<PAGE> 1
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON AUGUST 5, 1998
REGISTRATION NO. 333-58443
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
AMENDMENT NO. 3
TO
FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
------------------------
VISUAL NETWORKS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
2092 GAITHER ROAD
ROCKVILLE, MARYLAND 20850
(301) 296-2300
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
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<S> <C> <C>
DELAWARE 3576 52-1837515
(STATE OR OTHER JURISDICTION OF (PRIMARY STANDARD INDUSTRIAL (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) CLASSIFICATION CODE NUMBER) IDENTIFICATION NUMBER)
</TABLE>
------------------------
SCOTT E. STOUFFER
PRESIDENT AND CHIEF EXECUTIVE OFFICER
VISUAL NETWORKS, INC.
2092 GAITHER ROAD
ROCKVILLE, MARYLAND 20850
(301) 296-2300
(NAME, ADDRESS, INCLUDING ZIP CODE AND TELEPHONE NUMBER,
INCLUDING AREA CODE, OF AGENT FOR SERVICE)
------------------------
Copies to:
<TABLE>
<S> <C>
EDWIN M. MARTIN, JR., ESQUIRE MARK G. BORDEN, ESQUIRE
NANCY A. SPANGLER, ESQUIRE DAVID SYLVESTER, ESQUIRE
PIPER & MARBURY L.L.P. HALE AND DORR LLP
1200 19TH STREET, N.W. 1455 PENNSYLVANIA AVENUE, N.W.
WASHINGTON, D.C. 20036 WASHINGTON, D.C. 20004
(202) 861-3900 (202) 942-8400
</TABLE>
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC:
As soon as practicable after this Registration Statement becomes effective.
If any of the securities being registered on this form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, as amended (the "Securities Act") check the following box. [ ]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, check the following box and
list the Securities Act registration statement number of the earlier effective
registration statement for the same offering. [ ]
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If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ]
- ---------------
If this Form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ]
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If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. [ ]
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CALCULATION OF REGISTRATION FEE
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<S> <C> <C> <C>
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PROPOSED MAXIMUM PROPOSED MAXIMUM
TITLE OF EACH CLASS OF AMOUNT TO BE OFFERING PRICE AGGREGATE
SECURITIES TO BE REGISTERED REGISTERED(1) PER UNIT(2) OFFERING PRICE(2)
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Shares of Common Stock, par value $.01...... 4,025,000 shares $32.50 $130,812,500
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<CAPTION>
<S> <C>
TITLE OF EACH CLASS OF AMOUNT OF
SECURITIES TO BE REGISTERED REGISTRATION FEE
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Shares of Common Stock, par value $.01...... $0(3)
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</TABLE>
(1) Includes 525,000 shares which the Underwriters have the option to purchase
to cover over-allotments, if any.
(2) Estimated solely for the purpose of determining the registration fee
pursuant to Rule 457(c) under the Securities Act.
(3) A registration fee of $38,590 was paid at the time of the initial filing of
this registration statement.
------------------------
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF
THE SECURITIES ACT, OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME EFFECTIVE
ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(a), MAY
DETERMINE.
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<PAGE> 2
EXPLANATORY NOTE
This Registration Statement contains two forms of prospectus: one to be
used in connection with a United States offering of shares (the "U.S.
Prospectus") and one to be used in connection with a concurrent international
offering of shares (the "International Prospectus"). The U.S. Prospectus and the
International Prospectus are identical except that they contain different front
and back cover pages and different descriptions of the plan of distribution
(contained under the caption "Underwriting" in each of the U.S. and
International Prospectuses). The form of U.S. Prospectus is included herein and
is followed by those pages to be used in the International Prospectus which
differ from, or are in addition to, those in the U.S. Prospectus. Each of the
pages for the International Prospectus included herein is labeled "Alternate
Page for International Prospectus".
<PAGE> 3
SUBJECT TO COMPLETION, DATED AUGUST 5, 1998
3,500,000 SHARES
LOGO
COMMON STOCK
(PAR VALUE $.01 PER SHARE)
------------------------
Of the 3,500,000 shares of Common Stock offered, 2,800,000 shares are being
offered hereby in the United States and 700,000 shares are being offered in a
concurrent international offering outside the United States. The public offering
price and the aggregate underwriting discount per share will be identical for
both offerings. See "Underwriting".
Of the 3,500,000 shares of Common Stock offered, 1,000,000 shares are being
sold by the Company and 2,500,000 shares are being sold by the Selling
Stockholders. See "Principal and Selling Stockholders". The Company will not
receive any part of the proceeds from the sale of shares being sold by the
Selling Stockholders.
SEE "RISK FACTORS" BEGINNING ON PAGE 5 FOR CERTAIN CONSIDERATIONS RELEVANT
TO AN INVESTMENT IN THE COMMON STOCK.
The last reported sale price of the Common Stock, which is quoted on the
Nasdaq National Market under the symbol "VNWK", on July 31, 1998 was $26.75 per
share. See "Price Range of Common Stock".
------------------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
------------------------
<TABLE>
<CAPTION>
INITIAL PUBLIC UNDERWRITING PROCEEDS TO PROCEEDS TO SELLING
OFFERING PRICE DISCOUNT(1) COMPANY(2) STOCKHOLDERS(2)
-------------- ------------ ----------- -------------------
<S> <C> <C> <C> <C>
Per Share............... $ $ $ $
Total(3)................ $ $ $ $
</TABLE>
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(1) The Company and the Selling Stockholders have agreed to indemnify the
Underwriters against certain liabilities, including liabilities under the
Securities Act of 1933. See "Underwriting".
(2) Before deducting estimated expenses of $750,000 payable by the Company.
(3) The Company and the Selling Stockholders have granted the U.S. Underwriters
an option for 30 days to purchase up to an additional 420,000 shares at the
initial public offering price per share, less the underwriting discount,
solely to cover over-allotments. Additionally, the Company and the Selling
Stockholders have granted the International Underwriters a similar option
with respect to an additional 105,000 shares as part of the concurrent
international offering. If such options are exercised in full, the total
initial public offering price, underwriting discount, proceeds to Company
and proceeds to the Selling Stockholders will be $ , $ ,
$ and $ , respectively. See "Underwriting".
------------------------
The shares offered hereby are offered severally by the U.S. Underwriters,
as specified herein, subject to receipt and acceptance by them and subject to
their right to reject any order in whole or in part. It is expected that
certificates for the shares will be ready for delivery in New York, New York, on
or about , 1998, against payment therefor in immediately
available funds.
GOLDMAN, SACHS & CO.
NATIONSBANC MONTGOMERY SECURITIES LLC
DAIN RAUSCHER WESSELS
A DIVISION OF DAIN RAUSCHER
INCORPORATED
------------------------
The date of this Prospectus is , 1998.
INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A
REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY
OFFERS TO BUY THEM BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT
BECOMES EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR THE
SOLICITATION OF AN OFFER TO BUY, NOR SHALL THERE BE ANY SALE OF THESE SECURITIES
IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE UNLAWFUL PRIOR
TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF ANY SUCH STATE.
<PAGE> 4
AVAILABLE INFORMATION
Visual Networks, Inc. (the "Company") is subject to the informational
requirements of the Securities Exchange Act of 1934, as amended (the "Exchange
Act"), and in accordance therewith files reports, proxy statements and other
information with the Securities and Exchange Commission (the "Commission").
Reports, proxy statements and other information filed by the Company may be
inspected and copied at the public reference facilities maintained by the
Commission at 450 Fifth Street, N.W., Washington, D.C. 20549, and at the
Commission's Regional Offices located at Citicorp Center, 500 West Madison
Street, Suite 1400, Chicago, Illinois 60661 and 7 World Trade Center, 7th Floor,
New York, New York 10048. Copies of such materials may be obtained from the Web
site that the Commission maintains at http://www.sec.gov.
The Company has filed with the Commission a registration statement on Form
S-1 (herein, together with all amendments and exhibits, referred to as the
"Registration Statement") under the Securities Act of 1933, as amended (the
"Securities Act"). This Prospectus does not contain all of the information set
forth in the Registration Statement, certain parts of which are omitted in
accordance with the rules and regulations of the Commission. For further
information, reference is hereby made to the Registration Statement.
------------------------
Visual Networks and Visual UpTime are registered trademarks of the Company.
This Prospectus contains other product names, trade names and trademarks of the
Company and of other organizations.
------------------------
CERTAIN PERSONS PARTICIPATING IN THE OFFERINGS MAY ENGAGE IN TRANSACTIONS
THAT STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE PRICE OF THE COMMON STOCK,
INCLUDING OVER-ALLOTMENT, STABILIZING AND SHORT-COVERING TRANSACTIONS IN SUCH
SECURITIES, AND THE IMPOSITION OF A PENALTY BID, IN CONNECTION WITH THE
OFFERINGS. IN ADDITION, CERTAIN UNDERWRITERS (AND SELLING GROUP MEMBERS, IF ANY)
ALSO MAY ENGAGE IN PASSIVE MARKET MAKING TRANSACTIONS IN THE COMMON STOCK ON THE
NASDAQ NATIONAL MARKET, IN ACCORDANCE WITH RULE 103 UNDER THE SECURITIES
EXCHANGE ACT OF 1934. FOR A DESCRIPTION OF THESE ACTIVITIES, SEE "UNDERWRITING".
<PAGE> 5
PROSPECTUS SUMMARY
The following summary is qualified in its entirety by, and should be read
in conjunction with, the more detailed information and consolidated financial
statements and notes thereto appearing elsewhere in this Prospectus. Certain
terms used in this Prospectus are defined in the Glossary. Unless otherwise
indicated, all information in this Prospectus assumes no exercise of the
over-allotment options granted to the Underwriters. See "Underwriting".
THE COMPANY
Visual Networks, Inc. ("Visual" or the "Company") designs, manufactures and
sells wide-area-network ("WAN") service level management systems for
statistically multiplexed technologies such as Frame Relay, ATM and IP/Internet.
The Company's Visual UpTime system combines WAN access functionality with
innovative software for performance monitoring, troubleshooting and network
planning. Visual UpTime provides instrumentation for network performance
measurement and analysis that allows WAN service providers ("providers") to
achieve the service levels required by their customers ("subscribers") and to
lower operating costs associated with statistically multiplexed services. The
availability of performance monitoring and troubleshooting instrumentation also
allows subscribers to verify the service levels being supplied by their service
provider and monitor traffic traversing the WAN, a requirement for many
subscribers wishing to use statistically multiplexed services to carry
mission-critical data traffic. The Company believes Visual UpTime systems are
deployed in configurations managing up to 1,300 circuits and the system is
currently designed to support configurations of up to 30,000 circuits on a
single managed network.
The Company believes it is a worldwide leader in providing WAN service
level management systems and has shipped systems for deployment on an aggregate
of over 25,000 WAN circuits. The Company has developed relationships with major
service providers such as AT&T Corp. ("AT&T"), Sprint/United Management Company
("Sprint"), MCI Telecommunications Corporation ("MCI"), Ameritech Corporation
("Ameritech"), Bell Atlantic Network Integration, Inc. ("Bell Atlantic") and
BellSouth Communication Systems, Inc. ("BellSouth"). These service providers
either resell Visual UpTime to their subscribers or integrate Visual UpTime into
their networks to enable them to offer enhanced data transport service levels.
Visual UpTime has been deployed in Frame Relay networks utilized by over 425
subscribers, including ABN-AMRO Bank, Cargill, Inc., Delta Air Lines, Inc., EDS
Electronic Commerce Division ("EDS"), Federal Express Corporation ("FedEx"),
Household International, Inc., Marriott International, Inc. ("Marriott"),
Reynolds Metals, Inc. ("Reynolds") and Waste Management, Inc. For the year ended
December 31, 1997, and the six months ended June 30, 1998, the Company had
revenue of $27.3 million and $22.3 million, respectively.
Vertical Systems Group ("Vertical Systems"), a leading WAN industry
analyst, estimates that approximately 920,000 Frame Relay circuits and 30,000
ATM circuits will be installed worldwide from 1998 through 2000. To take
advantage of this projected growth in these markets, the Company plans to expand
its relationships with its service provider customers which together account for
the majority of statistically-multiplexed traffic worldwide. The percentage of
revenue attributable to sales to service providers increased from approximately
30% of revenue for the six months ended June 30, 1997, to approximately 60% of
revenue for the six months ended June 30, 1998. Sprint, AT&T and MCI accounted
for 27%, 7% and 2%, respectively, of revenue for the year ended December 31,
1997, and 33%, 12% and 11%, respectively, of revenue for the six months ended
June 30, 1998.
The Company was incorporated in Maryland in August 1993 under the name
Avail Networks, Inc. and reincorporated in Delaware in December 1994 as Visual
Networks, Inc. On May 15, 1998, the Company acquired Net2Net Corporation
("Net2Net"). This acquisition was accounted for as a pooling of interests
transaction. References to "Visual" or the "Company" refer to Visual Networks,
Inc. and its wholly-owned subsidiaries. The Company's principal executive
offices are located at 2092 Gaither Road, Rockville, Maryland 20850, and its
telephone number is (301) 296-2300.
3
<PAGE> 6
THE OFFERINGS
The offering of 2,800,000 shares of Common Stock initially being offered in
the United States (the "U.S. Offering") and the concurrent offering of 700,000
shares of Common Stock initially being offered outside the United States (the
"International Offering") are collectively referred to herein as the
"Offerings". The closing of the International Offering is conditioned upon the
closing of the U.S. Offering and vice versa. See "Underwriting".
<TABLE>
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Common Stock offered:
By the Company:
U.S. Offering........................................ 800,000 shares
International Offering............................... 200,000 shares
1,000,000 shares
By the Selling Stockholders(1):
U.S. Offering........................................ 2,000,000 shares
International Offering............................... 500,000 shares
2,500,000 shares
Total.............................................. 3,500,000 shares
Common Stock to be outstanding after the Offerings(2)..... 20,886,099 shares
Nasdaq National Market symbol............................. "VNWK"
Use of Proceeds........................................... General corporate purposes.
See "Use of Proceeds".
</TABLE>
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(1) The Selling Stockholders may effect transactions in the Common Stock
pursuant to Rule 144 promulgated under the Securities Act.
(2) Excludes 2,101,686 shares of Common Stock issuable upon exercise of options
outstanding as of June 30, 1998, at a weighted average exercise price of
$5.05 per share. See "Capitalization" and "Management -- Stock Plans".
SUMMARY CONSOLIDATED FINANCIAL DATA
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
<TABLE>
<CAPTION>
FOR THE PERIOD
FROM INCEPTION SIX MONTHS
(AUGUST 12, 1993) YEAR ENDED DECEMBER 31, ENDED JUNE 30,
THROUGH --------------------------------------- -----------------------
DECEMBER 31, 1993 1994 1995 1996 1997 1997 1998
----------------- ----- ------- -------- ---------- ---------- ----------
(UNAUDITED)
<S> <C> <C> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Revenue.......................... $-- $ -- $ 567 $ 8,279 $ 27,345 $ 10,217 $ 22,306
Gross profit..................... -- -- 325 4,592 16,591 6,090 13,405
Merger-related costs(1).......... -- -- -- -- -- -- 7,347
Loss from operations............. (5) (439) (3,466) (12,359) (7,123) (4,502) (8,260)
Net loss......................... $(5) $(438) $(3,403) $(12,193) $ (7,030) $ (4,436) $ (7,205)
Pro forma basic and diluted net
loss per common share(2)....... $ (0.45) $ (0.29) $ (0.38)
Pro forma basic and diluted
weighted average common shares
outstanding(2)................. 15,532,537 15,485,515 18,862,904
</TABLE>
<TABLE>
<CAPTION>
JUNE 30, 1998
--------------------------
ACTUAL AS ADJUSTED(3)
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(UNAUDITED)
<S> <C> <C>
CONSOLIDATED BALANCE SHEET DATA:
Cash and cash equivalents................................... $ 48,556 $ 73,152
Working capital............................................. 36,977 61,573
Total assets................................................ 61,470 86,066
Total stockholders' equity.................................. 40,011 64,607
</TABLE>
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(1) During the six months ended June 30, 1998, the Company incurred certain
merger-related costs in connection with its acquisition of Net2Net. See Note
1 of Notes to Consolidated Financial Statements.
(2) For an explanation of the determination of the number of shares used in
computing pro forma per share amounts, see Note 1 of Notes to Consolidated
Financial Statements.
(3) As adjusted to reflect the sale of Common Stock offered by the Company
hereby and the application of the estimated net proceeds therefrom.
4
<PAGE> 7
RISK FACTORS
In addition to the other information in this Prospectus, prospective
investors should consider carefully the following risk factors in evaluating the
Company and its business before purchasing Common Stock in the Offerings. In
addition to the historical information contained herein, this Prospectus
contains forward-looking statements that involve risks and uncertainties. The
Company's actual results may differ materially from those discussed in this
Prospectus. Factors that might cause such a difference include, but are not
limited to, those discussed in the following risk factors and in "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
"Business" as well as those discussed elsewhere in this Prospectus.
IMPLEMENTATION OF PROVIDER DEPLOYMENT MODEL; LENGTHY SALES CYCLE
To date, substantially all of the Company's revenue from its products have
been attributable to sales to subscribers ("subscriber deployment model"), and
the Company expects that such sales will continue to account for a significant
portion of its revenue through at least mid-1999. The Company is currently
implementing a sales and marketing strategy whereby sales of Visual UpTime will
be made directly to providers, which will deploy the systems as part of their
network infrastructure ("provider deployment model"). The Company anticipates
that a significant portion of its future revenue will be attributable to sales
of Visual UpTime to these providers. The Company's future performance will
therefore be substantially dependent on incorporation of Visual UpTime by
providers into their service offerings to subscribers. Providers have not
typically offered solutions that enable the subscriber to measure and test the
WAN service levels offered by the provider, and the Company could encounter
resistance on the part of some providers to offering these solutions. There can
be no assurance that the Company will be successful in persuading providers to
adopt the provider deployment model. The Company believes the success or failure
of the provider deployment model, and the timing of success, if achieved, will
depend on a number of factors over which the Company may have little or no
control, including: provider and subscriber acceptance of and satisfaction with
the Company's systems; the realization of operating cost efficiencies for
providers when service level management systems are deployed and the ability of
the Company to demonstrate such operational benefits; generation of demand for
these systems from subscribers and support for the systems within the providers'
sales forces; competitive dynamics between WAN service providers and the
development of the WAN services market overall; successful development by the
Company of systems and products which address the requirements for systems
deployed as part of a provider's infrastructure; the timing and successful
completion of integration development work by providers to incorporate the
Company's service level management functionality into their operational support
systems; and the absence of new technologies which make the Company's products
and systems obsolete before they can achieve broad acceptance. The failure of
the Company's products to become an accepted part of the providers' service
offerings or a slower than expected increase in the volume of sales by the
Company to providers would have a material adverse effect upon the Company's
business, financial condition and results of operations.
The provider deployment model is characterized by a lengthy sales cycle.
The Company expects that sales of Visual UpTime will require a substantial
commitment of capital from providers, with the attendant delays frequently
associated with providers' internal procedures to approve large capital
expenditures and lengthy decision-making processes. The sales cycle can also be
expected to be subject to a number of significant risks, including providers'
budgetary constraints and technology assessment and other internal acceptance
reviews over which the Company has little or no control. Sales of Visual UpTime
generally involve significant testing by and education of both providers and
subscribers as well as a substantial commitment of the Company's sales and
marketing resources. As a result, the Company may expend significant resources
pursuing potential sales opportunities that will not be consummated. Even if the
provider deployment model is implemented, curtailment or termination of provider
purchasing programs, decreases in provider capital budgets or reduction in the
purchasing priority assigned to systems such as Visual UpTime,
5
<PAGE> 8
particularly if significant and unanticipated by the Company, could have a
material adverse effect on the Company's business, financial condition and
results of operations.
DEPENDENCE ON MAJOR CUSTOMERS
The Company is dependent on a small number of customers for a substantial
portion of its revenue. For the year ended December 31, 1996, sales of products
or services to Hewlett-Packard Company ("HP") and Sprint accounted for 10% and
8%, respectively, of the Company's revenue. For the year ended December 31,
1997, sales of products or services to Sprint, FedEx and AT&T accounted for 27%,
9% and 7%, respectively, of the Company's revenue. For the six months ended June
30, 1998, sales of products or services to Sprint, AT&T and MCI accounted for
33%, 12% and 11%, respectively, of the Company's revenue. If the Company's
evolution to the provider deployment model is successful, the Company's customer
base will consist predominantly of large public network service providers. There
are only a small number of these providers, and the substantial capital
requirements involved in the establishment of public networks significantly
limit additional entrants into this market. In addition, the number of these
providers may decrease if and as providers merge or acquire one another.
Accordingly, the loss of any provider customer, or the reduction, delay or
cancellation of orders or a delay in shipment of the Company's products to any
provider customer, could materially and adversely affect the Company's business,
financial condition and results of operations.
The Company's anticipated dependence on sizable orders from a limited
number of providers will make the relationship between the Company and each
provider critically important to the Company's business. As relationships evolve
over time, adjustments to product specifications, forecasts and delivery
timetables may be required in response to provider demands and expectations.
Further, because none of the Company's agreements contain minimum purchase
requirements, there can be no assurance that the issuance of a purchase order
will result in significant repeat business. The inability of the Company to
manage its provider relationships successfully would have a material adverse
effect on the Company's business, financial condition and results of operations.
RISKS ASSOCIATED WITH RAPID TECHNOLOGICAL CHANGE; EMERGING SERVICES MARKET; NEW
PRODUCTS
Visual UpTime is the Company's principal product and is focused on service
level management for WANs that utilize statistically multiplexed technologies.
Accordingly, the Company's future financial performance will depend in large
part on continued growth in the number of enterprises adopting solutions based
on Frame Relay, Asynchronous Transfer Mode ("ATM") and IP/Internet services. The
market for these services is characterized by rapid changes, including
continuing advances in technology, frequent new product introductions, changes
in customer requirements and preferences and industry standards. The
introduction of new technologies or advances in techniques for statistically
multiplexed WAN services or the integration of WAN service level management
functionality into other network hardware components could render Visual UpTime
obsolete or unmarketable. Further, the Company will be required to make
enhancements and refinements to the product for wide scale implementation
through the provider deployment model. There can be no assurance that (i) Visual
UpTime will continue to compete successfully; (ii) the Company's future product
offerings will keep pace with the technological changes implemented by its
competitors; (iii) the Company's products will satisfy evolving industry
standards or preferences of existing or prospective customers; or (iv) the
Company will be successful in developing and marketing products for any future
technology. Failure to develop and introduce new products and product
enhancements in a timely fashion could have a material adverse effect on the
Company's business, financial condition and results of operations.
Because Visual UpTime is deployed predominantly on Frame Relay networks,
the Company's near-term success will depend on the continued market acceptance
of Frame Relay technology as a preferred networking solution. The failure of
Frame Relay-based services to maintain widespread market acceptance would have a
material adverse effect on the Company's business, financial
6
<PAGE> 9
condition and results of operations. The Company is currently devoting
significant resources toward the development of additional products, including
the integration of ATM and Frame Relay technologies. There can be no assurance
that the Company will complete the development of these or any future products
in a timely fashion, that the Company will manage successfully the transition
from existing products, that the Company's future products will achieve market
acceptance, or if market acceptance is achieved, that the Company will be able
to maintain such acceptance for a significant period of time. Any inability of
the Company to develop products on a timely basis that address changing customer
needs and technologies may result in a loss of market share to competitors or
may require the Company to substantially increase development expenditures. Such
an increase in research and development expenditures will have a material effect
on the Company's business, financial condition and results of operations. There
also can be no assurance that products or technologies developed by others will
not adversely affect the Company's competitive position or render its products
or technologies noncompetitive or obsolete.
Products as complex as those offered by the Company may contain undetected
errors or failures when first introduced or as new versions are released. There
can be no assurance that, despite testing by the Company and by current and
potential customers, errors will not be found in new products after commencement
of commercial shipments. The occurrence of such errors could result in the loss
of or delay in market acceptance of the Company's products, diversion of
development resources, damage to the Company's reputation or increases in
service or warranty costs, any of which could have a material adverse effect
upon the Company's business, financial condition and results of operations.
INTENSE AND EVOLVING COMPETITION
The WAN equipment market is highly competitive. The Company faces
competition from participants in three distinct market segments: the WAN access
equipment market, the network test and analysis market and the market for
telecommunications operational support systems ("OSS"). Companies participating
in these market segments which compete or can be expected to compete with the
Company include ADC Telecommunications, Inc. ("ADC"), Adtran, Inc. ("Adtran"),
Concord Communications, Inc. ("Concord"), Digital Link Corp. ("Digital Link"),
HP, NetScout Systems, Inc. ("NetScout"), Network Associates, Inc. ("Network
Associates"), Paradyne Corporation ("Paradyne") and Sync Research, Inc.
("Sync").
The Company expects that it may experience price competition from products
and services that provide a portion of the functionality provided by Visual
UpTime. In particular, as prices for network equipment components such as data
service units/channel service units ("DSU/CSUs") decrease, customers may decide
to purchase these less expensive products even though they lack certain features
offered by the Company's products. The Company expects that, in some cases,
participants with strong capabilities in these various segments may partner with
each other to offer products that supply functionality approaching that provided
by Visual UpTime. The Company is aware of such arrangements between Digital Link
and NetScout, and NetScout and Paradyne.
Many of the Company's current and possible competitors have greater
financial, technical, marketing and other resources than the Company, and some
have well established relationships with current and potential customers of the
Company. As a result, these competitors may be able to respond to new or
emerging technologies and changes in customer requirements more effectively than
the Company, or devote greater resources than the Company to the development,
promotion and sale of products. Increased competition may result in price
reductions, reduced profitability and loss of market share, any of which would
have a material adverse effect on the Company's business, financial condition
and results of operations.
POTENTIAL FLUCTUATIONS IN QUARTERLY OPERATING RESULTS
The Company's revenue and operating results may vary significantly from
quarter to quarter and from year to year as a result of a number of factors,
including the size and timing of orders, product mix and shipment of systems.
The timing of order placement, size of orders, satisfaction of
7
<PAGE> 10
contractual customer acceptance criteria, as well as order delays or deferrals
and shipment delays and deferrals, may cause material fluctuations in revenue.
Operating results may also fluctuate on a quarterly basis based upon factors
such as the continued acceptance of Frame Relay-based products, demand for the
Company's current and future product offerings, the introduction of product
enhancements by the Company or its competitors, market acceptance of new
products offered by the Company or its competitors and the size, timing,
cancellation or delay of customer orders, including cancellation or delay in
anticipation of new product offerings. The Company's quarterly operating results
are also affected by the budgeting cycles of customers, the relative percentages
of products sold through the Company's direct and indirect sales channels,
product pricing and competitive conditions in the industry. Any unfavorable
changes in these or other factors could have a material adverse effect on the
Company's business, financial condition and results of operations. Accordingly,
the Company believes that period-to-period comparisons of its results of
operations may not be meaningful and should not be relied upon as an indication
of future performance. Furthermore, there can be no assurance that the Company
will be able to achieve profitability on a quarterly or annual basis.
CHALLENGES OF INTEGRATION OF NET2NET
Achieving the anticipated benefits of the merger between Visual Networks
and Net2Net will depend in part upon whether the integration of the two
companies' businesses is accomplished in an efficient and effective manner, and
there can be no assurance that this will occur. The successful combination of
companies in a rapidly changing high technology industry may be more difficult
to accomplish than in other industries. The combination of the two companies
requires, among other things, integration of the companies' respective product
offerings and coordination of their sales and marketing and research and
development efforts. There can be no assurance that such integration will be
accomplished smoothly or successfully. The difficulties of such integration are
increased by the necessity of coordinating geographically separated
organizations and addressing possible differences in corporate cultures and
management philosophies. The integration of certain operations will require the
dedication of management resources which may temporarily distract attention from
the day-to-day business of the combined companies. The business of the combined
companies may also be disrupted by employee uncertainty and lack of focus during
such integration. The inability of management to successfully integrate the
operations of the two companies and, in particular to integrate and retain key
engineering personnel, could have a material adverse effect on the Company's
business, results of operations and financial condition.
HISTORY OF LOSSES AND ACCUMULATED DEFICIT
The Company was organized in 1993 and introduced Visual UpTime in mid-1995.
Accordingly, the Company has only a limited operating history upon which an
evaluation of the Company, its products and prospects can be based. At June 30,
1998, the Company had an accumulated deficit of $33.3 million. The Company
incurred losses from operations for the years ended December 31, 1995, 1996 and
1997 and for the six months ended June 30, 1998 of $3.5 million, $12.4 million,
$7.1 million and $8.3 million, respectively. The loss incurred during the last
three years resulted primarily from expenditures associated with the development
and marketing of the Company's products. The loss for the six months ended June
30, 1998 was due primarily to merger-related costs associated with the
acquisition of Net2Net.
There can be no assurance that the Company's revenue will grow or be
sustained in future periods. Although the Company has recently experienced an
increase in revenue from providers, such growth should not be considered
indicative of future revenue growth, if any, or of future operating results. The
Company's revenue in any period depends primarily on the volume and timing of
orders received during the period, which are difficult to predict. The Company's
expense levels are based, in part, on its expectation of future revenue. If
revenue levels are below expectations due to delays associated with customers'
decision-making processes or for any other reason, operating results are likely
to be materially and adversely affected. Results of operations may be affected
8
<PAGE> 11
disproportionately by a reduction in revenue because a large portion of the
Company's expenses are fixed and cannot be easily reduced without adversely
affecting the Company's business. In addition, the Company currently intends to
increase its funding of research and product development, increase its sales and
marketing and customer support operations and expand distribution channels. To
the extent such expenses precede or are not promptly followed by increased
revenue, the Company's business, financial condition and results of operations
could be materially and adversely affected. For the foregoing reasons, there can
be no assurance that the Company will be profitable in any future period.
DEPENDENCE ON SOLE AND LIMITED SOURCE SUPPLIERS AND FLUCTUATIONS IN COMPONENT
PRICING
Certain key components used in the manufacture of the Company's products
are currently purchased only from sole, single or limited sources. At present,
sole-source components, where the Company has identified no other supplier for
the components, include framers, certain semiconductors, embedded communications
processors, communication controllers and line interface components. While
alternative suppliers have been identified for certain key components, those
alternative sources have not been qualified by the Company. The qualification
process could be lengthy and no assurance can be given that any additional
sources would become available to the Company on a timely basis, or, if such
sources were to become available, that the Company would not experience a
degradation in the quality of components provided by such new suppliers. The
Company generally does not have long-term agreements with its suppliers that
guarantee the continuity of supply for sole, single or limited source components
or that provide protection against sudden increases in component prices. The
Company has from time to time experienced minor delays in the receipt of key
components, and any future difficulty in obtaining sufficient and timely
delivery of them could result in delays or reductions in product shipments,
which, in turn, could have a material adverse effect on the Company's business,
financial condition and results of operations. In the event any significant
supplier becomes unable or unwilling to continue to supply required components
for the Company's products, the Company would have to identify and qualify
acceptable replacements. In addition, although the Company's sole or limited
source suppliers are all based in the United States, some of them may
manufacture components, or acquire components from, outside of the United
States. If events in a country where a key component is produced reduce or
eliminate the supply of such component, and the Company's supplier is unable to
obtain the component from another country, the Company would have to identify
and qualify acceptable replacements. Any interruption in the supply of required
or key components, or the inability of the Company to procure these components
from alternate sources at acceptable prices and within a reasonable time, could
have a material adverse effect upon the Company's business, financial condition
and results of operations. In the event of significant increases in the cost of
components, the Company would be forced either to increase the price of its
products or accept lower profit margins. In particular, certain of Visual
UpTime's key components, including dynamic random access memories ("DRAMs") and
embedded communications processors, are subject to fluctuations in pricing. An
increase in prices for the Company's products resulting from such component
price fluctuations would make the Company's products less competitive with
products which do not incorporate such components. Lower margins or less
competitive product pricing could have a material adverse effect on the
Company's business, financial condition and results of operations.
MANAGEMENT OF CHANGE AND EXPANSION
Since its inception, the Company has experienced rapid and significant
growth, including a significant increase in its number of employees. This growth
and changes in the Company's operations have placed significant demands on the
Company's administrative, operational, technical and financial resources. To
compete effectively, and to manage future growth, if any, the Company must
continue to strengthen, on a timely basis, its operational, financial and
management information reporting systems and its controls and procedures, and to
expand, train and manage its work force. There can be no assurance that the
Company will be able to take such actions successfully.
9
<PAGE> 12
The failure of the Company's management team to effectively manage growth could
have a material adverse effect on the Company's business, financial condition
and results of operations.
DEPENDENCE ON KEY PERSONNEL
The Company's success depends to a significant degree upon the continuing
contributions of its key management and technical employees, particularly Scott
E. Stouffer, Chairman, President and Chief Executive Officer. The loss of the
services of any key employee would adversely affect the Company's business,
financial condition and results of operations. The Company maintains, and is the
beneficiary under, a $2.0 million key person life insurance policy on Mr.
Stouffer. The Company believes that its future success will depend in large part
upon its ability to attract and retain highly-skilled managerial, sales,
marketing, customer support and product development personnel. The Company
requires sales consultants and product development personnel who are highly
technically trained in the field of telecommunications, and the competition for
such individuals is intense. The Company has at times experienced, and continues
to experience, difficulty in recruiting qualified personnel. There can be no
assurance that the Company will be successful in retaining its key employees or
that it can attract or retain additional skilled personnel as required. Failure
to attract and retain key personnel would have a material adverse effect on the
Company's business, financial condition and results of operations.
INTELLECTUAL PROPERTY AND PROPRIETARY RIGHTS
As the number of products in the network management industry increases and
the functionality of these products further overlaps, companies may increasingly
become subject to claims of infringement or misappropriation of the intellectual
property or proprietary rights of others. There can be no assurance that third
parties will not assert infringement or misappropriation claims against the
Company in the future with respect to current or future products, or that any
such assertion will not require the Company to enter into royalty arrangements
or litigation that would be costly to the Company. Any claims or litigation,
with or without merit, could result in a diversion of management's attention and
the Company's financial resources, which could have a material adverse effect on
the Company's business, financial condition and results of operations. Adverse
determinations in such claims or litigation could also have a material adverse
effect on the Company's business, financial condition and results of operations.
While the Company believes that its success will depend principally upon
its ability to develop and effectively market products that meet the
requirements of customers for service level management functionality, its
ability to compete is also dependent in part upon its proprietary technology and
rights. The Company holds one patent and also relies on copyright and trade
secret laws, trademarks, confidentiality procedures and contractual provisions
to protect its proprietary software, documentation and other proprietary
information. There can be no assurance that the confidentiality agreements and
other methods on which the Company relies to protect its trade secrets and
proprietary information and rights will be adequate to prevent competitors from
developing similar technology. Moreover, in the absence of patent protection,
the Company's business may be adversely affected by competitors that develop
functionally equivalent technology. Furthermore, the Company may be subject to
additional risk as it enters into transactions in countries where intellectual
property laws are not well developed or enforced effectively. Legal protection
of the Company's rights may be ineffective in such countries, and technology
developed or used in such countries may not be protectable in jurisdictions
where protection is ordinarily available. Litigation to defend and enforce the
Company's intellectual property rights, regardless of the final outcome of such
litigation, could result in substantial costs and diversion of resources and
could have a material adverse effect on the Company's business, financial
condition and results of operations. There can also be no assurance that the
Company's trade secrets or non-disclosure agreements will provide meaningful
protection of the Company's proprietary information. The Company's inability to
protect its proprietary rights would have a material adverse effect on the
Company's business, financial condition and results of operations.
10
<PAGE> 13
CONTROL BY DIRECTORS AND OFFICERS
The Company's officers, directors and their affiliates will, in the
aggregate, beneficially own approximately % of the Company's outstanding
Common Stock after the Offerings. As a result, these stockholders, if acting
together, would be able effectively to control substantially all matters
requiring approval by the stockholders of the Company, including the election of
directors. This ability may have the effect of delaying or preventing a change
in control of the Company, or causing a change in control of the company which
may not be favored by the Company's other stockholders. See "Management" and
"Principal and Selling Stockholders".
