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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, 1997
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)
(781) 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 6, 1998 was $181,722,930 (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 6, 1998 was 13,183,189.
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 13,
1998 are incorporated by reference herein.
2. Portions of the 1997 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.
1997 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
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PAGE
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PART I
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Item 1. Business .......................................................................................................... 3
Item 2. Description of Property ........................................................................................... 15
Item 3. Legal Proceedings.................................................................................................. 15
Item 4. Submission of Matters to a Vote of Security Holders................................................................ 15
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters ............................................. 16
Item 6. Selected Financial Data ........................................................................................... 16
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations ............................. 16
Item 8. Financial Statements and Supplementary Data ....................................................................... 16
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure .............................. 16
PART III
Item 10. Directors and Executive Officers of the Registrant ................................................................ 17
Item 11. Executive Compensation ............................................................................................ 17
Item 12. Security Ownership of Certain Beneficial Owners and Management .................................................... 17
Item 13. Certain Relationships and Related Transactions .................................................................... 17
PART IV
Item 14. Exhibits, Financial Statements Schedules and Reports on Form 8-K .................................................. 18
Signatures.................................................................................................................. 20
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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 1997 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
network servers for multimedia conferencing that enable people in multiple
locations to communicate together using any combination of voice, video, and
data information. The Company's Multimedia Conference Server products (MCSs)
provide multipoint conferencing, gateway services, 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 strategy is to expand its leadership position in the
conferencing market by developing and supplying networking products that enable
multimedia collaboration, whether through end-user networks or carrier-provided
conferencing services.
The Company sells its MCS products worldwide through leading suppliers and
integrators of videoconferencing and networking equipment, and directly to major
providers of conferencing services, including long-distance and regional
telephone carriers, and private service providers. The Company believes that it
was the largest supplier in annual shipments of multimedia conference servers in
1995, 1996, and 1997.
In April, 1997, the Company acquired the network access card business unit
of Promptus Communications, Inc. (Promptus). Network access cards are an
important component of conferencing systems, and Promptus has been a market
leader and 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
compatible. 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 $6,000. In
addition, increasing competition between network carriers, and increasing demand
for applications such as Internet access, have led 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
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plug into personal computers. Companies shipping H.320 compliant desktop
conferencing products include Intel, PictureTel, Sony, 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 below $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 1997 Intel
incorporated this capability into its Pentium II processor.
In May 1996, another important expansion of conferencing standards was
realized with the introduction of the H.323 standard governing real-time
collaboration over IP (Internet Protocol) networks, including local area
networks (LAN's), corporate 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 and
Microsoft have now introduced desktop conferencing products conforming to these
standards.
Each of these endpoints, whether room systems or desktop systems, require
server resources to conduct a multipoint conference. And, with the extension of
conferencing to multiple network platforms, new devices are needed in the
network to provide translations between these networks. A larger installed base
of endpoints and expanding number of network types are expected to lead to more
multipoint conferencing and an increased need for network services, 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. Microsoft has bundled a standards-based
realtime voice, video, and data conferencing package, NetMeeting(TM), into its
Windows operating system, providing an embedded collaborative capability to
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 enable 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
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conferencing capability allowing users to connect their terminals to multimedia
conference servers located in the carriers' central offices.
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. Servers traditionally
provided connectivity largely to T-1, ISDN, private digital networks, and analog
voice networks, but connectivity requirements are increasing with the emergence
of endpoints connected to IP (Internet Protocol) and ATM (Asynchronous Transfer
Mode) networks. 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 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.
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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 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.
SERIES 2000 MCS
The Series 2000 MCS product line of servers designed for switched digital
circuit networks include 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 $20,000 to more than $200,000. Each Series 2000 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 Series 2000 MCS.
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MODEL CAPACITY TARGET MARKET/APPLICATION
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Velocity 8 users Entry level Audio/Video/Data (A/V/D) multipoint for customer premises
equipment (CPE) networks; designed for on-demand multipoint for workgroups
2007 8 users Mid-range CPE for distributed network environments
2020 48 users Large CPE/central office network with extensive multimedia applications
CO 48 users High availability central office server
</TABLE>
Each of these systems may be interconnected to provide support for larger
conferences.
The VideoServer Series 2000 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
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Voice Activated Switching......... Dynamic switching of video presentation based on current
speaker
Audio Add-on...................... Conferencing for audio-only conference participants
Operator Attended Conferencing.... Operator interface at conference initiation and assistance
during the conference
NETWORK SERVICES AND MANAGEMENT
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Outbound Dialing.................. Automatic 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................. Integrated ISDN switching functionality
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The Series 2000 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. Additionally, the MCS
supports network connections such as V.35 and RS449, to support both private and
secure networks.
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.
NETWORK ACCESS CARDS
In April 1997, the Company acquired the network access card (NAC) business unit
of Promptus Communications, Inc. NACs are an integral component of a
videoconferencing solution, providing the technology by which conferencing
terminals, or endpoints, and servers connect to either public or private ISDN
networks. NAC products are PC compatible boards that provide a standardized
physical interface to the host known as the Multi-Vendor Integration Protocol
(MVIP) and are controlled through a published Application Program Interface
(API).
In addition to providing network access, NAC products provide additional value
added facilities oriented specifically for the videoconference industry. These
facilities are designed to improve network reliability for conference terminals
and to allow access to higher transmission speeds than are available through a
single ISDN line. The ability to connect to multiple ISDN lines for a
videoconference call, referred to as inverse multiplexing, improves the picture
and sound quality experienced during a call. The key elements of the NAC product
line are:
- - Single or Triple BRI ISDN NAC
- - Single or Dual T1 and E1 PRI ISDN NAC (24 and 30 Channel)
- - Digital Data Interface Card (Dual V.35 and RS366 data and control
interfaces)
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All NAC products are compatible with a range of common PC operating systems and
are supported by a full Software Developers Toolkit (SDK).
FUTURE PRODUCTS
The Company expects to begin shipping its first products in the Encounter
family of IP-based network servers and gateways in the first quarter of 1998.
The following table lists the principal products in the Encounter family, and
the typical target market and application in which each is used.
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MODEL CAPACITY TARGET MARKET/APPLICATION
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NetServer 48 users Network server that enables multipoint, multimedia conferencing for H.323
endpoints
NetGate 16 users LAN/WAN gateway that enables point-to-point conferences between ISDN and LAN
based endpoints
Gatekeeper n/a Network management software used to control access and bandwidth utilization
by H.323 endpoints, gateways and MCSs
</TABLE>
The Encounter MCS brings to IP networks many of the same multipoint and
conference management capabilities and features of the original Series 2000
MCS. The Encounter NetGate enables users connected to ISDN networks to
conference with users on IP networks. The Gatekeeper is a network management
application that allows network administrators to manage and control multimedia
conferencing on TCP/IP networks.
MARKETS AND CUSTOMERS
VideoServer traditionally has marketed its products primarily through
videoconferencing equipment Original Equipment Manufacturers (OEMs), which
generally remarket the Company's products in combination with other products to
resellers or directly to end-users, and to service providers, including public
and private telephone carriers, which generally offer conferencing services
based on the Company's products. In 1997, in an effort to broaden its
distribution channels, expand the number of people selling the Company's
products, and decrease the Company's dependence on any single large company or
channel, the Company began to establish distribution relationships directly with
resellers of conferencing, communications, and networking products. These
resellers, including value added resellers (VAR's), dealers and systems
integrators, typically sell the Company's products with other conferencing or
communications products to companies of all sizes.
