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SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

For The Quarterly Period Ended September 30, 2002

OR

For the transition period from                      to

Commission file number 000-23305

FIRST VIRTUAL COMMUNICATIONS, INC.

3393 Octavius Drive
Santa Clara, CA 95054
(Address of principal executive offices)

(408) 567-7200
(Registrant’s telephone number, including area code)

         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 o

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First Virtual Communications, Inc.

Index

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PART 1. FINANCIAL INFORMATION

Item 1. Financial Statements

First Virtual Communications, Inc.

See accompanying notes to condensed consolidated financial statements.

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First Virtual Communications, Inc.

See accompanying notes to condensed consolidated financial statements.

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First Virtual Communications, Inc.

See accompanying notes to condensed consolidated financial statements.

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First Virtual Communications, Inc.

Notes to Unaudited Condensed Consolidated Financial Statements

1. Basis of Presentation

         First Virtual Communications, Inc. (the “Company”) has prepared the accompanying financial data for the quarterly period ended September 30, 2002 pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”). Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to such rules and regulations.

         In the opinion of management, the accompanying condensed consolidated financial statements contain all normal and recurring adjustments necessary to present fairly the Company’s consolidated financial position as of September 30, 2002, consolidated results of operations for the three and nine months ended September 30, 2002 and 2001, and consolidated cash flow activities for the nine months ended September 30, 2002 and 2001.

         The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amounts reported in the condensed consolidated financial statements and accompanying notes. Actual results may differ from those estimates.

         The results of operations for the nine months ended September 30, 2002 are not necessarily indicative of the results to be expected for the full year. The information included in this Form 10-Q should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations and the consolidated financial statements and notes thereto included in the Company’s 2001 Annual Report on Form 10-K/A.

2. Acquisition of Business

         In July 2002, the Company acquired the remaining 48% interest of FVC.COM (UK) Ltd. in a transaction accounted for as a purchase business combination. The purchase price comprised cash consideration of $437,000, including direct acquisition costs of $178,000 for legal and consulting fees. Contingent on certain events, the purchase price may be further adjusted based on (1) 5.4% of the gross profit of the UK sales territory for the period from June 1, 2002 to December 31, 2002 and (2) the results of collection of certain receivables as of the acquisition date. The purchase price was allocated to the assets acquired and liabilities assumed based upon their estimated fair market values at the date of acquisition. At the acquisition date, the book value of the assets and liabilities acquired approximated fair value; accordingly, the purchase price was allocated to goodwill.

3. Short Term Investments

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

         The Company regularly monitors and evaluates the realizable value of its marketable securities. If events and circumstances indicate that a decline in the value of these assets has occurred and is other than temporary, the Company records a charge to investment income (expense).

         Marketable securities are comprised as follows (in thousands):

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         As of September 30, 2002, the Company’s available for sale securities had contractual maturities of less than one year. Available for sale securities are comprised as follows at September 30, 2002 and December 31, 2001 (in thousands):

4. Inventory

         Inventories as of September 30, 2002 and December 31, 2001 were (in thousands):

5. Net Loss Per Share

         Basic loss per share is based on the weighted-average number of common shares outstanding excluding contingently issuable or returnable shares, such as shares of unvested restricted common stock. Diluted loss per share is based on the weighted-average number of common shares outstanding and dilutive potential common shares outstanding.

         As a result of the losses incurred by the Company for the three and nine months ended September 30, 2002 and 2001, all potential common shares were anti-dilutive and were excluded from the diluted net loss per share calculations for such periods.

         The following table summarizes securities outstanding that were not included in the calculations of diluted net loss per share for the three and nine months ended September 30, 2002 and 2001, since their inclusion would be anti-dilutive:

         The common stock warrants are exercisable at $.91 to $12.00 per share and expire at various times from December 31, 2002 through April 12, 2007. The stock options outstanding at September 30, 2002, had a weighted average exercise price per share of $2.67 and expire beginning in June 2004 through July 2012.

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6. Adoption of SFAS 142, Goodwill and Other Intangible Assets

         The Company adopted Statement of Financial Accounting Standards No. 142 (SFAS 142), “Goodwill and Other Intangible Assets,” in the first quarter of 2002. SFAS 142 supersedes Accounting Principles Board Opinion No. 17, “Intangible Assets,” and discontinues the amortization of goodwill. In addition, SFAS 142 includes provisions regarding: 1) the reclassification between goodwill and identifiable intangible assets in accordance with the new definition of intangible assets set forth in Statement of Financial Accounting Standards No. 141, “Business Combinations;” 2) the reassessment of the useful lives of existing recognized intangibles; and 3) the testing for impairment of existing goodwill and other intangibles.