VOLATILITY OF STOCK PRICE
Between February 1998 when the Company's Common Stock became publicly
traded and the date hereof, the closing sales price of the Common Stock has
ranged from a low of $16.81 per share to a high of $37.75 per share. The
offering of shares of Common Stock pursuant to this Prospectus, the limited
trading history of the Common Stock, the relatively small size of the Company's
stockholder base, announcements concerning the Company or its competitors,
quarterly fluctuations in operating results, announcements of technological
innovations, the introduction of new products or changes in product pricing
policies by the Company or its competitors, changes in proprietary rights or
changes in earnings estimates or recommendations by analysts could cause the
market price of the Common Stock to fluctuate substantially. In addition, stock
prices for many technology companies fluctuate widely for reasons which may be
unrelated to operating results. Such fluctuations in the Company's market price
of the Common Stock may affect the visibility and credibility of the Company in
its markets. These fluctuations, as well as general economic, political and
market conditions such as recessions, international instabilities or military
conflicts, may materially and adversely affect the market price of the Common
Stock.
IMMEDIATE AND SUBSTANTIAL DILUTION
Purchasers of the Common Stock offered hereby will suffer immediate and
substantial dilution of $23.66 per share in the net tangible book value from an
assumed public offering price of $26.75 per share. To the extent outstanding
options to purchase the Company's Common Stock are exercised, there will be
further dilution. See "Dilution".
ANTITAKEOVER CONSIDERATIONS
The Company's Board of Directors has the authority to issue up to 5,000,000
shares of preferred stock ("Preferred Stock") and to determine the price,
rights, preferences, privileges and restrictions, including voting rights, of
those shares without any further vote or action by the stockholders. The rights
of the holders of Common Stock will be subject to, and may be adversely affected
by, the rights of the holders of any Preferred Stock that may be issued in the
future. See "Description of Capital Stock -- Preferred Stock". The issuance of
Preferred Stock could have the effect of making it more difficult for a third
party to acquire a majority of the outstanding voting stock of the Company.
Furthermore, certain provisions of the Company's Certificate of Incorporation
and Bylaws and of Delaware law could delay or make more difficult a merger,
tender offer or proxy contest involving the Company. The Company is subject to
the anti-takeover provisions of Section 203 of the Delaware General Corporation
Law. In general, the statute prohibits a publicly held Delaware corporation from
engaging in a "business combination" with an "interested stockholder" for a
period of three years after the date of the transaction in which the person
became an interested stockholder, unless the business combination is approved in
a prescribed manner.
The Company's Certificate of Incorporation contains other provisions that
may have the effect of delaying or preventing a change in control of the
Company, including a classified Board of Directors and a limitation on
stockholder action by written consent. See "Description of Capital
Stock -- Delaware Law and Certain Charter Provisions". In addition, the
Company's credit facility with Silicon Valley Bank prohibits the Company from
engaging in a merger with or being acquired by another entity without the bank's
consent.
11
<PAGE> 14
YEAR 2000 COMPLIANCE
Many currently installed operating systems and software products are coded
to accept only two digit entries in the date code field. These date code fields
need additional digits to distinguish 21st century dates from 20th century
dates. As a result, computer systems and/or software used by many companies may
need to be upgraded to comply with such "Year 2000" requirements. Significant
uncertainty exists in the software industry concerning the potential effects
associated with such compliance. The Company is in the process of reviewing its
internal systems to ensure Year 2000 compliance. The Company believes that the
purchasing patterns of customers and potential customers may be significantly
affected by Year 2000 issues. Many companies are expending significant resources
to correct or patch their current software systems for Year 2000 compliance.
These expenditures may result in reduced funds available to purchase software
products such as those offered by the Company. Conversely, Year 2000 issues may
cause other companies to accelerate purchases, thereby causing an increase in
short-term demand and a consequent decrease in long-term demand for software
products.
Additionally, Year 2000 compliance issues could cause a significant number
of companies, including current customers of the Company, to re-evaluate their
current systems' needs, and as a result, consider switching to other systems or
suppliers. This could have a material adverse effect on the Company's business,
operating results and financial condition.
SHARES ELIGIBLE FOR FUTURE SALE
Sales of a substantial number of shares of Common Stock, or the perception
that such sales could occur, could adversely affect prevailing market prices for
the Common Stock and could impair the Company's ability to raise capital through
the sale of equity securities. Upon completion of the Offerings, the Company
will have outstanding 20,886,099 shares of Common Stock, assuming no exercise of
outstanding options. Of the Common Stock outstanding upon completion of the
Offerings, the 3,500,000 shares of Common Stock offered hereby as well as the
4,025,000 shares issued in the Company's initial public offering (the "IPO")
will be freely tradeable without restriction or further registration under the
Securities Act, except for shares held by "affiliates" of the Company or persons
who have been affiliates within the preceding three months. Approximately
2,153,196 shares issued or issuable upon exercise of options outstanding under
the Company's 1994 Stock Option Plan, 1997 Stock Option Plan, 1997 Directors'
Stock Option Plan and the Net2Net 1994 Stock Plan (collectively, the "Stock
Plans") as of June 30, 1998, which have been registered on Form S-8 under the
Securities Act, will also be freely tradeable. Approximately 998,419 shares are
available for grants under the Stock Plans, which upon exercise, will be freely
tradeable.
The Company also has a significant number of shares of Common Stock
outstanding that have not been registered under the Securities Act. Of these
shares, approximately shares are eligible for sale under Rule 144,
Rule 144(k), Rule 701 or otherwise and, unless held by an affiliate, are freely
tradeable. Of such shares, 210,488 shares will be eligible for sale on August 5,
1998. Approximately of the shares that will be eligible for sale under
Rule 144, Rule 144(k) or Rule 701 are subject to a 90-day lock-up agreement with
the Underwriters and approximately of the shares so eligible are
subject to a 45-day lock-up agreement with the Underwriters. Other shares of
Common Stock will become eligible for sale under Rule 144 or Rule 701 at varying
times. See "Shares Eligible for Future Sale". The Company is unable to estimate
the number of shares which may be sold under Rule 144 or Rule 701 or pursuant to
registration rights since this will depend upon the market price of the Common
Stock, the individual circumstances of the sellers and other factors.
12
<PAGE> 15
The holders of 10,119,845 shares of Common Stock have the right to require
the Company to register under the Securities Act the sale of such shares of
Common Stock, subject to certain limitations. The holders of 15,537,918 shares
of Common Stock have the right to require the Company to include their shares in
a registered offering of securities by the Company for its own account. Of these
shares, approximately 2,500,000 shares are being sold by the Selling
Stockholders in the Offerings. See "Description of Capital Stock -- Registration
Rights of Certain Holders" and "Shares Eligible for Future Sale".
DISCRETIONARY USE OF PROCEEDS
The net proceeds to the Company from the Offerings, estimated at $24.6
million (at an assumed public offering price of $26.75 per share), will be used
for general corporate purposes and have not been designated for any particular
purpose. Accordingly, the Company will have broad discretion as to the
application of such proceeds. See "Use of Proceeds".
13
<PAGE> 16
USE OF PROCEEDS
The net proceeds to the Company from the sale of the 1,000,000 shares of
Common Stock offered by the Company hereby are estimated to be $24.6 million
($28.4 million if the Underwriters' over-allotment option is exercised in full)
based on an assumed public offering price of $32.50 per share. The Company will
not receive any proceeds from the sale of Common Stock by the Selling
Stockholders in the Offerings. See "Principal and Selling Stockholders".
The Company has no current plans for the net proceeds of the Offerings. The
Company intends to add the net proceeds from the Offerings to working capital,
where such proceeds will be available to support general corporate purposes
which are expected to include capital equipment expenditures to support selling
and marketing, manufacturing and product development activities. A portion of
the proceeds may also be used to acquire or invest in complementary businesses
or products or to obtain the right to use complementary technologies. From time
to time, in the ordinary course of business, the Company evaluates potential
acquisitions of such businesses, products or technologies. However, the Company
has no present understandings, commitments or agreements with respect to any
material acquisition of other businesses, products or technologies. Pending use
of the net proceeds for any purposes, the Company intends to invest such funds
in short-term, interest-bearing, investment grade obligations.
PRICE RANGE OF COMMON STOCK
The Company's Common Stock has been traded on the Nasdaq National Market
under the symbol "VNWK" since February 6, 1998. The following table sets forth,
for the periods indicated, the range of high and low closing sales prices for
the Common Stock as reported on the Nasdaq National Market:
<TABLE>
<CAPTION>
HIGH LOW
------ ------
<S> <C> <C>
1998:
First Quarter (from February 6, 1998).................. $26.00 $16.81
Second Quarter......................................... $37.25 $28.25
Third Quarter (through July 31, 1998).................. $37.75 $25.13
</TABLE>
On July 31, 1998, the last reported sale price of the Common Stock was
$26.75 per share. At June 30, 1998, the Company had approximately 201
stockholders of record.
DIVIDEND POLICY
The Company has never paid or declared any cash dividends on its Common
Stock. It is the present policy of the Company to retain earnings to finance the
growth and development of the business and, therefore, the Company does not
anticipate declaring or paying cash dividends on its Common Stock in the
foreseeable future. In addition, the Company's credit facility with Silicon
Valley Bank prohibits the Company from paying cash dividends without the bank's
consent. See Note 2 of Notes to Consolidated Financial Statements.
14
<PAGE> 17
CAPITALIZATION
The following table sets forth the capitalization of the Company as of June
30, 1998 on an actual basis and as adjusted to reflect the sale of 1,000,000
shares of Common Stock offered by the Company hereby and the application of the
estimated net proceeds therefrom (at an assumed public offering price of $32.50
per share). This table should be read in conjunction with the Company's
Consolidated Financial Statements and Notes thereto appearing elsewhere in this
Prospectus.
<TABLE>
<CAPTION>
JUNE 30, 1998
-----------------------
ACTUAL AS ADJUSTED
-------- -----------
(IN THOUSANDS)
(UNAUDITED)
<S> <C> <C>
Long-term debt.............................................. $ 228 $ 228
Stockholders' equity (deficit):
Preferred stock, $.01 par value, 5,000,000 shares
authorized, no shares issued and outstanding (actual
and as adjusted)(1).................................... -- --
Common stock, $.01 par value, 50,000,000 shares
authorized, 19,886,099 shares issued and outstanding
(actual), 20,886,099 shares issued and outstanding (as
adjusted)(2)........................................... 199 209
Deferred compensation..................................... (227) (227)
Additional paid-in capital................................ 73,306 97,892
Accumulated deficit....................................... (33,267) (33,267)
-------- ---------
Total stockholders' equity.................................. 40,011 64,607
-------- ---------
Total capitalization........................................ $ 40,239 $ 64,835
======== =========
</TABLE>
- ---------------
(1) See Note 3 of Notes to Consolidated Financial Statements.
(2) Excludes 3,101,077 shares of Common Stock reserved for issuance under the
Stock Plans, under which options to purchase 2,101,686 shares at a weighted
average exercise price of $5.05 were outstanding as of June 30, 1998. See
"Management -- Stock Plans" and Note 5 of Notes to Consolidated Financial
Statements.
15
<PAGE> 18
DILUTION
The net tangible book value of the Company as of June 30, 1998 was
approximately $40.0 million, or approximately $2.01 per share of Common Stock.
Net tangible book value per share represents the amount of the Company's
stockholders' equity, less intangible assets, divided by 19,886,099 shares of
Common Stock outstanding as of June 30, 1998. After giving effect to the sale by
the Company of 1,000,000 shares of Common Stock offered hereby and receipt of
the estimated net proceeds therefrom, the adjusted net tangible book value of
the Company as of June 30, 1998 would have been approximately $64.6 million, or
$3.09 per share. This represents an immediate increase in such net tangible book
value of $1.08 per share to existing stockholders and an immediate dilution of
$23.66 per share to new investors. The following table illustrates this per
share dilution:
<TABLE>
<S> <C> <C>
Public offering price per share............................. $26.75
------
Net tangible book value per share as of June 30, 1998..... $2.01
Increase per share attributable to new investors.......... 1.08
-----
Net tangible book value after the Offerings................. 3.09
------
Dilution per share to new investors......................... $23.66
======
</TABLE>
16
<PAGE> 19
SELECTED CONSOLIDATED FINANCIAL DATA
The selected consolidated financial data below should be read in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and the consolidated financial statements, notes
thereto and other financial information included elsewhere in this Prospectus.
The selected consolidated financial data as of and for the years ended December
31, 1995, 1996 and 1997, are derived from consolidated financial statements of
the Company which have been audited by Arthur Andersen LLP, independent public
accountants. The selected consolidated financial data for the period from
inception through December 31, 1993 and for the year ended December 31, 1994 are
derived from audited consolidated financial statements not included in this
Prospectus. The selected consolidated financial data for the six months ended
June 30, 1997 and 1998 have been derived from the unaudited consolidated
financial statements of the Company, which in the opinion of management, include
all adjustments (consisting only of normal recurring adjustments) necessary to
present fairly the information set forth therein. The results for the six months
ended June 30, 1998 are not necessarily indicative of the results that may be
expected for the full year or for any future period.
<TABLE>
<CAPTION>
FOR THE PERIOD SIX MONTHS
FROM INCEPTION ENDED
(AUGUST 12, 1993) YEAR ENDED DECEMBER 31, JUNE 30,
THROUGH --------------------------------------- ------------------------
DECEMBER 31, 1993 1994 1995 1996 1997 1997 1998
----------------- ----- ------- -------- ---------- ---------- -----------
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) (UNAUDITED)
<S> <C> <C> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF
OPERATIONS DATA:
Revenue........................... $ -- $ -- $ 567 $ 8,279 $ 27,345 $ 10,217 $ 22,306
Cost of goods sold................ -- -- 242 3,687 10,754 4,127 8,901
---- ----- ------- -------- ---------- ---------- -----------
Gross profit.................... -- -- 325 4,592 16,591 6,090 13,405
---- ----- ------- -------- ---------- ---------- -----------
Operating expenses:
Research and development........ -- 163 2,038 5,432 7,321 3,281 4,915
Sales and marketing............. -- -- 1,187 9,483 13,182 5,851 7,287
General and administrative...... 5 276 566 2,036 3,211 1,460 2,116
Merger-related costs (1)........ -- -- -- -- -- 7,347
---- ----- ------- -------- ---------- ---------- -----------
Total operating expenses...... 5 439 3,791 16,951 23,714 10,592 21,665
---- ----- ------- -------- ---------- ---------- -----------
Loss from operations.............. (5) (439) (3,466) (12,359) (7,123) (4,502) (8,260)
Interest income, net.............. -- 1 63 166 93 66 1,055
---- ----- ------- -------- ---------- ---------- -----------
Net loss.......................... $ (5) $(438) $(3,403) $(12,193) $ (7,030) $ (4,436) $ (7,205)
==== ===== ======= ======== ========== ========== ===========
Pro forma Basic and diluted net
loss per share (2).............. $ (0.45) $ (0.29) $ (0.38)
========== ========== ===========
Pro forma Basic and diluted
weighted average common shares
outstanding (2)................. 15,532,537 15,485,515 18,862,904
========== ========== ===========
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------------------------------------- JUNE 30,
1993 1994 1995 1996 1997 1998
-------- -------- -------- -------- -------- -----------
(IN THOUSANDS) (UNAUDITED)
<S> <C> <C> <C> <C> <C> <C>
CONSOLIDATED BALANCE SHEET DATA:
Cash and cash equivalents.................... $ 1 $ 1,424 $ 3,548 $ 7,551 $ 8,902 $ 48,556
Working capital.............................. -- 1,319 3,632 7,031 103 36,977
Total assets................................. 1 1,489 5,091 13,344 18,611 61,470
Long-term debt, net of current portion....... 6 -- 86 148 374 228
Redeemable convertible preferred stock....... -- 1,170 3,385 13,398 14,855 --
Stockholders' equity (deficit)............... (5) 205 678 (4,980) (13,302) 40,011
</TABLE>
- ---------------
(1) During the six months ended June 30, 1998, the Company incurred certain
merger-related costs in connection with its acquisition of Net2Net. See Note
1 of Notes to Consolidated Financial Statements.
(2) For an explanation of the determination of the number of shares used in
computing pro forma per share amounts, see Note 1 of Notes to Consolidated
Financial Statements.
17
<PAGE> 20
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion of the financial condition and results of
operations of the Company should be read in conjunction with the Company's
consolidated financial statements, the related notes thereto, and other
financial information included elsewhere in this Prospectus. In addition to the
historical information contained herein, this Prospectus contains
forward-looking statements that involve risks and uncertainties. The Company's
actual results may differ materially from the results discussed in this
Prospectus. Factors that might cause such a difference include, but are not
limited to, those discussed in "Risk Factors", "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and "Business" as
well as those discussed elsewhere in this Prospectus.
OVERVIEW
The Company was incorporated in Maryland in August 1993 as Avail Networks,
Inc. and reincorporated in Delaware in December 1994 as Visual Networks, Inc.
From incorporation through December 1994, the Company's principal objective was
to secure sufficient equity financing to enable the Company to accelerate
product development efforts. The Company secured its initial round of equity
financing in December 1994.
During 1995 and 1996, the Company devoted substantial resources to
developing Visual UpTime for Frame Relay deployment and to developing sales and
marketing functions and general and administrative infrastructure. Visual UpTime
was first shipped in mid-1995. The Company began generating significant revenue
from sales of Visual UpTime during 1996.
During 1995 and 1996, most of the Company's sales were to subscribers. In
August 1996, the Company entered into a master reseller agreement with Sprint,
resulting in the Company's products shipping through Sprint to subscribers. In
October 1997, the Company entered into a similar master reseller agreement with
MCI, which also resulted in shipments of the Company's products through MCI to
subscribers. During 1997 and the first half of 1998, the Company has focused on
selling Visual UpTime directly to providers as part of their network
infrastructure. In December 1997, the Company entered into an agreement with
AT&T, which provides for the sale of the Company's products to AT&T for
deployment as part of AT&T's infrastructure.
The Company realizes revenue from sales of hardware, from the licensing of
related software and from maintenance contracts. The Company generally
recognizes revenue upon shipment or delivery of the product and passage of title
to the customer. Where the agreements provide for evaluation or customer
acceptance, the Company recognizes revenue upon the completion of the evaluation
process and acceptance of the product by the customer. Maintenance contracts
call for the Company to provide technical support and software updates to
customers. The Company recognizes maintenance revenue, including maintenance
revenue that is bundled with product sales, ratably over the contract period,
which currently ranges from one to three years.
The Company currently contracts with third parties for board assembly and
has manufacturing operations that perform final assembly, testing and shipping
of its product at its facilities in Rockville, Maryland and Hudson,
Massachusetts. The Company anticipates maintaining a portion of its internal
manufacturing function for the foreseeable future at its Rockville, Maryland
facility, but is exploring opportunities with contract manufacturers to have its
products assembled, tested and shipped at a third-party location.
On May 15, 1998, Visual Networks acquired Net2Net in a merger accounted for
as a pooling of interests. The combination with Net2Net will affect the future
results of the operations reported by the Company. See Note 1 of Notes to
Consolidated Financial Statements.
18
<PAGE> 21
RESULTS OF OPERATIONS
The following table presents for the periods indicated certain consolidated
statement of operations data as a percentage of the Company's revenue:
<TABLE>
<CAPTION>
SIX MONTHS
YEAR ENDED DECEMBER 31, ENDED JUNE 30,
------------------------- --------------
1995 1996 1997 1997 1998
------ ------ ----- ----- -----
<S> <C> <C> <C> <C> <C>
Revenue....................................... 100.0% 100.0% 100.0% 100.0% 100.0%
Cost of goods sold............................ 42.7 44.5 39.3 40.4 39.9
------ ------ ----- ----- -----
Gross profit................................ 57.3 55.5 60.7 59.6 60.1
------ ------ ----- ----- -----
Operating expenses:
Research and development.................... 359.4 65.6 26.8 32.1 22.0
Sales and marketing......................... 209.4 114.6 48.2 57.2 32.7
General and administrative.................. 99.8 24.6 11.7 14.3 9.5
Merger-related costs........................ -- -- -- -- 32.9
------ ------ ----- ----- -----
Total operating expenses................. 668.6 204.8 86.7 103.6 97.1
------ ------ ----- ----- -----
Loss from operations.......................... (611.3) (149.3) (26.0) (44.0) (37.0)
Interest income, net.......................... 11.1 2.0 0.3 0.6 4.7
------ ------ ----- ----- -----
Net loss...................................... (600.2)% (147.3)% (25.7)% (43.4)% (32.3)%
====== ====== ===== ===== =====
</TABLE>
SIX MONTHS ENDED JUNE 30, 1998 COMPARED WITH SIX MONTHS ENDED JUNE 30,
1997.
REVENUE. The Company recognized $22.3 million in revenue for the six months
ended June 30, 1998, a 118.6% increase over revenue of $10.2 million reported
for the six months ended June 30, 1997. The increase was due primarily to the
continued acceptance of Visual UpTime in the Frame Relay market, with a
significant increase in sales to providers, particularly Sprint and, to a lesser
extent, to the increase in sales of the Company's network analysis tools. Sales
to providers accounted for approximately 60% of revenue for the six months ended
June 30, 1998 as compared to approximately 30% for the six months ended June 30,
1997. Revenue from Sprint totaled approximately 33% and 23% of revenue for the
six months ended June 30, 1998 and 1997, respectively.
GROSS PROFIT. Cost of goods sold consists of component parts, direct
compensation costs, warranty and other contractual obligations, royalties,
license fees and other overhead expenses related to manufacturing operations.
Gross profit was $13.4 million for the six months ended June 30, 1998, as
compared to $6.1 million for the six months ended June 30, 1997, an increase of
$7.3 million. Gross margin was 60.1% of revenue for the six months ended June
30, 1998, as compared to 59.6% of revenue for the six months ended June 30,
1997. The increase in gross margin percentage was due primarily to product cost
reductions and to product sales mix. The Company's future gross margins may be
adversely affected by a number of factors, including product mix, the proportion
of sales to providers, competitive pricing, manufacturing volumes and an
increase in component parts.
RESEARCH AND DEVELOPMENT EXPENSE. Research and development expense consists
of compensation for research and development staff, depreciation of test and
development equipment, certain software development costs and costs of prototype
materials. Research and development expense was $4.9 million for the six months
ended June 30, 1998 as compared to $3.3 million for the six months ended June
30, 1997, an increase of $1.6 million. The increase in research and development
expense was due primarily to increased staffing levels and, to a lesser extent,
purchases of materials used in the development of new or enhanced products.
Research and development expense was 22.0% and 32.1% of revenue for the six
months ended June 30, 1998 and 1997, respectively. The Company expects that
research and development expenditures will increase in absolute dollars, and may
decrease as a percentage of revenue, during 1998 and thereafter. The
19
<PAGE> 22
increase in absolute dollars will support continued development of new enhanced
products and the exploration of new or complementary technologies.
SALES AND MARKETING EXPENSE. Sales and marketing expense consists of
compensation for the sales and marketing staff, commissions, pre-sales support,
travel and entertainment expense, trade shows and other marketing programs.
Sales and marketing expense was $7.3 million for the six months ended June 30,
1998, as compared to $5.9 million for the six months ended June 30, 1997, an
increase of $1.4 million. The increase in sales and marketing expense was due
primarily to increased staffing levels and related costs, such as commissions.
Sales and marketing expense was 32.7% and 57.2% of revenue for the six months
ended June 30, 1998 and 1997, respectively. The Company expects that sales and
marketing expenditures will increase in absolute dollars, and may decrease as a
percentage of revenue, during 1998 and thereafter. This increase in absolute
dollars is expected to be incurred as additional personnel are hired, field
offices are opened and promotional expenditures increase to allow the Company to
increase its market penetration and to pursue market opportunities.
GENERAL AND ADMINISTRATIVE EXPENSE. General and administrative expense
consists of finance, administration and general management activities. General
and administrative expense was $2.1 million for the six months ended June 30,
1998 as compared to $1.5 million for the six months ended June 30, 1997, an
increase of $0.6 million. The increase in general and administrative expense was
due primarily to increased staffing levels. General and administrative expense
was 9.5% and 14.3% of revenue for the six months ended June 30, 1998 and 1997,
respectively. The Company expects that general and administrative expenditures
will increase in absolute dollars, and may decrease as a percentage of revenue,
during 1998 and thereafter. The increase in absolute dollars is expected to be
required for the expansion of the Company's administrative staff and internal
systems to support expanding operations.
MERGER-RELATED COSTS. In connection with the Net2Net acquisition, the
Company recorded merger-related costs of $7.3 million in the three months ended
June 30, 1998 consisting of transaction costs, integration expenses and
restructuring charges. Transaction costs of $4.4 million consisted primarily of
fees for investment bankers, attorneys, accountants and other direct costs.
Integration expenses of $0.2 million consisted of incremental and non-recurring
costs necessary to integrate Net2Net and Visual. The restructuring charge of
$2.7 million includes severance, outplacement and other costs relating primarily
to the elimination of certain field offices, the consolidation of the Company's
manufacturing, sales, marketing and administrative functions and the
discontinuance of certain product development efforts.
INTEREST INCOME, NET. Interest income, net, for the six months ended June
30, 1998 was approximately $1.1 million as compared to $66,000 for the six
months ended June 30, 1997. The increase was due to the significant increase in
cash and cash equivalents between periods resulting from the proceeds of the
Company's IPO in February 1998.
NET LOSS. Net loss for the six months ended June 30, 1998 was $7.2 million
as compared to a net loss of $4.4 million for the six months ended June 30,
1997, an increase of $2.8 million. Increased operating expenses and the effect
of the merger-related costs described above offset the increases in revenue,
gross profit and interest income achieved in 1998.
YEAR ENDED DECEMBER 31, 1997 COMPARED WITH YEAR ENDED DECEMBER 31, 1996
REVENUE. The Company recognized $27.3 million in revenue for the year ended
December 31, 1997, as compared to $8.3 million for the year ended December 31,
1996, an increase of $19.0 million. The increase was due primarily to acceptance
of Visual UpTime in the Frame Relay market and to sales resulting from the
reseller agreement signed with Sprint in August 1996 and, to a lesser extent, to
the increase in sales of the Company's network analysis tools. Revenue from this
reseller agreement accounted for approximately 27% of revenue for the year ended
December 31, 1997.
20
<PAGE> 23
GROSS PROFIT. Gross profit was $16.6 million for the year ended December
31, 1997, as compared to $4.6 million for the year ended December 31, 1996, an
increase of $12.0 million. Gross margin was 60.7% for the year ended December
31, 1997, as compared to 55.5% for the year ended December 31, 1996. The
increase in gross margin percentage was due primarily to product cost reductions
and to the mix of product sales.
RESEARCH AND DEVELOPMENT EXPENSE. Research and development expense was $7.3
million for the year ended December 31, 1997, as compared to $5.4 million for
the year ended December 31, 1996, an increase of $1.9 million. The increase in
research and development expense was due primarily to increased staffing levels
and, to a lesser extent, purchases of materials used in the development of new
or enhanced products.
SALES AND MARKETING EXPENSE. Sales and marketing expense was $13.2 million
for the year ended December 31, 1997, as compared to $9.5 million for the year
ended December 31, 1996, an increase of $3.7 million. The increase in sales and
marketing expense was due primarily to increased staffing levels.
GENERAL AND ADMINISTRATIVE EXPENSE. General and administrative expense was
$3.2 million for the year ended December 31, 1997, as compared to $2.0 million
for the year ended December 31, 1996, an increase of $1.2 million. The increase
in general and administrative expense was due primarily to increased staffing
levels.
NET LOSS. The Company's net loss was $7.0 million for the year ended
December 31, 1997, as compared to net loss of $12.2 million for the year ended
December 31, 1996, a decrease of $5.2 million. This decrease was due primarily
to the revenue and gross profit increases described above.
YEAR ENDED DECEMBER 31, 1996 COMPARED WITH YEAR ENDED DECEMBER 31, 1995
REVENUE. The Company recognized $8.3 million in revenue for the year ended
December 31, 1996, as compared to $0.6 million for the year ended December 31,
1995, an increase of $7.7 million. The increase was due primarily to the initial
acceptance of Visual UpTime by subscribers and, to a lesser extent, to the
increase in sales of the Company's network analysis tools and network management
products.
GROSS PROFIT. Gross profit was $4.6 million for the year ended December 31,
1996, as compared to $0.3 million for the year ended December 31, 1995, an
increase of $4.3 million. Gross margin was 55.5% for the year ended December 31,
1996.
RESEARCH AND DEVELOPMENT EXPENSE. Research and development expense was $5.4
million for the year ended December 31, 1996, as compared to $2.0 million for
the year ended December 31, 1995, an increase of $3.4 million. The increase in
research and development expense was due primarily to increased staffing levels
and, to a lesser extent, purchases of materials used in the development of new
or enhanced products. Research and development expense was 65.6% of revenue for
the year ended December 31, 1996.
SALES AND MARKETING EXPENSE. Sales and marketing expense was $9.5 million
for the year ended December 31, 1996, as compared to $1.2 million for the year
ended December 31, 1995, an increase of $8.3 million. The increase in sales and
marketing expense was due primarily to increased staffing levels. Sales and
marketing expense was 114.6% of revenue for the year ended December 31, 1996.
GENERAL AND ADMINISTRATIVE EXPENSE. General and administrative expense was
$2.0 million for the year ended December 31, 1996, as compared to $0.6 million
for the year ended December 31, 1995, an increase of $1.4 million. The increase
in general and administrative expense was due primarily to increased staffing
levels and the development of infrastructure to support the antici-
21
<PAGE> 24
pated revenue growth. General and administrative expense was 24.6% of revenue
for the year ended December 31, 1996.
NET LOSS. The Company's net loss was $12.2 million for the year ended
December 31, 1996, as compared to a net loss of $3.4 million for the year ended
December 31, 1995, an increase of $8.8 million. This increase was due primarily
to increased operating expenses which offset the revenue and gross profit
increases described above.
22
<PAGE> 25
SELECTED QUARTERLY CONSOLIDATED RESULTS OF OPERATIONS
The following tables present consolidated statement of operations data in
dollars and as a percentage of the Company's revenue. This quarterly information
is unaudited but has been prepared on a basis consistent with the Company's
audited consolidated financial statements presented elsewhere herein, and in the
Company's opinion, includes all adjustments (consisting only of normal recurring
adjustments), necessary for a fair presentation of the information for the
quarters presented. The results of operations for any quarter are not
necessarily indicative of results that may be expected for any subsequent
periods. See "Risk Factors -- Potential Fluctuations in Quarterly Operating
Results".
<TABLE>
<CAPTION>
QUARTER ENDED
---------------------------------------------------------------------------------------
SEPT. 30, DEC. 31, MAR. 31, JUN. 30, SEPT. 30, DEC. 31, MAR. 31, JUN. 30,
1996 1996 1997 1997 1997 1997 1998 1998
--------- -------- -------- -------- --------- -------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF
OPERATIONS DATA:
Revenue.......................... $ 2,168 $ 3,260 $ 3,988 $ 6,229 $ 7,934 $ 9,194 $10,327 $11,979
Cost of goods sold............... 1,044 1,334 1,705 2,422 2,987 3,640 4,541 4,360
------- ------- ------- ------- ------- ------- ------- -------
Gross profit................... 1,124 1,926 2,283 3,807 4,947 5,554 5,786 7,619
------- ------- ------- ------- ------- ------- ------- -------
Operating expenses:
Research and development....... 1,632 1,588 1,584 1,697 1,835 2,205 2,427 2,488
Sales and marketing............ 3,008 3,099 2,839 3,012 3,451 3,880 3,698 3,589
General and administrative..... 489 760 690 770 830 921 1,190 926
Merger-related costs........... -- -- -- -- -- -- -- 7,347
------- ------- ------- ------- ------- ------- ------- -------
Total operating expenses..... 5,129 5,447 5,113 5,479 6,116 7,006 7,315 14,350
------- ------- ------- ------- ------- ------- ------- -------
Loss from operations............. (4,005) (3,521) (2,830) (1,672) (1,169) (1,452) (1,529) (6,731)
Interest income, net............. 11 60 37 29 2 25 389 666
------- ------- ------- ------- ------- ------- ------- -------
Loss before income taxes......... (3,994) (3,461) (2,793) (1,643) (1,167) (1,427) (1,140) (6,065)
Income taxes..................... -- -- -- -- -- -- (495) 495
------- ------- ------- ------- ------- ------- ------- -------
Net loss......................... $(3,994) $(3,461) $(2,793) $(1,643) $(1,167) $(1,427) $(1,635) $(5,570)
======= ======= ======= ======= ======= ======= ======= =======
</TABLE>
<TABLE>
<CAPTION>
QUARTER ENDED
---------------------------------------------------------------------------------------
SEPT. 30, DEC. 31, MAR. 31, JUN. 30, SEPT. 30, DEC. 31, MAR. 31, JUN. 30,
1996 1996 1997 1997 1997 1997 1998 1998
--------- -------- -------- -------- --------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF
OPERATIONS DATA:
Revenue.......................... 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Cost of goods sold............... 48.2 40.9 42.8 38.9 37.6 39.6 44.0 36.4
------- ------- ------- ------- ------- ------- ------- -------
Gross profit................... 51.8 59.1 57.2 61.1 62.4 60.4 56.0 63.6
------- ------- ------- ------- ------- ------- ------- -------
Operating expenses:
Research and development....... 75.3 48.7 39.7 27.2 23.1 24.0 23.5 20.8
Sales and marketing............ 138.7 95.1 71.2 48.3 43.5 42.2 35.8 30.0
General and administrative..... 22.5 23.3 17.3 12.4 10.5 10.0 11.5 7.7
Merger-related costs........... -- -- -- -- -- -- -- 61.3
------- ------- ------- ------- ------- ------- ------- -------
Total operating expenses..... 236.5 167.1 128.2 87.9 77.1 76.2 70.8 119.8
------- ------- ------- ------- ------- ------- ------- -------
Loss from operations............. (184.7) (108.0) (71.0) (26.8) (14.7) (15.8) (14.8) (56.2)
Interest income, net............. 0.5 1.8 0.9 0.5 0.0 0.3 3.8 5.6
------- ------- ------- ------- ------- ------- ------- -------
Loss before income taxes......... (184.2) (106.2) (70.1) (26.3) (14.7) (15.5) (11.0) (50.6)
Income taxes..................... -- -- -- -- -- -- (4.8) 4.1
------- ------- ------- ------- ------- ------- ------- -------
Net loss......................... (184.2)% (106.2)% (70.1)% (26.3)% (14.7)% (15.5)% (15.8)% (46.5)%
======= ======= ======= ======= ======= ======= ======= =======
</TABLE>
THREE MONTHS ENDED SEPTEMBER 30, 1997, DECEMBER 31, 1997, MARCH 31, 1998
AND JUNE 30, 1998.
Revenue has increased in each of the last four quarters from $7.9 million
for the three months ended September 30, 1997 to $9.2 million, $10.3 million and
$12.0 million for the three months ended December 31, 1997, March 31, 1998 and
June 30, 1998, respectively. These increases were due
23
<PAGE> 26
primarily to the continued acceptance of Visual UpTime in the Frame Relay market
and increases in sales to subscribers by Sprint and other providers and, to a
lesser extent, to the increase in sales of the Company's network analysis tools
and network management products. The Company's sales strategy is to focus on
selling Visual UpTime to providers for deployment as part of their core network
infrastructure. There can be no assurance that the Company will be successful in
executing this provider deployment sales model and the impact of this sales
model, if successfully implemented, on the Company's future growth is uncertain.
See "Business -- Sales, Marketing and Support".
Gross margins were 62.4%, 60.4%, 56.0% and 63.6% for three months ended
September 30, 1997, December 31, 1997, March 31, 1998 and June 30, 1998,
respectively. Gross margins for these periods are primarily affected by the
product mix of sales between the Company's Visual UpTime products and network
analysis tools, as well as by the Company's continued focus on cost reductions.
