-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, EKuQjQK5py0OOdXA+hM4AVk87G687r5jzsaauxqBrxOWqQvTuSeDQrsgVY+w624E 9bKmXlZ9s/8H7aonYi6OVg== 0000950135-97-001544.txt : 19970401 0000950135-97-001544.hdr.sgml : 19970401 ACCESSION NUMBER: 0000950135-97-001544 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 11 CONFORMED PERIOD OF REPORT: 19961231 FILED AS OF DATE: 19970331 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: PROTEON INC/MA CENTRAL INDEX KEY: 0000874316 STANDARD INDUSTRIAL CLASSIFICATION: COMPUTER COMMUNICATIONS EQUIPMENT [3576] IRS NUMBER: 042531856 STATE OF INCORPORATION: MA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-19175 FILM NUMBER: 97569768 BUSINESS ADDRESS: STREET 1: NINE TECHNOLOGY DRIVE CITY: WESTBOROUGH STATE: MA ZIP: 01581 BUSINESS PHONE: 5088982800 MAIL ADDRESS: STREET 1: 9 TECHNOLOGY DR CITY: WESTBOROUGH STATE: MA ZIP: 01581 10-K 1 PROTEON, INC. ANNUAL REPORT ON FORM 10-K 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K (MARK ONE) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 [FEE REQUIRED] For the fiscal period ended December 31, 1996 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED] 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 ---------------------------- (Title of each class) (Number of shares) 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 reports), 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 10K. [ ] Aggregate market value of Registrant's voting stock held by non-affiliates of the Registrant as of March 27, 1997; $25,778,750 (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 comon stock as of the latest practicable date. Shares of Common Stock oustanding as of March 27, 1997: 15,276,296 DOCUMENTS INCORPORATED BY REFERENCE Portions of the Registrant's Annual Report to Shareholders for the Company's fiscal year ended December 31, 1996 (the "1996 Annual Report") are incorporated by reference into Parts II and IV of this Report and portions of the Registrant's Proxy Statement for its 1997 Annual Meeting of Shareholders to be held on May 21st, 1997 (the "1997 Proxy Statement") are incorporated by reference into Part III of this Report. With the exception of those portions of the 1996 Annual Report and 1997 Proxy Statement expressly incorporated in this Report by reference, such documents shall not be deemed filed as a part of this Report. Page 1 of 150 pages Exhibit index at page 2 PART I ITEM 1. GENERAL BUSINESS COMPANY OVERVIEW - ---------------- Proteon, Inc., together with its subsidiaries, including, OpenROUTE Networks, Inc., ("Proteon," or "the Company") is known as an innovative product provider in the multi-billion dollar data communications industry. Proteon and its subsidiary, OpenROUTE Networks, have distinguished themselves as leaders in helping customers with network connectivity. For more than 16 years, Proteon has shipped network connectivity products that have helped customers grow and prosper through deploying network computing. Historically, Proteon networking products have provided connectivity solutions in more than 70 percent of the Fortune 100 companies. Leveraging this expertise in mission-critical network solutions, Proteon is delivering this same quality for Internet, Intranet, and small to medium-sized enterprise users. The Company is committed to providing access solutions that make networks more accessible, secure, easier to use, manage, and operate. The Company's comprehensive line of access solutions includes products for Internet/Intranet access, branch office access, Token Ring and Ethernet switching, hubs and adapters. 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 9 Technology Drive, Westborough, Massachusetts 01581, and its telephone number at that location is (508) 898-2800. The Company's manufacturing facilities are located at the same address. In January 1997, the company announced the formation of a new wholly owned subsidiary, OpenROUTE Networks, Inc. This new subsidiary was incorporated in the state of Delaware, USA. OpenROUTE Networks' markets encompass the fast growing components of the 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 products. Proteon, Inc.'s customers encompass local area networking sites that implement Token Ring and Ethernet network topologies. Specific products marketed by Proteon include network adapter cards, network hubs, LAN switches, and a switch-router. At the core of the Company's design philosophy is a commitment to deliver reliable, high-performance networking products based on industry standards. Proteon's and OpenROUTE Networks' products incorporate the highest possible technical specifications to provide open, interoperable solutions for today's shared bandwidth internetworks. 3 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, enabling users to more fully leverage and manage information resources. As the deployment of networks matures, three 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 LAN segmentation using various switching technologies; and the massive drive for businesses of all sizes and individuals to connect their systems and networks to the Internet and Intranet. 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. The client/server shift has also created the demand for greater performance in the LAN, and hence is driving the market for switching solutions. Also, 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. Proteon and OpenROUTE Networks believe that one of the keys to their success will be making networks more accessible to a new, broader base of customers. The Company 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, use, network security and network compatibility. - --------------------------- FORMATION OF NEW SUBSIDIARY - --------------------------- 3 4 The formation of the new OpenROUTE Networks subsidiary was decided in keeping with the Company's strengthened focus on the rapidly growing market for Internet and Intranet connectivity. The Company defines the Internet as a "public" network representing it to 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. This new OpenROUTE Networks subsidiary will focus on the development, marketing and distribution of the Company's award-winning GlobeTrotter router products. The new subsidiary was formed to bring together the Company's resources on the GlobeTrotter family of high-performance, low-cost remote access routers and the ongoing licensing of its OpenROUTE internetworking software suite. The name "OpenROUTE Networks" reflects the Company's specific emphasis in the remote access marketplace. In conjunction with the establishment of this new subsidiary, the Company also unveiled a new corporate logo. The new logo will also be used in a corporate branding campaign to better position GlobeTrotter products. 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 will be to focus on key and emerging product features for Internet Service Providers (ISPs) and the distributors who service this segment of the market. Major ISPs and distributors to ISPs have already become important OpenROUTE Networks customers. OpenROUTE Networks also markets products through OEM relationships. Digital Equipment Corporation and Nippon Telegraph and Telephone's (NTT) Advanced Technology Division currently resell GlobeTrotter remote access routers under their own brand names. OpenROUTE Networks expects to announce other OEM relationships during 1997. OpenROUTE Networks also sells remote access products through some of the world's largest distributors such as Tech Data Corp. and Ingram Micro. In addition, a large base of Value Added Resellers (VARs), including Racal DataGroup, actively market GlobeTrotter products in all domestic and international markets. OpenROUTE Networks is targeting major sales in markets such as government, health care, education, publishing, manufacturing, insurance, professional services, libraries and entertainment. LAN PRODUCTS AGREEMENT - ---------------------- Proteon, Inc. and Microvitec PLC jointly announced the signing of a reseller agreement and a letter of intent, subject to contract closure, for an additional series of agreements that provide Microvitec to resell Proteon's products and obtain intellectual property rights for LAN products, manufacturing licenses, and access to other Proteon resources to develop products and services for the LAN marketplace. 4 5 SIGNIFICANT EXECUTIVE APPOINTMENTS AND CHANGES - ---------------------------------------------- In March 1996, the Company promoted William Greer to Vice President of American Sales Operations. Greer had been serving as Regional Sales Director for the Eastern Region of the United States since he joined Proteon in 1995. Early in 1997, Mr. Greer was given additional responsibilities as Vice President of Worldwide Sales. In this role, Greer is responsible for all sales programs in North, Central and South America, Asia Pacific and Europe. He supervises Proteon's sales force, as well as manages relationships with Proteon sales partners including large scale systems integrators, Value Added Resellers, master distributors, and Internet Service Providers. In the fall of 1996, Robert J. Connaughton, the company's Chief Legal Counsel, was given additional corporate responsibilities as Vice President of Finance and Chief Financial Officer. Mr. Connaughton, who joined Proteon in 1995, has nearly two decades of experience in senior management, law, operations and finance. During the year, three senior executives resigned their positions. David Allen resigned his position as Vice President of European Sales Operations. Jeffrey B. Low resigned his position as Vice President of Worldwide Marketing, and Joseph A. DiGiantomasso resigned his position as Chief Financial Officer. Information regarding employee contracts is available in the Company's Proxy filing with the Securities and Exchange Commission. 5 6 REMOTE ACCESS (ROUTERS) - ----------------------- OpenROUTE Networks' product focus is anticipated to be in the market segment of Remote Access Routing. This rapidly growing market is fueled by large corporations deploying client/server applications in remote offices and connections to the Internet. Proteon shipped the industry's first "plug and play" low end router, the DNX 300, in early 1993. In November 1994, Proteon began shipping the RBX 200. This router is the product of a joint development agreement with IBM and at that time differentiated itself, the Company believes, through low price, custom designed, remote access routing features, and a high degree of interoperability with IBM's internetworking products. The RBX 200 runs the full range of the Company's OpenROUTE(TM) routing software. To date, Proteon has shipped more than 150,000 access ports with its routers. In April 1996, the Company expanded its line of connectivity products with the introduction of the Globe Trotter (GT) Access Manager Point-of-Presence (POP) platform. The GT Access Manager POP has been specifically designed as a total Point-of-Presence solution for the thousands of Internet Service Providers (ISPs) around the world that are currently expanding their connectivity infrastructure. With an attractive entry-level price point of $8,995 (U.S.) -- the lowest price in the industry in its class -- and a scaleable architecture, the Company believes the GT Access Manager gives ISPs maximum flexibility to accommodate the dynamic requirements of their customers. The GT Access Manager includes resilient features such as dual power supplies, high density wide area network (WAN) connections and a highly optimized RISC-based routing engine. The Company continues to market this product along with its high-end routers, the CNX 500 and CNX 600. In April of 1996, the Company made one of its most significant product announcements of the year when it announced a major expansion of its line of GlobeTrotter Remote Access routers. This expansion included six new models that address all the major options for Internet/Intranet connectivity. The new models included: o The GlobeTrotter 70-U, which provides full Internet Protocol (IP) connectivity for Integrated Services Digital Network (ISDN) links and includes an integrated NT-1. It is also the industry's only product of its type for under $1,000; o The GlobeTrotter 70-S/T, which provides the same features as the GlobeTrotter 70-U, plus support for other ISDN peripherals through the S/T interface, also at under $1,000; o The GlobeTrotter 72-U, which provides IP, IPX, AppleTalk and bridging connectivity for ISDN links with an integrated NT-1, priced at only $1,195; o The GlobeTrotter 72-S/T, which provides IP, IPX, AppleTalk, and Bridging connectivity, plus support for other ISDN peripherals through the S/T interface, also priced at only $1,195; o The GlobeTrotter 60 which now features asynchronous dial-up and synchronous Frame Relay or leased-line IP connectivity, priced at only $795; and o The GlobeTrotter 62, with the same asynchronous and synchronous functionality, with additional protocol support for IPX, AppleTalk and Bridging, priced at only $995. The Company believes that the expansion of the GlobeTrotter line is critical to growth in 1997. The Company believes that having a more complete line of Remote Access routers will give it a better entry point into business partnerships with ISPs and OEM prospects. This line of products is expected to strengthen the Company's position in the market for ISDN routers. 6 7 During the summer of 1996, the Company's ISDN product line was even further strengthened when it participated in an industry-wide testing consortium. In recent laboratory testing conducted by Proteon, the GlobeTrotter 70-U -- running Version 5 of Stac(R) LZS(R) compression algorithm and compression control protocols -- achieved data throughput rates over an ISDN link that were between 30 and 70 percent faster than competing products. At the fall Networld+Interop industry trade show in Atlanta, the Company released the results of another industry test that demonstrated the performance of its ISDN products. The testing, which measured Integrated Services Digital Network (ISDN) router and bridge performance, was sponsored by Strategic Networks Consulting, Inc., Rockland, Mass., a leading market research firm and networking consultant. The GlobeTrotter 70 -- at a list price of only $995 per unit for unlimited users -- beat out all competing products in two critical areas: data compression and ISDN call setup. MAJOR EMPHASIS ON NETWORK SECURITY - ---------------------------------- In an effort to significantly expand its GlobeTrotter product line, the Company 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) 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. As 1997 unfolds, OpenROUTE Networks intends to address each of those levels of users 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. 7 8 The first product implementation of this program is being marketed as 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 this low-cost approach provides adequate network security for most small office users. In the Fall of 1996, 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. GTSecure Firewall Routers start at pricing levels of only $1,395 per unit (U.S. list). As 1997 unfolds, the Company intends to offer other products that integrate routing and security in the same system platform. All of OpenROUTE Networks' routers feature the Company's award-winning OpenROUTE(TM) internetworking software. By using OpenROUTE(TM) software, users have assurance that the products will interoperate with a wide range of existing installed equipment. OpenROUTE(TM) has been accepted by industry leaders as the most open, standards-based internetworking software available. The Company has continued to devote significant engineering resources to its OpenROUTE internetworking software. Recently, the Company announced two new versions that encompass major new technologies and features. OpenROUTE Release 2.2 includes new features such as: o Support for NetWare Link Service Protocol (NLSP), a technology that provides link state routing for Internetwork Packet Exchange (IPX) based networks that are among the largest in the industry; o Implementation of IPXWAN Version 2, a link management and negotiation protocol for use over serial lines and other wide area services; and o A series of IPX enhancements that aid in routing traffic, load sharing, bandwidth management and diagnostics. One of the most attractive features of OpenROUTE 2.2 is the support for NLSP. NLSP is a protocol for information exchanged among routers geared to the needs of large IPX internetworks. IPX is the Network-Layer protocol used by the NetWare operating system, and by the compatible network products of other system providers. NLSP addresses the limitations of the IPX Routing Information Protocol and Service Advertisement Protocol (RIP/SAP). Users are much better able to scale their networks with NLSP. NLSP was designed and specified by Novell. Support of NLSP makes the company's products attractive in the large base of Novell users. 8 9 OpenROUTE Release 2.3, which was recently announced, further expands the capabilities of the software suite. This release introduces several new WAN capabilities that significantly enhance the software for ISDN links. Key new features include: o Internet Protocol (IP) Address Assignment, a capability that allows IP addresses to be automatically assigned to a router's WAN ports; o Support for Callback, a new feature that allows an OpenROUTE GlobeTrotter router to make or accept call requests to and from the remote routers or access servers; o Improved IP filters that block unwanted traffic and allow users to create a collection of access control lists to route traffic based on an organization's network policy; and o Support for Internetwork Packet Exchange Wide Area Net (IPXWAN), a new Novell protocol that standardizes the transfer of IPX packets over various WAN media. During 1997, the Company plans to introduce other new versions of OpenROUTE that will expand the current product line and open new markets in the Remote Access segment. 9 10 JOINT DEVELOPMENT - ----------------- In the fall of 1996, the Company announced an important strategic partnership with NTT Advanced Technology Corporation (NTT-AT) of Japan in which OpenROUTE Networks and NTT-AT will work together to provide the Japanese marketplace with high-performance connectivity products for ISDN. The companies have jointly developed an ISDN router which is now being marketed in Japan. These new products are being sold in Japan with an integrated NTT-AT Data Service Unit (DSU). The Company believes that the market for network access solutions in Japan is currently showing dramatic growth as small offices and Internet/Intranet users take advantage of ISDN's high bandwidth capabilities. NTT-AT has a high degree of proficiency in the data communications sector utilizing LAN technologies, and now is focusing on the Remote Access market as one of its key areas. The Company believes that this method of joint development is important to its future growth. The Company intends to aggressively seek out other, similar joint partnerships with telecommunications carriers in both domestic and international markets. OpenROUTE Networks also currently builds product under an OEM relationship for Digital Equipment Corporation of Maynard, Mass. Digital currently markets a small Remote Access router that carries the Digital name but is built by OpenROUTE Networks. BUSINESS PARTNERING WITH INTERNET SERVICE PROVIDERS - --------------------------------------------------- A major initiative is the Company's decision to seek business partnerships with Internet Service Providers. The Company believes that Internet Service Providers offer a new path of wide-scale distribution for GlobeTrotter routers. 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 a Remote Access Router is necessary. By solidifying its presence with ISPs on a global basis, the Company expands its distribution and increases 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, thus ensuring that OpenROUTE Networks' products are the preferred choice. The Company's first significant relationship in this area was established with PSINet, Inc. of Herndon, Virginia, in the Spring when OpenROUTE Networks GlobeTrotter routers were certified to connect to PSINet's massive Internet-optimized network. At the time, PSINet's network had more than 300 Points-of-Presence around the world. The certification is important to the Company because it means that for business and corporate users PSINet may specify OpenROUTE Networks products. The GlobeTrotter products were certified after a series of rigid lab tests and comparisons with many competitive products. During the course of the year, OpenROUTE Networks expanded its relationship with PSINet on many fronts. The companies jointly announced that they would develop a range of technologies that strengthen the security of PSINet's Internet Services and enable advanced network capabilities for future service offerings. This technology from OpenROUTE Networks enables PSINet to enhance security services that are integrated into the network itself. Subsequently, this technology from OpenROUTE Networks was offered by 11 11 PSINet under the name "RouteWaller." This joint development with PSINet also enabled the Company to develop its own GTSecure Firewall Routers. Going forward, the Company's strategy is to increase the number of ISPs that carry OpenROUTE Networks routers. Other companies added in 1996 include SundayNET, Northern Net, Best Internet, Supernet, EasyNET, Vossnet, SingNET, Athena Internet, ContribNET, Tokyo Internet, ILK Internet, Global Internet, and Asia On Line. During the year, the Company hopes to announce other agreements with ISPs from around the world. Designed in accordance with general ISP requirements, GlobeTrotter remote access routers give users shared Internet access, thus avoiding multiple phone line costs and expensive modem banks. GlobeTrotters feature plug-and-play operation, user-friendly graphical interfaces, Internet Protocol (IP) standards-based internetworking and security, and local and remote manageability. COMPANY AWARD - ------------- OpenROUTE Networks won an important industry award when its comprehensive portfolio of GlobeTrotter Remote Access routers won a 1996 Users' Choice Award from Communications News. The honor singled out OpenROUTE Networks in the category for internetworking equipment. The Communications News awards are based on actual inquiries from subscribers. Inquiries about the OpenROUTE Networks products came from communications and networking professionals at end user sites. 12 12 LOCAL AREA NETWORKING PRODUCTS - ------------------------------ The Company is continuing to market a number of LAN products. However, the Company is putting less emphasis on LAN products than in previous years. The decision to partner with third parties in license arrangements is intended to enhance development. 