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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE YEAR ENDED DECEMBER 31, 1996
COMMISSION FILE NUMBER 0-25882
VIDEOSERVER, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 04-3114212
(State or other jurisdiction of incorporation (IRS Employer Identification No.)
or organization)
63 THIRD AVENUE, BURLINGTON, MASSACHUSETTS 01803
(Address of principal executive offices, including Zip Code)
(617) 229-2000
(Registrant's telephone number, including area code)
Securities Registered Pursuant to Section 12(b) of the Act:
None
Securities Registered Pursuant to Section 12(g) of the Act:
Common Stock $.01 par value
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [x] No[ ]
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
The aggregate market value of voting stock held by non-affiliates of
the registrant as of March 7, 1997 was $290,511,143 (based on the last reported
sale price on the Nasdaq National Market on that date).
The number of shares outstanding of the registrant's Common Stock as of
March 7, 1997 was 12,641,004.
DOCUMENTS INCORPORATED BY REFERENCE
1. Portions of the definitive Proxy Statement to be delivered to Shareholders
in connection with the Annual Meeting of Shareholders to be held May 14,
1997 are incorporated by reference herein.
2. Portions of the 1996 Annual Report to Shareholders are incorporated by
reference herein.
3. Portions of the registrant's Registration Statement on Form S-1
(Registration No. 33-91132) are incorporated by reference herein.
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VIDEOSERVER, INC.
1996 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
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PAGE
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PART I
Item 1. Business ............................................................... 3
Item 2. Description of Property ................................................ 13
Item 3. Legal Proceedings ...................................................... 13
Item 4. Submission of Matters to a Vote of Security Holders .................... 13
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters... 14
Item 6. Selected Financial Data ................................................ 14
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations .......................................................... 14
Item 8. Financial Statements and Supplementary Data ............................ 14
Item 9. Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure ................................. 14
PART III
Item 10. Directors and Executive Officers of the Registrant ..................... 15
Item 11. Executive Compensation ................................................. 15
Item 12. Security Ownership of Certain Beneficial Owners and Management ......... 15
Item 13. Certain Relationships and Related Transactions ......................... 15
PART IV
Item 14. Exhibits, Financial Statements Schedules and Reports on Form 8-K ....... 16
Signatures ................................................................................ 18
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This Report contains "forward-looking statements" within the meaning of the
Private Securities Litigation Reform Act of 1995. Such statements are subject to
certain risks and uncertainties, including without limitation those discussed in
the Company's 1996 Annual Report to Shareholders in the section titled "Other
factors which may affect future operations" (which section is hereby
incorporated by reference herein). Such forward-looking statements speak only as
of the date on which they are made, and the Company cautions readers not to
place undue reliance on such statements.
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PART I
ITEM 1. BUSINESS
VideoServer, Inc. ("VideoServer" or "the Company") is a leading supplier of
networking equipment and associated software used to create multimedia
conferences that connect multiple users over wide area networks and allow them
to interact as a group. The Company's products, Multimedia Conference Servers
(MCSs), provide multipoint conferencing, as well as applications for conference
control, network management and bandwidth management. VideoServer's products
enable interoperability between dissimilar communications networks, video
conferencing systems and the encoding technologies used by those systems. The
Company's products, which combine audio, video and data information, are
positioned to become a key enabler of communications networks supporting
emerging collaborative multimedia applications.
VideoServer's objective is to expand its leadership position in the
conferencing market by developing and supplying products that enable multipoint
conferencing, whether through end-user multimedia networks or carrier-provided
conferencing services.
The Company provides Multimedia Conference Servers to a wide variety of
technology and distribution partners, including leading videoconferencing
equipment suppliers, telephone carriers, private conferencing service providers,
computer companies and PBX suppliers. The Company believes that it was the
largest supplier in annual shipments of multimedia conference servers in 1994,
1995, and 1996.
In March 1997, the Company entered into a definitive purchase agreement with
Promptus Communications to acquire certain assets comprising Promptus' network
access card business, for approximately $21,000,000 in cash and stock. The
transaction is expected to close in the second calendar quarter of 1997.
Promptus manufactures and markets a comprehensive line of digital network access
products used for a variety of applications, including videoconferencing, ISDN
Internet access, remote LAN access, and high-speed file transfer. Network
access technology is an important component of the Company's MCS products, and
Promptus is a significant supplier to the Company.
INDUSTRY BACKGROUND
VIDEOCONFERENCING
The multimedia conferencing market has evolved from videoconferencing. In
the late 1980s, with increasing numbers of conferencing endpoints installed and
customers desiring to connect multiple locations into the same conference,
videoconferencing equipment suppliers introduced multipoint control units (MCUs)
to transfer video and audio signals between all conference participants.
However, because of the proprietary nature of the encoding used, video terminals
and associated multipoint control units from different manufacturers were not
interoperable. In December 1990, the International Telecommunications Union
(ITU) introduced the H.320 standards for videoconferencing over switched digital
circuit networks to provide a framework for equipment from different
manufacturers to communicate with each other. Compatibility is particularly
important for communication via these networks, since the advantage of these
services is dial-up communications without regard to the type of equipment being
used at the receiving ends of the transmission.
In recent years, lower-priced, standards-based products emerged that have
expanded the market for videoconferencing systems. Room systems that were once
priced in the $100,000 to $200,000 range are now priced as low as $8,000. In
addition, increasing competition between network carriers, and increasing demand
for applications such as Internet access, are leading to wider availability and
significantly declining costs of digital lines.
With the introduction of chip sets incorporating ITU standards, a growing
number of companies have entered the desktop videoconferencing market, either
with stand-alone complete PC-based systems or with board sets that plug into
personal computers. Companies shipping H.320 compliant desktop conferencing
products include
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British Telecom, Compression Labs, IBM, Intel, Olivetti, PictureTel, VTEL and
VCON. The costs of such desktop conferencing products have rapidly declined with
the introduction of more powerful chip sets and further miniaturization of
components such as cameras and monitors. Since early 1994, desktop conferencing
subsystems have dropped in price from $6,000 per seat to less than $1,500, with
some products available for as low as $1,000. As with the decrease in the price
of room systems, this decrease in price has fueled demand for desktop endpoints.
Extending the reach of conferencing, in November 1995 the ITU introduced the
H.324 standard for low bit rate video, enabling videoconferencing over analog
lines using PCs or videophones. This is expected to bring conferencing
capability to an entirely new segment of end users, including those in smaller
businesses and homes. PC vendors such as AST, Compaq, Hewlett-Packard, IBM,
Sony, and Toshiba, and modem suppliers such as Boca Research and U.S. Robotics
began offering H.324 conferencing capabilities late in 1996.
In May 1996, another important expansion of conferencing standards was
realized with the introduction of the H.323 standard governing real-time
collaboration over local area networks, intranets, and the Internet. Enabling
conferencing over traditional business networks provides a foundation for the
adoption of this application as a mainstream business tool. Vendors such as
Intel, PictureTel, and Microsoft have announced their intention to introduce
H.323 based endpoints in 1997.
Each of these endpoints, whether room systems or desktop systems, require
server resources to conduct a multipoint conference. A larger installed base of
endpoints is expected to lead to more multipoint conferencing, and therefore to
a greater demand for the Company's MCS products.
COLLABORATIVE MULTIMEDIA APPLICATIONS
Concurrent with advances in videoconferencing, significant investments have
been made in software to extend traditional desktop computing applications into
conference enabled real-time information sharing tools. Collaborative data
conferencing applications are emerging that redefine the way groups can work
together. With the ability to see and hear one another over telecommunications
lines and share a common desktop application like a white board, spreadsheet or
word-processing document, participants can share ideas and collaborate in real
time to improve the work product.
In response to the emerging customer demand for multimedia applications, in
February 1996 the ITU extended the T.120 standards for collaborative multimedia
conferencing wherein video, audio and data information can be shared between
endpoints in a multipoint setting. In 1996 Microsoft bundled a standards-based
realtime voice and data conferencing package, NetMeeting, into its Windows
operating system. This product will provide an embedded collaborative capability
for potentially millions of PC users. In addition, Intel and IBM are offering
collaborative desktop applications with optional audio and video capabilities
sold through retail computer channels. Fundamental to the architecture of these
products is the presence of a multimedia conference server to provide the
multipoint link and data distribution mechanism among all the endpoints.
CARRIER-PROVIDED SERVICES
The intense competition among carriers has increased the demand for
technologies that allow carriers to provide additional value-added services.
Multimedia conferencing technology offers such an opportunity, and carriers are
initiating collaborative multimedia conferencing services that provide on-demand
multipoint conferencing capability allowing users to connect their terminals to
multimedia conference servers located in the carriers' central offices.
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A NEW CLASS OF NETWORK EQUIPMENT
These trends -- the growth in room systems and desktop videoconferencing,
growth in collaborative desktop conferencing and expansion in services offered
by carriers -- are driving the need for sophisticated, networked multimedia
conference servers.
THE VIDEOSERVER SOLUTION
VideoServer was founded in 1991 to develop a new generation of networking
equipment architected for the videoconferencing market as well as the emerging
multimedia conferencing market. The VideoServer MCS product line is built on an
industry standard hardware and software platform that combines a powerful set of
real-time conferencing applications with management tools and network
connectivity features that address today's customer requirements and are
positioned to meet emerging requirements. These requirements include:
INTEROPERABILITY. VideoServer's Multimedia Conference Servers today provide
transparent interoperability among many different kinds of endpoints such as
room videoconferencing systems, desktop video terminals, and regular telephones
in the same conference, using combinations of voice, video, and data. In the
future, this level of interworking will be expected to encompass emerging
conferencing endpoint technologies such as data conferencing computers,
audio-graphics systems and videophones. Similarly, interoperability must be
provided between the many different brands of equipment and applications. The
technology also must be able to accommodate various encoding algorithms used to
compress multimedia information. The Company has expended substantial effort to
make its MCS interoperable with the products of virtually all suppliers of
standards-based videoconferencing terminals. In many cases this has required
subtle accommodations in the MCS for the specific characteristics of each brand
of endpoint due to the manufacturer's implementation of the ITU standards and
product performance. When different encoding technology is employed in terminals
for audio algorithms, the MCS provides the transcoding needed to deliver the
audio mix to each endpoint in the proper algorithm for that endpoint.
CONNECTIVITY. Conference servers must be able to provide gateways between
diverse network services and between multiple carriers. While today's servers
provide connectivity largely to T-1, ISDN, private digital networks, and analog
voice networks, in the future, endpoints are expected to be connected to
ethernet and token ring local area networks, the Internet, and to advanced
networks based on ATM. In addition, as carriers add features to their networks,
conference servers must be able to support them.
FUNCTIONALITY. In addition to video switching and audio mixing, application
features are needed to facilitate ease of operation, perform centralized
processing, interconnect with traditional data network servers and deliver many
new kinds of network information. These network servers will be required to
scale throughout the enterprise, provide redundancy for high reliability and
incorporate network management capabilities.
PRODUCTS
The Company provides technology advances to its OEM and carrier customers
through products that incorporate rapid standards deployment, extensive feature
content, scalability, network flexibility and interoperability. The Company
believes that its technology leadership enables its customers to reduce their
time-to-market and their own product costs, and that the Company's technology
relationships with customers allow it to anticipate market requirements critical
to its products.
The Company's products have been designed within a scaleable, modular
architecture to allow the customer to add capacity, processing power and
conferencing features as the customer's network and application requirements
grow. Using a common set of hardware and software building blocks, customers can
choose from a wide range of product configurations that differ in capacity,
price, network connectivity and features, all of which
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share the same operating software user interface. The product may be configured
for use in customer premises environments or may be configured with specialized
packaging for use in a telephone carrier's central office setting.
