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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
X Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange
- - ---- Act of 1934
FOR THE QUARTERLY PERIOD ENDED OCTOBER 4, 1998
or
Transition report pursuant to Section 13 or 15(d) of the Securities
- - ---- Exchange Act of 1934
For the transition period from ________to _______
COMMISSION FILE NUMBER 0-27130
POLYCOM, INC.
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(Exact name of registrant as specified in its charter)
DELAWARE 94-3128324 .
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(State or other jurisdiction of (I.R.S. employer
incorporation or organization) identification number)
2584 JUNCTION AVENUE, SAN JOSE, CA. 95134-1902 .
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(Address of principal executive offices) (Zip Code)
(Registrant's telephone number, including area code, is (408) 474-2900)
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
--- ---
There were 29,602,124 shares of the Company's Common Stock, par value $.0005,
outstanding on November 2, 1998.
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POLYCOM, INC.
INDEX
REPORT ON FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 1998
Page
Number
------
PART I FINANCIAL INFORMATION
Item 1 Financial Statements:
Condensed Consolidated Balance Sheets as of September 30, 1998 and
December 31, 1997 . . . . . . . . . . . . . . . . . . . . . . . . . . 3
Condensed Consolidated Statements of Operations for the Three and Nine
Month Periods Ended September 30, 1998 and September 30, 1997 . . . . 4
Condensed Consolidated Statements of Cash Flows for the Nine
Month Periods Ended September 30, 1998 and September 30, 1997 . . . . 5
Notes to Condensed Consolidated Financial Statements. . . . . . . . . 6
Item 2 Management's Discussion and Analysis of Financial Condition
and Results of Operations . . . . . . . . . . . . . . . . . . . . . . 11
PART II OTHER INFORMATION
Item 1 - Legal Proceedings. . . . . . . . . . . . . . . . . . . . . . 23
Item 2 - Changes in Securities. . . . . . . . . . . . . . . . . . . . 23
Item 3 - Defaults Upon Senior Securities. . . . . . . . . . . . . . . 23
Item 4 - Submission of Matters to a Vote of Security Holders. . . . . 23
Item 5 - Other Information. . . . . . . . . . . . . . . . . . . . . . 23
Item 6 - Exhibits and Reports on Form 8-K . . . . . . . . . . . . . . 25
SIGNATURE. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26
2
PART 1 FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
POLYCOM, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
September 30, December 31,
1998 1997
---------------- --------------
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 12,979 $ 12,486
Short-term investments 7,035 5,184
Accounts receivable, net of allowance for doubtful
accounts of $838 at September 30, 1998 and $438
at December 31, 1997 20,459 8,135
Inventories 14,694 9,915
Other current assets 2,921 2,930
---------------- --------------
Total current assets 58,088 38,650
Fixed assets, net 6,559 4,528
Other assets 652 351
---------------- --------------
Total assets $ 65,299 $ 43,529
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---------------- --------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 13,226 $ 11,552
Accrued and other current liabilities 8,418 5,694
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Total current liabilities 21,644 17,246
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Stockholders' equity:
Common stock 17 17
Additional paid-in capital 61,733 52,602
Notes receivable from stockholders --- (24)
Accumulated deficit (18,095) (26,312)
---------------- --------------
Total stockholders' equity 43,655 26,283
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Total liabilities and stockholders' equity $ 65,299 $ 43,529
---------------- --------------
---------------- --------------
The accompanying notes are an integral part of these financial statements.
3
POLYCOM, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Three Months Ended Nine Months Ended
Sept. 30, Sept. 30, Sept. 30, Sept. 30,
1998 1997 1998 1997
------------ ----------- ------------ -----------
Net revenues $ 31,603 $ 12,507 $ 75,674 $ 34,517
Cost of net revenues 15,794 6,755 38,102 18,556
------------ ----------- ------------ -----------
Gross profit 15,809 5,752 37,572 15,961
------------ ----------- ------------ -----------
Operating expenses:
Sales and marketing 6,236 3,360 15,377 9,207
Research and development 3,485 4,163 10,410 10,568
General and administrative 1,363 1,301 3,765 3,114
Acquisition expenses --- 133 185 473
------------ ----------- ------------ -----------
Total operating expenses 11,084 8,957 29,737 23,362
------------ ----------- ------------ -----------
Operating income/(loss) 4,725 (3,205) 7,835 (7,401)
Interest income, net 233 302 735 893
Other income/(expense), net 10 (2) 6 13
------------ ----------- ------------ -----------
Income/(loss) before taxes 4,968 (2,905) 8,576 (6,495)
Provision for income taxes 201 28 359 110
------------ ----------- ------------ -----------
Net income/(loss) $ 4,767 $ (2,933) $ 8,217 $ (6,605)
------------ ----------- ------------ -----------
------------ ----------- ------------ -----------
Basic net income/(loss) per share $ 0.17 $ (0.14) $ 0.30 $ (0.33)
------------ ----------- ------------ -----------
------------ ----------- ------------ -----------
Dilutive net income/(loss) per share $ 0.15 $ (0.14) $ 0.26 $ (0.33)
------------ ----------- ------------ -----------
------------ ----------- ------------ -----------
Weighted average shares outstanding for basic EPS 27,962 20,256 27,194 20,027
------------ ----------- ------------ -----------
------------ ----------- ------------ -----------
Weighted average shares outstanding for dilutive EPS 32,829 20,256 32,118 20,027
------------ ----------- ------------ -----------
------------ ----------- ------------ -----------
The accompanying notes are an integral part of these financial statements.
4
POLYCOM, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(IN THOUSANDS)
Nine Months Ended
Sept. 30, Sept. 30,
1998 1997
--------- ---------
Cash flows from operating activities:
Net income/(loss) $ 8,217 $ (6,605)
Adjustments to reconcile net income/(loss) to net cash
provided by operating activities:
Depreciation and amortization 2,373 1,411
Provision for doubtful accounts 400
Provision for excess and obsolete inventories 2,115 643
Value of stock options to outside consultants 90 -
Gain on the sale of fixed assets (6) -
Changes in assets & liabilities:
Accounts receivable (12,724) (268)
Inventories (6,894) (2,410)
Prepaid expenses and other current assets 9 (1,166)
Deposits and other assets (301) 8
Accounts payable 1,674 3,758
Accrued and other liabilities 3,276 476
--------- ---------
Net cash used in operating activities (1,771) (4,153)
--------- ---------
Cash flows from investing activities:
Acquisition of fixed assets (4,352) (2,383)
Proceeds from sale of fixed assets 27 -
Proceeds from sale and maturity of short term
investments 7,146 11,154
Purchases of short term investments (8,997) (2,805)
--------- ---------
Net cash provided by/(used in) investing (6,176) 5,966
--------- ---------
Cash flows from financing activities:
Proceeds from issuance of common stock, net of
repurchases 9,041 7,830
Repayment of stockholder notes receivable, net 24 7
Proceeds from line of credit borrowings 4,951 350
Repayment of line of credit borrowings (5,576) -
--------- ---------
Net cash provided by financing activities 8,440 8,187
--------- ---------
Net increase in cash and cash equivalents 493 10,000
Cash and cash equivalents, beginning of year 12,486 11,253
--------- ---------
Cash and cash equivalents, end of period $ 12,979 $ 21,253
--------- ---------
--------- ---------
The accompanying notes are an integral part of these financial statements.
5
POLYCOM, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION
The condensed consolidated balance sheet as of September 30, 1998, the condensed
consolidated statements of operations for the three and nine month periods
ending September 30, 1998 and 1997 and condensed consolidated statements of cash
flows for the nine month periods ending September 30, 1998 and 1997 have been
prepared by the Company without audit. The condensed consolidated balance sheet
at December 31, 1997 has been derived from the audited financial statements at
that date.
The preparation of financial statements in conformity with United States'
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the reported
period. Actual results could differ from those estimates. In the opinion of
management, all adjustments (which include only normal recurring adjustments)
necessary to present fairly the financial position, results of operations and
cash flows at September 30, 1998 and for all periods presented have been made.
The Company uses a 52-53 week fiscal year. As a result, a fiscal year may not
end as of the same day as the calendar period. However, for convenience of
presentation, the accompanying consolidated financial statements have been shown
as ending on September 30, and December 31 of each applicable period. Due to
timing, 1998 is a 53 week fiscal year. Consequently, the first quarter of 1998
had 14 weeks rather than the usual 13 weeks.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted pursuant to the Securities and Exchange
Commission rules and regulations. These condensed financial statements should
be read in conjunction with the audited financial statements and notes thereto
included in the Company's Report on Form 10-K dated March 13, 1998 and filed
with the Securities and Exchange Commission.
