We generated cash from operating activities totaling $9.4 million in the first three months of 2001 compared to $9.3 million in the same period of 2000. The improvement in cash from operating activities when comparing these two periods was due primarily to a reduction in trade receivables, slower growth in inventories and a reduction in deferred taxes. This improvement was offset by a decrease in net income before non-cash items, a net reduction in liabilities in the current three month period compared to an increase in liabilities for the same period in 2000 and an increase in prepaid and other assets.
The total net change in cash and cash equivalents for the three months ended March 31, 2001 was a decrease of $35.5 million. The primary uses of cash during this period were $46.0 million for net purchases of investments and $2.8 million for purchases of property, plant and equipment. The primary sources of cash were $9.4 million from operating activities and $3.9 million associated with the exercise of stock options and purchases under the employee stock purchase plan. The positive cash from operating activities was primarily the result of net income before considering non-cash expenses (such as depreciation, amortization, the provision for doubtful accounts and the tax benefits from the exercise of employee stock options), lower trade receivables and lower deferred taxes, offset by a net decrease in total current liabilities (including accounts payable), an increase in inventories, and an increase in prepaid and other assets.
Our material commitments consist of obligations under our operating leases. We also maintain, from time to time, commercial letters of credit as payments for the importation of certain products. These amounts do not exceed $100,000 and are outstanding less than 120 days. In addition, our bank has issued letters of credit to secure the leases on some of our offices. These letters of credit total less than $100,000 and are secured by our credit facilities or cash deposits with our banks.
We believe that our available cash, cash equivalents, investments and our bank line of credit will be sufficient to meet our operating expenses and capital requirements through at least the next eighteen months. Our future liquidity and cash requirements will depend on numerous factors, including the introduction of new products and potential acquisitions of related businesses or technologies.
In June 1998, the Financial Accounting Standards Board (FASB) issued SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” (SFAS 133). SFAS 133, as amended by SFAS 138, established methods of accounting for derivative financial instruments and hedging activities related to those instruments as well as other hedging activities, and is effective for the fiscal years beginning after June 15, 2000. We adopted this pronouncement on January 1, 2001. This adoption did not have a material impact on our consolidated financial position, results of operations or cash flows.
Other Factors Affecting Future Operations
INVESTORS SHOULD CAREFULLY CONSIDER THE RISKS DESCRIBED BELOW BEFORE MAKING AN INVESTMENT DECISION. IN ADDITION, THESE RISKS ARE NOT THE ONLY ONES FACING OUR COMPANY. ADDITIONAL RISKS WE ARE NOT PRESENTLY AWARE OF OR THAT WE CURRENTLY BELIEVE ARE IMMATERIAL MAY ALSO IMPAIR OUR BUSINESS OPERATIONS. OUR BUSINESS COULD BE HARMED BY ANY OF THESE RISKS. THE TRADING PRICE OF OUR COMMON STOCK COULD DECLINE DUE TO ANY OF THESE RISKS, AND INVESTORS MAY LOSE ALL OR PART OF THEIR INVESTMENT. IN ASSESSING THESE RISKS, INVESTORS SHOULD ALSO REFER TO THE OTHER INFORMATION CONTAINED OR INCORPORATED BY REFERENCE IN OUR ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 2000 FILED WITH THE SECURITIES AND EXCHANGE COMMISSION INCLUDING OUR CONSOLIDATED FINANCIAL STATEMENTS AND RELATED NOTES.
OUR QUARTERLY OPERATING RESULTS FLUCTUATE SIGNIFICANTLY AND WE MAY NOT BE ABLE TO MAINTAIN OUR HISTORICAL GROWTH RATES.
Our quarterly operating results have fluctuated significantly in the past and may vary significantly in the future as a result of a number of factors. These factors include:
| • | changes in general economic conditions, as has been the case recently, and specific economic conditions prevailing in the broadband communications industry; |
| • | market acceptance of new product introductions and product enhancements by us or our competitors; |
| • | our prices and those of our competitors' products; |
| • | the timing and size of the orders for our products; |
| • | the mix of products sold; |
| • | fluctuations in the level of international sales; |
| • | the delay in the rollout of DSL technology; |
| • | the cost and availability of components; |
| • | manufacturing costs; |
| • | the level and cost of warranty claims; |
| • | changes in our distribution network; |
| • | fluctuations in demand for our products; |
| • | the impact of seasonality; and |
| • | the level of royalties to third parties. |
Although we have had significant sequential revenue growth in the recent quarters prior to the quarter ended March 31, 2001, fluctuations in our quarterly operating results due to these or other factors could prevent us from sustaining these growth rates or meeting our expectations, and you should not use these past results to predict future operating margins and results. For example, in the first quarter of 2001, we did not meet original revenue and profit expectations and the second quarter of 2001 is unpredictable. In particular, a number of these factors negatively affected our results of operations in the first quarter of 2001. Further, our quarterly revenues and operating results depend upon the volume and timing of customer orders received during a given quarter, and the percentage of each order which we are able to ship and recognize as revenue during each quarter, each of which is difficult to forecast. In addition, the majority of our orders in a given quarter historically have been shipped in the third month of that quarter. If this trend continues, any failure or delay in the closing of orders during the last part of a quarter will seriously harm our business.