         In accordance with SFAS 142, beginning January 1, 2002, goodwill is no longer being amortized, but will be reviewed periodically for impairment. The Company did not identify any intangibles to be reclassified out of previously reported goodwill under the new definition of intangible assets. Purchased technology and other intangible assets are being amortized over their estimated useful lives of five years using the straight-line method. No changes were made to the useful lives of amortizable intangibles in connection with the adoption of SFAS 142.

         Components of intangible assets were as follows (in thousands):

The Company reclassified previously identified intangible assets related to the purchase of an assembled workforce with a net unamortized balance of $1,346,000 to goodwill. During the nine months ended September 30, 2002, the Company settled certain pre-acquisition contingencies, resulting in a net decrease of goodwill in the amount of approximately $303,000.

Aggregate amortization expense was $396,000 for the three months ended September 30, 2002 and $793,000 for the three months ended September 30, 2001. Aggregate amortization expense was $1.2 million for the nine months ended September 30, 2002 and $1.1 million for the nine months ended September 30, 2001. As of September 30, 2002, future estimated amortization expense is expected to be: $0.4 million for the last quarter of 2002, $1.5 million for 2003, $1.5 million for 2004, $1.4 million for 2005 and $0.6 million for 2006.

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

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7. Comprehensive Loss

         Comprehensive loss is defined as the change in equity of a business enterprise during a period from transactions and other events and circumstances from non-owner sources, including foreign currency translation adjustments and unrealized gains and losses on marketable securities.

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

         Comprehensive losses for the three and nine month periods ended September 30, 2002 and 2001 were as follows (in thousands):

8. Litigation

         On April 23, 2001, the Company received notice of a stockholder’s derivative action filed in California Superior Court in the County of Santa Clara, alleging that, among other things, certain directors and officers of the Company sold shares of the Company’s common stock between January 21, 1999 and April 6, 1999, while in possession of material non-public information pertaining to the Company. The Company and the individual defendants demurred to the complaint, and moved to dismiss the action, or in the alternative to stay the action pending the outcome of the appeal in the related federal court class action or, if necessary, the investigation of the claims by the Company. The court granted the demurrer in part and denied it in part, granting plaintiff leave to file an amended complaint, and stayed the action pending the outcome of the appeal in the federal court class action. The court also ordered that certain limited discovery of documents could take place with respect to the filing of the amended complaint. In December 2001, the plaintiff moved for leave to take certain third-party discovery. The motion was denied by the court. Plaintiff filed an amended complaint on February 22, 2002. A hearing on the defendants’ demurrer to the amended complaint was scheduled to take place on May 21, 2002. The parties agreed to a continuance of the hearing in order to permit them to engage in settlement discussions with a third-party mediator. On July 25, 2002, the parties reached a tentative settlement of the derivative action, subject to a number of conditions, including approval of the settlement by a special committee of independent directors appointed by the Company’s Board of Directors and empowered to act on behalf of the Company with respect to the action. Under the terms of the tentative settlement, the Company would not pay any money to any party in connection with the settlement, nor would it pay any money as indemnification to present or former officers and directors in the event of a settlement of the SEC enforcement action described in the following paragraph.

         On April 25, 2002, the Company was informed by the staff of the SEC that the staff intends to recommend that the SEC commence an enforcement action against the Company, Ralph Ungermann and two former officers of the Company in connection with the Company’s January 1999 announcement of unaudited financial results for the quarter and year ended December 31, 1998, which were revised by the Company prior to the release of the Company’s Form 10-K in April 1999. The staff indicated that the basis for such an action would be allegations that the January 1999 announcement was misleading and/or the result of inadequate financial controls. The staff did not state what remedies it would seek in such an action, but noted that the remedies it might seek could include an injunction against future violations, disgorgement, civil penalties and an officer and director bar against the individuals. The Company expresses no opinion as to the likely outcome of this matter. While no assurances can be provided, the Company does not believe that the

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investigation will have a material adverse effect on its business, financial condition or results of operations. However, the Company’s evaluation of the likely impact of these actions could change in the future and an unfavorable outcome, depending upon the amount and timing, could have a material effect on our results of operations or cash flows of a future period.