The MCS product line includes a number of basic platform configurations that
are expanded by the customer's selection of optional processing modules and
software applications. The platforms, configured for the typical end-user, range
in list price from under $25,000 to more than $200,000. Each MCS configuration
is built from a common set of processing modules, network interfaces, software
systems and optional features.
The following table lists the basic chassis configurations offered by the
Company and the typical target market and application in which each is used. In
this table, user capacity is a measure of the number of simultaneous conference
participants that can be connected to the MCS.
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MODEL CAPACITY TARGET MARKET/APPLICATION
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2007 8 users Entry level Audio/Video/Data (A/V/D) multipoint for customer premises
equipment (CPE) networks; distributed server
2012 16 users Mid-range CPE network central server
2020 48 users Large CPE/central office network with extensive multimedia applications
CO 48 users High availability central office server
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Each of these systems may be interconnected to provide support for larger
conferences.
The VideoServer MCS has an extensive number of available software and
hardware features, some of which are listed in the following table.
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APPLICATIONS DESCRIPTION
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CONFERENCE SERVICES AND MANAGEMENT
Continuous Presence .............. Continuous viewing of multiple conference sites
Multimedia Conferencing......... Simultaneous audio visual conferencing and data conferencing
Reservation and Scheduling......... Schedule and manage MCS use
Directory Services................. Database of potential conference participants and sites
Chairperson Conference Control Management of conference activities by a selected video
participant
Security and Password Control...... Conference password and application security controls
Accounting and Billing............. System usage tracking for service billing
Voice Activated Switching.......... Dynamic switching of video presentation based on current
speaker
Audio Add-on....................... Conferencing module for audio-only conference participants
Operator Attended Conferencing Operator interface at conference initiation
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NETWORK SERVICES AND
MANAGEMENT
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Centralized Multipoint Management
Multi-MCS conference and network management package
Outbound Dialing................. Optional feature for MCS dial-out capability
Conference Monitor............... Real-time monitor of conference activities and status
Bandwidth Management............. Bandwidth aggregation using inverse multiplexing
Event Management................. System activity and alarms applications for network management
Network Diagnostics.............. Network loop-back and problem isolation tool kit
Premise Switching............... Adds the function of an ISDN switch
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The entry level Model 2007 MCS, continuous presence, T.120 conferencing
capability, operator attended conferencing features and premise switching all
began shipping in 1996.
The VideoServer MCS can be directly connected to public networks (either T-1
or ISDN networks, or both) or private networks. The T-1 interface can be
configured as either a full or fractional T-1 (FT-1). If FT-1 service is
selected, multiple FT-1 circuits may be multiplexed and delivered by the network
to the MCS in a single T-1 pipe. ISDN Primary Rate Interface (PRI) support
allows the MCS to cost-effectively support multiple basic rate terminal
connections across a single interface. ISDN Basic Rate Interface (BRI) support
offers a cost effective solution for customer premise applications not requiring
PRI. The MCS supports the various ISDN network protocols used in the United
States, the United Kingdom, France, Germany, Japan, Australia and the
European-wide standard, and thus can be used worldwide.
The Company offers add-on software to its installed base in the form of
either major new software releases or unbundled software options. Customers may
purchase new software releases on an as-needed basis or as part of a maintenance
agreement. Unbundled software options are priced separately and are not part of
maintenance agreements.
MARKETS AND CUSTOMERS
VideoServer markets its products to Original Equipment Manufacturers (OEMs),
which generally resell the Company's products to end-users, and to service
providers, including public and private telephone carriers, which generally
offer conferencing services based on the Company's products. This distribution
strategy focuses on four types of customers: conferencing equipment
manufacturers and resellers, telephone companies as conferencing service
providers, computer systems and workstation companies, and PBX and network
equipment suppliers.
Traditional videoconferencing equipment suppliers have historically
represented the primary market for delivering conferencing equipment to users.
The Company has relationships with most of the significant videoconferencing
suppliers around the world, including Compression Labs, Inc. (CLI) and
PictureTel Corporation in the United States, and British Telecom, GPT Video
Systems (a division of the UK-based GPT Limited), and Societe Anonyme de
Telecommunications (a division of the French-based Sagem Group), three of the
leading European suppliers of conferencing products. Each is offering the
Company's products to its customers under private label. The Company also has
agreements with leading Japanese manufacturers, including Sony Corporation,
which resells the products globally, as well as NEC America Inc., Fujitsu
Business Communications Systems, Inc. and Panasonic Corporation, which remarket
the products primarily in English-speaking countries worldwide.
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Telecommunication service providers are increasingly seeking to
differentiate themselves by offering multimedia conferencing services to
customers who desire on-demand conferencing capability without installing their
own conference servers. The Company markets its products and services directly
to public and private telecommunications service providers, including
Interexchange Carriers (IXCs) such as AT&T, MCI and Sprint, Regional Bell
Operating Companies (RBOCs) such as BellSouth and Southwestern Bell, a number of
private conferencing service providers in the U.S. such as Link VTC and
1-800-Video On, and to international Post Telephone and Telegraph companies
(PTTs) in Europe and Asia, such as British Telecom, Deutsche Telekom, France
Telecom, and NTT.
As conferencing moves to desktop computing, computer systems companies are
beginning to address the emerging collaborative multimedia market. The Company
believes these companies view multimedia applications as a strategic technology
thrust that will fuel demand for computing resources and network bandwidth.
Since late 1993, Intel Corporation and VideoServer have participated in joint
development and marketing of products for the conferencing market. In late 1996,
the Company and Compaq Computer announced their intention to work closely with
Compaq's value-added resellers in North America to incorporate VideoServer
technology into Compaq servers.
With the continued expansion of standards, network equipment and PBX
companies, whose products form the data and telecommunications backbone of the
enterprise network, are beginning to incorporate conferencing technology into
their product lines. In late 1996, the Company announced an OEM arrangement with
Cisco Systems, initially under which the Company will provide standards-based
conferencing gateways to Cisco for integration into certain of its enterprise
routers. Additionally, major PBX companies such as Nortel and Siemens/Rolm, who
are expanding their traditional audio-based offerings to include video and data
capabilities, have begun to resell the Company's MCS products.
The Company's agreements with its customers generally do not include minimum
purchase requirements and are non-exclusive. In 1994, CLI and British Telecom
accounted for 55% and 12% of net sales. In 1995, CLI, PictureTel, who became a
customer during 1995, and BellSouth accounted for 23%, 19% and 18% of net sales.
In 1996, PictureTel and CLI accounted for 43% and 10% of net sales. Sales to
international customers accounted for 29%, 25% and 32% of the Company's net
sales for the years ended December 31, 1994, 1995 and 1996.
VideoServer conducts its sales and marketing activities from its principal
offices in Burlington, Massachusetts, as well as from four other North American
sales offices and its European headquarters located in the United Kingdom.
RESEARCH AND PRODUCT DEVELOPMENT
The Company believes that its future success depends on its ability to
continue to enhance and expand its existing products and to develop new products
which maintain its technology leadership. VideoServer has invested, and expects
to continue to invest heavily, in the development of products and core
technologies. Extensive product development input is obtained from OEM partners,
from service providers, from end users, and through the Company's active
participation and leadership in industry groups responsible for establishing
technical standards such as the ITU and the IMTC .
Since its founding, the Company's research and development effort has been
directed towards the development of standards-based conference server
technology. In concert with the evolution of industry standards, these efforts
currently are focused on extending the breadth of network services supported
beyond switched digital services to include local area networks, corporate
intranets, the Internet, and ATM. This includes the development of multipoint
products for particular network platforms and gateway products to provide
interoperability between dissimilar network types. Development is also underway
to support emerging data conferencing applications, provide additional
conferencing management capabilities including enhanced user interfaces, and to
add higher capacities to the product family. The Company is extending and
accelerating its
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efforts through development relationships with its customers. The Company
receives funding under certain of these arrangements which, when earned, is
recorded as a reduction of research and development expense in the Company's
financial statements.
At December 31, 1996, VideoServer's research and development staff consisted
of 77 employees, including 65 software engineers and 12 hardware engineers. The
Company's net research and development expenditures were $3.3 million, $5.3
million and $7.8 million in 1994, 1995 and 1996, representing 21%, 19% and 16%
of net sales in those years. Development funding from customers of $340,000,
$1,000,000 and $1,150,000 was recorded as a reduction of research and
development costs in 1994, 1995 and 1996. All software development costs have
been expensed as incurred because costs eligible for capitalization have not
been material to date.
In January 1997, the Company began to establish an international development
operation in the United Kingdom.
CUSTOMER SUPPORT AND SERVICE
The Company provides technical support and services to its resellers and
customers. A high level of continuing service and support is critical to the
Company's objective of developing long-term relationships with customers. The
Company's resellers install, maintain and provide on-site and headquarters-level
technical support of products to their end-user customers, and VideoServer
provides comprehensive problem management, training, diagnostic tools, repair
services and spare parts to facilitate and supplement these efforts. The Company
installs, maintains and directly supports products sold to its direct customers.
The Company offers a technical support hotline to its resellers and
customers. Network support engineers answer technical support calls placed by
the support engineers of the Company's resellers and by its direct customers.
The engineers generally provide same-day responses to questions that cannot be
resolved during the initial call. The products are designed with advanced remote
diagnostic capabilities that permit a reseller's or the Company's support
engineers to immediately begin the process of diagnosing any problems in the
field, thereby reducing both response time and cost. When necessary, however,
support engineers are dispatched to the customer's facility.
The Company warrants its software products for 90 days. During this 90-day
warranty period, the Company will investigate all reported problems and will
follow escalation procedures to provide resolution. The Company warrants its
hardware products for 12 months. During this warranty period, the Company will
repair or replace any failed hardware component. The Company also offers
post-warranty support programs ranging from services on a time-and-materials
basis to full-service contracts on a 24-hour, 7-days-a-week basis, and a full
suite of training courses.
MANUFACTURING
The Company's manufacturing operations consist primarily of materials
planning and procurement, quality control of materials, components and
subassemblies and final product configuration and testing. The Company designs
the significant hardware subassemblies for its products and uses independent
third-party contract assembly companies to perform printed circuit board
assembly. The Company configures and tests the hardware and software in
combinations to meet a wide variety of customer requirements. The Company uses
automated testing equipment, "burn-in" procedures and comprehensive inspection
and statistical process control testing intended to assure the quality and
reliability of its products. The Company has received the International Standard
Organization (ISO) 9002 certification for quality.
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Although the Company generally uses standard parts and components for
its products, certain components, including key digital signal processors from
Texas Instruments, are presently available only from single sources or from
limited sources. The Company has no supply commitments from its vendors,
including Texas Instruments, and generally purchases components on a purchase
order basis as opposed to entering into long term procurement agreements with
vendors. The Company has been able to obtain adequate supplies of components in
a timely manner from current vendors, or when necessary to meet production
needs, from alternate vendors. The Company believes that, for the Texas
Instruments digital signal processors in particular, alternative sources of
supply would be difficult to develop over a short period of time and an
interruption in supply or a significant increase in the price of these
components would adversely affect the Company's operating results and business.
Because of the generally short cycle between order and shipment and because
the majority of the Company's sales in each quarter results from orders booked
in that quarter, the Company does not believe that its backlog as of any
particular date is indicative of future sales levels.
COMPETITION
The market for communications products is intensely competitive and is
subject to rapid technological change. Although to date the Company has
experienced limited competition from products with comparable capabilities, the
Company expects competition to increase significantly in the future. Currently,
the Company's principal competition from producers of multipoint control units
comes from Lucent Technologies, and to a lesser extent from VTEL Corporation.
Other companies such as Multilink, Teleos (a division of Madge Networks) Accord,
Databeam, and Outreach, have introduced or announced their intention to
introduce products which could be competitive with the Company's products.
