ITEM 1. BUSINESS
Videonics, Inc., a California corporation organized in 1986 (the "Company"), is a leader in the design, development, manufacture, and sale of affordable, high quality, real time, digital video post-production equipment. The Company's products process, edit, and mix raw video footage as well as enhance such footage with audio, special effects, and titles, resulting in professional quality video production. Videonics equipment is used throughout the world in the post-production of videos. As of December 31, 1997, more than 460,000 units of Videonics equipment have been sold worldwide.
Videonics' products incorporate general purpose computers, special-purpose microprocessor-based systems, and internally developed application specific integrated circuits ("ASICs") with digital signal processing ("DSP") and other capabilities. The Company also implements much of its products' functionality in software. The Company believes that its proprietary technologies provide the infrastructure to develop a broad array of video post-production solutions in a timely manner. By reducing the cost of high performance post-production equipment, Videonics is making post-production capabilities available to an expanding market of potential users.
The Video Production Process
The video production process consists of three steps: pre-production, production, and post-production.
Pre-production is the planning of a video: writing a script, creating storyboards (sketches which show how a scene will look and describing transitions), planning shots, budgeting, obtaining props and locations, and scheduling. Production is the shooting of the video scenes, with or without sound. Post-production involves assembling and combining video footage with titles, effects, and audio elements to create a master tape ready for distribution.
The need for video post-production processing arises from the fact that it is very difficult to make an original recording serve as the finished production. Doing so would require that scenes be shot in the final order and that no errors occur during the original recording session. Each time a mistake is made, the user would have to position the tape precisely at the end of the previous scene and reshoot the desired scene perfectly. Titles and effects must be planned ahead of time and inserted exactly at the appropriate moments, working from a complete, thorough script. Since this scenario is impractical in most situations, the user instead shoots raw footage and assembles the final video production by using post-production equipment to arrange the desired scenes and add effects, titles, and other improvements. For video makers who desire a polished product, the post-production process is essential.
Generally, post-production includes five major elements. Video editing is the process of removing, rearranging, and recording video footage from one or more video sources onto a single video output medium (e.g., videotape). Video mixing allows video from multiple sources to be combined in many ways beyond a simple cut or fade. Transition effects, such as dissolves or fades (one video scene fades away as another appears), wipes and slides (a moving boundary
sweeps in new video as the old video is pushed away), and compression effects (videos shrink away or expand to fill the screen) are all used as "fillers" between scenes. Video special effects manipulate video images to add dramatic elements. Special effects can be used to modify the video material, changing its color, flipping the image, and adding picture warping effects to achieve a different mood or appearance such as those created by a picture within a picture. A chroma key helps to superimpose one image over another (e.g., enabling a TV weather forecaster to stand in front of an animated weather map). Video titling is the process of adding text, special characters, and basic graphic elements to the video. Titles can be superimposed on the video or on colored backgrounds. Titles help tell the story, identify people, places, and objects, add credits, and the like. A variety of colors, patterns, fonts, sizes, and effects (e.g., scrolls and crawls) can be used. Audio mixing is the process of combining various sound elements such as native sound (the original sound recorded with the video), narration, music, and sound effects (e.g., a crashing window, a lion's roar, or an explosion).
The Markets For Video Post-Production Equipment
The Company believes that the market for video post-production equipment generally can be separated into five segments, categorized by the users' requirements and individual expertise: videographer; business and industry; videophile; education; and broadcast professional. These markets for video post-production equipment cover a wide range of users, price sensitivity, expertise levels, applications, demographics, and objectives.
Videographer. Videographers are typically full-time or part-time entrepreneurs producing videotapes on a commercial basis. They may record special events such as weddings, birthdays, sporting competitions, religious ceremonies, and other celebrations. Videographers also perform substantial work on a commercial basis for business and industry. For instance, a videographer may produce videos for customer instruction in the use of a product, create a "home" or "commercial property" tour video for small residential and commercial real estate brokerage concerns, or make videos of vacation destinations for travel agents. Videographers want their videos to have the same appearance as those produced by broadcast professionals.
Business and Industry. The business and industry category includes both internal and external production facilities producing video for government, corporate, institutional, and other large organizations. An internal user could include the in-house production department of a large corporation or a charitable organization. The external user could be an independent video production facility marketing its expertise to large institutions which lack an in-house video production department. A typical corporate user in this market might produce videos for instruction in the use of the corporation's products (e.g., how to install and use a cellular telephone or a new computer), employee training manuals, sales or promotional aids for product presentation, video informational brochures, or video newsletters from management to shareholders or employees.
Videophile. The videophile is a video enthusiast or hobbyist whose interest has led to the adoption of new video technology for personal use. The videophile generally shoots a video for personal non-commercial purposes with the intention of editing raw video footage into a finished video production. The videophile's camcorders, VCRs, and editing equipment are affordable and high quality. Occasionally, videophiles capitalize on their growing expertise by becoming videographers. A typical videophile may belong to a "video club" along with other video making enthusiasts or merely want to record entertainment events and historical milestones for family and friends. Videophiles may create a tape library in several different video formats and may want an easy method to consolidate and edit tapes into a single, standard format. Videophiles require affordable post-production equipment that works with different tape formats and is easy to use.
Education. The education market consists of the audio-visual departments of educational institutions, which use video internally to serve the needs of the institution as well as teach
students the art of video production. While some uses in an educational setting may be no different than those of business and industry, other uses include recording sporting events to improve a player's performance, recording a debate or dramatic performance to teach speaking or other acting skills, and replacing, as in the case of a video yearbook, still photography with video.
Broadcast Professional. The broadcast professional is the most demanding video post-production equipment user, requiring equipment to meet the highest quality broadcast standards in order to create finished commercial video productions. Industry analysts have estimated that there are more than 16,000 worldwide sites for equipment in this user category, including studio, cable, network, and television broadcasters as well as independent post-production facilities. Users in this market are generally less price-sensitive than those in other categories, frequently paying from $100,000 to $2,000,000 for a complete suite of video post-production equipment. This specialized equipment also requires a large investment in user training and studio facilities.
The Videonics Solution
The Company's solution is to design, develop, manufacture and market products that incorporate advanced proprietary digital video technologies to reduce significantly the cost and difficulty of creating high quality video. The Company's current product line provides solutions for each stage of the post-production process. The majority of the Company's products are single-purpose microprocessor-based systems that utilize DSP algorithms in ASICs and proprietary software, all developed by the Company. The Company also provides post-production solutions which operate on general purpose computers and local area networks. These solutions are generally categorized as desktop video. Company-developed software, incorporated in each Videonics product, provides easy-to-use implementations of sophisticated video post-production processes.
By using proprietary ASICs and software to replace more costly video post-production equipment, the Company has been able to significantly reduce the cost of digital video post-production products. As a consequence, the Company has been able to offer its products at attractive prices to users in this market. Moreover, the Company's products contain features that have minimized the need for most video makers to purchase more expensive systems in order to create high quality video.
Strategy
Videonics' objective is to maintain and expand its position in the video post-production market. The Company has implemented this strategy by means of its acquisitions, as well as internally developed technologies, products, and marketing programs. By reducing the cost of high performance post-production equipment, the Company makes post-production capabilities available to an expanding market of potential users. The Company's business strategy incorporates the following elements:
Expand Proprietary Technology Base. The Company believes that its proprietary digital video hardware and software technology provides a competitive advantage in achieving timely development of a broad array of video post-production solutions. The Company intends to continue to devote significant resources to expanding its library of circuits, proprietary ASICs and associated software to develop products that incorporate higher levels of performance, functionality, and integration.
Broaden Product Line. The Company intends to expand its product line in order to broaden its potential market and to reduce its reliance on any specific market segment. Videonics has been an innovator in developing affordable, full-featured editing products primarily for the videographer, business and industry, and videophile market segments. The Company seeks to
leverage this expertise by developing new products with enhanced functionality that establish price/performance leadership in other market segments, including broadcast and desktop video. The acquisitions of Nova, Abbate, and KUB, along with the development of the PowerScript Character Generator, are all tactics used to accomplish this objective.
Expand Worldwide Distribution. The Company intends to further develop its United States market by targeting specific vertical distribution channels to reach the broadcast professional and business and industry markets. Internationally, the Company is expanding its distribution channels in emerging markets. The Company believes that distributing products through domestic dealers and international wholesalers is a cost-effective method of reaching potential product users.
