that the expectations reflected in such
forward-looking statements are reasonable, it can give no assurance that such
expectations will prove to have been correct. Important factors with respect to
any such forward-looking statements, including certain risks and uncertainties
that could cause actual results to differ materially from the Company's
expectations ("Cautionary Statements"), are disclosed in this report on Form
10-Q.
In addition, a variety of factors could cause actual results to differ
materially from those anticipated in the Company's forward-looking statements, including the following factors: market acceptance of existing and new products,
difficulties in developing and marketing new products, competition from other
products and technologies, access to capital, changes from anticipated levels of
sales, and future national and international economic and competitive
conditions.
All subsequent written and oral forward-looking statements attributable to the
Company or persons acting on its behalf are expressly qualified in their entirety by the Cautionary Statements.
Readers are cautioned not to place undue reliance on these forward-looking
statements, which reflect management's analysis only as of the date hereof. The
Company does not undertake any obligation to publicly revise these
forward-looking statements to reflect events or circumstances that arise after
the date hereof. Readers should carefully review the risk factors described in
other documents the Company files from time to time with the Securities and
Exchange Commission.
The Company is principally engaged in the design and development of affordable
Internet access devices that enable consumer and business end-users to, simply
and easily, use the Internet for communication, access to information and other
applications typically associated with Internet access. The focus of the Company
during this quarter was on the following:
1. Begin production of its Version 5 Internet access device
(described below).
2. Obtain additional working capital.
3. Reduce the Company's debt position through the conversion of
the outstanding convertible debentures.
4. Complete the Company Voluntary Arrangement (described in the
next paragraph below) through the issuance of promissory notes
to Web 2 U Limited creditors as described in Note 6 -
"Restructuring of Web 2 U".
5. Obtain sales orders and establish new distribution and
marketing relationships worldwide.
In accordance with the restructuring of the UK operations, the Company has
expended significant effort towards the settlement of obligations with creditors
of Web 2 U Limited. On May 15, 2001, Web 2 U Limited filed a company voluntary
arrangement ("CVA") pursuant to Part 1 of The Insolvency Act 1986. The CVA,
described in detail below, was approved by the creditors of Web 2 U Limited at a
meeting held in the United Kingdom in July 2001.
The arrangement approved by all creditors and submitted to the UK Courts is as
follows:
o Claims of preferential creditors (as defined under the UK
Insolvency Act) would be discharged in full in priority to the
claims of unsecured creditors;
o After the claims of preferential creditors have been
satisfied, unsecured creditors whose admitted claims are less
than or equal to (pound)2,500 would be paid in full; and
o Unsecured creditors whose admitted claims are greater than
(pound)2,500 would be issued 5% convertible promissory notes
(the "5% Notes") by the Company for the principal sum of the
individual unsecured creditors admitted claim. The principal
amount of the 5% Notes will be paid in three equal
installments: the first on the third anniversary of the issue
date, the second on the fourth anniversary and the third on
the fifth anniversary. At any time after the Company's stock
price closes at $1.25 for five consecutive trading days, the
Company will have the option to convert the outstanding
balance and accrued and unpaid interest of the 5% Notes into
shares of common stock at a conversion rate of one share of
common stock per $1.00 owed.
On August 20, 2001, Web 2 U Limited was discharged from the administration order
and remains an active international sales office of MSU Devices Inc. At the time
of this filing, the preferential creditor and unsecured creditor claims have
been paid in full and the total amount of the 5% Notes are approximately
(pound)588,000 (approximately $852,000 as of December 31, 2001). The promissory
notes were issued on December 31, 2001.
On August 27, 2001, the Company announced its Version 5 ("V5") Internet access
device. The V5 product supports multiple levels of software programmability with
Microsoft Windows CE(TM) as the operating system. The product was available in
quantity in the fourth calendar quarter 2001 under the MSU Devices brand name
and also under the Company's private label program. Production began in December
2001.
During the six-month period ending December 31, 2001, there were no significant
sales of V5 or prior versions. The Company was focused on establishing new
relationships and developing worldwide distribution channels for the V5 device.
As a result, a number of trial agreements were signed and samples of the product
were distributed worldwide.
In addition, the Company continued its presence at industry trade shows. The V5
product was exhibited in November 2001 at Comdex/Las Vegas in the Internet
Appliance Pavilion.
In October 2001, the Company announced new distributors in Canada and the United
States. MillenniumNet Inc. of Fairfax, Virginia will distribute the MSU V5
device in the federal government market in the United States, which includes the
civilian and defense departments, as well as related government agencies, such
as systems integrators and major suppliers. Two new distributors were announced
who will serve the Canadian market. Packet Communications and InterSol
Interactive Solutions will represent MSU Devices to a list of exclusive
customers with whom they have business relationships.
