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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 JULY 4, 1999
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 (IRS 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) 474-2904)
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 32,541,025 shares of the Company's Common Stock, par value $.0005,
outstanding on August 6, 1999.
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POLYCOM, INC.
INDEX
REPORT ON FORM 10-Q
FOR THE QUARTER ENDED JUNE 30, 1999
Page
Number
------
PART I FINANCIAL INFORMATION
Item 1 Financial Statements:
Condensed Consolidated Balance Sheets as of June 30, 1999 and
December 31, 1998.......................................................... 3
Condensed Consolidated Statements of Income for the Three and Six
Month Periods Ended June 30, 1999 and June 30, 1998........................ 4
Condensed Consolidated Statements of Cash Flows for the Six
Month Periods Ended June 30, 1999 and June 30, 1998........................ 5
Notes to Condensed Consolidated Financial Statements....................... 6
Item 2 Management's Discussion and Analysis of Financial Condition
and Results of Operations.................................................. 9
Item 3 Quantitative and Qualitative Disclosures About Market Risk................. 22
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................................................. 24
Item 6 - Exhibits and Reports on Form 8-K.................................. 24
SIGNATURE.................................................................................... 25
2
PART 1 FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
POLYCOM, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
June 30, December 31,
1999 1998
------------------- -------------
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 36,510 $ 17,548
Short-term investments 16,211 5,483
Accounts receivable, net of allowance for doubtful
accounts of $1,008 at June 30, 1999 and
$838 at December 31, 1998 33,309 25,011
Inventories 19,219 16,699
Deferred taxes 2,594 2,594
Other current assets 4,007 2,196
------------------- -------------
Total current assets 111,850 69,531
Fixed assets, net 8,369 6,727
Noncurrent deferred taxes 3,157 0
Long-term investments 2,075 0
Other assets 498 696
------------------- -------------
Total assets $ 125,949 $ 76,954
------------------- -------------
------------------- -------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 24,102 $ 12,412
Taxes payable 2,389 1,405
Accrued and other current liabilities 10,474 10,083
------------------- -------------
Total current liabilities 36,965 23,900
------------------- -------------
Stockholders' equity:
Common stock 18 18
Additional paid-in capital 85,956 64,590
Accumulated earnings/(deficit) 3,010 (11,554)
------------------- -------------
Total stockholders' equity 88,984 53,054
------------------- -------------
Total liabilities and stockholders' equity $ 125,949 $ 76,954
------------------- -------------
------------------- -------------
The accompanying notes are an integral part of these
condensed consolidated financial statements.
3
POLYCOM, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Three Months Ended Six Months Ended
June 30, June 30, June 30, June 30,
1999 1998 1999 1998
-------------- ------------- -------------- -------------
Net revenues $ 45,112 $ 26,040 $ 85,125 $ 44,071
Cost of net revenues 20,172 13,127 38,888 22,309
-------------- ------------- -------------- -------------
Gross profit 24,940 12,913 46,237 21,762
-------------- ------------- -------------- -------------
Operating expenses:
Sales and marketing 8,293 5,116 15,640 9,141
Research and development 4,624 3,387 8,159 6,925
General and administrative 1,916 1,360 3,423 2,402
Acquisition expenses --- --- --- 185
-------------- ------------- -------------- -------------
Total operating expenses 14,833 9,863 27,222 18,653
-------------- ------------- -------------- -------------
Operating income 10,107 3,050 19,015 3,109
Interest income, net 387 261 686 502
Other expense, net (16) (5) (21) (3)
-------------- ------------- -------------- -------------
Income before taxes 10,478 3,306 19,680 3,608
Provision for income taxes 3,667 151 5,117 158
-------------- ------------- -------------- -------------
Net income $ 6,811 $ 3,155 $ 14,563 $ 3,450
-------------- ------------- -------------- -------------
-------------- ------------- -------------- -------------
Basic net income per share $ 0.22 $ 0.12 $ 0.48 $ 0.13
-------------- ------------- -------------- -------------
-------------- ------------- -------------- -------------
Dilutive net income per share $ 0.20 $ 0.10 $ 0.42 $ 0.11
-------------- ------------- -------------- -------------
-------------- ------------- -------------- -------------
Weighted average shares outstanding for basic EPS 31,269 27,402 30,435 26,810
-------------- ------------- -------------- -------------
-------------- ------------- -------------- -------------
Weighted average shares outstanding for dilutive EPS 34,646 33,181 34,340 31,763
-------------- ------------- -------------- -------------
-------------- ------------- -------------- -------------
The accompanying notes are an integral part of these
condensed consolidated financial statements.
4
POLYCOM, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(IN THOUSANDS)
Six Months Ended
June 30, June 30,
1999 1998
-------------- -------------
Cash flows from operating activities:
Net income $ 14,563 $ 3,450
Adjustments to reconcile net income to net cash
provided by/(used in) operating activities:
Depreciation and amortization 1,862 1,434
Provision for doubtful accounts 170 -
Provision for excess and obsolete inventories 1,403 595
Value of stock options to outside consultants 14 58
Changes in assets and liabilities:
Accounts receivable (8,468) (7,882)
Inventories (3,923) (6,210)
Deferred taxes (3,157) -
Prepaids, deposits and other assets (1,863) 88
Accounts payable 11,690 2,478
Taxes payable 4,804 160
Accrued and other liabilities 391 2,635
-------------- -------------
Net cash provided by / (used in) operating activities 17,486 (3,194)
-------------- -------------
Cash flows from investing activities:
Acquisition of fixed assets (3,504) (2,587)
Proceeds from repayment of note receivable 250 -
Proceeds from sale and maturity of investments 3,251 4,035
Purchases of investments (16,054) (4,834)
-------------- -------------
Net cash used in investing activities (16,057) (3,386)
-------------- -------------
Cash flows from financing activities:
Proceeds from issuance of common stock, net of repurchases 2,533 8,326
Proceeds from exercise of warrants 15,000 -
Repayment of stockholder notes receivable, net - 24
Proceeds from line of credit borrowings - 3,451
Repayment of line of credit borrowings - (4,076)
-------------- -------------
Net cash provided by financing activities 17,533 7,725
-------------- -------------
Net increase in cash and cash equivalents 18,962 1,145
Cash and cash equivalents, beginning of year 17,548 12,486
-------------- -------------
Cash and cash equivalents, end of period $ 36,510 $ 13,631
-------------- -------------
-------------- -------------
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Income taxes paid $ 3,457 $ 137
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING:
Conversion of preferred shares to common stock $ - $ 9,496
Tax benefit from exercise of employee stock options $ 3,820 $ -
The accompanying notes are an integral part of these
condensed consolidated financial statements.
