-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, BUW4+ooyulayXdowT/RVMpKxyuigTdZ9n2SsThLU9WOYtl/9xXIx2V37HloJxw12 S1fUEqlkmfW1J86VfAkGbw== 0000950135-97-001517.txt : 19970401 0000950135-97-001517.hdr.sgml : 19970401 ACCESSION NUMBER: 0000950135-97-001517 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 19961231 FILED AS OF DATE: 19970331 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: VIDEOSERVER INC CENTRAL INDEX KEY: 0000943894 STANDARD INDUSTRIAL CLASSIFICATION: COMPUTER COMMUNICATIONS EQUIPMENT [3576] IRS NUMBER: 043114212 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-25882 FILM NUMBER: 97569184 BUSINESS ADDRESS: STREET 1: NORHTWEST PARK STREET 2: 63 THIRD AVE CITY: BURLINGTON STATE: MA ZIP: 01803 BUSINESS PHONE: 6178632300 MAIL ADDRESS: STREET 1: NORTHWEST PARK STREET 2: 63 THIRD AVE CITY: BURLINGTON STATE: MA ZIP: 01803 10-K 1 VIDEOSERVER 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE YEAR ENDED DECEMBER 31, 1996 COMMISSION FILE NUMBER 0-25882 VIDEOSERVER, INC. (Exact name of registrant as specified in its charter) DELAWARE 04-3114212 (State or other jurisdiction of incorporation (IRS Employer Identification No.) or organization) 63 THIRD AVENUE, BURLINGTON, MASSACHUSETTS 01803 (Address of principal executive offices, including Zip Code) (617) 229-2000 (Registrant's telephone number, including area code) Securities Registered Pursuant to Section 12(b) of the Act: None Securities Registered Pursuant to Section 12(g) of the Act: Common Stock $.01 par value Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [x] No[ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] The aggregate market value of voting stock held by non-affiliates of the registrant as of March 7, 1997 was $290,511,143 (based on the last reported sale price on the Nasdaq National Market on that date). The number of shares outstanding of the registrant's Common Stock as of March 7, 1997 was 12,641,004. DOCUMENTS INCORPORATED BY REFERENCE 1. Portions of the definitive Proxy Statement to be delivered to Shareholders in connection with the Annual Meeting of Shareholders to be held May 14, 1997 are incorporated by reference herein. 2. Portions of the 1996 Annual Report to Shareholders are incorporated by reference herein. 3. Portions of the registrant's Registration Statement on Form S-1 (Registration No. 33-91132) are incorporated by reference herein. 2 VIDEOSERVER, INC. 1996 FORM 10-K ANNUAL REPORT TABLE OF CONTENTS
PAGE ---- PART I Item 1. Business ............................................................... 3 Item 2. Description of Property ................................................ 13 Item 3. Legal Proceedings ...................................................... 13 Item 4. Submission of Matters to a Vote of Security Holders .................... 13 PART II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters... 14 Item 6. Selected Financial Data ................................................ 14 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations .......................................................... 14 Item 8. Financial Statements and Supplementary Data ............................ 14 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure ................................. 14 PART III Item 10. Directors and Executive Officers of the Registrant ..................... 15 Item 11. Executive Compensation ................................................. 15 Item 12. Security Ownership of Certain Beneficial Owners and Management ......... 15 Item 13. Certain Relationships and Related Transactions ......................... 15 PART IV Item 14. Exhibits, Financial Statements Schedules and Reports on Form 8-K ....... 16 Signatures ................................................................................ 18
This Report contains "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements are subject to certain risks and uncertainties, including without limitation those discussed in the Company's 1996 Annual Report to Shareholders in the section titled "Other factors which may affect future operations" (which section is hereby incorporated by reference herein). Such forward-looking statements speak only as of the date on which they are made, and the Company cautions readers not to place undue reliance on such statements. 2 3 PART I ITEM 1. BUSINESS VideoServer, Inc. ("VideoServer" or "the Company") is a leading supplier of networking equipment and associated software used to create multimedia conferences that connect multiple users over wide area networks and allow them to interact as a group. The Company's products, Multimedia Conference Servers (MCSs), provide multipoint conferencing, as well as applications for conference control, network management and bandwidth management. VideoServer's products enable interoperability between dissimilar communications networks, video conferencing systems and the encoding technologies used by those systems. The Company's products, which combine audio, video and data information, are positioned to become a key enabler of communications networks supporting emerging collaborative multimedia applications. VideoServer's objective is to expand its leadership position in the conferencing market by developing and supplying products that enable multipoint conferencing, whether through end-user multimedia networks or carrier-provided conferencing services. The Company provides Multimedia Conference Servers to a wide variety of technology and distribution partners, including leading videoconferencing equipment suppliers, telephone carriers, private conferencing service providers, computer companies and PBX suppliers. The Company believes that it was the largest supplier in annual shipments of multimedia conference servers in 1994, 1995, and 1996. In March 1997, the Company entered into a definitive purchase agreement with Promptus Communications to acquire certain assets comprising Promptus' network access card business, for approximately $21,000,000 in cash and stock. The transaction is expected to close in the second calendar quarter of 1997. Promptus manufactures and markets a comprehensive line of digital network access products used for a variety of applications, including videoconferencing, ISDN Internet access, remote LAN access, and high-speed file transfer. Network access technology is an important component of the Company's MCS products, and Promptus is a significant supplier to the Company. INDUSTRY BACKGROUND VIDEOCONFERENCING The multimedia conferencing market has evolved from videoconferencing. In the late 1980s, with increasing numbers of conferencing endpoints installed and customers desiring to connect multiple locations into the same conference, videoconferencing equipment suppliers introduced multipoint control units (MCUs) to transfer video and audio signals between all conference participants. However, because of the proprietary nature of the encoding used, video terminals and associated multipoint control units from different manufacturers were not interoperable. In December 1990, the International Telecommunications Union (ITU) introduced the H.320 standards for videoconferencing over switched digital circuit networks to provide a framework for equipment from different manufacturers to communicate with each other. Compatibility is particularly important for communication via these networks, since the advantage of these services is dial-up communications without regard to the type of equipment being used at the receiving ends of the transmission. In recent years, lower-priced, standards-based products emerged that have expanded the market for videoconferencing systems. Room systems that were once priced in the $100,000 to $200,000 range are now priced as low as $8,000. In addition, increasing competition between network carriers, and increasing demand for applications such as Internet access, are leading to wider availability and significantly declining costs of digital lines. With the introduction of chip sets incorporating ITU standards, a growing number of companies have entered the desktop videoconferencing market, either with stand-alone complete PC-based systems or with board sets that plug into personal computers. Companies shipping H.320 compliant desktop conferencing products include 3 4 British Telecom, Compression Labs, IBM, Intel, Olivetti, PictureTel, VTEL and VCON. The costs of such desktop conferencing products have rapidly declined with the introduction of more powerful chip sets and further miniaturization of components such as cameras and monitors. Since early 1994, desktop conferencing subsystems have dropped in price from $6,000 per seat to less than $1,500, with some products available for as low as $1,000. As with the decrease in the price of room systems, this decrease in price has fueled demand for desktop endpoints. Extending the reach of conferencing, in November 1995 the ITU introduced the H.324 standard for low bit rate video, enabling videoconferencing over analog lines using PCs or videophones. This is expected to bring conferencing capability to an entirely new segment of end users, including those in smaller businesses and homes. PC vendors such as AST, Compaq, Hewlett-Packard, IBM, Sony, and Toshiba, and modem suppliers such as Boca Research and U.S. Robotics began offering H.324 conferencing capabilities late in 1996. In May 1996, another important expansion of conferencing standards was realized with the introduction of the H.323 standard governing real-time collaboration over local area networks, intranets, and the Internet. Enabling conferencing over traditional business networks provides a foundation for the adoption of this application as a mainstream business tool. Vendors such as Intel, PictureTel, and Microsoft have announced their intention to introduce H.323 based endpoints in 1997. Each of these endpoints, whether room systems or desktop systems, require server resources to conduct a multipoint conference. A larger installed base of endpoints is expected to lead to more multipoint conferencing, and therefore to a greater demand for the Company's MCS products. COLLABORATIVE MULTIMEDIA APPLICATIONS Concurrent with advances in videoconferencing, significant investments have been made in software to extend traditional desktop computing applications into conference enabled real-time information sharing tools. Collaborative data conferencing applications are emerging that redefine the way groups can work together. With the ability to see and hear one another over telecommunications lines and share a common desktop application like a white board, spreadsheet or word-processing document, participants can share ideas and collaborate in real time to improve the work product. In response to the emerging customer demand for multimedia applications, in February 1996 the ITU extended the T.120 standards for collaborative multimedia conferencing wherein video, audio and data information can be shared between endpoints in a multipoint setting. In 1996 Microsoft bundled a standards-based realtime voice and data conferencing package, NetMeeting, into its Windows operating system. This product will provide an embedded collaborative capability for potentially millions of PC users. In addition, Intel and IBM are offering collaborative desktop applications with optional audio and video capabilities sold through retail computer channels. Fundamental to the architecture of these products is the presence of a multimedia conference server to provide the multipoint link and data distribution mechanism among all the endpoints. CARRIER-PROVIDED SERVICES The intense competition among carriers has increased the demand for technologies that allow carriers to provide additional value-added services. Multimedia conferencing technology offers such an opportunity, and carriers are initiating collaborative multimedia conferencing services that provide on-demand multipoint conferencing capability allowing users to connect their terminals to multimedia conference servers located in the carriers' central offices. 4 5 A NEW CLASS OF NETWORK EQUIPMENT These trends -- the growth in room systems and desktop videoconferencing, growth in collaborative desktop conferencing and expansion in services offered by carriers -- are driving the need for sophisticated, networked multimedia conference servers. THE VIDEOSERVER SOLUTION VideoServer was founded in 1991 to develop a new generation of networking equipment architected for the videoconferencing market as well as the emerging multimedia conferencing market. The VideoServer MCS product line is built on an industry standard hardware and software platform that combines a powerful set of real-time conferencing applications with management tools and network connectivity features that address today's customer requirements and are positioned to meet emerging requirements. These requirements include: INTEROPERABILITY. VideoServer's Multimedia Conference Servers today provide transparent interoperability among many different kinds of endpoints such as room videoconferencing systems, desktop video terminals, and regular telephones in the same conference, using combinations of voice, video, and data. In the future, this level of interworking will be expected to encompass emerging conferencing endpoint technologies such as data conferencing computers, audio-graphics systems and videophones. Similarly, interoperability must be provided between the many different brands of equipment and applications. The technology also must be able to accommodate various encoding algorithms used to compress multimedia information. The Company has expended substantial effort to make its MCS interoperable with the products of virtually all suppliers of standards-based videoconferencing terminals. In many cases this has required subtle accommodations in the MCS for the specific characteristics of each brand of endpoint due to the manufacturer's implementation of the ITU standards and product performance. When different encoding technology is employed in terminals for audio algorithms, the MCS provides the transcoding needed to deliver the audio mix to each endpoint in the proper algorithm for that endpoint. CONNECTIVITY. Conference servers must be able to provide gateways between diverse network services and between multiple carriers. While today's servers provide connectivity largely to T-1, ISDN, private digital networks, and analog voice networks, in the future, endpoints are expected to be connected to ethernet and token ring local area networks, the Internet, and to advanced networks based on ATM. In addition, as carriers add features to their networks, conference servers must be able to support them. FUNCTIONALITY. In addition to video switching and audio mixing, application features are needed to facilitate ease of operation, perform centralized processing, interconnect with traditional data network servers and deliver many new kinds of network information. These network servers will be required to scale throughout the enterprise, provide redundancy for high reliability and incorporate network management capabilities. PRODUCTS The Company provides technology advances to its OEM and carrier customers through products that incorporate rapid standards deployment, extensive feature content, scalability, network flexibility and interoperability. The Company believes that its technology leadership enables its customers to reduce their time-to-market and their own product costs, and that the Company's technology relationships with customers allow it to anticipate market requirements critical to its products. The Company's products have been designed within a scaleable, modular architecture to allow the customer to add capacity, processing power and conferencing features as the customer's network and application requirements grow. Using a common set of hardware and software building blocks, customers can choose from a wide range of product configurations that differ in capacity, price, network connectivity and features, all of which 5 6 share the same operating software user interface. The product may be configured for use in customer premises environments or may be configured with specialized packaging for use in a telephone carrier's central office setting. The MCS product line includes a number of basic platform configurations that are expanded by the customer's selection of optional processing modules and software applications. The platforms, configured for the typical end-user, range in list price from under $25,000 to more than $200,000. Each MCS configuration is built from a common set of processing modules, network interfaces, software systems and optional features. The following table lists the basic chassis configurations offered by the Company and the typical target market and application in which each is used. In this table, user capacity is a measure of the number of simultaneous conference participants that can be connected to the MCS.
