**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

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**FORM 10-Q**

 
| **ý** | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934** |
|------------|----------------------------------------------------------------------------------------------|

** **

**For TheQuarterly Period Ended March 31, 2002**

** **

**OR**

** **
| **o** | **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934** |
|-------|-----------------------------------------------------------------------------------------------|

 

**For the transition period from                 ****to                **

 

**Commission file number 000-23305**

 

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**FIRST VIRTUAL COMMUNICATIONS, INC.**

(Exactname of registrant in its character)

 

| **Delaware**                                                      |   | **77-0357037**                          |
|-------------------------------------------------------------------|--------|-----------------------------------------|
| (State or other jurisdiction of incorporation or    organization) |   | (I.R.S. employer identification number) |
|                                                              |   |                                    |
| **3393 Octavius Drive**                                           |
| **Santa Clara, CA 95054**                                         |
| (Address of principal executive offices)                          |
|                                                              |   |                                    |
| **(408) 567-****7200**                                            |
| (Registrant’s telephone number, including area  code)        |

 

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Indicate by check mark whether the registrant(1) has filed all reports required to be filed by Section 13 or 15(d)of the Securities Exchange Act of 1934 during the preceding 12 months (orfor such shorter period that the registrant was required to file such reports),and (2) has been subject to such filing requirements for the past90 days. Yes ý  No o

 
| Common Stock, $0.001 par value |   | 40,116,179 shares              |   |
|--------------------------------|--------|--------------------------------|--------|
| (Class)                        |   | Outstanding as of May  8, 2002 |   |

 

 

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**First Virtual Communications, Inc.**

**Form****10-Q**

 

**Index**

 
| **PART 1.**       | **FINANCIAL INFORMATION**                                                                   |
|-------------------|---------------------------------------------------------------------------------------------|
| Item 1.           | Financial Statements                                                                        |
|              | Condensed  Consolidated Balance Sheets at March 31, 2002 (unaudited) and December 31,  2001 |
|              | Condensed  Consolidated Statements of Operations for the three months ended March 31,  2002 |
|              | Condensed  Consolidated Statements of Cash Flows for the three months ended March 31,  2002 |
|              | Notes  to Unaudited Condensed Consolidated Financial Statements                             |
| Item  2.          | Management’s  Discussion and Analysis of Financial Condition and Results of Operations |
| Item  3.          | Quantitative  and Qualitative Disclosures About Market Risk                                 |
| **PART II.**      | **OTHER INFORMATION**                                                                       |
| Item  1.          | Legal Proceedings                                                                           |
| Item 2.           | Change in Securities                                                                        |
| Item  6.          | Exhibits and  Reports on Form 8-K                                                           |
| **SIGNATURES**    |
| **EXHIBIT INDEX** |

 

2

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**PART 1. FINANCIAL INFORMATION**

 

Item 1.Financial Statements

 

**First Virtual Communications, Inc.**

**Condensed Consolidated BalanceSheets**

**(in thousands, Unaudited except sharedata)**

 
|                                                                                                                                 |   | **March 31,** |   | **December 31,** |   |
|--------------------------------------------------------------------------------------------------------------------------------------|--------|---------------|--------|------------------|--------|
|                                                                                                                                 |   | **2002**      |   | **2001**         |   |
| **ASSETS**                                                                                                                           |   |          |   |             |   |
| Current assets:                                                                                                                      |   |          |   |             |   |
| Cash and cash equivalents                                                                                                            |   | $             | 6,762  |             | $      | 6,946 |   |
| Short-term investments                                                                                                               |   | 550           |   | 2,438            |   |
| Accounts receivable                                                                                                                  |   | 6,457         |   | 6,365            |   |
| Inventory                                                                                                                            |   | 2,741         |   | 3,188            |   |
| Prepaids and other current assets                                                                                                    |   | 957           |   | 1,227            |   |
| Total current assets                                                                                                                 |   | 17,467        |   | 20,164           |   |
| Property and equipment, net                                                                                                          |   | 3,048         |   | 3,183            |   |
| Intangible assets, net                                                                                                               |   | 13,498        |   | 14,489           |   |
| Other assets                                                                                                                         |   | 373           |   | 322              |   |
|                                                                                                                                 |   | $             | 34,386 |             | $      | 38,158 |   |
|                                                                                                                                 |   |          |   |             |   |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                        |   |          |   |             |   |
| Current liabilities:                                                                                                                 |   |          |   |             |   |
| Current portion of long-term debt                                                                                                    |   | $             | 36     |             | $      | 36 |   |
| Accounts payable                                                                                                                     |   | 2,188         |   | 3,268            |   |
| Accrued liabilities                                                                                                                  |   | 4,531         |   | 5,561            |   |
| Deferred revenue                                                                                                                     |   | 3,028         |   | 2,936            |   |
| Total current liabilities                                                                                                            |   | 9,783         |   | 11,801           |   |
|                                                                                                                                 |   |          |   |             |   |
| Long-term debt, net of current portion                                                                                               |   | —        |   | —           |   |
|                                                                                                                                 |   |          |   |             |   |
| Minority interest in consolidated subsidiary                                                                                         |   | 29            |   | —           |   |
|                                                                                                                                 |   |          |   |             |   |
| Stockholders’ equity:                                                                                                           |   |          |   |             |   |
| Convertible Preferred Stock, $.001 par value; 5,000,000 share  authorized; 27,437 shares issued and outstanding, respectively        |   | —        |   | —           |   |
| Common stock, $.001 par value; 100,000,000 shares authorized;  33,430,179 and 33,327,995 shares issued and outstanding, respectively |   | 33            |   | 33               |   |
| Additional paid-in capital                                                                                                           |   | 113,353       |   | 113,437          |   |
| Accumulated other comprehensive income                                                                                               |   | 128           |   | 153              |   |
| Accumulated deficit                                                                                                                  |   | (88,940       | )      | (87,266          | )      |
| Total stockholders’ equity                                                                                                      |   | 24,574        |   | 26,357           |   |
|                                                                                                                                 |   | $             | 34,386 |             | $      | 38,158 |   |

 

Seeaccompanying notes to condensed consolidated financial statements.

 

3

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**First Virtual Communications, Inc.**

**Condensed Consolidated Statementsof Operations**

**(in thousands, except per share data;unaudited)**

 
|                                         |   | **Three months ended** |   |
|----------------------------------------------|--------|------------------------|--------|
|                                         |   | **March 31,**          |   |
|                                         |   | **2002**               |   | **2001** |   |
| Revenue:                                     |   |                   |   |   |   |
| Software                                     |   | $                      | 4,082  |   | $ | 484 |   |
| Product                                      |   | 1,341                  |   | 2,760 |   |
| Support Services                             |   | 1,178                  |   | 1,138 |   |
| Total Revenue                                |   | $                      | 6,601  |   | $ | 4,382 |   |
| Cost of revenue                              |   | 1,348                  |   | 2,587 |   |
| Gross profit                                 |   | 5,253                  |   | 1,795 |   |
|                                         |   |                   |   |   |   |
| Operating expense:                           |   |                   |   |   |   |
| Research and development                     |   | 2,757                  |   | 3,986 |   |
| Selling and marketing                        |   | 1,915                  |   | 3,015 |   |
| General and administrative                   |   | 2,284                  |   | 3,439 |   |
| Total operating expense                      |   | 6,956                  |   | 10,440 |   |
| Operating loss                               |   | (1,703                 | )      | (8,645 | ) |
|                                         |   |                   |   |   |   |
| Other income, net                            |   | 44                     |   | 316 |   |
| Minority interest in consolidated subsidiary |   | (15                    | )      | (2 | ) |
| Net loss                                     |   | $                      | (1,674 | ) | $ | (8,331 | ) |
|                                         |   |                   |   |   |   |
| Net loss per share:                          |   |                   |   |   |   |
| Basic and diluted                            |   | $                      | (0.05  | ) | $ | (0.48 | ) |
|                                         |   |                   |   |   |   |
| Shares used to compute net loss per share:   |   |                   |   |   |   |
| Basic and diluted                            |   | 33,380                 |   | 17,414 |   |

 

Seeaccompanying notes to condensed consolidated financial statements.

 

4

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**First Virtual Communications, Inc.**

**Condensed Consolidated Statementsof Cash Flows**

**(in thousands; unaudited)**

 
|                                                                       |   | **Three Months Ended March 31** |   |
|----------------------------------------------------------------------------|--------|---------------------------------|--------|
|                                                                       |   | **2002**                        |   | **2001** |   |
|                                                                       |   |                            |   |   |   |
| Cash flows from operating activities:                                      |   |                            |   |   |   |
| Net loss                                                                   |   | $                               | (1,674 | ) | $ | (8,331 | ) |
| Adjustments to reconcile net loss to net cash used inoperating activities: |   |                            |   |   |   |
| Depreciation and amortization                                              |   | 771                             |   | 589 |   |
| Provision for returns and doubtful accounts                                |   | (488                            | )      | (20 | ) |
| Stock compensation                                                         |   | 13                              |   | 40 |   |
| Provision for inventory                                                    |   | —                          |   | 587 |   |
| Other                                                                      |   | (50                             | )      | 37 |   |
| Changes in assets and liabilities net of effects of acquisitions           |   | —                          |   |   |   |
| Accounts receivable                                                        |   | 396                             |   | 5,609 |   |
| Inventory                                                                  |   | 447                             |   | (4,085 | ) |
| Prepaid expenses and other assets                                          |   | 230                             |   | 230 |   |
| Accounts payable                                                           |   | (1,080                          | )      | (917 | ) |
| Accrued liabilities                                                        |   | (430                            | )      | 596 |   |
| Deferred revenue                                                           |   | 92                              |   | 351 |   |
|                                                                       |   |                            |   |   |   |
| Net cash used in operating activities                                      |   | (1,773                          | )      | (5,314 | ) |
|                                                                       |   |                            |   |   |   |
| Cash flows from investing activities:                                      |   |                            |   |   |   |
| Acquisition of property and equipment,net                                  |   | (256                            | )      | (207 | ) |
| Proceeds from sales of short-term investments                              |   | 1,837                           |   | 9,867 |   |
|                                                                       |   |                            |   |   |   |
| Net cash provided by investing activities                                  |   | 1,581                           |   | 9,660 |   |
|                                                                       |   |                            |   |   |   |
| Cash flows from financing activities:                                      |   |                            |   |   |   |
| Proceeds from issuance of stock, net                                       |   | 8                               |   | — |   |
| Increase (repayment) of capital lease obligations                          |   | —                          |   | 10 |   |
|                                                                       |   |                            |   |   |   |
| Net cash provided by financing activities                                  |   | 8                               |   | 10 |   |
|                                                                       |   |                            |   |   |   |
| Net increase/(decrease) in cash and cash equivalents                       |   | (184                            | )      | 4,356 |   |
| Cash and cash equivalents at beginning of period                           |   | 6,946                           |   | 7,077 |   |
|                                                                       |   |                            |   |   |   |
| Cash and cash equivalents at end of period                                 |   | $                               | 6,762  |   | $ | 11,433 |   |

 

Seeaccompanying notes to condensed consolidated financial statements.

 

5

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**First Virtual Communications, Inc.**

 

**Notes to Unaudited CondensedConsolidated Financial Statements**

 

**1. Basis of Presentation**

 

First Virtual Communications, Inc. (the"Company") has prepared the accompanying financial data for thequarterly period ended March 31, 2002 pursuant to the rules and regulations ofthe Securities and Exchange Commission (SEC). Certain information and footnotedisclosures normally included in financial statements prepared in accordancewith accounting principles generally accepted in the United States of Americahave been condensed or omitted pursuant to such rules and regulations.