Heighten Brand Name Awareness. The Company believes that its brand name awareness will remain an important factor in the distribution channels where its products are sold, and it takes steps to heighten such recognition by selected advertising, attendance at industry trade shows, and maintaining a focused public relations campaign.
Leverage Manufacturing and Distribution. The Company's strategy is to use its resources in a cost-effective manner. Wherever practical, the Company uses third party services for activities such as manufacturing and accessing certain sales channels. For instance, except for start-up production and the specialized signal processing products from Nova, the Company contracts with third party manufacturers located in Mexico for most product manufacturing.
Technology
Digital technology has been incorporated in all of the Company's products developed in the 1990s. This technology is principally implemented by means of Company-developed DSP ASICs and software. All of the Company's ASICs have been developed by the Company's resident team of designers. The software is all proprietary and has been developed by the Company's software engineers.
Selected Products
The Company offers a broad range of digital video products, each designed to meet specific video post-production needs. The products work with most of the commonly used broadcast standards, videotape formats, and with most brands and models of video equipment. The Company's products range in price from under $100 for certain software products to more than $34,700 for certain broadcast products.
Videographer
Digital Video Mixer. The Digital Video Mixer, first shipped in February 1994, effectively provides a user with a portable video production facility. The Digital Video Mixer has four video inputs and offers over 200 effects at any of ten speeds; these effects include fades, wipes, slides, dissolves, picture-in-picture, flips, luminance key, color generation, zooms, freeze frames, color and negative reversals, rolls, the ability to superimpose one video image over another, and a split screen. The Digital Video Mixer incorporates four ASICs, including an ASIC with a TBC feature that allows it to produce video mixing. A reduced view of all four video inputs on a single "preview" monitor shows the action of all four sources without the need for additional monitors. The Digital Video Mixer offers a "picture-in-picture" which allows two moving video images to be placed on the screen at once. A unique "compose" function allows the user to create a complex image made up of any number of still images and colored rectangles, along with a moving video or solid color background. The "chroma key" feature allows the user to shoot a subject against a solid color background and replace that color with a separate video source. This is the same technique used to place a weather forecaster in front of a weather map. The product has S-video as well as composite connectors. The Digital Video Mixer has won numerous awards, including the Outstanding New Editing Equipment Award for 1994 by Video Magazine, the European Video Editing Product of The Year for 1994-1995 by the European Video Awards Panel, the Video Post-Production Product of The Year 1994-1995 by Video Camera Magazine U.K, and the 1997 Audio Video International Product of The Year Award for Special Effects Generator. The Digital Video Mixer has a U.S. suggested retail price of $1,199.
Video TitleMaker 3000. First shipped in September 1996, the Video TitleMaker 3000 is a step up from the TitleMaker 2000. Its two-piece design, with a separate PC-style keyboard, makes it easier to type in text. User productivity is also improved with the superior keyboard and more than three times the processing speed of the TitleMaker 2000. The product offers more than 200 font-size combinations (compared to 92 in TitleMaker 2000) and doubles the amount of user memory to store over 16,000 characters. A clock/calendar function allows the user to display the time and date and permits the user to automatically trigger a page of titles at a specified time and date, and to repeat that action periodically. The product features the same video quality and resolution as the TitleMaker 2000 and includes its other features: 1,000,000 colors; fades, rolls and crawls; bold, shadow, and outline; ability to superimpose over video or colored or patterned backgrounds; full set of accented and international characters; and storage as projects. The Video TitleMaker 3000 received the 1997 Consumer Electronics Show Innovations Award. TitleMaker 3000 carries a U.S. suggested retail price of $799 and is available in other language versions.
Personal TitleMaker. First shipped in November 1997, the Personal TitleMaker is a character generator primarily aimed at the camcorder enthusiasts looking for an entry-level titler. The Personal TitleMaker offers its users: a choice of 7 high-resolution fonts; over 1,000,000 colors for titles, backgrounds and borders; fades, rolls and crawls; ability to superimpose over video or colored or patterned backgrounds; full set of accented and international characters and a GPI trigger input allows remote triggering of titles from external controllers, such as Videonics' Thumbs Up editor and Edit Suite. Personal TitleMaker carries a U.S. suggested retail price of $399.
MediaMotion. MediaMotion is a machine-control plug-in software product for non-linear (disk-based) video editing applications including Adobe Premiere. MediaMotion adds the ability to control VCRs, camcorders and other GPI triggerable devices from inside Adobe Premiere and Ulead's MediaStudio Pro. With MediaMotion, a user can batch-digitize select portions of source tapes, allowing unattended recording to disk. This saves time and disk space. MediaMotion is available for Windows operating systems at a U.S. suggested retail price of $179.
Python. First shipped in November 1997, Python captures, digitally compresses, and plays back full-motion video from any video source including camcorders, VCRs, and cameras. Python is an external video capture device which allows PC and laptop users to send video e-mails, create video Web pages, and add full-motion video to multimedia presentations. Python creates highly compressed video files in real time, using the industry-standard MPEG-1 format. Python also captures high-resolution JPEG still pictures. Software for viewing MPEG video and JPEG still pictures is widely available on most PCs. It has a U.S. suggested retail price of $349.
Broadcast
Effetto Pronto. Shipped beta version units in limited quantities in the fourth quarter of 1997. Effetto Pronto is slated for the video industry's most creative professionals who use desktop graphics and video production tools. It combines software with add-in hardware for real-time rendering of video effects. With near-real-time previewing of effects, Effetto Pronto allows significant increases in productivity and frees the creative process by allowing multiple iterations and rapid re-edits. Designed to be platform independent, Effetto Pronto consists of Effetto, a QuickTime based compositing software and Pronto, a dedicated resolution independent PCI hardware accelerator card. The Pronto PCI accelerator card can process almost one million pixels of film, video, graphics and CG elements in real-time.
Effetto Pronto offers virtually unlimited creative control, with effects and functions previously unavailable in an integrated compositing package which includes: chrominance and luminance keying; a full complement of special effects; and a professional character generator with complete animation control over every letter of text.
The Videonics' Effetto Pronto system will have a U.S. suggested retail price of $4,995.
PowerScript. First shipped in September 1996, PowerScript is an advanced PostScript video character generator designed for broadcast, video production, multimedia, industrial, and videography applications. It displays high quality (10-bit 4:2:2 digital video) anti-aliased titles and offers the character, graphics display, and formatting features supported by the PostScript(TM) display technology. Two high-end versions of PowerScript were added in 1997; PowerScript Studio has composite and Y/C video inputs and outputs while PowerScript Studio Component offers analog component inputs and outputs, in addition to composite and Y/C. Both models are available in PAL and NTSC versions.
PowerScript is a standalone character generator - it makes images, characters, and graphics internally, without the aid of an external computer. Rotation, sizing, stretch, outlines, color, transparency, and other advanced functions are imaged by its internal PostScript engine.
While PowerScript is standalone, it also includes extensive networking capabilities that allow users to connect the product to a separate computer or computer network. It supports industry-standard Internet protocols (TCP/IP, FTP, PPP) and accepts serial or Ethernet connections. These allow desktop computers, using standard software and hardware, to transfer projects, fonts, graphics, and other files. PowerScript images EPS-format graphic files, created using standard graphic applications like Adobe Illustrator, CorelDraw, and Adobe Photoshop, on standard platforms, including Macintosh, Windows, DOS, UNIX, and Amiga. A wide
range of additional features include expandable PC Card (PCMCIA) storage, TBC (time base corrector), user-definable styles, roll and crawl, transition effects, clock/calendar, GPI trigger, video test patterns, and optional analog component output.
The Videonics' PowerScript product line has a U.S. suggested retail price of $3,000 to $5,000 depending on the model.
The Company's Nova product line includes time base correctors, frame synchronizers, transcoders, video converters and signal distribution products. Nova's end users are in broadcasting, cable television ("CATV"), multimedia studios, corporate A/V, video conferencing and presentation, and industrial market areas.
StudioFrame Series. First shipped in the summer of 1996, the Nova StudioFrame Series is a modular, flexible, digital/analog signal processing system. StudioFrame is designed to accommodate the evolving video and audio interfacing requirements of both today and tomorrow. Targeting applications where the highest video quality is demanded, the system can be easily configured to accomplish a wide variety of ultra-transparent signal conversion/processing functions. A comprehensive range of both digital and analog function modules are available, including: Serial Digital Converters, Noise Reducers, Synchronizers, Time-Base-Correctors, Distribution Amplifiers, and Format Converters. The Nova StudioFrame Series range in price from $1,345 to $34,700 depending on the configuration.