13 13 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. MARKETING PROGRAMS - ------------------ The Company understands the critical nature of creating end-user awareness for its products and capabilities. The Company's marketing programs in 1996 and planned marketing programs for 1997 continue to focus on channel, 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 branding of the OpenROUTE Networks nameplate. In conjunction with the creation of OpenROUTE Networks, the Company launched a new, colorful logo that will play a key role in the corporate campaign. WORLD WIDE WEB SITE DEVELOPMENT - ------------------------------- To better communicate its messages, the Company is making a major commitment to the World Wide Web. Since deploying its World Wide Web site in 1995, the Company has continued to enhance and improve the site. The current site includes a wide range of Company information such as corporate information, product information, investor information, business partners, etc. To further improve its Web site, the Company intends to launch a new "business oriented" site that is more closely tied to the Company's Remote Access business. The new site, currently under construction, is found at URL http://www.openroute.com. The Company is committed to using its Internet site as an important factor for its business. In the near future, the Company also plans to use the Internet for electronic commerce. To implement the new site, the Company is using the outside resources of a web development vendor. INVESTOR RELATIONS PROGRAMS - --------------------------- The Company's marketing efforts also include an Investor Relations program that encompasses a wide range of activities. On a daily basis, the Company has communications personnel available to speak with current investors, investor prospects, buy-side and sell-side analysts, portfolio managers, and others interested in the Company's finances and products. The Company also conducts an outreach program to present its business story to security analysts. These analyst forums are typically conducted by the Company's Chief Executive Officer. Venues have included New York City, San Francisco, and Boston. During 1997, the Company expects to continue to leverage its marketing efforts through these analyst forums. The Company also conducts regular quarterly conference calls with Wall Street securities analysts and makes its senior executives available for on-site visits. Other investor relations activities include the Company's annual meeting, annual report, financial reports, etc. The Company recently launched a new service called "Shareholder direct." This telecommunications-based service features a toll-free number for inbound callers. Interested parties can hear recorded messages and retrieve documents at no charge. The Company has instituted this service in lieu of quarterly mailings. The Company believes this new system gives interested parties better and faster access to financial statements and recent press announcements. The Company also makes investor relations information available through its World Wide Web site. The Company's Web site can be reached at http://www.proteon.com or http://www.openroute.com. VARs/ISPs - --------- The Company continues to reinforce its long-standing commitment to indirect sales channels with the Premier Access and Internet Access Partner Program. This is an ongoing cooperative effort designed to increase sales opportunities for the hundreds of value added resellers (VARs) and ISPs that currently carry the Company's product line, and expand the Company's reach into new geographical regions. Under the program, partners have a direct relationship with the Company, but may continue to procure products through distribution. Access Partners are authorized to sell all the Company's solutions, which currently includes products for Internet access, Small Office/Home Office Access, Branch Office Access, Shared Remote Access Routing and Local Access Token Ring and Ethernet switching, hubs and adapters. Access Partners have to meet certain criteria in order to qualify for the program. Once qualified, this group of partners is eligible for co-op funding on all products purchased. The Company also provides training, evaluation, and beta testing programs exclusively to these partners. The new plan creates one partner program for all classifications of resellers including network integrators, VARs, Internet service providers, national integrators, and systems integrators. The Company works with its sales partners to guarantee geographical and product exclusivity for partner products and provides free sales and technical training. The Company also participates in joint sales 17 14 calls and provides its partners with qualified sales leads by territory. Access Partners also receive early access to new products and technical information, and are eligible for a demonstration/evaluation equipment program. 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 1996, 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, North Sydney, Tokyo, Toronto, Paris, Kelkheim, and Hong Kong. SYSTEMS INTEGRATORS AND OEMS - ---------------------------- Proteon and OpenROUTE Networks sell networking products primarily through a large number of 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. 18 15 DISTRIBUTORS - ------------ Proteon sells a substantial portion of its Token Ring and Ethernet 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. The Company also decided to initiate programs to sell its router and switch products through distributors. As a result of this initiative, certain distributors will carry OpenROUTE Networks' internetworking products and service the needs of VARs and other types of system integrators. The Company believes this new sales distribution channel for internetworking products will broaden the accessibility of its products. INTERNATIONAL SALES - ------------------- The Company's products are currently marketed, sold and serviced internationally by over 60 distributors, VARs, and OEMs. These resellers have generally non-exclusive agreements applying to a country-wide territory. In 1996, international sales accounted for 38.3% of net sales. In 1995, the number was 35.7%. In 1994, the number was 35.3%. 19 16 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. The Company's users have the option of contracting directly with the Company, or with a number of Company supported service providers, enabling them to choose the service model that best complements their business model. Proteon and OpenROUTE Networks' product warranties range from 90 days for software products to a Lifetime Hardware Warranty for network adapter cards. 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. The Company significantly enhanced its service capabilities when it announced a joint support agreement with IBM. The agreement further strengthened the Company's ability to provide on-site 20 17 support across the United States and Canada. The three-year agreement pairs IBM's service and support resources with OpenROUTE Networks' comprehensive line of multiprotocol internetworking systems to provide users with more options in servicing their growing, mission-critical networks. Under the terms of the agreement, OpenROUTE Networks' customers will be able to choose from multiple on-site support options. OpenROUTE Networks' expects its own customer service unit to handle most U.S. requirements. When on-site support is required, OpenROUTE Networks will contact IBM's national dispatch center and make all necessary arrangements. OpenROUTE Networks will continue to be responsible for problem resolution. IBM provides direct support for Canadian maintenance requirements, including telephone support, equipment exchange, and on-site service. While OpenROUTE Networks provides second and third level technical support, IBM Canada maintains ownership through problem resolution. 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, 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. The Company believes it is essential to work cooperatively with other organizations that have complementary technologies. Significant relationships have been developed with IBM, Motorola ISG, Digital Equipment Corp., Yokogawa Digital Computer Corp. (Japan), Plaintree Systems, AT&T, and TELDAT, S.A. of Spain. The Company believes that interoperability with other vendors' networking products will be of increasing importance in the future. The Company expends considerable efforts on interoperability to increase market acceptance of its products. The Company's laboratories conduct ongoing interoperability tests with IBM and other vendors' products. In several cases, development partners provide reciprocal testing. To pursue broader interoperability, Proteon, in 1992, helped found the University of New Hampshire Token Ring Interoperability Laboratory, and joined other vendors in the Token Ring Interoperability Laboratory (TRIL). In 1996, 1995, and 1994, the Company's research and product development expenditures were $9,353,000, $8,802,000, and $11,162,000, respectively. All of the Company's expenditures for hardware and software research and development costs have been expensed as incurred. MANUFACTURING - ------------- 21 18 The Company's manufacturing operations primarily consist of assembly, testing and quality control of materials, components, subassemblies, and systems. The Company has developed a strategic relationship with SCI Systems (SCI), a major subcontract manufacturer with access to cost-effective, high volume manufacturing, distribution, and repair capability worldwide. SCI manufactures a majority of the Company's board assemblies for its router, hub, and adapter card product lines. The Company believes that in the event of an interruption in manufacturing at SCI, alternative subcontractors could be brought on line quickly. However, such a transition could result in production delays which might adversely affect the Company's business. The Company also subcontracts board assemblies with other local vendors for lower volume products. Proteon and OpenROUTE Networks 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. In the fall of 1996, the Company's manufacturing facilities were consolidated into Company headquarters at 9 Technology Drive. The Company has since undertaken efforts to sub-lease its now unused manufacturing space, and expects to do so in the near future. 22 19 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. 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. 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 23 20 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 - ------------ In this 10K, under the provisions of the "safe harbor" section of the Private Securities Litigation Reform Act of 1995, Proteon, Inc. makes forward-looking statements that involve a number of risks and uncertainties. Among the factors that could cause actual future results to differ materially are the level of acceptance of Proteon's and OpenROUTE Networks' products in the marketplace; the company's ability to generate revenue across all existing product lines; future reventues generated by the licensing of OpenROUTE software; general competitive pressures in the marketplace; the company's ability to sign agreements with reseller partners including both Premier Access Partner VARs and Internet Service Providers (ISPs); the ability to sign OEM agreements; and continued overall growth in the networking industry. Risk factors are listed in the company's annual report, Form 10-K, Form 10-Q, and other filings with the Securities and Exchange Commission. 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. As the deployment of networks mature, 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. The Company is still in the process of repositioning itself from a company emphasizing deployment of Token Ring solutions to one that is focused on network access - or shared access. The Company's overall business strategy is to provide leading edge product solutions in this 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 (1) its continuing ability to enhance and expand its existing products; (2) to develop or private label other manufacturer's technology; and (3) 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. 24 21 INTELLECTUAL PROPERTY - --------------------- Currently, the Company 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 the Company 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. 25 22 INTERNETWORKING SOFTWARE LICENSING - ---------------------------------- OpenROUTE(TM), the Company's world class internetworking software suite, is the foundation of the Company's high performance local and remote access internetworking products. All of the Company's internetworking products ship with some variant of this software technology installed. The Company licenses this software to other providers of internetworking products. The market for routers and bridges is dominated by Cisco Systems. The Company's intent, as a smaller participant, is to: develop innovative new products for emerging niche markets with superior performance characteristics and cost effectiveness; license its proprietary router software source code to major manufacturers for use in their routing 27 23 and bridging products; identify markets for its routing, bridging and shared access products; and develop and market products which have the features desired by the market and interoperate with the products manufactured by the major industry participants. While the Company has had some success in implementing this strategy, there can be no assurance that this strategy will prove to be the correct one for the future. Similarly, there can be no assurance that the Company has chosen the right products for development, that it will be able to develop and produce the chosen products, or that those products will gain acceptance in the marketplace. In addition, while each router source code license sale can produce significant revenue, there is a limited market of customers for the Company's router source code and each license draws heavily on the Company's engineering resources. Failure by the Company to identify new licensing prospects, to continue to make such licensing arrangements, or to be able to support the sales made to date would have an adverse effect on the Company's operations. Additionally, as routing technology progresses, the Company may be required to modify its routing and bridging software to maintain compatibility 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. It is the Company's intention to rely less on software licensing as an overall source or revenue. The Company also expects that in future months certain revenue streams from IBM and Digital Equipment Corp. will diminish and end. The loss of these revenue streams could adversely affect future results unless the Company generates revenues from other products. 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 that one of the keys to success will be making networks more accessible to a broader base of customers. The Company 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, security, interoperability and ease of use. There is no guarantee that the Company will be able to fully succeed against the competition. 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 communications networks. The Company is developing new products to improve price/performance ratios, enhance its network 28 24 management capabilities, simplify ease of use, and ensure interoperability with other vendors' standards-based products. Proteon is also helping to define and support emerging industry standards underlying the use of new technological capabilities. 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 large systems integrators, OEMs, 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, Ingram Micro, accounted for approximately 14%, 12%, and 11%, of the Company's sales in 1996, 1995, and 1994, respectively, and a second reseller, Tech Data, 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 the Company's products have typically been organizations with critical applications requiring connectivity integrating their branch offices or headquarters and wide area computing environments. OpenROUTE Networks' 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), and distributors with experience in network integration and reputation for excellent service. In addition, the Company's strategy includes increased presence of its sales force in end-user sites. In some cases, the Company will sell directly to an end user. However, this accounts for a very small percentage of overall sales. 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 - --------- 29 25 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. Significant reductions in revenue could cause adverse effects on cost and the ability to finance operations. INTERNATIONAL SALES, REGULATORY STANDARDS AND CURRENCY EXCHANGE - --------------------------------------------------------------- International sales accounted for 38.3%, 35.7%, and 35.3% in 1996, 1995, and 1994, respectively, of the Company's net sales. The Company expects that international sales will continue to be a significant portion of the its business. Foreign regulatory bodies often establish standards different from those in the United States, and the Company's products are designed generally to meet those international 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 as well as by risks such as tariff regulations and difficulties in obtaining export licenses. SHARES ELIGIBLE FOR FUTURE SALE - ------------------------------- Approximately 15,428,000 outstanding shares of Common Stock are now freely tradable on the open market. A total of 522,604 shares are exercisable under vested options as of December 31, 1996, and the shares issuable upon exercise of any such option will be tradable or eligible for sale in the public market pursuant to a registration statement, or Rule 144 or Rule 701 under the Securities Act. 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 - ---------------------------------- Based on the recent trading of the Company's stock, the Company believes factors such as announcements of new products by the Company or its competitors, quarterly variations in financial results, or other events 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 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. EMPLOYEES - --------- As of December 31, 1996, the Company employed a total of 193 persons, including 63 in sales, marketing and customer support, 53 in engineering and product development, 30 26 55 in manufacturing, and 22 in finance and administration. None of the Company's employees are represented by a labor union. The Company has experienced no work stoppages and believes its employee relations are in good standing. REGISTERED TRADEMARKS - --------------------- Proteon, OpenROUTE, TokenVIEW and ProNET are registered trademarks and JitterBuster CNX 600, CNX 500, CNX 400, DNX 350, DNX 300, 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. 31 27 ITEM 2. PROPERTIES The Company's principal administrative, marketing, manufacturing and product development facilities are located in one building in Westborough, Massachusetts and occupy a total of approximately 42,000 square feet as of December 31, 1996. The Company occupies these facilities under an agreement which expires in April 2002. In addition, the Company leases 11 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 or its subsidiaries 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, 1996. 32 28 PART II ITEM 5. MARKET FOR PROTEON COMMON STOCK AND RELATED STOCKHOLDER MATTERS The section entitled "Stock Price History" on page __ of the 1996 Annual Report is incorporated herein by reference. ITEM 6. SELECTED FINANCIAL DATA The table entitled "Selected Consolidated Financial Data" contained on page __ of the 1996 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 1996 Annual Report, including Management's Discussion and Analysis of Financial Condition and Results of Operations on pages __ through __ of the Annual Report. 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 on pages __ through __ of the 1996 Annual Report is incorporated herein by reference. 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," and "Report of Independent Accountants" contained on pages __ through __ of the 1996 Annual Report are incorporated herein by reference. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. 33 29 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 1997 Proxy Statement which the Company intends to file with the Securities and Exchange Commission on or about April 11, 1997 are incorporated herein by reference. ITEM 11. EXECUTIVE COMPENSATION The section entitled "Compensation of Directors and Executive Officers" contained in the 1997 Proxy Statement (except for those portions entitled "Certain Relationships and Related Transactions", "Information About the Executive Officers", "Compensation Committee Report on Executive Compensation", "Compensation Committee Report on Option Repricing", and "Comparison of Cumulative Total Return Since Initial Public Offering among Proteon, Inc., NASDAQ Stock Market and H & Q Communication Section Index") is incorporated herein by reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The section entitled "Principal Shareholders" contained in the 1997 Proxy Statement is incorporated herein by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The section entitled "Certain Relationships and Related Transactions" contained in the 1997 Proxy Statement is incorporated herein by reference. 34 30 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:
Sequentially Numbered Page ------------- 1. Financial statements (Data incorporated by reference from the attached 1996 Annual Report to the shareholders of Proteon, Inc.): Consolidated Balance Sheets as of December 31, 1996 and 1995 ___ Consolidated Statements of Operations for the years ended December 31, 1996, 1995 and 1994 ___ Consolidated Statements of Stockholders' Equity for the years ended December 31, 1996, 1995 and 1994 ___ Consolidated Statements of Cash Flows for the years ended December 31, 1996, 1995 and 1994 ___ 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. 35 31 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) Agreement to Manufacture, dated December 1, 1988 between the Registrant and SCI Manufacturing, Inc. (10.3) Purchase Agreement, dated December 1, 1990 between the Registrant and Texas Instruments, Inc. (10.4) Software License Agreement, dated January 1, 1990 between the Registrant and Noel Chiappa (10.5)* 1991 Restated Stock Option Plan (10.6)* 1988 Nonqualified Stock Option Plan (10.7)* Restated Employee Stock Award Plan (10.8)* Consulting Agreement, dated August 31, 1989 between the Registrant and David Clark (10.9) Form of Indemnification Agreement. An Indemnification Agreement was entered into by and between the Registrant and each of: David Allen, Steven J. Bielagus, Daniel J. Capone, Jr., David Clark, Robert J. Connaughton Jr., Joe Grillo, Jeffrey B. Low, Julius Marcus, Howard C. Salwen, L.J. Sevin, 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. (10.10) Amendment dated April 18, 1991 to Agreement to Manufacture, dated December 1, 1988 between the Registrant and SCI Manufacturing, Inc. (10.11)* Executive Compensation Arrangements Not Set Forth in Formal Documents (10.12)* Consulting Agreement, dated August 25, 1993, between the Registrant and Howard Salwen (10.13)* Employment Agreement, dated February 25, 1994, between Registrant and Joseph A. DiGiantommaso (10.14)* Employment Agreement, dated March 18, 1994, between the Registrant and Steven J. Bielagus (10.15)* Employment Agreement, dated June 27, 1994 between the Registrant and Daniel J. Capone, Jr. (10.16) Lease Agreement dated December 19, 1994 between the Registrant and WCB Twenty Limited Partnership (10.17) Lease Agreement dated December 1, 1994 between the Registrant and John Hancock Mutual Life Insurance Company (10.18)* Letter Agreement dated March 2, 1995, between the Registrant and Jeffrey B. Low (10.19)* Letter Agreement dated April 11, 1995, between the Registrant and Bruce W. Lichorowic (10.20)* Severance Compensation Agreement dated October 11, 1995 between the Registrant and Daniel J. Capone, Jr.
