1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(MARK ONE)
[ x ] ANNUAL REPORT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 For the fiscal
year ended December 31, 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 (I.R.S. Employer Identification Number)
incorporation or organization)
NINE TECHNOLOGY DRIVE, WESTBOROUGH, MA 01581
- -------------------------------------- -----
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (508) 898-2800
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, $.01 PAR VALUE
----------------------------
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such report(s), and (2) has been subject to such
filing requirements for the past 90 days.
YES X NO
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
Aggregate market value of Registrant's voting stock held by non-affiliates of
the Registrant as of March 12, 1998; $16,252,911 (without admitting that any
person whose shares are not included in determining such value is an affiliate).
Indicate the number of shares outstanding of each of the Registrant's classes of
common stock as of the latest practicable date. Shares of Common Stock
outstanding as of March 12, 1998: 15,296,857.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's Annual Report to Shareholders for the Company's
fiscal year ended December 31, 1997 (the "1997 Annual Report") are incorporated
by reference into Parts II and IV of this Report and portions of the
Registrant's Proxy Statement for its 1998 Annual Meeting of Shareholders to be
held on May 27, 1998 (the "1998 Proxy Statement") are incorporated by reference
into Part III of this Report. With the exception of those portions of the 1997
Annual Report and 1998 Proxy Statement expressly incorporated in this Report by
reference, such documents shall not be deemed filed as part of this Report.
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PART I
ITEM 1. GENERAL BUSINESS
COMPANY OVERVIEW
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Proteon, Inc. (together with its subsidiaries, including "OpenROUTE Networks,
Inc.," "Proteon," or "the Company") is known worldwide as a pioneer in the
multi-billion dollar data communications industry. Proteon and its wholly owned
subsidiary, OpenROUTE Networks Inc., have distinguished themselves as leaders in
helping customers with network connectivity, and now, in particular, with
connectivity from what is commonly referred to as the network edge. For more
than 17 years, Proteon has shipped network connectivity products that have
helped customers grow and prosper through deploying network-centric computing.
Historically, Proteon local area networking (LAN) products have provided
connectivity solutions in more than 70 percent of the Fortune 100 companies.
Leveraging this expertise in mission-critical network solutions, Proteon has now
started to aggressively deliver this same quality of product and service for
Internet and Intranet connectivity. The Company is committed to providing
complete network access solutions that make networks more accessible, secure,
easier to use, manage, and operate. The Company's comprehensive line of network
access solutions includes products for Internet and Intranet access, and
supports small- to medium-sized enterprise businesses and large corporations
that outsource to network service providers.
The Company was incorporated in Massachusetts in January 1974 as Proteon
Associates, Inc. The Company changed its name to Proteon, Inc. in July 1983. Its
executive offices are located at Nine Technology Drive, Westborough,
Massachusetts, 01581, and its telephone number at that location is (508)
898-2800. The Company's testing and final-assembly facilities are located at the
same address. In January 1997, the Company announced the formation of a new
wholly owned subsidiary named OpenROUTE Networks, Inc. ("OpenROUTE Networks").
This new subsidiary was incorporated in the state of Delaware. Going forward,
the Company intends to focus its business on markets served by this new
subsidiary.
OpenROUTE Networks' markets encompass the fast growing Internet and Intranet
segments of the overall networking industry. For Internet and Intranet
connections, OpenROUTE Networks' products combine cost effectiveness with ease
of operation, interoperability, network security, reliability and performance.
The Company's customers include both the Global 1000 multinationals, as well as
those small to medium-sized enterprises requiring connections to the Internet
and to suppliers, customers, and business partners. Proteon, Inc.'s customers
encompass local area networking sites that implement the Token Ring network
topology.
During the second half of 1997, the Company aggressively redefined its business
strategy for its OpenROUTE Networks subsidiary. The new market opportunity for
OpenROUTE Networks can best be described as the connection of businesses and
institutions to public network services such as the Internet. The Company
believes that this market -- which is expected to be the focus of the Company's
energy throughout 1998 -- is just beginning to emerge. The Company believes
there are two main segments of this market. The first addresses the connecting
of a new generation of small- to medium-sized business users who do not have a
network today, but will use a public network service to extend their competitive
advantage and to transact business with each other. The Yankee Group, a leading
market research group based in Boston, Massachusetts, has estimated that on a
worldwide basis there are more than 10 million businesses with fewer than 500
employees. The second target is the outsourcing of networks from the traditional
corporate MIS manager to an outside provider such as MCI, Sprint, Worldcom,
PSINet, UUNet, or the Bell operating companies. Outsourcing allows the corporate
enterprise to focus on its core business, and not the operation of the network.
Corporations do not manage their own phone network, and the Company believes
that they are beginning to realize that their data networks can be viewed in the
same fashion. The Company believes that selling its customer premise equipment
to these major outsourcing providers is another powerful way to grow the
OpenROUTE Networks brand name.
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NETWORKING INDUSTRY
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. This enables users to more fully leverage and manage
information resources.
The peer-to-peer evolution has created an increased demand for client/server
based applications. The first impact of client/server based networks is the
increasing demand for inexpensive, easy to use, remote access routers. Remote
offices can now access corporate databases while running local application
programs. In addition, users are now gaining access to previously unreachable
resources including the Internet, corporate headquarters and other remote sites.
Any LAN-attached workstation with Internet Protocol (IP) client software can
send and receive electronic mail, access public databases worldwide, share files
and programs through File Transfer Protocol (FTP), participate in thousands of
business and consumer-related newsgroups, and easily browse the massive
quantities of information available on the World Wide Web. The Company believes
its OpenROUTE Networks products address the needs of this marketplace.
FORMATION OF NEW SUBSIDIARY
The formation of the new OpenROUTE Networks subsidiary is in keeping with the
Company's strengthened focus on the rapidly growing market for Internet and
Intranet connectivity. The Company defines Internet as a "public" network
accessible by all audiences, and the Intranet as a "private," secure network
with Internet-like characteristics that is most often used only by the employees
of a specific company or organization. OpenROUTE Networks is focusing on the
development, marketing and distribution of the Company's award-winning GT and
GTX Internet access router products and the new Dragon series of Internet
connectivity devices.
The new subsidiary was formed to bring together the Company's resources on the
GT family of high-performance, low-cost Internet Access routers and the ongoing
licensing of its OpenROUTE internetworking software suite. The name OpenROUTE
Networks is intended to reflect the Company's specific emphasis in the Internet
Access marketplace. In conjunction with the establishment of this new
subsidiary, the Company in 1997 also unveiled a new corporate logo. The new logo
is being used in a corporate branding campaign to better position GT and GTX
products in the market for Internet access connectivity, and Dragon products for
eventual sale at the retail level. The new name also reflects the "open" nature
of the public Internet. OpenROUTE Networks has a multi-faceted sales strategy to
meet the growing need to connect hundreds of thousands of organizations to the
Internet in a cost-effective and secure manner. A major OpenROUTE Networks sales
thrust is to focus on key and emerging product features for Internet Service
Providers (ISPs) and service providers which include ISPs, carriers and telcos
among their customers. PSINet, Inc., of Herndon, Virginia, one of the largest
independent ISPs in North America, has been a large customer of OpenROUTE
Networks for more than 18 months. Other significant ISP partners announced in
1997 included Ultranet Communications and IDT Corporation. The Company continues
to seek partnerships with other large ISPs.