This Report on Form 10-Q contains forward looking statements that involve risks
and uncertainties, including possible fluctuations in quarterly results; the
market acceptance of ShowStation IP, the ViewStation product line, WebStation
and MeetingSite and the risks associated with these emerging markets; the impact
of competitive products and pricing; the profitability of the videoconferencing,
dataconferencing and mutlipoint conferecing product lines; the success of new
audio, data, video and mutlipoint conferencing products; the schedule of and
costs associated with the manufacturing production ramp of the ShowStation IP,
ViewStation, SoundPoint Pro, WebStation, MeetingSite and other new products; the
ongoing success of the 3M royalty relationship; uncertainties relating to the
integration of operations of ViaVideo Communications, Inc.; effects of the
acquisition on existing business partnerships; the impact of the legal
proceedings involving VTEL; the successful expansion of the Company's
infrastructure to support the recent and future anticipated growth; the timely
resolution of the Year 2000 issue by the Company and its customers and suppliers
and the other risks detailed from time to time in the Company's SEC reports,
including the Form 10-K dated March 13, 1998.
2. INVENTORIES
Inventories are stated at the lower of cost or market. Cost is determined in a
manner which approximates the first-in, first-out ("FIFO") method. Inventories
consisted of the following (in thousands):
Sept 30, Dec 31,
1998 1997
---- ----
Raw Materials $ 650 $2,526
Finished Goods 14,044 7,389
-------- -------
$ 14,694 $ 9,915
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6
3. BANK LINE OF CREDIT
The Company has a $5.0 million bank revolving line of credit under an agreement
with Silicon Valley Bank. Borrowings under the line are unsecured and bear
interest at the bank's prime rate (8.0% at September 30, 1998). The agreement
allows for an additional facility of $5.0 million upon request of Polycom and
payment of associated fees. Borrowings under the line are subject to certain
financial covenants and restrictions on indebtedness, equity distributions,
financial guarantees, business combinations and other related items. The line
expires in October 1999. There were no borrowings under the line at September
30, 1998.
4. PER SHARE INFORMATION
The Company prepares earnings/(loss) per share information using the guidelines
of the Statement of Financial Standards No. 128 (SFAS 128), "Earnings Per
Share". SFAS 128 requires net income/(loss) per share to be presented under two
calculations, Basic EPS and Diluted EPS. Basic net income/(loss) per share is
computed using the weighted average number of common shares outstanding during
the periods presented. Diluted net income/(loss) per share is computed using
common and dilutive common equivalent shares outstanding during the periods
represented. Common equivalent shares, including shares issued under the Stock
Option Plan which are subject to repurchase, shares offered through the
Company's Stock Option Plan and warrants, are included in the computation of
diluted net income per share as their effect is dilutive for the three months
and nine months ended September 30, 1998. Common equivalent shares are not
included in the computation of fully diluted net loss per share as their effect
is antidilutive for the three months and nine months ended September 30, 1997.
In accordance with the disclosure requirements of SFAS 128, a reconciliation of
the numerator and denominator of basic and diluted EPS is provided as follows
(in thousands except per share amounts).
Three Months Ended Nine Months Ended
September 30, September 30,
1998 1997 1998 1997
------------------- -------------------
Numerator - basic and diluted EPS
Net income/(loss) $4,767 $(2,933) $8,217 $(6,605)
------------------- -------------------
Denominator - Basic EPS
Common stock outstanding 27,962 20,256 27,194 20,027
------------------- -------------------
Total Shares used in calculation of Basic EPS 27,962 20,256 27,194 20,027
------------------- -------------------
Basic net income/(loss) per share $0.17 $(0.14) $0.30 $(0.33)
------------------- -------------------
Denominator - Diluted EPS
Denominator - Basic EPS 27,962 20,256 27,194 20,027
Effect of Dilutive Securities:
Common stock options 2,467 --- 2,603 ---
Stock subject to repurchase 1,492 --- 1,661 ---
Warrants 908 --- 660 ---
------------------- -------------------
Total Shares used in calculation of Diluted EPS 32,829 20,256 32,118 20,027
------------------- -------------------
Diluted net income/(loss) per share $0.15 $(0.14) $0.26 $(0.33)
------------------- -------------------
Stock options to purchase 3,832,936 shares of common stock, 1,961,300 shares of
common stock subject to repurchase and warrants to purchase 2,000,000 shares of
common stock were outstanding at September 30, 1997 but were not included in the
computation of diluted net income (loss) per share as their effect was
antidilutive.
7
5. FIRST AND SECOND AGREEMENTS WITH 3M
In March 1997, the Company entered into a joint marketing and development
agreement (The First Agreement) with Minnesota Mining and Manufacturing Company
("3M"). Under the terms of this agreement, 3M provided $3.0 million in funding
to Polycom for certain deliverables related to the development of
dataconferencing products and may also provide shared technology resources for
the development of future products. Additionally, Polycom granted 3M exclusive
private-label rights in certain distribution channels to the products developed
under this agreement subject to certain minimum volumes. In 1997, Polycom
recorded the $3.0 million as revenue, $1.0 million in each of the first three
quarters of 1997, based on delivery of the items specified in the contract.
Further, 3M received warrants to purchase up to 2,000,000 shares of the
Company's common stock at an exercise price of $7.50 per share. The warrants
expire in March 1999, which may be extended until March 2000 depending on the
delivery of Polycom's first product developed under the agreement. 3M also has
certain rights of first offer under its stock warrant agreement with Polycom
which gives 3M the right, for a period of 45 days after the Effective Time, to
purchase additional shares of Polycom Common Stock at a purchase price of $7.50
per share. On February 19, 1998, 3M exercised this option and purchased
approximately one million shares of Polycom common stock for a consideration of
approximately $7.6 million. As a result of the purchase, 3M owns approximately
3.5% of outstanding Polycom common stock.
In June 1997, the Company entered into a second joint marketing and development
agreement (The Second Agreement) with 3M. Under this agreement, 3M provided
$2.5 million in funding to Polycom for certain deliverables related to the
development of videoconferencing products and may also provide shared technology
resources for the development of future products. Polycom granted 3M exclusive
private-label rights in certain distribution channels to the products developed
under this agreement. In the three months ended March 31, 1998 and the three
months ended June 30, 1998, the Company received, and recognized as revenue,
$1.5 million and $1.0 million, respectively, under this agreement, using the
percentage of completion methodology.
6. ACQUISITION OF VIAVIDEO COMMUNICATIONS, INC.
On January 2, 1998, the Company completed the acquisition of ViaVideo
Communications, Inc., ("ViaVideo") whereby a wholly owned subsidiary of Polycom,
Inc. was merged with and into ViaVideo. ViaVideo was a development stage
company that designed and developed high quality, low cost, easy to use, group
videoconferencing systems that utilize advanced video and audio compression
technologies along with Internet/Web-based features. Approximately 8.7 million
shares of Polycom common stock were exchanged for all of the issued and
outstanding capital stock of ViaVideo. In addition, outstanding stock options
to purchase ViaVideo common stock were converted into options to purchase
approximately 1.1 million shares of Polycom common stock. The transaction was
treated as a pooling of interests for financial reporting purposes and,
consequently, all prior period figures have been restated as if the combined
entity existed for all periods presented. All intercompany transactions between
the two companies have been eliminated in consolidation. Polycom and ViaVideo
had the same fiscal year ends of December 31 and activity from the start of the
current fiscal period to the merger date was not material. Further, there were
no adjustments required to conform accounting policies between the two
companies.
7. LEASE COMMITMENTS
On November 15, 1997, the Company entered into a two year operating lease for
23,248 square feet of a building in Austin, Texas. The space is being used
primarily as the offices for the engineering and marketing organization
associated with the videoconferencing product line. The lease associated with
this building will expire on December 31, 1999 and the minimum annual payments
under this lease are as follows: 1998 - $424,373; 1999 - $439,543.
8
8. LITIGATION
On September 3, 1997, VTEL Corporation ("VTEL") filed a lawsuit in the U. S.
District Court in Travis County, Texas against ViaVideo, a subsidiary of
Polycom, and its founders (who were formerly employed by VTEL). On May 27, 1998
VTEL amended its suit to add Polycom as a defendant. In the lawsuit, VTEL
alleges breach of contract, breach of confidential relationship, disclosure of
proprietary information, and related allegations. ViaVideo and Polycom have
answered the suit, denying in their entirety VTEL's allegations. If ViaVideo
or Polycom were found to have infringed upon the proprietary rights of VTEL or
any other third party, the companies could be required to pay damages, cease
sales of the infringing products, discontinue such products or such other
injunctive relief a court may determine, any of which could have a material
adverse effect on Polycom's business, financial condition or results of
operations. On April 22, 1998, Polycom filed a declaratory relief action
against VTEL in the Superior Court of Santa Clara County, California seeking a
declaration that Polycom has not infringed on any proprietary rights of VTEL.
VTEL has filed a response to Polycom's complaint asking that the complaint be
dismissed or stayed in favor of the Texas suit.
On October 2, 1997, Datapoint Corporation filed a complaint against Intel
Corporation for infringement of two U.S. patents related to videoconferencing
network technology in the U.S. District Court in Dallas, Texas. On November 25,
1997, the complaint was amended to include several additional defendants, and
Datapoint also filed a motion for certification of the action as a class action.
