September 26, 2001
MSU DEVICES INC (MUCP.OB)
Annual Report (SEC form 10-K)
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
Overview
We design, market and sell affordable Internet access devices
that enable consumer and business end-users to communicate simply and easily by
using e-mail and over the World Wide Web via the Internet without the necessity
of technical or personal computer knowledge or expertise. When using our
products and services, end-users have access to an Internet service provider,
e-mail hosting and content in a single, easy to use hardware/software appliance.
We have been in business since 1994. In the past three years,
we have released three versions of our Internet access device. In undertaking
our business activities since 1994, we have realized an accumulated deficit of
$32 million. In January of 2001, the following management team was recruited by
our new President and Chief Executive Officer, Mr. Walter: Mr. Patel, Vice
President and Chief Technology Officer, Ms. Brown, Vice President and Chief
Financial Officer and Mr. Dittrich, Vice President Sales and Market Development.
Beginning in January of 2001, our new management team
undertook a complete review of our strategic direction. As a result of this
review, the Board of Directors adopted the recommendation of the new management
team, which was to (1) remain in the Internet access device business, (2)
undergo several significant changes in strategy, and (3) begin restructuring the
activities of the Company. In the third calendar quarter of 2001, we launched
our new Internet access device product, the MSU/5. The MSU/5 will sell in volume
for under $200 per device.
The above strategy was in place for only approximately 25% of
the 2001 fiscal year. As a result, the management team believes that the
Company's operating results are not indicative of the future operating results
of the Company.
Significant Risks
The Company's consolidated financial statements have been
prepared assuming that the Company will continue as a going concern. During the
year ended June 30, 2001, the Company incurred a net loss of approximately
$10,232,000. The Company expects that it is likely to incur net losses into
fiscal 2002 as it attempts to further develop, upgrade and market the MSU/5 and
to develop its infrastructure to support its operations. The Company is likely
to incur net losses beyond 2002 if anticipated revenues from orders for MSU/5
are not realized. Such orders require, without limitation, approval of final
production samples, customer acceptance of MSU/5, satisfactory product
performance, and the ability of the products to compete successfully in a highly
competitive market. The Company believes these assumptions are reasonable;
however, should any one of these assumptions fail, the Company could incur net
losses beyond 2002 and be unable to continue as a going concern.
Results of Operations
Revenues
Revenues during the years ended June 30, 2001, 2000, and 1999
were approximately $1,394,000, $905,000, and $32,000, respectively. The Company
has only recently commenced sales of its new product MSU/5 and consequently, has
only a limited number of customers.
Sales in the year ended June 30, 2001 of approximately
$1,394,000 were to four customers, which were primarily based in the United
Kingdom, India, Greece and Australia. Revenues reported during the period ended
June of 2001 relate to the sale of the ISP3 product. MSU does not expect to
report on-going sales related to this product.
Our new management team will spend the next twelve months
focusing our resources and sales efforts with respect to our core market:
consumers and businesses who need to access the Internet in order to use e-mail
and browse the World Wide Web. We successfully launched our new MSU/5 product
with the signing of a new distribution agreement with CPS Broadcast B.V. for the
distribution of the new MSU/5 product into South Africa.
Comparison of revenues for the year ended June 30, 1999 with
the year ended June 30, 2000 is not meaningful because in fiscal 1999, apart
from the sale of a small number of samples, there were no revenues generated by
the Company.
A concentration of revenues in such a small number of
customers, where the loss of one customer could have a material adverse effect
on the business is a risk. The Company is focused on a number of trial
opportunities worldwide to increase its customer base. The Company's revenues by
geographic region during the years ended June 30 2001, 2000, and 1999 were
approximately as follows:
-
Location 2001 ($) 2000 ($) 1999 ($)
------------------------------- ---------------------------- ---------------------------- ----------------------------
Europe........................ 617,611 343,000 2,000
------------------------------- ---------------------------- ---------------------------- ----------------------------
Asia.......................... 610,289 562,000 17,000
------------------------------- ---------------------------- ---------------------------- ----------------------------
North America................. 166,480 None 13,000
------------------------------- ---------------------------- ---------------------------- ----------------------------
Cost of Revenues
The cost of revenues for the years ended June 30, 2001, 2000
and 1999 were approximately $3,782,000, $928,000, and $53,000 respectively. The
cost of revenues in the year ended June 30, 2001 at 271% of revenues is due to
the costs involved with the production of ISP3 and a reserve for obsolescence of
the ISP3 product in the amount of $1,920,000. The cost of revenues in the year
ended June 30, 2000, at 103% of revenues were significantly higher than expected
due to the high costs involved with the initial production run of ISP 2. The
cost of revenues in the year ended June 30, 1999, mostly related to the direct
production cost of samples which were expensed to the extent the Company
considered such cost was not recoverable. As a percentage of revenues, cost of
revenues were approximately 168% in 1999.
