VIDEO NETWORK COMMUNICATIONS INC, 10QSB, 2000-11-14

VIDEO NETWORK COMMUNICATIONS INC
10QSB, 2000-11-14
TELEGRAPH & OTHER MESSAGE COMMUNICATIONS

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<PAGE> 1

U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-QSB

(Mark One)

[x] Quarterly report under Section 13 or 15(d) of the Securities Exchange Act
of 1934

For the quarterly period ended September 30, 2000

[ ] Transition report under Section 13 or 15(d) of the Exchange Act

For the transition period from _________ to ____________

Commission file number 000-22235
---------

VIDEO NETWORK COMMUNICATIONS, INC.
-------------------------------------------------------------------------------
(Exact Name of Small Business Issuer as Specified in Its Charter)

<TABLE>
<CAPTION>
Delaware 54-1707962
-------- ----------
<S> <C>
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
</TABLE>

50 International Drive
Portsmouth, NH 03801
-------------------------------------------------------------------------------
(Address of Principal Executive Offices)

(603) 334-6700
-------------------------------------------------------------------------------
(Issuer's Telephone Number, Including Area Code)

-------------------------------------------------------------------------------
(Former Name, Former Address and Former Fiscal Year, if Changed Since
Last Report)

Check whether the issuer: (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 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
------ ------

APPLICABLE ONLY TO CORPORATE ISSUERS

State the number of shares outstanding of each of the issuer's classes of
common equity, as of November 5, 2000: 10,667,970

Transitional Small Business Disclosure Format (check one):

Yes No X
------ -------

<PAGE> 2

PART I - FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

VIDEO NETWORK COMMUNICATIONS, INC.

BALANCE SHEETS

ASSETS

<TABLE>
<CAPTION>
September 30, December 31,
2000 1999
---- ----
<S> <C> <C>
Current assets: (Unaudited)
Cash and cash equivalents $ 1,116,628 $ 2,594,529
Accounts receivable, net 916,380 376,580
Inventory, net 4,495,103 4,913,115
Other current assets 78,676 107,379
------------ -----------

Total current assets 6,606,787 7,991,603

Property and equipment, net 822,728 1,304,785
Trademarks and patents, net 265,464 234,343
Other assets 8,309 68,309
------------ -----------

$ 7,703,288 $ 9,599,040
============ ===========

LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities:
Notes payable $ 44,926 $ 20,000
Accounts payable 1,183,513 462,065
Deferred revenue 95,399 28,068
Accrued liabilities 937,852 858,785
Current portion of long term debt 314,192 1,685,536
Obligations under capital lease, current portion 10,895 7,798
------------ -----------

Total current liabilities 2,586,777 3,062,252

Long term debt 2,844,970 1,717,805
Obligations under capital lease 24,556 37,890

Commitments

Stockholders' equity :

Common stock, par value $.01, 30,000,000 shares authorized; 10,667,970 and
8,812,141 issued and outstanding at September 30, 2000 and
December 31, 1999, respectively 106,680 88,121

Additional paid-in capital 59,681,878 57,170,884
Accumulated deficit (57,541,573) (52,477,912)
------------ -----------

Total stockholders' equity 2,246,985 4,781,093
------------ -----------

$ 7,703,288 $ 9,599,040
============ ===========
</TABLE>

The accompanying notes are an integral part of these financial statements.

<PAGE> 3

VIDEO NETWORK COMMUNICATIONS, INC.

STATEMENTS OF OPERATIONS

(UNAUDITED)

-----------

<TABLE>
<CAPTION>
For the three months ended For the nine months ended
September 30, September 30,
2000 1999 2000 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
Revenues:

Products $ 1,605,909 $ 149,496 $ 3,143,349 $ 1,554,921

Services 1,106,064 326,556 2,015,042 401,626
------------- ------------- ------------ -------------

2,711,973 476,052 5,158,391 1,956,547
------------- ------------- ------------ -------------

Cost of sales:

Products 1,129,472 80,164 2,156,576 768,684

Services 749,123 225,950 1,444,346 248,471
------------- ------------- ------------ -------------

1,878,595 306,114 3,600,922 1,017,155
------------- ------------- ------------ -------------

Gross margin 833,378 169,938 1,557,469 939,392
------------- ------------- ------------ -------------

Operating expenses:

Research and development 975,001 1,920,651 2,908,921 4,006,514

Selling, general and administrative 1,196,843 1,418,458 3,543,974 3,691,086
------------- ------------- ------------ -------------

Total operating expenses 2,171,844 3,339,109 6,452,895 7,697,600
------------- ------------- ------------ -------------

Loss from operations (1,338,466) (3,169,171) (4,895,426) (6,758,208)

Interest expense, net 62,721 36,039 168,235 2,183,784
------------- ------------- ------------ -------------

Net loss (1,401,187) (3,205,210) (5,063,661) (8,941,992)
------------- ------------- ------------ -------------

Cumulative Series B dividend - - - (22,672)
------------- ------------- ------------ -------------
Net loss attributable to common stockholders $ (1,401,187) $ (3,205,210) $(5,063,661) $ (8,964,664)
============= ============= ============ =============

Net loss per common share -basic and

diluted $ (.15) $ (.36) $ (.56) $ (2.29)
============= ============= ============ =============

Weighted average shares outstanding -

basic and diluted 9,596,666 8,812,141 9,119,381 3,919,867
============= ============= ============ =============
</TABLE>

The accompanying notes are an integral part of these financial statements.

<PAGE> 4

VIDEO NETWORK COMMUNICATIONS, INC.

STATEMENTS OF CASH FLOWS

(UNAUDITED)

<TABLE>
<CAPTION>
Nine months ended September 30,
2000 1999
---- ----
<S> <C> <C>
Cash flows from operating activities:
Net loss $ (5,063,661) $ (8,941,992)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation 524,490 872,777
Amortization 15,198 11,405
Interest expense related to issuance of warrants 38,907 36,714
Interest expense accrued on debentures - 74,649
Amortization of debt discount - 1,270,214
Amortization of debt issuance costs - 472,313
Non-cash compensation expense 18,738 422,765
Net loss on sale of fixed assets - 10,469
Reserve for obsolescence 100,000 250,000
Other non-cash charges 60,000 354,992

Changes in operating assets and liabilities:
Accounts receivable (539,800) (48,157)
Other current assets 79,793 69,159
Inventory 318,012 310,592
Trademarks and patents (46,319) (31,686)
Other assets - 2,095
Accounts payable 721,448 (2,621,761)
Deferred revenue 67,331 (26,897)
Accrued liabilities 89,321 40,628
-------------- -------------
Net cash used in operating activities (3,616,542) (7,471,721)
-------------- -------------

Cash flows from investing activities:
Proceeds from sale of property and equipment - 84,580
Purchase of property and equipment (42,433) (37,719)
-------------- -------------

Net cash (used in) provided by investing activities (42,433) 46,861
-------------- -------------

Cash flows from financing activities:
Net proceeds from the issuance of common stock 2,259,263 14,127,017
Net proceeds from the issuance of representative's purchase option - 100
Net proceeds from the exercise of stock options 251,552 -
Net proceeds from the issuance of unsecured promissory notes and
common stock - 2,395,604
Repayment of unsecured promissory notes - (2,850,000)
Repayment of notes payable (26,164) (105,543)
Repayment of long term debt (293,340) (1,175,000)
Proceeds from the issuance of notes payable to related parties - 36,000
Repayment of notes payable to related parties - (36,000)
Principal payments on capital leases (10,237) (148,278)
-------------- -------------

Net cash provided by financing activities 2,181,074 12,243,900
-------------- -------------

Net (decrease) increase in cash and cash equivalents (1,477,901) 4,819,040

Cash and cash equivalents, at beginning of period 2,594,529 8,532
-------------- -------------

Cash and cash equivalents, at end of period $ 1,116,628 $ 4,827,572
============== =============

Supplemental disclosure of non-cash investing and
financing activities: See Note 6.
</TABLE>

The accompanying notes are an integral part of these financial statements.

<PAGE> 5

VIDEO NETWORK COMMUNICATIONS, INC.