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 VTEL Corporation, PictureTel Corporation, Tandberg, First
Virtual Corporation, VCON, Zydacron, and the leading Japanese manufacturers,
including Sony Corporation, Fujitsu Business Communications Systems, Inc. and
Panasonic Corporation. In 1997, PictureTel, currently the Company's largest OEM
customer, took steps to introduce competing products of its own manufacture. In
addition, there were significant consolidations and reorganizations during the
year among the Company's other OEM customers.
Telecommunication service providers have sought 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
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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. and to international Post Telephone and Telegraph
companies (PTTs) in Europe and Asia, such as British Telecom, Deutsche Telekom,
France Telecom, the Chinese MPT, and NTT.
As conferencing moves to desktop computing and to traditional business
networks, computer systems companies, network equipment companies, and PBX
companies, whose products form the data and telecommunications backbone of the
enterprise, are beginning to incorporate conferencing technologies into their
product lines. 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 1997, Cisco Systems incorporated portions of the Company's H.323
software into Cisco's operating system software, and the companies have begun
joint marketing to large corporate accounts who are evaluating the requirements
to provision their networks for the deployment of multimedia conferencing.
The Company's agreements with its customers generally do not include minimum
purchase requirements and are non-exclusive. 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,
and in 1997 PictureTel and VTEL (who merged with CLI in 1997) accounted for 34%
and 16% of net sales. Sales to international customers accounted for 25% of the
Company's net sales in the year ended December 31, 1995, and 32% of the
Company's net sales for the years ended December 31, 1996 and 1997.
VideoServer conducts its sales and marketing activities from its principal
offices in Burlington, Massachusetts, as well as from seven other North American
sales locations, its European headquarters in the United Kingdom, and an office
recently opened in Australia.
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 types 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 also investing to
further develop the network access technologies acquired from Promptus
Communications in April 1997. Development is focused on the introduction of more
cost effective modules for ISDN connectivity, , and . The Company extends and
accelerates its efforts through development relationships with its customers.
The Company periodically 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.
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At December 31, 1997, VideoServer's research and development staff consisted
of 100 employees, including 88 software engineers and 12 hardware engineers. The
Company's net research and development expenditures were $5.3 million, $7.8
million and $12.9 in 1995, 1996 and 1997, representing 19%, 16% and 24% of net
sales in those years. Development funding from customers of $1,000,000 and
$1,150,000 and $464,000 was recorded as a reduction of research and development
costs in 1995, 1996 and 1997. All software development costs have been expensed
as incurred because costs eligible for capitalization have not been material to
date.
In 1997, the Company established an international development operation in
the United Kingdom, and added network access development capability through the
Promptus acquisition.
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, software updates and upgrades, and spare parts programs 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 MCS 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.
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
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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 highly competitive and is
subject to rapid technological change. Currently, the Company's principal
competitor is Lucent Technologies. In addition, PictureTel Corporation,
currently the Company's largest customer, has announced its intention to
introduce competitive products of its own manufacture, and in 1997 acquired
MultiLink, Inc., a developer and supplier of multipoint control units and a
competitor of the Company. The impact of the acquisition of MultiLink on the
Company's relationship with PictureTel, and on the Company's future sales and
operating results, is unclear, but it is likely that sales of the Company's MCS
products to PictureTel, which decreased significantly in 1997 from 1996, will
continue to decline.
Many other companies have introduced or announced their intention to
introduce products which could be competitive with the Company's existing
products and those under development, including Teleos (a division of Madge
Networks), Accord, Databeam, Radvision, and White Pine. Companies competing with
the Company's network access card product line include Aculab and NetAccess (a
division of Brooktrout, Inc.). It is anticipated that other companies will
perceive opportunities to compete with the Company, and that competition will
increase significantly in the future.
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, technical, and
sales and marketing 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
The Company relies primarily on a combination of contractual rights, trade
secrets and copyright laws to establish and protect its intellectual property
rights. The Company holds one U.S. Patent and has several patent applications
pending. 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
11
<PAGE> 12
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.
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 patent infringement litigation brought against it by
Datapoint Corporation (Datapoint) for a cash payment by the Company in the
amount 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, or attempted to bring legal action against, a significant number of others
in the videoconferencing market, including some customers of the Company. In
these actions, Datapoint has offered to sell them nonexclusive licenses, or has
attempted to compel them to pay them damages and ongoing royalties, 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 MCS's.
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 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 at least until the validity of the patents is adjudicated.
EMPLOYEES
At December 31, 1997, the Company employed a total of 253 persons, including
100 in research and development, 87 in sales, marketing and customer support, 34
in manufacturing, and 32 in finance and administration. Twenty-five 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.
The Company does not have employment contracts with its key personnel. The
Company has recently experienced turnover, particularly in several senior sales
positions, and is currently seeking to hire additional skilled sales and
marketing personnel and development engineers.
EXECUTIVE OFFICERS OF THE REGISTRANT
The executive officers of the Company are:
<TABLE>
<CAPTION>
NAME. AGE POSITION
----- --- --------
<S> <C> <C>
Robert L. Castle 48 President, Chief Executive Officer and Director
Khoa D. Nguyen 44 Executive Vice President, Chief Operating Officer,
and Director
Dane A. Donaldson 50 Vice President of Customer Service and Support
Arnold C. Englander 46 Vice President of Marketing
Martin M. Falaro 42 Vice President of Business Development
Walter A. Jones 50 Vice President of Engineering
Paul Moeller 49 Vice President of Sales -- Americas
Richard J. Moulds 34 Vice President, Network Access Products
Stephen J. Nill 46 Vice President of Finance and Chief Financial Officer, Treasurer,
and Secretary
Edward C. Wade 61 Vice President of Manufacturing
</TABLE>
12
<PAGE> 13
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.
Khoa D. Nguyen has served as Executive Vice President and Chief Operating
Officer of the Company since September 1997, and as a Director since December
1997. Prior to joining the Company, Mr. Nguyen was employed at PictureTel
Corporation, a videoconferencing company, where he served as Vice President of
Engineering from January 1993 to February 1994, and as Chief Technology Officer
and General Manager of the Group Systems and Networking Products divisions from
February 1994 to August 1996. From August 1991 to December 1992, he was Vice
President of Engineering at VTEL Corporation, a videoconferencing company, and
previously held various engineering management positions with International
Business Machines, a computer manufacturer.
Dane A. Donaldson has served as Vice President of Customer Service since
December 1997. Prior to joining the Company, Mr. Donaldson was employed from
January 1993 to December 1997 at PictureTel Corporation, a videoconferencing
company, where he held various positions including Vice President of Worldwide
Customer Maintenance. From December 1987 to January 1993, Mr. Donaldson held
various service management positions at Motorola Codex, a networking equipment
company. Prior to that he was employed with Philips Electronic Instruments, a
manufacturer of scientific equipment, and Prime Computer, a computer company.
Arnold C. Englander has served as Vice President of Marketing since June
1997. Prior to joining VideoServer, he served as Product Management Director for
various enhanced consumer services at Lucent Technologies, a telecommunications
equipment company, from September 1996 until June 1997. Prior to the date when
Lucent Technologies was formed upon their divestiture from AT&T in September
1996, Mr. Englander was employed with AT&T Microelectronics, a division of AT&T,
from March 1990 to the time of the divestiture. Before joining AT&T,
Mr. Englander was employed at Wang Laboratories, a computer company, and Itran
Corporation, a start-up company in the field of robotic visioning systems.
Martin M. Falaro has served as the Vice President of Business Development
since November 1997. Prior to joining the company, Mr. Falaro was Chief
Executive Officer of VDOnet Corporation, a start-up company in the internet
software industry, from January 1997 to November 1997. Mr. Falaro previously
held various senior management positions at PictureTel Corporation, a
videoconferencing company, from February 1992 to January 1997, most recently as
Vice President of Corporate Business Development. Mr. Falaro was also the
founding executive of PictureTel's Desktop Video business unit. Prior to
PictureTel, Mr. Falaro held several senior sales management positions at Lotus
Development Corporation, a software supplier.