         On August 28, 2002, the Company was served with a Complaint filed by Eric Hamilton in the United States District Court for the District of Maryland alleging that in connection with the Company’s use of its CUseeME and Click-to-Meet products the Company infringes the United States Patent No. 5,176,520 (the “’520 Patent”), issued on January 5, 1993 and relating to “Computer Assisted Instructional Delivery System and Method,” seeking unspecified damages for infringement and willful infringement, in addition to seeking injunctive relief. On November 1, 2002, the Company filed its Answer to the Complaint in which it denied all material allegations made against it. The Company also filed a Counterclaim seeking a judicial declaration that (i) its products do not infringe any valid claim of the ‘520 Patent and (ii) the ‘520 Patent is invalid and unenforceable on the grounds of obviousness, lack of enablement and failure to meet the written description requirements under the patent laws. The Company intends to vigorously defend itself against these claims.

         On May 1, 2002, the Company received notice that Clover Technologies, Inc. (“Clover”) submitted a claim to the American Arbitration Association initiating an arbitration proceeding claiming that Clover is entitled to compensation from the Company for allegedly defective video access nodes (“VANS”) supplied by the Company to Clover. The Company filed an answer to Clover’s demand for arbitration, denying all material allegations and claims, on May 30, 2002. Since filing a demand for arbitration against the Company, Clover has specified that its claim is for damages totaling in excess of $2.7 million, based on claims that certain of the VANS which Clover purchased for resale to its customers were defective. The purchase arises out of a written agreement between the Company and Clover, dated June 22, 1998. Clover seeks damages based on claims for alleged breach of express and implied warranties, in the amount purportedly paid for replacement products, plus unspecified incidental and consequential damages. The Company has responded to the arbitration demand by denying all material allegations, and it intends to vigorously defend itself. An arbitration hearing before the American Arbitration Association is scheduled for March 10, 2003 through March 17, 2003 in Santa Clara, California.

9. New Accounting Pronouncements

         On October 3, 2001, the FASB issued Statement of Financial Accounting Standard No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (SFAS 144). SFAS 144 supercedes Statement of Financial Accounting Standard No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed of.” SFAS 144 applies to all long-lived assets (including discontinued operations) and consequently amends Accounting Principles Board Opinion No. 30. SFAS 144 develops one accounting model for long-lived assets that are to be disposed of by sale. SFAS 144 requires that long-lived assets that are to be disposed of by sale be measured at the lower of book value or fair value less cost to sell. Additionally, SFAS 144 expands the scope of discontinued operations to include all components of an entity with operations that (1) can be distinguished from the rest of the entity and (2) will be eliminated from the ongoing operations of the entity in a disposal transaction. SFAS 144 is effective for the Company for all financial statements issued in fiscal 2002.

         In April 2002, the FASB issued FAS 145, “Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections,” which is effective for transactions occurring after May 15, 2002. FAS 145 rescinds FAS 4 and FAS 64, which addressed the accounting for gains and losses from extinguishment of debt. FAS 44 set forth industry-specific transitional guidance that did not apply to the Company. FAS 145 amends FAS 13 to require that certain lease modifications that have economic effects similar to sale-leaseback transactions be accounted for in the same manner as sale-leaseback transactions. FAS 145 also makes technical corrections to certain existing pronouncements that are not substantive in nature. The Company does not expect the adoption of FAS 145 to have a significant impact on its financial position or results of operations.

         In July 2002, the FASB issued SFAS 146, “Accounting for Costs Associated with Exit or Disposal Activities” (SFAS 146). SFAS 146 addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies emerging Issues Task Force (EITF) Issue No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (Including Certain Costs Incurred in a Restructuring).” SFAS 146 is effective for exit or disposal activities that are initiated after December 31, 2002, with early application encouraged. The Company is currently evaluating the provisions of SFAS 146 but does not believe that the adoption will have a material impact on its results of operations, financial position, or cash flows.

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10. Issuance of Common Stock and Warrants

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

11. Subsequent Event(s)

         On October 29, 2002 the Company announced that Killko Caballero, the Company’s Chief Executive Officer, left the Company. Jonathan Morgan, a member of the Company’s Board of Directors, was appointed as the Company’s acting President and Chief Executive Officer, while the Company’s Board of Directors searches for a permanent replacement.