NOTES TO FINANCIAL STATEMENTS (UNAUDITED)

1. BASIS OF PRESENTATION

The accompanying unaudited condensed financial statements of Video
Network Communications, Inc. (the "Company" or "VNCI") as of September 30, 2000
and for the three and nine months ended September 30, 2000 and 1999 have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with instructions to Form 10-QSB and Article 10 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, such financial statements
contain all adjustments consisting only of normal recurring entries, necessary
to present fairly the financial position of the Company as of September 30, 2000
and the results of operations for the three and nine months ended September 30,
2000 and 1999. The interim financial statements should be read in conjunction
with the audited financial statements and notes thereto for the year ended and
as of December 31, 1999 included in the Video Network Communications, Inc.
Annual Report on Form 10-KSB, as filed with the Securities and Exchange
Commission under the Securities Exchange Act of 1934, as amended. Certain prior
year items have been reclassified to conform to the current period's format. The
results of operations for the three and nine months ended September 30, 2000 are
not necessarily indicative of the results that may be expected for the entire
year.

The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that effect the reported amounts of assets and liabilities at the
date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.

To date, the Company has not generated substantial revenues from the sale
of its products and services. The Company recognized $2,395,000 in revenues
during the year 1999, and recognized $5,158,000 in revenues during the nine
months ended September 30, 2000. The Company has suffered recurring losses from
operations, has recurring negative cash flow from operations and had an
accumulated deficit of $57,542,000 at September 30, 2000 that raise substantial
doubt about its ability to continue as a going concern. The financial statements
do not include any adjustments that might result from the outcome of this
uncertainty. The Company has required substantial funding through debt and
equity financings since its inception to complete its development plans and
commence full-scale operations.

The Company requires additional cash to fund operations. At September 30,
2000, the Company had $1,117,000 in cash and cash equivalents. The Company
expects to generate revenues from operations during the next twelve months.
The Company is currently experiencing a cash flow shortage and to achieve
sufficient cash flow to meet immediate and near term operating expenditures,
it must accelerate cash receipts. At November 7, 2000, the Company had cash
and cash equivalents totaling only $837,000. The Company has undertaken a
number of different initiatives designed to generate cash, and believes that
through some combination of these initiatives, it will be able to generate
sufficient cash flow to meet its immediate and near term operating
expenditures. However, given that the Company's ability to complete these
initiatives is subject to a number of factors, many of which are beyond its
control, the Company cannot assure you that it will be able to do so. There
can be no guarantee that the Company will be able to accelerate its cash flows
sufficiently to meet its short-term operational cash flow requirements. If it
is unable to do so, the Company may become insolvent and may have to cease
operations, declare bankruptcy or similar actions.

2. NET LOSS PER SHARE

The Company computes basic and diluted earnings per share in accordance
with Statement of Financial Accounting Standards No. 128, "Earnings per Share."
Net loss per common share is based on the weighted average number of common
shares and dilutive common share equivalents outstanding during the periods
presented. Basic earnings (loss) per share are calculated by dividing net income
(loss) by the weighted average shares outstanding. Diluted earnings (loss) per
share reflect the dilutive effect of stock options and warrants and are
presented only if the effect is not anti-dilutive. As the Company incurred
losses for all periods, there is no difference between basic and diluted
earnings per share. Had options and warrants been included in the computation,
shares for the diluted computation would have increased by 7,485,056 and
10,005,904 as of September 30, 1999 and 2000, respectively.

3. INCOME TAXES

The Company did not record a provision for income taxes for the three and
nine months ended September 30, 2000 and 1999 since the Company had net
operating losses during each of those periods. The Company recorded a full
valuation allowance against the net deferred tax asset generated primarily from
its net operating loss carryforwards.

<PAGE> 6

4. INVENTORY

Inventory consisted of the following at:

<TABLE>
<CAPTION>
September 30, December 31,
2000 1999
---- ----
(Unaudited)
<S> <C> <C>
Raw Materials $ 4,104,673 $ 4,355,895
Finished Goods 390,430 557,220
------------- ------------

$ 4,495,103 $ 4,913,115
============= ============
</TABLE>

5. DEBT

SANMINA NOTE

In January 1999, the Company converted outstanding accounts payable to
Sanmina Corporation of $3,200,000 and $1,100,000, the latter representing the
value of inventory and materials located at a subcontract manufacturer, to a
$4,300,000 three-year term note accruing interest at 7% per year. The Company
paid Sanmina $1,100,000 in principal on the note in June 1999 upon completion of
its public offering of units and Sanmina transferred to the Company the title to
certain inventory and materials located at Sanmina.

In connection with the restructuring of accounts payable balances to a
long-term note, the Company issued to Sanmina warrants to purchase 39,286 shares
of common stock, with a $19.25 exercise price per share. An independent
appraisal assigned a market value of $127,759 to these warrants. The Company has
recorded the value of the warrants as a discount against the face amount of the
note and will amortize the value of the warrants over the life of the note.

In January 2000, the Company defaulted on the interest payment due to
Sanmina and did not make subsequent interest and principal payments to Sanmina
when due through August 2000. In August 2000, the Company renegotiated the terms
of the note to Sanmina. Under the current terms of the note, the Company is
obligated to pay Sanmina (i) $150,000 on or about August 15, 2000, which the
Company has done, (ii) $150,000 on or before November 15, 2000 and (iii) an
amount each month equal to a percentage of the accounts receivable collected in
the previous calendar month, with the percentage ranging from 0% to 5%, based on
the net amount of accounts receivable that we collect. Any principal and accrued
interest thereon remaining on the note is due in full on January 12, 2002. The
Sanmina note is secured by personal property and substantially all of the
Company's assets, other than its intellectual property. At September 30, 2000,
the Company owed Sanmina approximately $3.3 million in principal and interest on
this note. The Company is currently in compliance with the terms of its
renegotiated debt agreement with Sanmina, and we intend to make the required
payment on November 15, 2000 when due.

LEGAL COUNSEL NOTE

In January 1999, the Company also converted $375,000 of outstanding
accounts payable to legal counsel to a two-year term loan accruing interest at
7% per year. The Company paid $75,000 of the principal balance of this note
during 1999. Under the terms of the note, the Company is obligated to make two
semi-annual interest-only payments. In February 2000, the Company was to have
commenced making twelve equal monthly payments to fully amortize the remaining
balance of the note.

In connection with converting the restructuring of accounts payable
balances to a long-term note, the Company issued to legal counsel warrants to
purchase 5,714 shares of common stock, with a $18.59 exercise price per share.
An independent appraisal assigned a market value of $18,583 to these warrants.
The Company has recorded the value of the warrants as a discount against the
face amount of the note and will amortize the value of the warrants over the
life of the note.

Prior to the August 2000 private placement of units discussed in Note 10,
the Company had paid legal counsel $77,874 on the note, but continued to be in
default with respect to payments required by the terms of the debt instrument.
The note was renegotiated in August 2000 in connection with the private
placement to require the Company to make an approximately $50,000 payment at the
time of the closing of the private placement in August 2000, which the Company
did, and to make monthly payments of $20,000 until the balance of the note is
fully paid. At September 30, 2000, the Company owed legal counsel approximately
$167,000 in principal and interest on this note. The Company is in compliance
with the terms of this renegotiated debt agreement.

The Company cannot assure you that they will be able to make the required
principal and interest payments on these notes when

<PAGE> 7

due. . If we default on these notes, the Company may lose those assets that
serve as security or we may not be able to continue to receive legal services
from our attorneys and we could be found liable to pay immediately in one
payment all of the aggregate outstanding principal and interest on the notes.