No ruling occurred relative to the motion for class action certification.
Although neither Polycom nor its subsidiary ViaVideo had been served as a
defendant in any Datapoint complaints, both Polycom and ViaVideo were named as
putative class members in the Datapoint motion for class action certification
along with over 500 other companies. During the third quarter of 1998, the
Company was notified that this case was dismissed by stipulation and an order
entered by the court to that effect.
The Company will vigorously defend against the VTEL claim. While litigation is
inherently uncertain, Polycom believes that the ultimate resolution of this
matter beyond that provided in its balance sheet as of September 30, 1998, will
not have a material adverse effect on the Company's financial position.
9. PREFERRED SHARE PURCHASE RIGHTS PLAN
On July 15, 1998, pursuant to a Preferred Shares Rights Agreement between
Polycom, Inc. and BankBoston N.A., as Rights Agent, the Company's Board of
Directors declared a dividend of one right to purchase one one-thousandth of a
share of the Company's Series A Preferred Stock for each outstanding share of
Common Stock, par value of $0.0005 per share, of the Company. The dividend is
payable on July 31, 1998 to stockholders of record as of the close of business
on that day. Each Right entitles the registered holder to purchase from the
Company one one-thousandth of a share of Series A Preferred at an exercise price
of $90.00, subject to adjustment. The Rights become exercisable (the
"Distribution Date") upon the earlier of: (i) fifteen days following the first
date a public announcement by the Company or an Acquiring Person that an
Acquiring Person has become such (the "Shares Acquisition Date") and (ii)
fifteen days (or such later date as may be determined by the Board of Directors)
following the commencement of, or announcement of an intention to make, a tender
offer or exchange offer, the consummation of which would result in a person or
group becoming an Acquiring Person. A person or group of affiliated or
associated persons that beneficially owns, or has the right to acquire
beneficial ownership of, 20% or more of the outstanding Common Shares is
referred to as an "Acquiring Person." The Rights will expire on the earliest of
(i) July 15, 2008 (the "Final Expiration Date") or (ii) redemption or exchange
of the Rights as described below.
Unless the Rights are earlier redeemed, in the event that a person becomes an
Acquiring Person (a "Triggering Event"), each holder of a Right which has not
theretofore been exercised (other than Rights beneficially owned by the
Acquiring Person or any affiliate of the Acquiring Person, which will thereafter
be void) will thereafter have the right to receive, upon exercise, Common Shares
having a value equal to two times the Purchase Price. The Company may instead
substitute cash, assets or other securities for the Common Shares for which the
Rights would have been exercisable.
9
Similarly, unless the Rights are earlier redeemed, in the event that, after a
Triggering Event, (i) the Company is acquired in a merger or other business
combination transaction, or (ii) 50% or more of the Company's assets or earning
power are sold (other than in transactions in the ordinary course of business),
proper provision must be made so that each holder of a Right which has not
theretofore been exercised (other than Rights beneficially owned by the
Acquiring Person or any affiliate of the Acquiring Person, which will thereafter
be void) will thereafter have the right to receive, upon exercise, shares of
common stock of the acquiring company having a value equal to two times the
Purchase Price.
At any time after a Triggering Event and prior to the acquisition by any person
or entity of beneficial ownership of 50% or more of the Company's outstanding
Common Shares, the Board of Directors of the Company may exchange the Rights
(other than Rights owned by the Acquiring Person), in whole or in part, at an
exchange ratio of one Common Share per Right.
At any time on or prior to the close of business on the earlier of (i) the
Shares Acquisition Date and (ii) the Final Expiration Date of the Rights, the
Company may redeem the Rights in whole, but not in part, at a price of $0.005
per Right.
10. COMPREHENSIVE INCOME
Effective March 31, 1998, the Company adopted SFAS No. 130, "Reporting
Comprehensive Income". SFAS No. 130 establishes standards for the reporting and
display of comprehensive income and its components in a full set of general
purpose financial statements. Comprehensive income 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. As the components of
comprehensive income are not material, the Company has not reflected the
additional reporting and display provisions of SFAS No. 130 in the accompanying
financial statements.
11. RECENT ACCOUNTING PRONOUNCEMENTS
In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information". SFAS No. 131 requires publicly-held
companies to report financial and other information about key revenue-producing
segments of the entity for which such information is available and is utilized
by the chief operating decision maker. Specific information to be reported for
individual segments includes profit or loss, certain revenue and expense items
and total assets. A reconciliation of segment financial information to amounts
reported in the financial statements would be provided. SFAS No. 131 is
effective for the Company for the year ended 1998 and will have no impact on the
Company's financial reporting.
10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
THIS MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS AND OTHER SECTIONS OF THIS DOCUMENT CONTAIN FORWARD-LOOKING
STATEMENTS THAT ARE BASED ON CURRENT EXPECTATIONS, ESTIMATES AND PROJECTIONS
ABOUT THE COMPANY'S INDUSTRY, MANAGEMENT'S BELIEFS, AND ASSUMPTIONS MADE BY
MANAGEMENT. WORDS SUCH AS "ANTICIPATES," "EXPECTS," "INTENDS," "PLANS,"
"BELIEVES," "SEEKS," "ESTIMATES," "TARGETS" AND VARIATIONS OF SUCH WORDS AND
SIMILAR EXPRESSIONS ARE INTENDED TO IDENTIFY SUCH FORWARD-LOOKING STATEMENTS.
THESE STATEMENTS ARE NOT GUARANTEES OF FUTURE PERFORMANCE AND ARE SUBJECT TO
CERTAIN RISKS, UNCERTAINTIES AND ASSUMPTIONS THAT ARE DIFFICULT, IF NOT
IMPOSSIBLE, TO PREDICT. THEREFORE, ACTUAL RESULTS MAY DIFFER MATERIALLY FROM
THOSE EXPRESSED OR FORECASTED IN ANY SUCH FORWARD-LOOKING STATEMENTS. SUCH
RISKS AND UNCERTAINTIES INCLUDING POTENTIAL FLUCTUATIONS IN RESULTS AND FUTURE
GROWTH RATES, IF AT ALL; THE SUCCESSFUL LAUNCH OF NEW PRODUCTS AND MANUFACTURING
RAMP OF THE VIEWSTATION, SHOWSTATION IP, WEBSTATION, MEETINGSITE AND OTHER NEW
PRODUCTS; THE MARKET ACCEPTANCE OF VIEWSTATION, SHOWSTATION IP, WEBSTATION,,
MEETINGSITE AND OTHER NEW PRODUCTS; THE SUCCESS OF 3M IN ESTABLISHING AND
MAINTAINING CHANNELS FOR THE VIEWSTATION 128, VIEWSTATION 512, VIEWSTATION V.35
AND SHOWSTATION IP PRODUCTS; THE ONGOING SUCCESS OF THE 3M ROYALTY RELATIONSHIP;
THE PROFITABILITY OR EVEN POSITIVE GROSS MARGIN OF THE DATACONFERENCING PRODUCT
LINE; DEPENDENCE ON NEW PRODUCTS; TECHNOLOGICAL CHANGE; UNCERTAINTIES RELATING
TO THE INTEGRATION OF OPERATIONS OF VIAVIDEO COMMUNICATIONS, INC.; EFFECTS OF
THE ACQUISITION ON EXISTING BUSINESS PARTNERSHIPS; DEPENDENCE ON THIRD PARTY
DISTRIBUTORS; RISKS ASSOCIATED WITH INTERNATIONAL OPERATIONS; DEPENDENCE ON
RESEARCH AND DEVELOPMENT; EXISTING AND NEW COMPETITION; DEPENDENCE ON THIRD
PARTY MANUFACTURERS; DEPENDENCE ON INTELLECTUAL PROPERTY AND OTHER PROPRIETARY
RIGHTS; DEPENDENCE ON THIRD-PARTY LICENSES; DEPENDENCE ON PERSONNEL; THE IMPACT
OF LEGAL PROCEEDINGS INVOLVING VTEL; THE SUCCESSFUL EXPANSION OF THE COMPANY'S
INFRASTRUCTURE TO SUPPORT THE RECENT AND FUTURE ANTICIPATED GROWTH; THE TIMELY
RESOLUTION OF THE YEAR 2000 ISSUE BY THE COMPANY AND ITS CUSTOMERS AND SUPPLIERS
AND OTHER RISKS DETAILED FROM TIME TO TIME IN THE COMPANY'S SEC REPORTS,
INCLUDING THE COMPANY'S CURRENT REPORT ON FORMS 8-K FILED WITH THE COMMISSION
JANUARY 16, 1998 AND JULY 22, 1998, QUARTERLY REPORT ON FORMS 10-Q FILED WITH
THE COMMISSION MAY 19, 1998 FOR THE PERIOD ENDED MARCH 31, 1998 AND AUGUST 19,
1998 FOR THE PERIOD ENDED JUNE 30, 1998 AND ANNUAL REPORT ON FORM 10-K FOR THE
YEAR ENDED DECEMBER 31, 1997 UNDER "OTHER FACTORS AFFECTING FUTURE OPERATIONS"
ON PAGES 25 THROUGH 28 AND ELSEWHERE IN THE FORM 10-K. UNLESS REQUIRED BY LAW,
THE COMPANY UNDERTAKES NO OBLIGATION TO UPDATE PUBLICLY ANY FORWARD-LOOKING
STATEMENTS, WHETHER AS A RESULT OF NEW INFORMATION, FUTURE EVENTS OR OTHERWISE.