The Company's future gross margins may be adversely affected by a number of
factors, including product mix, proportion of sales to providers, competitive
pricing, manufacturing volumes and increases in component costs.
The Company's operating expenses have increased in each of the last four
quarters, from $6.1 million in the three month period ended September 30, 1997
to $7.0 million, $7.3 million and $14.4 million in the three month periods ended
December 31, 1997, March 31, 1998 and June 30, 1998, respectively. The increases
were due primarily to increased staffing in sales and marketing and to a lesser
extent increases in research and development and administrative personnel. The
Company expects that operating expenses will continue to increase for the
remainder of 1998 as the Company attempts to increase its market penetration,
develops new and enhanced products, and increases administrative staff and the
systems required to support the Company's expanding operations. Operating
expenses (excluding the effect of merger-related costs) as a percentage of
revenue have declined from 77.1% of revenue for the three months ended September
30, 1997 to 76.2%, 70.8% and 58.5% of revenues for the three month periods ended
December 31, 1997, March 31, 1998 and June 30, 1998, respectively. The Company
expects that operating expenses as a percentage of revenue will continue to
decrease as, and if, its revenue increases.
The Company's quarterly revenue and operating results may vary
significantly as a result of a number of factors, including the size and timing
of orders, product mix and shipment of systems. Operating results may also
fluctuate on a quarterly basis based upon factors such as the continued
acceptance of Frame Relay-based products, demand for the Company's current and
future product offerings, the introduction of product enhancements by the
Company or its competitors and market acceptance of new products offered by the
Company or its competitors. The Company's quarterly operating results are also
affected by the budgeting cycles of customers, the relative percentages of
products sold through the Company's direct and indirect sales channels, product
pricing and competitive conditions in the industry. Any unfavorable changes in
these or other factors could have a material adverse effect on the Company's
business, financial condition and results of operations. Accordingly, the
Company believes that period-to-period comparisons of its results of operations
may not be meaningful and should not be relied upon as an indication of future
performance. Furthermore, there can be no assurance that the Company will be
able to achieve profitability on a quarterly or annual basis.
LIQUIDITY AND CAPITAL RESOURCES
At June 30, 1998, the Company's combined balance of cash and cash
equivalents was $48.6 million as compared to $8.9 million as of December 31,
1997. This increase is primarily attributable to the $45.4 million in net
proceeds that the Company received from the sale of common stock in its IPO in
February 1998. Cash used in operating activities was $3.7 million during the six
months ended June 30, 1998, primarily for funding operating losses of Net2Net,
as well as to pay bonuses and commissions related to the year ended December 31,
1997 and for increases in
24
<PAGE> 27
inventories. Capital expenditures were approximately $2.0 million during the six
months ended June 30, 1998.
On May 15, 1998, Visual acquired Net2Net in a stock transaction accounted
for as a pooling of interests. In the three months ended June 30, 1998, the
Company incurred merger-related costs of approximately $7.3 million. The payment
of these costs will constitute a significant use of cash by the Company during
the remainder of 1998.
The Company requires substantial working capital to fund its business,
particularly to finance inventories, accounts receivable, research and
development activities and capital expenditures. The Company currently has
commitments for capital expenditures for the remainder of 1998 that are not
expected to exceed $2.5 million. The Company's future capital requirements will
depend on many factors, including the rate of revenue growth, if any, the timing
and extent of spending to support product development efforts and expansion of
sales and marketing, the timing of introductions of new products and
enhancements to existing products and market acceptance of the Company's
products. There can be no assurance that additional equity or debt financing, if
required, will be available on acceptable terms, if at all.
In addition to the Company's cash and cash equivalents, the Company's other
principal source of liquidity is its bank credit facility. The credit facility
includes a revolving line of credit providing for borrowings up to the lesser of
$7.0 million or 80% of eligible accounts receivable (as defined in the credit
facility). The agreement entitles Silicon Valley Bank to a security interest in
the Company's inventory and accounts receivable. The agreement contains
restrictive financial covenants, including, but not limited to, restrictions
related to liquidity and net worth as well as restrictions related to
acquisitions, dispositions of assets, distributions and investments. Interest is
payable monthly at the prime rate plus 0.25%. As of July 31, 1998, there were no
borrowings outstanding under the bank credit facility. The Company and the bank
have a letter of intent to modify the terms of the credit facility.
Substantially all of the Company's product sales to date have been made to
customers in the U.S. The Company intends to increase its sales efforts in
foreign markets. The Company plans to sell its products to foreign customers at
prices denominated in U.S. dollars. However, if the Company commences selling
material volumes of product to such customers at prices not denominated in U.S.
dollars, the Company intends to adopt a strategy to hedge against fluctuations
in foreign currency.
25
<PAGE> 28
BUSINESS
OVERVIEW
The Company designs, manufactures and sells WAN service level management
systems for statistically multiplexed technologies such as Frame Relay, ATM and
IP/Internet. The Company's Visual UpTime system combines WAN access
functionality with innovative software for performance monitoring,
troubleshooting and network planning. Visual UpTime provides instrumentation for
network performance measurement and analysis that allows providers to achieve
the service levels required by their subscribers and to lower operating costs
associated with statistically multiplexed services. The availability of
performance monitoring and troubleshooting instrumentation also allows
subscribers to verify the service levels being supplied by their service
provider and monitor traffic traversing the WAN, a requirement for many
subscribers wishing to use statistically multiplexed services to carry
mission-critical data traffic. The Company believes Visual UpTime systems are
deployed in configurations managing up to 1,300 circuits and the system is
currently designed to support configurations of up to 30,000 circuits on a
single managed network.
The Company believes it is a worldwide leader in providing WAN service
level management systems and has shipped systems for deployment on an aggregate
of over 25,000 WAN circuits. The Company has developed relationships with major
service providers such as AT&T, Sprint, MCI, Ameritech, Bell Atlantic and
BellSouth. These service providers either resell Visual UpTime to their
subscribers or integrate Visual UpTime into their networks to enable them to
offer enhanced data transport service levels. Visual UpTime has been deployed in
Frame Relay networks utilized by over 425 subscribers, including ABN-AMRO Bank,
Cargill, Inc., Delta Air Lines, Inc., EDS, FedEx, Household International, Inc.,
Marriott, Reynolds and Waste Management, Inc. For the year ended December 31,
1997, and the six months ended June 30, 1998, the Company had revenue of $27.3
million and $22.3 million, respectively.
Vertical Systems, a leading WAN Industry analyst, estimates that
approximately 920,000 Frame Relay circuits and 30,000 ATM circuits will be
installed worldwide from 1998 through 2000. To take advantage of this projected
growth in these markets, the Company plans to expand its relationships with its
service provider customers which together account for the majority of
statistically-multiplexed traffic worldwide. The percentage of revenue
attributable to sales to service providers increased from approximately 30% of
revenue for the six months ended June 30, 1997, to approximately 60% of revenue
for the six months ended June 30, 1998. Sprint, AT&T and MCI accounted for 27%,
7% and 2%, respectively, of revenue for the year ended December 31, 1997, and
33%, 12% and 11%, respectively, of revenue for the six months ended June 30,
1998.
INDUSTRY BACKGROUND
WAN SERVICES MARKET
The WAN services market has grown rapidly with the increase in computing
and the associated data traffic volumes carried over WANs. WAN services are used
to interconnect the computing facilities of geographically dispersed sites
within an enterprise or to connect the computing facilities of one enterprise to
another. The Company believes WAN data traffic volumes will continue to expand
rapidly due to three key trends driving telecommunications markets worldwide:
- Proliferation of distributed computing applications such as electronic
mail, electronic transaction processing, enterprise resource planning and
inter-enterprise information transfer based on Web technologies;
- Deregulation of the telecommunications services industry, which has
intensified competition and resulted in decreasing prices of WAN
services; and
26
<PAGE> 29
- The continued deployment of high capacity fiber-optic networks and the
emergence of high-bandwidth network access technologies that increase the
ability to transfer large volumes of electronic information.
Vertical Systems forecasts that WAN traffic on leased-line, Frame Relay and
ATM services in the U.S. market will triple from 1996 to 2000, estimates the
U.S. market for these services exceeded $13 billion in 1997 and projects that it
will grow to $19.5 billion in 2000. Vertical Systems estimates that the non-U.S.
market for these services exceeded $13 billion in 1997.
WAN NETWORK DEPLOYMENT
A typical WAN deployment to support distributed computing environments
includes various types of customer premise equipment ("CPE") owned by the
subscriber, deployed at the subscriber's sites and interconnected by the WAN
service. The points at which the subscriber CPE connects to the WAN service are
known as service demarcations ("demarcs"). The subscribers are responsible for
network performance on the subscriber side of the demarcs, while providers are
responsible for network performance on the provider side of the demarcs.
TYPICAL WAN DEPLOYMENT
[WAN DEPLOYMENT CHART]
The equipment used for Frame Relay, ATM and IP/Internet services comprises
both the access equipment located at the subscriber premises and the switches
located at the provider's central office. Access equipment includes devices such
as DSU/CSUs, FRADs (frame relay access devices), frame relay cards for routers
and ATM access multiplexers. Vertical Systems projects that the markets for this
equipment will grow significantly in parallel with the projected growth in the
underlying service markets. The market for Frame Relay, ATM and IP/Internet
access equipment is projected to grow from $353 million in 1996 to $1.4 billion
in 2000.
WAN NETWORK ARCHITECTURES
WAN services are provided through two network architectures, time division
multiplexing ("TDM") and statistical multiplexing. TDM services, such as
leased-line and ISDN, rely on
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architectures which provide dedicated circuits between computing facilities and
provide fixed bandwidth regardless of traffic flow. Unless information is
continuously transmitted, the dedicated bandwidth is often idle, resulting in
the inefficient use of expensive bandwidth. The use of dedicated bandwidth does,
however, provide guaranteed throughput and fixed delay, ensuring high quality of
service for all network traffic. Consequently, TDM services are suitable for the
large installed base of mainframe computing environments running
mission-critical, host-centric applications where the variability in traffic
volume is low and the traffic volume is relatively predictable. By contrast,
statistical multiplexing technologies and their derivative services, such as
Frame Relay, ATM, IP/Internet, X.25 and Switched Multimegabit Data Services
("SMDS"), are based on the concept of shared bandwidth which is dynamically
allocated in real time according to prevailing traffic patterns. As a result of
this shared bandwidth, WANs based on these services can be up to 50% less
expensive than WANs based on leased-line services for distributed computing
applications. Because bandwidth in the WAN is shared among multiple subscribers,
however, these services are generally characterized by "best efforts" throughput
and variable delay, often resulting in lower quality of service more suitable
for non-mission-critical distributed computing applications where the traffic is
highly variable and unpredictable.
WAN services are undergoing a significant shift from TDM architectures to
statistically multiplexed architectures. Vertical Systems estimates that
worldwide revenues for Frame Relay service, the most widely used service, grew
at a compound annual growth rate of 117% between 1995 and 1997 and will grow at
a compound annual growth rate of 41% through the year 2000. The worldwide number
of installed Frame Relay circuits is projected to grow from approximately
580,000 in 1997 to more than 1.5 million in 2000. ATM services, which are
characterized by higher capacities and higher speeds, are less widely offered
today but also are projected to experience rapid growth. The worldwide number of
installed ATM circuits is projected by Vertical Systems to grow from
approximately 4,000 in 1997 to more than 33,000 in 2000. Accordingly, the U.S.
market for Frame Relay and ATM services is expected to shift from 12% of WAN
bandwidth in 1996 to nearly 40% in 2000 (with the majority of growth attributed
to Frame Relay services) while the U.S. market for leased-line services is
expected to decrease from approximately 88% of WAN bandwidth to 60% from 1996 to
2000.
The growth of statistically multiplexed services has resulted in increased
focus by subscribers on WAN service levels, defined by parameters such as
service availability, throughput and delay. Subscribers have historically been
able to tolerate the lower reliability and quality of service of statistically
multiplexed services because most of the distributed computing applications
supported by these services, including E-mail and file transfer, were not
mission-critical. Today, however, the importance of distributed computing
applications is increasing as enterprises implement newer mission-critical
applications for enterprise resource planning, transaction processing, work
group collaboration, remote telecommuting, sales force automation and electronic
order entry. Subscribers, therefore, are demanding that their providers offer,
achieve and, increasingly, guarantee higher service levels.
The proliferation of statistically multiplexed services has also resulted
in increased administrative costs for subscribers as more network managers
manage multiple networks consisting of leased-line services supporting
mission-critical legacy applications and statistically-multiplexed services
supporting recently-deployed, distributed computing applications. The high cost
of administering multiple networks coupled with the attractive pricing of
statistically-multiplexed services is driving the need for subscribers to
consolidate their applications onto a single statistically-multiplexed WAN. The
migration of mainframe computing environments running mission-critical
host-centric applications onto lower cost statistically multiplexed services has
highlighted the need to provide higher service levels with such services. This
migration and the proliferation of distributed computing applications have also
generated subscriber demand for providers to offer multiple classes of service
levels. Multiple service levels enable subscribers to deploy statistically
multiplexed WANs that have service characteristics commensurate with the
performance requirements
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of their differing computing applications, thereby optimizing price and
performance. Subscriber demand for multiple, guaranteed and verified WAN service
levels presents challenges to providers, which must be able to offer these
service levels while maintaining profitability.
The WAN services segment of deregulated telecommunications markets is
intensely competitive and price sensitive, and cost leadership tends to drive
competitive strategies. Providers can only achieve cost leadership if they can
realize economies of scale. They must also avoid a costly dependence on highly
skilled personnel for service provisioning and maintenance, a dependence that
has historically existed for statistically multiplexed services. Therefore,
providers face the challenge of increasing the manageability of statistically
multiplexed services while simultaneously developing service deployment and
operational models that can satisfy rapid growth requirements and achieve
economies of scale.
PROBLEMS MANAGING FRAME RELAY, ATM AND IP/INTERNET SERVICES
In leased-line environments, the performance, quality and maintainability
of the service are independent of the volume and type of traffic running over
the service. Accordingly, the diagnostic and measurement capabilities required
to sufficiently maintain these services are fairly simplistic and are focused
largely on physical transmission characteristics such as bit error rates or line
coding violations. These capabilities are widely available within the providers'
facilities and work in conjunction with simple DSU/CSUs deployed by the
subscribers. By contrast, the performance, quality and maintainability of
statistically multiplexed services are highly dependent on the volume and type
of traffic running over the service. This extensive interplay between the
subscriber application traffic and the provider service dictates the need for
sophisticated diagnostic and measurement capabilities which not only analyze
physical transmission characteristics but can also analyze the traffic itself.
Historically, this level of measurement and analysis capability has generally
required the use of expensive portable protocol analyzers, which are typically
not deployed on a continuous basis at the demarc. This inability to measure
service performance and quality has created difficulties for both subscribers
and providers including the following:
SUSPECT SERVICE LEVELS INHIBIT SUBSCRIBER ACCEPTANCE OF
SERVICE. Subscribers generally view statistically multiplexed services as
offering deficient service levels and are therefore reluctant to run
mission-critical applications across statistically multiplexed WANs. As the
demand for higher service levels and multiple service levels has increased,
subscribers and providers need a mechanism to measure, verify and improve
service levels at the demarc.
OPERATIONAL COST MODELS ARE NOT SCALEABLE. The inability to
cost-effectively measure performance at the demarc, and thereby demonstrate to
subscribers the WAN service level being provided, results in providers requiring
many highly skilled personnel to provision and operate statistically multiplexed
services. This cost is exacerbated by the gap between the demand for and supply
of such personnel. The implication of this model is that operating costs are
driven up and providers' WAN service businesses are not scaleable to the levels
required to generate the economies of scale necessary for cost leadership. The
specific areas of concern are:
- INEFFICIENT SERVICE PROVISIONING. It is difficult for the provider to
ascertain if the WAN service is properly deployed until the subscriber's
network has been connected to the service and the subscriber's
applications are operational. This often results in multiple dispatches
of personnel to the subscriber site and extensive interaction with the
subscriber for its equipment and applications to be configured properly
for the WAN service. At the same time, the provider is typically
restricted from billing the subscriber for the service until the
subscriber's applications are working properly over the WAN service.
- EXTENSIVE TROUBLESHOOTING AND HIGH MAINTENANCE. When the subscriber
applications experience degraded performance, subscribers generally
assume there is a problem with the WAN service supplied by the provider.
It can often take days, weeks or even months to diagnose the causes of
degraded performance and require highly skilled personnel with
sophisticated
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instrumentation and diagnostic tools. Although these degraded performance
conditions are frequently caused by faulty or misconfigured subscriber
equipment or applications, the provider is forced to expend significant
time and effort without reimbursement to help the subscriber diagnose the
problem.
- INACCURATE NETWORK ENGINEERING AND PLANNING. The shared bandwidth nature
of these WAN services coupled with subscriber demand for many classes of
service levels increases the importance of accurate network planning and
design to ensure that the network architecture is optimized for
performance and cost. If the network is engineered with excess capacity,
it may improve the performance of subscriber applications, but it will
tend to negate the inherent bandwidth efficiencies of statistically
multiplexed technologies. By contrast, if the network is designed with
inadequate capacity, performance will suffer. Successful network
engineering and planning is dependent on accurate historical usage
information which, because of the inability of traditional equipment to
measure traffic at the demarc, is difficult to ascertain for these
services.
The Company believes that the potential subscriber demand for statistically
multiplexed services has been constrained by the inability to manage and verify
service levels. Additionally, the Company believes that it will be difficult for
providers to meet the increasing demand for statistically multiplexed services
without systems for managing service levels because the labor-intensity of
provisioning and maintaining the service inhibits the providers' ability to
scale these WAN services profitably. As the providers' focus shifts to
profitability, the growth in Frame Relay, ATM and IP/Internet services will
depend, in part, on the ability of providers to implement systems that can
manage service levels, lower operational costs and increase scaleability.
THE VISUAL NETWORKS SOLUTION
The Company's Visual UpTime offering is a leading WAN service level
management system that combines WAN access functionality with planning,
monitoring and troubleshooting capabilities and enables the implementation of
required service levels while simultaneously decreasing the costs and complexity
of achieving such levels. Visual UpTime deploys instrumentation for measurement
and analysis at the demarc and provides innovative software applications that
address the historical problems of managing service levels.
INCREASED CONFIDENCE IN SERVICE LEVELS. By instrumenting the demarc, Visual
UpTime enables providers and subscribers to accurately measure, report on and
improve service levels. These abilities serve to clarify the relationship
between subscriber and provider, resulting in increased subscriber confidence in
running mission-critical computing applications on statistically multiplexed
services.
INCREASED SCALEABILITY AND LOWER COSTS OF PROVIDERS' OPERATIONAL MODEL.
Visual UpTime can reduce the labor-intensive nature of deploying statistically
multiplexed services, decreasing providers' costs and increasing their ability
to generate revenues:
- RAPID AND COST-EFFECTIVE SERVICE PROVISIONING. Visual UpTime allows the
provider to verify that its service is properly provisioned without
waiting for the subscriber network or applications to be connected and
configured. This tends to reduce customer support costs during initiation
of service. Additionally, it positions the provider to begin billing for
the service earlier than was previously possible.
- REDUCED NEED FOR TROUBLESHOOTING. Visual UpTime reduces the need for
providers to perform troubleshooting by continuously monitoring the
service performance at the demarc and proactively alerting the provider
and subscriber to anomalous performance characteristics. Such early
warnings allow the network operator to take corrective action before the
performance of any computing application on the network is impaired.
Furthermore, since many of the anomalous characteristics are
subscriber-related, the subscriber is more likely to
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take corrective action without involving the provider. The net result of
this early warning system is that fewer maintenance personnel are
required to solve fewer problems, thereby increasing provider efficiency
and subscriber satisfaction.
- MORE RAPID BUT LESS COSTLY TROUBLESHOOTING. Because Visual UpTime
provides information which enables isolation of problems between provider
network and subscriber equipment and applications, the provider can more
quickly diagnose the cause of faulty or degraded performance. With Visual
UpTime, many problems that would otherwise last for days and require
on-site visits of highly skilled personnel can be diagnosed remotely
within minutes. Because Visual UpTime is architected to allow both the
provider and the subscriber to access the same reports and analyses
simultaneously, more problem conditions can be resolved collaboratively.
- MORE ACCURATE NETWORK ENGINEERING AND PLANNING. Visual UpTime
continuously provides an accurate and detailed view of historical WAN
service usage patterns along with automated guidance regarding the need
to change circuit capacities. This allows subscribers and providers to
implement a network design optimized for cost and performance.
VISUAL NETWORKS' STRATEGY
The Company's strategy is to maintain and build upon its market leadership
in the deployment of WAN service level management systems for statistically
multiplexed WAN services. Key elements of the Company's strategy include:
EMBED SERVICE LEVEL MANAGEMENT FUNCTIONALITY INTO NETWORK
INFRASTRUCTURE. Visual UpTime provides an innovative integration of service
level management functionality with WAN access equipment. The Company believes
that this integration substantially enhances the cost effectiveness of deploying
Visual UpTime.
DEPLOY VISUAL UPTIME AS PART OF PROVIDER NETWORKS. The Company believes
providers will become the predominant vehicle for the deployment of service
level management systems such as Visual UpTime. Although these systems can be
deployed by either providers or subscribers, the Company believes the maximum
benefit is achieved when the systems are deployed by the providers and access to
performance data is provided by the providers to their subscribers. In this
deployment model, providers can employ collaborative fault and performance
management techniques that lead to greater network quality. More importantly,
the Company believes the benefits of lower provisioning and maintenance costs
may be most effectively captured if the system is deployed by the provider.
EXTEND TECHNOLOGY LEADERSHIP. The Company believes a combination of
technological competencies have been crucial to its success. These competencies
include network analysis technology and its application to the effective
operation of WANs, the integration of network analysis with WAN access
technology, and collaborative subscriber/provider system architectures. Since
introducing Visual UpTime in mid-1995, the Company has continued to invest in
its core competencies by focusing on feature development, architectural
enhancements and cost reductions. The Company intends to continue to invest in
the development of Visual UpTime, with particular emphasis on features and
architectural improvements designed to accommodate large scale deployment by
providers. This includes leveraging its current Frame Relay, ATM and IP/Internet
technologies to provide customers with a single-vender solution for end-to-end
service level management as well as to address emerging opportunities such as
virtual private networks ("VPN") over the Internet.
ACHIEVE COST LEADERSHIP. The Company believes its sales levels represent a
volume advantage over any other systems being used to manage statistically
multiplexed WAN services. The Company intends to leverage this volume advantage
with investments in cost reduction to continue to provide the lowest cost WAN
service level management system.
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EXPAND SALES AND SUPPORT FUNCTIONS GLOBALLY. Although over 70% of the
worldwide circuits for Frame Relay and ATM are deployed in the U.S., many of the
Company's largest provider and subscriber customers are multinational
corporations. The Company intends to develop a presence outside of the U.S. with
particular focus on the providers which have the largest share of the worldwide
markets for Frame Relay, ATM and IP/Internet services.
LEVERAGE OUTSOURCED MANUFACTURING MODEL. The Company believes scaleable and
flexible manufacturing will be critical to its growth. The Company believes it
can best meet these requirements by outsourcing the majority of its
manufacturing, allowing the Company to focus on its core competencies in product
development and sales and marketing.
PRODUCTS
VISUAL UPTIME SYSTEM
Visual UpTime is a service level management system consisting of analysis
service elements ("ASEs"), performance archive managers ("PAMs") and platform
applicable clients ("PACs") that perform data collection, data interpretation
and presentation, respectively. By intelligently monitoring network-wide
performance, Visual UpTime enables users to track and solve service level
problems either on the subscriber or provider side of the demarc.
THE VISUAL UPTIME SYSTEM
[THE VISUAL UPTIME SYSTEM CHART GRAPHIC]
ASE. The ASE is a combination of embedded proprietary software and hardware
that performs detailed analysis of network performance at the demarc. Most
versions of the ASE provide the functionality of WAN access equipment, such as a
DSU/CSU. Visual UpTime ASEs use sophisticated proprietary software in
conjunction with networking-specific microprocessors and integrated circuits to
perform detailed analysis of every bit, frame and packet traversing the demarc.
The ASEs generally store the analysis results locally in memory and wait for the
PAM to request the results. When the ASE detects an anomalous condition, it
sends an unsolicited alert to the PAM so that network operators can take prompt
action. The analysis results are organized in accordance with the structure of
standard management information bases ("MIBs") as defined by the Internet
Engineering Task Force ("IETF"). These MIBs are compatible with simple network
management protocol ("SNMP") and include relevant parts of industry standard
MIBs such as MIB I, MIB II and the remote monitoring ("RMON") MIB. Additionally,
the ASEs include proprietary MIB extensions that provide added value for WAN
service level management. Depending on customer requirements, the Company's core
ASE technology can be deployed in a number of configurations based on
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physical circuit speed, number of virtual circuits supported, type of access
functionality and subscriber local area network environment.
PAM. The PAM is the system database and request broker between the PACs and
either the database or ASEs. The PAM runs the Company's proprietary software on
Microsoft's WindowsNT Server and SQL Server database. The PAM communicates with
the PACs using a proprietary application programming interface ("API"). The PAM
communicates with the ASEs using either SNMP or trivial file transfer protocol
("TFTP"). Unlike traditional SNMP management architectures which depend on
continuous polling between the manager (PAM) and agents (ASEs), a bandwidth
consuming process, Visual UpTime distributes most of the processing burden to
the ASE, allowing the PAM-ASE data sharing to take place less frequently,
typically once a day. This feature is critical in WAN environments where costly
bandwidth makes continuous management polling impractical.
PAC. The PAC is Visual UpTime's client software for packaging and
presenting information stored in the PAM and ASE. Multiple PACs may access a
single PAM or ASE. Current versions of the PAC run on Windows95, WindowsNT and
major versions of UNIX.
The PAC includes three integrated toolsets:
PERFORMANCE MONITORING. This toolset is an early warning system,
alerting operators to impending service degradation, that allows corrective
action to be taken before the subscriber's application performance
degrades. This toolset displays network performance related events and
alarms. The performance monitoring toolset is tightly linked to the
troubleshooting toolset, allowing an operator to evaluate quickly and
precisely the conditions which caused the event or alarm.
TROUBLESHOOTING. This toolset enables an operator to rapidly perform
detailed diagnostics to identify the cause of service level problems. This
toolset displays real-time and historical network performance statistics.
The troubleshooting toolset includes a protocol capture and analysis
capability used by network operators to isolate problems arising from the
interplay between a subscriber's CPE or applications and the WAN service.
PLANNING AND REPORTING. This toolset is a report generation tool that
creates a wide variety of reports from the network performance data stored
in the PAM. This toolset is used primarily for capacity planning and
network engineering, management of service level agreements between
provider and subscriber and executive reporting from the network operations
staff to senior management personnel. The planning and reporting toolset is
accessible through a PAC or a Web-browser.
The Visual UpTime components are sold as a complete system which requires
at least one PAC/PAM per deployment along with one ASE deployed at the demarc of
each circuit on which service level management is required. The system
architecture currently supports configurations with up to 30,000 circuits. The
Company believes the system is currently deployed in configurations managing
more than 1,300 circuits. System pricing varies by size of deployment and
relative mix between circuit speeds. For the six months ended June 30, 1998, the
Company's average selling price per system approximated $1,500 for each circuit
on which the system was deployed. The Company expects its average selling price
to decrease significantly as its sales to providers increase.
ANALYZER
The Company's analyzer (the "Analyzer") is a combination of embedded
proprietary software and hardware and Microsoft Windows presentation software
that performs detailed analysis of network performance on ATM circuits. The
Windows software running on a Pentium-based computer connects either locally or
remotely to the hardware to perform detailed analysis of every bit, cell and
packet traversing the ATM circuit. The Analyzer is designed to meet both the
network monitoring and troubleshooting needs of field support personnel and the
centralized operational needs for supporting remote ATM circuits. Depending on
customer requirements, the Analyzer can be utilized in a number of
configurations based on physical circuit speed, access line type and
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monitoring application. The Company distributes the Analyzer through a number of
channels, including VARs, resellers and OEM arrangements. The Company expects
that it will utilize the OEM channel for future sales.
VISUAL'S SELLING STRATEGY AND VISUAL UPTIME SYSTEM DEPLOYMENT MODELS
The Company has deployed a long-term, multi-stage selling strategy.
Initially, the Company sold Visual UpTime to subscribers, with the objective of
creating demand among subscribers for higher service levels for statistically
multiplexed WAN services and stimulating demand among providers for the
infrastructure necessary to provide and maintain such service levels. In 1995
and 1996, the majority of the Company's sales were made to subscribers directly
or through value-added resellers. At the same time, the Company commenced
marketing Visual UpTime to providers for resale or lease as value-added CPE in
conjunction with their service offerings. In furtherance of this stage of the
Company's selling strategy, the Company has executed reseller agreements with
Sprint and MCI. The portion of the Company's revenue derived from these and
other provider relationships has grown from approximately 30% for the six months
ended June 30, 1997 to approximately 60% for the six months ended June 30, 1998.
Substantially all Visual UpTime systems sold to date have been deployed by
subscribers and are configured so that only the subscriber has access to the WAN
service performance data collected and presented by the system ("subscriber
deployment model"). The Company recently has focused on demonstrating to
providers the incremental value of provisioning and operating cost savings
arising from wide scale deployment by the provider. The Company's selling
strategy contemplates an evolution of the deployment model so that sales of
Visual UpTime systems will be made directly to providers and the providers will
deploy the systems as a part of their network infrastructure ("provider
deployment model").
SUBSCRIBER DEPLOYMENT MODEL
In the subscriber deployment model, a subscriber deploys an ASE instead of
conventional WAN access equipment on each circuit to be managed, thus providing
instrumentation on every circuit. The PAM is deployed at the subscriber's
network operations center. PACs are deployed wherever there are subscriber
network operators who need to access the system.
SUBSCRIBER DEPLOYMENT MODEL
[GRAPHIC: SUBSCRIBER DEPLOYMENT MODEL]
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PROVIDER DEPLOYMENT MODEL
In the provider deployment model, the WAN access equipment is similarly
replaced by an ASE. The ASE is then owned by the provider and represents a
critical element of the provider's network infrastructure, thereby extending the
WAN service demarc to include the functionality of the WAN access equipment. By
extending WAN service level management capabilities to the subscriber's site,
the providers will be in a position to offer a new class of "intelligent"
service levels, which can effectively increase revenue, increase quality of
service levels and decrease cost at the same time. The provider can scale the
service by adding additional ASEs. In the provider deployment model, the PAM is
deployed within the provider's network operations center and one PAM typically
supports multiple subscribers, yielding significant economies of scale for the
provider. PACs are deployed at the provider network operations center and at the
subscriber network operations centers, enabling simultaneous access for
providers and subscribers to the information generated by Visual UpTime.
PROVIDER DEPLOYMENT MODEL
[GRAPHIC: PROVIDER DEPLOYMENT MODEL]
PRODUCT DEVELOPMENT
The Company has developed core competencies in network analysis technology
and its application to the effective operation of WANs, the integration of
network analysis with WAN access technology and collaborative
subscriber/provider system architectures.
The Company has made significant investments in Visual UpTime architecture
and feature development. Through the acquisition of Net2Net, the Company has
accelerated the development of ATM functionality into Visual UpTime to provide
customers with a single-vendor solution for end-to-end service level management,
encompassing Frame Relay, ATM and IP/Internet. In addition, the Company will
continue to expand the functionality of Visual UpTime to address emerging
opportunities such as VPNs over the Internet. The Company is focused on the
further enhancement and refinement of Visual UpTime, including the development
of the architectural scaleability that will be required for wide-scale
implementation through the provider deployment model. Additionally, the Company
expects to invest in system refinements which increase the economic benefit of
deployments outside North America. The Company's success will depend to a
substantial degree on its ability to bring to market in a timely fashion new
products and enhancements to Visual UpTime that
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meet changing market requirements. The Company expects to employ a combined
strategy of developing products internally and acquiring products and technology
to meet evolving market requirements.
As of June 30, 1998, there were 77 persons working in the Company's
research and development area, 23 of whom focus on ATM technologies. The
Company's research and development expenditures were $2.0 million, $5.4 million,
$7.3 million and $4.9 million for the years ended December 31, 1995, 1996 and
1997, and the six months ended June 30, 1998, respectively.
CUSTOMERS
Visual UpTime has been shipped to more than 425 subscribers. Subscriber
deployments represent the majority of deployments to date. The following
subscribers each have generated, either directly or through resellers,
cumulative revenue of more than $250,000:
<TABLE>
<S> <C>
ABN-AMRO Bank Federal Express Corporation
Cargill, Inc. Household International, Inc.
Columbia Gas System Inc. Marriott International, Inc.
Delta Air Lines, Inc. Waste Management, Inc.
EDS
</TABLE>
The Company is dependent on a small number of customers for a substantial
portion of its revenue. For the year ended December 31, 1996, sales of products
or services to HP and Sprint accounted for 10% and 8%, respectively, of the
Company's revenue. For the year ended December 31, 1997, sales of products or
services to Sprint, FedEx and AT&T accounted for 27%, 9% and 7%, respectively,
of the Company's revenue. For the six months ended June 30, 1998, sales of
products or service to Sprint, AT&T and MCI accounted for 33%, 12% and 11%,
respectively, of the Company's revenue. See "Risk Factors -- Dependence on Major
Customers".
Since mid-1996, the Company has developed business relationships with a
number of providers, including AT&T, MCI, Sprint, Ameritech, Bell Atlantic and
BellSouth. These providers supply approximately 50% of worldwide Frame Relay and
ATM services. While these relationships are at different levels of business
maturity, the portion of the Company's revenue derived from these relationships
has grown from approximately 30% in the six months ended June 30, 1997, to
approximately 60% in the six months ended June 30, 1998. The Company expects to
expend substantial additional effort to evolve these business partners to the
provider deployment model. See "Risk Factors -- Implementation of Provider
Deployment Model; Lengthy Sales Cycle".
AT&T RELATIONSHIP
In December 1997, the Company entered into a non-exclusive procurement
agreement with AT&T. The agreement is for an initial term of three years and
automatically renews until terminated by either party upon 30 days' notice.
Prices and discounts for all equipment purchased by AT&T are fixed for the term,
except in certain limited circumstances. The equipment carries a five-year
warranty. If the Company offers more favorable prices and terms to any other
customer during the term of the agreement, the Company will amend the agreement
to provide AT&T with the same or comparable overall terms. The agreement does
not obligate AT&T to make any minimum purchases from the Company. The Company
also provides certain support services to AT&T.
MCI RELATIONSHIP
In August 1997, the Company entered into a non-exclusive three-year
reseller agreement with MCI, which automatically renews for successive one-year
terms unless terminated by either party at least 60 days prior to expiration.
Prices and discounts for all equipment purchased by MCI are fixed for the term.
The equipment carries a five year warranty. If the Company offers more favorable
prices to any other customer for the same quantity of products purchased over a
similar period of
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time, the prices charged to MCI will be adjusted to the more favorable price.
The reseller agreement does not obligate MCI to make any minimum purchases from
the Company. The Company also provides certain support services to MCI.
SPRINT RELATIONSHIP
In August 1996, the Company entered into a non-exclusive three-year
reseller agreement with Sprint. Prices for all equipment purchased by Sprint are
fixed for the term, unless Sprint does not purchase a certain minimum amount of
equipment and services, in which event prices for equipment and services are
subject to increase. The equipment carries a five year warranty. If the Company
offers more favorable prices and terms to any other customer during the term of
the agreement, such terms and prices will be applicable to Sprint's orders. The
reseller agreement does not obligate Sprint to make any minimum purchases from
the Company. The Company also provides certain escrow rights and support
services to Sprint.
SALES, MARKETING AND SUPPORT
The Company's sales, marketing and support operations vary according to the
type of deployment model being targeted:
SUBSCRIBER DEPLOYMENT
The Company has targeted subscriber deployment opportunities through a
combination of direct sales, sales through value-added resellers and integrators
and sales through providers acting in the capacity of resellers. The Company
provides pre-sale technical support to each of its channels. The development of
relationships with the various channels varies from 2 to 12 months for value
added resellers and integrators and from 12 to 24 months in the case of
providers. The sales cycle for subscriber deployment when handled directly or
through resellers is typically 4 to 6 months, and, for this reason, a large
majority of sales to date have been subscriber deployments.