36 32
Exhibit Number Description ------ ----------- (10.21)* Severance Compensation Agreement dated October 11, 1995 between the Registrant and Joseph A. DiGiantommaso (10.22)* Severance Compensation Agreement dated October 18, 1995 between the Registrant and Steven J. Bielagus (10.23)* Severance Compensation Agreement dated October 30, 1995 between the Registrant and Jeffrey B. Low (10.24)* Severance Compensation Agreement dated November 15, 1995 between the Registrant and Bruce W. Lichorowic (10.25)* Employment Separation Agreement dated February 9, 1996 between the Registrant and Bruce W. Lichorowic (10.26)* Employment Agreement, dated January 4, 1996 between the Registrant and Robert J. Connaughton, Jr. (10.27)* Employment Agreement, dated March 11, 1996 between the Registrant and William T. Greer (10.28)* Severance Compensation Agreement dated March 11, 1996 between the Registrant and William T. Greer (10.29)* Employment Agreement, dated October 16, 1996 between the Registrant and Robert J. Connaughton, Jr. (10.30)* Severance Compensation Agreement dated October 21, 1996 between the Registrant and Robert J. Connaughton, Jr. (11) Statement RE: Computation of Per Share Earnings (13) The Annual Report to Stockholders of the Company for the fiscal year ended December 31, 1996 (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, 1996. 37 33 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 on March 27, 1997. PROTEON, INC. (Registrant) March 27, 1997 By: /s/ Daniel J. Capone, Jr. ----------------------------- Daniel J. Capone, Jr. President & Chief Executive Officer (principal executive officer) Authorized Signatory 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 on the dates indicated. March 27, 1997 By: /s/ Robert J. Connaughton, Jr. ----------------------------- Robert J. Connaughton, Jr. Vice President, Finance and Administration Chief Financial Officer Treasurer and Clerk (principal financial officer) March 27, 1997 By: /s/ David Clark ----------------------------- David Clark, Director March 27, 1997 By: /s/ Julius Marcus ----------------------------- Julius Marcus, Director March 27, 1997 By: /s/ Howard C. Salwen ----------------------------- Howard C. Salwen, Director March 27, 1997 By: /s/ L.J. Salwen ----------------------------- L.J. Salwen, Director 34 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 page 30 of the 1996 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 the index on page 35 of 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 February 11, 1997 38 35 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, 1996 $889,276 $ - $(217,521) $671,755 Year ended December 31, 1995 887,524 - 1,752 889,276 Year ended December 31, 1994 419,393 348,000 120,131 887,524
36 EXHIBIT INDEX
Exhibit Sequentially Number Description Numbered Page - ------ ----------- ------------- (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) Agreement to Manufacture, dated December 1, 1988 between the Registrant and SCI Manufacturing, Inc. * (a) (filed as Exhibit 10.2)(+) (10.3) Purchase Agreement, dated December 1, 1990 between the Registrant and Texas Instruments, Inc. * (a) (filed as Exhibit 10.4) (+) (10.4) Software License Agreement, dated January 1, 1990 between the Registrant and Noel Chiappa * (a) (filed as Exhibit 10.5) (+) (10.5) 1991 Restated Stock Option Plan * (d) (filed as Exhibit 19.1) (10.6) 1988 Nonqualified Stock Option Plan * (a) (filed as Exhibit 10.7) (10.7) Restated Employee Stock Award Plan * (a) (filed as Exhibit 10.8) (10.8) Consulting Agreement, dated August 31, 1989 between the Registrant and David Clark * (a) (filed as Exhibit 10.11) (10.9) Form of Indemnification Agreement. An Indemnification Agreement was entered into by and between the Registrant and each of: David Allen, Steven J. Bielagus, Daniel J. Capone, Jr., David Clark, Robert J. Connaughton Jr., Jeffrey B. Low, Julius Marcus, Howard C. Salwen, L.J. Sevin, 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) (10.10) Amendment dated April 18, 1991 to Agreement to Manufacture, dated December 1, 1988 between the Registrant and SCI Manufacturing, Inc. * (a) (filed as Exhibit 10.24) (10.11) Executive Compensation Arrangement Not Set Forth in Formal Document* (e) (filed as Exhibit 10.26) (10.12) Consulting Agreement, dated August 25, 1993, between the Registrant and Howard Salwen * (f) (filed as Exhibit 10.1) (10.13) Employment Agreement, dated February 25, 1994, between Registrant and Joseph A. DiGiantommaso *(h) (filed as Exhibit 10.2) (10.14) Employment Agreement, dated March 18, 1994, between the Registrant and Steven J. Bielagus * (h) (filed as Exhibit 10.3) (10.15) Employment Agreement, dated June 27, 1994 between the Registrant and Daniel J. Capone, Jr. * (i) (filed as Exhibit 10.4) (10.16) Lease Agreement dated December 19, 1994 between the Registrant and WCB Twenty Limited Partnership * (j) (filed as Exhibit 10.31) (10.17) Lease Agreement dated December 1, 1994 between the Registrant and John Hancock Mutual Life Insurance Company * (j) (filed as Exhibit 10.32)
41 37 EXHIBIT INDEX
Exhibit Sequentially Number Description Numbered Page - ------ ----------- ------------- (10.18) Letter Agreement dated March 2, 1995, between the Registrant and Jeffrey B. Low * (j) (Filed as Exhibit 10.33) (10.19) Letter Agreement dated April 11, 1995, between the Registrant and Bruce W. Lichorowic * (k) (Filed as Exhibit 10.1) (10.20) Severance Compensation Agreement dated October 11, 1995 between the Registrant and Daniel J. Capone, Jr.* (l) (Filed as Exhibit 10.20) 40 (10.21) Severance Compensation Agreement dated October 11, 1995 between the Registrant and Joseph A. DiGiantommaso* (l) (Filed as Exhibit 10.21) 51 (10.22) Severance Compensation Agreement dated October 18, 1995 between the Registrant and Steven J. Bielagus* (l) (Filed as Exhibit 10.22) 65 (10.23) Severance Compensation Agreement dated October 30, 1995 between the Registrant and Jeffrey B. Low* (l) (Filed as Exhibit 10.23) 79 (10.24) Severance Compensation Agreement dated November 15, 1995 between the Registrant and Bruce W. Lichorowic* (l) (Filed as Exhibit 10.24) 92 (10.25) Employment Separation Agreement dated February 9, 1996 between the Registrant and Bruce W. Lichorowic* (l) (Filed as Exhibit 10.25) 106 (10.26) Employment Agreement, dated January 4, 1996 between the Registrant and Robert J. Connaughton, Jr. (10.27) Employment Agreement, dated March 11, 1996 between the Registrant and William T. Greer (10.28) Severance Compensation Agreement dated March 11, 1996 between the Registrant and William T. Greer (10.29) Employment Agreement, dated October 16, 1996 between the Registrant and Robert J. Connaughton, Jr. (10.30) Severance Compensation Agreement dated October 21, 1996 between the Registrant and Robert J. Connaughton, Jr. (11) Statement RE: Computation of Per Share Earnings 112 (13) The Annual Report to Stockholders of the Company for the fiscal year ended December 31, 1996 (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) 113 (21) Subsidiaries of the Registrant 149 (23) Consent of Coopers & Lybrand L.L.P. 150 (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. 42 38 (f) Registrant's Quarterly Report on Form 10-Q for the quarter ended October 2, 1993. (g) Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1993. (h) Registrant's Quarterly Report on Form 10-Q for the quarter ended April 2, 1994. (i) Registrant's Quarterly Report on Form 10-Q for the quarter ended July 2, 1994. (j) Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1994. (k) Registrant's Quarterly Report on Form 10-Q for the quarter ended April 1, 1995. (l) Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1995. All exhibit descriptions followed by a (+) indicate documents with respect to which confidential treatment has been granted. 43 EX-10.26 2 EMPLOYMENT AGREEMENT DATED 4-JAN-96 1 Exhibit 10.26 proteon Proteon Inc. - ------- Nine Technology Drive Wesborough, MA 01581-1799 508 / 898-2800 January 4, 1996 Mr. Robert J. Connaughton, Jr. 102 Den Quarry Road Lynn, MA 01904 Dear Bob: It is my pleasure to offer you the position of General Counsel reporting to me. The terms of our agreement will be as follows: - - BASE SALARY: Your initial base salary for this position will be $4,230.77 bi-weekly ($110,000 annualized) which will be reviewed annually on the anniversary date of hire. After completion of your first six (6) months of employment you will receive a prorated performance evaluation. As well, your title and level of responsibility will be re-evaluated within the first twelve (12) months of employment. - - BONUS: You will be eligible for Proteon's Management Incentive Program annual bonus of 25% of base salary. Payment of this bonus is based upon Proteon's Executive Compensation Plan and goals mutually agreed to. - - STOCK: A recommendation will be made to the Compensation Committee that you receive an option to purchase 15,000 shares of stock which vest over a 4 year period. - - SEVERANCE BENEFIT: A severance benefit of six (6) months salary then current (base) continuation benefit for you should your position be involuntarily or constructively eliminated for any reason other than cause within the first 24 months of employment will be granted. As well, a severance benefit of eight (8) months salary then current (base) continuation benefit for you should your position be involuntarily or constructively eliminated for any reason other than cause commencing after 24 months of employment, as defined in Proteon's Policies and Procedures Manual, will be granted. Should you become employed at any time during payment of the severance period, such severance payments shall terminate except to the extent that base salary in your new employment is less than the installment portion amount. In such event Proteon shall only be obligated to pay the amount equal to the difference for the balance of the severance period. - - PROTEON GROUP HEALTH PLAN: You will be eligible to participate in Proteon's comprehensive benefits package (see enclosed benefits summary). 2 Page -2- Offer letter - R. Connaughton, Jr. January 4, 1996 This offer is contingent upon providing proper identification and employment eligibility documents according to Immigration and Naturalization Service Regulation. Please complete Section I of the enclosed Employment Verification Form (I-9) and present it with original documents as outlined in Section II, on your first day of employment. Bob, I look forward to your decision to accept our offer and join Proteon as General Counsel. Please indicate your acceptance of this offer by signing below and returning it by January 8, 1996. Also enclosed are two copies of Proteon's Proprietary Information Agreement. Proteon requires all individuals joining the company to sign this standard agreement. Please return one copy of the signed agreement along with the signed offer letter. If you have any questions regarding this offer or Proteon in general, please give me a call. Sincerely, /s/ Michele Scholl for Joe DiGiantommaso Joseph A. DiGiantommaso Vice President and C.F.O. Accepted by: /s/ Robert J. Connaughton, Jr. Start date: 1/29/96 ------------------------------------- ------------------- Robert J. Connaughton, Jr. proteon - ------- EX-10.27 3 EMPLOYMENT AGREEMENT DATED 11-MAR-96 1 Exhibit 10.27 proteon Proteon. Inc - -------- Nine Technology Drive Wesborough, MA 01581-1799 508 / 898-2800 March 11, 1996 Mr. William T. Greer 53 South Street Upton, MA 01568 Dear Tim: It is my pleasure to offer you the position of Vice President Sales for North, South and Latin America, reporting directly to me. The terms of our agreement will be as follows: - - BASE SALARY: You will receive an initial minimum annual base salary of $95,000, which will be reviewed annually, plus incentive and bonus compensation as described below. - - INCENTIVE COMPENSATION: You will be eligible for $67,000, Incentive Compensation, without a cap, based on Sales Revenue performance. - - BONUS: You will be eligible for an additional annual MIP bonus compensation of 40% of Base salary. ($38,000 annualized target on base salary of $95,000, for example). Payment of this bonus is based upon Proteon's Management Incentive Program. - - STOCK: A recommendation will be made to the Compensation Committee that you receive an option to purchase 25,000 shares of stock which vest over a 4 year period. Tim, I look forward to the contributions you will make in your new role at Proteon, and wish you great success. Please indicate your acceptance of this offer by signing below. Please return one copy of the signed offer letter. It is understood that the contents herein are confidential to both yourself and Proteon. Sincerely, /s/ Daniel J. Capone, Jr. Daniel J. Capone, Jr. President and C.E.O. Accepted by: Start date: -------------------------------- ----------------------- William T. Greer EX-10.28 4 SEVERANCE COMPENSATION AGREEMENT 1 Exhibit 10.28 SEVERANCE COMPENSATION AGREEMENT SEVERANCE COMPENSATION AGREEMENT dated as of March 11, 1996 by and between PROTEON, INC. (the "Company"), a Massachusetts corporation with its principal offices at Nine Technology Drive, Westboro, Massachusetts 01581, and William T. Greer (the "Executive"), residing at 52 South Street, Upton, MA 01568. WHEREAS, the Company's Board of Directors has recognized that the possibility of a change in control of the Company may cause uncertainty among the Company's senior management and may result in the departure or distraction of its senior management to the detriment of the Company and its stockholders; WHEREAS, the Company's Board of Directors has determined that it is appropriate to reinforce and encourage the continued attention and dedication of members of the Company's senior management, including the Executive, to their duties without distraction arising from the possibility of a change in control of the Company; WHEREAS, the Executive desires assurance as to his compensation and benefits in the event of any change in control of the company; NOW, THEREFORE, in consideration of the covenants and agreements herein contained and for other good and valuable consideration, the receipt and adequacy of which are hereby acknowledged, the Company and the Executive agree as follows: 1. TERM. This Agreement shall terminate, except to the extent that any obligation of the Company hereunder remains unpaid as such time, upon the earliest to occur of: (a) two (2) years from the date hereof; (b) the termination of the Executive's employment with the Company based on (i) the death of the Executive, (ii) the Disability of the Executive, (iii) termination by the Company for Cause, or (iv) termination by the Executive other than for Good Reason; and (c) one year after the date of a Change in Control. As used in this Agreement the term "Term" shall mean the period beginning on the date hereof and ending upon the earliest to occur of events specified above. 2 2. CHANGE IN CONTROL. No compensation shall be payable under this Agreement unless and until there shall have been a Change in Control. As used in this Agreement, the term "Change in Control" means that any of the following events has occurred: (i) any person (as defined in Section 3(a) (9) of the Securities Exchange Act of 1934, as amended (the "1934 Act") (or any successor provision), becomes the beneficial owner (determined in accordance with Rule 13d-3 under the 1934 Act, or any successor provision), directly or indirectly, of more than fifty percent (50%) of the outstanding Common Stock of the Company, or otherwise becomes entitled to vote more than fifty percent (50%) of the voting power entitled to be cast at elections for directors ("Voting Power") of the Company; (ii) there shall have been consummated any consolidation or merger of the Company (A) in which the Company is not the continuing or surviving corporation unless such merger is with a corporation at least eighty percent (80%) of the Voting Power of which is held by the Company, or (B) pursuant to which the holders of the Company's shares of Common Stock immediately prior to such merger or consolidation are not the holders immediately after such merger or consolidation of at least a majority of the Voting Power of the entity resulting from such consolidation or merger; iii) there shall have been consummated any sale, lease, exchange or other transfer (in one transaction or a series of related transactions) of all or substantially all of the assets of the Company; or (iv) during any period of two consecutive years, individuals who at the beginning of such period were members of the Board of Directors of the Company ceased for any reason to constitute a majority thereof, unless the election, or the nomination for election by the Company's stockholders, of each new director was approved by a vote of at least two-thirds of the directors still in office at the time of such election or nomination who were directors at the beginning of such Period. As used in this definition of Change in Control, "Common Stock" means the Common Stock, or if changed, the capital stock of the Company as it shall be constituted from time to time entitling the holders thereof to share generally in the distribution of all assets available for distribution to the Company's stockholders 3 after the distribution to any holders of capital stock with preferential rights. 3. TERMINATION FOLLOWING CHANGE IN CONTROL. The Executive shall be entitled to the compensation provided in Section 4 hereof upon the termination of the Executive's employment with the Company during the Term of this Agreement and after a Change in Control unless such termination is as a result of (i) the Executive's death, (ii) the Executive's Disability, (iii) termination by the Company for Cause, or (iv) termination by the Executive other than for Good Reason. As used in this Agreement, the following terms shall have the following meanings: (a) the term "Disability" shall mean that as a result of the Executive's incapacity due to physical or mental illness or physical injury (excluding illness or injury which was caused by repeated substance abuse by the Executive), the Executive shall have been absent from his duties with the Company on a full-time basis (i) for a period of sixty (60) consecutive days or (ii) an aggregate of ninety (90) days during any period of twelve (12) consecutive months; (b) the term "Cause" shall mean any of (i) the willful and continued failure by the Executive to perform his duties with the Company, other than any such willful or continued failure resulting from his incapacity due to physical or mental illness or physical injury (provided that if such willful and continued failure resulted from illness or injury which was caused by repeated substance abuse by the Executive, then the foregoing exception for physical or mental illness or physical injury shall not be applicable), (ii) the willful or knowingly reckless engaging by the Executive in misconduct which is materially injurious to the Company, financially or otherwise, including, without limitation, willful breach by the Executive of any employment or other agreement between the Executive and the Company, or (iii) the conviction of the Executive of a felony by a court of competent jurisdiction. For purposes of the foregoing, (x) the failure of the Company to achieve desired or projected results shall not constitute Cause, but Cause shall only mean and include acts and/or omissions by the Executive which are specified in clauses (i), (ii) and (iii) of the immediately preceding sentence, and (y) no act or failure to act on the part of the Executive shall be considered "willful" unless done or admitted to be done by him not in good faith and without reasonable belief that his action or omission was in the best interests 4 of the Company. Notwithstanding the first sentence of this subparagraph (b), the Executive's employment shall not be deemed to have been terminated for Cause unless (A) reasonable notice shall have been given to him setting forth in detail the reasons for the Company's intention to terminate for Cause and, if such termination is pursuant to clause (i) or (ii) above, only if the Executive has been provided a period of five (5) business days from receipt of such notice to cease the actions or inactions, and if he has not done so (B) an opportunity shall have been provided for the Executive, together with his counsel, to be heard before the Board of Directors of the Company, and (C), if such termination is pursuant to clause (i) or (ii) above, delivery shall have been made to the Executive of a Notice of Termination from the Board of Directors stating that in the good faith opinion of a majority of the Board of Directors (excluding the Executive) he was guilty of conduct set forth in clause (i) or (ii) above and specifying the particulars thereof in detail; (c) the term "Good Reason" shall mean any of the following (without the Executive's express written consent): (i) after a Change in Control, the assignment to the Executive by the Company of duties inconsistent with the Executive's position, duties, responsibilities and status with the Company immediately prior to such Change in Control, or a change in the Executive's titles or offices as in effect immediately prior to such Change in Control, or any removal of the Executive from or any failure to reelect the Executive to any of such positions, except in connection with the termination of his employment for Disability, for Cause, as a result of the Executive's death or by the Executive other than for Good Reason: (ii) after a Change in Control, a reduction by the Company in the Executive's base salary as in effect on the date hereof or as the same may be increased from time to time during the Term of this Agreement, or the Company's failure after a Change in Control to increase (within 12 months of the Executive's last increase in base salary) the Executive's base salary by an amount which, on a percentage basis, is not more than two percentage points below the average percentage increase in base salary effected in the preceding 12 months 5 for all officers of the Company having severance compensation agreements similar to this Agreement; (iii) after a Change in Control, any failure by the Company to continue in effect any benefit plan or arrangement (including, without limitation, the Company's group life insurance plan, and medical, dental, accident and disability plans) in which the Executive is participating at the time of a Change in Control (or any other substitute plans providing the Executive with substantially similar benefits) (hereinafter referred to as "Benefit Plans"), or the taking of any action by the Company which would adversely affect the Executive's participation in or materially reduce the Executive's benefits under any such Benefit Plan or deprive the Executive of any material fringe benefit enjoyed by the Executive at the time of a Change in Control; (iv) after a Change in Control, any failure by the Company to continue in effect any incentive plan or arrangement (including, without limitation, the Company's Management Incentive Plan, and the right to receive performance awards and similar incentive compensation benefits) in which the Executive is participating at the time of a Change in Control (or any other substitute plans or arrangements providing him with substantially similar benefits) (hereinafter referred to as "Incentive Plans") or the taking of any action by the Company which would adversely affect the Executive's participation in any such Incentive Plan or reduce the Executive's benefits under any such Incentive Plan, expressed as a percentage of his base salary, by more than 10 percentage points in any fiscal year as compared to the immediately preceding fiscal year; (v) after a Change in Control, any failure by the Company to continue in effect any plan or arrangement to receive securities of the Company (including, without limitation, the Company's 1991 Restated Stock Option Plan and any other plan or arrangement to receive and exercise stock options, stock appreciation rights, restricted stock or grants thereof) in which the Executive is participating at the time of a Change in Control of the Company (or substitute plans or arrangements providing him with substantially 6 similar benefits) (hereinafter referred to as "Securities Plans") or the taking of any action by the Company which would adversely affect the Executive's participation in or materially reduce the Executive's benefits under any such Securities Plans; (vi) after a Change in Control, requirement by the Company of the Executive's relocation to any place other than the location at which the Executive performed the Executive's duties prior to a Change in Control, except for required travel by the Executive on the Company's business to an extent substantially consistent with the Executive's business travel obligations at the time of a Change in Control; (vii)after a Change in Control, any failure by the Company to provide the Executive with the number of paid vacation days to which the Executive is entitled at the time of a Change in Control; (viii)any material breach by the Company of any provision of this Agreement; (xi) any failure by the Company to obtain the assumption of this Agreement by any successor or assign of the Company in accordance with Section 7 hereof: or (x) any purported termination of the Executive's employment which is not effected pursuant to a Notice of Termination, and for purposes of this Agreement, no such purported termination shall be effective. (d) The term "Notice of Termination" shall mean a written notice which shall indicate those specific termination provisions in this Agreement relied upon and which sets forth in reasonable detail the facts and circumstances claimed to provide a basis for termination of the Executive's employment under the provision so indicated. For purposes of this Agreement, no such purported termination by the Company shall be effective without such Notice of Termination. (e) the term "Date of Termination" shall mean (i) if the Executive's employment is terminated by the Company for Disability, 30 days after Notice of Termination is 7 given to the Executive (provided that the Executive shall not have returned to the performance of the Executive's duties on a full-time basis during such 30-day period) or (b) if the Executive's employment is terminated by the Company for any other reason, the date on which a Notice Of Termination is given; PROVIDED that if within 30 days after any Notice of Termination is given to the Executive by the Company the Executive notifies the Company that a dispute exists concerning the Termination, the Date of Termination shall be the date the dispute is finally determined, whether by mutual agreement by the parties or upon final judgment, order or decree of a court of Competent jurisdiction (the time for appeal therefrom having expired and no appeal having been perfected). 