6. NON-CASH TRANSACTIONS

The following non-cash transactions occurred in the periods indicated:

Nine months ended September 30,
2000 1999
---- ----
(Unaudited) (Unaudited)

<S> <C> <C>
Current asset financed by issuance of note payable $ 51,090 $ -
Dividend on preferred stock - 22,672
Conversion of preferred stock to common stock - 1,196,630
Conversion of subordinated debentures to common stock - 3,275,323
Accounts payable transferred to long term debt - 3,575,000
Common stock issued with private placement - 1,270,214
Warrants issued with long term debt - 146,342
Inventory financed with long term debt - 1,100,000
Equity financing costs in prepaid expenses - 28,867
Reduction in accrued liabilities due to sale of fixed assets - 181,678
Cost of fixed assets sold - net - 262,258
Reclassification of accrued interest to long-term debt 10,254 -
Vendor credit issued against formerly recorded fixed asset - 10,123
Debt issuance costs in other assets - net 17,917
</TABLE>

7. INVESTMENTS

On December 31, 1999, the Company entered into an Agreement with B2BVideo
Network, Corp. (formerly b2bvideo.com, Corp.), a high technology startup company
that intends to provide aggregated business video content to the business
market. The Agreement became effective on March 15, 2000, the day after the
closing of B2BVideo Network's private placement of Series A Preferred Stock.
Under the Agreement, VNCI received one million shares of B2BVideo Network common
stock (representing approximately 14.5% of B2BVideo Network on a fully diluted
basis upon issuance) in exchange for favorable purchase terms and conditions
regarding technical support and equipment provided to B2BVideo Network by VNCI.
Mr. James F. Bunker, Chairman of the Board of VNCI and a director of B2BVideo
Network, is VNCI's representative on B2BVideo Network's Board of Directors, and
purchased shares of B2BVideo Network Series A preferred stock in the private
placement (representing less than 1% of the total offering). The Company is
using the cost method to account for this investment and has elected to value
the investment at zero, as there was no tangible consideration given for the
investment.

8. NEW ACCOUNTING PRONOUNCEMENTS

In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements," as
amended by SAB No. 101A and SAB No. 101B ("SAB 101"), which is effective no
later than the quarter ending December 31, 2000. SAB No. 101 clarifies the
Securities and Exchange Commission's views regarding the recognition of revenue.
The Company will adopt SAB No. 101 in the fourth quarter of 2000. The Company
does not expect the application of SAB No. 101 to have a material impact on the
Company's financial position or results of operations.

9. RELATED PARTY TRANSACTIONS

Included in product revenues in the quarter ended September 30, 2000 was
$176,000 related to shipments of equipment to B2BVideo Network, Corp. Cost of
products sold included $130,000 related to that sale. One member of VNCI's board
of directors also serves as VNCI's designee on B2BVideo's board of directors and
is an investor in the company. Please see note 7, Investments.

10. PRIVATE PLACEMENT OF 1,760,000 UNITS

<PAGE> 8

On August 25, 2000, the Company completed a private placement (the
"Private Placement") of 1,760,000 Units (individually, a "Unit" and
collectively, the "Units"), each Unit consisting of one share of common stock,
par value $.01 per share, of the Company (the "Common Stock") and one redeemable
common stock purchase warrant (individually, a "Warrant" and collectively, the
"Warrants"). The gross proceeds of the offering were $2,640,000. Net proceeds,
after expenses of $380,737, were $2,259,263.

The Warrants offered in the Private Placement entitle the holder to
purchase one share of Common Stock for an initial exercise price of $4.00 during
the period (the "Exercise Period") commencing February 26, 2001 and ending on
June 15, 2004, subject to prior redemption. The Warrants are identical to the
Company's outstanding warrants which are currently trading on the Nasdaq
SmallCap market under the symbol "VNCIW," except that the Warrants may not be
exercised until February 26, 2001. The Company may redeem the Warrants at any
time after February 26, 2001 so long as they are the subject of an effective
registration statement filed with the Securities and Exchange Commission (the
"SEC"), at a price of $.01 per Warrant on not less than 30 days' prior written
notice if the last sale price of the Common Stock has been at least 200% of the
then exercise price per Warrant (initially $8.00) for the 20 consecutive trading
days ending on the third day prior to the date on which the notice is given.

The Company offered the Units through EarlyBirdCapital, Inc. ("EBC"), as
the exclusive placement agent, on a "best efforts, all or none" basis. The Units
were offered and sold only to persons who qualified as "accredited investors,"
as defined in Rule 501(a) under the Securities Act of 1933, as amended (the
"Securities Act"). The price per unit was $1.50. The minimum subscription was
25,000 Units at a total subscription price of $37,500, although lesser amounts
could have been accepted in the discretion of the Company and EBC.

As compensation to EBC for its services as placement agent, the Company
paid EBC an 8% commission and a 2% non-accountable expense allowance. The
Company also issued to EBC an option (the "Placement Agent's Option") to
purchase 264,000 Units at a price per Unit equal to $2.125. The Company also
granted to EBC a 30-day right of first refusal to underwrite or place future
offerings for which the Company engages the services of an investment banker for
a period of three years after closing. In addition, the Company agreed that, for
a period of three years from August 25, 2000, the closing date of the Private
Placement (the "Closing Date"), to either appoint to its Board of Directors (the
"Board") a person designated by EBC or to permit EBC to send a representative to
observe each meeting of the Board. The Company will also pay "source fees" to
EBC, for a period of 24 months, if EBC introduces potential investors to the
Company and such investors make subsequent investments in the Company.

Pursuant to the terms of the Placement Agent Agreement with EBC, the
Company filed on October 13, 2000, a registration statement (the "Registration
Statement") under the Securities Act with the SEC, and will make appropriate
filings in such states as EBC shall reasonably specify, to register (i) for
resale (a) the 1,760,000 shares of Common Stock and 1,760,000 Warrants included
in the Units purchased in the Private Placement and (b) the 1,760,000 shares of
Common Stock underlying the Warrants included in the Units, (ii) the issuance of
(a) the 1,760,000 shares of Common Stock issuable upon exercise of the Warrants
include in the Units, (b) the 264,000 shares of Common Stock and 264,000
Warrants underlying the Placement Agent's Option, and (c) the 264,000 shares of
Common Stock underlying such Warrants.

The Company has filed a Registration Statement declared effective by the
SEC no later than December 22, 2000 (the "Target Date"). If the Registration
Statement is not declared effective by the Target Date, then on the Target Date
and on each monthly anniversary of the Target Date thereafter until the earlier
of the effective date of the Registration Statement or the 19th monthly
anniversary of the Target Date, the Company is required to issue to each holder
of Units and to EBC (or its designee) as holder of the Placement Agent's Option,
warrants (the "Extra Warrants") to purchase a number of shares of Common Stock
equal to 5% of the number of Warrants purchased by the holder in the Private
Placement (and, as to EBC or its designee, 5% of the number of Warrants
underlying the Placement Agent's Option). The Extra Warrants are to have the
same terms as the Warrants.

The holders of the Common Stock or Warrants included in the Units are
also entitled to have their securities included in any registration statement
the Company files with the SEC for an offering of securities (subject to the
right of the underwriters of that offering to require the holders to delay the
sale of their securities for a period of up to 90 days after that registration
statement is declared effective), for any period of time during which the
Registration Statement is not effective.

For the period from August 25, 2000 through the 12-month anniversary of
the effective date of the Registration Statement, the Company has agreed not to
(i) allow any new registration statement to be declared effective (other than
the Registration Statement and those on Form S-8 or Form S-4 or any
post-effective amendments) or (ii) issue any securities under Regulation D or
Regulation S under the Securities Act with respect to which a registration
statement is required to be filed within 12 months, without the prior consent of
EBC; provided, however, that this restriction does not apply to registration
statements or private offerings in connection with a strategic partnership,
joint venture or similar arrangement. The Company's officers and directors also
have executed "lock-up

<PAGE> 9

agreements" with EBC restricting the sale of the Company's common stock for a
period of 12 months from the effective date of the Registration Statement,
without the consent of EBC.

The Company plans to use the proceeds of the Private Placement for
research and development, product sales and marketing, and customer support
operations, to repay a portion of certain debt outstanding to an inventory
supplier and its legal counsel, and for working capital. The Company is also
subject to certain restrictions on its ability to use the net proceeds of the
Private Placement for debt repayment.

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS

Certain statements contained in this Quarterly Report on Form 10-QSB,
other than historical financial information, constitute "forward-looking
statements" within the meaning of the Private Securities Litigation Reform Act
of 1995. All such forward-looking statements involve known and unknown risks,
uncertainties or other factors which may cause our actual results, performance
or achievements to be materially different from any future results, performance
or achievement expressed or implied by such forward-looking statements. Factors
that might cause such a difference include risks and uncertainties related to
our dependence on the emerging market for video broadcast, retrieval and
conferencing, development of additional products, protection of our intellectual
property, limited marketing experience, limited number of customers, and the
need for additional personnel, as well as risks and uncertainties associated
with our growth strategy, technological changes and competitive factors
affecting us.