PROVIDER DEPLOYMENT
The Company targets provider deployment opportunities on an account by
account basis in descending order of their Frame Relay and ATM market shares.
According to Vertical Systems, AT&T, Sprint and MCI together control more than
55% of the U.S. market and 40% of the worldwide market for Frame Relay and ATM
services. Because of current levels of competition for WAN services, the Company
believes its most significant opportunities for Visual UpTime are with
U.S.-based long distance providers. The Company believes its relationships with
AT&T, Sprint and MCI will influence other providers to adopt Visual UpTime.
The provider deployment model involves a complex sale with very large
companies. The sales cycle begins with the presentation of Visual UpTime's value
proposition to multiple departments within a provider organization followed by a
lengthy evaluation process. The Company then works with the provider to develop
a service definition and business plan for the integration of Visual UpTime into
the provider's existing services.
The Company has sales and technical support teams assigned to each account.
In addition, the Company's senior management team devotes significant time
furthering the business relationships with these providers and the Company
invests significant marketing resources to stimulate sales to these providers.
The Company expects to increase its sales, marketing and support efforts
addressed to these providers and extend those efforts to international and
IP/Internet providers.
As of June 30, 1998, the Company employed 65 persons in sales, marketing
and technical support. The Company's expenditures on sales, marketing and
support were approximately $1.2 million, $9.5 million, $13.2 million and $7.3
million for the years ended December 31, 1995, 1996 and 1997, and for the six
months ended June 30, 1998, respectively.
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COMPETITION
The markets for telecommunications equipment and software are intensely
competitive. Visual UpTime integrates key functionality traditionally found in
three distinct market segments: the WAN access equipment market; the network
test and analysis market; and the market for telecommunications OSS. The Company
believes that Visual UpTime is the only system which integrates functional
attributes from these three market segments to cost-effectively provide WAN
service level management. Because of the size and growth opportunity associated
with the WAN service level management market, the Company expects to encounter
increased competition from current and potential participants in each of these
segments. See "Risk Factors -- Intense and Evolving Competition".
WAN ACCESS EQUIPMENT
The WAN access equipment market is highly fragmented. This market includes
DSU/CSUs, low to mid-range time division multiplexers, Frame Relay access
devices and ATM access products. Leading vendors in this segment include ADC,
Paradyne, Adtran, Sync and Digital Link. The Company expects that, in some
cases, these companies may partner with companies offering network test and
analysis products in order to compete in the WAN service level management
market. The Company is aware of such arrangements between Digital Link and
NetScout and NetScout and Paradyne. Furthermore, internetworking providers, such
as Cisco Systems, Inc., may integrate WAN access functionality with routers,
which may adversely affect Visual UpTime's cost justification.
NETWORK TEST AND ANALYSIS
An essential element of a WAN service level management system is technology
and expertise associated with network test and analysis. Products in this market
include portable and distributed protocol analyzers and transmission test
instruments. The major vendors in this market segment are Network Associates,
HP, Telecommunications Techniques Corp. and NetScout.
TELECOMMUNICATIONS OPERATIONAL SUPPORT SYSTEMS
OSSs encompass all of the systems related to service deployment including
provisioning systems, billing systems, trouble-ticketing systems, and fault and
performance management systems. Historically, OSS's have been developed by the
in-house staffs of the providers and have sometimes been a source of competitive
advantage to providers. Visual UpTime provides a significant portion of the
functionality that might otherwise be found in a fault and performance
management system for statistically multiplexed WAN services. Therefore, in some
cases, a provider may consider in-house development as an alternative to
deployment of Visual UpTime.
The Company intends to compete by offering superior features, performance,
reliability and flexibility at competitive prices. The Company also intends to
compete on the strength of its relationships with providers. As competition in
the WAN service level management market increases, the Company believes that the
industry may be characterized by intense price competition similar to that
present in the broader networking market. In response to competitive trends, the
Company expects that it will continue to reduce the cost of its systems to seek
ways to improve upon Visual UpTime's price-to-performance ratio. Increased
competition may result in price reductions, reduced profitability and loss of
market share, any of which would have a material adverse effect on the Company's
business, financial condition and results of operations.
MANUFACTURING
The Company currently uses a combination of subcontracting and internal
manufacturing, but anticipates moving to a predominately outsourced
manufacturing model in order to achieve significant scaleability. In connection
with its outsourcing strategy and increased volumes, the Company is seeking to
secure additional sources of supply, including additional contract manufac-
38
<PAGE> 41
turers. The Company was recently ISO 9001 certified and has not experienced any
significant delays or material unanticipated costs resulting from the use of
subcontractors; however, such a strategy involves certain risks, including the
potential absence of adequate capacity and reduced control over delivery
schedules, manufacturing yields, quality and costs. Although the Company
attempts to maintain appropriate back-up suppliers, in the event that any
significant subcontractor were to become unable or unwilling to continue to
manufacture and/or test the Company's products in required volumes, the Company
would have to identify and qualify acceptable replacements. This qualification
process could be lengthy and no assurance could be given that any additional
sources would become available to the Company on a timely basis. A delay or
reduction in component shipments, or a delay or increase in costs in the
assembly and testing of products by third party subcontractors, could materially
and adversely affect the Company's business, financial condition and results of
operations.
Although the Company generally uses standard parts and components for its
products, several key components are currently purchased only from sole, single
or limited sources. Any interruption in the supply of these components, or the
inability of the Company or its subcontractors to procure these components from
alternate sources at acceptable prices and within a reasonable time, could have
a material adverse effect upon the Company's business, financial condition and
results of operations. See "Risk Factors -- Dependence on Sole and Limited
Source Suppliers and Fluctuations in Component Pricing".
PATENTS AND OTHER INTELLECTUAL PROPERTY RIGHTS
The Company presently has one issued patent on the "Measurement of Round
Trip Delay", which expires in April 2015. It also has three patents pending, one
of which, "Method for Apparatus for Measurement of Peak Throughput in Packetized
Data Network," has been allowed, is scheduled to be issued in the next several
months and will expire in 2016. No assurance can be given that competitors will
not successfully challenge the validity or scope of the Company's patents or
that such patents will provide a competitive advantage to the Company. As part
of its confidentiality procedures, the Company generally enters into
non-disclosure agreements with its employees and business partners and license
agreements with respect to its software, documentation and other proprietary
information. Despite these precautions, it may be possible for a third party to
copy or otherwise obtain and use the Company's products or technology without
authorization, or to develop similar technology independently. Policing
unauthorized use of the Company's products is difficult. Effective protection of
intellectual property rights is unavailable or limited in certain foreign
countries. There can be no assurance that the Company's protection of its
proprietary rights will be adequate or that the Company's competitors will not
independently develop similar technology, duplicate the Company's products or
design around any patents issued to the Company or other intellectual rights of
the Company.
The Company expects that software and communications product developers
will increasingly be subject to claims of infringement of patents as the number
of products and competitors in the Company's industry segment grows and the
functionality of products in the industry segment overlaps. The Company is not
aware that any of its products infringe the property rights of third parties.
There can be no assurance, however, that third parties will not claim such
infringement by the Company with respect to current or future products. Any such
claims, with or without merit, could result in costly litigation that could
absorb significant management time, which could have a material adverse effect
on the Company's business, financial condition and results of operations. Such
claims might require the Company to enter into license or royalty agreements.
Such license or royalty agreements, if required, may not be available on terms
acceptable to the Company or at all, which could have a material adverse effect
on the Company's business, financial condition and results of operations. See
"Risk Factors -- Intellectual Property and Proprietary Rights".
39
<PAGE> 42
LITIGATION
The Company is involved in legal proceedings from time to time in the
ordinary course of its business. Management believes that none of these legal
proceedings will have a materially adverse effect on the Company's business,
financial condition or results of operations.
FACILITIES
The Company's principal administrative, sales and marketing, research and
development and customer support facility is located in approximately 23,000
square feet of office space in Rockville, Maryland which the Company has leased
through November 2001. The Company is obligated to lease an additional 13,000
square feet at this location at the earlier of November 1999 or the departure of
the current tenant. The Company also leases 12,000 square feet of space for its
Hudson, Massachusetts facility which the Company has leased through December
1998. While the Company believes that its facilities in Rockville are adequate
for its immediate needs, it may need additional space in late 1998. The Company
is seeking to obtain alternative space in Hudson.
EMPLOYEES
As of June 30, 1998, the Company had 191 full-time employees, including 77
in product development, 48 in sales, 10 in marketing, 18 in manufacturing, 7 in
customer service and 31 in finance, centralized services and administration.
The Company's future success will depend in significant part on the
continued service of its key technical, sales and senior management personnel.
Competition for such personnel is intense and there can be no assurance that the
Company can retain its key managerial, sales and technical employees, or that it
can attract, assimilate or retain other highly qualified technical, sales and
managerial personnel in the future. None of the Company's employees is
represented by a labor union. The Company has not experienced any work stoppages
and considers its relations with its employees to be good.
40
<PAGE> 43
MANAGEMENT
EXECUTIVE OFFICERS AND DIRECTORS
The table below sets forth certain information concerning each of the
directors and executive officers of the Company:
<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<S> <C> <C>
Scott E. Stouffer........... 38 Chairman of the Board of Directors, President and
Chief Executive Officer
Peter J. Minihane........... 49 Executive Vice President, Chief Financial Officer
and Treasurer
Henry A. Cheli.............. 48 Senior Vice President, Market Operations
Gregory J. Langford......... 48 Senior Vice President, Product Operations
Robert C. Troutman.......... 42 Senior Vice President, Advance Planning
Patricia L. Cotter.......... 39 Vice President, Manufacturing Operations
Grant G. Behrman............ 44 Director
Marc F. Benson(1)........... 48 Director
Theodore R. Joseph(1)(2).... 58 Director
Ted H. McCourtney(2)........ 59 Director
Thomas A. Smith(1)(2)....... 36 Director
William J. Smith............ 64 Director
</TABLE>
- ---------------
(1) Member of the Compensation Committee.
(2) Member of the Audit Committee.
SCOTT E. STOUFFER has been Chairman of the Board of Directors, President
and Chief Executive Officer of the Company since its inception in 1993. From
August 1990 to May 1993, Mr. Stouffer was Director of Marketing of
Telecommunications Techniques Corporation, a wholly-owned subsidiary of Dynatech
Corporation, a global communications equipment and network technology company.
PETER J. MINIHANE has been Executive Vice President, Chief Financial
Officer and Treasurer of the Company since October 1997. From June 1997 to
October 1997, Mr. Minihane was Senior Vice President, Chief Financial Officer
and Treasurer of the Company. From August 1985 to May 1997, Mr. Minihane was
Executive Vice President, Chief Financial Officer and Treasurer of Microcom,
Inc., a remote access technology company.
HENRY A. CHELI has been Senior Vice President, Market Operations of the
Company since March 1997. From June 1994 to March 1996, Mr. Cheli was Senior
Vice President America's Product Business of Racal Datacom Inc., USA, a
telecommunications, electronics and technology company. From December 1993 to
June 1994, Mr. Cheli was General Manager and Corporate Vice President Network
Products Division of Andrew Corporation, Inc., a communications hardware
company. From July 1993 to December 1993, Mr. Cheli was Senior Vice President
and General Manager of America's Managed Network Services Division of Racal
Managed Service LTD, UK. From April 1992 to July 1993, Mr. Cheli was Director,
Racal Data Group Sales and Special Products of Racal Data Group LTD, UK.
GREGORY J. LANGFORD has been Senior Vice President, Product Operations of
the Company since October 1997. From November 1996 to October 1997, he was Vice
President, Product Management and Planning of the Company. From February 1995 to
August 1996, Mr. Langford was Vice President, Marketing of IPC Information
Systems, Inc, a provider of telecommunications products and services to the
financial services industry. From January 1991 to January 1995, Mr. Langford was
Vice President, Marketing, of Integrated Network Corporation, a broadband
networking company.
41
<PAGE> 44
ROBERT C. TROUTMAN has been Senior Vice President, Advance Planning of the
Company since October 1997. From the Company's inception in 1993 to October
1997, he was Vice President, Engineering and Manufacturing of the Company. From
March 1992 to March 1994, Mr. Troutman was a Vice President of Cardzilla, Inc.,
a retail company. From August 1981 until August 1992, Mr. Troutman was employed
by Telecommunications Techniques Corporation, in various capacities, including
as Director of Engineering.
PATRICIA L. COTTER has been Vice President of Manufacturing Operations of
the Company since September 1996. From October 1993 to September 1996, she was
Director of Corporate Programs at Stratus Computer, Inc., a provider of fault
tolerant computers. From 1987 to September 1993, Ms. Cotter was Manufacturing
Engineering Manager at Sun Microsystems, Inc., a provider of UNIX computing
platforms.
GRANT G. BEHRMAN has been a director of the Company since September 1996.
Mr. Behrman has been a Managing Partner of Behrman Capital, a venture capital
fund, since February 1991. Mr. Behrman is also a director of Nimbus CD
International, Inc., a compact disc manufacturing company.
MARC F. BENSON has been a director of the Company since December 1994.
Since July 1992, Mr. Benson has been a principal and partner of Mid-Atlantic
Venture Funds, formerly NEPA Venture Funds, a venture capital fund.
THEODORE R. JOSEPH has been a director of the Company since December 1995.
Mr. Joseph has been the President, Chief Executive Officer and a director of
Relay Technologies, Inc., a provider of mobile and connectivity software, since
December 1994. From March 1993 until August 1994, Mr. Joseph was the Chairman of
the Board, President and Chief Executive Officer of Bridge Builder Technologies,
Inc., a graphical user interface application development company.
TED H. McCOURTNEY has been a director of the Company since January 1996.
Mr. McCourtney has been a general partner of Venrock Associates, a venture
capital fund, since 1970. Mr. McCourtney is also a director of MedPartners,
Inc., a physician practice management company and NTL, Inc., a
telecommunications company.
THOMAS A. SMITH has been a director of the Company since September 1995.
Mr. Smith has been a principal and partner of Mid-Atlantic Venture Funds since
April 1998, and Mr. Smith has been a general partner of Edison Venture Fund III,
a venture capital fund, since June 1993. From October 1990 until May 1993, Mr.
Smith was an employee of Edison Venture Fund. Mr. Smith is a director of
Versatility, Inc., a software company.
WILLIAM J. SMITH has been a director of the Company since March 1997. Since
November 1997, Mr. Smith has been Vice President, Sales of FlowWise Networks,
Inc., an IP switching technology company. From August 1992 to October 1997, Mr.
Smith was Senior Vice President, Sales and Marketing of Premisys Communications,
Inc., an integrated digital access company.
ELECTION OF DIRECTORS
Officers of the Company are elected by the Board of Directors on an annual
basis and serve until their successors have been duly elected and qualified. The
Company's Certificate of Incorporation provides for a classified Board of
Directors consisting of three classes of directors with each class required to
be as nearly equal in number as possible. The number of directors is determined
from time to time by the Board of Directors and is currently fixed at seven
members. A single class of directors is elected each year at the Company's
annual meeting of stockholders. Directors elected at each such meeting will
serve for a term ending on the date of the third annual meeting of stockholders
after election and the election and qualification of their respective
successors. Messrs. Joseph and Benson are serving for terms expiring on the date
of the Company's 1999 Annual Meeting of Stockholders, Messrs. Stouffer,
McCourtney and William Smith are serving for terms expiring on the date of the
Company's 2000 Annual Meeting of Stockholders and
42
<PAGE> 45
Messrs. Behrman and Thomas Smith are serving for terms expiring on the date of
the Company's 2001 Annual Meeting of Stockholders.
There are no family relationships among any of the Company's directors or
executive officers.
BOARD COMMITTEES
The Company's Board of Directors currently has two committees, the Audit
Committee and the Compensation Committee. The Audit Committee, among other
things, recommends the firm to be appointed as independent accountants to audit
the Company's consolidated financial statements, discusses the scope and results
of the audit with the independent accountants, reviews with management and the
independent accountants the Company's interim and year-end operating results,
considers the adequacy of the internal accounting controls and audit procedures
of the Company and reviews the non-audit services to be performed by the
independent accountants. The current members of the Audit Committee are Messrs.
Joseph, McCourtney and Thomas Smith. The Compensation Committee reviews and
recommends the compensation arrangements for management of the Company and
administers the Company's stock option plans. The members of the Compensation
Committee are Messrs. Benson, Joseph and Thomas Smith.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
The Compensation Committee of the Company's Board of Directors was formed
in December 1994, and the current members of the Compensation Committee are
Messrs. Benson, Joseph and Thomas Smith. None of the members was, during 1997,
an officer or employee of the Company at any time.
DIRECTORS' COMPENSATION
Messrs. Joseph and William Smith have been granted options to purchase the
Company's Common Stock as compensation for their services as Board members. Mr.
Joseph was granted options to purchase 29,400 shares of Common Stock in December
1995, at an exercise price of $.19 per share, of which options to purchase 9,800
shares vested immediately and options to purchase 9,800 shares vested on each of
the first and second anniversaries of the grant date. Mr. William Smith was
granted options to purchase 27,000 shares of Common Stock in March 1997, at an
exercise price of $1.43 per share, of which options to purchase 9,000 shares
have vested and an additional 9,000 shares will vest on each of the second and
third anniversaries of the grant date.
Each Eligible Director has also received options under the Company's 1997
Directors' Stock Option Plan. See "Stock Plans -- 1997 Directors' Stock Option
Plan", below.
43
<PAGE> 46
EXECUTIVE COMPENSATION
The following summary compensation table sets forth the compensation paid
by the Company during the year ended December 31, 1997 to the Company's chief
executive officer and the four other most highly compensated executive officers
whose total compensation for services in all capacities exceeded $100,000 during
such year (the "Named Executive Officers").
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG-TERM
COMPENSATION
------------
ANNUAL COMPENSATION SECURITIES
------------------------------- UNDERLYING
YEAR SALARY BONUS(1) OTHER OPTIONS
---- -------- -------- ------- ------------
<S> <C> <C> <C> <C> <C>
Scott E. Stouffer.................. 1997 $165,000 $71,880 -- --
Chairman of the Board, President 1996 125,000 48,756 $ 3,090(2) 40,600
and Chief Executive Officer 1995 110,861 -- -- --
Peter J. Minihane.................. 1997 100,550(3) 45,939 92,951(4) 175,000
Executive Vice President, Chief 1996 -- -- -- --
Financial Officer and Treasurer 1995 -- -- -- --
Henry A. Cheli..................... 1997 119,048(3) 82,618 96,697(5) 135,000
Senior Vice President, Market 1996 -- -- -- --
Operations 1995 -- -- -- --
Gregory J. Langford................ 1997 125,000 50,940 61,662(4) 35,000
Senior Vice President, Product 1996 14,147(6) 4,167 -- 65,000
Operations 1995 -- -- -- --
Robert C. Troutman................. 1997 140,000 61,366 -- --
Senior Vice President, Advance 1996 110,000 39,482 3,090(2) 35,000
Planning 1995 100,925 -- -- --
</TABLE>
- ---------------
(1) The 1997 bonuses were paid in January 1998.
(2) Consists of payment by the Company of legal fees related to estate planning.
(3) The salaries paid Messrs. Minihane and Cheli are for the periods from their
respective dates of employment, June 15, 1997 and March 20, 1997.
(4) Consists of relocation payments.
(5) Consists of commissions of $40,000 and relocation payments of $56,697.
(6) The salary paid Mr. Langford in 1996 is for the period from his hiring in
November 1996.
44
<PAGE> 47
OPTION GRANTS
The following table provides information concerning grants of options to
purchase the Company's Common Stock made during the year ended December 31, 1997
to each of the Named Executive Officers.
<TABLE>
<CAPTION>
OPTION GRANTS IN LAST FISCAL YEAR
---------------------------------------------------------------------------------
POTENTIAL REALIZABLE VALUE
AT ASSUMED ANNUAL RATES
NUMBER OF PERCENTAGE OF OF STOCK PRICE
SECURITIES TOTAL OPTIONS APPRECIATION FOR OPTION
UNDERLYING GRANTED TO EXERCISE TERM(4)
OPTIONS EMPLOYEES IN PRICE PER EXPIRATION --------------------------
GRANTED(1) 1997(2) SHARE(3) DATE 5% 10%
---------- ------------- --------- ---------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
Scott E. Stouffer........ -- --% $ -- -- $ -- $ --
Peter J. Minihane........ 175,000 18.6 1.75 6/18/07 192,599 488,084
Henry A. Cheli........... 135,000 14.3 1.43 3/17/07 121,408 307,672
Gregory J. Langford...... 35,000 3.7 3.00 8/20/07 66,034 167,343
Robert C. Troutman....... -- -- -- -- -- --
</TABLE>
- ---------------
(1) All options were granted under the Company's 1994 Stock Option Plan (the
"1994 Plan"). Mr. Langford's options become exercisable at a rate of 1.67%
monthly over the five-year period following the date of grant. The options
granted to Messrs. Cheli and Minihane vest 20% one year after grant and in
equal increments over the next 48 months. Vesting continues so long as an
officer remains continuously employed by the Company.
(2) Based on options to purchase 942,192 shares of Common Stock granted in 1997.
(3) All options were granted at exercise prices equal to the fair market value
of the Common Stock, as determined by the Board of Directors, on the grant
date, based upon the price at which the Company's Preferred Stock had been
issued, an independent valuation of the Company's Common Stock in November
1996, arms-length transactions in the Company's Preferred Stock, valuations
of comparable companies and the financial condition and results of
operations of the Company at each of the dates of grant. The Company's
Common Stock was not traded publicly at the time the options were granted to
the Named Executive Officers.
(4) Potential realizable values are net of exercise price, but before taxes
associated with exercise. Amounts represent hypothetical gains that could be
achieved for the respective options if exercised at the end of the option
term. The assumed 5% and 10% rates of stock price appreciation are provided
in accordance with rules of the United States Securities and Exchange
Commission and do not represent the Company's estimate or projection of the
future Common Stock price. Actual gains, if any, on stock option exercises
are dependent on the future performance of the Common Stock, overall market
conditions and the option holders' continued employment through the vesting
period. This table does not take into account any appreciation in the price
of the Common Stock from the date of grant to date. Assuming the fair market
value of the Common Stock at the date of grant was the initial public
offering price of $12.50 (which is significantly less than the last sales
price of the Common Stock on June 30, 1998), the potential realizable value
of these options at a 5% assumed annual rate of stock price appreciation
would be $3,256,960 for Mr. Minihane, $2,555,712 for Mr. Cheli and $607,642
for Mr. Langford.
None of the Named Executive Officers exercised any stock options during
1997.
45
<PAGE> 48
YEAR-END OPTION VALUES
The following table provides the specified information concerning
unexercised options held as of December 31, 1997 by the Named Executive
Officers.
<TABLE>
<CAPTION>
NUMBER OF SECURITIES VALUE OF UNEXERCISED
UNDERLYING IN-THE-MONEY
UNEXERCISED OPTIONS AT OPTIONS AT
DECEMBER 31, 1997 DECEMBER 31, 1997(1)
---------------------------- ----------------------------
EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
----------- ------------- ----------- -------------
<S> <C> <C> <C> <C>
Scott E. Stouffer..................... 38,237 25,012 $377,119 $ 244,892
Peter J. Minihane..................... -- 175,000 -- 1,443,750
Henry A. Cheli........................ -- 135,000 -- 1,156,950
Gregory J. Langford................... 5,584 94,416 44,162 757,888
Robert C. Troutman.................... 13,799 21,201 135,368 207,982
</TABLE>
- ---------------
(1) Calculated on the basis of $10.00 per share, the fair market value of the
Common Stock at December 31, 1997, as determined by the Company's Board of
Directors, less the exercise price payable for such shares, multiplied by
the number of shares underlying the option.
No compensation intended to serve as incentive for performance to occur
over a period longer than one year was paid pursuant to a long-term incentive
plan during the last year to any of the Named Executive Officers.
EMPLOYMENT ARRANGEMENTS
The Company has entered into employment agreements with Scott E. Stouffer
and Robert C. Troutman (the "Employees"), dated December 15, 1994 (the
"Employment Agreements"). The Employment Agreements provide that Mr. Stouffer
and Mr. Troutman currently receive annual salaries of $200,000 and $150,000,
respectively (to be reviewed annually), an annual bonus and reimbursement of
certain expenses. The Employees are also entitled to participate in any heath,
life or accident insurance plans or programs made available to other similarly
situated employees. The Employees are also entitled to 20 business days
sabbatical following completion of every four years of employment.
The Employment Agreements continue on a year-to-year basis, renewing each
December 15 unless terminated (1) upon 90 days notice from either the applicable
Employee or the Company prior to the end of the then-current term; (2) by death;
(3) due to disability; (4) by the Company without cause upon 45 days' prior
written notice to the Employee; or (5) by the Company for cause upon 30 days'
prior written notice, or in the case of embezzlement or theft, immediately
without notice. Upon termination without cause by the Company, the Company will
pay the Employee severance equal to six months base salary.
The Employment Agreements contain a covenant not to compete which provides
that for a period of 24 months (decreasing to 12 months after the Employee has
been an employee for four years) after the Employee's termination for any
reason, the Employee is subject to a non-solicitation restriction and will not
compete with the Company or accept employment with a competitor of the Company.
The Employment Agreements also contain confidentiality and assignment of
inventions provisions.
In March 1997, Mr. Cheli entered into an employment arrangement with the
Company, pursuant to which Mr. Cheli serves as Senior Vice President, Market
Operations. The arrangement provides for a current annual base salary of
$150,000 (to be reviewed annually), in addition to certain other benefits. Mr.
Cheli's compensation can increase based on the Company's 1998 financial
performance. Upon termination of employment by the Company without cause, Mr.
Cheli is entitled to receive the compensation and benefits which would otherwise
be payable to him for a maximum of six months following such termination. The
Company granted Mr. Cheli an option to purchase
46
<PAGE> 49
135,000 shares of Common Stock at an exercise price of $1.43 per share, vesting
20% at the end of the first year after grant and in equal monthly increments
over the next four years. Upon a change of control of the Company, Mr. Cheli's
options will automatically vest, depending on the time of the change of control,
as follows: (i) 40% if the change of control occurs on or before the first
anniversary of Mr. Cheli's option grant; (ii) 80% if the change of control
occurs after the first anniversary, but prior to the second anniversary of the
option grant; and (iii) 100% after the second anniversary of the option grant.
In November 1996, Mr. Langford entered into an employment arrangement with
the Company, pursuant to which Mr. Langford serves as Vice President, Product
Management and Planning. He subsequently has been promoted to Senior Vice
President, Product Operations. The arrangement provides for a current annual
base salary of $135,000 (to be reviewed annually), in addition to certain other
benefits. Mr. Langford's compensation can increase based on the Company's 1998
financial performance. Upon termination of employment by the Company without
cause, Mr. Langford is entitled to receive the compensation and benefits which
would otherwise be payable to him for a maximum of six months following such
termination. Mr. Langford was granted options to purchase 49,000 shares of
Common Stock in November 1996 at an exercise price of $1.43 per share, vesting
25% at the end of the second year after grant and in equal monthly increments
over the next three years, options to purchase 16,000 shares of Common Stock in
December 1996 at an exercise price of $1.43 per share, vesting in equal monthly
increments over five years, and options to purchase 35,000 shares of Common
Stock in August 1997 at an exercise price of $3.00 per share, vesting in equal
monthly increments over five years. Fifty percent of Mr. Langford's unvested
options vest upon a change of control of the Company.
In June 1997, Mr. Minihane entered into an employment arrangement with the
Company, pursuant to which Mr. Minihane serves as Executive Vice President,
Chief Financial Officer and Treasurer of the Company. The arrangement provides
for a current annual base salary of $160,000 (to be reviewed annually), in
addition to certain other benefits. Mr. Minihane's compensation can increase
based on the Company's 1998 financial performance. Upon termination of
employment by the Company without cause, Mr. Minihane is entitled to receive the
compensation and benefits which would otherwise be payable to him for a maximum
of six months following such termination. Mr. Minihane was granted options to
purchase 175,000 shares of Common Stock in June 1997 at an exercise price of
$1.75 per share, vesting 20% at the end of the first year after grant and in
equal monthly increments over the next four years. All of Mr. Minihane's
unvested options vest upon a change of control of the Company. Upon commencement
of his employment with the Company, Mr. Minihane purchased 25,000 shares of the
Company's Common Stock at $1.75 per share.
The Company's employment agreement with each of Messrs. Cheli, Langford and
Minihane contains general non-solicitation and non-competition provisions
applicable during the period of such employee's employment with the Company and
for two years thereafter (or one year if his employment terminates after January
1, 1999).
All other employees of the Company are required to sign agreements which
prohibit the employee from directly or indirectly competing with the Company
while employed by the Company and generally for a period of two years thereafter
(or one year if their employment terminates after January 1, 1999). All
employees have executed agreements which prohibit the disclosure of the
Company's confidential or proprietary information.
STOCK PLANS
1994 STOCK OPTION PLAN
The Company's 1994 Stock Option Plan (the "1994 Plan") authorizes the
issuance of an aggregate of 1,975,000 shares of Common Stock pursuant to the
exercise of stock options. As of
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<PAGE> 50
June 30, 1998, 358,260 shares had been issued under the 1994 Plan, options to
purchase 1,591,321 shares were outstanding and 25,419 shares remained available
for future grant under the 1994 Plan.
The 1994 Plan provides for grants of options to employees, consultants and
directors of the Company. Each stock option granted under the 1994 Plan is
evidenced by a written stock option agreement between the Company and the
optionee. The 1994 Plan provides for the granting of both "incentive stock
options" within the meaning of Section 422 of the Internal Revenue Code of 1986,
as amended, and non-statutory options. The 1994 Plan is administered by the
Compensation Committee, which has sole discretion and authority, consistent with
the provisions of the 1994 Plan, to determine which eligible participants will
receive options, the time when options will be granted, the terms of options
granted and the number of shares that will be subject to options granted under
the 1994 Plan.
For any option intended to qualify as an incentive stock option, the
exercise price must not be less than 100% of the fair market value of the Common
Stock on the date the option is granted (110% of the fair market value of such
Common Stock with respect to any optionee who immediately before any option is
granted, directly or indirectly, possesses more than 10% of the total combined
voting power of all classes of stock of the Company ("10% Owners")). The
Compensation Committee has the authority to determine the time or times at which
options granted under the 1994 Plan become exercisable; provided that, for any
option intended to qualify as an incentive stock option, such option must expire
no later than ten years from the date of grant (five years with respect to 10%
Owners). Options are non-assignable and non-transferable, unless a stock option
agreement provides that such option may be transferred by the optionee upon
death, by will or the laws of descent and distribution. Options generally may be
exercised only while the optionee is either employed by, or rendering services
to, the Company or within a specified period of time thereafter. The
Compensation Committee may accelerate the date of exercise of any option or
waive any condition or restriction pertaining to such option at any time. Unless
terminated sooner by the Board, the 1994 Plan will terminate in December 2004 or
the date on which all shares available for issuance shall have been issued
pursuant to the exercise or cancellation of options granted under the 1994 Plan.
1997 OMNIBUS STOCK PLAN
The Company's 1997 Omnibus Stock Plan (the "Omnibus Plan") authorizes the
issuance of an aggregate of up to 1,000,000 shares of Common Stock with respect
to certain "Awards" made under the Omnibus Plan. As of June 30, 1998, options to
purchase 147,000 shares were outstanding and 853,000 shares remained available
for future grant under the Omnibus Plan.
The Omnibus Plan provides for grants of options to employees, officers,
directors and consultants of the Company or any affiliate of the Company;
provided, however, that no individual may receive an award of more than 250,000
shares in any one fiscal year. "Awards" under the Omnibus Plan may take the form
of grants of stock options, stock appreciation rights, restricted or
unrestricted stock, phantom stock, performance awards or any combination
thereof. The Omnibus Plan is administered by the Board of Directors, or by such
committee or committees as may be appointed by the Board of Directors from time
to time (the "Administrator"). The Administrator has sole power and authority,
consistent with the provisions of the Omnibus Plan, to determine which eligible
participants will receive Awards, the form of the Awards and the number of
shares of Common Stock covered by each Award, to impose terms, limits,
restrictions and conditions upon Awards, to modify, amend, extend or renew
Awards (with the consent of the awardee), to accelerate or change the exercise
timing of Awards or to waive any restrictions or conditions to an Award and to
establish objective and conditions for earning Awards.
Unless otherwise determined by the Administrator, and in any event in the
case of an incentive stock option or a stock appreciation right granted with
respect to an incentive stock option, Awards are not transferable other than by
will or the laws of descent and distribution. Unless otherwise
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<PAGE> 51
determined by the Administrator in accord with the provisions of the immediately
preceding sentence, an Award may be exercised during the lifetime of the
grantee, only by the grantee or, during the period the grantee is under a legal
disability, by the grantee's guardian or legal representative. Unless terminated
sooner by the Board, the Omnibus Plan terminates in October 2007 or the date on
which all shares available for issuance shall have been issued pursuant to the
exercise or cancellation of Awards under the Omnibus Plan.
1997 DIRECTORS' STOCK OPTION PLAN
The 1997 Directors' Stock Option Plan (the "Director Plan") was adopted in
October 1997. Under the terms of the Director Plan, directors of the Company who
are not employees of the Company (the "Eligible Directors") are eligible to
receive non-statutory options to purchase shares of Common Stock. A total of
300,000 shares of Common Stock may be issued upon exercise of options granted
under the Director Plan. As of June 30, 1998, options to purchase 180,000 shares
were outstanding and 120,000 shares remained available for future grant under
the Director Plan. Unless terminated sooner by the Board of Directors, the
Director Plan will terminate in October 2007, or the date on which all shares
available for issuance under the Director Plan shall have been issued pursuant
to the exercise of options granted under the Director Plan.
Upon a member's initial election or appointment to the Board of Directors,
such member will be granted options to purchase up to 24,000 shares of Common
Stock, vesting over four years, with options to purchase 6,000 shares vesting at
the first anniversary of the grant and options to purchase the remaining 18,000
shares vesting in 36 equal monthly installments. Annual options to purchase
6,000 shares of Common Stock (the "Annual Options") will be granted to each
Eligible Director on the date of each annual meeting of stockholders. Annual
Options will vest at the rate of one-twelfth of the total grant per month, and
will vest in full at the earlier of (i) the first anniversary of the date of the
grant or (ii) the date of the next annual meeting of stockholders. The exercise
price of options granted under the Director Plan will equal the fair market
value per share of the Common Stock on the date of grant. Upon the closing of
the Company's IPO, each Eligible Director received an option to purchase 24,000
shares of Common Stock, and at the 1998 Annual Meeting of Stockholders, each
Eligible Director received an option to purchase 6,000 shares of Common Stock.
Options granted under the Director Plan are not transferable by the
optionee except by will or by the laws of descent and distribution or pursuant
to a qualified domestic relations order. In the event an optionee ceases to
serve as a director, each option may be exercised by the optionee for the
portion then exercisable at any time within 60 days after the optionee ceases to
serve as a director; provided, however, that in the event that the optionee
ceases to serve as a director due to his death or disability, then the optionee,
or his or her administrator, executor or heirs, may exercise the exercisable
portion of the option for up to 180 days following the date the optionee ceases
to serve as a director. No option is exercisable after the expiration of five
years from the date of grant.
NET2NET 1994 STOCK PLAN
The Net2Net 1994 Stock Plan (the "Net2Net Plan") authorizes the issuance of
an aggregate of up to 189,733 shares of Common Stock with respect to certain
"Stock Rights" granted under the Net2Net Plan. In connection with the Company's
acquisition of Net2Net, the Company assumed the obligations of Net2Net under the
Net2Net Plan. As of June 30, 1998, Stock Rights with respect to 183,365 shares
of Common Stock were outstanding. The Board of Directors has adopted a
resolution not to make any future option grants under the Net2Net Plan.