5
POLYCOM, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION
The condensed consolidated balance sheet as of June 30, 1999, the condensed
consolidated statements of income for the three and six month periods ending
June 30, 1999 and 1998 and condensed consolidated statements of cash flows
for the six month periods ending June 30, 1999 and 1998 have been prepared by
the Company without audit. The condensed consolidated balance sheet at
December 31, 1998 has been derived from the audited financial statements as
of 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 June 30, 1999 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 June 30 and December 31 of each applicable period. Due to
timing, 1998 was 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
for the year ended December 31, 1998 dated March 15, 1999 and filed with the
Securities and Exchange Commission.
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):
June 30, Dec 31,
1999 1998
-------- -------
Raw Materials $ 888 $ 974
Finished Goods 18,331 15,725
-------- --------
$ 19,219 $ 16,699
-------- --------
-------- --------
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 (8.00% at June 30, 1999). 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 June 30, 1999.
6
4. PER SHARE INFORMATION
The Company prepares earnings per share information using the guidelines of
the Statement of Financial Standards No. 128 (SFAS 128), "Earnings Per
Share". SFAS 128 requires net income per share to be presented under two
calculations, Basic EPS and Diluted EPS. Basic net income per share is
computed using the weighted average number of common shares outstanding
during the periods presented. Diluted net income 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 and
six months ended June 30, 1999 and June 30, 1998.
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 Six Months Ended
June 30, June 30,
1999 1998 1999 1998
-------------- ------------ ----------- ----------
Numerator - basic and diluted EPS
Net income $ 6,811 $ 3,155 $14,563 $ 3,450
-------------- ------------ ----------- ----------
-------------- ------------ ----------- ----------
Denominator - Basic EPS
Common stock outstanding 31,269 27,402 30,435 26,810
-------------- ------------ ----------- ----------
Total shares used in calculation of Basic EPS 31,269 27,402 30,435 26,810
-------------- ------------ ----------- ----------
Basic net income per share $ 0.22 $ 0.12 $ 0.48 $ 0.13
-------------- ------------ ----------- ----------
-------------- ------------ ----------- ----------
Denominator - Diluted EPS
Denominator - Basic EPS 31,269 27,402 30,435 26,810
Effect of Dilutive Securities:
Common stock options 2,363 3,055 2,378 2,671
Stock subject to repurchase 1,014 1,746 1,104 1,745
Warrants 0 978 423 537
-------------- ------------ ----------- ----------
Total shares used in calculation of Diluted EPS 34,646 33,181 34,340 31,763
-------------- ------------ ----------- ----------
Diluted net income per share $ 0.20 $ 0.10 $ 0.42 $ 0.11
-------------- ------------ ----------- ----------
-------------- ------------ ----------- ----------
5. FIRST AND SECOND AGREEMENTS WITH 3M
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 ShowStation IP. Additionally, Polycom granted 3M exclusive
private-label rights and distribution rights in certain distribution channels
to the products developed under this agreement, subject to certain minimum
volumes. Effective January 1999; however, 3M no longer has exclusive
distribution rights and effective April 1999 3M no longer distributes the
products developed under this agreement. 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. In March 1999, 3M exercised the warrants and
purchased 2,000,000 shares of Polycom's common stock. 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 was also granted certain rights of first offer
under its stock warrant agreement with Polycom which gave 3M the right 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. With the exercise of the warrants, this right
of first offer expired. As of June 30, 1999, 3M owned approximately 9% of the
outstanding Polycom common stock.
7
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. Polycom granted 3M
exclusive private-label rights and distribution rights in certain
distribution channels to the products developed under this agreement subject
to certain minimum volumes. Effective April 1999 3M no longer distributes 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.
As mentioned earlier, in April 1999, 3M announced that they are exiting the
businesses associated with the First and Second Agreements. Under the Product
Exit and Transfer Agreement between Polycom and 3M, both parties are working
to transition 3M's resellers to Polycom. Polycom will be purchasing some
video products from 3M. Further, existing warranty obligations 3M has
concerning the sale of these products will be assumed by Polycom.
6. LITIGATION
On September 3, 1997, VTEL Corporation ("VTEL") filed a lawsuit in the State
District Court in Travis County, Texas against ViaVideo Communications, Inc.
(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, its founders 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, 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 may have a material adverse effect on Polycom's
business, financial condition or results of operations. The parties have
engaged in written discovery. No trial date is presently scheduled.
The Company intends to vigorously defend against the VTEL claim. However,
litigation is inherently uncertain and, because of such, the actual impact of
the outcome of the VTEL litigation is unknown at this time. If the courts
find in favor of VTEL in this matter, it may have a material adverse impact
on Polycom's results of operations and financial position.