The following discussion should be read in conjunction with the unaudited
financial statements and notes thereto appearing elsewhere in this Quarterly
Report on Form 10-QSB.

OVERVIEW

Video Network Communications, Inc. is a Delaware corporation formed in
1993 to design, develop and market full motion, high resolution, cost-effective
video network systems. Users of our VidPhone video network system can view
broadcast video, participate in multi-party video conferences and retrieve
stored video on demand from their desktop. Our VidPhone system distributes video
to and from desktop and laptop personal computers and conference rooms
configured with VidPhone stations, over the same wiring used by the telephone
without interfering with normal telephone usage. We believe that the VidPhone
system offers greater functionality and compatibility with existing
infrastructure and higher quality than other video network or conferencing
systems available today.

We are a relatively new company offering a new technology product. We
first introduced our technology and initial products in late 1998 and our
products first demonstrated commercial readiness during the first half of 1999.
The price for our typical 30-user video network system is $132,250 including
installation, but this price can vary significantly based on configuration
options. We believe that we have shown revenue and sales growth over the past
year despite limited sales and marketing resources and our unstable financial
condition during the period. However, we believe that in order for our company
to be successful, we will need to achieve a significantly higher level of sales
in a relatively short time, which will require substantially higher sales and
marketing expenditures in the future.

We reported revenues of $2,712,000 for the quarter ended September 30,
2000, an increase of 51% when compared with revenues reported for the second
quarter of 2000 and an increase of 470% compared to the third quarter of 1999.
Our operating expenses for the quarter ended September 30, 2000 of $2,172,000
were approximately 5% lower than our operating expenses in the second quarter of
2000 and 35% lower than our operating expenses in the third quarter of 1999. At
this stage of our product's market development, it is difficult for us to
predict with accuracy the level of our sales in future periods, or when our
marketing initiatives will result in higher sales. Each sale of our equipment
continues to account for a significant portion of our revenues. Accordingly, we
expect to continue to experience significant, material fluctuations in our
revenues on a quarterly basis for the foreseeable future.

Our VidPhone enterprise video system utilizes patented technology to
distribute TV-quality video, FM-quality stereo audio and data to laptop or
personal computers using the telephone wiring connecting telephones to the PBX
or CENTREX, bypassing the enterprise's local area network ("LAN"), and, thereby
avoiding the issues associated with bandwidth limitations. We believe that
bandwidth limitations have been the major impediment to delivering full-motion
TV-quality video to the desktop on a cost-effective basis.

We are continuing to invest a significant amount of our resources in
research and development, because we consider the com-

<PAGE> 10

mercialization of our products to be fundamental to our future success. In April
2000, we announced our implementation of Java technology, V2.0, which will
enable us to offer customers a platform-independent video network solution. In
October 2000, the Company announced the release of its IP/ISDN Gateway, offering
customers the flexibility of using H.323 (IP) and H.320 (ISDN) at their
discretion for transporting high quality, on-demand video communications from
the desktop across the wide area network.

We have completed a restructuring of our sales and marketing team that
began in November 1999. As part of this effort, we have recently concentrated
our sales and marketing efforts in five vertical markets and we have experienced
some success in each of these markets. We have targeted the finance, medicine,
education, video broadcast and government sectors of the market. Several of our
recent sales have been to key reference accounts such as the Inter-American
Development Bank (IADB), the Cole Eye Institute of the Cleveland Clinic, the
First District of the Federal Court System in Concord, New Hampshire, and Naval
Air Systems Command. We believe that further development of these and additional
reference accounts will shorten our sales cycle in the future, while promoting
relationships with resellers. In October 2000, the Company announced its VIP
Partner Program, an innovative channel program offering vertical market training
and co-marketing to resellers of the Company's products. The Company entered
into approximately five agreements with new resellers and sales representatives
during the quarter ended September 30, 2000.

For the remainder of 2000, we intend to focus on selling and marketing
our video network solutions and continuing product development to meet customer
demands for new functionality and to lower the cost of our systems.
Specifically, our goals are to: (i) develop new strategic partnerships committed
to marketing our video network system as the video solution of choice to
business users, (ii) use our current strategic and reseller arrangements to
increase sales of our systems and create brand name recognition of our product,
(iii) significantly enhance our marketing and public relations programs to
create better awareness of our products among customers, industry analysts and
financial analysts, (iv) develop our direct sales, and (v) continue engineering
our video network system to refine and improve its functionality to meet new
customer requirements and to lower our costs and the price of our system through
improved design. Our ability to meet these objectives is subject to a number of
risks and uncertainties, including our ability to develop new strategic
relationships with significant potential resellers, our ability to sell and
market our product and develop market awareness of our video network system and
our ability to obtain financing when required. We cannot assure you that we will
be able to meet these objectives. We plan to continue to subcontract all major
manufacturing and production activities for the foreseeable future, but we will
continue to retain test and quality assurance functions until all subcontractors
are certified with respect to quality.

We expect to continue to incur significant operating expenses to support
our product development efforts and to enhance our sales and marketing
capabilities and organization, but we anticipate that our product development
expenditures will be lower than in prior years because we have introduced the
commercial version of our video network system. We expect that our results of
operations will vary significantly from quarter to quarter for the foreseeable
future.

RESULTS OF OPERATIONS

COMPARISON OF THE THREE MONTHS ENDED SEPTEMBER 30, 2000 AND SEPTEMBER 30, 1999

Revenues. We recognized $2,712,000 in revenues during the three months
ended September 30, 2000 compared to $476,000 recognized in the comparable
period of 1999, representing an increase of $2,236,000 or 470%. The revenues
recognized in the third quarter of 2000 consisted of revenues related to
equipment sales, $1,606,000, and services, $1,106,000. In the third quarter of
1999, the Company recognized equipment sales of $149,000 and service sales of
$327,000. The services revenues recognized in 2000 were related primarily to
completed and accepted installation activities at one significant customer's
multiple locations.

Cost of Sales. Cost of sales for the three months ended September 30,
2000 was $1,879,000. Of the costs of sales recognized in the third quarter of
2000, $1,130,000 was related to the cost of equipment sold in the quarter and
$749,000 was related to the cost of providing installation services.

Gross Margin on Sales. Overall gross margin on revenues recognized in the
third quarter of 2000 was $833,000, yielding a gross margin percentage of
approximately 31%, compared to gross margin earned in the comparable period of
1999 of $170,000, or 36%. Gross margin percentage on equipment sales declined to
30% during the third quarter of 2000 compared to 46% in the third quarter of
1999 due primarily to favorable pricing granted to a significant reference
account in the third quarter of 2000. The gross margin percentage on service
revenues increased slightly from 31% in the third quarter of 1999 to 32% in same
period of 2000.

Research and Development. Research and development costs decreased to
$975,000 in the three months ended September 30, 2000, from $1,921,000 in the
comparable period of 1999, representing a decrease of $946,000, or 49%. Included
the third quarter of 1999 was a charge of $355,000 representing the write-off of
previously capitalized costs of constructing certain testing equipment.

<PAGE> 11

Staffing costs declined approximately $217,000 in the third quarter of 2000
compared to the same period of 1999 due to a reduction in engineering and
operations staffing levels and severance costs incurred in 1999 not repeated in
2000. Materials and equipment used in support of research and development
activities remained approximately level in the third quarter of 2000 relative to
the same period of 1999. The third quarter of 1999 included a $250,000 charge
related to the reduction in the net realizable value of certain engineering
equipment that was not repeated in the comparable period of 2000. Professional
services and software licensing costs declined by approximately $108,000
relative to the third quarter of 1999 due primarily to the discontinuation of a
particular development project. Depreciation on equipment utilized in support of
research and development activities declined by $82,000 between these periods.
Offsetting these reductions was a relative increase in relocation costs of
$62,000, due largely to the third quarter 1999 reversal of previously accrued
relocation costs.

Selling, General and Administrative Expenses. Overall selling, general,
and administrative expenses decreased to $1,197,000 during the quarter ended
September 30, 2000 from $1,418,000 incurred in the comparable period of 1999, a
decrease of $221,000, or 16%.