Marketing
The primary goal of the Company's marketing efforts is to increase awareness of the Company's products and technology and of their advantages over competing products or technologies. These objectives are accomplished through advertising programs directed at users of post-production equipment, a targeted public relations program, trade show exhibitions, and educational programs in video making.
The Company advertises principally in magazines directed at broadcast professionals, videographers, and video producers in the business, industrial, and educational segments of the market. Videonics has received editorial mention in many of these publications. The Company exhibited its products at 19 different U.S. trade shows during 1997, including the Consumer Electronics Show, the National Association of Broadcasters, and COMDEX.
The Company's standalone products carry a standard two-year warranty on both parts and labor. Each of the Company's computer based products carry either a two-year warranty on hardware and a 90 day warranty on software or a one-year warranty on both hardware and software. In 1995, the Company added a ProService feature that enabled customers to receive their repaired units within 48-72 hours in exchange for payment of rush charges. The Company's HelpLine allows customers to talk directly with support personnel equipped to answer user questions. This support is free to the Company's customers except for the cost of the phone call. The Company believes that it obtains valuable feedback from offering this service, which it then uses in developing new products.
Sales
Domestic Sales. The Company wholesales its products in the United States through a direct sales organization, supported by independent manufacturers representative organizations. In 1997, 1996, and 1995, respectively, sales in the United States accounted for approximately 67%, 58%, and 51% of the Company's total revenues. The Company sells to a variety of sales channels which in turn sell to end users. The Company's sales channels include Value Added Resellers (VARs) who specialize in selling to the Broadcast Market, direct mail order businesses, audio/visual specialty stores, camera and video shops, industrial dealers which service business and industry, catalogs, and certain mass merchants. The majority of the Company's sales channels specialize in audio-visual or video products and have product knowledgeable sales personnel.
International Sales. The Company has addressed the international market opportunity by selling its products through wholesale distributors servicing 78 different countries and by selling selected products to several international private label customers. The Company currently has eight employees who service and support its international private label customers and country specific distributors. The Company's international distributors also sell the Company's products under the Videonics and Nova brand names, through channels similar to those used by the Company in the United States. These distributors also provide dealers with marketing programs, such as advertising and public relations, as well as customer service and technical support.
Distribution channels. The Company sells to three categories of buyers, both internationally and domestically: videographer, broadcast, and desktop video.
Videographer products may be defined as free standing, easy to use, inexpensive products which address a particular need, such as video mixing or titling. These products are sold through direct mail order businesses, audio/visual specialty stores, camera and video shops.
Broadcast products may be defined as those which operate in a professional edit studio and may be used in conjunction with a master control panel or a switcher, or may also operate
as stand alone units. These units must comply with industry technical specifications for video quality. An example of this type of product is the PowerScript Character Generator. Broadcast products are sold principally through VARs and system houses which service the broadcast industry.
Desktop video products, such as Python and Effetto Pronto, use a general purpose computer as their control element. These products are sold through VARs and retailers who may also sell general purpose computers, software, and peripherals.
Localized marketing. The Company works with its private label customers and international distributors to provide extensive support by adapting both its products and accompanying publications for the local country of distribution. Promotional materials, such as brochures, are produced in the local language. Universal symbols, rather than language specific text, are used for many user interface elements such as on-screen displays. All products are designed to meet most local regulatory standards. In Europe, for example, products are manufactured for the PAL television standard. The Company's products are further designed to support local languages. The Company's Video TitleMaker products include special characters and accents to support French, German, Italian, Spanish, Dutch, Russian, Hungarian, Polish, Greek, Romanian, Turkish, and the Scandinavian languages. The Company's product architecture facilitates additional localization by substituting one read only memory ("ROM") component for another (e.g., a Czech/Slovak ROM for an English ROM) to become a local product.
Private label relationships. The Company believes that strategic alliances are essential to compete successfully in certain large foreign markets, particularly Japan. The Company therefore distributes in Japan through select private label relationships. These relationships are with well known electronics manufacturers having highly developed distribution channels and substantial brand name recognition in the country of distribution. This strategy enables the Company to concentrate its efforts on technology and product development, rather than making the heavy financial and time commitment required to build distribution channels in these difficult-to-access markets. The Company's first private label relationship in Japan was with Matsushita Electrical Industrial Co., Ltd. ("Matsushita.") Matsushita purchased a custom version of the Company's EditMaker product which was manufactured by the Company and is sold under the Panasonic brand name. While the Company has discontinued its domestic version of this product, it has an ongoing sales and support obligation to Matsushita. The Company currently manufactures the Sony Titler, a Japanese language character generator for sale in Japan known as the Sony XV-J1000. Designed to Sony specifications by the Company's product development team in Campbell, California, the Sony Titler is manufactured by the Company and shipped to Sony from the United States. The Sony Titler includes a front-end processor, which translates from a standard keyboard into 6,930 unique Kanji and Kana (Japanese) characters for subsequent video display (up to 110,880 different font/size character variations). This software-intensive product provides all the functionality of its English language counterpart, plus some additional functions required by the Japanese language. Such features include the ability to present text (titles) in either a horizontal or a vertical format. The Company's private label sales decreased significantly in 1997.
For 1997, 1996, and 1995, no one customer accounted for more than 10% of revenues.
Backlog. The Company typically operates with a small amount of backlog. Accordingly, the Company generally does not have a material backlog of unfilled orders, and revenues in any quarter are substantially dependent on orders booked in that quarter. Any significant weakening in customer demand would therefore have and has had in the past an almost immediate adverse impact on the Company's operating results and on the Company's ability to maintain profitability.
Manufacturing and Suppliers
Typically, the Company initiates small production runs of new products at the Company's headquarters in Campbell, California before transferring manufacturing to third party contract manufacturers located in Mexico. Final configuration and testing ordinarily take place at the Company's headquarters. Generally, when received in Campbell, each of the products undergoes testing and inspection before final shipment to customers. The Company uses an integrated materials management system for purchasing, inventory control, cost accounting, and invoicing. All products in the Nova product line are assembled, tested, and distributed from the Company's facility in Canton, Connecticut. As of December 31, 1997, the Company employed 33 persons directly in manufacturing and operations management in Campbell and has a permanent quality and test assurance program at its contract manufacturers' locations in Mexico. Nova employed four people in its separate manufacturing and operations group in Canton, Connecticut.
The Company is dependent on sole source suppliers for certain components used in its products. These components include certain key integrated circuits, which are utilized in the Company's products, ASICs or gate arrays, microprocessors, filters, converters, and other parts. Although the Company has generally been able to procure components on a timely basis, an extended interruption in the supply of any of the components currently obtained from a single source could have a material adverse effect on the Company's operating results. While the Company believes alternative sourcing of these items could be developed, this might result in additional cost in materials and overhead. In addition, the Company buys most of its components from third party vendors on a purchase order basis without any advance contractual commitments and does not carry significant inventories of these items. A shortage of any one part such as ROM semiconductor devices, or an increase in the price of a part, could adversely affect production of the Company's products or reduce gross margins. There can be no assurance that component supplies will be adequate at all times to ensure that customer product orders will be manufactured or filled in a timely manner.
Research and Development
The Company places a high priority on research and development. Development efforts focus on video quality, system performance, feature set expansion, user productivity, improved processing, and storage. In 1997, 1996, and 1995, the Company invested $7.0 million, $5.0 million, and $3.1 million, respectively, constituting 35%, 17%, and 9% of its total net revenues in research and development, respectively. Because digitized video consumes large amounts of data and requires substantial computer power to process such data, the Company's engineers constantly seek new methods to improve its products' capacity and manipulation of video. Maximizing the processing of video information contained in video random access memory ("VRAM"), through the development of ASICs, is a focus of the Company's development staff, as are the compression and storage issues necessitated when integrating and manipulating large amounts of video data. As part of this ongoing effort, the Company has made significant investments in advanced computer programming tools. The Company's engineers work extensively with VHDL design methodology. Any new ASIC designs are maintained in VHDL libraries, which product designers may then use to prototype subsequent new products.
As of December 31, 1997, the Company employed 46 hardware and software engineers with technical skills in design and development of ASICs, digital or analog video signal generation-processing, or embedded software.