Some of our products have experienced seasonal fluctuations which have affected sequential growth rates for these products. For example, there appears to be a slow down in the summer quarter for our products in the European region. In addition, sales of our video communications products appear to decline in the first quarter of the year compared to the fourth quarter of the prior year. These fluctuations negatively affect our business during those quarters which could cause operating results to fall short of anticipated results, which would have a negative impact on our stock price.
As a result of these and other factors, we believe that period-to-period comparisons of our historical results of operations are not a good predictor of our future performance. If our future operating results are below the expectations of stock market analysts, our stock price will decline.
GENERAL ECONOMIC CONDITIONS MAY REDUCE OUR REVENUES AND HARM OUR BUSINESS.
As our business has grown, we have become increasingly subject to adverse changes in general economic conditions, which can result in reductions in capital expenditures by our end-user customers, longer sales cycles, deferral or delay of purchase commitments for our products, and increased price competition. These factors did impact our operating results in the first quarter of 2001, and, if the current economic slowdown continues or worsens, these factors will continue to adversely affect our business and results of operations. In addition, we also face the risk that our resellers will build up inventories in anticipation of a growth in sales. If such sales growth does not occur as anticipated by these resellers for any reason, including the current slowdown in economic growth that began in the fourth quarter of 2000 and is expected to continue for most of the remainder of 2001, these resellers may substantially decrease the amount of product ordered in subsequent periods, which would harm our business. As such, we believe our channel partners will reduce their inventory levels in the future including in the second quarter of 2001.
DIFFICULTY IN ESTIMATING CUSTOMER ORDERS COULD HARM OUR OPERATING RESULTS.
We typically ship products within a short time after we receive an order and historically have had no material backlog. As a result, backlog, at any point in time, is not a good indicator of future net revenues, and net revenues for any particular quarter cannot be predicted with any degree of accuracy. Additionally, orders from our reseller customers are based on the level of demand from end-users. The uncertainty of end-user demand means that any quarter could be significantly negatively impacted by lower end-user orders, which could in turn negatively affect orders we receive from our resellers. Accordingly, our expectations for both short- and long-term future net revenues are based almost exclusively on our own estimate of future demand and not on firm reseller orders. Expense levels are based, in part, on these estimates. Since a majority of our customer orders are received in the last month of a quarter, we are limited in our ability to reduce expenses quickly if for any reason orders and net revenues do not meet our expectations in a particular period. In addition, we have historically experienced a lag in demand during the summer months, which adds to the level of difficulty in predicting revenue levels.
WE DEPEND ON DISTRIBUTORS AND RESELLERS TO SELL OUR PRODUCTS, AND WE ARE SUBJECT TO RISKS ASSOCIATED WITH THEIR INVENTORIES OF OUR PRODUCTS, THEIR PRODUCT SELL-THROUGH AND THE SUCCESS OF THEIR BUSINESSES.
We sell a significant amount of our products to distributors and resellers who maintain their own inventory of products for sale to dealers and end-users. A substantial percentage of the total products sold during a particular quarter consists of distributor and reseller stocking orders. We typically provide special cost or early payment incentives for distributors and resellers to purchase the minimum or more than the minimum quantities required under their agreements with us. If these distributors and resellers are unable to sell an adequate amount of their inventory of our products in a given quarter to dealers and end-users or if distributors and resellers decide to decrease their inventories for numerous reasons, including the current slowdown in economic growth that began in the fourth quarter of 2000 and is expected to continue for most of the remainder of 2001, it would negatively affect the volume of our sales to these distributors and resellers and also negatively affect our net revenues which could harm our business. These conditions negatively affected our business and operating results in the last quarter of 2001, and we are uncertain about how long these conditions will impact our business for the remainder of 2001. Also, if we choose to eliminate or reduce stocking incentive programs, quarterly revenues may fail to meet our expectations or be lower than historical levels.
Our revenue estimates are based largely on end-user sales reports that our distributors and resellers provide to us on a monthly basis. To date, we believe this data has been generally accurate in North America but less reliable outside of this region. To the extent that this sales and channel inventory data is inaccurate in either North America or outside of North America, we may not be able to make revenue estimates or may find that our previous estimates were inaccurate.