8
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
THIS REPORT ON FORM 10-Q CONTAINS FORWARD LOOKING STATEMENTS, INCLUDING
STATEMENTS CONCERNING FUTURE REVENUES OF THE VIEWSTATION AND SOUNDSTATION
PRODUCT FAMILIES, FLUCTUATIONS, OR LACK THEREOF, OF THE COST OF NET REVENUES
AS A PERCENTAGE OF NET REVENUES, EXPENSE FLUCUATIONS IN ABSOLUTE DOLLARS AND
AS A PERCENTAGE OF NET REVENUES, AND THE IMPACT OF THE YEAR 2000 ISSUE ON THE
COMPANY. 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 INCLUDE POTENTIAL FLUCTUATIONS IN
RESULTS AND FUTURE GROWTH RATES, IF AT ALL; THE SUCCESSFUL LAUNCH OF NEW
PRODUCTS AND MANUFACTURING RAMP OF THE VIEWSTATION, WEBSTATION,
STREAMSTATION, MEETINGSITE AND OTHER NEW PRODUCTS; THE MARKET ACCEPTANCE OF
VIEWSTATION, STREAMSTATION, SHOWSTATION IP, WEBSTATION, SOUNDPOINT PRO,
MEETINGSITE AND OTHER NEW PRODUCTS; SALES OF THE SOUNDPOINT PRODUCT GIVEN THE
INTRODUCTION OF THE SOUNDPOINT PRO; THE PROFITABILITY OR EVEN POSITIVE GROSS
MARGIN OF THE DATACONFERENCING PRODUCT LINE; THE SUCCESS OF THE REALNETWORKS
RELATIONSHIP; DEPENDENCE ON NEW PRODUCTS; TECHNOLOGICAL CHANGE; THE
SUCCESSFUL TRANSITION OF 3M'S AUDIO/VISUAL AND OFFICE SUPPLY CHANNELS;
DEPENDENCE ON THIRD PARTY DISTRIBUTORS; RISKS ASSOCIATED WITH INTERNATIONAL
OPERATIONS; THE CONTRIBUTION OF INTERNATIONAL REVENUES; DEPENDENCE ON
RESEARCH AND DEVELOPMENT; EXISTING AND NEW COMPETITION; DEPENDENCE ON THIRD
PARTY MANUFACTURERS AND SOLE-SOURCE SUPPLIERS; DEPENDENCE ON INTELLECTUAL
PROPERTY AND OTHER PROPRIETARY RIGHTS; DEPENDENCE ON THIRD-PARTY LICENSES;
DEPENDENCE ON PERSONNEL; THE SUCCESSFUL GROWTH IN OPERATING EXPENSES IN
PROPORTION TO THE ANTICIPATED GROWTH IN REVENUES AND THE COMPANY; 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 ANNUAL REPORT ON FORM 10-K FOR THE YEAR
ENDED DECEMBER 31, 1998 UNDER "OTHER FACTORS AFFECTING FUTURE OPERATIONS" ON
PAGES 29 THROUGH 33 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. FURTHERMORE, 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
conferencing 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 June 30, 1999, Polycom's audioconferencing
product line consisted principally of the SoundStation, SoundStation Premier,
SoundPoint and SoundPoint Pro product families. Polycom began shipping its
first dataconferencing product, ShowStation, in November 1995. As of June 30,
1999, Polycom's dataconferencing product line consisted principally of the
ShowStation IP and WebStation. On January 2, 1998, the Company completed the
acquisition of ViaVideo Communications, Inc., ("ViaVideo"), 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. In
February 1998, Polycom began customer shipments of the ViewStation 128, its
first videoconferencing product. As of June 30, 1999, Polycom's
videoconferencing product line consisted principally of the ViewStation 128,
ViewStation 512, ViewStation V.35, ViewStation MP and ViewStation
9
SP. In September 1998, the Company began shipping its MeetingSite product, a
Multipoint Conferencing Unit (MCU) product, which provides connectability for
large multipoint videoconference calls. In June 1999, the Company shipped it
first collaborative product with RealNetworks, the StreamStation, in beta
volumes. The StreamStation incorporates RealNetworks' RealSystem-TM- G2
industry-leading streaming media technology to stream point-to-point or
multipoint videoconferencing using the Polycom ViewStation to the Web. Using
StreamStation, real-time or on-demand videoconferences can be webcast to any
PC with a RealPlayer-Registered Trademark- G2, enabling meeting participants
to join videoconferences from the desktop.
Polycom markets its products domestically and internationally through a
network of value-added resellers ("VARs"), original equipment manufacturers
("OEMs"), and retailers. The Company also sells its audioconferencing
products through its direct sales force. Effective January 1999, the direct
sales force also began selling the dataconferencing product line. Through
June 30, 1999, Polycom has derived a majority of its net revenues from sales
of its SoundStation and ViewStation products. Polycom anticipates that sales
of the SoundStation and ViewStation product lines will continue to account
for a significant portion of the Company's net revenues at least through the
year ending December 31, 1999. Any factor adversely affecting the demand or
supply for these products would 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 returned to profitability in each quarter
of 1998 and the first two quarters of 1999. The Company intends to continue
to invest significantly in research and development, sales and marketing and
the Company's infrastructure in 1999. Although Polycom plans to generate
operating income through 1999, there is a limited history of profitability
for the Company. Additionally, because Polycom's profitability is very
dependent on the market acceptance and profitability of a relatively small
amount of products, 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 ShowStation IP. Additionally, Polycom granted 3M exclusive
private-label rights and distribution rights in certain distribution channels
to the products developed under this agreement, subject to certain minimum
volumes. Effective January 1999; however, 3M no longer has exclusive
distribution rights and effective April 1999 3M no longer distributes the
products developed under this agreement. 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. In March 1999, 3M exercised the warrants and
purchased 2,000,000 shares of Polycom's common stock. 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 was also granted certain rights of first offer
under its stock warrant agreement with Polycom which gave 3M the right 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. With the exercise of the warrants, this right
of first offer expired. As of June 30, 1999, 3M owned approximately 9% of the
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. Polycom granted 3M
exclusive private-label rights and distribution rights in certain
distribution channels to the products developed under this agreement subject
to certain minimum volumes. Effective April 1999 3M no longer distributes 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.
10
As mentioned earlier, in April 1999, 3M announced that they are exiting the
businesses associated with the First and Second Agreements. Under the Product
Exit and Transfer Agreement between Polycom and 3M, both parties are working
to transition 3M's resellers to Polycom. Polycom will be purchasing some
video products from 3M. Further, existing warranty obligations 3M has
concerning the sale of these products will be assumed by Polycom.