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

         The following discussion of the financial condition and results of operations of First Virtual Communications, Inc. should be read in conjunction with the Unaudited Condensed Consolidated Financial Statements and the Notes thereto included in Item 1 of this Quarterly Report on Form 10-Q.

         In addition to the historical information contained in this Item, this Item contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, that involve risks and uncertainties. These forward looking statements include, without limitation, statements containing the words “believes,” “anticipates,” “expects,” and words of similar import. Such forward-looking statements will have known and unknown risks, uncertainties and other factors that may cause the actual results, performance or achievements of the Company, or industry results, to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. Such factors include, among others: the Company’s limited operating history and variability of operating results, market acceptance of video technology, web conferencing and collaboration technology dependence on IP, ISDN, ATM and other technologies, the Company’s potential inability to maintain business relationships with telecommunications carriers, distributors and suppliers, rapid technological changes, competition and consolidation in the video conferencing industry, the importance of attracting and retaining personnel, management of the Company’s growth, the risk that the benefits expected from the merger with CUseeMe Networks will not be realized, consolidation and cost pressures in the video conferencing industry, dependence on key employees, and other risk factors set forth below and described in this Form 10-Q report and in other documents the Company files with the SEC. The Company assumes no obligation to update any forward-looking statements contained herein.

Overview

         The Company delivers integrated, end-to-end rich media Web conferencing and collaboration solutions, including both hardware and software technologies, for IP, ISDN and ATM networks. The Company combines its expertise in networking systems, real-time audio and video technology, and Web-based collaboration to provide integrated voice, video, data, text and streaming media solutions for a wide range of rich media enterprise applications, including Web conferences, broadcasts, video-on-demand, video conferences and video calls over converged multi-service networks. The Company provides integrated, end-to-end rich media communications solutions, including both hardware and software technologies, for IP, ISDN and ATM networks. The Company was incorporated in California in October 1993 and reincorporated in Delaware in December 1997. The Company first shipped its products in 1995.

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

         In the three months ended September 30, 2002, the Company recorded $6.1 million in revenue, a decrease of 21% compared to the same period of the previous year. In the nine months ended September 30, 2002, the Company recorded $19.4 million in revenue, a decrease of 4.4% compared to the same period of the previous year. The Company derived its revenue in the nine months ended September 30, 2002 from the sale of products and services to distributors, value-added resellers, or VARS, federal government agencies, enterprise customers and telecommunications service providers. The Company sells primarily through indirect sales channels and directly to certain telecommunications service providers and other major end-users. Major customers include companies such as Net One Systems, Hitron, EDS Operating Services, AT&T and France Telecom. For the three months ended September 30, 2002, 91.3% of the Company’s revenue was from enterprise customers and 8.7% was from service providers, compared to 80.7% from enterprise customers and 19.3% from service providers in the same period of the prior year. For the nine months ended September 30, 2002, 77.2% of the Company’s revenue was from enterprise customers and 22.8% was from service providers, while for the nine months ended September 30, 2001, revenue

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from enterprise customers was 69.8% and 30.2% was from service providers. The Company’s internal sales force qualifies and stimulates end-user demand, and manages the Company’s strategic relationships with its distribution partners, including original equipment manufacturers, or OEMs, and value-added resellers and systems integrators. IBM accounted for 23.7% of net revenue in the three months ended September 30, 2002, and AT&T Corp. accounted for 10.3% of net revenue in the nine months ended September 30, 2002. General Motors Corp. accounted for 11.3% of net revenue in the three months ended September 30, 2001, and EDS Operating Services accounted for 13.5% of net revenue in the nine months ended September 30, 2001. At September 30, 2002, one customer accounted for 26.1% of total accounts receivable. At September 30, 2001, no single customer accounted for 10% or more of the Company’s total accounts receivable.

         Internationally, the Company maintains sales offices in the United Kingdom, France, Italy, Hong Kong, Beijing, Shanghai and Japan, and distributes its products under the FVC.COM name in both Europe and Asia through resellers and distributors in more than 25 countries. For the three months ended September 30, 2002 and September 30, 2001, approximately 30.9% and 23.1%, respectively, of the Company’s sales were generated from customers outside of the United States. For the nine months ended September 30, 2002 and September 30, 2001, approximately 30.4% and 22.0%, respectively, of the Company’s sales were generated from customers outside of the United States.