HOWEVER, INVESTORS SHOULD CAREFULLY REVIEW THE RISK FACTORS AND OTHER
INFORMATION SET FORTH IN THE REPORTS AND OTHER DOCUMENTS THE COMPANY FILES FROM
TIME TO TIME WITH THE COMMISSION.
OVERVIEW
Polycom was incorporated in December 1990 to develop, manufacture and
market audioconferencing, dataconferencing and videoconferencing products that
facilitate meetings at a distance. Polycom was engaged principally in research
and development from inception through September 1992, when it began volume
shipments of its first audioconferencing product, SoundStation. As of September
30, 1998, Polycom's audioconferencing product line consisted principally of the
SoundStation, SoundStation EX, SoundStation Premier, SoundStation Premier EX,
SoundPoint and SoundPoint Pro. Polycom began shipping its first dataconferencing
product, ShowStation, in November 1995. In March 1998, Polycom began shipments
of its next generation ShowStation, the ShowStation IP. On January 2, 1998, the
Company completed the
11
acquisition of ViaVideo Communications, Inc., ("ViaVideo"), a development stage
company that designs and develops high quality, low cost, easy to use, group
videoconferencing systems that utilize advanced video and audio compression
technologies along with Internet/Web-based features. Polycom's ViewStation
products (ViewStation 128kbps version, ViewStation 512kbps version and
ViewStation V.35) are the first product offerings resulting from this merger.
The Company commenced first customer shipments of the ViewStation 128 in
February 1998, the ViewStation 512 in April 1998 and the ViewStation V.35 in
August 1998. In September 1998, the Company began shipping its MeetingSite
product, a new Multipoint Conferencing Unit (MCU) product, which assists
connections to existing videoconferencing bridging services.
Polycom markets its products domestically and internationally through a
network of value-added resellers ("VARS"), original equipment manufacturers
("OEMS"), and retailers and also sells its audioconferencing products through
its direct sales force. Through September 30, 1998, Polycom has derived a
majority of its net revenues from sales of its SoundStation products. Polycom
anticipates that sales of its SoundStation product line will continue to account
for a significant portion of the Company's net revenues at least through the
year ending December 31, 1998. Any factor adversely affecting the demand or
supply for the SoundStation product line could materially adversely affect
Polycom's business, financial condition, cash flows or results of operations.
For the nine months ended September 30, 1998, an increasing portion of the
Company's net revenues are related to sales of the ViewStation product line.
The Company anticipates that sales of its ViewStation product line will account
for more than half of its net revenues at least for the three months ended
December 31, 1998. Any factor adversely affecting the demand or supply for the
ViewStation product line could materially adversely affect Polycom's business,
financial condition, cash flows or results of operations.
From inception through the nine month period ended September 30, 1995, the
Company incurred losses from operations, primarily as a result of its
investments in the development of its products and the expansion of its sales
and marketing, manufacturing and administrative organizations. The Company
achieved profitability in the fourth quarter of 1995 and generated net income in
fiscal 1996. The Company incurred a quarterly operating loss in each quarter of
1997 as a result of investments in the next generation dataconferencing product,
the videoconferencing product line and the sales and marketing function. The
Company intends to continue to invest significantly in research and development
and the Company's infrastructure in 1998. Although Polycom plans to generate
operating income, excluding acquisition expenses, through 1998, there can be no
assurance that the Company will achieve its operating plans or achieve
profitable operations in any subsequent period.
In March 1997, Polycom entered into a joint marketing and development
agreement (the "FIRST AGREEMENT") with 3M. Under the agreement, 3M provided
$3.0 million in funding to Polycom for certain deliverables related to the
development of the next generation dataconferencing product and may also provide
shared technology resources for the development of future products. Through
December 31, 1997, Polycom recorded the $3.0 million as revenue, $1.0 million in
each of the first three quarters of 1997, based on delivery of the items
specified in the contract. The amounts were recognized as revenue using the
percentage of completion methodology. Additionally, Polycom granted 3M exclusive
private-label rights in certain distribution channels to the products developed
under this agreement subject to certain minimum volumes. Further, 3M received
warrants to purchase up to 2,000,000 shares of Polycom's common stock at an
exercise price of $7.50 per share. The warrants expire in March 1999. At the
time of grant, the warrants were valued using the Black-Scholes model and were
determined to have a value of $40,000. 3M also has certain rights of first offer
under its stock warrant agreement with Polycom which will give 3M the right, for
a period of 45 days after the Effective Time, to purchase additional shares of
Polycom Common Stock at a purchase price of $7.50 per share. In February 1998,
3M exercised this option and purchased approximately one million shares of
Polycom common stock for a consideration of approximately $7.6 million. As a
result of the purchase, 3M owns approximately 3.5% of outstanding Polycom common
stock.
In June 1997, the Company entered into a second joint marketing and
development agreement (The "SECOND AGREEMENT") with 3M. Under this agreement,
3M provided $2.5 million in funding to Polycom for certain deliverables related
to the development of videoconferencing products and may also provide shared
technology resources for the development of future products. Polycom will grant
3M exclusive private-label
12
rights in certain distribution channels to the products developed under this
agreement. In the three months ended March 31, 1998 and the three months ended
June 30, 1998, the Company received, and recognized as revenue, $1.5 million and
$1.0 million, respectively, under this agreement, using the percentage of
completion methodology.
On July 21, 1998, the Company announced that Robert C. Hagerty,
previously Polycom's president and COO, was appointed the role of president and
CEO. Brian L. Hinman, formerly chairman and CEO, will continue as chairman and
contribute to Polycom's long range strategy on a part-time basis.
RESULTS OF OPERATIONS
The following table sets forth, as a percentage of net revenues, condensed
consolidated statements of operations data for the periods indicated.
Three Months Ended Nine Months Ended
Sept. 30, Sept. 30, Sept. 30, Sept 30,
1998 1997 1998 1997
--------- --------- --------- --------
Net revenues 100% 100% 100% 100%
Cost of net revenues 50% 54% 50% 54%
--------- --------- --------- --------
Gross profit 50% 46% 50% 46%
--------- --------- --------- --------
Operating expenses:
Sales and marketing 20% 27% 21% 26%
Research and development 11% 33% 14% 31%
General and administrative 4% 10% 5% 9%
Acquisition expenses 0% 1% 0% 1%
--------- --------- --------- --------
Total operating expenses 35% 71% 40% 67%
--------- --------- --------- --------
Operating income/(loss) 15% 25% 10% (21%)
Interest income, net 1% 2% 1% 2%
Other income/(expense), net 0% 0% 0% 0%
--------- --------- --------- --------
Income/(loss) before taxes 16% (23%) 11% (19%)
Provision for Income Taxes 1% 0% 0% 0%
--------- --------- --------- --------
Net income/(loss) 15% (23%) 11% (19%)
--------- --------- --------- --------
--------- --------- --------- --------
NET REVENUES
Total net revenues were $31.6 million in the third quarter of 1998 compared
to $12.5 million in the third quarter of 1997, an increase of 153%. The
increase was due, in large part, to the revenues generated from the sales of the
ViewStation 512, which began shipping in April of 1998, and, to lesser extent,
increases in the SoundStation, SoundStation Premier, ViewStation V.35 and
ShowStation IP product lines. The ViewStation product sales were made
primarily to resellers with sell-through to end-users anticipated over the next
several months, although there can be no assurances that this will happen.
For the first nine months of 1998, total net revenues were $75.7 million,
an increase of $41.2 million or 119%, compared to the same period in 1997. The
increase was due mainly to the revenues generated from the sales of the
ViewStation products which began shipping in 1998. In addition, sales volume
increases in the SoundStation and SoundStation Premier product lines over the
same period last year contributed to the revenue increase. Offsetting these
increases was a decline in revenue associated with the deliverables under the 3M
agreements. Polycom recorded $2.5 million in revenues in the first nine months
of 1998 associated with the deliverables under the Second 3M agreement compared
to $3.0 million in the same period of 1997 associated with the deliverables
under the First 3M agreement.
13
During the first nine months of 1998 and 1997, the Company derived a
majority of its net revenues from sales of its SoundStation product family. In
the three months ended September 30, 1998 Lucent Technologies accounted for 13%
of the Company's net revenues. For the first nine months of 1998, Lucent
Technologies accounted for 12% of the Company's net revenues. No other customer
or reseller accounted for more than 10% of the Company's net revenues in the
three months and nine months ended September 30, 1998. No customer or reseller
accounted for more than 10% of the Company's net revenues during the same
periods for 1997.
