1 FORM 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 (MARK ONE) [ x ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 28, 1997 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period ___________ to ____________. Commission File Number 0-19175 PROTEON, INC. (Exact name of registrant as specified in its charter) Massachusetts 04-2531856 (State or other jurisdiction of incorporation (IRS Employer Identification Number) or organization) Nine Technology Drive, Westborough, MA 01581 (Address of principal executive offices) Registrant's telephone number, including area code: (508) 898-2800 Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such report(s), and (2) has been subject to such filing requirements for the past 90 days. - -------------------------------- ----------------------------------- YES X NO - -------------------------------- ----------------------------------- Indicate the number of shares outstanding of each of the Issuer's classes of common stock as of August 1, 1997 Common Stock, $0.01 par value 15,307,089 (Title of each class) (Number of shares) 2 PROTEON, INC. Form 10-Q QUARTERLY REPORT June 28, 1997 Table of Contents Part I Financial Information Item 1. Consolidated Balance Sheets as of June 28, 1997 and December 31, 1996 Consolidated Statements of Operations for the three and six months ended June 28, 1997 and June 29, 1996 Consolidated Statements of Cash Flows for the six months ended June 28, 1997 and June 29, 1996 Notes to the Consolidated Financial Statements Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Part II. Other Information Item 1. Legal Proceedings Item 2. Changes in Securities Item 3. Defaults Upon Senior Securities Item 4. Submission of Matters to a Vote of Security Holders Item 5. Other Information Item 6. Exhibits and Reports on Form 8-K 3 Proteon, Inc. Consolidated Balance Sheets (in thousands) ASSETS June 28, December 31, 1997 1996 (unaudited) ----------- ------------ Current assets: Cash and cash equivalents $ 10,546 $ 16,612 Marketable securities 8,189 6,918 Accounts receivable, net 10,521 7,625 Inventories 6,014 8,737 Deposits and other assets 1,113 1,085 -------- -------- Total current assets 36,383 40,977 Property and equipment, net 3,987 4,594 -------- -------- Total assets $ 40,370 $ 45,571 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable $ 2,465 $ 3,010 Accrued compensation 593 1,075 Accrued expenses 2,487 3,560 Accrued restructuring cost 552 1,661 Accrued warranty 957 1,074 -------- -------- Total current liabilities 7,054 10,380 Stockholders' equity: Preferred stock - - Common stock 156 156 Capital in excess of par value 49,295 49,292 Accumulated deficit (15,265) (13,819) Accumulated translation adjustments 129 177 Less treasury stock, at cost (999) (615) -------- -------- Total stockholders' equity 33,316 35,191 -------- -------- Total liabilities and stockholders' equity $ 40,370 $ 45,571 ======== ======== The accompanying notes are an integral part of the consolidated financial statements. 4 Proteon, Inc. Consolidated Statements of Operations for the three and six months ended (in thousands, except per share data) (unaudited) Three months ended Six months ended June 28, June 29, June 28, June 29, 1997 1996 1997 1996 -------- -------- -------- -------- Sales: Product $ 6,442 $ 7,759 $14,034 $18,056 Software licensing 248 1,499 756 3,682 Service and other 1,058 1,388 2,083 2,926 ------- ------- ------- ------- Net sales 7,748 10,646 16,873 24,664 Cost of sales: Product 3,414 4,599 7,696 10,284 Software licensing - 14 - 94 Service and other 586 1,101 1,173 2,123 ------- ------- ------- ------- Cost of sales 4,000 5,714 8,869 12,501 Gross profit 3,748 4,932 8,004 12,163 Operating expenses: Research and development 1,469 2,361 3,046 5,030 Selling and marketing 2,881 4,093 5,468 7,857 General and administrative 794 1,102 1,378 2,218 ------- ------- ------- ------- Total operating expenses 5,144 7,556 9,892 15,105 ------- ------- ------- ------- (Loss) from operations (1,396) (2,624) (1,888) (2,942) Interest income, net 268 279 519 738 ------- ------- ------- ------- (Loss) before income taxes (1,128) (2,345) (1,369) (2,204) Provision for income taxes 5 - 77 - ------- ------- ------- ------- Net loss $(1,133) $(2,345) $(1,446) $(2,204) ======= ======= ======= ======= Net loss per common and common equivalent share $ (0.07) $ (0.15) $ (0.09) $ (0.14) ======= ======= ======= ======= Weighted average number of common and common equivalent shares outstanding 15,267 15,515 15,355 15,514 ======= ======= ======= ======= The accompanying notes are an integral part of the consolidated financial statements. 