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 Six Months Ended
June 30, June 30, June 30, June 30,
1999 1998 1999 1998
------------- ------------ ------------- ------------
Net revenues 100% 100% 100% 100%
Cost of net revenues 45% 50% 46% 51%
------------- ------------ ------------- ------------
Gross profit 55% 50% 54% 49%
------------- ------------ ------------- ------------
Operating expenses:
Sales and marketing 19% 20% 18% 21%
Research and development 10% 13% 10% 16%
General and administrative 4% 5% 4% 5%
Acquisition expenses 0% 0% 0% 0%
------------- ------------ ------------- ------------
Total operating expenses 33% 38% 32% 42%
------------- ------------ ------------- ------------
Operating income 22% 12% 22% 7%
Interest income, net 1% 1% 1% 1%
Other income/(expense), net 0% 0% 0% 0%
------------- ------------ ------------- ------------
Income before taxes 23% 13% 23% 8%
Provision for Income Taxes 8% 1% 6% 0%
------------- ------------ ------------- ------------
Net income 15% 12% 17% 8%
------------- ------------ ------------- ------------
------------- ------------ ------------- ------------
NET REVENUES
Total net revenues for the three months ended June 30, 1999 were $45.1
million, an increase of $19.1 million, or 73%, as compared to the same period
of 1998. For the first six months of 1999, total net revenues were $85.1
million, an increase of $41.1 million or 93%, compared to the first six
months of 1998. These increases were due in large part to an increased sales
volume of videoconferencing products. This product line began shipping in
February of 1998 and the Company has added various models to it since that
time. Additionally, sales volume increases in the audioconferencing product
line also contributed to the growth in revenue during the three and six-month
periods ended June 30, 1999 over the comparable periods of 1998.
During the first six months of 1999, Polycom derived a substantial majority
of its net revenues from sales of its ViewStation and SoundStation product
families. During the first six months of 1998, the Company derived a
substantial majority of its net revenues from its SoundStation product line.
Lucent Technologies accounted for 11% of net revenues in the three months
ended June 30, 1999 and for the first six months of 1999. In the three months
ended June 30, 1998 and for the first six months of 1998, Lucent Technologies
accounted for 14% and 11% of the Company's net revenues, respectively. No
other customer or reseller accounted for more than 10% of the Company's net
revenues during these periods in 1999 and 1998.
International net revenues for the second quarter of 1999 accounted for 32%
of total net revenues for the Company, up from 22% in the second quarter of
1998. International net revenues for the first six months of 1999 accounted
for 29% of total net revenues for the Company, up from 22% in the same period
of 1998. The increase in international revenue as a percentage of total net
revenues for the second quarter of 1999
11
compared to the second quarter of 1998 and for the six months ended June 30,
1999 over the six months ended June 30, 1998 was due primarily to growth in
ViewStation shipments in Europe and Asia. 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 as a percentage of net revenues 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. Also, the ongoing economic problems in the
Asian and Latin American markets could adversely affect the Company's
profitability if such economic problems continue. Further, the Company plans
to expand operations in the Europe, Middle East and Africa region in 1999.
This expansion of marketing and administrative functions could initially
divert management's attention from the sales effort which could materially
adversely affect revenue growth in this region. 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. Further, beginning January 1, 1999, the participating
member countries of the European Union agreed to adopt the European Currency
Unit (the "Euro") as the common legal currency. On that same date they
established fixed conversion rates between their existing sovereign
currencies and the Euro. This establishment of the Euro should not have any
immediate significant impact on Polycom since a substantial majority of the
Company's international sales has been denominated in U.S. currency; however,
this could change in the future if more of Polycom's international business
is denominated in currencies other than the U.S. currency.
COST OF NET REVENUES
Cost of net revenues consists primarily of contract manufacturer costs
including material and direct labor, Polycom's manufacturing organization,
tooling depreciation, warranty expense and an allocation of overhead
expenses. The cost of net revenues represented 45% of net revenues in the
three months ended June 30, 1999 compared to 50% in the same period of 1998.
For the first six months of 1999 the cost of net revenues percentage was 46%,
compared to 51% for the same period in 1998. This improvement in cost over
1998 is attributable to a more favorable product mix as more shipments of the
higher margin video products occurred, and favorable material price
improvements. These increases were offset by the lack of revenue received
under the Second Agreement with 3M which had very low associated costs. The
Company received $1.5 million in revenue under this agreement in the first
three months of 1998 and $1.0 million in revenue in the three months ended
June 30, 1998.
Forecasting future gross margin percentages is difficult. Polycom expects
that the overall cost of net revenues percentage will be within a few
percentage points of the current level; however, there can be no assurances
that this will happen. For example, uncertainties surrounding competition,
changes in technology, changes in product mix, the royalty revenue stream,
manufacturing efficiencies of subcontractors, manufacturing and purchased
part variances, warranty costs, and timing of sales within the remaining
quarters of 1999 can cause the cost of net revenues percentage to fluctuate
significantly. Additionally, Polycom may reduce prices on its products in the
future for competitive reasons or to stimulate demand which could have a
material adverse effect on the cost of net revenues percentage. There can be
no guarantee that future possible price reductions will offset competitive
pressures or stimulate demand. Also, costs variances associated with the
manufacturing ramp of the StreamStation product or any other new product
could occur which would have an adverse effect on the Company's cost of net
revenues percentage. Further, gross margins associated with the ShowStation
IP and the SoundPoint Pro are lower than the targeted gross margins of the
total product portfolio, yet the gross margins for the WebStation are closer
to the targeted gross margins. The contribution of these products throughout
the remainder of 1999 can have a significant impact on the Company's overall
gross margins. There can be no assurances on achieving profitability targets
due to these and other uncertainties.
12
In the future, the cost of net revenue percentage may be affected by price
competition and changes in unit volume shipments, product cost and warranty
expenses. The cost of net revenues percentage may also be impacted by the mix of
distribution channels used by Polycom, the mix of products sold and the mix of
international versus North American revenues. Polycom 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, Polycom's cost of net revenues percentage would be materially
adversely impacted.
SALES AND MARKETING EXPENSES
THREE MONTHS ENDED SIX MONTHS ENDED
---------------------------------- ---------------------------------
JUNE 30, JUNE 30, INCREASE/ JUNE 30, JUNE 30, INCREASE/
$ IN THOUSANDS 1999 1998 (DECREASE) 1999 1998 (DECREASE)
- -------------- -------- -------- ---------- -------- -------- ----------
Expenses $ 8,293 $5,116 62% $15,640 $ 9,141 71%
% of Net Revenues 19% 20% (1%) 18% 21% (3%)
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 increase in sales and marketing
expenses in absolute dollars in the three months ended June 30, 1999 over the
same period of 1998 and the increase in expenses for the first six months of
1999 over the comparable period of 1998 were primarily related to increased
advertising and promotional expenditures for the video and audio product
lines. Additionally, an increase in the investment in the videoconferencing
sales effort also contributed to the increase over 1998.