13
<PAGE> 14
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.
Paul Moeller has served as Vice President of Sales since October 1996. He
was previously employed at Wang Laboratories, a computer company, as Vice
President of Marketing from August 1994 to October 1996. Previously, he was Vice
President and General Manager at Network Imaging Systems Corporation, a software
company, from March 1992 to August 1994, and prior to that held various sales
management positions at FileNet Corporation, a supplier of document imaging
equipment, from October 1984 to March 1992.
Richard J. Moulds has served as Vice President of Network Access Products
for the Company since April 1997. From August 1996 to April 1997 he served as
Director of Business Development. Prior to joining the Company, he was
employed with GPT Limited, a manufacturer of telecommunications products
including videoconferencing equipment, as Marketing Manager for the Visual
Communications division from June 1992 to July 1996, and before that as a
Product Marketing Manager and Senior Design Engineer.
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 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.
Edward C. Wade has served as Vice President of Operations since October
1997. He served at PictureTel Corporation, a video conferencing company, as
Director of Manufacturing for the Group & Network Systems Divisions from March
1991 until October 1997. From July 1988 until March 1991, he served as Vice
President of Materials Management for Symbol Technologies, a supplier of hand
held terminals and bar code scanning devices. Previously, Mr. Wade held various
manufacturing and materials management positions for Polaroid Corporation, a
manufacturer of commercial and industrial instant photographic and digital
imaging devices.
Officers are elected on an annual basis to serve at the discretion of the
Board of Directors.
14
<PAGE> 15
ITEM 2. DESCRIPTION OF PROPERTY
The Company's corporate office and principal research, development, and
manufacturing facility is 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. The Company also has
manufacturing and development facilities in a 12,000 square foot facility
located in Middletown, Rhode Island and in Marlboro, Massachusetts, both of
which are leased on a short-term basis.
In 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 1997, the Company entered
into a lease for a 3,100 square foot facility in Roswell, 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; Herndon, Virginia; Huntington, New York; and
Dallas, Texas. In 1998, the Company secured sales office space in Sydney,
Australia.
The Company believes its existing 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, 1997.
15
<PAGE> 16
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 1997 Annual
Report to Shareholders, and is incorporated herein by reference.(1)
As of March 6, 1998, the Company had approximately 130 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 1997 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 1997 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 1997 Annual Report to Shareholders on pages 26 through 36, 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 1997 Annual Report to Shareholders is not to be deemed
filed as part of this report except for those parts thereof specifically
incorporated by reference.
16
<PAGE> 17
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 13, 1998. 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 13, 1998. 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 13, 1998. 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 13, 1998. Such information is incorporated
herein by reference.
17
<PAGE> 18
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, 1996 and 1997
- Consolidated Statements of Operations for the years ended
December 31, 1995, 1996 and 1997
- Consolidated Statements of Stockholders' Equity for the years
ended December 31, 1995, 1996 and 1997
- Consolidated Statements of Cash Flows for the years ended
December 31, 1995, 1996 and 1997
- 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.
<TABLE>
<CAPTION>
Exhibit
Number Description of Exhibit
------ ----------------------
<S> <C>
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.
</TABLE>
18
<PAGE> 19
<TABLE>
<S> <C>
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.
10.18*** Asset Purchase Agreement by and between VideoServer, Inc. and subsidiaries, and Promptus
Communications, Inc., dated March 25, 1997.
13.1 Financial Section of the 1997 Annual Report to Shareholders, pages 26 through 36.
21.1 Subsidiaries of the Registrant.
23.1 Consent of Ernst & Young LLP.
27.1 Financial Data Schedule
27.1996 1996 Financial Data Schedule (Restated)
</TABLE>
(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.
** Incorporated by reference from the Company's Form 10-K
filed with the Securities and Exchange Commission for the year
ended December 31, 1995.
*** Incorporated by reference from the Company's Form 8-K filed
with the Securities and Exchange Commission May 13, 1997.
(b) REPORTS ON FORM 8-K
The Company filed no reports on Form 8-K during the quarter ended
December 31, 1997.
19
<PAGE> 20
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 27, 1998
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 27, 1998
- -------------------------------------- (Principal Executive Officer),
Robert L. Castle and Director
/s/ Khoa D. Nguyen Executive Vice President and March 27, 1998
- -------------------------------------- Chief Operating Officer, and Director
Khoa D. Nguyen
/s/ Stephen J. Nill Vice President and March 27, 1998
- -------------------------------------- Chief Financial Officer
Stephen J. Nill (Principal Financial
and Accounting Officer)
/s/ Paul J. Ferri Director March 27, 1998
- --------------------------------------
Paul J. Ferri
/s/ William E. Foster Director March 27, 1998
- --------------------------------------
William E. Foster
/s/ Steven C. Walske Director March 27, 1998
- --------------------------------------
Steven C. Walske
</TABLE>
20
<PAGE> 21
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 Uncollectible Balance at
Beginning Of Costs and Other Accounts End of
Allowance for Doubtful Accounts Period Expenses Accounts Written Off Period
- ------------------------------------ -------------- --------------- --------------- --------------- ---------------
<S> <C> <C> <C> <C> <C>
Year Ended December 31, 1997 $1,077,453 $ 58,939 $201,919 $- $1,338,311
Year Ended December 31, 1996 650,313 427,140 - - 1,077,453
Year Ended December 31, 1995 118,509 531,804 - - 650,313
</TABLE>
21
<PAGE> 1
FINANCIAL SECTION
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
CONTENTS
<S> <C>
Management's Discussion and Analysis of Financial Condition and Results of Operations ..................22
Consolidated Balance Sheets ............................................................................26
Consolidated Statements of Operations ..................................................................27
Consolidated Statements of Stockholders' Equity ........................................................28
Consolidated Statements of Cash Flows ..................................................................29
Notes to Consolidated Financial Statements .............................................................30
Report of Independent Auditors .........................................................................36
</TABLE>
21
<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
- -----------------------------------------------------------------------------------------------
1996/95 1997/96 Income and Expense Items 1995 1996 1997
- -----------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
73% 10% Net sales 100% 100% 100%
60% 22% Cost of sales 35% 33% 36%
- -----------------------------------------------------------------------------------------------
80% 4% Gross profit 65% 67% 64%
Operating expenses:
46% 66% Research and development 19% 16% 24%
68% 37% Sales and marketing 19% 18% 23%
32% 12% General and administrative 11% 8% 8%
* Purchased research and development 27%
- -----------------------------------------------------------------------------------------------
52% 110% Total operating expenses 49% 42% 82%
- -----------------------------------------------------------------------------------------------
167% (178%) Income (loss) from operations 16% 25% (18%)
38% (5%) Interest income, net 5% 4% 3%
138% (156%) Income (loss) before income taxes 21% 29% (15%)
- -----------------------------------------------------------------------------------------------
222% (181%) Provision (benefit) for income taxes 4% 8% (6%)
- -----------------------------------------------------------------------------------------------
117% (146%) Net income (loss) 17% 21% (9%)
- -----------------------------------------------------------------------------------------------
</TABLE>
* Percentage not meaningful.
OVERVIEW
VideoServer was founded in 1991 as a provider of networking equipment and
software that enables people in multiple locations to communicate together
electronically using any combination of voice, video and data information. The
Company shipped its first Multimedia Conference Server (MCS) products in 1992.
Since that time, the Company has continued to enhance and broaden its line of
MCSs, with regular introductions of new versions of its software and hardware.