Many of our distributors and resellers that carry multiple Polycom products, and from whom we derive significant revenues, are undercapitalized. The failure of these businesses to establish and sustain profitability or obtain financing could have a significant negative effect on our future revenue levels and profitability. For example, in the fiscal year 2000, we increased our allowance for bad debt by $1.6 million for specific reseller default situations for which collection is doubtful. The economic slowdown in the United States, and its potential negative effect on the economic impact of the rest of the world, could cause more of our customers’ businesses to fail which would harm our business.
Lucent Technologies, one of our larger resellers, accounted for 12% of our net revenues in the three months ended December 31, 2000, primarily related to Lucent’s purchases of our network access products during that period. In addition, Lucent accounted for 11% of net revenues in both 1999 and 1998. In the three months ended March 31, 2001, the amount of orders we received from Lucent dropped significantly which had a negative effected on our revenues and profitability. If Lucent Technologies continues to reduce its purchases of our products due to the current economic slowdown or any other factor, it will continue to harm our business. In addition, Lucent Technologies has spun off its business equipment division, now known as Avaya Inc. We do not yet know how this spin-off will affect us. In connection with this restructuring, if the combined business from Lucent and Avaya yields a significant reduction in the amount of orders to us, it could harm our business.
Late in the first quarter of 2000, we began shipping the ViewStation FX product. The timing of this delivery date likely created confusion in our reseller customer base and end-user customer market as these groups waited to see if this new ViewStation product was more desirable than the existing products. Therefore, the timing of this new product release likely had a negative effect on our 2000 first quarter sales-in to resellers and sales-out to end-users. We cannot assure you that a similar situation will not happen again.
A major contributor to the expected growth of the broadband distribution market has been the deployment of digital subscriber lines, or DSL. Beginning in the second half of 2000 and continuing into the first quarter of 2001, some DSL providers experienced delays in delivering their service which caused financial troubles for these companies. These DSL providers are customers of our network access products through OEM providers we use as resellers. These service delays slowed the expected growth in this market which in turn slowed sales of our network access products. If these conditions persist, they will negatively impact revenues from our network access products.
WE MAY EXPERIENCE DELAYS IN PRODUCT INTRODUCTIONS AND OUR PRODUCTS MAY CONTAIN DEFECTS WHICH COULD ADVERSELY AFFECT MARKET ACCEPTANCE FOR THESE PRODUCTS AND OUR REPUTATION AND SERIOUSLY HARM OUR RESULTS OF OPERATIONS.
Since the beginning of 1998, our revenue growth has been due in large part to new video communications product introductions. Although we are continuing to introduce new products, such as the ViaVideo, ViewStation 4000, ViewStation FX, SoundPoint Pro 3.0 products and our new voice over internet protocol (VoIP) products, we cannot assure you that new product releases will be timely or that they will be made at all. In fact, the ViewStation FX and ViaVideo were delayed from their original release dates, which we believe negatively affected our net revenues in 2000. Additionally, we cannot assure you that any new or existing product introductions will be free from defects or produce the revenue growth experienced in 1999 and 2000.
In the past we have experienced other delays in the introduction of certain new products and enhancements and believe that such delays may occur in the future. For instance, we experienced delays in introducing the ViewStation FX in 2000 and the ViewStation MP and WebStation in 1998 from their original expected release dates due to unforeseen technology and manufacturing ramping issues. Similar delays occurred during the introduction of the ShowStation IP, SoundStation Premier and ShowStation, affecting the first customer ship dates of these products. Any similar delays in the future for other new product offerings such as VoIP, desktop or other product line extensions could adversely affect market acceptance for these products and our reputation and seriously harm our results of operations. Further, due to the dynamic nature of the network access market sector, any delays in NetEngine product line extensions would seriously harm our business.
WE HAVE LIMITED SUPPLY SOURCES FOR SOME KEY COMPONENTS OF OUR PRODUCTS, AND OUR OPERATIONS COULD BE HARMED BY SUPPLY INTERRUPTIONS, COMPONENT DEFECTS OR UNAVAILABILITY OF THESE COMPONENTS.
Some key components used in our products are currently available from only one source and others are available from only a limited number of sources, including some key integrated circuits and optical elements. We also obtain certain plastic housings, metal castings and other components from suppliers located in Singapore and China, and any political or economic instability in that region in the future, or future import restrictions, may cause delays or an inability to obtain these supplies. We have no supply commitments from our suppliers and generally purchase components on a purchase order basis either directly or through our contract manufacturers. We and our contract manufacturers have had limited experience purchasing volume supplies of various components for our products and some of the components included in our products, such as microprocessors and other integrated circuits, have from time to time been subject to limited allocations by suppliers. In the event that we or our contract manufacturers were unable to obtain sufficient supplies of components or develop alternative sources as needed, our operating results could be seriously harmed. In particular we have recently encountered some development delays and component shortages relating to our network access products, and if such conditions continue, our business will suffer. Moreover, our operating results would be seriously harmed by receipt of a significant number of defective components, an increase in component prices or our inability to obtain lower component prices in response to competitive price reductions. Additionally, our video communications products are designed based on integrated circuits produced by Philips and video equipment produced by Sony. If we could no longer obtain integrated circuits or video equipment from these suppliers, we would incur substantial expense and take substantial time in redesigning our products to be compatible with components from other manufacturers, and we cannot assure you that we would be successful in obtaining these components from alternative sources in a timely or cost-effective manner. Additionally, both Sony and Philips are our competitors in the video communications market, which may adversely affect our ability to obtain necessary components. The failure to obtain adequate supplies could prevent or delay product shipments, which could harm our business. We also rely on the introduction schedules of some key components in the development or launch of new products, in particular, our network access products. Any delays in the availability of these key components could harm our business.
