<PAGE> 1
================================================================================
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549 - 0001
---------------
FORM 10-Q
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE THREE MONTHS ENDED MARCH 31, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER 000-23699
---------------
VISUAL NETWORKS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 52-1837515
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2092 GAITHER ROAD, ROCKVILLE, MD 20850-4013
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (301) 296-2300
---------------
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to the
filing requirements for the past 90 days. Yes [X] No [ ]
As of May 11, 1999, 20,371,341 shares of the registrant's Common Stock, par
value $.01 per share, were issued and outstanding.
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VISUAL NETWORKS, INC.
QUARTERLY REPORT ON FORM 10-Q FOR THE THREE MONTHS ENDED MARCH 31, 1999
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements:
Consolidated Balance Sheets -- March 31, 1999 and December 31, 1998.............................. 3
Consolidated Statements of Operations -- Three months ended March
31, 1999 and 1998............................................................................... 4
Consolidated Statements of Cash Flows -- Three months ended March 31, 1999
and 1998........................................................................................ 5
Notes to Consolidated Financial Statements....................................................... 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of
Operations....................................................................................... 9
Item 3. Qualitative and Quantitative Disclosure about Market Risk................................... 14
PART II. OTHER INFORMATION
Items 1. -- 6....................................................................................... 14
Signatures.......................................................................................... 16
</TABLE>
2
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PART I: FINANCIAL INFORMATION
ITEM 1: FINANCIAL STATEMENTS
VISUAL NETWORKS, INC.
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
(IN THOUSANDS EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
1999 1998
------------ ------------
ASSETS
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents................................................ $ 46,958 $ 50,531
Accounts receivable, net of allowance of $486 and
$493, respectively.................................................. 6,397 5,038
Inventory................................................................ 5,777 5,086
Other current assets..................................................... 2,340 1,715
------------ -----------
Total current assets................................................ 61,472 62,370
Property and equipment, net................................................... 5,176 4,478
------------ -----------
Total assets........................................................ $ 66,648 $ 66,848
============ ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable and accrued expenses.................................... $ 7,866 $ 5,575
Accrued compensation..................................................... 1,248 2,366
Customer deposits........................................................ -- 4,613
Deferred revenue......................................................... 5,238 5,246
Capital lease obligations................................................ 297 383
------------ -----------
Total current liabilities........................................... 14,649 18,183
------------ -----------
STOCKHOLDERS' EQUITY:
Preferred stock, $.01 par value, 5,000,000 shares
authorized, no shares issued and outstanding........................ -- --
Common stock, $.01 par value, 50,000,000 shares
authorized, 20,339,214 and 20,095,129 shares
issued and outstanding as of March 31, 1999 and
December 31, 1998, respectively..................................... 203 201
Deferred compensation.................................................... (182) (197)
Additional paid-in capital............................................... 74,762 74,215
Accumulated deficit...................................................... (22,784) (25,554)
------------ -----------
Total stockholders' equity........................................... 51,999 48,665
------------ -----------
Total liabilities and stockholders' equity........................... $ 66,648 $ 66,848
============ ===========
</TABLE>
See notes to consolidated financial statements.