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
ViewStation, StreamStation, WebStation and ShowStation IP products, the
Company believes it will be required to incur significant additional expenses
for sales and marketing, especially advertising, to educate potential
customers as to the desirability of these products. In addition, the Company
is currently making 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, the launch of the
StreamStation product, a collaborative product with RealNetworks that streams
point-to-point or multipoint videoconferencing using the Polycom ViewStation
to the Web, will cause an increase in the Company's sales and marketing
expenses. Additionally, this video streaming market is new for Polycom and
significant investments may need to be made to become successful. Further,
Polycom is currently expanding the service organization to provide expanded
and improved support for its video, data, multipoint and web-based
conferencing products which will increase the Company's sales and marketing
expenses.
RESEARCH AND DEVELOPMENT EXPENSES
THREE MONTHS ENDED SIX MONTHS ENDED
---------------------------------- ---------------------------------
JUNE 30, JUNE 30, INCREASE/ JUNE 30, JUNE 30, INCREASE/
$ IN THOUSANDS 1999 1998 (DECREASE) 1999 1998 (DECREASE)
- -------------- -------- -------- ---------- -------- -------- ----------
Expenses $ 4,624 $ 3,387 37% $8,159 $6,925 18%
% of Net Revenues 10% 13% (3%) 10% 16% (6%)
Research and development expenses consist primarily of compensation costs,
consulting fees, an allocation of overhead expense, supplies and
depreciation. Expense increases in video and audio product development in the
three and six months ended June 30, 1999 over the respective comparable
periods of
13
1998, was offset by a reduction in dataconferencing product development. As
of June 30, 1999, all research and development costs have been expensed as
incurred.
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 and as a percentage of net revenues in the
future. However, due to the extremely competitive hiring market in the
high-technology industries, Polycom may not be able to find or hire qualified
personnel in a timely manner.
GENERAL AND ADMINISTRATIVE EXPENSES
THREE MONTHS ENDED SIX MONTHS ENDED
---------------------------------- ---------------------------------
JUNE 30, JUNE 30, INCREASE/ JUNE 30, JUNE 30, INCREASE/
$ IN THOUSANDS 1999 1998 (DECREASE) 1999 1998 (DECREASE)
- -------------- -------- -------- ---------- -------- -------- ----------
Expenses $ 1,916 $ 1,360 41% $3,423 $2,402 43%
% of Net Revenues 4% 5% (1%) 4% 5% (1%)
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 the three and six
months ended June 30, 1999 over the respective comparable periods of 1998 is
due to increased staffing and infrastructure costs to support the Company's
growth. Additionally, costs associated with implementing a new tax deferral
strategy for the Company have contributed to the increases.
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. These additional charges include expenses
related to a new information system, a new tax deferral strategy and
infrastructure charges related to the investments being made in Europe.
INTEREST INCOME, NET AND OTHER EXPENSES, NET
Interest income consists of interest earned on Polycom's cash, cash
equivalents and investments. Interest expense is from Polycom's bank debt
facilities. Interest income, net of interest expense was $0.4 million and
$0.3 million for the three months ended June 30, 1999 and 1998, respectively.
For the first six months of 1999, the interest income, net amount was $0.7
million compared to $0.5 million for the comparable period of 1998. The
fluctuations in interest income, net are due primarily to changes in average
cash balances throughout the year.
PROVISION FOR INCOME TAXES
Polycom accounts for income taxes in accordance with the Financial Accounting
Standards Board's Statement of Financial Accounting Standards No. 109
"Accounting for Income Taxes." In the three months ended June 30, 1999,
income tax expense was $3.7 million compared to $0.2 million for the same
period of 1998. For the first six months of 1999, income tax expense was $5.1
million compared $0.2 million for the first six months of 1998. The increases
in income taxes for the three month and six month periods under comparison are
due to increased profitability of the Company and the decreased amount of tax
loss carryforward and tax credit carryforward benefits available for use.
These carryforward benefits reduced the income tax provision in 1998.
As of June 30, 1999, Polycom had approximately $8.3 million in deferred tax
assets arising from federal net operating loss carryforwards, tax credit
carryforwards and timing differences. Polycom had a valuation allowance
against a portion of these deferred tax assets due to the uncertainty
surrounding the realization of
14
such. The Company reversed $5.1 million of this allowance in the first six
months of 1999 due to management's belief that it is more likely than not
that these deferred tax assets will be realized. Management evaluates on a
quarterly basis the recoverability of the deferred tax assets and the level
of the valuation allowance and, accordingly, the valuation allowance may
change based upon the Company's financial performance and market condition.
YEAR 2000
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 six months, computer systems and/or software products
used by many companies may need to be upgraded to comply with such Year 2000
requirements. The Company has completed its review of its internal use
software in order to identify and modify those systems that are not Year 2000
compliant. Efforts to modify or replace those systems that are not Year 2000
compliant continue on schedule described below. Contingency plans have been
established for those few systems that have some risk associated with Year
2000 Compliance. The Company's products and services have already been
reviewed and certified to be Year 2000 compliant. The costs associated with
this effort may be incremental to the Company and also represent a
reallocation of existing resources. In addition, the Company has initiated a
project to replace its current internal business information system. While
this effort will also address the Year 2000 issues of the legacy system, this
internal system implementation effort is principally being conducted to
improve operating efficiencies.
Polycom takes seriously the potential issues that could arise due to the Year
2000 impact on internal systems, facilities, and its suppliers. In connection
with the Year 2000 initiative, the Company is working to assure that its
internal systems, facilities, and suppliers are Year 2000 compliant in
advance of January 1, 2000. The schedule for this program and percentage of
tasks complete are as follows:
% SCHEDULED
YEAR 2000 INITIATIVE PHASES COMPLETE COMPLETION
--------------------------- -------- ----------
Conduct inventory 100% 10/1/98
Survey suppliers 100% 2/15/99
Assess Year 2000 compliance 100% 3/31/99
Develop action & contingency plans 100% 5/30/99
Assess need to implement contingencies 100% 6/30/99
Complete upgrades & replacements 93% 10/15/99
The results of our assessments, modifications and replacements to date are
that 100% of Polycom product are Year 2000 Compliant. Of the inventoried
internal systems, 93% are Year 2000 Compliant, 5% require an upgrade and 2%
require replacement.