 

In the opinion of management, the accompanyingcondensed consolidated financial statements contain all normal and recurringadjustments necessary to present fairly the Company’s consolidated financialposition as of March 31, 2002, consolidated results of operations for the threemonths ended March 31, 2002 and 2001, and consolidated cash flow activities forthe three months ended March 31, 2002 and 2001.

 

The preparation of financial statements in accordancewith accounting principles generally accepted in the United States of Americarequires management to make estimates and assumptions that affect the amountsreported in the condensed consolidated financial statements and accompanyingnotes. Actual results may differ from those estimates.

 

The results of operationsfor the three months ended March 31, 2002 are not necessarily indicative of theresults to be expected for the full year. The information included in this Form10-Q should be read in conjunction with Management s Discussion and Analysis ofFinancial Condition and Results of Operations, the consolidated financialstatements and notes thereto included in First Virtual Communications’ 2001Annual Report on Form 10-K/A.

 

**2. Short Term Investments**

 

Management determines theappropriate classification of short term investments in marketable securitiesat the time of purchase and reevaluates such designation as of each balancesheet date. Held-to-maturity securities are carried at amortized cost, whichapproximates fair value. Available-for-sale securities are stated at fair valueas determined by the most recently traded price of each security at the balancesheet date. The net unrealized gains or losses on available-for-sale securitiesare reported as a component of comprehensive loss, net of tax. The specificidentification method is used to compute the realized gains and losses on debtand equity securities.

 

The Company regularlymonitors and evaluates the realizable value of its marketable securities. Ifevents and circumstances indicate that a decline in the value of these assetshas occurred and is other than temporary, the Company records a charge toinvestment income (expense).

 

Marketable securities arecomprised as follows (in thousands):

 
|                        |   | **March 31,** |   | **December  31,** |   |
|-----------------------------|--------|---------------|--------|-------------------|--------|
|                        |   | **2002**      |   | **2001**          |   |
| Available-for-sale:         |   |          |   |              |   |
| Corporate debt              |   | $             | 418    |              | $      | 414 |   |
| Corporate medium-term notes |   | —        |   | 1,850             |   |
| Certificate of Deposit      |   | 70            |   | 60                |   |
| Equity securities           |   | 62            |   | 114               |   |
|                        |   | $             | 550    |              | $      | 2,438 |   |

 

6

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As of March 31, 2002, theCompany's available for sale securities had contractual maturities of less thanone year. Available-for-sale securities are comprised as follows at March 31,2002 and December 31, 2001 (in thousands):

 
|                  |   | **Cost** |   | **Unrealized  Gains** |   | **Unrealized  Losses** |   | **Fair  Value** |   |
|-----------------------|--------|----------|--------|-----------------------|--------|------------------------|--------|-----------------|--------|
| **December 31, 2001** |   |     |   |                  |   |                   |   |            |   |
| Equity  securities    |   | $        | 169    |                  | $      | —                 |   | $               | (55    | ) | $ | 114 |   |
| Debt securities       |   | 2,320    |   | 5                     |   | (1                     | )      | 2,324           |   |
| Total                 |   | $        | 2,489  |                  | $      | 5                      |   | $               | (56    | ) | $ | 2,438 |   |
|                  |   |     |   |                  |   |                   |   |            |   |
| **March 31, 2002**    |   |     |   |                  |   |                   |   |            |   |
| Equity  securities    |   | $        | 113    |                  | $      | —                 |   | $               | (51    | ) | $ | 62 |   |
| Debt securities       |   | 488      |   | —                |   | —                 |   | 488             |   |
| Total                 |   | $        | 601    |                  | $      | —                 |   | $               | (51    | ) | $ | 550 |   |

 

**3. Inventory**

 

Inventories as of March 31, 2002and December 31, 2001 were (in thousands):

 
|            |   | **March 31, 2002** |   | **December 31, 2001** |   |
|-----------------|--------|--------------------|--------|-----------------------|--------|
|            |   |               |   |                  |   |
| Raw materials   |   | $                  | 1,545  |                  | $      | 2,384 |   |
| Finished goods  |   | 1,196              |   | 804                   |   |
| Total inventory |   | $                  | 2,741  |                  | $      | 3,188 |   |

 

 

7

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**4. Net Loss Per Share**

 

Basic earnings (loss) per shareis based on the weighted-average number of common shares outstanding excludingcontingently issuable or returnable shares, such as shares of unvestedrestricted common stock. Diluted earnings (loss) per share is based on theweighted-average number of common shares outstanding and dilutive potentialcommon shares outstanding.

 

As a result of the lossesincurred by the Company for the three months ended March 31, 2002 and2001, all potential common shares were anti-dilutive and were excluded from thediluted net loss per share calculations for such periods.

 

The following table summarizes securitiesoutstanding which were not included in the calculations of diluted net loss pershare for the three months ended March 31, 2002 and 2001, since their inclusionwould be anti-dilutive:

 
|                              |   | **March 31,**      |   |
|-----------------------------------|--------|--------------------|--------|
|                              |   | **2002**           |   | **2001** |   |
|                              |   | **(in thousands)** |   |
| Unvested restricted common  stock |   | —             |   | — |   |
| Common stock options              |   | 11,626             |   | 8,125 |   |
| Common stock warrants             |   | 3,589              |   | 1,016 |   |
| Convertible preferred stock       |   | 3,617              |   | 3,430 |   |

 

The common stock warrants areexercisable at $.91 to $12.00 per share and expire at various times from April2002 through May 2006.  The stockoptions outstanding at March 31, 2002, had a weighted average exercise priceper share of $2.88, and expire beginning in June 2004 through March 2012.

 

**5. Adoption of SFAS 142, Goodwill and Other Intangible Assets**

 

The Company adopted Statement ofFinancial Accounting Standards No. 142 (SFAS 142), “Goodwill and OtherIntangible Assets,” in the first quarter of 2002. SFAS 142 supersedesAccounting Principles Board Opinion No. 17, “Intangible Assets,” and discontinuesthe amortization of goodwill. In addition, SFAS 142 includes provisionsregarding: 1) the reclassification between goodwill and identifiable intangibleassets in accordance with the new definition of intangible assets set forth inStatement of Financial Accounting Standards No. 141, “Business Combinations;”2) the reassessment of the useful lives of existing recognized intangibles; and3) the testing for impairment of existing goodwill and other intangibles.

 

In accordance with SFAS 142,beginning January 1, 2002, goodwill is no longer being amortized, but will bereviewed periodically for impairment. The Company has not completed the firststep of the transitional goodwill impairment test as of the beginning of fiscal2002, and expects that the transitional goodwill impairment test will becompleted by June 30, 2002. The Company did not identify any intangibles to bereclassified out of previously reported goodwill under the new definition ofintangible assets.  Purchased technologyand other intangible assets are being amortized over their estimated usefullives of five years using the straight-line method. No changes were made to theuseful lives of amortizable intangibles in connection with the adoption of SFAS142.

 

Components of intangible assetswere as follows (in thousands):

 
|                            |   | **March 31, 2002**         |   | **December 31, 2001**        |   |
|---------------------------------|--------|----------------------------|--------|------------------------------|--------|
|                            |   | **Gross Carrrying Amount** |   | **Accumulated Amortization** |   | **Gross Carrying Amount** |   | **Accumulated Amortization** |   |
|                            |   |                       |   |                         |   |   |   |   |   |
| Amortized intangible  assets:   |   |                       |   |                         |   |   |   |   |   |
| Purchased technology            |   | $                          | 6,161  |                         | $      | (913 | ) | $ | 6,161 |   | $ | (651 | ) |
| Assembled workforce             |   | —                     |   | —                       |   | 1,505 |   | (159 | ) |
| Trademark                       |   | 661                        |   | (99                          | )      | 661 |   | (70 | ) |
| Other                           |   | 218                        |   | (171                         | )      | 218 |   | (74 | ) |
|                            |   |                       |   |                         |   |   |   |   |   |
| Total                           |   | $                          | 7,040  |                         | $      | (1,183 | ) | $ | 8,545 |   | $ | (954 | ) |
|                            |   |                       |   |                         |   |   |   |   |   |
| Unamortized intangible  assets: |   |                       |   |                         |   |   |   |   |   |
| Goodwill                        |   | $                          | 8,769  |                         | $      | (1,128 | ) | $ | 8,026 |   | $ | (1,128 | ) |

 

The Company reclassifiedpreviously identified intangible assets related to the purchase of an assembledworkforce with a net unamortized balance of $1,346,000 to goodwill.  During the three months ended March 31,2002, the Company settled a pre-acquisition contingency for less than facevalue resulting in a decrease of goodwill in the amount of $603,000.

 

Aggregate amortization expense was $380,000for the three months ended March 31, 2002 and $170,000 for the three monthsended March 31, 2001. As of March 31, 2002, future estimated amortizationexpense is expected to be: $1.1 million for 2002, $1.5  million for 2003, $1.5 million for 2004,$1.5 million for 2005 and $0.6 million for 2006.

 

8

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Net income on a pro forma basis, excludinggoodwill amortization expense, would have been as follows (in thousands):

 
|                              |   | **Three  Months Ended** |   |
|-----------------------------------|--------|-------------------------|--------|
|                              |   | **March 31,  2002**     |   | **March 31, 2001** |   |
| Reported net loss                 |   | $                       | (1,674 | ) | $ | (8,331 | ) |
|                              |   |                    |   |   |   |
| Adjustments:                      |   |                    |   |   |   |
| Goodwill amortization             |   | —                  |   | 154 |   |
|                              |   |                    |   |   |   |
| Adjusted net income/(loss)        |   | $                       | (1,674 | ) | $ | (8,177 | ) |
|                              |   |                    |   |   |   |
| Basic and diluted loss per share: |   |                    |   |   |   |
| Reported net loss                 |   | $                       | (0.05  | ) | $ | (0.48 | ) |
| Adjusted net loss                 |   | $                       | (0.05  | ) | $ | (0.47 | ) |

 

 

**7. Comprehensive Income (Loss)**

 

Comprehensive income (loss) is defined as the changein equity of a business enterprise during a period from transactions and otherevents and circumstances from non-owner sources, including foreign currency translationadjustments and unrealized gains and losses on marketable securities.

 

Components of accumulated other comprehensive lossconsist of the following (in thousands):

 
|                                                                 |   | **March 31,** |   | **December  31,** |   |
|----------------------------------------------------------------------|--------|---------------|--------|-------------------|--------|
|                                                                 |   | **2002**      |   | **2001**          |   |
| Foreign currency translation                                         |   | $             | 179    |              | $      | 204 |   |
| Unrealized (loss) gain on marketable securities, net of income taxes |   | (51           | )      | (51)              |   |
|                                                                 |   | $             | 128    |              | $      | 153 |   |
|                                                                      |        |               |        |                   |        |  |  |  |  |

 

9

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Comprehensive losses for the three monthperiods ended March 31, 2002 and 2001 were as follows (in thousands):

 
|                                                                 |   | **Three  Months Ended  March 31,** |   |
|----------------------------------------------------------------------|--------|------------------------------------|--------|
|                                                                 |   | **2002**                           |   | **2001** |   |
|                                                                 |   |                               |   |   |   |
| Net loss, as reported                                                |   | $                                  | (1,674 | ) | $ | (8,331 | ) |
| Cumulative translation adjustment                                    |   | 25                                 |   | (2 | ) |
| Unrealized gain (loss) on marketable Securities, net of income Taxes |   | —                             |   | — |   |
| Comprehensive loss                                                   |   | $                                  | (1,649 | ) | $ | (8,333 | ) |

 

**8. Litigation**

 

On or about April 9, 1999,several purported class action suits were filed in the United States DistrictCourt for the Northern District of California alleging violations of thefederal securities laws against the Company and certain of its officers anddirectors in connection with the Company’s reporting of its financial resultsfor the period ended December 31, 1998. The court dismissed these actionswithout leave to amend on February 14, 2000 and the plaintiffs appealedthe dismissal to the U.S. Court of Appeals for the Ninth Circuit. The appealwas taken under submission by the court of Appeals following the filing ofbriefs by the parties and the presentation of oral argument on July 11,2001. On March 15, 2002, the Court of Appeals affirmed the districtcourt’s judgment, dismissing the complaint without leave to amend. OnMarch 28, 2002, plaintiffs filed a Petition for Rehearing in the NinthCircuit. On April 5, 2002, the Ninth Circuit denied the plaintiffs' Petitionfor Rehearing.

