10QSB 1 s295667.txt QUARTERLY REPORT U.S. SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-QSB (Mark One) [x] Quarterly report under Section 13 or 15(d) of the Securities Exchange Act of 1934 For the quarterly period ended March 31, 2002 [ ] Transition report under Section 13 or 15(d) of the Exchange Act For the transition period from _________ to ____________ Commission file number 000-22235 ---------- Video Network Communications, Inc. ------------------------------------------------------------------------------- (Exact Name of Small Business Issuer as Specified in Its Charter) Delaware 54-1707962 -------- ---------- (State or Other (I.R.S. Jurisdiction of Employer Incorporation or Identification Organization) No.) 50 International Drive Portsmouth, NH 03801 ------------------------------------------------------------------------------- (Address of Principal Executive Offices) (603) 334-6700 ------------------------------------------------------------------------------- (Issuer's Telephone Number, Including Area Code) ------------------------------------------------------------------------------- (Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report) Check whether the issuer: (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes __X__ No_____ - APPLICABLE ONLY TO CORPORATE ISSUERS State the number of shares outstanding of each of the issuer's classes of common equity, as of May 30, 2002: 48,622,635 shares of common stock Transitional Small Business Disclosure Format (check one): Yes _____ No __X__ PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS VIDEO NETWORK COMMUNICATIONS, INC. BALANCE SHEETS ASSETS March 31, December 31, 2002 2001 ------------- ------------- (Unaudited) Current assets: Cash and cash equivalents $ 193,126 $ 507,396 Accounts receivable 101,875 604,921 Inventories 1,044,193 1,194,749 Other Current Assets 16,820 61,480 ------------ ------------ Total current assets 1,356,014 2,368,546 Property and equipment, net 230,316 276,729 Trademarks and patents, net 279,313 285,435 Other assets 8,309 8,309 ------------ ------------ $ 1,873,952 $ 2,939,019 ============ ============ LIABILITIES AND STOCKHOLDERS' DEFICIT Current liabilities: Accounts payable $ 2,350,021 $ 2,335,933 Deferred revenue 26,872 28,263 Accrued liabilities 1,120,105 1,200,579 Current portion of notes payable 6,107,380 5,095,739 Current portion of capital lease obligations 19,926 20,742 ------------ ------------ Total current liabilities 9,624,304 8,681,256 Capital lease obligations, less current portion 23,227 29,003 Commitments Stockholders' equity: Preferred stock, par value $.01 Authorized shares - 2,500,000 -- -- Issued and outstanding shares - 0 Common stock, par value $.01 21,336 21,336 Authorized shares - 90,000,000 Issued and outstanding shares - 2,133,594 Additional paid-in capital 62,436,674 61,879,866 Accumulated deficit (70,231,589) (67,672,442) ------------ ------------ Total stockholders' deficit (7,773,579) (5,771,240) ------------ ------------ $ 1,873,952 $ 2,939,019 ============ ============ See Notes to Financial Statements. VIDEO NETWORK COMMUNICATIONS, INC. STATEMENTS OF OPERATIONS (UNAUDITED) For the three months ended March 31, 2002 2001 ------------- ----------- Revenues: Products $ 316,109 $ 2,084,788 Services 51,337 568,800 ----------- ----------- 367,446 2,653,588 Cost of sales: Products 241,108 1,210,987 Services 14,051 45,523 ----------- ----------- 255,159 1,256,510 Gross margin 112,287 1,397,078 ----------- ----------- Operating expenses: Research and development 560,889 704,019 Selling, general and administrative 1,341,282 1,429,582 ----------- ----------- Total operating expenses 1,902,171 2,133,601 ----------- ----------- Loss from operations (1,789,884) (736,523) Interest expense, net 769,263 57,827 ----------- ----------- Net loss $(2,559,147) $ (794,350) =========== =========== Net loss per common share - basic and diluted $ (1.20) $ (.37) =========== =========== Weighted average shares outstanding - basic and diluted 2,133,594 2,133,594 =========== =========== See Notes to Financial Statements. VIDEO NETWORK COMMUNICATIONS, INC. STATEMENTS OF CASH FLOWS (UNAUDITED)
Three months ended March 31, 2002 2001 --------------- ------------ Cash flows from operating activities: Net loss $(2,559,147) $ (794,350) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation 46,413 86,240 Amortization 6,122 5,468 Interest expense related to issuance of warrants 1,795 11,047 Amortization of debt discount 646,043 -- Non-cash compensation expense 85,000 -- Changes in operating assets and liabilities: Accounts receivable 503,046 956,006 Inventory 150,556 (1,270,171) Other current assets 44,660 (30,584) Accounts payable 14,088 (44,139) Deferred revenue (1,391) 708,228 Accrued liabilities (80,474) 19,809 ----------- ----------- Net cash used in operating activities (1,143,289) (352,446) ----------- ----------- Cash flows from investing activities: Increase in trademarks and patents -- (1,729) Purchase of property and equipment -- (27,475) ----------- ----------- Net cash used in investing activities -- (29,204) ----------- ----------- Cash flows from financing activities: Costs of issuing common stock -- (56,584) Net proceeds from the issuance of notes payable 849,000 -- Repayments of notes payable (13,389) (48,641) Principal payments on capital leases (6,592) (3,355) ----------- ----------- Net cash provided by (used in) financing activities 829,019 (108,580) ----------- ----------- Net decrease in cash and cash equivalents (314,270) (490,230) Cash and cash equivalents, at beginning of period 507,396 1,660,051 ----------- ----------- Cash and cash equivalents, at end of period $ 193,126 $ 1,169,821 =========== =========== Supplemental disclosure of non-cash investing and financing activities: See Note 6
See Notes to Financial Statements. VIDEO NETWORK COMMUNICATIONS, INC. Notes To Financial Statements (Unaudited) On May 17, 2002, we announced that we had entered into a Stock Purchase Agreement with an affiliate of Moneyline Telerate Holdings, which is majority owned by One Equity Partners, the private equity arm of Bank One Corporation, and an Agreement and Plan of Merger with B2BVideo Network Corp. In connection with the merger agreement, B2BVideo became a wholly owned subsidiary of the Company and B2B's shareholders were issued 3 million shares of the Company's common stock. Pursuant to the Stock Purchase Agreement, Moneyline purchased 25 million new shares of our common stock at $0.60 per share, for a total investment of approximately $15,000,000. In addition, Moneyline was issued warrants to purchase an additional 11.25 million shares of common stock at an exercise price of $0.60 per share, and was granted the right to appoint a majority of the directors of the Company's board of directors. Simultaneously, certain existing investors and new investors introduced to the Company by EarlyBirdCapital, a NY-based private equity investment bank, invested a total of $11.1 million, purchasing new shares of our common stock and converting certain outstanding loans to us and to B2BVideo into shares of our common stock at $0.60 per share. Moneyline beneficially owns approximately 61% of the Company's common stock. The Company, B2BVideo Network and Moneyline also entered into a Strategic Alliance Agreement and certain technology license agreements pursuant to which the Company and B2BVideo will license software and network processes and sell video equipment to Moneyline. Moneyline will be the exclusive distributor of our equipment to the financial services market. As a result of these developments, certain information in this Form 10-QSB may be substantially changed. Additional information regarding these events is contained in reports on Form 8-K, filed on May 17, 2002 and May 28, 2002. See Note 8, Subsequent Events. 1. Basis of Presentation The accompanying unaudited financial statements of Video Network Communications, Inc. (the "Company") as of March 31, 2002 and for the three months ended March 31, 2002 and 2001 have been prepared in accordance with generally accepted accounting principles for interim financial information and with instructions to Form 10-QSB and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, such financial statements contain all adjustments consisting only of normal recurring entries, necessary to present fairly the financial position of the Company as of March 31, 2002 and the results of operations for the three months ended March 31, 2002 and 2001. The interim financial statements should be read in conjunction with the audited financial statements and notes thereto for the year ended and as of December 31, 2001 included in the Video Network Communications, Inc. Annual Report on Form 10-KSB, as filed with the Securities and Exchange Commission under the Securities Exchange Act of 1934, as amended. The results of operations for the three months ended March 31, 2002 are not necessarily indicative of the results that may be expected for the entire year. The Company effected a one-for-five reverse stock split on February 5, 2002. The data presented in these financial statements has been adjusted to reflect the effects of that reverse stock split. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that effect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. To date, the Company has not generated substantial revenues from the sale of its products and services. The Company recognized $12,976,000 in revenues during the year 2001, and recognized $367,000 in revenues during the three months ended March 31, 2002. , Of the revenues earned in the first quarter of 2002, 73% were to B2BVideo Network Corp., a related party. Through the first quarter of 2002, the Company had suffered recurring losses from operations, and had recurring negative cash flow from operations. At March 31, 2002, the Company had an accumulated deficit of $70.2 million that, together with its recurring losses from operations and negative cash flow, raise substantial doubt about its ability to continue as a going concern. The financial statements do not include any adjustments that might result from the outcome of this uncertainty. The Company has required substantial funding through debt and equity financings since its inception to complete its development plans and commence full-scale operations. 2. Net Loss Per Share The Company computes basic and diluted earnings per share in accordance with Statement of Financial Accounting Standards No. 128, "Earnings per Share". Net loss per common share is based on the weighted average number of common shares and dilutive common share equivalents outstanding during the periods presented. Basic loss per share is calculated by dividing net income by the weighted average shares outstanding. Diluted loss per share reflects the dilutive effect of stock options and warrants and are presented only if the effect is not anti-dilutive. As the Company incurred losses for all periods, there is no difference between basic and diluted earnings per share. Had options and warrants been included in the computation, shares for the diluted computation would have increased by 4,269,673 and 1,856,770 as of March 31, 2002 and 2001, respectively. 