The Net2Net Plan provides for grants of options to employees, officers,
directors and consultants of the Company or any affiliate of the Company. Stock
Rights under the Net2Net Plan may take the form of grants of incentive stock
options, non-statutory stock options, awards of stock of the Company,
opportunities to make direct purchases of stock in the Company or any
combination thereof. The Net2Net Plan is administered by the Board of Directors,
or by such committee as may
49
<PAGE> 52
be appointed by the Board of Directors from time to time. The Board of Directors
has sole power and authority, consistent with the provisions of the Net2Net
Plan, to determine which eligible participants will receive Stock Rights, the
form of the Stock Rights and the number of shares of Common Stock covered by
each Stock Right, to impose terms, limits, restrictions and conditions upon
Stock Rights, to modify, amend, extend or renew Stock Rights (with the consent
of the recipient), to accelerate or change the exercise timing of Stock Rights
or to waive any restrictions or conditions to a Stock Right.
Stock Rights are not transferable other than by will or the laws of descent
and distribution. Unless pursuant to the provisions of the immediately preceding
sentence, a Stock Right may be exercised during the lifetime of the grantee only
by the grantee. Unless terminated sooner by the Board of Directors, the Net2Net
Plan terminates in November 2004 or the date on which all shares available for
issuance shall have been issued pursuant to the exercise or cancellation of
Stock Rights under the Net2Net Plan.
INDEMNIFICATION OF DIRECTORS AND EXECUTIVE OFFICERS AND LIMITATION OF LIABILITY
The Company's Certificate of Incorporation provides that to the fullest
extent permitted by Delaware law a director of the Company shall not be liable
to the Company or its stockholders for monetary damages for breach of fiduciary
duty as a director. Under current Delaware law, liability of a director may not
be limited (i) for any breach of the director's duty of loyalty to the Company
or its stockholders, (ii) for acts or omissions not in good faith or which
involve intentional misconduct or a knowing violation of law, (iii) in respect
of certain unlawful dividend payments or stock redemptions or repurchases and
(iv) for any transaction from which the director derives an improper personal
benefit. The effect of this provision of the Company's Certificate of
Incorporation is to limit or eliminate the rights of the Company and its
stockholders (through stockholders' derivative suits on behalf of the Company)
to recover monetary damages against a director for breach of the fiduciary duty
of care as a director (including breaches resulting from negligent or grossly
negligent behavior) except in those circumstances described in clauses (i)
through (iv) above. This provision does not limit or eliminate the rights of the
Company or any stockholder to seek nonmonetary relief such as an injunction or
rescission in the event of a breach of a director's duty of care. In addition,
the Company's Certificate of Incorporation and Bylaws provide that the Company
shall indemnify its directors, officers, employees and agents to the fullest
extent permitted by Delaware law.
The Company's Bylaws provide that the Company shall indemnify its officers
and directors to the fullest extent permitted by Delaware law, including in
circumstances in which indemnification is otherwise discretionary under Delaware
law. The Company has obtained officer and director liability insurance with
respect to liabilities arising out of certain matters, including matters arising
under the Securities Act.
At present, there is no pending litigation or proceeding involving any
officer or director, employee or agent of the Company where indemnification will
be required or permitted. The Company is not aware of any threatened litigation
or proceeding which may result in a claim for such indemnification.
CERTAIN TRANSACTIONS
In August 1995, the Company issued 1,600,000 shares of its Series C
Convertible Preferred Stock at a price of $1.25 per share, including 800,000
shares to Edison Venture Fund III, L.P. ("Edison") and 366,666 shares to NEPA
Venture Fund II, L.P. ("NEPA").
In January 1996, the Company issued 2,285,714 shares of its Series D
Convertible Preferred Stock at a price of $1.75 per share, including an
aggregate of 1,428,571 shares to Venrock
50
<PAGE> 53
Associates and Venrock Associates II, L.P. (collectively, "Venrock"), 261,258
shares to Edison, 225,917 shares to NEPA and 42,857 shares to Mr. Joseph.
In September 1996, the Company issued 754,321 shares of its Series E
Convertible Preferred Stock at a price of $6.66 per share, including 120,120
shares to Venrock, 120,120 shares to Edison, 18,769 shares to NEPA, 12,012
shares to Mr. Joseph and affiliates and an aggregate of 454,021 shares to
Behrman Capital L.P., Behrman Capital B L.P. and Strategic Entrepreneur Fund
L.P.
On June 15, 1997, the Company issued 25,000 shares of its Common Stock at a
price of $1.75 per share to Mr. Minihane. See "Management -- Employment
Arrangements".
On September 13, 1997, the Company issued 10,504 shares of its Common Stock
at a price of $4.76 per share to Mr. William Smith. The Company's Board of
Directors, excluding Mr. Smith, determined the sale price based on a recently
completed arms-length sale of securities by a stockholder to an individual
retirement account of Mr. Joseph.
The Company believes that all transactions set forth above were made on
terms no less favorable to the Company than would have been obtained from
unaffiliated third parties. The Company has adopted a policy whereby all future
transactions between the Company and its officers, directors and affiliates will
be on terms no less favorable to the Company than could be obtained from
unrelated third parties and will be approved by a majority of the disinterested
members of the Board of Directors.
51
<PAGE> 54
PRINCIPAL AND SELLING STOCKHOLDERS
The following table sets forth certain information regarding the beneficial
ownership of the Company's Common Stock as of June 30, 1998, and as adjusted to
reflect the sale of the shares of Common Stock offered hereby: (i) by each
person who is known by the Company to own beneficially more than five percent of
the Company's Common Stock, (ii) by each director and Named Executive Officer,
and (iii) by all executive officers and directors as a group. The Selling
Stockholders may effect transactions in the Common Stock pursuant to Rule 144
promulgated under the Securities Act.
<TABLE>
<CAPTION>
SHARES OF COMMON
SHARES OF COMMON STOCK
STOCK BENEFICIALLY OWNED
BENEFICIALLY OWNED AFTER THIS
PRIOR TO THIS OFFERING(1) SHARES OFFERING(1)(2)
-------------------------- TO BE ----------------------
NAME OF BENEFICIAL OWNER NUMBER PERCENTAGE SOLD(2) NUMBER PERCENTAGE
------------------------ ----------- ------------ --------- --------- ----------
<S> <C> <C> <C> <C> <C>
NEPA Venture Fund II, L.P.(3).............................. 2,172,280 10.9% 434,156 1,736,624 8.3%
c/o Mid-Atlantic Venture Funds
1801 Reston Parkway-Suite 203
Reston, VA 20190
Venrock Entities(4)........................................ 2,160,680 10.9 432,136 1,728,544 8.3
30 Rockefeller Plaza
New York, NY 10112
Edison Venture Fund III, L.P.(5)........................... 1,655,429 8.3 330,786 1,323,143 6.3
997 Lenox Drive, Building No. 3
Lawrenceville, NJ 08648
Grant G. Behrman(6)........................................ 637,128 3.2 127,126 510,002 2.4
Marc F. Benson(7).......................................... 2,172,280 10.9 434,156 1,736,624 8.3
Henry A. Cheli(8)(18)...................................... 38,000 * --
Patricia L. Cotter(9)...................................... 9,680 *
Theodore R. Joseph(10)..................................... 127,204 *
Gregory J. Langford(11)(18)................................ 12,376 * --
Ted H. McCourtney(12)...................................... 2,162,180 10.9 432,136 1,728,544 8.3
Peter J. Minihane(13)(18).................................. 67,948 * --
Thomas A. Smith(14)........................................ 1,660,429 8.3 330,786 1,324,643 6.3
William J. Smith(15)....................................... 25,004 * --
Scott E. Stouffer(16)(18).................................. 1,498,341 7.5 299,668 1,198,673 5.7
Robert C. Troutman(17)(18)................................. 471,410 2.4 89,600 381,810 1.8
All executive officers and directors as a group (12
persons)(19)............................................. 8,881,980 44.2
James D. Ennis, Jr.(20).................................... 274,437 1.4 40,923 233,514 1.1
Stephen A. McCalmont(21)................................... 198,896 1.0 39,486 159,410 *
Thomas R. Nisbet(22)....................................... 269,937 1.3 40,000 229,937 *
John G. Puente............................................. 206,742 1.0 40,000 166,742 *
Commonwealth Capital Ventures LP........................... 198,627 1.0 40,000 158,627 *
Pioneer Entities(23)....................................... 200,313 1.0 39,339 160,974 *
John E. Hasselkus(24)...................................... 238,482 1.1
Robert Markovich........................................... 151,053 *
James G. and Patricia A. Marshall, Jt. Ten. ............... 20,263 *
Maryland Department of Business and Economic Development... 754,959 3.8
W. Samuel and Veronica Nisbet, Jt. Ten. ................... 40,696 *
William R.T. Oakes(25) .................................... 780,610 3.9
John J. and Katherine J. Privette, Jt. Ten. ............... 20,263 *
William F. and Mary Alice Rooney(26)....................... 61,044 *
</TABLE>
52
<PAGE> 55
<TABLE>
<CAPTION>
SHARES OF COMMON
SHARES OF COMMON STOCK
STOCK BENEFICIALLY OWNED
BENEFICIALLY OWNED AFTER THIS
PRIOR TO THIS OFFERING(1) SHARES OFFERING(1)(2)
-------------------------- TO BE ----------------------
NAME OF BENEFICIAL OWNER NUMBER PERCENTAGE SOLD(2) NUMBER PERCENTAGE
------------------------ ----------- ------------ --------- --------- ----------
<S> <C> <C> <C> <C> <C>
Andre G. Seynhaeve Irrevocable Trust....................... 212,465 1.1
Denis Seynhaeve............................................ 220,033 1.1
Amerindo Entities(27)...................................... 240,276 1.2
Michael Barza.............................................. 18,092 *
Ralph Beck(28)............................................. 54,490 *
Columbia Ventures Trust.................................... 7,935 *
Robert M. and Carol M. Cotter.............................. 7,829 *
Frederick R. Cronin........................................ 23,805 *
Cutler Associates Inc...................................... 15,870 *
The Duclos Family Trust.................................... 7,300 *
David H. Feinberg.......................................... 3,967 *
Allan M. Kline............................................. 4,364 *
Richard A. Kline........................................... 317 *
Alexander E. Kukielka...................................... 52,531 *
Nigel C. Machin(29)........................................ 14,281 *
Ernest Magaro.............................................. 7,300 *
Arnold M. McCalmont........................................ 15,394 *
Jennifer McCalmont......................................... 7,935 *
Rebekah R. McCalmont....................................... 23,329 *
MHF Sylvan Fund............................................ 33,853 *
Frederick S. and Nancee Nixdorf............................ 7,776 *
Rodger Nordblom............................................ 19,995 *
David Robbins.............................................. 1,904 *
Larry and Eileen Samberg................................... 2,380 *
Richard Steinberg.......................................... 8,483 *
Waterline Capital LLC...................................... 39,676 *
Richard Arena.............................................. 98,740 *
Mark Galvin................................................ 3,650 *
Abbot Gilman............................................... 15,870 *
Independence Trust......................................... 28,884 *
Paul Kelley(30)............................................ 99,214 *
Dennis Kirshy.............................................. 51,579 *
Herbert A. and Rose Lerner................................. 2,777 *
Kevin Little............................................... 34,915 *
Stuart P. Maceachern(31)................................... 5,767 *
The Ocean Fund............................................. 341,936 1.7
Vincent M. O'Reilly........................................ 9,124 *
Technical Communications Corporation....................... 36,184 *
Worcester Venture Group Trust(32).......................... 12,850 *
</TABLE>
- ---------------
* Less than 1%.
(1) As of June 30, 1998, the Company had outstanding 19,886,099 shares of
Common Stock. The persons named in this table have sole voting power with
respect to all shares of Common Stock shown as beneficially owned by them,
subject to community property laws where applicable and except as indicated
in the other footnotes to this table. Beneficial ownership is determined in
accordance with the rules of the SEC. In computing the number of shares
beneficially owned by a person and the percentage ownership of that person,
shares of Common Stock subject to options held by that person that are
currently exercisable or exercisable within 60 days after June 30, 1998,
are deemed outstanding.
53
<PAGE> 56
Such shares, however, are not deemed outstanding for the purpose of
computing the percentage ownership of any other person.
(2) Assumes that the Underwriters' over-allotment options are not exercised.
(3) Represents 2,170,780 shares of Common Stock beneficially owned by
Mid-Atlantic Venture Funds, formerly NEPA Venture Funds ("NEPA") and 1,500
shares of Common Stock issuable upon exercise of stock options held by Marc
F. Benson, a director of the Company. Mr. Benson is a principal and partner
of NEPA. Mr. Benson has shared voting and investment power over the shares
held by NEPA but disclaims beneficial ownership thereof except to the
extent of his proportionate partnership interest therein.
(4) Represents 1,338,475 shares of Common Stock beneficially owned by Venrock
Associates, 822,205 shares of Common Stock beneficially owned by Venrock
Associates II, L.P. (Venrock Associates and Venrock Associates II, L.P.,
collectively "Venrock"). Ted H. McCourtney, a director of the Company, is a
general partner of both Venrock Associates and Venrock Associates II, L.P.
Mr. McCourtney has shared voting and investment power over the shares held
by Venrock but disclaims beneficial ownership thereof except to the extent
of his proportionate partnership interest therein.
(5) Represents 1,653,929 shares of Common Stock beneficially owned by Edison
Venture Fund III, L.P. ("Edison") and 1,500 shares of Common Stock issuable
upon exercise of stock options held by Thomas A. Smith, a director of the
Company. Mr. Smith is a general partner of Edison. Mr. Smith has shared
voting and investment power over shares held by Edison but disclaims
beneficial ownership thereof except to the extent of his proportionate
partnership interest therein.
(6) Represents 251,441 shares of Common Stock held by Behrman Capital L.P.,
379,188 shares held by Behrman Capital B L.P., and 4,999 shares held by
Strategic Entrepreneur Fund, L.P., which Mr. Behrman may be deemed to
beneficially own by virtue of his status as a General Partner of Behrman
Brothers L.P., the general partner of such entities, and 1,500 shares of
Common Stock issuable upon exercise of stock options held by Mr. Behrman.
Mr. Behrman has shared voting and investment power over shares held by
these entities but disclaims beneficial ownership thereof except to the
extent of his proportionate partnership interest therein.
(7) Represents 2,170,780 shares of Common Stock beneficially owned by NEPA
which Mr. Benson may be deemed to beneficially own by virtue of his status
as a principal and general partner of NEPA, and 1,500 shares of Common
Stock issuable upon exercise of stock options held by Mr. Benson. Mr.
Benson has shared voting and investment power over shares held by NEPA but
disclaims beneficial ownership thereof except to the extent of his
proportionate partnership interest therein.
(8) Represents 2,000 shares of Common Stock held by Mr. Cheli and 36,000 shares
of Common Stock issuable upon exercise of stock options.
(9) Includes 9,197 shares of Common Stock and 483 shares of Common Stock
issuable upon exercise of stock options.
(10) Represents 73,904 shares of Common Stock held by Mr. Joseph, 22,400 shares
of Common Stock held by Mr. Joseph's IRA and 30,900 shares of Common Stock
issuable upon exercise of stock options.
(11) Represents 9,433 shares of Common Stock held by Mr. Langford and 2,943
shares of Common Stock issuable upon exercise of stock options.
(12) Represents 2,160,680 shares of Common Stock beneficially owned by Venrock
which Mr. McCourtney may be deemed to beneficially own by virtue of his
status as a general partner of Venrock, and 1,500 shares of Common Stock
issuable upon exercise of stock options. Mr. McCourtney has shared voting
and investment power over the shares held by Venrock but disclaims
beneficial ownership thereof except to the extent of his proportionate
partnership interest therein.
(13) Represents 30,000 shares of Common Stock held by Mr. Minihane and 37,948
shares of Common Stock issuable upon exercise of stock options.
(14) Represents 1,653,929 shares of Common Stock beneficially owned by Edison
which Mr. Smith may be deemed to beneficially own by virtue of his status
as a general partner of Edison, 5,000 shares of Common Stock held by Mr.
Smith and 1,500 shares of Common Stock issuable upon exercise of options
held by Mr. Smith. Mr. Smith has shared voting and investment power over
shares held by Edison but disclaims beneficial ownership thereof except to
the extent of his proportionate partnership interest therein.
(15) Represents 14,504 shares of Common Stock held by Mr. Smith and 10,500
shares of Common Stock issuable upon exercise of stock options.
(16) Includes 863,334 shares of Common Stock held by Mr. Stouffer, 270,666
shares of Common Stock held by the Scott E. Stouffer Grantor Retained
Annuity Trust ("GRAT"), 320,696 shares of Common Stock held by Mr.
Stouffer's wife and 43,645 shares of Common Stock issuable upon exercise of
stock options.
(17) Includes 398,517 shares of Common Stock held by Mr. Troutman, 48,083 shares
held by the Robert C. Troutman GRAT, 3,500 shares held by Mr. Troutman as
custodian for each of two children and 17,810 shares of Common Stock
issuable upon exercise of stock options.
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<PAGE> 57
(18) The address of Messrs. Cheli, Langford, Minihane, Stouffer and Troutman is
c/o the Company, 2092 Gaither Road, Rockville, Maryland 20850.
(19) Before the Offerings, includes an aggregate of 185,746 shares of Common
Stock issuable upon exercise of stock options. See notes 6, 7, 8, 9, 10,
11, 12, 13, 14, 15, 16 and 17 above.
(20) Includes 204,228 shares of Common Stock held by Mr. Ennis, 68,595 shares of
Common Stock held by the James Donald Ennis, Jr. GRAT and 1,614 shares of
Common Stock issuable upon exercise of stock options.
(21) Includes 197,429 shares of Common Stock and 1,467 shares of Common Stock
issuable upon exercise of stock options.
(22) Includes 190,096 shares of Common Stock held by Mr. Nisbet, 54,904 shares
of Common Stock held by the Thomas R. Nisbet GRAT and 24,937 shares of
Common Stock issuable upon exercise of stock options.
(23) Includes 32,361 shares of Common Stock held by Pioneer Capital Corp.,
164,337 shares of Common Stock held by Pioneer Ventures Limited Partnership
II and 3,615 shares of Common Stock held by Le Serre.
(24) Includes 175,000 shares of Common Stock held by Mr. Hasselkus, 42,000
shares of Common Stock held by the John E. Hasselkus GRAT and 21,482 shares
of Common Stock issuable upon exercise of stock options.
(25) Includes 390,305 shares of Common Stock held by Mr. Oakes and 390,305
shares of Common Stock held by Carol B. Oakes, his wife.
(26) Shares held by William F. or Mary Alice Rooney or their successors in
trust, under the William F. or Mary Alice Rooney Living Trust dated May 10,
1996, and any amendments thereto.
(27) Includes 180,207 shares of Common Stock held by Amerindo Tech Growth Fund
II and 60,069 shares of Common Stock held by Litton Master Trust.
(28) Includes 54,118 shares of Common Stock and 372 shares of Common Stock
issuable upon exercise of stock options.
(29) Includes 3,490 shares of Common Stock held by Mr. Machin as custodian for
his minor children.
(30) Includes 98,714 shares of Common Stock and 500 shares of Common Stock
issuable upon exercise of stock options.
(31) Includes 5,395 shares of Common Stock and 372 shares of Common Stock
issuable upon exercise of stock options.
(32) Includes 1,000 shares of Common Stock to be sold on behalf of John C.
Gilberg and 150 shares of Common Stock to be sold on behalf of Patrick B.
Holland.
55
<PAGE> 58
DESCRIPTION OF CAPITAL STOCK
The Company's authorized capital stock will consist of 50,000,000 shares of
Common Stock, $.01 par value per share, and 5,000,000 shares of Preferred Stock,
$.01 par value per share.
COMMON STOCK
At June 30, 1998, the Company had outstanding 19,886,099 shares of Common
Stock held of record by approximately 201 stockholders. Each holder of Common
Stock is entitled to one vote for each share held. Following the conversion of
the Convertible Preferred Stock to Common Stock, the holders of Common Stock,
voting as a single class, will be entitled to elect all of the directors of the
Company.
Holders of Common Stock are entitled to receive ratably such dividends as
may be declared by the Board of Directors out of funds legally available
therefor. See "Dividend Policy." In the event of a liquidation, dissolution or
winding up of the Company, holders of Common Stock would be entitled to share in
the Company's assets remaining after the payment of liabilities and the
satisfaction of any liquidation preference granted the holders of any
outstanding shares of Preferred Stock. Holders of Common Stock have no
preemptive or other subscription rights. The shares of Common Stock are not
convertible into any other security. The outstanding shares of Common Stock are,
and the shares to be issued upon completion of the Offerings will be, upon
issuance and sale, fully paid and nonassessable.
PREFERRED STOCK
The Company has the authority to issue up to 5,000,000 shares of Preferred
Stock. The Board of Directors has the authority to issue, without any further
action by the stockholders, the Preferred Stock in one or more series, to
establish from time to time the number of shares to be included in each series,
and to fix the designations, powers, preferences and rights of the shares of
each series and the qualifications, limitations or restrictions thereof.
Although the ability of the Board of Directors to designate and issue Preferred
Stock could provide flexibility in possible acquisitions or other corporate
purposes, issuance of Preferred Stock may have adverse effects on the holders of
Common Stock, including restrictions on dividends on the Common Stock if
dividends on the Preferred Stock have not been paid; dilution of voting power of
the Common Stock to the extent the Preferred Stock has voting rights; or
deferral of participation in the Company's assets upon liquidation until
satisfaction of any liquidation preference granted to holders of the Preferred
Stock. In addition, issuance of Preferred Stock could make it more difficult for
a third party to acquire a majority of the outstanding voting stock and
accordingly may be used as an "anti-takeover" device. The Board of Directors,
however, currently does not contemplate the issuance of any Preferred Stock and
is not aware of any pending transactions that would be affected by such
issuance.
REGISTRATION RIGHTS OF CERTAIN HOLDERS
Holders of an aggregate of 10,119,845 shares of Common Stock (the
"Registrable Shares") are entitled to certain demand rights with respect to the
registration of such shares under the Securities Act. Subject to certain
limitations, the Company is required, upon request of the holders of at least
two-thirds of the Registrable Shares outstanding, to file a registration
statement under the Securities Act covering such Registrable Shares (a "Demand
Registration"). The Company is not required to effect more than two Demand
Registrations. In addition to the Demand Registration rights described above,
and subject to certain conditions and limitations, such holders may require the
Company to file an unlimited number of registration statements on Form S-2 or
Form S-3 under the Securities Act, when such form is available for use by the
Company, provided that no more than two such requests may be made per year.
Holders of an aggregate of 2,056,204 shares of Common Stock issued by the
Company in connection with certain acquisitions (the "Acquisition Stockholders")
are entitled to certain
56
<PAGE> 59
registration rights with respect to the registration of such shares under the
Securities Act. Subject to certain limitations, the Company is required to file
a registration statement on Form S-3 under the Securities Act with respect to
the sale of such shares (an "Acquisition Registration"), when such form is
available for use by the Company. If the Company is not eligible to use Form S-3
before March 1, 1999, it is obligated to effect such Acquisition Registration on
Form S-1 under the Securities Act.
Holders of an aggregate of 15,537,918 shares of Common Stock, including the
Acquisition Stockholders, also are entitled to include their shares of Common
Stock in a registered offering of securities by the Company (a "Piggyback
Registration") for its own account, subject to certain conditions and
restrictions.
All expenses incurred in connection with Demand or Piggyback Registrations
(excluding underwriters' discounts and commissions but including the reasonable
fees and disbursements of one counsel chosen by the holders requesting a Demand
Registration or a registration on Form S-2 or S-3) shall be borne by the
Company; except, that if a Demand Registration is begun and subsequently
withdrawn by the requesting holders, the requesting holders may elect to either
treat such withdrawn registration as one of their two Demand Registrations or
pay all expenses with respect to the registration.
DELAWARE LAW AND CERTAIN CHARTER PROVISIONS
The Company's Certificate of Incorporation or Bylaws, as applicable, among
other things, (i) provide that the number of directors shall be determined from
time to time by resolution adopted by a majority of the Board of Directors; and
(ii) provide for a classified Board of Directors consisting of three classes of
directors having staggered terms of three years each, with each of the classes
being as nearly equal in number as possible. The Company's Certificate of
Incorporation provides that any action required or permitted to be taken by the
stockholders of the Company may be taken only at a duly called annual or special
meeting of the stockholders, and may not be effected by any consent in writing
of such stockholders. These and other provisions could have the effect of making
it more difficult for a third party to effect, or of discouraging a third party
from trying to effect, a change in the control of the Board of Directors. Such
provisions may also discourage another person from making a tender offer for the
Company's Common Stock, including offers at a premium over the market price of
the Common Stock, and might result in a delay in changes in control of
management.
Section 203 of the Delaware General Corporation Law, as amended ("Section
203"), provides that, subject to certain exceptions specified therein, an
"interested stockholder" of a Delaware corporation shall not engage in any
business combination, including mergers or consolidations or acquisitions of
additional shares of the corporation, with the corporation for a three-year
period following the date at which the stockholder becomes an "interested
stockholder" unless (i) prior to such date, the board of directors of the
corporation approved either the business combination or the transaction which
resulted in the stockholder becoming an "interested stockholder," (ii) upon
consummation of the transaction which resulted in the stockholder becoming an
"interested stockholder," the interested stockholder owned at least 85% of the
voting stock of the corporation outstanding at the time that the transaction
commenced (excluding certain shares), or (iii) on or subsequent to such date,
the business combination is approved by the board of directors of the
corporation and authorized at an annual or special meeting of stockholders by
the affirmative vote of at least 66 2/3% of the outstanding voting stock which
is not owned by the "interested stockholder." Except as otherwise specified in
Section 203, an "interested stockholder" is defined to include (x) any person
which is the owner of 15% or more of the outstanding voting stock of the
corporation, or is an affiliate or associate of the corporation and was the
owner of 15% or more of the outstanding voting stock of the corporation at any
time within three years immediately prior to the relevant date and (y) the
affiliates and associates of any such person. The Company's stockholders, by
adopting an amendment to its Certificate of Incorporation or Bylaws, may elect
not
57
<PAGE> 60
to be governed by Section 203, effective twelve months after adoption. Neither
the Certificate of Incorporation nor the Bylaws presently exclude the Company
from the restrictions imposed by Section 203.
TRANSFER AGENT AND REGISTRAR
The Transfer Agent and Registrar for the Common Stock is BankBoston, N.A.
CERTAIN U.S. TAX CONSIDERATIONS APPLICABLE TO
NON-U.S. HOLDERS OF THE COMMON STOCK
The following is a general discussion of certain U.S. federal income and
estate tax consequences of the ownership and disposition of Common Stock by a
person that, for U.S. federal income tax purposes, is a non-resident alien
individual, a foreign corporation, a foreign estate or trust, or, with respect
to certain aspects of the discussion, a foreign partnership, in each case as
defined in the U.S. Internal Revenue Code of 1986, as amended (the "Code") (a
"non-U.S. holder"). This discussion does not consider specific facts and
circumstances that may be relevant to a particular non-U.S. holder's tax
position and does not deal with all aspects of U.S. federal income and estate
taxation that may be relevant to non-U.S. holders, or with U.S. state and local
or non-U.S. tax consequences. Furthermore, the following discussion is based on
provisions of the Code, existing and proposed regulations promulgated
thereunder, and administrative and judicial interpretations thereof as of the
date hereof, all of which are subject to change, possibly with retroactive
effect. Each prospective non-U.S. holder is urged to consult a tax adviser with
respect to the U.S. federal tax consequences of holding and disposing of Common
Stock, as well as any tax consequences that may arise under the laws of any U.S.
state, municipality or other taxing jurisdiction.
An individual may, among other ways, be deemed to be a resident alien (as
opposed to a non-resident alien) with respect to any calendar year by virtue of
being present in the United States for at least 31 days in such calendar year
and for an aggregate of at least 183 days during such calendar year and the two
preceding calendar years (counting for such purposes all of the days present in
such year, one-third of the days present in the immediately preceding year, and
one-sixth of the days present in the second preceding year). Resident aliens are
subject to U.S. federal tax as if they were U.S. citizens.
DIVIDENDS
As described above, the Company does not expect to pay dividends. In the
event the Company does pay dividends, dividends paid to a non-U.S. holder of
Common Stock will be subject to withholding of U.S. federal income tax at a rate
of 30% of the gross amount of the dividend or such lower rate as may be
specified by an applicable income tax treaty, unless the dividends are
effectively connected with the conduct of a trade or business by the non-U.S.
holder within the U.S. Dividends that are effectively connected with such
holder's conduct of a trade or business in the U.S. are subject to U.S. federal
income tax on a net income basis at applicable graduated individual or corporate
rates, and are not generally subject to withholding, if the holder complies with
certain certification and disclosure requirements. Any such effectively
connected dividends received by a foreign corporation may also, under certain
circumstances, be subject to an additional "branch profits tax" at a 30% rate or
such lower rate as may be specified by an applicable income tax treaty.
Dividends paid to an address outside the U.S. are presumed to be paid to a
resident of the country of address (unless the payer has knowledge to the
contrary) for purposes of the withholdings discussed above and for purposes of
determining the applicability of a tax treaty rate. However, under final U.S.
Treasury regulations that are currently scheduled to become effective for
distributions after 1999 (the "New Regulations"), a non-U.S. holder of Common
Stock who wishes to claim the benefit of an applicable treaty rate would be
required to satisfy applicable certification
58
<PAGE> 61
requirements. The New Regulations include special rules that apply to dividends
paid to foreign partnerships.
A non-U.S. holder of Common Stock that is eligible for a reduced rate of
U.S. withholding tax pursuant to an income tax treaty may obtain a refund of any
excess amounts withheld by filing an appropriate claim for refund with the U.S.
Internal Revenue Service.
GAIN ON DISPOSITION OF COMMON STOCK
A non-U.S. holder generally will not be subject to U.S. federal income tax
in respect of gain recognized on a disposition of Common Stock unless (i) the
gain is effectively connected with a trade or business of the non-U.S. holder in
the U.S. or, if a tax treaty so provides, is attributable to a permanent
establishment maintained by the non-U.S. holder in the U.S. or (ii) the Company
is or has been a "U.S. real property holding corporation" for federal income tax
purposes at any time during the five-year period ending on the date of the
disposition and the non-U.S. holder owned more than 5% of the Company's Common
Stock at any time during such period. The Company believes that it has not been
and it is not a "U.S. real property holding corporation" for U.S. federal income
tax purposes and does not currently anticipate becoming a "U.S. real property
holding corporation." If an individual non-U.S. holder falls under clause (i)
above, he or she will be taxed on his or her net gain derived from the sale at
regular graduated U.S. federal income tax rates. If a non-U.S. holder that is a
foreign corporation falls under clause (i) above, it will be taxed on its gain
at regular graduated U.S. federal income tax rates and, in addition, may be
subject to the branch profits tax equal to 30% of its "effectively connected
earnings and profits" within the meaning of the Code for the taxable year, as
adjusted for certain items, or at such lower rate as may be specified by an
applicable income tax treaty.
FEDERAL ESTATE TAXES
Common Stock owned or treated as owned by a non-U.S. holder at the time of
death, or Common Stock of which the non-U.S. holder made certain lifetime
transfers, will be included in such holder's gross estate for U.S. federal
estate tax purposes, unless an applicable estate tax treaty provides otherwise.
U.S. INFORMATION REPORTING REQUIREMENTS AND BACKUP WITHHOLDING TAX
The Company must report annually to the U.S. Internal Revenue Service and
to each non-U.S. holder the amount of dividends paid to such holder and the tax
withheld with respect to such dividends, regardless of whether withholding was
required. Copies of the information returns reporting such dividends and
withholding may also be made available to the tax authorities in the country in
which the non-U.S. holder resides under the provisions of an applicable income
tax treaty or information-sharing agreements.
Under current law, backup withholding (which generally is a withholding tax
imposed at the rate of 31% on certain payments to persons that fail to furnish
certain information under the U.S. information reporting requirements) will
generally not apply to dividends paid to a non-U.S. holder at an address outside
the U.S. unless such non-U.S. holder is engaged in a trade or business in the
U.S. or unless the payer has knowledge that the payee is a U.S. person. Under
the New Regulations, however, dividend payments generally will be subject to
backup withholding unless applicable certification requirements are satisfied.
Information reporting and backup withholding will generally not apply to
any payment of the proceeds of the sale of Common Stock by a non-U.S. holder,
unless such holder fails to comply with certification or documentation
requirements, if applicable.
59
<PAGE> 62
Any amounts withheld under the backup withholding rules may be allowed as a
refund or a credit against such holder's U.S. federal income tax liability
provided the required information is furnished to the U.S. Internal Revenue
Service.
SHARES ELIGIBLE FOR FUTURE SALE
Upon completion of the Offerings, the Company will have 20,886,099 shares
of Common Stock outstanding, assuming no exercise of options to purchase Common
Stock after June 30, 1998. Of this amount, 3,500,000 shares offered hereby as
well as the 4,025,000 shares issued in the IPO will be available for immediate
sale in the public market as of the date of this Prospectus, except for any
shares held by affiliates of the Company or persons who have been affiliates
within the preceding three months. Approximately 2,153,196 shares issued or
issuable upon exercise of options outstanding under the 1994 Plan, the Omnibus
Plan, the Director Plan and the Net2Net Plan will also be freely tradeable. The
Company also has a significant number of shares of Common Stock outstanding that
have not been registered under the Securities Act. Of these shares,
approximately shares are eligible for sale under Rule 144, Rule 144(k)
or Rule 701 or, unless held by affiliates, are freely tradeable. Of such shares,
210,488 shares will be eligible for sale on August 5, 1998. Approximately
of the shares that are eligible for sale under Rule 144, Rule
144(k) or Rule 701 are subject to 90-day lock-up agreements with the
Underwriters, and approximately of the shares so eligible are
subject to a 45-day lock-up agreement with the Underwriters.
In general, under Rule 144 as currently in effect, a person (or persons
whose shares are aggregated) who has beneficially owned shares for at least one
year is entitled to sell within any three-month period a number of shares that
does not exceed the greater of (i) 1% of the then outstanding shares of the
Common Stock (approximately 208,861 shares immediately after the Offerings) or
(ii) the average weekly trading volume during the four calendar weeks preceding
such sale, subject to the filing of Form 144 with respect to such sale. A person
(or persons whose shares are aggregated) who is not deemed to have been an
affiliate of the Company at any time during the 90 days immediately preceding
the sale who has beneficially owned his or her shares for at least two years is
entitled to sell such shares pursuant to Rule 144(k) without regard to the
limitations described above. Persons deemed to be affiliates must always sell
pursuant to Rule 144, even after the applicable holding periods have been
satisfied.
The Company is unable to estimate the number of shares that will be sold
under Rule 144, since this will depend on the market price for the Common Stock
of the Company, the personal circumstances of the sellers and other factors. Any
future sale or anticipated future sale of substantial amounts of Common Stock in
the open market may adversely affect the market price of the Common Stock
offered hereby.
The Company, its directors, executive officers, stockholders with
registration rights and certain other stockholders have agreed pursuant to the
Underwriting Agreement and other agreements that they will not sell any Common
Stock without the prior consent of the Representatives of the Underwriters for a
period of 90 days from the date of this Prospectus (the "90-day Lockup Period"),
except that the Company may, without such consent, grant certain options to
purchase stock pursuant to the Option Plan, the Omnibus Plan and the Director
Plan. The Representatives of the Underwriters may, at their sole discretion and
at any time without notice, release all or any portion of the securities subject
to the lockup arrangements.
Any employee or consultant to the Company who purchased his or her shares
pursuant to a written compensatory plan or contract is entitled to rely on the
resale provisions of Rule 701, which permits nonaffiliates to sell their Rule
701 shares without having to comply with the public information, holding period,
volume limitation or notice provisions of Rule 144 and permits affiliates to
sell their Rule 701 shares without having to comply with the Rule 144 holding
period restrictions.