 

*OnApril 23, 2001, the Company received notice of a stockholder’s derivativeaction filed in California Superior Court in the County of Santa Clara,alleging that, among other things, certain directors and officers of the Company sold shares of the Company’scommon stock between January 21, 1999 and April 6, 1999, while inpossession of material non-public information pertaining to the Company. TheCompany and the individual defendants demurred to the complaint, and moved todismiss the action, or inthe alternative to stay the action pending the outcome of the appeal in therelated federal court class action or, if necessary, the investigation of theclaims by the Company. The court granted the demurrer in part and denied it in part, granting plaintiff leaveto file an amended complaint, and stayed the action pending the outcome of theappeal in the federal court class action. The court also ordered that certainlimited discovery of documents could take place with respect to the filing ofthe amended complaint. In December 2001, the plaintiff moved for leave totake certain third-party discovery. The motion was denied by the court.Plaintiff filed an amended complaint on February 22, 2002. A hearing onthe defendants’ demurrer to the amended complaint is scheduled to take place onMay 21, 2002. The parties have tentatively agreed to a continuance of thehearing in order to permit them to engage in settlement discussions with a  third-party mediator.*

 

See "Note 10" relating to a recently commenced SECenforcement proceeding.

 

10

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**9. New Accounting Pronouncements**

 

On October 3, 2001, the FASB issued Statement of Financial AccountingStandard No. 144, “Accounting for the Impairment or Disposal of Long-LivedAssets” (SFAS 144).  SFAS 144 supercedesStatement of Financial Accounting Standard 121, “Accounting for the Impairmentof Long-Lived Assets and for Long-Lived Assets to Be Disposed of.” SFAS 144applies to all long-lived assets (including discontinued operations) andconsequently amends Accounting Principles Board Opinion No. 30. SFAS 144develops one accounting model for long-lived assets that are to be disposed ofby sale. SFAS 144 requires that long-lived assets that are to be disposed of bysale be measured at the lower of book value or fair value less cost to sell.Additionally, SFAS 144 expands the scope of discontinued operations to includeall components of an entity with operations that (1) can be distinguished fromthe rest of the entity and (2) will be eliminated from the ongoing operationsof the entity in a disposal transaction. SFAS 144 is effective for the Companyfor all financial statements issued in fiscal 2003.

 

In April 2002, the FASB issued FAS 145, “Rescission of FASB StatementsNo. 4, 44, and 64, Amendment of FASB Statement No. 13, and TechnicalCorrections,” which is effective for transactions occurring after May 15,2002.  FAS 145 rescinds FAS 4 and FAS64, which addressed the accounting for gains and losses from extinguishment ofdebt.  FAS 44 set forthindustry-specific transitional guidance that did not apply to the Company.  FAS 145 amends FAS 13 to require thatcertain lease modifications that have economic effects similar tosale-leaseback transactions be accounted for in the same manner assale-leaseback transactions.   FAS 145also makes technical corrections to certain existing pronouncements that arenot substantive in nature.  The Companydoes not expect the adoption of FAS 145 to have a significant impact on itsfinancial position or results of operations.

 

11

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**10.  SubsequentEvent(s)**

 

On March 29, 2002, theCompany signed a definitive binding agreement to raise approximately$4.8 million from a private placement of common stock and warrants topurchase common stock. On April 12, 2002, the Company issued 6,686,000 sharesof common stock at $0.72 per share and warrants to purchase 3,343,001 shares ofcommon stock at an exercise price of $1.01 per share. The warrants areexercisable for five years, commencing six months from the closing date. Amongothers, the investors in the offering included Mr. Ungermann andDr. Gaut, members of the Company’s Board of Directors, and SpecialSituations Technology Fund, L.P., of which Adam Stettner, a member of theCompany's Board of Directors, serves as the Managing Director.

 

On April 25, 2002, the Securities and Exchange Commissionadvised the Company that the staff intends to recommend that the Commissioncommence civil enforcement proceedings against the Company, its ExecutiveChairman and two former officers relating to the April 1999 revisions of theCompany’s reported financial results for the year ended December 31, 1998.  The Company expresses no opinion as to the likelyoutcome of this matter. While no assurances can be provided, the Company doesnot believe that the investigation will have a material adverse effect on itsbusiness, financial condition or results of operations.  However, our evaluation of the likely impactof these actions could change in the future and an unfavorable outcome,depending upon the amount and timing, could have a material effect on ourresults of operations or cash flows of a future period.

 

 

**11.  Issuance ofcommon stock and warrants**

 

On March 29, 2002, the Company signed a definitivebinding agreement to raise approximately $4.8 million from a privateplacement of common stock and warrants. On April 12, 2002, the Company issued 6,686,000 shares of common stockat $0.72 per share and warrants to purchase 3,343,001 shares of common stock atan exercise price of $1.01 per share. The warrants are exercisable for fiveyears, commencing six months from the closing date. Among others, the investorsin the offering also included Mr. Ungermann and Dr. Gaut, members ofthe Company’s Board of Directors, and Special Situations Technology Fund L.P.,of which Adam Stattner, a member of the Company's Board of Directors, serves asthe Managing Director.

 

Item 2. Management’s Discussion and Analysis of FinancialCondition and  Results of Operations

 

The following discussion of thefinancial condition and results of operations of First Virtual Communications,Inc. (the “Company”) should be read in conjunction with the Unaudited CondensedConsolidated Financial Statements and the Notes thereto included in Item 1 ofthis Quarterly Report on Form 10-Q.

 

In addition to thehistorical information contained in this Item, this Item containsforward-looking statements within the meaning of Section 27A of the SecuritiesAct of 1933, as amended, and Section 21E of the Securities Exchange Act of1934, as amended, that involve risks and uncertainties. These forward lookingstatements include, without limitation, statements containing the words“believes,” “anticipates,” “expects,” and words of similar import. Suchforward-looking statements will have known and unknown risks, uncertainties andother factors that may cause the actual results, performance or achievements ofthe Company, or industry results, to be materially different from any futureresults, performance or achievements expressed or implied by suchforward-looking statements. Such factors include, among others: the Company’slimited operating history and variability of

 

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operating results, marketacceptance of video technology, including the Company’s new broadband videoservices business, dependence on ATM and other technologies, the Company’spotential inability to maintain business relationships with telecommunicationscarriers, distributors and suppliers, rapid technological changes, competitionand consolidation in the video networking industry, the importance ofattracting and retaining personnel, management of the Company’s growth, therisk that the benefits****expected from the merger with CUseeMeNetworks will not be realized, consolidation and cost pressures in the videonetworking industry, dependence on key employees, and other risk factors setforth below and described in this Form 10-Q report and in other documents theCompany files with the SEC. The Company assumes no obligation to update anyforward-looking statements contained herein.

 

**Overview**

 

The Company deliversintegrated, end-to-end rich media Web conferencing and collaboration solutions,including both hardware and software technologies, for IP, ISDN and ATMnetworks. The Company combines its expertise in networking systems, real-timeaudio and video technology, and Web-based collaboration to provide integratedvoice, video, data, text and streaming media solutions for a wide range of richmedia enterprise applications, including Web conferences, broadcasts,video-on-demand, videoconferences and video calls over converged multi-servicenetworks. The Company provides integrated, end-to-end rich media communicationssolutions, including both hardware and software technologies, for IP, ISDN andATM networks. The Company was incorporated in California in October 1993and reincorporated in Delaware in December 1997. The Company first shippedits video networking products in 1995.

 

On June 19, 2001, theCompany and CUseeMe Networks completed a merger, pursuant to which CUseeMeNetworks became a wholly owned subsidiary of the Company. CUseeMe Networksprovided innovative software-based solutions to enable voice, video, and datacollaboration over IP-based networks. CUseeMe Networks specialized indelivering a solution that was both centrally managed and centrally deployed,enabling large-scale deployments of rich media collaboration to enterprise desktops.As a result of the merger, the Company is able to provide a broad range ofintegrated rich media Web conferencing solutions that run seamlessly acrossmultiple network types to enterprise customers and service providers worldwide.

 

In the three months endedMarch 31, 2002, the Company recorded $6.6 million in revenue, a increase of 51%compared to the same period of the previous year.  In fiscal 2001, the Company recorded $27.7 million inrevenue, a decrease of 31% compared to the previous year. The Company derivedits revenue in the three months ended March 31, 2002 and fiscal 2001 from thesale of video networking systems and services to enterprise customers, whichinclude business customers, government agencies, educational institutions andhealthcare providers, primarily through indirect sales channels and totelecommunications service providers, which include expanded customerrelationships with AT&T, Electronic Data Systems, Wind, Noicom and ChinaTelecom, all of which are deploying broadband video services using theCompany’s products and solutions. For the three months ended March 31, 2002,87% of the Company’s revenue was from enterprise customers and 13% was fromservice providers compared to 77% from enterprise customers and 23% fromservice providers in the same period of the prior year. For the year ended

 

 

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December 31, 2001, 71% of the Company’srevenue was from enterprise customers and 29% was from service providers, whilefor the year ended December 31, 2000, revenue from enterprise customerswas 78% and 22% was from service providers. The Company’s internal sales forcequalifies and stimulates end-user demand, and manages the Company’s strategicrelationships with its distribution partners, including OEMs, VARs and systemsintegrators. In the three months ended March 31, 2002 and the years endedDecember 31, 2001 and 2000, approximately 36%, 43%and 43% of the Company’srevenue was derived through its distribution partners, including EDS, Verizon,Avaya, Williams Communications, Dataserv, AT&T, and Total SystemsIntegration in the USA, Mistel SPA and Feeder in Europe, and Tomen CyberBusiness Solutions in Asia.

 

The Company maintains salesoffices in the United Kingdom, France, Italy, Hong Kong and Japan, anddistributes its products under the FVC.COM name in both Europe and Asia throughresellers and distributors in more than 25 countries. In 2002, sales in Asia,excluding Japan, will be conducted through the Company’s Hong Kong sales subsidiary,since the Company’s acquisition of its exclusive distributor for Asia inJanuary of 2002. For the three months ended March 31, 2002 and March 31, 2001and the years ended December 31, 2001, 2000 and 1999, approximately 25%,32%, 21%, 12% and 14%, respectively, of the Company’s sales were generated fromcustomers outside of the United States. The Company expects that direct salesfrom shipments to customers outside of the United States will continue torepresent a significant portion of its future revenue. In addition, the Companybelieves that a small portion of its sales through OEMs, resellers andintegrators are ultimately sold to international end-users. Revenue from theCompany’s international operations are subject to various risks, including seasonality,longer payment cycles, changes in regulatory requirements and tariffs, reducedprotection of intellectual property rights, political and economic restraints,and currency risks, among others. To date, the Company has not engaged in anyforeign currency hedging activity.

 

Some of the Company’sproducts are assembled and tested by subcontract manufacturers, the largestprovider being InnerStep, Inc.