During 1997, the Company continued to experience substantial delays in completing the successful development of products. The Company completed and began shipping Python, Personal TitleMaker and a beta version of Effetto Pronto in the fourth quarter of 1997. Shipments of Python and Effetto Pronto occurred later than originally planned, resulting in a significant revenue shortfall for 1997, which, in turn, significantly affected profitability as the
Company suffered substantial operating losses. MX Pro, the Company's advanced Digital Mixer, introduced in September of 1997 and scheduled to begin shipments in the fourth quarter of 1997, has not shipped as of March 23, 1998. The PowerScript Character Generator in the NTSC video format, introduced in 1995, was completed for shipment in September of 1996. After extensive field use, major revisions of PowerScript's software were made in 1997, with additional improvements being made in the first quarter of 1998. The ASIC and software technology of PowerScript will be utilized in other products that the Company currently has in development. As the complexity of the Company's product designs and feature sets continues to increase, the Company may continue to experience similar product development delays which would have an adverse effect on the profitability of its operations. There can be no assurance that the Company will be successful in the timely development of new products to replace or supplement existing products or that the Company will be successful in integrating acquired products or technologies with its current business. Delays in new product development have had an adverse material impact on the Company's growth in 1995, 1996 and 1997. Similar adverse effects on the Company's results of operations can be expected until new products are successfully introduced and accepted by end users. See "Management's Discussion and Analysis of Financial Condition and Results of Operations."
The Company's success depends, in part, on its ability to anticipate new technological developments, to develop expertise in such technologies, and to develop and introduce in a timely and cost-effective manner additional features and new products that satisfy customer needs and desires. As noted above, the Company has been unable to ship new products in a timely fashion in 1995, 1996 and 1997, which has had a substantial adverse impact on the Company's results of operations. Such results have, in any event, fluctuated widely on a quarterly basis. There can be no assurance that any new products will be developed successfully, that the Company will be able to introduce additional new products which will gain acceptance in the marketplace, that the Company will successfully assess new technological developments and incorporate them into future or current products, or that the Company will be able to do so in a timely fashion. Any future failure to develop or introduce new products in a timely manner, or customer rejection of new products, may have a material adverse effect on the Company's future results of operations.
Competition
In the videographer and desktop video markets, the Company has encountered competition from smaller and comparably-sized companies which offer functionally similar products, as well as from larger companies, such as Sony, Matsushita, and JVC, which market both traditional analog equipment as well as new digital video post-production devices. A number of competitors exist who have substantially greater resources than the Company and who make digital video editing products and other post-production devices for operation on personal computers and workstations. Although these desktop computer and workstation-based vendors sell more sophisticated products primarily for the broadcast professional and business and industrial markets and at significantly higher price points than the Company's products, it is possible that such vendors may at some future time introduce products which target the same markets as the Company's products.
The character generation and graphics imaging systems market is highly competitive and is characterized by rapid technological change and evolving industry standards. Rapid obsolescence of products, frequent development of new products and significant price erosion are all features of the industry in which the Company operates. The Company anticipates increased competition from both existing companies and new market entrants. The Company is currently aware of several major and a number of smaller competitors. In the standalone character generator area, the Company believes its primary competitors are Chyron, For-A, Knox, and AVS. Many of these companies have significantly greater financial, technical, manufacturing and marketing resources than the Company. In addition, certain product categories and market segments, on a region-by-region basis, in which the Company does or
may compete, are dominated by certain vendors. As a result, the Company's ability to compete in these areas may be limited.
The Company believes that the markets for the Company's products will remain highly competitive. The Company believes that its ability to compete depends on factors both within and outside its control, including the success and timing of new product developments introduced by the Company and its competitors, product performance and price, market presence and customer support. There can be no assurance that the Company will be able to compete successfully with respect to these factors. Maintaining any advantage that the Company may have over its competitors will require continuing investments by the Company in research and development, sales and marketing and customer service and support. In addition, as the Company enters new markets, whether through acquisitions, alliances with other companies or on its own, the Company may encounter distribution channels, technical requirements and competitive factors that differ from those in the markets in which it currently operates. There can be no assurance the Company will be able to compete successfully in these new markets. In addition, increased competition in any of the Company's current markets could result in price reductions, reduced margins or loss of market share, any of which could materially and adversely affect the Company's business, financial condition and results of operations. There can be no assurance that the Company will be able to compete successfully against current or future competitors.
Proprietary Rights
The Company relies on a combination of trade secret, copyright and trademark laws, and contractual agreements to safeguard its proprietary rights in technology and products. In addition, the Company has several patents. The Company has registered the Videonics brand name and certain product trademarks in the United States, as well as in some of its international markets. The Company routinely enters into confidentiality and assignment of inventions agreements with each of its employees and nondisclosure agreements with its key customers and vendors.
While the Company relies on these measures to protect its proprietary rights, there can be no assurance that the Company's technology is adequately protected by such measures or that the technology will not be reverse-engineered by third parties without violation of the Company's proprietary rights. Such protection may not preclude competitors from developing products with features and prices similar to or even better than those of the Company. The Company believes that its products and other proprietary rights do not infringe upon the proprietary rights or products of third parties. In 1997, the Company reached an agreement with a third party patent holder in which royalties are payable on certain of the Company's products. Payment of these royalties will not have an adverse material effect on the Company's financial condition or results of operations. There can be no assurance, however, that other third parties will not assert infringement claims against the Company in the future or that such claims will not result in costly litigation or require the Company to license intellectual property rights from third parties. There can be no assurance that any such licenses would be available on terms acceptable to the Company, if at all.
The Company believes that, because the pace of technological change is so rapid in the digital video electronics industry, the best protection for its proprietary rights is its continued substantial investment in research and development to apply the latest advances in data storage and data compression to the integration of video post-production functions. The Company believes that any legal protection afforded by patent, copyright, and trade secret laws will be less of a factor on the Company's ability to compete than the ability and creativity of its research and development staff to develop products which satisfy customer needs. Moreover, the Company believes that market positioning and rapid market entry are equally important to the success of its products.
Employees
As of March 2, 1998, the Company had 122 full-time employees, including 38 in research and development, 37 in sales and marketing, 36 in operations, and 11 in finance and administration. None of the Company's employees is represented by a labor union or is covered by collective bargaining agreements. The Company believes that its employee relations are good. The Company has never experienced a work stoppage.
ITEM 2.
ITEM 2. PROPERTIES.
The Company's principal administrative, sales and marketing, research and development, and operating facilities are located in Campbell, California and consist of approximately 29,900 square feet under a lease which expires on July 31, 1999. The Company also has a research and development facility in Millis, Massachusetts which has 2,500 square feet under a lease which expires on February 28, 1999. The Company has an administrative, sales and marketing, research and development, and operating facility in Canton, Connecticut. The building is approximately 5,000 square feet and under a lease which expires on October 31, 1998. The Company has an administrative, sales and marketing and research and development facility in Belmont, California which has 6,050 square feet under a sublease which expires on December 31, 1998.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS.
The Company is not currently involved in any material legal proceedings.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
No matter was submitted to a vote of the Company's shareholders during the fourth quarter of the fiscal year ended December 31, 1997.
PART II
ITEM 5.
ITEM 5. MARKET FOR THE COMPANY'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
As of March 2, 1998, there were approximately 2,200 holders of the Company's Common Stock. The closing sales price of the Company's Common Stock on March 2, 1998 was $2.875 per share.
Other than the distributions to S corporation shareholders for certain income tax liabilities associated with the Company's 1994 earnings through December 14, 1994,, the Company has never declared or paid dividends on its Common Stock and does not anticipate paying any dividends in the foreseeable future. The Company currently intends to retain its earnings, if any, for the operation and development of its business.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion in this section "Management's Discussion and Analysis of Financial Condition and Results of Operations" contains trend analysis and other forward looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Actual results could differ materially from those projected in the forward looking statements as a result of the factors set forth below and elsewhere in this Form 10-K.
Overview
Videonics is a designer of affordable, high-quality, digital video post-production equipment. Videonics products are used by videographers, business, industry, education and videophiles; they are also used in the broadcast, cable, video presentation and video conferencing markets. The company manufactures standalone and personal-computer-based hardware and software products that capture, edit and mix raw video footage and add special effects and titles. Products include edit controllers, video and audio mixers, video processors, character generators, multimedia software, computer-based animation and video compositing systems, frame synchronizers, time base correctors, video format converters, transcoders, distribution amplifiers, routing switchers and audio/visual delay systems.
