<PAGE>
- -------------------------------------------------------------------------------
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 APRIL 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.
--------------------
(Exact name of registrant as specified in its charter)
DELAWARE 94-3128324
------------------------------- ---------------------------
(State or other jurisdiction of (I.R.S. employer
incorporation or organization) identification number)
2584 JUNCTION AVENUE, SAN JOSE, CA. 95134-1902
- -------------------------------------- -------------------------
(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 32,224,258 shares of the Company's Common Stock, par value $.0005,
outstanding on May 5, 1999.
- -------------------------------------------------------------------------------
<PAGE>
POLYCOM, INC.
INDEX
REPORT ON FORM 10-Q
FOR THE QUARTER ENDED MARCH 31, 1999
<TABLE>
<CAPTION>
Page
Number
------
<S> <C>
PART I FINANCIAL INFORMATION
Item 1 Financial Statements:
Condensed Consolidated Balance Sheets as of March 31,
1999 and December 31, 1998. . . . . . . . . . . . . . . . . . 3
Condensed Consolidated Statements of Income for the
Three Month Periods Ended March 31, 1999 and March 31,
1998. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
Condensed Consolidated Statements of Cash Flows for the
Three Month Periods Ended March 31, 1999 and March 31,
1998. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
Notes to Condensed Consolidated Financial Statements. . . . . 6
Item 2 Management's Discussion and Analysis of Financial Condition
and Results of Operations . . . . . . . . . . . . . . . . . . 9
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 . . . . . . . . . .24
SIGNATURE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .25
</TABLE>
2
<PAGE>
PART 1 FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
POLYCOM, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
<TABLE>
<CAPTION>
March 31, December 31,
1998 1998
--------------- --------------
(Unaudited)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 39,929 $ 17,548
Short-term investments 7,301 5,483
Accounts receivable, net of allowance for doubtful
accounts of $838 at March 31, 1999 and
at December 31, 1998 29,269 25,011
Inventories 15,172 16,699
Deferred taxes 2,594 2,594
Other current assets 2,861 2,196
--------------- --------------
Total current assets 97,126 69,531
Fixed assets, net 7,501 6,727
Noncurrent deferred taxes 3,157 0
Other assets 446 696
--------------- --------------
Total assets $ 108,230 $ 76,954
--------------- --------------
--------------- --------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 16,616 $ 12,412
Taxes payable 3,348 1,405
Accrued and other current liabilities 9,374 10,083
--------------- --------------
Total current liabilities 29,338 23,900
--------------- --------------
Stockholders' equity:
Common stock 18 18
Additional paid-in capital 82,676 64,590
Accumulated deficit (3,802) (11,554)
--------------- --------------
Total stockholders' equity 78,892 53,054
--------------- --------------
Total liabilities and stockholders' equity $ 108,230 $ 76,954
--------------- --------------
--------------- --------------
</TABLE>
The accompanying notes are an integral part of these
condensed consolidated financial statements.
3
<PAGE>
POLYCOM, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
Three Months Ended
March 31, March 31,
1999 1998
-------------- --------------
<S> <C> <C>
Net revenues $ 40,013 $ 18,031
Cost of net revenues 18,716 9,182
-------------- --------------
Gross profit 21,297 8,849
-------------- --------------
Operating expenses:
Sales and marketing 7,347 4,025
Research and development 3,535 3,538
General and administrative 1,507 1,042
Acquisition expenses --- 185
-------------- --------------
Total operating expenses 12,389 8,790
-------------- --------------
Operating income 8,908 59
Interest income, net 299 241
Other income/(expense), net (5) 1
-------------- --------------
Income before taxes 9,202 301
Provision for income taxes 1,450 7
-------------- --------------
Net income $ 7,752 $ 294
-------------- --------------
-------------- --------------
Basic net income per share $ 0.26 $ 0.01
-------------- --------------
-------------- --------------
Dilutive net income per share $ 0.23 $ 0.01
-------------- --------------
-------------- --------------
Weighted average shares outstanding for basic EPS 29,600 26,219
-------------- --------------
-------------- --------------
Weighted average shares outstanding for dilutive EPS 34,035 30,344
-------------- --------------
-------------- --------------
</TABLE>
The accompanying notes are an integral part of these
condensed consolidated financial statements.