 

**CRITICAL ACCOUNTING POLICIES**

 

We have identified thepolicies below as critical to our business operations and the understanding ofour results of operations. The impact and any associated risks related to thesepolicies on our business operations is discussed throughout Management’sDiscussion and Analysis of Financial Condition and Results of Operations wheresuch policies affect our reported and expected financial results. For adetailed discussion of the application of these and other

 

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accounting policies, see Note 1 in theNotes to the Consolidated Financial Statements in Item 14 of our Annual Reporton Form 10-K.  The preparation ofour financial statements requires us to make estimates and assumptions thataffect the reported amount of assets and liabilities, disclosure of contingentassets and liabilities at the date of our financial statements, and thereported amounts of revenue and expenses during the reporting period. There canbe no assurance that actual results will not differ from those estimates.

 

**Revenuerecognition**. We derive our revenue from primarily two sources(i) product revenue, which includes software license and hardware revenue,and (ii) services and support revenue which includes software licensemaintenance, training and consulting revenue. As described below, significantmanagement judgments and estimates must be made and used in connection with therevenue recognized in any accounting period. Material differences may result inthe amount and timing of our revenue for any period if our management madedifferent judgments or utilized different estimates.

 

We apply the provisions of Statement of Position 97-2,“Software Revenue Recognition,” to all transactions involving the sale ofsoftware products and hardware transactions where the software is notincidental. For hardware transactions where software is incidental, we applythe provisions of SEC Staff Accounting Bulletin 101, “Revenue Recognition.”

 

We license our software products on a perpetual basis.We recognize revenue from the sale of software licenses when persuasive evidenceof an arrangement exists, the product has been delivered, the fee is fixed anddeterminable and collection of the resulting receivable is reasonably assured.Delivery generally occurs when product is delivered to a common carrier.

 

At the time of the transaction,we assess whether the associated fee is fixed and determinable and whether ornot collection is reasonably assured. We assess whether the fee is fixed anddeterminable based on the payment terms associated with the transaction. If asignificant portion of a fee is due after our normal payment terms, which are30 to 90 days from invoice date, we account for the fee as not being fixedand determinable. In these cases, we recognize revenue as the fees become due.

 

We assess collection based on a number of factors,including past transaction history with the customer and the credit-worthinessof the customer. We do not request collateral from our customers. If wedetermine that collection of a fee is not reasonably assured, we defer the feeand recognize revenue at the time collection becomes reasonably assured, whichis generally upon receipt of cash.

 

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For all sales, except those completed over theInternet, we use either a binding purchase order or other signed agreement asevidence of an arrangement. For sales over the Internet, we use a credit cardauthorization as evidence of an arrangement. Sales through our distributors areevidenced by a master agreement governing the relationship with or withoutbinding purchase orders on a transaction by transaction basis.

 

For arrangements with multiple obligations (forexample, undelivered maintenance and support), we allocate revenue to eachcomponent of the arrangement using the residual value method based on the fairvalue of the undelivered elements, which is specific to the Company. This meansthat we defer revenue from the arranged fee that is equivalent to the fairvalue of the undelivered elements. Fair values for the ongoing maintenance andsupport obligations for our perpetual licenses are based upon separate sales ofrenewals to other customers or upon renewal rates quoted in the contracts. TheCompany bases the fair value of services, such as training or consulting, uponseparate sales of these services to other customers. We recognize revenue formaintenance services ratably over the contract term. Our training andconsulting services are billed based on hourly rates, and we generallyrecognize revenue as these services are performed.

 

Our arrangements do not generally include acceptanceclauses. However, if an arrangement includes an acceptance provision,acceptance occurs upon the earlier of receipt of a written customer acceptanceor expiration of the acceptance period.

 

Revenue from sales to certain of the Company’sresellers are subject to agreements allowing rights of return and priceprotection. In these cases, the Company provides reserves for estimated futurereturns and allowances upon revenue recognition. These reserves are estimated basedupon historical rates of returns and allowances, reseller inventory levels, theCompany’s estimates of sell through by resellers and other related factors.Actual results could differ from these estimates. In the event of the inabilityto estimate returns from any reseller, the Company defers revenue recognitionuntil the reseller has sold the products to the end-user. Advance paymentsreceived from customers and gross margin deferred with respect to sales, forwhich revenue has not been recorded, are recorded as deferred revenue.

 

**Sales returns and other allowances,allowance for doubtful accounts and litigation.** The preparation of financial statements requires ourmanagement to make estimates and assumptions that affect the reported amount ofassets and disclosure of contingent assets and liabilities at the date of thefinancial statements and the reported amounts of revenue and expense during theperiod. Specifically, our management must make estimates of potential future

 

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product returns related to current period product revenue. Managementanalyzes historical returns, current economic trends, and changes in customerdemand and acceptance of our products when evaluating the adequacy of the salesreturn and other allowances. Significant management judgments and estimatesmust be made and used in connection with establishing the sales return andother allowances in any accounting period. Material differences may result inthe amount and timing of our revenue for any period if management madedifferent judgments or utilized different estimates. The provision for salesreturn and other allowances amounted to $726,000 at March 31, 2002,$869,000 at December 31, 2001 and $542,000 at December 31, 2000.Similarly, our management must make estimates of the uncollectability of ouraccounts receivable. Management specifically analyzes accounts receivable,including historical bad debts, customer concentrations, customercredit-worthiness, current economic trends and changes in our customer paymentterms when evaluating the adequacy of the allowance for doubtful accounts. Theaccounts receivable balance was $6.5 million, net of allowance for doubtfulaccounts and returns of $1.5 million as of March 31, 2002.  The accounts receivable balance was$6.4 million, net of allowance for doubtful accounts and returns of$2.5 million as of December 31, 2001.

 

Management’s current estimated range of liabilityrelated to some of the pending litigation involving the Company is based onclaims for which our management can estimate the amount and range of loss. Wehave recorded the minimum estimated liability related to those claims, wherethere is a range of loss. Because of the uncertainties related to both theamount and range of loss on the remaining pending litigation, management isunable to make a reasonable estimate of the liability that could result from anunfavorable outcome. As additional information becomes available, we willassess the potential liability related to our pending litigation and revise ourestimates. Such revisions in our estimates of the potential liability couldmaterially impact our results of operation and financial position.

 

**Valuation of Inventories.**    The Companywrites down its inventory for estimated obsolescence or unmarketable inventoryequal to the difference between the cost of inventory and the estimated marketvalue based upon assumptions about future demand and market conditions. Ifactual future demand or market conditions are less favorable than thoseprojected by management, additional inventory write-downs may be required.During the three months ended March 31, 2002, the Company did not record anyinventory related charges.  During thethree months ended March 31, 2001, the Company recorded inventory relatedcharges of $587,000.  During the yearended December 31, 2001, the Company recorded inventory related charges of$7.3 million, which related to the write down of inventories for certainexcess and obsolete products. During the year ended December 31, 2000, theCompany recorded inventory related charges of 

 

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$2.3 million, which related to the write down of inventories forcertain excess and obsolete products.

 

**Valuation of long-lived andintangible assets and goodwill.**   We will perform goodwillimpairment tests on an annual basis and between annual tests in certaincircumstances. In response to changes in industry and market conditions, we maystrategically realign our resources and consider restructuring, disposing of,or otherwise exiting businesses, which could result in an impairment ofgoodwill. Factors weconsider important that could trigger an impairment review include thefollowing:

 

•significant underperformance relative to expectedhistorical or projected future operating results;

•significant changes in the manner of our use of theacquired assets or the strategy for our overall business;

•significant negative industry or economic trends;

•significant decline in our stock price for a sustainedperiod; and

•our market capitalization relative to net book value.

 

When we determine that the carrying value ofintangibles, long-lived assets and goodwill may not be recoverable based uponthe existence of one or more of the above indicators of impairment, we measureany impairment based on a projected discounted cash flow method using adiscount rate determined by our management to be commensurate with the riskinherent in our current business model.

 

**Accounting for income taxes.**    As part of theprocess of preparing our consolidated financial statements we are required toestimate our income taxes in each of the jurisdictions in which we operate.This process involves us estimating our actual current tax exposure togetherwith assessing temporary differences resulting from differing treatment ofitems, such as deferred revenue, for tax and accounting purposes. Thesedifferences result in deferred tax assets and liabilities, which are includedwithin our consolidated balance sheet. We must then assess the likelihood thatour deferred tax assets will be recovered from future taxable income and to theextent we believe that recovery is not likely, we must establish a valuationallowance. To the extent we establish a valuation allowance or increase thisallowance in a period, we must include an expense within the tax provision inthe statement of operations.

 

Significant management judgment is required indetermining our provision for income taxes, our deferred tax assets andliabilities and any valuation allowance recorded against our net deferred taxassets. We have recorded a valuation allowance of $46.5 million as ofDecember 31, 2001, due to uncertainties related to our ability to utilizesome of our deferred tax assets, primarily consisting of certain net operatinglosses carried forward and foreign tax credits, before they expire. Thevaluation allowance is based on our estimates of taxable income by jurisdictionin

 

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which we operate and the period over which our deferred tax assets willbe recoverable. In the event that actual results differ from these estimates orwe adjust these estimates in future periods we may need to establish anadditional valuation allowance which could materially impact our financialposition and results of operations.  AtMarch 31, 2002, the deferred tax asset continued to be fully reserved.

 

**Results of Operations**

The following table sets forthcertain items from the Company’s condensed consolidated statements ofoperations as a percentage of total revenues for the periods indicated.

 
|                                         |   | **Three months ended** |   |
|----------------------------------------------|--------|------------------------|--------|
|                                         |   | **March 31,**          |   |
|                                         |   | **2002**               |   | **2001** |   |
|                                         |   |                   |   |   |   |
| Revenue                                      |   | 100.0                  | %      | 100.0 | % |
| Cost of revenue                              |   | 20.4                   | %      | 59.0 | % |
| Gross profit                                 |   | 79.6                   | %      | 41.0 | % |
|                                         |   |                   |   |   |   |
| Operating expense:                           |   |                   |   |   |   |
| Research and development                     |   | 41.8                   | %      | 91.0 | % |
| Selling and marketing                        |   | 29.0                   | %      | 68.8 | % |
| General and administrative                   |   | 34.6                   | %      | 78.5 | % |
| Total operating expense                      |   | 105.4                  | %      | 238.2 | % |
| Operating loss                               |   | -25.8                  | %      | -197.3 | % |
|                                         |   |                   |   |   |   |
| Other income, net                            |   | 0.7                    | %      | 7.2 | % |
| Minority interest in consolidated subsidiary |   | -0.2                   | %      | 0.0 | % |
| Net loss                                     |   | -25.4                  | %      | -190.1 | % |

 

 

*Revenue.*  Revenue was $6.6 million for the threemonths ended March 31, 2002, an increase of 50.6% from $4.4 million forthe three months ended March 31, 2001. The increase resulted from the Company’s efforts to transition fromsales of hardware based ATM legacy products to more software-based products andto expand its customer base worldwide. Revenue generated from the Company’sstrategic products, Click to Meet and the Conference Server accounted for 61.8%of total revenue.

 

*Gross Profit.*  Gross profit consists of revenue less thecost of revenues, which consists primarily of costs associated with thepurchase of components from outside manufacturers or the manufacture of theCompany’s products by outside manufacturers and related costs of freight,inventory obsolescence, royalties, warranties and customer support costs, whichwere expensed in the period incurred.

 

Gross profit for the three monthsended March 31, 2002 increased by $3.5 million to $5.3 million, or 79.6% ofrevenue, compared to $1.8 million, or 41.0% of revenue in the comparable periodof 2001.  The increase was due to asignificantly higher percentage of revenue from software-based products in thequarter.