3. Income taxes The Company did not record a provision for income taxes for the three months ended March 31, 2002 and 2001 since the Company had a significant net operating loss carryforward available to it at March 31, 2002 and the Company had a net operating loss during the period ending March 31, 2001. The Company recorded a full valuation allowance against the net deferred tax asset generated primarily from its net operating loss carryforwards. 4. Inventories Inventories consisted of the following at: March 31, December 31, 2002 2001 ----------- ------------ (Unaudited) Raw Materials $1,044,193 $1,194,749 Finished Goods -- -- ---------- ---------- $1,044,193 $1,194,749 ========== ========== 5. Debt On May 17, 2002, we announced that we had entered into a Stock Purchase Agreement with an affiliate of Moneyline Telerate Holdings, which is majority owned by One Equity Partners, the private equity arm of Bank One Corporation, and an Agreement and Plan of Merger with B2BVideo Network Corp. In connection with the merger agreement, B2BVideo became a wholly owned subsidiary of the Company and B2B's shareholders were issued 3 million shares of the Company's common stock. Pursuant to the Stock Purchase Agreement, Moneyline purchased 25 million new shares of our common stock at $0.60 per share, for a total investment of approximately $15,000,000. In addition, Moneyline was issued warrants to purchase an additional 11.25 million shares of common stock at an exercise price of $0.60 per share, and was granted the right to appoint a majority of the directors of the Company's board of directors. Simultaneously, certain existing investors and new investors introduced to the Company by EarlyBirdCapital, a NY-based private equity investment bank, invested a total of $11.1 million, purchasing new shares of our common stock and converting certain outstanding loans to us and to B2BVideo into shares of our common stock at $0.60 per share. Moneyline beneficially owns approximately 61% of the Company's common stock. The Company, B2BVideo Network and Moneyline also entered into a Strategic Alliance Agreement and certain technology license agreements pursuant to which the Company and B2BVideo will license software and network processes and sell video equipment to Moneyline. Moneyline will be the exclusive distributor of our equipment to the financial services market. As a result of these developments, certain information in this Form 10-QSB may be substantially changed. Additional information regarding these events is contained in reports on Form 8-K, filed on May 17, 2002 and May 28, 2002. See Note 8, Subsequent Events. Sanmina Note In January 1999, the Company converted outstanding accounts payable to Sanmina Corporation to a $4,300,000 three-year term note accruing interest at 7% per year. In connection with the restructuring of accounts payable balances to a long-term note, the Company issued to Sanmina warrants to purchase 7,857 shares of common stock, with a $96.25 exercise price per share. An independent appraisal assigned a market value of $127,759 to these warrants. The Company recorded the value of the warrants as a discount against the face amount of the note and amortized the value of the warrants over the life of the note. In January 2000, the Company defaulted on the interest payment due to Sanmina and did not make subsequent interest and principal payments to Sanmina when due through August 2000. In August 2000, the Company renegotiated the terms of the note to Sanmina. Under the current terms of the note, the Company paid $150,000 on August 25, 2000 and $150,000 in November 2000. The Company is obligated to pay an amount each month equal to a percentage of the accounts receivable that it collected in the previous calendar month, with the percentage ranging from 0% to 5%, based upon the net amount of accounts receivable that we collect, beginning in February 2001. Any principal and accrued interest thereon remaining on the note was due in full on January 12, 2002. The Sanmina note is collateralized by the Company's personal property and certain other assets. At March 31, 2002, the Company owed Sanmina approximately $3.5 million in principal and interest on this note. See Note 8, Subsequent Events Bridge Loans On January 24, 2002, the Company issued to investors in a private placement $500,000 in aggregate principal amount of 9% Unsecured Promissory Notes (the "Unsecured Notes") and warrants (the "Warrants") to purchase 200,000 shares of the Company's common stock at an initial exercise price of $1.30 per share (the "Bridge Financing"). The Company offered the Unsecured Notes and Warrants directly to persons who qualified as "accredited investors" under the Securities Act of 1933, as amended, and not through any placement agent. Each investor who participated in the Bridge Financing received an Unsecured Note representing the principal amount of the investor's investment and a Warrant to purchase the Company's common stock. For every dollar that an investor invested in the Bridge Financing, the investor received a Warrant to purchase four-tenths of a share of the Company's common stock. The Unsecured Notes are unsecured debt obligations of the Company and will be due and payable upon the earlier of April 24, 2002 or the date on which the Company completes its next debt or equity financing in which it raises in the aggregate, on a cumulative basis, in excess of $2,500,000 in gross proceeds. The holders of the Unsecured Notes have the right to convert all or any portion of the principal amount of the Unsecured Notes into the securities that the Company issues in its next financing. The Notes bear interest at a rate of 9% per annum. Interest accrues from January 24, 2002 through the date on which the Notes become due and payable. The Notes were not paid when due and interest accrued at the rate of 18% per annum thereafter. See Note 8, Subsequent Events. The Warrants will be first exercisable beginning on July 24, 2002 and will be exercisable until July 23, 2007. The initial exercise price for the Warrants of $1.30 per share is subject to adjustment in certain limited events, including recapitalizations, reclassifications or split-ups of the Company's common stock. The Warrants have a cashless exercise provision. The Company is using the net proceeds from the Bridge Financing to provide short-term working capital. On March 28, 2002, the Company borrowed the aggregate principal amount of $349,000 pursuant to a 9% Unsecured Promissory Note (the "Unsecured Note"). In connection with the loan, the Company also issued to the lender a warrant (the "Warrant") to purchase 698,000 shares of the Company's common stock at an initial exercise price of $1.30 per share (the "Bridge Financing"). The Unsecured Note is an unsecured debt obligation of the Company and is due and payable on the earlier of June 26, 2002 or the date on which the Company completes its next debt or equity financing in which it raises in the aggregate, on a cumulative basis, in excess of $2,500,000 in gross proceeds. The holder of the Unsecured Note has the right to convert all or any portion of the principal amount of the Unsecured Note into the securities that the Company issues in its next financing. The Unsecured Note bears interest at a rate of 9% per annum. Interest accrues from March 28, 2002 through the date on which the Unsecured Note becomes due and payable See Note 8, Subsequent Events. The Warrant issued in connection with the loan will first be exercisable beginning on August 26, 2002 and will be exercisable until August 26, 2007. The initial exercise price for the Warrant of $1.30 per share is subject to adjustment in certain limited events, including recapitalizations, reclassifications or split-ups of the Company's common stock and for issuances of securities at a price less than the then current exercise price. The Warrant has a cashless exercise provision. The Company is using the net proceeds from the Bridge Financing to provide short-term working capital. Defaults on Prior Bridge Notes and Sanmina Note. The Company is currently in default on certain of its outstanding bridge note obligations. The Company is in default on its repayment obligations to holders of the $1,000,000 aggregate principal amount of 9% Senior Secured Promissory Notes issued in September and October of 2001 (the "First Bridge Notes") and is in breach of certain of its covenants in the First Bridge Notes and related documentation. The First Bridge Notes are secured by substantially all of the Company's intellectual property and, as amended, were due and payable on February 15, 2002 or, in the case of $300,000 aggregate principal amount of the First Bridge Notes the holders of which agreed to extend the maturity date to March 31, 2002. As a result of the Company's default on the First Bridge Notes, the holders of the First Bridge Notes have the right to exercise various legal and contractual remedies, including the right to foreclose on substantially all of the Company's intellectual property which constitutes a material portion of the Company's assets, and interest will accrue on the First Bridge Notes from the first date of default at the rate of 18% per year. The Company also is in default in its repayment obligations to the holders of the $1,674,982 aggregate principal amount of 9% Unsecured Promissory Notes issued in November and December of 2001 (the "Second Bridge Notes"), and is in breach of certain covenants of the Company set forth in the Second Bridge Notes and related documentation. The Second Bridge Notes are unsecured debt obligations of the Company and, as amended, were due and payable on February 19, 2002 or, in the case of $350,000 aggregate principal amount of Second Bridge Notes, the holders of which agreed to extend the maturity date to March 31, 2002. As a result of the Company's defaults on the Second Bridge Note obligations, the holders of the Second Bridge Notes have the right to exercise various contractual and legal remedies and interest will accrue on the Second Bridge Notes from the first date of default at the rate of 18% per year. The Company also has outstanding $500,000 aggregate principal amount of 9% Unsecured Promissory Notes issued on January 24, 2002 (the "Third Bridge Notes" and, together with the First and Second Bridge Notes, the "Prior Bridge Notes"), which are due and payable upon the earlier of (i) April 24, 2002 or (ii) the date on which the Company completes its next debt or equity financing in which it raises in the aggregate, on a cumulative basis, in excess of $2,500,000 in gross proceeds (a "Qualified Financing"). See Note 8, Subsequent Events. The Company is also in default on its outstanding note to Sanmina Corporation (the "Sanmina Note"). The Sanmina Note is secured by substantially all of the Company's assets, other than its intellectual property. The Sanmina Note became due and payable on February 28, 2002. As a result of the default on the Sanmina Note, Sanmina Corporation has the right to foreclose on a material portion of the Company's assets. The Company has pledged substantially all of its material assets as security for the First Bridge Notes and the Sanmina Note. As a result of the Company's defaults on the Prior Bridge Notes and the Sanmina Note, the holders of those notes may accelerate the Company's obligation to repay in full the Company's outstanding obligations under these notes, including principal, interest and costs associated with the acceleration, and any such acceleration could trigger a cross-default provision in other obligations, requiring the Company to pay immediately all of the aggregate outstanding principal and interest on other obligations. The loss of the assets that serve as security for the Company's outstanding obligations would materially and adversely affect its business and could require it to file for bankruptcy. 