4. Severance Compensation ---------------------- (a) Subject to the provisions of section 4 (b) below, and subject to the Executive's continuing compliance with the provisions of Section 6 hereof and the Agreement Regarding Confidential Information and Intellectual Property attached hereto as EXHIBIT A. the compensation and benefits payable to the Executive pursuant to this Agreement shall be the following (collectively the "Severance Benefits"): (i} The Company shall pay to the Executive in cash an amount equal to the Executive's aggregate compensation from the Company for the twelve (12) months ending upon the Change in Control. Such amount shall be payable by, the Company in twelve (12) equal monthly installments payable on the first day of each month commencing with the month following the Executive's Date of Termination. For purposes of this Section 4(a) (1), the Executive's "compensation" preceding a Change in Control shall include the Executive's base salary and any amounts paid or accrued pursuant to any Incentive Plans, but shall not include any amounts or benefits paid or accrued pursuant to any Benefit Plans or any Securities Plan nor shall it include the value of any other fringe benefits, (ii} Within thirty (30) days following the Date of Termination, the Company shall pay to the Executive, in a lump sum in cash, any accrued but unpaid salary, vacation and awards under any Incentive Plans earned but not paid as of the Date of Termination; 8 (iii) Effective not later than the Date of Termination, the Company shall (notwithstanding any contrary provision in any Securities Plan or any employment agreement) accelerate and make immediately exercisable in full all unvested options and other rights which the Executive holds under any Securities Plans as of the Date of Termination, and all such options and rights shall be exercisable for an exercise period of 60 days following the Date of Termination; and (iv) The Company at its own expense shall maintain in full force and effect for the Executive's continued benefit until the earlier of (i) two (2) years after the Date of Termination or (ii) the Executive's commencement of full-time employment with a new employer, medical and dental (but not life insurance or disability) plans, programs or arrangements in which the Executive was entitled to participate immediately prior to the Date of Termination, provided that his continued participation is possible under the general terms and provisions of such plans and programs. In the event that his participation in any such plan or program is barred, the Company shall arrange to provide the Executive with benefits substantially similar to those to which he was entitled to receive under such plans and programs. (b) Notwithstanding the foregoing, any Severance Benefits otherwise payable to the Executive hereunder shall be limited as follows: (I) No Severance Benefits shall be payable to the Executive under this Agreement to the extent that the total of such Severance Benefits and any payments otherwise payable to the Executive by the Company on or after a Change in Control, which would be deemed under Section 280(of the Internal Revenue Code of 1986 as amended (the "Code"), to constitute "parachute payments" without regard to Section 280G(b) (2) (A) (ii), would equal or exceed in their present value (as determined under Section 280G(d) (4) of the Code and any regulations thereunder) 300% of the Executive's base amount (as defined in Section 280G (b) (3) of the Code and regulations thereunder). In the event that the present value of such payments equals or exceeds such amount, the provisions set forth below will apply, and Severance Benefits payable to the Executive under this Agreement will be made only in accordance with this Section 4(b) notwithstanding any other provision to the contrary in this Agreement. 9 (ii) Not later than thirty (30) days after the Date of Termination, the Company will provide the Executive with a schedule specifying the present value of such Severance Benefits payable to the Executive under this Agreement (specifying the Section hereof under which each such payment is to be made) and any other payments otherwise payable to the Executive by the Company on or after the Change in Control which, in the Company's opinion, could constitute parachute payments under Section 280G. No payments under this Agreement shall be made until after thirty (30) days from the receipt of such schedule by the Executive. At any time prior to the expiration of said 30-day period, the Executive shall have the right to select from all or part of any category of payment to be made under this Agreement those payments to be made to the Executive in an amount the present value of which (when combined with the present value of any other payments otherwise payable to the Executive by the Company that may be deemed to be parachute payments) the Company determines is less than 300% of the Executive's base amount. If the Executive fails to exercise his right to make a selection, the selection shall be made by the Company. (iii)At any time prior to exercising the right to make a selection under paragraph (ii) of this Section 4(b), the Executive shall have the right to request that the Company obtain a ruling from the Internal Revenue Service ("Service") as to whether any or all payments listed on the schedule provided hereunder are, in the view of the Service, parachute payments under section 280G. Such ruling shall be sought made at the Company's expense unless, in the written opinion of independent counsel for the Company, there is no reasonable likelihood of obtaining a favorable ruling, in which event such expense shall be borne by the Executive. If a ruling is sought pursuant to such request, no Severance Benefit under this Agreement shall be paid to the Executive until after thirty (30) days from the date the Company provides the Executive with a copy of such ruling, and the period during which the Executive may exercise his right to make a selection under paragraph (ii) hereof shall be extended to a date thirty (30) days from such date. For purposes of this Section 4(b), the Executive and the Company hereby agree to be bound by the Service's ruling as to whether payments constitute parachute payments under Section 280G. If the Service declines, for any reason, to provide the ruling requested, the Company's 10 determination with respect to what payments constitute parachute payments shall control, and the period during which the Executive may exercise his right to make a selection under paragraph (ii) hereof shall be extended to a date thirty (30) days from the date of the Service's notice indicating that no ruling will be forthcoming. (iv) The references to Section 280G herein are specific references to Section 280G as amended to date. If Section 280G is amended prior to the expiration or termination of this Agreement, or replaced by a successor statute, the limitations imposed by this Section 4(b) upon payments to be made to the Executive under this Agreement shall be deemed modified without further action of the parties so as to provide only for such limitations that are consistent with such amendment(s) or successor statute(s), as the case may be. In the event that Section 280G, or any successor statute, is repealed, this Section 4(b) shall cease to be effective on the date of such repeal. The parties to this Agreement recognize that final Treasury Regulations under Section 280G may affect the amounts that may be paid hereunder and agree that, upon issuance of such final Regulations, this Agreement may be modified as in good faith deemed necessary in light of the provisions of such Regulations to achieve the purposes hereof, and that consent to such modification(s) shall not be unreasonably withheld 5. No Obligation To Mitigate Damages; No Effect on Other Contractual Rights. ------------------------------------------------------------------------ (a) The Executive shall not be required to mitigate damages or the amount of any payment provided for under this Agreement by seeking other employment or otherwise, nor shall the amount of any payment provided for under this Agreement be reduced by any compensation earned by the Executive as the result of employment by another employer after the Date of Termination, or otherwise. (b) The provisions of this Agreement, and any payment provided for hereunder, shall not reduce any amounts otherwise payable, or in any way diminish the Executive's existing rights, or rights which would accrue solely as a result of the passage of time, under any Benefit Plan, Incentive Plan or Securities Plan, employment agreement or other contract, plan or arrangement. 11 6. Non-Competition; Confidentiality. -------------------------------- (a) The Executive covenants and agrees that if the Executive shall become entitled to compensation hereunder as provided in Section 3 hereof, then for a period of twelve (12) months following the Date of Termination, the Executive shall not, without the Company's prior written consent, engage, directly or indirectly, in any work or other activity which is in competition with the business of the Company in the local area network or internetworking field in any geographical area in which the Company conducts or is then actively planning to conduct business at the Date of Termination. By way of example only of the types of activities prohibited hereby, the Executive shall not: solicit or accept (or assist any person or entity in soliciting or accepting) any business in the local area network or internetworking field from any person or entity who or which was an active account of the Company at the Date of Termination (b) Contemporaneously with the execution and delivery of this Agreement, the Executive and the Company shall enter into an Agreement Regarding Confidential Information and Intellectual Property in the Company's standard form, a copy of which is attached hereto as EXHIBIT A. 7. Successors. ---------- (a) The Company will require any successor or assign (whether direct or indirect, by purchase, merger, consolidation or otherwise) to all or substantially all of the business and/or assets of the Company, by agreement in form and substance satisfactory to the Executive, expressly, absolutely and unconditionally to assume and agree to perform this Agreement in the same manner and to the same extent that the Company would be required to perform it if no such succession or assignment had taken place. Any failure of the Company to obtain such agreement prior to the effectiveness of any such succession or assignment shall be a material breach of this Agreement and shall entitle the Executive to terminate the Executive's employment for Good Reason. As used in this Agreement, "Company" shall mean the Company as hereinbefore defined and any successor or assign to its business and/or assets as aforesaid which executes and delivers the agreement provided for in this Section 7 or which otherwise becomes bound by all the terms and provisions of this Agreement by operation of law. If at any time during the Term of this Agreement the Executive is employed by any corporation a majority of the Voting Power of which is then owned by the Company, directly or indirectly, "Company" as used in Sections 3,4 and 12 hereof shall in addition include such employer. In such event, the Company agrees that it shall pay or shall cause 12 such employer to pay any amounts owed to the Executive pursuant to Section 4 hereof (b) This Agreement shall inure to the benefit of and be enforceable by the Executive's personal and legal representatives, executors, administrators, successors, heirs, distributees, devisees and legatees. If the Executive should die while any amounts are still payable to him hereunder, all such amounts, unless otherwise provided herein, shall be paid in accordance with the terms of this Agreement to the Executive's devisee, legatee, or other designee or, if there be no such designee, to the Executive's estate. 8. NOTICE. For purposes of this Agreement, notices and all other communications provided for in the Agreement shall be in writing and shall be deemed to have been duly given when delivered in person (including by any commercial courier service) or three (3) days after mailing by United States certified or registered mail, return receipt requested, postage prepaid, to a party at his or its address set forth at the beginning of this Agreement or such other address as either party may have furnished to the other in writing in accordance herewith, except that notices of change of address shall be effective only upon receipt. 9. MISCELLANEOUS. No provisions of this Agreement may be modified, waived or discharged unless such waiver, modification or discharge is agreed to in writing signed by the Executive and the Company. No waiver by either party hereto at any time of any breach by the other party hereto of, or compliance with, any condition or provision of this Agreement to be performed by such other party shall be deemed a waiver of similar or dissimilar provisions or conditions at the same or at any prior or subsequent time. No agreements or representations, oral or otherwise, express or implied, with respect to the subject matter hereof have been made by either party which are not set forth expressly in this Agreement. This Agreement shall be governed by and construed in accordance with the laws of the Commonwealth of Massachusetts (without regard to conflicts of laws rules). 10. VALIDITY. The invalidity or unenforceability of any provisions of this Agreement shall not affect the validity or enforceability of any other provision of this Agreement, which shall remain in full force and effect 11. COUNTERPARTS. This Agreement may be executed in one or more counterparts, each of which shall be deemed to be an original but all of which together will constitute one and the same instrument. 13 12. LEGAL FEES AND EXPENSES. The Company shall pay all legal fees and expenses which the Executive may incur as a result of the Company's contesting the validity, enforceability or the Executive's interpretation of, or determinations under, this Agreement. 13. FURTHER ASSURANCES. The Company shall do, make, execute and deliver all such additional and further acts, things, assurances and instruments as the Executive may reasonably request in order to assure to the Executive his rights hereunder and to carry into effect the provisions and intent of this Agreement. Without limiting the generality of the foregoing, the Company shall, upon request of the Executive, convert any options under any Securities Plan which are "incentive stock options" into "non-qualified options" and amend outstanding option agreements in a manner not inconsistent with such Securities Plans IN WITNESS WHEREOF, the parties have executed this Severance Compensation Agreement as of the date first above written. PROTEON, INC. By: V.P. Sales ----------------------------- Title: /s/ William T. Greer ---------------------------------- Executive /s/ Daniel J. Capone, Jr. 3/11/96 14 EXHIBIT A --------- AGREEMENT REGARDING CONFIDENTIAL AND INTELLECTUAL PROPERTY [to be attached] EX-10.29 5 EMPLOYMENT AGREEMENT DATED 10-OCT-96 1 Exhibit 10.29 proteon Proteon. Inc - ------- Nine Technology Drive Westborough, MA 01581-1799 508 / 898-2800 October 16, 1996 Mr. Robert Connaughton 102 Den Quarry Road Lynn, MA 01904 Dear Bob: It is my pleasure to offer you the position of Vice President, Finance/Chief Financial Officer, Treasurer, General Counsel and Clerk reporting directly to me. As agreed, each of us reserves the right to make a final determination as to whether you continue in this capacity or continue in the position of Vice President, General Counsel and Clerk for Proteon. This discussion will take place no later than March 31, 1997. If the decision is made that you will not retain the duties of Chief Financial Officer and Treasurer, such action will not constitute constructive termination under this offer or the severance compensation agreement but thereafter will. The terms of our agreement will be as follows: - - BASE SALARY: You will receive an initial minimum annual base salary of $120,000, which will be reviewed annually. If you become Vice President, General Counsel and Clerk, salary will not be adjusted downward. - - BONUS: You will be eligible for an additional annual MIP bonus compensation of 40% of Base salary. ($48,000 annualized target on base salary of $120,000, for example). Payment of this bonus is based upon Proteon's Management Incentive Program. - - STOCK: A recommendation will be made to the Compensation Committee that you receive an option to purchase 25,000 shares of stock which vest over a 4 year period. - - SEVERANCE BENEFIT: A severance benefit of twelve (12) months salary and benefits, then current (base) continuation for you, should your position be involuntarily eliminated for any reason other than for cause, (as defined in the Severance Compensation Agreement), will be granted. Should you become employed at any time during payment of the severance year, such severance payments shall terminate except to the extent that base salary in your new employment is less than the installment position amount. In such event Proteon shall only be obligated to pay the amount equal to the difference of the balance of the severance period. If you are paid salary benefits under Section 4(a)(1) of the severance compensation agreement described below, you will not be entitled to receive the severance benefit described in this paragraph. 2 Upon acceptance of this offer, Proteon and you will execute a severance compensation and indemnification agreements in the respective forms upon which we agreed. Bob, I look forward to the contributions you will make in your new role at Proteon, and wish you great success. Please indicate your acceptance of this offer by signing below. Please return one copy of the signed offer letter. It is understood that the contents herein are confidential to both yourself and Proteon. Sincerely, /s/ Daniel J. Capone, Jr. - ---------------------------- Daniel J. Capone, Jr. President and C.E.O. Accepted by: /s/ Robert J. Connaughton, Jr. ------------------------------ Robert Connaughton proteon - ------- EX-10.30 6 SEVERANCE COMPENSATION AGREEMENT 1 EXHIBIT 10.30 SEVERANCE COMPENSATION AGREEMENT SEVERANCE COMPENSATION AGREEMENT dated as of October 21, 1996 and between PROTEON, INC. (the "Company"), a Massachusetts corporation with its principal offices at Nine Technology Drive Westborough, Massachusetts 01581, and Robert J. Connaughton, Jr. (the "Executive"), residing at 102 Den Quarry Road, Lynn Massachusetts 01904. WHEREAS, the Company's Board of Directors has recognized that the possibility of a change in control of the Company may cause uncertainty among the Company's senior management and may result in the departure or distraction of its senior management to the detriment of the Company and its stockholders; WHEREAS, the Company's Board of Directors has determined that it is appropriate to reinforce and encourage the continued attention and dedication of members of the Company's senior management, including the Executive, to their duties without distraction arising from the possibility of a change in control of the Company; WHEREAS, the Executive desires assurance as to his compensation and benefits in the event of any change in control of the company; NOW, THEREFORE, in consideration of the covenants and agreements herein contained and for other good and valuable consideration, the receipt and adequacy of which are hereby acknowledged, the Company and the Executive agree as follows: 1. TERM. This Agreement shall terminate, except to the extent that any obligation of the Company hereunder remains unpaid as such time, upon the earliest to occur of: (a) two (2) years from the date hereof; (b) the termination of the Executive's employment with the Company based on (i) the death of the Executive, (ii) the Disability of the Executive, (iii) termination by the Company for Cause, or (iv) termination by the Executive other than for Good Reason; and (c) one year after the date of a Change in Control. As used in this Agreement the term "Term" shall mean the period beginning on the date hereof and ending upon the earliest to occur of events specified above. 2 2. CHANGE IN CONTROL. No compensation shall be payable under this Agreement unless and until there shall have been a Change in Control. As used in this Agreement, the term "Change in Control" means that any of the following events has occurred: (i) any person (as defined in Section 3(a)(9) of the Securities Exchange Act of 1934, as amended (the "1934 Act")) (or any successor provision), becomes the beneficial owner (determined in accordance with Rule 13d-3 under the 1934 Act, or any successor provision) directly or indirectly, of more than fifty percent (50%) of the outstanding Common Stock of the Company or otherwise becomes entitled to vote more than fifty percent (50%) of the voting power entitled to be cast at elections for directors ("Voting Power") of the Company; (ii) there shall have been consummated any consolidation merger of the Company (A) in which the Company is not the continuing or surviving corporation unless such merger is with a corporation at least eighty percent (80%) of the Voting Power of which is held by the Company, or (B) pursuant to which the holders of the Company's shares of Common Stock immediately prior to such merger or consolidation are not the holders immediately after such merger or consolidation of at least a majority of the Voting Power of the entity resulting from such consolidation or merger; (iii) there shall have been consummated any sale, lease, exchange or other transfer (in one transaction or a series of related transactions) of all or substantially all of the assets of the Company; or (iv) during any period of two consecutive years, individuals who at the beginning of such period were members of the Board of Directors of the Company ceased for any reason to constitute a majority thereof, unless the election, or the nomination for election by the Company's stockholders, of each new director was approved by a vote of at least two-thirds of the directors still in office at the time of such election or nomination who were directors at the beginning of such Period. As used in this definition of Change in Control, "Common Stock" means the Common Stock, or if changed, the capital stock of the Company as it shall be constituted from time to time entitling the holders thereof to share generally in the distribution of all assets available for distribution to the Company's stockholders 2 3 after the distribution to any holders of capital stock with preferential rights. 