 

*Research and Development.*  Research and development expense consistprimarily of personnel costs, costs of contractors and outside consultants,supplies and materials expenses, equipment depreciation and overhead costs.Research and development expense decreased $1.2 million to $2.8 million in thethree months ended March 31, 2002, a decrease of 30.8% over the $4.0 millionduring the three months ended March 31, 2001. The decrease in absolute dollarswas principally due to a $1.0 million decrease in  personnel-related expenses and a $212,000 decrease in equipmentand supply expense after the Company implemented cost cutting measuresthroughout the organization. As a percentage of total revenue, research anddevelopment expense decreased to 41.8% for the three months ended March 31,2002, from 91.0% for the three months ended March 31, 2001. The decrease as apercentage of revenue was due to the higher sales and lower spending during thethree months ended March 31, 2002.

 

*Sales and Marketing.*  Sales and marketing expense includespersonnel and related overhead costs for sales and marketing, costs of outsidecontractors, advertising, trade shows and other related marketing andpromotional expenses. Sales and marketing expense decreased $1.1 million or36.5% for the three months ended March 31, 2002, to $1.9 million from $3.0during the three months ended March 31, 2001. The decrease in absolute dollarswas principally due to a $510,000 decrease in personnel-related expenses, and a $228,000 decrease in trade show andpromotional activities

 

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after the Company implemented cost cutting measuresthroughout the organization, and a $359,000 decrease in bad debt expense due tothe subsequent collection of the amounts receivable from one of oursubsidiaries, which was originally reserved as doubtful accounts in the quarterended December 31, 2001. As a percentage of total revenue, sales and marketingexpense decreased to 29.0% for the three months ended March 31, 2002, from68.8% for the three months ended March 31, 2001.

 

*General and Administrative.*  General and administrative expense includepersonnel and related overhead costs for finance, human resources, informationtechnology, product operations, and general management and the amortization ofintangible assets. General and administrative expense decreased $1.1 million or33.6% for the three months ended March 31, 2002, to $2.3 million, from $3.4million in the three months ended March 31, 2001. The decrease was mainly dueto a $1.1 million decrease in personnel-related expenses after the Companyimplemented cost cutting measures throughout the organization. As a percentageof revenue, general and administrative expense decreased to 34.6% in the threemonths ended March 31, 2002, compared to 78.5% in the three months ended March31, 2001. The decrease in general and administrative expense as a percentage ofrevenues for the three months ended March 31, 2002 reflects the higher revenueand lower spending from the comparable period of 2001.

 

*Other Income, Net.*  Other income, net consists primarily ofinterest income earned on short-term investments and cash balances, offset byinterest expense relating to the Company’s credit facilities and long-termdebt.  Other income, net totaled $44,000for the three months ended March 31, 2002, compared to $316,000 for the threemonths ended March 31, 2001. The decrease was as a result of lowerinterest income from lower average cash and short term investment balances in2002.

 

*Minority Interest in Consolidated Subsidiary.*  Minority interest reflects theinterest of minority stockholders in the operating results of the Company’sconsolidated subsidiary in the United Kingdom. The Company acquired acontrolling interest in this entity in May 1999. For the three monthsended March 31, 2002, the amount reflects the portion of losses in thissubsidiary that were attributable to minority stockholders.

 

*Income Taxes.*  The Company has incurred losses since itsinception. No tax benefit was recorded for any period presented, as the Companybelieves that, based on the history of such losses and other factors, theweight of available evidence indicates that it is more likely than not that itwill not be able to realize the benefit of these net operating losses, and thusa full valuation reserve has been recorded.

 

**Liquidity and Capital Resources**

 

Since inception, the Company has financed itsoperations primarily through private and public placements of equity securitiesand to a lesser extent through certain credit facilities and long-term debt. Asof March 31, 2002, the Company had cash and cash equivalents and short-terminvestments of $7.3 million and working capital of $7.7 million. TheCompany believes that its cash and cash equivalents and short-term investmentswill provide adequate cash to fund its current operations for the next twelvemonths.

 

On March 29, 2002, the Company entered into abinding agreement to sell common stock and warrants to purchase common stock toinvestors in a private placement for aggregate proceeds of approximately$4.8 million. On April 12, 2002 the Company issued 6,686,000 shares ofcommon stock at $0.72 per share and warrants to purchase 3,343,001 shares ofcommon stock at an exercise price of $1.01 per share. The warrants areexercisable for five years, commencing six months from the closing date. Theinvestors in the financing included Special Situations Funds, including SpecialSituations Technology Funds, L.P., of which Adam Stettner, a member of theCompany's Board of Directors, serves as Managing Director, Mr. Ungermannand Dr. Gaut, each of whom are members of the Company’s Board ofDirectors, and other purchasers.

 

The Company has experienced significant netoperating losses from inception. In the three months ended March 31, 2002, theCompany incurred losses of $1.7 million and used $1.8 million of cash in itsoperating activities.  In 2001, theCompany incurred net losses of $31.6 million and used $20.7 millionof cash in its operating activities. Management currently expects thatoperating losses and negative cash flows will continue for the foreseeablefuture. In 2001, the Company decreased the size of its workforce by 26% andinstituted measures to control discretionary spending. Management currently believesthat the Company’s existing cash and investments, together with the fundsprovided pursuant to the stock purchase agreement are adequate to fund theCompany’s operations through December 31, 2002. However, the Company’scash requirements depend on several factors, including the rate of marketacceptance of its products and services, the ability to expand and retain itscustomer base and other factors. If the Company fails to achieve its plannedrevenue or expense targets, management believes that it has the plans, intentand ability to curtail capital and operating spending to ensure that cash andinvestments will be sufficient to meet the Company’s cash requirements throughDecember 31, 2002.

 

In order to aggressively pursue businessopportunities, the Company may be required to seek equity investments fromexisting or potential strategic partners in the future. Should the Company selladditional equity, the sale may result in dilution to the Company’s currentstockholders. Should the Company be unsuccessful in its efforts to raise equityfrom strategic partners, it may seek additional capital from the public and/orprivate equity markets that will likely result in dilution of the Company’scurrent stockholders. There can be no assurance that any financing will beavailable at acceptable terms or at all.

 

Cash used in operating activities totaled$1.8 million for the three months ended March 31, 2002, compared to $5.3million for the three months ended March 31, 2001.  Cash used in operating activities primarily consisted of$1.7 million from a net loss adjusted for non-cash items, and an decreaseof $1.1 million in accounts payable and $430,000 in accrued liabilities,partially offset by a decrease of $447,000 in inventory, $396,000 in accountsreceivable and $230,000 in other assets. Cash used in operating activities for the three month ended March 31,2001, reflect $8.3 million from a net loss adjusted for non-cash items,and an increase of $4.1 million in inventory, a

 

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decreaseof $1.0 million in accounts payable, offset in part by a decrease of$5.6 million in accounts receivable, an increase of $596,000 in accruedliabilities and $351,000 in deferred revenue.

 

Cash provided in investment activities totaled$1.6 million for the three months ended March 31, 2002, compared to $9.7million for the three months ended March 31, 2001.  Cash provided by investment activities primarily consisted of$1.8 million of net sales of short-term investments, offset by $256,000 ofcash used in the acquisition of property and equipment. Cash provided ininvestment activities for the three month ended March 31, 2001, primarilyconsisted of net sales of short-term investments of $9.9 million, offsetby the acquisition of property and equipment of $207,000.

 

Cash provided by financing activities was $8,000for the three months ended March 31, 2002, principally from the issuance ofstock. Cash provided by financing activities was $10,000 for the three monthsended March 31, 2001, principally from the increase in capital leaseobligations.

 

*New Accounting Pronouncements*. On October 3, 2001, the FASB issued Statement of Financial AccountingStandard No. 144, “Accounting for the Impairment or Disposal of Long-LivedAssets” (SFAS No. 144).  SFAS 144supercedes SFAS 121, “Accounting for the Impairment of Long-Lived Assets andfor Long-Lived Assets to Be Disposed of.” SFAS 144 applies to all long-livedassets (including discontinued operations) and consequently amends AccountingPrinciples Board Opinion No. 30. SFAS 144 develops one accounting model forlong-lived assets that are to be disposed of by sale. SFAS 144 requires thatlong-lived assets that are to be disposed of by sale be measured at the lowerof book value or fair value less cost to sell. Additionally, SFAS 144 expandsthe scope of discontinued operations to include all components of an entitywith operations that (1) can be distinguished from the rest of the entity and(2) will be eliminated from the ongoing operations of the entity in a disposaltransaction. SFAS 144 is effective for the Company for all financial statementsissued in fiscal 2003.

 

In April 2002, the FASB issued FAS 145,“Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB StatementNo. 13, and Technical Corrections,” which is effective for transactionsoccurring after May 15, 2002.  FAS 145rescinds FAS 4 and FAS 64, which addressed the accounting for gains and lossesfrom extinguishment of debt.  FAS 44 setforth industry-specific transitional guidance that did not apply to theCompany.  FAS 145 amends FAS 13 torequire that certain lease modifications that have economic effects similar tosale-leaseback transactions be accounted for in the same manner assale-leaseback transactions.   FAS 145also makes technical corrections to certain existing pronouncements that arenot substantive in nature.  The Companydoes not expect the adoption of FAS 145 to have a significant impact on itsfinancial position or results of operations.

 

**Risk Factors**

 

In addition to the other information provided inthis report, the following risk factors should be considered in evaluating theCompany and its business.

 

*The Companyhas a history of operating losses and will incur losses in the future. TheCompany may never generate sufficient revenue to achieve profitability.*

 

The Company has incurred operating losses in eachquarter since it commenced operations in 1993. The Company expects to continueto devote substantial resources to its research and development and sales andmarketing activities. As a result, the Company expects that it will continue toincur operating losses for the foreseeable future. The Company’s revenuesincreased from $4.4 million for the three months ended March 31, 2001 to$6.6 million for the three months ended March 31, 2002, while its net lossdecreased from $8.3 million for the three months ended March 31, 2001 to$1.7 million for the three months ended March 31, 2002. The Company’srevenues decreased from $40 million for the year ended December 31,2000 to $27.7 million for the year

 

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endedDecember 31, 2001, while its net loss increased from $18.8 millionfor the year ended December 31, 2000 to $31.6 million for the yearended December 31, 2001. At March 31, 2002, the Company had anaccumulated deficit of $88.9 million.

 

*The Company’squarterly financial results are expected to fluctuate and may cause the priceof the Company’s common stock to fall.*

 

The Company has experienced inthe past, and is likely to experience in the future, fluctuations in revenue,gross margin and operating results. Various factors could contribute to thefluctuations in revenue, gross margin and operating results, including theCompany’s:

 

•                                           success in developing its rich media Web conferencing business and indeveloping, introducing and shipping new products and product enhancements,particularly for Click to Meet and the Multi Conferencing Unit;

 

•                                           success in accurately forecasting demand for new orders (that may haveshort lead-times before required shipment), product mix, percentage of revenuederived from OEMs versus distributors or resellers;

 

•                                           new product introductions and price reductions by competitors;

 

•                                           results from strategic collaborations;

 

•                                           use of OEMs, distributors, resellers, and other third parties;

 

•                                           ability to attract, retain and motivate qualified personnel;

 

•                                           research and development efforts and success;

 

•                                           cost and outcome of the SEC enforcement proceeding against the Company;and

 

•                                           selling, general and administrative expenditures.