In 1995, the Company improved its gross profit through volume related purchasing, improved manufacturing, and a lower proportional amount of OEM revenues. The Company began shipping its Edit Suite product in June 1995. In September 1995, the Company hired all the personnel, acquired substantially all the assets and certain liabilities of Nova, a manufacturer of video signal processing equipment in the broadcast market, and incurred a one time charge of approximately $2.0 million for purchased in-process research and development. In addition, in September of 1995, the Company hired the personnel and acquired substantially all the assets of Abbate, a developer of desktop video products.
In 1996, the Company continued to diversify into the broadcast and desktop markets with the acquisition of the assets of KUB Systems, a developer of desktop digital video production equipment for the broadcast market. In addition, the Company made significant changes in the structure of its Research and Development department which included the addition of a new Vice President of R&D. The TitleMaker 3000 and the PowerScript Character Generator were introduced at the end of the third quarter of 1996 resulting in the first quarterly increase in revenues in five quarters. However, after shipping PowerScript to a wide base of customers, deficiencies in the user interface and certain signal timing issues in specific applications were discovered that made the product difficult to sell. With additional costs in Research and Development and Sales and Marketing related to the Company's diversification into the broadcast and desktop markets, combined with lower sales of the Company's older Videographer products and a delay in bringing additional new products to market, the Company expected losses for the first quarter of 1997, with results for the remainder of the year dependent on planned shipment and customer acceptance of new products.
In 1997, the Company continued to improve the PowerScript Character Generator. New versions of the operating software which enhanced the user interface and operating speed of the product were released in 1997. Signal timing issues were addressed with the introduction of two new higher priced versions of PowerScript (PowerScript Studio and PowerScript Studio Component) targeted at higher end customers. In 1997, the Company announced four major new products which were expected to ship in 1997: Effetto Pronto, MXPro, Python and Personal TitleMaker. As of December 31, 1997, the Company had brought Python and Personal TitleMaker to market in commercial quantities. Since Python and Personal TitleMaker were shipped in the fourth quarter of 1997, the first three quarters of 1997 did not contain revenues from any of the aforementioned new products. With additional costs in Research and
Development and Sales and Marketing related to the Company's diversification into the broadcast and desktop markets, declining sales of the Company's older Videographer products and delays in shipment of new products, the Company had operating losses in each quarter of 1997. The Company expects losses during its first and second quarter of 1998, with results for the remainder of the year dependent on planned shipment and customer acceptance of new products. To reduce expenses, the Company reduced its personnel by twelve percent on January 15, 1998.
Comparison of Years Ended December 31, 1997 and 1996
Net Revenues. Net revenues decreased 32% to $20.0 million in 1997, from $29.2 million in 1996. This decrease is primarily attributable to reduced sales of older Videographer products, and the absence of major new product sales during the first three quarters of the year. International revenues for 1997 were $6.6 million or 33% of net revenues compared to $12.3 million or 42% of net revenues in 1996. The percentage decrease in international revenue in 1997 is due primarily to decreased sales of older Videographer products and delays in the introduction of Python and other new products in the international market.
Gross Profit. Gross profit decreased 57% to $6.1 million in 1997 from $13.9 million in 1996. Gross profit, as a percentage of net revenues, decreased to 30% in 1997 from 48% in 1996. The percentage decrease in gross profit is principally attributable to charges for the following: a $1.4 million increase in inventory reserves for components rendered obsolete by product revisions of which approximately $458,000 related to PowerScript, $265,000 related to KUB Systems and $700,000 related to obsolete and slow moving assets at Nova Systems; and a $274,000 increase in warranty reserves for PowerScript hardware updates. Additionally, fixed manufacturing overhead, such as salaries and facilities costs, have been spread over lower revenues.
Research and Development: Research and development expenses increased 38% to $7.0 million during 1997 compared to $5.0 million in 1996, and increased as a percentage of net
revenues to 35% in 1997 from 17% in 1996. The increased expenses were primarily due to the Company's hiring of additional hardware and software engineers who are working on the development of the Company's new products, combined with increased salary levels. In addition, research and development expenses include the personnel of KUB Systems for the full 1997 year compared to only seven months in 1996. The Company anticipates that research and development expenses should decrease slightly in 1998 due to reductions in personnel and decreased usage of consultants and should also decline as a percentage of net revenues as sales of new products take hold and increase the overall net revenues of the Company.
Selling and Marketing. Selling and marketing expenses increased 19% to $8.0 million in 1997 compared to $6.7 million in 1996, and increased to 40% in 1997 compared to 23% in 1996, as a percentage of net revenues. This increase in selling and marketing expenses was primarily a result of increased personnel, advertising and promotional expenses as the Company diversifies into the broadcast and desktop markets and the expenses of the German sales office for the full year compared to only three months of 1996.
General and Administrative. General and administrative expenses increased 30% to $1.8 million in 1997 compared to $1.4 million in 1996, and increased to 9% in 1997 compared to 5% in 1996 as a percentage of net revenues. This increase was primarily due to a charge of $375,000 to bad debt reserves for specific accounts, the inclusion of KUB Systems expenses for the full 1997 year compared to only seven months in 1996, and increased salary levels.
Write-off of Intangibles: In 1997, the Company wrote-off the remaining unamortized value of the purchased technology and goodwill established in connection with the acquisition of Nova Systems. The write-off totaled $1.9 million and was primarily due to continued losses and lack of commercially successful new product introductions.
Interest Income, net. Interest income decreased 28% to $261,000 in 1997 compared to $361,000 in 1996, primarily as a result of a significantly lower average cash balance.
Provision for Income Taxes. At December 31, 1997 the Company incurred a tax charge of $718,000 on a pretax loss of $12.7 million. This charge was the result of the establishment of a $5.9 million valuation allowance against the Company's deferred tax assets offset partially by an income tax benefit of $4.6 million the Company recorded on its pretax loss. The Company has established a valuation allowance against its deferred tax assets due to the uncertainty surrounding the realization of such assets. If it is determined that it is more likely than not that the deferred tax assets are realizable, the valuation allowance will be reduced. In 1996, the effective rate of 2% was below the 36% rate which the Company had utilized in calculating its tax provision for the first three quarters of 1996 and less than its 32% rate for 1995. The rate of 2% for 1996 was primarily the result of higher than expected federal and state research tax credits on significantly increased research and development spending, and lower than expected taxable income.
Factors That May Affect Future Results of Operations: The Company believes its future results of operations will likely be impacted by factors such as delays in development and shipment of the Company's new products and major new versions of existing products, market acceptance of new products and upgrades, growth in the marketplace in which it operates, competitive product offerings, and adverse changes in general economic conditions in any of the countries in which the Company does business. The Company's results in prior years have been affected by these factors, particularly with respect to developing and introducing new products such as PowerScript, Effetto Pronto, MX Pro and Python.
Due to the factors noted above, the Company's future earnings and stock price may be subject to significant volatility, particularly on a quarterly basis. Any shortfall in revenue or earnings from levels expected by securities analysts or anticipated by the Company based upon product development and introduction schedules could have an immediate and significant
adverse effect on the trading price of the Company's common stock in any given period. Additionally, the Company may not learn of such shortfalls until late in the fiscal quarter, which could result in an even more immediate and adverse effect on the trading price of the Company's common stock. Finally, the Company participates in a highly dynamic industry, which often results in significant volatility of the Company's common stock price. See "Business - Research and Development".
Year 2000 Issues: The Year 2000 problem is the result of computer programs being written using two digits rather than four to define the applicable year. The Company's plan for the Year 2000 problem entails the research and testing of its computer systems. The plan calls for compliance verification with external vendors supplying the Company's software. To date, the Company has not encountered any material Year 2000 issues concerning its respective computer programs. The Company plans to complete its Year 2000 research and testing by the end of 1998. All costs associated with carrying out the Company's plan for the Year 2000 problem are being expensed as incurred. The costs associated with the Year 20000 problem, as presently estimated, are not expected to have a material adverse effect on the Company's business, financial condition and results of operations.
Comparison of Years Ended December 31, 1996 and 1995
Net Revenues. Net revenues decreased 13% to $29.2 million in 1996, from $33.6 million in 1995. This decrease is primarily attributable to decreased sales of older Videographer products and the absence of new products during the first three quarters of the year, partially offset by the additional revenues of Nova Systems. International revenues for 1996 were $12.3 million or 42% of net revenues compared to $16.4 million or 49% of net revenues in 1995. The percentage decrease in international revenue in 1996 is due primarily to delays in the introduction of PowerScript and other new products in the international market.