3
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VISUAL NETWORKS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
<TABLE>
<CAPTION>
FOR THE THREE MONTHS
ENDED
MARCH 31,
----------------------------
1999 1998
------------ ------------
<S> <C> <C>
Revenue...................................... $ 16,782 $ 10,327
Cost of goods sold........................... 5,806 4,541
------------ ------------
Gross profit............................ 10,976 5,786
------------ ------------
Operating expenses:
Research and development................ 2,902 2,427
Sales and marketing..................... 3,477 3,698
General and administrative.............. 1,099 1,190
------------ ------------
Total operating expenses........... 7,478 7,315
------------ ------------
Income (loss) from operations................ 3,498 (1,529)
Interest income, net......................... 576 389
------------ ------------
Income (loss) before taxes................... 4,074 (1,140)
Income taxes................................. (1,303) (495)
------------ ------------
Net income (loss)............................ 2,771 (1,635)
Dividends and accretion on preferred stock... -- (171)
------------ ------------
Net income (loss) attributable to
common stockholders........................ $ 2,771 $ (1,806)
============ ============
Basic income (loss) per share................ $ 0.14 $ (0.14)
============ ============
Diluted income (loss) per share.............. $ 0.13 $ (0.14)
============ ============
Pro forma diluted income (loss) per
share...................................... $ (0.09)
============
Basic weighted average shares
outstanding................................ 20,223,932 12,777,327
Diluted weighted average shares
outstanding................................ 21,873,875 12,777,327
Pro forma diluted weighted average
shares outstanding......................... 17,788,828
</TABLE>
See notes to consolidated financial statements.
4
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VISUAL NETWORKS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(IN THOUSANDS)
<TABLE>
<CAPTION>
FOR THE THREE MONTHS
ENDED
MARCH 31,
--------------------------
1999 1998
---------- ----------
<S> <C> <C>
Cash flows from operating activities:
Net income (loss)......................................................... $ 2,771 $ (1,635)
Adjustments to reconcile net income (loss) to net cash
used in operating activities:
Depreciation and amortization........................................ 398 478
Changes in assets and liabilities:
Accounts receivable.................................................. (1,359) (47)
Inventory............................................................ (691) (562)
Other current assets................................................. (625) 89
Accounts payable and accrued expenses................................ 2,291 1,118
Customer deposits.................................................... (4,613) (154)
Accrued compensation................................................. (1,118) (753)
Deferred revenue..................................................... (8) 50
---------- ----------
Net cash used in operating activities.......................... (2,954) (1,416)
---------- ----------
Cash flows from investing activities:
Expenditures for property and equipment.............................. (1,081) (613)
---------- ----------
Net cash used in investing activities.......................... (1,081) (613)
---------- ----------
Cash flows from financing activities:
Exercise of stock options............................................ 548 164
Proceeds from issuance of common stock, net of
issuance costs.................................................... -- 45,447
Repayments under credit agreements................................... -- 679
Payment of Series A dividends........................................ -- (30)
Principal payments on capital lease obligations...................... (86) (106)
---------- ----------
Net cash provided by financing activities...................... 462 46,154
---------- ----------
Net (decrease) increase in cash and cash equivalents........................... (3,573) 44,125
Cash and cash equivalents, beginning of period................................. 50,531 8,902
---------- ----------
Cash and cash equivalents, end of period....................................... $ 46,958 $ 53,027
========== ==========
Supplemental cash flow information:
Cash paid for interest.................................................... $ 16 $ 83
Cash paid for income taxes................................................ $ -- $ 193
</TABLE>
See notes to consolidated financial statements.
5
<PAGE> 6
VISUAL NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 1999
(UNAUDITED)
(1) NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Visual Networks, Inc. ("Visual" or the "Company") 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 acquisition of Net2Net Corporation
("Net2Net"), uncertainty of future profitability and possible fluctuations in
financial results.
Financial Statement Presentation
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, the
disclosure of contingent assets and liabilities at the date of statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
These financial statements are unaudited and have been prepared by the
Company pursuant to the rules and regulations of the Securities and Exchange
Commission regarding interim financial reporting. Accordingly, they do not
include all of the information and footnotes required by generally accepted
accounting principles for complete financial statements, and it is suggested
that these financial statements be read in conjunction with the financial
statements and the notes thereto, included in the Company's Annual Report on
Form 10-K for the year ended December 31, 1998. In the opinion of management,
the comparative financial statements for the fiscal periods presented herein
include all adjustments that are normal and recurring which are necessary for a
fair statement of results for the interim periods. The results of operations for
the three months ended March 31, 1999 are not necessarily indicative of the
results for the entire year ending December 31, 1999.