WE RELY ON THIRD-PARTY LICENSE AGREEMENTS AND TERMINATION OR IMPAIRMENT OF THESE AGREEMENTS MAY CAUSE DELAYS OR REDUCTIONS IN PRODUCT INTRODUCTIONS OR SHIPMENTS WHICH WOULD HARM OUR BUSINESS.
We have licensing agreements with various suppliers for software incorporated into our products. For example, we license video communications source code from RADVision, VTEL, Telesoft, Omnitel, Adtran and EBSNet, video algorithm protocols from Real Networks and Ezenia!, development source code from Digital Equipment and Philips Semiconductor, audio algorithms from Lucent Technologies, communication software from DataBeam and Windows software from Microsoft. In addition, for our new network access products, we have interoperability agreements with Jetstream Communications and Tollbridge Technologies, and we depend significantly on these agreements and our ability to secure similar licenses from other gateway providers. These third-party software licenses may not continue to be available to us on commercially reasonable terms, if at all. The termination or impairment of these licenses could result in delays or reductions in new product introductions or current product shipments until equivalent software could be developed, licensed and integrated, if at all possible, which would harm our business.
LOWER THAN EXPECTED MARKET ACCEPTANCE OF OUR PRODUCTS AND PRICE COMPETITION WOULD NEGATIVELY IMPACT OUR BUSINESS.
If our products are not accepted by the market, our profitability could be harmed. For example, we lowered the price of the ShowStation IP by 23% effective March 1999 due to market acceptance issues for this product. Similar price reductions and demand issues could occur for any of our products which could negatively impact our net revenues and profitability. Further, through the end of 2000, growth rates of voice and video product sales from our sales channels to end-users have been significant. Future growth rates for these and our other products may not achieve these levels of growth.
Our profitability could also be negatively affected in the future as a result of continuing competitive price pressure in the conferencing equipment and network access device markets. Although past price reductions have been driven by our desire to expand the market for our products, and we expect that in the future we may further reduce prices or introduce new products that carry lower margins in order to further expand the market or to respond to competitive pricing pressures, such actions may not have the desired impact.
INTERNATIONAL SALES ARE ACCOUNTING FOR AN INCREASING PORTION OF OUR NET REVENUES, AND RISKS INHERENT IN INTERNATIONAL SALES COULD HARM OUR BUSINESS.
International sales are accounting for an increasing portion of our net revenues, and we anticipate that international sales will continue to account for a significant portion of our net revenues for the foreseeable future. International sales are subject to certain inherent risks, including unexpected changes in regulatory requirements and tariffs, difficulties in staffing and managing foreign operations, longer payment cycles, problems in collecting accounts receivable and potentially adverse tax consequences. Additionally, international net revenues may fluctuate as a percentage of net revenues in the future as we introduce new products, since we expect to initially introduce any new products in North America and also because of the additional time required for product homologation and regulatory approvals of new products in international markets. To the extent we are unable to expand international sales in a timely and cost-effective manner, our business could be harmed. We cannot assure you that we will be able to maintain or increase international market demand for our products. Additionally, to date, a substantial majority of our international sales has been denominated in U.S. currency; however, if international sales were denominated in local currencies in the future, these transactions would be subject to currency fluctuation risks.
OUR RECENT ACQUISITIONS OF ACCORD NETWORKS AND CIRCA COMMUNICATIONS COULD ADVERSELY IMPACT OUR BUSINESS
We completed the acquisition of Accord Networks, or Accord, on February 28, 2001 and completed the acquisition of Circa Communications on April 2, 2001. As a result of the completion of the Accord acquisition, we face additional risks that are set forth in the section entitled “Risk Factors,” on pages 13-22 of the proxy statement/prospectus dated January 29, 2001, and filed with the Securities and Exchange Commission on January 24, 2001. These risks relate to the impact of the merger on our business, risks related to the operation of the combined company, and risks related to the business of Accord, including its operations in Israel. We face similar risks in the integration of Circa Communications. Failure to achieve the anticipated benefits of these or any future acquisition or to successfully integrate the operations of Accord and Circa could also harm our business and results of operations. Additionally, we cannot assure you that we will not incur material charges in future quarters to reflect additional costs associated with any future acquisitions we may make.