60
<PAGE> 63
The Company has filed a registration statement on Form S-8 under the
Securities Act to register shares of Common Stock issued or reserved for
issuance under the Stock Plans, thus permitting the resale of such shares by
nonaffiliates in the public market without restriction under the Securities Act.
See "Management -- Stock Plans".
In addition, after the Offerings, the holders of 13,037,918 shares of
Common Stock will be entitled to certain rights with respect to registration of
such shares under the Securities Act. Registration of such shares under the
Securities Act would result in such shares becoming freely tradable without
restriction under the Securities Act (except for shares purchased by affiliates
of the Company) immediately upon the effectiveness of such registration. See
"Description of Capital Stock -- Registration Rights of Certain Holders".
LEGAL MATTERS
The validity of the shares of Common Stock being offered hereby and certain
other legal matters regarding the shares of Common Stock will be passed upon for
the Company by Piper & Marbury L.L.P., Washington, D.C., counsel to the Company.
Certain legal matters in connection with the Offerings will be passed upon for
the Underwriters by Hale and Dorr LLP, Washington, D.C.
EXPERTS
The consolidated financial statements and schedules of the Company as of
December 31, 1996 and 1997, and for each of the three years in the period ended
December 31, 1997, included in this Prospectus and elsewhere in the Registration
Statement have been audited by Arthur Andersen LLP, independent public
accountants, as indicated in their reports with respect thereto, and are
included herein in reliance upon the authority of said firm as experts in giving
said reports.
OTHER MATTERS
In August 1997, the Company's Board of Directors retained Arthur Andersen
LLP as its independent public accountants and dismissed the Company's former
auditors. From the Company's inception and throughout the time they were
retained by the Company, the former auditors did not disagree with the Company
on any matter of accounting principles or practices, financial statement
disclosure or auditing scope or procedure or any reportable events. The former
auditors' reports on the Company's financial statements, contained no adverse
opinion or disclaimer of opinion and were not qualified or modified as to
uncertainty, audit scope or accounting principles. Prior to retaining Arthur
Andersen LLP, the Company had not consulted with Arthur Andersen LLP on any
accounting, auditing or reporting matter.
61
<PAGE> 64
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<S> <C>
Report of Independent Public Accountants.................... F-2
Consolidated Balance Sheets as of December 31, 1996 and 1997
and June 30, 1998 (unaudited)............................. F-3
Consolidated Statements of Operations for the years ended
December 31, 1995, 1996 and 1997 and for the six months
ended June 30, 1997 and 1998 (unaudited).................. F-4
Consolidated Statements of Changes in Stockholders' Equity
(Deficit) for the years ended December 31, 1995, 1996 and
1997 and for the six months ended June 30, 1998
(unaudited)............................................... F-5
Consolidated Statements of Cash Flows for the years ended
December 31, 1995, 1996 and 1997 and for the six months
ended June 30, 1997 and 1998 (unaudited).................. F-6
Notes to Consolidated Financial Statements.................. F-7
</TABLE>
F-1
<PAGE> 65
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Stockholders of
Visual Networks, Inc.:
We have audited the accompanying consolidated balance sheets of Visual
Networks, Inc., a Delaware corporation, and subsidiary, as of December 31, 1996
and 1997, and the related consolidated statements of operations, changes in
stockholders' equity (deficit) and cash flows for each of the three years in the
period ended December 31, 1997. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform an 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 financial statements referred to above present fairly,
in all material respects, the financial position of Visual Networks, Inc. and
subsidiary as of December 31, 1996 and 1997, and the results of their operations
and their cash flows for each of the three years in the period ended December
31, 1997, in conformity with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Washington, D.C.
June 30, 1998
F-2
<PAGE> 66
VISUAL NETWORKS, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
<TABLE>
<CAPTION>
DECEMBER 31,
------------------- JUNE 30,
1996 1997 1998
-------- -------- -----------
(UNAUDITED)
<S> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................. $ 7,551 $ 8,902 $ 48,556
Accounts receivable, net of allowance of $260, $412 and
$489, respectively...................................... 2,539 3,559 4,154
Inventory................................................. 1,398 3,724 4,325
Other current assets...................................... 321 602 1,173
-------- -------- --------
Total current assets.................................... 11,809 16,787 58,208
Property and equipment, net................................. 1,535 1,824 3,262
-------- -------- --------
Total assets............................................ $ 13,344 $ 18,611 $ 61,470
======== ======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable and accrued expenses..................... $ 1,692 $ 5,794 $ 11,984
Customer deposits......................................... -- 3,068 1,954
Accrued compensation...................................... 936 1,606 1,320
Deferred revenue.......................................... 1,124 5,211 5,141
Bank line of credit....................................... 848 126 --
Loan payable to stockholder............................... -- 500 500
Current portion of capital lease obligation............... 178 379 332
-------- -------- --------
Total current liabilities............................... 4,778 16,684 21,231
Capital lease obligation, net of current portion............ 148 374 228
-------- -------- --------
Total liabilities....................................... 4,926 17,058 21,459
-------- -------- --------
Commitments and contingencies (Note 8)
Redeemable convertible preferred stock (Note 3):
Series B, Series C, Series D and Series E redeemable
convertible cumulative preferred stock, $.01 par value,
7,229,438 shares authorized in aggregate, 7,228,473
shares issued and outstanding in aggregate as of
December 31, 1996 and 1997, respectively, and no shares
outstanding as of June 30, 1998 (aggregate liquidation
preference of $13,262 and $14,484 as of December 31,
1996 and 1997, respectively)............................ 13,398 14,855 --
-------- -------- --------
Stockholders' equity (deficit) (Note 4):
Preferred stock, $.01 par value, 5,000,000 shares
authorized, no shares issued and outstanding............ -- -- --
Series A convertible cumulative preferred stock, $.01 par
value, 347,070 shares authorized, issued and outstanding
as of December 31, 1996 and 1997 and no shares
outstanding as of June 30, 1998 (liquidation preference
of $130 and $149 as of December 31, 1996 and 1997,
respectively)........................................... 3 3 --
Common stock, $.01 par value, 50,000,000 shares
authorized, 4,839,495 and 5,005,140 shares issued and
outstanding as of December 31, 1996 and 1997,
respectively, 19,886,099 shares issued and outstanding
as of June 30, 1998..................................... 48 50 199
Deferred compensation..................................... -- (247) (227)
Additional paid-in capital................................ 12,373 12,783 73,306
Accumulated deficit....................................... (17,404) (25,891) (33,267)
-------- -------- --------
Total stockholders' equity (deficit).................... (4,980) (13,302) 40,011
-------- -------- --------
Total liabilities and stockholders' equity (deficit).... $ 13,344 $ 18,611 $ 61,470
======== ======== ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-3
<PAGE> 67
VISUAL NETWORKS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
<TABLE>
<CAPTION>
YEAR ENDED SIX MONTHS ENDED
DECEMBER 31, JUNE 30,
---------------------------------- ----------------------
1995 1996 1997 1997 1998
--------- ---------- --------- --------- ----------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Revenue.......................... $ 567 $ 8,279 $ 27,345 $ 10,217 $ 22,306
Cost of goods sold............... 242 3,687 10,754 4,127 8,901
--------- ---------- --------- --------- ----------
Gross profit................... 325 4,592 16,591 6,090 13,405
--------- ---------- --------- --------- ----------
Operating expenses:
Research and development....... 2,038 5,432 7,321 3,281 4,915
Sales and marketing............ 1,187 9,483 13,182 5,851 7,287
General and administrative..... 566 2,036 3,211 1,460 2,116
Merger-related costs........... -- -- -- -- 7,347
--------- ---------- --------- --------- ----------
Total operating expenses.... 3,791 16,951 23,714 10,592 21,665
--------- ---------- --------- --------- ----------
Loss from operations............. (3,466) (12,359) (7,123) (4,502) (8,260)
Interest income, net............. 63 166 93 66 1,055
--------- ---------- --------- --------- ----------
Net loss......................... (3,403) (12,193) (7,030) (4,436) (7,205)
Dividends and accretion on
preferred stock................ (250) (1,012) (1,457) (729) (144)
--------- ---------- --------- --------- ----------
Net loss attributable to common
shareholders................... $ (3,653) $ (13,205) $ (8,487) $ (5,165) $ (7,349)
========= ========== ========= ========= ==========
Basic and diluted net loss per
common share................... $ (1.04) $ (2.97) $ (1.72) $ (1.06) $ (0.45)
========= ========== ========= ========= ==========
Weighted average common shares
outstanding.................... 3,524,681 4,439,522 4,926,802 4,879,780 16,401,905
========= ========== ========= ========= ==========
Pro forma basic and diluted net
loss per common share.......... $ (0.45) $ (0.29) $ (0.38)
========= ========= ==========
Pro forma weighted average common
shares outstanding............. 15,532,537 15,485,515 18,862,904
========= ========= ==========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
<PAGE> 68
VISUAL NETWORKS, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT)
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
STOCKHOLDERS' EQUITY (DEFICIT)
REDEEMABLE ------------------------------------------------------------
CONVERTIBLE SERIES A CONVERTIBLE
PREFERRED STOCK PREFERRED STOCK COMMON STOCK
--------------------- ----------------------- ------------------- DEFERRED
SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT COMPENSATION
---------- -------- ---------- ---------- ---------- ------ ------------
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE, DECEMBER 31, 1994......... 2,588,438 $ 1,170 347,070 $ 3 2,800,000 $ 28 $ --
Adjustment for pooling of
interests with Net2Net (Note
1)............................ -- -- -- -- 617,337 6 --
---------- -------- -------- --- ---------- ---- -----
BALANCE, DECEMBER 31, 1994, AS
RESTATED.......................... 2,588,438 1,170 347,070 3 3,417,337 34 --
Issuance of common stock........ -- -- -- -- 591,652 6 --
Exercise of stock options....... -- -- -- -- 23,805 -- --
Issuance of Series C preferred
stock......................... 1,600,000 1,965 -- -- -- -- --
Accretion on preferred stock.... -- 47 -- -- -- -- --
Accrued dividends on preferred
stock......................... -- 203 -- -- -- -- --
Net loss........................ -- -- -- -- -- -- --
---------- -------- -------- --- ---------- ---- -----
BALANCE, DECEMBER 31, 1995......... 4,188,438 3,385 347,070 3 4,032,794 40 --
Issuance of common stock........ -- -- -- -- 776,645 8 --
Issuance of Series D preferred
stock......................... 2,285,714 3,983 -- -- -- -- --
Issuance of Series E preferred
stock......................... 754,321 5,018 -- -- -- -- --
Accretion on preferred stock.... -- 177 -- -- -- -- --
Accrued dividends on preferred
stock......................... -- 835 -- -- -- -- --
Redemption of common stock...... -- -- -- -- (8,729) -- --
Exercise of stock options....... -- -- -- -- 38,785 -- --
Net loss........................ -- -- -- -- -- -- --
---------- -------- -------- --- ---------- ---- -----
BALANCE, DECEMBER 31, 1996......... 7,228,473 13,398 347,070 3 4,839,495 48 --
Issuance of common stock........ -- -- -- -- 35,504 -- --
Exercise of stock options....... -- -- -- -- 130,141 2 --
Deferred compensation........... -- -- -- -- -- -- (292)
Amortization of deferred
compensation.................. -- -- -- -- -- -- 45
Accretion on preferred stock.... -- 235 -- -- -- -- --
Accrued dividends on preferred
stock......................... -- 1,222 -- -- -- -- --
Net loss........................ -- -- -- -- -- -- --
---------- -------- -------- --- ---------- ---- -----
BALANCE, DECEMBER 31, 1997......... 7,228,473 14,855 347,070 3 5,005,140 50 (247)
Accretion on preferred stock
(unaudited)................... -- 16 -- -- -- -- --
Accrued dividends on preferred
stock (unaudited)............. -- 125 -- 30 -- -- --
Conversion of preferred stock
and payment of dividend
(unaudited)................... (7,228,473) (14,996) (347,070) (33) 10,605,735 106 --
Issuance of common stock
(unaudited)................... -- -- -- -- 4,025,000 40 --
Exercise of stock options
(unaudited)................... -- -- -- -- 250,224 3 --
Amortization of deferred
compensation (unaudited)...... -- -- -- -- -- -- 20
Net loss (unaudited)............ -- -- -- -- -- -- --
---------- -------- -------- --- ---------- ---- -----
BALANCE, JUNE 30, 1998
(UNAUDITED)....................... -- $ -- -- $-- 19,886,099 $199 $(227)
========== ======== ======== === ========== ==== =====
<CAPTION>
STOCKHOLDERS' EQUITY (DEFICIT)
-----------------------------------
ADDITIONAL
PAID-IN- ACCUMULATED
CAPITAL DEFICIT TOTAL
---------- ----------- --------
<S> <C> <C> <C>
BALANCE, DECEMBER 31, 1994......... $ 121 $ (235) $ (83)
Adjustment for pooling of
interests with Net2Net (Note
1)............................ 528 (215) 319
------- -------- --------
BALANCE, DECEMBER 31, 1994, AS
RESTATED.......................... 649 (450) 236
Issuance of common stock........ 4,096 (7) 4,095
Exercise of stock options....... -- -- --
Issuance of Series C preferred
stock......................... -- -- --
Accretion on preferred stock.... -- (47) (47)
Accrued dividends on preferred
stock......................... -- (203) (203)
Net loss........................ -- (3,403) (3,403)
------- -------- --------
BALANCE, DECEMBER 31, 1995......... 4,745 (4,110) 678
Issuance of common stock........ 7,618 (89) 7,537
Issuance of Series D preferred
stock......................... -- -- --
Issuance of Series E preferred
stock......................... -- -- --
Accretion on preferred stock.... -- (177) (177)
Accrued dividends on preferred
stock......................... -- (835) (835)
Redemption of common stock...... -- -- --
Exercise of stock options....... 10 -- 10
Net loss........................ -- (12,193) (12,193)
------- -------- --------
BALANCE, DECEMBER 31, 1996......... 12,373 (17,404) (4,980)
Issuance of common stock........ 94 -- 94
Exercise of stock options....... 24 -- 26
Deferred compensation........... 292 -- --
Amortization of deferred
compensation.................. -- -- 45
Accretion on preferred stock.... -- (235) (235)
Accrued dividends on preferred
stock......................... -- (1,222) (1,222)
Net loss........................ -- (7,030) (7,030)
------- -------- --------
BALANCE, DECEMBER 31, 1997......... 12,783 (25,891) (13,302)
Accretion on preferred stock
(unaudited)................... -- (16) (16)
Accrued dividends on preferred
stock (unaudited)............. -- (155) (125)
Conversion of preferred stock
and payment of dividend
(unaudited)................... 14,923 -- 14,996
Issuance of common stock
(unaudited)................... 45,378 -- 45,418
Exercise of stock options
(unaudited)................... 222 -- 225
Amortization of deferred
compensation (unaudited)...... -- -- 20
Net loss (unaudited)............ -- (7,205) (7,205)
------- -------- --------
BALANCE, JUNE 30, 1998
(UNAUDITED)....................... $73,306 $(33,267) $ 40,011
======= ======== ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-5
<PAGE> 69
VISUAL NETWORKS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED SIX MONTHS
DECEMBER 31, ENDED JUNE 30,
---------------------------- -----------------
1995 1996 1997 1997 1998
------- -------- ------- ------- -------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Cash flows from operating activities:
Net loss.................................... $(3,403) $(12,193) $(7,030) $(4,436) $(7,205)
Adjustments to reconcile net loss to net
cash (used in) provided by operating
activities --
Depreciation and amortization........... 101 481 1,009 438 598
Loss on disposal of property and
equipment............................ -- 323 408 --
Changes in assets and liabilities --
Accounts receivable..................... (212) (2,327) (1,020) (939) (595)
Inventory............................... (720) (675) (2,326) (376) (601)
Other current assets.................... (83) (231) (281) (177) (572)
Accounts payable and accrued expenses... 478 1,203 4,186 2,327 6,190
Customer deposits....................... -- -- 3,068 -- (1,114)
Accrued compensation.................... 160 702 586 (123) (286)
Deferred revenue........................ 162 962 4,087 1,220 (70)
------- -------- ------- ------- -------
Net cash (used in) provided by
operating activities............ (3,517) (11,755) 2,686 (2,066) (3,655)
------- -------- ------- ------- -------
Cash flows from investing activities:
Proceeds from sale leaseback
transactions......................... 138 -- 544 473 --
Expenditures for property and
equipment............................ (535) (1,509) (1,487) (730) (2,015)
------- -------- ------- ------- -------
Net cash used in investing
activities...................... (397) (1,509) (943) (257) (2,015)
------- -------- ------- ------- -------
Cash flows from financing activities:
Proceeds from issuance of preferred
stock, net of issuance costs......... 1,965 9,001 -- -- --
Net borrowings (repayments) under credit
agreements........................... -- 848 (722) -- (126)
Proceeds from issuance of common stock,
net of issuance costs................ 4,095 7,537 94 44 45,448
Exercise of stock options............... -- 11 26 12 225
Proceeds from loan payable to
stockholder.......................... -- -- 500 -- --
Payment of Series A Convertible
Preferred Stock dividend............. -- -- -- -- (30)
Principal payments on capital lease
obligations.......................... (22) (130) (290) (97) (193)
------- -------- ------- ------- -------
Net cash provided by (used in)
financing activities............ 6,038 17,267 (392) (41) 45,324
------- -------- ------- ------- -------
Net (decrease) increase in cash and cash
equivalents............................... 2,124 4,003 1,351 (2,364) 39,654
Cash and cash equivalents, beginning of
period.................................... 1,424 3,548 7,551 7,551 8,902
------- -------- ------- ------- -------
Cash and cash equivalents, end of period.... $ 3,548 $ 7,551 $ 8,902 $ 5,187 $48,556
======= ======== ======= ======= =======
Supplemental cash flow information:
Cash paid for interest...................... $ 20 $ 71 $ 143 $ 70 $ 125
======= ======== ======= ======= =======
Cash paid for income taxes.................. $ -- $ -- $ -- $ -- $ 495
======= ======== ======= ======= =======
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-6
<PAGE> 70
VISUAL NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(INFORMATION AS OF JUNE 30, 1998 AND FOR
THE SIX MONTHS ENDED JUNE 30, 1997 AND 1998 IS UNAUDITED)
1. NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Visual Networks, Inc. ("Visual") is engaged in developing, manufacturing
and marketing wide-area-network service level management systems. Visual's
operations are subject to certain risks and uncertainties, including among
others, successful implementation of the Visual sales and distribution model,
dependence on significant customers, rapidly changing technology, current and
potential competitors with greater financial, technological, production, and
marketing resources, dependence on sole and limited source suppliers, dependence
on key management personnel, limited protection of intellectual property and
proprietary rights, integration of its recent acquisition of Net2Net
corporation, uncertainty of future profitability and possible fluctuations in
financial results.
NET2NET ACQUISITION
On May 15, 1998, Visual acquired Net2Net Corporation ("Net2Net") in a
merger transaction accounted for as a pooling of interests. Net2Net is engaged
in developing, manufacturing and marketing Asynchronous Transfer Mode ("ATM")
wide-area-network management and analysis systems. Visual issued 2,056,204
shares of its common stock in exchange for all of the outstanding preferred and
common stock of Net2Net. In addition, outstanding Net2Net stock options were
converted into options to purchase 189,733 shares of Visual common stock. The
accompanying consolidated financial statements have been retroactively restated
to reflect the combined financial position and combined results of operations
and cash flows for all periods presented, giving effect to the acquisition as if
it had occurred at the beginning of the earliest period presented (hereafter,
Visual and Net2Net are collectively referred to as the "Company").
Results of operations for the separate and combined companies prior to the
pooling are as follows (in thousands).
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, THREE MONTHS
------------------------------- ENDED MARCH 31,
1995 1996 1997 1998
-------- --------- -------- ---------------
(UNAUDITED)
<S> <C> <C> <C> <C>
Revenue:
Visual....................................... $ 250 $ 6,335 $23,651 $ 9,162
Net2Net...................................... 317 1,944 3,694 1,165
------- -------- ------- ----------
$ 567 $ 8,279 $27,345 $ 10,327
======= ======== ======= ==========
Net (Loss) Income
Visual....................................... $(1,791) $ (6,983) $ (152) $ 1,005
Net2Net...................................... (1,612) (5,210) (6,878) (2,640)
------- -------- ------- ----------
$(3,403) $(12,193) $(7,030) $ (1,635)
======= ======== ======= ==========
</TABLE>
In connection with the Net2Net acquisition, the Company recorded
merger-related costs in the three months ended June 30, 1998 for transaction
costs, integration expenses and restructuring charges of approximately
$7,347,000. Transaction costs totaled approximately $4,391,000 and consisted
primarily of fees for investment bankers, attorneys, accountants and other
direct costs necessary to complete the transaction. Integration expenses totaled
$207,000 and represented
F-7
<PAGE> 71
VISUAL NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INFORMATION AS OF JUNE 30, 1998 AND FOR
THE SIX MONTHS ENDED JUNE 30, 1997 AND 1998 IS UNAUDITED)
incremental and non-recurring costs necessary to integrate Net2Net and Visual.
These costs are expensed as incurred.
The restructuring charge totaled approximately $2,749,000 and relates
primarily to the consolidation of the Company's manufacturing, sales, marketing
and administrative functions and the discontinuance of certain product
development efforts. This consolidation will include a reduction of
approximately 20 employees which will result in severance and out-placement
costs. Other restructuring costs relate to the termination of lease agreements
or other contractual arrangements with no future benefit.
UNAUDITED INTERIM FINANCIAL STATEMENTS
The accompanying consolidated balance sheet as of June 30, 1998, and the
accompanying consolidated statements of operations and cash flows for the six
months ended June 30, 1997 and 1998, are unaudited. The unaudited financial
statements include all adjustments (consisting of normal recurring adjustments)
which are, in the opinion of management, necessary for a fair presentation of
such financial statements. The data disclosed in the notes to the financial
statements for those periods are unaudited. The results of operations for the
six months ended June 30, 1998, are not necessarily indicative of the results to
be expected for the entire fiscal year.
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. Actual results could differ from those estimates.
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid instruments with an original
maturity of three months or less at the time of purchase to be cash equivalents.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying values of current assets and current liabilities approximate
fair value because of the relatively short maturities of these instruments.
REVENUE RECOGNITION
The Company generally recognizes revenue from the sale or license of its
products upon delivery and passage of title to the customer. Where agreements
provide for evaluation or customer acceptance, the Company recognizes revenue
upon the completion of the evaluation process and acceptance of the product by
the customer. Maintenance contracts call for the Company to provide technical
support and software updates to customers. The Company recognizes product
support and maintenance revenue, including maintenance revenue that is bundled
with product sales, ratably over the term of the contract period, which
generally ranges from one to three years.
F-8
<PAGE> 72
VISUAL NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INFORMATION AS OF JUNE 30, 1998 AND FOR
THE SIX MONTHS ENDED JUNE 30, 1997 AND 1998 IS UNAUDITED)
The Company has an agreement with one reseller that provides price
protection for units that remain in that reseller's inventory. Reserves for
estimated price protection credits are established by the Company concurrently
with the recognition of revenue. The Company monitors the factors that influence
the pricing of its products and reseller inventory levels and makes adjustments
to these reserves when management believes that actual price protection credits
may differ from established estimates.
CREDIT RISK
Financial instruments that potentially subject the Company to significant
concentrations of credit risk consist principally of cash and cash equivalents
and accounts receivable. The Company maintains its cash and cash equivalents
with high credit quality financial institutions. The Company's cash equivalents
consist primarily of investments in money market funds that invest in U.S.
Treasury obligations and may also invest in repurchase agreements collateralized
by U.S. Treasury securities. As of December 31, 1996, December 31, 1997 and June
30, 1998, the Company had approximately $2,637,000, $8,650,000 and $46,622,000,
respectively, invested in money market funds.
The Company sells its hardware and licenses its software products to large
telecommunications providers and subscribers primarily in the United States. The
Company grants uncollateralized credit terms to its customers and has not
experienced any significant credit related losses. Accounts receivable include
allowances to record receivables at their estimated net realizable value. During
1996, one customer individually represented 10% of revenue. During 1997, one
customer individually represented 27% of revenue. For the six months ended June
30, 1998, three customers individually represented 33%, 12% and 11% of revenue,
respectively.
WARRANTY
The Company warrants its hardware products for periods ranging from two to
five years. Estimated warranty costs are charged to cost of goods sold in the
period in which revenue from the related product sale is recognized.
INVENTORY
Inventory is stated at the lower of average cost or market. Inventory
consists of the following (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30,
---------------- -----------
1996 1997 1998
------ ------ -----------
(UNAUDITED)
<S> <C> <C> <C>
Raw materials.......................................... $ 262 $ 439 797
Work-in-progress....................................... 403 635 1,449
Finished goods......................................... 733 2,650 2,079
------ ------ ------
$1,398 $3,724 $4,325
====== ====== ======
</TABLE>
PROPERTY AND EQUIPMENT
Property and equipment is carried at cost and depreciated over its
estimated useful life, ranging from three to four years, using the straight-line
method. Equipment held under capital leases is
F-9
<PAGE> 73
VISUAL NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INFORMATION AS OF JUNE 30, 1998 AND FOR
THE SIX MONTHS ENDED JUNE 30, 1997 AND 1998 IS UNAUDITED)
recorded at the present value of the future minimum lease payments and is
amortized on a straight-line basis over the shorter of the assets' useful lives
or the relevant lease term, ranging from three to four years.
Property and equipment consists of the following (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30,
--------------- -----------
1996 1997 1998
------ ------ -----------
(UNAUDITED)
<S> <C> <C> <C>
Equipment and software................................. $1,998 $2,659 $ 4,655
Furniture and fixtures................................. 64 137 155
------ ------ -------
2,062 2,796 4,810
Less-accumulated depreciation.......................... (527) (972) (1,548)
------ ------ -------
$1,535 $1,824 $ 3,262
====== ====== =======
</TABLE>
ACCOUNTS PAYABLE AND ACCRUED EXPENSES
Accounts payable and accrued expenses consist of the following (in
thousands):
<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30,
---------------- -----------
1996 1997 1998
------ ------ -----------
(UNAUDITED)
<S> <C> <C> <C>
Accounts payable....................................... $ 625 $1,966 $ 1,197
Accrued expenses....................................... 1,067 3,830 3,715
Accrued transaction costs.............................. -- -- 4,222
Accrued restructuring costs............................ -- -- 2,735
------ ------ -------
$1,692 $5,794 $11,984
====== ====== =======
</TABLE>
RESEARCH AND DEVELOPMENT
Research and development costs are expensed as incurred.
The Company accounts for software development costs in accordance with
Statement of Financial Accounting Standards ("SFAS") No. 86, "Accounting for the
Costs of Computer Software to be Sold, Leased, or Otherwise Marketed". Costs
incurred prior to establishment of technological feasibility are expensed as
incurred and reflected as research and development costs in the accompanying
consolidated statements of operations.
For the years ended December 31, 1995, 1996 and 1997, and for the six
months ended June 30, 1998, the Company did not capitalize any costs related to
software development. During these periods, the time between the establishment
of technological feasibility and general release of products was very short.
Consequently, costs otherwise capitalizable after technological feasibility were
expensed as they were immaterial.
F-10
<PAGE> 74
VISUAL NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INFORMATION AS OF JUNE 30, 1998 AND FOR
THE SIX MONTHS ENDED JUNE 30, 1997 AND 1998 IS UNAUDITED)
INCOME TAXES
The Company accounts for income taxes in accordance with SFAS No. 109
"Accounting for Income Taxes". Under SFAS No. 109, deferred tax assets and
liabilities are computed based on the difference between the financial statement
and income tax bases of assets and liabilities using the enacted marginal tax
rate. SFAS No. 109 requires that the net deferred tax asset be reduced by a
valuation allowance if, based on the weight of available evidence, it is more
likely than not that some portion or all of the net deferred tax asset will not
be realized.
BASIC AND DILUTED NET LOSS PER COMMON SHARE
In March 1997, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 128, "Earnings Per Share". SFAS No. 128 is effective for financial
statements issued for periods ending after December 15, 1997. The Company has
implemented SFAS No. 128 for 1997. SFAS No. 128 requires dual presentation of
basic and diluted earnings per share. Basic loss per share includes no dilution
and is computed by dividing net loss available to common stockholders by the
weighted average number of common shares outstanding for the period.
Diluted loss per share includes the potential dilution that could occur if
securities or other contracts to issue common stock were exercised or converted
into common stock. Options to purchase 590,716, 1,295,305, 1,988,875, 1,681,265
and 2,101,686 shares of common stock that were outstanding at December 31, 1995,
1996 and 1997, and at June 30, 1997 and 1998 were not included in the
computation of diluted loss per share as their effect would be anti-dilutive.
The effect of preferred stock convertible into 6,349,699, 10,605,735 and
10,605,735 shares of common stock as of December 31, 1995, 1996, 1997,
respectively, has also not been included in the computation of diluted loss per
share as such effect would have been anti-dilutive. The effect of preferred
stock convertible into 10,605,735 shares of common stock as of June 30, 1997 was
not included in the computation of diluted loss per share for the six months
ended June 30, 1997, as such effect would have been anti-dilutive. The effect of
preferred stock convertible into 10,605,735 shares of common stock outstanding
from January 1, 1998 to February 11, 1998 was not included in the computation of
diluted loss per share for the six months ended June 30, 1998 as such effect
would have been anti-dilutive. The effect of the conversion of the preferred
stock into 10,605,735 shares of common stock is included in the computation of
both basic and diluted loss per share from the date of conversion on February
11, 1998. As a result, the basic and diluted loss per share amounts are
identical for all periods presented. Pro forma basic and diluted weighted
average common shares outstanding assumes the conversion of all of the Company's
outstanding convertible preferred stock into common stock for each period
presented.
NEW ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board issued SFAS No. 130,
"Reporting Comprehensive Income" and No. 131, "Disclosures about Segments of an
Enterprise and Related Information." The Company adopted SFAS No. 130 for the
three months ended March 31, 1998 and will adopt SFAS No. 131 with the issuance
of its financial statements for the year ending December 31, 1998. The adoption
of these new pronouncements will not have a material impact on the Company's
results of operations, financial position or cash flows.
F-11
<PAGE> 75
VISUAL NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INFORMATION AS OF JUNE 30, 1998 AND FOR
THE SIX MONTHS ENDED JUNE 30, 1997 AND 1998 IS UNAUDITED)
2. CREDIT AGREEMENTS AND NOTES PAYABLE:
Effective June 30, 1998, Visual amended its bank credit agreement. This
revolving line of credit, as amended (the "Revolving Line"), provides for
borrowings up to the lesser of $7,000,000 or 80% of eligible accounts
receivable. The Revolving Line matures on April 5, 1999 and borrowings under the
Revolving Line bear interest at the prime rate plus 0.25%. Borrowings are
collateralized by the assets of the Company. The loan and security agreement
also contains restrictive covenants, including, but not limited to, restrictions
related to liquidity and net worth, as well as restrictions related to
acquisitions, dispositions of assets, distributions and investments. As of
December 31, 1997 and June 30, 1998, the Company had no borrowings against the
Revolving Line. As of December 31, 1997, and June 30, 1998, $190,000 had been
committed against the Revolving Line through the issuance of a letter of credit
(Note 8).
Net2Net had a $1,000,000 accounts receivable based line-of-credit facility
with a bank. Borrowings under this line were collateralized by substantially all
of Net2Net's assets. The maximum available borrowings are the lesser of
$1,000,000 or 75% of Net2Net's eligible domestic accounts receivable plus 80% of
international accounts receivable backed by letters of credit or foreign credit
insurance. The Company had outstanding borrowings of approximately $126,000,
under this line as of December 31, 1997. Interest on outstanding borrowings
under this line is generally based on the bank's prime rate (8.5% at December
31, 1997) plus 2%. The agreement contained, among other things, covenants that,
required Net2Net to meet certain financial ratios and to maintain minimum
tangible net worth. As of June 30, 1998, the Company had no borrowings against
the line-of-credit.
In January 1998, Net2Net borrowed $500,000 from a bank in the form of a
note payable. The note bears interest at the bank's prime rate (8.5% at December
31, 1997) plus 2% and was repaid in April 1998.
Effective as of December 31, 1997, Net2Net issued a $500,000 subordinated
note payable to a stockholder, bearing interest at a per annum rate of 15%. This
note matured at the earlier of September 30, 1998, the issuance of a newly
designated series or class of preferred stock which results in proceeds to the
Company of at least $1,500,000, or upon the closing of a sale of the Company, as
defined. This note payable is subordinate to that of the outstanding borrowings
under the Net2Net line-of-credit arrangement.
3. PREFERRED STOCK:
The Company had a total of 12,576,508 shares of authorized preferred stock,
7,576,508 shares of which were designated as Series A, B, C, D and E convertible
preferred stock and 5,000,000 of which has not been designated. All of the then
outstanding shares of Series A, B, C, D and E convertible preferred stock were
converted to common stock in connection with the Company's initial public
offering ("IPO") in February 1998. The following details the number of shares
issued
F-12
<PAGE> 76
VISUAL NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INFORMATION AS OF JUNE 30, 1998 AND FOR
THE SIX MONTHS ENDED JUNE 30, 1997 AND 1998 IS UNAUDITED)
and the liquidation preference (in thousands) for each series of the convertible
preferred stock as of December 31, 1996 and 1997.
<TABLE>
<CAPTION>
AMOUNT LIQUIDATION PREFERENCE
SHARES OUTSTANDING --------------------------- ---------------------------
AS OF DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31,
1996 AND 1997 1996 1997 1996 1997
------------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
Series A.............. 347,070 $ 3 $ 3 $ 130 $ 149
Series B.............. 2,588,438 1,464 1,611 1,440 1,560
Series C.............. 1,600,000 2,316 2,551 2,283 2,483
Series D.............. 2,285,714 4,433 4,904 4,373 4,773
Series E.............. 754,321 5,185 5,789 5,166 5,668
--------- ------- ------- ------- -------
7,575,543 $13,401 $14,858 $13,392 $14,633
========= ======= ======= ======= =======
</TABLE>
SERIES A PREFERRED STOCK
In connection with the Series B Preferred Stock ("Series B") offering,
notes payable of $119,500 together with accrued interest of $1,176 were
converted into shares of Series A Preferred Stock ("Series A"). The Series A had
liquidation preferences over the common stock. The Series A had cumulative
dividends equal to 8% per annum. Dividends were not payable for a period of
twenty-four months from the date of issuance (December 1994). The Company had
not declared dividends through December 1997 on Series A shares based on legal
limitations on the declarations of dividends. At December 31, 1996 and 1997,
dividends in arrears on Series A were approximately $19,000 and $29,000,
respectively.
The Series A shares had voting rights entitling Series A holders to the
number of votes per share equal to the number of shares of common stock into
which each share of Series A was then convertible. The Series A shares were
convertible at any time at the option of the holder, or automatically upon the
consummation of an underwritten public offering at a selling price per share of
common stock equal to or exceeding $3.57 per share and where aggregate proceeds
are not less than $10,000,000, into an aggregate of 485,890 shares of common
stock. The conversion price was subject to adjustment for certain dilutive
events.
Upon conversion, all accrued and unpaid dividends could also be converted
into common stock at the then current market price of the common stock (as
defined). The Company could, however, elect to pay any accrued but unpaid
dividends in cash in lieu of converting such dividends into shares of common
stock. In connection with the conversion of the Series A into common stock upon
completion of the IPO, the Company declared and paid cash dividends of
approximately $30,000 to holders of the Series A.
SERIES B PREFERRED STOCK
In December 1994, the Company issued 2,588,438 shares of Series B and
received approximately $1,170,000 in proceeds, net of issuance costs of
approximately $30,000. The Series B had liquidation preferences over the Series
A and the common stock. The holders of Series B were entitled to receive
dividends payable equal to 10% of the Series B stated value annually. Such
dividends were cumulative from the date of issuance. Upon the conversion of
Series B shares into
F-13
<PAGE> 77
VISUAL NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INFORMATION AS OF JUNE 30, 1998 AND FOR
THE SIX MONTHS ENDED JUNE 30, 1997 AND 1998 IS UNAUDITED)
shares of common stock, any accrued but unpaid or undeclared dividends on Series
B would be waived.