Furthermore, PictureTel Corporation, currently the Company's largest customer,
and Radvision have announced their intention to introduce products related to
the new H.323 standards which may be competitive with products the Company
currently has under development, and others are expected to enter the H.323
conferencing market. This additional competition could adversely affect the
Company's sales and profitability through price reductions and loss of market
share. In particular, should one or more of the Company's current customers,
including videoconferencing equipment suppliers, telecommunications carriers or
traditional network equipment vendors choose to provide or distribute
competitive products (including their own products) and services, the Company's
business could be materially adversely affected. Many of the Company's current
and potential competitors have substantially greater financial, marketing and
technical resources than the Company.
The principal competitive factors in the market for multimedia conference
servers are, and are expected to continue to be, breadth of network services
supported, conformance to industry standards, price per port, performance,
network management capabilities, transcoding capabilities, reliability and
customer support. While the Company believes it presently competes favorably in
all of these areas, there can be no assurance that it will continue to do so.
PROPRIETARY RIGHTS
While the Company has applied for several patents, it currently holds only
one U.S. patent relating to its existing products, and relies on a combination
of contractual rights, trade secrets and copyright laws to establish and protect
its intellectual property rights. The Company believes that, because of the
rapid pace of technological change in the data communications and
telecommunications industries, the intellectual property protection for its
products is a less significant factor in the Company's success than the
knowledge, abilities and experience of the Company's employees, the frequency of
its product enhancements, its relationships with its partners, the effectiveness
of its marketing activities, and the timeliness and quality of its support
services.
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The Company is subject to the risk of adverse claims and litigation
alleging infringement of the intellectual property rights of others. In December
1994, the Company settled a patent infringement litigation brought against it by
Datapoint Corporation (Datapoint) for a cash payment by the Company of $500,000.
There can be no assurance that additional third parties will not assert claims
against the Company in the future with respect to the Company's current or
future products or that any such claims would not require the Company to enter
into license arrangements or result in protracted and costly litigation,
regardless of the merits of such claims. No assurance can be given that the
Company would prevail with respect to any such claim, or that a license to
third-party rights, if needed, would be available on acceptable terms.
Patent infringement litigation still exists between Datapoint and two of the
Company's largest customers. In addition, Datapoint has written inquiry letters
to a significant number of others in the videoconferencing market offering to
sell them nonexclusive licenses under certain Datapoint patents in the
videoconferencing field (the Datapoint Patents). While the validity or scope of
the Datapoint Patents has not been adjudicated by a court, Datapoint has, in
effect, asserted that the Datapoint Patents cover certain aspects of multipoint
videoconferencing operations involving terminals and multipoint control units,
including the Company's MCSs. As a result of the December 1994 settlement, the
Company obtained a nonexclusive license for its MCS under the Datapoint Patents,
which license includes limited rights for the products and services of the
Company's customers. However, the conferencing market in general, and the
Company's future sales and operating results in particular, could be adversely
affected as a result of ongoing uncertainties regarding the Datapoint Patents.
Such uncertainty, and any related potential impact, is likely to exist until the
validity of the patents is adjudicated.
EMPLOYEES
At December 31, 1996, the Company employed a total of 193 persons, including
77 in research and development, 73 in sales, marketing and customer support, 24
in manufacturing and 19 in finance and administration. Thirteen of the Company's
employees were located in the United Kingdom and the remainder were located in
the United States. None of the Company's employees are represented by a labor
organization and the Company believes that its relations with employees are
good.
Competition for qualified personnel in the computer networking and
communications industry is intense. VideoServer believes that its future success
will depend on its continued ability to attract and retain qualified personnel.
EXECUTIVE OFFICERS OF THE REGISTRANT
The executive officers of the Company are:
<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<S> <C> <C>
Robert L. Castle. . . . . . . . . . 47 President, Chief Executive Officer and Director
Jules L. DeVigne. . . . . . . . . 57 Vice President of Worldwide Sales
Rubin Gruber. . . . . . . . . . . . 52 Vice President of Business Development, and Director
Derek M. James. . . . . . . . . . 54 Chief Technology Officer
John Jones. . . . . . . . . . . . . . 49 Vice President of Customer Service and Support
Walter A. Jones. . . . . . . . . . . 49 Vice President of Research and Development
Stephen J. Nill. . . . . . . . . . . 45 Vice President of Finance and Chief Financial Officer, Treasurer,
and Secretary
John E. O'Neil. . . . . . . . . . . 41 Vice President of Marketing
Frank T. Winiarski. . . . . . . . 54 Vice President of Manufacturing
</TABLE>
- --------------------
11
<PAGE> 12
Robert L. Castle has served as President and Chief Executive Officer of the
Company since March 1993, and as a Director since March 1992. From February 1992
until March 1993, he served as President and Chief Operating Officer. Prior to
joining the Company, Mr. Castle was employed for eight years at FileNet
Corporation, a supplier of document imaging equipment, in various positions
including Senior Vice President of Marketing from October 1990 to February 1992
and Vice President of Marketing from December 1987 to October 1990. Previously,
Mr. Castle held marketing and general management positions at Basic Four Corp.,
a developer of software applications, and Sycor, Inc., a developer and
manufacturer of data-entry terminals.
Jules L. DeVigne has served as Vice President of Worldwide Sales since
October 1992. He served as President of Innovative Technology, Inc., a
manufacturer of interactive voice response systems, from March 1990 until June
1992, and served as Senior Vice President of Sales and Marketing of Netrix
Corporation, a manufacturer of wide area networks, from February 1989 until
March 1990. Previously, Mr. DeVigne held various sales and executive management
positions with AT&T Paradyne Corporation, a manufacturer of modems and wide area
network products, and International Business Machines Corporation.
Rubin Gruber was a founder of the Company and has served as a Director since
inception of the Company and as Vice President of Business Development since
February 1992. Mr. Gruber served as President of the Company from the Company's
inception until February 1992. He was a founder and served as President of Span
Communications, Inc., a development stage company, from August 1989 to August
1990. Previously, Mr. Gruber was a founder and served as President of both
Cambridge Telecommunications, Inc., a manufacturer of networking equipment, and
Davox Corporation, a developer of terminals supporting concurrent voice and data
applications, and as a Senior Vice President of Bolt, Beranek and Newman
Communications Corporation, a manufacturer of data communications equipment.
Derek M. James was a founder of the Company, has served as Vice President of
Engineering since the Company's inception, and currently serves as the Chief
Technology Officer. He was Vice President of Engineering of Span Communications,
Inc., a development stage company, and an independent consultant from August
1989 until August 1990, and was Vice President of Product Development for Bolt,
Beranek and Newman Communications Corporation, a manufacturer of data
communications equipment, from August 1987 until August 1989. Previously, Mr.
James served as Vice President of Engineering of Decision Data, Inc., a
manufacturer of terminals and communications equipment, and Engineering Director
at Raytheon Data Systems, a manufacturer of data communications equipment.
John Jones has served as Vice President of Customer Service since October
1995. He served as Director and General Manager of the Core Products Group at
Kronos, Inc., a manufacturer of time and attendance data collection systems from
April 1992 until October 1995, and served as General Manager of the Industrial
Applications Division of ModComp, an AEG Company, a manufacturer of
mini-computer systems and applications from June, 1989 until April 1992.
Previously, Mr. Jones held various technical and marketing positions with Apollo
computer, a manufacturer of technical workstations, and Data General
Corporation.
Walter A. Jones has served as Vice President of Research and Development
since September, 1996. He served as Director of Engineering for the Isis
Distributed Systems Division at Stratus Computer, Inc., a manufacturer of fault
tolerant servers, from January 1994 until September 1996, and served as Vice
President of Engineering at Coral Networks, a manufacturer of high performance,
multi-protocol, network routers from April, 1992 until January 1994. Previously,
Mr. Jones served as Vice President of Engineering at Prime Computer, a
manufacturer of minicomputers and network servers.
Stephen J. Nill has served as Vice President of Finance and Chief Financial
Officer since June 1994, and as Treasurer and Secretary since June 1995. He
served at Lotus Development Corporation, a software supplier, as Director of
Finance and Operations, Consulting Services Group, from October 1993 until May
1994, as Director of Worldwide Finance and Administration Systems from April
1993 until September 1993 and as Corporate
12
<PAGE> 13
Controller and Chief Accounting Officer from January 1989 until March 1993.
Previously, Mr. Nill held various financial positions with Computervision, Inc.,
a supplier of workstation-based software, International Business Machines
Corporation and Arthur Andersen & Co.
John E. O'Neil has served as Vice President of Marketing since February
1995. He served at Xylogics, Inc., a computer networking company, as Vice
President of Marketing from January 1992 until February 1995, and as Director of
Network Products Marketing from December 1988 until January 1992. Previously,
Mr. O'Neil held software engineering positions at Encore Computer, Inc., a
manufacturer of multiprocessor computer systems, and Datatrol, Inc., a supplier
of transaction-processing terminals.
Frank T. Winiarski has served as Vice President of Manufacturing since June
1992. He served as Vice President of Manufacturing at Synernetics, a supplier of
local area networks, from July 1990 until May 1992, and as Executive Vice
President of The Lambda Group, a network hardware and software consulting firm,
from October 1989 until June 1990. Previously, Mr. Winiarski was Vice President
of Operations at Ashton-Tate Corporation, a software supplier, and held various
positions with Digital Equipment Corporation, a manufacturer of computer
equipment.
Officers are elected on an annual basis to serve at the discretion of the
Board of Directors.
ITEM 2. DESCRIPTION OF PROPERTY
At December 31, 1996, the Company's principal offices were located in
Burlington, Massachusetts, in a 60,000 square foot facility which the Company
leases under agreements that expire in February 1999, with an option to renew
for two years.
In March 1997, the Company relocated its European headquarters to a 4,500
square foot facility in Bracknell, United Kingdom, which the company leases
under a three year lease expiring in February, 2000. Also in March, 1997, the
Company entered into a lease for a 3,100 square foot facility in Dunwoodie,
Georgia, which will serve as a sales office, under a five year lease which
expires in February 2002.
The Company also leases, on a short-term basis, various sales office space
in San Francisco, California; Reston, Virginia; and Dallas, Texas.
The Company believes its existing and pending facilities are adequate for
its current needs and that suitable additional or substitute space will be
available as needed.
ITEM 3. LEGAL PROCEEDINGS
The Company is not currently involved in any legal proceedings that it
believes could have, either individually or in the aggregate, a material adverse
effect on its business or financial condition.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the last
quarter of the fiscal year ended December 31, 1996.
13
<PAGE> 14
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS.
The information required by this item may be found in the section captioned
"Quarterly Financial Information (unaudited)" appearing in the 1996 Annual
Report to Shareholders, and is incorporated herein by reference.(1)
As of March 7, 1997, the Company had approximately 95 shareholders of
record. This does not reflect persons or entities who hold their stock in
nominee or "street" name through various brokerage firms. The Company has not
paid dividends on its Common Stock. The Company anticipates it will continue to
reinvest earnings to finance future growth, and therefore does not intend to pay
dividends in the foreseeable future.
ITEM 6. SELECTED FINANCIAL DATA
Information required by this item may be found in the section captioned
"Financial Highlights" appearing in the 1996 Annual Report to Shareholders, and
is incorporated herein by reference.(1)
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
Information required by this item may be found in the section captioned
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" appearing in the 1996 Annual Report to Shareholders, and is
incorporated herein by reference.(1)
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
Information with respect to this item may be found in the Financial Section
of the 1996 Annual Report to Shareholders on pages 22 through 32, and is
incorporated herein by reference.(1)
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
----------------------------------------------------------------------------
(1) The Company's 1996 Annual Report to Shareholders is not to be deemed
filed as part of this report except for those parts thereof specifically
incorporated by reference.
14
<PAGE> 15
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
Information with respect to Directors and compliance with Section 16(a) of
the Securities Exchange Act may be found in the sections captioned "Proposal No.