On May 15, 1998, Visual acquired 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. 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. For the three months ended March 31, 1998, Visual had
previously reported revenues of $9,162,000 as compared to combined revenues of
$10,327,000 and net income of $1,005,000 as compared to combined net loss of
$1,635,000.
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
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the evaluation process and acceptance of the product by the customer.
Maintenance contracts require 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.
Inventory
Inventory is stated at the lower of cost or market. Inventory consists of
the following (in thousands):
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
1999 1998
----------- ------------
(unaudited)
<S> <C> <C>
Raw materials $ 1,159 $ 821
Work-in-progress 2,133 1,228
Finished goods 2,485 3,037
----------- -----------
$ 5,777 $ 5,086
=========== ===========
</TABLE>
Income Taxes
The Company accounts for income taxes in accordance with Statement of
Financial Accounting Standards ("SFAS") No. 109 "Accounting for Income Taxes"
("SFAS No. 109"). 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
Basic earnings (loss) per share includes no dilution and is computed by
dividing net income (loss) attributable to common stockholders by the weighted
average number of common shares outstanding for the period. Diluted income
(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. The effect of the conversion of preferred stock into 10,605,735 shares
of common stock is included in the computation of basic loss per share from the
date of conversion on February 11, 1998 for the three months ended March 31,
1998. The effect of preferred stock convertible into 10,605,735 shares of
common stock for the period January 1, 1998 through February 10, 1998 was not
included in the computation of diluted loss per share for the three months
ended March 31, 1998 as such effect would have been anti-dilutive. Pro forma
basic and diluted weighted average shares outstanding for the three months
ended March 31, 1998 assumes the conversion of all of the Company's outstanding
convertible preferred stock into common stock as of January 1, 1998. Options to
purchase 2,041,107 of common stock that were outstanding at March 31, 1998 were
not included in the computation of diluted loss per share for the three months
ended March 31, 1998 as their effect would be anti-dilutive.
7
<PAGE> 8
The following details the computation of the income (loss) per share.
<TABLE>
<CAPTION>
FOR THE THREE MONTHS ENDED
MARCH 31,
-----------------------------------
1999 1998
------------- -------------
(unaudited) (unaudited)
<S> <C> <C>
ADJUSTMENTS TO NET INCOME (LOSS):
Net income (loss).............................. $ 2,771 $ (1,635)
Preferred dividends and accretion.............. -- (171)
------------- -------------
Net income (loss) attributable to
Common stockholders..................... $ 2,771 $ (1,806)
------------- -------------
WEIGHTED AVERAGE SHARE CALCULATION:
Basic weighted average shares
outstanding:
Average number of shares of
common stock outstanding
during the period ...................... 20,223,932 12,777,327
Diluted weighted average shares
outstanding:
Treasury stock effect of options 1,649,943 --
------------- -------------
Diluted weighted average shares
outstanding.................................. 21,873,875 12,777,327
Pro forma diluted weighted average
shares outstanding:
Conversion of preferred stock 5,011,501
-------------
Pro forma diluted weighted
average shares outstanding.............. 17,788,828
=============
INCOME (LOSS) PER COMMON SHARE:
Basic income (loss) per share ................. $ 0.14 $ (0.14)
============= =============
Diluted income (loss) per share................ $ 0.13 $ (0.14)
============= =============
Pro forma income (loss) per share.............. $ (0.09)
=============
</TABLE>
(2) CREDIT AGREEMENTS:
Effective April 5, 1999, the Company renewed its bank credit agreement
for an additional term of one year. The agreement provides for borrowings up to
the lesser of $7,000,000 or 85% of eligible accounts receivable (the "Revolving
Line") as well as a $1,000,000 capital equipment line (the "Equipment Line").