3. TERMINATION FOLLOWING CHANGE IN CONTROL. The Executive shall be entitled to the compensation provided in Section 4 hereof upon the termination of the Executive's employment with the Company during the Term of this Agreement and after a Change in Control unless such termination is as a result of (i) the Executive's death, (ii) the Executive's Disability, (iii) termination by the Company for Cause, or (iv) termination by the Executive other than for Good Reason. As used in this Agreement, the following terms shall have the following meanings: (a) the term "Disability" shall mean that as a result the Executive's incapacity due to physical or mental illness or physical injury (excluding illness or injury which was caused by repeated substance abuse by the Executive), the Executive shall have been absent from his duties with the Company on a full-time basis (i] for a period of sixty (60) consecutive days or (ii) for an aggregate of ninety (90) days during any period of twelve (12) consecutive months; (b) the term "Cause" shall mean any of (i) the willful and continued failure by the Executive to perform his duties with the Company, other than any such willful continued failure resulting from his incapacity due to physical or mental illness or physical injury (provided that if such willful and continued failure resulted from illness or injury which was caused by repeated substance abuse by the Executive, then the foregoing exception for physical or mental illness or physical injury shall not be applicable), (ii) the willful or knowingly reckless engaging by the Executive in misconduct which is materially injurious to the Company, financially or otherwise, including, without limitation, willful breach by the Executive of any employment or other agreement between the Executive and the Company, or (iii) the conviction of the Executive of a felony by a court of competent jurisdiction. For the purposes of the foregoing, (x) the failure of the Company to achieve desired or projected results shall not constitute Cause, but Cause shall only mean and include acts and/or omissions by the Executive which are specified in clauses (i), (ii) and (iii) of the immediately preceding sentence, and (y) no act or failure to act on the part of the Executive shall be considered "willful" unless done or admitted to be done by him not in good faith and without reasonable belief that his action or omission was in the best interest 3 4 of the Company. Notwithstanding the first sentence of this subparagraph (b), the Executive's employment shall not be deemed to have been terminated for Cause unless (A) reasonable notice shall have been given to him setting forth in detail the reasons for the Company's intention to terminate for Cause and, if such termination is pursuant to clause (i) or (ii) above only if the Executive has been provided a period of five (5) business days from receipt of such notice to cease the actions or inactions, and if he has not done so (B) an opportunity shall have been provided for Executive, together with his counsel, to be heard before the Board of Directors of the Company, and (C) if such termination is pursuant to clause (i) or (ii) above, delivery shall have been made to the Executive of a Notice of Termination from the Board of Directors stating that in the good faith opinion of a majority of the Board of Directors (excluding the Executive) he was guilty of conduct set forth in clause (i) or (ii) above and specifying the particulars thereof in detail; (c) the term "Good Reason" shall mean any of the following (without the Executive's express written consent): (i) after a Change in Control, the assignment to the Executive by the Company of duties inconsistent with the Executive's position, duties, responsibilities and status with the Company immediately prior to such Change in Control, or change in the Executive's titles or offices as in effect immediately prior to such Change in Control, or any removal of the Executive from or any failure to reelect the Executive to any of such positions, except in connection with the termination of his employment for Disability, for Cause, as a result of the Executive's death or by the Executive other than for Good Reason: (ii) after a Change in Control, a reduction by the Company in the Executive's base salary as in effect on the date hereof or as the same may be increased from time to time during the Term of this Agreement, or the Company's failure after a Change in Control to increase (within 12 months of the Executive's last increase in base salary) the Executive's base salary by an amount which, on percentage basis, is not more than two percentage points below the average percentage increase in base salary effected in the preceding 12 months 4 5 for all officers of the Company having severance compensation agreements similar to this Agreement (iii) after a Change in Control, any failure by the Company to continue in effect any benefit plan or arrangement (including, without limitation, the Company's group life insurance plan, and medical, dental, accident and disability plans) in which the Executive is participating at the time of a Change in Control (or any other substitute plans providing the Executive with substantially similar benefits) (hereinafter referred to as "Benefit Plans"), or the taking of any action by the Company which would adversely affect the Executive's participation in or materially reduce the Executive's benefits under any such Benefit Plan or deprive the Executive of any material fringe benefit enjoyed by the Executive at the time of a Change in Control; (iv) after a Change in Control, any failure by the Company to continue in effect any incentive plan or arrangement (including, without limitation, the Company's Management Incentive Plan, and the right to receive performance awards and similar incentive compensation benefits) in which the Executive is participating at the time of a Change in Control (or any other substitute plans or arrangements providing him with substantially similar benefits) (hereinafter referred to as "Incentive Plans") or the taking of any action by the Company which would adversely affect the Executive's participation in any such Incentive Plan or reduce the Executive's benefits under any such Incentive Plan, expressed as a percentage of his base salary, by more than 10 percentage points in any fiscal year as compared to the immediately preceding fiscal year; (v) after a Change in Control, any failure by the Company to continue in effect any plan or arrangement to receive securities of the Company (including, without limitation, the Company's 199_ Restated Stock Option Plan and any other plan or arrangement to receive and exercise stock options, stock appreciation rights, restricted stock or grants thereof) in which the Executive is participating at the time of a Change in Control of the Company (or substitute plans or arrangements providing him with substantially 5 6 similar benefits) (hereinafter referred to as "Securities Plans") or the taking of any action by the Company which would adversely affect the Executive's participation in or materially reduce the Executive's benefits under any such Securities Plans; (vi) after a Change in Control, requirement by the Company of the Executive's relocation to any place other than the location at which the Executive performed the Executive's duties prior to a Change in Control, except for required travel by the Executive on the Company's business to an extent substantially consistent with the Executive's business travel obligations at the time of a Change in Control; (vii) after a Change in Control, any failure by the Company to provide the Executive with the number of paid vacation days to which the Executive is entitled at the time of a Change in Control; (viii) any material breach by the Company of any provision of this Agreement; (xi) any failure by the Company to obtain the assumption of this Agreement by any successor assign of the Company in accordance with Section 7 hereof: or (x) any purported termination of the Executive's employment which is not effected pursuant Notice of a Termination, and for purposes of this Agreement, no such purported termination shall be effective. (d) The term "Notice of Termination" shall mean a written notice which shall indicate those specific termination provisions in this Agreement relied upon and which sets forth in reasonable detail the facts and circumstances claimed to provide a basis for termination of the Executive's employment under the provision so indicated. For purposes of this Agreement, no such purported termination by the Company shall be effective without such Notice of Termination. (e) the term "Date of Termination" shall mean (i) if the Executive's employment is terminated by the Company for Disability, 30 days after Notice of Termination is 6 7 given to the Executive (provided that the Executive shall not have returned to the performance of the Executive's duties on a full-time basis during such 30 day period) or (b) if the Executive's employment is terminated by the Company for any other reason, the date on which a Notice Of Termination is given; PROVIDED that if within 30 days after any Notice of Termination is given to the Executive by the Company the Executive notifies the Company that a dispute exists concerning the Termination, the Date of Termination shall be the date the dispute is finally determined, whether by mutual agreement by the parties or upon final judgment, order or decree of a court of Competent jurisdiction (the time for appeal therefrom having expired and no appeal having been perfected) 4. Severance Compensation ---------------------- (a) Subject to the provisions of section 4 (b) below, and subject to the Executive's continuing compliance with the provisions of Section 6 hereof and the Agreement Regarding Confidential Information and Intellectual Property attached hereto as EXHIBIT A, the compensation and benefits payable to the Executive pursuant to this Agreement shall be the following (collectively the "Severance Benefits"): (i} The Company shall pay to the Executive in cash an amount equal to the Executive's aggregate compensation from the Company for the twelve (12) months ending upon the Change in Control. Such amount shall be payable the Company in twelve (12) equal monthly installment payable on the first day of each month commencing with the month following the Executive's Date of Termination. For purposes of this Section 4(a)(1), the Executive's "compensation" preceding a Change in Control shall include the Executive's base salary an any amounts paid or accrued pursuant to any Incentive Plans, but shall not include any amounts or benefits paid or accrued pursuant to any Benefit Plans or any Securities Plan nor shall it include the value of an other fringe benefits, (ii} Within thirty (30) days following the Date of Termination, the Company shall pay to the Executive, in a lump sum in cash, any accrued but unpaid salary, vacation and awards under any Incentive Plans earned but not paid as of the Date of Termination; 7 8 (iii) Effective not later than the Date of Termination, the Company shall (notwithstanding any contrary provision in any Securities Plan or any employment agreement) accelerate and make immediately exercisable in full unvested options and other rights which the Executive holds under any Securities Plans as of the Date of Termination, and all such options and rights shall be exercisable for an exercise period of 60 days following the Date of Termination; and (iv) The Company at its own expense shall maintain in full force and effect for the Executive's continued benefit until the earlier of (i) two (2) years after the Date of Termination or (ii) the Executive's commencement of full-time employment with a new employer, medical and dental (but not life insurance or disability) plans, programs or arrangements in which the Executive was entitled to participate immediately prior to the Date of Termination, provided that his continued participation is possible under the general terms and provisions of such plans and programs. In the event that his participation in any such plan or program is barred, the Company shall arrange to provide the Executive with benefits substantially similar to those which he was entitled to receive under such plan and programs. (b) Notwithstanding the foregoing, any Severance Benefits otherwise payable to the Executive hereunder shall be as limited follows: (I) No Severance Benefits shall be payable to the Executive under this Agreement to the extent that the total of such Severance Benefits and any payments otherwise payable to the Executive by the Company on or after a Change in Control, which would be deemed under Section 280(of the Internal Revenue Code of 1986 as amendment (the "Code"), to constitute "parachute payments" without regard to Section 280G(b) (2} (A)(ii), would equal or exceed in their present value (as determined under Section 280G(d)(4) of the Code and any regulations thereunder) 300% of the Executive's base amount (as defined in Section 280G (b) (3) of the Code and regulations thereunder). In the event that the present value of such payments equals or exceeds such amount, the provisions set forth below will apply, and Severance Benefits payable to the Executive under this Agreement will be made only in accordance with this Section 4(b) notwithstanding any other provision to the contrary in this Agreement. 8 9 (ii) Not later than thirty (30) days after the Date of Termination, the Company will provide the Executive with a schedule specifying the present value of such Severance Benefits payable to the Executive under this Agreement (specifying the Section hereof under which each such payment is to be made) and any other payment otherwise payable to the Executive by the Company on or after the Change in Control which, in the Company's opinion, could constitute parachute payments under Section 280G. No payments under this Agreement shall be made until after thirty (30) days from the receipt of such schedule by the Executive. At any time prior to the expiration of said 30-day period, the Executive shall have the right to select from all or part of any category of payment to be made under this Agreement those payments to be made to the Executive in an amount the present value of which (when combined with the present value of any other payments otherwise payable to the Executive by the Company that may be deemed be parachute payments) the Company determines is than 300% of the Executive's base amount. If the Executive fails to exercise his right to make a selection, the selection shall be made by the Company (iii) At any time prior to exercising the right to make a selection under paragraph (ii) of this Section 4(b), the Executive shall have the right to request that the Company obtain a ruling from the Internal Revenue Service ("Service") as to whether any or all payments listed on the schedule provided hereunder are, in the view of the Service, parachute payments under section 280G. Such ruling shall be sought made at the Company expense unless, in the written opinion of independent counsel for the Company, there is no reasonable likelihood of obtaining a favorable ruling, in which event such expense shall be borne by the Executive. If a ruling is sought pursuant to such request, no Severance Benefit under this Agreement shall be paid to the Executive until after thirty (30) days from the date the Company provides the Executive with a copy of such ruling, and the period during which the Executive may exercise his right to make a selection under paragraph (ii) hereof shall be extended to a date thirty (30) days from such date. For purposes of this Section 4(b), the Executive and the Company hereby agree to be bound by the Service's ruling as to whether payments constitute parachute payments under Section 280G. If the Service declines, for any reason, to provide the ruling requested, the Company's 9 10 determination with respect to what payments constitute parachute payments shall control, and the period during which the Executive may exercise his right to make selection under paragraph (ii) hereof shall be extended to a date thirty (30) days from the date of the Service's notice indicating that no ruling will be forthcoming. (iv) The references to Section 280G herein are specific references to Section 280G as amended to date. If Section 280G is amended prior to the expiration or termination of this Agreement, or replaced by a successor statute, the limitations imposed by this Section 4(b) upon payments to be made to the Executive under this Agreement shall be deemed modified without further action of the parties so as to provide only for such limitations that are consistent with such amendment(s) or successor statute(s), as the case may be. In the event that Section 280G, or any successor statute, is repealed, this Section 4(b) shall cease to be effective on the date of such repeal. The parties to this Agreement recognize that final Treasury Regulations under Section 280G may affect the amount that may be paid hereunder and agree that, upon issuance of such final Regulations, this Agreement may be modified as in good faith deemed necessary in light of the provisions of such Regulations to achieve purposes hereof, and that consent to such modification(s) shall not be unreasonably withheld 5. No Obligation To Mitigate Damages; No Effect on Other Contractual Rights. ------------------------------------------------------------------------ (a) The Executive shall not be required to mitigate damages or the amount of any payment provided for under this Agreement by seeking other employment or otherwise, nor shall the amount of any payment provided for under this Agreement be reduced by any compensation earned by the Executive as the result of employment by another employer after the Date of Termination, or otherwise (b) The provisions of this Agreement, and any payment provided for hereunder, shall not reduce any amounts otherwise payable, in any way diminish the Executive's existing rights, or rights which would accrue solely as a result of the passage of time, under any Benefit Plan, Incentive Plan or Securities Plan, employment agreement or other contract, plan or arrangement; PROVIDED, HOWEVER, IF THE EXECUTIVE ELECTS TO TAKE PAYMENT, AND IS PAID, UNDER SECTION 4(a)(i) HEREOF, SUCH SEVERANCE PAYMENTS SHALL BE IN LIEU OF ANY OTHER SEVERANCE PAYMENTS DUE FROM THE 10 11 COMPANY UNDER ANY EMPLOYMENT AGREEMENT OR OTHER CONTRACT, PLAN OR ARRANGEMENT WITH THE COMPANY. 6. Non-Competition; Confidentiality. -------------------------------- (a) The Executive covenants and agrees that if the Executive shall become entitled to compensation hereunder as provided in Section 3 hereof, then for a period of twelve (12) months following the Date of Termination, the Executive shall not, without the Company's prior written consent, engage, directly or indirectly, in any work or other activity which is in competition with the business of the Company in the local area network or internetworking field in any geographical area in which the Company conducts or is then actively planning to conduct business at the Date of Termination. By way of example only of the type of activities prohibited hereby, the Executive shall not solicit or accept (or assist any person or entity in soliciting or accepting) any business in the local area network or internetworking field from any person or entity who or which was an active account of the Company at the Date of Termination (b) Contemporaneously with the execution and delivery of this Agreement, the Executive and the Company shall enter into an Agreement Regarding Confidential Information and Intellectual Property in the Company's standard form, a copy of which is attached hereto as EXHIBIT A. 7. Successors. ---------- (a) The Company will require any successor or assign (whether direct or indirect, by purchase, merger, consolidation or otherwise) to all or substantially all of the business and/or assets of the Company, by agreement in form and substance satisfactory to the Executive, expressly, absolutely and unconditionally to assume and agree to perform this Agreement in the same manner and to the same extent that the Company would be required to perform it if no such succession or assignment had taken place. Any failure of the Company to obtain such agreement prior to the effectiveness of any such succession or assignment shall be a material breach of this Agreement and shall entitle the Executive to terminate the Executive's employment for Good Reason. As used in this Agreement, "Company" shall mean the Company as hereinbefore defined and any successor or assign to its business and/or assets as aforesaid which executes and delivers the agreement provided for in this Section 7 or which otherwise becomes bound by all the terms and provisions of this Agreement by operation of law. If at any time during the Term of this Agreement the Executive is employed by any corporation a majority of the Voting Power of which is then owned by the 11 12 Company, directly or indirectly, "Company" as used in Section 3,4 and 12 hereof shall in addition include such employer. In such event, the Company agrees that it shall pay or shall cause such employer to pay any amounts owed to the Executive pursuant to Section 4 hereof (b) This Agreement shall inure to the benefit of and be enforceable by the Executive's personal and legal representatives, executors, administrators, successors, heirs, distributees, devisees and legatees. If the Executive should die while any amounts are still payable to him hereunder, all such amounts, unless otherwise provided herein, shall be paid in accordance with the terms of this Agreement to the Executive's devisee, legatee, or other designee or, if there be no such designee, to the Executive's estate. 8. NOTICE. For purposes of this Agreement, notices and all other communications provided for in the Agreement shall be in writing and shall be deemed to have been duly given when delivered in person (including by any commercial courier service or three (3) days after mailing by United States certified or registered mail, return receipt requested, postage prepaid, to a party at his or its address set forth at the beginning of this Agreement or such other address as either party may have furnished to the other in writing in accordance herewith, except that notices of change of address shall be effective only upon receipt. 9. MISCELLANEOUS. No provisions of this Agreement may be modified, waived or discharged unless such waiver, modification or discharge is agreed to in writing signed by the Executive and the Company. No waiver by either party hereto at any time of a breach by the other party hereto of, or compliance with, any condition or provision of this Agreement to be performed by such other party shall be deemed a waiver of similar or dissimilar provisions or conditions at the same or at any prior or subsequent time. No agreements or representations, oral or otherwise, express or implied, with respect to the subject matter hereof have been made by either party which are not set forth expressly in this Agreement. This Agreement shall be governed by and construed in accordance with the laws of the Commonwealth of Massachusetts (without regard to conflicts of laws rules). 10. VALIDITY. The invalidity or unenforceability of any provisions of this Agreement shall not affect the validity or enforceability of any other provision of this Agreement, which shall remain in full force and effect 11. COUNTERPARTS. This Agreement may be executed in one or more counterparts, each of which shall be deemed to be an original but 12 13 all of which together will constitute one and the same instrument. 12. LEGAL FEES AND EXPENSES. The Company shall pay all legal fees and expenses which the Executive may incur as a result of the Company's contesting the validity, enforceability or the Executive's interpretation of, or determinations under, this Agreement. 13. FURTHER ASSURANCES. The Company shall do, make, execute and deliver all such additional and further acts, things, assurances and instruments as the Executive may reasonably request in order to assure to the Executive his rights hereunder and to carry into effect the provisions and intent of this Agreement. Without limiting the generality of the foregoing, the Company shall, upon request of the Executive, convert any options under any Securities Plan which are "incentive stock options" into "non-qualified options" and amend outstanding option agreements in a manner not inconsistent with such Securities Plans. IN WITNESS WHEREOF, the parties have executed this Severance Compensation Agreement as of the date first above written. PROTEON, INC. By: /s/ Daniel J. Capone, Jr. -------------------------------------- Daniel J. Capone, Jr. President and Officer Chief Executive /s/ Robert J. Connaughton, Jr. -------------------------------------- Robert J. Connaughton, Jr. 13 14 EXHIBIT A --------- AGREEMENT REGARDING CONFIDENTIAL AND INTELLECTUAL PROPERTY [to be attached] 14 15 RESOLUTION PROTEON BOARD OF DIRECTOR'S MEETING WEDNESDAY, OCTOBER 23, 1996 VOTED: The Directors hereby authorize and direct Daniel J. Jr., President and Chief Executive Officer of the Company to execute in the name and on behalf of the Company and deliver to the person named below a severance compensation agreement in the form attached to these minutes: Robert J. Connaughton, Jr. Vice President, Finance and Chief Financial Officer EX-11 7 COMPUTATION OF PER SHARE EARNINGS 1 EXHIBIT 11 PROTEON, INC. STATEMENT RE: COMPUTATION OF PER SHARE EARNINGS (in thousands, except per share amounts)
Twelve months ended December 31, December 31, December 31, 1996 1995 1994 ------------ -------------------- ------------ Net (Loss) Income $(12,014) $ 8,220 $(1,339) ======== ======= ======= Primary: Weighted average number of common shares outstanding 15,630 15,416 14,808 Weighted average common equivalent shares - 276 - -------- ------- ------- Weighted average number of common and common equivalent shares outstanding used to calculate per share data 15,630 15,692 14,808 ======== ======= ======= Fully diluted: Weighted average number of common shares outstanding 15,630 15,416 14,808 Weighted average common equivalent shares - 276 - -------- ------- ------- Weighted average number of common and common equivalent shares outstanding used to calculate per share data 15,630 15,692 14,808 ======== ======= ======= Net (loss) income per share Primary $ (0.77) $ 0.52 $ (0.09) ======== ======= ======= Fully diluted $ (0.77) $ 0.52 $ (0.09) ======== ======= =======
EX-13 8 ANNUAL REPORT TO SHAREHOLDERS 1 EXHIBIT 13 PROTEON, INC 1996 Annual Report Simplifying the future of [SYMBOL] Internet Intranet * WORKING for a new generation of network users OpenROUTE(R) Networks, Inc. 2 - -------------------- Financial Highlights - -------------------- - -----------------------------------------------------------------------------------
Years ended December 31, (in thousands, except per share data) 1996 1995 1994 - ----------------------------------------------------------------------------------- CONSOLIDATED STATEMENT OF OPERATIONS DATA: Net sales $ 45,296 $75,323 $93,912 Gross profit 19,626 38,659 45,764 Net (loss) income (12,014) 8,220 (1,339) Per share data: Net (loss) income (0.77) 0.52 (0.09) Weighted average number of common and common equivalent shares outstanding 15,630 15,692 14,808 CONSOLIDATED BALANCE SHEET DATA: Working capital $ 30,597 $39,006 $27,550 Total assets 45,571 59,029 56,911 Stockholders' equity 35,191 47,323 37,679