1 - Election of Director" and "Section 16(a) - Beneficial Ownership Reporting
Compliance" appearing in the definitive Proxy Statement to be delivered to
shareholders in connection with the Annual Meeting of Shareholders to be held on
May 14, 1997. Such information is incorporated herein by reference. Information
with respect to Executive Officers may be found under the section captioned
"Executive Officers of the Registrant" in Part I.
ITEM 11. EXECUTIVE COMPENSATION.
The information required with respect to this item may be found in the
sections captioned "Executive Compensation and Other Information Concerning
Directors and Executive Officers" appearing in the definitive Proxy Statement to
be delivered to shareholders in connection with the Annual Meeting of
Shareholders to be held on May 14, 1997. Such information is incorporated herein
by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information required with respect to this item may be found in the
section captioned "Security Ownership of Certain Beneficial Owners and
Management" appearing in the definitive Proxy Statement to be delivered to
shareholders in connection with the Annual Meeting of Shareholders to be held on
May 14, 1997. Such information is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information required with respect to this item may be found in the
section captioned "Certain Transactions" appearing in the definitive Proxy
Statement to be delivered to shareholders in connection with the Annual Meeting
of Shareholders to be held on May 14, 1997. Such information is incorporated
herein by reference.
15
<PAGE> 16
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM
8-K.
(a) DOCUMENTS FILED AS PART OF FORM 10-K
1. CONSOLIDATED FINANCIAL STATEMENTS.
The following consolidated financial statements and supplementary data
are included in Part II Item 8 filed as part of this report:
- Consolidated Balance Sheets as of December 31, 1995 and 1996
- Consolidated Statements of Income for the years ended December 31,
1994, 1995 and 1996
- Consolidated Statements of Stockholders' Equity for the years
ended December 31, 1994, 1995 and 1996
- Consolidated Statements of Cash Flows for the years ended December
31, 1994, 1995 and 1996
- Notes to Consolidated Financial Statements
- Quarterly Financial Information (unaudited)
- Report of Independent Auditors
2. FINANCIAL STATEMENT SCHEDULE.
- Schedule II - Valuation and Qualifying Accounts
Schedules not listed above have been omitted because they are not
applicable, not required or the information required is shown in the
consolidated financial statements or the notes thereto.
3. LIST OF EXHIBITS.
Exhibit
Number Description of Exhibit
3.1* Form of Amended and Restated Certificate of
Incorporation of the Registrant.
3.2* Amended and Restated By-Laws of the Registrant.
4.1* Specimen Stock Certificate.
10.1* Amended and Restated 1991 Stock Incentive Plan of the
Registrant.
10.2* Amended and Restated 1994 Director Option Plan of the
Registrant.
10.3* 1995 Employee Stock Purchase Plan of the Registrant.
10.4* Sublease for 5 Forbes Road, Second Floor, Lexington,
MA, dated as of May 1, 1991 between the Registrant
and Unitrode Corporation.
10.5* Lease for 5 Forbes Road, First Floor, Lexington, MA,
dated as of June 22, 1993 between the Registrant and
the Trustees of Lexington Development Company Trust.
10.6* First Amendment to Lease for 5 Forbes Road,
Lexington, MA, dated as of December 20, 1994 between
the Registrant and the Trustees of Lexington
Development Company Trust.
10.7* Unit Purchase Agreement, dated May 22, 1992 between
the Registrant and Edward Botwinick.
16
<PAGE> 17
10.8* Series B Convertible Preferred Stock Agreement dated
as of August 10, 1992 and October 29, 1992 between
the Registrant and the purchasers named therein.
10.9* Series C Convertible Preferred Stock Agreement dated
as of March 28, 1994, May 16, 1994, and November 9,
1994 between the Registrant and the purchasers named
therein.
10.10* Noncompetition Agreement dated February 2, 1992
between the Registrant and Robert Castle.
10.11* Noncompetition Agreement dated March 28, 1991 between
the Registrant and Rubin Gruber.
10.12* Noncompetition Agreement dated March 28, 1991 between
the Registrant and Derek M. James.
10.13* Purchase and OEM License Agreement dated January 8,
1993 between the Registrant and Compression Labs,
Inc.
10.14* WorldWorx Personal Conferencing Service Multipoint
Control Unit Agreement dated February 15, 1995
between the Registrant and AT&T Corp.
10.15* License Agreement dated January 2, 1995 between the
Registrant and Datapoint Corporation.
10.16* Letter Agreement dated December 31, 1994 between the
Registrant and Fleet Bank of Massachusetts, N.A.
10.17** Lease for 63 Third Avenue, Burlington, MA dated as of
March 1, 1996 between the Registrant and the Trustees
of Building #27 Associates.
11.1 Computation of Per Share Earnings.
13.1 Financial Section of the 1996 Annual Report to
Shareholders, pages 17 through 32.
21.1* Subsidiaries of the Registrant.
23.1 Consent of Ernst & Young LLP.
(Note: The Company agrees to furnish to the
Securities and Exchange Commission upon request a
copy of any instrument with respect to long-term debt
of the Company or any of its subsidiaries which is
not filed herewith or listed herein since it relates
to outstanding debt in an amount not greater than 10%
of the total assets of the Company and its
subsidiaries on a consolidated basis.)
* Incorporated by reference from the Company's Registration Statement
on Form S-1.
** Included as part of the Company's Form 10-K filed with the
Securities and Exchange Commission for the year ended December 31,
1995.
(b) REPORTS ON FORM 8-K
The Company filed no reports on Form 8-K during the quarter ended
December 31, 1996.
17
<PAGE> 18
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
VIDEOSERVER, INC.
/s/ Robert L. Castle
-------------------------------------
Robert L. Castle
President and Chief Executive Officer
(Principal Executive Officer)
Date: March 28, 1997
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on its behalf of the registrant
and in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
- --------- ----- ----
<S> <C> <C>
/s/ Robert L. Castle President, Chief Executive Officer, March 28, 1997
- --------------------- (Principal Executive Officer)
Robert L. Castle and Director
/s/ Rubin Gruber Vice President of Business March 28, 1997
- --------------------- Development and Director
Rubin Gruber
/s/ Stephen J. Nill Vice President and March 28, 1997
- --------------------- Chief Financial Officer
Stephen J. Nill (Principal Financial
and Accounting Officer)
/s/ Paul J. Ferri Director March 28, 1997
- ---------------------
Paul J. Ferri
/s/ William E. Foster Director March 28, 1997
- ---------------------
William E. Foster
/s/ Steven C. Walske Director March 28, 1997
- ---------------------
Steven C. Walske
</TABLE>
18
<PAGE> 19
VIDEOSERVER, INC.
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
<TABLE>
<CAPTION>
Column A - Description Column B Column C - Additions Column D Column E
- ---------------------- -------- -------------------- --------- --------
Deductions -
Balance At Charged to Charged to Uncollectable Balance at
Beginning Of Costs and Other Accounts End of Period
Allowance for Doubtful Accounts Period Expenses Accounts Written Off
- ------------------------------------ -------------- --------------- --------------- --------------- ---------------
<S> <C> <C> <C> <C> <C>
Year Ended December 31, 1996 $650,313 $427,140 $- $- $1,077,453
Year Ended December 31, 1995 118,509 531,804 - - 650,313
Year Ended December 31, 1994 6,000 112,509 - - 118,509
</TABLE>
19
<PAGE> 1
EXHIBIT 11.1
VIDEOSERVER, INC.
COMPUTATION OF PER SHARE EARNINGS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
1994 1995 1996
---- ---- ----
<S> <C> <C> <C>
Net income $ 1,072,000 $ 4,687,000 $10,194,000
=========== =========== ===========
Primary net income per common share:
Weighted average common shares outstanding
during the period 9,502,316 11,285,940 12,497,360
Weighted average common equivalent shares
resulting from stock options 236,043 710,348 813,433
Dilutive effect of common and common
equivalent shares issued subsequent to
April 12, 1994 (1)
534,183 69,073
----------- ----------- -----------
10,272,542 12,065,361 13,310,793
=========== =========== ===========
Primary net income per share $ 0.10 $ 0.39 $ 0.77
=========== =========== ===========
Fully diluted net income per common share:
Weighted average common shares
outstanding during the period 9,502,316 11,285,940 12,497,360
Weighted average common equivalent shares
resulting from stock options 236,043 710,348 909,429
Dilutive effect of common and common
equivalent shares issued subsequent to
April 12, 1994 (1)
534,183 69,073
----------- ----------- -----------
10,272,542 12,065,361 13,406,789
=========== =========== ===========
Fully diluted net income per share $ 0.10 $ 0.39 $ 0.76
=========== =========== ===========
</TABLE>
(1) Pursuant to Securities and Exchange Commission Staff Accounting Bulletin
No. 83, certain common and common equivalent shares issued by the Company
during the twelve months immediately preceding the initial filing of the
registration statement relating to the Company's initial public offering
have been included in the calculation of weighted average shares, using
the treasury stock method and the initial public offering price, as if
these shares were outstanding for all periods prior to the initial public
offering.
<PAGE> 1
FINANCIAL SECTION
CONTENTS
Management's Discussion and Analysis of
Financial Condition and Results of Operations 18
Consolidated Balance Sheets ....................... 22
Consolidated Statements of Income ................. 23
Consolidated Statements of Stockholders' Equity ... 24
Consolidated Statements of Cash Flows ............. 25
Notes to Consolidated Financial Statements ........ 26
Report of Independent Auditors .................... 32
[BAR GRAPH]
[BAR GRAPH]
17
<PAGE> 2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
The following table sets forth the percentage change in certain financial data
compared to the previous year, and the financial data as a percentage of net
sales for the years indicated.
<TABLE>
<CAPTION>
Percent changes year to year Items as a percentage of net sales
- ----------------------------------------------------------------------------
1995/1994 1996/1995 Income and expense items 1994 1995 1996
- ----------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
81% 73% Net sales 100% 100% 100%
70% 60% Cost of sales 38% 35% 33%
- ----------------------------------------------------------------------------
88% 80% Gross profit 62% 65% 67%
Expenses:
60% 46% Research and development 21% 19% 16%
69% 68% Sales and marketing 20% 19% 18%
41% 32% General and administrative 14% 11% 8%
- ----------------------------------------------------------------------------
58% 52% Total expenses 55% 49% 42%
- ----------------------------------------------------------------------------
336% 167% Income from operations 7% 16% 25%
882% 38% Interest income, net 1% 5% 4%
397% 138% Income before income taxes 8% 21% 29%
- ----------------------------------------------------------------------------
1,005% 222% Provision for income taxes 1% 4% 8%
- ----------------------------------------------------------------------------
337% 117% Net income 7% 17% 21%
- ----------------------------------------------------------------------------
</TABLE>
[BAR GRAPH]
[BAR GRAPH]
OVERVIEW
The Company was founded in February 1991, and commenced shipments of its
Multimedia Conference Server (MCS) products in 1992. It has experienced
significant sales growth since that time. The Company has continued to develop
and enhance its product line, with regular introductions of new versions of its
software and hardware. The Company markets its products to OEM suppliers of
conferencing equipment, which resell the Company's products, and to public and
private telecommunications carriers, which generally offer services to end-users
based on the Company's products. More recently, the Company has begun to market
its products to computer and network equipment manufacturers as those companies
enter the conferencing industry. Unit shipments have grown due to growth in the
conferencing market, increased acceptance of the Company's MCS products, and
expansion of the Company's domestic and international OEM and carrier
relationships. The Company initially achieved profitability in the first quarter
of 1994 and has been profitable each quarter thereafter.
The Company completed an initial public offering of its Common Stock in June,
1995, in which 2,300,000 shares of its newly issued common stock were sold for
net proceeds to the Company of $35.4 million. The principal purposes of the
offering were to increase the Company's working capital and equity base, to
provide a public market for the Company's Common Stock, and to facilitate future
access by the Company to public equity markets.