The Company believes 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 insignificant (less than $30,000) and have been expensed as incurred. A
budget of $150,000 was established for software and hardware upgrades, while
the replacement of the internal business information system is funded under a
separate budget. All other 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
remediation 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 above, 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. This contingency plan
would be invoked if it is determined that any material risk exists that the
business systems replacement project would slip beyond
15
the end of 1999. The business systems replacement project is proceeding on
the schedule referenced above and the Company does not expect to invoke this
contingency plan.
To date, no significant projects have been delayed due to the Year 2000
project. It is not expected that any significant project will be delayed in
the future if the current Year 2000 plan meets the compliance objectives and
does not significantly change. However, if events occur that require the
Company to implement its Year 2000 contingency plan, the new business system
implementation may be delayed three to six months which is not expected to
have a material adverse impact on the Company.
Polycom is highly dependent on the performance of services by key suppliers,
such as the Company's banking institutions, manufacturing partners, and
communications suppliers. Our key suppliers have certified themselves to be
Year 2000 compliant. Verifications of certifications will be conducted to
reduce the uncertainty of the Year 2000 readiness of suppliers' services. The
consequences of Year 2000 failures on the part of said suppliers would have a
material adverse affect on the Company's results of operations, liquidity or
financial condition and there can be no guarantee that the Company's
certification process will identify all Year 2000 exposures.
It is unlikely that a failure to correct a material year 2000 problem will
result in an interruption, or a failure, of certain normal business
activities or operations. Although significant efforts would be required, any
Year 2000 problem in business activities or operations could be accommodated
through manual efforts in the short term. The Company believes that with the
completion of the Year 2000 Compliance Project and the implementation of new
business systems as scheduled, the possibility of significant interruptions
of normal operations should be reduced. However, 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 or financial position could be materially adversely
affected.
At this time the Company cannot predict the impact concerns about the Year
2000 issue will have on revenues. For example, it is difficult, if not
impossible, to predict the worldwide consequences of the Year 2000 issue and,
therefore, the Company's resellers and/or end-users may suspend some or all
technology spending until it is resolved. If this were to occur, it could
have a material adverse effect on Polycom's revenues, results of operations
and financial position.
LIQUIDITY AND CAPITAL RESOURCES
As of June 30, 1999, Polycom's principal sources of liquidity included cash
and cash equivalents of $36.5 million and investments of $18.3 million.
Additionally, the Company has a $5.0 million revolving bank line of credit
from Silicon Valley Bank. 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 line of credit facility contains
provisions that require the maintenance of certain financial ratios and
profitability requirements. As of June 30, 1999, Polycom was in compliance
with these covenants.
Polycom generated cash from operating activities totaling $17.5 million in
the first six months of 1999 compared to a use of cash of $3.2 million from
operating activities for the same period of 1998. The improvement in cash
from operating activities in 1999 over 1998 was due primarily to the
improvement in net income before non-cash items, lower inventories increases
and the timing of liabilities. These cash improvements were offset slightly
by a larger growth in prepaid assets, deferred taxes and accounts receivable.
The total net change in cash and cash equivalents for the first six months of
1999 was an increase of $19.0 million. The primary sources of cash were $17.5
million from operating activities, $15.0 million proceeds from an exercise of
warrants by 3M, and $2.5 million from the issuance of stock associated with
the exercise of stock options and purchases under the employee stock purchase
plan. The primary uses of cash during the first six months of 1999 were net
purchases of investments of $12.8 million and purchases of property, plant
and equipment of $3.5 million. The positive cash from operating activities
was primarily the result of positive net income before considering non-cash
expenses such as depreciation and higher total
16
current liabilities (including accounts payable and taxes payable), offset by
an increase in deferred taxes, prepaid assets, accounts receivable and
inventory.
The Company's material commitments consist of obligations under its revolving
bank line of credit, operating leases and a $300,000 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 and are outstanding less than
120 days.
The Company believes that its available cash, cash equivalents, investments
and bank line of credit will be sufficient to meet the Company's operating
expenses and capital requirements through at least December 31, 1999.
However, 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, such as acquisitions or competitive reasons, 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 acquisitions of related
businesses or technology.
OTHER FACTORS AFFECTING FUTURE OPERATIONS
REVENUE GROWTH, CHANNEL INVENTORIES AND PROFITABILITY. A substantial
percentage of the total products sold during a particular quarter consist of
distributor stocking orders and, typically each quarter, Polycom has provided
special incentives for distributors to purchase the minimum or more than the
minimum quantities required under their agreements with Polycom. These
distributors sell the products through to end-users. If these resellers are
unable to sell through their inventory of Polycom products in a given quarter
to end-users or if resellers decide to decrease their inventories, it would
negatively affect the volume of Polycom's sales to these resellers in the
current or future quarters and also negatively affect Polycom's total
revenues. Also, if the Company chooses to eliminate or reduce stocking
incentive programs, quarterly revenue may be materially adversely affected.
Further, many of Polycom's resellers, on whom Polycom's revenues depend
significantly, are undercapitalized yet carry multiple Polycom product lines.
Failure of these businesses to establish and sustain profitability or obtain
financing could significantly affect future revenue levels for Polycom.
Polycom typically ships products within a short time after receipt of an
order and historically has 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. 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. 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. This
seasonality can make predicting revenues levels difficult, if not impossible.
A substantial portion of Polycom's orders are received and shipped within the
last few weeks of a quarter, therefore, should Polycom, its suppliers or
major customers be subject to a business interruption, for example, a natural
disaster, during the last few weeks of a quarter, it would have a material
adverse impact on Polycom's results of operations or financial condition.
Further, there can be no guarantee that Polycom's contract manufacturers will
be able to meet product demand before any given quarter ends.
The Company depends on these third-party resellers for a substantial majority
of its revenue. Certain of these third-party resellers also act as resellers
for competitors of the Company that can devote greater effort
17
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.
As a result of these and other factors, Polycom has been uncertain,
throughout most of each quarter, as to the level of revenues it will achieve
in the quarter and the impact 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.
Due to all of the foregoing factors, it is likely that in the current or some
future quarter or quarters 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.
Polycom's net revenues have grown primarily through increased market
acceptance of its established SoundStation, SoundStation Premier and the
ViewStation product lines 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, the Company lowered
the price of the ShowStation IP 23% effective March 1999 due to market
acceptance issues for this product and other price reductions could occur for
this and other reasons which could negatively impact Polycom's net revenues
and profitability. Further, recent growth rates of audio and video product
sales out from the sales channels to end-users have been significant. Future
growth rates may not achieve these levels of success which would have a
material adverse affect on Polycom's revenue growth and profitability.