MODEL CAPACITY TARGET MARKET/APPLICATION ----- -------- ------------------------- 2007 8 users Entry level Audio/Video/Data (A/V/D) multipoint for customer premises equipment (CPE) networks; distributed server 2012 16 users Mid-range CPE network central server 2020 48 users Large CPE/central office network with extensive multimedia applications CO 48 users High availability central office server
Each of these systems may be interconnected to provide support for larger conferences. The VideoServer MCS has an extensive number of available software and hardware features, some of which are listed in the following table.
APPLICATIONS DESCRIPTION ------------ ----------- CONFERENCE SERVICES AND MANAGEMENT Continuous Presence .............. Continuous viewing of multiple conference sites Multimedia Conferencing......... Simultaneous audio visual conferencing and data conferencing Reservation and Scheduling......... Schedule and manage MCS use Directory Services................. Database of potential conference participants and sites Chairperson Conference Control Management of conference activities by a selected video participant Security and Password Control...... Conference password and application security controls Accounting and Billing............. System usage tracking for service billing Voice Activated Switching.......... Dynamic switching of video presentation based on current speaker Audio Add-on....................... Conferencing module for audio-only conference participants Operator Attended Conferencing Operator interface at conference initiation
6 7
NETWORK SERVICES AND MANAGEMENT Centralized Multipoint Management Multi-MCS conference and network management package Outbound Dialing................. Optional feature for MCS dial-out capability Conference Monitor............... Real-time monitor of conference activities and status Bandwidth Management............. Bandwidth aggregation using inverse multiplexing Event Management................. System activity and alarms applications for network management Network Diagnostics.............. Network loop-back and problem isolation tool kit Premise Switching............... Adds the function of an ISDN switch
The entry level Model 2007 MCS, continuous presence, T.120 conferencing capability, operator attended conferencing features and premise switching all began shipping in 1996. The VideoServer MCS can be directly connected to public networks (either T-1 or ISDN networks, or both) or private networks. The T-1 interface can be configured as either a full or fractional T-1 (FT-1). If FT-1 service is selected, multiple FT-1 circuits may be multiplexed and delivered by the network to the MCS in a single T-1 pipe. ISDN Primary Rate Interface (PRI) support allows the MCS to cost-effectively support multiple basic rate terminal connections across a single interface. ISDN Basic Rate Interface (BRI) support offers a cost effective solution for customer premise applications not requiring PRI. The MCS supports the various ISDN network protocols used in the United States, the United Kingdom, France, Germany, Japan, Australia and the European-wide standard, and thus can be used worldwide. The Company offers add-on software to its installed base in the form of either major new software releases or unbundled software options. Customers may purchase new software releases on an as-needed basis or as part of a maintenance agreement. Unbundled software options are priced separately and are not part of maintenance agreements. MARKETS AND CUSTOMERS VideoServer markets its products to Original Equipment Manufacturers (OEMs), which generally resell the Company's products to end-users, and to service providers, including public and private telephone carriers, which generally offer conferencing services based on the Company's products. This distribution strategy focuses on four types of customers: conferencing equipment manufacturers and resellers, telephone companies as conferencing service providers, computer systems and workstation companies, and PBX and network equipment suppliers. Traditional videoconferencing equipment suppliers have historically represented the primary market for delivering conferencing equipment to users. The Company has relationships with most of the significant videoconferencing suppliers around the world, including Compression Labs, Inc. (CLI) and PictureTel Corporation in the United States, and British Telecom, GPT Video Systems (a division of the UK-based GPT Limited), and Societe Anonyme de Telecommunications (a division of the French-based Sagem Group), three of the leading European suppliers of conferencing products. Each is offering the Company's products to its customers under private label. The Company also has agreements with leading Japanese manufacturers, including Sony Corporation, which resells the products globally, as well as NEC America Inc., Fujitsu Business Communications Systems, Inc. and Panasonic Corporation, which remarket the products primarily in English-speaking countries worldwide. 7 8 Telecommunication service providers are increasingly seeking to differentiate themselves by offering multimedia conferencing services to customers who desire on-demand conferencing capability without installing their own conference servers. The Company markets its products and services directly to public and private telecommunications service providers, including Interexchange Carriers (IXCs) such as AT&T, MCI and Sprint, Regional Bell Operating Companies (RBOCs) such as BellSouth and Southwestern Bell, a number of private conferencing service providers in the U.S. such as Link VTC and 1-800-Video On, and to international Post Telephone and Telegraph companies (PTTs) in Europe and Asia, such as British Telecom, Deutsche Telekom, France Telecom, and NTT. As conferencing moves to desktop computing, computer systems companies are beginning to address the emerging collaborative multimedia market. The Company believes these companies view multimedia applications as a strategic technology thrust that will fuel demand for computing resources and network bandwidth. Since late 1993, Intel Corporation and VideoServer have participated in joint development and marketing of products for the conferencing market. In late 1996, the Company and Compaq Computer announced their intention to work closely with Compaq's value-added resellers in North America to incorporate VideoServer technology into Compaq servers. With the continued expansion of standards, network equipment and PBX companies, whose products form the data and telecommunications backbone of the enterprise network, are beginning to incorporate conferencing technology into their product lines. In late 1996, the Company announced an OEM arrangement with Cisco Systems, initially under which the Company will provide standards-based conferencing gateways to Cisco for integration into certain of its enterprise routers. Additionally, major PBX companies such as Nortel and Siemens/Rolm, who are expanding their traditional audio-based offerings to include video and data capabilities, have begun to resell the Company's MCS products. The Company's agreements with its customers generally do not include minimum purchase requirements and are non-exclusive. In 1994, CLI and British Telecom accounted for 55% and 12% of net sales. In 1995, CLI, PictureTel, who became a customer during 1995, and BellSouth accounted for 23%, 19% and 18% of net sales. In 1996, PictureTel and CLI accounted for 43% and 10% of net sales. Sales to international customers accounted for 29%, 25% and 32% of the Company's net sales for the years ended December 31, 1994, 1995 and 1996. VideoServer conducts its sales and marketing activities from its principal offices in Burlington, Massachusetts, as well as from four other North American sales offices and its European headquarters located in the United Kingdom. RESEARCH AND PRODUCT DEVELOPMENT The Company believes that its future success depends on its ability to continue to enhance and expand its existing products and to develop new products which maintain its technology leadership. VideoServer has invested, and expects to continue to invest heavily, in the development of products and core technologies. Extensive product development input is obtained from OEM partners, from service providers, from end users, and through the Company's active participation and leadership in industry groups responsible for establishing technical standards such as the ITU and the IMTC . Since its founding, the Company's research and development effort has been directed towards the development of standards-based conference server technology. In concert with the evolution of industry standards, these efforts currently are focused on extending the breadth of network services supported beyond switched digital services to include local area networks, corporate intranets, the Internet, and ATM. This includes the development of multipoint products for particular network platforms and gateway products to provide interoperability between dissimilar network types. Development is also underway to support emerging data conferencing applications, provide additional conferencing management capabilities including enhanced user interfaces, and to add higher capacities to the product family. The Company is extending and accelerating its 8 9 efforts through development relationships with its customers. The Company receives funding under certain of these arrangements which, when earned, is recorded as a reduction of research and development expense in the Company's financial statements. At December 31, 1996, VideoServer's research and development staff consisted of 77 employees, including 65 software engineers and 12 hardware engineers. The Company's net research and development expenditures were $3.3 million, $5.3 million and $7.8 million in 1994, 1995 and 1996, representing 21%, 19% and 16% of net sales in those years. Development funding from customers of $340,000, $1,000,000 and $1,150,000 was recorded as a reduction of research and development costs in 1994, 1995 and 1996. All software development costs have been expensed as incurred because costs eligible for capitalization have not been material to date. In January 1997, the Company began to establish an international development operation in the United Kingdom. CUSTOMER SUPPORT AND SERVICE The Company provides technical support and services to its resellers and customers. A high level of continuing service and support is critical to the Company's objective of developing long-term relationships with customers. The Company's resellers install, maintain and provide on-site and headquarters-level technical support of products to their end-user customers, and VideoServer provides comprehensive problem management, training, diagnostic tools, repair services and spare parts to facilitate and supplement these efforts. The Company installs, maintains and directly supports products sold to its direct customers. The Company offers a technical support hotline to its resellers and customers. Network support engineers answer technical support calls placed by the support engineers of the Company's resellers and by its direct customers. The engineers generally provide same-day responses to questions that cannot be resolved during the initial call. The products are designed with advanced remote diagnostic capabilities that permit a reseller's or the Company's support engineers to immediately begin the process of diagnosing any problems in the field, thereby reducing both response time and cost. When necessary, however, support engineers are dispatched to the customer's facility. The Company warrants its software products for 90 days. During this 90-day warranty period, the Company will investigate all reported problems and will follow escalation procedures to provide resolution. The Company warrants its hardware products for 12 months. During this warranty period, the Company will repair or replace any failed hardware component. The Company also offers post-warranty support programs ranging from services on a time-and-materials basis to full-service contracts on a 24-hour, 7-days-a-week basis, and a full suite of training courses. MANUFACTURING The Company's manufacturing operations consist primarily of materials planning and procurement, quality control of materials, components and subassemblies and final product configuration and testing. The Company designs the significant hardware subassemblies for its products and uses independent third-party contract assembly companies to perform printed circuit board assembly. The Company configures and tests the hardware and software in combinations to meet a wide variety of customer requirements. The Company uses automated testing equipment, "burn-in" procedures and comprehensive inspection and statistical process control testing intended to assure the quality and reliability of its products. The Company has received the International Standard Organization (ISO) 9002 certification for quality. 