The Company depends on third-party resellers for a substantial portion of
its international sales. Certain of these third-party resellers also act as
resellers for competitors of the Company that can devote greater effort and
resources to marketing competitive products. The loss of certain of these
third-party resellers could have a material adverse effect on the Company's
business and results of operations.
Polycom has a number of resellers, such as 3M and Sprint North Supply, that
sell into a sub-distribution network. The sub-distribution network may, at
times, encounter channel conflict. As a result, this conflict has the potential
to negatively affect the Company's direct reseller relationships. If this were
to occur the Company's net revenue and results of operations could be materially
adversely affected.
International net revenues for the third quarter of 1998 accounted for 25%
of total net revenues for the Company, which equaled the third quarter of 1997.
International net revenues for the first nine months of 1998 accounted for 23%
of total net revenues for the Company, no change from the same period of 1997.
The Company anticipates that international sales will continue to account for a
significant portion of total 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 in the future as the Company introduces
new products, since the Company expects to initially introduce such products in
North America and also because of the additional time required for product
homologation and regulatory approvals of new products in international markets.
Further, the ongoing economic problems in the Asian market could adversely
offset the Company's profitability if such economic problems continue. To the
extent the Company is unable to expand international sales in a timely and
cost-effective manner, the Company's business, financial condition or results of
operations could be materially adversely affected. There can be no assurance
that the Company will be able to maintain or increase international market
demand for the Company's products. To date, a substantial majority of the
Company's international sales has been denominated in U.S. currency; however,
the Company expects that in the future more international sales may be
denominated in local currencies and, therefore, subject to currency fluctuation
risks.
COST OF NET REVENUES
Cost of net revenues consists primarily of the Company's manufacturing
organization, contract manufacturers, tooling depreciation, warranty expense and
an allocation of overhead expenses. The cost of net revenues represented 50%
and 54% of net revenues for the third quarters of 1998 and 1997, respectively.
The decrease in the cost of net revenues percentage is due to lower product
costs associated with the SoundStation product line, an improved product mix and
overall favorable manufacturing variances due to the new ViewStation product
family. These improvement were offset by lower margins from the revenue
associated with the Joint Development and Marketing Agreements with 3M and a
substantial write down of excess ShowStation inventory during the third quarter
of 1998.
For the first nine months of 1998 the cost of net revenues percentage was
50%, compared to 54% for the same period in 1997. The decrease was again due to
lower SoundStation product costs and favorable variances due to the new
ViewStation product family. Again, these improvement were offset by lower
margins from the revenue associated with the Joint Development and Marketing
Agreements with 3M and a substantial write down of excess ShowStation inventory
during the third quarter of 1998.
The Company has lowered product prices in the past which was driven by the
Company's desire to expand the market for its products, and the Company may
further reduce prices or introduce new products
14
that carry higher costs relative to price in order to further expand the market
or to respond to competitive pricing pressures, although there can be no
assurance that such actions by the Company will expand the market for its
products or be sufficient to meet competitive pricing pressures. In the future,
the cost of net revenues percentage may be affected by price competition and
changes in unit volume shipments, product costs and warranty expenses. The cost
of net revenues percentage may also be impacted by the mix of distribution
channels used by the Company, the mix of products sold and the mix of
international versus North American revenues. The Company typically realizes
lower cost of net revenue percentages on direct sales than on sales through
indirect channels. If sales through resellers, especially OEMs, increase as a
percentage of total revenues, the Company's cost of net revenues percentage
would be adversely impacted.
As discussed earlier, the Company began shipping the ShowStation IP product
in late March 1998. To date, the Company has not achieved the target level of
volume production from the contract manufacturer for this product. The failure
to meet volume production expectations has negatively affected this product's
cost of net revenues percentage and, consequently, its profitability. Although
the Company is currently addressing these delays with the contract manufacturer,
further production problems could continue to negatively impact the cost of net
revenues percentage. If this happens, the Company's profitability could be
materially adversely affected.
The Company anticipates the first customer shipments of the WebStation
product during the fourth quarter of 1998. This new dataconferencing product
could compete directly with the ShowStation IP product and, consequently,
adversely affect future sales of the ShowStation IP. If this occurs, the
Company's total revenue could be significantly adversely affected and it could
create an excess and obsolescence issue concerning the ShowStation IP inventory
which could materially adversely affect the Company's profitability.
In late 1997 and early 1998, the Company began using its contract
manufacturer in Thailand as its main source of refurbishing SoundStation and
ViewStation service inventory. Through the end of September 1998, the
transition had not been completed, thereby, increasing the cost of this
function. It is expected that improvements will be realized later in the year;
however, there can be no assurances that this will occur. If the transition is
not completed during this time period or if, when complete, the transition does
not produce the desired results, the Company's cost of net revenues percentage
could increase.
SALES AND MARKETING EXPENSES
THREE MONTHS ENDED NINE MONTHS ENDED
------------------ -----------------
SEPT. 30, SEPT. 30, INCREASE/ SEPT. 30, SEPT. 30, INCREASE/
$ IN THOUSANDS 1998 1997 (DECREASE) 1998 1997 (DECREASE)
- - -------------- ---- ---- -------- ---- ---- --------
Expenses $ 6,236 $ 3,360 86 % $ 15,377 $ 9,207 67 %
% of Net Revenues 20 % 27 % (7 %) 21 % 26 % (5%)
Sales and marketing expenses consist primarily of salaries and commissions,
advertising and promotional expenses, an allocation of overhead expenses and
customer service and support costs. The expense increase in the third quarter
of 1998 over the third quarter of 1997 and for the nine months ended September
30, 1998 compared to the same period of 1997 was primarily related to increased
investment in the videoconferencing sales effort. As mentioned previously, the
Company only began selling the ViewStation in 1998 and, consequently, had little
sales and marketing expense in the comparable periods of 1997 associated with
these products. Additionally, increases in the audioconferencing sales efforts
for the three and nine months ended September 30, 1998 have also contributed to
the overall increase over the respective comparable periods of 1997.
The Company expects to continue to increase its sales and marketing
expenses in absolute dollar amounts in an effort to expand North American and
international markets, market new products and establish and expand distribution
channels. In particular, due to the innovative nature of the ShowStation IP,
WebStation, ViewStation products and MeetingSite, the Company believes it will
be required to incur significant additional expenses for sales and marketing,
especially advertising, to educate potential
15
customers as to the desirability of these products. In addition, the Company is
currently evaluating a significant investment in the European market which will
decentralize the marketing and sales effort for this region, thereby, increasing
the absolute dollars spent in this area. Also, Polycom is currently expanding
the service organization to provide expanded and improved support for its video,
data and mutlipoint conferencing products which will increase the Company's
sales and marketing expenses. Further, the launch of the MeetingSite product, a
new Multipoint Conferencing Unit (MCU) product, which assists connections to
existing videoconferencing bridging services, will cause an increase in the
Company's sales and marketing expenses.
RESEARCH AND DEVELOPMENT EXPENSES
THREE MONTHS ENDED NINE MONTHS ENDED
------------------ -----------------
SEPT. 30, SEPT. 30, INCREASE/ SEPT. 30, SEPT. 30, INCREASE/
$ IN THOUSANDS 1998 1997 (DECREASE) 1998 1997 (DECREASE)
- - -------------- ---- ---- -------- ---- ---- --------
Expenses $ 3,485 $ 4,163 (16) % $10,410 $10,568 (1) %
% of Net Revenues 11 % 33 % (22 %) 14 % 31 % (17 %)
Research and development expenses consist primarily of compensation costs,
consulting fees, an allocation of overhead expense, supplies and depreciation.
The expense decrease for the third quarter of 1998 when compared to the third
quarter of 1997 was primarily attributable to lower development expenses for the
ShowStation IP and ViewStation products. The decrease in research and
development expenses for the nine months ended September 30, 1998 when compared
to the same period last year was primarily associated with the dataconferencing
line as the large investments in the next generation ShowStation IP made in 1997
begin to normalize. This year-to-date decrease was offset somewhat by increases
in development associated with the SoundPoint Pro and ViewStation products.
The Company believes that technological leadership is critical to its
success and is committed to continuing a high level of research and development.
Consequently, the Company intends to increase its research and development
expenses in absolute dollars in the future.
GENERAL AND ADMINISTRATIVE EXPENSES
THREE MONTHS ENDED NINE MONTHS ENDED
SEPT. 30, SEPT. 30, INCREASE/ SEPT. 30, SEPT. 30, INCREASE/
$ IN THOUSANDS 1998 1997 (DECREASE) 1998 1997 (DECREASE)
- - -------------- ---- ---- -------- ---- ---- --------
Expenses $ 1,363 $ 1,301 5 % $3,765 $3,114 21 %
% of Net Revenues 4 % 10 % (6) % 5 % 9 % (4 %)
General and administrative expenses consist primarily of compensation
costs, an allocation of overhead expense, and outside legal and accounting
expenses. The increase in general and administrative expenses in absolute
dollars for the three and nine months ended September 30, 1998 versus the same
periods of 1997 is primarily due to increased staffing and infrastructure to
support the Company's growth. Additionally, during the third quarter of 1998,
the Company reversed a contingency reserve associated with the Datapoint
litigation which was resolved favorably during the quarter. This adjustment was
offset somewhat by additional bad debt and compensation expenses also recorded
during the third quarter of 1998.