Our new management team is targeting cost of revenues for the
next twelve months for the MSU/5 to be approximately 90% of revenues due to
initial production costs and lower volumes.
Research and Development Expenses
Research and development expenses generally consist of
expenditure related to the Company's development of its hardware and software.
We have excluded all overhead costs other than employee, independent contractor,
development tool and prototype costs. All research and development costs have
been fully expensed.
For the years ended June 30, 2001, 2000, and 1999, research
and development costs were approximately $1,111,000, $2,036,000, and $1,556,000,
respectively. As a percentage of revenues, research and development expenses
were approximately 80% in 2001, 225% in 2000, and 490% in 1999.
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, and the requirements of the Company's customers. The new management team
was successful in leveraging outside contractors to assist in the design and
development of the MSU/5 at significantly lower costs than in the past. This was
achieved through the integration of off-the-shelf software and OEM components,
which resulted in lower costs to the Company.
The Company entered into a consulting agreement with Dr.
Avinash Palaniswamy in March of 2001. Dr. Palaniswamy is providing strategic
software development on the MSU/5. The contract terms are $12,500 per month and
12,500 stock options per month from March of 2001 to August of 2001. The Company
will pay Dr. Palaniswamy a bonus of $10,000 upon the
completion of the project. The Company is currently in negotiating a full-time employment arrangement with Dr. Palaniswamy.
Selling, General and Administrative Expenses
Selling, general and administrative and other expenses
principally consist of the cost of employees (other than those dedicated to
research and development), advertising, promotional costs, communication,
occupancy costs, and professional fees.
Selling general and administrative expenses were approximately
$5,542,000, $2,190,000, and $1,544,000 for the years ended June 30, 2001, 2000,
and 1999 respectively. The increase in the year ended June 30, 2001 is primarily
due to an increase in personnel in the United States and in investment banking
and professional fees.
The new management team intends to decrease selling, general
and administrative expenses as a percent of revenues during the 2002 fiscal
year.
Depreciation Expense
Depreciation is calculated using the straight line method over
the estimated useful lives of our depreciable assets, which consist principally
of electronics equipment used in the design and testing of our products.
Depreciation expense was approximately $71,000, $83,000, and
$74,000 for the fiscal years ended June 30, 2001, 2000, and 1999, respectively.
Interest Expense
Interest expense was approximately $297,000, $113,000 and
$158,000 for the fiscal years ended June 30, 2001, 2000, and 1999, respectively.
Interest expense in the current year represents interest payable on promissory
notes totaling $1,330,000 issued prior to fiscal year 2001, and on the bridge
loan promissory notes of $4,500,000 that were issued in the second, third, and
fourth quarters of fiscal 2001. The interest expense in 2000 is attributable to
promissory notes in the amount of $1,330,000. The interest expense in 1999 is
mainly attributable to the interest on a $2.3 million 10% convertible promissory
note issued in 1997, which were either converted or repaid in fiscal 1999,
together with interest on the 6% and 8% convertible promissory notes issued in
December 1998 and January 1999.
Non-Operating Income (expense)
In the year ended June 30, 2001, the Company expensed
approximately $228,000 in deferred financing costs associated with the bridge
loan convertible notes during the year. These costs were incurred in connection
with the sale of the $4,500,000 10% convertible promissory notes between October
of 2000 and July of 2001. In addition, the Company expensed approximately
$382,000 in relation to its investment in American Interactive Media which
investment the Company has deemed to be unrecoverable.
In the year ended June 30, 2000, the Company capitalized and
immediately charged to expense approximately $56,000 with respect to common
stock sold at less than
market value. Similarly, there was a $441,000 discount associated with the issuance of convertible notes during the year.
In 1999, MSU recorded an impairment loss on its investment of
approximately $2,500,000 in shares of American Interactive Media common stock,
which substantially declined in market value. Management believes that the
decline in market value is permanent. The Company recorded an additional
impairment of approximately $382,000 in fiscal year 2001, which represents an
impairment of 100% in the investment. Additionally, during 1999 the Company
capitalized and immediately charged to expense approximately $3,670,000 of the
discount associated with the issuance of convertible notes during fiscal 1999.