CONFLICTS WITH OUR CHANNEL PARTNERS COULD HURT SALES OF OUR PRODUCTS.
We have various OEM agreements with some major telecommunications equipment manufacturers, such as Lucent Technologies, whereby we manufacture our products to work with the equipment of the OEM. These relationships can create channel conflicts with our other distributors who directly compete with the OEM partner, which could adversely affect revenue from non-OEM channels. Because many of our distributors also sell equipment that competes with our products, the distributors could devote more attention to the other products, which could harm our business. For example, a significant amount of our network systems revenues are generated from sales to PictureTel which competes with us in the video communications product market. Due to this conflict, they may significantly reduce their orders to us for network systems products which could harm our business. Further, other channel conflicts could arise which cause distributors to devote resources to other non-Polycom communications equipment, which would negatively affect our business or results of operations.
We currently have agreements with video communications equipment suppliers under which these equipment suppliers resell our SoundPoint PC voice products along with their video communications products. We compete with these equipment suppliers in the voice conferencing market and, as such, we cannot assure you that they will enter into future agreements to resell or supply any of our new or enhanced communication products. Further, some of our current video products and video products under development are directly competitive with the products of these suppliers. As a consequence, competition between us and these suppliers is likely to increase, resulting in a strain on the existing relationship between the companies. Any such strain could limit the potential contribution of these relationships to our business.
In addition, we depend on several key agreements, including our agreement with Jetstream Communications in the network access products market. Conflicts may occur in this evolving market as we seek other relationships. These conflicts could harm our business.
OUR SUCCESS DEPENDS ON OUR ABILITY TO ASSIMILATE NEW TECHNOLOGIES IN OUR PRODUCTS AND TO PROPERLY TRAIN OUR RESELLERS IN THE USE OF THOSE PRODUCTS.
The markets for voice and video communications products and network access products are characterized by rapidly changing technology, evolving industry standards and frequent new product introductions. The success of our new products depends on several factors, including proper new product definition, product cost, timely completion and introduction of new products, differentiation of new products from those of our competitors and market acceptance of these products. Additionally, properly addressing the complexities associated with DSL and ISDN compatibility, reseller training, technical and sales support as well as field support are also factors that may affect our success in this market. Further, the shift of communications from circuit-switched to IP-based wired and wireless technologies over time may require us to add new resellers and gain new core technological competencies. We are attempting to address these needs and the need to develop new products through our internal development efforts and joint developments with other companies. We cannot assure you that we will successfully identify new voice, video, network systems and network access product opportunities and develop and bring new voice, video and network access products to market in a timely manner. Further, we cannot assure you that competing technologies developed by others will not render our products or technologies obsolete or noncompetitive. The failure of our new voice, video, network systems and network access product development efforts and any inability to service or maintain the necessary third-party interoperability licenses would harm our business and results of operations.
MANUFACTURING DISRUPTIONS OR CAPACITY CONSTRAINTS WOULD HARM OUR BUSINESS.
We subcontract the manufacture of our SoundStation, SoundStation Premier, SoundPoint Pro, ViewStation and our new network access products to Celestica, a third-party contract manufacturer. We use Celestica's Thailand facilities, and should there be any disruption in services due to natural disaster or economic or political difficulties in Thailand and Asia, or for any other reason, such disruption would harm our business and results of operations. Also, Celestica is currently the sole source manufacturer of these products, and if this subcontractor experiences an interruption in operations or otherwise suffers from capacity constraints, we would experience a delay in shipping these products and we may not be able to meet any demand for our products, either of which could negatively affect revenues in the quarter of the disruption and harm our reputation. In addition, operating in the international environment exposes us to certain inherent risks, including unexpected changes in regulatory requirements and tariffs, difficulties in staffing and managing foreign operations and potentially adverse tax consequences, all of which could harm our business and results of operations. Further, our network systems products are manufactured in Israel which is currently experiencing internal and external conflicts that include terrorist and military action. We could experience a manufacturing disruption due to acts associated with this conflict which could harm our business. In addition, the technology used in the network system products was developed through grants from the Office of the Chief Scientist in Israel. Under Israeli law, it is prohibited to transfer technology developed pursuant to these grants to any person without the prior written consent of the Office of the Chief Scientist. The grants also contain restrictions on the ability to manufacture products developed with these grants outside of Israel. Approval to manufacture such products outside of Israel, if granted, is generally subject to an increase in the total amount to be repaid to the Office of the Chief Scientist to between 120% to 300% of the amount granted, depending on the extent of the manufacturing to be conducted outside of Israel. These restrictions on the ability to transfer technology to third parties or manufacture products outside Israel may adversely affect our operating results and significantly reduce the value of the technology developed under these grants.