At any time after five years following the Series E Preferred Stock
("Series E") issuance, the Company was required to redeem at the option of the
holder, the outstanding Series B shares at a redemption price equal to 110% of
the Series B stated value plus all accrued and unpaid dividends. The Company
recorded periodic accretion under the interest method for the excess of the
redemption value over the stated value.
The Series B shares had voting rights entitling Series B holders to the
number of votes per share equal to the number of shares of common stock into
which each share of Series B was then convertible and to vote as a single class.
The Series B was convertible at any time at the option of the holder, or
automatically upon the consummation of an underwritten public offering at a
selling price per share of common stock equal to or exceeding $3.57 per share,
and where aggregate proceeds were not less than $10,000,000, into an aggregate
of 3,623,811 shares of common stock. The conversion price was subject to
adjustment for certain dilutive events.
SERIES C PREFERRED STOCK
In August 1995, the Company issued 1,600,000 shares of Series C Preferred
Stock ("Series C") and received approximately $1,965,000 in proceeds, net of
issuance costs of approximately $35,000. The Series C had liquidation
preferences over the Series B and Series A and the common stock and had parity
with the Series D Preferred Stock ("Series D") with respect to liquidation. The
holders of Series C were entitled to receive dividends payable equal to 10% of
the Series C stated value annually. Such dividends were cumulative from the date
of issuance. Upon the conversion of Series C shares into shares of common stock,
any accrued but unpaid or undeclared dividends on Series C would be waived.
At any time after five years following the issuance of the Series E, the
holders of at least 66 2/3% of the shares of Series C, Series D and Series E,
together as one class, could request that the Company redeem all or a part of
the outstanding Series C, Series D, and Series E. Any redemption was to be made
pro rata among all of the holders of the Series C, Series D, and Series E, in
proportion to their respective stated values. The redemption price for each
series of preferred stock was equal to 110% of the stated value for such series
of preferred stock plus all accrued and unpaid dividends. The Company recorded
periodic accretion under the interest method of the excess of the redemption
values of each series over the stated value.
The Series C shares had voting rights entitling Series C holders to the
number of votes per share equal to the number of shares of common stock into
which each share of Series C was then convertible and to vote as a single class.
The Series C was convertible at any time at the option of the holder, or
automatically upon the consummation of an underwritten public offering at a
selling price per share of common stock equal to or exceeding $3.57 per share,
and where aggregate proceeds were not less than $10,000,000, into an aggregate
of 2,239,998 shares of common stock. The conversion price was subject to
adjustment for certain dilutive events.
SERIES D PREFERRED STOCK
In January 1996, the Company issued 2,285,714 shares of Series D and
received approximately $3,983,000 in proceeds, net of issuance costs of
approximately $17,000. The Series D had
F-14
<PAGE> 78
VISUAL NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INFORMATION AS OF JUNE 30, 1998 AND FOR
THE SIX MONTHS ENDED JUNE 30, 1997 AND 1998 IS UNAUDITED)
liquidation preferences over the Series B and Series A preferred stock and the
common stock and had parity with the Series C with respect to liquidation. The
holders of Series D were entitled to receive dividends payable equal to 10% of
the Series D stated value annually. Such dividends were cumulative from the date
of issuance. Upon the conversion of Series D shares into shares of common stock,
any accrued but unpaid or undeclared dividends on Series D would be waived.
At any time after five years following the issuance of the Series E, the
holders of at least 66 2/3% of the shares of Series C, Series D and Series E,
together as one class, could request that the Company redeem all or a part of
the outstanding Series C, Series D and Series E. Any redemption was to be made
pro rata among all of the holders of the Series C, Series D and Series E, in
proportion to their respective stated values. The redemption price for each
series of preferred stock was equal to 110% of the stated value for such series
of preferred stock plus all accrued and unpaid dividends. The Company recorded
periodic accretion under the interest method of the excess of the redemption
values of each series over the stated value.
The Series D shares had voting rights entitling Series D holders to the
number of votes per share as equal to the number of shares of common stock into
which each share of Series D was then convertible and to vote as a single class.
The Series D was convertible at any time at the option of the holder, or
automatically upon the consummation of an underwritten public offering at a
selling price per share of common stock equal to or exceeding $3.57 per share,
and where aggregate proceeds were not less than $10,000,000, into an aggregate
of 3,199,996 shares of common stock. The conversion price was subject to
adjustment for certain dilutive events.
SERIES E PREFERRED STOCK
In September 1996, the Company issued 754,321 shares of Series E and
received approximately $5,018,000 in proceeds, net of issuance costs of
approximately $6,000. The Series E had liquidation preferences over the Series
D, Series C, Series B and Series A preferred stock and the common stock. The
holders of Series E were entitled to receive dividends payable equal to 10% of
the Series E stated value annually. Such dividends were cumulative from the date
of issuance. Upon the conversion of Series E shares into shares of common stock,
any accrued but unpaid or undeclared dividends on Series E would be waived.
At any time after five years following the issuance of the Series E, the
holders of at least 66 2/3% of the shares of Series C, Series D and Series E,
together as one class, could request that the Company redeem all or a part of
the outstanding Series C, Series D, and Series E. Any redemption was to be made
pro rata among all of the holders of the Series C, Series D and Series E, in
proportion to their respective stated values. The redemption price for each
series of preferred stock was equal to 110% of the stated value for such series
of preferred stock plus all accrued and unpaid dividends. The Company recorded
periodic accretion under the interest method of the excess of the redemption
values of each series over the stated value.
The Series E shares had voting rights entitling Series E holders to the
number of votes per share as equal to the number of shares of common stock into
which each share of Series E was then convertible and to vote as a single class.
The Series E was convertible at any time at the option of the holder, or
automatically upon the consummation of an underwritten public offering at a
selling price per share of common stock equal to or exceeding $7.86 per share,
and where aggregate
F-15
<PAGE> 79
VISUAL NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INFORMATION AS OF JUNE 30, 1998 AND FOR
THE SIX MONTHS ENDED JUNE 30, 1997 AND 1998 IS UNAUDITED)
proceeds are not less than $10,000,000, into an aggregate of 1,056,040 shares of
common stock. The conversion price was subject to adjustment for certain
dilutive events.
4. STOCKHOLDERS' EQUITY (DEFICIT):
INITIAL PUBLIC OFFERING
In February 1998, the Company completed an IPO of 4,025,000 shares of the
Company's common stock resulting in net proceeds of approximately $45,448,000.
All of the shares sold were issued and sold by the Company. Concurrent with the
offering, the Series A convertible preferred stock and its Series B, C, D, and E
redeemable convertible preferred stock were converted into 485,890 and
10,119,845 shares of common stock, respectively.
OTHER SALES OF COMMON STOCK
In June 1997, the Company sold 25,000 shares of common stock to an officer
of the Company for $1.75 per share. In September 1997, the Company sold 10,504
shares of common stock to a director of the Company for $4.76 per share.
COMMON STOCK SPLIT
In December 1996, the Board of Directors declared a 1.4 for one stock split
of the common stock of the Company effected in the form of a stock dividend. All
share and per-share amounts, including stock option information, have been
restated in these notes and the accompanying financial statements to reflect
this stock split.
5. STOCK OPTIONS:
1994 STOCK OPTION PLAN
The Company's 1994 Stock Option Plan (the "Option Plan") authorizes the
issuance of an aggregate of 1,975,000 shares of Common Stock pursuant to the
exercise of stock options. The Option Plan provides for grants of options to
employees, consultants, and directors of the Company. The Option Plan provides
for the granting of both incentive stock options and non-statutory options. The
Option Plan is administered by the Compensation Committee of the Board of
Directors, which has sole discretion and authority, consistent with the
provisions of the Option Plan, to determine which eligible participants will
receive options, the time when options will be granted, the terms of options
granted, and the number of shares that will be subject to options granted under
the Option Plan.
For any option intended to qualify as an incentive stock option, the
exercise price must not be less than 100% of the fair market value of the common
stock on the date the option is granted (110% of the fair market value of such
common stock with respect to any optionee who immediately before any option is
granted, directly or indirectly, possesses more than 10% of the total combined
voting power of all classes of stock of the Company ("10% Owners")). In the case
of non-statutory options, the exercise price shall not be less than 20% of the
fair value of the common stock at the time of the grant. The Compensation
Committee has the authority to determine the time or times at which options
granted under the Option Plan become exercisable (typically up to five years);
provided that, for any option intended to qualify as an incentive stock option,
such option must expire no later than ten years from the date of grant (five
years with respect to 10% Owners).
F-16
<PAGE> 80
VISUAL NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INFORMATION AS OF JUNE 30, 1998 AND FOR
THE SIX MONTHS ENDED JUNE 30, 1997 AND 1998 IS UNAUDITED)
Unless terminated sooner by the Board, the Option Plan terminates in December
2004 or the date on which all shares available for issuance shall have been
issued pursuant to the exercise or cancellation of options granted under the
Option Plan.
1997 OMNIBUS STOCK PLAN
The Company's 1997 Omnibus Stock Plan (the "Omnibus Plan") authorizes the
issuance of an aggregate of up to 1,000,000 shares of common stock with respect
to certain "Awards" made under the Omnibus Plan. The Omnibus Plan provides for
grants of options to employees, officers, directors, and consultants of the
Company or any affiliate of the Company; provided, however, that no individual
may receive an award of more than 250,000 shares in any year. Awards under the
Omnibus Plan may take the form of grants of stock options, stock appreciation
rights, restricted or unrestricted stock, phantom stock, performance awards, or
any combination thereof. The Omnibus Plan is administered by the Board of
Directors, or by such committee or committees as may be appointed by the Board
of Directors from time to time (the "Administrator"). The Administrator has sole
power and authority, consistent with the provisions of the Omnibus Plan, to
determine which eligible participants will receive Awards, the form of the
Awards and the number of shares of common stock covered by each Award, to impose
terms, limits, restrictions, and conditions upon Awards, to modify, amend,
extend, or renew Awards (with the consent of the awardee), to accelerate or
change the exercise timing of Awards or to waive any restrictions or conditions
to an Award and to establish objectives and conditions for earning Awards.
Unless terminated sooner by the Board, the Omnibus Plan will terminate in
October 2007 or the date on which all shares available for issuance shall have
been issued pursuant to the exercise or cancellation of Awards under the Omnibus
Plan.
1997 DIRECTORS' STOCK OPTION PLAN
The 1997 Directors' Stock Option Plan (the "Director Plan") was adopted in
October 1997. Under the terms of the Director Plan, directors of the Company who
are not employees of the Company (the "Eligible Directors") are eligible to
receive non-statutory options to purchase shares of common stock. A total of
300,000 shares of common stock may be issued upon exercise of options granted
under the Director Plan. Unless terminated sooner by the Board of Directors, the
Director Plan will terminate in October 2007, or the date on which all shares
available for issuance under the Director Plan shall have been issued pursuant
to the exercise of options granted under the Director Plan.
Upon a member's initial election or appointment to the Board of Directors,
such member will be granted options to purchase 24,000 shares of common stock,
vesting over four years, with options to purchase 6,000 shares vesting at the
first anniversary of the grant and options to purchase the remaining 18,000
shares vesting in 36 equal monthly installments. Annual options to purchase
6,000 shares of common stock (the "Annual Options") will be granted to each
Eligible Director on the date of each annual meeting of stockholders. Annual
Options will vest at the rate of one-twelfth of the total grant per month, and
will vest in full at the earlier of (i) the first anniversary of the date of the
grant or (ii) the date of the next annual meeting of stockholders. The exercise
price of options granted under the Director Plan will equal the fair market
value per share of the common stock on the date of grant.
F-17
<PAGE> 81
VISUAL NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INFORMATION AS OF JUNE 30, 1998 AND FOR
THE SIX MONTHS ENDED JUNE 30, 1997 AND 1998 IS UNAUDITED)
NET2NET 1994 STOCK PLAN
The Net2Net 1994 Stock Plan (the "Net2Net Plan") authorizes the issuance of
an aggregate of up to 189,733 shares of Common Stock with respect to certain
"Stock Rights" granted under the Net2Net Plan. In connection with the Company's
acquisition of Net2Net, the Company assumed the obligations of Net2Net under the
Net2Net Plan. As of June 30, 1998, stock options with respect to 183,365 shares
of common stock were outstanding. Subsequent to the merger, Visual's Board of
Directors adopted a resolution not to make any future option grants under the
Net2Net Plan. Stock Rights under the Net2Net Plan took the form of grants of
incentive stock options, non-statutory stock options, awards of stock of the
Company, opportunities to make direct purchases of stock in the Company or any
combination thereof. The Net2Net Plan provided for grants of options to
employees, officers, directors and consultants of Net2Net or any affiliate of
Net2Net.
A summary of the Company's stock option activity is presented below:
<TABLE>
<CAPTION>
WEIGHTED
OPTION AVERAGE
PRICE PER EXERCISE
OPTIONS SHARE PRICE
--------- ----------- --------
<S> <C> <C> <C>
Options outstanding at December 31, 1993......... -- -- --
Granted.......................................... 255,744 $0.02- 1.27 $ 0.23
--------- ----------- ------
Options outstanding at December 31, 1994......... 255,744 0.02- 1.27 0.23
Granted.......................................... 414,777 0.07- 1.58 0.23
Canceled......................................... (56,000) 0.07 0.07
Exercised........................................ (23,805) 0.02 0.02
--------- ----------- ------
Options outstanding at December 31, 1995......... 590,716 0.02- 1.58 0.26
Granted.......................................... 842,054 0.19- 4.73 0.86
Canceled......................................... (98,680) 0.19- 1.58 0.34
Exercised........................................ (38,785) 0.02- 1.58 0.28
--------- ----------- ------
Options outstanding at December 31, 1996......... 1,295,305 0.02- 4.73 0.64
Granted.......................................... 942,192 1.43- 7.00 3.64
Canceled......................................... (118,608) 0.07- 7.00 2.03
Exercised........................................ (130,141) 0.02- 7.00 0.19
--------- ----------- ------
Options outstanding at December 31, 1997......... 1,988,748 0.07- 7.00 2.01
Granted.......................................... 393,058 5.36-34.13 17.60
Canceled......................................... (29,896) 0.29- 7.00 2.26
Exercised........................................ (250,224) 0.07- 7.00 0.90
--------- ----------- ------
Options outstanding at June 30, 1998............. 2,101,686 $0.07-34.13 $ 5.05
========= =========== ======
</TABLE>
As of December 31, 1996, December 31, 1997 and June 30, 1998, options to
purchase 240,602, 396,364 and 418,392 shares of common stock were exercisable
with a weighted average exercise price of $0.24, $0.81, and $1.72 respectively.
The weighted average remaining contractual life of options outstanding at
December 31, 1996, December 31, 1997 and June 30, 1998 was 8.88, 8.59 and 8.51
years, respectively.
In October 1995, the FASB issued SFAS No. 123, "Accounting for Stock-Based
Compensation". SFAS No. 123 defines a "fair value based method" of accounting
for stock-based compensa-
F-18
<PAGE> 82
VISUAL NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INFORMATION AS OF JUNE 30, 1998 AND FOR
THE SIX MONTHS ENDED JUNE 30, 1997 AND 1998 IS UNAUDITED)
tion. Under the fair value based method, compensation cost is measured at the
grant date based on the fair value of the award and is recognized over the
service period. Prior to the issuance of SFAS No. 123, stock-based compensation
was accounted for under the "intrinsic value method" as defined by Accounting
Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to
Employees". Under the intrinsic value method, compensation is the excess, if
any, of the market price of the stock at grant date or other measurement date
over the amount an employee must pay to acquire the stock.
SFAS No. 123 allows an entity to continue to use the intrinsic value
method. However, entities electing the accounting in APB Opinion No. 25 must
make pro forma disclosures as if the fair value based method of accounting had
been applied. The Company applies APB Opinion No. 25 and the related
interpretations in accounting for its stock-based compensation. Under APB
Opinion No. 25, no compensation expense has been recognized in the accompanying
financial statements related to stock option grants in 1995 and 1996. The
Company has recorded deferred compensation of approximately $292,000 related to
stock option grants in 1997, of which approximately $45,000 and $20,000 has been
amortized in the year ended December 31, 1997 and the six months ended June 30,
1998, respectively.
Had compensation expense been determined based on the fair value of the
options at the grant dates consistent with the method of accounting under SFAS
No. 123, the Company's net loss and net loss per share would have been increased
to the pro forma amounts indicated below (in thousands, except per share
amounts):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------
1995 1996 1997
------- -------- -------
<S> <C> <C> <C>
NET LOSS ATTRIBUTED TO COMMON STOCKHOLDERS:
As reported......................................... $(3,653) $(13,205) $(8,487)
Pro forma........................................... (3,655) (13,231) (8,625)
BASIC AND DILUTED NET LOSS PER COMMON AND COMMON
EQUIVALENT SHARE:
As reported......................................... $ (1.04) $ (2.97) $ (1.72)
Pro forma........................................... $ (1.04) $ (2.98) $ (1.75)
</TABLE>
The fair value of each option is estimated on the date of grant using the
Black-Scholes option-pricing model with the following assumptions used for
grants during the years ended December 31, 1995, 1996 and 1997: no dividend
yield, expected volatility of zero, risk-free interest rates from 5.2% to 7.6%
and an expected terms ranging from 5 to 10 years.
6. EMPLOYEE 401(k) SAVINGS PLAN:
Effective January 1, 1996, Visual adopted a defined contribution plan (the
"Savings Plan"), available to all full-time employees upon employment. The
Savings Plan qualifies for preferential tax treatment under Section 401(a) of
Internal Revenue Code. Employee contributions are voluntary and are determined
on an individual basis with a maximum annual amount equal to 15% of compensation
paid during the plan year, not to exceed the annual Internal Revenue Service
contribution limitations. All participants are fully vested in their
contributions. There were no employer contributions under the Savings Plan.
F-19
<PAGE> 83
VISUAL NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INFORMATION AS OF JUNE 30, 1998 AND FOR
THE SIX MONTHS ENDED JUNE 30, 1997 AND 1998 IS UNAUDITED)
In March 1996, Net2Net adopted a qualified 401(k) retirement plan (the
"Net2Net 401(k) Plan"). The Net2Net 401(k) Plan covers substantially all
employees who have satisfied a three-month service requirement and have attained
the age of 21. The Net2Net 401(k) Plan provides for an optional Net2Net
contribution for any plan year at Net2Net's discretion. Vesting in Net2Net
contributions will be based on a five-year schedule (20% per year). There were
no Net2Net contributions to the plan for the years ended December 31, 1996 and
1997.
7. INCOME TAXES:
For the years ended December 31, 1995, 1996 and 1997, the tax provision was
comprised primarily of a deferred tax benefit which was offset by a valuation
allowance of the same amount. The tax provision differed from the expected tax
benefit, computed by applying the U.S. Federal statutory rate of 35% to the loss
before income taxes, principally due to the effect of increases in the valuation
allowance.
The components of the Company's net deferred tax asset (liability) are as
follows (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------
1996 1997
------- -------
<S> <C> <C>
Deferred tax asset:
Net operating loss carryforwards............................ $ 5,022 $ 5,140
Depreciation................................................ (8) 161
Allowance for doubtful accounts............................. 55 144
Inventory valuation......................................... 273 657
Warranty reserve............................................ 23 106
Accrued liabilities......................................... 213 734
Deferred revenue............................................ 435 1,547
Other....................................................... 14 122
Valuation allowance......................................... (6,027) (8,611)
------- -------
Total net deferred tax asset...................... $ -- $ --
======= =======
</TABLE>
Visual had net operating loss carryforwards to offset future taxable income
of approximately $2,260,000 as of December 31, 1997. These net operating loss
carryforwards expire through 2011. Under the provisions of the Tax Reform Act of
1986, when there has been a change in an entity's ownership, utilization of net
operating loss carryforwards may be limited. The Company's ability to use its
net operating losses in future periods may be limited in the event of
significant ownership changes. In addition, Visual had research and development
tax credit carryforwards of approximately $270,000 as of December 31, 1997 to
offset future taxable income subject to certain limitations.
The Company has additional net operating loss carryforwards of
approximately $10,773,000 that expire though 2012 as a result of the acquisition
of Net2Net. Because of the change in the ownership of Net2Net, the use of the
Net2Net net operating losses will be limited to approximately $3,500,000 per
year and may not be available to offset future taxable income.
F-20
<PAGE> 84
VISUAL NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INFORMATION AS OF JUNE 30, 1998 AND FOR
THE SIX MONTHS ENDED JUNE 30, 1997 AND 1998 IS UNAUDITED)
8. COMMITMENTS AND CONTINGENCIES:
LEASES
The Company leases office space and office equipment under noncancelable
operating leases expiring through October 2001. The Company recorded rent
expense of approximately $97,000, $286,000 and $718,000 during 1995, 1996 and
1997, respectively.
The Company also leases certain equipment under noncancelable capital lease
agreements which expire through 2000. Future minimum lease payments as of
December 31, 1997 under noncancelable operating and capital leases are as
follows (in thousands):
<TABLE>
<CAPTION>
CAPITAL OPERATING
LEASES LEASES
------- ---------
<S> <C> <C>
1998........................................................ $ 473 $ 589
1999........................................................ 325 440
2000........................................................ 87 648
2001........................................................ -- 638
----- ------
Total minimum lease payments...................... 885 $2,315
======
Interest element of lease payment........................... (132)
-----
Present value of future minimum lease payments.............. 753
Current portion............................................. (379)
-----
Long-term portion........................................... $ 374
=====
</TABLE>
The Company's office lease required a $230,000 letter of credit through
either the 5-year lease term plus two months or ninety days after the
registration of the Company's stock on a nationally recognized stock exchange.
Effective November 25, 1997, the required letter of credit was reduced to
$190,000. The required letter of credit decreases on a straight-line basis over
the period of the lease to a minimum of $50,000. The Company's letter of credit
is collateralized by the Revolving Line which expires in January 1999 (Note 2).
If the Revolving Line is not extended beyond its current maturity date, the
letter of credit will become collateralized by a pledged treasury investment or
pledged certificate of deposit for the remaining period in which a letter of
credit is required pursuant to the lease agreement.
During 1995, Visual entered into two sale-leaseback transactions under
which equipment with a net book value of approximately $122,000 was sold and
leased back under noncancelable capital leases. Proceeds generated from the
sale-leaseback transactions totaled approximately $138,000. The gain of $16,000
resulting from the sale has been deferred and is being amortized on a basis
consistent with the amortization of the asset.
During 1997, Visual entered into additional sale-leaseback transactions in
which equipment with a net book value of approximately $544,000 was sold and
leased back under noncancelable capital leases. Proceeds from the transactions
totaled approximately $544,000, resulting in no gain or loss on the
transactions.
During 1996 and 1997, Net2Net entered into sale/leaseback transactions
involving computer and lab equipment. Such equipment was sold at its net book
value and leased back under capital leases. Such leases are part of a $400,000
equipment lease line of credit that expired in February 1998.
F-21
<PAGE> 85
VISUAL NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INFORMATION AS OF JUNE 30, 1998 AND FOR
THE SIX MONTHS ENDED JUNE 30, 1997 AND 1998 IS UNAUDITED)
LITIGATION
The Company is periodically a party to disputes arising from normal
business activities. In the opinion of management, resolution of these matters
will not have a material adverse effect upon the financial position or future
operating results of the Company, and adequate provision for any potential
losses has been made in the accompanying financial statements.
F-22
<PAGE> 86
UNDERWRITING
Subject to the terms and conditions of the Underwriting Agreement, the
Company and the Selling Stockholders have agreed to sell to each of the U.S.
Underwriters named below, and each of such U.S. Underwriters, for whom Goldman,
Sachs & Co., NationsBanc Montgomery Securities LLC and Dain Rauscher Wessels, a
division of Dain Rauscher Incorporated ("Dain Rauscher Wessels"), are acting as
representatives (collectively, the "Representatives"), has severally agreed to
purchase from the Company and the Selling Stockholders, the respective number of
shares of Common Stock set forth opposite its name below:
<TABLE>
<CAPTION>
NUMBER OF
SHARES OF
UNDERWRITER COMMON STOCK
----------- ------------
<S> <C>
Goldman, Sachs & Co....................................
NationsBanc Montgomery Securities LLC..................
Dain Rauscher Wessels..................................
---------
Total............................................. 2,800,000
=========
</TABLE>
Under the terms and conditions of the Underwriting Agreement, the U.S.
Underwriters are committed to take and pay for all of the shares offered hereby,
if any are taken.
The U.S. Underwriters propose to offer the shares of Common Stock in part
directly to the public at the initial public offering price set forth on the
cover page of this Prospectus and in part to certain securities dealers at such
price less a concession of $ per share. The U.S. Underwriters may allow, and
such dealers may reallow, a concession not in excess of $ per share to
certain brokers and dealers. After the shares of Common Stock are released for
sale to the public, the offering price and other selling terms may from time to
time be varied by the representatives.
The Company and the Selling Stockholders have entered into an underwriting
agreement (the "International Underwriting Agreement") with the underwriters of
the international offering (the "International Underwriters") providing for the
concurrent offer and sale of 700,000 shares of Common Stock in an international
offering outside the United States. The offering price and aggregate
underwriting discounts and commissions per share for the two offerings are
identical. The closing of the offering made hereby is a condition to the closing
of the international offering, and vice versa. The International Underwriters
are Goldman Sachs International, NationsBanc Montgomery Securities LLC and Dain
Rauscher Wessels.
Pursuant to an Agreement between the U.S. and International Underwriting
Syndicates (the "Agreement Between") relating to the two offerings, each of the
U.S. Underwriters named herein has agreed that, as a part of the distribution of
the shares offered hereby and subject to certain exceptions, it will offer, sell
or deliver the shares of Common Stock, directly or indirectly, only in the
United States of America (including the States and the District of Columbia),
its territories, its possessions and other areas subject to its jurisdiction
(the "United States") and to U.S. persons, which term shall mean, for purposes
of this paragraph: (a) any individual who is a resident of the United States or
(b) any corporation, partnership or other entity organized in or under the laws
of the United States or any political subdivision thereof and whose office most
directly involved with the purchase is located in the United States. Each of the
International Underwriters has agreed pursuant to the Agreement Between that, as
part of the distribution of the shares offered as a part of the international
offering, and subject to certain exceptions, it will (i) not, directly or
indirectly, offer, sell or deliver shares of Common Stock (a) in the United
States or to any U.S. persons or (b) to any person whom it believes intends to
reoffer, resell or deliver the shares in the United States or to any U.S.
persons, and (ii) cause any dealer to whom it may sell such shares at any
concession to agree to observe a similar restriction.
Pursuant to the Agreement Between, sales may be made between the U.S.
Underwriters and the International Underwriters of such numbers of shares of
Common Stock as may be mutually agreed. The price of any shares so sold shall be
the initial public offering price, less an amount not greater than the selling
concession.
U-1
<PAGE> 87
The Company and the Selling Stockholders have granted the U.S. Underwriters
an option exercisable for 30 days after the date of this Prospectus to purchase
up to an aggregate of 420,000 additional shares of Common Stock solely to cover
over-allotments, if any. If the U.S. Underwriters exercise their over-allotment
option, the U.S. Underwriters have severally agreed, subject to certain
conditions, to purchase approximately the same percentage thereof that the
number of shares to be purchased by each of them, as shown in the foregoing
table, bears to the 2,800,000 shares of Common Stock offered. The Company and
the Selling Stockholders have granted the International Underwriters a similar
option to purchase up to an aggregate of 105,000 additional shares of Common
Stock.
The Company, its directors and officers and certain of its stockholders and
optionholders have agreed that, during the period beginning from the date of
this Prospectus and continuing to and including the date 90 days, and with
respect to certain other stockholders, 45 days, after the date of the
Prospectus, they will not offer, sell, contract to sell, pledge or otherwise
dispose of any shares of Common Stock or any other securities of the Company
(other than, in the case of the Company, pursuant to employee stock option plans
existing, or on the conversion or exchange of convertible or exchangeable
securities outstanding, on the date of this Prospectus) which are substantially
similar to the shares of the Common Stock or which are convertible into or
exchangeable for securities which are substantially similar to the shares of
Common Stock without the prior written consent of the Representatives, except
for the shares of Common Stock offered in connection with the concurrent U.S.
and international offerings. In addition, stockholders owning approximately
210,488 shares are subject to lock-up agreements which expire August 4, 1998.
In connection with the Offerings, the Underwriters may purchase and sell
the Common Stock in the open market. These transactions may include
over-allotment and stabilizing transactions, "passive" market making (see below)
and purchases to cover syndicate short positions created in connection with the
Offerings. Stabilizing transactions consist of certain bids or purchases for the
purpose of preventing or retarding a decline in the market price of the Common
Stock; and syndicate short positions created by the Underwriters involve the
sale by the Underwriters of a greater number of shares of Common Stock than they
are required to purchase from the Company in the Offerings. The Underwriters
also may impose a penalty bid, whereby selling concessions allowed to syndicate
members or other broker-dealers in respect of the securities sold in the
Offerings for their account may be reclaimed by the syndicate if such shares of
Common Stock are repurchased by the syndicate in stabilizing or covering
transactions. These activities may stabilize, maintain or otherwise affect the
market price of the Common Stock, which may be higher than the price that might
otherwise prevail in the open market; and these activities, if commenced, may be
discontinued at any time. These transactions may be effected on the Nasdaq
National Market, in the over-the-counter market or otherwise.
As permitted by Rule 103 under the Exchange Act, certain Underwriters (and
selling group members, if any) that are market makers ("passive market makers")
in the Common Stock may make bids for or purchases of the Common Stock in the
Nasdaq National Market until such time, if any, when a stabilizing bid for such
securities has been made. Rule 103 generally provides that (i) a passive market
maker's net daily purchases of the Common Stock may not exceed 30% of its
average daily trading volume in such securities for the two full consecutive
calendar months (or any 60 consecutive days ending within the 10 days)
immediately preceding the filing date of the registration statement of which
this Prospectus forms a part, (2) a passive market maker may not effect
transactions or display bids for the Common Stock at a price that exceeds the
highest independent bid for the Common Stock by persons who are not passive
market makers and (3) bids made by passive market makers must be identified as
such.
The Company and the Selling Stockholders have agreed to indemnify the
several Underwriters against certain liabilities, including liabilities under
the Securities Act.
In May 1998, Goldman, Sachs & Co. rendered investment banking services to
Visual in connection with the acquisition of Net2Net.
U-2
<PAGE> 88
GLOSSARY
ASYNCHRONOUS TRANSFER MODE
("ATM") A communications protocol and switching
technology using fixed-length packets of data
to transport voice, data, and video traffic
across WANs or LANs.
APPLICATION PROGRAMMING
INTERFACE ("API") A documented and publicly available set of
programming rules for conducting communications
between two software systems.
BANDWIDTH The information carrying capacity of a
transmission line, typically measured in bits
per second.
CUSTOMER PREMISES EQUIPMENT
("CPE") Communications and network equipment physically
located on a subscriber's property (e.g.
router, DSU/CSU)
DATA SERVICE UNIT/CHANNEL
SERVICE UNIT ("DSU/CSU") A type of CPE that adapts the physical
interface of data terminal equipment (such as a
router) to the physical interface requirement
of a digital WAN service.
DEMARC See Service Demarcation.
FRAME RELAY A communications protocol using variable-length
packets of data to transport data from a
subscriber location to the provider network.
FRAME RELAY ACCESS DEVICE
("FRAD") A type of CPE that is predominantly used to
connect mainframe, host-centric computing
environments over a Frame Relay WAN.
INTEGRATED SERVICES DIGITAL
NETWORK ("ISDN") A time division multiplexed WAN service that
allows for circuits to be established or broken
down on demand.
INTERNET Originally, a government-funded initiative to
interconnect networks from a variety of
scientific and educational institutions. More
recently, a publicly available network
interconnecting scientific, educational,
government, and commercial institutions as well
as individuals.
INTERNET PROTOCOL
("IP") A communications protocol widely used to enable
computer-to-computer communication for
distributed computing applications.
LEASED LINE A time division multiplexed WAN service that
dedicates fixed bandwidth between two
subscriber locations.
LOCAL AREA NETWORK
("LAN") A data communications network that connects a
variety of data devices in the same location to
enable the exchange and sharing of files,
applications, and other services.
MANAGEMENT INFORMATION BASE
("MIB") A structured approach to storing network
management information within network
equipment.
MULTIPLEXER A type of network equipment that aggregates
multiple low-speed inputs onto a high speed
output.
NETWORK OPERATIONS CENTER
("NOC") A control center from which network operators
run a network, typically engaging in
performance monitoring and troubleshooting.
G-1
<PAGE> 89
OPERATIONAL SUPPORT SYSTEM
("OSS") The software systems used by providers to
provision, maintain and administer their WAN
services.
PROTOCOL ANALYZER A diagnostic instrument that evaluates network
traffic by monitoring and analyzing the
conditions of the underlying communications
protocols.
ROUTER The prevalent type of CPE used to interconnect
LANs.
SERVICE DEMARCATION ("DEMARC") The point at which a subscriber's CPE connects
to a provider's WAN service.
SIMPLE NETWORK MANAGEMENT
PROTOCOL ("SNMP") A communications protocol used to transfer
network management information.
STATISTICAL MULTIPLEXING A technique for combining multiple traffic
streams dynamically based on the activity of
each traffic stream.
SWITCHED MULTIMEGABIT DATA
SERVICE ("SMDS") A communications protocol using fixed-length
packets of data to transport voice, data, and
video traffic across WANs.
TIME DIVISION MULTIPLEXING
("TDM") A technique for combining multiple traffic
streams by allocating a fixed amount of
bandwidth for each traffic stream.
TRIVIAL FILE TRANSFER PROTOCOL
("TFTP") A communications protocol used to transfer
electronic documents across a network.
VIRTUAL PRIVATE NETWORK
("VPN") A network used for intra-enterprise
communications over the Internet but
characterized by robust security.
WIDE AREA NETWORK ("WAN") A network used to connect geographically
dispersed computing locations.
X.25 A communication protocol using data from a
subscriber location to the provider
variable-length packets of data to transport
network
G-2
<PAGE> 90
- ------------------------------------------------------
- ------------------------------------------------------
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS, AND, IF GIVEN OR
MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN
AUTHORIZED. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR THE
SOLICITATION OF AN OFFER TO BUY ANY SECURITIES OTHER THAN THE SECURITIES TO
WHICH IT RELATES OR AN OFFER TO SELL OR THE SOLICITATION OF AN OFFER TO BUY SUCH
SECURITIES IN ANY CIRCUMSTANCES IN WHICH SUCH OFFER OR SOLICITATION IS UNLAWFUL.
NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE HEREUNDER SHALL, UNDER
ANY CIRCUMSTANCES, CREATE ANY IMPLICATION THAT THERE HAS BEEN NO CHANGE IN THE
AFFAIRS OF THE COMPANY SINCE THE DATE HEREOF OR THAT THE INFORMATION CONTAINED
HEREIN IS CORRECT AS OF ANY TIME SUBSEQUENT TO ITS DATE.
------------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Prospectus Summary.................... 3
Risk Factors.......................... 5
Use of Proceeds....................... 14
Price Range of Common Stock........... 14
Dividend Policy....................... 14
Capitalization........................ 15
Dilution.............................. 16
Selected Consolidated Financial
Data................................ 17
Management's Discussion and Analysis
of Financial Condition and Results
of Operations....................... 18
Business.............................. 26
Management............................ 41
Certain Transactions.................. 50
Principal and Selling Stockholders.... 52
Description of Capital Stock.......... 54
Certain U.S. Tax Considerations
Applicable to Non-U.S. Holders of
the Common Stock.................... 56
Shares Eligible for Future Sale....... 58
Legal Matters......................... 59
Experts............................... 59
Other Matters......................... 59
Index to Consolidated Financial
Statements.......................... F-1
Underwriting.......................... U-1
Glossary.............................. G-1
</TABLE>
- ------------------------------------------------------
- ------------------------------------------------------
- ------------------------------------------------------
- ------------------------------------------------------
3,500,000 SHARES
VISUAL NETWORKS, INC.