The Company believes that its general and administrative expenses will
increase in absolute dollar amounts in the future primarily as a result of
expansion of the Company's administrative staff and costs related to supporting
a larger company created by the completion of the acquisition of ViaVideo.
16
ACQUISITION EXPENSES
For the nine months ended September 30, 1998, the Company incurred expenses
totaling $0.2 million related to the acquisition of ViaVideo. For the nine
months ended September 30, 1997, the Company incurred $0.5 million of expenses
related to the acquisition. A significant portion of these charges were for
outside legal, accounting and consulting services. Management does not
anticipate any further material ViaVideo acquisition related expenses throughout
the remainder of this fiscal year; however, there can be no assurances that this
will happen or that the future charges will not be material.
INTEREST INCOME, NET AND OTHER EXPENSES, NET
Interest income, net consists of interest earned on the Company's cash
equivalents and short-term investments net of any interest expense. For the
third quarter of 1998, interest income, net was $0.2 million, a decrease of 23%
from the third quarter of 1997. For the nine months ended September 30, 1998,
interest income, net was $0.7 million, a decrease of 18% from the comparable
period of 1997. These decreases were due to lower levels of cash available for
investment.
The Company accounts for income taxes in accordance with the Financial
Accounting Standards Board's Statement of Financial Accounting Standards No. 109
"Accounting for Income Taxes." The current quarter's profitable results
generated minimal federal and state income taxes in the first quarter of 1998.
Throughout the remainder of 1998 and beyond, to the extent the Company realizes
profitable results, the Company will generate higher federal and state income
tax expense, although there can be no assurance the Company will achieve
profitable results. As of September 30, 1998, the Company had approximately
$3.3 million in federal net operating loss carryforwards and $0.7 million in tax
credit carryforwards. The future utilization of the Company's net operating
loss carryforwards may be subject to certain limitations upon certain changes in
ownership of the Company.
The Company has established a full valuation allowance against its deferred
tax assets due to the uncertainty surrounding the realization of such assets.
Management evaluates the recoverability of the deferred tax assets and the level
of the valuation allowance on a quarterly basis. At such time, if it is
determined that it is more likely than not those deferred tax assets are
realizable, the valuation allowance will be appropriately reduced.
OTHER FACTORS AFFECTING FUTURE OPERATIONS
Polycom's net revenues have grown primarily through increased market
acceptance of its established SoundStation, SoundStation Premier and ViewStation
product lines, other new product introductions and through the expansion of
Polycom's North American and International distribution networks. While Polycom
has experienced growth in net revenues in recent quarters, it does not believe
that the historical growth rates in net revenues will be sustainable nor are
they indicative of future operating results. For example, Polycom believes that
the 37% price reduction in the North American list price of its SoundStation
product line, effective December 1996 for resellers and January 1997 for end
user customers, and the 30% price reduction for SoundStation products sold
internationally effective April 1997, negatively impacted Polycom's net revenues
and profitability in 1997. Polycom believes that profitability could continue
to be negatively affected in the future as a result of several factors including
low to negative gross margins for the ShowStation IP, the reduction in the list
prices of the SoundStation product line and continuing competitive price
pressure in the conferencing equipment market. Although price reductions have
been driven by Polycom's desire to expand the market for its products, and
Polycom expects that in the future it 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, there can be no assurance that such
actions by Polycom will expand the market for its products or be sufficient to
meet competitive pricing pressures. Additionally, if the WebStation product
materially negatively affects the future sales of the ShowStation IP, as
discussed earlier, the Company's total revenue could be significantly adversely
affected and it could create an excess and obsolescence issue concerning the
ShowStation IP inventory which could materially adversely affect the Company's
profitability. In addition, costs related to the merger with ViaVideo, and its
integration into Polycom, expense growth related to the activities of the
combined entities and costs related to the introduction
17
of the new ShowStation IP, ViewStation, SoundStation Satellite, WebStation,
MeetingSite and SoundPoint Pro products could negatively impact future
profitability. Also, the impacts of pending or future litigation against Polycom
or ViaVideo, including the suit filed by VTEL against ViaVideo, as mentioned in
Polycom's Form 8-K filed on September 9, 1997, beyond that already provided in
the Company's Balance Sheet as of September 30, 1998, are difficult to predict
at this time. Further, Polycom's limited operating history and limited
resources, among other factors, make the prediction of future operating results
difficult, if not impossible.
In the past Polycom has experienced delays from time to time in the
introduction of certain new products and enhancements and expects that such
delays may occur in the future. For instance, the introduction of ShowStation
was delayed by approximately eighteen months from the originally anticipated
date of introduction because of unforeseen technical challenges and difficulties
in building core technologies and, for approximately nine weeks in the first
quarter of 1996, shipments were interrupted in order to correct software and
other technical problems identified by initial customers. In addition,
SoundStation Premier first customer shipments were delayed from its original
shipment target of September 1996 to November 1996 and ShowStation IP was
delayed from its original shipment target of September 1997 to its first
customer shipment date of March 1998 due to engineering and manufacturing
start-up issues. Any similar delays in the future could have a material adverse
effect on Polycom's results of operations.
Polycom's operating results have fluctuated in the past and may fluctuate
in the future as a result of a number of factors, including market acceptance of
ShowStation IP, ViewStation, WebStation, MeetingSite and other new product
introductions and product enhancements by Polycom or its competitors, the prices
of Polycom's or its competitors' products, the mix of products sold, the mix of
products sold directly and through resellers, fluctuations in the level of
international sales, the cost and availability of components, manufacturing
costs, the level and cost of warranty claims, changes in Polycom's distribution
network, the level of royalties to third parties and changes in general
economic conditions. In addition, competitive pressure on pricing or demand
levels in a given quarter could adversely affect Polycom's operating results
for such period, and such price pressure over an extended period could
materially adversely affect Polycom's long-term profitability. Polycom's
ability to maintain or increase net revenues will depend upon its ability to
increase unit sales volumes of its SoundStation, SoundStation Premier and
SoundPoint families of products, the ShowStation line of products, the
ViewStation product line, and any new products or product enhancements. There
can be no assurance that Polycom will be able to increase unit sales volumes of
existing products, introduce and sell new products or reduce its costs as a
percentage of net revenues.
Polycom typically ships products within a short time after receipt of an
order, and historically has not had a significant backlog; however, backlog may
fluctuate significantly from period to period. 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.
Accordingly, Polycom's expectations for both short- and long-term future net
revenues are based almost exclusively on its own estimate of future demand and
not on firm customer orders. In addition, Polycom has in the past received
orders and shipped a substantial percentage of the total products sold during a
particular quarter in the last few weeks of the quarter. In some cases, these
orders have consisted of distributor stocking orders and Polycom has from time
to time provided special incentives for distributors to purchase more than the
minimum quantities required under their agreements with Polycom. Additionally,
a majority of Polycom's net revenues are from sales to resellers who sell the
products through to end users. If these resellers are unable to sell through
their inventory of Polycom products in a given quarter, it could affect the
volume of Polycom's sales to these resellers in future quarters. This is
especially true for new product channel shipments, such as the ViewStation 512
and ViewStation V.35 shipments, in the third quarter of 1998. Therefore,
Polycom has been uncertain, throughout most of each quarter, as to the level of
revenues it will achieve in the quarter and the impact that distributor
stocking orders will have on revenues and profitability in that quarter and
subsequent quarters. In addition, because a substantial percentage of product
sales occur at the end of the quarter, product mix and, therefore,
profitability is difficult, if not impossible, to predict. The Company also
depends on third-party resellers for a substantial portion of its revenue.
Certain of these third-party resellers also act as resellers for competitors of
the Company that can devote greater effort and resources to marketing
competitive products. The loss of certain of these third-party resellers could
have a material adverse effect on the Company's business and results of
operations. Further, there can be no guarantee that Polycom's contract
manufacturers will be able to meet product demand before any given
18
quarter ends. Polycom anticipates that this pattern of sales may continue in
the future with the exception that the Company may reduce and ultimately
eliminate the end of quarter incentives offered to distributors. If the Company
chooses to eliminate or reduce stocking incentive programs, quarterly revenue
may be materially adversely affected. Expense levels are based, in part, on
these estimates and, since Polycom is limited in its ability to reduce expenses
quickly if orders and net revenues do not meet expectations in a particular
period, operating results would be adversely affected. In addition, a seasonal
demand appears to have developed for Polycom's products particularly evident in
a lag in demand during the summer months. Due to all of the foregoing factors,
it is likely that in some future quarter Polycom's operating results will be
materially below the expectations of public market analysts and investors. In
such event, the price of Polycom's Common Stock would likely be materially
adversely affected.