6. Non-cash Transactions The following non-cash transactions occurred in the periods indicated: Three months ended March 31, 2002 2001 ---- ---- (Unaudited) (Unaudited) Note payable issued to fund prepaid insurance $ - $75,000 Issuance of warrants with bridge notes 471,808 7. New Accounting Pronouncements In June 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards ("SFAS") No. 141, Business Combinations, and No. 142, Goodwill and other Intangible Assets. SFAS No. 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001. Use of the pooling of interests method is no longer permitted. SFAS No. 141 also includes guidance on the initial recognition and measurement of goodwill and other intangible assets acquired in a business combination that is completed after June 30, 2001. SFAS No. 142 no longer permits the amortization of goodwill and indefinite-lived intangible assets. Instead, these assets must be reviewed annually (or more frequently under certain conditions) for impairment in accordance with the Statement. The impairment test uses a fair value approach rather than the undiscounted cash flows approach previously required by SFAS No. 121, Accounting for the Impairment of Long-Lived Assets to Be Disposed Of. Intangible assets that do not have indefinite lives will continue to be amortized over their useful lives and reviewed for impairment in accordance with SFAS No. 121. The Company has adopted SFAS No. 142 effective January 1, 2002, and it had no significant impact on the Company's financial position or results of operations. In August 2001, the Financial Accounting Standards Board issued SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, which addresses financial accounting and reporting for the impairment or disposal of long-lived assets and supersedes SFAS No. 121, Accounting for the Impairment of Long-Lived Assets to Be Disposed Of, and the accounting and reporting provisions of APB Opinion No. 30, Reporting the Results of Operations for a disposal of a segment of a business. SFAS No. 144 is effective for fiscal years beginning after December 14, 2001, with earlier application encouraged. The Company has adopted SFAS No. 144 as of January 1, 2002, and it had no significant impact on the Company's financial position or results of operations. 8. Subsequent Events On May 17, 2002, we announced that we had entered into a Stock Purchase Agreement with an affiliate of Moneyline Telerate Holdings, which is majority owned by One Equity Partners, the private equity arm of Bank One Corporation, and an Agreement and Plan of Merger with B2BVideo Network Corp. In connection with the merger agreement, B2BVideo became a wholly owned subsidiary of the Company and B2B's shareholders were issued 3 million shares of the Company's common stock. Pursuant to the Stock Purchase Agreement, Moneyline purchased 25 million new shares of our common stock at $0.60 per share, for a total investment of approximately $15,000,000. In addition, Moneyline was issued warrants to purchase an additional 11.25 million shares of common stock at an exercise price of $0.60 per share, and was granted the right to appoint a majority of the directors of the Company's board of directors. Simultaneously, certain existing investors and new investors introduced to the Company by EarlyBirdCapital, a NY-based private equity investment bank, invested a total of $11.1 million, purchasing new shares of our common stock and converting certain outstanding loans to us and to B2BVideo into shares of our common stock at $0.60 per share. Moneyline beneficially owns approximately 61% of the Company's common stock. The Company, B2BVideo Network and Moneyline also entered into a Strategic Alliance Agreement and certain technology license agreements pursuant to which the Company and B2BVideo will license software and network processes and sell video equipment to Moneyline. Moneyline will be the exclusive distributor of our equipment to the financial services market. As a result of these developments, certain information in this Form 10-QSB may be substantially changed. Additional information regarding these events is contained in reports on Form 8-K, filed on May 17, 2002 and May 28, 2002. The following material events took place subsequent to March 31, 2002. These events are material events in the Company's operations and this section should be read carefully and thoroughly by readers. Data in the following has been adjusted to give effect to the Company's one-for-five reverse stock split effected on February 5, 2002. Defaults on Prior Bridge Notes and Sanmina Note. On May 17, 2002, the Company was in default on certain of its outstanding bridge note obligations. The Company was in default on its repayment obligations to holders of the $1,000,000 aggregate principal amount of 9% Senior Secured Promissory Notes issued in September and October of 2001 (the "First Bridge Notes") and is in breach of certain of its covenants in the First Bridge Notes and related documentation. The First Bridge Notes are secured by substantially all of the Company's intellectual property and, as amended, were due and payable on February 15, 2002 or, in the case of $300,000 aggregate principal amount of the First Bridge Notes the holders of which agreed to extend the maturity date to March 31, 2002. As a result of the Company's default on the First Bridge Notes, the holders of the First Bridge Notes have the right to exercise various legal and contractual remedies, including the right to foreclose on substantially all of the Company's intellectual property which constitutes a material portion of the Company's assets, and interest will accrue on the First Bridge Notes from the first date of default at the rate of 18% per year. The Company also is in default in its repayment obligations to the holders of the $1,674,982 aggregate principal amount of 9% Unsecured Promissory Notes issued in November and December of 2001 (the "Second Bridge Notes"), and is in breach of certain covenants of the Company set forth in the Second Bridge Notes and related documentation. The Second Bridge Notes are unsecured debt obligations of the Company and, as amended, were due and payable on February 19, 2002 or, in the case of $350,000 aggregate principal amount of Second Bridge Notes, the holders of which agreed to extend the maturity date to March 31, 2002. As a result of the Company's defaults on the Second Bridge Note obligations, the holders of the Second Bridge Notes have the right to exercise various contractual and legal remedies and interest will accrue on the Second Bridge Notes from the first date of default at the rate of 18% per year. At May 17, 2002 the Company also had outstanding $500,000 aggregate principal amount of 9% Unsecured Promissory Notes issued on January 24, 2002 (the "Third Bridge Notes" and, together with the First and Second Bridge Notes, the "Prior Bridge Notes"), which are due and payable upon the earlier of (i) April 24, 2002 or (ii) the date on which the Company completes its next debt or equity financing in which it raises in the aggregate, on a cumulative basis, in excess of $2,500,000 in gross proceeds (a "Qualified Financing"). The Company did not complete a Qualified Financing prior to April 23, 2002 and did not repay the Third Bridge Note obligations when they became due and is in default. Accordingly, the holders of the Third Bridge Notes have the right to exercise various contractual and legal remedies and interest would accrue on the Third Bridge Notes from the date of default at the rate of 18% per year. On May 17, 2002, the Company was also in default on its outstanding note to Sanmina Corporation (the "Sanmina Note"). The Sanmina Note is secured by substantially all of the Company's assets, other than its intellectual property. The Sanmina Note became due and payable on January 12, 2002. As a result of the default on the Sanmina Note, Sanmina Corporation has the right to foreclose on a material portion of the Company's assets. The Company has pledged substantially all of its material assets as security for the First Bridge Notes and the Sanmina Note. As a result of the Company's defaults on the Prior Bridge Notes and the Sanmina Note, the holders of those notes may accelerate the Company's obligation to repay in full the Company's outstanding obligations under these notes, including principal, interest and costs associated with the acceleration, and any such acceleration could trigger a cross-default provision in other obligations, requiring the Company to pay immediately all of the aggregate outstanding principal and interest on other obligations. The loss of the assets that serve as security for the Company's outstanding obligations would materially and adversely affect its business and could require it to file for bankruptcy. On April 28, 2002, the Company completed a fifth short-term debt financing when the Company borrowed the aggregate principal amount of $200,000 pursuant to a 9% Unsecured Promissory Note (the "Unsecured Note"). In connection with the loan, the Company also issued to the lender a warrant (the "Warrant") to purchase 400,000 shares of the Company's common stock at an initial exercise price of $1.30 per share (the "Bridge Financing"). The Unsecured Note is an unsecured debt obligation of the Company and is due and payable on demand or on the date on which the Company completes its next debt or equity financing in which it raises in the aggregate, on a cumulative basis, in excess of $2,500,000 in gross proceeds. The holder of the Unsecured Note has the right to convert all or any portion of the principal amount of the Unsecured Note into the securities that the Company issues in its next financing. The Unsecured Note bears interest at a rate of 9% per annum. Interest accrues from March 28, 2002 through the date on which the Unsecured Note becomes due and payable. If the Unsecured Note is not paid when due, interest will accrue at the rate of 18% per annum thereafter. The Warrant issued in connection with the loan will first be exercisable beginning on August 26, 2002 and will be exercisable until August 26, 2007. The initial exercise price for the Warrant of $1.30 per share is subject to adjustment in certain limited events, including recapitalizations, reclassifications or split-ups of the Company's common stock and for issuances of securities at a price less than the then current exercise price. The Warrant has a cashless exercise provision. The Company is using the net proceeds from the