Restructuring Charges
Due to insufficient liquidity and product obsolescence
associated with the operation of the Web 2 U Limited subsidiary, the Board in
March of 2001 approved the following actions in accordance with the
restructuring plan:
1. Cease active trading in the UK in order to minimize
the loss to Web 2 U Limited creditors;
2. Reduce the size of the UK workforce; and
3. Attempt to settle the outstanding creditors.
The plan was implemented in March of 2001, and a total of
fourteen positions at Web 2 U Limited were eliminated, principally in the
Company's management and research development departments. The decision was also
made to relocate the accounting system and accounting operations to the U.S. As
a result, the Company recorded a restructuring charge of approximately $289,000
in the fiscal year 2001 for the restructuring of the UK operations, which is
comprised of involuntary termination benefits and legal fees.
On May 15, 2001, Web 2 U Limited filed a company voluntary
arrangement (the "CVA") pursuant to Part 1 of The Insolvency Act 1986, as
amended (the "Insolvency Act"). The substance of the CVA proposal was as
follows:
o Claims of preferential creditors (as defined under the 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 convertible promissory notes (the "CVA Notes") by the Company for the
principal sum of the individual unsecured creditors admitted claim. The principal amount of the CVA 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. Interest will accrue on the CVA Notes at a rate of 5% per
annum and be payable annually by the Company, with the first interest payment due on the first year anniversary of the issue date. 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 automatically convert the outstanding
balance and accrued and unpaid interest of the CVA Notes into shares of common stock at a conversion rate of one share of common stock per $1.00 owed.
The CVA was approved by Web 2 U Limited's creditors at a meeting of those creditors held in the United Kingdom on July 16, 2001. At the time of this filing, the
preferential creditor and unsecured creditor claims are under review by the supervisor of the CVA.
On August 20, 2001, Web 2 U Limited was discharged from the administration order and the officers and directors of the Company are in control of the operations of
Web 2 U Limited.
Liquidity and Capital Resources
MSU has financed its operations primarily through private
sales of unregistered equity and debt securities.
For the year ended June 30, 2001, cash used in operating
activities of approximately $6,044,000 was mainly attributable to the Company's
net operating loss for the year of $10,223,000. Cash flows used in investing
activities of approximately $54,000 during such period related primarily to the
acquisition of computer equipment.
Cash flows from financing activities of approximately
$4,067,000 for the year ended June 30, 2001 were primarily attributable to an
issue of new convertible bridge loan notes of $4.25 million and to the
repayment, in cash, of $150,000 of convertible notes.
At June 30, 2001, the Company's principal source of liquidity
was approximately $1,280,000 in cash and cash equivalents, which will be
available to fund the development and production of the MSU/5 in the calendar
fourth quarter of 2001. The Company will need additional funds for working
capital in the calendar fourth quarter of 2001. The Company is currently in
discussions with underwriters in Toronto, Canada regarding a private placement
of approximately $5 million. The terms have yet to be finalized as of the filing
of this report. The sale of additional equity or convertible debt securities
will result in 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.
Market Risk
We are exposed to market risk from changes in
interest rates that may adversely affect our results of
operations and financial conditions. We seek to minimize the risks from these
interest rate fluctuations through our regular operating and financing
activities. Our policy is not to use financial instruments for trading or other
speculative purposes. We are not currently a party to any financial instruments.
Goodwill and Intangible Assets
None
Forward-Looking Statements
This annual report contains forward-looking statements about
the Company's business, products and projected operating results. When used in
this annual report, the words
"anticipate", "believe", "estimate", "may", "should", "expect", "plan", "predict", "potential", "continue" or "intend", in addition to the negative of these terms or similar
expressions, are generally intended to identify forward-looking statements. Stockholders and potential investors are cautioned that such statements are predictions. All
such forward-looking statements involve risks and uncertainties, including, but not limited to, our history of significant operating losses which together with an inability to
raise capital could impact on our ability to continue as a going concern; our limited sales history; the acceptance of our product by business and consumer end-users;
rapid technological change; the pressures of a competitive industry; our ability to license technology; our ability to anticipate and respond to technological and market
changes; our ability to cut costs and realize economies of scale and our dependency upon one third party manufacturer. In light of the significant uncertainties inherent to
the forward looking statements included herein, the inclusion of such information should not be regarded as a representation or warranty by us or any other person that
our objective and plans will be achieved in any specific time frame, if at all. The Company and management do not intend to update and do not undertake any obligation
to update publicly any of the forward-looking statements contained herein. |