Borrowings under the Revolving Line bear interest at the prime rate. Borrowings
under the Equipment Line bear interest at the prime rate and are collateralized
by the equipment financed. The Equipment Line will be payable in equal
installments of principal and interest over a three year term as defined in
the credit facility. The credit facility contains restrictive covenants,
including, but not limited to, restrictions related to liquidity, profitability
and net worth, as well as restrictions related to acquisitions, disposition of
assets, distributions and investments. As of March 31, 1999, the Company had no
borrowings under the credit facility.
(3) NEW ACCOUNTING PRONOUNCEMENTS
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities" effective for all fiscal quarters of fiscal
years beginning after June 15, 1999. The adoption of this pronouncement will not
have a material impact on the Company's results of operations, financial
position or cash flows.
(4) INITIAL PUBLIC OFFERING
In February 1998, the Company completed an initial public offering ("IPO")
of 4,025,000 shares of common stock, resulting in net proceeds of approximately
$45.4 million. All of the shares sold were issued and sold by the Company.
Concurrent with the closing of the offering, the outstanding shares of Series A
convertible preferred stock and Series B, C, D and E redeemable convertible
preferred stock were converted into 485,890 and 10,119,845 shares of common
stock, respectively.
8
<PAGE> 9
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
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. Since 1997, 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, the licensing of
related software and 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
other production processes 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.
On May 15, 1998, the Company 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.
RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED MARCH 31, 1999 COMPARED WITH
THE THREE MONTHS ENDED MARCH 31, 1998
REVENUE. The Company recognized $16.8 million in revenue for the three
months ended March 31, 1999, a 63% increase over revenue of $10.3 million for
the three months ended March 31, 1998. The increase was due primarily to the
continued acceptance of Visual UpTime in the Frame Relay and the Asynchronous
Transfer Mode ("ATM") markets. Sales to providers accounted for approximately
67% of revenue for the three months ended March 31, 1999 as compared to
approximately 55% for the three months ended March 31, 1998.
GROSS PROFIT. Cost of goods sold consists of subcontracting costs, component
parts, direct compensation costs, warranty and other contractual obligations,
royalties, license fees and other overhead expenses related to manufacturing
operations. Gross profit was $11.0 million for the three months ended March 31,
1999, as compared to $5.8 million for the three months ended March 31, 1998, an
increase of $5.2 million. Gross margin was 65.4% of revenue for the three months
ended March 31, 1999, as compared to 56.0% of revenue for the three months ended
March 31, 1998. The increase in gross margin percentage was due primarily to
product cost reductions and to changes in 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 costs.
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<PAGE> 10
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 $2.9 million for the three
months ended March 31, 1999 as compared to $2.4 million for the three months
ended March 31, 1998, an increase of $0.5 million. The increase in research and
development expense was due primarily to increased staffing levels and related
support costs and, purchases of materials used in the development of new or
enhanced products. Research and development expense was 17.3% and 23.5% of
revenue for the three months ended March 31, 1999 and 1998, respectively. The
Company expects that research and development expenditures will increase in
absolute dollars, and may decrease as a percentage of revenue, during the
remainder of 1999 and thereafter. The 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, trade shows and other marketing programs. Sales and
marketing expense was $3.5 million for the three months ended March 31, 1999, as
compared to $3.7 million for the three months ended March 31, 1998, a decrease
of $0.2 million. The decrease in sales and marketing expense was due primarily
to the consolidation of Visual's and Net2Net's sales and marketing functions,
with a corresponding decrease in employees subsequent to the May 15, 1998
acquisition of Net2Net. Sales and marketing expense was 20.7% and 35.8% of
revenue for the three months ended March 31, 1999 and 1998, respectively. The
Company expects that sales and marketing expenditures will increase in absolute
dollars, and may decrease as a percentage of revenue, during the remainder of
1999 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 $1.1 million for the three months ended March 31,
1999 as compared to $1.2 million for the three months ended March 31, 1998, a
decrease of $0.1 million. The decrease in general and administrative expense was
due primarily to the consolidation of Visual's and Net2Net's general and
administrative functions. General and administrative expense was 6.5% and
11.5% of revenue for the three months ended March 31, 1999 and 1998,
respectively. The Company expects that general and administrative expenditures
will increase in absolute dollars, and may decrease as a percentage of revenue,
during the remainder of 1999 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.