9 10 Although the Company generally uses standard parts and components for its products, certain components, including key digital signal processors from Texas Instruments, are presently available only from single sources or from limited sources. The Company has no supply commitments from its vendors, including Texas Instruments, and generally purchases components on a purchase order basis as opposed to entering into long term procurement agreements with vendors. The Company has been able to obtain adequate supplies of components in a timely manner from current vendors, or when necessary to meet production needs, from alternate vendors. The Company believes that, for the Texas Instruments digital signal processors in particular, alternative sources of supply would be difficult to develop over a short period of time and an interruption in supply or a significant increase in the price of these components would adversely affect the Company's operating results and business. Because of the generally short cycle between order and shipment and because the majority of the Company's sales in each quarter results from orders booked in that quarter, the Company does not believe that its backlog as of any particular date is indicative of future sales levels. COMPETITION The market for communications products is intensely competitive and is subject to rapid technological change. Although to date the Company has experienced limited competition from products with comparable capabilities, the Company expects competition to increase significantly in the future. Currently, the Company's principal competition from producers of multipoint control units comes from Lucent Technologies, and to a lesser extent from VTEL Corporation. Other companies such as Multilink, Teleos (a division of Madge Networks) Accord, Databeam, and Outreach, have introduced or announced their intention to introduce products which could be competitive with the Company's products. Furthermore, PictureTel Corporation, currently the Company's largest customer, and Radvision have announced their intention to introduce products related to the new H.323 standards which may be competitive with products the Company currently has under development, and others are expected to enter the H.323 conferencing market. This additional competition could adversely affect the Company's sales and profitability through price reductions and loss of market share. In particular, should one or more of the Company's current customers, including videoconferencing equipment suppliers, telecommunications carriers or traditional network equipment vendors choose to provide or distribute competitive products (including their own products) and services, the Company's business could be materially adversely affected. Many of the Company's current and potential competitors have substantially greater financial, marketing and technical resources than the Company. The principal competitive factors in the market for multimedia conference servers are, and are expected to continue to be, breadth of network services supported, conformance to industry standards, price per port, performance, network management capabilities, transcoding capabilities, reliability and customer support. While the Company believes it presently competes favorably in all of these areas, there can be no assurance that it will continue to do so. PROPRIETARY RIGHTS While the Company has applied for several patents, it currently holds only one U.S. patent relating to its existing products, and relies on a combination of contractual rights, trade secrets and copyright laws to establish and protect its intellectual property rights. The Company believes that, because of the rapid pace of technological change in the data communications and telecommunications industries, the intellectual property protection for its products is a less significant factor in the Company's success than the knowledge, abilities and experience of the Company's employees, the frequency of its product enhancements, its relationships with its partners, the effectiveness of its marketing activities, and the timeliness and quality of its support services. 10 11 The Company is subject to the risk of adverse claims and litigation alleging infringement of the intellectual property rights of others. In December 1994, the Company settled a patent infringement litigation brought against it by Datapoint Corporation (Datapoint) for a cash payment by the Company of $500,000. There can be no assurance that additional third parties will not assert claims against the Company in the future with respect to the Company's current or future products or that any such claims would not require the Company to enter into license arrangements or result in protracted and costly litigation, regardless of the merits of such claims. No assurance can be given that the Company would prevail with respect to any such claim, or that a license to third-party rights, if needed, would be available on acceptable terms. Patent infringement litigation still exists between Datapoint and two of the Company's largest customers. In addition, Datapoint has written inquiry letters to a significant number of others in the videoconferencing market offering to sell them nonexclusive licenses under certain Datapoint patents in the videoconferencing field (the Datapoint Patents). While the validity or scope of the Datapoint Patents has not been adjudicated by a court, Datapoint has, in effect, asserted that the Datapoint Patents cover certain aspects of multipoint videoconferencing operations involving terminals and multipoint control units, including the Company's MCSs. As a result of the December 1994 settlement, the Company obtained a nonexclusive license for its MCS under the Datapoint Patents, which license includes limited rights for the products and services of the Company's customers. However, the conferencing market in general, and the Company's future sales and operating results in particular, could be adversely affected as a result of ongoing uncertainties regarding the Datapoint Patents. Such uncertainty, and any related potential impact, is likely to exist until the validity of the patents is adjudicated. EMPLOYEES At December 31, 1996, the Company employed a total of 193 persons, including 77 in research and development, 73 in sales, marketing and customer support, 24 in manufacturing and 19 in finance and administration. Thirteen of the Company's employees were located in the United Kingdom and the remainder were located in the United States. None of the Company's employees are represented by a labor organization and the Company believes that its relations with employees are good. Competition for qualified personnel in the computer networking and communications industry is intense. VideoServer believes that its future success will depend on its continued ability to attract and retain qualified personnel. EXECUTIVE OFFICERS OF THE REGISTRANT The executive officers of the Company are:
NAME AGE POSITION ---- --- -------- Robert L. Castle. . . . . . . . . . 47 President, Chief Executive Officer and Director Jules L. DeVigne. . . . . . . . . 57 Vice President of Worldwide Sales Rubin Gruber. . . . . . . . . . . . 52 Vice President of Business Development, and Director Derek M. James. . . . . . . . . . 54 Chief Technology Officer John Jones. . . . . . . . . . . . . . 49 Vice President of Customer Service and Support Walter A. Jones. . . . . . . . . . . 49 Vice President of Research and Development Stephen J. Nill. . . . . . . . . . . 45 Vice President of Finance and Chief Financial Officer, Treasurer, and Secretary John E. O'Neil. . . . . . . . . . . 41 Vice President of Marketing Frank T. Winiarski. . . . . . . . 54 Vice President of Manufacturing
- -------------------- 11 12 Robert L. Castle has served as President and Chief Executive Officer of the Company since March 1993, and as a Director since March 1992. From February 1992 until March 1993, he served as President and Chief Operating Officer. Prior to joining the Company, Mr. Castle was employed for eight years at FileNet Corporation, a supplier of document imaging equipment, in various positions including Senior Vice President of Marketing from October 1990 to February 1992 and Vice President of Marketing from December 1987 to October 1990. Previously, Mr. Castle held marketing and general management positions at Basic Four Corp., a developer of software applications, and Sycor, Inc., a developer and manufacturer of data-entry terminals. Jules L. DeVigne has served as Vice President of Worldwide Sales since October 1992. He served as President of Innovative Technology, Inc., a manufacturer of interactive voice response systems, from March 1990 until June 1992, and served as Senior Vice President of Sales and Marketing of Netrix Corporation, a manufacturer of wide area networks, from February 1989 until March 1990. Previously, Mr. DeVigne held various sales and executive management positions with AT&T Paradyne Corporation, a manufacturer of modems and wide area network products, and International Business Machines Corporation. Rubin Gruber was a founder of the Company and has served as a Director since inception of the Company and as Vice President of Business Development since February 1992. Mr. Gruber served as President of the Company from the Company's inception until February 1992. He was a founder and served as President of Span Communications, Inc., a development stage company, from August 1989 to August 1990. Previously, Mr. Gruber was a founder and served as President of both Cambridge Telecommunications, Inc., a manufacturer of networking equipment, and Davox Corporation, a developer of terminals supporting concurrent voice and data applications, and as a Senior Vice President of Bolt, Beranek and Newman Communications Corporation, a manufacturer of data communications equipment. Derek M. James was a founder of the Company, has served as Vice President of Engineering since the Company's inception, and currently serves as the Chief Technology Officer. He was Vice President of Engineering of Span Communications, Inc., a development stage company, and an independent consultant from August 1989 until August 1990, and was Vice President of Product Development for Bolt, Beranek and Newman Communications Corporation, a manufacturer of data communications equipment, from August 1987 until August 1989. Previously, Mr. James served as Vice President of Engineering of Decision Data, Inc., a manufacturer of terminals and communications equipment, and Engineering Director at Raytheon Data Systems, a manufacturer of data communications equipment. John Jones has served as Vice President of Customer Service since October 1995. He served as Director and General Manager of the Core Products Group at Kronos, Inc., a manufacturer of time and attendance data collection systems from April 1992 until October 1995, and served as General Manager of the Industrial Applications Division of ModComp, an AEG Company, a manufacturer of mini-computer systems and applications from June, 1989 until April 1992. Previously, Mr. Jones held various technical and marketing positions with Apollo computer, a manufacturer of technical workstations, and Data General Corporation. Walter A. Jones has served as Vice President of Research and Development since September, 1996. He served as Director of Engineering for the Isis Distributed Systems Division at Stratus Computer, Inc., a manufacturer of fault tolerant servers, from January 1994 until September 1996, and served as Vice President of Engineering at Coral Networks, a manufacturer of high performance, multi-protocol, network routers from April, 1992 until January 1994. Previously, Mr. Jones served as Vice President of Engineering at Prime Computer, a manufacturer of minicomputers and network servers. Stephen J. Nill has served as Vice President of Finance and Chief Financial Officer since June 1994, and as Treasurer and Secretary since June 1995. He served at Lotus Development Corporation, a software supplier, as Director of Finance and Operations, Consulting Services Group, from October 1993 until May 1994, as Director of Worldwide Finance and Administration Systems from April 1993 until September 1993 and as Corporate 12 13 Controller and Chief Accounting Officer from January 1989 until March 1993. Previously, Mr. Nill held various financial positions with Computervision, Inc., a supplier of workstation-based software, International Business Machines Corporation and Arthur Andersen & Co. John E. O'Neil has served as Vice President of Marketing since February 1995. He served at Xylogics, Inc., a computer networking company, as Vice President of Marketing from January 1992 until February 1995, and as Director of Network Products Marketing from December 1988 until January 1992. Previously, Mr. O'Neil held software engineering positions at Encore Computer, Inc., a manufacturer of multiprocessor computer systems, and Datatrol, Inc., a supplier of transaction-processing terminals. Frank T. Winiarski has served as Vice President of Manufacturing since June 1992. He served as Vice President of Manufacturing at Synernetics, a supplier of local area networks, from July 1990 until May 1992, and as Executive Vice President of The Lambda Group, a network hardware and software consulting firm, from October 1989 until June 1990. Previously, Mr. Winiarski was Vice President of Operations at Ashton-Tate Corporation, a software supplier, and held various positions with Digital Equipment Corporation, a manufacturer of computer equipment. Officers are elected on an annual basis to serve at the discretion of the Board of Directors. ITEM 2. DESCRIPTION OF PROPERTY At December 31, 1996, the Company's principal offices were located in Burlington, Massachusetts, in a 60,000 square foot facility which the Company leases under agreements that expire in February 1999, with an option to renew for two years. In March 1997, the Company relocated its European headquarters to a 4,500 square foot facility in Bracknell, United Kingdom, which the company leases under a three year lease expiring in February, 2000. Also in March, 1997, the Company entered into a lease for a 3,100 square foot facility in Dunwoodie, Georgia, which will serve as a sales office, under a five year lease which expires in February 2002. The Company also leases, on a short-term basis, various sales office space in San Francisco, California; Reston, Virginia; and Dallas, Texas. The Company believes its existing and pending facilities are adequate for its current needs and that suitable additional or substitute space will be available as needed. ITEM 3. LEGAL PROCEEDINGS The Company is not currently involved in any legal proceedings that it believes could have, either individually or in the aggregate, a material adverse effect on its business or financial condition. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of security holders during the last quarter of the fiscal year ended December 31, 1996. 13 14 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. The information required by this item may be found in the section captioned "Quarterly Financial Information (unaudited)" appearing in the 1996 Annual Report to Shareholders, and is incorporated herein by reference.(1) As of March 7, 1997, the Company had approximately 95 shareholders of record. This does not reflect persons or entities who hold their stock in nominee or "street" name through various brokerage firms. The Company has not paid dividends on its Common Stock. The Company anticipates it will continue to reinvest earnings to finance future growth, and therefore does not intend to pay dividends in the foreseeable future. ITEM 6. SELECTED FINANCIAL DATA Information required by this item may be found in the section captioned "Financial Highlights" appearing in the 1996 Annual Report to Shareholders, and is incorporated herein by reference.(1) ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. Information required by this item may be found in the section captioned "Management's Discussion and Analysis of Financial Condition and Results of Operations" appearing in the 1996 Annual Report to Shareholders, and is incorporated herein by reference.(1) ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. Information with respect to this item may be found in the Financial Section of the 1996 Annual Report to Shareholders on pages 22 through 32, and is incorporated herein by reference.(1) ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. None. ---------------------------------------------------------------------------- (1) The Company's 1996 Annual Report to Shareholders is not to be deemed filed as part of this report except for those parts thereof specifically incorporated by reference. 14 15 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. Information with respect to Directors and compliance with Section 16(a) of the Securities Exchange Act may be found in the sections captioned "Proposal No. 1 - Election of Director" and "Section 16(a) - Beneficial Ownership Reporting Compliance" appearing in the definitive Proxy Statement to be delivered to shareholders in connection with the Annual Meeting of Shareholders to be held on May 14, 1997. Such information is incorporated herein by reference. Information with respect to Executive Officers may be found under the section captioned "Executive Officers of the Registrant" in Part I. ITEM 11. EXECUTIVE COMPENSATION. The information required with respect to this item may be found in the sections captioned "Executive Compensation and Other Information Concerning Directors and Executive Officers" appearing in the definitive Proxy Statement to be delivered to shareholders in connection with the Annual Meeting of Shareholders to be held on May 14, 1997. Such information is incorporated herein by reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. The information required with respect to this item may be found in the section captioned "Security Ownership of Certain Beneficial Owners and Management" appearing in the definitive Proxy Statement to be delivered to shareholders in connection with the Annual Meeting of Shareholders to be held on May 14, 1997. Such information is incorporated herein by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. The information required with respect to this item may be found in the section captioned "Certain Transactions" appearing in the definitive Proxy Statement to be delivered to shareholders in connection with the Annual Meeting of Shareholders to be held on May 14, 1997. Such information is incorporated herein by reference. 15 16 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K. (a) DOCUMENTS FILED AS PART OF FORM 10-K 1. CONSOLIDATED FINANCIAL STATEMENTS. The following consolidated financial statements and supplementary data are included in Part II Item 8 filed as part of this report: - Consolidated Balance Sheets as of December 31, 1995 and 1996 - Consolidated Statements of Income for the years ended December 31, 1994, 1995 and 1996 - Consolidated Statements of Stockholders' Equity for the years ended December 31, 1994, 1995 and 1996 - Consolidated Statements of Cash Flows for the years ended December 31, 1994, 1995 and 1996 - Notes to Consolidated Financial Statements - Quarterly Financial Information (unaudited) - Report of Independent Auditors 2. FINANCIAL STATEMENT SCHEDULE. - Schedule II - Valuation and Qualifying Accounts Schedules not listed above have been omitted because they are not applicable, not required or the information required is shown in the consolidated financial statements or the notes thereto. 3. LIST OF EXHIBITS. Exhibit Number Description of Exhibit 3.1* Form of Amended and Restated Certificate of Incorporation of the Registrant. 3.2* Amended and Restated By-Laws of the Registrant. 4.1* Specimen Stock Certificate. 10.1* Amended and Restated 1991 Stock Incentive Plan of the Registrant. 10.2* Amended and Restated 1994 Director Option Plan of the Registrant. 10.3* 1995 Employee Stock Purchase Plan of the Registrant. 10.4* Sublease for 5 Forbes Road, Second Floor, Lexington, MA, dated as of May 1, 1991 between the Registrant and Unitrode Corporation. 10.5* Lease for 5 Forbes Road, First Floor, Lexington, MA, dated as of June 22, 1993 between the Registrant and the Trustees of Lexington Development Company Trust. 10.6* First Amendment to Lease for 5 Forbes Road, Lexington, MA, dated as of December 20, 1994 between the Registrant and the Trustees of Lexington Development Company Trust. 10.7* Unit Purchase Agreement, dated May 22, 1992 between the Registrant and Edward Botwinick. 16 17 10.8* Series B Convertible Preferred Stock Agreement dated as of August 10, 1992 and October 29, 1992 between the Registrant and the purchasers named therein. 10.9* Series C Convertible Preferred Stock Agreement dated as of March 28, 1994, May 16, 1994, and November 9, 1994 between the Registrant and the purchasers named therein. 10.10* Noncompetition Agreement dated February 2, 1992 between the Registrant and Robert Castle. 10.11* Noncompetition Agreement dated March 28, 1991 between the Registrant and Rubin Gruber. 10.12* Noncompetition Agreement dated March 28, 1991 between the Registrant and Derek M. James. 10.13* Purchase and OEM License Agreement dated January 8, 1993 between the Registrant and Compression Labs, Inc. 10.14* WorldWorx Personal Conferencing Service Multipoint Control Unit Agreement dated February 15, 1995 between the Registrant and AT&T Corp. 10.15* License Agreement dated January 2, 1995 between the Registrant and Datapoint Corporation. 10.16* Letter Agreement dated December 31, 1994 between the Registrant and Fleet Bank of Massachusetts, N.A. 10.17** Lease for 63 Third Avenue, Burlington, MA dated as of March 1, 1996 between the Registrant and the Trustees of Building #27 Associates. 11.1 Computation of Per Share Earnings. 13.1 Financial Section of the 1996 Annual Report to Shareholders, pages 17 through 32. 21.1* Subsidiaries of the Registrant. 23.1 Consent of Ernst & Young LLP. (Note: The Company agrees to furnish to the Securities and Exchange Commission upon request a copy of any instrument with respect to long-term debt of the Company or any of its subsidiaries which is not filed herewith or listed herein since it relates to outstanding debt in an amount not greater than 10% of the total assets of the Company and its subsidiaries on a consolidated basis.) * Incorporated by reference from the Company's Registration Statement on Form S-1. ** Included as part of the Company's Form 10-K filed with the Securities and Exchange Commission for the year ended December 31, 1995. (b) REPORTS ON FORM 8-K The Company filed no reports on Form 8-K during the quarter ended December 31, 1996. 17 18 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. VIDEOSERVER, INC. /s/ Robert L. Castle ------------------------------------- Robert L. Castle President and Chief Executive Officer (Principal Executive Officer) Date: March 28, 1997 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on its behalf of the registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE - --------- ----- ---- /s/ Robert L. Castle President, Chief Executive Officer, March 28, 1997 - --------------------- (Principal Executive Officer) Robert L. Castle and Director /s/ Rubin Gruber Vice President of Business March 28, 1997 - --------------------- Development and Director Rubin Gruber /s/ Stephen J. Nill Vice President and March 28, 1997 - --------------------- Chief Financial Officer Stephen J. Nill (Principal Financial and Accounting Officer) /s/ Paul J. Ferri Director March 28, 1997 - --------------------- Paul J. Ferri /s/ William E. Foster Director March 28, 1997 - --------------------- William E. Foster /s/ Steven C. Walske Director March 28, 1997 - --------------------- Steven C. Walske
18 19 VIDEOSERVER, INC. SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
Column A - Description Column B Column C - Additions Column D Column E - ---------------------- -------- -------------------- --------- -------- Deductions - Balance At Charged to Charged to Uncollectable Balance at Beginning Of Costs and Other Accounts End of Period Allowance for Doubtful Accounts Period Expenses Accounts Written Off - ------------------------------------ -------------- --------------- --------------- --------------- --------------- Year Ended December 31, 1996 $650,313 $427,140 $- $- $1,077,453 Year Ended December 31, 1995 118,509 531,804 - - 650,313 Year Ended December 31, 1994 6,000 112,509 - - 118,509
19 EX-11.1 2 COMPUTATION OF EARNINGS 1 EXHIBIT 11.1 VIDEOSERVER, INC. COMPUTATION OF PER SHARE EARNINGS
YEAR ENDED DECEMBER 31, 1994 1995 1996 ---- ---- ---- Net income $ 1,072,000 $ 4,687,000 $10,194,000 =========== =========== =========== Primary net income per common share: Weighted average common shares outstanding during the period 9,502,316 11,285,940 12,497,360 Weighted average common equivalent shares resulting from stock options 236,043 710,348 813,433 Dilutive effect of common and common equivalent shares issued subsequent to April 12, 1994 (1) 534,183 69,073 ----------- ----------- ----------- 10,272,542 12,065,361 13,310,793 =========== =========== =========== Primary net income per share $ 0.10 $ 0.39 $ 0.77 =========== =========== =========== Fully diluted net income per common share: Weighted average common shares outstanding during the period 9,502,316 11,285,940 12,497,360 Weighted average common equivalent shares resulting from stock options 236,043 710,348 909,429 Dilutive effect of common and common equivalent shares issued subsequent to April 12, 1994 (1) 534,183 69,073 ----------- ----------- ----------- 10,272,542 12,065,361 13,406,789 =========== =========== =========== Fully diluted net income per share $ 0.10 $ 0.39 $ 0.76 =========== =========== ===========
(1) Pursuant to Securities and Exchange Commission Staff Accounting Bulletin No. 83, certain common and common equivalent shares issued by the Company during the twelve months immediately preceding the initial filing of the registration statement relating to the Company's initial public offering have been included in the calculation of weighted average shares, using the treasury stock method and the initial public offering price, as if these shares were outstanding for all periods prior to the initial public offering. EX-13.1 3 FINANCIAL SECTION FROM 1996 ANNUAL REPORT 1 FINANCIAL SECTION CONTENTS Management's Discussion and Analysis of Financial Condition and Results of Operations 18 Consolidated Balance Sheets ....................... 22 Consolidated Statements of Income ................. 23 Consolidated Statements of Stockholders' Equity ... 24 Consolidated Statements of Cash Flows ............. 25 Notes to Consolidated Financial Statements ........ 26 Report of Independent Auditors .................... 32 [BAR GRAPH] [BAR GRAPH] 17 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.