Net sales have grown primarily due to growth in the videoconferencing market,
increased acceptance of the Company's MCS products, and expansion of the
Company's domestic and international distribution channels.
The Company's MCS products provide multipoint conferencing and gateway
solutions, conference control, network management, and bandwidth management. The
Company sells its products worldwide through leading suppliers and integrators
of videoconferencing and networking equipment, and directly to major providers
of conferencing services including long-distance and regional telephone carriers
and private service bureaus.
In April, 1997, the Company acquired the network access card business unit of
Promptus Communications, Inc. ("Promptus"). Network access cards are a critical
component of conferencing systems, and Promptus had been a market leader and a
major supplier to VideoServer of these products.
RESULTS OF OPERATIONS -- YEARS ENDED DECEMBER 31, 1995, 1996, AND 1997
NET SALES
Net sales increased 73% from $28.2 million in 1995 to $48.8 million in 1996, and
10% to $53.5 million in 1997. The growth in net sales in 1996 was primarily due
to an increase in unit shipments of MCS products, 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 began to offer conferencing services to
end-users. The introduction of several significant new features in 1996, such as
Continuous Presence and data conferencing capability, also contributed to the
increase.
22
<PAGE> 3
The net sales growth in 1997 was primarily the result of sales of network access
card products, included in the Company's revenue as a result of the acquisition
of the Promptus business unit. Sales of MCS products were somewhat lower than in
1996, primarily attributed to softness in the market for videoconferencing
products generally, lower sales to conferencing service providers, and to lower
sales to PictureTel Corporation, currently, the Company's largest customer.
PictureTel has announced its intention to introduce competing products of its
own manufacture.
A significant factor influencing the demand for VideoServer's products is the
rate of deployment and use of conferencing endpoints, such as room-based
conferencing systems and desktop conferencing terminals, sold by conferencing
OEMs and computer equipment and software manufacturers. Growth in the sales of
endpoints slowed in 1997, as end users began to evaluate new technologies such
as Internet Protocol (IP) based endpoints and lower priced ISDN-based endpoints
currently being introduced. This softness in endpoint demand is expected to
continue in the near term, and may affect growth rates for the Company's sales
and operating results.
Three customers accounted for 23%, 19% and 18% of net sales in 1995, two
customers accounted for 43% and 10% of net sales in 1996, and two customers
accounted for 34% and 16% of net sales in 1997.
International sales, primarily in Europe, were approximately 25% of net sales in
1995, and 32% of net sales in 1996 and 1997. 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.
<PAGE> 4
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 65% in 1995 to 67% in 1996, and declined to 64% in 1997. The
increase in 1996 was primarily due to lower component costs and economies in
manufacturing, a higher mix of product upgrades which provide a higher gross
profit, and stable selling prices through the majority of the product line. The
decrease in 1997 was primarily due to a greater proportion of lower margin
products in the sales mix than in 1996, including network access cards, and
somewhat higher fixed costs as a percentage of net sales in 1997.
Gross profit rates may be lower in future periods, as low-end, lower margin
products are expected to become a larger proportion of the sales mix, and
increased competition may result in lower selling prices.
RESEARCH AND DEVELOPMENT
Research and development expenses consist principally of compensation costs for
engineers, depreciation expense, supplies and testing. Research and development
expenses increased 46% from $5.3 million in 1995 to $7.8 million in 1996, and
increased 66% to $12.9 million in 1997, representing 19%, 16% and 24% of net
sales in those years. The increases in spending were primarily due to increased
engineering staffing. The Company is continuing to develop and enhance its
current MCS product line, which incorporates the H.320 industry standard for
conferencing over switched digital services, and to extend its conferencing
technologies to more traditional network platforms, in concert with newly
released industry standards. These network platforms include local area networks
(LANs), corporate intranets, and the Internet, governed by the new H.323
industry standards for voice, video and data collaboration, as well as ATM and
frame relay. Spending increases in 1997 were also the result of the addition of
development efforts associated with the network access card business acquired
from Promptus. In connection with the acquisition, the Company recorded a $14
million charge for purchased research and development, which had not reached
technological feasibility and had no alternative future use. The Company
estimates that between $1 million and $2 million will be expensed over the next
two years in connection with the completion of purchased research and
development projects.
Research and development spending includes joint development projects with
customers. Funding from customers for these projects, which amounted to $1.0
million in 1995, $1.2 million in 1996, and $464,000 in 1997, is treated as a
reduction of research and development expenses as contracted work is performed
and defined milestones are achieved by the Company. 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.
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 68% from $5.3
million in 1995 to $8.9 million in 1996, and increased 37% to $12.2 million in
1997, representing 19%, 18% and 23% of net sales in those years. The Company is
expanding its sales and marketing personnel and program resources to broaden the
distribution model for its products, including the addition of selected value
added resellers and dealers, and to support its anticipated future growth. The
increased spending was primarily due to the addition of sales and marketing
personnel in the U.S. and Europe, the expansion of field sales offices, and an
increase in marketing programs. The Company expects continued increases in sales
and marketing expenses as it addresses broader markets and geographic
territories for its products, including the Asia/Pacific region.
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 32%
from $3.0 million in 1995 to $4.0 million in 1996, and increased 12% to $4.5
million in 1997, representing 11%, 8% and 8% of net sales in those years. The
increased spending was primarily due to the addition of finance and
administrative personnel, including those to support the acquired Promptus
business unit. The Company expects continued increases in general and
administrative expenses in 1998, although the rate of increase of these expenses
over time is expected to be less than that of net sales.
INTEREST INCOME, NET
Interest income, net, consists of interest on cash, cash equivalents, and
marketable securities offset by interest expense on equipment financing and
other short-term loans. The increase from $1.3 million in 1995 to $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. The decrease in 1997 to $1.7 million was due to a
higher proportion of the Company's cash, cash equivalents, and marketable
securities being invested in tax-exempt U.S. and state government securities,
and to the decrease in cash available for investment resulting from the
Company's acquisition of the network access card business from Promptus.
PROVISION (BENEFIT) FOR INCOME TAXES
The provision (benefit) for income taxes was 20% in 1995, 27% in 1996, and (39%)
in 1997. The effective tax rates in 1995 and 1996 were less than the combined
federal and state statutory rate. In 1995, this was the result of the
utilization of net operating loss carryforwards, which were fully utilized for
federal income tax purposes in that year. In 1996, this was primarily the result
of the recognition of deferred tax assets previously subject to valuation
allowances. These valuation allowances were eliminated in 1996, when the Company
deemed it more likely than not that sufficient future taxable income would be
generated to realize the full benefit of the deferred tax assets. Income taxes
for 1997 include tax benefits related to the charge to operations of $14.0
million for purchased in-process research and development resulting from the
acquisition of the network access card business unit from Promptus. Excluding
this charge and related benefit, the effective rate for 1997 was 32%, which is
less than the combined federal and state statutory rate primarily as a result of
interest earned on tax-exempt U.S. and state government securities, and research
and development tax credits. In 1998, the effective tax rate is expected to more
closely approximate the combined federal and state statutory rate.
23
<PAGE> 5
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.
DEPENDENCE ON MAJOR CUSTOMERS
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 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 combine their operations with another company who had an
established relationship with 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.
In particular, PictureTel Corporation, currently the Company's largest customer,
has announced its intention to introduce competitive products of its own
manufacture. Furthermore, in 1997, PictureTel acquired MultiLink, Inc., a
developer and supplier of multipoint control units and a competitor of the
Company. The impact of the acquisition of MultiLink on the Company's
relationship with PictureTel, and on the Company's future sales and operating
results, is unclear, but it is likely that sales of the Company's MCS products
to PictureTel, which decreased significantly in 1997 from 1996, may continue to
decline.