INTEREST INCOME, NET. Interest income, net, for the three months ended March
31, 1999 was approximately $0.6 million as compared to $0.4 million for the
three months ended March 31, 1998. The increase was due to the significant
increase in cash and cash equivalents resulting from the proceeds of the
Company's IPO in February 1998.
INCOME TAXES. Income taxes for the three months ended March 31, 1999 were
$1.3 million, reflecting an effective tax rate of 32%.
NET INCOME (LOSS). Net income for the three months ended March 31, 1999 was
$2.8 million as compared to a net loss of $1.6 million for the three months
ended March 31, 1998, an increase of $4.4 million. Increases in revenue, gross
profit and interest income achieved in the three months ended March 31, 1999
offset the increased operating expenses and income taxes described above.
LIQUIDITY AND CAPITAL RESOURCES
At March 31, 1999, the Company's combined balance of cash and cash
equivalents was $47.0 million as compared to $50.5 million as of December 31,
1998, a decrease of $3.5 million. This decrease is primarily attributable to a
$6.1 million decrease in working capital and $1.1 million in capital
expenditures in the current year which offset the Company's $2.8 million in net
income for the three months ended March 31, 1999.
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 1999 that are not
expected to exceed $2.0 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
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<PAGE> 11
expansion of sales and marketing, the timing and extent of spending to support
continued expansion of internal systems and networks, the timing of
introductions of new products and enhancements to existing products and market
acceptance of the Company's products.
In addition to the Company's cash and cash equivalents, the Company's other
principal source of liquidity is its bank credit facility. The current credit
facility includes a revolving line of credit providing for borrowings up to the
lesser of $7.0 million or 85% of eligible accounts receivable (as defined in the
credit facility). In April 1999, the Company renewed the credit facility for an
additional term of one year. As amended, the credit facility includes a $1.0
million equipment line. The credit facility contains restrictive financial
covenants, including, but not limited to, restrictions related to liquidity,
profitability and net worth, as well as restrictions related to acquisitions,
dispositions of assets, distributions and investments. As of March 31, 1999,
there were no borrowings outstanding under the bank credit facility. The Company
believes that its current cash position combined with the $7.0 million line of
credit facility are sufficient to meet its capital expenditures and working
capital requirements for the next 18 to 24 months. The Company may consider from
time to time various alternatives and may seek to raise additional capital
through equity or debt financing or to enter into strategic agreements. There
can be no assurance, however, that any of such financing alternatives will be
available on terms acceptable to the Company, if at all.
YEAR 2000 COMPLIANCE
Many of the world's computer systems (including those in non-information
technology equipment and systems) currently record years in a two-digit format.
If not addressed, such computer systems will be unable to properly interpret
dates beyond the year 1999, which could lead to business disruptions. The
potential costs and uncertainties associated with the Year 2000 issue will
depend on a number of factors, including software, hardware and the nature of
the industry in which a company operates.
The Company has instituted a company-wide project for addressing the Year
2000 issue (the "Project"). The Project is divided into four major
sections-Product Compliance, Oracle Implementation and System Infrastructure
Upgrades, Vendor Compliance and Customer Assessment. Each of these sections is
discussed separately below. The Company has engaged third party consultants to
assist in program management of the Project and in testing of critical
business systems. The Project is on schedule for completion by the end of the
third quarter, 1999.
PRODUCT COMPLIANCE
The Company believes that the products that it is currently shipping have
already achieved Year 2000 compliance as defined within the requirements
established by the U.S. Government detailed in the Federal Acquisition
Regulations (FAR) Section 39 -- Final. Should a Year 2000 compliance issue arise
in the future, the Company will take whatever steps it deems necessary to
correct it in accordance with its Year 2000 product warranty.