Bridge Financing to provide short-term working capital. On May 17, 2002, we announced that we had entered into a Stock Purchase Agreement with an affiliate of Moneyline Telerate Holdings, which is majority owned by One Equity Partners, the private equity arm of Bank One Corporation, and an Agreement and Plan of Merger with B2BVideo Network Corp. In connection with the merger agreement, B2BVideo became a wholly owned subsidiary of the Company and B2B's shareholders were issued 3 million shares of the Company's common stock. Pursuant to the Stock Purchase Agreement, Moneyline purchased 25 million new shares of our common stock at $0.60 per share, for a total investment of approximately $15,000,000. In addition, Moneyline was issued warrants to purchase an additional 11.25 million shares of common stock at an exercise price of $0.60 per share, and was granted the right to appoint a majority of the directors of the Company's board of directors. Simultaneously, certain existing investors and new investors introduced to the Company by EarlyBirdCapital, a NY-based private equity investment bank, invested a total of $11.1 million, purchasing new shares of our common stock and converting certain outstanding loans to us and to B2BVideo into shares of our common stock at $0.60 per share. Moneyline beneficially owns approximately 61% of the Company's common stock. The Company, B2BVideo Network and Moneyline also entered into a Strategic Alliance Agreement and certain technology license agreements pursuant to which the Company and B2BVideo will license software and network processes and sell video equipment to Moneyline. Moneyline will be the exclusive distributor of our equipment to the financial services market. As a result of these developments, certain information in this Form 10-QSB may be substantially changed. Additional information regarding these events is contained in reports on Form 8-K, filed on May 17, 2002 and May 28, 2002. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Certain statements contained in this Quarterly Report on Form 10-QSB, other than historical financial information, constitute "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. All such forward-looking statements involve known and unknown risks, uncertainties or other factors which may cause our actual results, performance or achievements to be materially different from any future results, performance or achievement expressed or implied by such forward-looking statements. Factors that might cause such a difference include risks and uncertainties related to our dependence on the emerging market for video broadcast, retrieval and conferencing, development of additional products, protection of our intellectual property, limited marketing experience, limited number of customers, and the need for additional personnel, as well as risks and uncertainties associated with our growth strategy, technological changes and competitive factors affecting us. The most important of these risks are discussed in more detail below under the heading "Risk Factors," and we urge you to read these in their entirety. On May 17, 2002, we announced that we had entered into a Stock Purchase Agreement with an affiliate of Moneyline Telerate Holdings, which is majority owned by One Equity Partners, the private equity arm of Bank One Corporation, and an Agreement and Plan of Merger with B2BVideo Network Corp. In connection with the merger agreement, B2BVideo became a wholly owned subsidiary of the Company and B2B's shareholders were issued 3 million shares of the Company's common stock. Pursuant to the Stock Purchase Agreement, Moneyline purchased 25 million new shares of our common stock at $0.60 per share, for a total investment of approximately $15,000,000. In addition, Moneyline was issued warrants to purchase an additional 11.25 million shares of common stock at an exercise price of $0.60 per share, and was granted the right to appoint a majority of the directors of the Company's board of directors. Simultaneously, certain existing investors and new investors introduced to the Company by EarlyBirdCapital, a NY-based private equity investment bank, invested a total of $11.1 million, purchasing new shares of our common stock and converting certain outstanding loans to us and to B2BVideo into shares of our common stock at $0.60 per share. Moneyline beneficially owns approximately 61% of the Company's common stock. The Company, B2BVideo Network and Moneyline also entered into a Strategic Alliance Agreement and certain technology license agreements pursuant to which the Company and B2BVideo will license software and network processes and sell video equipment to Moneyline. Moneyline will be the exclusive distributor of our equipment to the financial services market. As a result of these developments, certain information in this Form 10-QSB may be substantially changed. Additional information regarding these events is contained in reports on Form 8-K, filed on May 17, 2002 and May 28, 2002. See Note 8, Subsequent Events. The following discussion should be read in conjunction with the unaudited financial statements and notes thereto appearing elsewhere in this Quarterly Report on Form 10-QSB. OVERVIEW Our financial results for the quarter ending March 31, 2002 were disappointing. We reported revenues of $ 367,000 for the quarter ended March 31, 2002, a decrease of 86% when compared with revenues reported for the same period in 2001. Our operating expenses for the quarter ended March 31, 2002 of $1,902,000 were approximately 11% lower than our operating expenses for the first quarter of 2001. At this stage of our product's market development, it is difficult for us to predict with accuracy the level of our sales in future periods, or when our marketing initiatives will result in higher sales. We have relatively few customers and individual system purchases normally exceed one hundred thousand dollars. While not occurring in the first quarter of 2002, large individual sales could continue to account for a significant portion of our revenues. Accordingly, we expect to continue to experience significant, material fluctuations in our revenues on a quarterly basis for the foreseeable future. We believe these results are, in part, indicative of the quarter to quarter variability inherent in our business because purchases of our video network system constitute a substantial capital expenditure by our customers and, at this stage of our development as we build our customer base, each sale of our equipment constitutes a relatively large portion of our revenues for the period in which the sale is recognized. One factor adversely affecting our revenues was that the U.S. government has delayed notification of contract awards under its subsidized education program, the E-Rate Program, well beyond the date that we expected the announcements to be made. In forecasting our results of operations for the first quarter, we had anticipated that contracts would be awarded under that program prior to the beginning of the E-Rate Program fiscal year that began on July 1, 2001, and that contract announcements would continue through October 2001. We had also projected that the Company would be awarded substantial contracts or subcontracts for our video network equipment under this program. In 2000 and 2001, VNCI received substantial contract and subcontract awards under this program, resulting in significant revenues to the Company, and we had projected awards in our second quarter of 2001 that would have been performed in part as early as our third quarter of 2001. The failure of this program to generate any revenues for us in the second half of 2001 was unexpected. During the first quarter of 2002, several school districts were notified that the Schools and Libraries Division (SLD) of the Universal Service Administrative Company (USAC) had approved funding of projects which, if accepted by the school districts, may result in revenues to us in 2002. At March 31, 2002, and as of the date of this report we had not been notified that any of these school districts had accepted the funding awarded. The extent to which our weak balance sheet has affected potential sales is difficult to assess. Our customers tend to be large entities and we believe they have been hesitant to make substantial commitments to our proprietary technology in light of the condition of our balance sheet. In the first quarter of 2002, we hired a new Vice President Sales and Marketing. He has continued our sales strategy of focusing on our five vertical markets: healthcare, government, video production and distribution, finance and education. We have established reference accounts in the healthcare, government and video production and distribution markets and we believe that we have made substantial inroads in the education market. While we achieved important successes in both the healthcare and government markets during the year, customers in the video production and distribution market are indicating that future capital budgets are heavily constrained as a result of the slowing economy. As the economy continues to be generally weak, we continue to focus on identifying new potential customers for whom video application is "mission critical," because we believe these potential customers will be able to realize a return on their investment or an overall cost savings as the result of an investment in a video network system. Although we experienced a delay in purchases as a result of the tragic events of September 11, 2001, these same events also have generated significant new interest in our video network products as corporate America and the Federal government evaluate alternatives to travel for business purposes and the increased use of video for security. Our web-site traffic and telephone inquires have roughly doubled. We believe this new interest in visual communications will accelerate the adoption of video networks by large, complex organizations. However, we cannot predict when or if this new interest will result in orders for our products, and we remain particularly concerned given the downturn in the economy generally. Between September 2001 and March 2002, we raised approximately $3,524,000 by issuing a series of four bridge notes. Issued in connection with these notes were warrants to purchase approximately 2,168,000 shares of common stock which, when fully amortized, will represent approximately $5,745,000 in interest expense. For the remainder of 2002, we intend to intensify our focus on selling and marketing our video network solutions and continuing product development to meet customer demands for new functionality and to lower the cost of our systems. Specifically, our goals are to (i) significantly enhance our marketing and public relations programs to create better awareness of our products among customers, industry analysts and financial analysts, (ii) develop our direct sales, (iii) continue engineering our video network system to refine and improve its functionality to meet new customer requirements and to lower our costs and the price of our system through improved design, (iv) develop new strategic partnerships committed to marketing our video network