 

Additionally, the Company’soperating results may vary significantly depending on a number of factors thatare outside of its control. Further, a significant portion of the Company’sexpenses are fixed. The Company has made significant progress in reducing itsoperating expenses in the last year and expects that operating expenses willdecrease in the future due to continued expense reduction measures. However, tothe extent that operating expenses are not reduced and to the extent thatrevenue or gross margin cannot be increased, the Company’s business, financialcondition and results of operations would be materially adversely affected. Dueto all the foregoing factors, it is likely that in some future quarter, as attimes in past quarters, the Company’s results of operations will be below theexpectations of public market analysts and investors, resulting in a negativeimpact on the Company’s common stock price.

 

**The Company’s success depends on themarket’s acceptance of rich media and Web conferencing services and theCompany’s products, including Click to MeetTM and the Multi Conferencing Unit.**

 

The Company’s success depends inpart on the market’s acceptance of rich media and Web conferencing services andthe Company’s products, including Click to MeetTM and the MCU. Potentialend-users must accept video applications as a viable alternative toface-to-face meetings and conventional classroom-based learning. Newapplications, such as the use of video conferencing in marketing, selling andmanufacturing, are still in the development stage. The Company’s contracts withtelecommunications service providers to provide broadband video and Webconferencing solutions are in the early stage and only recently has the Companyreceived significant revenue from this market segment. If rich media, Webconferencing and broadband video services fail to achieve broad commercialacceptance or if such acceptance is delayed, the Company’s business, financialcondition and results of operations will be materially adversely affected. TheCompany anticipates that significant revenue and growth in the foreseeablefuture will come from the sale of its Click to MeetTM and MCU products andservices. Broad market acceptance of these products and services is thereforecritical to the Company’s operating success.

 

22

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*The Companyfaces potential delisting from The Nasdaq National Market. If delisting occurs,the market price and market liquidity of the Company’s common stock will beadversely affected.*

 

The Company’s common stock islisted on The Nasdaq National Market. Pursuant to its rules, The NasdaqNational Market may commence procedures to delist any shares trading below$1.00 per share on The Nasdaq National Market for a period of 30 consecutivetrading days. The Company’s common stock has at times been trading below $1.00per share. In March 2002, the Company received notice from The NasdaqNational Market of its non-compliance with the Nasdaq rules. If the Company isunable to regain compliance, or if appeals to The Nasdaq National Market forrelief from compliance are unsuccessful, then the Company’s common stock willbe delisted from The Nasdaq National Market. On May 10, 2002, the last salereported on the Nasdaq National Market System for the Company’s stock was at$0.75.

 

If delisting occurs, the tradingof the Company’s common stock is likely to be conducted on the OTC BulletinBoard, which will have an adverse affect on the market price of the Company’scommon stock and on the ability of stockholders and investors to buy and sellthe common stock. If delisting occurs you may lose some or all of yourinvestment.

 

*The Company’sinability to secure additional funding could adversely effect its business.*

 

In order to meet the Company’santicipated working capital and Company’s capital expenditure requirements, theCompany may need to raise additional funds through the issuance of equitysecurities in the future. If additional funds are raised through the issuanceof equity securities, the percentage ownership of the stockholders of theCompany will be reduced, stockholders may experience additional dilution, andthe new equity securities may have rights, preferences or privileges senior to thoseof the holders of the Company’s common stock. Additional financing may not beavailable when needed or on terms favorable to the Company, or at all. Ifadequate funds are not available or are not available on acceptable terms, theCompany may be required to delay, reduce or eliminate some or all of itsdevelopment programs for its products or services, and may be unable to takeadvantage of future opportunities or respond to competitive pressures, whichcould have a material adverse effect on the Company’s business, financialcondition and operating results.

 

*The Companyfaces potential volatility in its common stock price.*

 

The market price of the Company’scommon stock has been extremely volatile in the past and, like that of othertechnology companies, may be subject to significant volatility in the future,depending upon many factors, including:

 

•                                           fluctuations in the Company’s financial results;

 

•                                           technological innovations or new commercial products developed by theCompany or its competitors;

 

•                                           establishment of and success of corporate partnerships or licensingarrangements;

 

•                                           announcements regarding the acquisition of technologies, products orcompanies;

 

•                                           regulatory changes and developments that affect the Company’s business;

 

•                                           developments or disputes concerning patent and proprietary rights andother legal matters;

 

•                                           an adverse outcome from the SEC enforcement proceedings;

 

23

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•                                           issuance of new or changed stock market analyst reports and/orrecommendations; and

 

•                                           economic and other external factors.

 

One or more of these factorscould significantly harm the Company’s business and decrease the price of itscommon stock in the public market. Severe price fluctuations in a company’sstock have frequently been followed by securities litigation. Such litigationcan result in substantial costs and a diversion of management’s attention andresources and therefore could have a material adverse effect on the Company’sbusiness, financial condition and results of operations. Past financialperformance of the Company should not be considered a reliable indicator offuture performance, and investors should not use historical trends toanticipate results or trends in future periods.

 

*The Companyhas a history of generating a large percentage of its revenue at the end ofeach quarterly accounting period.*

 

Due to the way that manycustomers in the Company’s target markets allocate and spend their budgetedfunds for acquisition of the Company’s products and other products, a largepercentage of the Company’s business is booked at the end of each quarterlyaccounting period. Because of this, the Company may not be able to reliablypredict order volumes or prepare orders for shipment on time. If the Company isunable to ship its customer orders on time, there could be a material adverseeffect on the Company’s results of operations.

 

*The Company’ssuccess depends on the performance of participants in the Company’sdistribution channels.*

 

The Company currently sells itsproducts through OEMs, distributors and resellers. The Company’s futureperformance will depend in large part on sales of its products through thesedistribution relationships, such as SBC Communications, Verizon and other keypartners. Agreements with distribution partners generally provide for discountsbased on the Company’s list prices, and do not require minimum purchases orrestrict development or distribution of competitive products. Therefore,entities that distribute the Company’s products may compete with the Company.In addition, OEMs, distributors and resellers may not dedicate sufficientresources or give sufficient priority to selling the Company’s products. TheCompany additionally depends on its respective distribution relationships formost customer support, and expends significant resources to train itsrespective OEMs, distributors and resellers to support customers. Theseentities can generally terminate the distribution relationship upon30 days notice. The loss of a distribution relationship or a decline inthe efforts of a material distributor, or loss in business or cancellation oforders from, significant changes in scheduled deliveries to, or decreases inthe prices of products sold to, any of these distribution relationships couldhave a material adverse effect on the Company’s results of operations.

 

*The Companyexpects to rely on a limited number of large customer projects for its revenuein the future. Losing one or more of these customers may adversely affect theCompany’s future revenue.*

 

The Company depends on a limitednumber of large end-user projects for a majority of its revenue, which hasresulted in, and may in the future result in, significant fluctuations inquarterly revenue. The Company expects that revenue from the sale of productsto large resellers and telecommunications service providers will continue toaccount for a significant percentage of its revenue in any particular quarterfor the foreseeable future. Additionally, a significant portion of Company’s salesof video networking products has historically been to government agencies, suchas military and educational institutions, or to third parties using theCompany’s products on behalf of government agencies. Such government customersare often subject to budgetary pressures and may from time to time reduce theirexpenditures and/or cancel orders. The loss of any major customer, or anyreduction or delay in orders by a customer, or the failure of the Company orits distribution partners to market the Company’s products successfully to newcustomers could have a material adverse effect on the Company’s business,financial condition and results of operations.

 

*Because salesof some of the Company’s products require a lengthy sales effort andimplementation cycle, revenue may be unpredictable and the Company’s businessmay be harmed.*

 

Sales of some of the Company’sproducts have required and will continue to require an extended sales effort.For some projects the period from an initial sales call to an end-user agreementcan range from six to twelve months,

 

24

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andcan be longer. Therefore, the timing of revenue booking and recognition may beunpredictable. A lengthy delay in recognizing revenue could have a materialadverse effect on the Company’s business, financial condition and results ofoperations.

 

*Rapidtechnological change and evolving industry standards and regulations may impairthe Company’s ability to develop and market its products and services.*

 

Rapid technological change andevolving industry standards characterize the market for the Company’s productsand services. The Company’s success will depend, in part, on its ability tomaintain technological leadership and enhance and expand its existing productand services offerings. The Company’s success also will depend in part upon itsability and the ability of its strategic partners to comply with evolvingindustry standards. The Company’s products must meet a significant number ofdomestic and international video, voice and data communications regulations andstandards, some of which are evolving as new technologies are deployed. TheCompany’s products are currently in compliance with applicable regulatoryrequirements. However, as standards evolve, the Company will be required tomodify its products, or develop and support new versions of its products. Inaddition, telecommunications service providers require that equipment connectedto their networks comply with their own environment and standards, which mayvary from industry standards.

 

The Company’s ability to competesuccessfully is also dependent upon the continued compatibility andinteroperability of its products with products and architectures offered byother vendors. The Company’s business, financial condition and results ofoperations would be materially adversely affected if it were unable in a timelymanner to comply with evolving industry standards or to address compatibilityissues. In addition, from time to time, the Company may announce new products,capabilities or technologies that have the potential to replace or shorten thelife cycle of the Company’s existing product offerings. The announcement ofproduct enhancements or new product or service offerings could cause customersto defer purchasing the Company’s products. In addition, the Company hasexperienced delays in the introduction of new products in the past and mayexperience such delays in the future. The failure of the Company tosuccessfully introduce new products, product enhancements or services onschedule or in time to meet market opportunities, or customer delays inpurchasing products in anticipation of new product introductions or because ofchanges in industry standards, could have a material adverse effect on the Company’sbusiness, financial condition and results of operations.

 

*The Companyfaces intense competition from other industry participants and may not be ableto compete effectively.*

 

The market for Web conferencingand networking products and services is extremely competitive. Because thebarriers to entry in the market are relatively low and the potential market islarge, the Company expects continued growth in existing competitors and theentrance of new competitors in the future. Many of the Company’s current andpotential competitors have significantly longer operating histories andsignificantly greater managerial, financial, marketing, technical and othercompetitive resources, as well as greater name recognition, than that of theCompany. As a result, these companies may be able to adapt more quickly to newor emerging technologies and changes in customer requirements and may be ableto devote greater resources to the promotion and sale of their competingproducts and services.

 

25

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As a result, the Company may notbe able to compete successfully with existing or new competitors in the richmedia Web conferencing and collaboration solutions market. The Company believesthat its ability to compete successfully in this market will depend on a numberof factors both within and outside its control, including:

 

•                                           the timing of the introduction of new products and services by theCompany and its competitors;

 

•                                           the pricing policies of the Company’s competitors and suppliers;

 

•                                           the Company’s ability to hire and retain highly qualified employees;

 

•                                           continued investment in research and development;

 

•                                           continued investment in sales and marketing; and

 

•                                           the adoption and evolution of industry standards.

 

*The Company’sbusiness may be harmed if it is unable to protect its proprietary rights.*

 

The Company’s success and abilityto compete in the rich media Web conferencing and collaboration solutionsmarket depends, in part, upon its ability to protect its proprietary technology.The Company may be unable to deter misappropriation of its proprietarytechnology, detect unauthorized use, and take appropriate steps to enforce itsintellectual property rights.

 

The Company does not rely onpatent protection for its products, and does not hold any patents, although ithas filed two patent applications relating to systems and methods forcontinuous presence video conferencing and initiation and support of videoconferencing using instant messaging. These patent applications may not beapproved, however, and even if issued by the United States Patent and TrademarkOffice, they may not give the Company an advantage over competitors. TheCompany’s adherence to industry-wide technical standards and specifications maylimit its opportunities to provide proprietary product features. The Companycurrently licenses certain technology from third parties and plans to continueto do so in the future. The commercial success of the Company will depend, inpart, on its ability to continue to obtain licenses to use third-partytechnology in its products.