Sales and marketing expenses increased $38,000 in the third quarter of
2000 relative to the same period of 1999. Staffing costs increased $192,000 due
to higher staffing levels and to increased commissions. $48,000 of the increase
was attributable to higher travel and related costs associated with increased
outside sales activity. Professional services expenses declined by $117,000.
Depreciation declined $36,000 between the two periods.

Customer support costs increased by $17,000 in the three months ended
September 30, 2000 compared to the same period of 1999. Increased staffing in
this functional area increased staffing costs $39,000 and travel related costs
$15,000. Offsetting these increases was lower depreciation, $6,000, and
increased allocations of customer support costs to cost of sales, $22,000.

General and administrative costs declined approximately $276,000 in the
third quarter of 2000 compared to the same period of 1999. Staffing costs
declined approximately $203,000 due in part to reduced staffing levels and to a
severance accrual in the third quarter of 1999 not repeated in 2000.
Professional services expenses declined $107,000, due largely the amortization
of costs assigned to options granted an investment banking firm in 1997 which
was included in the third quarter of 1999 but not in 2000. Recruiting costs
declined $81,000 from the 1999 period to the 2000 period. Depreciation also
declined $9,000 between these periods. During the third quarter of 1999 the
company reversed previously accrued expenses, $50,000, and had received refunds
from regulatory agencies or stock exchanges, $54,000, neither of which was
repeated in the third quarter of 2000.

Net interest expense in the three months ended September 30, 2000 was
$63,000 compared to $36,000 in the comparable period of 1999, a reduction of
$27,000. Of the $73,000 of interest expense incurred in the third quarter of
2000, $70,000 was related to interest and amortization of debt discount
associated with long-term debt, compared to $71,000 in 1999. The remaining
interest expense incurred in each period related to that incurred on vendor
account balances and capital leases, totaling $3,000 and $35,000 for the 2000
and 1999 periods respectively.

Interest income earned in the third quarter of 2000 was $10,000, compared
to $70,000 earned in the third quarter of 1999. The decrease reflects lower cash
balances in the third quarter of 2000 compared to the same period of 1999.

Net loss. As a result of the foregoing factors, the net loss for the
three months ended September 30, 2000 decreased to $1,401,000 compared to a loss
of $3,205,000 incurred in the three months ended September 30, 1999, a decrease
of $1,804,000, or 56%.

COMPARISON OF THE NINE MONTHS ENDED SEPTEMBER 30, 2000 AND SEPTEMBER 30, 1999

Revenues. We recognized $5,158,000 in revenues during the nine months
ended September 30, 2000 compared to $1,957,000 recognized in the comparable
period in 1999 representing an increase of $3,201,000, or 164%. We recognized
$3,143,000 of equipment sales in the first nine months of 2000 compared to
$1,555,000 in the comparable period of 1999, an increase of $1,588,000, or 102%.
Revenues related to installation services and service contracts were $2,015,000
in the first nine months of 2000 compared to $402,000 earned in the comparable
period of 1999, representing an increase of $1,613,000, or 401%.

Cost of Sales. Cost of sales for the nine months ended September 30, 2000
was $3,601,000 compared to $1,017,000 recognized in the comparable period of
1999, representing an increase of $2,584,000, or 254%. Of the cost of sales
recognized in the first nine months of 2000, $2,157,000 was related to the cost
of equipment and $1,444,000 was related to the cost of providing installation
services. Cost of equipment sales recorded in the first nine months of 1999 was
$769,000. Cost of service revenues was $248,000 during the first nine months of
1999.

<PAGE> 12

Gross Margin on Sales. Overall gross margin on revenues recognized in the
first nine months of 2000 was $1,557,000, yielding a gross margin percentage of
approximately 30%, compared to gross margin earned in the comparable period of
1999 of $939,000, or 48%. Gross margin percentage on equipment sales declined to
31% during the first nine months of 2000 compared to 51% in the first nine
months of 1999 due primarily to favorable pricing granted to significant
reference accounts in the first nine months of 2000. The gross margin percentage
on service revenues declined from 38% in the first nine months of 1999 to 28% in
same period of 2000 due to lower margins experienced on a significant systems
integration contract we managed in the 2000 period.

Research and Development. Research and development costs decreased
$1,098,000, or 27%, during the nine months ended September 30, 2000 compared to
the comparable period of 1999. Staffing costs declined by $439,000. Included in
the first nine months of 1999 was a charge of $355,000 representing the
write-off of previously capitalized costs of constructing certain testing
equipment. The Company also reduced the use of outside consultants, $89,000,
cancelled software maintenance agreements, $47,000, and avoided equipment rental
cost, $68,000. Depreciation declined during the period by $221,000. During the
first nine months of 1999 inventory reserves were increased by $250,000,
compared to $100,000 during the same period of 2000. Offsetting these reductions
was an increase of $446,000 in costs of materials, testing, and uncapitalized
tools and equipment as the Company increased development activities relative to
the same period of 1999.

Selling, General and Administrative Expenses. Selling, general, and
administrative expenses decreased by $147,000, or 4%, in the nine months ended
September 30, 2000 compared to the comparable period of 1999.

Sales and marketing expenses increased $360,000 in the first nine months
of 2000 compared to the same period of 1999 due to increases in sales and
marketing staffing costs, $305,000, increases in travel costs, $102,000, and
increased advertising, promotional, and trade show costs, $62,000. Offsetting
these increases were reductions in office rent, $27,000, decreased costs
associated with outside marketing and sales consulting services, $39,000 and
depreciation, $59,000.

Customer support costs increased $30,000 as staffing and travel increased
to meet the service requirements of a larger installed customer base. Offsetting
these costs were reductions in depreciation charged to the department and
increased allocations to cost of sales - services.

General and administrative costs decreased $538,000, or 31%, in the first
nine months of 2000 compared to the comparable period of 1999. During the first
nine months of 1999 the company incurred $423,000 in charges related to the
amortization of expense related to the issuance of options to a financial
advisor. This charge was not incurred in 2000. Staffing expenses were reduced
$228,000, largely due to a severance charge in 1999. Other reductions in
expenses were realized in travel costs, $15,000, investor relations costs,
$13,000, and contract labor, $12,000. Offsetting these reductions were higher
professional and consulting fees, $82,000.

Net Interest Expense. We recorded $168,000 of net interest expense in the
nine months ended September 30, 2000, compared to $2,184,000 of net interest
expense in the comparable period of 1999. Interest expense totaled $220,000
during the first nine months of 2000, compared to $2,272,000 during the
comparable period of 1999. Included in the interest expense in the first nine
months of 1999 was $1,742,000 related to the amortization of debt discount and
debt issuance costs associated with the unsecured promissory notes. The
remainder of the interest expense was related to long-term debt, to capital
lease obligations, and to vendor finance charges, all of which were reduced in
the first nine months of 2000 as the balances of related indebtedness has been
reduced.

We earned $52,000 in interest income during the first nine months of
2000, compared to $89,000 in interest income during the comparable period of
1999. We had lower average cash balances during first nine months of 2000
available for investment compared to 1999 and accordingly earned less interest
income.

Net Loss. As a result of the foregoing factors, the net loss for the nine
months ended September 30, 2000 decreased to $5,064,000 from $8,942,000 in the
nine months ended September 30, 1999, a decrease of $3,878,000, or 43%.

<PAGE> 13

LIQUIDITY AND CAPITAL RESOURCES

We have incurred cumulative losses aggregating $57.5 million from our
inception through September 30, 2000. We expect to incur additional operating
losses for the foreseeable future, principally as a result of expenses
associated with product development efforts and anticipated sales, marketing,
and general and administrative expenses. During the first nine months of 2000,
we satisfied our cash requirements principally from cash on hand as of December
31,1999, from the proceeds of a private placement of units, which included
common stock and warrants, from the exercise of options, and from collections
from customers.

We had cash and cash equivalents of $1,117,000 at September 30, 2000
compared to $2,595,000 at December 31, 1999, a decrease of $1,478,000. The
decrease in cash and cash equivalents was primarily the result of cash used in
operations offset by cash generated from customers, from the private placement
of units, and from the exercise of employee stock options during the first nine
months of 2000.