Although all previously shipped products are believed to be compliant, the
company does not commit to perform tests on product versions that it is no
longer shipping. Should such non-shipping products be found non-compliant, the
Company will not update them to make them compliant.
The Company does not guarantee and specifically disclaim any liability for
the Year 2000 compliance of operating systems, hardware, software or other
products not developed by it.
ORACLE IMPLEMENTATION & SYSTEM INFRASTRUCTURE UPGRADES
Early in 1998, in order to improve access to business information through
scaleable, integrated computing systems across the company, the Company began a
business systems replacement project. The new Oracle, Enterprise Resources
Planning (ERP) application software system has replaced the core legacy systems,
and is expected to make approximately 75 percent of the Company's systems Year
2000 compliant. The implementation of the ERP software was substantially
completed in January 1999.
Following replacement of the core legacy systems with the ERP software, the
Company will seek to achieve Year 2000 compliance for other application
software, computer hardware, network equipment and miscellaneous components of
its internal business systems. The Company anticipates that this effort will be
less significant compared to the replacement of core applications with ERP
software.
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<PAGE> 12
The Company intends to achieve Year 2000 compliance for its remaining
internal systems as soon as possible after the ERP implementation. The
Company's limited number of personal computers and application systems is
anticipated to facilitate rapid progress toward full Year 2000 compliance after
ERP is fully implemented.
The Company intends to continue to work to achieve Year 2000 compliance for
its systems using a methodology that incorporates the following steps:
Update the inventory of computer hardware, software and miscellaneous
network components,
Evaluate application development environment compliance,
Conduct overall assessment of systems infrastructure compliance,
Complete business risk analysis,
Take remedial actions (upgrade, repair, replace, retire or retain),
Develop appropriate contingency plans, and develop and implement regimes to
test Year 2000 compliance for mission-critical systems.
The Company currently anticipates completion of this process by the end of
the third quarter 1999 in order to avoid Year 2000 impact on remaining core
legacy systems.
VENDOR COMPLIANCE
This section includes the process of identifying and prioritizing critical
suppliers at the direct interface level and communicating with them about their
plans and progress in addressing the Year 2000 problem. This process will
include not only component part suppliers for the Company's products, but also
providers of insurance, financial and other services.
The Company's vendor compliance program will include the following steps:
Catalog and classify all vendors,
On-site review and testing of out-sourced services or systems,
Review responses from vendors to determine the level of compliance,
Determine the timing, method and cost of vendor solutions,
Assess vendor Year 2000 compliance and business risks, and
Develop remedial actions or contingency plans, as necessary.
Achievement of vendor Year 2000 compliance is anticipated to be an on-going
effort during 1999. The current target to achieve compliance or complete
contingency plans is the end of the third quarter 1999.
CUSTOMER ASSESSMENT
The Company is developing a program to assess the impact that Year 2000
issues may have upon its customers and their purchasing decisions. The Company
expects to complete customer assessment by the end of the third quarter 1999.
12
<PAGE> 13
COSTS
The estimated total cost of the Year 2000 compliance project, exclusive of
the ERP implementation, is approximately $300,000. These costs are expected to
be incurred throughout 1999. These costs will be incurred primarily for the use
of outside consultants, setting up Year 2000 testing environments and the
replacement of existing software and hardware.