Percent changes year to year Items as a percentage of net sales - ---------------------------------------------------------------------------- 1995/1994 1996/1995 Income and expense items 1994 1995 1996 - ---------------------------------------------------------------------------- 81% 73% Net sales 100% 100% 100% 70% 60% Cost of sales 38% 35% 33% - ---------------------------------------------------------------------------- 88% 80% Gross profit 62% 65% 67% Expenses: 60% 46% Research and development 21% 19% 16% 69% 68% Sales and marketing 20% 19% 18% 41% 32% General and administrative 14% 11% 8% - ---------------------------------------------------------------------------- 58% 52% Total expenses 55% 49% 42% - ---------------------------------------------------------------------------- 336% 167% Income from operations 7% 16% 25% 882% 38% Interest income, net 1% 5% 4% 397% 138% Income before income taxes 8% 21% 29% - ---------------------------------------------------------------------------- 1,005% 222% Provision for income taxes 1% 4% 8% - ---------------------------------------------------------------------------- 337% 117% Net income 7% 17% 21% - ----------------------------------------------------------------------------
[BAR GRAPH] [BAR GRAPH] OVERVIEW The Company was founded in February 1991, and commenced shipments of its Multimedia Conference Server (MCS) products in 1992. It has experienced significant sales growth since that time. The Company has continued to develop and enhance its product line, with regular introductions of new versions of its software and hardware. The Company markets its products to OEM suppliers of conferencing equipment, which resell the Company's products, and to public and private telecommunications carriers, which generally offer services to end-users based on the Company's products. More recently, the Company has begun to market its products to computer and network equipment manufacturers as those companies enter the conferencing industry. Unit shipments have grown due to growth in the conferencing market, increased acceptance of the Company's MCS products, and expansion of the Company's domestic and international OEM and carrier relationships. The Company initially achieved profitability in the first quarter of 1994 and has been profitable each quarter thereafter. The Company completed an initial public offering of its Common Stock in June, 1995, in which 2,300,000 shares of its newly issued common stock were sold for net proceeds to the Company of $35.4 million. The principal purposes of the offering were to increase the Company's working capital and equity base, to provide a public market for the Company's Common Stock, and to facilitate future access by the Company to public equity markets. RESULTS OF OPERATIONS -- YEARS ENDED DECEMBER 31, 1994, 1995, AND 1996 NET SALES Net sales increased 81% from $15.6 million in 1994 to $28.2 million in 1995, and 73% to $48.8 million in 1996. The growth in net sales was primarily due to an increase in unit shipments of MCS products. This increase was driven by greater market demand for the Company's products in U.S. and international markets, an expanding number of OEM customers, and a greater number of public and private telecommunications carriers who have become customers as they begin to offer conferencing services to end-users. The introduction of new features, such as Continuous Presence and data conferencing capability, both of which began shipping in the first quarter of 1996, also contributed to the increase. Service revenues, which include fees from maintenance contracts, software subscriptions, and training were higher as well, primarily as a result of the growth in the Company's installed base. Two customers accounted for 55% and 12% of net sales in 1994, three customers accounted for 23%, 19%, and 18% of net sales in 1995, and two customers accounted for 43% and 10% of net sales in 1996. International sales, primarily in Europe, were approximately 29%, 25%, and 32% of net sales in 1994, 1995, and 1996. The Company expects that international sales, which are currently denominated in U.S. dollars, will continue to be a significant portion of the Company's business. 18 3 GROSS PROFIT The Company's cost of sales consists of materials costs, manufacturing labor and overhead, and customer support costs. Gross profit as a percentage of net sales increased from 62% in 1994 to 65% in 1995, and to 67% in 1996. The increases in 1995 and 1996 were primarily due to lower component costs and economies in manufacturing, a higher mix of product upgrades which carry a higher gross profit, and stable selling prices through the majority of the product line. The higher gross profit rates experienced in 1996 are not likely to continue, as recently introduced and planned low end, lower margin products may become a larger proportion of the sales mix. In addition, increased competition may result in lower selling prices, and the proportion of sales to carriers, which generally have been at higher gross profit rates than sales to OEMs, may be uneven. RESEARCH AND DEVELOPMENT Research and development expenses consist principally of compensation costs for engineers, depreciation expense, supplies, and testing. Research and development expenses increased 60% from $3.3 million in 1994 to $5.3 million in 1995, and increased 46% to $7.8 million in 1996, representing 21%, 19%, and 16% of net sales in those years. The increases in spending were primarily due to increased engineering staffing required to develop and enhance the Company's MCS product line, including joint development projects with customers. Funding from customers for these projects, which amounted to $340,000 in 1994, $1.0 million in 1995, and $1.2 million in 1996, is treated as a reduction of research and development expenses as contracted work is performed and defined milestones are achieved by the Company. The percentage relationship of research and development expenses to net sales may vary depending upon the level of development funding from customers. All software development costs have been expensed as incurred because costs eligible for capitalization have not been material. The Company expects to continue to commit substantial resources to research and development in the future, and to increase its development expenditures in absolute terms in 1997. In January 1997, the Company began to establish an international development operation in the United Kingdom. SALES AND MARKETING Sales and marketing expenses consist principally of compensation costs (including sales commissions and bonuses), travel expenses, trade shows, and other marketing programs. Sales and marketing expenses increased 69% from $3.2 million in 1994 to $5.3 million in 1995, and increased 68% to $8.9 million in 1996, representing 20%, 19%, and 18% of net sales in those years. The increased spending was primarily due to the addition of sales and marketing personnel, both in the U.S. and internationally, to support an increasing number of OEM and carrier customers, increased commissions on higher sales, and the opening of new sales offices. The Company expects continued increases in sales and marketing expenses as it addresses broader markets and geographic territories for its products. GENERAL AND ADMINISTRATIVE General and administrative expenses consist principally of expenses for finance, administration, and general management activities, including legal, accounting, and other professional fees. General and administrative expenses increased 41% from $2.2 million in 1994 to $3.0 million in 1995, and increased 32% to $4.0 million in 1996, representing 14%, 11%, and 8% of net sales in those years. The increased spending was primarily due to the addition of finance and administrative personnel, increased costs associated with being a public company, and the costs of relocating to a larger primary facility in May 1996. The Company expects continued increases in general and administrative expenses in 1997, although it expects that these expenses should continue to decrease as a percentage of net sales due to the more rapid growth in net sales. General and administrative expenses in 1994 also included costs of $850,000 relating to a patent infringement lawsuit, which was settled in 1994. INTEREST INCOME, NET Interest income, net, consists of interest on cash, cash equivalents, and marketable securities offset by interest expense on equipment financing. The increase from approximately $133,000 in 1994 to $1.3 million in 1995 and $1.8 million in 1996 was due to higher cash balances, resulting from the proceeds received upon the closing of the Company's initial public offering in June, 1995 and cash generated from operations. PROVISION FOR INCOME TAXES The provision for income taxes was 9% in 1994, 20% in 1995, and 27% in 1996. The effective tax rate in both 1994 and 1995 was less than the combined federal and state statutory rate primarily as a result of the utilization of net operating loss carryforwards. Net operating loss carryforwards for federal income tax purposes were fully utilized during 1995. The effective tax rate in 1996 was less than the combined federal and state statutory rate primarily as a result of the elimination of valuation reserves related to deferred tax assets. These reserves were recorded in 1994 and 1995, but were eliminated in 1996, as the Company has now deemed it more likely than not that sufficient future taxable income will be generated to realize the benefits of these deferred tax assets. For 1997, the effective tax rate is expected to more closely approximate the combined federal and state statutory rate. OTHER FACTORS WHICH MAY AFFECT FUTURE OPERATIONS The Company's Annual Report includes discussions of its long term growth outlook, including various forward-looking statements. The following risks and uncertainties, among others, could affect the degree to which such expectations are realized. [BAR GRAPH] [BAR GRAPH] [BAR GRAPH] 19 4 EVOLVING MARKETS Sales of Multimedia Conference Server (MCS) products account for substantially all of the Company's sales. The Company's success depends to a significant extent on the acceptance, and the rate of acceptance, of MCS products in a number of markets, all of which are in the early stages of development. These markets include videoconferencing, desktop video, collaborative data-sharing, and carrier-based conferencing services. A number of telecommunications carriers have purchased the Company's products to offer conferencing services to end-users. In many instances, there is inadequate experience to predict the ultimate success of these service offerings, and therefore the degree to which these customers may order additional products from the Company. There can be no assurance that any of the markets for the Company's products will develop to the extent, in the manner or at the rate anticipated by the Company. In addition, future prices the Company is able to obtain for its products may decrease from historical levels as a result of new product introductions by others, price competition, technological change, or otherwise. DEPENDENCE ON MAJOR CUSTOMERS Consolidation among traditional videoconferencing equipment companies is increasing. In January 1997, Compression Labs, Inc., who in 1996 represented 10% of the Company's revenues, and Vtel Corporation announced an agreement to merge. While the number of OEM and carrier customers of the Company continues to grow, sales to a relatively small number of them have accounted for a significant portion of the Company's net sales, and the Company believes that its dependence on these customers, or a similarly few number of customers, will continue. This concentration of customers may cause net sales and operating results to fluctuate from quarter to quarter based on major customers' requirements and the timing of their orders and shipments. The Company's agreements with its customers generally do not include minimum purchase commitments or exclusivity for purchases of a similar product. The Company's operating results could be materially and adversely affected if any present or future major customer were to choose to reduce its level of orders, were to change to another vendor for purchases of a similar product, were to experience financial, operational or other difficulties, or were to delay paying or fail to pay amounts due the Company. RAPID TECHNOLOGICAL CHANGE The market for the Company's products is characterized by rapidly changing technology, evolving industry standards, emerging network architectures, and frequent new product introductions. To date, the Company's products have primarily addressed video telecommunications over switched digital networks such as ISDN, under the International Telecommunication Union's H.320 standard. Newly promulgated industry standards, such as the H.323 standard for audio, video, and data communications over local area networks and the Internet, are expected to foster growth in conferencing over new types of networks in addition to ISDN. The adoption rate of these new standards may adversely impact near-term growth of the conferencing market as users evaluate network platforms. The Company has invested, and for 1997 plans to continue to invest, in software development and products related to certain of these new standards. Many other companies, including PictureTel Corporation, currently the Company's largest customer, have announced their intention to develop products related to these new standards that could be competitive with the Company's future offerings. The Company's success will depend, in part, upon its ability through continued investments to maintain its technological leadership, to enhance and expand its existing product offerings, and to select and develop in a timely manner new products that achieve market acceptance. COMPETITION The market for networking and communications products is highly competitive. Although to date the Company has experienced limited competition from products with comparable capabilities, the Company expects competition to