Net cash used in operations during the nine months ended September 30,
2000 was $3,617,000. The net loss in the first nine months of 2000, reduced by
depreciation, amortization, non-cash compensation and other non-cash charges was
$4,306,000. Inventory decreased by $418,000 during the first nine months of
2000, primarily as a result of sales made during the period and a $100,000
increase to the reserve for obsolescence. Accounts receivable increased by
$540,000 during the first nine months of 2000 as a result of new sales during
the period, offset by cash received from customers relating to outstanding
accounts receivable. Accounts payable increased by $721,000 in the first nine
months of 2000 due primarily to increased levels of product development and
inventory purchases.

The Company generated $ 2,181,000 in cash from financing activities
during the nine months ended September 30, 2000.

On August 25, 2000, Video Network Communications, Inc., a Delaware
corporation (the "Company"), completed a private placement (the "Private
Placement") of 1,760,000 Units (individually, a "Unit" and collectively, the
"Units"), each Unit consisting of one share of common stock, par value $.01 per
share, of the Company (the "Common Stock") and one redeemable common stock
purchase warrant (individually, a "Warrant" and collectively, the "Warrants").
The Units, priced at $1.50, generated gross proceeds of $2,640,000. Net
proceeds, after expenses of $380,737, were $2,259,263.

The Company used the approximately $2.3 million net proceeds of the
Private Placement for research and development, product sales and marketing, and
customer support operations, to repay a portion of certain debt outstanding to
an inventory supplier and its legal counsel, and for working capital. The
Company is also subject to certain restrictions on its ability to use the net
proceeds of the Private Placement for debt repayment.

For a more complete discussion of this private placement, see Note 10 -
Private Placement Of 1,760,000 Units in the financial statements.

Exercises of employee options generated $252,000 in the first three
months of 2000, offset by payments of $330,000 against outstanding debt
obligations.

The Company has notes outstanding to Sanmina and its legal counsel, the
terms of which were re-negotiated in August 2000. Under the re-negotiated terms,
the Company made mandatory payments on both notes at the close of the Private
Placement. In addition, the Company is required to make a mandatory payment to
Sanmina of $150,000 on November 15, 2000 and then contingent payments ranging
from 0% to 5% of monthly collections of accounts receivable beginning in
February 2001. The current outstanding principal amount of and accrued interest
on the Sanmina note was $3.3 million at September 30, 2000, and it bears
interest at 7% per annum. The remaining principal and related accrued interest
balances on the Sanmina note are due in full in January 2002. The Company is
obligated to make a monthly payment of $20,000 per month under the terms of the
re-negotiated legal counsel note, which will be fully paid down in June 2001.
The outstanding principal and accrued interest on the legal counsel note totaled
approximately $167,000 at September 30, 2000, and the note bears interest at 7%
per annum.

The Company's investing activities in the first nine months of 2000
consisted of capital equipment purchases of $42,000.

We are currently experiencing a cash flow shortage and to achieve
sufficient cash flow to meet immediate and near term operating expenditures, we
must accelerate cash receipts. At November 7, 2000, we had cash and cash
equivalents totaling only $837,000. We have undertaken the following to
generate cash for operations. We are in the process of putting in place a
factoring arrangement for accounts receivable that would result in the receipt
by the Company of cash in an amount up to eighty percent of qualified
receivables. While we cannot assure you that we will be successful in putting
the factoring arrangement in place, or the timing, we currently expect that this
arrangement will be in place by the end of November and we intend to factor
some of our future receivables. We also are pursuing a sale of non-operating
assets that could result in a cash infusion of an estimated $500,000 in cash
within thirty days. We are also engaged in negotiations with certain of our
customers to accelerate payment of invoices. We believe that through some
combination of the foregoing initiatives, we will be able to generate sufficient
cash flow to meet our immediate and near term operating expenditures. However,
given that our ability to complete these initiatives is subject to a number of
factors, many of which are beyond our control, we cannot assure you that we will
be able to do so.

We also believe that we will be successful long-term in funding our
ongoing operating expenses with cash from accounts receivable. We believe that
we will be able to generate sufficient customer payments to pay our expenses and
to sustain operations for the foreseeable future. However, if we are not
successful in our efforts to accelerate short-term cash receipts and generate
sufficient customer payments so as to permit us to timely meet our obligations,
we will require additional financing. We do not have any other sources of
financing in place and we do not believe it is feasible to return to the equity
markets at this time to support our cash flow requirements. There can be no
guarantee that we will be able to accelerate our cash flows sufficiently to meet
our short-term operational cash flow requirements or to generate sufficient
customer payments to fund ongoing operations. If we are unable to do so, we may
become insolvent and may have to cease operations, declare bankruptcy or similar
actions.

<PAGE> 14

RISK FACTORS THAT MAY AFFECT OUR RESULTS OF OPERATIONS AND FINANCIAL CONDITION

The following are some of the important risks associated with our
business and our strategy, which could impact our future financial condition and
results of operations. You should read and consider carefully the following risk
factors.

WE HAVE LIMITED SOURCES OF FINANCING

As described above in "Liquidity and Capital Resources," we are
experiencing a short-term cash flow shortage and require cash to continue
operations. At November 7, 2000, we had cash and cash equivalents totaling only
$837,000. We have exhausted the net proceeds from our private financing
completed in August 2000 and, accordingly, our operating needs are funded
principally from the receipt of cash from our operations. We have undertaken a
number of different initiatives to generate cash to fund our obligations.
However, Our ability to complete these initiatives is subject to a number of
factors, many of which are beyond our control. Accordingly, we cannot assure
you that we will be successful in these initiatives or, if successful, the
timing of our receipt of the cash generated from these arrangements. We
currently have no other sources of financing.

While we continue to believe that in the future cash from our operations
will support our operations, each customer order and payment continues to
account for a relatively large portion of our commercial sales and, accordingly,
the timing and amounts of customer payments continues to be an important factor
in financing our business. We cannot control customer payments and, accordingly,
the failure to receive timely sufficient customer payments will continue to have
a serious impact on our business for the foreseeable future. Timely receipt of
that cash, however, is essential to continuing our operations. If we are unable
to raise cash in the near future, or if we continue to fail to timely receive
anticipated customer payments, we may be unable to sustain operations. There can
be no guarantee that we will be able to generate sufficient customer payments on
a timely basis to fund ongoing operations. If we are unable to secure cash in
the near future, or if we are unable to secure future sufficient customer
payments on a timely basis to fund our operations, we may become insolvent and
may have to cease operations, declare bankruptcy or similar actions.

WE WILL REQUIRE ADDITIONAL FINANCING

After our available cash is exhausted, we will need additional funds to
continue operating. To date, the cash generated from operations has not been
sufficient to fund our business and we have been dependent on financings to
continue operating. However, in the future, we believe that cash from operations
will support continuing operations. We do not currently have any lines of
credit or bank financing, and we do not anticipate having access to bank
financing for the foreseeable future. We do not have any other sources of
financing in place and we do not believe it is feasible to return to the equity
markets at this time to support our cash flow requirements. There can be no
guarantee that we will be able to generate sufficient timely customer payments
to fund ongoing operations. If we are unable to do so, we may become insolvent
and may have to cease operations, declare bankruptcy or similar actions.

WE MAY BE UNABLE TO MEET THE PAYMENT SCHEDULE ON NOTES PAYABLE

We currently have an outstanding note to a trade creditor, Sanmina Corp.,
in the original principal amount of $4.3 million, relating to 1998 accounts
payable due Sanmina which were reduced to a note in January 1999. In January
2000, we defaulted on the interest payment due to Sanmina and did not make
subsequent interest and principal payments to Sanmina when due through August
2000. In August 2000, we renegotiated the terms of the note to Sanmina. Under
the current terms of the note, we are obligated to pay Sanmina (i) $150,000 on
or about August 15, 2000, which we have done, (ii) $150,000 on or before
November 15, 2000 and (iii) an amount each month equal to a percentage of the
accounts receivable that we collected in the previous calendar month, with the
percentage ranging from 0% to 5%, based upon the net amount of accounts
receivable that we collect. Any principal and accrued interest thereon remaining
on the note is due in full on January 12, 2002. The Sanmina note is secured by
our personal property and certain of our other assets. At September 30, 2000, we
owed Sanmina approximately $3.3 million in principal and interest on this note.