5 Proteon, Inc. Consolidated Statements of Cash Flows for the six months ended (in thousands, unaudited) June 28, June 29, 1997 1996 -------- -------- Cash flows from operating activities: Cash received from customers $ 13,977 $ 30,185 Cash paid to suppliers and employees (18,564) (35,483) Interest received 486 745 Interest paid - (7) Income taxes paid (21) (317) -------- -------- Net cash (consumed) by operating activities (4,122) (4,877) Cash flows from investing activities: Proceeds from the sale of fixed assets 48 114 Capital expenditures (291) (1,127) Marketable security sales 5,411 7,863 Marketable security purchases (6,683) (8,621) -------- -------- Net cash (used in) provided by investing activities (1,515) (1,771) Cash flows from financing activities: Proceeds from the issuance of common stock 3 79 Purchase of treasury stock (385) - -------- -------- Net cash (used in) financing activities (382) 79 Effects of exchange rate changes on cash (47) 23 -------- -------- Net decrease in cash and cash equivalents (6,066) (6,546) Cash and cash equivalents at the beginning of year 16,612 25,829 -------- -------- Cash and cash equivalents at the end of the period $ 10,546 $ 19,283 ======== ======== Reconciliation of net income to net cash (consumed) by operating activities: Net (loss) income $ (1,446) $ (2,204) -------- -------- Adjustments to reconcile net loss to net cash (consumed) by operating activities: Depreciation and amortization 878 1,680 gain on disposition of assets (27) (105) Changes in assets and liabilities: (Increase) decrease in accounts receivable (2,896) 5,522 Decrease (increase) in inventories 2,723 (7,166) (Increase) in deposits and other assets (28) (480) (Decrease) increase in payables and accrued expenses (3,326) (2,124) -------- -------- Total adjustments (2,676) (2,673) -------- -------- Net cash (consumed) generated by operating activities $ (4,122) $ (4,877) ======== ======== The accompanying notes are an integral part of the consolidated financial statements. 6 PROTEON, INC. Notes to Consolidated Financial Statements, unaudited Management's Opinion: In the opinion of the management of Proteon, Inc. (the "Company"), the Company's consolidated financial position as of June 28, 1997 and the results of its consolidated operations and consolidated cash flows for the interim periods ended June 28, 1997 and June 29, 1996, reflect all adjustments (consisting of only normal recurring adjustments) necessary to present fairly the results for the interim periods presented. It is suggested that these statements be read in conjunction with the Company's consolidated financial statements and notes thereto for the year ended December 31, 1996, included in the Company's 1996 Annual Report to Shareholders. Inventories: Inventories are stated at the lower of cost or market, with cost determined under the first-in, first-out method. - --------------------------------------------------------------------------- (in thousands) June 28, 1997 December 31, 1996 - --------------------------------------------------------------------------- Raw materials $ 983 $1,373 Work in progress 546 718 Finished goods 4,485 6,646 - --------------------------------------------------------------------------- Total Inventories $6,014 $8,737 - --------------------------------------------------------------------------- Net Income (Loss) Per Common and Common Equivalent Share: Net income (loss) per share is computed based on the weighted average number of common share and common share equivalents outstanding during the period. Common share equivalents are determined under the assumption that outstanding stock options are exercised and the proceeds are used to purchase treasury stock. No common share equivalents are included in the 1997 and 1996 calculations as their effect would be antidilutive. Newly Issued Accounting Standards In February 1997, the Financial Accounting Standards Board issued Statements of Financial Accounting Standards (FAS) No. 128," Earnings per Share" and No. 129, "Disclosure of Information About Capital Structure." FAS 128 modifies the way in which earnings per share is calculated and disclosed. FAS 128 requires a presentation of basic and diluted earnings per share for all years presented in the Income Statement. The FASB recently issued Statement No. 130 ("SFAS 130") "Reporting Comprehensive Income." This Statement requires changes in comprehensive income to be shown in a financial statement that is displayed with the same prominence as other financial statements. While not mandating a specific financial statement format, the Statement requires that an amount representing total comprehensive income be reported. The Statement will become effective for fiscal years beginning after December 15, 1997. Reclassification of financial statements for earlier periods is required for comparative purposes. The Company does not believe that the adoption of SFAS 130 will have a material impact on result of operations. The FASB also issued Statement No. 131 ("SFAS 131"), "Disclosures about Segments of an Enterprise and Related Information". This Statement, which supersedes Statement No. 14 "Financial Reporting for Segments of a Business Enterprise," changes the way public companies report information about segments. The Statement, which is based on the management approach to segment reporting, includes requirements to report segment information quarterly and entity-wide disclosures about products and services, major customers, and the material countries in which the entity holds assets and reports revenues. The Statement is effective for periods beginning after December 15, 1997. Restatement for earlier years is required for comparative purposes unless impracticable. In addition, SFAS 131 need not be applied to interim periods in the initial year; however, in subsequent years, interim period information must be presented on a comparative basis. The Company is currently evaluating this Statement and its effect on financial statement disclosures. 