4
<PAGE>
POLYCOM, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(IN THOUSANDS)
<TABLE>
<CAPTION>
Three Months Ended
March 31, March 31,
1999 1998
-------------- -------------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 7,752 $ 294
Adjustments to reconcile net income to net cash
provided by/(used in) operating activities:
Depreciation and amortization 894 638
Provision for excess and obsolete inventories 1,082 130
Value of stock options to outside consultants 7 3
Changes in assets & liabilities:
Accounts receivable (4,258) (2,863)
Inventories 445 (845)
Deferred taxes (3,157) -
Prepaid expenses and other current assets (665) (429)
Deposits and other assets - (61)
Accounts payable 4,204 (1,187)
Taxes payable 1,943 (6)
Accrued and other liabilities (709) 984
-------------- -------------
Net cash provided by/(used in) operating activities 7,538 (3,342)
-------------- -------------
Cash flows from investing activities:
Acquisition of fixed assets (1,668) (1,046)
Proceeds from repayment of note receivable 250 -
Proceeds from sale and maturity of short term investments 1,700 1,444
Purchases of short term investments (3,518) (2,726)
-------------- -------------
Net cash used in investing activities (3,236) (2,328)
-------------- -------------
Cash flows from financing activities:
Proceeds from issuance of common stock 3,079 7,975
Proceeds from exercise of warrants 15,000 -
Repayment of line of credit borrowings - (628)
-------------- -------------
Net cash provided by financing activities 18,079 7,347
-------------- -------------
Net increase in cash and cash equivalents 22,381 1,677
Cash and cash equivalents, beginning of year 17,548 12,486
-------------- -------------
-------------- -------------
Cash and cash equivalents, end of period $ 39,929 $ 14,163
-------------- -------------
-------------- -------------
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Income taxes paid $ 1,196 $ 21
SUPPLEMENTAL SCHEUDLE OF NONCASH INVESTING AND FINANCING:
Conversion of preferred shares to common stock $ - $ 9,496
</TABLE>
The accompanying notes are an integral part of these
condensed consolidated financial statements.
5
<PAGE>
POLYCOM, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION
The condensed consolidated balance sheet as of March 31, 1999, the condensed
consolidated statements of income for the three month periods ending March
31, 1999 and 1998 and condensed consolidated statements of cash flows for the
three month periods ending March 31, 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 March 31, 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 March 31 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.
This Report on Form 10-Q contains forward looking statements that involve
risks and uncertainties, including potential fluctuations in results and
future growth rates, if at all; the market acceptance of ViewStation-TM-,
ShowStation-Registered Trademark- IP, WebStation-TM-, StreamStation-TM-,
SoundPoint-Registered Trademark- Pro, MeetingSite-TM- and other new products;
the profitability of the dataconferencing and MCU product lines; the impact
of competitive products and pricing; technological change; risks associated
with international operations; dependence on research and development; 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 successful transition of 3M's audio/visual and office supply
channels; 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 1998 Form 10-K Report, filed March 15,
1999.
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):
<TABLE>
<CAPTION>
March 31, Dec 31,
1999 1998
-------- --------
<S> <C> <C>
Raw Materials $ 1,175 $ 974
Finished Goods 13,997 15,725
-------- --------
$ 15,172 $ 16,699
-------- --------
-------- --------
</TABLE>
6
<PAGE>
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 (7.75% at March 31, 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 March 31,
1999.
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 months ended March 31, 1999 and March 31, 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).