         The Company expects that direct sales from shipments to customers outside of the United States will continue to represent a significant portion of its future revenue. In addition, the Company believes that a small portion of its sales through OEMs, resellers and integrators in the United States are ultimately sold to international end-users. Revenue from the Company’s international operations is subject to various risks, including seasonality, longer payment cycles, changes in regulatory requirements and tariffs, reduced protection of intellectual property rights, political and economic restraints, and currency risks, among others. To date, the Company has not engaged in any foreign currency hedging activity.

Results of Operations

         The following table sets forth certain items from the Company’s condensed consolidated statements of operations as a percentage of total revenue for the periods indicated.

Three Months Ended September 30, 2002 Compared to Three Months Ended September 30, 2001

Revenue. Revenue was $6.1 million for the three months ended September 30, 2002, a decrease of 21.0% from $7.8 million for the three months ended September 30, 2001. The decrease in revenue was primarily a result of deferral of software orders

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booked and shipped in the quarters ending June 30, 2002 and September 30, 2002, as well as lower demand and lower average selling prices of hardware-based ATM legacy products.

Gross Profit. Gross profit consists of revenue less the cost of revenue, which consists primarily of costs associated with the purchase of components from outside manufacturers or the manufacture of the Company’s products by outside manufacturers and related costs of freight, inventory obsolescence, royalties, warranties and customer support costs, which were expensed in the period incurred.

         Gross profit for the three months ended September 30, 2002 increased by $5.2 million to $4.1 million, or 66.8% of revenue, compared to gross loss of $1.1 million in the comparable period of 2001. The increase was primarily due to the provision for excess and obsolete inventory of $5.5 million related to legacy ATM products in the three months ended September 30, 2001.

Research and Development. Research and development expense consist primarily of personnel costs, costs of contractors and outside consultants, supplies and materials expenses, equipment depreciation and overhead costs. Research and development expense decreased $782,000 to $2.3 million in the three months ended September 30, 2002, a decrease of 25.0% over the $3.1 million during the three months ended September 30, 2001. The decrease in absolute dollars was principally due to a $563,000 decrease in personnel-related expenses and a $219,000 decrease in other expenses after the Company implemented cost cutting measures throughout the organization. As a percentage of total revenue, research and development expense decreased to 38.2% for the three months ended September 30, 2002, from 40.3% for the three months ended September 30, 2001. The decrease as a percentage of revenue primarily was due to the lower spending during the three months ended September 30, 2002.

Sales and Marketing. Sales and marketing expense includes personnel and related overhead costs for sales and marketing, costs of outside contractors, advertising, trade shows and other related marketing and promotional expenses. Sales and marketing expense decreased $386,000 to $2.6 million for the three months ended September 30, 2002, a decrease of 12.8% from the $3.0 million for the three months ended September 30, 2001. The decrease in 2002 primarily was due to a $318,000 decrease in trade show and advertising activities. As a percentage of total revenue, sales and marketing expense increased to 42.7% for the three months ended September 30, 2002, from 38.7% for the three months ended September 30, 2001. The increase as a percentage of revenue primarily was due to lower revenue during the three months ended September 30, 2002.

General and Administrative. General and administrative expense includes personnel and related overhead costs for finance, human resources, information technology, product operations and general management and the amortization of intangible assets. General and administrative expense decreased $646,000, or 18.8%, for the three months ended September 30, 2002, to $2.8 million, from $3.4 million in the three months ended September 30, 2001. The decrease primarily was due to a $504,000 decrease in personnel-related expenses, and a $521,000 decrease in depreciation and amortization expense and a $245,000 decrease in equipment and maintenance costs after the Company implemented cost cutting measures throughout the organization, offset by an increase of $625,000 in legal expense. As a percentage of revenue, general and administrative expense increased slightly to 45.4% in the three months ended September 30, 2002, compared to 44.2% for the three months ended September 30, 2001. The increase in general and administrative expense as a percentage of revenues for the three months ended September 30, 2002 primarily reflects the lower revenue from the comparable period of 2001.

Other Income, Net. Other income, net consists primarily of interest income earned on short-term investments and cash balances, offset by interest expense relating to the Company’s credit facilities and long-term debt, if any. Other income, net totaled $40,000 for the three months ended September 30, 2002, compared to $122,000 for the three months ended September 30, 2001. The decrease was primarily related to a decline in interest income due to lower market interest rates and cash balances.