RISKS
The failure to correct a material Year 2000 problem could result in an
interruption in, or a failure of, certain normal business activities or
operations. Such failures could materially and adversely affect the Company's
business, financial condition and results of operations. Moreover, even if the
Company successfully remediates its Year 2000 issues, the Company can be
materially and adversely affected by failures of third parties to remediate
their own year 2000 issues. The failure of third parties with which the Company
has financial or operational relationships (such as our customers and vendors)
to remediate their computer and technology systems issues in a timely manner
could result in a material financial risk to the Company. In addition, the
Company believes that the purchasing patterns of customers and potential
customers may be significantly affected by Year 2000 issues. Due to the general
uncertainty inherent in the Year 2000 problem, resulting in part from the
uncertainty of the Year 2000 readiness of third-party customers and vendors, the
Company is unable to determine at this time whether the consequences of year
2000 failures will have a material impact on our business, financial condition
and results of operations. Accordingly, the Company may experience business
interruption or shutdown, financial loss, damage to its reputation and legal
liability. The Company believes that, with the implementation of new business
systems and completion of the Project as scheduled, the possibility of
significant interruptions of normal operations should be reduced.
The Company's expectations about future costs and the timely completion of
the Project are subject to uncertainties that could cause actual results to
differ materially from what has been discussed above. Factors that could
influence the amount of future costs and the effective timing of remediation
efforts include the Company's success in identifying computer programs and
technology systems that contain two-digit year codes, the nature and amount of
programming and testing required to upgrade or replace each of the affected
programs and systems, the rate and magnitude of related labor and consulting
costs, and the success of the Company's vendors and customers in addressing the
Year 2000 issue.
FACTORS THAT MAY AFFECT FUTURE RESULTS
The market for the Company's products is growing rapidly and the Company's
business environment is characterized by rapid technological changes, changes in
customer requirements and new emerging market segments. Consequently, to compete
effectively, the Company must make frequent new product introductions and
enhancements and deploy sales and marketing resources to take advantage of new
business opportunities. The Company's operations are also subject to certain
other risks and uncertainties including, among other things, the effectiveness
of actual and potential competition, the success of the Company's relationships
with its current strategic partners, the continued development of reseller
relationships with new service providers, and the risks associated with
acquisitions and international expansion. Failure to meet any of these
challenges could adversely affect future operating results.
Although a significant majority of the Company's sales to date have been
made to customers in the United States, the Company intends to increase its
sales efforts in international markets. The Company plans to sell or license its
products to international customers at prices denominated in U.S. dollars.
However, if the Company experiences material levels of sales at prices not
denominated in U.S. dollars, the Company intends to adopt a strategy to hedge
against currency fluctuations.
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.
The foregoing discussion contains forward-looking information within the
meaning of Section 27A of the Securities Act of 1933 and Section 21E of the
Securities Exchange Act of 1934, and is subject to the safe harbor created by
those sections. The Company assumes no obligations to update the information
contained in this press release. The Company's future results may be impacted by
various important factors including, but not limited to, its ability to
implement its provider deployment model, its lengthy sales cycle, dependence on
its major customers, risks associated with rapid technological change and the
emerging services market, potential
13
<PAGE> 14
fluctuations in quarterly results, its dependence on sole and limited source
suppliers and fluctuations in component pricing and its dependence on key
employees and other risk factors set forth in the Company's Annual Report on
Form 10-K for the year ended December 31, 1998.
ITEM 3. QUALITATIVE AND QUANTITATIVE DISCLOSURE ABOUT MARKET RISK
See Item 2 "Management's Discussion and Analysis of Financial Condition and
Results of Operations - - Factors that may affect future results."
PART II -- OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None
ITEM 2. CHANGES IN SECURITIES
None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS
None
ITEM 5. OTHER INFORMATION
None
ITEM 6. (a) EXHIBITS
14
<PAGE> 15
<TABLE>
<CAPTION>
EXHIBIT
NUMBER EXHIBIT DESCRIPTION
---------- --------------------------------------------------------------------
<S> <C>
3.1* Restated Certificate of Incorporation of the Registrant.
3.2* Restated By-Laws of the Registrant.
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.
10.5.1#++ Second Amendment, dated November 4,1998, to the
Reseller/Integration Agreement between the Registrant and MC
Telecommunications Corporation (relating to Exhibit 10.5).
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 and the Licensing of Software, dated as of
December 3, 1997, between the 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.