RESULTS OF OPERATIONS -- YEARS ENDED
DECEMBER 31, 1994, 1995, AND 1996
NET SALES
Net sales increased 81% from $15.6 million in 1994 to $28.2 million in 1995, and
73% to $48.8 million in 1996. The growth in net sales was primarily due to an
increase in unit shipments of MCS products. This increase was driven by greater
market demand for the Company's products in U.S. and international markets, an
expanding number of OEM customers, and a greater number of public and private
telecommunications carriers who have become customers as they begin to offer
conferencing services to end-users. The introduction of new features, such as
Continuous Presence and data conferencing capability, both of which began
shipping in the first quarter of 1996, also contributed to the increase. Service
revenues, which include fees from maintenance contracts, software subscriptions,
and training were higher as well, primarily as a result of the growth in the
Company's installed base. Two customers accounted for 55% and 12% of net sales
in 1994, three customers accounted for 23%, 19%, and 18% of net sales in 1995,
and two customers accounted for 43% and 10% of net sales in 1996.
International sales, primarily in Europe, were approximately 29%, 25%, and 32%
of net sales in 1994, 1995, and 1996. The Company expects that international
sales, which are currently denominated in U.S. dollars, will continue to be a
significant portion of the Company's business.
18
<PAGE> 3
GROSS PROFIT
The Company's cost of sales consists of materials costs, manufacturing labor and
overhead, and customer support costs. Gross profit as a percentage of net sales
increased from 62% in 1994 to 65% in 1995, and to 67% in 1996. The increases in
1995 and 1996 were primarily due to lower component costs and economies in
manufacturing, a higher mix of product upgrades which carry a higher gross
profit, and stable selling prices through the majority of the product line.
The higher gross profit rates experienced in 1996 are not likely to continue, as
recently introduced and planned low end, lower margin products may become a
larger proportion of the sales mix. In addition, increased competition may
result in lower selling prices, and the proportion of sales to carriers, which
generally have been at higher gross profit rates than sales to OEMs, may be
uneven.
RESEARCH AND DEVELOPMENT
Research and development expenses consist principally of compensation costs for
engineers, depreciation expense, supplies, and testing. Research and development
expenses increased 60% from $3.3 million in 1994 to $5.3 million in 1995, and
increased 46% to $7.8 million in 1996, representing 21%, 19%, and 16% of net
sales in those years. The increases in spending were primarily due to increased
engineering staffing required to develop and enhance the Company's MCS product
line, including joint development projects with customers. Funding from
customers for these projects, which amounted to $340,000 in 1994, $1.0 million
in 1995, and $1.2 million in 1996, is treated as a reduction of research and
development expenses as contracted work is performed and defined milestones are
achieved by the Company. The percentage relationship of research and development
expenses to net sales may vary depending upon the level of development funding
from customers. All software development costs have been expensed as incurred
because costs eligible for capitalization have not been material. The Company
expects to continue to commit substantial resources to research and development
in the future, and to increase its development expenditures in absolute terms in
1997. In January 1997, the Company began to establish an international
development operation in the United Kingdom.
SALES AND MARKETING
Sales and marketing expenses consist principally of compensation costs
(including sales commissions and bonuses), travel expenses, trade shows, and
other marketing programs. Sales and marketing expenses increased 69% from $3.2
million in 1994 to $5.3 million in 1995, and increased 68% to $8.9 million in
1996, representing 20%, 19%, and 18% of net sales in those years. The increased
spending was primarily due to the addition of sales and marketing personnel,
both in the U.S. and internationally, to support an increasing number of OEM and
carrier customers, increased commissions on higher sales, and the opening of new
sales offices.
The Company expects continued increases in sales and marketing expenses as it
addresses broader markets and geographic territories for its products.
GENERAL AND ADMINISTRATIVE
General and administrative expenses consist principally of expenses for finance,
administration, and general management activities, including legal, accounting,
and other professional fees. General and administrative expenses increased 41%
from $2.2 million in 1994 to $3.0 million in 1995, and increased 32% to $4.0
million in 1996, representing 14%, 11%, and 8% of net sales in those years. The
increased spending was primarily due to the addition of finance and
administrative personnel, increased costs associated with being a public
company, and the costs of relocating to a larger primary facility in May 1996.
The Company expects continued increases in general and administrative expenses
in 1997, although it expects that these expenses should continue to decrease as
a percentage of net sales due to the more rapid growth in net sales. General and
administrative expenses in 1994 also included costs of $850,000 relating to a
patent infringement lawsuit, which was settled in 1994.
INTEREST INCOME, NET
Interest income, net, consists of interest on cash, cash equivalents, and
marketable securities offset by interest expense on equipment financing. The
increase from approximately $133,000 in 1994 to $1.3 million in 1995 and $1.8
million in 1996 was due to higher cash balances, resulting from the proceeds
received upon the closing of the Company's initial public offering in June, 1995
and cash generated from operations.
PROVISION FOR INCOME TAXES
The provision for income taxes was 9% in 1994, 20% in 1995, and 27% in 1996. The
effective tax rate in both 1994 and 1995 was less than the combined federal and
state statutory rate primarily as a result of the utilization of net operating
loss carryforwards. Net operating loss carryforwards for federal income tax
purposes were fully utilized during 1995. The effective tax rate in 1996 was
less than the combined federal and state statutory rate primarily as a result of
the elimination of valuation reserves related to deferred tax assets. These
reserves were recorded in 1994 and 1995, but were eliminated in 1996, as the
Company has now deemed it more likely than not that sufficient future taxable
income will be generated to realize the benefits of these deferred tax assets.
For 1997, the effective tax rate is expected to more closely approximate the
combined federal and state statutory rate.
OTHER FACTORS WHICH MAY AFFECT
FUTURE OPERATIONS
The Company's Annual Report includes discussions of its long term growth
outlook, including various forward-looking statements. The following risks and
uncertainties, among others, could affect the degree to which such expectations
are realized.
[BAR GRAPH]
[BAR GRAPH]
[BAR GRAPH]
19
<PAGE> 4
EVOLVING MARKETS
Sales of Multimedia Conference Server (MCS) products account for substantially
all of the Company's sales. The Company's success depends to a significant
extent on the acceptance, and the rate of acceptance, of MCS products in a
number of markets, all of which are in the early stages of development. These
markets include videoconferencing, desktop video, collaborative data-sharing,
and carrier-based conferencing services. A number of telecommunications carriers
have purchased the Company's products to offer conferencing services to
end-users. In many instances, there is inadequate experience to predict the
ultimate success of these service offerings, and therefore the degree to which
these customers may order additional products from the Company. There can be no
assurance that any of the markets for the Company's products will develop to the
extent, in the manner or at the rate anticipated by the Company. In addition,
future prices the Company is able to obtain for its products may decrease from
historical levels as a result of new product introductions by others, price
competition, technological change, or otherwise.
DEPENDENCE ON MAJOR CUSTOMERS
Consolidation among traditional videoconferencing equipment companies is
increasing. In January 1997, Compression Labs, Inc., who in 1996 represented 10%
of the Company's revenues, and Vtel Corporation announced an agreement to merge.
While the number of OEM and carrier customers of the Company continues to grow,
sales to a relatively small number of them have accounted for a significant
portion of the Company's net sales, and the Company believes that its dependence
on these customers, or a similarly few number of customers, will continue. This
concentration of customers may cause net sales and operating results to
fluctuate from quarter to quarter based on major customers' requirements and the
timing of their orders and shipments. The Company's agreements with its
customers generally do not include minimum purchase commitments or exclusivity
for purchases of a similar product. The Company's operating results could be
materially and adversely affected if any present or future major customer were
to choose to reduce its level of orders, were to change to another vendor for
purchases of a similar product, were to experience financial, operational or
other difficulties, or were to delay paying or fail to pay amounts due the
Company.
RAPID TECHNOLOGICAL CHANGE
The market for the Company's products is characterized by rapidly changing
technology, evolving industry standards, emerging network architectures, and
frequent new product introductions. To date, the Company's products have
primarily addressed video telecommunications over switched digital networks such
as ISDN, under the International Telecommunication Union's H.320 standard. Newly
promulgated industry standards, such as the H.323 standard for audio, video, and
data communications over local area networks and the Internet, are expected to
foster growth in conferencing over new types of networks in addition to ISDN.
The adoption rate of these new standards may adversely impact near-term growth
of the conferencing market as users evaluate network platforms. The Company has
invested, and for 1997 plans to continue to invest, in software development and
products related to certain of these new standards. Many other companies,
including PictureTel Corporation, currently the Company's largest customer, have
announced their intention to develop products related to these new standards
that could be competitive with the Company's future offerings. The Company's
success will depend, in part, upon its ability through continued investments to
maintain its technological leadership, to enhance and expand its existing
product offerings, and to select and develop in a timely manner new products
that achieve market acceptance.
COMPETITION
The market for networking and communications products is highly competitive.
Although to date the Company has experienced limited competition from products
with comparable capabilities, the Company expects competition to increase
significantly in the future. A number of companies have introduced or announced
their intention to introduce products that could be competitive with the
Company's products, and the rapidly evolving nature of the markets in which the
Company competes may attract other new entrants as they perceive opportunities.
The Company's current and potential competitors may have longer operating
histories and greater financial, technical, and sales and marketing resources.
PERIOD TO PERIOD FLUCTUATIONS
The Company's operating results are likely to vary significantly from quarter to
quarter as a result of several factors, including: the timing of new product
announcements and introductions by the Company, its major customers and its
competitors; market acceptance of new or enhanced versions of the Company's
products; changes in the product mix of sales; changes in the relative
proportions of sales among distribution channels or among customers within each
distribution channel;
20
<PAGE> 5
changes in manufacturing costs; price reductions for the Company's products; the
gain or loss of significant customers; increased research and development
expenses associated with new product introductions; seasonality; and general
economic conditions. New customers orders have generally been characterized by
lengthy sales cycles, making it difficult to predict the quarter in which sales
will occur. Carriers' deployment projects involve particularly long sales
cycles, and shipments for such projects are therefore often difficult to
forecast. In addition, such shipments are subject to delays in the timing of
such projects. The Company typically operates with a small backlog. As a result,
quarterly sales and operating results generally depend on the volume, timing of,
and ability to fulfill orders received within the quarter, which are difficult
to forecast. Also, the Company may recognize a substantial portion of its sales
in a given quarter from sales booked and shipped in the last weeks of that
quarter. All of the above factors can materially adversely affect the Company's
business and operating results for one quarter or a series of quarters, and are
difficult to forecast. The Company establishes its expenditure levels for
product development and other operating expenses based, in large part, on its
expected future sales. As a result, if sales fall below expectations, there
would likely be a material adverse effect on the Company's operating results and
net income because only a small portion of the Company's expenses vary with its
sales in the short term.
PROTECTION OF PROPRIETARY TECHNOLOGY
The Company's success depends, to a large extent, on its ability to protect its
proprietary technology. While the Company has applied for several patents, it
currently holds only one U.S. patent relating to its existing products and
relies primarily on a combination of contractual rights, trade secrets, and
copyrights to protect its intellectual property rights.
UNCERTAINTIES REGARDING PATENTS
In December 1994, the Company settled patent infringement litigation brought
against it by Datapoint Corporation (Datapoint) for a cash payment by the
Company in the amount of $500,000. However, patent infringement litigation still
exists between Datapoint and two of the Company's largest customers. In
addition, Datapoint has written inquiry letters to a significant number of
others in the videoconferencing market offering to sell them nonexclusive
licenses under certain Datapoint patents in the videoconferencing field (the
Datapoint Patents). While the validity or scope of the Datapoint Patents has not
been adjudicated by a court, Datapoint has, in effect, asserted that the
Datapoint Patents cover certain aspects of multipoint conferencing operations
involving terminals and multipoint control units, including MCSs. As a result of
the December 1994 settlement, the Company obtained a nonexclusive license for
its MCS under the Datapoint Patents, which license includes limited rights for
the products and services of the Company's customers. However, the conferencing
market in general, and the Company's future sales and operating results in
particular, could be adversely affected as a result of ongoing uncertainties
regarding the Datapoint Patents. Such uncertainty, and any related potential
impact of it, is likely to exist until the validity of the patents is
adjudicated.