PRODUCT OBSOLESCENCE AND OTHER ASSET IMPAIRMENT CAN NEGATIVELY AFFECT OUR RESULTS OF OPERATIONS.
We operate in a high technology market which is subject to rapid and frequent technology changes. These technology changes can and do often render existing technologies obsolete. These obsolescence issues can require write-downs in inventory value when it is determined that the existing inventory cannot be sold at or above net realizable value. This situation occurred in the first quarter of 2001 when we recorded additional excess and obsolescence charges associated with our inventory of network access products. This situation also occurred during the first quarter of 2000 for the ShowStation IP. In addition, if the introduction of our SoundPoint Pro product has a materially negative effect on the future sales of our SoundPoint product, our net revenues could be reduced and an excess and obsolescence issue concerning our SoundPoint inventory could result, which could lower our profitability. The potential for new products to render existing products obsolete or reduce the demand for existing products exists for every one of our products. We cannot assure you that future inventory, investment, license, fixed asset or other asset writedowns will not happen. If future writedowns do occur, they could harm our business.
FAILURE TO ADEQUATELY SERVICE AND SUPPORT OUR PRODUCTS COULD HARM OUR RESULTS OF OPERATIONS.
Our recent growth has been due in large part to an expansion into products with more complex technologies and protocols, including our recently introduced network access products. This has increased the need for increased product warranty and service capabilities. If we cannot develop and train our internal support organization or maintain our relationship with our outside technical support, it could harm our business.
OUR CASH FLOW COULD FLUCTUATE DUE TO OUR ABILITY TO COLLECT RECEIVABLES.
Over the past several quarters, we initiated significant investments in Europe and Asia to expand our business in these regions. In Europe and Asia, as with other international regions, credit terms are typically longer than in the United States. Therefore, as Europe, Asia and other international regions grow as a percentage of our net revenues, as happened in 1999 and 2000, and in the first quarter of 2001, accounts receivable balances will likely increase over previous years. Additionally, sales in the network access and video communications markets typically have longer payment periods over our traditional experience in the voice communications market. Therefore, if network access and video products constitute a greater percentage of net revenues, accounts receivable balances will likely increase. These increases would cause our days sales outstanding to increase over prior years and will negatively affect future cash flows. Although we have been able to offset the effects of these influences through additional incentives offered to resellers at the end of the quarter in the form of prepaid discounts, these additional incentives have lowered our profitability and, given the slow down in the economy of the United States, many companies are opting to not take advantage of our incentives and instead preserve their liquidity. In addition, the economic slowdown in the U.S. may squeeze the availability of capital which may decrease our collections from our resellers.
OUR STOCK PRICE FLUCTUATES AS A RESULT OF THE CONDUCT OF OUR BUSINESS AND STOCK MARKET FLUCTUATIONS.
The market price of our common stock has experienced significant fluctuations and may continue to fluctuate significantly. The market price of our common stock may be significantly affected by a variety of factors, including:
| • | statements or changes in opinions, ratings or earnings estimates made by brokerage firms or industry analysts relating to the market in which we do business or relating to us specifically; |
| • | the announcement of new products or product enhancements by us or our competitors; |
| • | technological innovations by us or our competitors; |
| • | quarterly variations in our results of operations; |
| • | general market conditions or market conditions specific to particular industries; and |
| • | international macroeconomic factors. |
In addition, recently the stock market has experienced extreme price and volume fluctuations. These fluctuations have had a substantial effect on the market prices for many high technology companies, such as Polycom. These fluctuations are often unrelated to the operating performance of the specific companies.
BUSINESS INTERRUPTIONS COULD ADVERSELY AFFECT OUR BUSINESS.
Our operations are vulnerable to interruption by fire, earthquake, power loss, telecommunications failure and other events beyond our control. We do not have a detailed disaster recovery plan. Our facilities in the State of California are currently subject to electrical blackouts as a consequence of a shortage of available electrical power. In the event these blackouts continue or increase in severity, they could disrupt the operations of our affected facilities. In addition, we do not carry sufficient business interruption insurance to compensate us for losses that may occur and any losses or damages incurred by us could have a material adverse effect on our business.
OUR RESELLER CUSTOMER CONTRACTS ARE TYPICALLY SHORT-TERM AND EARLY TERMINATIONS OF OUR CONTRACTS MAY HARM OUR RESULTS OF OPERATIONS.
We do not typically enter into long-term contracts with our reseller customers, and we cannot be certain as to future order levels from our reseller customers. When we do enter into a long-term contract, the contract is generally terminable at the convenience of the customer. In the event of an early termination by one of our major customers, it is unlikely that we will be able to rapidly replace that revenue source, which would harm our results of operations.
FAILURE TO MANAGE OUR GROWTH MAY HARM OUR BUSINESS.