GROWTH IN DEMAND FOR VIDEOCONFERENCING PRODUCTS
The rate of growth of the videoconferencing market slowed in 1997 compared to
the previous year, and the growth rate was lower than many in the industry
expected. The factors contributing to the slower growth included delays in
buying while users anticipate the introduction of new technologies and products.
The impact of these factors on customer demand is difficult to predict in terms
of both timing and scope. There can be no assurance that the current rate of
market growth can be sustained, or whether it will accelerate in the future.
EVOLVING MARKETS
Sales of Multimedia Conference Server (MCS) products account for most 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 market
segments, many of which are in the early stages of development. These markets
include traditional room-based teleconferencing, 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. 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. In fact,
sales of the Company's products to telecommunications carriers were lower in
1997 than in the previous year. 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 other factors.
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 telecommunications over switched digital networks such as
ISDN, governed by 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 networks in addition to ISDN. The
adoption rate of technologies and products incorporating these new standards may
adversely impact near-term growth of the conferencing market as users evaluate
the newer alternatives. The Company has invested, and for 1998 plans to continue
to invest, in software development and products related to certain of these new
standards. Many other companies 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.
Some of the Company's current and potential competitors have longer operating
histories and greater financial, technical, and sales and marketing resources.
ACQUISITIONS
In 1997, the Company acquired Promptus' network access card business. The
Company may continue to make acquisitions of, or significant investments in,
businesses that offer complementary products, services, and technologies as part
of its overall business strategy. Any such acquisitions or investments will
likely be accompanied by the risks commonly encountered in acquisitions of
businesses, including, among others, the difficulty of assimilating the
operations and personnel of the acquired businesses, and the potential
disruption of the Company's ongoing business.
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; 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 customer orders have
generally been characterized by lengthy sale cycles, making it difficult to
predict the quarter in which sales will occur.
24
<PAGE> 6
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, in the Company's most recent quarters, it has recognized 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.
RETENTION OF KEY EMPLOYEES
The Company's success depends, to a significant degree, upon the continuing
contributions of its key management, sales, marketing, and research and
development personnel, many of whom would be difficult to replace. The Company
does not have employment contracts with its key personnel. The Company believes
that its future success will depend in large part upon its ability to attract
and retain such employees. The Company has recently experienced turnover in
several senior sales positions, and is currently seeking to hire additional
skilled sales and marketing personnel and development engineers. Competition for
such personnel is intense, and there can be no assurance that the Company will
be successful in attracting and retaining such personnel.
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, or attempted to bring legal
action against, a significant number of others in the videoconferencing market,
including some customers of the Company. In these actions, Datapoint has offered
to sell them nonexclusive licenses, or has attempted to compel them to pay
damages and ongoing royalties, 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 MCS's. 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 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 at least until the validity of the patents is
adjudicated.
IMPACT OF YEAR 2000
The Company has made an assessment of the nature and extent of the impact of the
year 2000 on the products it has sold or expects to sell, and on its business
operations including its operating systems and equipment. The Company has
determined that no modifications are required to its products to allow them to
function as intended with respect to dates in the year 2000 and beyond. However,
the Company will need to either upgrade or replace its internal enterprise
resource planning system in order to effectively operate its business. Costs to
upgrade the system are not expected to be material; costs to replace the system
would approximate $1.5 million, most of which would be attributable to the
purchase of new software and capitalized. The Company expects this upgrade or
replacement to begin in 1998. If the upgrade or replacement is not made, or not
completed before the end of 1999, the year 2000 could have a material impact on
the operations of the Company.
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 1997, the Company has cash, cash equivalents, and marketable
securities of $46.5 million. The Company regularly invests excess funds in
short-term money market funds, government securities, and commercial paper. The
Company has no long-term debt.
The Company generated cash from operations of $9.7 million in 1997, primarily
resulting from net income before a one-time charge of $14.0 million related to
purchased research and development. The purchased research and development was
associated with the April, 1997 acquisition of the network access card business
unit of Promptus Communications.
Investing activities in 1997 included the acquisition of the network access card
business unit from Promptus for total consideration of approximately $18.8
million, including $14.5 million of cash and 223,881 shares of the Company's
common stock. Other significant investing activities to date have included 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 principal operation to a larger facility
in Burlington, Massachusetts.
At December 31, 1997, the Company has available a bank revolving credit facility
providing for borrowings up to $7.5 million. Borrowings are limited to a
percentage of eligible accounts receivable and are unsecured. Under this credit
facility, 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. No borrowings have been made under
this facility.
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 facility, will be sufficient to meet the
Company's cash requirements for the foreseeable future.
NEW ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 130, "Reporting Comprehensive Income ("SFAS
130") and Statement of Financial Accounting Standards No. 131, "Disclosures
About Segments of an Enterprise and Related Information" ("SFAS 131"). The
Company will adopt both SFAS 130 and SFAS 131 in fiscal 1998, but does not
expect that the adoption of either of these standards will have a material
effect on the financial condition or results of operations of the Company.
25
<PAGE> 7
CONSOLIDATED BALANCE SHEETS
- --------------------------------------------------------------------------------
(In thousands, except for share-related data)
<TABLE>
<CAPTION>
December 31
- --------------------------------------------------------------------------------------
1996 1997
- --------------------------------------------------------------------------------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $27,876 $24,866
Marketable securities 26,808 21,665
Accounts receivable, net of allowance for doubtful
accounts of $1,077 and $1,338 in 1996 and 1997 7,252 7,244
Inventories 3,653 3,882
Deferred income taxes 2,280 2,619
Other current assets 843 941
- --------------------------------------------------------------------------------------
Total current assets 68,712 61,217
Equipment and improvements, net of accumulated depreciation 4,180 5,142
Deferred income taxes 4,341
Other assets, net of accumulated amortization of $253
and $984 in 1996 and 1997 204 2,199
- --------------------------------------------------------------------------------------
Total assets $73,096 $72,899
======================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 3,481 $ 2,458
Accrued expenses 8,240 9,219
Deferred revenue 831 964
Current portion of long-term debt 506 167
- --------------------------------------------------------------------------------------
Total current liabilities 13,058 12,808
Long-term debt, less current portion 167
Commitments and contingencies - Note 9
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; 12,620,760 issued and outstanding in 1996;
13,122,843 issued and outstanding in 1997 126 131
Capital in excess of par value 49,573 54,584
Retained earnings 10,225 5,493
Cumulative translation adjustment (53) (117)
- --------------------------------------------------------------------------------------
Total stockholders' equity 59,871 60,091
- --------------------------------------------------------------------------------------
Total liabilities and stockholders' equity $73,096 $72,899
======================================================================================
See accompanying notes.
</TABLE>
26
<PAGE> 8
CONSOLIDATED STATEMENTS OF OPERATIONS
- ----------------------------------------------------------------------------
(In thousands, except for per-share related data)
<TABLE>
<CAPTION>
Year ended December 31
- ----------------------------------------------------------------------------
1995 1996 1997
- ----------------------------------------------------------------------------
<S> <C> <C> <C>
Net sales $28,197 $48,833 $53,495
Cost of sales 9,978 15,955 19,396
- ----------------------------------------------------------------------------
Gross profit 18,219 32,878 34,099
Operating expenses:
Research and development 5,303 7,767 12,886
Sales and marketing 5,326 8,945 12,217
General and administrative 3,038 4,004 4,490
Purchased research and development 14,000
- ----------------------------------------------------------------------------
Total operating expenses 13,667 20,716 43,593
- ----------------------------------------------------------------------------
Income (loss) from operations 4,552 12,162 (9,494)
Interest expense (118) (93) (165)
Interest income 1,424 1,895 1,877
- ----------------------------------------------------------------------------
Income (loss) before income taxes 5,858 13,964 (7,782)
Provision (benefit) for income taxes 1,171 3,770 (3,050)
- ----------------------------------------------------------------------------
Net income (loss) $ 4,687 $10,194 $(4,732)
============================================================================
Net income (loss) per share:
Basic $ 0.41 $ 0.82 $ (0.37)
Diluted $ 0.39 $ 0.77 $ (0.37)
- ----------------------------------------------------------------------------
See accompanying notes.