<TABLE>
<CAPTION>
Three Months Ended
March 31,
1999 1998
----------- -----------
<S> <C> <C>
Numerator - basic and diluted EPS
Net income $7,752 $ 294
----------- -----------
----------- -----------
Denominator - Basic EPS
Common stock outstanding 29,600 26,219
----------- -----------
Total shares used in calculation of Basic EPS 29,600 26,219
----------- -----------
Basic net income per share $ 0.26 $ 0.01
----------- -----------
----------- -----------
Denominator - Diluted EPS
Denominator - Basic EPS 29,600 26,219
Effect of Dilutive Securities:
Common stock options 2,394 2,287
Stock subject to repurchase 1,195 1,743
Warrants 846 95
----------- -----------
Total shares used in calculation of Diluted EPS 34,035 30,344
----------- -----------
Diluted net income per share $0.23 $ 0.01
----------- -----------
----------- -----------
</TABLE>
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
7
<PAGE>
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 March 31, 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 and may
also provide shared technology resources for the development of future
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 a
memorandum of understanding between Polycom and 3M, both parties will work to
transition 3M's resellers to Polycom and existing OEM video and data products
in 3M's inventory purchased under the First and Second Agreements will be
available for purchase by Polycom. 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 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
would 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 subsequently filed a response.
Polycom has voluntarily dismissed, without prejudice, the California action
and agreed to litigate the claims in Texas. No trial date is presently
scheduled.
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 March 31, 1999,
will not have a material adverse effect on the Company's financial position.
8
<PAGE>
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 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, MEETINGSITE AND OTHER NEW PRODUCTS; THE MARKET ACCEPTANCE OF
VIEWSTATION, 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 PROFITABILITY OF THE MCU 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; 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 AND SOLE-SOURCE SUPPLIERS; 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 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. 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 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 March 31, 1999, 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. As of March 31, 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
9
<PAGE>
along with Internet/Web-based features. In February 1998, Polycom began
customer shipments of the ViewStation 128, its first videoconferencing
product. As of March 31, 1999, Polycom's videoconferencing product line
consisted principally of the ViewStation 128, ViewStation 512, ViewStation
V.35 and ViewStation MP. 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 May
1998, the Company announced it first collaborative product with RealNetworks,
the StreamStation. 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 broadcast 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
March 31, 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. 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 March 31, 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 and may
also provide shared technology resources for the development of future
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
10
<PAGE>
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 a
memorandum of understanding between Polycom and 3M, both parties will work to
transition 3M's resellers to Polycom and existing OEM video and data products
in 3M's inventory purchased under the First and Second Agreements will be
available for purchase by Polycom. 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.
<TABLE>
<CAPTION>
Three Months Ended
March 31, March 31,
1999 1998
-------------- ------------
<S> <C> <C>
Net revenues 100% 100%
Cost of net revenues 47% 51%
-------------- ------------
Gross profit 53% 49%
-------------- ------------
Operating expenses:
Sales and marketing 18% 22%
Research and development 9% 20%
General and administrative 4% 6%
Acquisition expenses 0% 1%
-------------- ------------
Total operating expenses 31% 49%
-------------- ------------
Operating income 22% 0%
Interest income, net 1% 2%
Other income/(expense), net 0% 0%
-------------- ------------
Income before taxes 23% 2%
Provision for income taxes 4% 0%
-------------- ------------
Net income 19% 2%
-------------- ------------
-------------- ------------
</TABLE>
NET REVENUES
Total net revenues for the three months ended March 31, 1999 were $40.0
million, an increase of $22.0 million, or 122%, compared to the same period
for 1998. This increase was due in large part to revenues from the
videoconferencing products which had initial shipments in February of 1998.
Additionally, audioconferencing product line sales volume increases,
primarily in North America, also contributed to the revenue growth.
During the first three months of 1999, Polycom derived a substantial
majority of its net revenues from sales of its SoundStation and ViewStation
product families. During the first three months of 1998, the Company derived
a substantial majority of its net revenues from its SoundStations product
line. Lucent Technologies accounted for 10% of net revenues in the first
three months of 1999. In the first three months of 1998, 3M, after
considering the revenue from the Second Agreement and product sales,
accounted for 12% of total net revenues. No other customer or reseller
accounted for more than 10% of Polycom's net revenues during these periods in
1999 and 1998.