Gross Profit. Gross profit decreased 15% to $13.9 million in 1996 from $16.4 million in 1995. Gross profit, as a percentage of net revenues, decreased to 48% in 1996 from 49% in 1995. The percentage decrease in gross profit is principally attributable to spreading fixed manufacturing overhead, such as salaries and facilities costs, over lower revenues.
Research and Development: Research and development expenses increased 60% to $5.0 million during 1996 compared to $3.1 million in 1995, and increased as a percentage of net revenues to 17% in 1996 from 9% in 1995. The increased expenses were primarily due to the Company's hiring of consultants and engineers in 1996, who are working on the development of the Company's new products. In addition, research and development expenses include the personnel of Nova and Abbate for the full 1996 year and the personnel of KUB Systems since June 1996. The Company anticipates that research and development expenses will continue to increase in absolute terms due to ongoing and future product development.
Selling and Marketing. Selling and marketing expenses increased 30% to $6.7 million in 1996 compared to $5.2 million in 1995, and increased to 23% in 1996 compared to 15% in 1995, as a percentage of net revenues. This increase in selling and marketing expenses was primarily a result of increased personnel, advertising and promotional expenses as the Company diversifies into the broadcast and desktop markets.
General and Administrative. General and administrative expenses increased 13% to $1.4 million in 1996 compared to $1.2 million in 1995, and increased to 5% in 1996 compared to 4% in 1995 as a percentage of net revenues. This increase was primarily due to the addition of personnel.
Interest Income, net. Interest income decreased 51% to $361,000 in 1996 compared to $732,000 in 1995, primarily as a result of the Company's investment in tax exempt securities for the full year 1996 combined with a significantly lower average cash balance.
Provision for Income Taxes. The Company's December 31, 1996 effective rate of 2% was below the 36% rate which the Company had utilized in calculating its tax provision for the first three quarters of 1996 and less than the 32% rate for 1995. The rate of 2% was primarily the result of higher than expected federal and state research credits on significantly increased research and development spending, and lower than expected 1996 taxable income.
The Company has experienced significant quarterly fluctuations in operating results and anticipates that these fluctuations will continue in the future. The fluctuation in revenues in the periods reflected above are attributable to various factors, including the timing of new product introductions and shipments, variations in product mix sold, and private label sales. Particularly in 1997 and 1996, the Company's delay in the sales of previously announced new products had a significant effect on the Company's results of operations, and there can be no assurance that the Company will be able to introduce and timely sell new products on a basis which will avoid quarterly fluctuations in the future, or even that such new products will be successful in the marketplace.
The Company typically operates with a small backlog. Therefore, quarterly revenues and operating results have generally depended on the volume and timing of orders received during the quarter. Backlog is not an accurate predictor of what the Company's revenues will be in future periods, and there can be no assurance that the Company will be profitable in any particular quarter.
Liquidity and Capital Resources
From the Company's inception until its initial public offering in December 1994, which resulted in net proceeds of $15.8 million, the Company financed its operations through private sales of equity, shareholder loans, cash flow from operations, and bank borrowings. At December 31, 1997, the Company's principal source of liquidity is cash of $992,000 dollars. In January 1998, the Company borrowed $619,000 from a major shareholder at an interest rate of 8.5 percent, terms which the Company considered more favorable than those it could obtain from other commercial sources.
Operating Activities. In 1997, net cash used in operating activities was $5.6 million, resulting primarily from an operating loss of $6.6 million after adjusting for non-cash items, an increase in inventories of $2.3 million, offset by a decrease in accounts receivable of $1.7 million. Inventories increased primarily in anticipation of new product shipments and lower than expected shipments of new products in 1997. Receivables decreased primarily because of decreased sales. In 1996, net cash used in operating activities was $1.4 million, resulting primarily from an increase in inventories of $3.2 million, an increase in prepaid and other current assets of $203,000, a decrease in the provision for excess and obsolete inventory of $240,000 offset by a profit of $744,000, depreciation and amortization of $1.2 million, and a decrease in accounts receivable of $428,000. Inventories increased primarily in anticipation of new product shipments and lower than expected shipments of new products in 1996. In 1995, net cash provided by operating activities was $339,000, resulting from a profit of $3.8 million, which included a non-cash charge of $2.0 million for purchased in-process research and development related to the Nova acquisition. In 1995, operating profit excluding the non-cash charge, was partially offset by an increase in accounts receivable of $1.7 million and an increase in inventories of $3.3 million. Receivables increased due to third and fourth quarter 1995 sales promotions with extended terms and inventories increased in anticipation of new product shipments.
Investing Activities. Capital equipment expenditures in 1997, 1996 and 1995 were $1.6 million, $1.3 million, and $958,000 respectively, primarily for computers, software and engineering equipment used in research and development and other activities. The Company currently anticipates that additions to property and equipment will require capital expenditures of $1.5 million through the end of 1998. In 1997, the Company had redemptions of $1.5 million of marketable securities. In 1996, the Company had net redemptions of $3.2 million of marketable securities. In May 1996, the Company acquired substantially all the assets and assumed certain liabilities of KUB Systems for $350,000 in cash. In 1995, the Company purchased $4.7 million of marketable securities and had no redemptions. In September 1995, the Company acquired substantially all the assets and certain liabilities of Nova for $5.0 million in cash, $4.0 million of which was paid at closing and $1.0 million through a promissory note payable in two installments of $500,000 each in March 1996 and September 1996, with accrued interest.
Financing Activities. In 1997, the Company received $154,000 from the exercise of stock options under the Company's stock option plan. In 1996, the Company received $100,000 from the exercise of stock options under the Company's stock option plan. Additionally, the Company paid the $1.0 million promissory note issued in connection with the Nova acquisition. In 1995, the only cash generated from financing activities was $135,000 from the exercise of stock options under the Company's stock option plan.
The Company believes that its current cash, borrowings from a shareholder, together with its operating cash flows, will be sufficient to meet the Company's requirements for working capital, and capital expenditures, through the end of 1998.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Balance sheets of the Company as of December 31, 1997 and 1996 and statements of income, shareholders' equity and cash flows for each of the three years in the period ended December 31, 1997, together with the related notes and the report of Coopers & Lybrand L.L.P., independent accountants, are set forth on the following pages. Other required financial information is set forth herein, as more fully described in Item 14 hereof.
VIDEONICS, INC.
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FINANCIAL STATEMENTS
as of December 31, 1997 and 1996 and for each of the three years in the period ended December 31, 1997
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors Videonics, Inc. Campbell, California
We have audited the accompanying consolidated balance sheets of Videonics, Inc. and subsidiaries as of December 31, 1997 and 1996, and the related statements of operations, shareholders' equity and cash flows for each of the three years in the period ended December 31, 1997. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Videonics, Inc. and subsidiaries as of December 31, 1997 and 1996, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1997, in conformity with generally accepted accounting principles.
Coopers & Lybrand L.L.P.
San Jose, California January 30, 1998
VIDEONICS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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1. Business:
Videonics, Inc. (the Company) was incorporated on July 3, 1986. The Company is a designer of digital video post-production equipment. The Company's products are used by videographers, business, industry, education and videophiles; they are also used in the broadcast, cable, video presentation and video conferencing markets. The Company manufactures standalone and personal-computer-based hardware and software products that edit and mix raw video footage, add special effects and titles, and process audio and video signals.
2. Summary of Significant Accounting Policies:
Principles of Consolidation:
The consolidated financial statements include the accounts of Videonics, Inc. and its wholly owned subsidiaries. All significant intercompany accounts and transactions have been eliminated.
Use of Estimates:
The preparation of 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 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.
Revenue Recognition:
The Company recognizes revenues from gross sales, less a provision for estimated future customer returns and exchanges, upon shipment of product.
Research and Development Expenditures:
Research and development expenditures are charged to operations as incurred.
Advertising:
The Company expenses the production costs of advertising as the expenses are incurred. The production costs of advertising consist primarily of magazine advertisements, agency fees and other direct production costs.
Continued
VIDEONICS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
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2. Summary of Significant Accounting Policies, continued:
Advertising, continued:
Advertising expense for the period ended December 31, 1997, 1996, and 1995 was $1,412,000, $947,000, and $502,000, respectively.
Income Taxes:
The Company accounts for income taxes under the liability method. Under the liability method, deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. The Company is required to adjust its deferred tax liabilities in the period when tax rates or the provisions of the income tax laws change. Valuation allowances are established when necessary to reduce deferred tax assets to the amounts expected to be realized.