</TABLE>
27
<PAGE> 9
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
- --------------------------------------------------------------------------------
(in thousands, except for share-related data)
<TABLE>
<CAPTION>
Convertible Retained
Preferred Capital Earnings Cumulative Treasury Total
Stock Common Stock In Excess of (Accumulated Translation Stock Stockholders'
Par Value Shares Par Value Par Value Deficit) Adjustment Shares Cost Equity
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Balances as of
January 1, 1995 $ 2 6,047,055 $ 60 $ 9,791 $(4,656) $ 0 237,300 $(2) $ 5,195
Sale of 196 shares
of Series C
preferred stock 20 20
Purchase of
treasury stock 438
Stock issued in
initial public
offering, net of
issuance costs of
$950 2,300,000 23 $35,390 35,413
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 (74,700) 124
Tax benefit related
to employee stock
plans 350 350
Net income 4,687 4,687
- ------------------------------------------------------------------------------------------------------------------------------------
Balances as of
December 31, 1995 0 12,548,769 125 45,635 31 0 163,038 (2) 45,789
Stock issued under
employee benefit
plans 71,991 1 1,788 (163,038) 2 1,791
Tax benefit related
to employee Stock
plans 2,150 2,150
Foreign currency
translation
adjustment (53) (53)
Net income 10,194 10,194
- ------------------------------------------------------------------------------------------------------------------------------------
Balances as of
December 31, 1996 0 12,620,760 126 49,573 10,225 (53) 0 0 59,871
Stock issued under
employee benefit
plans 278,202 3 1,418 1,421
Tax benefit related
to employee Stock
plans 180 180
Stock issuance related
to acquisition of
business, net of
issuance costs
of $27 223,881 2 3,413 3,415
Foreign currency
translation
adjustment (64) (64)
Net loss (4,732) (4,732)
- ------------------------------------------------------------------------------------------------------------------------------------
Balances as of
December 31, 1997 $ 0 13,122,843 $131 $54,584 $ 5,493 $(117) 0 $ 0 $60,091
====================================================================================================================================
See accompanying notes.
</TABLE>
28
<PAGE> 10
CONSOLIDATED STATEMENTS OF CASH FLOWS
- --------------------------------------------------------------------------------
(In thousands)
<TABLE>
<CAPTION>
Year ended December 31
- -------------------------------------------------------------------------------------------------
1995 1996 1997
- -------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net income (loss) $ 4,687 $ 10,194 ($ 4,732)
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Purchased research and development 14,000
Depreciation and amortization 1,071 1,739 3,076
Provision for doubtful accounts 532 427 261
Deferred taxes (300) (1,980) (4,680)
Tax benefit related to stock plan activities 350 2,150 180
Changes in operating assets and liabilities:
Accounts receivable (2,378) (3,448) 1,859
Inventories (498) (2,055) 979
Other current assets (382) (300) (50)
Accounts payable and accrued expenses 3,083 6,085 (1,338)
Deferred revenue 568 (298) 133
- -------------------------------------------------------------------------------------------------
Net cash provided by operating activities 6,733 12,514 9,688
- -------------------------------------------------------------------------------------------------
INVESTING ACTIVITIES
Net purchases of equipment and improvements (1,583) (3,901) (2,954)
Purchases of marketable securities (13,489) (21,438) (2,634)
Proceeds from sale of marketable securities 8,119 7,777
Acquisition of business, net of cash acquired (15,416)
Increase in other assets (5) (160) (271)
- -------------------------------------------------------------------------------------------------
Net cash used in investing activities (15,077) (17,380) (13,498)
- -------------------------------------------------------------------------------------------------
FINANCING ACTIVITIES
Proceeds from long-term debt 811
Repayment of long-term debt (713) (675) (557)
Net proceeds from issuance of preferred stock 20
Net proceeds from issuance of common stock 35,413
Net proceeds from issuance of stock under
employee benefit plans 124 1,791 1,421
Redemption of preferred stock (3,612)
Payment of preferred dividends (215)
- -------------------------------------------------------------------------------------------------
Net cash provided by financing activities 31,828 1,116 864
- -------------------------------------------------------------------------------------------------
Effect of exchange rate on cash and cash equivalents (53) (64)
Increase (decrease) in cash and cash equivalents 23,484 (3,803) (3,010)
Cash and cash equivalents at beginning of year 8,195 31,679 27,876
- -------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of year $ 31,679 $ 27,876 $ 24,866
=================================================================================================
Supplementary disclosure of cash flow information:
Interest paid $ 118 $ 94 $ 165
=================================================================================================
See accompanying notes.
</TABLE>
29
<PAGE> 11
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
1. BUSINESS
VideoServer, Inc. and its subsidiaries (the Company) operate 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, 1997, by contractual maturity, included
$18,004,000 due in one year or less, and $3,661,000 due between one year and two
years.
CONCENTRATIONS OF CREDIT RISK
Sales to three, two, and two customers accounted for 60%, 53% and 50% of total
net sales in 1995, 1996 and 1997. The accounts receivable from these customers
amounted to approximately $2,993,000 and $3,060,000 at December 31, 1996 and
1997. Export sales, primarily to Europe, were $7,129,000 in 1995, $15,791,000 in
1996, and $17,376,000 in 1997.
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:
<TABLE>
<S> <C>
Computer and office equipment 3 to 5 years
Furniture and fixtures 5 years
Leasehold improvements Shorter of lease term
or estimated useful life
</TABLE>
DEFERRED REVENUE
Deferred revenue represents amounts paid under maintenance agreements or for
product sales in advance of revenue recognition.
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 $1,000,000, $1,150,000 and $464,000 in 1995, 1996 and 1997.
30
<PAGE> 12
NET INCOME (LOSS) PER SHARE
In February 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 128 "Earnings per Share" ("SFAS 128"). SFAS
128 replaced the calculation of primary and fully diluted earnings per share
with basic and diluted earnings per share. Unlike primary earnings per share,
basic earnings per share excludes any dilutive effects of stock options. Diluted
earnings per share is very similar to the previously reported fully diluted
earnings per share. All net income (loss) per share amounts have been presented,
and where appropriate restated, in accordance with SFAS 128. Additionally, the
calculation of net income per share in 1995 has been restated to reflect
Securities and Exchange Commission Staff Accounting Bulletin No. 98 regarding
earnings per share, issued in February 1998.
Shares used in computing basic and diluted net income (loss) per share are as
follows:
<TABLE>
<CAPTION>
1995 1996 1997
- ------------------------------------------------------------
<S> <C> <C> <C>
Basic 11,355,000 12,486,000 12,867,000
Diluted 12,065,000 13,311,000 12,867,000
</TABLE>
The effect of dilutive stock options on the total shares used to compute diluted
net income per share was 710,000 and 825,000 in 1995 and 1996.
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. To date, there
have been no impairment losses recorded.
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 (the "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, and because of the
nature of the Stock Purchase Plan, no compensation expense is recognized under
APB 25.