<PAGE> 15
We also have a note outstanding to our legal counsel for legal fees that
were incurred prior to 1999. Under the terms of the note, we are obligated to
make two semi-annual interest only payments and monthly principal and interest
payments of approximately $26,000 per month. In January 2000, we did not make
the required interest payment to our counsel and we did not make subsequent
interest and principal payments to legal counsel in 2000 when due. Subsequently,
we paid our legal counsel $77,874 on the note, but continue to owe legal counsel
$83,200 in late principal and interest payments. We have agreed to pay legal
counsel a lump sum payment of approximately $50,000, which we have done, and
$20,000 each month until the note is paid in full. At September 30, 2000, we
owed our legal counsel approximately $167,000 in principal and interest on this
note.

We cannot assure you that we will be able to make the required principal
and interest payments on these notes when due. If we default on these notes, we
may lose those assets that serve as security or we may not be able to continue
to receive legal services from our attorneys and we could be found liable to pay
immediately in one payment all of the aggregate outstanding principal and
interest on the notes.

CUSTOMERS MAY NOT BUY OUR PRODUCTS DUE TO CONCERNS OVER OUR VIABILITY

Due to our recurring losses from operations and lack of cash, some
potential customers may decide not to purchase our video network system because
of concerns that we may be unable to service, enhance or upgrade the systems. If
we are not able to alleviate concerns about our long-term viability, we may not
be able to market and sell our video network system successfully and continue
operations.

WE HAVE A HISTORY OF SIGNIFICANT LOSSES AND EXPECT LOSSES TO CONTINUE

We have incurred substantial losses from operations to date and had an
accumulated deficit of $57.5 million through September 30, 2000. Our financial
statements for the year ended and as of December 31, 1999, indicate that there
is substantial doubt about our ability to continue as a going concern. We expect
to continue to lose money for the foreseeable future.

We recognized only $5.2 million in revenues during the first nine months
of 2000, recognized only $2.4 million in revenues during 1999, and recognized
only $766,000 in revenues from the sale of products during 1998. We did not
recognize any revenues in 1997. Accordingly, there is no historical basis for
you to expect that we will be able to realize operating revenues or profits in
the future. We have a limited number of orders for delivery during the remainder
of 2000, and we cannot predict with accuracy what our revenues will be in the
future. Our ability to generate sales and to recognize operating revenues in the
future will depend on a number of factors, certain of which are beyond our
control, including:

- customer acceptance of products shipped and installed to date and
in the future;

- our ability to generate new sales of products and secure customer
acceptance; and

- customer payments.

WE HAVE A LIMITED OPERATING HISTORY

Although we were incorporated in 1993, we focused on research and
development until we shipped our first commercial VidPhone system in the third
quarter of 1998. James F. Bunker, our Chairman, has been with us since July 1998
and Carl Muscari, our President and Chief Executive Officer, joined us in
September 1999. In January 2000, we hired Stephen A. LaMarche as Vice President,
Sales and Marketing. Because of our limited operating history and the relatively
short tenure of several of our key senior managers, you have limited information
on which to assess our ability to realize operating revenues or profits in the
future.

<PAGE> 16

WE MAY NOT BE ABLE TO MARKET OUR PRODUCTS EFFECTIVELY

We Are Dependent on Resellers. We distribute our products primarily
through major sellers of telephony products, system integrators and Value Added
Resellers ("VARs"). Currently, we have agreements with approximately twelve
resellers. These arrangements are for relatively short contractual periods and
may be terminated under certain circumstances. We cannot assure you that we will
be able to maintain existing reseller relationships or establish new ones. We
compete for relationships against third-party resellers with larger,
better-established companies with substantially greater financial resources. If
we cannot maintain our current reseller relationships and cannot develop new
relationships, we may not be able to sell our video network system.

Resellers May Not Be Effective Distributors. Sales to third party
resellers are expected to generate a significant part of our future revenues.
However, we have sold only a limited number of video network systems and
components under our reseller arrangements, and to date have recognized minimal
revenues from those sales. We currently have limited orders from our resellers
for additional sales of VidPhone systems. If our resellers fail to market and
sell our products, or our products fail to become an accepted part of the
resellers' product offerings, the value of your investment could be reduced.

We May Not Be Able To Develop Direct Sales and Marketing Capabilities. We
expect to depend on the marketing efforts of our resellers for the foreseeable
future. However, we are developing a small direct marketing capability to
promote our video network system and to support our resellers. We cannot assure
you that we will be able to create awareness of, and demand for, our products
through our marketing efforts, or that the development of our direct marketing
capabilities will lead to sales of our products and services. If we cannot
successfully develop our own sales and marketing capabilities, we may not
succeed in building brand-name recognition of the VidPhone system, and we will
remain solely dependent on reseller efforts.

UNCERTAIN PROTECTION OF INTELLECTUAL PROPERTY

Our success will depend, in part, on our ability to protect our
intellectual property rights to our proprietary hardware products. Toward that
end, we rely in part on trademark, copyright and trade secret law to protect our
intellectual property in the U.S. and abroad. The degree of protection provided
by patents is uncertain and involves largely unresolved complex legal and
factual questions.

The process of seeking patent and trademark protection can be long and
expensive, and there is no assurance that any pending or future applications
will result in patents and/or registered trademarks. Further, although we have
some patents on our technology, we cannot assure you that these or any other
proprietary rights granted will provide meaningful protection or any commercial
advantage to us. We also cannot assure you that claims for infringement will not
be asserted or prosecuted against us in the future, although we are not
presently aware of any basis for claims. A number of companies have developed
and received proprietary rights to technologies that may be competitive with our
technologies. Most of these entities are larger and have significantly greater
resources than we do. Given the rapid development of technology in the
telecommunications industry, we cannot assure you that our products do not or
will not infringe upon the proprietary rights of others.

WE ARE DEPENDENT ON THIRD PARTIES FOR MANUFACTURING

We outsource the manufacturing and assembly of many of the components of
our products. We cannot assure you that our subcontractors will continue to
perform under our agreements with them or that we will be able to negotiate
continuing arrangements with these manufacturers on acceptable terms and
conditions, or at all. In particular, our failure to pay these manufacturers
when due could affect their willingness to continue working with us. If we
cannot maintain relationships with our current subcontractors, we may not be
able to find other suitable manufacturers. Any difficulties encountered with
these manufacturers could cause product defects and/or delays and cost overruns
and may cause us to be unable to fulfill orders on a timely basis. Any of these
difficulties could materially and adversely affect us.

GOVERNMENT REGULATION

Several components of our video network system, including the VidModem
and VidPhone Switch, must comply with certain regulations of the Federal
Communications Commission ("FCC"). Under FCC regulations, we will be required to
follow a verification procedure consisting of a self-certification that the
VidModem complies with applicable regulations pertaining to radio frequency
devices. A qualified, independent testing facility tested the VidModem, and it
was found to comply with FCC regulations. We obtained equipment registrations
from the FCC for certain VidPhone system components, including the VidPhone
switch that is connected to the public switched telephone network.

<PAGE> 17

Although we believe that at present the VidPhone system complies with all
applicable government regulations, future government regulations could increase
the cost of bringing products to market or adversely affect our ability to
market and sell our products and technology.
PART II

ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.

(a) Not applicable.

(b) Not applicable.

(c) On August 25, 2000, the Company completed the private placement of
1,760,000 shares of Common Stock and 1,760,000 redeemable
Warrants. The Warrants offered in the private placement entitle
the holder to purchase one share of Common Stock for an initial
exercise price of $4.00 during the period commencing February 26,
2001 and ending on June 15, 2004, subject to prior redemption. The
Company offered the Units through EarlyBirdCapital, Inc. ("EBC"),
as the exclusive placement agent, on a "best efforts, all or none"
basis. The Units were offered and sold only to persons who
qualified as "accredited investors," as defined in Rule 501(a)
under the Securities Act of 1933, as amended (the "Securities
Act"). The Company issued the securities in reliance upon the
exemption from registration provided under Rule 506 of Regulation
D of the Securities Act. The price per Unit was $1.50, and the
aggregate offering proceeds were $2.64 million. As compensation to
EBC for its services as placement agent, the Company paid EBC an
8% commission and a 2% non-accountable expense allowance. The
Company also issued to EBC an option to purchase 264,000 Units at
a price per Unit equal to $2.125. For a more complete discussion
of the Private Placement, see Note 10 - Private Placement Of
1,760,000 Units in the financial statements.