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 1996, the Company has cash, cash equivalents, and marketable
securities of $54.7 million. The Company regularly invests excess funds in
short-term money market funds, government securities, and commercial paper. The
Company has no material long-term debt.
The Company generated cash from operations of $12.5 million in 1996, primarily
resulting from net income during the year.
The Company's primary investing activities to date have been the purchase of
computers and equipment for research and development, product support, sales,
marketing, and administration to support the Company's growth. In May 1996, the
Company relocated its principle operation to a larger facility in Burlington,
Massachusetts.
In June 1995, the Company completed an initial public offering in which
2,300,000 shares of its newly issued common stock were sold for net proceeds to
the Company of $35.4 million. Of the net proceeds, $3.6 million was used to
redeem all outstanding shares of Series A Preferred Stock.
At December 31, 1996, the Company has available a bank revolving credit facility
providing for borrowings up to $5.0 million. Borrowings are limited to a
percentage of eligible accounts receivable and are unsecured. The Company also
has a $2.0 million term credit facility for equipment purchases during 1997. The
Company's equipment is pledged as collateral under this facility. No borrowings
have been made under either facility. Under these credit facilities, the Company
is required to maintain certain financial ratios and minimum levels of net worth
and profitability, and is prohibited from paying cash dividends without the
bank's consent.
The Company believes that its existing cash, cash equivalents, and marketable
securities, together with cash generated from operations and borrowings
available under the Company's credit facilities, will be sufficient to meet the
Company's cash requirements for the foreseeable future.
[BAR GRAPH]
[BAR GRAPH]
21
<PAGE> 6
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
(In thousands, except for share-related data) December 31
- ----------------------------------------------------------------------------------------
1995 1996
- ----------------------------------------------------------------------------------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 31,679 $27,876
Marketable securities 13,489 26,808
Accounts receivable, net of allowance for doubtful accounts
of $650 and $1,077 in 1995 and 1996 4,231 7,252
Inventories 1,598 3,653
Deferred taxes 300 2,280
Other current assets 543 843
- ----------------------------------------------------------------------------------------
Total current assets 51,840 68,712
Equipment and improvements,
net of accumulated depreciation and amortization 1,921 4,180
Other assets, net of accumulated amortization of $156 and $253
in 1995 and 1996 141 204
- ----------------------------------------------------------------------------------------
Total assets $ 53,902 $73,096
- ----------------------------------------------------------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 1,040 $ 3,481
Accrued expenses 4,596 8,240
Deferred revenue 1,129 831
Current portion of long-term debt 675 506
- ----------------------------------------------------------------------------------------
Total current liabilities 7,440 13,058
Long-term debt, less current portion 673 167
Stockholders' equity:
Preferred stock, $.01 par value; 2,000,000 shares authorized,
none issued and outstanding
Common stock, $.01 par value; 40,000,000 shares authorized;
12,548,769 issued and 12,385,731 outstanding in 1995;
12,620,760 issued and outstanding in 1996 125 126
Capital in excess of par value 45,635 49,573
Retained earnings 31 10,225
Cumulative translation adjustment (53)
Treasury stock, 163,038 common shares in 1995 (2)
- ----------------------------------------------------------------------------------------
Total stockholders' equity 45,789 59,871
- ----------------------------------------------------------------------------------------
Total liabilities and stockholders' equity $ 53,902 $73,096
- ----------------------------------------------------------------------------------------
</TABLE>
See accompanying notes
22
<PAGE> 7
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
(In thousands, except for share-related data) Year ended December 31
- -----------------------------------------------------------------------------------
1994 1995 1996
- -----------------------------------------------------------------------------------
<S> <C> <C> <C>
Net sales $ 15,557 $ 28,197 $ 48,833
Cost of sales 5,874 9,978 15,955
- -----------------------------------------------------------------------------------
Gross profit 9,683 18,219 32,878
Operating expenses:
Research and development 3,324 5,303 7,767
Sales and marketing 3,158 5,326 8,945
General and administrative 2,156 3,038 4,004
- -----------------------------------------------------------------------------------
Total operating expenses 8,638 13,667 20,716
- -----------------------------------------------------------------------------------
Income from operations 1,045 4,552 12,162
Interest expense (71) (118) (93)
Interest income 204 1,424 1,895
- -----------------------------------------------------------------------------------
Income before income taxes 1,178 5,858 13,964
Provision for income taxes 106 1,171 3,770
- -----------------------------------------------------------------------------------
Net income $ 1,072 $ 4,687 $ 10,194
- -----------------------------------------------------------------------------------
Net income per share:
Primary $ 0.10 $ 0.39 $ 0.77
Fully diluted $ 0.10 $ 0.39 $ 0.76
- -----------------------------------------------------------------------------------
</TABLE>
See accompanying notes
23
<PAGE> 8
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(In thousands, except for share-related data)
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------------------------
Convertible Retained
Preferred Capital Earnings Cumulative
Stock Common Stock In Excess of (Accumulated Translation
Par Value Shares Par Value Par Value Deficit) Adjustment
- -------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Balances as of January 1, 1994 $ 1 5,949,575 $ 59 $5,625 $(5,513) $ 0
Sale of 41,920 shares of
Series C preferred stock 1 4,159
Purchase of treasury stock
Stock issued under
employee benefit plans 97,480 1 7
Declared dividend (215)
Net income 1,072
- -------------------------------------------------------------------------------------------------------------------------
Balances as of December 31, 1994 2 6,047,055 60 9,791 (4,656) 0
Sale of 196 shares of
Series C preferred stock 20
Purchase of treasury stock
Stock issued in initial public
offering, net of issuance
costs of $950 2,300,000 23 35,390
Conversion of 57,150 shares of
Series B and 42,116 shares of
Series C preferred stock (2) 4,164,944 42 (40)
Stock issued under
employee benefit plans 36,770 124
Tax benefit related to
employee stock plans 350
Net income 4,687
- -------------------------------------------------------------------------------------------------------------------------
Balances as of December 31, 1995 0 12,548,769 125 45,635 31 0
Stock issued under employee
benefit plans 71,991 1 1,788
Tax benefit related to
employee stock plans 2,150
Foreign currency translation
adjustment (53)
Net income 10,194
- -------------------------------------------------------------------------------------------------------------------------
Balances as of December 31, 1996 $ 0 12,620,760 $126 $49,573 $10,225 $(53)
- -------------------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
- --------------------------------------------------------------------
Treasury Total
Stock Stockholders'
Shares Cost Equity
- --------------------------------------------------------------------
<S> <C> <C> <C>
Balances as of January 1, 1994 235,500 $(2) $ 170
Sale of 41,920 shares of
Series C preferred stock 4,160
Purchase of treasury stock 1,800
Stock issued under
employee benefit plans 8
Declared dividend (215)
Net income 1,072
- --------------------------------------------------------------------
Balances as of December 31, 1994 237,300 (2) 5,195
Sale of 196 shares of
Series C preferred stock 20
Purchase of treasury stock 438
Stock issued in initial public
offering, net of issuance
costs of $950 35,413
Conversion of 57,150 shares of
Series B and 42,116 shares of
Series C preferred stock
Stock issued under
employee benefit plans (74,700) 124
Tax benefit related to
employee stock plans 350
Net income 4,687
- --------------------------------------------------------------------
Balances as of December 31, 1995 163,038 (2) 45,789
Stock issued under employee
benefit plans (163,038) 2 1,791
Tax benefit related to
employee stock plans 2,150
Foreign currency translation
adjustment (53)
Net income 10,194
- --------------------------------------------------------------------
Balances as of December 31, 1996 0 $ 0 $59,871
- --------------------------------------------------------------------
</TABLE>
See accompanying notes.
24
<PAGE> 9
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
(In thousands) Year ended December 31
- --------------------------------------------------------------------------------------------
1994 1995 1996
- --------------------------------------------------------------------------------------------
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net income $ 1,072 $ 4,687 $ 10,194
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 764 1,071 1,739
Provision for doubtful accounts 113 532 427
Deferred taxes (300) (1,980)
Tax benefit related to employee stock plans 350 2,150
Changes in operating assets and liabilities:
Accounts receivable (1,093) (2,378) (3,448)
Inventories (249) (498) (2,055)
Other current assets (135) (382) (300)
Accounts payable and accrued expenses 1,294 3,083 6,085
Deferred revenue 380 568 (298)
- --------------------------------------------------------------------------------------------
Net cash provided by operating activities 2,146 6,733 12,514
- --------------------------------------------------------------------------------------------
INVESTING ACTIVITIES
Net purchases of equipment and improvements (992) (1,583) (3,901)
Purchases of marketable securities (13,489) (21,438)
Proceeds from sale of marketable securities 8,119
Increase in other assets (232) (5) (160)
- --------------------------------------------------------------------------------------------
Net cash used in investing activities (1,224) (15,077) (17,380)
- --------------------------------------------------------------------------------------------
FINANCING ACTIVITIES
Proceeds from long-term debt 931 811
Repayment of long-term debt (312) (713) (675)
Net proceeds from issuance of preferred stock 4,160 20
Net proceeds from issuance of common stock 35,413
Net proceeds from issuance of stock under
employee benefit plans 8 124 1,791
Redemption of preferred stock (3,612)
Payment of preferred dividends (215)
- --------------------------------------------------------------------------------------------
Net cash provided by financing activities 4,787 31,828 1,116
- --------------------------------------------------------------------------------------------
Effect of exchange rate on cash and cash equivalents (53)
Increase (decrease) in cash and cash equivalents 5,709 23,484 (3,803)
Cash and cash equivalents at beginning of year 2,486 8,195 31,679
- --------------------------------------------------------------------------------------------
Cash and cash equivalents at end of year $ 8,195 $ 31,679 $ 27,876
- --------------------------------------------------------------------------------------------
Supplementary disclosure of cash flow information:
Interest paid $ 71 $ 118 $ 94
- --------------------------------------------------------------------------------------------
</TABLE>
See accompanying notes.
25
<PAGE> 10
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BUSINESS
VideoServer, Inc. (the Company) operates in one business segment, which is the
design, development, manufacture, marketing, sale, and service of networking
equipment and associated software used to create multimedia conferences that
connect multiple users over wide area networks and allow them to interact as a
group.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The consolidated financial statements include the accounts of the Company and
its wholly owned subsidiaries. All significant intercompany transactions and
balances have been eliminated. All assets and liabilities of foreign
subsidiaries are translated at the rate of exchange at year end, while sales
and expenses are translated at the average rates in effect during the year. The
net effect of these translation adjustments is shown in the accompanying
financial statements as a component of stockholders' equity.
SIGNIFICANT ESTIMATES AND ASSUMPTIONS
The preparation of the 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, if any, at the date of the
financial statements and the reported amounts of revenues and expenses during
the reporting period. Actual results could differ from these estimates.
REVENUE RECOGNITION
Revenue from product sales is recognized upon shipment, and the Company's
products are generally delivered without significant post-sale obligations to
the customer. If significant obligations exist, revenue recognition is deferred
until the obligations are satisfied. Estimated product warranty costs are
provided for at the time of sale. Revenue from maintenance agreements is
recognized ratably over the term of the agreements, and other service revenue is
recognized as the services are performed.