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<PAGE>
International net revenues accounted for 26% and 22% of total net
revenues for the first three months of 1999 and 1998, respectively. The
increase in the international percentage of total net revenues was due to
volume increases in all international regions, primarily Europe. 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 significant impact on Polycom since a substantial
majority of the Company's international sales has been denominated in 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 47% of net revenues in the
first three months of 1999 compared to 51% in the same period of 1998. This
improvement in cost over 1998 is attributable to a more favorable product
mix, royalty revenues with no associated costs and favorable material price
improvements. These increases were offset by no 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.
Forecasting future gross margin percentages is difficult. Polycom
expects that the overall cost of net revenues percentage will remain at
current levels; 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, 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.
Polycom's historical price reductions have been driven by Polycom's
desire to expand the market for its products, and Polycom may further reduce
prices or introduce new products that carry higher costs 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. 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
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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
<TABLE>
<CAPTION>
THREE MONTHS ENDED
--------------------
MARCH 31, MARCH 31, INCREASE/
$ IN THOUSANDS 1999 1999 (DECREASE)
- -------------- --------- --------- ----------
<S> <C> <C> <C>
Expenses $ 7,347 $ 4,025 82%
% of Net Revenues 18% 22% (4%)
</TABLE>
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 first three months of 1999 over
the same period of 1998 was primarily related to increased advertising and
promotional expenditures for the video, audio and MCU 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
ShowStation IP, WebStation, ViewStation products and MeetingSite product, 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
MeetingSite product, a Multipoint Conferencing Unit (MCU) product, which
provides connectability for large multipoint videoconference calls, will
cause an increase in the Company's sales and marketing expenses.
Additionally, this MCU 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 and multipoint conferencing products which will increase
the Company's sales and marketing expenses.
RESEARCH AND DEVELOPMENT EXPENSES
<TABLE>
<CAPTION>
THREE MONTHS ENDED
--------------------
MARCH 31, MARCH 31, INCREASE/
$ IN THOUSANDS 1999 1999 (DECREASE)
- -------------- --------- --------- ----------
<S> <C> <C> <C>
Expenses $3,535 $3,538 0%
% of Net Revenues 9% 20% (11%)
</TABLE>
Research and development expenses consist primarily of compensation
costs, consulting fees, an allocation of overhead expense, supplies and
depreciation. The expense increases in video and audio product development in
the first three months of 1999 over the first three months of 1998, was
offset by a reduction in dataconferencing product development. As of March
31, 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 a percentage of net revenues in
the future.
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<PAGE>
GENERAL AND ADMINISTRATIVE EXPENSES
<TABLE>
<CAPTION>
THREE MONTHS ENDED
-------------------
MARCH 31, MARCH 31, INCREASE/
$ IN THOUSANDS 1999 1999 (DECREASE)
- -------------- --------- --------- ----------
<S> <C> <C> <C>
Expenses $1,507 $1,042 45%
% of Net Revenues 4% 6% (2%)
</TABLE>
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 first
three months of 1999 when compared to the same period in 1998 is due to
increased staffing and infrastructure costs to support the Company's growth.
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 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 and cash
equivalents and short-term investments. Interest expense is from Polycom's
bank debt facilities. Interest income, net of interest expense was $0.3
million and $0.2 million for the first three months of 1999 and 1998,
respectively. 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 first three months of 1999 and
1998, Polycom's provision for income taxes was $1.5 million and approximately
$0.01 million, respectively. The increase in income taxes is due to increased
profitability of the Company. The provision for income taxes in the first
three months of 1998 was primarily for federal alternative minimum and
certain foreign taxes.