 

The Company relies upon acombination of trade secret, copyright and trademark laws and contractualrestrictions to establish and protect proprietary rights in its technology. TheCompany also enters into confidentiality and invention assignment agreementswith its employees and enters into non-disclosure agreements with itsconsultants, suppliers, distributors and customers to limit access to anddisclosure of its proprietary information. However, these statutory andcontractual arrangements may not be sufficient to deter misappropriation of theCompany’s proprietary technologies. In addition, independent third parties maydevelop similar or superior technologies to those of the Company. Furthermore,the laws of some foreign countries do not provide the same degree of protectionof the Company’s proprietary information as do the laws of the United States.

 

*Claims bythird parties that the Company infringes their proprietary technology couldprevent the Company from offering its products or otherwise hurt the Company’sbusiness.*

 

The commercial success of theCompany also will depend, in part, on the Company not breaching third-partyintellectual property rights. The Company licenses certain third-partytechnology for use in its products, but is subject to the risk of litigationalleging infringement of other third–party intellectual property rights.A number of companies have developed technologies or received patents ontechnologies that may be related to or be competitive with the Company’stechnologies. The Company has not conducted a patent search relating to thetechnology used in its products. In addition, since patent applications in theUnited States are not publicly disclosed until the patent issues, applicationsmay have been filed, which, if issued as patents, would relate to the Company’sproducts. The

 

26

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Company’s lack of patents may inhibit the Company’sability to negotiate or obtain licenses from or oppose patents of thirdparties, if necessary.

 

The Company could incursubstantial costs in defending itself and its customers against anyintellectual property litigation, regardless of the merits of such claims. TheCompany may also be required by contract or by statutory implied warranties toindemnify its distribution partners and end-users against third–partyinfringement claims. Parties making infringement claims against the Company maybe able to obtain injunctive or other equitable relief which could effectivelyblock the Company’s ability to sell its products in the United States andabroad, and could result in an award of substantial damages. In the event of asuccessful claim of infringement, the Company, its customers and end-users maybe required to obtain one or more licenses from third parties. The Company, orits customers, may not be able to obtain necessary licenses from third partiesat a reasonable cost, or at all. The defense of any lawsuit could result intime-consuming and expensive litigation, damages, license fees, royaltypayments and restrictions on the Company’s ability to sell its products, any ofwhich could have a material adverse effect on the Company’s business, financialcondition, and results of operations.

 

*The Company isdependent on key personnel and must hire and retain skilled personnel.*

 

The Company’s success issignificantly dependent on the contributions of a number of its key personnel.The Company’s success depends to a significant degree on the services of RalphUngermann, its executive chairman of the board of directors, and KillkoCaballero, its chief executive officer and president. The loss of the servicesof either of these individuals or any of the Company’s key personnel could havea material adverse effect on the Company. The Company believes that its futuresuccess also will depend upon its ability to attract and retain additionalhighly skilled technical, managerial, manufacturing, sales and marketingpersonnel. Competition for these personnel is intense. The Company may not beable to anticipate accurately, or to obtain, the personnel that it may requirein the future.

 

*The Company’sreliance on third party manufacturers and suppliers could adversely affect theCompany’s business.*

 

The Company currently outsourcesthe manufacturing of some of its products and purchases critical components forsome of its products from single suppliers. The Company relies on severalvendors to manufacture certain of its products. If one or more of thesemanufacturers experiences quality control or other problems, product shipmentsby the Company may be delayed. The Company does not have long-term agreementswith suppliers, and its current suppliers are not obligated to providecomponents to the Company for any specific period, in any specific quantity orat any specific price, except as may be provided in a particular purchaseorder. Qualifying additional suppliers is a time consuming and expensiveprocess, and there is a greater likelihood of problems arising during atransition period to a new supplier. If the Company is required to findreplacements for its manufacturers or suppliers, this could result inshort-term cost increases and delays in delivery, which could have a materialadverse effect on the Company’s business, financial condition and results ofoperations. The Company may not be able to continue to negotiate arrangementswith its existing, or any future, manufacturers or suppliers on terms favorableto the Company.

 

*The Companyfaces additional risks from its international operations.*

 

The Company’s internationalbusiness involves a number of risks that could adversely affect its operatingresults or contribute to fluctuations in those results. The Company’s revenuefrom international sales represented 32% of its total revenue in the threemonths ended March 31, 2002, 21% of its total revenue in 2001 and 12% of itstotal revenue in 2000. The Company intends to seek opportunities to expand itsproduct and service offerings into additional international markets, although

 

27

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the Company may not succeed in developing localizedversions of its products for new international markets or in marketing ordistributing products and services in those markets.

 

The majority of the Company’sinternational sales are currently denominated in U.S. dollars. However, it ispossible that a significantly higher level of future sales of the Company’sproducts may be denominated in foreign currencies. To the extent that the Company’ssales are denominated in currencies other than U.S. dollars, fluctuations inexchange rates may result in foreign exchange losses. The Company does not haveexperience in implementing hedging techniques that might minimize the Company’srisks from exchange rate fluctuations.

 

                TheCompany’s international business also involves a number of other difficultiesand risks, including risks associated with:

 

•                                           changing economic conditions and political instability in foreigncountries;

 

•                                           export restrictions and export controls relating to the Company’stechnology;

 

•                                           compliance with existing and changing regulatory requirements;

 

•                                           tariffs and other trade barriers;

 

•                                           difficulties in staffing and managing international operations;

 

•                                           longer payment cycles and problems in collecting accounts receivable;

 

•                                           software piracy;

 

•                                           seasonal reductions in business activity in Europe and certain otherparts of the world during the summer months; and

 

•                                           potentially adverse tax consequences.

 

*The Company’ssoftware products may contain undetected defects.*

 

Software developed by the Companyor developed by others and incorporated by the Company into its products maycontain significant undetected errors, especially when first released or as newversions are released. Although the Company’s software products are testedbefore commercial release, errors in the products may be found after customersbegin to use the software. Any defects in the Company’s current or futureproducts may result in significant decreases in revenue or increases inexpenses because of adverse publicity, reduced orders, product returns,uncollectible accounts receivable, delays in collecting accounts receivable,and additional and unexpected costs of further product development to correctthe defects.

 

*Control By Insiders*

 

As of April 15, 2002, theCompany’s executive officers, directors and their affiliates beneficially ownedapproximately 10,424,812 shares or 22.6% of the outstanding shares of theCompany’s outstanding common stock, on an as-converted to common stock basis.As a result, these persons may have the ability to effectively control theCompany and direct its affairs and business, including the election ofdirectors and approval of significant corporate transactions. Thisconcentration of ownership may also have the effect of delaying, deferring orpreventing a change in control of the Company, and making certain transactionsmore difficult or impossible absent the support of these stockholders,including proxy contests, mergers involving the Company, tender offers,open-market purchase programs or other purchases of common stock that couldgive stockholders of the Company the opportunity to realize a premium over thethen prevailing market price for shares of common stock.

 

Item 3. Quantitative and Qualitative Disclosures aboutMarket Risk

 

The Company’s market riskexposures as set forth in its Annual Report on Form 10-K/A for the yearended December 31, 2001, have not materially changed.

 

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PART II. OTHER INFORMATION

 

Item 1.

 

LegalProceedings

 

On or about April 9, 1999,several purported class action suits were filed in the United States DistrictCourt for the Northern District of California alleging violations of thefederal securities laws against the Company and certain of its officers anddirectors in connection with the Company’s reporting of its financial resultsfor the period ended December 31, 1998. The court dismissed these actionswithout leave to amend on February 14, 2000 and the plaintiffs appealedthe dismissal to the U.S. Court of Appeals for the Ninth Circuit. The appealwas taken under submission by the court of Appeals following the filing ofbriefs by the parties and the presentation of oral argument on July 11,2001. On March 15, 2002, the Court of Appeals affirmed the districtcourt’s judgment, dismissing the complaint without leave to amend. OnMarch 28, 2002, plaintiffs filed a Petition for Rehearing in the NinthCircuit. On April 5, 2002, the Ninth Circuit denied the plaintiffs' Petitionfor Rehearing.

 

On April 23, 2001, theCompany received notice of a stockholder’s derivative action filed inCalifornia Superior Court in the County of Santa Clara, alleging that, amongother things, certain directors and officers of the Company sold shares of theCompany’s common stock between January 21, 1999 and April 6, 1999,while in possession of material non-public information pertaining to theCompany. The Company and the individual defendants demurred to the complaint,and moved to dismiss the action, or in the alternative to stay the actionpending the outcome of the appeal in the related federal court class action or,if necessary, the investigation of the claims by the Company. The court grantedthe demurrer in part and denied it in part, granting plaintiff leave to file anamended complaint, and stayed the action pending the outcome of the appeal inthe federal court class action. The court also ordered that certain limiteddiscovery of documents could take place with respect to the filing of theamended complaint. In December 2001, the plaintiff moved for leave to takecertain third–party discovery. The motion was denied by the court.Plaintiff filed an amended complaint on February 22, 2002. A hearing onthe defendants’ demurrer to the amended complaint is scheduled to take place onMay 21, 2002. The parties have tentatively agreed to a continuance of thehearing in order to permit them to engage in settlement discussions with athird-party mediator.

 

On April 25, 2002, the Companywas informed by the staff of the SEC that the staff intends to recommend thatthe SEC commence an enforcement action against the Company, Ralph Ungermann andtwo former officers of the Company in connection with the Company’s January1999 announcement of unaudited financial results for the quarter and year endedDecember 31, 1998, which were revised by the Company prior to the release ofthe Company’s Form 10-K in April 1999. The staff indicated that the basis for such an action would beallegations that the January 1999 announcement was misleading and/or the resultof inadequate financial controls.  Thestaff did not state what remedies it would seek in such an action, but notedthat the remedies it might seek could include an injunction against futureviolations, disgorgement, civil penalties and an officer and director baragainst the individuals.  The Companyexpresses no opinion as to the likely outcome of this matter.  While no assurances can be provided, theCompany does not believe that the investigation will have a material adverseeffect on its business, financial condition or results of operations. However,our evaluation of the likely impact of these actions could change in the futureand an unfavorable outcome, depending upon the amount and timing, could have amaterial effect on our results of operations or cash flows of a future period.

 

Item 2:  Changes in Securities

 

On March 29, 2002, theCompany entered into a purchase agreement with certain investors pursuant towhich the Company agreed to issue and sell an aggregate of 6,686,000 shares ofCommon Stock at a per share purchase price of $0.72, the closing bid price ofthe Common Stock as traded on The Nasdaq National Market ("Nasdaq")on the date immediately prior to the date the parties signed the purchaseagreement for the transaction, to the following investors: (i) SpecialSituations Fund III, L.P.; (ii) Special Situations Cayman Fund, L.P.; (iii)Special Situations Technology Fund, L.P.; (iv) Stratford Partners, L.P.; (v)Ralph Ungermann; (vi) Norman Gaut; (vii) Net One Systems Co., LTD; and (vii)Shigeru Ota. In addition, the Company agreed to issue warrants to the investorsto purchase up to 3,343,001 shares of Common Stock exercisable at any time onor after October 12, 2002 at an exercise price of $1.01 per share (a 40%premium to the fair market value as determined by the Nasdaq rules). Theclosing occured on April 12, 2002, pursuant to which the Company issued theCommon Stock and warrants for aggregate cash proceeds of $4,813,290. Pursuantto a registration rights agreement, the Company filed a Form S-3 registrationstatement (File No. 333-88058) with the SEC on May 10, 2002 covering the resaleof the shares of its Common Stock issued and the Common Stock issuable uponexercise of warrants in the private placement.