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OpenROUTE Networks also markets products through OEM relationships. Digital
Equipment Corporation's Networking Division (now owned by Cabletron, Inc.) and
Nippon Telegraph and Telephone's (NTT) Advanced Technology Division currently
resell Proteon's GT Internet Access routers under their own brand names. A
business goal of OpenROUTE Networks is to announce other OEM relationships
during 1998. OpenROUTE Networks also sells Internet Access products through some
of the world's largest distributors such as Tech Data Corp. and Ingram Micro. In
addition, Value Added Resellers (VARs), including Racal Data Group, actively
market GT and GTX products in most domestic and international markets. OpenROUTE
Networks is targeting major sales in markets such as government, financial
services, health care, education, publishing, manufacturing, insurance,
professional services, libraries and entertainment through its service provider
partners.
SIGNIFICANT EXECUTIVE APPOINTMENTS AND CHANGES
During the second half of 1997, the Company initiated a program to significantly
strengthen its senior management staff. The Company believes this series of
appointments will enhance its position in the marketplace, allow for better
management of the Company's financial operations, and further strengthen its
sales and marketing operations.
The Company appointed Steven T. Shedd as Vice President, Finance, Chief
Financial Officer, Treasurer and Clerk in July 1997. Prior to joining Proteon,
Mr. Shedd served as the Vice President and Chief Financial Officer of Zoom
Telephonics since 1996. In 1995 Mr. Shedd was the Vice President and Chief
Financial Officer for Versyss, Inc. and from 1992 to 1995 Mr. Shedd served as
Vice President and Chief Financial Officer of TSI Corporation.
Mr. Eugene Y. Chang joined the Company as Vice President, Marketing in September
1997 from General DataComm Industries, Inc. where he had been serving as
Assistant Vice President for Systems and Architectures. From 1995 to early 1997,
Mr. Chang was Vice President for Strategic Business Development at Zoom
Telephonics. From 1985-1995, Mr. Chang served as Vice President of ISDN/Digital
Access Technologies at Microcom, Inc.
Mr. Robert A. Koch is presently Vice President, Engineering, Product Planning
and Management for the Company, a position he has held since October 1997. Mr.
Koch joined the Company in August 1993 as Product Marketing Director and held
that position until April 1997. From April 1997 until October 1997, Mr. Koch
served as Vice President of Product Planning for the Company.
In November 1997, Mr. Kenneth W. Hovaldt joined the Company as Vice President,
Sales for the Americas and Canada. From September 1996 to October 1997, Mr.
Hovaldt held the position of Vice President, Global Sales for Telco Systems.
From 1988 to 1996 Mr. Hovaldt served as Senior Vice President of Marketing,
Sales and Business Services for Fijitsu Network Switching of America, Inc.
Mr. Jack A. Ritter joined the Company in December 1997 as Vice President, Asia
Pacific Operations. Prior to joining Proteon, Mr. Ritter was the Director of
Marketing and Sales for the Southeast Asia Trade Alliance since 1995. From 1993
to 1995 Mr. Ritter held the position of Director of Independent Company Sales
for Fujitsu Networking Switching of America, Inc.
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LAN PRODUCTS AGREEMENT
In mid-1997, Proteon, Inc. and Microvitec PLC jointly announced the signing of
an agreement that provides for Microvitec to resell certain of Proteon's
products and obtain intellectual property rights for the Company's Ethernet LAN
products, manufacturing licenses, and access to other Proteon resources to
develop products and services for the LAN marketplace. Proteon LAN Products are
now being sold under the name "Proteon LAN Products by Microvitec," as well as
under the "Proteon" nameplate.
Microvitec PLC is a publicly listed information technology group based in
Bradford, UK, with 1997 annual revenues of approximately 55 million pounds ($91
million U.S.). The group has three divisions - Software, Networking and Displays
- - and operations in the UK, Germany, Canada and USA. The Network Division
includes companies that supply components to the major LAN equipment
manufacturers, manufacturers of Token Ring, Ethernet and wireless LAN products
and a large systems integrator.
COMMITMENT TO OPEN STANDARDS
Proteon and OpenROUTE Networks have always been committed to open,
standards-based product offerings. The Company believes that developing products
that offer multi-vendor interoperability achieved through leadership in, and
adherence to, open networking standards will continue to expand market
opportunities for many years to come. Proteon believes that the Company
contributes significant technical expertise to the development, promulgation and
adoption of key industry standards.
From a historical perspective, The Company co-authored both the Simple Network
Management Protocol (SNMP) network management standard and the Open Shortest
Path First (OSPF) internetwork routing standard. The Company has also developed
and shipped an extension to OSPF known as Multicast. Proteon continues to be an
active member of the OSPF Interoperability Group, an industry consortium formed
to ensure interoperability and further the acceptance of this important
standard. The Company has also continued to execute another high-level standards
activity as it has aggressively marketed its Data Link Switching (DLSw)
technology. DLSw technology, an industry standard, allows the Company's routers
to encapsulate Systems
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Network Architecture (SNA) traffic in IP, thus eliminating the need to have
separate backbone networks for SNA and LAN traffic. The implementation of DLSw
technology in its routing products continues to give the Company opportunities
in larger, headquarters site operations.
STRENGTHENING THE INTERNET ACCESS PRODUCT LINE
The Company continued to make progress during 1997 in introducing products for
the segments of the Internet Access marketplace that it believes are key to its
business strategy.
During 1997, the Company introduced two new major product lines. At the
Networld+Interop trade show in Atlanta, OpenROUTE Networks unveiled the GTX
1000, a new class of modular router that the Company believes leads the industry
in price/performance, network security, ease-of-use and management, and
investment protection. Designed and engineered to significantly reduce the cost
of investment in the essential networking equipment for Internet, Intranet and
Wide Area Networking (WAN) Connectivity, the GTX 1000 has a unique design that
puts the processing unit, memory, operating system software, and a built-in
Ethernet interface in the base unit. Depending on their individual needs, users
then select from a wide range of interface modules to be plugged into the three
configurable slots. This breakthrough design in a single box gives users the
flexibility to mix and match modules and add or change capabilities as their
needs change. The Company has applied for a U.S. Patent on the GTX 1000.