Minority Interest in Consolidated Subsidiary. Minority interest reflects the interest of minority stockholders in the operating results of the Company’s consolidated subsidiary in the United Kingdom. The Company acquired a controlling interest in this entity in May 1999. For the three months ended September 30, 2002, the amount reflects the portion of losses in this subsidiary that were attributable to minority stockholders. On July 31, 2002, the Company acquired the remaining 48% interest in this subsidiary for $437,000.

Income Taxes. The Company has incurred losses since its inception. No tax benefit was recorded for any period presented, as the Company believes that, based on the history of such losses and other factors, the weight of available evidence indicates that it is more likely than not that it will not be able to realize the benefit of these net operating losses, and thus a full valuation reserve has been recorded.

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Nine Months Ended September 30, 2002 Compared to Nine Months Ended September 30, 2001

Revenue. Revenue was $19.4 million for the nine months ended September 30, 2002, a decrease of 4.4% from $20.3 million for the nine months ended September 30, 2001. The decrease in revenue primarily was due to deferral of software orders booked and shipped in the nine months ending September 30, 2002 as well as to the lower demand and lower average selling prices of hardware based ATM legacy products.

Gross Profit. Gross profit consists of revenue less the cost of revenue, which consists primarily of costs associated with the purchase of components from outside manufacturers or the manufacture of the Company’s products by outside manufacturers and related costs of freight, inventory obsolescence, royalties, warranties and customer support costs, which were expensed in the period incurred. Gross profit for the nine months ended September 30, 2002 increased by $7.9 million to $12.3 million, or 63.7% of revenue, compared to $4.4 million, or 21.8% of revenue in the comparable period of 2001. The increase primarily was due to a higher percentage of revenue from software-based products in the nine months ended September 30, 2002 and gross profit for the nine months ended September 30, 2001 included an incremental provision for excess and obsolete inventory of $5.9 million.

Research and Development. Research and development expense consists primarily of personnel costs, costs of contractors and outside consultants, supplies and materials expenses, equipment depreciation and overhead costs. Research and development expense decreased $2.4 million to $7.5 million for the nine months ended September 30, 2002, a decrease of 24.3% from the $10.0 million for the nine months ended September 30, 2001. The decrease in absolute dollars in 2002 principally was due to $1.5 million decrease in personnel-related expenses, a $412,000 decrease in professional expenditures, a $230,000 decrease in travel and entertainment expenses, a $146,000 decrease in equipment and supply expenses and a decrease of $112,000 in other expenses after the Company implemented cost cutting measures throughout the organization. As a percentage of total revenue, research and development expense decreased to 38.9% for the nine months ended September 30, 2002, from 49.1% for the nine months ended September 30, 2001. The decrease as a percentage of revenue primarily was due to the lower spending during the nine months ended September 30, 2002.

Sales and Marketing. Sales and marketing expense includes personnel and related overhead costs for sales and marketing, costs of outside contractors, advertising, trade shows and other related marketing and promotional expenses. Sales and marketing expense decreased $1.5 million, or 17.5%, for the nine months ended September 30, 2002, to $6.9 million from $8.4 for the nine months ended September 30, 2001. The decrease in absolute dollars in 2002 primarily was due to a $596,000 decrease in trade show and marketing activity expenditures, a $340,000 decrease in personnel-related expenses, a $200,000 decrease in equipment and supply expense and other expenses after the Company implemented cost cutting measures throughout the organization and a $359,000 decrease in bad debt expense due to the subsequent collection of the accounts receivable from one of our subsidiaries, which was originally reserved as doubtful accounts in the quarter ended December 31, 2001. As a percentage of total revenue, sales and marketing expense decreased to 35.6% for the nine months ended September 30, 2002, from 41.3% for the nine months ended September 30, 2001. The decrease as a percentage of revenue primarily was due to lower spending during the nine months ended September 30, 2002.