7 PROTEON, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Results of Operations Net Sales Net sales for the quarter ended June 28, 1997, were $7,748,000 as compared with $10,646,000 for the quarter ended June 29, 1996, a decrease of $2,898,000, or 27.2%. For the first six months of 1997, net sales were $16,873,000 as compared with $24,664,000 for the same period in 1996, a decrease of $7,791,000, or 31.6%. Product sales for the quarter ended June 28, 1997, were $6,442,000 as compared with $7,759,000 for the quarter ended June 29, 1996, a decrease of $1,317,000, or 17.0%. For the first six months of 1997 product sales were $14,034,000 as compared with $18,056,000 for the same period in 1996, a decrease of $4,022,000 or 22.3%. The Company's product sales are categorized as either Remote Access or Local Area Network (LAN). Overall product sales results reflect Proteon's ongoing product transition from LAN products to Remote Access products. Overall product revenue was down from a year ago for the quarter and for the six months ended June 28, 1997, due to anticipated decreases in both the LAN products and CNX Router categories. For the quarter and for the six months ended June 28, 1997, the decreases in LAN products net sales were due primarily to lower average selling prices and declining unit volumes of Adapter Cards, Switches and Hubs. The reductions in sales of CNX products were due to planned reductions in CNX backbone Router units as the company shifts to remote access Routers. Although sales of units in the Remote Access Product category increased 89.0% for the second quarter of 1997 as compared to the second quarter of 1996, and 94.3% for the first six months of 1997 as compared to the first six months of 1996, primarily due to increases in GlobeTrotter sales, these increased volumes were not enough to offset the anticipated product revenue declines in the LAN products and Corporate Enterprise categories. Software licensing revenue for the quarter ended June 28, 1997, was $248,000 compared to $1,499,000 for the quarter ended June 29, 1996, a decrease of $1,251,000, or 83.5%. For the first six months of 1997, software licensing revenues were $756,000 as compared with $3,682,000 for the same period in 1996, a decrease of $2,926,000 or 79.5%. This anticipated reduction in software licensing revenue is a result of the completion of two major, multi-year agreements 8 with IBM and Digital Equipment Corporation during 1996. The Company expects that in future quarters software licensing revenue will continue to decrease in total. For the quarter ended June 28, 1997, service and other revenues decreased by $330,000 or 23.8%, to $1,058,000, as compared to $1,388,000 for the quarter ended June 29, 1996. For the first six months of 1997, service and other revenues were $2,083,000 as compared with $2,926,000 for the same period in 1996, a decrease of $843,000 or 28.8%. These decreases were primarily due to the reduction in upgrades revenue worldwide, which are included in CNX Router revenues. Gross Profit Total gross profit increased as a percentage of net sales to 48.4% for the quarter ended June 28, 1997, from 46.3% for the quarter ended June 29, 1996. This change was the result of increased unit sales and gross margin in the GlobeTrotter product line partially offset by the overall decline in software licensing revenues. For the first six months of 1997, total gross profit decreased as a percentage of net sales to 47.4% from 49.3% for the same period in 1996. This decrease was the result of the overall decline in highly profitable software licensing revenues partially offset by increased unit sales and gross margin in the GlobeTrotter product line. The Company's product gross profit for the quarter ended June 28, 1997 increased to 47.0% from 40.7% when compared to the same period in the prior year, and for the six month period ended June 28, 1997, product gross profit was 45.2%, an increase from 43.0% for the same period in 1996. These increases were due primarily to increased unit sales and gross margin in the GlobeTrotter product line as stated above. For the quarter ended June 28, 1997, gross profit from service and other sales increased to 44.6% from 20.7% a year ago and for the six months ended June 28, 1997, gross profit from service and other sales increased to 43.7% from 27.4%. These increases were mainly due to reduced fixed costs associated with these software licensing revenues. Research and Development Research and development expenses were $1,469,000 or 19.0% of net sales for the quarter ended June 28, 1997, compared to $2,361,000 or 22.2% of net sales for the same period in the prior year. The decrease in expenses of $892,000 or 37.8% was primarily due to lower personnel and personnel related costs. For the first six months of 1997, research and development expenses were $3,046,000 or 18.1% of net sales compared to $5,030,000 or 20.4% of net sales for the first half of 1996. The decrease of $1,984,000 or 39.4% was due primarily to the same factors stated above. The Company considers investments in research and development to be critical to future revenues and intends to focus these expenditures on Remote Access products. Selling and Marketing Selling and marketing expenses were $2,881,000 or 37.2% of net sales for the quarter ended June 28, 1997, compared to $4,093,000 or 38.4% of net sales for the quarter ended June 29, 1996, a 9 decrease of $1,212,000, or 29.6%. This decrease was primarily the result of lower personnel and personnel related costs partially offset by an increase