The GTX 1000 is also the first router in its class to ship with true Virtual
Private Network (VPN) functionality. VPNs, which are rapidly driving the global
acceptance of Internet commerce, connect sites within an organization's Intranet
over a public network such as the Internet. The VPN provides secure connections
via data encryption and authentication to guarantee the privacy of the
information as it passes over the public network. The GTX 1000 is priced
according to the modules selected. The product began shipping in December 1997.
When ordering, users can start with a single module and then add other
capabilities as their networks grow internally and expand geographically. The
GTX 1000 can support up to three "personality modules" including serial
interfaces with integrated CSU/DSU technology. ISDN modules are offered in four
variations (ISDN "U", ISDN "S/T", ISDN "U" with POTS, and ISDN "S/T" with POTS)
and are homologated for worldwide deployment. The GTX 1000 can also support up
to three modem modules, including support for 56K.
Toward the end of 1997, the Company introduced the Dragon(TM) series of
Internet Access devices. The two new Dragon products, which were formally
introduced before some 50,000 Internet World attendees in New York City, allow
small businesses to connect all their employees to the Internet through one
small unit. The base model Dragon features the ultimate in ease-of-use features
and the Company believes it is the best value on the market. The Dragon series
gives users the cost benefit of connecting their workgroup of PCs to the
Internet using a single shared Internet account via a shared modem and one
telephone line. Dragon users also have room to grow with an upgrade path to the
Dragon Pro. The Dragon Pro is ideal for the professional working at home or in a
small office. It features support for inbound calls; support for inbound
connections from the Internet; support for personal Web servers and other small
office servers; upgradability to dedicated high speed Internet links; and an
upgrade path to OpenROUTE Networks' GT Business Series product line. The base
model Dragon comes standard with a wide range of software features including
TCP/IP, asynchronous dial-up operation, PPP with PAP, CHAP, and compression. A
secure Internet connection is provided through Network Address Translation
(NAT). The Dragon Pro adds support for synchronous operation and other advanced
software features. Both Dragon products feature a 5-year limited warranty.
Dragon models, which began shipping in February 1998, are first available from
OpenROUTE Networks' Web site (http://www.openroute.com) and specialty catalogs.
The Company is also recruiting partners to sell Dragon products through the
retail channel.
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Also during the past year, the Company continued to expand its GT product line.
New products included: the GT 65 and GT 75, which provide support for the OSPF
protocol; the GTS 100 and GTS 205, more fully functional routers that now
include firewall support; the GT 255, a versatile wide area network
concentrator; and the GTSecure 250, a high performance LAN to LAN and LAN to WAN
firewall router for more complex network connections.
MAJOR EMPHASIS ON NETWORK SECURITY AND VIRTUAL PRIVATE NETWORKS
The Company has launched a major product marketing effort for network security
products. The program has been designed to address the networking marketplace's
need for affordable and secure ways of remotely accessing the Internet and
corporate Intranets. The Secure Internet/Intranet Program is offered to Internet
Service Providers (ISPs), telcos, carriers and end users, and is based on a
security hierarchy that recognizes the need for increasingly stronger security
mechanisms depending upon the type of user and the type of application. During
1997, OpenROUTE Networks addressed each of those levels of user/application with
strategic partnerships and products. Recent industry research indicates that in
a drive to achieve greater business success in the face of increasing global
competition, Internet and Intranet-based services hold the key for today's
virtual organization. Acting as a global backbone, these networks can link
branch offices, telecommuters, partners, suppliers or customers directly into
the business process.
The first product implementation of this program was the GTSecure-60 Firewall
Router, a high-performance, cost-effective solution that uniquely integrates
both full firewall and routing capabilities into a single product. The Company
believes that it was one of the first in the industry to offer this type of
integrated security product. Most other solutions call for users to manage
security in a separate server environment running expensive security software.
The Company believes that its low-cost approach provides adequate network
security for most small office users. Key features in the GTSecure-60 include a
dynamic firewall capability that restricts access from unauthorized users, a
sophisticated filtering system that opens only required ports while adapting to
changing network and user activity, and extensive authentication services via
industry-standard based RADIUS technology.
Later, the Company added the GTSecure-70 Firewall Router to its product line for
ISDN connections. In addition, the Company added IP filtering technology and
began active participation in testing with the National Computer Security
Association. The GTSecure Firewall Routers were subsequently certified by the
NCSA.
During the spring of 1997, OpenROUTE Networks, Inc. expanded the functionality
of its GT line of Internet Access products to include Sun Microsystems' Simple
Key Management for IP (SKIP) technology standard. Sun and OpenROUTE Networks
also announced plans for future joint sales and marketing activities. OpenROUTE
Networks' GTX and GT Business Series VPN solutions are interoperable with other
SKIP equipped network devices, including Sun's own SunScreen(TM) SPF and
SunScreen(TM) EFS Product lines, as well as the SunScreen(TM) SKIP client
software for Solaris and Windows '95 (also available from Sun). The Company
believes that customers who wish to communicate with their partners, customers
or employees using the scalability, ubiquity, and low costs of the Internet --
but demand industrial grade security -- now have a solution that scales from
client software, to the network infrastructure, on into the large scale Intranet
servers. The Company believes that the combination of Sun and OpenROUTE Networks
technology provides users with seamless, end-to-end network security for privacy
on the Internet today.
In the fall of 1997, OpenROUTE Networks continued to expand the functionality of
its product line by announcing expanded capabilities for its "ALLWays
Secure(TM)" network security portfolio. The Company believes that the "ALLWays
Secure" portfolio is the industry's broadest program for all-in-one, bulletproof
network security. With this new VPN capability, the Company believes OpenROUTE
Networks products now offer the most extensive levels of network security
including; stateful IP packet inspection, user authentication for Remote Access
users under the RADIUS protocol; and a dynamic Internal Firewall capability.
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INTERNETWORKING SOFTWARE LICENSING WITH OPENROUTE
OpenROUTE Networks' world class internetworking software suite -- known as
OpenROUTE -- is the foundation of the Company's high performance internetworking
solutions. All of OpenROUTE Networks' internetworking products ship with this
software technology. The Company has been developing this software suite for
approximately 12 years. In the later half of 1994, Proteon began licensing this
software. At that time, the Company completed two major internetworking software
licensing agreements. These agreements were reached with IBM and Digital
Equipment Corporation, two of the world's largest information technology
providers. The Company has also licensed its OpenROUTE software to Motorola's
Information Systems Group (ISG) and TELDAT, S.A., a leading European networking
products vendor headquartered in Madrid, Spain. In late 1997, the Company
announced that it had licensed a subset of OpenROUTE software to Ascend
Communications.
The Company believes that open routing software will be pervasive throughout
next generation networking technologies. OpenROUTE Network's charter is to
expand and manage the OpenROUTE software licensing business. This unit is
providing technology assessment, design feasibility and software porting
analysis for OpenROUTE licensees.