 

The parties intended theprivate placement to be exempt from registration and prospectus deliveryrequirements under the Securities Act of 1933, as amended (the"Act"), pursuant to Section 4(2) of the Act and Regulation Dpromulgated thereunder. Each of the investors represented that it is anaccredited investor and its intention was to acquire the securities forinvestment only and not with a view to distribution thereof. An appropriatelegend was affixed to each Common Stock certificate and warrant. Each investorwas knowledgeable, sophisticated and experienced in making investment decisionsof this kind and received adequate information about the Company or hadadequate access, through its business relationships with the Company, toinformation about the Company.

 

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Item 6.

 

Exhibitsand Reports on Form 8-K.

 

(a)                                          Exhibits

 
| **Exhibit  Number** |   | **Description**                                                                                                                                                                                  |   |
|---------------------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
|                |   |                                                                                                                                                                                             |   |
| 3.1                 |   | Amended and Restated Certificate of Incorporation (1)                                                                                                                                            |   |
| 3.1(i)              |   | Certificate of Ownership and Merger, effective August  3, 1998 (2)                                                                                                                               |   |
| 3.1(ii)             |   | Certificate of Designation of Series A Convertible  Preferred Stock (3)                                                                                                                          |   |
| 3.1(iii)            |   | Certificate of Ownership and Merger, effective February  5, 2001 (4)                                                                                                                             |   |
| 3.1(iv)             |   | Certificate of Amendment of Restated Certificate of  Incorporation filed on June 19, 2001 (4)                                                                                                    |   |
| 3.2                 |   | Amended Bylaws of the Company (5) (Exhibit 3.3)                                                                                                                                                  |   |
| 4.1                 |   | Specimen Common Stock Certificate (6)                                                                                                                                                            |   |
| 4.2                 |   | Specimen Series A Convertible Preferred Stock  Certificate (3)                                                                                                                                   |   |
| 4.3                 |   | Warrant to purchase 2,614,377 shares of the Company’s  Common Stock, dated May 7, 2001 issued by the Company to PictureTel  Corporation (7)                                                 |   |
| 4.4                 |   | Warrant to purchase 850,000 shares of the Company’s  Common Stock, dated June 8, 2000 issued by the Company to Vulcan Ventures  Incorporated (5) (Exhibit 10.5)                             |   |
| 4.5                 |   | Warrant to purchase 18,750 shares of the Company’s  Common Stock, dated April 11, 1997 issued by the Company to Silicon Valley  Bank (1) (Exhibit 10.18)                                    |   |
| 4.6                 |   | Warrant to purchase the Company's Common Stock, dated  April 12, 2002, issued by the Company to the purchasers and in the amounts as  set forth on Schedule A attached thereto (8) (Exhibit 4.3) |   |
| 10.1                |   | Employment and Non-Competition Agreement, dated March  22, 2001, between the Company and Killko Caballero (9) (Exhibit 10.40)                                                                    |   |
| 10.2                |   | Offer Letter, dated January 7, 2002 between the Company  and Timothy Rogers.                                                                                                                     |   |
| 10.3                |   | Letter Agreement, dated January 7, 2002 between the  Company and Randy Acres.                                                                                                                    |   |
| 10.4                |   | Letter Agreement, dated January 7, 2002 between the Company  and Raymond Cavanaugh.                                                                                                              |   |
| 10.5                |   | Release and Waiver, dated March 12, 2002 between the  Company and James Griffin.                                                                                                                 |   |
| 10.6                |   | Letter Agreement, dated March 20, 2002 between the  Company and Robert Scott.                                                                                                                    |   |
| 10.7                |   | Purchase Agreement, dated as of March 29, 2002, by and  among the Company and each of the purchasers listed therein (8) (Exhibit 4.1)                                                            |   |
| 10.8                |   | Registration Rights Agreement, dated April 12, 2002, by  and among the Company and each of the purchasers listed therein (8) (Exhibit  4.2)                                                      |   |
| 10.9                |   | Amended and Restated Promissory Note and related  Security Agreement executed by Killko Caballero in favor of the Company.                                                                       |   |

 

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(1)                                  Incorporated by reference to the corresponding or indicated exhibit tothe Company’s Registration Statement on Form S-1 (File No. 333-38755), asfiled on October 24, 1997.

 

(2)                                  Incorporated by reference to the corresponding or indicated exhibit tothe Company’s Quarterly Report on Form 10-Q for the period ended June 30, 1998,as filed on August 11, 1998 (File No. 000-23305).

 

(3)                Incorporated by reference tothe corresponding or indicated exhibit to the Company’s Quarterly Report onForm 10-Q for the period ended June 30, 2000, as filed on August 14, 2000 (FileNo. 333-72533).

 

(4)                Incorporated by reference tothe corresponding or indicated exhibit to the Company’s Quarterly Report onForm 10-Q for the period ended June 30, 2001, as filed on August 15, 2001 (FileNo. 000-23305).

 

(5)                Incorporated by reference tothe corresponding or indicated exhibit to the Company’s Annual Report on Form10-K 405/A for the period ended December 31, 1999, as filed on April 15, 2000(File No. 333-72533).

 

(6)                Incorporated by reference tothe corresponding or indicated exhibit to the Company’s Registration Statementon Form S-1/A (File No. 333-38755), as filed on December 4, 1997.

 

(7)                Incorporated by reference tothe corresponding or indicated exhibit to the Company’s Quarterly Report onForm 10-Q for the period ended September 30, 2001, as filed on November 14,2001 (File No. 000-23305).

 

(8)                Incorporated by reference to the corresponding orindicated exhibit to the Company's Registration Statement on Form S-3 (File No.333-88058), as filed on May 10, 2002.

 

(9)                Incorporated by reference to the corresponding orindicated exhibit to the Company's Registration Statement on Form S-4 (File No.333-59480), as filed on April 25, 2001.

 

(b)           Reportson Form 8-K.

 

None.

 

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**SIGNATURES**

 

Pursuant to the requirements of the SecuritiesExchange Act of 1934, as amended, the registrant has duly caused this report tobe signed on its behalf by the undersigned thereunto duly authorized.

 
| Date: May 15, 2001 | **FIRST  VIRTUAL COMMUNICATIONS, INC.** |
|--------------------|-----------------------------------------|
|               |                                    |
|               | By:                                     | /s/ Timothy A. Rogers |   |
|               |                                    | Timothy A. Rogers |
|               |                                    | Chief Financial Officer and Senior Vice President |
|               |                                    | (Duly Authorized Officer and Principal Financial and  Accounting Officer) |

 

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**Exhibit Index**

 
| **Exhibit  Number** |   | **Description**                                                                                                                                                                                  |   |
|---------------------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
|                |   |                                                                                                                                                                                             |   |
| 3.1                 |   | Amended and Restated Certificate of Incorporation (1)                                                                                                                                            |   |
| 3.1(i)              |   | Certificate of Ownership and Merger, effective August  3, 1998 (2)                                                                                                                               |   |
| 3.1(ii)             |   | Certificate of Designation of Series A Convertible  Preferred Stock (3)                                                                                                                          |   |
| 3.1(iii)            |   | Certificate of Ownership and Merger, effective February  5, 2001 (4)                                                                                                                             |   |
| 3.1(iv)             |   | Certificate of Amendment of Restated Certificate of  Incorporation filed on June 19, 2001 (4)                                                                                                    |   |
| 3.2                 |   | Amended Bylaws of the Company (5) (Exhibit 3.3)                                                                                                                                                  |   |
| 4.1                 |   | Specimen Common Stock Certificate (6)                                                                                                                                                            |   |
| 4.2                 |   | Specimen Series A Convertible Preferred Stock  Certificate (3)                                                                                                                                   |   |
| 4.3                 |   | Warrant to purchase 2,614,377 shares of the Company’s  Common Stock, dated May 7, 2001 issued by the Company to PictureTel  Corporation (7)                                                 |   |
| 4.4                 |   | Warrant to purchase 850,000 shares of the Company’s  Common Stock, dated June 8, 2000 issued by the Company to Vulcan Ventures  Incorporated (5) (Exhibit 10.5)                             |   |
| 4.5                 |   | Warrant to purchase 18,750 shares of the Company’s  Common Stock, dated April 11, 1997 issued by the Company to Silicon Valley  Bank (1) (Exhibit 10.18)                                    |   |
| 4.6                 |   | Warrant to purchase the Company's Common Stock, dated  April 12, 2002, issued by the Company to the purchasers and in the amounts as  set forth on Schedule A attached thereto (8) (Exhibit 4.3) |   |
| 10.1                |   | Employment and Non-Competition Agreement, dated March  22, 2001, between the Company and Killko Caballero (9) (Exhibit 10.40)                                                                    |   |
| 10.2                |   | Offer Letter, dated January 7, 2002 between the Company  and Timothy Rogers.                                                                                                                     |   |
| 10.3                |   | Letter Agreement, dated January 7, 2002 between the  Company and Randy Acres.                                                                                                                    |   |
| 10.4                |   | Letter Agreement, dated January 7, 2002 between the  Company and Raymond Cavanaugh.                                                                                                              |   |
| 10.5                |   | Release and Waiver, dated March 12, 2002 between the  Company and James Griffin.                                                                                                                 |   |
| 10.6                |   | Letter Agreement, dated March 20, 2002 between the  Company and Robert Scott.                                                                                                                    |   |
| 10.7                |   | Purchase Agreement, dated as of March 29, 2002, by and  among the Company and each of the purchasers listed therein (8) (Exhibit 4.1)                                                            |   |
| 10.8                |   | Registration Rights Agreement, dated April 12, 2002, by  and among the Company and each of the purchasers listed therein (8) (Exhibit  4.2)                                                      |   |
| 10.9                |   | Amended and Restated Promissory Note and related  Security Agreement executed by Killko Caballero in favor of the Company.                                                                       |   |

 

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(1)                Incorporated by reference tothe corresponding or indicated exhibit to the Company’s Registration Statementon Form S-1 (File No. 333-38755), as filed on October 24, 1997.

 

(2)                Incorporated by reference tothe corresponding or indicated exhibit to the Company’s Quarterly Report onForm 10-Q for the period ended June 30, 1998, as filed on August 11, 1998 (FileNo. 000-23305).

 

(3)                Incorporated by reference tothe corresponding or indicated exhibit to the Company’s Quarterly Report onForm 10-Q for the period ended June 30, 2000, as filed on August 14, 2000 (FileNo. 333-72533).

 

(4)                Incorporated by reference tothe corresponding or indicated exhibit to the Company’s Quarterly Report onForm 10-Q for the period ended June 30, 2001, as filed on August 15, 2001 (FileNo. 000-23305).

 

(5)                Incorporated by reference tothe corresponding or indicated exhibit to the Company’s Annual Report on Form10-K 405/A for the period ended December 31, 1999, as filed on April 15, 2000(File No. 333-72533).

 

(6)                Incorporated by reference tothe corresponding or indicated exhibit to the Company’s Registration Statementon Form S-1/A (File No. 333-38755), as filed on December 4, 1997.

 

(7)                Incorporated by reference to thecorresponding or indicated exhibit to the Company’s Quarterly Report on Form10-Q for the period ended September 30, 2001, as filed on November 14, 2001(File No. 000-23305).

 

(8)                Incorporated by reference to the corresponding orindicated exhibit to the Company's Registration Statement on Form S-3 (File No.333-88058), as filed on May 10, 2002.

 

(9)                Incorporated by reference to the corresponding orindicated exhibit to the Company's Registration Statement on Form S-4 (File No.333-59480), as filed on April 25, 2001.

 

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