in marketing and promotional spending. For the first six months of 1997, selling and marketing expenses were $5,468,000 or 32.4% of net sales, as compared to $7,857,000 or 31.9% of net sales for the same period in the prior year. This decrease in expenses of $2,389,000 or 30.4% also reflects the reduction in personnel and personnel related costs partially offset by the increase in marketing spending. General and Administrative General and administrative expenses were $794,000, or 10.2% of net sales for the quarter ended June 28, 1997, compared to $1,102,000 or 10.4% of net sales for the quarter ended June 29, 1996, a decrease of $308,000, or 28.0%. This decrease was due primarily to lower personnel and personnel related costs. For the six months ended June 28, 1997, general and administrative expenses were $1,378,000 or 8.2% of net sales, compared to $2,218,000 or 9.0% of sales for the same period in 1996. The decrease of $840,000 or 37.9% was due to the same factors stated above. Provision for Income Taxes For the quarter ended June 28, 1997, the Company increased its income tax provision by $5,000, bringing the 1997 year to date provision to $77,000. This is a result of anticipated state income taxes and tax liabilities in its foreign subsidiaries. Liquidity and Capital Resources During the first six months of 1997, the Company consumed $4,122,000 of cash from operating activities. This cash consumption was due to a decrease in accounts payable and accrued expenses totaling $3,326,000, plus an increase in accounts receivable of $2,896,000. These were partially offset by a reduction in inventory of $2,723,000. During the quarter ended June 28, 1997, the cash impact from the Company's 1996 restructuring was $320,000. For the six months ended June 28, 1997, the cash impact from this restructuring has been $1,109,000. The Company anticipates that the remaining accrual of $552,000 as of June 28, 1997, will be paid during 1997. Investing activities for the six months ended June 28, 1997, consumed $1,515,000 due principally to the net purchase of marketable securities. Financing activities consumed $382,000 due principally to the repurchase of treasury common stock. The Company's management believes that its cash, cash equivalents and marketable securities will satisfy its expected working capital and capital expenditure requirements through the next twelve months. 10 Safe Harbor for Forward-Looking Statements This Form 10-Q filing contains forward-looking statements within the meaning of the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995. These forward looking statements are based on management's current expectations and involve a number of risks and uncertainties. The Company's future results remain difficult to predict and may be affected by the factors described below. RISK FACTORS Technological Change, New Products and Industry Standards The data communications industry continues to undergo a fundamental shift away from hierarchical single-vendor systems to open, peer-to-peer communications networks and information management tools that provide users with greater computing power and access to information. This evolution has fostered the growth of two dynamic markets: workstations and networking. Workstations deliver increasingly powerful, personal productivity tools, and data communications networks provide the "highways" that distribute and share this processing power throughout an organization, enabling users to more fully leverage and manage information resources. 11 As the deployment of networks matures, four recent trends continue to develop: networking of remote sites to the headquarters office via remote access routers; reduction of network congestion with the implementation of local area networks (LAN's); segmentation using various switching technologies; and the push by businesses of all sizes and individuals to connect their systems and networks to the Internet. Proteon is positioning itself as a company focused on the network access market. Proteon views the network access market as having two segments -- remote access and local access. Its current strategy is based upon concentration on the remote access market segment. The market for the Company's products is characterized by rapidly changing technology, new product introductions and a multiplicity of current and evolving industry standards. Accordingly, the Company believes that its future success will depend on its continuing ability to enhance and expand its existing products and to develop or private label other manufacturer's technology and introduce in a timely fashion new products which incorporate new technologies, conform to standards and achieve market acceptance. There can be no assurance that the Company's strategy is the correct one under the circumstances; that the Company has correctly assessed trends in the marketplace; that the Company will be able to develop, market or support, or secure external supplies of, such products successfully; or that the Company will be able to respond effectively to technological changes, new product announcements by others or new industry standards. Manufacturing and Supply; Dependence on Suppliers The Company's manufacturing operations primarily consist of assembly, testing and quality control of materials, components, subassemblies, and systems. SCI Systems, a major subcontract manufacturer with access to