OPENROUTE DEVELOPMENT
The Company continues to invest research and development spending in its
OpenROUTE software. During the past year, the Company announced two new
OpenROUTE software upgrades. Early in the year, the Company released OpenROUTE
2.3 which included several new WAN capabilities that significantly enhance the
GT product line for ISDN links. Key new features included IP Address assignment,
support for callback, improved IP filters and support for IPXWAN, a new Novell
protocol that standardizes the transfer of IPX packets over various WAN media.
Later in the year, the Company announced Version 3.0 of OpenROUTE software. This
release featured support for OpenROUTE Addressing Services (OAS) which includes:
an extensive array of IP address management and configuration capabilities; a
number of Traffic Control Services (TCS) for better management of costly
connections and increased traffic associated with Internet and Intranet-based
networks; and enhanced ISDN with D-Channel Call-back, DOSBS and ISDN leased line
support.
BUSINESS PARTNERING WITH INTERNET SERVICE PROVIDERS
The Company continues to seek out business partnerships with Internet Service
Providers. The Company believes that Internet Service Providers offer a solid
path of wide-scale distribution for GT and GTX products. As ISPs have evolved
around the world, their equipment needs have paralleled this process. In many
cases where ISPs are connecting small businesses to the Internet or Intranet,
the installation of an Internet Access router is a necessity. By solidifying its
presence with ISPs on a global basis, the Company believes it can expand its
distribution and increase the potential to grow its business. The Company does
not currently have any agreements with ISPs that provide for the exclusive
installation of OpenROUTE Networks products. However, a major effort is being
made to work on development with ISPs, the goal of which is to ensure that
OpenROUTE Networks' products are the preferred choice. The Company's most
significant relationship continued to be with PSINet, Inc. of Herndon, Virginia.
Going forward, the Company's strategy is to increase the number of ISPs that
carry OpenROUTE Networks routers. The Company will also work with ISPs as they
support carriers and telcos who provide outsourced networking services for
corporations.
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COMPANY AWARDS AND HONORS
The Company continued to participate in industry-wide product testing and
evaluation and, as a result, has earned a number of recent honors. In the fall
of 1997, the Company won a "Tester's Choice" Award from Data Communications
magazine for the performance of its GlobeTrotter (GT) 72 and 75 ISDN routers. In
the September 1997 issue of ZD Internet magazine, the GT 72 was number one in a
data compression test that ranked 11 competitors. Earlier, Strategic Networks
Consulting, a leading market research firm, named the GT 70 the fastest overall
ISDN router in a major performance test among 10 leading vendors. The GT line
has also won a "Users' Choice" award from Communications News magazine. During
the first quarter of 1998, the Company's GTSecure 70 Firewall Router scored one
of the top two performance marks in an industry-wide test sponsored by Network
Computing magazine. The Company earned further recognition of its innovative
products when the GTX 1000 was voted a finalist in the Paris Networld+Interop
'97 Best of Show Awards for Best Internetworking Product.
LOCAL AREA NETWORKING PRODUCTS
The Company is continuing to market a number of Token Ring LAN products.
However, as mentioned earlier in this report, the Company is putting less
emphasis on LAN products than in previous years. The decision to partner with
Microvitec enhances the Company's ability to support current LAN customers and
future prospects. As the relationship with Microvitec ensues, Proteon will
continue to sell and service its brand name LAN products. Microvitec will
undertake its own sales and marketing efforts to market products under the
Proteon LAN Products by Microvitec brand name. In the future, Microvitec and
Proteon will share product development and engineering resources.
LOCAL ACCESS (TOKEN RING ADAPTERS)
Token Ring adapters provide the physical connectivity and Token Ring signaling
between the PC or workstation and the LAN cabling. Proteon markets the ProNET
family of Token Ring adapters. The family supports unshielded twisted pair (UTP)
and shielded twisted pair (STP) cabling options, the major PC platforms, and the
leading network operating systems.
The ProNET-4/16 Plus Series features models for all popular personal computer
bus types, including Industry Standard Architecture (ISA), Extended Industry
Standard Architecture (EISA), MicroChannel Architecture (MCA), Personal Computer
Memory Card International Association (PCMCIA), and Peripheral Component
Interconnect (PCI). The Company's newer model adapters are fully compatible with
the hundreds of thousands of earlier ProNET-4/16 models now operating in
production systems around the world.
The ProNET-4/16 family has demonstrated a Mean Time Between Failure (MTBF) of
more than 900,000 hours, or 200 years of continuous operation. All the Plus
Series adapters have a limited lifetime warranty, are designed with
state-of-the-art technology such as Surface Mounted Technology components, have
high levels of integration and are software configurable.
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Plus Series adapters also come with an assurance of interoperability. Proteon
offers a broad suite of certified compatible software drivers. Its RapiDrivers
are included as a standard feature inside leading network operating system
software such as Novell NetWare 4.0, Banyan VINES and Microsoft Windows NT.
Proteon's adapters have achieved interoperability certification with popular
third-party intelligent hub products in testing at the Token Ring
Interoperability Lab (TRIL) in Santa Clara, California.
Intelligent hubs are important elements for building structured and manageable
local area networks (LANs), since they provide connectivity and management of
the different cabling schemes and LAN topologies used throughout the network.
Proteon's Token Ring intelligent hubs and wire centers, which compete in the
workgroup network computing market, provide flexible and modular solutions to
cabling, as well as centralized physical network management and configuration.
The Company's Series 80 and Series 70 Intelligent Wire Center families provide
integrated support for 4/16 Mbps UTP, STP and fiber optic cabling, and are
appropriate for workgroups of up to 30 users.
The Company also markets the Series 75 Stackable Hub family, a portfolio of
standards-based, high-performance products that provides a cost effective
solution for building networked workgroups and extended workgroups and meeting
the demands for current and evolving client/server applications. The Series 75
Hub line is based on the p7500 base unit, a 16-port, self-managed active UTP
hub. The p7500 has a rear panel option slot for the addition of stack and SNMP
management modules, and modular ports for installation of trunk options such as
fiber optic links. The Series 75 architecture will support a stack of nine units
high, thus providing connectivity for up to 144 users.
MARKETING, SALES AND CUSTOMERS
End-users of the Company's products have typically been organizations with
critical applications requiring connectivity integrating their headquarters and
wide area computing environments. The Company's marketing and distribution
strategy is to reach these end-users primarily through an indirect sales channel
comprised of selected large systems integrators, Internet Service Providers,
original equipment manufacturers (OEMs), value added resellers (VARs),
telecommunications carriers, and distributors with experience in network
integration and a reputation for excellent service. As the Company moves
forward, it will be targeting a customer base that may not be familiar with
standard networking terms. The Company believes that this new generation of
users is mainly comprised of business executives who have used the Internet in
the home environment, and are now demanding this type of connectivity in the
workplace.