increase significantly in the future. A number of companies have introduced or announced their intention to introduce products that could be competitive with the Company's products, and the rapidly evolving nature of the markets in which the Company competes may attract other new entrants as they perceive opportunities. The Company's current and potential competitors may have longer operating histories and greater financial, technical, and sales and marketing resources. PERIOD TO PERIOD FLUCTUATIONS The Company's operating results are likely to vary significantly from quarter to quarter as a result of several factors, including: the timing of new product announcements and introductions by the Company, its major customers and its competitors; market acceptance of new or enhanced versions of the Company's products; changes in the product mix of sales; changes in the relative proportions of sales among distribution channels or among customers within each distribution channel; 20 5 changes in manufacturing costs; price reductions for the Company's products; the gain or loss of significant customers; increased research and development expenses associated with new product introductions; seasonality; and general economic conditions. New customers orders have generally been characterized by lengthy sales cycles, making it difficult to predict the quarter in which sales will occur. Carriers' deployment projects involve particularly long sales cycles, and shipments for such projects are therefore often difficult to forecast. In addition, such shipments are subject to delays in the timing of such projects. The Company typically operates with a small backlog. As a result, quarterly sales and operating results generally depend on the volume, timing of, and ability to fulfill orders received within the quarter, which are difficult to forecast. Also, the Company may recognize a substantial portion of its sales in a given quarter from sales booked and shipped in the last weeks of that quarter. All of the above factors can materially adversely affect the Company's business and operating results for one quarter or a series of quarters, and are difficult to forecast. The Company establishes its expenditure levels for product development and other operating expenses based, in large part, on its expected future sales. As a result, if sales fall below expectations, there would likely be a material adverse effect on the Company's operating results and net income because only a small portion of the Company's expenses vary with its sales in the short term. PROTECTION OF PROPRIETARY TECHNOLOGY The Company's success depends, to a large extent, on its ability to protect its proprietary technology. While the Company has applied for several patents, it currently holds only one U.S. patent relating to its existing products and relies primarily on a combination of contractual rights, trade secrets, and copyrights to protect its intellectual property rights. UNCERTAINTIES REGARDING PATENTS In December 1994, the Company settled patent infringement litigation brought against it by Datapoint Corporation (Datapoint) for a cash payment by the Company in the amount of $500,000. However, patent infringement litigation still exists between Datapoint and two of the Company's largest customers. In addition, Datapoint has written inquiry letters to a significant number of others in the videoconferencing market offering to sell them nonexclusive licenses under certain Datapoint patents in the videoconferencing field (the Datapoint Patents). While the validity or scope of the Datapoint Patents has not been adjudicated by a court, Datapoint has, in effect, asserted that the Datapoint Patents cover certain aspects of multipoint conferencing operations involving terminals and multipoint control units, including MCSs. As a result of the December 1994 settlement, the Company obtained a nonexclusive license for its MCS under the Datapoint Patents, which license includes limited rights for the products and services of the Company's customers. However, the conferencing market in general, and the Company's future sales and operating results in particular, could be adversely affected as a result of ongoing uncertainties regarding the Datapoint Patents. Such uncertainty, and any related potential impact of it, is likely to exist until the validity of the patents is adjudicated. LIQUIDITY AND CAPITAL RESOURCES At December 31, 1996, the Company has cash, cash equivalents, and marketable securities of $54.7 million. The Company regularly invests excess funds in short-term money market funds, government securities, and commercial paper. The Company has no material long-term debt. The Company generated cash from operations of $12.5 million in 1996, primarily resulting from net income during the year. The Company's primary investing activities to date have been the purchase of computers and equipment for research and development, product support, sales, marketing, and administration to support the Company's growth. In May 1996, the Company relocated its principle operation to a larger facility in Burlington, Massachusetts. In June 1995, the Company completed an initial public offering in which 2,300,000 shares of its newly issued common stock were sold for net proceeds to the Company of $35.4 million. Of the net proceeds, $3.6 million was used to redeem all outstanding shares of Series A Preferred Stock. At December 31, 1996, the Company has available a bank revolving credit facility providing for borrowings up to $5.0 million. Borrowings are limited to a percentage of eligible accounts receivable and are unsecured. The Company also has a $2.0 million term credit facility for equipment purchases during 1997. The Company's equipment is pledged as collateral under this facility. No borrowings have been made under either facility. Under these credit facilities, the Company is required to maintain certain financial ratios and minimum levels of net worth and profitability, and is prohibited from paying cash dividends without the bank's consent. The Company believes that its existing cash, cash equivalents, and marketable securities, together with cash generated from operations and borrowings available under the Company's credit facilities, will be sufficient to meet the Company's cash requirements for the foreseeable future. [BAR GRAPH] [BAR GRAPH] 21 6 CONSOLIDATED BALANCE SHEETS
(In thousands, except for share-related data) December 31 - ---------------------------------------------------------------------------------------- 1995 1996 - ---------------------------------------------------------------------------------------- ASSETS Current assets: Cash and cash equivalents $ 31,679 $27,876 Marketable securities 13,489 26,808 Accounts receivable, net of allowance for doubtful accounts of $650 and $1,077 in 1995 and 1996 4,231 7,252 Inventories 1,598 3,653 Deferred taxes 300 2,280 Other current assets 543 843 - ---------------------------------------------------------------------------------------- Total current assets 51,840 68,712 Equipment and improvements, net of accumulated depreciation and amortization 1,921 4,180 Other assets, net of accumulated amortization of $156 and $253 in 1995 and 1996 141 204 - ---------------------------------------------------------------------------------------- Total assets $ 53,902 $73,096 - ---------------------------------------------------------------------------------------- LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable $ 1,040 $ 3,481 Accrued expenses 4,596 8,240 Deferred revenue 1,129 831 Current portion of long-term debt 675 506 - ---------------------------------------------------------------------------------------- Total current liabilities 7,440 13,058 Long-term debt, less current portion 673 167 Stockholders' equity: Preferred stock, $.01 par value; 2,000,000 shares authorized, none issued and outstanding Common stock, $.01 par value; 40,000,000 shares authorized; 12,548,769 issued and 12,385,731 outstanding in 1995; 12,620,760 issued and outstanding in 1996 125 126 Capital in excess of par value 45,635 49,573 Retained earnings 31 10,225 Cumulative translation adjustment (53) Treasury stock, 163,038 common shares in 1995 (2) - ---------------------------------------------------------------------------------------- Total stockholders' equity 45,789 59,871 - ---------------------------------------------------------------------------------------- Total liabilities and stockholders' equity $ 53,902 $73,096 - ----------------------------------------------------------------------------------------
See accompanying notes 22 7 CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except for share-related data) Year ended December 31 - ----------------------------------------------------------------------------------- 1994 1995 1996 - ----------------------------------------------------------------------------------- Net sales $ 15,557 $ 28,197 $ 48,833 Cost of sales 5,874 9,978 15,955 - ----------------------------------------------------------------------------------- Gross profit 9,683 18,219 32,878 Operating expenses: Research and development 3,324 5,303 7,767 Sales and marketing 3,158 5,326 8,945 General and administrative 2,156 3,038 4,004 - ----------------------------------------------------------------------------------- Total operating expenses 8,638 13,667 20,716 - ----------------------------------------------------------------------------------- Income from operations 1,045 4,552 12,162 Interest expense (71) (118) (93) Interest income 204 1,424 1,895 - ----------------------------------------------------------------------------------- Income before income taxes 1,178 5,858 13,964 Provision for income taxes 106 1,171 3,770 - ----------------------------------------------------------------------------------- Net income $ 1,072 $ 4,687 $ 10,194 - ----------------------------------------------------------------------------------- Net income per share: Primary $ 0.10 $ 0.39 $ 0.77 Fully diluted $ 0.10 $ 0.39 $ 0.76 - -----------------------------------------------------------------------------------
See accompanying notes 23 8 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (In thousands, except for share-related data)
- ------------------------------------------------------------------------------------------------------------------------- Convertible Retained Preferred Capital Earnings Cumulative Stock Common Stock In Excess of (Accumulated Translation Par Value Shares Par Value Par Value Deficit) Adjustment - ------------------------------------------------------------------------------------------------------------------------- Balances as of January 1, 1994 $ 1 5,949,575 $ 59 $5,625 $(5,513) $ 0 Sale of 41,920 shares of Series C preferred stock 1 4,159 Purchase of treasury stock Stock issued under employee benefit plans 97,480 1 7 Declared dividend (215) Net income 1,072 - ------------------------------------------------------------------------------------------------------------------------- Balances as of December 31, 1994 2 6,047,055 60 9,791 (4,656) 0 Sale of 196 shares of Series C preferred stock 20 Purchase of treasury stock Stock issued in initial public offering, net of issuance costs of $950 2,300,000 23 35,390 Conversion of 57,150 shares of Series B and 42,116 shares of Series C preferred stock (2) 4,164,944 42 (40) Stock issued under employee benefit plans 36,770 124 Tax benefit related to employee stock plans 350 Net income 4,687 - ------------------------------------------------------------------------------------------------------------------------- Balances as of December 31, 1995 0 12,548,769 125 45,635 31 0 Stock issued under employee benefit plans 71,991 1 1,788 Tax benefit related to employee stock plans 2,150 Foreign currency translation adjustment (53) Net income 10,194 - ------------------------------------------------------------------------------------------------------------------------- Balances as of December 31, 1996 $ 0 12,620,760 $126 $49,573 $10,225 $(53) - -------------------------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------- Treasury Total Stock Stockholders' Shares Cost Equity - -------------------------------------------------------------------- Balances as of January 1, 1994 235,500 $(2) $ 170 Sale of 41,920 shares of Series C preferred stock 4,160 Purchase of treasury stock 1,800 Stock issued under employee benefit plans 8 Declared dividend (215) Net income 1,072 - -------------------------------------------------------------------- Balances as of December 31, 1994 237,300 (2) 5,195 Sale of 196 shares of Series C preferred stock 20 Purchase of treasury stock 438 Stock issued in initial public offering, net of issuance costs of $950 35,413 Conversion of 57,150 shares of Series B and 42,116 shares of Series C preferred stock Stock issued under employee benefit plans (74,700) 124 Tax benefit related to employee stock plans 350 Net income 4,687 - -------------------------------------------------------------------- Balances as of December 31, 1995 163,038 (2) 45,789 Stock issued under employee benefit plans (163,038) 2 1,791 Tax benefit related to employee stock plans 2,150 Foreign currency translation adjustment (53) Net income 10,194 - -------------------------------------------------------------------- Balances as of December 31, 1996 0 $ 0 $59,871 - --------------------------------------------------------------------