cost-effective, high volume manufacturing, distribution, and repair capability worldwide, and others manufacture the majority of Proteon's board assemblies for its router, hub, and adapter card product lines. The Token Ring chipsets used in the Company's 4/16 Mbps and 4 Mbps adapters are currently manufactured for external sale solely by Texas Instruments. The Company has an agreement with Texas Instruments under which it believes it will be able to obtain adequate supplies of these chipsets in a timely manner to meet customer demand. Certain logic semiconductors, signal processors, and subassembly components used in the Company's products are also available only from limited sources. The Company has not experienced any significant problems in obtaining required supplies of such limited source components and believes that alternative sources could be developed quickly, if necessary. Proteon continues to have OEM arrangements with manufacturers for some of its Ethernet product offerings. In most cases, if supplies from one vendor were interrupted or reduced, the 12 Company could find a comparable source for the affected product with limited delays in shipment. The inability to obtain sufficient sole or limited source components as required, or to develop alternative sources if and as required in the future, could result in delays or reductions in product shipments which would adversely affect the Company's operating results. There can be no assurance that, in the event of interruptions in contract manufacturing, supplies of components from sole or limited sources or supplies of units from OEM vendors or similar occurrences, the Company could find and engage suitable alternatives in a timely manner. Such interruptions or the inability of Proteon to counteract them successfully could have an adverse effect on the Company's business, operations and finances. Intellectual Property Currently, Proteon relies principally upon a combination of contractual rights, trade secrets, and copyright laws to establish and protect proprietary aspects of its products. The Company believes that, because of the rapid pace of technological change in the data communications and computer industries, legal protection for its products is a less significant factor in the Company's success than the knowledge, ability, and experience of the Company's employees, the frequency of product enhancements and the timeliness and quality of support services provided by the Company. However, should a successful challenge be mounted against the rights of Proteon in and to its intellectual property, by allegations of infringement on the rights of others or for any other reason, the Company's business, operations and finances could be adversely affected. Certain technology used in the Company's products is licensed by the Company from third parties. The termination of certain of these licenses would have a material adverse effect on the Company's operations. Product Compatibility and Competition Network Interface Card Products The market for Token Ring network interface card products is dominated by IBM. While Token Ring networking is an industry standard, Proteon believes that its ability to address successfully the market for Token Ring network products is dependent upon the compatibility and interoperability of the Company's products with products offered by IBM and upon maintaining compatibility with the Token Ring standard as it continues to evolve. Remote Access (Routers) Proteon expects to participate significantly in the market segment of remote access routing specifically addressing the needs of users to connect to the Internet or build corporate intranets. The Company has enhanced its remote access capabilities with the introduction of new products and expanded its presence in the Integrated Services Digital Networks (ISDN) marketplace. 13 LAN Access The Company continues to sell Token Ring Switches; intelligent hubs that provide connectivity and management of different network cabling schemes and LAN topologies; Ethernet hubs, the ProNET/E series, for the workgroup market segment; Token Ring hubs, the Serial 75 Stackable Hub family for building networked and extended workgroups; Token Ring adapters for physical connectivity and Token Ring signaling between a PC or workstation and LAN cabling; a multiport Token Ring PCI network adapter card; and a line of Ethernet network adapter cards intended to provide a full range of solutions for the client/server marketplace. The Company also seeks opportunities to leverage technology through licensing arrangements. Internetworking Software OpenROUTE(TM), Proteon's internetworking software suite, is the foundation of the Company's high performance remote access internetworking products. All of Proteon's internetworking products ship with this software technology installed. Also, Proteon licenses this software to other providers of internetworking products. As routing technology progresses, the Company may be required to modify its routing and bridging software to maintain compatibility of its products with various standards and interoperability with other manufacturers router products. Failure by the Company to maintain such compatibility, interoperability, and technical competencies could adversely affect the Company's business, operations and finances. Competition The data communications, networking and computer industries