About Proteon, Inc. and its new subsidiary OpenROUTE(R) Networks, Inc. Founded in 1972 as a communication firm, Proteon is now known around the world as a true pioneer in the multi-billion dollar data communications industry. As a publicly held company since 1991, (NASDAQ:PTON), Proteon now distinguishes itself through its products as a leading provider of Remote Access connectivity solutions. Proteon products allow workers that are in small to medium sized businesses or remote offices of larger enterprises to connect themselves to each other through public networks such as the Internet, or their private corporate Intranet. OpenROUTE Networks, Inc., a wholly owned subsidary of Proteon, founded in January 1997, and headquarted in Westboro, Mass., focuses on Internet/Intranet solutions to help customers connect to the Internet. For nearly two decades, Proteon and now OpenROUTE Networks has shipped network connectivity products that help customers expand their networks and grow their businesses. Historically, products carrying the Proteon nameplate have been selected by more than 70 percent of the Fortune 100 companies. With its new subsidiary OpenROUTE Networks, Inc. Proteon is committed to providing best-in-class connectivity products that make the Internet and corporate Intranets more accessible, easier to use, and more secure for today's new generation of network users. 3 [Photo of Daniel J. Capone, Jr. President and Chief Executive Officer] TO OUR SHAREHOLDERS As the year 1996 came to a close, Proteon accomplished several significant business milestones. Chief among these was the formation of OpenROUTERegistration Mark Networks, Inc., a new wholly owned subsidiary of Proteon, Inc., headquartered along with its parent company in Westboro, Mass. OpenROUTE Networks was formed to strengthen the company's focus on the rapidly growing Internet and Intranet market and to develop and merchandise the company's award-winning GlobeTrotter router products to that market. The name OpenROUTE reflects the company's specific mission: to "Open Routes of access" to the exploding multi-media world of Internet/Intranet information for a new generation of business network users. Another event in 1996 was the decision to allow business partners to license intellectual property rights for local area networking products, including trademarks, manufacturing licenses, and access to other Proteon resources to develop products and services for the LAN marketplace. This is intended to allow Proteon to better serve its loyal base of LAN customers and give our new subsidiary, OpenROUTE Networks, a better opportunity to focus and gain market share in the rapidly expanding Internet and Intranet marketplace. We continued to expand our product line in the Internet/Intranet market with the introduction of breakthrough technology in GTSecure, our Firewall router. ISDN routers for Europe and Asia Pacific are another example of products now available. Our access routers continued to earn industry accolades. In a comprehensive industry test report released at the Networld+Interop trade show, OpenROUTE Networks' GlobeTrotter 70 won top honors in two important categories. Compared to more than 15 other products, the GlobeTrotter demonstrated outstanding performance in 1) best overall throughput of compressed data and 2) fastest ISDN call setup time. During the summer, the GlobeTrotter line also won a 1996 Users' Choice Award from Communications News magazine. These new product initiatives position Proteon and OpenROUTE Networks with a broad array of network connectivity solutions for workgroups seeking shared access to the Internet and corporate Intranets. Each is designed to deliver the company's basic values of technology excellence, reliability, ease of use, affordability, security, top performance and simplified network connections. 1996 FINANCIAL RESULTS For the year ended December 31, 1996, Proteon reported a net loss of $12,014,000, or $0.77 per share, compared with net income of $8,220,000, or $0.52 per share, for the previous year. Net sales for 1996 were $45,296,000, compared with $75,323,000 for 1995. These results reflect a $.21 per share charge to accomplish the restructuring of our business, and the formation of OpenROUTE Networks, Inc. Also, Remote Access routing products, although increasing in unit shipments, typically have much lower average selling prices than the corporate enterprise routers we previously sold. This shift in product mix was underway throughout the year and contributed to these results. We believe that as a result of the restructuring, we have now better aligned our expenses with our anticipated revenues. We ended the year with a very strong cash position of $23.5 million and no long-term debt. We are confident we have the financial resources to execute our business plan. 4 IMPORTANT BUSINESS PARTNERSHIPS Throughout 1996, Proteon announced a number of business partnerships that strengthen the company. We announced a prestigious partnership with NTT-AT Corporation of Japan, in which OpenROUTE Networks and NTT-AT provided the Japanese marketplace with a high-performance router that is already being distributed. Around the world, the company continued to sign strategic reseller agreements. Some of the names added to the list included SundayNET, EasyNET, SkyWorld, United Arm, Vossnet, SingNET, Tokyo Internet, Global Internet, Asia On Line, and ILK Internet. As 1997 unfolds, we expect to add to this list in national and international markets. THE INTERNET/INTRANET ACCESS COMPANY As we move toward the next century, our ongoing mission is to continue to make networks more accessible to a new generation of users. When I became president of Proteon three years ago, the company was serving many markets. I am happy to report to you that the company has dramatically narrowed its focus to a market that we believe holds the most opportunity for long-term growth and profitability. The achievements of 1996 are the latest of a list that include restructuring the company, developing a new set of products for the Internet/Intranet market, and establishing many new channel relationships. I believe our Company is now positioned to leverage its competencies and grow revenues in the exciting Internet/Intranet marketplace. In 1997, our most important priorities will be to restore the company to profitability and increase shareholder value by achieving product revenue momentum in the GlobeTrotter line. We are moving in the right direction. On behalf of our employees, I would like to thank all of our shareholders that have kept their confidence in our efforts. We have many goals to achieve, and your continued support is of the highest value to the Company. I look forward to updating you throughout the year on what I'm confident will be many successes. Sincerely, Daniel J. Capone, Jr. President and Chief Executive Officer March 21, 1997 [Symbol] 5 Proteon/OpenROUTE(R) NETWORKS: For The New Millennium "By the year 2000, every 12-year-old in America must be able to log on to the Internet....." Bill Clinton, President of the United States State of the Union Address "Our mission is to open routes to the exploding world of multimedia information for a new generation of network users." Dan Capone, President and CEO Proteon, Inc. and OpenROUTE Networks, Inc. Sales Meeting Address The two men quoted above share a vision of technology that is fundamentally changing the way the world communicates. It's called the Internet. And it's still in its infancy. When President Clinton delivered his State of the Union Address, he emphasized the importance of technology and, in particular, the Internet. In fact, President Clinton called for national educational standards that can be achieved only if students across the country grasp the power of getting on line and communicating through this powerful medium. When Daniel J. Capone Jr., President and CEO of Proteon/OpenROUTE Networks, Inc., addressed the company's [SYMBOL] 6 national sales meeting earlier this year, he also stressed the power of the Internet, and took the opportunity to introduce technology that makes it possible for students and businesses to tap into this vast information resource. The formation of OpenROUTE Networks, Inc. is an important step in the company's drive toward profitability and growth. The reference to "open" identifies OpenROUTE Networks mission: "Simplifying the future of Internet/Intranet WORKING for a new generation of network users by 'opening the way' to a New World of multimedia information." As the new year unfolds and technology companies position themselves for the next millennium, OpenROUTE Networks is building on Proteon's tradition in the networking business. Going forward, the Company will leverage its investment in the OpenROUTE brand and create market awareness that OpenROUTE Networks provides best-in-class products for traveling the many pathways of the Internet. While OpenROUTE Networks is being unveiled as a new company, it has a decade of leading edge technology innovation that gives it a clear advantage over many other competitors. The open, standards-based code found in all OpenROUTE Networks' products had its genesis more than a decade ago when Proteon was recognized as one of the original companies to develop internetworking software. Since that time, the Company has been enhancing the code and now complies with more than 100 industry standard networking transport technologies. When it comes to linking everyone to the Internet, this dependable connectivity is a critical factor. OpenROUTE software has been licensed and endorsed by many of the industry's top providers including IBM, Digital, Motorola, AT&T and PSINet. Today, companies worldwide are running more than 100,000 routers with "OpenROUTERegistration Mark inside". This diverse customer base encompasses more than a quarter million connected workgroups, serving millions of end users. OpenROUTE Networks products carry the Proteon tradition of excellence into the world of Internet access. The GlobeTrotter product line set the standard for dependable connectivity, price/performance, security, and ease of use. [PHOTO] 4 7 [PICTURE] "By the year 2000, every 12-year-old in America must be able to log on to the Internet....." Bill Clinton, President of the United States State of the Union Address 8 GLOBETROTTER Routers Help INTERNET WORKING Make PSINet A Worldwide Internet Service Provider One of the company's most important business goals for 1996 was to expand its presence as a leading supplier of Internet/Intranet connectivity products to Internet Service Providers worldwide. The first step toward this goal was realized early in the year when GlobeTrotter routers were certified to connect business users to PSINet's massive network. This certification was especially beneficial to OpenROUTE Networks because it began PSINet's connection of business and corporate users to the Internet, with GlobeTrotter routers. PSINet, headquartered in Herndon, Virginia, USA, is a leading provider of corporate Internet and Intranet connection services worldwide. Having helped more than 18,000 companies find the Internet solution that's right for their business, PSINet has played a critical role in redefining how today's new generation of network users work. As testimony to its success in helping businesses use their networks to grow and prosper, PSINet was the 1996 winner of Network Computing magazine's "Well Connected" award for Best Internet Access Provider. The successful business partnership between OpenROUTE Networks and PSINet is demonstrated by the way the two companies have worked together to make the Internet a safe place to conduct business. One example was the introduction of PSINet's "RouteWaller" network security service. Jointly developed by PSINet and OpenROUTE Networks, PSINet's service with OpenROUTE's GTSecure Firewall Router provides secure network access to business users. This capability is a critical enabling factor in the continuing acceptance of the Internet as a viable means of worldwide commerce. William L. Schrader, PSINet Chairman, President and Chief Executive Officer, explained his company's important relationship with OpenROUTE Networks: "As we launched PSINet and started to experience rapid growth, we began using connectivity [PHOTO] 6 9 products from a number of different vendors. One of the most critical pieces of equipment in making the customer connection is the router. With this device, all the users within the business being connected can equally share the power of the Internet." "With the explosive growth of our business, we needed to install equipment that works the first time every time." "From the first day we began testing, our engineers were impressed with the quality and performance of OpenROUTE Networks' products. We are now deploying GlobeTrotters at a rapid rate. The products are reliable and easy to install. The cost, performance, and guaranteed connectivity are the best in the industry. It's these products that have helped us provide our customers with the most reliable Internet access in the world. As we move forward and expand Internet connectivity to a whole new generation of users, we will continue to install GlobeTrotter routers. OpenROUTE Networks will make connecting to the Internet with PSINet as easy as plugging a phone into a wall jack." Proteon/OpenROUTE Networks and Internet*WORKING Racal Data Group:A Decade of Cooperation in Making Networks Work In the fast-paced, ever-changing world of global networking, these two companies are a steady force in enabling networks to perform at peak efficiency and help grow the businesses of customers who demand top performance and 100 percent reliability. This long relationship began more than a decade ago when Proteon, Inc. began supplying Token Ring networking products to Racal in the European marketplace. It has expanded from a reseller relationship to one which includes technology exchange and system/service integration. Most recently, Racal has become a licensee of OpenROUTE software, joining other licensees IBM, Digital, Motorola, and AT&T. During the past five years, Proteon, and now OpenROUTE Networks, and Racal Data Group have expanded their business relationship across North America and around the [PHOTO] 7 10 world. Together, they have connected thousands of worldwide users. Senior executives and sales personnel from both companies work diligently to focus on capturing the rapidly growing market for remote access routers. Products manufactured by Proteon/OpenROUTE Networks and installed and maintained by Racal Data Network Integration Group are the glue that binds remote sites to headquarters locations. Together, the two companies have been concentrating on areas which currently represent the hottest segments of growth, Small and Medium sized businesses, and Corporate Enterprise Remote Offices. While each market has distinct needs, OpenROUTE Networks and Racal Data Group have used their design and engineering skills and support services to meet user needs head on. Paul G. Kozlowski, Racal Chairman and Chief Executive Officer, commented on the various benefits of this long-standing cooperative business relationship. "The first thing that comes to mind about OpenROUTE Networks is the quality of the products they offer. Our network integration business in the U.S. has been installing OpenROUTE devices for more than 10 years and has continually found them to be reliable and easy to install and maintain. "In addition, OpenROUTE Networks' products are a cost and performance leader in their class. And, their commitment to standards-based engineering and conformance to industry standards in all their routers is world class." "Racal often works as a network integrator, necessitating the mixing and matching of products to our customers' existing networks. We have found that OpenROUTE Networks' products integrate with other standards-based products already installed." "Working together, Racal Data Group and OpenROUTE Networks continue to be successful in various areas of commercial business such as manufacturing, retail, and banking. Recently, we have used OpenROUTE Networks' products for applications in the state and local government marketplace. Racal has always held strength in this sector, and as government networks have migrated out to the remote and regional branch offices, we have remained committed to combining our services with the highest quality products that will enable us to maintain our position of strength." [PHOTO] 8 11 [PICTURE] "Our mission is to open routes to the exploding world of multimedia information for a new generation of network users." Dan Capone, President and CEO Proteon, Inc. and OpenROUTE Networks, Inc. Sales Meeting Address [LOGO] OPENROUTE NETWORKS, INC. 12 Corporate Volunteer Program Helps Students Explore The Fascinating World Of The Internet Proteon/OpenROUTE Networks participated in a number of ways in "Mass NetDay '96" a state sponsored multi-faceted corporate volunteer program launched across Massachusetts in 1996. President and CEO Daniel J. Capone. Jr. called upon headquarters' employees to volunteer support in their respective school districts. In fact Mr. Howard C. Salwen Proteon's Founder and Chairman has volunteered on the Board of Mass Networks, a non-profit organization which implemented "Mass Net Day' 96". The company donated time and equipment and participated in a "NetDay Store" allowing qualified schools to purchase Internet connectivity products at substantial savings helping thousands of young school children explore the fascinating world of the Internet and the World Wide Web. The company's involvement in the educational process began a decade ago when Proteon, Inc. began connecting universities. The company has always been interested in the education of the nation's students. For example, Proteon/OpenROUTE Networks has installed a massive, 800-router network for the Arkansas Public School Computer Network. This state-of-the-art network has been praised by both President Bill Clinton and Sen. Edward M. Kennedy. As school districts around the world accelerate their networking programs, OpenROUTE Networks is ready to provide simple, cost-effective equipment that makes those connections. Mr. Capone took a leadership role in the program when he visited a number of schools around the state. He met with school principals and headmasters, discussed the enormous power of the Internet as an educational tool, and even had the opportunity to install a number of networking hubs and routers. "It was exciting to work with public, parochial, and charter schools in our state. In one case we connected the town's library to the internet. Giving something back to the community is an important part of the culture at OpenROUTE Networks," said Mr. Capone. 13 - ----------------- Financial Section - ----------------- Selected Consolidated Financial Data 12 Management's Discussion and Analysis of Financial Condition and Results of Operations 13 Consolidated Balance Sheets 18 Consolidated Statements of Operations 19 Consolidated Statements of Stockholders' Equity 20 Consolidated Statements of Cash Flows 21 Notes to Consolidated Financial Statements 22 Report of Independent Accountants 30 Quarterly Financial Data 31 Stock Price History 31 Corporate Officers 32 Board of Directors 32 Corporate Information 33 11 14 - ------------------------------------- Selected Consolidated Financial Data - ------------------------------------- Consolidated Statement of Operations Data
- -------------------------------------------------------------------------------------- Years ended December 31, (in thousands, except per share data) 1996 1995 1994 1993 1992 - -------------------------------------------------------------------------------------- Net sales $45,296 $75,323 $93,912 $103,405 $120,294 Cost of sales 25,670 36,664 48,148 61,723 60,110 - -------------------------------------------------------------------------------------- Gross profit 19,626 38,659 45,764 41,682 60,184 Operating expenses: Research and development 9,353 8,802 11,162 15,481 13,985 Selling and marketing 15,486 17,903 23,955 31,778 28,522 General and administrative 4,590 4,683 7,065 10,222 8,150 Restructure costs 3,312 - 6,330 7,711 - - -------------------------------------------------------------------------------------- Total operating expenses 32,741 31,388 48,512 65,192 50,657 - -------------------------------------------------------------------------------------- (Loss) income from operations (13,115) 7,271 (2,748) (23,510) 9,527 Interest income (expense), net 1,261 1,437 455 330 655 Other income - - 1,205 - - - -------------------------------------------------------------------------------------- (Loss) income before income taxes (11,854) 8,708 (1,088) (23,180) 10,182 Provision (benefit) for income taxes 160 488 251 (3,385) 3,686 - -------------------------------------------------------------------------------------- (Loss) income before cumulative effect of accounting change (12,014) 8,220 (1,339) (19,795) 6,496 Cumulative effect of accounting change for income taxes - - - 452 - - -------------------------------------------------------------------------------------- Net (loss) income ($12,014) $8,220 ($1,339) ($19,343) $6,496 ====================================================================================== (Loss) income per share before cumulative effect of accounting change ($0.77) $0.52 ($0.09) ($1.36) $0.43 Cumulative effect per share - - - 0.03 - ====================================================================================== Net (loss) income per common and common equivalent share ($0.77) $0.52 ($0.09) ($1.33) $0.43 ====================================================================================== Weighted average number of common and common equivalent share outstanding 15,630 15,692 14,808 14,527 15,148 ====================================================================================== Consoliated Balance Sheet Data Working capital $30,597 $39,006 $27,550 $20,698 $35,591 Total assets 45,571 59,029 56,911 56,767 71,970 Stockholders' equity 35,191 47,323 37,679 36,739 55,946
12 15 - -------------------------------------------------------------------------------- Management's Discussion and Analysis of Financial Condition and Results of Operations - ------------------------------------------------------------------------------- The following discussion and analysis should be read in conjunction with the consolidated financial statements and notes thereto. Results of Operations During 1996, the Company continued to shift its product focus from the LAN and Corporate Enterprise business environments to that of Remote Access. The Company's operating groups increased their efforts to implement the engineering, product development, marketing and sales components of this strategic redirection. Proteon was faced with the challenge of maintaining service to its existing customers while striving to position itself in the rapidly growing Remote Access market. The initial effect of this ongoing redefinition of the Company was significant losses for 1996. Net Sales Product sales decreased by 37.9% to $32.2 million in 1996 from $51.8 million in 1995. This decline was due to the Company's redirection of its business and products. The Company experienced declining revenues in both its LAN products and Corporate Enterprise product categories. The decrease in LAN products net sales in 1996 was due primarily to continued lower average selling prices and declining unit volumes of Adapter Cards, Switches and Hubs. The Corporate Enterprise reduction was due to a planned reduction in CNX backbone routers as the Company shifts to remote access routers. Although in 1996 total units in the Remote Access category increased 63.3% from 1995 due primarily to GlobeTrotter sales which are typically lower average per unit sales prices, this increase was not enough to offset the decline in product revenues in the LAN and Corporate Enterprise categories. Software licensing sales in 1996 decreased by 47.3% to $7.5 million from $14.3 million in 1995. This anticipated reduction in software licensing revenue was a result of the continued decline in remaining revenue from the near completion of two major multi-year agreements with IBM and Digital Equipment Corporation. The Company expects software licensing revenue from these agreements to decrease quarterly as the contracts near completion. Service and other sales in 1996 decreased by 39.4% to $5.6 million from $9.2 million in 1995. This decrease was primarily due to the reduction in service spares and upgrades revenue worldwide as corporate enterprise sales decreased. Product sales in 1995 decreased by 31.7% to $51.8 million from $75.8 million in 1994. This decrease was due to continued competitive pressures in the Company's LAN and Internetworking businesses. In addition, the Company believes the transition of its product lines from an enterprise network supplier, with higher average selling prices, to a remote access supplier, with lower average selling prices, contributed to the decline in product revenue in 1995. In the Company's LAN business, the decrease in product sales resulted from a combination of a decline in unit volumes of its Token Ring adapters and low-end hubs and price reductions of approximately 20% for the Company's Token Ring adapters implemented in the first quarter of 1995. In the Company's Internetworking business, product sales decreased in 1995 due to product mix shifting from enterprise routers in 1994 to remote routers in 1995. Software licensing sales in 1995 increased by 57.0% from 1994 due principally to the achievement of certain milestones, and the consummation of three additional licensing agreements during 1995. Service and other sales increased slightly in 1995 by 2.2% to $9.2 million from $9.0 million in 1994 due mainly to an increase in maintenance agreements in the Asia-Pacific region. International sales accounted for approximately 38.3%, 35.7% and 35.1% of net sales in 1996,1995,and 1994, respectively. 13 16 Gross Profit Total gross profit margin decreased in 1996 to 43.3% from 51.3% in 1995. Certain offsetting factors contributed to the decrease in gross profit in 1996. Gross profit margin from the Company's software licensing and service and other sales increased in 1996 to 63.1% from 60.5% in 1995 due primarily to the decreased engineering efforts related to existing licensing agreements. Gross profit on product sales decreased in 1996 to 35.3% from 47.2% in 1995 due mainly to both declining margins and volume decreases in token ring adapter card segment of the LAN product category. During the fourth quarter of 1996, the Company recorded an additional inventory provision of $2.4 million to reflect further inventory exposures as the Company transitioned from LAN to remote products. Total gross profit increased in 1995 to 51.3% from 48.7% in 1994. Gross profit from software licensing and service and other sales increased in 1995 to 60.5% from 38.4% in 1994 due mainly to an increased margin associated with software licensing. Gross profit on product sales decreased in 1995 to 47.2% from 51.2% in 1994 due primarily to price reductions of the Company's Token Ring adapters and the transition in product mix to lower margin products associated with Remote Access markets. Research and Development Research and development expenses were $9.4 million or 20.6%, $8.8 million or 11.7%, and $11.2 million or 11.9% of net sales in 1996, 1995 and 1994, respectively. When comparing 1996 to 1995, the increase of $0.6 million in research and development expenses was due to the reallocation of engineering efforts from software licensing contracts to internally funded development. The decrease in expenses of $2.4 million in 1995 from 1994 was due to more research and development costs being allocated to cost of sales of Software licensing revenues. Major efforts in 1996 and 1995 included development of the GlobeTrotter series of routers, the RBX remote router, the CSX 900ER routing and switching product, the CSX 900E Ethernet switch/repeater, the CSX 901T Token Ring switch, and the Token Ring PCI adapter single and dual port configurations. The Company considers product development expenditures to be critical to future revenues. These activities are closely related to product enhancement and new product development. The Company's strategy also includes joint development partnerships to bring new technologies and products to market. All of the Company's research and development costs to date have been expensed as incurred. Selling and Marketing Selling and marketing expenses were $15.5 million or 34.2%, $17.9 million or 23.8%, and $24.0 million or 25.5% of net sales in 1996, 1995 and 1994, respectively. In 1996 sales and marketing expenses decreased by $2.4 million when compared to 1995. This decrease was due mainly to lower personnel and personnel-related costs as well as a reduction in advertising expenses for 1996. The decrease in expenses in 1995 from 1994 of $6.1 million was due principally to the reorganization of the Company's sales and marketing resources. During 1995 the Company reduced its sales and marketing personnel and personnel-related expenses by approximately 25%, while implementing an approximately $3.0 million end-user visibility campaign. This campaign included advertisements in trade publications, direct mail programs, and reseller literature. 