system as the video solution of choice to business users, and (v) use our current strategic and reseller arrangements to increase sales of our systems and create brand name recognition of our product. Our ability to meet these objectives is subject to a number of risks and uncertainties, including our ability to develop new strategic relationships with significant potential resellers, our ability to sell and market our product and develop market awareness of our video network system and our ability to obtain financing when required. We plan to continue to subcontract all major manufacturing and production activities for the foreseeable future, but we will continue to retain test and quality assurance functions until all subcontractors are certified with respect to quality. Our ability to meet these objectives is subject to a number of risks and uncertainties, including our ability to develop new strategic relationships with significant potential resellers, our ability to sell and market our product and develop market awareness of our video network system and our ability to obtain financing when required. We plan to continue to subcontract all major manufacturing and production activities for the foreseeable future, but we will continue to retain test and quality assurance functions until all subcontractors are certified with respect to quality. We have a limited customer base with several customers providing in excess of 10% of our total revenues. Three customers accounted for 73%, 6%, and 6% of our total revenues in the first quarter ended March 31, 2002, and two customers accounted for 50% and 30%, respectively, of total revenues for the year ended December 31, 2001. In the first quarter of 2002, 73% of revenues were to B2BVideo Network Corp., a related party. Three customers accounted for 40%, 29%, and 20 % of our accounts receivable at March 31, 2002, and four customers accounted for 30%, 16%, 13%, and 10%, respectively, of accounts receivable outstanding as of December 31, 2001. RECENT EVENTS Readers are encouraged to see Note 8 Subsequent Events to Notes To Financial Statements (Unaudited). On May 17, 2002, we announced that we had entered into a Stock Purchase Agreement with an affiliate of Moneyline Telerate Holdings, which is majority owned by One Equity Partners, the private equity arm of Bank One Corporation, and an Agreement and Plan of Merger with B2BVideo Network Corp. In connection with the merger agreement, B2BVideo became a wholly owned subsidiary of the Company and B2B's shareholders were issued 3 million shares of the Company's common stock. Pursuant to the Stock Purchase Agreement, Moneyline purchased 25 million new shares of our common stock at $0.60 per share, for a total investment of approximately $15,000,000. In addition, Moneyline was issued warrants to purchase an additional 11.25 million shares of common stock at an exercise price of $0.60 per share, and was granted the right to appoint a majority of the directors of the Company's board of directors. Simultaneously, certain existing investors and new investors introduced to the Company by EarlyBirdCapital, a NY-based private equity investment bank, invested a total of $11.1 million, purchasing new shares of our common stock and converting certain outstanding loans to us and to B2BVideo into shares of our common stock at $0.60 per share. Moneyline beneficially owns approximately 61% of the Company's common stock. The Company, B2BVideo Network and Moneyline also entered into a Strategic Alliance Agreement and certain technology license agreements pursuant to which the Company and B2BVideo will license software and network processes and sell video equipment to Moneyline. Moneyline will be the exclusive distributor of our equipment to the financial services market. RESULTS OF OPERATIONS COMPARISON OF THE THREE MONTHS ENDED MARCH 31, 2002 AND MARCH 31, 2001 Revenues. We recognized $367,000 in revenues during the three months ended March 31, 2002 compared to $2,654,000 in the comparable period in 2001, representing a decrease of approximately $2,287,000, or 86%. Of these revenues, $316,000 related to product sales in the first three months of 2002 compared to $2,085,000 recognized in the comparable period of 2001, representing a $1,769,000, or 85%, decrease in equipment sales. The decrease in equipment sales is due to a decrease in both the number of customers and the average order size experienced in the first quarter of 2002 compared to the comparable period of 2001. Revenues related to installation and other services were $51,000 in the first three months of 2002 compared to $569,000 in the comparable period of 2001. Included in service revenues in the first three months of 2001 was $467,000 of management fees. No management fees were recognized in the comparable period of 2002. Eighty five percent of total sales in the first three months of 2002 were from three customers. Of the revenues earned in the first quarter of 2002, 73% were to B2BVideo Network Corp., a related party. Cost of Sales. Cost of sales for the three months ended March 31, 2002 was $255,000. This represents a decrease of $1,002,000 from the $1,257,000 recorded in the comparable period of 2001. Cost of product sales as a percentage of product sales was approximately 76% and 58% in the three months ending March 31, 2002 and 2001, respectively. Cost of service sales for the three months ended March 31, 2002 were $14,000 compared to $46,000 in the same period of 2001, and reflect the costs of providing installation and other services. Gross Margin on Sales. Gross margin on total sales was approximately $112,000, or 31%, for the period ending March 31, 2002 compared to gross margin of $1,397,000, or 53%, for the comparable period in 2001. The gross margin percentage on equipment sales in the first three months of 2002 was 24%, compared to 42% realized on equipment sales in the comparable period of 2001. The lower gross margin experienced in 2002 was attributable primarily to under-absorption of manufacturing costs due to low product sales volume. The gross margin percentage on service revenues for the first three months of 2002 was 73% compared to 92% in the first quarter of 2001. The higher gross margin percentage on service revenues achieved in the first quarter of 2001 was attributable to the management fees earned in that quarter. No management fees were earned in the first quarter of 2002. Research and Development. Research and development costs decreased to $561,000 in the three months ended March 31, 2002, compared to $704,000 in the first quarter of 2001, a decrease of $143,000, or 20%. Approximately $115,000 of the reduction resulted from reduced staffing costs due to a reduction in staffing levels in the research and development departments. Depreciation charged to research and development decreased $24,000. Approximately $31,000 of the decrease was due to reduced spending on materials, equipment and testing services used in support of research projects in the first quarter of 2002 compared to the same period in 2001. Selling, General and Administrative Expenses. Selling, general, and administrative expenses decreased to $1,341,000 during the three months ended March 31, 2002, from $1,430,000 during the three months ended March 31, 2001, a decrease of approximately $89,000 or 6%. Sales and marketing expenses decreased approximately $180,000, from $802,000 to $622,000, or 22%, in the first three months of 2002 as compared to the same period of 2001. Approximately $202,000 of this decrease was due to lower sales and marketing personnel costs. Reduced commissions expense as a result on the reduced level of sales in the first quarter of 2002 was a significant proportion of the overall reduction in sales and marketing staffing costs. Travel related expenses decreased approximately $27,000. The cost of outside consultants and other professional services declined $42,000. Depreciation charged to the sales and marketing departments declined $11,000. Offsetting these reductions was an increase of $85,000 related to the value of options granted to outside sales consultants and other recruiting expense of $10,000. Customer support expenses decreased from $198,000 to $87,000, a decrease of $111,000, or 56%, for the period ending March 31, 2002 compared to the same period of 2001. Decreases in salaries, benefits, travel expenses, and materials costs, totaling approximately $129,000, were offset by reductions in allocations of customer support costs to Cost of sales - Services due to decreased service revenues recognized during the quarter. General and administrative costs increased by approximately $202,000 in the three months ended March 31, 2002 compared to the same period in 2001. An increase in legal costs of $228,000 was related to various financing initiatives being pursued in the first quarter of 2002. Offsetting this increase were reductions in recruiting charges, $6,000, depreciation, $10,000, and service department allocations, $24,000, compared to the same period of 2001. Net Interest Expense. Net interest expense of $769,000 incurred in the first quarter of 2002 was $711,000 higher than the $58,000 recorded in the same period of 2001. Interest expense increased from $73,000 in the first quarter of 2001 to $769,000 in the first quarter of 2002. Of the increase, $646,000 was due to the amortization of debt discount recorded on the bridge notes. Interest on notes payable increased from $59,000 in the first quarter of 2001 to $120,000 in the first quarter of 2002 due to the increased level of debt assumed through the issuance of bridge notes in 2001 and 2002, offset by declining levels of other debt. Interest income decreased by $15,000 in the first quarter of 2002 compared to the comparable period of 2001 due to the decreased level of average cash balances and declining interest rates in general over the period. Net Loss. As a result of the foregoing factors, the net loss for the period ended March 31, 2002 increased to $2,559,000, from $794,000 in the comparable period of 2001, an increase of $1,765,000, or 222%. LIQUIDITY AND CAPITAL RESOURCES We have an accumulated deficit of approximately $70.2 million from our inception through March 31, 2002. We may incur additional operating losses in the future, principally as a result of expenses associated with product development efforts and anticipated sales, marketing, and general and administrative expenses. During the quarter ended March 31, 2002, we satisfied our cash requirements principally from cash generated by bridge notes. We had cash and cash equivalents of $ 193,000 at March 31, 2002 compared to cash and cash equivalents of $507,000 at December 31, 2001, a decrease of $314,000. Net cash used in operations during the three months ended March 31, 2002 was approximately $1,143,000. Inventory decreased by approximately $150,000 during the three months ended March 31, 2002 , due to product sales during the quarter, partially offset by inventory purchases. Accounts receivable decreased by $503,000 during the three months ended March 31, 2002 as a result of cash received from customers relating to outstanding accounts receivable, offset by new sales during the