MARKETING PROGRAMS
The Company understands the critical nature of creating end-user awareness for
its products and capabilities. The Company's marketing programs in 1997 and
planned marketing programs for 1998 are focused on channel, telco, ISP, and
end-user awareness through: direct mail campaigns; targeted advertising;
significant educational and product announcement activities; public relations;
seminar programs; electronic advertising mediums such as the Internet; and
regional and large, national industry trade shows. These programs are intended
to enhance brand name recognition for the Company and its products with
end-users, generate sales leads for the Company's field sales force and the
Company's resellers, and support the sales efforts of its resellers. In the
future, the Company plans to devote more time and money to increasing
recognition of OpenROUTE Networks brand name. In conjunction with the creation
of OpenROUTE Networks, the Company adopted a new, colorful logo that will play a
key role in the branding campaign. The Company plans to use some
consumer-oriented branding techniques to better drive sales. In 1998, the
Company also intends to launch new reseller programs and recruit more reseller
partners.
11
Field Sales Force
The Company's field sales force is primarily responsible for providing sales
support and training to the Company's systems integrators, OEMs, ISPs, VARs,
telecommunications carriers, and distributors. In 1997, the Company focused a
portion of its sales force on direct presence at end-user sites with the goal of
providing awareness to the end-user of Proteon and OpenROUTE Networks' products
and the development of leads to support its reseller partners. The field sales
force has a number of offices in the United States, and international offices in
London, Singapore, Tokyo, Toronto, Paris, and Hong Kong. In late 1997, the
Company incurred expenses to add additional sales personnel in various parts of
the world. In a limited number of sales situations, the Company sells directly
to end user customers.
Systems Integrators and OEMs
Proteon and OpenROUTE Networks sell a large number of units through systems
integrators and OEMs. These organizations typically have technical expertise and
an installed customer base in either telecommunications or computer
communications, and are experienced in the sale and support of complex
networking solutions. In late 1997, and continuing into 1998, the Company
is attempting to increase its shipments through telecommunications providers
who install customer premise equipment. This trend is often referred to as
outsourcing.
VARs
The Company also sells its complete product line through Value Added Resellers
(VARs), which include Premier Access Partners and smaller regional VARs in
markets around the world. Many of these VARs are selected for their capability
to sell to and service small to medium-sized organizations, as well as for their
expertise in vertical industries or technologies. The Company's VARs also
include a number of large national and regional resellers. In late 1997, and
continuing into 1998, the Company has been de-emphasizing its reliance on VARs
and concentrating more of its sales efforts through telecommunications carriers,
ISPs and other service providers.
Distributors
Proteon sells a substantial portion of its Token Ring adapter and intelligent
hub and wirecenter products in North America to a number of distributors, which
usually resell to resellers and dealers, including several national chains.
Typically, distributors market Proteon's Token Ring and intelligent hub products
to dealers, whereas VARs sell the complete product line, including routers, to
end-users. The Company's distributors include Ingram Micro and Tech Data.
Distributors also carry OpenROUTE Networks' internetworking products and service
the needs of VARs and other types of system integrators.
INTERNATIONAL SALES
The Company's products are currently marketed, sold and serviced internationally
by over 60 distributors, VARs, and OEMs. These resellers generally have
non-exclusive agreements applying to a countrywide territory. International
sales accounted for approximately 35.4% percent of net sales in 1997.
BACKLOG
Because of the generally short cycle between order and shipment (typically less
than 45 days) and occasional customer-initiated changes in delivery schedules,
the Company does not believe its backlog as of any particular date is
necessarily indicative of future sales levels.
12
CUSTOMER SUPPORT AND SERVICE
The Company's customer service organization provides a comprehensive suite of
service and support programs for resellers and end-users. The underlying
philosophy of the Company is to provide end-users with alternatives for
acquiring services for their networking requirements. Users can contract
directly with the Company for service. Additionally, Proteon offers multiple
maintenance contract options designed to match the servicing capabilities and
needs of the customer. The service offerings consist of technical support
(remote and on-site), maintenance contracts, hardware and software upgrades,
product exchange, spares, depot repair, and professional services.
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 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, enhance network security and ensure interoperability with other
vendors' standards-based products. The Company is also helping to define and
support emerging industry standards that underly the use of new technological
capabilities. The Company is currently participating in a variety of Internet
Engineering Task Force (IETF) working groups, and the IEEE 802.5 and 802.12
subcommittees.
In 1997, 1996, and 1995, the Company's research and product development
expenditures were $5,987,000, $9,353,000, and $8,802,000, respectively. All of
the Company's expenditures for hardware and software research and development
costs have been expensed as incurred.
MANUFACTURING
The Company's manufacturing operations primarily consist of systems level
integration and testing. The Company has developed a strategic relationship
with U.S. Assemblies, Taunton, Mass., a major subcontract manufacturer with
access to cost-effective, high volume manufacturing, distribution, and repair
capability worldwide. U.S. Assemblies manufactures the Company's board
assemblies for its router, hub, and adapter card product lines and specific,
turnkey manufacturing for a number of Proteon and OpenROUTE Networks products.
The Company believes that in the event of an interruption in manufacturing at
U.S. Assemblies, alternative subcontractors could be brought on line quickly.
U.S. Assemblies also operates a number of other facilities across the United
States. Proteon does some final assembly and testing of its intelligent hubs
and routers at its Westborough, Massachusetts manufacturing facility. A repair
depot and logistic operation is also located at Westborough, coordinating
global service requirements for all products.
The Token Ring chipsets used in the Company's 4/16 Mbps adapters are currently
manufactured 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. However, the
reduction or interruption in supply or a significant price increase could
adversely affect the Company's operating results. The RISC processor presently
used in the Company's CNX 600 and CNX 500 bridging routers is available solely
from AMD. The Company believes, however, that other available RISC processors
could be substituted for the AMD chip, if necessary, with some product
modifications. 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. However, such shortages could
result in production delays that might adversely affect the Company's business.
The Company's line of GTX and GT Business Series products incorporates
microprocessors supplied by Motorola. The Company is not aware of any shortages
of chips from Motorola, and believes that supplies will be adequate for the
coming year.
13
Proteon continues to have OEM arrangements with manufacturers for some of its
Token Ring product offerings. The Company does not feel these arrangements
jeopardize the quality of the products the Company is shipping. In most cases,
if supply from one vendor was interrupted or made scarce, the Company could find
a comparable source for the affected product with limited delays in shipment.
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. 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
Proteon and OpenROUTE Networks.
Internet Access Market Competition
In its newer GTX and GT Business Series product lines, the Company manufactures
routers that connect users on the network edge. The Company believes that major
competitors in this market segment include Ascend Communications, Livingston
Systems, Netopia Systems, Cisco Systems, 3COM, Bay Networks, Xyplex, ACC, and
Ramp Networks, among others.