Our business has grown in recent years through both internal expansion and acquisitions, and continued growth may cause a significant strain on our infrastructure and internal systems. To manage our growth effectively, we must continue to improve and expand our management information systems and continue resource additions such as headcount, capital and processes in a timely and efficient manner. We cannot assure you that resources will be available when we need them or that we will have sufficient capital to fund these resource needs. In addition, our success depends to a significant extent on the management skills of our executive officers. If we are unable to manage growth effectively, or we experience a shortfall in resources, our results of operations will be harmed.
IF WE FAIL TO SUCCESSFULLY COMPETE, OUR BUSINESS AND RESULTS OF OPERATIONS WOULD BE SIGNIFICANTLY HARMED.
We have significant competition in the broadband communications industry, which is subject to rapid technological change. In video communications, our major competitors include C-Phones, NEC, PictureTel, RSI, Sony, Tandberg, VCON and VTEL. Many of these companies have substantial financial resources and production, marketing, engineering and other capabilities with which to develop, manufacture, market and sell their products. In addition, with advances in telecommunications standards, connectivity and video processing technology and the increasing market acceptance of video communications, other established or new companies may develop or market products competitive with our video communications products. We believe we will face increasing competition from alternative video communications solutions that employ new technologies or new combinations of technologies from companies such as Cisco, MeetingOne, Microsoft, Nortel, 3Com, RealNetworks or WebEx, that enable web-based or network-based video communications with low-cost digital camera systems. The market for voice communications equipment, particularly voiceconferencing products, is highly competitive and also subject to rapid technological change, regulatory developments and emerging industry standards. We expect competition to persist and increase in the future in this area. In voice communications, our major competitors include SoundGear, NEC, Gentner and other companies that offer lower cost, full-duplex speakerphones such as Lucent Technologies and Hello Direct. Hello Direct, one of our resellers, offers a competitive product under the Hello Direct name through an OEM relationship with Gentner. Most of these companies have substantial financial resources and production, marketing, engineering and other capabilities with which to develop, manufacture, market and sell their products. In addition, all major telephony manufacturers produce hands-free speakerphone units that are lower cost than our voice communications products. Our network access products have significant competition from Adtran, Netopia, 3Com and Cisco Systems and our network systems business has significant competition from Radvision, Avaya and Ezenia. Our network systems revenue are heavily dependent on purchases by our video product competitors. If these network systems’ customers decide to reduce their purchases due to this or other potential competition, it will harm our business.
We cannot assure you that we will be able to compete successfully against our current or future competitors. We expect our competitors to continue to improve the performance of their current products and to introduce new products or new technologies that provide improved performance characteristics. New product introductions by our competitors could cause a significant decline in sales or loss of market acceptance of our existing products and future products. We believe that the possible effects from ongoing competition may be the reduction in the prices of our products and our competitors' products or the introduction of additional lower priced competitive products. We expect this increased competitive pressure may lead to intensified price-based competition, resulting in lower prices and gross margins which would significantly harm our results of operations.
WE RELY ON PATENTS, TRADEMARKS, COPYRIGHTS AND TRADE SECRETS TO PROTECT OUR PROPRIETARY RIGHTS, WHICH MAY NOT BE SUFFICIENT TO PROTECT OUR INTELLECTUAL PROPERTY.
We rely on a combination of patent, copyright, trademark and trade secret laws and confidentiality procedures to protect our proprietary rights. Others may independently develop similar proprietary information and techniques or gain access to our intellectual property rights or disclose such technology. In addition, we cannot assure you that any patent or registered trademark owned by us will not be invalidated, circumvented or challenged in the U.S. or foreign countries, that the rights granted thereunder will provide competitive advantages to us or that any of our pending or future patent applications will be issued with the scope of the claims sought by us, if at all. Furthermore, others may develop similar products, duplicate our products or design around our patents. In addition, foreign intellectual property laws may not protect our intellectual property rights. Litigation may be necessary to enforce our patents and other intellectual property rights, to protect our trade secrets, to determine the validity of and scope of the proprietary rights of others, or to defend against claims of infringement or invalidity. Litigation could result in substantial costs and diversion of resources and could harm our business.
WE FACE AND MIGHT IN THE FUTURE FACE INTELLECTUAL PROPERTY INFRINGEMENT CLAIMS THAT MIGHT BE COSTLY TO RESOLVE.
We have from time to time received, and may in the future receive, communications from third parties asserting patent or other intellectual property rights covering our products. For example, we have been named in (along with approximately 90 manufacturers or distributors of electronic or semiconductor products) and served with a complaint filed by the Lemelson Medical, Education and Research Foundation alleging patent infringement by us.