NEW ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS
130") and Statement of Financial Accounting Standards No. 131, "Disclosures
About Segments of An Enterprise and Related Information" ("SFAS 131"). SFAS 130
establishes standards for reporting and displaying comprehensive income and its
components as part of a complete set of financial statements. Comprehensive
income is a measure of all changes in stockholders' equity that result from
recognized transactions and other economic events of a period, other than
transactions with owners in their capacity as owners. SFAS 131 requires the use
of the "management approach" in disclosing segment information, based largely on
how senior management generally analyzes at the business operations. The Company
will adopt both SFAS 130 and SFAS 131in fiscal 1998, but does not expect that
the adoption of either of these standards will have a material effect on the
financial condition or results of operations of the Company.
3. BUSINESS COMBINATION
On April 28, 1997, the Company purchased the network access card ("NAC")
business unit of Promptus Communications, Inc. ("Promptus"), through a
wholly-owned subsidiary of the Company. The assets acquired included all
tangible and intangible assets of Promptus' NAC business unit, including fixed
assets, inventories, trade receivables, products, and technology. Liabilities
assumed included all third-party trade liabilities and other accrued obligations
pertaining to the acquired NAC assets. The total purchase price of approximately
$18.8 million included $14.5 million of cash consideration and 223,881 shares of
the Company's common stock. The acquisition was accounted for under the purchase
method of accounting.
The purchase price was allocated to the tangible and intangible assets acquired
based upon their estimated fair market values. The intangible assets acquired
were valued using risk adjusted cash flow models under which estimated future
cash flows were discounted taking into account risks related to existing and
future target markets and to the completion of the products expected to be
ultimately marketed by the Company, and assessments of the life expectancy of
the underlying technology. The analysis resulted in an allocation of $2.0
million to purchased software which had reached technological feasibility,
principally represented by the technology comprising the NAC products being sold
by Promptus at the acquisition date. This amount was capitalized and is being
amortized over a five year period. In addition, $14.0 million was allocated to
purchased research and development which had not reached technological
feasibility and had no alternative future use. This amount was charged to
operations at the acquisition date.
31
<PAGE> 13
Operating results of the NAC business unit have been included in the financial
statements from the acquisition date. The following pro forma information
presents the results of operations for the years ended December 31, 1996 and
1997, as if the NAC business unit of Promptus had been acquired as of January 1,
1996 and 1997, including the charge to operations of $14.0 million related to
purchased in-process research and development resulting from the acquisition, as
if expensed on the date acquired.
<TABLE>
<CAPTION>
Years ended December 31
1996 1997
- -----------------------------------------------------------------------
(In thousands, except for per-share related data)
<S> <C> <C>
Total revenues $58,469 $57,122
Net income (loss) $ 1,257 $(4,692)
Net income (loss) per share:
Basic $ 0.10 $( 0.36)
Diluted $ 0.09 $( 0.36)
</TABLE>
The unaudited pro forma results do not purport to be indicative of the results
which actually would have been obtained had the acquisition been effected on the
dates indicated, or of results which may be achieved in the future.
4. INVENTORIES
Inventories consist of:
<TABLE>
<CAPTION>
December 31
1996 1997
- ----------------------------------------------------------------------
(In thousands)
<S> <C> <C>
Raw materials and subassemblies $2,881 $2,673
Work in process 247 761
Finished goods 525 448
- ----------------------------------------------------------------------
$3,653 $3,882
</TABLE>
5. EQUIPMENT AND IMPROVEMENTS
Equipment and improvements consist of:
<TABLE>
<CAPTION>
December 31
1996 1997
- ----------------------------------------------------------------------
(In thousands)
<S> <C> <C>
Computer and office equipment $7,323 $11,041
Furniture and fixtures 227 383
Leasehold improvements 656 895
- ----------------------------------------------------------------------
8,206 12,319
Less accumulated depreciation 4,026 7,177
- ----------------------------------------------------------------------
$4,180 $ 5,142
</TABLE>
6. ACCRUED EXPENSES
Accrued expenses consist of:
<TABLE>
<CAPTION>
December 31
1996 1997
- ----------------------------------------------------------------------
(In thousands)
<S> <C> <C>
Employee compensation and benefits $2,378 $2,975
Professional fees 505 599
Warranties and other customer-related costs 2,940 3,966
Income and other taxes payable 1,024 1,119
Development fee advances 464
Other accrued expenses 929 560
- ----------------------------------------------------------------------
$8,240 $9,219
</TABLE>
7. BANK ARRANGEMENTS
The Company has a revolving credit facility of $7,500,000 which bears interest
at the prime rate (8.50% at December 31, 1997) and is available until January
1999. Borrowings under the facility may not exceed 80% of qualified accounts
receivable, as defined. There have been borrowings under this facility. 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 the loan agreement.
Current portion of long-term debt at December 31, 1997 consists of a
variable-rate equipment installment note, aggregating $167,000, bearing interest
at the prime rate plus .5%, payable in monthly installments through October
1998.
8. INCOME TAXES
The provision (benefit) for income taxes is as follows:
<TABLE>
<CAPTION>
Year ended December 31
1995 1996 1997
- ------------------------------------------------------
(In thousands)
<S> <C> <C> <C>
Current:
Federal $1,188 $4,359 $ 1,104
State 195 1,330 403
Foreign 88 61 123
- ------------------------------------------------------
1,471 5,750 1,630
Deferred:
Federal (300) (1,695) (4,095)
State (285) (585)
- ------------------------------------------------------
$1,171 $3,770 $(3,050)
</TABLE>
32
<PAGE> 14
Cash payments for income taxes totaled approximately $1,171,000, $2,408,000 and
$1,254,000 in 1995, 1996 and 1997.
The effective tax rate differs from the statutory federal income tax rate due to
the following:
<TABLE>
<CAPTION>
Year ended December 31
1995 1996 1997
- -------------------------------------------------------------------------------
<S> <C> <C> <C>
Statutory income tax rate 34.0% 35.0% (34.0)%
State income taxes, net of federal benefit 3.3 4.9 (1.5)
Research and development tax credits (1.3) (1.4) (2.0)
Tax benefit from Foreign Sales Corporation (1.0) (1.9) --
Tax-exempt interest income (1.4) (2.7) (4.1)
Foreign and other 1.7 0.4 2.4
Utilization of net operating loss carryforwards (15.3) -- --
Change in valuation allowance -- (7.3) --
- -------------------------------------------------------------------------------
Effective tax rate 20.0% 27.0% (39.2)%
</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.
A valuation allowance was recorded in 1995 to offset certain net deferred tax
assets, due to the uncertainty of realizing the benefit of these assets. The
valuation allowance was eliminated in 1996, when the Company deemed it more
likely than not that sufficient future taxable income would be generated to
realize the full benefit of the deferred tax assets. Income taxes for 1997
include tax benefits related to the charge to operations of $14.0 million for
purchased research and development resulting from the acquisition of the NAC
business unit.
The following is a summary of the significant components of the Company's
deferred tax assets and liabilities:
<TABLE>
<CAPTION>
December 31
1996 1997
- -------------------------------------------------------------------
(In thousands)
<S> <C> <C>
Deferred tax assets:
Purchased research and development -- $4,900
Deferred revenue $ 116 168
Reserves not currently deductible 2,044 2,136
Depreciation and other 283 (50)
- -------------------------------------------------------------------
Total deferred tax assets 2,443 7,154
Deferred tax liability:
Amortization of start-up costs (163) (194)
- -------------------------------------------------------------------
Net deferred tax $2,280 $6,960
</TABLE>
9. 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 2001. Future minimum lease payments at December
31, 1997 under these noncancelable operating leases are approximately $783,000
in 1998, $276,000 in 1999, $60,000 in 2000, and $41,000 in 2001.