Cash and Equivalents:
Cash equivalents consist of highly liquid investments with original maturities at time of purchase of three months or less.
Marketable Securities:
Marketable securities are classified as available-for-sale and therefore are carried at fair value. Unrealized holding gains and losses on such securities are reported net of related taxes as a separate component of shareholders' equity. Realized gains and losses on sales of all such securities are reported in earnings and computed using the specific identification cost method.
Inventories:
Inventories are stated at the lower of standard cost (which approximates actual cost on a first-in, first-out basis) or market.
Continued
VIDEONICS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
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2. Summary of Significant Accounting Policies, continued:
Property and Equipment:
Property and equipment are stated at cost and depreciated on a straight-line basis over the estimated useful lives of the assets ranging from two to five years. Leasehold improvements are amortized on a straight-line basis over the lesser of the term of the lease or the estimated useful life of the asset.
Goodwill and Intangible Assets:
Capitalized purchased technology and goodwill relating to an acquisition (see Note 3) are amortized over a seven year life.
Product Warranty:
Since 1994, the Company warrants all parts and labor on domestic sales for two years. The Company provides for the estimated cost to repair or replace these products at the time of sale.
Concentrations of Credit Risk:
Financial instruments that potentially subject the Company to significant concentrations of credit risk consist principally of cash and cash equivalents and trade accounts receivable.
The Company maintains its cash and cash equivalents with financial institutions located in California and in high grade commercial paper with original maturities of less than three months. As part of its cash management process, the Company performs periodic evaluations of the relative credit standing of these financial institutions.
The Company's customer base is dispersed across many different geographic areas throughout the world and consists principally of distributors and dealers in the electronics industry. The Company performs ongoing credit evaluations of its customers and maintains an allowance for potential credit losses. The Company generally receives confirmed letters of credit or cash in advance of shipping to distributors located outside North America.
Continued
VIDEONICS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
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2. Summary of Significant Accounting Policies, continued:
Stock Based Compensation:
The Company accounts for stock based compensation using the intrinsic value method prescribed by APB Opinion No. 25, "Accounting for Stock Issued to Employees." Accordingly, compensation cost for stock options is measured as the excess, if any, of the quoted market price of the Company's stock at the date of the grant over the amount an employee must pay to acquire the stock. The Company has adopted the disclosure-only provisions of Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation."
Net Income (Loss) Per Share:
The Company has adopted Financial Accounting Standards No. 128 ("SFAS 128"), "Earnings Per Share" and, accordingly, all prior periods presented have been restated. Basic net income (loss) per share is calculated by dividing income (loss) available to common shareholders by the weighted average number of common shares outstanding for the period. Diluted net income per share is calculated by dividing net income available to common shareholders by the weighted average number of common and dilutive common equivalent shares outstanding during the period. Dilutive common equivalent shares consist of common stock issuable upon the exercise of stock options (using the treasury stock method). The adoption of this standard did not have a material impact on the Company's net income (loss) per share.
Fair Value of Financial Instruments:
Carrying amounts of certain of the Company's financial instruments including cash and cash equivalents, accounts receivable, accounts payable and other accrued liabilities approximate fair value due to their short maturities. Estimated fair values for marketable securities, which are separately disclosed elsewhere are based on quoted market prices for the same or similar instruments.
Continued
VIDEONICS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
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2. Summary of Significant Accounting Policies, continued:
Recent Accounting Pronouncements:
In June 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 130 ("SFAS 130"), "Reporting Comprehensive Income". This statement establishes requirements for disclosure of comprehensive income and becomes effective for the Company for the fiscal year beginning after December 15, 1997, with reclassification of earlier financial statements for comparative purposes. Comprehensive income generally represents all changes in shareholders' equity except those resulting from investments or contributions by shareholders. The Company is evaluating alternative formats for presenting this information, but does not expect this pronouncement to materially impact the Company's results of operations.
In June 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 131 ("SFAS 131"), "Disclosures about Segments of an Enterprise and Related Information". This statement establishes standards for disclosure about operating segments in annual financial statements and selected information in interim financial reports. It also establishes standards for related disclosures about products and services, geographic areas and major customers. This statement supersedes Statement of Financial Accounting Standards No. 14, "Financial Reporting for Segments of a Business Enterprise". The new standard becomes effective for the Company for the fiscal year beginning after December 15, 1997, and requires that comparative information from earlier years be restated to conform to the requirement of this standard. The Company is evaluating the requirements of SFAS 131 and the effects, if any, on the Company's current reporting and disclosures.
3. Acquisition of Nova Systems:
Effective September 7, 1995, the Company acquired substantially all the assets and certain liabilities of Nova Systems (Nova). Nova is a developer and manufacturer of video frame synchronizers, digital time base correctors and video signal processing equipment used for video and audio post production in the broadcast, cable, video presentation, and video conferencing markets. Under the terms of the acquisition, the Company agreed to pay Nova $4,000,000 in cash and $1,000,000 in a note payable due in two installments of $500,000 on March 7, 1996 and September 6, 1996, with accrued interest at a rate of 6% per annum. In accordance with the acquisition agreement, the purchase price is subject to certain adjustments. Adjustments have been established at $200,000 and are shown as a receivable from the seller and serve to reduce the purchase price. The acquisition has been accounted for as a purchase transaction and the results of operations of Nova have been included with those of the Company since September 7, 1995.
Continued
VIDEONICS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
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3. Acquisition of Nova Systems, continued:
The purchase price consisted of (in thousands):
Cash paid $ 4,000 Notes payable to seller 1,000 Receivable from seller (200) ------- $ 4,800 =======
The purchase price was allocated to assets and liabilities acquired based on the underlying fair value of assets and liabilities as follows (in thousands):
Cash $ 80 Accounts receivable 134 Inventory 517 Other assets 13 Property and equipment 35 Intangible assets 2,665 Purchased research and development 1,965 Accounts payable (247) Accrued expenses (362) ------ $4,800 ======
Intangibles consist of purchased technology and goodwill of $2,443,000 and $222,000, respectively, which are being amortized over a period of seven years. In 1997, the Company wrote-off the remaining unamortized value of the purchased technology and goodwill established in connection with the acquisition of Nova Systems. The write-off totaled $1,875,000 and was primarily due to continued losses and lack of commercially successful new product introductions.
The amount allocated to purchased in-process research and development totaling $1,965,000 was expensed on the acquisition date as the technology had not reached technological feasibility and had no alternative future use. Net of income taxes, this charge was equal to $0.23 per share.
Continued
VIDEONICS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
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4. Acquisition of KUB Systems:
Effective May 24, 1996, the Company hired all the personnel and acquired certain assets and certain liabilities of KUB Systems (KUB). KUB is a developer and manufacturer of advanced digital video production equipment for the broadcast, post-production, and institution video production markets. Under the terms of acquisition, the Company paid KUB $350,000 in cash. The acquisition has been accounted for as a purchase transaction and the results of operations of KUB have been included with those of the Company since May 24, 1996, the date the purchase was consummated.
The purchase price consisted of (in thousands):
Cash paid $350
The purchase price was allocated to assets and liabilities acquired as follows (in thousands):
Inventory $276 Other current assets 6 Property 133 Accrued expenses (65) ---- $350 ====
5. Marketable Securities:
At December 31, 1996 marketable securities consist of municipal securities which were held by one investment bank, bearing interest at 4.0% per annum. At December 31, 1997 and 1996, there were no realized gains or losses on the disposal of marketable securities.
Continued
VIDEONICS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
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6. Balance Sheet Detail:
Continued
VIDEONICS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
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6. Balance Sheet Detail, continued:
7. Commitments and Contingencies:
The Company leases a building for its principal facility under an operating lease which expires in July 1999. Under the terms of the lease, the Company is responsible for utilities, taxes, insurance and maintenance. At December 31, 1997, future minimum lease payments under all noncancelable operating leases were as follows (in thousands):
1998 $ 399 1999 142 ---------- $ 541 ==========
Continued
VIDEONICS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
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7. Commitments and Contingencies, continued:
Rent expense for the years ended December 31, 1997, 1996, and 1995 amounted to $423,000, $396,000, and $239,000, respectively.
The Company has received communications from a third party patent holder asserting patent rights embracing certain of the Company's products. Management believes that the ultimate resolution of these matters will not have a material adverse effect on the Company's financial condition or results of operations.