General and Administrative. General and administrative expense includes personnel and related overhead costs for finance, human resources, information technology, product operations and general management and the amortization of intangible assets. General and administrative expense decreased $2.1 million, or 21.1%, for the nine months ended September 30, 2002, to $7.8 million, from $9.9 million for the nine months ended September 30, 2001. The decrease primarily was due to a $1.5 million decrease in personnel-related expenses, a $236,000 decrease in equipment and supply expense, a $232,000 decrease in professional expenditures, a $193,000 decrease in depreciation and amortization expenses, a $172,000 decrease in travel and entertainment expenditures and a $365,000 decrease in other expenses after the Company implemented cost cutting measures throughout the organization, offset by an increase of $598,000 in bad debt expense. As a percentage of revenue, general and administrative expense decreased to 40.5% in the nine months ended September 30, 2002, compared to 49.0% for the nine months ended September 30, 2001. The decrease in general and administrative expense as a percentage of revenue for the nine months ended September 30, 2002 primarily reflects the lower spending from the comparable period of 2001.

Acquisition and other non recurring costs, net. The $1.8 million of one time charges in the second quarter of 2001 includes $276,000 of in process research and development activities as a result of the acquisition of CUseeMe Networks, the impairment of $1.1 million of goodwill, associated with the 1998 acquisition of ICAST Corporation and $422,000 of costs associated with the reduction in workforce during the quarter ended of September 30, 2001. We incurred no acquisition or other non-recurring costs, net, in the period ending September 30, 2002.

Other Income, Net. Other income, net consists primarily of interest income earned on short-term investments and cash balances, offset by interest expense relating to the Company’s credit facilities and long-term debt. Other income, net totaled $132,000 for

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the nine months ended September 30, 2002, compared to $608,000 for the nine months ended September 30, 2001. The decrease primarily related to a decline in interest income due to lower market interest rates and cash balances.

Minority Interest in Consolidated Subsidiary. Minority interest reflects the interest of minority stockholders in the operating results of the Company’s consolidated subsidiary in the United Kingdom. The Company acquired a controlling interest in this entity in May 1999 and acquired the remaining 48% interest on July 31, 2002 for $437,000. For the nine months ended September 30, 2002, the amount reflects the portion of losses in this subsidiary that were attributable to minority stockholders.

Income Taxes. The Company has incurred losses since its inception. No tax benefit was recorded for any period presented, as the Company believes that, based on the history of such losses and other factors, the weight of available evidence indicates that it is more likely than not that it will not be able to realize the benefit of these net operating losses, and thus a full valuation reserve has been recorded.

Liquidity and Capital Resources

         Since inception, the Company has financed its operations primarily through private and public placements of equity securities and to a lesser extent through certain credit facilities and long-term debt. As of September 30, 2002, the Company had cash and cash equivalents and short-term investments of $9.1 million and working capital of $4.6 million.

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

         The Company has experienced significant net operating losses from inception. In the nine months ended September 30, 2002, the Company incurred losses of $9.8 million and used $4.2 million of cash in its operating activities. In the comparable period of 2001, the Company incurred net losses of $25.0 million and used $19.2 million of cash in its operating activities. Management currently expects that operating losses and negative cash flows will continue for the foreseeable future. The Company decreased the size of its workforce by 26% in 2001 and 7% in 2002, and also instituted measures to control discretionary spending. Management currently believes that the Company’s existing cash and investments are adequate to fund the Company’s operations through December 31, 2002. Management is currently evaluating liquidity needs for fiscal 2003. The Company’s cash requirements depend on several factors, including the rate of market acceptance of its products and services, the ability to expand and retain its customer base, the Company’s ability to continue to control its expenses and other factors.

         In order to pursue business opportunities, the Company may be required to seek equity investments from existing or potential strategic partners in the future. Should the Company sell additional equity, the sale may result in dilution to the Company’s current stockholders. Should the Company be unsuccessful in its efforts to raise equity from strategic partners, it may seek additional capital from the public and/or private equity markets that will likely result in dilution of the Company’s current stockholders. There can be no assurance that any financing will be available at acceptable terms or at all.

         Cash used in operating activities totaled $4.2 million for the nine months ended September 30, 2002, compared to $19.2 million for the nine months ended September 30, 2001. Cash used in operating activities primarily consisted of $9.8 million from a net loss adjusted for non-cash items, a decrease of $1.1 million in accounts payable and $493,000 in accrued liabilities and an increase of $362,000 in prepaid expenses and other current assets, partially offset by an increase of $3.1 million of deferred revenue, a decrease of $814,000 in inventory and $202,000 in accounts receivable. Cash used in operating activities for the nine months ended September 30, 2001, reflects $25.0 million from a net loss adjusted for non-cash items, an increase of $3.7 million in inventory, $806,000 in prepaid expenses and other assets, a decrease of $2.1 million in accounts payable and $2.1 million in accrued liabilities, offset in part by a decrease of $3.6 million in accounts receivable and an increase of $1.1 million in deferred revenue.