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 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,
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. Similarly, if the SoundPoint Pro product materially negatively
affects the future sales of the SoundPoint product, the Company's total
revenue could be significantly adversely affected and it could create an
excess and obsolescence issue concerning the SoundPoint inventory which could
materially adversely affect the Company's profitability. The issue of new
products rendering existing Polycom products obsolete or reducing the demand
for existing products, exists for every Polycom product. In addition, costs
related to the introduction of Polycom's new products such as ViewStation MP,
ViewStation SP, WebStation, SoundPoint Pro and StreamStation could also
negatively impact future profitability. Further, Polycom's limited operating
history and limited resources, among other factors, make the prediction of
future operating results difficult, if not impossible.
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
ViewStation, SoundPoint Pro, WebStation, ShowStation IP, MeetingSite,
StreamStation 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, the success of the transition of 3M resellers to
Polycom 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 the ViewStation
product line, SoundStation, SoundStation Premier and SoundPoint families of
products, the ShowStation and WebStation line of products, and any new
products or product enhancements. There can be no assurance that Polycom will
be able to increase unit sales
18
volumes of existing products, introduce and sell new products or reduce its
costs as a percentage of net revenues.
PRODUCT INTRODUCTIONS. Polycom recent revenue growth was due in large part to
new product introductions in the videoconferencing product line. In fact,
each quarter of 1998 had a major new video product introduction which
significantly contributed to the revenue growth. Although new product
releases are planned for 1999 there can be no assurance that releases will
happen when planned or that they will happen at all. Additionally, there can
be no guarantee that any new product introductions in 1999 will produce the
revenue growth experienced in 1998.
In the past Polycom has experienced delays from time to time in the
introduction of certain new products and enhancements and believes that such
delays may occur in the future. For instance, Polycom experienced delays in
introducing the ViewStation MP and WebStation in 1998 from their original
expected release dates due to unforeseen technology and manufacturing ramp
issues. Additionally, the 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. Similar
delays occurred during the introduction of the SoundStation Premier and the
ShowStation affecting the first customer ship dates of these products. Any
similar delays in the future for other new product offerings such as the
StreamStation could have a material adverse effect on Polycom's results of
operations.
CHANNEL CONFLICTS. Polycom has various OEM agreements with some major
telecommunications equipment manufacturers whereby Polycom manufactures its
products to work with the equipment of the OEM partner. These partnerships
can create channel conflicts with other Polycom distributors who directly
compete with Polycom's OEM partner, which could adversely affect revenue from
such non-OEM channels. Additionally, Polycom has its own direct sales
organization which could at times compete with other Polycom resellers for
national account, government or other business. Because many of the Company's
distributors also sell equipment that competes with the Polycom product
lines, the distributors could devote more attention to the other product
lines which could materially adversely affect the Company's profitability.
Further, other channel conflicts could arise which cause distributors to
devote resources to other non-Polycom conferencing equipment thereby
materially adversely affecting Polycom's financial position or results of
operations.
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 conferencing 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 conferencing 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 potential
contribution of these relationships on the financial results of operations of
Polycom.
TECHNOLOGY AND TRAINING. 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 that may affect
the Company's success in this market. Further, the shift of communications
from the circuit-switched to IP network over time may require Polycom to add
new resellers and gain new core technological competencies. Polycom is
attempting to address these needs and 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 video and audioconferencing product opportunities and develop and bring
new video and audioconferencing products to market in a timely manner, or
that video and audioconferencing products and technologies developed by
others will not render Polycom's ViewStation and SoundStation products or
technologies obsolete or noncompetitive. The failure of Polycom's new video
and audioconferencing product development efforts would have a material
adverse effect on Polycom's business, financial
19
condition and results of operations.
MANUFACTURING DISRUPTIONS. Polycom subcontracts the manufacture of its
SoundStation, SoundStation Premier, SoundPoint Pro and ViewStation product
families to Celestica, Inc., a global third-party contract manufacturer.
Polycom uses Celestica'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. Also,
Celestica is currently the sole source provider of these product lines and if
the supply from this subcontractor experiences an interruption in operations,
Polycom would experience a delay in shipping it products which could
negatively affect revenues in the quarter of the disruption. 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 results of
operations. Further, Celestica recently merged operations with International
Manufacturing Services, Inc. ("IMS"), the company with which Polycom had the
original contracted manufacturing relationship. The impact of this merger
agreement on Polycom is currently unknown but could have a material adverse
impact on Polycom's business, financial condition or results of operations.
INFRASTRUCTURE GROWTH. The Company's recent overall growth has and will
likely continue to cause strains on the normal business processes and
infrastructure of the Company. If Polycom does not manage this growth through
resource additions such as headcount and capital, in a timely and efficient
manner, future growth and profitability will likely be significantly
negatively affected. There can be no assurances that resources will be
available when the Company needs them or that capital will be available to
fund these resource needs.
SERVICE AND SUPPORT. The Company's recent growth has been due in large part
to an expansion into product lines with more complex technologies. This shift
has increased the need for increased product warranty and service
capabilities. The Company maintains an in-house hotline support group and
subcontracts on-site technician support functions. If the Company cannot
develop and train its internal support organization, maintain its
relationship with its outside technical support or efficiently transition to
a new service contractor, it could negatively affect future sales of the
higher technology products like video and web conferencing equipment which
would have a material negative effect on its results from operations and
financial condition.
CASH FLOW FLUCTUATIONS DUE TO RECEIVABLE COLLECTIONS. In 1999, Polycom is
making a significant investment in Europe to expand its business in this
region. 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 Polycom's total
revenues, as has happened during the three months ended June 30, 1999,
accounts receivable balances will likely increase over previous years.
Additionally, sales in the videoconferencing product market typically have
longer payment periods over Polycom's traditional experience in the
audioconferencing market. Therefore, as Polycom sells more video products as
a percentage of its revenue, accounts receivable balances will increase over
previous experience. These increases will cause Polycom's days sales
outstanding to increase over prior years and will negatively affect future
cash flows.