10.8.1* Lease Amendment, dated September 2, 1997, by and between the
Company and The Equitable Life Assurances Society of The
United States (relating to Exhibit 10.8).
10.8.2# Second Lease Amendment, dated February 8, 1999, by and between
the Company and TA/Western, LLC, successor to the Equitable
Life Assurance Society of the United States (relating to
Exhibit 10.8).
10.9* Omitted.
10.10* Employment Agreement dated December 15, 1994, by and between
the Company and Scott E. Stouffer, as amended.
10.11* Employment Agreement dated December 15, 1994, by and between
the Company and Robert Troutman, as amended.
10.12* Terms of Employment dated June 11, 1997, by and between the
Company and Peter J. Minihane, as amended.
10.13* Terms of Employment dated March 5, 1997, by and between the
Company and Henri A. Cheli, as amended.
10.14* Terms of Employment dated November 12, 1996, by and between
the Company and Gregory J. Langford, as amended.
10.15* Loan and Security Agreement dated January 8, 1998, by and
between Silicon Valley Bank and the Company.
10.15.1* Revolving Promissory Note issued by the Company as of January
8, 1998, to Silicon Valley Bank.
10.15.2@ First Amendment to Loan and Security Agreement dated June 30,
1998, by and between Silicon Valley Bank and the Company.
10.15.3@ Amended and Restated Revolving Promissory Note issued by the
Company as of June 30, 1998, to Silicon Valley Bank.
10.15.4@@ Second Amendment to Loan and Security Agreement dated December
1998, by and between Silicon Valley Bank and the Company.
10.15.5@@ Second Amended and Restated Revolving Promissory Note issued
by the Company on December 28,1998 to Silicon Valley Bank.
10.16** Agreement and Plan of Merger dated April 15, 1998, by and
among the Company, Visual Acquisition, Inc. and Net2Net.
10.17*** Net2Net 1994 Stock Plan, assumed by the Company.
10.18# Sublease Agreement, dated January 28, 1999, between Visual
Networks Operations, Inc. and Compus Services Corporation.
10.19# Sublease Agreement, dated January 8, 1999 between Compus Service
Corporation and Visual Networks Operations, Inc.
27 Financial Data Schedule.
</TABLE>
- ----------
@ Incorporated herein by reference to the Company's Registration Statement
on Form S-1, No. 333-58443.
@@ Incorporated herein by reference to the Company's Registration Statement
on Form S-3, No. 333-73229.
* 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
Form on Form 8-K dated May 19, 1998.
15
<PAGE> 16
*** Incorporated herein by reference to Exhibit 10.1 to the Company's
Registration Statement on Form S-8, No. 333-53153.
# Incorporated herein by referral to the Company's Annual Report for 10-K
dated Mary 31, 1999.
+ Portions of this Exhibit were omitted and have been filed separately with
the Secretary of the Commission pursuant to the Company's Application
Requesting Confidential Treatment under Rule 406 of the Act, filed on
December 22, 1997, January 28, 1998 and February 4, 1998.
++ Portion's of this Exhibit were omitted and have been filed separately with
the Secretary of the Commission pursuant to the Company's Application
Requesting Confidential Treatment under Rule 24b-2 of the Securities
Exchange Act of 1934.
(b) Reports on Form 8-K
None.
SIGNATURES
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THE
COMPANY HAS DULY CAUSED THIS REPORT TO BE SIGNED ON ITS BEHALF BY THE
UNDERSIGNED THEREUNTO DULY AUTHORIZED.
VISUAL NETWORKS, INC.
BY: /s/ SCOTT E. STOUFFER
---------------------------------------------
Scott E. Stouffer
Chief Executive Officer
and President
BY: /s/ PETER J. MINIHANE
---------------------------------------------
Peter J. Minihane
Executive Vice President,
Chief Financial Officer and
Treasurer (principal financial
and accounting officer)
May 17, 1999
16
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