In addition, our industry is characterized by uncertain and conflicting intellectual property claims and vigorous protection and pursuit of intellectual property rights or positions, which have on occasion resulted in significant and often protracted and expensive litigation. In the past, we have been involved in such litigation, which adversely affected our operating results. We cannot assure you that we will prevail in any such litigation, that intellectual property claims will not be made against us in the future or that we will not be prohibited from using the technologies subject to any such claims or be required to obtain licenses and make corresponding royalty payments. In addition, the necessary management attention to and legal costs associated with litigation can have a significant adverse effect on operating results.
IF WE FAIL TO SUCCESSFULLY ATTRACT AND RETAIN QUALIFIED PERSONNEL, OUR BUSINESS WILL BE HARMED.
Our future success will depend in part on our continued ability to hire, assimilate and retain qualified personnel. Competition for such personnel is intense, and we may not be successful in attracting or retaining such personnel. The loss of any key employee, the failure of any key employee to perform in his or her current position or our inability to attract and retain skilled employees, particularly technical and management, as needed, could harm our business. The loss of the services of any executive officer or other key technical or management personnel could harm our business.
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our exposure to market risk for changes in interest rates relates primarily to our investment portfolio and bank borrowings. We do not use derivative financial instruments and our investment portfolio only includes highly liquid, high quality instruments.
We are subject to fluctuating interest rates that may impact, adversely or otherwise, our results of operations or cash flows for our variable rate bank borrowings, available-for-sale securities and cash and cash equivalents.
The table below presents principal amounts and related weighted average interest rates by year of maturity for our investment portfolio and debt obligations:
| As of March 31, 2001: | | Expected Maturity | |
| | 2001
| 2002
| 2003
| Total
|
| | (in thousands, except interest rates) |
| Assets | | | | |
| Cash and cash equivalents | 153,854 | --- | --- | 153,854 |
| Average interest rates | 4.26% | --- | --- | 4.26% |
| Short-term and long-term investments | 84,238 | 55,136 | 12,505 | 151,879 |
| Average interest rates | 5.24% | 5.73% | 5.39% | 5.43% |
| Liabilities | | | | |
| Bank line of credit | --- | --- | --- | --- |
| Average interest rates | 6.50% | --- | --- | 6.50% |
The estimated fair value of our cash and cash equivalents approximates the principal amounts reflected above based on the short maturities of these financial instruments. We also hold a $0.3 million investment in publicly traded equity securities which was marked to market from our original $1.0 million investment value. The market risk for this investment is driven by movements in the market price of this investment.
We have made investments in private companies. These investments are included in “Other Investments” in our balance sheet and are carried at cost less any impairment loss. We monitor these investments for impairment and make appropriate reductions in carrying value when necessary. Impairment losses are evaluated regularly and are driven by movements in the current valuations of these companies, which are influenced by general securities market conditions, the general business market in which these companies operate and the specific operational capabilities of these companies. For all of these investments, our ownership is less than 20% of the company and we do not have the ability to exercise significant influence over their operations.
All of our sales are denominated in US dollars. Only a small amount of foreign bills are paid in currencies other than the US dollar and these bills are funded at the time of payment; therefore, our foreign exchange risk is considered immaterial to our consolidated financial position, results of operations and cash flows.
| PART II | OTHER INFORMATION |
| | |
| Item 1. | LEGAL PROCEEDINGS |
| | |
| | Not Applicable |
| | |
| Item 2. | CHANGES IN SECURITIES |
| | |
| | Not Applicable. |
| | |
| Item 3. | DEFAULTS UPON SENIOR SECURITIES |
| | |
| | Not Applicable |
| | |
| Item 4. | SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS |
| | |
| | Not Applicable |
| | |
| Item 5. | OTHER INFORMATION |
| | |
| | Not Applicable |
| | |
| Item 6. | EXHIBITS AND REPORTS ON FORM 8-K |
| | |
| (a) | List of Exhibits |
| | |
| | Number
| Exhibit
|
| | 11.1 | Form of Change of Control Severance Agreement with the Chief Executive Officer and Chief Financial Office of the Registrant, effective as of March 28, 2001. |
| | | |
| | 10.2 | Form of Change of Control Severance Agreement with management of the Registrant other than the Chief Executive Officer and Chief Financial Officer, effective as of March 28, 2001. |
| | | |
| (b) | Reports on Form 8-K: | |
| | | |
| | A report on Form 8-K was filed on January 30, 2001, to report that the Company had issued a press release dated January 18, 2001 reporting its operating results for the fourth quarter ended December 31, 2000. |
| | |
| | A report on Form 8-K was filed on March 12, 2001, regarding the completion of the acquisition of Accord Networks, Ltd. on February 28, 2001. |
| | | |
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| Dated: | May 16, 2001 | POLYCOM, INC. |
| | | |
| | | /s/ Michael R. Kourey
|
| | | Michael R. Kourey |
| | | Chief Financial Officer |
| | | (Principal Financial and Accounting Officer) |