period. Accounts payable increased by approximately $ 14,000 in the three months ended March 31, 2002. Included in the loss for the period was $85,000 related to a non-cash charge for options issued to outside consultants for sales and sales staff recruiting services. No cash was used in investing activities during the first quarter of 2002. Cash provided by in financing activities was $829,000, consisting of the net proceeds of bridge notes issued in the quarter, offset by payments of principal of other notes payable and payments of other capital lease obligations. SUBSEQUENT EVENTS On May 17, 2002, we announced that we had entered into a Stock Purchase Agreement with an affiliate of Moneyline Telerate Holdings, which is majority owned by One Equity Partners, the private equity arm of Bank One Corporation, and an Agreement and Plan of Merger with B2BVideo Network Corp. In connection with the merger agreement, B2BVideo became a wholly owned subsidiary of the Company and B2B's shareholders were issued 3 million shares of the Company's common stock. Pursuant to the Stock Purchase Agreement, Moneyline purchased 25 million new shares of our common stock at $0.60 per share, for a total investment of approximately $15,000,000. In addition, Moneyline was issued warrants to purchase an additional 11.25 million shares of common stock at an exercise price of $0.60 per share, and was granted the right to appoint a majority of the directors of the Company's board of directors. Simultaneously, certain existing investors and new investors introduced to the Company by EarlyBirdCapital, a NY-based private equity investment bank, invested a total of $11.1 million, purchasing new shares of our common stock and converting certain outstanding loans to us and to B2BVideo into shares of our common stock at $0.60 per share. Moneyline beneficially owns approximately 61% of the Company's common stock. The Company, B2BVideo Network and Moneyline also entered into a Strategic Alliance Agreement and certain technology license agreements pursuant to which the Company and B2BVideo will license software and network processes and sell video equipment to Moneyline. Moneyline will be the exclusive distributor of our equipment to the financial services market. As a result of these developments, certain information in this Form 10-QSB may be substantially changed. Additional information regarding these events is contained in reports on Form 8-K, filed on May 17, 2002 and May 28, 2002. See Note 8, Subsequent Events. The following material events took place subsequent to March 31, 2002. These events are material events in the Company's operations and this section should be read carefully and thoroughly by readers. Data in the following has been adjusted to give effect to the Company's one-for-five reverse stock split effected on February 5, 2002. Defaults on Prior Bridge Notes and Sanmina Note. On May 17, 2002, the Company was in default on certain of its outstanding bridge note obligations. The Company was in default on its repayment obligations to holders of the $1,000,000 aggregate principal amount of 9% Senior Secured Promissory Notes issued in September and October of 2001 (the "First Bridge Notes") and is in breach of certain of its covenants in the First Bridge Notes and related documentation. The First Bridge Notes are secured by substantially all of the Company's intellectual property and, as amended, were due and payable on February 15, 2002 or, in the case of $300,000 aggregate principal amount of the First Bridge Notes the holders of which agreed to extend the maturity date, March 31, 2002. As a result of the Company's default on the First Bridge Notes, the holders of the First Bridge Notes have the right to exercise various legal and contractual remedies, including the right to foreclose on substantially all of the Company's intellectual property which constitutes a material portion of the Company's assets, and interest will accrue on the First Bridge Notes from the first date of default at the rate of 18% per year. The Company also is in default in its repayment obligations to the holders of the $1,674,982 aggregate principal amount of 9% Unsecured Promissory Notes issued in November and December of 2001 (the "Second Bridge Notes"), and is in breach of certain covenants of the Company set forth in the Second Bridge Notes and related documentation. The Second Bridge Notes are unsecured debt obligations of the Company and, as amended, were due and payable on February 19, 2002 or, in the case of $350,000 aggregate principal amount of Second Bridge Notes, the holders of which agreed to extend the maturity date, March 31, 2002. As a result of the Company's defaults on the Second Bridge Note obligations, the holders of the Second Bridge Notes have the right to exercise various contractual and legal remedies and interest will accrue on the Second Bridge Notes from the first date of default at the rate of 18% per year. At May 17, 2002 the Company also had outstanding $500,000 aggregate principal amount of 9% Unsecured Promissory Notes issued on January 24, 2002 (the "Third Bridge Notes" and, together with the First and Second Bridge Notes, the "Prior Bridge Notes"), which are due and payable upon the earlier of (i) April 24, 2002 or (ii) the date on which the Company completes its next debt or equity financing in which it raises in the aggregate, on a cumulative basis, in excess of $2,500,000 in gross proceeds (a "Qualified Financing"). The Company did not complete a Qualified Financing prior to April 23, 2002 and did not repay the Third Bridge Note obligations when they became due and is in default. Accordingly, the holders of the Third Bridge Notes have the right to exercise various contractual and legal remedies and interest would accrue on the Third Bridge Notes from the date of default at the rate of 18% per year. On May 17, 2002, the Company was also in default on its outstanding note to Sanmina Corporation (the "Sanmina Note"). The Sanmina Note is secured by substantially all of the Company's assets, other than its intellectual property. The Sanmina Note became due and payable on January 12, 2002. As a result of the default on the Sanmina Note, Sanmina Corporation has the right to foreclose on a material portion of the Company's assets. The Company has pledged substantially all of its material assets as security for the First Bridge Notes and the Sanmina Note. As a result of the Company's defaults on the Prior Bridge Notes and the Sanmina Note, the holders of those notes may accelerate the Company's obligation to repay in full the Company's outstanding obligations under these notes, including principal, interest and costs associated with the acceleration, and any such acceleration could trigger a cross-default provision in other obligations, requiring the Company to pay immediately all of the aggregate outstanding principal and interest on other obligations. The loss of the assets that serve as security for the Company's outstanding obligations would materially and adversely affect its business and could require it to file for bankruptcy. On April 28, 2002, the Company completed a fifth short-term debt financing when the Company borrowed the aggregate principal amount of $200,000 pursuant to a 9% Unsecured Promissory Note (the "Unsecured Note"). In connection with the loan, the Company also issued to the lender a warrant (the "Warrant") to purchase 400,000 shares of the Company's common stock at an initial exercise price of $1.30 per share (the "Bridge Financing"). The Unsecured Note is an unsecured debt obligation of the Company and is due and payable on demand or on the date on which the Company completes its next debt or equity financing in which it raises in the aggregate, on a cumulative basis, in excess of $2,500,000 in gross proceeds. The holder of the Unsecured Note has the right to convert all or any portion of the principal amount of the Unsecured Note into the securities that the Company issues in its next financing. The Unsecured Note bears interest at a rate of 9% per annum. Interest accrues from March 28, 2002 through the date on which the Unsecured Note becomes due and payable. If the Unsecured Note is not paid when due, interest will accrue at the rate of 18% per annum thereafter. The Warrant issued in connection with the loan will first be exercisable beginning on August 26, 2002 and will be exercisable until August 26, 2007. The initial exercise price for the Warrant of $1.30 per share is subject to adjustment in certain limited events, including recapitalizations, reclassifications or split-ups of the Company's common stock and for issuances of securities at a price less than the then current exercise price. The Warrant has a cashless exercise provision. The Company is using the net proceeds from the Bridge Financing to provide short-term working capital. On May 17, 2002, we announced that we had entered into a Stock Purchase Agreement with an affiliate of Moneyline Telerate Holdings, which is majority owned by One Equity Partners, the private equity arm of Bank One Corporation, and an Agreement and Plan of Merger with B2BVideo Network Corp. In connection with the merger agreement, B2BVideo became a wholly owned subsidiary of the Company and B2B's shareholders were issued 3 million shares of the Company's common stock. Pursuant to the Stock Purchase Agreement, Moneyline purchased 25 million new shares of our common stock at $0.60 per share, for a total investment of approximately $15,000,000. In addition, Moneyline was issued warrants to purchase an additional 11.25 million shares of common stock at an exercise price of $0.60 per share, and was granted the right to appoint a majority of the directors of the Company's board of directors. Simultaneously, certain existing investors and new investors introduced to the Company by EarlyBirdCapital, a NY-based private equity investment bank, invested a total of $11.1 million, purchasing new shares of our common stock and converting certain outstanding loans to us and to B2BVideo into shares of our common stock at $0.60 per share. Moneyline beneficially owns approximately 61% of the Company's common stock. The Company, B2BVideo Network and Moneyline also entered into a Strategic Alliance Agreement and certain technology license agreements pursuant to which the Company and B2BVideo will license software and network processes and sell video equipment to Moneyline. Moneyline will be the exclusive distributor of our equipment to the financial services market. As a result of these developments, certain information in this Form 10-QSB may be substantially changed. Additional information regarding these events is contained in reports on Form 8-K, filed on May 17, 2002 and May 28, 2002. See Note 8, Subsequent Events. New Accounting Pronouncements In June 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards ("SFAS") No. 141, Business Combinations, and No. 142, Goodwill and other Intangible Assets. SFAS No. 