As of March 31, 1999, Polycom had approximately $9.4 million in deferred
tax assets arising from federal net operating loss carryforwards, federal tax
credit carryforwards as well as from other timing differences. Polycom had a
valuation allowance against a portion of these deferred tax assets due to the
uncertainty surrounding the realization of such. The Company reversed $3.2
million of this allowance 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 one year, 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
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<PAGE>
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:
<TABLE>
<CAPTION>
% Scheduled
Year 2000 Initiative Phases Complete Completion
--------------------------- -------- ----------
<S> <C> <C>
Conduct inventory 100% 10/1/98
Survey suppliers 100% 2/15/99
Assess Year 2000 compliance 100% 3/31/99
Develop action & contingency plans 74% 5/30/99
Assess need to implement contingencies 0% 6/30/99
Complete upgrades & replacements 12% 10/15/99
</TABLE>
The results of our assessments to date are that 100% of Polycom product
are Year 2000 Compliant. Of the inventoried internal systems, 74% are Year
2000 Compliant, 19% require an upgrade and 7% require replacement.
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 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 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 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 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. A decision to
implement the contingency plan would be made no later than the middle of
1999, with completion by the end of 1999. This contingency plan would be
invoked if it is determined that any material risk exists that the business
systems replacement project would slip beyond the end of 1999.
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 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. Due to the general uncertainty of the Year 2000
readiness of suppliers' services, the Company is unable to determine at this
time whether there is any risk associated with the Year 2000 readiness of the
Company's suppliers. The consequences of
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<PAGE>
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.
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.
LIQUIDITY AND CAPITAL RESOURCES
As of March 31, 1999, Polycom's principal sources of liquidity included
cash and cash equivalents of $39.9 million and short-term investments of $7.3
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 March 31, 1999, Polycom was in
compliance with these covenants.
Polycom generated cash from operating activities totaling $7.5 million
in the first three months of 1999 compared to a use of cash of $3.3 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, reduction in inventories
compared to an increase in 1998, and net increases in current liabilities
compared to a net reduction in 1998. These cash improvements were offset
slightly by a larger growth in accounts receivables and deferred taxes.
The total net change in cash and cash equivalents for the first three
months of 1999 was an increase of $22.4 million. The primary sources of cash
were $15.0 million proceeds from an exercise of warrants by 3M, $7.5 million
from operating activities and $3.1 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
three months of 1999 were purchases of property, plant and equipment of $1.7
million and net cash invested in short-term investments of $1.8 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 current liabilities (including accounts payable and taxes
payable), offset by an increase in accounts receivable and deferred taxes.
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,
short-term 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.
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<PAGE>
OTHER FACTORS AFFECTING FUTURE OPERATIONS
Polycom's net revenues have grown primarily through increased market
acceptance of its established SoundStation, SoundStation Premier and the
initial acceptance of the 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, 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. Further,
costs related to the introduction of Polycom's new products such as
ViewStation MP, ViewStation SP, WebStation, and SoundPoint Pro could also
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
March 31, 1999, 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 believes 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. Polycom also experienced delays in introducing
the WebStation and ViewStation MP in 1998 from their original expected
release dates. 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 ViewStation, SoundPoint Pro, WebStation, ShowStation IP,
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, 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
17
<PAGE>
increase unit sales volumes of the SoundStation, SoundStation Premier and
SoundPoint families of products, the ShowStation and WebStation 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.
In 1998, Polycom began marketing and selling its MeetingSite product
which is a multipoint conference product manufactured by Lucent Technologies.
Because Polycom is reselling Lucent's product, the gross margins for this
business are significantly lower than the rest of Polycom's product
portfolio. Additionally, this product is new for Polycom and significant
investments in marketing, sales, service and other areas may need to be made
to successfully sell this product. There can be no guarantee that the MCU
business will ever be profitable.
Polycom typically ships products within a short time after receipt of an
order and historically has no material backlog and backlog fluctuates
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 typically receives
orders and ships a substantial percentage of the total products sold during
a particular quarter in the last few weeks of the quarter. Often these
orders consist of distributor stocking orders and, typically each quarter,
Polycom has 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
or if resellers decide to change their stocking methodology, 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 MP, in the first quarter of 1999. Further, Polycom
depends significantly on sales to resellers, many of whom are
undercapitalized yet carry multiple Polycom product lines. Failure of these
business to establish and sustain profitability could significantly affect
future revenue levels for Polycom. Also, since a substantial portion of
Polycom's orders are received and shipped within the last few weeks of a
quarter, 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. 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 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 depends on these 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
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 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 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
18
<PAGE>
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.