Local Area Networking Competition
IBM dominates the market for Token Ring network adapter card products. Other
significant competitors in the market for Token Ring adapter cards include Madge
Networks and Olicom. While Token Ring networking is an industry standard,
Proteon believes that its ability to successfully address 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.
In addition, IBM is both the dominant supplier of Token Ring network products as
well as an established vendor of computer and networking systems and products at
most of the Company's existing and potential end user sites. As a result, the
Company believes that in order to address the market for Token Ring network
interface card products successfully, the Company's products and systems must
have more features, greater functionality, higher performance and/or lower price
than those offered by IBM. In the past, the Company believes it has been
successful in offering Token Ring network interface card products with better
features, functionality, performance and/or price than Token Ring products
offered by IBM.
INTELLECTUAL PROPERTY RIGHTS
The Company was granted a patent on February 18, 1992, for its Token Ring
synchronization technology, commonly referred to as JitterBuster. On July 21,
1992 the Company was granted a patent for Token Ring Equalizer. Each of these
patents has a life of 17 years from the date of grant. In September 1997 the
Company applied for a U.S. patent for its GTX modular Internet Access router.
Currently, Proteon relies principally upon a combination of contractual rights,
trade secrets, and copyright laws to establish and protect its proprietary
rights in its products. The Company believes that because of the rapid pace of
technological change in the data communications and computer industries, the
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.
14
Certain technology used in the Company's products is licensed by the Company
from third parties, generally on a non-exclusive basis. These license agreements
generally require the Company to pay royalties (certain of these license
agreements include minimum royalty requirements) and to fulfill confidentiality
obligations in order to maintain the licenses. One of the Company's license
agreements is an exclusive license for a portion of the software incorporated in
the Company's bridging routers. In order to maintain the exclusivity of this
license, the Company must make minimum annual royalty or other payments in
addition to those required to maintain the license. The sum of these payments
for each year is relatively insignificant to the Company. The maximum royalties
payable under this license are limited in accordance with a formula. Generally,
if the Company does not pay minimum royalties or make other minimum payments
each year under this license, the license may be terminated. Absent a breach of
this license agreement by the Company, the license may be continued indefinitely
at the Company's option. The termination of this license would have a material
adverse effect on the Company's operations because the technology licensed under
this agreement is included in the software incorporated in the Company's
bridging router products, which provide a significant portion of the Company's
revenues.
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 leverage and manage
information resource.
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 connection their systems and
networks to the Internet.
Proteon is positioning itself as a company focused on the network access
market. Proteon views the networks access market as having two segments -
Internet access and local access. Its current strategy is based upon
concentration on the Internet access market segment.
The market for the Company's products in characterized by rapidly changing
technology, new product introductions and 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. US
Assemblies, a major subcontract manufacturer with access to cost effective,
high volume manufacturing, distribution, and repair capability worldwide, and
other manufacture and 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 a agreement with Texas Instruments under which it believes it will
be able to obtain adequate suppliers 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, in necessary.
Proteon continues to have OEm arrangement with manufacturers for some of its
Ethernet product offering. In most cases, if supplies from one vendor were
interrupted or reduced, the 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 operation 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 employee,
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 other 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 license 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.
Internet Access (Routers)
Proteon expects to participate significantly in the market segment of internet
access routing specifically addressing the needs to users to connect to the
Internet of build corporate intranets The Company has enhanced its internet
access capabilities with the introduction of new products and expanded its
presence in the Integrated Services Digital Network (INDN) marketplace.
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 muliport cards intended to provide a full range of solution 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 Internet access products. All of the Proteon's
internetworking products ship 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.
15
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 ratio, 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 technological excellence, but also improve the
capabilities, efficiency, and cost effectiveness of the end users' data
communication 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 of future sales. If sales levels are below
expectations, operating results may be adversely affected. Also, quarterly
results can be materially affected by the existence and/or the timing of
software licensing revenues.
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
distributor. 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 11%, 11% and 12%, of the Company's sales
in 1997, 1996 and 1995, respectively, and a second reseller accounted for
approximately 8%, 14% and 10% of the Company's sales in 1997, 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 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.
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 35.4%, 38.3% and 35.7% in 1997, 1996 and 1995
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.
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 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
the 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.
YEAR 2000
The Company has given careful consideration to all systems and equipment, which
may be affected by the Year 2000 issue. Management is in the process of
developing an action plan that provides for the repair of replacement of all
systems with exposure to Year 2000 problems by the end of 1998, the cost of
which is not expected to have a material financial impact on the Company. The
plan calls for a combination of internal and external resources. The commitment
of internal resources is not expected to have a significant impact on the
Company's future sales and operating results.
EMPLOYEES
As of December 31, 1997, The Company employed a total of 127 persons, including
69 in sales, marketing and customer support, 27 in engineering and product
development, 13 in manufacturing, and 18 in finance and administration. None of
the Company's employees is represented by a labor union. The Company has
experienced no work stoppages and believes its employee relations are good.
REGISTERED TRADEMARKS
Proteon, OpenROUTE, TokenVIEW and ProNET are registered trademarks and
JitterBuster CNX 600, CNX 500, CNX 400, DNX 350, RapiDriver, OneVIEW, and
OverVIEW are trademarks of Proteon. Ethernet is a registered trademark and XNS
is a trademark of Xerox Corporation. IBM and NetView are registered trademarks
and SNA is a trademark of IBM. Motorola is a trademark of Motorola, Inc.; AMD is
a trademark of Advanced Micro Devices, Inc. AT&T is a trademark of AT&T.
16
ITEM 2. PROPERTIES
The Company's principal administrative, marketing, manufacturing and product
development facilities are located in one building in Westborough, Massachusetts
and occupied a total of approximately 44,000 square feet as of December 31,
1997. The Company occupies these facilities under a lease agreement that expires
in April 2002. The Company has the option to extend the term of the lease of its
primary office and manufacturing facility for two five-year periods commencing
on May 1, 2002 and May 1, 2007. In addition, the Company leases nine sales and
support offices elsewhere in the United States and abroad. The Company believes
that its existing facilities are adequate for its current needs.
ITEM 3. LEGAL PROCEEDINGS
Neither the Company nor any of its subsidiaries is a party to any material legal
proceedings nor is any property of the Company the subject of material legal
proceedings.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of stockholders during the fourth quarter of
the fiscal year ended December 31, 1997.
17
PART II
ITEM 5. MARKET FOR PROTEON COMMON STOCK
AND RELATED STOCKHOLDER MATTERS
The section entitled "Stock Price History" in the 1997 Annual Report is
incorporated herein by reference.