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001. Use of the pooling of interests method is no longer permitted. SFAS No. 141 also includes guidance on the initial recognition and measurement of goodwill and other intangible assets acquired in a business combination that is completed after June 30, 2001. SFAS No. 142 no longer permits the amortization of goodwill and indefinite-lived intangible assets. Instead, these assets must be reviewed annually (or more frequently under certain conditions) for impairment in accordance with the Statement. The impairment test uses a fair value approach rather than the undiscounted cash flows approach previously required by SFAS No. 121, Accounting for the Impairment of Long-Lived Assets to Be Disposed Of. Intangible assets that do not have indefinite lives will continue to be amortized over their useful lives and reviewed for impairment in accordance with SFAS No. 121. The Company has adopted SFAS No. 142 effective January 1, 2002, and it had no significant impact on the Company's financial position or results of operations. In August 2001, the Financial Accounting Standards Board issued SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, which addresses financial accounting and reporting for the impairment or disposal of long-lived assets and supersedes SFAS No. 121, Accounting for the Impairment of Long-Lived Assets to Be Disposed Of, and the accounting and reporting provisions of APB Opinion No. 30, Reporting the Results of Operations for a disposal of a segment of a business. SFAS No. 144 is effective for fiscal years beginning after December 14, 2001, with earlier application encouraged. The Company has adopted SFAS No. 144 as of January 1, 2002, and it had no significant impact on the Company's financial position or results of operations. RISK FACTORS On May 17, 2002, we announced that we had entered into a Stock Purchase Agreement with an affiliate of Moneyline Telerate Holdings, which is majority owned by One Equity Partners, the private equity arm of Bank One Corporation, and an Agreement and Plan of Merger with B2BVideo Network Corp. In connection with the merger agreement, B2BVideo became a wholly owned subsidiary of the Company and B2B's shareholders were issued 3 million shares of the Company's common stock. Pursuant to the Stock Purchase Agreement, Moneyline purchased 25 million new shares of our common stock at $0.60 per share, for a total investment of approximately $15,000,000. In addition, Moneyline was issued warrants to purchase an additional 11.25 million shares of common stock at an exercise price of $0.60 per share, and was granted the right to appoint a majority of the directors of the Company's board of directors. Simultaneously, certain existing investors and new investors introduced to the Company by EarlyBirdCapital, a NY-based private equity investment bank, invested a total of $11.1 million, purchasing new shares of our common stock and converting certain outstanding loans to us and to B2BVideo into shares of our common stock at $0.60 per share. Moneyline beneficially owns approximately 61% of the Company's common stock. The Company, B2BVideo Network and Moneyline also entered into a Strategic Alliance Agreement and certain technology license agreements pursuant to which the Company and B2BVideo will license software and network processes and sell video equipment to Moneyline. Moneyline will be the exclusive distributor of our equipment to the financial services market. As a result of these developments, certain information in these RISK FACTORS may be substantially changed. Additional information regarding these events is contained in reports on Form 8-K, filed on May 17, 2002 and May 28, 2002. See Note 8, Subsequent Events. We Have Negative Working Capital, a History of Losses and Limited Revenue; We Have Accumulated a Substantial Deficit At March 31, 2002, we had negative working capital of $8.3 million, and we had an accumulated deficit of approximately $70.2 million. We incurred losses from continuing operations of approximately $1.8 million, $7.4 million, $5.9 million, and $10.7 million for the quarter ended March 31, 2002 and for the years ended December 31, 2001, 2000, and 1999, respectively. Revenues of approximately $367,000 were substantially lower than revenues recorded in the comparable period of 2001. The report of our independent auditors on our financial statements for the period ended December 31, 2001 contains an explanatory paragraph, which indicates that we have suffered recurring losses from operations, have negative cash flows from operations and have an accumulated deficit that raise substantial doubt about our ability to continue as a going concern. We urge potential investors to review this report before making a decision to invest in our company. Given our financial position, our ability to continue our operations and to repay our substantial outstanding indebtedness depends entirely on the completion of this financing. We Have Low Cash Balances; We Require Additional Financing At March 31, 2002, we require additional cash to fund our operations. At March 31, 2002, we had cash equivalents totaling only 193,000. We intend to continue to fund operations with existing cash and with cash generated from customer payments of accounts receivable. However, the timing of customer payments is uncertain. Customers May Not Buy Our Products Due To Concerns Over Our Viability Due to our recurring losses from operations and lack of cash, some potential customers may decide not to purchase our video network system because of concerns that we may be unable to service, enhance or upgrade the systems. If we are not able to alleviate concerns about our long-term viability, we may not be able to market and sell our video network system successfully and continue operations. We Have a Limited Customer Base and Attendant Risk Concentration; We are Dependent Upon a Few Significant Sources of Customers We have a limited customer base with several customers providing in excess of 10% of our total revenues. Three customers accounted for 73%, 6%, and 6% of our total revenues in the first quarter ended March 31, 2002, and two customers accounted for 50% and 30%, respectively, of total revenues for the year ended December 31, 2001. In the first quarter of 2001, 73% of revenues were to B2BVideo Network Corp., a related party. Three customers accounted for 40%, 29%, and 20 % of our accounts receivable at March 31, 2002, and four customers accounted for 30%, 16%, 13%, and 10%, respectively, of accounts receivable outstanding as of December 31, 2001. We generally grant uncollateralized credit terms to our customers, and have not experienced any credit-related losses. We anticipate that the concentration of our customer base will continue for the foreseeable future, as we continue to expand our marketing efforts within our vertical target markets. Failure to diversify this customer concentration could increase our exposure to credit-related losses. In addition, we are dependent upon a few significant sources of customers, and the loss of a single source of customers could adversely affect our business. We Have a History of Significant Losses and Expect Losses to Continue We have incurred substantial losses from operations to date and had an accumulated deficit of $70.2 million through March 31, 2002. Our audited financial statements for the year ended and as of December 31, 2001, indicate that there is substantial doubt about our ability to continue as a going concern. We recognized $367,000 in revenues during the first three months of 2002, $12,976,000 during 2001, $8,800,000 in revenues during 2000, and we recognized $2,400,000 in revenues during 1999 Accordingly, there is limited historical basis for you to expect that we will be able to realize sufficient operating revenues or profits in the future to support continuing operations. We have a limited backlog for revenue, and we cannot predict with accuracy what our revenues will be in the future. Our ability to generate sales and to recognize operating revenues in the future will depend on a number of factors, certain of which are beyond our control, including: o customer acceptance of products shipped and installed to date and in the future; o our ability to generate new sales of products and secure customer acceptance; and o customer payments. We Have a Limited Operating History Although we were incorporated in 1993, we focused on research and development until we shipped our first commercial VidPhone system in the third quarter of 1998. Carl Muscari, our Chairman, President and Chief Executive Officer, joined us in September 1999. Ronald K. Dobes, our Vice President of Engineering, joined us on November 28, 2001. In January 2002, we hired John F. Baney as Vice President, Sales and Marketing. Because of our limited operating history and the relatively short tenure of several of our key senior managers, you have limited information on which to assess our ability to realize operating revenues or profits in the future. We Expect to Continue to Experience Quarterly Fluctuations in our Operating Results We have experienced in the past quarterly fluctuations in revenues and operating results as a result of a number of factors, including the fact that the typical cost of our system is relatively high, each purchase of our video network system constitutes a substantial portion of our revenues for the period in which it is accepted by our customer, and the timing of our sales and marketing campaigns and the costs associated with those efforts, and our overall expenses during the period. Customers generally pay for our products and services only after they are installed and accepted by the customer, and we typically incur the costs associated with the sales and installation of our video network systems prior to receipt of any customer payments. We expect these to continue and accordingly, we expect to continue to experience quarterly fluctuations in our revenues and operating results for the foreseeable future. We May Not Be Able to Market Our Products Effectively We Are Dependent on Resellers. We distribute our products through major sellers of telephony products, system integrators and Value Added Resellers ("VARs"). Currently, we have agreements with approximately twelve resellers. These arrangements are for relatively short contractual periods and may be terminated under certain circumstances. We cannot assure you that we will be able to maintain existing reseller relationships or establish new ones. We compete for relationships against third-party resellers with larger, better-established companies with substantially greater financial resources. If we cannot maintain our current reseller relationships and cannot develop new relationships, we may not be able to sell our video network system. Resellers May Not Be Effective Distributors. Sales to third party resellers are expected to generate a significant part of our future revenues. However, we have sold only a limited number of video network systems and components under our reseller arrangements and to date have recognized minimal revenues from those sales. We currently have limited orders from our resellers for additional sales of VidPhone systems. If our resellers fail to market and sell our products, or our products fail to become an accepted part of the resellers' product offerings, the value of your investment