14 17 General and Administrative General and administrative expenses were $4.6 million or 10.1%, $4.7 million or 6.2%, and $7.1 million or 7.5% of net sales in 1996, 1995 and 1994, respectively. During 1996, general and administrative expenses decreased by $0.1 million when compared to 1995. This slight decrease was due to a lower level of personnel and personnel-related costs for 1996. When comparing 1995 to 1994, the decrease in general and administrative expenses of $2.4 million was also due to a 28% reduction in personnel and personnel-related costs. Restructuring of Operations The Company's management continually reviews methods to reduce its expense base in response to decreased revenue streams. As a result of this review, the Company has implemented a series of restructurings, the most recent of which transpired in 1996. This restructuring of operations was necessary to reestablish the strategic direction of the Company and better align its operating expenses with anticipated revenues. During the fourth quarter of 1996, the Company's management announced a restructuring plan for the strategic redirection of the Company. The 1996 restructuring principally addressed the move toward the development of the OpenROUTE Networks subsidiary. The strategies for this new subsidiary are designed to allow the Company to aggressively focus its efforts on the rapidly growing Internet/Intranet connectivity marketplace. The Company is attempting to leverage its strengths in the OpenROUTE internetworking software and its successful line of GlobeTrotter Remote Access routers. The Company is concentrating its efforts on gaining more market share and increasing revenue. As a result, the Company recorded a $3,312,000 charge for restructuring costs in the fourth quarter of 1996. This included a reduction in the Company's work force of approximately forty employees, or 22%, accounting for approximately $140,000 of severance costs. The Company incurred a charge of approximately $785,000 in connection with the substantial reduction in the Company's occupancy requirements. In addition, the charge included approximately $1,922,000 for disposal of fixed assets and approximately $195,000 of other costs. In the second quarter of 1994, as a result of a significant strategic redirection the Company recorded an $11,230,000 charge for restructuring of operations. This included a reduction in the Company's workforce of ninety-two employees, or approximately 25%, accounting for approximately $1,672,000 of severance costs. The Company incurred a charge of approximately $6,215,000 for lease payments in connection with the substantial reduction in the Company's occupancy requirements. In addition, the charge included approximately $3,072,000 for the disposal of fixed assets and approximately $271,000 of other costs. In the fourth quarter of 1994, the Company recorded a benefit of approximately $4.9 million related to the reversal of certain previously accrued restructuring costs. The $4.9 million benefit included approximately $3.3 million resulting from a new tenant assuming direct lease responsibility for the Company's unused office space in its leased headquarters building. In addition, the Company reversed inventory costs, provided for the in the December 1993 restructuring of operations, of approximately $1.6 million related to its hub inventory. The reversal was due to better than expected sales of Series 90 hubs as the Company increased its focus on the remote-site hub market. During 1996, the cash impact from restructuring was immaterial. The remaining accrual of $1.7 million will be paid during 1997. During 1995, the cash impact from restructuring was approximately $1.9 million. 15 18 Other Income Other income of $1.2 million recorded in 1994 consisted of a one time refund of license payments paid in 1993 and 1992. The refund related to the favorable arbitration decision regarding the Company's claim that its Token Ring networking products did not infringe on the widely-licensed "Soderblom patent." The benefit of not having to accrue for these license payments has been reflected in the cost of goods sold since the beginning of 1994. Provision for Income Taxes In 1996, the Company recorded an income tax provision of $160,000, or 1.3%, primarily due to foreign taxes on income earned outside the United States. The difference between the effective tax rate and the statutory tax rate is due primarily to current year net operating losses whose future realization is uncertain. In 1995, the Company recorded an income tax provision of 5.6% principally associated with alternative minimum tax, and state and foreign taxes. The difference between the effective tax rate and the statutory tax rate in 1995 is due primarily to the utilization of net operating loss carryforwards in 1995. In 1994, the Company recorded an income tax provision of 23.1% related primarily to foreign taxes as a result of the income earned outside of the United States. 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 specifies the computation, presentation and disclosure requirements for earnings per share and is designed to improve earnings per share information by simplifying the existing computational guidelines, revising the disclosure requirements, and increasing the comparability of per share data on an international basis. FAS 129 requires the disclosure of certain information about an entity's capital structure which would include a brief discussion of rights and privileges for securities outstanding. These standards will be effective for financial statements for periods ending after December 15, 1997. The Company is currently reviewing the adoption and impact of these standards, but does not expect them to have a material impact on the Company's results of operations or its financial position. 16 19 Liquidity and Capital Resources During 1996, the Company's working capital decreased to $30.6 million from $39.0 million in 1995. Cash, cash equivalents and marketable securities constituted $23.5 million of the $30.6 million in working capital at December 31, 1996. Cash consumed by operating activities increased by $14.1 million in 1996 from 1995. This change was due mainly to the 1996 operating loss of $13.1 million and an increase in inventory of $4.3 million, partially offset by a reduction in accounts receivable of $4.5 million. Cash used in investing activities decreased by $5.6 million in 1996 from 1995. This decrease was due primarily to the net sale of marketable securities during 1996 of approximately $4.7 million. 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. Safe Harbor for Forward-Looking Statements This annual report, including the President's Letter and Management's Discussion and Analysis of Financial Condition and Results of Operations, 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 a number of factors including: business conditions within the networking industry; timing of orders from, and shipments to major customers; timing of new products introductions; acceptance of products in the marketplace; increased competition; changes in manufacturing costs; changes in the mix of product sales; and changes in world economic conditions. Other risk factors are listed from time to time in the required documents including the Company's annual report on Form 10-K filed with the SEC. 17 20 - --------------------------- Consolidated Balance Sheets - --------------------------- As of December 31, - ----------------------------------------------------------------------- (in thousands, except share data) 1996 1995 - ----------------------------------------------------------------------- ASSETS Current assets: Cash and cash equivalents $16,612 $25,829 Marketable securities 6,918 6,863 Accounts receivable less reserve for doubtful accounts of $672 and $889 at December 31, 1996 and 1995, respectively 7,625 12,138 Inventories 8,737 4,425 Deposits and other assets 1,085 1,457 - ----------------------------------------------------------------------- Total current assets 40,977 50,712 Property and equipment, net 4,594 8,317 - ----------------------------------------------------------------------- Total assets $45,571 $59,029 ======================================================================= LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable $3,010 $4,064 Accrued compensation 1,075 1,375 Accrued expenses 3,560 4,249 Accrued restructuring costs 1,661 457 Accrued warranty 1,074 1,561 - ----------------------------------------------------------------------- Total current liabilities 10,380 11,706 Commitments (Note F) - - Stockholders' equity: Preferred stock, par value $.01 per share, authorized 7,500,000 shares - - Common stock, par value $.01 per share, authorized 30,000,000 shares, issued 15,637,670 and 15,589,330 shares at December 31, 1996 and 1995, respectively 156 156 Capital in excess of par value 49,292 49,141 Accumulated deficit (13,819) (1,805) Cumulative translation adjustments 177 118 Less treasury stock, at cost, 210,685 and 80,685 shares at December 31, 1996 and 1995, respectively (615) (287) - ----------------------------------------------------------------------- Total stockholders' equity 35,191 47,323 - ----------------------------------------------------------------------- Total liabilities and stockholders' equity $45,571 $59,029 ======================================================================= The accompanying notes are an integral part of the consolidated financial statements. 18 21 - ------------------------------------- Consolidated Statements of Operations - ------------------------------------- For the years ended December 31, - -------------------------------------------------------------------------------- (in thousands, except per share data) 1996 1995 1994 - -------------------------------------------------------------------------------- Sales: Product $ 32,175 $ 51,810 $ 75,817 Software licensing 7,530 14,284 9,098 Service and other 5,591 9,229 8,997 - -------------------------------------------------------------------------------- Net sales 45,296 75,323 93,912 Cost of sales: Product 20,825 27,373 36,996 Software licensing 538 2,656 2,300 Service and other 4,307 6,635 8,852 - -------------------------------------------------------------------------------- Cost of sales 25,670 36,664 48,148 - -------------------------------------------------------------------------------- Gross profit 19,626 38,659 45,764 Operating expenses: Research and development 9,353 8,802 11,162 Selling and marketing 15,486 17,903 23,955 General and administrative 4,590 4,683 7,065 Restructure costs 3,312 -- 6,330 - -------------------------------------------------------------------------------- Total operating expenses 32,741 31,388 48,512 - -------------------------------------------------------------------------------- (Loss) income from operations (13,115) 7,271 (2,748) Interest income 1,271 1,490 513 Interest expense (10) (53) (58) Other income -- -- 1,205 - -------------------------------------------------------------------------------- (Loss) income before income taxes (11,854) 8,708 (1,088) Provision for income taxes 160 488 251 - -------------------------------------------------------------------------------- Net (loss) income ($12,014) $ 8,220 ($ 1,339) ================================================================================ Net (loss) income per common and common equivalent share ($ 0.77) $ 0.52 ($ 0.09) ================================================================================ Weighted average number of common and common equivalent shares outstanding 15,630 15,692 14,808 ================================================================================ The accompanying notes are an integral part of the consolidated financial statements. 19 22 - ----------------------------------------------- Consolidated Statements of Stockholders' Equity - -----------------------------------------------
Common stock ------------------------------- Capital in Cumulative Treasury stock Total excess of Accumulated translation ----------------- stockholders' (in thousands) Shares Amount par value deficit adjustment Shares Amount equity - ------------------------------------------------------------------------------------------------------------------------------- Balance, December 31, 1993 14,684 $147 $45,504 ($ 8,686) ($208) 36 ($ 18) $36,739 Issuance of common stock 631 6 2,380 2,386 Conversion of treasury stock 45 (269) (269) Currency translation 162 162 Net loss (1,339) (1,339) - ------------------------------------------------------------------------------------------------------------------------------- Balance, December 31, 1994 15,315 153 47,884 (10,025) (46) 81 (287) 37,679 Issuance of common stock 274 3 1,257 1,260 Currency translation 164 164 Net income 8,220 8,220 - ------------------------------------------------------------------------------------------------------------------------------- Balance, December 31, 1995 15,589 156 49,141 (1,805) 118 81 (287) 47,323 Issuance of common stock 48 151 151 Repurchase of stock as treasury stock 130 (328) (328) Currency translation 59 59 Net loss (12,014) (12,014) - ------------------------------------------------------------------------------------------------------------------------------- Balance, December 31, 1996 15,637 $156 $49,292 ($13,819) $177 211 ($615) $35,191 ===============================================================================================================================
The accompanying notes are an integral part of the consolidated financial statements. 20 23
- ------------------------------------- Consolidated Statements of Cash Flows - ------------------------------------- For the years ended December 31, - -------------------------------------------------------------------------------- (in thousands) 1996 1995 1994 - -------------------------------------------------------------------------------- Cash flows from operating activities: Cash received from customers 49,810 $75,172 $94,360 Cash paid to suppliers and employees (58,311) (69,724) (85,139) Interest received 1,271 1,490 514 Interest paid (10) (53) (58) Income taxes paid (321) (344) (206) Other cash received - - 3,975 - -------------------------------------------------------------------------------- Net cash (consumed) generated by operating activities (7,561) 6,541 13,446 Cash flows from investing activities: Proceeds from the sale of fixed assets 117 82 163 Capital expenditures (1,600) (2,411) (3,159) Marketable securities sales and maturities 15,456 7,120 7,396 Marketable securities purchases (15,511) (11,883) (6,289) - -------------------------------------------------------------------------------- Net cash used in investing activities (1,538) (7,092) (1,889) Cash flows from financing activities: Proceeds from the issuance of common stock 151 1,260 2,116 Purchase of treasury stock (328) - - - -------------------------------------------------------------------------------- Net cash (used) provided by financing activities (177) 1,260 2,116 Effect of exchange rate changes on cash 59 164 162 - -------------------------------------------------------------------------------- Net (decrease) increase in cash and cash equivalents (9,217) 873 13,835 Cash and cash equivalents at beginning of year 25,829 24,956 11,121 - -------------------------------------------------------------------------------- Cash and cash equivalents at end of year $16,612 $25,829 $24,956 - -------------------------------------------------------------------------------- Reconciliation of net (loss) income to net cash (consumed) generated by operating activities: Net (loss) income ($12,014) $8,220 ($1,339) - -------------------------------------------------------------------------------- Adjustments to reconcile net (loss) income to net cash (consumed) generated by operating activities: Bad debt provision - - 348 Inventory provision 2,374 - - Depreciation and amortization 3,401 4,185 5,824 Restructuring cost 1,922 - 1,958 (Gain) loss on disposition of fixed assets (117) (44) 3,085 Changes in assets and liabilities: Decrease (increase) in accounts receivable 4,513 (152) 447 (Increase) decrease in inventories (6,686) 598 4,536 Decrease in deposits and other assets 372 1,260 1,340 Decrease in accounts payable and accrued expenses (1,326) (7,526) (2,753) - -------------------------------------------------------------------------------- Total adjustments 4,453 (1,679) 14,785 - -------------------------------------------------------------------------------- Net cash (consumed) generated by operating activities ($7,561) $6,541 $13,446 ================================================================================ Noncash investing and financing activities: Conversion of common stock to treasury stock - - ($269) ================================================================================
The accompanying notes are an integral part of the consolidated financial statements. 21 24 - ------------------------------------------ Notes To Consolidated Financial Statements - ------------------------------------------ A. Nature of Operations Nature of Operations Proteon, Inc. and its subsidiaries including its new wholly owned subsidiary OpenROUTE Networks, Inc. develops, markets, and supports a wide range of networking products that encompass the Local Area Networking and Remote Access components of the networking industry. The Company's principal markets include North America, Europe and the Far East. B. Summary of Significant Accounting Policies Use of Estimates To prepare the financial statements in conformity with generally accepted accounting principles, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. In particular, the Company records reserves for estimated product returns and regarding the collectibility of accounts receivable. Actual results could differ from the estimates and assumptions used by management. Principles of Consolidation The consolidated financial statements include the accounts of the Company and its subsidiaries including its new wholly owned subsidiary OpenROUTE Networks, Inc. All intercompany transactions have been eliminated in consolidation. Revenue Recognition The Company recognizes revenue from product sales upon shipment of the product. Revenue from service agreements is recognized ratably over the term of the agreement. Revenue from software licensing is recognized upon performance of milestones when collectibility is reasonably assured. Revenue from development contracts is recognized under the percentage-of-completion method of accounting as costs are incurred. Provisions for estimated losses on contracts are recorded in the period when such losses are determined. Significant Customers and Export Sales In 1996, 1995 and 1994, net sales to one customer accounted for approximately 14%, 12% and 11%, respectively. A second customer accounted for approximately 14% and 10% of net sales in 1996 and 1995, respectively. The Company had international sales of approximately $17,355,000, $26,884,000 and $32,985,000 in 1996, 1995 and 1994 respectively. The Company had export sales of approximately $11,698,000, $18,548,000 and $28,572,000 in 1996, 1995 and 1994, respectively. Of these export sales, sales into Europe were approximately $8,185,000, $13,089,000 and $15,799,000 in 1996, 1995 and 1994, respectively. Export sales do not include direct sales from the Company's foreign subsidiaries. Translation of Foreign Currencies The Company has designated the local currency as the functional currency for all foreign locations. Accordingly, assets and liabilities of all foreign subsidiaries are translated at year-end rates of exchange, and income statement accounts are translated at average rates of exchange. The resulting translation adjustments are excluded from net earnings, and accumulated as a separate component of stockholder's equity. Foreign currency transaction gains and losses are included in results of operations in the periods in which they occur, and are immaterial for all periods presented. Cash, Cash Equivalents, and Marketable Securities The Company considers all highly liquid instruments purchased with a maturity of three months or less to be cash equivalents. Marketable securities consist of highly liquid U.S. Government and commercial paper obligations with maturities of more than three months when purchased. Investments are stated at cost, plus accrued interest, which 22 25 approximates fair market value. In addition, the Company classifies all investments as available-for-sale securities. Realized gains and losses are determined on the specific identification method and are included in interest income or expense. The portfolio at December 31, 1996 matures at various dates through December 31, 1997. Inventories Inventories are stated at the lower of cost or market, with cost determined under the first-in, first-out method. Property and Equipment Property and equipment are stated at cost. Depreciation and amortization of property and equipment are computed principally using the straight-line method over the estimated useful lives of the assets as follows: Machinery and equipment 1 - 5 years Furniture and fixtures 7 years Leasehold improvements shorter of lease term or estimated useful life Maintenance and repairs are charged to expense as incurred. Upon retirement or sale, the cost of the disposed assets and the related accumulated depreciation are removed from the accounts and any resulting gain or loss is credited or charged to income. Income Taxes Deferred tax assets and liabilities reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. A valuation allowance is provided for the net deferred tax assets if, based on the weighted available evidence, it is more likely than not that some or all of the deferred tax assets will not be realized. Accrued Warranty The Company provides an accrual for future warranty costs based upon the relationship of prior years' sales to actual warranty costs which approximates expected future warranty costs. Research and Development Cost incurred in the research and development of software products are expensed as incurred until the technological feasibility of the product has been established. After technological feasibility is established, any additional costs would be capitalized. As the Company believes the current process for developing software is essentially completed concurrently with the establishment of technological feasibility, no costs have been capitalized to date. Concentrations of Credit Risk Financial instruments, which potentially subject the Company to concentration of credit risk, are principally cash and cash equivalents, marketable securities, and accounts receivable. The Company places its investments in highly rated financial institutions and, by policy, limits the amount of credit exposure to any one financial institution. Concentration of credit risk with respect to accounts receivable is limited to certain customers with whom the Company makes substantial sales. Two customers accounted for approximately 30% and 39% of the Company's outstanding accounts receivable at December 31, 1996 and 1995, respectively. To reduce credit risk, the Company performs ongoing credit evaluation, account monitoring procedures and maintains reserves for potential losses. These losses have been within management's expectations. 23 26 Net Income (Loss) Per Common And Common Equivalent Share Net income (loss) per share is computed based on the weighted average number of common shares and common share equivalents outstanding during each year. 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 1996 and 1994 calculations as they would be anti-dilutive. 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 specifies the computation, presentation and disclosure requirements for earnings per share and is designed to improve earnings per share information by simplifying the existing computational guidelines, revising the disclosure requirements, and increasing the comparability of per share data on an international basis. FAS 129 requires the disclosure of certain information about an entity's capital structure which would include a brief discussion of rights and privileges for securities outstanding. These standards will be effective for financial statements for periods ending after December 15, 1997. The Company is currently reviewing the adoption and impact of these standards, but does not expect them to have a material impact on the Company's results of operations or its financial position. C. Investments Investments classified as current assets were as follows:
December 31, - -------------------------------------------------------------------------------- (in thousands) 1996 1995 - -------------------------------------------------------------------------------- Cash equivalents: U.S. Government securities $ - $160 Repurchase agreements 1,950 1,886 Mutual Funds 6,750 3,000 Commercial paper 2,448 16,509 - -------------------------------------------------------------------------------- Total cash equivalents $11,148 $21,555 ================================================================================ Marketable securities: U.S. Government securities $4,000 $ - Commercial paper 2,918 6,863 - -------------------------------------------------------------------------------- Total marketable securities $6,918 $6,863 ================================================================================ D. Inventories Inventories consist of: December 31, - -------------------------------------------------------------------------------- (in thousands) 1996 1995 - -------------------------------------------------------------------------------- Raw materials $1,373 $134 Work in process 718 405 Finished goods 6,646 3,886 - -------------------------------------------------------------------------------- Total inventories $8,737 $4,425 ================================================================================