See accompanying notes. 24 9 CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands) Year ended December 31 - -------------------------------------------------------------------------------------------- 1994 1995 1996 - -------------------------------------------------------------------------------------------- OPERATING ACTIVITIES Net income $ 1,072 $ 4,687 $ 10,194 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 764 1,071 1,739 Provision for doubtful accounts 113 532 427 Deferred taxes (300) (1,980) Tax benefit related to employee stock plans 350 2,150 Changes in operating assets and liabilities: Accounts receivable (1,093) (2,378) (3,448) Inventories (249) (498) (2,055) Other current assets (135) (382) (300) Accounts payable and accrued expenses 1,294 3,083 6,085 Deferred revenue 380 568 (298) - -------------------------------------------------------------------------------------------- Net cash provided by operating activities 2,146 6,733 12,514 - -------------------------------------------------------------------------------------------- INVESTING ACTIVITIES Net purchases of equipment and improvements (992) (1,583) (3,901) Purchases of marketable securities (13,489) (21,438) Proceeds from sale of marketable securities 8,119 Increase in other assets (232) (5) (160) - -------------------------------------------------------------------------------------------- Net cash used in investing activities (1,224) (15,077) (17,380) - -------------------------------------------------------------------------------------------- FINANCING ACTIVITIES Proceeds from long-term debt 931 811 Repayment of long-term debt (312) (713) (675) Net proceeds from issuance of preferred stock 4,160 20 Net proceeds from issuance of common stock 35,413 Net proceeds from issuance of stock under employee benefit plans 8 124 1,791 Redemption of preferred stock (3,612) Payment of preferred dividends (215) - -------------------------------------------------------------------------------------------- Net cash provided by financing activities 4,787 31,828 1,116 - -------------------------------------------------------------------------------------------- Effect of exchange rate on cash and cash equivalents (53) Increase (decrease) in cash and cash equivalents 5,709 23,484 (3,803) Cash and cash equivalents at beginning of year 2,486 8,195 31,679 - -------------------------------------------------------------------------------------------- Cash and cash equivalents at end of year $ 8,195 $ 31,679 $ 27,876 - -------------------------------------------------------------------------------------------- Supplementary disclosure of cash flow information: Interest paid $ 71 $ 118 $ 94 - --------------------------------------------------------------------------------------------
See accompanying notes. 25 10 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. BUSINESS VideoServer, Inc. (the Company) operates in one business segment, which is the design, development, manufacture, marketing, sale, and service of networking equipment and associated software used to create multimedia conferences that connect multiple users over wide area networks and allow them to interact as a group. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES BASIS OF PRESENTATION The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All significant intercompany transactions and balances have been eliminated. All assets and liabilities of foreign subsidiaries are translated at the rate of exchange at year end, while sales and expenses are translated at the average rates in effect during the year. The net effect of these translation adjustments is shown in the accompanying financial statements as a component of stockholders' equity. SIGNIFICANT ESTIMATES AND ASSUMPTIONS The preparation of the financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities, if any, at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates. REVENUE RECOGNITION Revenue from product sales is recognized upon shipment, and the Company's products are generally delivered without significant post-sale obligations to the customer. If significant obligations exist, revenue recognition is deferred until the obligations are satisfied. Estimated product warranty costs are provided for at the time of sale. Revenue from maintenance agreements is recognized ratably over the term of the agreements, and other service revenue is recognized as the services are performed. CASH EQUIVALENTS AND MARKETABLE SECURITIES All of the Company's cash equivalents and marketable securities are classified as available-for-sale, and accordingly are carried at fair market value based on quoted market prices, which approximates their cost. Unrealized gains and losses, which are reported as a component of stockholders' equity, were not material in 1995 or 1996. Realized gains and losses are included in net interest income. The Company considers all liquid investments with a maturity of three months or less at the date of purchase to be cash equivalents. Cash equivalents and marketable securities consist of highly rated U.S. and state government securities, commercial paper, and short-term money market funds. Marketable securities at December 31, 1996, by contractual maturity, included approximately $24,167,000 due in one year or less, and $2,641,000 due between one year and two years. CONCENTRATIONS OF CREDIT RISK Sales to two, three and two customers accounted for 67%, 60%, and 53% of total net sales in 1994, 1995, and 1996. The accounts receivable from these customers amounted to approximately $3,122,000 and $2,993,000 at December 31, 1995 and 1996. Export sales, primarily to Europe, were approximately $4,524,000 in 1994, $7,129,000 in 1995, and $15,791,000 in 1996. Financial instruments which potentially subject the Company to concentrations of credit risk are cash equivalents, marketable securities, and accounts receivable. All of the Company's cash equivalents and marketable securities are maintained by major financial institutions. Concentration of credit risk with respect to accounts receivable is limited to certain customers to whom the Company makes substantial sales. To reduce risk, the Company routinely assesses the financial strength of its customers. The Company has not incurred any material write-offs related to its accounts receivable. INVENTORIES Inventories are stated at the lower of cost or market, with cost determined using the first-in, first-out method. EQUIPMENT AND IMPROVEMENTS Equipment and improvements are stated at cost. Depreciation is computed using the straight-line method over the following estimated useful lives: Computer and office equipment 3 to 5 years Furniture and fixtures 5 years Leasehold improvements Shorter of lease term or estimated useful life DEFERRED REVENUE Deferred revenue represents amounts paid under maintenance agreements or for product sales in advance of revenue recognition. 26 11 RESEARCH AND DEVELOPMENT COSTS Research and development costs are charged to expense as incurred. To date, costs of internally developed software eligible for capitalization have been immaterial and have been expensed as incurred. The Company receives fees under product development contracts with certain customers. Product development fees are recorded as a reduction of research and development costs as work is performed pursuant to the related contracts and defined milestones are achieved. Payments received in advance are recorded as accrued liabilities. Fees recorded as a reduction of research and development costs, including amounts received from a customer who is also a stockholder, amounted to $340,000, $1,000,000 and $1,150,000 in 1994, 1995, and 1996. NET INCOME PER SHARE Net income per share is calculated based on the weighted average number of common shares and common equivalent shares assumed outstanding during the period. Pursuant to Securities and Exchange Commission Staff Accounting Bulletin No. 83, certain common and common equivalent shares issued by the Company during the twelve months immediately preceding the initial filing of the registration statement relating to the Company's initial public offering have been included in the calculation of weighted average shares, using the treasury stock method and the initial public offering price, as if these shares were outstanding for all periods prior to the initial public offering. Shares used in computing both primary and fully diluted earnings per share were 10,272,542 in 1994 and 12,065,361 in 1995. Shares used in computing primary and fully diluted earnings per share in 1996 were 13,310,793 and 13,406,789. ACCOUNTING FOR IMPAIRMENT OF LONG-LIVED ASSETS In accordance with Statement of Financial Accounting Standards No. 121, "Accounting for Impairment of Long-Lived Assets," the Company records impairment losses on long-lived assets used in operations when indicators of impairment are present. On an on-going basis, management reviews the value and period of amortization or depreciation of long-lived assets. During this review, the Company reevaluates the significant assumptions used in determining the original cost of long-lived assets. Although the assumptions may vary from transaction to transaction, they generally include revenue growth, operating results, cash flows, and other indicators of value. Management then determines whether there has been a permanent impairment of the value of long-lived assets based upon events or circumstances which have occurred since acquisition. ACCOUNTING FOR STOCK-BASED COMPENSATION In 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123"). This statement establishes financial accounting and reporting standards for stock-based compensation plans, including stock options for the purchase of common stock provided for under the Amended and Restated 1991 Stock Incentive Plan (the "1991 Plan"), options to acquire shares of common stock issued under the Amended and Restated 1994 Non-Employee Director Stock Option Plan (the "Director Plan"), and shares purchased under the 1995 Employee Stock Purchase Plan. As permitted under SFAS 123, the Company has elected to follow Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" (APB 25) and related interpretations in accounting for its stock-based benefit plans, as opposed to the alternative fair value accounting provided for under SFAS 123. Because the exercise price of the options granted under the 1991 Plan and the Director Plan to date equals the market price of the underlying stock on the date of grant, no compensation expense is recognized under APB 25. 3. INVENTORIES Inventories consist of:
December 31 1995 1996 - ------------------------------------------------------------- (In thousands) Raw materials and subassemblies $1,100 $2,881 Work in process 187 247 Finished goods 311 525 - ------------------------------------------------------------- $1,598 $3,653
4. EQUIPMENT AND IMPROVEMENTS Equipment and improvements consist of:
December 31 1995 1996 - ------------------------------------------------------------- (In thousands) Computer and office equipment $4,020 $7,323 Furniture and fixtures 110 227 Leasehold improvements 175 656 - ------------------------------------------------------------- 4,305 8,206 Less accumulated depreciation 2,384 4,026 - ------------------------------------------------------------- $1,921 $4,180
27 12 5. ACCRUED EXPENSES Accrued expenses consist of:
December 31 1995 1996 - --------------------------------------------------- (In thousands) Employee compensation and benefits $1,356 $2,378 Professional fees 207 505 Warranties and other customer-related costs 1,385 2,940 Income and other taxes payable 1,024 Development fee advances 654 464 Other accrued expenses 994 929 - --------------------------------------------------- $4,596 $8,240
6. BANK ARRANGEMENTS The Company has a revolving credit facility of $5,000,000 which bears interest at the prime rate (8.25% at December 31, 1996) and is available until January 1998. Borrowings under the facility may not exceed 80% of qualified accounts receivable, as defined. The Company also has a $2,000,000 equipment line of credit, bearing interest at the prime rate plus .5%, available for equipment purchases made in 1997. No borrowings have been made under either facility. Long-term debt at December 31, 1996 consists of variable-rate equipment installment notes, aggregating $673,000, bearing interest at the prime rate plus .5% to .75%, payable in various monthly installments through October 1998. Maturities of long-term debt are $506,000 in 1997, and $167,000 in 1998. The Company's equipment is pledged as collateral against the equipment line of credit. The revolving credit facility is unsecured; however, the Company is required to maintain certain financial ratios and minimum levels of net worth and profitability, and the Company's ability to pay dividends to stockholders is restricted under the terms of both the revolving and equipment lines of credit. 7. INCOME TAXES The provision for income taxes for 1994, 1995, and 1996 is as follows:
Year ended December 31 1994 1995 1996 - -------------------------------------------------------- (In thousands) Current: Federal $ 46 $1,188 $ 4,359 State 52 195 1,330 Foreign 8 88 61 - -------------------------------------------------------- 106 1,471 5,750 Deferred: Federal (300) (1,695) State (285) - -------------------------------------------------------- (300) (1,980) - -------------------------------------------------------- Total tax provision $106 $1,171 $ 3,770
Cash payments for income taxes totaled approximately $1,171,000 and $2,408,000 in 1995 and 1996. The effective tax rate differs from the statutory federal income tax rate of 34% in 1994 and 1995, and 35% in 1996, due to the following:
Year ended December 31 1994 1995 1996 - ------------------------------------------------------------------- Statutory income tax rate 34.0% 34.0% 35.0% State income taxes, net of federal benefit 2.8 3.3 4.9 Research and development tax credits -- (1.3) (1.4) Tax benefit from Foreign Sales Corporation -- (1.0) (1.9) Tax-exempt interest income -- (1.4) (2.7) Foreign and other 2.3 1.7 0.4 Utilization of net operating loss carryforwards (30.1) (15.3) -- Change in valuation allowance -- -- (7.3) - ------------------------------------------------------------------- Effective tax rate 9.0% 20.0% 27.0%
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Valuation allowances were recorded in 1994 and 1995 to offset certain net deferred tax assets due to the uncertainty of realizing the benefit of these assets, but were 28 13 eliminated in 1996, as the Company has now deemed it more likely than not that sufficient future taxable income will be generated to realize the benefit of these deferred tax assets. The following is a summary of the significant components of the Company's deferred tax assets and liabilities:
December 31 1995 1996 - ---------------------------------------------------------- (In thousands) Deferred tax assets: State tax loss carryforwards$ 28 -- Deferred revenue 164 $ 116 Research and development credits 100 -- Reserves not currently deductible 958 2,044 Depreciation and other 196 283 - ---------------------------------------------------------- Total deferred tax assets 1,446 2,443 Deferred tax liability: Amortization of start-up costs (124) (163) Valuation allowance for deferred tax assets (1,022) -- - ---------------------------------------------------------- Net deferred tax $ 300 $ 2,280
8. COMMITMENTS AND CONTINGENCIES The Company rents its primary facility under an operating lease which expires in February 1999. The Company also leases sales offices under leases that expire on various dates through February 2000. Future minimum lease payments at December 31, 1996 under these noncancelable operating leases are approximately $695,000 in 1997, $650,000 in 1998, $235,000 in 1999, and $20,000 in 2000. Rent expense was approximately $341,000, $430,000, and $595,000 in 1994, 1995, and 1996. In December 1994, the Company settled a patent infringement lawsuit brought against it by Datapoint Corporation. As a result of the settlement, the Company obtained a nonexclusive license for its MCS products, which includes limited rights for the products and services of the Company's customers. The Company recorded charges against 1994 operations of approximately $850,000 for the agreed-upon costs of the settlement and indemnification of one of its customers. Patent infringement litigation still exists between Datapoint and two of the Company's largest customers. In addition, Datapoint has written inquiry letters to a significant number of others in the videoconferencing market offering to sell them nonexclusive licenses under certain Datapoint Patents in the videoconferencing field (the Datapoint Patents). While the validity or scope of the Datapoint Patents has not been adjudicated by a court, Datapoint has, in effect, asserted that the Datapoint Patents cover certain aspects of multipoint videoconferencing operations involving terminals and multipoint control units, including the Company's MCSs. The Company believes that the videoconferencing market in general, and the Company's future sales and operating results in particular, could be adversely affected as a result of ongoing uncertainties regarding the Datapoint Patents. Such uncertainty, and any impact of it, is likely to remain until a definitive action is brought in court and the validity of the patents is adjudicated. 9. STOCKHOLDERS' EQUITY INITIAL PUBLIC OFFERING In June 1995, the Company completed an initial public offering (IPO) of its common stock in which 2,300,000 shares of common stock were issued at a price of $17.00 per share, resulting in net proceeds, after deducting underwriting discounts and expenses, of $35,413,000. In connection with the offering, all outstanding shares of Series A Preferred Stock were redeemed and all outstanding shares of Series B and Series C Convertible Preferred Stock were automatically converted into 4,164,944 shares of common stock, in accordance with the underlying agreements. COMMON STOCK In connection with the IPO, the Company's Board of Directors and stockholders approved a one-for-two reverse stock split of its common stock effective May 1, 1995. All share and per share related data in the accompanying consolidated financial statements reflect the reverse stock split. Effective upon the closing of the IPO, the authorized capital stock of the Company increased from 15,000,000 to 40,000,000 shares. PREFERRED STOCK Effective upon the closing of the IPO, the Company's Board of Directors and stockholders approved an amendment to its charter to authorize 2,000,000 shares of undesignated preferred stock, $.01 par value per share. Each such series of Preferred Stock shall have such rights, preferences, privileges, and restrictions, including voting rights, dividend rights, conversion rights, redemption privileges, and liquidation preferences as determined by the Board of Directors. 29 14 10. BENEFIT PLANS 1991 STOCK INCENTIVE PLAN In 1995, the Company's Board of Directors and stockholders approved the Amended and Restated 1991 Stock Incentive Plan (the "1991 Plan"). The 1991 Plan provides for the sale or award of common stock, or the grant of incentive stock options or nonqualified stock options for the purchase of common stock, of up to 3,469,286 shares to officers, employees, and consultants. The Plan is administered by the Board of Directors. Options have been granted at a price not less than the fair market value on the date of grant. The options generally become exercisable over a five-year period and expire over a period not exceeding ten years. Shares issuable will increase as of January 1, 1997, and will increase each January 1 thereafter during the term of the plan, by an additional number of shares of common stock equal to five percent of the total number of shares of common stock issued and outstanding as of December 31 of the preceding year. In 1991 and 1992 employees purchased 706,575 shares of common stock at $.01 per share pursuant to stock awards which are subject to the Company's right to repurchase at cost in the event employment is terminated prior to specified dates. As of December 31, 1996, 18,988 shares have been repurchased, and 29,838 shares remain subject to this repurchase right. There have been no stock awards since 1992. 1994 NON-EMPLOYEE DIRECTOR STOCK OPTION PLAN In 1995, the Company's Board of Directors and stockholders approved the Amended and Restated 1994 Non-Employee Director Stock Option Plan (the "Director Plan"). The Director Plan provides that each non-employee director of the Company be granted an option to acquire 15,000 shares of common stock on the date that person becomes a director, but, in any event, not earlier than the effective date of the Director Plan, and annually be granted, beginning with the January 1 falling at least twelve months after a Director's initial grant, an option to purchase an additional 3,000 shares. Options are granted at a price equal to the fair market value on the date of grant. The option becomes exercisable over a four-year period, and the term of the option is ten years from the date of grant. The Company has reserved 200,000 shares of common stock for issuance under the Director Plan. A summary of option activity under the 1991 Plan and the Director Plan is as follows:
Weighted Average Shares Exercise Price - ---------------------------------------------------------------- Outstanding at January 1, 1995 597,330 $ 1.32 Granted 513,814 $12.79 Terminated (26,820) $ 2.71 Exercised (111,424) $ 1.13 --------- Outstanding at December 31, 1995 972,900 $ 7.36 Granted 791,425 $26.75 Terminated (97,775) $17.20 Exercised (191,011) $ 5.53 --------- Outstanding at December 31, 1996 1,475,539 $17.35 - ---------------------------------------------------------------- Exercisable at December 31, 1995 102,006 Exercisable at December 31, 1996 202,192 - ----------------------------------------------------------------
Related information for options outstanding and exercisable as of December 31, 1996 under the 1991 Plan and Director Plan is as follows:
Weighted Average Weighted Remaining Average Contractual Exercise Range of Exercise Prices Shares Life Price - ---------------------------------------------------------------- $ .01 - $ .10 30,064 1.7 $ .08 $ .20 - $ .60 131,859 2.4 .20 $ 2.00 - $ 6.00 202,224 3.7 3.58 $ 8.50 - $21.25 657,847 4.8 14.72 $23.25 - $43.25 453,545 5.6 33.44 --------- Total outstanding 1,475,539 4.6 $17.35 - ----------------------------------------------------------------
Weighted Average Exercise Range of Exercise Prices Shares Price - ----------------------------------------------- $ .01 - $ .10 1,963 $ .07 $ .20 - $ .60 66,666 .20 $ 2.00 - $ 6.00 63,303 3.61 $ 8.50 - $21.25 64,890 8.55 $23.25 - $43.25 5,370 30.83 ------- Total exercisable 202,192 $ 4.76 - -----------------------------------------------
30 15 1995 EMPLOYEE STOCK PURCHASE PLAN In 1995, the Company's Board of Directors and stockholders approved the 1995 Employee Stock Purchase Plan (the "Stock Purchase Plan") under which eligible employees may purchase common stock at a price per share equal to 85% of the lower of the fair market value of the common stock at the beginning or end of each offering period. Participation in the offering is limited to 10% of an employee's compensation (not to exceed amounts allowed under Section 423 of the Internal Revenue Code), may be terminated at any time by the employee and automatically ends on termination of employment with the Company. A total of 300,000 shares of common stock have been reserved for issuance under this plan. The first offering period commenced on the effective date of the Company's initial public offering of shares of its common stock, and continued until January 31, 1996. Subsequent six month offering periods commenced on February 1 and August 1, 1996, and are intended to commence on each February 1 and August 1 thereafter. PRO FORMA INFORMATION FOR STOCK-BASED COMPENSATION Pro forma information regarding net income and earnings per share, as if the Company had used the fair value method of SFAS 123 to account for stock options issued under its 1991 Plan and Director Plan, and shares purchased under the Stock Purchase Plan, is presented below. The fair value of stock activity under these plans was estimated at the date of grant using a Black-Scholes option pricing model with the following assumptions as of the date of grant: risk-free interest rates equal to the then available rate for zero-coupon U.S. government issues with a remaining term equal to the expected life of the options; no dividend yields; an average volatility factor of the expected market price of the Company's common stock over the expected life of the option of .50; and a weighted-average expected life of the option of 5.4 years. For purposes of pro forma disclosures, the estimated weighted average fair value of options granted during the year of $4.53 in 1995 and $9.51 in 1996 is amortized to expense over the related vesting period. Pro forma information is as follows:
1995 1996 - ----------------------------------------------------------- (In thousands, except for earnings per share information) Pro forma net income $4,147 $8,973 Pro forma net income per share: Primary $ 0.35 $ 0.68 Fully diluted $ 0.35 $ 0.68
SAVINGS PLAN The Company sponsors a savings plan for its employees which has been qualified under Section 401(k) of the Internal Revenue Code. Eligible employees are permitted to contribute to the 401(k) plan through payroll deductions within statutory and plan limits. Contributions from the Company are made at the discretion of the Board of Directors. Through December 1996, the Company made no contributions to the 401(k) plan. Beginning in 1997, the Board of Directors has authorized the Company to commence with a matching of a portion of its employees' contributions to the plan. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
Quarter ended March 31 June 30 September 30 December 31 - --------------------------------------------------------------------------------- (In thousands, except per share amounts) 1995 - --------------------------------------------------------------------------------- Net sales $5,512 $6,810 $7,311 $8,564 Gross profit 3,498 4,417 4,744 5,560 Operating income 620 1,134 1,230 1,568 Net income 594 985 1,300 1,808 Net income per share 0.05 0.08 0.10 0.14 Common stock price* - high -- $47.25 $49.50 $45.00 - low -- $25.00 $30.25 $21.50
* Initial public offering May 25, 1995
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 0.15 0.17 0.21 0.24 Common stock price - high $32.00 $41.75 $39.25 $55.00 - low $17.25 $21.50 $24.50 $32.63
31 16 REPORT OF INDEPENDENT AUDITORS THE BOARD OF DIRECTORS AND STOCKHOLDERS VIDEOSERVER, INC. We have audited the accompanying consolidated balance sheets of VideoServer, Inc. as of December 31, 1995 and 1996, and the related consolidated statements of income, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1996. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of VideoServer, Inc. at December 31, 1995 and 1996, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 1996 in conformity with generally accepted accounting principles. ERNST & YOUNG LLP Boston, Massachusetts January 14, 1997 32 EX-23.1 4 CONSENT OF ERNST AND YOUNG 1 Exhibit 23.1 CONSENT OF INDEPENDENT AUDITORS We consent to the incorporation by reference in this Annual Report (Form 10-K) of VideoServer,Inc. of our report dated January 14, 1997, included in the 1996 Annual Report to Shareholders of VideoServer, Inc. Our audits also included the financial statement schedule of VideoServer, Inc. listed in Item 14(a). This schedule is the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits. In our opinion, the financial statement schedule referred to above, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein. We also consent to the incorporation by reference in the Registration Statement (Form S-8 No. 33-96192) of VideoServer, Inc. of our report dated January 14, 1997, with respect to the consolidated financial statements incorporated herein by reference, and our report included in the preceding paragraph with respect to the financial statement schedule included in this Annual Report (Form 10-K) of VideoServer, Inc. ERNST & YOUNG LLP Boston, Massachusetts March 25, 1997 EX-27 5 FINANCIAL DATA SCHEDULE
5 1,000 US DOLLARS YEAR DEC-31-1996 JAN-01-1996 DEC-31-1996 1 27,876 26,808 8,329 (1,077) 3,653 68,712 4,180 0 73,096 13,058 167 0 0 126 59,745 73,096 48,833 48,833 15,955 15,955 20,716 0 (93) 13,964 3,770 10,194 0 0 0 10,194 0.77 0.76 ADDITIONAL CURRENT ASSET DEFERRED TAXES 2,280 ADDITIONAL CURRENT ASSET OTHER 843 OTHER ASSETS, NET 204 INTEREST INCOME 1,895
-----END PRIVACY-ENHANCED MESSAGE-----