8. Income Taxes:
The components of the provision for income taxes are as follows (in thousands):
1997 1996 1995 ------------- ------------ -------------
Current: Federal $ (380) $ (110) $ 2,117 State - 17 440 Deferred: Federal 995 239 (640) State 103 (128) (120) ------------- ------------ ------------- $ 718 $ 18 $ 1,797 ============= ============ =============
Continued
VIDEONICS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
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8. Income Taxes, continued:
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets are presented below (in thousands):
1997 1996 ------------- -------------
Intangible assets $ 1,366 $ 848 Inventory reserves 891 149 Depreciation 45 99 Net operating loss carryforward 2,198 Tax credit carryforward 815 Other accrued liabilities and reserves 537 203 ------------- ------------- Subtotal 5,852 1,299 Less valuation allowance (5,852) ------------- ------------- Net deferred tax asset $ - $ 1,299 ============= =============
At December 31, 1997, the Company has federal and state net operating losses of $5,500,000 and $3,200,000, respectively, which expire in 2012 and 2002, respectively. The Company also has federal and state tax credit carryforwards of $580,000 and $235,000, respectively, which expire in 2012.
Continued
8. Income Taxes, continued:
In accordance with generally accepted accounting principles, a valuation allowance must be established for a deferred tax asset if its uncertain that a tax benefit may be realized from the asset in the future. The Company has established a valuation allowance to the extent of its deferred tax assets since it is not certain that a benefit can be realized in the future due to the Company's operating losses. The Company's valuation allowance increased from zero at December 31, 1996 to $5,852,000 at December 31, 1997.
Continued
VIDEONICS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
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10. Shareholders' Equity:
At December 31, 1997, the Company has reserved 1,000,000 shares of common stock for issuance under its 1996 Amended Stock Option Plan. In addition, the Company has reserved 900,000 shares of common stock for issuance under its 1987 Stock Option Plan (1987 Plan). The 1987 Plan had been set to terminate, in accordance with its terms, on January 1, 1997. Effective May 1997, the Company's Board of Directors authorized the amendment of the 1987 Plan to permit the grant of nonstatutory stock options beyond the expiration date for replacement or substitution of options previously granted under the 1987 Plan that have expired or terminated. The Plans provide for the granting of incentive stock options to officers and employees of the Company and nonqualified incentive stock options to employees, officers and directors of the Company at prices not less than the fair market value of the Company's common stock. Options generally vest over a three-to-four year period and are canceled 90 days after termination of employment.
Compensation of approximately $114,000 had been attributed to stock options granted after March 1994 and prior to the sale of the Company's common stock in an initial public offering. The compensation was recognized as a charge to income over the three-year vesting period commencing in October 1994 and terminating in September 1997.
Continued
VIDEONICS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
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10. Shareholders' Equity, continued:
On August 19, 1997, the Company offered employees the right to cancel certain outstanding stock options at original exercise prices and receive new options with a new exercise price. Options to purchase a total of 733,072 shares at original exercise prices ranging from $7.50 to $14.75 per share were canceled and new options were issued at an exercise price of $5.00 per share, the fair market value of the stock on August 19, 1997. Vesting under the new options commenced on the date of the original options first vest date with an additional year added to the new options vesting period, increasing their original vesting period from three years to four years.
The impact on pro forma income (loss) and pro forma net income (loss) per share in the table above may not be indicative of the effect in future years as options vest over several years and the Company continues to grant stock options to employees. This policy may or may not continue.
The weighted average expected life was calculated based on the vesting period and the exercise behavior of the Company's employees. The risk-free interest rate was calculated in accordance with the grant date and estimated expected life.
Continued
VIDEONICS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
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10. Shareholders' Equity, continued:
11. Segment Information:
The Company is engaged in a single industry segment encompassing the development and marketing of computer based video products. The Company markets and services its products in North America through its own direct sales organization and through sales representatives. The Company markets its products in foreign countries outside North America through distributors and its wholly owned subsidiary in Germany.
Continued
VIDEONICS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
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11. Segment Information, continued:
The Company's German office is primarily a sales office. Revenue, loss and assets employed by the Company's foreign subsidiary were not material to the consolidated financial statements.
For the years ended December 31, 1997, 1996, and 1995, no one customer accounted for more than 10% of revenues during the periods. The Company has no significant assets in foreign countries.
12. 401(k) Plan:
In August 1994, the Company adopted a 401(k) employee savings plan wherein the employee can contribute up to specified Internal Revenue Code limits and the Company matches, at a rate of 50%, the first $800 contributed by the employee. The employee's entitlement to the Company matching contributions is fully vested on the date of contribution. The Company at its sole discretion with the Board of Directors' approval can make incremental contributions. To date, the Company has not made discretionary contributions. The Company's matching contributions charged against income totaled approximately $51,000, $52,000, and $38,000 for the years ended December 31, 1997, 1996, and 1995, respectively.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY
Information concerning the directors and executive officers of the Company is set forth under the caption "Election of Directors" with respect to directors and under the caption "Management" with respect to executive officers, contained in the Company's Proxy Statement (the "Proxy Statement") relating to its 1998 Annual Meeting of Shareholders to be held on or about August 19,1998 and is incorporated by reference into this Report. The Proxy Statement will be filed with the Securities and Exchange Commission in accordance with Rule 14a-6(B) promulgated under the Securities Exchange Act of 1934. With the exception of the foregoing information and other information specifically incorporated by reference into this Report, the Proxy Statement is not being filed as a part hereof.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is incorporated by reference to the information under the caption "Executive Compensation" contained in the Proxy Statement.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information concerning the Common Stock beneficially owned by each director and executive officer of the Company, by all officers and directors of the Company as a group, and by each shareholder known by the Company to be the beneficial owner of 5% of the outstanding Common Stock, is incorporated herein by reference to the information under the caption "Security Ownership of Certain Beneficial Owners and Management" contained in the Proxy Statement.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information responsive to this item is incorporated herein by reference to the information under the caption "Certain Transactions" contained in the Proxy Statement.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) 1. Financial Statements
The following financial statement schedule is included in Item 14(d):
Schedule II -- Valuation and Qualifying Accounts
Schedules other than the one listed above have been omitted since the required information is not present in amounts sufficient to require submission of the schedule, or because the information required is included in the financial statements or notes thereto.
(b) Reports on Form 8-K
The Company filed no reports on Form 8-K with the Commission during the fiscal quarter ended December 31, 1997. - ----------
(1) Filed as an Exhibit to the Company's Registration Statement on Form S-1 (No. 33-85734) as declared effective by the Commission on December 15, 1994, and incorporated herein by reference.
(2) Incorporated by reference to Registration Statement (No. 333-21003) on Form S-8.
(3) Filed as an exhibit to the Company's Annual Report on Form 10-K for the year ended December 31, 1994, and incorporated herein by reference.
(4) Filed as an exhibit to the Company's Annual Report on Form 10-K for the year ended December 31, 1996, and incorporated herein by reference.
(5) Filed as an Exhibit to the Company's Current Report on Form 8-K dated September 7, 1995, and incorporated herein by reference.
(6) Filed as an Exhibit to the Company's Current Report on Form 8-K dated June 6, 1996, and incorporated herein by reference.
+ Confidential treatment of certain portions of this Letter of Employment Agreement has been applied for with the Securities and Exchange Commissions.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Company has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized, on this 27th day of March, 1998.
VIDEONICS, INC.
By: /s/ Michael L. D'Addio By: /s/ James A. McNeill ----------------------------- ------------------------------- Michael L. D'Addio James A. McNeill Chief Executive Vice President of Finance, Officer Chief Financial Officer and Assistant Secretary
VIDEONICS, INC.
ANNUAL REPORT ON FORM 10-K
YEAR ENDED DECEMBER 31, 1997
ITEM 14(d)
FINANCIAL STATEMENT SCHEDULE
INDEPENDENT ACCOUNTANTS' REPORT ON SCHEDULE
Our report on the financial statements of Videonics, Inc. and subsidiaries is included on page 27 of this Form 10-K. In connection with our audits of such financial statements, we have also audited the related financial statement schedule listed in the index on page 52 of this Form 10-K.
In our opinion, the financial statement schedule referred to above, when considered in relation to the basis financial statements taken as a whole, present fairly, in all material respects, the information required to be included therein.
Coopers & Lybrand L.L.P.
San Jose, California January 30, 1998
VIDEONICS, INC.
ANNUAL REPORT ON FORM 10-K
YEAR ENDED DECEMBER 31, 1997
ITEM 14(c)
EXHIBITS