POTENTIAL ASSET IMPAIRMENT CONCERNS. The Company operates 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 can not be sold at or
above net realizable value. This situation occurred for the original
ShowStation product and during the third quarter of 1998, Polycom wrote-down
an additional $1.5 million related to the loss in value associated with this
inventory. There can be no guarantee that this situation will not occur again
for any product in Polycom's inventory.
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 June
30, 1999, the trade credits are classified as a prepaid asset
20
at their net realizable value which approximates the original value of the
inventory. The credits have no expiration date. If the Company subsequently
determines that it cannot utilize these trade credits, it could have a
material adverse impact on its profitability.
STOCK PRICE FLUCTUATIONS. 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, such as Polycom, 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.
BUSINESS INTERRUPTION. Polycom's operations are vulnerable to interruption by
fire, earthquake, power loss, telecommunications failure and other events
beyond Polycom's control. Polycom does not have a detailed disaster recovery
plan. In addition, 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.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Polycom's exposure to market risk for changes in interest rates relates
primarily to its investment portfolio and bank borrowings. Polycom does not
use derivative financial instruments in its investment portfolio, and its
investment portfolio only includes highly liquid instruments with a maturity
of no more than two years.
Polycom is subject to fluctuating interest rates that may impact, adversely
or otherwise, its results of operations or cash flows for its 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 Polycom's investment portfolio and
debt obligations:
As of June 30, 1999:
Expected Maturity
1999 2000 2001 Total
---- ---- ---- -----
(in thousands, except interest rates)
ASSETS
Cash and cash equivalents 36,510 --- --- 36,510
Average interest rates 2.45% --- --- 2.45%
Investments 16,211 2,075 --- 18,286
Average interest rates 4.71% 4.79% --- 4.72%
LIABILITIES
Bank line of credit --- --- --- ---
Average interest rates 8.00% --- --- 8.00%
The estimated fair value of Polycom's cash and cash equivalents approximates
the principal amounts reflected above based on the short maturities of these
financial instruments. The estimated fair value of Polycom's debt obligations
approximates the principal amounts reflected above based on rates currently
available to Polycom for debt with similar terms and remaining maturities.
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PART II OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS
On September 3, 1997, VTEL Corporation ("VTEL") filed a
lawsuit in the State District Court in Travis County, Texas
against ViaVideo Communications, Inc. (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, its
founders 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, 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 may have
a material adverse effect on Polycom's business, financial
condition or results of operations. The parties have engaged
in written discovery. No trial date is presently scheduled.
The Company intends to vigorously defend against the VTEL
claim. However, litigation is inherently uncertain and,
because of such, the actual impact of the outcome of the VTEL
litigation is unknown at this time. If the courts find in
favor of VTEL in this matter, it may have a material adverse
impact on Polycom's results of operations and 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
The Company distributed its Definitive Proxy Statement, Proxy
and Annual Report to Stockholders on or about April 19, 1999
to each stockholder of record on April 12, 1999, for its
Annual Meeting of Stockholders held May 20, 1999 (the "Annual
Meeting"). At the Company's Annual Meeting, the Stockholders
were asked to consider five proposals.
The first proposal involved the election of directors. The
existing Board of Directors selected eight nominees, all of
whom ran unopposed and all of whom were then serving as
directors of the Company. The nominees of the Board, and the
voting results with respect thereto, were:
Votes Votes Votes Broker
Name For Against Abstaining Non-Votes
---- --- ------- ---------- ---------
Brian L. Hinman 25,653,349 3,788,719 0 0
Robert C. Hagerty 25,674,296 3,767,772 0 0
Michael R. Kourey 25,669,140 3,772,928 0 0
Betsy S. Atkins 25,674,058 3,768,010 0 0
Bandel Carano 25,671,162 3,770,906 0 0
Stanley J. Meresman 25,674,445 3,767,623 0 0
John P. Morgridge 25,674,645 3,767,423 0 0
James R. Swartz 25,674,245 3,767,823 0 0
The second proposal concerned amendments to the Company's 1996
Stock Incentive Plan changing the amount and characteristics
of options granted to non-employee directors under the
automatic option grant program, and ratify and approve the
material terms of the Company's 1996 Stock Incentive Plan. The
results were:
23
For: 22,011,107
Against: 7,402,823
Abstentions: 28,138
Broker Non-Votes: 0
The third proposal concerned amendments to the Company's 1996
Stock Incentive Plan increasing the number of shares of Common
Stock reserved for issuance thereunder from 4,125,000 to
5,625,000 shares, and to ratify and approve the material terms
of the Company's 1996 Stock Incentive Program. The results
were:
For: 12,680,712
Against: 11,243,005
Abstentions: 25,130
Broker Non-Votes: 5,493,221
The fourth proposal concerned amendments to the Company's
Employee Stock Purchase Plan increasing the number of shares
of Common Stock reserved for issuance thereunder from 500,000
to 1,000,000 shares, and to ratify and approve the material
terms of the Company's Employee Stock Purchase Plan. The
results were:
For: 22,827,348
Against: 1,101,669
Abstentions: 19,830
Broker Non-Votes: 5,493,221
The fifth and final proposal concerned the ratification of the
Company's independent accountants (PricewaterhouseCoopers LLP)
for the fiscal year ending January 2, 2000. The results were:
For: 29,424,425
Against: 11,232
Abstentions: 6,411
Broker Non-Votes: 0
Item 5. OTHER INFORMATION
On July 27, 1999, Bandel Carano resigned as a member of
Polycom's Board of Directors. Mr. Carano became a member of
Polycom's Board of Directors in July 1991 and during his
tenure as a director he served as a General Partner at Oak
Investment Partners. Oak Investment Partners had a substantial
beneficial ownership interest in Polycom. Oak Investment
Partners has since divested a substantial majority of their
ownership interests in Polycom and now beneficially own less
than 1% of the Company.
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) List of Exhibits
NUMBER EXHIBIT
- ------ ----------------------------------------------------------------------
27 Financial Data Schedule
27.1 Restated Financial Data Schedule for Year-ended December 31, 1998
(b) Reports on Form 8-K:
Not Applicable
24
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: August 17, 1999 POLYCOM, INC.
/s/ Michael R. Kourey
--------------------------------------------
Michael R. Kourey
Chief Financial Officer
(Principal Financial and Accounting Officer)
25