During the fourth quarter of 1996, the Company recorded an additional inventory provision of $2.4 million to reflect further inventory exposures as the Company transitioned from LAN to remote products. 24 27 E. Property and Equipment Property and equipment consist of: December 31, - -------------------------------------------------------------------------------- (in thousands) 1996 1995 - -------------------------------------------------------------------------------- Machinery and equipment $12,083 $27,894 Furniture and fixtures 572 1,755 Leasehold improvements 970 2,226 - -------------------------------------------------------------------------------- 13,625 31,875 Less accumulated depreciation and amortization 9,031 23,558 - -------------------------------------------------------------------------------- Property and equipment, net $4,594 $8,317 ================================================================================ F. Commitments Letter of Credit The Company has an outstanding letter of credit of approximately $288,000 at December 31, 1996 and 1995. This letter of credit which matures on April 30, 2002, automatically renews annually on December 31. This letter of credit collateralizes the Company's obligation to a third party for a certain lease transaction. The fair value of this letter of credit is estimated to be the same as the contract amount. Operating Leases The Company leases its office and manufacturing facilities under operating leases expiring at various dates through 2002. Under certain leases the Company is obligated to pay taxes, repairs, and other operating costs. 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. Rental expense amounted to approximately $1,556,000, $1,666,000 and $3,879,000 in 1996, 1995 and 1994, respectively. At December 31, 1996, future rental commitments are as follows: - -------------------------------------------------------------------------------- (in thousands) - -------------------------------------------------------------------------------- 1997 $1,338 1998 1,177 1999 1,081 2000 1,048 2001 1,029 Thereafter 343 - -------------------------------------------------------------------------------- Total $6,016 ================================================================================ G. Capital Stock Common Stock The Company has an Employee Stock Purchase Plan ("Purchase Plan") available to most full time employees. Under this plan, 600,000 shares of common stock were reserved for issuance. Eligible employees may designate not more than 5% of their cash compensation to be deducted each pay period for the purchase of common stock under the Purchase Plan. The purchase price of the shares under the plan is at the lower of 85% of the fair market value per share, as defined by the plan, as of the date the option is exercised. Typically, the exercise date is six months after the date of the grant. The Company sold 41,628 shares and 30,140 shares to the employees in 1996 and 1995, respectively, under the plan. At December 31, 1996, 320,834 shares remained unissued under the plan. The weighted average fair value of the purchase right to a share of Company stock under the plan was estimated to be $1.65 and $1.94 for 1996 and 1995, respectively. No compensation cost has been recognized for shares purchased. 25 28 The Company has an employee stock award plan to recognize contributions made by employees of the Company. Under this plan, employees are granted shares of the Company's common stock from the Company's treasury shares. The company has reserved 25,000 shares of common stock for such issuance. The market value of shares awarded under the plan has been recorded as stock grant compensation. No such shares have been issued since 1993 and as of December 31, 1996 18,800 shares were available for award. Preferred Stock In 1991, the Shareholders approved the authorization of 7,500,000 shares of preferred stock. The Board of Directors is authorized, subject to any limitations prescribed by law, to issue from time to time such shares of preferred stock in one or more series. Each such series of preferred stock will have such number of shares, designations, preferences, voting power, qualifications, and special or private rights or privileges as shall be determined by the Board of Directors, which may include, among others, dividend rights, voting rights, preemptive and sinking fund provisions, liquidation preferences, conversion rights and preemptive rights. No such shares have been issued to date. Stock Options The Company's stock option plans generally provide for the granting to employees of incentive stock options to purchase shares of common stock at the fair market value as defined by the plan on the date of grant of non-qualified stock options at no less than 50% of the fair market value as defined by the plan on the date of the grant. To date the Company has never issued non-qualified stock options at an exercise price less than the fair market value on the date of the grant. Generally, options become exercisable at the rate of 25% at the end of each of the four years beginning on the first anniversary of the grant. Options issued prior to June, 1991 generally expire five years from the date of grant, or thirty days from the date of termination of employment. Options issued subsequent to June 1991 generally expire ten years from the date of grant, or ninety days from the date of termination of employment. As of December 31, 1996, 4,384,000 shares of common stock were reserved under the plans and 835,796 shares were available for grant. In September 1996, the Compensation Committee of the Board of Directors, pursuant to the authority granted under the Company's 1991 Restated Stock Option Plan, voted to allow employees of the Company holding options with exercise prices greater than $3.625 per share to exchange those options for substitute options having an option exercise price of $3.625 per share. In October 1996, 707,154 options were surrendered by employees and exchanged for new options at the new option exercise price and vesting schedule. A summary of the status of the Company's stock plans as of December 31, 1996, 1995 and 1994, and changes during the years ended on those dates is presented below:
1996 1995 1994 - ----------------------------------------------------------------------------------------------------------- Weighted- Weighted- Weighted- Average Average Average Number Exercise Number Exercise Number Exercise of Options Price of Options Price of Options Price - ----------------------------------------------------------------------------------------------------------- Outstanding at the beginning of the year 1,237,649 $5.52 1,446,597 $5.37 1,962,859 $5.49 Granted 1,245,726 4.11 404,700 6.76 . 1,069,725 5.17 Exercised (6,712) 4.01 (218,875) 4.72 (561,289) 3.74 Cancelled (1,204,654) 6.23 (394,773) 6.67 (1,024,698) 6.22 - ----------------------------------------------------------------------------------------------------------- Outstanding 1,272,009 $3.34 1,237,649 $5.52 1,446,597 $5.37 - ----------------------------------------------------------------------------------------------------------- Options exercisable at year-end 522,604 $3.41 440,778 $5.44 480,709 $5.78
26 29 Weighted-average fair value of options granted during the year $2.78 $4.70 The exercise prices of the options outstanding as of December 31, 1996 ranged from $2.64 to $3.63 and had a weighted average contractual life of 8 years and 9 months. Pro Forma Impact of SFAS 123 In October 1995 the FASB issued SFAS 123, "Accounting for Stock-Based Compensation." SFAS 123 is effective for periods beginning after December 15, 1995. SFAS 123 requires that companies either recognize compensation expense for grants of stock, stock options, and other equity instruments based on fair value, or provide pro forma disclosure of net income and earnings per share in the notes to the financial statements. The Company adopted the disclosure provisions of SFAS 123 in 1996 and has applied APB Opinion 25 and related interpretations in accounting for its plans. Had compensation cost for the Company's stock-based compensation plans been determined based on the fair value at the grant dates as calculated in accordance with SFAS 123, the Company's net income and earnings per share for the years ended December 31, 1996 and 1995 would have been reduced to the pro forma amounts indicated below: 1996 1995 (Loss) Earnings Net (loss) Per Share Net Income Per Share - -------------------------------------------------------------------------------- As Reported ($12,014) ($0.77) $8,220 $0.52 Pro Forma ($12,627) ($0.81) $8,011 $0.51 - -------------------------------------------------------------------------------- The fair value of each stock option is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions for 1995 and 1996: an expected life of six years, expected volatility of 75%, and no dividends assumed. The weighted average assumptions for the risk-free interest rates for 1996 and 1995 were 6.32% and 6.58% respectively. The effects of applying SFAS 123 in this pro forma disclosure are not indicative of future amounts. SFAS 123 does not apply to awards prior to 1995, and additional awards in future years are anticipated. 27 30 H. Restructuring of Operations During the fourth quarter of 1996, the Company's management announced a restructuring plan for the strategic redirection of the Company. The restructuring principally addressed the move toward the continued development of the OpenROUTE Networks subsidiary. The strategies for this new subsidiary are designed to allow the Company to aggressively focus its efforts on the rapidly growing Internet/Intranet connectivity marketplace. The Company is attempting to leverage its strengths in the OpenROUTE internetworking software and its successful line of GlobeTrotter Remote Access routers. The Company is concentrating its efforts on gaining more market share and increasing revenue. As a result, the Company recorded a $3,312,000 charge for restructuring costs in the fourth quarter of 1996. This included a reduction in the Company's work force of approximately forty employees, or 22%, accounting for approximately $410,000 of severance costs. The Company incurred a charge of approximately $785,000 in connection with the substantial reduction in the Company's occupancy requirements. In addition, the charge included approximately $1,922,000 for disposal of fixed assets and approximately $195,000 of other costs. In the second quarter of 1994, as a result of a significant strategic redirection, the Company recorded an $11,230,000 charge for restructuring of operations. This included a reduction in the Company's work force of ninety-two employees, or approximately 25%, accounting for approximately $1,672,000 of severance costs. The Company incurred a charge of approximately $6,215,000 for lease payments in connection with the substantial reduction in the Company's occupancy requirements. In addition, the charge included approximately $3,072,000 for the disposal of fixed assets and approximately $271,000 of other costs. In the fourth quarter of 1994, the Company recorded a benefit of approximately $4,900,000 related to the reversal of certain previously accrued restructuring costs. The $4,900,000 benefit included approximately $3,300,000 resulting from a new tenant assuming direct lease responsibility for all the Company's unused office space in its leased headquarters building. In addition, the Company reversed inventory costs, provided for the in the December 1993 restructuring of operations, of approximately $1,600,000 related to its hub inventory. The reversal was due to better than expected sales of Series 90 hubs as the Company increased its focus on the remote-site hub market. During 1996, the cash impact from restructuring restructuring was immaterial. The remaining accrual of $1.7 million as of December 31, 1996 will be paid during 1997. During 1995, the cash impact from restructuring was approximately $1.9 million. I. Income Taxes The provision for income taxes consists of the following: December 31, - -------------------------------------------------------------------------------- (in thousands) 1996 1995 1994 - -------------------------------------------------------------------------------- Federal - current ($ 65) $319 $ 0 State - current 10 57 50 Foreign - current 215 112 201 - -------------------------------------------------------------------------------- Total $ 160 $488 $251 ================================================================================ 28 31 A reconciliation between the Company's effective tax rate and the U.S. statutory rate is as follows: - -------------------------------------------------------------------------------- December 31, 1996 1995 1994 - -------------------------------------------------------------------------------- U.S. statutory rate (34.0%) 34.0% (34.0%) Foreign tax rate differential .1 (2.8) 4.2 Change in valuation allowance 35.2 (26.1) 49.8 State income taxes, net of U.S. Federal income tax effect -- .5 3.1 - -------------------------------------------------------------------------------- Effective tax rate 1.3% 5.6% 23.1% ================================================================================ A valuation allowance of $9,112,000 and $4,934,000 for 1996 and 1995, respectively has been recorded to offset the related net deferred tax assets due to the uncertainty of realizing the benefit of these assets. The following is a summary of the significant components of the Company's deferred tax assets and liabilities as of December 31, 1996 and 1995: - -------------------------------------------------------------------------------- (in thousands) 1996 1995 - -------------------------------------------------------------------------------- Deferred tax assets: Restructuring charge $ 644 $ 177 Inventory reserves 884 983 Product warranty 417 606 Federal tax benefit of net operating loss carryforwards 3,878 -- State tax benefit of net operating loss carryforwards 1,286 720 Tax credit carryforwards 912 912 Alternative minimum tax credit 542 699 Other items 919 1,146 - -------------------------------------------------------------------------------- Total deferred tax assets 9,482 5,243 Valuation allowance for deferred tax assets (9,112) (4,934) - -------------------------------------------------------------------------------- Net deferred tax asset 370 309 Deferred tax liability: Depreciation 370 309 - -------------------------------------------------------------------------------- Net deferred tax asset $ 0 $ 0 ================================================================================ As of December 31, 1996 the Company had net operating loss carryforwards of approximately $10,000,000 and $22,000,000 for federal and state income tax purposes respectively. The federal net operating losses begin to expire in 2010 and state net operating losses begin to expire in 1998. Similarly, research and experimentation credit carryforwards of approximately $912,000 were available at December 31, 1996, expiring at various dates through 2005. J. Retirement Savings Plan The Company has a retirement savings plan for its employees, which has been qualified under Section 401(k) of the Code. Eligible employees are permitted to contribute to the 401(k) Plan through payroll deductions within statutory limitations and subject to any limitations included in the 401(k) Plan. The Plan provides for the matching contribution by the Company in an annual amount not to exceed 2% of a participant's compensation. The Company contributed approximately $185,000, $165,000, and $236,000 to the plan in 1996, 1995, and 1994, respectively. 29 32 --------------------------------- Report of Independent Accountants --------------------------------- To the Board of Directors and Stockholders of Proteon, Inc.: We have audited the accompanying consolidated balance sheets of Proteon, Inc. as of December 31, 1996 and 1995, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1996. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Proteon, Inc. as of December 31, 1996 and 1995, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 1996 in conformity with generally accepted accounting principles. /s/ COOPERS & LYBRAND L.P.P. Boston, Massachusetts February 11, 1997 30 33 - ------------------------- QUARTERLY FINANCIAL DATA (unaudited) - ------------------------- Selected quarterly financial data for the years ended December 31, 1996 and 1995 is as follows:
- ----------------------------------------------------------------------------------------- Net income Net Gross Net income (loss) (in thousands, except per share amounts) sales profit (loss) per share - ----------------------------------------------------------------------------------------- 1996 First Quarter $14,018 $ 7,231 $ 141 $ 0.01 Second Quarter 10,646 4,932 (2,345) (0.15) Third Quarter 10,589 5,119 (1,763) (0.11) Fourth Quarter 10,043 2,344 (8,047) (0.52) - ----------------------------------------------------------------------------------------- Year to Date $45,296 $19,626 $(12,014) $(0.77) ========================================================================================= 1995 First Quarter $22,145 $11,788 $ 3,281 $ 0.21 Second Quarter 19,510 9,720 1,810 0.12 Third Quarter 16,440 8,463 1,558 0.10 Fourth Quarter 17,228 8,688 1,571 0.10 - ----------------------------------------------------------------------------------------- Year to Date $75,323 $38,659 $ 8,220 $ 0.52 =========================================================================================
- ------------------- STOCK PRICE HISTORY - ------------------- The following table sets forth the high and low sales prices of the Company's Common Stock as reported on the NASDAQ Stock Market from January 1, 1995 to December 31, 1996. As of December 31, 1996, the Company had approximately 530 stockholders of record. The Company has paid no dividends on its Common Stock and anticipates it will continue to reinvest earnings to finance future growth.
For the year ended December 31, 1996 High Low - -------------------------------------------------------------------------------- First Quarter 7 1/2 4 3/4 Second Quarter 6 1/2 3 5/8 Third Quarter 4 1/4 2 3/8 Fourth Quarter 4 1/4 2 1/16 For the year ended December 31, 1995 High Low - -------------------------------------------------------------------------------- First Quarter 8 1/8 5 3/8 Second Quarter 6 1/2 5 5/8 Third Quarter 9 7/8 5 7/8 Fourth Quarter 9 6 1/4
31 34 - ------------------ CORPORATE OFFICERS - ------------------ Daniel J. Capone, Jr. President and Chief Executive Officer Steven J. Bielagus Vice President, Engineering Robert J. Connaughton, Jr. Vice President, Finance, Chief Financial Officer, Treasurer, and Clerk William T. Greer Vice President, Sales Operations - ------------------ BOARD OF DIRECTORS - ------------------ Daniel J. Capone, Jr. President and Chief Executive Officer Proteon, Inc., and OpenROUTE Networks, Inc. David Clark, PhD. Senior Research Scientist Massachusetts Institute of Technology Laboratory of Computer Science Robert M. Glorioso President and Chief Executive Officer Marathon Technologies Corporation Howard C. Salwen Chairman of the Board L.J. Sevin General Partner Sevin, Rosen, Bayless, Borovoy A Venture Capital Firm 32 35 - ---------------------- CORPORATE INFORMATION - ---------------------- INDEPENDENT ACCOUNTANTS Coopers & Lybrand L.L.P. Boston, Massachusetts TRANSFER AGENT & REGISTRAR The First National Bank of Boston Boston EquiServe Boston, Massachusetts LEGAL COUNSEL Mintz, Levin, Cohn, Ferris, Glovsky, and Popeo, P.C. Boston, Massachusetts SEC FORM 10-K AND SHAREHOLDER INQUIRIES A copy of the Company's most recent Form 10-K, filed with the Securities and Exchange Commission, is available upon written request, free of charge from the Company. These requests, as well as inquiries relating to the Company, its activities or its securities should be addressed to: INVESTOR RELATIONS Proteon, Inc. Nine Technology Drive Westborough, MA 01581 Tel: (508) 898-2800 Fax: (508) 898-2147 Internet: Ppacket@proteon.com ANNUAL MEETING OF SHAREHOLDERS The Annual Meeting of Shareholders will take place at 10:00 a.m. on Wednesday, May 21, 1997 at the First National Bank of Boston, Blue Hills Office Park, 150 Royall Street, Canton, MA 02021 Proteon and ProNET are registered trademarks and CNX 600, CNX 500, CNX 400, DNX 350, DNX 300, OpenROUTE and OneVIEW are trademarks of Proteon, Inc. Other brand, company and product names are trademarks or registered trademarks of their respective holders. CORPORATE HEADQUARTERS Proteon, Inc. Nine Technology Drive Westborough, MA 01581 DOMESTIC SALES OFFICES Irvine, CA Pleasanton, CA Atlanta, GA Hoffman Estates, IL New York, NY Dallas, TX Reston, VA Baltimore, MD EUROPEAN HEADQUARTERS Proteon International Ltd Lockington Hall Lockington Derby DE74 2RH England ASIA PACIFIC HEADQUARTERS Proteon Networks PTE. Ltd. 30 Bideford, #02-02 Thongsia Building Singapore 229922 INTERNATIONAL SALES OFFICES North Sydney, Australia Toronto, Canada Hong Kong, China Paris, France Kelkheim, Germany Tokyo, Japan ANNOUNCING A NEW INFORMATIONSERVICE FOR PROTEON SHAREHOLDERS Now there is a faster, easier way to obtain information about Proteon, Inc., 24 hours a day, every day of the year. It's called Shareholder Direct, our new free telephone information service. By dialing this new toll-free number 888-OPEN-RTE (888-6736-783)current and prospective Proteon shareholders can find out about the most current earnings releases, hear the most recent news releases and a corporate profile, speak with a shareholder services representative, or ask to receive a variety of printed financial information by fax or mail. With the implementation of this free service, there is no longer the need to wait for a scheduled mailing, when some of the information may be outdated. With the immediacy of Shareholder Direct, the company will no longer mail quarterly reports. Replacing the mass mailings with an information-upon-request service allows the Company to save on printing and postage costs while expanding the menu available to shareholders. Using Shareholder Direct is easy. After dialing 1-888-OPEN-RTE, press or say "one" to be connected with the main menu. Callers using a rotary phone should wait for the announcement of the complete menu before hearing the earnings information. Proteon is pleased to offer this new free service. We believe Shareholder Direct will provide increased and more timely information about the Company's continuing efforts to enhance the investment of our shareholders. For your convenience, listed below, are tentative dates for issuing our quarterly earnings results: 1st Quarter -- Thursday, April 24, 1997 2nd Quarter -- Thursday, July 24, 1997 3rd Quarter -- Thursday, October 23, 1997 Shareholder information is also available on Proteon's World Wide Web site at: http://www.proteon.com, or, http://www.openroute.com. Design and images: Copy Rights 1997 Bomzer Communications, Inc. 36 OpenROUTE(R) Networks, Inc. A wholly owned subsidiary of Proteon, Inc. Nine Technology Drive Westborough, MA 01581 #1062-AR97 [LOGO]Proteon network with the pro(TM) [LOGO] OpenROUTE(R) Networks, Inc. EX-21 9 SUBSIDIARIES OF THE REGISTRANT 1 Proteon, Inc. EXHIBIT 21 Subsidiaries of the registrant: I. Proteon International Ltd. Lockington Hall Derby DE74 2RH England Organized under the laws of England II. Proteon International SARL 2000 route des Lucioles Les Algorithmes Bat Aristote A-BP 29 Sophia Antipolis 06901 France Organized under the laws of France III. Proteon International GMBH Falkensteiner Strasse 11 Kelkheim D 65779 Germany Incorporated under the laws of Germany IV. Proteon Networks PTE Ltd. 30 Bideford Road #02-02 Thongsia Building Singapore 229922 Organized under the laws of Singapore V. OpenROUTE Networks, Inc. Nine Technology Drive Westborough, Massachusetts 01581-1799 USA Incorporated in the Commonwealth of Massachusetts VI. Proteon Securities Corporation Nine Technology Drive Westborough, Massachusetts 01581-1799 USA Incorporated into the Commonwealth of Massachusetts VII. Proteon Federal Systems, Inc. (Inactive) Nine Techology Drive Westborough, Massachusetts 01581-1799 USA Incorporated in the Commonwealth of Massachusetts VIII. Proteon FSC, Inc. 55-11 Curaco Gade Charlotte Amalie Virgin Islands 00803 Incorporated in the U.S. Virgin Islands IX. Proteon Australia PTY 80 Mount Street Level 8 North Sydney NSW 2060 Australia Organized under the laws of Australia EX-23 10 CONSENT OF COOPERS & LYBRAND LLP 1 Exhibit 23 CONSENT OF INDEPENDENT ACCOUNTANTS We consent to the incorporation by reference in the registration statement of Proteon, Inc. on Form S-8 (File No. 33-85524) of our reports dated February 11, 1997, on our audits of the consolidated financial statements and financial statement schedule of Proteon, Inc. as of December 31, 1996 and 1995, and for the three years ended December 31, 1996, which reports are included or incorporated by reference in this Annual Report on Form 10-K. /s/ COOPERS & LYBRAND L.L.P. Boston, Massachusetts March 28, 1997 EX-27 11 FINANCIAL DATA SCHEDULE
5 1,000 US DOLLARS YEAR YEAR YEAR DEC-31-1994 DEC-31-1995 DEC-31-1996 JAN-01-1994 JAN-01-1995 JAN-01-1996 DEC-31-1994 DEC-31-1995 DEC-31-1996 1 1 1 24,956 25,829 16,612 2,100 6,863 6,918 11,986 12,138 7,625 0 0 0 5,023 4,425 8,737 46,782 50,712 40,977 31,089 31,875 13,625 20,960 23,558 9,031 56,911 59,029 45,571 19,232 11,706 10,380 0 0 0 0 0 0 0 0 0 47,884 49,141 49,292 (10,205) (1,818) (14,101) 56,991 59,029 45,571 75,817 51,810 32,175 93,912 75,323 45,296 36,996 27,373 20,825 48,148 36,664 25,670 48,512 31,388 32,741 0 0 0 (455) (1,437) (1,261) (1,088) 8,708 (11,854) 251 488 160 (1,339) 8,220 (12,014) 0 0 0 0 0 0 0 0 0 (1,339) 8,220 (12,014) (0.09) 0.52 (0.77) (0.09) 0.52 (0.77)
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