ITEM 6. SELECTED FINANCIAL DATA
The table entitled "Selected Consolidated Financial Data" contained in
the 1997 Annual Report is incorporated herein by reference. The table should be
read in conjunction with the consolidated financial statements and related notes
and other financial information appearing elsewhere in the 1997 Annual Report,
including Management's Discussion and Analysis of Financial Condition and
Results of Operations.
ITEM 7. MANAGEMENT'S DISCUSSION
AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The section entitled "Management's Discussion and Analysis of Financial
Condition and Results of Operations" contained in the 1997 Annual Report is
incorporated herein by reference.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK
Not applicable.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The sections entitled "Consolidated Balance Sheets," "Consolidated
Statements of Operations," "Consolidated Statements of Stockholders' Equity,"
"Consolidated Statements of Cash Flows," "Notes to Consolidated Financial
Statements," "Quarterly Financial Data" and "Report of Independent Accountants"
contained in the 1997 Annual Report are incorporated herein by reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE
None.
18
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS
OF PROTEON
The sections entitled "Information About The Executive Officers,"
"Proposal 1: Election of Directors" and "Section 16(a) Beneficial Ownership
Reporting Compliance" contained in the Company's 1998 Proxy Statement which the
Company intends to file with the Securities and Exchange Commission on or about
April 8, 1998 are incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
The sections entitled "Compensation of Directors and Executive
Officers" contained in the 1998 Proxy Statement is incorporated herein by
reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN
BENEFICIAL OWNERS AND MANAGEMENT
The section entitled "Principal Shareholders" contained in the 1998
Proxy Statement is incorporated herein by reference.
19
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULE, AND REPORTS ON FORM 8-K
(a) Financial Statements, Schedule, and Exhibits
The financial statements, schedule, and exhibits listed below are filed
as part of this Report:
1. Financial statements:
Consolidated Balance Sheets as of December 31, 1997 and 1996
Consolidated Statements of Operations for the years ended December 31,
1997, 1996 and 1995
Consolidated Statements of Stockholders' Equity for the years ended
December 31, 1997, 1996 and 1995
Consolidated Statements of Cash Flows for the years ended
December 31, 1997, 1996 and 1995
Notes to Consolidated Financial Statements
Report of Independent Accountants
2. Schedule:
II Valuation and Qualifying Accounts
Schedules not listed above are omitted because of the absence
of conditions under which they are required or because the
required information is included in the consolidated
financial statements or notes submitted.
20
3. Exhibits:
Exhibit
Number Description
(3.1) Restated Articles of Organization as Amended
(3.3) By-Laws, as amended and restated
(4.1) Article 4 of the Restated Articles of Organization, (See
Exhibit 3.1)
(4.2) Form of Common Stock Certificate
(10.1) Manufacturing Services Agreement, dated August 1, 1989 between
the Registrant and Texas Instruments, Inc.
(10.2) Purchase Agreement, dated August 1, 1989 between
the Registrant and Texas Instruments, Inc.
(10.3) Software License Agreement, dated January 1, 1990 between the
Registrant and Noel Chiappa
(10.4)* 1991 Restated Stock Option Plan
(10.5)* 1988 Nonqualified Stock Option Plan
(10.6)* Restated Employee Stock Award Plan
(10.7)* Consulting Agreement, dated August 31, 1989 between the
Registrant and David Clark
(10.8)* Form of Indemnification Agreement. An Indemnification
Agreement was entered into by and between the Registrant and
each of: Steven J. Bielagus, Daniel Capone, Jr., David Clark,
Howard C. Salwen, and certain other former Directors and
Executives. Although the agreements were executed on various
dates, each is the same as the Form of Indemnification
Agreements in all material respects and details, and therefore
the individual agreements are not filed herewith.
(10.9)* Executive Compensation Arrangements Not Set Forth in Formal
Documents
(10.10)* Consulting Agreement, dated August 25, 1993, between the
Registrant and Howard Salwen
(10.11)* Employment Agreement dated March 18, 1994, between the
Registrant and Steven J. Bielagus.
(10.12)* Employment Agreement dated June 27, 1994 between the
Registrant and Daniel J. Capone, Jr.
(10.13) Lease Agreement dated December 19, 1994 between the Registrant
and WCB Twenty Limited Partnership.
(10.14)* Severance Compensation Agreement dated March 11, 1996
between the Registrant and William T. Greer
(10.15)* Employment Agreement dated October 16, 1996 between the
Registrant and Robert J. Connaughton, Jr.
(10.16)* Severance Compensation Agreement dated October 21, 1996
between the Registrant and Robert J. connaugton, Jr.
(10.17)* Form of Severance Compensation Agreement. A Severance
Compensation Agreement was entered into by and between the
Registrant and each of: Robert Koch, Steven T. Shedd, Richard
J. Arena, Eugene Y. Chang, Daniel Capone, Jr., Steven J.
Bielagus, Kenneth Holvaldt and Jack A. Ritter. Although the
agreements were executed on various dates, each is the same as
the Form of Severance Compensation Agreements in all material
respects and details, and therefore the individual agreements
are not filed herewith.
(10.18) Amendment to Lease Agreement dated December 19, 1994 between
the Registrant and WCB Twenty Limited Partnership, dated May
23, 1997
21
3. Exhibits (continued)
Exhibit
Number Description
(11) Statement RE: Computation of Per Share Earnings
(13) The Annual Report to Stockholders of the Company for the
fiscal year ended December 31, 1997 (except for the pages and
information thereof expressly incorporated by reference in
this Form 10-K, the Annual Report to Shareholders is provided
solely for the information of the Securities and Exchange
Commission and is not deemed "filed" as part of this Form
10-K)
(21) Subsidiaries of the Registrant
(23) Consent of Coopers & Lybrand L.L.P.
(27) Financial Data Schedule
* Exhibit is a management contract or compensatory plan, contract or
arrangement required to be filed as an Exhibit to this Form 10-K.
(b) Reports on Form 8-K
The Company filed no reports on Form 8-K with the Securities and
Exchange Commission during the last quarter of the fiscal year ended
December 31, 1997.
22
SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange
Act of 1934, Proteon, Inc. has duly caused this Annual Report on Form 10-K to be
signed on its behalf by the undersigned, thereunto duly authorized.
PROTEON, INC.
(Registrant)
March 25, 1998 By:/s/ Daniel J. Capone, Jr.
------------------------------------
Daniel J. Capone, Jr.
President & Chief Executive Officer
(principal executive officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the Registrant and
in the capacities and on the dates indicated.
March 25, 1998 By:/s/ Daniel J. Capone, Jr.
----------------------------
Daniel J. Capone, Jr.