could be reduced. We May Not Be Able To Develop Direct Sales And Marketing Capabilities. We expect to depend on the marketing efforts of our resellers for the foreseeable future. However, we are developing a small direct marketing capability to promote our video network system and to support our resellers. We cannot assure you that we will be able to create awareness of, and demand for, our products through our marketing efforts, or that the development of our direct marketing capabilities will lead to sales of our products and services. If we cannot successfully develop our own sales and marketing capabilities, we may not succeed in building brand-name recognition of the VidPhone system, and we will remain solely dependent on reseller efforts. We May Not Be Able to Develop Effective Strategic Relationships with Indirect Channel Partners. We are seeking to develop additional strategic relationships with indirect channel partners to increase our sales. We may, however, be unable to attract or maintain effective partners, and we will have lower gross margins for sales through indirect channel partners. The Market for Video Communications Products Is Evolving and May Not Support Our Revenue Expectations; Our Business May be Adversely Affected by the Events of September 11, 2001 and the General Slowdown in the Economy The market for video communications products continues to evolve rapidly, and demand for and market acceptance of new products is unpredictable. In addition, while there is renewed interest in video networking products following the events of September 11, 2001, the economy overall has also experienced a significant slowdown recently. The cost of video communications systems typically represents a substantial investment by the customer and have tended to be discretionary purchases. Accordingly, we cannot predict whether the renewed interest in video networking products will result in higher overall sales of video communications equipment. If the market for video communications products develops more slowly than expected or is adversely effected by a slow down in the economy, our business and financial condition could be materially and adversely affected. Our Industry is Subject to Rapid Technological Change; If We Are Not Able to Adequately Respond to Changes, Our Products May Become Obsolete or Less Competitive, and Our Operating Results May Suffer. We may not be able, especially given our lack of financial resources, to respond effectively to the technological requirements of a changing market, including the need for substantial additional capital expenditures that may be required as a result of these changes. The video network systems industry is characterized by rapidly changing technology and continuing process development. The future success of our business will depend in large part upon our ability to maintain and enhance our technological capabilities and successfully anticipate or respond to technological changes on a cost-effective and timely basis. In addition, our industry could in the future encounter competition from new or revised technologies that render existing technology less competitive or obsolete. We May Not Receive Any Future Contract or Subcontract Awards Under the E-Rate Program Over the past two years, VNCI has received substantial contract and subcontract awards under the E-Rate Program, resulting in significant revenues to the Company. We had anticipated that contracts would be awarded under that program prior to the beginning of the E-Rate Program fiscal year that began on July 1, 2001, and that contract announcements would continue through October 2001. We had also anticipated that VNCI would be awarded substantial contracts or subcontracts for our video network equipment under this program. To date, no awards under this program have been announced for the fiscal year that began on July 1, 2001. We anticipate that we will be awarded future contracts and subcontracts under the E-Rate Program. In the past, awards to VNCI and to our potential prime contractors have been among the later awards to be made under the E-Rate Program. Therefore, we continue to believe that we will receive additional awards that will generate revenues for the Company from this program prior to the end of the E-Rate Program fiscal year in June 2002. However, we cannot provide you with any assurance that we will receive any future E-Rate Program contract or subcontract awards. If we do not receive any new contract or subcontract awards under the E-Rate Program, our future revenues could be materially and adversely affected. The Protection of Our Intellectual Property is Uncertain Our success will depend, in part, on our ability to protect our intellectual property rights to our proprietary hardware products. Toward that end, we rely in part on trademark, copyright and trade secret laws to protect our intellectual property in the U.S. and abroad. The degree of protection provided by patents is uncertain and involves largely unresolved complex legal and factual questions. The process of seeking patent and trademark protection can be long and expensive, and there is no assurance that any pending or future applications will result in patents and/or registered trademarks. Further, although we have some patents on our technology, we cannot assure you that these or any other proprietary rights granted will provide meaningful protection or any commercial advantage to us. We also cannot assure you that claims for infringement will not be asserted or prosecuted against us in the future, although we are not presently aware of any basis for claims. A number of companies have developed and received proprietary rights to technologies that may be competitive with our technologies. Most of these entities are larger and have significantly greater resources than we do. Given the rapid development of technology in the telecommunications industry, we cannot assure you that our products do not or will not infringe upon the proprietary rights of others. A majority of our patents and intellectual property have been pledged as collateral to the holders of the First Bridge Secured Notes. In the event that we are unable to pay the notes when they become due, and our note holders decide not to convert the principal amount of their notes into Units in this offering, our note holders will have the right to our important intellectual property. There can be no guarantee that we will be able to repay our note holders when their notes become due. We Are Dependent on Third Parties for Manufacturing We outsource the manufacturing and assembly of many of the components of our products. We cannot assure you that our subcontractors will continue to perform under our agreements with them or that we will be able to negotiate continuing arrangements with these manufacturers on acceptable terms and conditions, or at all. In particular, our failure to pay these manufacturers when due could affect their willingness to continue working with us. If we cannot maintain relationships with our current subcontractors, we may not be able to find other suitable manufacturers. Any difficulties encountered with these manufacturers could cause product defects and/or delays and cost overruns and may cause us to be unable to fulfill orders on a timely basis. Any of these difficulties could materially and adversely affect us. Future Government Regulation Could Adversely Affect Our Marketing and Sales Several components of our video network system, including the VidModem and VidPhone Switch, must comply with certain regulations of the Federal Communications Commission ("FCC"). Under FCC regulations, we will be required to follow a verification procedure consisting of a self-certification that the VidModem complies with applicable regulations pertaining to radio frequency devices. A qualified, independent testing facility tested the VidModem, and it was found to comply with FCC regulations. We obtained equipment registrations from the FCC for certain VidPhone system components, including the VidPhone switch that is connected to the public switched telephone network. Although we believe that at present the VidPhone system complies with all applicable government regulations, future government regulations could increase the cost of bringing products to market or adversely affect our ability to market and sell our products and technology. PART II - OTHER INFORMATION Item 2. Changes in Securities and Use of Proceeds. The information set forth in "Note 5. Debt" in Part I and in Item 4. Submission of Matters to a Vote of Security Holders. in Part II of this Form 10-QSB for the Quarter ended March 31, 2002 is incorporated herein by reference. Item 3. Defaults on Senior Securities. The information set forth in "Note 5. Debt" in Part I of this Form 10-QSB for the Quarter ended March 31, 2002 is incorporated herein by reference. Item 4. Submission of Matters to a Vote of Security Holders. On February 4, 2002, the Company held a special meeting of stockholders. At the special meeting the following three proposals were considered and approved by the Company's stockholders as set forth below: 1. An amendment to the Company's Certificate of Incorporation to increase the number of authorized shares of common stock from 30,000,000 shares to 90,000,000 shares, which increased the aggregate number of the Company's authorized capital stock from 32,500,000 shares to 92,500,000 shares. 8,565,748 shares were voted FOR this proposal, 78,689 shares were voted AGAINST this proposal and 9,728 shares abstained from voting on this proposal. 2. An amendment to the Company's Certificate of Incorporation to effect a one share for five shares reverse stock split of the Company's issued and outstanding shares of common stock. 8,536,407 shares were voted FOR this proposal, 114,385 shares were voted AGAINST this proposal and 3,373 shares abstained from voting on this proposal. 3. Adoption of an amendment to the 1999 Stock Incentive Plan to increase to 8,000,000 the number of shares of common stock issuable under the plan from the 2,640,000 shares of common stock previously authorized to be issued. 1,590,048 shares were voted FOR this proposal, 472,827 shares were voted AGAINST this proposal, 26,928 shares abstained from voting on this proposal and 6,564,362 shares were broker non-votes. The information included in the Company's definitive proxy statement dated January 14, 2002 and filed with the Securities Exchange Commission on January 14, 2002 is herein incorporated by reference. Item 6. Exhibits and Reports on Form 8-K (a) Exhibits. None (b) Reports on Form 8-K during the quarter ended March 31, 2002. Current Report on Form 8-K, dated January 24, 2002, filed with the Securities Exchange Commission on January 25, 2002. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized. Video Network Communications, Inc. By: /s/ Carl Muscari -------------------------------------- Carl Muscari Chairman, President and Chief Executive Officer (duly authorized executive officer) By: /s/ Robert H. Emery -------------------------------------- Robert H. Emery Chief Financial Officer Vice President, Administration (principal financial officer) May 31, 2002