CASH EQUIVALENTS AND MARKETABLE SECURITIES
All of the Company's cash equivalents and marketable securities are classified
as available-for-sale, and accordingly are carried at fair market value based on
quoted market prices, which approximates their cost. Unrealized gains and
losses, which are reported as a component of stockholders' equity, were not
material in 1995 or 1996. Realized gains and losses are included in net interest
income. The Company considers all liquid investments with a maturity of three
months or less at the date of purchase to be cash equivalents. Cash equivalents
and marketable securities consist of highly rated U.S. and state government
securities, commercial paper, and short-term money market funds.
Marketable securities at December 31, 1996, by contractual maturity, included
approximately $24,167,000 due in one year or less, and $2,641,000 due between
one year and two years.
CONCENTRATIONS OF CREDIT RISK
Sales to two, three and two customers accounted for 67%, 60%, and 53% of total
net sales in 1994, 1995, and 1996. The accounts receivable from these customers
amounted to approximately $3,122,000 and $2,993,000 at December 31, 1995 and
1996. Export sales, primarily to Europe, were approximately $4,524,000 in 1994,
$7,129,000 in 1995, and $15,791,000 in 1996.
Financial instruments which potentially subject the Company to concentrations of
credit risk are cash equivalents, marketable securities, and accounts
receivable. All of the Company's cash equivalents and marketable securities are
maintained by major financial institutions. Concentration of credit risk with
respect to accounts receivable is limited to certain customers to whom the
Company makes substantial sales. To reduce risk, the Company routinely assesses
the financial strength of its customers. The Company has not incurred any
material write-offs related to its accounts receivable.
INVENTORIES
Inventories are stated at the lower of cost or market, with cost determined
using the first-in, first-out method.
EQUIPMENT AND IMPROVEMENTS
Equipment and improvements are stated at cost. Depreciation is computed using
the straight-line method over the following estimated useful lives:
Computer and
office equipment 3 to 5 years
Furniture and fixtures 5 years
Leasehold improvements Shorter of lease term or
estimated useful life
DEFERRED REVENUE
Deferred revenue represents amounts paid under maintenance agreements or for
product sales in advance of revenue recognition.
26
<PAGE> 11
RESEARCH AND DEVELOPMENT COSTS
Research and development costs are charged to expense as incurred. To date,
costs of internally developed software eligible for capitalization have been
immaterial and have been expensed as incurred.
The Company receives fees under product development contracts with certain
customers. Product development fees are recorded as a reduction of research and
development costs as work is performed pursuant to the related contracts and
defined milestones are achieved. Payments received in advance are recorded as
accrued liabilities. Fees recorded as a reduction of research and development
costs, including amounts received from a customer who is also a stockholder,
amounted to $340,000, $1,000,000 and $1,150,000 in 1994, 1995, and 1996.
NET INCOME PER SHARE
Net income per share is calculated based on the weighted average number of
common shares and common equivalent shares assumed outstanding during the
period. Pursuant to Securities and Exchange Commission Staff Accounting Bulletin
No. 83, certain common and common equivalent shares issued by the Company during
the twelve months immediately preceding the initial filing of the registration
statement relating to the Company's initial public offering have been included
in the calculation of weighted average shares, using the treasury stock method
and the initial public offering price, as if these shares were outstanding for
all periods prior to the initial public offering. Shares used in computing both
primary and fully diluted earnings per share were 10,272,542 in 1994 and
12,065,361 in 1995. Shares used in computing primary and fully diluted earnings
per share in 1996 were 13,310,793 and 13,406,789.
ACCOUNTING FOR IMPAIRMENT OF LONG-LIVED ASSETS
In accordance with Statement of Financial Accounting Standards No. 121,
"Accounting for Impairment of Long-Lived Assets," the Company records impairment
losses on long-lived assets used in operations when indicators of impairment are
present. On an on-going basis, management reviews the value and period of
amortization or depreciation of long-lived assets. During this review, the
Company reevaluates the significant assumptions used in determining the original
cost of long-lived assets. Although the assumptions may vary from transaction to
transaction, they generally include revenue growth, operating results, cash
flows, and other indicators of value. Management then determines whether there
has been a permanent impairment of the value of long-lived assets based upon
events or circumstances which have occurred since acquisition.
ACCOUNTING FOR STOCK-BASED COMPENSATION
In 1995, the Financial Accounting Standards Board issued Statement of Financial
Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS
123"). This statement establishes financial accounting and reporting standards
for stock-based compensation plans, including stock options for the purchase of
common stock provided for under the Amended and Restated 1991 Stock Incentive
Plan (the "1991 Plan"), options to acquire shares of common stock issued under
the Amended and Restated 1994 Non-Employee Director Stock Option Plan (the
"Director Plan"), and shares purchased under the 1995 Employee Stock Purchase
Plan. As permitted under SFAS 123, the Company has elected to follow Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" (APB
25) and related interpretations in accounting for its stock-based benefit plans,
as opposed to the alternative fair value accounting provided for under SFAS 123.
Because the exercise price of the options granted under the 1991 Plan and the
Director Plan to date equals the market price of the underlying stock on the
date of grant, no compensation expense is recognized under APB 25.
3. INVENTORIES
Inventories consist of:
<TABLE>
<CAPTION>
December 31
1995 1996
- -------------------------------------------------------------
(In thousands)
<S> <C> <C>
Raw materials and subassemblies $1,100 $2,881
Work in process 187 247
Finished goods 311 525
- -------------------------------------------------------------
$1,598 $3,653
</TABLE>
4. EQUIPMENT AND IMPROVEMENTS
Equipment and improvements consist of:
<TABLE>
<CAPTION>
December 31
1995 1996
- -------------------------------------------------------------
(In thousands)
<S> <C> <C>
Computer and office equipment $4,020 $7,323
Furniture and fixtures 110 227
Leasehold improvements 175 656
- -------------------------------------------------------------
4,305 8,206
Less accumulated depreciation 2,384 4,026
- -------------------------------------------------------------
$1,921 $4,180
</TABLE>
27
<PAGE> 12
5. ACCRUED EXPENSES
Accrued expenses consist of:
<TABLE>
<CAPTION>
December 31
1995 1996
- ---------------------------------------------------
(In thousands)
<S> <C> <C>
Employee compensation
and benefits $1,356 $2,378
Professional fees 207 505
Warranties and other
customer-related costs 1,385 2,940
Income and other taxes payable 1,024
Development fee advances 654 464
Other accrued expenses 994 929
- ---------------------------------------------------
$4,596 $8,240
</TABLE>
6. BANK ARRANGEMENTS
The Company has a revolving credit facility of $5,000,000 which bears interest
at the prime rate (8.25% at December 31, 1996) and is available until January
1998. Borrowings under the facility may not exceed 80% of qualified accounts
receivable, as defined. The Company also has a $2,000,000 equipment line of
credit, bearing interest at the prime rate plus .5%, available for equipment
purchases made in 1997. No borrowings have been made under either facility.
Long-term debt at December 31, 1996 consists of variable-rate equipment
installment notes, aggregating $673,000, bearing interest at the prime rate plus
.5% to .75%, payable in various monthly installments through October 1998.
Maturities of long-term debt are $506,000 in 1997, and $167,000 in 1998.
The Company's equipment is pledged as collateral against the equipment line of
credit. The revolving credit facility is unsecured; however, the Company is
required to maintain certain financial ratios and minimum levels of net worth
and profitability, and the Company's ability to pay dividends to stockholders is
restricted under the terms of both the revolving and equipment lines of credit.
7. INCOME TAXES
The provision for income taxes for 1994, 1995, and 1996 is as follows:
<TABLE>
<CAPTION>
Year ended December 31
1994 1995 1996
- --------------------------------------------------------
(In thousands)
<S> <C> <C> <C>
Current:
Federal $ 46 $1,188 $ 4,359
State 52 195 1,330
Foreign 8 88 61
- --------------------------------------------------------
106 1,471 5,750
Deferred:
Federal (300) (1,695)
State (285)
- --------------------------------------------------------
(300) (1,980)
- --------------------------------------------------------
Total tax provision $106 $1,171 $ 3,770
</TABLE>
Cash payments for income taxes totaled approximately $1,171,000 and $2,408,000
in 1995 and 1996.
The effective tax rate differs from the statutory federal income tax rate of 34%
in 1994 and 1995, and 35% in 1996, due to the following:
<TABLE>
<CAPTION>
Year ended December 31
1994 1995 1996
- -------------------------------------------------------------------
<S> <C> <C> <C>
Statutory income
tax rate 34.0% 34.0% 35.0%
State income taxes,
net of federal benefit 2.8 3.3 4.9
Research and
development tax credits -- (1.3) (1.4)
Tax benefit from Foreign
Sales Corporation -- (1.0) (1.9)
Tax-exempt interest income -- (1.4) (2.7)
Foreign and other 2.3 1.7 0.4
Utilization of net operating loss
carryforwards (30.1) (15.3) --
Change in valuation allowance -- -- (7.3)
- -------------------------------------------------------------------
Effective tax rate 9.0% 20.0% 27.0%
</TABLE>
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes.
Valuation allowances were recorded in 1994 and 1995 to offset certain net
deferred tax assets due to the uncertainty of realizing the benefit of these
assets, but were
28
<PAGE> 13
eliminated in 1996, as the Company has now deemed it more likely than not that
sufficient future taxable income will be generated to realize the benefit of
these deferred tax assets.
The following is a summary of the significant components of the Company's
deferred tax assets and liabilities:
<TABLE>
<CAPTION>
December 31
1995 1996
- ----------------------------------------------------------
(In thousands)
<S> <C> <C>
Deferred tax assets:
State tax loss carryforwards$ 28 --
Deferred revenue 164 $ 116
Research and development credits 100 --
Reserves not currently deductible 958 2,044
Depreciation and other 196 283
- ----------------------------------------------------------
Total deferred tax assets 1,446 2,443
Deferred tax liability:
Amortization of start-up costs (124) (163)
Valuation allowance
for deferred tax assets (1,022) --
- ----------------------------------------------------------
Net deferred tax $ 300 $ 2,280
</TABLE>
8. COMMITMENTS AND CONTINGENCIES
The Company rents its primary facility under an operating lease which expires in
February 1999. The Company also leases sales offices under leases that expire on
various dates through February 2000. Future minimum lease payments at December
31, 1996 under these noncancelable operating leases are approximately $695,000
in 1997, $650,000 in 1998, $235,000 in 1999, and $20,000 in 2000.
Rent expense was approximately $341,000, $430,000, and $595,000 in 1994, 1995,
and 1996.
In December 1994, the Company settled a patent infringement lawsuit brought
against it by Datapoint Corporation. As a result of the settlement, the Company
obtained a nonexclusive license for its MCS products, which includes limited
rights for the products and services of the Company's customers. The Company
recorded charges against 1994 operations of approximately $850,000 for the
agreed-upon costs of the settlement and indemnification of one of its customers.
Patent infringement litigation still exists between Datapoint and two of the
Company's largest customers. In addition, Datapoint has written inquiry letters
to a significant number of others in the videoconferencing market offering to
sell them nonexclusive licenses under certain Datapoint Patents in the
videoconferencing field (the Datapoint Patents). While the validity or scope of
the Datapoint Patents has not been adjudicated by a court, Datapoint has, in
effect, asserted that the Datapoint Patents cover certain aspects of multipoint
videoconferencing operations involving terminals and multipoint control units,
including the Company's MCSs. The Company believes that the videoconferencing
market in general, and the Company's future sales and operating results in
particular, could be adversely affected as a result of ongoing uncertainties
regarding the Datapoint Patents. Such uncertainty, and any impact of it, is
likely to remain until a definitive action is brought in court and the validity
of the patents is adjudicated.
9. STOCKHOLDERS' EQUITY
INITIAL PUBLIC OFFERING
In June 1995, the Company completed an initial public offering (IPO) of its
common stock in which 2,300,000 shares of common stock were issued at a price of
$17.00 per share, resulting in net proceeds, after deducting underwriting
discounts and expenses, of $35,413,000. In connection with the offering, all
outstanding shares of Series A Preferred Stock were redeemed and all outstanding
shares of Series B and Series C Convertible Preferred Stock were automatically
converted into 4,164,944 shares of common stock, in accordance with the
underlying agreements.