(d) Not applicable.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a) EXHIBITS.

3.1 Third Amended and Restated Certificate of Incorporation (Incorporated by
reference to Exhibit No. 3.1 forming a part of the Company's Registration
Statement on Form SB-2 (File No. 333-72429) filed with the Securities and
Exchange Commission under the Securities Act of 1933, as amended (the
"1999 Form SB-2")).

<PAGE> 18

3.2 Amended and Restated Bylaws (Incorporated by reference to Exhibit 3.2
forming a part of Amendment No. 2 to the Company's Registration Statement
on Form SB-2 (File No. 333-20625) filed with the Securities and Exchange
Commission under the Securities Act of 1933, as amended).

4.1 Form of Warrant for the Purchase of Shares of Common Stock, issued in
connection with the private placement of $2,000,000 aggregate principal
amount of Bridge Notes (Incorporated by reference to Exhibit 3.4 forming
a part of the Company's Registration statement on Form SB-2 (File No.
333-20625) filed with the Securities and Exchange Commission under the
Securities Act of 1933, as amended).

4.1 Form of Warrant to Purchase Common Stock of the Company, issued in
connection with the private placement of units in June 1995 and August
1996 (Incorporated by reference to Exhibit 3.5 forming a part of the
Company's Registration Statement on Form SB-2 (File No. 333-20625) filed
with the Securities and Exchange Commission under the Securities Act of
1933, as amended).

4.2 Form of Warrants for the Purchase of 100,000 Shares of Common Stock, $.01
par value per share, issued in connection with the private placement of
Series A Convertible Preferred Stock and warrants in December 1996 and
January 1997 (Incorporated by reference to Exhibit 3.7 forming a part of
the Company's Registration Statement on Form SB-2 (File No. 333-20625)
filed with the Securities and Exchange Commission under the Securities
Act of 1933, as amended).

4.3 Form of Option for the Purchase of 180,000 shares of Common Stock issued
to Barington Capital Group, L.P. (Incorporated by reference to Exhibit
3.8 forming a part of the Company's Registration Statement on Form SB-2
(File No. 333-20625) filed with the Securities and Exchange Commission
under the Securities Act of 1933, as amended).

4.4 Form of Stock Option Agreement, dated December 18, 1997, by and between
the Company and Barington Capital Group, L.P. (Incorporated by reference
to Exhibit 10.8 forming a part of the Company's Annual Report on Form
10-KSB for the year ended December 31, 1997).

4.5 Specimen certificate evidencing shares of Common Stock of the Company
(Incorporated by reference to Exhibit 4.5 forming a part of the 1999 Form
SB-2).

4.6 Form of Warrant issued in connection with the Series B 5% Cumulative
Convertible Preferred Stock of the Registrant (Incorporated by reference
to Exhibit 4.11 forming a part of the 1998 S-3).

4.7 Senior Note issued to Sanmina Corporation by the Registrant with a
principal amount of $4,300,000. (Incorporated by reference to Exhibit
4.10 forming a part of the Registrant's Annual Report on Form 10-KSB for
the year ended December 31, 1998 (the "1998 Form 10-KSB").

4.8 Note issued to Shaw Pittman Potts & Trowbridge by the Registrant with a
principal amount of $400,000. (Incorporated by reference to Exhibit 4.11
forming a part of the 1998 Form 10-KSB).

4.9 Form of Warrant for the purchase of 275,000 shares of common stock,
issued to Sanmina Corporation. (Incorporated by reference to Exhibit 4.12
forming a part of the 1998 Form 10-KSB).

4.10 Form of Warrant for the purchase of 40,000 shares of common stock, issued
to Shaw Pittman Potts & Trowbridge. (Incorporated by reference to Exhibit
4.13 forming a part of the 1998 Form 10-KSB).

10.1 1994 Stock Option Plan (Incorporated by reference to Exhibit 10.1 forming
a part of the Company's Registration Statement on Form SB-2 (File No.
333-20625) filed with the Securities and Exchange Commission under the
Securities Act of 1933, as amended).

10.2 1996 Stock Incentive Plan (Incorporated by reference to Exhibit No. 10.2
forming a part of the Company's Registration Statement on Form SB-2 (File
No. 333-20625) filed with the Securities and Exchange Commission under
the Securities Act of 1933, as amended).

10.3 Voting Agreement, dated December 19, 1996, by and among the Company,
Steven A. Rogers, Applewood Associates, L.P. and Acorn Technology
Partners, L.P. (Incorporated by reference to Exhibit No. 10.7 forming a
part of Amendment No. 2 to the
<PAGE> 19
Company's Registration Statement on Form SB-2 (File No. 333-20625) filed
with the Securities and Exchange Commission under the Securities Act of
1933, as amended).

10.4 Agency Agreement, dated as of January 25, 1999, between Southeast
Research and the Registrant (Incorporated by reference to Exhibit 10.11
forming a part of the 1999 Form SB-2).

10.5 Form of Subscription Agreement, dated January 25, 1999, between
Registrant and certain Investors (Incorporated by reference to Exhibit
10.12 forming a part of the 1999 Form SB-2.)

10.6 Employment Agreement, dated July 13, 1998, between the Registrant and
James F. Bunker (Incorporated by reference to Exhibit 10.13 forming a
part of the 1999 Form SB-2).

10.7 Letter Agreement dated January 12, 1999 between the Registrant and
Sanmina Corporation (Incorporated by reference to Exhibit 10.15 to the
1999 Form 10-KSB).

10.8 Letter Agreement dated January 21, 1999 between the Registrant and Shaw
Pittman Potts & Trowbridge (Incorporated by reference to Exhibit 10.16 to
the 1999 Form 10-KSB).

10.9 Form of letter agreement between the Registrant and the holders of the
Series B 5% Cumulative Convertible Preferred Stock (Incorporated by
reference to Exhibit 10.17 to the 1999 Form 10-KSB).

10.10 Form of Agency Agreement dated August 2000 by and between the Registrant
and EarlyBirdCapital, Inc. (Incorporated by reference to Exhibit 4.0 to
the Registrant's Current Report on Form 8-K dated August 25, 2000 and
filed with the Securities and Exchange Commission on August 28, 2000
under the Securities Exchange Act of 1934, as amended (the "August 2000
8-K")).

10.11 Form of Subscription Agreement/Investor Information Statement dated
August 2000 by and among the Registrant and certain Investors
(Incorporated by reference to Exhibit 4.1 to the August 2000 8-K).

10.12 Form of Escrow Agreement dated August 2000 by and among the Registrant,
EarlyBirdCapital, Inc. and Continental Stock Transfer & Trust Company
(Incorporated by reference to Exhibit 4.3 to the August 2000 8-K).

11 Statement of Computation of Earnings Per Share.

27.1 Financial Data Schedule.

(b) REPORTS ON FORM 8-K DURING THE QUARTER ENDED SEPTEMBER 30, 2000.

Current Report of Form 8-K dated August 25, 2000 and filed on August 28,
2000 under Item 5 (Other Events) reporting the private placement of
1,760,000 Units.

Current Report of Form 8-K dated August 25, 2000 and filed on September
1, 2000 under Item 5 (Other Events) and Item 7 (Financial Statements)
including the pro forma balance sheet giving effect to the private
placement of 1,760,000 Units.

<PAGE> 20

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, as amended,
the Registrant has duly caused this Report to be signed on its behalf by the
undersigned, thereunto duly authorized.

Video Network Communications, Inc.

By: /s/ CARL MUSCARI
-----------------------------------------
Carl Muscari
President and Chief Executive Officer
(duly authorized executive officer)

/s/ ROBERT H. EMERY
-----------------------------------------
Robert H. Emery
Chief Financial Officer
Vice President, Administration
(principal financial officer)

November 14, 2000