During the third quarter of 1998, the Company traded $1.1 million of
SoundPoint inventory for barter trade credits. These trade credits are
convertible into a variety of goods or services, but the Company believes that a
majority of them will be used for media advertising. No revenue was recorded on
this transaction and it had no impact on net income. As of September 30, 1998,
the trade credits are classified as a prepaid asset at its net realizable value
which approximates the original value of the inventory. The credits have no
expiration date. If the Company subsequently determines that it can not utilize
these trade credits, it could have a material adverse impact on its
profitability.
The markets for videoconferencing products are characterized by changing
technology, evolving industry standards and frequent new product introductions.
The success of Polycom's new ViewStation products is dependent on several
factors, including proper new product definition, product cost, timely
completion and introduction of new products, differentiation of new products
from those of Polycom's competitors and market acceptance of these products.
Additionally, properly addressing the complexities associated with ISDN
compatibility, reseller training, technical and sales support as well as field
support are also factors affecting the Company's success in this market.
Polycom is attempting to address the need to develop new products through its
internal development efforts and joint developments with other companies. There
can be no assurance that Polycom will successfully identify new
videoconferencing product opportunities and develop and bring new
videoconferencing products to market in a timely manner, or that
videoconferencing products and technologies developed by others will not render
Polycom's ViewStation products or technologies obsolete or noncompetitive. The
failure of Polycom's new videoconferencing products development efforts would
have a material adverse effect on Polycom's business, financial condition and
results of operations.
Polycom subcontracts the manufacture for its SoundStation, SoundStation
Premier and ViewStation product families to International Manufacturing
Services, Inc. ("IMS"), a global third-party contract manufacturer. Polycom
uses IMS's Thailand facilities and should there be any disruption in supply due
to recent economic and political difficulties in Thailand and Asia, such
disruption would have a material adverse effect on Polycom's business, financial
condition and result of operations. In addition, operating in the international
environment exposes Polycom 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 have a material adverse effect on Polycom's business, financial
condition and result of operations. Further, IMS and Celestica, Inc., a world
leader in electronics manufacturing services, recently announced that they have
entered into a definitive merger agreement. The impact of this merger agreement
on Polycom is currently unknown but could have a material adverse impact on
Polycom's business, financial condition and result of operations.
Polycom completed the acquisition of ViaVideo Communications, Inc. on
January 2, 1998. Polycom acquired ViaVideo with the expectation that the
acquisition would result in operating and strategic benefits, including
operating cost reductions and product development, marketing and sales
synergies. If the operations of ViaVideo are not successfully combined with
those of Polycom in a coordinated, timely and efficient manner, Polycom's
business, financial condition and results of operations would be materially
adversely effected. The integration of ViaVideo's product offerings and
operations with Polycom's product offerings and operations and the coordination
of ViaVideo's sales and marketing efforts with those of Polycom will require
substantial attention from management. The diversion of the attention of
management and any difficulties encountered in the transition process could have
a material adverse affect on Polycom's business, financial condition or results
of operations. The difficulties of assimilation may be increased by the
necessity of integrating personnel with disparate business backgrounds and
combining two different
19
corporate cultures. In addition, the process of combining the two organizations
could cause the interruption of, or a loss of momentum in, the activities of
either or both of the companies' businesses, which could have an adverse effect
on the combined operations. As a result of the acquisition, Polycom's operating
expenses will significantly increase in absolute dollars. Should the expected
revenues from ViaVideo products not occur, or occur later or in an amount less
than expected, the higher operating expenses could have a material adverse
affect on the business, financial condition and results of operations of
Polycom. Failure to achieve the anticipated benefits of the acquisition or to
successfully integrate the operations of the companies could have a material
adverse effect upon the business, operating results or financial condition of
Polycom. Additionally, there can be no assuranc that Polycom will not incur
additional material charges in future quarters to reflect additional costs
associated with the acquisition.
The acquisition could cause customers and potential customers of Polycom or
ViaVideo to delay or cancel orders for products as a result of customer concerns
and uncertainty over product evolution, integration and support of ViaVideo's
products with Polycom's products. Such a delay or cancellation of orders could
have a material adverse effect on the business, financial condition or results
of operations of Polycom.
Polycom currently has agreements with certain videoconferencing equipment
providers whereby these equipment suppliers resell Polycom's SoundPoint PC
products along with their videoconferencing products. Polycom and these
equipment suppliers are competitors in the teleconferencing market and, as
such, there can be no assurance that they will enter into future agreements to
resell or supply any of the Company's new or enhanced teleconferencing
products. Further, certain current Polycom video products and other video
products under development at Polycom are directly competitive with the products
of these suppliers, and thus competition between Polycom and the other
suppliers is likely to increase, resulting in a strain on the existing
relationship between the companies. If this occurs, it could limit the
contribution that these relationships could have on the financial results of
operations of Polycom.
Polycom's stock price has varied greatly as has the volume of shares of the
Company's common stock that has traded. The Company expects these fluctuations
to continue due to factors such as announcements of new products, services or
technological innovations by Polycom or its competitors, announcements of major
restructurings by Polycom or its competitors, quarterly variations in Polycom's
results of operations, changes in revenue or earnings estimates by the
investment community, speculation in the press or investment community, general
conditions in the conferencing equipment industry, changes in the Company's
revenue growth rates or the growth rates of Polycom's competitors, and sales of
large blocks of the Company's stock.
The stock market may from time to time experience extreme price and volume
fluctuations. Many technology companies have experienced such fluctuations. In
addition, Polycom's stock price may be affected by general market conditions and
domestic and international macroeconomic factors unrelated to the Company's
performance. Often such fluctuations have been unrelated to the operating
performance of the specific companies. The market price for Polycom's common
stock may experience significant fluctuations in the future.
Polycom's operations are vulnerable to interruption by fire, earthquake,
power loss, telecommunications failure and other events beyond Polycom's
control. Additionally, most of Polycom's operations are currently located in the
San Francisco Bay Area, an area that is susceptible to earthquakes. Polycom does
not carry sufficient business interruption insurance to compensate Polycom for
losses that may occur, and any losses or damages incurred by Polycom could have
a material adverse effect on its business, financial condition or operating
results.
Many currently installed computer systems and software products are coded
to accept only two digit entries in the date code field. As the Year 2000
approaches, these code fields will need to accept four digit entries to
distinguish years beginning with "19" from those beginning with "20". As a
result, in less than two years, computer systems and/or software products used
by many companies may need to be upgraded to comply with such Year 2000
requirements. The Company is currently expending resources to review its
internal use software in order to identify and modify those systems that are not
Year 2000 compliant. The Company's products and services have already been
reviewed and certified to be Year 2000 compliant. In addition, the Company is
currently evaluating the necessity of upgrading its current
20
internal business information systems. The Company believes that this internal
system implementation effort, principally conducted to improve operating
efficiencies, will also address the Company's internal Year 2000 compliance
issues.
Polycom takes seriously the potential issues that could arise due to the Year
2000 impact on internal systems, facilities, and our suppliers. In connection
with the Year 2000 initiative, the Company is working to assure that our
internal systems, facilities, and suppliers are Year 2000 compliant in advance
of January 1, 2000.
Because the Company is in the early phases of its Year 2000 initiative, the
efforts required to become Year 2000 compliant have not been fully identified.
Therefore, the Company does not know the total incremental costs associated with
correcting the Year 2000 problem. The Company believes; however, that it is
unlikely to experience a material adverse impact on its financial condition or
results of operations due to Year 2000 compliance issues. Costs related to the
Year 2000 issue incurred to date have been expensed as incurred. All future
incremental costs associated with the Year 2000 project will be expensed as
incurred. Additionally, the Company expects to fund the Year 2000 project
through cash generated from operations. However, since the assessment process
is ongoing, the Year 2000 complications are not fully known, and potential
liability issues are not clear, the full potential impact of the Year 2000 on
the Company is not known at this time.
As mentioned earlier, Polycom has begun efforts on a business systems
replacement project. The new system, which will make the Company's business
computer systems fully Year 2000 compliant, is scheduled for completion by the
end of 1999. A contingency plan has been developed to make the systems that are
scheduled to be replaced Year 2000 compliant. A decision to implement the
contingency plan would be made no later than the middle of 1999, with completion
by the end of 1999. If the Company's assumptions and estimates are incorrect or
do not come to fruition, or if the Company does not achieve all of the key
factors associated with the Company's efforts to comply with Year 2000
requirements, then the Company's results from operations, liquidity and
financial position could be materially adversely affected.
LIQUIDITY AND CAPITAL RESOURCES
As of September 30, 1998, the Company's principal sources of liquidity
included cash, cash equivalents and short-term investments of $20 million, an
increase of $2.3 million from December 31, 1997. Additionally, on October 17,
1997, the Company re-established a $5.0 million revolving bank line of credit
from Silicon Valley Bank which had previously expired on April 15, 1997. This
line of credit allows for an additional facility of $5.0 million available upon
request by the Company and contingent upon payment of associated fees.