In November 2001, the Company announced a marketing agreement with EarthLink,
one of the world's largest Internet service providers. Under the terms of the
agreement, MSU Devices and EarthLink will work together to offer a low-cost
solution for consumer and business users interested in accessing the Internet
and sending and receiving email. In 2002, MSU Devices will offer EarthLink's
Internet access services on all shipments of its V5 device in the United States
and Canada.
In December 2001, the Company completed a private placement of equity for gross
proceeds of $1.225 million. Upon the completion of this financing and pursuant
to an automatic conversion feature in the agreement, the Company converted $4.5
million of convertible debentures, pursuant to the terms of the agreement, into
approximately 24 million shares of MSU common stock and special warrants.
FACTORS AFFECTING OUR BUSINESS, OPERATING RESULTS AND FINANCIAL CONDITION
The following is a discussion of certain risks, uncertainties and other factors
that currently impact or might impact business, operating results and financial
condition of MSU Devices Inc. Anyone making an investment decision with respect
to the common stock or other securities of the Company is cautioned to carefully
consider these factors, along with the disclosures in the Form 10-K for the year
ended June 30, 2001 and our other public filings with the Securities and
Exchange Commission.
The Company's consolidated financial statements have been prepared assuming that
the Company will continue as a going concern. Our auditors qualified their
report on our financial statements for the year ended June 30, 2001 as follows:
"The Company has suffered, and continues to suffer, significant losses from its
operations, has an accumulated deficit, continues to have negative cash flow
from operations and currently has a limited customer base. These factors, among
others, raise substantial doubt about its ability to continue as a going
concern." The Company has incurred losses since inception and may never achieve
profitability. At December 31, 2001 there was an accumulated deficit of
approximately $36 million. Additionally the Company has had recurring negative
cash flows from operations. We expect to incur significant additional losses and
continued negative cash flows from operations in fiscal 2002 and beyond and may
never become profitable.
The Company expects that it is likely to incur net losses as it attempts to
further develop, upgrade and market its products and to develop its infrastructure and organization to support anticipated operations, including
anticipated product demand. As a result of these expected losses, the Company
will need to raise additional capital to fund operations through fiscal 2002. No
assurance can be given that additional capital will be available, or if
available, on terms favorable to the Company. The Company's inability to raise
capital could require us to significantly curtail our operations.
The markets for the Company's products have only recently begun to develop, are
rapidly evolving and are highly competitive, with many competitors having
greater resources than the Company. The Company and its prospects must be
considered in light of the substantial risks, expenses and difficulties facing
the Company. There can be no guarantee that the Company will be successful in
addressing any of the foregoing risks and that it will be successful in
implementing its strategy. The market for Internet access devices may never
develop or may develop at a slower rate than we anticipate. In addition, the
Company's success in marketing its Internet access device solution is dependent
upon developing and maintaining relationships with industry-leading computer and
consumer electronics companies, system and hardware manufacturers. The Company
may not successfully meet any or all of these challenges. The Company's failure
to meet one or more of these challenges could have a material adverse effect on
our business and prospects.
Results of Operations
Comparison of the three and six months ended December 31, 2001 to the three and
six months ended December 31, 2000 follows:
Revenue. Revenues for the three months and six months ended December 31, 2001
were approximately $33,000 and $36,000, respectively, a 95% and 98% decrease
from the prior year period, respectively. Revenues for the three months and six
months ended December 31, 2000 were approximately $613,000 and $1.4 million,
respectively. The lack of sales for the three and six-month period ending
December 31, 2001 was due to the restructuring of the business operations, which
entailed the abandonment of the obsolete technology and the development of the
V5 product, which went into production in December 2001.
Cost of Revenues. Cost of revenues for the three months and six months ended
December 31, 2001 were approximately $15,000 and $28,000, respectively, and
represent storage costs associated with prior versions of the product. Efforts
are under way to scrap the older product to eliminate future storage
expenditures.
Research and Development. Research and development expenses generally consist of
expenditures related to the Company's development of its hardware and software.
For the three months ended December 31, 2001, research and development expenses
decreased by approximately $165,000 from $318,000 in the corresponding period in
2000. The decreased expenditures on research and development during the three
months ended December 31, 2001 is a result of the completion of the development
of the V5 device and the significant decrease in expenditures related to the software development for the V5 device.