are highly competitive and characterized by rapidly changing technology and evolving industry standards. These advances result in frequent new product introductions, increased capabilities and improvements in the relative price/performance of networking products. As a competitor in the networking industry, Proteon believes one of the keys to success will be making networks more accessible to a broader base of customers. Proteon is committed to open, standards-based products, innovative solutions to customer requirements for reliable and high performance networks, a favorable price/performance redo, ease of installation and ease of use. The Company competes with several companies having greater research and development, marketing and financial resources, manufacturing capability, customer support organizations, and name recognition than those of the Company. There can be no assurance that the Company will be able to compete successfully in the future or that competitive pressures will not adversely affect the Company's business. Research and Product Development Management believes the Company's future success depends in large part upon timely enhancement of existing products and the development of new products that not only maintain 14 technological excellence, but also improve the capabilities, efficiency, and cost-effectiveness of the end users' data communications networks. The Company is developing new products to improve price/performance ratios, enhance its network management capabilities, simplify ease of use, and ensure interoperability with other vendors' standards based products. Variability of Quarterly Operating Results The Company's quarterly operating results may vary significantly depending upon factors such as the timing of new product announcements and releases by the Company and its competitors, the timing of significant orders, the mix of products sold and the mix of distribution channels through which the products are sold. In addition, substantially all of the Company's sales in each quarter result from orders booked in that quarter. Consequently, if sales do not close in any quarter as anticipated, the Company's results of operations for that quarter would be adversely affected. Further, the Company's expense levels are based, in part, on its expectations as to future sales. If sales levels are below expectations, operating results may be adversely affected. Method of Distribution The Company sells its products to end users worldwide primarily through an indirect sales channel comprised of Internet Service Providers ("ISPs"), Original Equipment Manufacturers ("OEMs"), Value Added Resellers ("VARs") and distributors. These resellers also represent other lines of products which are, in some cases, identical or complementary to, or which compete with, those of the Company. While the Company attempts to encourage these resellers to focus on its products through marketing and support programs, there is a risk that these resellers may give higher priority to products of other suppliers, thereby reducing their efforts devoted to selling the Company's products. One reseller accounted for approximately 14%, 12% and 11%, of the Company's sales in 1994, 1995 and 1996, respectively, and a second reseller accounted for approximately 14% and 10% of the Company's sales in 1996, and 1995, respectively. There can be no assurance that the Company has selected appropriate channels of distribution for its products or that existing resellers will dedicate adequate resources to sales of the Company's products. Failure to do so could result in an adverse impact on the Company's business, operations and finances. Marketing, Sales and Customers End users of Proteon's products have typically been organizations with critical applications requiring connectivity integrating their headquarters and wide area computing environments. Proteon's marketing and distribution strategy is to reach these end users primarily through an indirect sales channel comprised of ISPs, OEMs, VARs, and distributors with experience in 15 network integration and reputation for excellent service. In addition, the Company's strategy includes increased presence of Proteon's sales force in end user sites. Proteon's markets encompass the fast growing local access switching and remote access internetworking segments of the network access market. Proteon's customers include both the Global 1000 multinationals, as well as those small to medium-sized enterprises requiring connection to the Internet and to suppliers, customers, and business products. There can be no assurance that the Company has correctly formulated its end-user profile or selected appropriate methods of marketing and selling its products. Failure to do so could result in an adverse impact on the Company's business, operations and finances. Liquidity Failure of the Company to create and maintain adequate working capital and liquidity, by sales of equity, obtaining lines of credit or otherwise, could adversely impact the Company's business, operations and finances. International Sales, Regulatory Standards and Currency Exchange International sales accounted for 38.3%, 35.7% and 35.1% in 1994, 1995 and 1996, respectively, of the Company's net sales and the Company expects that international sales will continue to be a significant portion of the Company's business. Foreign regulatory bodies continue to establish