The Company used $1.8 million in cash from operating activities for the
first nine months of 1998 compared to a use of $4.2 million in cash from
operating activities for the same period in 1997. The increase in cash from
operating activities was due primarily to the net income, before non-cash
adjustments, earned for the first nine months of 1998 compared to a net loss for
the same period of 1997. This increase was offset by a larger increase in
accounts receivable as a result of increased sales as well as an increase in
inventories.
The total net change in cash and cash equivalents for the first nine months
of 1998 was an increase of $0.5 million. The primary sources of cash were
proceeds totaling $7.6 million from a stock purchase from 3M and proceeds from
the exercise of stock options totaling $1.5 million. The primary uses of cash
during the first nine months of 1998 were $1.8 million from operating
activities, purchases of property, plant and equipment of $4.4 million, net
purchases of short-term investments of $1.9 million and net payment of line of
credit borrowings of $0.6 million. The use of cash from operating activities was
the result of an increase in trade accounts receivable and an increase in
inventories, offset by a positive net income, before non-cash expenses, and an
increase in accrued liability balances.
The Company's material commitments consist of obligations under its
revolving bank line of credit, operating leases and a $250,000 stand-by letter
of credit which has been issued to guarantee certain of the Company's
contractual obligations. The Company also maintains, from time to time,
commercial letters of credit as payments for the importation of certain
products. The amounts do not exceed $100,000
21
and are outstanding less than 120 days. The Company estimates that 1998 capital
expenditures will total approximately $6.0 million.
The Company believes that its available cash, cash equivalents and bank
line of credit will be sufficient to meet the Company's operating expenses and
capital requirements through at least December 31, 1998. Thereafter, it cannot
be determined with any degree of certainty how successful the Company will be at
growing the market for its products, if at all. If there is substantial growth
and, as a result, the Company goes beyond current acceptable liquidity levels,
or if the financial results were to violate the financial covenants of the bank
line of credit, Polycom may require additional funds to support its working
capital requirements or for other purposes and may seek to raise such additional
funds through public or private equity financing or from other sources. There
can be no assurance that additional financing will be available at all or that,
if available, such financing will be obtainable on terms favorable to the
Company and would not be dilutive. The Company's future liquidity and cash
requirements will depend on numerous factors, including introduction of new
products and potential product family, business or technology acquisitions.
22
PART II OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS
On September 3, 1997, VTEL Corporation ("VTEL") filed a lawsuit in the
U. S. District Court in Travis County, Texas against ViaVideo, a
subsidiary of Polycom, and its founders (who were formerly employed by
VTEL). On May 27, 1998 VTEL amended its suit to add Polycom as a
defendant. In the lawsuit, VTEL alleges breach of contract, breach of
confidential relationship, disclosure of proprietary information, and
related allegations. ViaVideo and Polycom have answered the suit,
denying in their entirety VTEL's allegations. If ViaVideo or Polycom
were found to have infringed upon the proprietary rights of VTEL or
any other third party, the companies could be required to pay damages,
cease sales of the infringing products, discontinue such products or
such other injunctive relief a court may determine, any of which could
have a material adverse effect on Polycom's business, financial
condition or results of operations. On April 22, 1998, Polycom filed
a declaratory relief action against VTEL in the Superior Court of
Santa Clara County, California seeking a declaration that Polycom has
not infringed on any proprietary rights of VTEL. VTEL has filed a
response to Polycom's complaint asking that the complaint be dismissed
or stayed in favor of the Texas suit.
On October 2, 1997, Datapoint Corporation filed a complaint against
Intel Corporation for infringement of two U.S. patents related to
videoconferencing network technology in the U.S. District Court in
Dallas, Texas. On November 25, 1997, the complaint was amended to
include several additional defendants, and Datapoint also filed a
motion for certification of the action as a class action. No ruling
occurred relative to the motion for class action certification.
Although neither Polycom nor its subsidiary ViaVideo had been served
as a defendant in any Datapoint complaints, both Polycom and ViaVideo
were named as putative class members in the Datapoint motion for class
action certification along with over 500 other companies. During the
third quarter of 1998, the Company was notified that this case was
dismissed by stipulation and an order entered by the court to that
effect.
The Company will vigorously defend against the VTEL claim. While
litigation is inherently uncertain, Polycom believes that the ultimate
resolution of this matter beyond that provided in its balance sheet as
of September 30, 1998, will not have a material adverse effect on the
Company's financial position.
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
On July 15, 1998, pursuant to a Preferred Shares Rights Agreement
between Polycom, Inc. and BankBoston N.A., as Rights Agent, the
Company's Board of Directors declared a dividend of one right to
purchase one one-thousandth of a share of the Company's Series A
Preferred Stock for each outstanding share of Common Stock, par value
of $0.0005 per share, of the Company. The dividend is payable on July
31, 1998 to stockholders of record as of the close of business on that
day. Each Right entitles the
23
registered holder to purchase from the Company one one-thousandth of a
share of Series A Preferred at an exercise price of $90.00, subject to
adjustment. The Rights become exercisable (the "Distribution Date")
upon the earlier of: (i) fifteen days following the first date a
public announcement by the Company or an Acquiring Person that an
Acquiring Person has become such (the "Shares Acquisition Date") and
(ii) fifteen days (or such later date as may be determined by the
Board of Directors) following the commencement of, or announcement of
an intention to make, a tender offer or exchange offer, the
consummation of which would result in a person or group becoming an
Acquiring Person. A person or group of affiliated or associated
persons that beneficially owns, or has the right to acquire beneficial
ownership of, 20% or more of the outstanding Common Shares is referred
to as an "Acquiring Person." The Rights will expire on the earliest of
(i) July 15, 2008 (the "Final Expiration Date") or (ii) redemption or
exchange of the Rights as described below.
Unless the Rights are earlier redeemed, in the event that a person
becomes an Acquiring Person (a "Triggering Event"), each holder of a
Right which has not theretofore been exercised (other than Rights
beneficially owned by the Acquiring Person or any affiliate of the
Acquiring Person, which will thereafter be void) will thereafter have
the right to receive, upon exercise, Common Shares having a value
equal to two times the Purchase Price. The Company may instead
substitute cash, assets or other securities for the Common Shares for
which the Rights would have been exercisable.
Similarly, unless the Rights are earlier redeemed, in the event that,
after a Triggering Event, (i) the Company is acquired in a merger or
other business combination transaction, or (ii) 50% or more of the
Company's assets or earning power are sold (other than in transactions
in the ordinary course of business), proper provision must be made so
that each holder of a Right which has not theretofore been exercised
(other than Rights beneficially owned by the Acquiring Person or any
affiliate of the Acquiring Person, which will thereafter be void) will
thereafter have the right to receive, upon exercise, shares of common
stock of the acquiring company having a value equal to two times the
Purchase Price.
At any time after a Triggering Event and prior to the acquisition by
any person or entity of beneficial ownership of 50% or more of the
Company's outstanding Common Shares, the Board of Directors of the
Company may exchange the Rights (other than Rights owned by the
Acquiring Person), in whole or in part, at an exchange ratio of one
Common Share per Right.
At any time on or prior to the close of business on the earlier of
(i) the Shares Acquisition Date and (ii) the Final Expiration Date of
the Rights, the Company may redeem the Rights in whole, but not in
part, at a price of $0.005 per Right.
The Securities and Exchange Commission has recently amended Rule
14a-4(c)(1) promulgated under the Securities Exchange Act of 1934, as
amended (the "Exchange Act"). As amended, Rule 14a-4(c)(1) provides
that where a stockholder proponent chooses not to use the procedures
set forth in Rule 14a-8 under the Exchange Act for placing such
stockholder's proposal in a company's proxy materials, a proxy may
confer discretionary authority to vote on a matter presented at an
annual meeting of stockholders if the proponent fails to notify the
company at least 45 days prior to the anniversary date of mailing of
the prior year's proxy statement. A statement conferring such
discretionary authority must be made in the proxy statement or proxy
for such annual meeting. The proxy statement for the Company's 1998
Annual Meeting of Stockholders was mailed to stockholders on April 21,
1998. Accordingly, if a proponent does not notify the Company on or
before March 7, 1999 of a proposal to be presented at the 1999 Annual
Meeting of Stockholders, the Company may use its discretionary voting
authority to vote on such proposal when and if presented at the 1999
Annual Meeting of Stockholders.
24
Item 6 EXHIBITS AND REPORTS ON FORM 8-K
(a) List of Exhibits
NUMBER EXHIBIT
- - ------ -------
11.1 Statement of Computation of Earning (Loss) Per Share (contained in
Note 4 of Notes to Condensed Consolidated Financial Statements)
27.1 Financial Data Schedule
(b) Reports on Form 8-K:
Not Applicable
25
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: November 17, 1998 POLYCOM, INC.
/s/ Michael R. Kourey
--------------------------
Michael R. Kourey
Chief Financial Officer
(Principal Financial and Accounting Officer)
26