For the six months ended December 31, 2001, research and development expenses
increased by approximately $13,000 from $699,000 in the corresponding period in
2000. The increased expenditures on research and development during the six
months ended December 31, 2001 relate to the development of the hardware
configuration of the V5 product and the development, adaptation and integration
of new and existing software for the V5 product on the Microsoft Windows CE(TM)
platform. The Company expected to expend considerable resources in research and
development of the V5 Internet access device and associated software. Generally
the fluctuations from period to period reflect the varying demands for research
and development which are dictated by technological changes and the need for the
Company's products to remain competitive and commercially viable.
Selling, general and administrative. Selling, general and administrative
expenses for the three months ended December 31, 2001 decreased by approximately
$336,000 from $636,000 in the same period of 2000. The decrease in the three
months ended December 31, 2001 is primarily due to 1) lower personnel costs as a
result of reduced headcount, 2) lower sales and marketing costs as result of
reduced sales activity and 3) a credit of approximately $245,000 recorded for
adjustments to the intrinsic value of variable stock options resulting from a
decline in the market value of the Company's common stock. For the six months
ended December 31, 2001, selling, general and administrative expenses increased
by approximately $34,000 from $1.4 million in the same period of 2000. The
increase is primarily due to costs associated with the newly formed US
operations and professional fees, and offset, in part, by the net credit of
$225,000 recorded for adjustments to the intrinsic value of variable stock
options resulting from a decline in the market value of the Company's common
stock. Selling, general and administrative expenses principally consist of the
cost of employees (other than those dedicated to research and development),
advertising and promotional costs which are charged to operations as incurred, communication, rent, occupancy costs and professional fees. In general terms,
the Company continues to develop a structured and professional sales and
marketing framework to market the current and future products. Investment in
this area is likely to increase during the next year.
Interest expense. Interest expense for the three months and six months ended
December 31, 2001 increased by approximately $35,000 and $92,000, respectively
from approximately $36,000 and $70,000 in the corresponding periods in 2000.
Liquidity and Capital Resources
The Company's business plan is predicated principally upon the successful
marketing of its V5 product. The Company anticipates that its existing working
capital resources and revenues from operations will not be adequate to satisfy
its funding requirements in 2002 and that it will be required to raise
additional capital.
Failure to obtain additional capital could cause delay or abandonment of our
business plans. The Company anticipates that it will depend on outside sources
of capital to fund operations losses for at least the next twelve months.
Additional capital may also be required for a variety of other reasons, including unforeseen delays, unanticipated expenses, increased capital
requirements, engineering design changes and other technology risks or other corporate purposes. These additional funds may not be available. Even if those
funds are available, we may not be able to obtain them on a timely basis, or on
terms acceptable or favorable to us. Failure to obtain additional funds could
result in the delay or abandonment of our development and expansion plans, and
we may be unable to fund our ongoing operations.
Historically, the Company has financed its operations through private sales of
unregistered equity and debt securities. During the six-month period ended
December 31, 2001, the Company received short term funding from the receipt of
$265,000 of cash in July related to the issuance of 10% convertible bridge loan
notes during fiscal 2001 that was in transit as of June 30, 2001. On October 10,
2001, the Company engaged Raymond James Ltd. to raise additional capital by way
of a private placement in Canada and the United States. In December 2001, the
Company terminated its engagement with Raymond James Ltd. and engaged McFarlane
Gordon, Inc. to raise capital by way of a private placement in Canada and the
United States. As of December 31, 2001, the Company received net proceeds of
$1.03 million pursuant to these two offerings.
For the six-month period ended December 31, 2001 cash used in operating
activities was approximately $2.2 million. Cash flows used in investing activities of approximately $64,000 during such period related mainly to the
acquisition of tooling related to the production of the V5 device.
At December 31, 2001 the Company's principal source of liquidity was
approximately $282,000 in cash and cash equivalents, which will be used to fund
the operations in the third quarter of fiscal 2002.
The Company believes that cash flows generated by operations through the
remainder of fiscal 2002 will be insufficient to meet its cash needs for working
capital and capital expenditures. The Company is actively pursuing additional
capital to fund its operations. The sale of additional equity or convertible
debt securities will result in an additional dilution to the Company's
stockholders. There can be no assurance that the Company's liquidity requirements will be met or that it will be able to continue as a going concern.
In February 2002, the Company issued approximately $638,000 in 10% Promissory
Notes secured by all of the Company's assets. Under the terms of the 10%
Promissory Notes, the Company covenants to raise $1.362 million in additional
financing within 105 days of the initial issuance of such notes. See Notes 7 -
Subsequent Events, to the financial statements contained in this Report on Form
10-Q. No assurance can be given that the Company will successfully raise such
additional financing, or that additional, if available, will be available on
terms favorable to the Company. Failure to raise such additional financing
could have a material adverse effect on the Company, including, without
limitation, foreclosure on all of the Company's assets by the holders of the
notes. |