         Cash provided from investment activities totaled $921,000 for the nine months ended September 30, 2002, compared to $18.3 million for the nine months ended September 30, 2001. Cash provided by investment activities for the nine months ended June 30, 2002, primarily consisted of $1.9 million of net sales of short-term investments, offset by $494,000 of cash used in the acquisition of property and equipment and $437,000 of cash paid in the acquisition of FVC.COM (UK) Ltd. Cash provided in

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investment activities for the nine month ended September 30, 2001, primarily consisted of net sales of short-term investments of $12.1 million and $6.6 million in cash acquired from the acquisition of CuseeMe Networks.

         Cash provided by financing activities was $5.0 million for the nine months ended September 30, 2002, principally from the issuance of stock. Cash provided by financing activities was $1.3 million for the nine months ended September 30, 2001, principally from the issuance of stock.

         New Accounting Pronouncements. On October 3, 2001, the FASB issued Statement of Financial Accounting Standard No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (SFAS 144). SFAS 144 supercedes SFAS 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed of.” SFAS 144 applies to all long-lived assets (including discontinued operations) and consequently amends Accounting Principles Board Opinion No. 30. SFAS 144 develops one accounting model for long-lived assets that are to be disposed of by sale. SFAS 144 requires that long-lived assets that are to be disposed of by sale be measured at the lower of book value or fair value less cost to sell. Additionally, SFAS 144 expands the scope of discontinued operations to include all components of an entity with operations that (1) can be distinguished from the rest of the entity and (2) will be eliminated from the ongoing operations of the entity in a disposal transaction. SFAS 144 is effective for the Company for all financial statements issued in fiscal 2002.

         In April 2002, the FASB issued SFAS 145, “Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections,” which is effective for transactions occurring after May 15, 2002. SFAS 145 rescinds SFAS 4 and FAS 64, which addressed the accounting for gains and losses from extinguishment of debt. SFAS 44 set forth industry-specific transitional guidance that did not apply to the Company. SFAS 145 amends SFAS 13 to require that certain lease modifications that have economic effects similar to sale-leaseback transactions be accounted for in the same manner as sale-leaseback transactions. SFAS 145 also makes technical corrections to certain existing pronouncements that are not substantive in nature. The Company does not expect the adoption of SFAS 145 to have a significant impact on its financial position or results of operations.

         In July 2002, the FASB issued SFAS 146, “Accounting for Costs Associated with Exit or Disposal Activities” (SFAS 146). SFAS 146 addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies emerging Issues Task Force (EITF) Issue No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (Including Certain Costs Incurred in a Restructuring).” SFAS 146 is effective for exit or disposal activities that are initiated after December 31, 2002, with early application encouraged. The Company is currently evaluating the provisions of SFAS 146 but does not believe that the adoption will have a material impact on its results of operations, financial position, or cash flows.

Risk Factors

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

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

         The Company has incurred operating losses in each quarter since it commenced operations in 1993. The Company expects to continue to devote substantial resources to its research and development and sales and marketing activities. As a result, the Company expects that it will continue to incur operating losses for the foreseeable future. The Company’s revenue decreased from $40 million for the year ended December 31, 2000 to $27.7 million for the year ended December 31, 2001, while its net loss increased from $18.8 million for the year ended December 31, 2000 to $31.6 million for the year ended December 31, 2001. At September 30, 2002, the Company had an accumulated deficit of $97 million.

The Company’s quarterly financial results are expected to fluctuate and may cause the price of the Company’s common stock to fall.

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

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	•		success in developing its rich media Web conferencing business and in developing, introducing and shipping new products and product enhancements, particularly for Click to Meet™ and the Multi Conferencing Unit, or MCU;
	•		success in accurately forecasting demand for new orders that may have short lead-times before required shipment, product mix, percentage of revenue derived from original equipment manufacturers, or OEMs, versus distributors or resellers;
	•		new product introductions and price reductions by competitors;
	•		results from strategic collaborations;
	•		use of OEMs, distributors, resellers, and other third parties;
	•		ability to attract, retain and motivate qualified personnel;
	•		research and development efforts and success; and
	•		selling, general and administrative expenditures.