COMMON STOCK
(PAR VALUE $.01 PER SHARE)
------------------------
[VISUAL NETWORKS LOGO]
------------------------
GOLDMAN, SACHS & CO.
NATIONSBANC MONTGOMERY
SECURITIES LLC
DAIN RAUSCHER WESSELS
A DIVISION OF DAIN RAUSCHER INCORPORATED
REPRESENTATIVES OF THE UNDERWRITERS
- ------------------------------------------------------
- ------------------------------------------------------
<PAGE> 91
INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A
REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY
OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT BECOMES
EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR THE
SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE SECURITIES
IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE UNLAWFUL PRIOR
TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF ANY SUCH STATE.
[ALTERNATE PAGE FOR INTERNATIONAL PROSPECTUS]
SUBJECT TO COMPLETION, DATED AUGUST 5, 1998
3,500,000 SHARES
VISUAL NETWORKS LOGO
COMMON STOCK
(PAR VALUE $.01 PER SHARE)
------------------------
Of the 3,500,000 shares of Common Stock offered, 700,000 shares are being
offered hereby in an international offering outside the United States and
2,800,000 shares are being offered in a concurrent United States offering. The
public offering price and the aggregate underwriting discount per share will be
identical for both offerings. See "Underwriting".
Of the 3,500,000 shares of Common Stock offered, 1,000,000 shares are being
sold by the Company and 2,500,000 shares are being sold by the Selling
Stockholders. See "Principal and Selling Stockholders". The Company will not
receive any proceeds from the sale of the shares being sold by the Selling
Stockholders.
SEE "RISK FACTORS" BEGINNING ON PAGE 5 FOR CERTAIN CONSIDERATIONS RELEVANT
TO AN INVESTMENT IN THE COMMON STOCK.
The last reported sale price of the Common Stock, which is quoted on the
Nasdaq National Market under the symbol "VNWK", on July 31, 1998 was $26.75 per
share. See "Price Range of Common Stock".
------------------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS
THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION
PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS.
ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
------------------------
<TABLE>
<CAPTION>
INITIAL PUBLIC UNDERWRITING PROCEEDS TO PROCEEDS TO SELLING
OFFERING PRICE DISCOUNT(1) COMPANY(2) STOCKHOLDERS(2)
-------------- ------------ ----------- -------------------
<S> <C> <C> <C> <C>
Per Share.............. $ $ $ $
Total (3).............. $ $ $ $
</TABLE>
- ---------------
(1) The Company and the Selling Stockholders have agreed to indemnify the
Underwriters against certain liabilities, including liabilities under the
Securities Act of 1933.
(2) Before deducting estimated expenses of $750,000 payable by the Company.
(3) The Company and the Selling Stockholders have granted the International
Underwriters an option for 30 days to purchase up to an additional 105,000
shares at the initial public offering price per share, less the underwriting
discount, solely to cover over-allotments. Additionally, the Company and the
Selling Stockholders have granted the U.S. Underwriters a similar option
with respect to an additional 420,000 shares as part of the concurrent U.S.
offering. If such options are exercised in full, the total initial public
offering price, underwriting discount, proceeds to the Company and proceeds
to Selling Stockholders will be $ , $ , $ and $ ,
respectively. See "Underwriting".
------------------------
The shares offered hereby are offered severally by the International
Underwriters, as specified herein, subject to receipt and acceptance by them and
subject to their right to reject any order in whole or in part. It is expected
that certificates for the shares will be ready for delivery in New York, New
York, on or about , 1998, against payment therefor in immediately
available funds.
GOLDMAN SACHS INTERNATIONAL
NATIONSBANC MONTGOMERY SECURITIES LLC
DAIN RAUSCHER WESSELS
A DIVISION OF DAIN RAUSCHER
INCORPORATED
------------------------
The date of this Prospectus is , 1998.
<PAGE> 92
[ALTERNATE PAGE FOR INTERNATIONAL PROSPECTUS]
AVAILABLE INFORMATION
Visual Networks, Inc. (the "Company") is subject to the informational
requirements of the Securities Exchange Act of 1934, as amended (the "Exchange
Act"), and in accordance therewith files reports, proxy statements and other
information with the Securities and Exchange Commission (the "Commission").
Reports, proxy statements and other information filed by the Company may be
inspected and copied at the public reference facilities maintained by the
Commission at 450 Fifth Street, N.W., Washington, D.C. 20549, and at the
Commission's Regional Offices located at Citicorp Center, 500 West Madison
Street, Suite 1400, Chicago, Illinois 60661 and 7 World Trade Center, 7th Floor,
New York, New York 10048. Copies of such materials may be obtained from the Web
site that the Commission maintains at http://www.sec.gov.
The Company has filed with the Commission a registration statement on Form
S-1 (herein, together with all amendments and exhibits, referred to as the
"Registration Statement") under the Securities Act of 1933, as amended (the
"Securities Act"). This Prospectus does not contain all of the information set
forth in the Registration Statement, certain parts of which are omitted in
accordance with the rules and regulations of the Commission. For further
information, reference is hereby made to the Registration Statement.
------------------------
This Prospectus does not constitute an offer to sell or the solicitation of
an offer to buy the shares of Common Stock in any jurisdiction in which such
offer or solicitation is unlawful. There are restrictions on the offer and sale
of the shares of Common Stock in the United Kingdom. All applicable provisions
of the Financial Services Act 1986 and the Public Offers of Securities
Regulations 1995 with respect to anything done by any person in relation to the
shares of Common Stock, in, from or otherwise involving the United Kingdom must
be complied with. See "Underwriting".
In this Prospectus, references to "dollars", "U.S.$" and "$" are to United
States dollars.
------------------------
Visual Networks and Visual UpTime are registered trademarks of the Company.
This Prospectus contains other product names, trade names and trademarks of the
Company and of other organizations.
------------------------
IN CONNECTION WITH THE OFFERINGS, THE UNDERWRITERS MAY OVER-ALLOT OR EFFECT
TRANSACTIONS WHICH STABILIZE OR MAINTAIN THE MARKET PRICE OF THE COMMON STOCK
OFFERED HEREBY AT A LEVEL ABOVE THAT WHICH MIGHT OTHERWISE PREVAIL IN THE OPEN
MARKET. SUCH TRANSACTIONS MAY BE EFFECTED ON THE NASDAQ NATIONAL MARKET, IN THE
OVER-THE-COUNTER MARKET OR OTHERWISE. SUCH STABILIZING, IF COMMENCED, MAY BE
DISCONTINUED AT ANY TIME.
<PAGE> 93
[ALTERNATE PAGE FOR INTERNATIONAL PROSPECTUS]
UNDERWRITING
Subject to the terms and conditions of the Underwriting Agreement, the
Company and the Selling Stockholders have agreed to sell to each of the
International Underwriters named below, and each of such International
Underwriters has severally agreed to purchase from the Company and the Selling
Stockholders the respective number of shares of Common Stock set forth opposite
its name below:
<TABLE>
<CAPTION>
NUMBER OF
SHARES OF
UNDERWRITERS COMMON STOCK
------------ ------------
<S> <C>
Goldman Sachs International.................................
NationsBanc Montgomery Securities LLC.......................
Dain Rauscher Wessels, a division of Dain Rauscher
Incorporated .............................................
---------
Total............................................. 700,000
=========
</TABLE>
Under the terms and conditions of the Underwriting Agreement, the
International Underwriters are committed to take and pay for all of the shares
offered hereby, if any are taken.
The International Underwriters propose to offer the shares of Common Stock
in part directly to the public at the initial public offering price set forth on
the cover page of this Prospectus and in part to certain securities dealers at
such price less a concession of $ per share. The International
Underwriters may allow, and such dealers may reallow, a concession not in excess
of $ per share to certain brokers and dealers. After the shares of
Common Stock are released for sale to the public, the offering price and other
selling terms may from time to time be varied by the representatives.
The Company and the Selling Stockholders have entered into an underwriting
agreement (the "U.S. Underwriting Agreement") with the underwriters of the U.S.
offering (the "U.S. Underwriters") providing for the concurrent offer and sale
of 2,800,000 shares of Common Stock in a U.S. offering in the United States. The
offering price and aggregate underwriting discounts and commissions per share
for the two offerings are identical. The closing of the offering made hereby is
a condition to the closing of the U.S. offering, and vice versa. The
representatives of the U.S. Underwriters are Goldman, Sachs & Co., NationsBanc
Montgomery Securities LLC and Dain Rauscher Wessels, a division of Dain Rauscher
Incorporated.
Pursuant to an Agreement between the U.S. and International Underwriting
Syndicates (the "Agreement Between") relating to the two offerings, each of the
U.S. Underwriters named herein has agreed that, as a part of the distribution of
the shares offered hereby and subject to certain exceptions, it will offer, sell
or deliver the shares of Common Stock, directly or indirectly, only in the
United States of America (including the States and the District of Columbia),
its territories, its possessions and other areas subject to its jurisdiction
(the "United States") and to U.S. persons, which term shall mean, for purposes
of this paragraph: (a) any individual who is a resident of the United States or
(b) any corporation, partnership or other entity organized in or under the laws
of the United States or any political subdivision thereof and whose office most
directly involved with the purchase is located in the United States. Each of the
International Underwriters named herein has agreed pursuant to the Agreement
Between that, as a part of the distribution of the shares offered as a part of
the international offering, and subject to certain exceptions, it will (i) not,
directly or indirectly, offer, sell or deliver shares of Common Stock (a) in the
United States or to any United States persons or (b) to any person who it
believes intends to reoffer, resell or deliver the shares in the U.S. or to any
U.S. persons, and (ii) cause any dealer to whom it may sell such shares at any
concession to agree to observe a similar restriction.
U-1
<PAGE> 94
[ALTERNATE PAGE FOR INTERNATIONAL PROSPECTUS]
Pursuant to the Agreement Between, sales may be made between the U.S.
Underwriters and the International Underwriters of such number of shares of
Common Stock as may be mutually agreed. The price of any shares so sold shall be
the initial public offering price, less an amount not greater than the selling
concession.
The Company and the Selling Stockholders have granted the International
Underwriters an option exercisable for 30 days after the date of this Prospectus
to purchase up to an aggregate of 105,000 additional shares of Common Stock
solely to cover over-allotments, if any. If the International Underwriters
exercise their over-allotment option, the International Underwriters have
severally agreed, subject to certain conditions, to purchase approximately the
same percentage thereof that the number of shares to be purchased by each of
them, as shown in the foregoing table, bears to the 700,000 shares of Common
Stock offered hereby. The Company and the Selling Stockholders have granted the
U.S. Underwriters a similar option to purchase up to an aggregate of 420,000
additional shares of Common Stock.
The Company and the Selling Stockholders have agreed that, during the
period beginning from the date of this Prospectus and continuing to and
including the date 90 days after the date of the Prospectus, they will not
offer, sell, contract to sell, pledge or otherwise dispose of any securities of
the Company (other than pursuant to employee stock option plans existing, or on
the conversion or exchange of convertible or exchangeable securities
outstanding, on the date of this Prospectus) which are substantially similar to
the shares of the Common Stock or which are convertible into or exchangeable for
securities which are substantially similar to the shares of Common Stock without
the prior written consent of the Representatives of the U.S. Underwriters,
except for the shares of Common Stock offered in connection with the concurrent
U.S. and international offerings. In addition, stockholders owning approximately
210,488 shares are subject to lock-up agreements which expire on August 4, 1998.
Each International Underwriter has also agreed that (a) it has not offered
or sold and prior to the date six months after the date of issue of the shares
of Common Stock will not offer or sell any shares of Common Stock to persons in
the United Kingdom except to those persons whose ordinary activities involve
them in acquiring, holding, managing or disposing of investments (as principal
or agent) for the purposes of their businesses or otherwise in circumstances
which have not resulted and will not result in an offer to the public in the
United Kingdom within the meaning of the Public Offers of Securities Regulations
1995, (b) it has complied, and will comply, with all applicable provisions of
the Financial Services Act of 1986 of Great Britain with respect to anything
done by it in relation to the shares of Common Stock in, from or otherwise
involving the United Kingdom, and (c) it has only issued or passed on and will
only issue or pass on in the United Kingdom any document received by it in
connection with the issuance of the shares of Common Stock to a person who is of
a kind described in Article 11(3) of the Financial Services Act of 1986
(Investment Advertisements) (Exemptions) Order 1996 of Great Britain or is a
person to whom the document may otherwise lawfully be issued or passed on.
Buyers of shares of Common Stock offered hereby may be required to pay
stamp taxes and other charges in accordance with the laws and practices of the
country of purchase in addition to the initial public offering price.
In connection with the offering, the Underwriters may purchase and sell the
Common Stock in the open market. These transactions may include over-allotment
and stabilizing transactions, "passive" market making (see below) and purchases
to cover syndicate short positions created in connection with the offering.
Stabilizing transactions consist of certain bids or purchases for the purpose of
preventing or retarding a decline in the market price of the Common Stock; and
syndicate short positions involve the sale by the Underwriters of a greater
number of shares of Common Stock than they are required to purchase from the
Company in the offering. The
U-2
<PAGE> 95
[ALTERNATE PAGE FOR INTERNATIONAL PROSPECTUS]
Underwriters also may impose a penalty bid, whereby selling concessions allowed
to syndicate members or other broker-dealers in respect of the securities sold
in the offering for their account may be reclaimed by the syndicate if such
shares of Common Stock are repurchased by the syndicate in stabilizing or
covering transactions. These activities may stabilize, maintain or otherwise
affect the market price of the Common Stock, which may be higher than the price
that might otherwise prevail in the open market; and these activities, if
commenced, may be discontinued at any time. These transactions may be effected
on the Nasdaq National Market in the over-the-counter market or otherwise.
As permitted by Rule 103 under the Exchange Act, certain Underwriters (and
selling group members, if any) that are market makers ("passive market makers")
in the Common Stock may make bids for or purchases of the Common Stock in the
Nasdaq National Market until such time, if any, when a stabilizing bid for such
securities has been made. Rule 103 generally provides that (1) a passive market
maker's net daily purchases of the Common Stock may not exceed 30% of its
average daily trading volume in such securities for the two full consecutive
calendar months (or any 60 consecutive days ending within the 10 days)
immediately preceding the filing date of the registration statement of which
this Prospectus forms a part, (2) a passive market maker may not effect
transactions or display bids for the Common Stock at a price that exceeds the
highest independent bid for the Common Stock by persons who are not passive
market makers and (3) bids made by passive market makers must be identified as
such.
The Company and the Selling Stockholders have agreed to indemnify the
Underwriters against certain liabilities, including liabilities under the
Securities Act.
In May 1998, Goldman, Sachs & Co., an affiliate of Goldman Sachs
International, rendered investment banking services to Visual in connection with
the acquisition of Net2Net.
U-3
<PAGE> 96
[ALTERNATE PAGE FOR INTERNATIONAL PROSPECTUS]
- ----------------------------------------------------------
- ----------------------------------------------------------
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS, AND, IF GIVEN OR
MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN
AUTHORIZED. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR THE
SOLICITATION OF AN OFFER TO BUY ANY SECURITIES OTHER THAN THE SECURITIES TO
WHICH IT RELATES OR AN OFFER TO SELL OR THE SOLICITATION OF AN OFFER TO BUY SUCH
SECURITIES IN ANY CIRCUMSTANCES IN WHICH SUCH OFFER OR SOLICITATION IS UNLAWFUL.
NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE HEREUNDER SHALL, UNDER
ANY CIRCUMSTANCES, CREATE ANY IMPLICATION THAT THERE HAS BEEN NO CHANGE IN THE
AFFAIRS OF THE COMPANY SINCE THE DATE HEREOF OR THAT THE INFORMATION CONTAINED
HEREIN IS CORRECT AS OF ANY TIME SUBSEQUENT TO ITS DATE.
----------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Prospectus Summary....................... 3
Risk Factors............................. 5
Use of Proceeds.......................... 14
Price Range of Common Stock.............. 14
Dividend Policy.......................... 14
Capitalization........................... 15
Dilution................................. 16
Selected Consolidated Financial Data..... 17
Management's Discussion and Analysis of
Financial Condition and Results of
Operations............................. 18
Business................................. 26
Management............................... 41
Certain Transactions..................... 50
Principal and Selling Stockholders....... 52
Description of Capital Stock............. 55
Certain U.S. Tax Considerations
Applicable to Non-U.S. Holders of the
Common Stock........................... 57
Shares Eligible for Future Sale.......... 59
Legal Matters............................ 60
Experts.................................. 60
Other Matters............................ 60
Index to Financial Statements............ F-1
Underwriting............................. U-1
Glossary................................. G-1
</TABLE>
- ----------------------------------------------------------
- ----------------------------------------------------------
- ----------------------------------------------------------
- ----------------------------------------------------------
3,500,000 SHARES
VISUAL NETWORKS, INC.
COMMON STOCK
(PAR VALUE $.01 PER SHARE)
------------------------
[VISUAL NETWORKS LOGO]
------------------------
GOLDMAN SACHS INTERNATIONAL
NATIONSBANC MONTGOMERY
SECURITIES LLC
DAIN RAUSCHER WESSELS
A DIVISION OF DAIN RAUSCHER INCORPORATED
- ----------------------------------------------------------
- ----------------------------------------------------------
<PAGE> 97
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION
The following table sets forth the various expenses in connection with the
sale and distribution of the securities offered hereby, other than underwriting
discounts and commissions. All of the amounts shown are estimated except the
Securities and Exchange Commission registration fee, the NASD filing fee and the
Nasdaq listing fee.
<TABLE>
<S> <C>
Securities and Exchange Commission filing fee............... $ 38,590
National Association of Securities Dealers, Inc. filing
fee....................................................... 13,581
Nasdaq listing fee.......................................... 17,500
Transfer agent's and registrar's fees....................... 25,000
Printing expenses........................................... 200,000
Legal fees and expenses..................................... 200,000
Accounting fees and expenses................................ 200,000
Blue Sky filing fees and expenses........................... 1,000
Miscellaneous expenses...................................... 54,329
--------
Total............................................. $750,000
========
</TABLE>
14. INDEMNIFICATION OF OFFICERS AND DIRECTORS
Section 145 of the Delaware General Corporation Law ("Section 145") permits
indemnification of directors, officers, agents and controlling persons of a
corporation under certain conditions and subject to certain limitations. The
Registrant's Bylaws include provisions to require the Registrant to indemnify
its directors and officers to the fullest extent permitted by Section 145,
including circumstances in which indemnification is otherwise discretionary.
Section 145 also empowers the Registrant to purchase and maintain insurance that
protects its officers, directors, employees and agents against any liabilities
incurred in connection with their service in such positions.
At present, there is no pending litigation or proceeding involving a
director or officer of the Registrant as to which indemnification is being
sought nor is the Registrant aware of any threatened litigation that may result
in claims for indemnification by any officer or director.
The forms of Underwriting Agreement filed as Exhibits 1.1 and 1.2 to this
Registration Statement provide for indemnification by the Underwriters of the
Registrant and its directors and officers, and by the Registrant of the
Underwriters, for certain liabilities arising under the Securities Act of 1933,
as amended (the "Act") or otherwise.
15. RECENT SALES OF UNREGISTERED SECURITIES
Since December 1994, the Registrant has issued unregistered securities in
the transactions described below. Securities issued in such transactions were
offered and sold in reliance upon the exemption from registration under Section
4(2) of the Act, relating to sales by an issuer not involving any public
offering, or under Rule 701 under the Act. The sales of securities were made
without the use of an underwriter and the certificates evidencing the shares
bear a restrictive legend permitting the transfer thereof only upon registration
of the shares or an exemption under the Act.
(1) In December 1994, the Registrant issued 347,070 shares of Series A
Convertible Preferred Stock to a group of accredited investors at a purchase
price of $.35 per share for an aggregate price of $120,676.
II-1
<PAGE> 98
(2) In December 1994, the Registrant issued 2,588,438 shares of Series B
Convertible Preferred Stock to a group of accredited investors at a purchase
price of $.46 per share for an aggregate price of $1,200,000.
(3) In August 1995, the Registrant issued 1,600,000 shares of Series C
Convertible Preferred Stock to a group of accredited investors at a purchase
price of $1.25 per share for an aggregate price of $2,000,000.
(4) In January 1996, the Registrant issued 2,285,714 shares of Series D
Convertible Preferred Stock to a group of accredited investors at a purchase
price of $1.75 per share for an aggregate price of $4,000,000.
(5) In September 1996, the Registrant issued 754,321 shares of Series E
Convertible Preferred Stock to a group of accredited investors at a purchase
price of $6.66 per share for an aggregate price of $5,023,778.
(6) On June 15, 1997, the Registrant issued 25,000 shares of Common Stock
to an executive officer of the Registrant at a purchase price of $1.75 per share
for an aggregate price of $43,750.
(7) On September 13, 1997, the Registrant issued 10,504 shares of Common
Stock to a director of the Registrant at a purchase price of $4.76 per share for
an aggregate price of $50,000.
(8) On May 15, 1998, the Registrant issued 2,056,204 shares of Common Stock
to the former stockholders of Net2Net Corporation in connection with the
Registrant's acquisition of Net2Net Corporation.
(9) From January 16, 1995 through May 11, 1998, the Registrant sold an
aggregate of 312,146 shares of Common Stock at purchase prices ranging from $.07
to $7.00 per share, for an aggregate consideration of $117,712 upon exercise of
stock options granted pursuant to the Registrant's 1994 Stock Option Plan.
16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION
----------- -----------
<C> <S>
1.1 Form of U.S. Underwriting Agreement.
1.2 Form of International Underwriting Agreement.
3.1* Restated Certificate of Incorporation of the Registrant.
3.2* Restated By-Laws of the Registrant.
4.1* Specimen stock certificate for shares of Common Stock of the
Registrant.
5.1 Opinion of Piper & Marbury L.L.P. regarding legality of
securities being registered.
10.1* 1994 Stock Option Plan.
10.2* 1997 Omnibus Stock Plan.
10.3* Amended and Restated 1997 Directors' Stock Option Plan.
10.4* Third Amended and Restated Stockholders and Registration
Rights Agreement, dated as of September 19, 1996, by and
among the Company and certain stockholders.
10.5*+ Reseller/Integration Agreement, dated August 29, 1997 by and
between the Company and MCI Telecommunication Corporation.
10.6*+ Master Reseller Agreement, dated as of August 23, 1996,
between Sprint/United Management Company and the Company.
10.7*+ General Agreement for the Procurement of Equipment, Services
and Supplies Company and AT&T Corp.
</TABLE>
II-2
<PAGE> 99
<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION
----------- -----------
<C> <S>
10.8* Lease Agreement, dated December 12, 1996, by and between the
Company and The Equitable Fire Assurance Society of The
United States.
10.9* Lease Amendment, dated September 2, 1997, by and between the
Company and The Equitable Fire Assurance Society of The
United States (relating to Exhibit 10.8).
10.10* Loan and Security Agreement dated April 5, 1996, by and
between Silicon Valley Bank and the Company.
10.11* Revolving Promissory Note issued by the Company on April 5,
1996, to Silicon Valley Bank.
10.11.1* Equipment Term Note No. 1 issued by the Company on April 5,
1996, to Silicon Valley Bank.
10.11.2* First Amendment to Loan and Security Agreement dated
November 8, 1996, by and between Silicon Valley Bank and the
Company (relating to Exhibit 10.10).
10.11.3* Second Amendment to Loan and Security Agreement dated
February 27, 1997, by and between Silicon Valley Bank and
the Company (relating to Exhibit 10.10).
10.12* Standby Letter of Credit Agreement, dated December 10, 1996
by and between the Company and Silicon Valley Bank.
10.12.1* Amendment No. 1 to Standby Letter of Credit Agreement dated
September 5, 1997, by and between the Company and Silicon
Valley Bank (relating to Exhibit 10.12).
10.13* Employment Agreement dated December 15, 1994, by and between
the Company and Scott E. Stouffer, as amended.
10.14* Employment Agreement dated December 15, 1994, by and between
the Company and Robert Troutman, as amended.
10.15* Terms of Employment dated June 11, 1997, by and between the
Company and Peter J. Minihane, as amended.
10.16* Terms of Employment dated March 5, 1997, by and between the
Company and Henry A. Cheli, as amended.
10.17* Terms of Employment dated November 12, 1996, by and between
the Company and Gregory J. Langford, as amended.
10.18* Loan and Security Agreement dated January 8, 1998, by and
between Silicon Valley Bank and the Company.
10.18.1* Revolving Promissory Note issued by the Company as of
January 8, 1998, to Silicon Valley Bank.
10.18.2@ First Amendment to Loan and Security Agreement dated June
30, 1998, by and between Silicon Valley Bank and the
Company.
10.18.3@ Amended and Restated Revolving Promissory Note issued by the
Company as of June 30, 1998, to Silicon Valley Bank.
10.19** Agreement and Plan of Merger dated April 15, 1998, by and
among the Company, Visual Acquisition, Inc. and Net2Net.
10.20*** Net2Net 1994 Stock Plan, assumed by the Company.
11.1 Statement of computation of loss per share.
16.1* Letter regarding change in certified accountants.
21.1 Subsidiaries of the Registrant.
23.1@@ Consent of Arthur Andersen LLP.
23.2 Consent of Piper & Marbury L.L.P. (included as part of
Exhibit 5.1 hereto).
</TABLE>
II-3
<PAGE> 100
<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION
----------- -----------
<C> <S>
24.1 Power of Attorney (included in signature pages).
27 Financial Data Schedule.
</TABLE>
- ---------------
@ Previously filed.
@@ Filed herewith.
* Incorporated herein by reference to the Company's Registration Statement
on Form S-1, No. 333-41517.
** Incorporated herein by reference to Exhibit 2.1 to the Company's Current
Report on Form 8-K dated May 19, 1998.
*** Incorporated herein by reference to Exhibit 10.1 to the Company's
Registration Statement on Form S-8, No. 333-53153.
+ Portions of this Exhibit were omitted and have been filed separately with
the Secretary of the Commission pursuant to the Registrant's Application
Requesting Confidential Treatment under Rule 406 of the Act, filed on
December 22, 1997, January 28, 1998 and February 4, 1998.
17. UNDERTAKINGS
A. The undersigned Registrant hereby undertakes to provide to the
Underwriter at the closing specified in the Underwriting Agreement certificates
in such denominations and registered in such names as required by the
Underwriter to permit prompt delivery to each purchaser.
B. Insofar as indemnification for liabilities arising under the Securities
Act of 1933 may be permitted to directors, officers and controlling persons of
the Registrant pursuant to the Delaware General Corporation Law, the Certificate
of Incorporation and the Bylaws, or otherwise, the Registrant has been advised
that in the opinion of the Securities and Exchange Commission such
indemnification is against public policy as expressed in the Act and is,
therefore, unenforceable. In the event that a claim for indemnification against
such liabilities (other than the payment by the registrant of expenses incurred
or paid by a director, officer or controlling person of the Registrant in the
successful defense of any action, suit, or proceeding) is asserted by such
director, officer or controlling person in connection with the securities being
registered, the Registrant will, unless in the opinion of its counsel the matter
has been settled by controlling precedent, submit to a court of appropriate
jurisdiction the question of whether such indemnification by it is against
public policy as expressed in the Act and will be governed by the final
adjudication of such issue.
C. (1) For purposes of determining any liability under the Securities Act
of 1933, the information omitted from the form of prospectus filed as part of
this registration statement in reliance upon Rule 430A and contained in a form
of prospectus filed by the Registrant pursuant to Rule 424(b)(1) or (4) or
497(h) under the Securities Act shall be deemed to be a part of this
registration statement as of the time it was declared effective.
(2) For the purpose of determining any liability under the Securities Act
of 1933, each post-effective amendment that contains a form of prospectus shall
be deemed to be a new registration statement relating to the securities offered
therein, and the offering of such securities at that time shall be deemed to be
the initial bona fide offering thereof.
II-4
<PAGE> 101
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, as amended, the
Company has duly caused this Amendment No. 3 to Registration Statement to be
signed on its behalf by the undersigned, thereunto duly authorized, in the City
of Rockville, Maryland, on the 5th day of August, 1998.
VISUAL NETWORKS, INC.
By: /s/ SCOTT E. STOUFFER
------------------------------------
Scott E. Stouffer
President and Chief Executive
Officer
POWER OF ATTORNEY
Pursuant to the requirements of the Securities Act of 1933, as amended,
this Amendment No. 1 to Registration Statement has been signed below by the
following persons in the capacities and on the date indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<C> <S> <C>
/s/ SCOTT E. STOUFFER President, Chief Executive August 5, 1998
- ----------------------------------------------------- Officer and Director
Scott E. Stouffer (Principal Executive Officer)
/s/ PETER J. MINIHANE Executive Vice President, August 5, 1998
- ----------------------------------------------------- Chief Financial Officer and
Peter J. Minihane Treasurer (Principal
Financial Officer)
* Director August 5, 1998
- -----------------------------------------------------
Grant G. Behrman
* Director August 5, 1998
- -----------------------------------------------------
Marc F. Benson
* Director August 5, 1998
- -----------------------------------------------------
Theodore R. Joseph
* Director August 5, 1998
- -----------------------------------------------------
Ted H. McCourtney
* Director August 5, 1998
- -----------------------------------------------------
Thomas A. Smith
* Director August 5, 1998
- -----------------------------------------------------
William J. Smith
*/s/ NANCY A. SPANGLER
- -----------------------------------------------------
Nancy A. Spangler
Attorney-in-fact
</TABLE>
II-5
<PAGE> 102
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Stockholders of
Visual Networks, Inc.:
We have audited, in accordance with generally accepted auditing standards,
the consolidated financial statements of Visual Networks, Inc. (a Delaware
corporation) and subsidiary included in this registration statement and have
issued our report thereon dated June 30, 1998. Our audits were made for the
purpose of forming an opinion on the basic financial statements taken as a
whole. The schedule listed in item 16(b) is the responsibility of the Company's
management and is presented for purposes of complying with the Securities and
Exchange Commission's rules and is not part of the basic financial statements.
This schedule has been subjected to the auditing procedures applied in the
audits of the basic financial statements and, in our opinion, fairly states, in
all material respects, the financial data required to be set forth therein in
relation to the basic financial statements taken as a whole.
ARTHUR ANDERSEN LLP
Washington, D.C.
June 30, 1998
S-1
<PAGE> 103
SCHEDULE II
VISUAL NETWORKS, INC.
VALUATION AND QUALIFYING ACCOUNTS
(IN THOUSANDS)
<TABLE>
<CAPTION>
ADDITIONS
CHARGED
BALANCE AT TO COSTS BALANCE AT
BEGINNING AND END OF
DESCRIPTION OF PERIOD EXPENSES DEDUCTIONS PERIOD
----------- ---------- --------- ---------- ----------
<S> <C> <C> <C> <C>
For the year ended December 31, 1995,
Deducted from assets accounts:
Allowance for doubtful accounts.......... $ -- $ -- $ -- $ --
For the year ended December 31, 1996,
Deducted from assets accounts:
Allowance for doubtful accounts.......... -- 260 -- 260
For the year ended December 31, 1997,
Deducted from assets accounts:
Allowance for doubtful accounts.......... 260 152 -- 412
</TABLE>
S-2
<PAGE> 104
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION
- ----------- -----------
<S> <C>
1.1 Form of U.S. Underwriting Agreement.
1.2 Form of International Underwriting Agreement.
3.1* Restated Certificate of Incorporation of the Registrant.
3.2* Restated By-Laws of the Registrant.
4.1* Specimen stock certificate for shares of Common Stock of the
Registrant.
5.1 Opinion of Piper & Marbury L.L.P. regarding legality of
securities being registered.
10.1* 1994 Stock Option Plan.
10.2* 1997 Omnibus Stock Plan.
10.3* Amended and Restated 1997 Directors' Stock Option Plan.
10.4* Third Amended and Restated Stockholders and Registration
Rights Agreement, dated as of September 19, 1996, by and
among the Company and certain stockholders.
10.5*+ Reseller/Integration Agreement, dated August 29, 1997 by and
between the Company and MCI Telecommunication Corporation.
10.6*+ Master Reseller Agreement, dated as of August 23, 1996,
between Sprint/United Management Company and the Company.
10.7*+ General Agreement for the Procurement of Equipment, Services
and Supplies Company and AT&T Corp.
10.8* Lease Agreement, dated December 12, 1996, by and between the
Company and The Equitable Fire Assurance Society of The
United States.
10.9* Lease Amendment, dated September 2, 1997, by and between the
Company and The Equitable Fire Assurance Society of The
United States (relating to Exhibit 10.8).
10.10* Loan and Security Agreement dated April 5, 1996, by and
between Silicon Valley Bank and the Company.
10.11* Revolving Promissory Note issued by the Company on April 5,
1996, to Silicon Valley Bank.
10.11.1* Equipment Term Note No. 1 issued by the Company on April 5,
1996, to Silicon Valley Bank.
10.11.2* First Amendment to Loan and Security Agreement dated
November 8, 1996, by and between Silicon Valley Bank and the
Company (relating to Exhibit 10.10).
10.11.3* Second Amendment to Loan and Security Agreement dated
February 27, 1997, by and between Silicon Valley Bank and
the Company (relating to Exhibit 10.10).
10.12* Standby Letter of Credit Agreement, dated December 10, 1996,
by and between the Company and Silicon Valley Bank.
10.12.1* Amendment No. 1 to Standby Letter of Credit Agreement dated
September 5, 1997, by and between the Company and Silicon
Valley Bank (relating to Exhibit 10.12).
10.13* Employment Agreement dated December 15, 1994, by and between
the Company and Scott E. Stouffer, as amended.
10.14* Employment Agreement dated December 15, 1994, by and between
the Company and Robert Troutman, as amended.
10.15* Terms of Employment dated June 11, 1997, by and between the
Company and Peter J. Minihane, as amended.
10.16* Terms of Employment dated March 5, 1997, by and between the
Company and Henry A. Cheli, as amended.
</TABLE>
<PAGE> 105
<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION
- ----------- -----------
<S> <C>
10.17* Terms of Employment dated November 12, 1996, by and between
the Company and Gregory J. Langford, as amended.
10.18* Loan and Security Agreement dated January 8, 1998, by and
between Silicon Valley Bank and the Company.
10.18.1* Revolving Promissory Note issued by the Company as of
January 8, 1998, to Silicon Valley Bank.
10.18.2@ First Amendment to Loan and Security Agreement dated June
30, 1998, by and between Silicon Valley Bank and the
Company.
10.18.3@ Amended and Restated Revolving Promissory Note issued by the
Company as of June 30, 1998, to Silicon Valley Bank.
10.19** Agreement and Plan of Merger dated April 15, 1998, by and
among the Company, Visual Acquisition, Inc. and Net2Net.
10.20*** Net2Net 1994 Stock Option Plan
11.1 Statement of computation of loss per share.
16.1* Letter regarding change in certified accountants.
21.1 Subsidiaries of Registrant.
23.1@@ Consent of Arthur Andersen LLP.
23.2 Consent of Piper & Marbury L.L.P. (included as part of
Exhibit 5.1 hereto).
24.1 Power of Attorney (included in signature pages).
27 Financial Data Schedule.
</TABLE>
- ---------------
@ Previously filed.
@@ Filed herewith.
* Incorporated herein by reference to the Company's Registration Statement
on Form S-1, No. 333-41517.
** Incorporated herein by reference to Exhibit 2.1 to the Company's Current
Report on Form 8-K dated May 19, 1998.
*** Incorporated herein by reference to Exhibit 10.1 to the Company's
Registration Statement on Form S-8, No. 333-53153.
+ Portions of this Exhibit were omitted and have been filed separately with
the Secretary of the Commission pursuant to the Registrant's Application
Requesting Confidential Treatment under Rule 406 of the Act, filed on
December 22, 1997, January 28, 1998 and February 4, 1998.
<PAGE> 1
EXHIBIT 23.1
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the use of our
reports and to all references to our Firm included in or made a part of this
Registration Statement.
ARTHUR ANDERSEN LLP
Washington, D.C.
August 5, 1998