COMMON STOCK
In connection with the IPO, the Company's Board of Directors and stockholders
approved a one-for-two reverse stock split of its common stock effective May 1,
1995. All share and per share related data in the accompanying consolidated
financial statements reflect the reverse stock split. Effective upon the closing
of the IPO, the authorized capital stock of the Company increased from
15,000,000 to 40,000,000 shares.
PREFERRED STOCK
Effective upon the closing of the IPO, the Company's Board of Directors and
stockholders approved an amendment to its charter to authorize 2,000,000 shares
of undesignated preferred stock, $.01 par value per share. Each such series of
Preferred Stock shall have such rights, preferences, privileges, and
restrictions, including voting rights, dividend rights, conversion rights,
redemption privileges, and liquidation preferences as determined by the Board of
Directors.
29
<PAGE> 14
10. BENEFIT PLANS
1991 STOCK INCENTIVE PLAN
In 1995, the Company's Board of Directors and stockholders approved the Amended
and Restated 1991 Stock Incentive Plan (the "1991 Plan"). The 1991 Plan provides
for the sale or award of common stock, or the grant of incentive stock options
or nonqualified stock options for the purchase of common stock, of up to
3,469,286 shares to officers, employees, and consultants. The Plan is
administered by the Board of Directors. Options have been granted at a price not
less than the fair market value on the date of grant. The options generally
become exercisable over a five-year period and expire over a period not
exceeding ten years. Shares issuable will increase as of January 1, 1997, and
will increase each January 1 thereafter during the term of the plan, by an
additional number of shares of common stock equal to five percent of the total
number of shares of common stock issued and outstanding as of December 31 of the
preceding year.
In 1991 and 1992 employees purchased 706,575 shares of common stock at $.01 per
share pursuant to stock awards which are subject to the Company's right to
repurchase at cost in the event employment is terminated prior to specified
dates. As of December 31, 1996, 18,988 shares have been repurchased, and 29,838
shares remain subject to this repurchase right. There have been no stock awards
since 1992.
1994 NON-EMPLOYEE DIRECTOR STOCK OPTION PLAN
In 1995, the Company's Board of Directors and stockholders approved the Amended
and Restated 1994 Non-Employee Director Stock Option Plan (the "Director Plan").
The Director Plan provides that each non-employee director of the Company be
granted an option to acquire 15,000 shares of common stock on the date that
person becomes a director, but, in any event, not earlier than the effective
date of the Director Plan, and annually be granted, beginning with the January 1
falling at least twelve months after a Director's initial grant, an option to
purchase an additional 3,000 shares. Options are granted at a price equal to the
fair market value on the date of grant. The option becomes exercisable over a
four-year period, and the term of the option is ten years from the date of
grant. The Company has reserved 200,000 shares of common stock for issuance
under the Director Plan.
A summary of option activity under the 1991 Plan and the Director Plan is as
follows:
<TABLE>
<CAPTION>
Weighted
Average
Shares Exercise Price
- ----------------------------------------------------------------
<S> <C> <C>
Outstanding at January 1, 1995 597,330 $ 1.32
Granted 513,814 $12.79
Terminated (26,820) $ 2.71
Exercised (111,424) $ 1.13
---------
Outstanding at December 31, 1995 972,900 $ 7.36
Granted 791,425 $26.75
Terminated (97,775) $17.20
Exercised (191,011) $ 5.53
---------
Outstanding at December 31, 1996 1,475,539 $17.35
- ----------------------------------------------------------------
Exercisable at December 31, 1995 102,006
Exercisable at December 31, 1996 202,192
- ----------------------------------------------------------------
</TABLE>
Related information for options outstanding and exercisable as of December 31,
1996 under the 1991 Plan and Director Plan is as follows:
<TABLE>
<CAPTION>
Weighted
Average Weighted
Remaining Average
Contractual Exercise
Range of Exercise Prices Shares Life Price
- ----------------------------------------------------------------
<S> <C> <C> <C>
$ .01 - $ .10 30,064 1.7 $ .08
$ .20 - $ .60 131,859 2.4 .20
$ 2.00 - $ 6.00 202,224 3.7 3.58
$ 8.50 - $21.25 657,847 4.8 14.72
$23.25 - $43.25 453,545 5.6 33.44
---------
Total outstanding 1,475,539 4.6 $17.35
- ----------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
Weighted
Average
Exercise
Range of Exercise Prices Shares Price
- -----------------------------------------------
<S> <C> <C>
$ .01 - $ .10 1,963 $ .07
$ .20 - $ .60 66,666 .20
$ 2.00 - $ 6.00 63,303 3.61
$ 8.50 - $21.25 64,890 8.55
$23.25 - $43.25 5,370 30.83
-------
Total exercisable 202,192 $ 4.76
- -----------------------------------------------
</TABLE>
30
<PAGE> 15
1995 EMPLOYEE STOCK PURCHASE PLAN
In 1995, the Company's Board of Directors and stockholders approved the 1995
Employee Stock Purchase Plan (the "Stock Purchase Plan") under which eligible
employees may purchase common stock at a price per share equal to 85% of the
lower of the fair market value of the common stock at the beginning or end of
each offering period. Participation in the offering is limited to 10% of an
employee's compensation (not to exceed amounts allowed under Section 423 of the
Internal Revenue Code), may be terminated at any time by the employee and
automatically ends on termination of employment with the Company. A total of
300,000 shares of common stock have been reserved for issuance under this plan.
The first offering period commenced on the effective date of the Company's
initial public offering of shares of its common stock, and continued until
January 31, 1996. Subsequent six month offering periods commenced on February 1
and August 1, 1996, and are intended to commence on each February 1 and August 1
thereafter.
PRO FORMA INFORMATION FOR STOCK-BASED COMPENSATION
Pro forma information regarding net income and earnings per share, as if the
Company had used the fair value method of SFAS 123 to account for stock options
issued under its 1991 Plan and Director Plan, and shares purchased under the
Stock Purchase Plan, is presented below. The fair value of stock activity under
these plans was estimated at the date of grant using a Black-Scholes option
pricing model with the following assumptions as of the date of grant: risk-free
interest rates equal to the then available rate for zero-coupon U.S. government
issues with a remaining term equal to the expected life of the options; no
dividend yields; an average volatility factor of the expected market price of
the Company's common stock over the expected life of the option of .50; and a
weighted-average expected life of the option of 5.4 years. For purposes of pro
forma disclosures, the estimated weighted average fair value of options granted
during the year of $4.53 in 1995 and $9.51 in 1996 is amortized to expense over
the related vesting period. Pro forma information is as follows:
<TABLE>
<CAPTION>
1995 1996
- -----------------------------------------------------------
(In thousands, except for
earnings per share information)
<S> <C> <C>
Pro forma net income $4,147 $8,973
Pro forma net income per share:
Primary $ 0.35 $ 0.68
Fully diluted $ 0.35 $ 0.68
</TABLE>
SAVINGS PLAN
The Company sponsors a savings plan for its employees which has been qualified
under Section 401(k) of the Internal Revenue Code. Eligible employees are
permitted to contribute to the 401(k) plan through payroll deductions within
statutory and plan limits. Contributions from the Company are made at the
discretion of the Board of Directors. Through December 1996, the Company made no
contributions to the 401(k) plan. Beginning in 1997, the Board of Directors has
authorized the Company to commence with a matching of a portion of its
employees' contributions to the plan.
QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
<TABLE>
<CAPTION>
Quarter ended
March 31 June 30 September 30 December 31
- ---------------------------------------------------------------------------------
(In thousands, except per share amounts)
<S> <C> <C> <C> <C>
1995
- ---------------------------------------------------------------------------------
Net sales $5,512 $6,810 $7,311 $8,564
Gross profit 3,498 4,417 4,744 5,560
Operating income 620 1,134 1,230 1,568
Net income 594 985 1,300 1,808
Net income per share 0.05 0.08 0.10 0.14
Common stock price* - high -- $47.25 $49.50 $45.00
- low -- $25.00 $30.25 $21.50
</TABLE>
* Initial public offering May 25, 1995
<TABLE>
<CAPTION>
1996
<S> <C> <C> <C> <C>
- ---------------------------------------------------------------------------------
Net sales $9,510 $11,270 $13,046 $15,007
Gross profit 6,437 7,528 8,781 10,132
Operating income 2,202 2,630 3,335 3,995
Net income 1,905 2,243 2,762 3,284
Net income per share 0.15 0.17 0.21 0.24
Common stock price - high $32.00 $41.75 $39.25 $55.00
- low $17.25 $21.50 $24.50 $32.63
</TABLE>
31
<PAGE> 16
REPORT OF INDEPENDENT AUDITORS
THE BOARD OF DIRECTORS AND STOCKHOLDERS
VIDEOSERVER, INC.
We have audited the accompanying consolidated balance sheets of VideoServer,
Inc. as of December 31, 1995 and 1996, and the related consolidated statements
of income, stockholders' equity, and cash flows for each of the three years in
the period ended December 31, 1996. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these 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 the 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 consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of
VideoServer, Inc. at December 31, 1995 and 1996, and the consolidated results of
its operations and its cash flows for each of the three years in the period
ended December 31, 1996 in conformity with generally accepted accounting
principles.
ERNST & YOUNG LLP
Boston, Massachusetts
January 14, 1997
32
<PAGE> 1
Exhibit 23.1
CONSENT OF INDEPENDENT AUDITORS
We consent to the incorporation by reference in this Annual Report (Form 10-K)
of VideoServer,Inc. of our report dated January 14, 1997, included in the 1996
Annual Report to Shareholders of VideoServer, Inc.
Our audits also included the financial statement schedule of VideoServer, Inc.
listed in Item 14(a). This schedule is the responsibility of the Company's
management. Our responsibility is to express an opinion based on our audits.
In our opinion, the financial statement schedule referred to above, when
considered in relation to the basic financial statements taken as a whole,
presents fairly in all material respects the information set forth therein.
We also consent to the incorporation by reference in the Registration Statement
(Form S-8 No. 33-96192) of VideoServer, Inc. of our report dated January 14,
1997, with respect to the consolidated financial statements incorporated herein
by reference, and our report included in the preceding paragraph with respect
to the financial statement schedule included in this Annual Report (Form 10-K)
of VideoServer, Inc.
ERNST & YOUNG LLP
Boston, Massachusetts
March 25, 1997
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<CURRENCY> US DOLLARS
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> DEC-31-1996
<EXCHANGE-RATE> 1
<CASH> 27,876
<SECURITIES> 26,808
<RECEIVABLES> 8,329
<ALLOWANCES> (1,077)
<INVENTORY> 3,653
<CURRENT-ASSETS> 68,712
<PP&E> 4,180
<DEPRECIATION> 0
<TOTAL-ASSETS> 73,096
<CURRENT-LIABILITIES> 13,058
<BONDS> 167
0
0
<COMMON> 126
<OTHER-SE> 59,745
<TOTAL-LIABILITY-AND-EQUITY> 73,096
<SALES> 48,833
<TOTAL-REVENUES> 48,833
<CGS> 15,955
<TOTAL-COSTS> 15,955
<OTHER-EXPENSES> 20,716
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> (93)
<INCOME-PRETAX> 13,964
<INCOME-TAX> 3,770
<INCOME-CONTINUING> 10,194
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 10,194
<EPS-PRIMARY> 0.77
<EPS-DILUTED> 0.76
<FN>
ADDITIONAL CURRENT ASSET DEFERRED TAXES 2,280
ADDITIONAL CURRENT ASSET OTHER 843
OTHER ASSETS, NET 204
INTEREST INCOME 1,895
</FN>
</TABLE>