Rent expense was approximately $430,000, $595,000 and $895,000 in 1995, 1996 and
1997.
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, or attempted to bring legal action against, a significant number of others
in the videoconferencing market, including some customers of the Company. In
these actions, Datapoint has offered to sell them nonexclusive licenses, or has
attempted to compel them to pay damages and ongoing royalties, 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 at least until the validity of the patents is
adjudicated.
33
<PAGE> 15
10. 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 shares 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.
11. 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
4,100,324 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, 1998, 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.
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 these benefit plans 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
Granted 1,343,000 $13.14
Terminated (411,102) $17.80
Exercised (217,798) $ 3.29
---------
Outstanding at December 31, 1997 2,189,639 $16.08
- -------------------------------------------------------------------------------
Exercisable at December 31, 1995 102,006
Exercisable at December 31, 1996 202,192
Exercisable at December 31, 1997 377,840
</TABLE>
Related information for options outstanding and exercisable as of December 31,
1997 under these benefit plans is as follows:
<TABLE>
<CAPTION>
Weighted
Average Weighted
Remaining Average
Contractual Exercise
Range of Exercise Prices Shares Life Price
- --------------------------------------------------------------------------
<S> <C> <C> <C> <C>
$ .01 - $ .10 7,187 .8 $ .08
$ .20 - $ .60 29,773 1.6 $ .22
$ 2.00 - $ 6.00 114,042 4.3 $ 3.04
$ 8.50 - $19.25 1,597,752 5.1 $12.47
$23.25 - $43.25 440,885 4.7 $33.89
---------
Total outstanding 2,189,639 5.0 $16.08
- --------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
Weighted
Average
Exercise
Range of Exercise Prices Shares Price
- -------------------------------------------------------------
<S> <C> <C> <C>
$ .01 - $ .10 6,562 $ .08
$ .20 - $ .60 15,989 $ .22
$ 2.00 - $ 6.00 58,898 $ 2.99
$ 8.50 - $21.25 181,502 $13.86
$23.25 - $43.25 114,889 $33.30
-------
Total exercisable 377,840 $17.26
- -------------------------------------------------------------
</TABLE>
34
<PAGE> 16
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 have commenced 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 in 1995
and 1996 and .68 in 1997; and a weighted-average expected life of the option of
5.4 years in 1995 and 1996 and 5.3 years in 1997.
For purposes of pro forma disclosures, the estimated weighted average fair value
of options granted during the year of $4.53, $9.51 and $8.39 in 1995, 1996 and
1997 is amortized to expense over the related vesting period. Pro forma
information is as follows:
<TABLE>
<CAPTION>
1995 1996 1997
- --------------------------------------------------------------------------
(in thousands except for per-share related data)
<S> <C> <C> <C>
Pro forma net income (loss) $4,147 $8,973 ($8,137)
Pro forma net income (loss) per share:
Basic $ 0.37 $ 0.73 ($ 0.63)
Diluted $ 0.35 $ 0.69 ($ 0.63)
</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. In 1997, as authorized by the Board of
Directors, the Company began to match a portion of its employees contributions
to the plan, which approximated $205,000 in 1997.
QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
All previously presented net income (loss) per share amounts have been restated
to comply with Statement of Financial Accounting Standards No. 128, Earnings per
Share.
<TABLE>
<CAPTION>
Quarter ended
- -------------------------------------------------------------------------------------------------
March 31 June 30 September 30 December 31
(In thousands, except per-share related data)
- -------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
1996
- -------------------------------------------------------------------------------------------------
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 - basic 0.15 0.18 0.22 0.26
Net income per share - diluted 0.15 0.17 0.21 0.24
Common stock price - high $ 32.00 $ 41.75 $ 39.25 $ 55.00
Common stock price - low $ 17.25 $ 21.50 $ 24.50 $ 32.63
1997
- -------------------------------------------------------------------------------------------------
Net sales $15,303 $ 11,451 $12,903 $13,838
Gross profit 10,344 7,231 7,961 8,563
Operating income (loss) 4,002 (13,970) 38 436
Net income (loss) 2,897 (8,679) 485 565
Net income (loss) per share - basic 0.23 (0.68) 0.04 0.04
Net income (loss) per share - diluted 0.22 (0.68) 0.04 0.04
Common stock price - high $ 46.25 $ 23.00 $ 13.63 $ 16.88
Common stock price - low $ 20.38 $ 12.13 $ 9.88 $ 9.88
</TABLE>
35
<PAGE> 17
REPORT OF INDEPENDENT AUDITORS
THE BOARD OF DIRECTORS AND STOCKHOLDERS
VIDEOSERVER, INC.
We have audited the accompanying consolidated balance sheets of VideoServer,
Inc. and subsidiaries (the Company) as of December 31, 1996 and 1997, and the
related consolidated statements of operations, stockholders' equity, and cash
flows for each of the three years in the period ended December 31, 1997. 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. and subsidiaries at December 31, 1996 and 1997, and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended December 31, 1997 in conformity with generally
accepted accounting principles.
Boston, Massachusetts [Ernst & Young LLP LOGO]
January 13, 1998
<PAGE> 1
EXHIBIT 21.1
SUBSIDIARIES:
The following is a list of the Company's current subsidiaries,
all of which are wholly-owned:
ORGANIZED
SUBSIDIARY NAME UNDER THE LAWS OF
- --------------- -----------------
VideoServer International Inc. Massachusetts
VideoServer Foreign Sales Corporation Barbados
VideoServer Securities Corporation Massachusetts
The following is a subsidiary of VideoServer International, Inc. which is
wholly-owned:
ORGANIZED
SUBSIDIARY NAME UNDER THE LAWS OF
- --------------- -----------------
VideoServer Ltd. United Kingdom
<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 13, 1998, included
in the 1997 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
Statements (Forms S-3 No. 333-29209 and S-8 No. 33-96192) of VideoServer,
Inc. and in the related Prospectus of our report dated January 13, 1998,
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, 1998
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<CURRENCY> US DOLLARS
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<EXCHANGE-RATE> 1
<CASH> 24,866
<SECURITIES> 21,665
<RECEIVABLES> 8,582
<ALLOWANCES> (1,338)
<INVENTORY> 3,882
<CURRENT-ASSETS> 61,217
<PP&E> 5,142
<DEPRECIATION> 0
<TOTAL-ASSETS> 72,899
<CURRENT-LIABILITIES> 12,808
<BONDS> 0
0
0
<COMMON> 131
<OTHER-SE> 59,960
<TOTAL-LIABILITY-AND-EQUITY> 72,899
<SALES> 53,495
<TOTAL-REVENUES> 53,495
<CGS> 19,396
<TOTAL-COSTS> 19,396
<OTHER-EXPENSES> 43,593
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> (165)
<INCOME-PRETAX> (7,782)
<INCOME-TAX> (3,050)
<INCOME-CONTINUING> (4,732)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (4,732)
<EPS-PRIMARY> (0.37)
<EPS-DILUTED> (0.37)<F1>
<FN>
<F1>ADDITIONAL CURRENT ASSET - DEFERRED TAXES 2,619
ADDITIONAL CURRENT ASSET - OTHER 941
OTHER ASSET - DEFERRED TAXES 4,341
OTHER ASSETS - NET 2,199
INTEREST INCOME 1,877
</FN>
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<RESTATED>
<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<F1>
<FN>
<F1>ADDITIONAL CURRENT ASSET - DEFERRED 2,280
ADDITIONAL CURRENT ASSET - OTHER 843
OTHER ASSET - DEFERRED TAXES
OTHER ASSETS - NET 204
INTEREST INCOME 1,895
</FN>
</TABLE>