President & Chief Executive
Officer and Director
March 25, 1998 By:/s/ Steven T. Shedd
----------------------
Steven T. Shedd
Vice President, Finance and Chief Financial Officer
Treasurer and Clerk
(principal financial officer)
March 25, 1998 By:/s/ James M. Roller
----------------------
James M. Roller
Corporate Controller
(principal accounting officer)
March 25, 1998 By:/s/ David Clark
----------------------
David Clark, Director
March 25, 1998 By:/s/ Robert M. Glorioso
-------------------------
Robert M. Glorioso, Director
March 25, 1998 By:/s/ Howard C. Salwen
-----------------------
Howard C. Salwen, Director
23
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors
and Stockholders of Proteon, Inc.:
Our report on the consolidated financial statements of Proteon, Inc. has been
incorporated by reference in the Form 10-K from the 1997 Annual Report to
Shareholders of Proteon, Inc. In connection with our audits of such financial
statements, we have also audited the related financial statement schedule
listed in item 14a(2) in this Form 10-K.
In our opinion, the financial statement schedule referred to above, when
considered in relation to the basic financial statements taken as a whole,
presents fairly, in all material respects, the information required to be
included therein.
/s/ COOPERS & LYBRAND L.L.P.
-----------------------------
Boston, Massachusetts
Date: February 11, 1998
24
SCHEDULE II
PROTEON, INC.
VALUATION AND QUALIFYING ACCOUNTS
Balance at Uncollectible Balance at
Allowance for Beginning Provision Accounts End of
Doubtful Accounts of Period for Bad Debt Written Off Period
- ---------------------------------------------------------------------------------------
Year ended December 31, 1997 $671,755 $438,773 ($183,920) $926,608
Year ended December 31, 1996 889,276 - (217,521) 671,755
Year ended December 31, 1995 887,524 - 1,752 889,276
25
EXHIBIT INDEX
Exhibit
Number Description
(3.1) Restated Articles of Organization as Amended*(c) (filed as Exhibit 3.1)
(3.3) By-Laws, as amended and restated, of the Registrant * (a) (filed as
Exhibit 3.3)
(4.1) Article 4 of the Restated Articles of Organization, (See Exhibit 3.1)
(4.2) Form of Common Stock Certificate * (b) (filed as Exhibit 4.2)
(10.1) Manufacturing Services Agreement, dated August 1, 1989 between the
Registrant and Texas Instruments, Inc. * (a) (filed as Exhibit 10.3)
(10.2) Purchase Agreement, dated December 1, 1990 between the Registrant and
Texas Instruments, Inc. * (a) (filed as Exhibit 10.4)
(10.3) Software License Agreement, dated January 1, 1990 between the
Registrant and Noel Chiappa * (a) (filed as Exhibit 10.5)(+)
(10.4) 1991 Restated Stock Option Plan * (d) (filed as Exhibit 19.1)
(10.5) 1988 Nonqualified Stock Option Plan * (a) (filed as Exhibit 10.7)
(10.6) Restated Employee Stock Award Plan * (a) (filed as Exhibit 10.8)
(10.7) Consulting Agreement, dated August 31, 1989 between the Registrant and
David Clark * (a) (filed as Exhibit 10.11)
(10.8) Form of Indemnification Agreement. An Indemnification Agreement was
entered into by and between the Registrant and each of: David Allen,
Steven J. Bielagus, Daniel Capone, Jr., David Clark, Howard C. Salwen,
and certain other former Directors and Executives. Although the
agreements were executed on various dates, each is the same as the Form
of Indemnification Agreements in all material respects and details, and
therefore the individual agreements are not filed herewith. * (a)
(filed as Exhibit 10.17)
(10.9) Executive Compensation Arrangement Not Set Forth in Formal Document*
(e) (filed as Exhibit 10.26)
(10.10) Consulting Agreement, dated August 25, 1993, between the Registrant and
Howard Salwen * (f) (filed as Exhibit 10.1)
(10.11) Employment Agreement, dated March 18, 1994, between the Registrant and
Steven J. Bielagus * (g) (filed as Exhibit 10.3)
(10.12) Employment Agreement, dated June 27, 1994 between the Registrant and
Daniel J. Capone, Jr. * (h) (filed as Exhibit 10.4)
(10.13) Lease Agreement dated December 19, 1994 between the Registrant and WCB
Twenty Limited Partnership * (i) (filed as Exhibit 10.31)
(10.14) Severance Compensation Agreement dated March 11, 1996 between the
Registrant and William T. Greer * (j) (filed as Exhibit 10.28)
(10.15) Employment Agreement, dated October 16, 1996 between the Registrant and
Robert J. Connaughton, Jr. * (j) (filed as Exhibit 10.29)
(10.16) Severance Compensation Agreement dated October 21, 1996 between the
Registrant and Robert J. Connaughton, Jr. * (j) (filed as Exhibit
10.30)
(10.17) Form of Severance Compensation Agreement. A Severance Compensation
Agreement was entered into by and between the Registrant and each of:
Robert Koch, Steven T. Shedd, Richard J. Arena, Eugene Y. Chang, Daniel
J. Capone, Jr., Steven J. Bielagus, Kenneth Holvaldt and Jack A.
Ritter. Although the agreements were executed on various dates, each is
the same as the Form of Severance Compensation Agreements in all
material respects and details, and therefore the individual agreements
are not filed herewith.
(10.18) Amendment to Lease Agreement dated December 19, 1994 between Registrant
and WCB Twenty Limited Partnership, dated May 23, 1997
26
EXHIBIT INDEX (continued)
Exhibit
Number Description
(11) Statement RE: Computation of Per Share Earnings
(13) The Annual Report to Stockholders of the Company for the fiscal year
ended December 31, 1997 (except for the pages and information thereof
expressly incorporated by reference in this Form 10-K, the Annual
Report to Shareholders is provided solely for the information of the
Securities and Exchange Commission and is not deemed "filed" as part of
this Form 10-K)
(21) Subsidiaries of the Registrant
(23) Consent of Coopers & Lybrand L.L.P.
(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 following documents:
(a) Registrant's Registration Statement on Form S-1 Registration
No. 33-40073.
(b) Amendment No. 1 on Form 8 to the Registrant's Registration
Statement on Form 8-A, File No. 0-19175.
(c) Registrant's Annual Report on Form 10-K for the fiscal year
ended December 31, 1991.
(d) Registrant's Quarterly Report on Form 10-Q for the quarter
ended June 27, 1992.
(e) Registrant's Annual Report on Form 10-K for the fiscal year
ended December 31, 1992.
(f) Registrant's Quarterly Report on Form 10-Q for the quarter
ended October 2, 1993.
(g) Registrant's Quarterly Report on Form 10-Q for the quarter
ended April 2, 1994.
(h) Registrant's Quarterly Report on Form 10-Q for the quarter
ended July 2, 1994.
(i) Registrant's Annual Report on Form 10-K for the fiscal year
ended December 31, 1994.
(j) Registrant's Annual Report on Form 10-K for the fiscal year
ended December 31, 1996
All exhibit descriptions followed by a (+) indicate documents with respect to
which confidential treatment has been granted.