Through March 1999, the Company had several distribution and marketing
agreements with 3M whereby 3M purchased video and data products from Polycom
and provided a royalty revenue stream for Polycom. In April 1999, 3M
announced that they are exiting this business and will transition its
resellers to Polycom. If this transition is unsuccessful or if the revenue
from the old 3M resellers are not enough to offset the royalty revenue stream
lost as a result of 3M exiting the business, it could materially adversely
affect the future profitability for Polycom.
Polycom experienced significant revenue growth in 1998. This 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 1999, Polycom is making a significant investment in Europe to expand
its business in this region. In Europe, as with other international regions,
credit terms are typically longer than in the United States. Therefore, as
Europe and other international regions grow as a percentage of Polycom's
total revenues, 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.
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 March
31, 1999, the trade credits are classified as a prepaid asset 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.
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 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.
19
<PAGE>
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. 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.
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.
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. Although there have not been material difficulties to date, if
outstanding merger related issues are not successfully addressed 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 video sales and
marketing efforts with those of Polycom 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
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 have significantly increased in absolute
dollars. Should future 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 or
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
assurance that Polycom will not incur additional material charges in future
quarters to reflect additional costs associated with the acquisition.
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.
The Company's overall business grew significantly in 1998. This level
of growth, if it persists, could 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
20
<PAGE>
assurances that resources will be available when the Company needs them or
that capital will be available to fund these resource needs.
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.
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.
21
<PAGE>
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 an original
maturity of generally less than one year.
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:
<TABLE>
<CAPTION>
Expected Maturity
1999 2000 2001 Total
---- ---- ---- -----
<S> <C> <C> <C> <C>
(in thousands, except interest rates)
Assets
- ------
Cash and cash equivalents 39,929 --- --- 39,929
Average interest rates 3.08% --- --- 3.08%
Investments 7,301 --- --- 7,301
Average interest rates 4.86% --- --- 4.86%
Liabilities
- -----------
Bank line of credit --- --- --- ---
Average interest rates 7.75% --- --- 7.75%
</TABLE>
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.
22
<PAGE>
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 would
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
subsequently filed a response. Polycom has voluntarily dismissed,
without prejudice, the California action and agreed to litigate the
claims in Texas. No trial date is presently scheduled.
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 March 31, 1999, 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
Not Applicable
23
<PAGE>
Item 6 EXHIBITS AND REPORTS ON FORM 8-K
(a) List of Exhibits
<TABLE>
<CAPTION>
NUMBER EXHIBIT
- ------ ------------------------------------------------------
<S> <C>
27.1 Financial Data Schedule
</TABLE>
(b) Reports on Form 8-K:
Not Applicable
24
<PAGE>
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
Dated: May 18, 1999 POLYCOM, INC.
/s/ Michael R. Kourey
----------------------------
Michael R. Kourey
Chief Financial Officer
(Principal Financial and
Accounting Officer)
25
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> MAR-31-1999
<CASH> 39,929
<SECURITIES> 7,301
<RECEIVABLES> 30,107
<ALLOWANCES> 838
<INVENTORY> 15,172
<CURRENT-ASSETS> 97,126
<PP&E> 17,194
<DEPRECIATION> 9,693
<TOTAL-ASSETS> 108,230
<CURRENT-LIABILITIES> 29,338
<BONDS> 0
0
0
<COMMON> 18
<OTHER-SE> 78,874
<TOTAL-LIABILITY-AND-EQUITY> 108,230
<SALES> 40,013
<TOTAL-REVENUES> 40,013
<CGS> 18,716
<TOTAL-COSTS> 18,716
<OTHER-EXPENSES> 12,095
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 9,202
<INCOME-TAX> 1,450
<INCOME-CONTINUING> 7,752
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 7,752
<EPS-PRIMARY> 0.26
<EPS-DILUTED> 0.23
</TABLE>