standards different from those in the United States, and the Company's products are designed generally to meet those standards. The inability of the Company to design products in compliance with such foreign standards could have an adverse effect on the Company's operating results. The Company's international business may be affected by changes in demand resulting from fluctuation in currency exchange rates and tariffs and difficulties in obtaining export licenses. Shares Eligible for Future Sale Approximately 15,307,089 outstanding shares of Common Stock as of August 1, 1997 are freely tradable or eligible for sale on the open market. In addition, options to acquire an aggregate of 522,604 shares of Common Stock were vested as of December 31, 1996, and the shares issuable upon exercise of any such option will be freely tradable or eligible for sale in the public market. Additional shares will become eligible for resale in the public market at subsequent dates. Sales of substantial numbers of such shares in the public market could adversely affect the market price of the Common Stock. Possible Volatility of Stock Price The Company believes factors such as announcements of new products by the Company or its competitors and quarterly variations in financial results could cause the market price of the Common Stock to fluctuate substantially. In addition, the stock market has experienced volatility which has particularly affected the market prices for many high technology companies' stock and 16 which often has been unrelated to the operating performance of such companies. These market fluctuations may adversely affect the price of the Company's Common Stock. Certain Charter and By-Law Provisions The Company's Amended and Restated Articles of Organization and By-Laws contain certain provisions that could have the effect of making it more difficult for a third party to acquire, or of discouraging a third party from attempting to acquire, control of the Company. Such provisions could limit the price that certain investors might be willing to pay in the future for shares of the Company's Common Stock. Certain of such provisions allow the Company to issue preferred stock with rights senior to those of the Common Stock and impose various procedural and other requirements which could make it more difficult for stockholders to effect certain corporate actions. 17 PART II - OTHER INFORMATION Item 1. Legal Proceedings: Not applicable. Item 2. Changes in Securities: Not applicable. Item 3. Defaults upon senior Securities: Not applicable. Item 4. Submission of Matters to a Vote of Security Holders: At the Company's Annual Meeting of Shareholders held on May 21, 1997, the following matter was voted upon: The following persons were elected as Directors: Daniel J. Capone, Jr. with 14,240,426 shares voting for election and votes of 477,185 shares withheld; Howard C. Salwen with 14,309,888 shares voting for election and votes of 407,723 shares withheld; Dr. David Clark with 14,304,088 shares voting for election and votes of 413,523 shares withheld; Robert M. Glorioso with 14,292,438 shares voting for election and votes of 425,173 shares withheld; and William R. Johnson with 14,292,338 shares voting for election and votes of 425,273 shares withheld. Item 5. Other Information: Not applicable. Item 6. Exhibits and Reports on Form 8-K: (a) Exhibits: See Exhibits Index, (b) Reports on Form 8-K: The Company filed no reports on Form 8-K with the Securities and Exchange Commission during the quarter ended June 28, 1997. 18 SIGNATURES In accordance with the requirements of the Exchange Act, the Registrant has caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. PROTEON, INC. August 12, 1997 By: /s/ Daniel J. Capone, Jr. ---------------------------------------- Daniel J. Capone, Jr. President & Chief Executive Officer (principal executive officer) By: /s/ Steven T. Shedd ---------------------------------------- Steven T. Shedd Chief Financial Officer, Vice President Treasurer and Clerk (principal financial officer) By: /s/ James M. Roller ---------------------------------------- James M. Roller Corporate Controller (principal accounting officer) 19 EXHIBIT INDEX Exhibit Number Description - ------- ----------- (3.1) Restated Articles of Organization as Amended *(a) (filed as Exhibit 3.1 to registration statement) (3.3) By-Laws, as amended and restated, of the Registrant *(b) (filed as Exhibit 3.3 to 1991 Form-K) (4.1) Article 4 of the Restated Article of Organization, (See 3.1 above) (4.2) Form of Common Stock Certificate *(c) (filed as Exhibit 4.2 to Form 10-Q) (11) Computation of Primary and Fully Diluted (Loss) per Share (27) Financial Data Schedule All exhibit descriptions followed by an asterisk and a letter in parentheses were previously filed with the Securities and Exchange Commission as Exhibits to, and are hereby incorporated by reference from, the document to which the letter in parentheses corresponds, as set forth below: (a) Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1991. (b) Registrant's Registration Statement on Form S-1 Registration No. 33-40073. (c) Registrant's Quarterly Report on Form 10-Q for the fiscal quarter ended June 29, 1996. Where documents are incorporated by reference from previous filings, the Exhibit number of the document in that previous filing is indicated in parentheses after the incorporation by reference code.