(<PAGE>
- --------------------------------------------------------------------------------
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
X Quarterly report pursuant to Section 13 or 15(d) of the Securities
- ----- Exchange Act of 1934
FOR THE QUARTERLY PERIOD ENDED OCTOBER 3, 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 (IRS 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 32,829,013 shares of the Company's Common Stock, par value $.0005,
outstanding on November 3, 1999.
<PAGE>
POLYCOM, INC.
INDEX
REPORT ON FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 1999
<TABLE>
<CAPTION>
Page
Number
------
PART I FINANCIAL INFORMATION
<S> <C>
Item 1 Financial Statements:
Condensed Consolidated Balance Sheets as of September 30, 1999 and
December 31, 1998................................................................. 3
Condensed Consolidated Statements of Income for the Three and Nine
Month Periods Ended September 30, 1999 and September 30, 1998..................... 4
Condensed Consolidated Statements of Cash Flows for the Nine
Month Periods Ended September 30, 1999 and September 30, 1998..................... 5
Notes to Condensed Consolidated Financial Statements.............................. 6
Item 2 Management's Discussion and Analysis of Financial Condition
and Results of Operations......................................................... 10
Item 3 Quantitative and Qualitative Disclosures About Market Risk........................ 23
PART II OTHER INFORMATION
Item 1 - Legal Proceedings........................................................ 24
Item 2 - Changes in Securities.................................................... 24
Item 3 - Defaults Upon Senior Securities.......................................... 24
Item 4 - Submission of Matters to a Vote of Security Holders...................... 24
Item 5 - Other Information........................................................ 24
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>
September 30, December 31,
1999 1998
------------------- -------------
(Unaudited)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 38,245 $ 17,548
Short-term investments 15,859 5,483
Accounts receivable, net of allowance for doubtful
accounts of $1,056 at September 30, 1999 and
$838 at December 31, 1998 38,938 25,011
Inventories 19,199 16,699
Deferred taxes 2,594 2,594
Other current assets 3,148 2,196
------------------- -------------
Total current assets 117,983 69,531
Fixed assets, net 9,188 6,727
Noncurrent deferred taxes 3,157 0
Long-term investments 7,056 0
Other assets 584 696
------------------- -------------
Total assets $ 137,968 $ 76,954
------------------- -------------
------------------- -------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 21,588 $ 12,412
Taxes payable 4,938 1,405
Accrued and other current liabilities 11,817 10,083
------------------- -------------
Total current liabilities 38,343 23,900
------------------- -------------
Stockholders' equity:
Common stock 18 18
Additional paid-in capital 88,742 64,590
Unrealized loss on marketable securities (40) 0
Accumulated earnings/(deficit) 10,905 (11,554)
------------------- -------------
Total stockholders' equity 99,625 53,054
------------------- -------------
Total liabilities and stockholders' equity $ 137,968 $ 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 Nine Months Ended
Sept. 30, Sept. 30, Sept. 30, Sept. 30,
1999 1998 1999 1998
-------------- ------------- -------------- -------------
<S> <C> <C> <C> <C>
Net revenues $ 50,989 $ 31,603 $ 136,113 $ 75,674
Cost of net revenues 22,433 15,794 61,321 38,102
-------------- ------------- -------------- -------------
Gross profit 28,556 15,809 74,792 37,572
-------------- ------------- -------------- -------------
Operating expenses:
Sales and marketing 9,583 6,236 25,222 15,377
Research and development 5,182 3,485 13,341 10,410
General and administrative 2,083 1,363 5,506 3,765
Acquisition expenses --- --- --- 185
-------------- ------------- -------------- -------------
Total operating expenses 16,848 11,084 44,069 29,737
-------------- ------------- -------------- -------------
Operating income 11,708 4,725 30,723 7,835
Interest income, net 450 233 1,136 735
Other expense, net (10) 10 (31) 6
-------------- ------------- -------------- -------------
Income before taxes 12,148 4,968 31,828 8,576
Provision for income taxes 4,252 201 9,369 359
-------------- ------------- -------------- -------------
Net income $ 7,896 $ 4,767 $ 22,459 $ 8,217
-------------- ------------- -------------- -------------
-------------- ------------- -------------- -------------
Basic net income per share $ 0.25 $ 0.17 $ 0.73 $ 0.30
-------------- ------------- -------------- -------------
-------------- ------------- -------------- -------------
Dilutive net income per share $ 0.23 $ 0.15 $ 0.65 $ 0.26
-------------- ------------- -------------- -------------
-------------- ------------- -------------- -------------
Weighted average shares outstanding for basic EPS
31,746 27,962 30,872 27,194
-------------- ------------- -------------- -------------
-------------- ------------- -------------- -------------
Weighted average shares outstanding for dilutive EPS
34,992 32,829 34,558 32,118
-------------- ------------- -------------- -------------
-------------- ------------- -------------- -------------
</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>
Nine Months Ended
Sept. 30, Sept. 30,
1999 1998
-------------- -------------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 22,459 $ 8,217
Adjustments to reconcile net income to net cash
provided by/(used in) operating activities:
Depreciation and amortization 2,995 2,373
Provision for doubtful accounts 218 400
Provision for excess and obsolete inventories 3,449 2,115
Value of stock options to outside consultants 21 90
Gain on sale of fixed assets - (6)
Changes in assets and liabilities:
Accounts receivable (14,145) (12,724)
Inventories (5,949) (6,894)
Deferred taxes (3,157) -
Prepaids, deposits and other assets (1,090) (292)
Accounts payable 9,176 1,674
Taxes payable 8,998 234
Accrued and other liabilities 1,734 3,042
-------- --------
Net cash provided by / (used in) operating activities 24,709 (1,771)
-------- --------
Cash flows from investing activities:
Acquisition of fixed assets (5,456) (4,352)
Proceeds from sales of fixed assets - 27
Proceeds from repayment of note receivable 250 -
Proceeds from sale and maturity of investments 8,179 7,146
Purchases of investments (25,651) (8,997)
-------- --------
Net cash used in investing activities (22,678) (6,176)
-------- --------
Cash flows from financing activities:
Proceeds from issuance of common stock, net of repurchases 3,666 9,041
Proceeds from exercise of warrants 15,000 -
Repayment of stockholder notes receivable, net - 24
Proceeds from line of credit borrowings - 4,951
Repayment of line of credit borrowings - (5,576)
-------- --------
Net cash provided by financing activities 18,666 8,440
-------- --------
Net increase in cash and cash equivalents 20,697 493
Cash and cash equivalents, beginning of year 17,548 12,486
-------- --------
Cash and cash equivalents, end of period $ 38,245 $ 12,979
-------- --------
-------- --------
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Income taxes paid $ 3,504 $ 307
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING:
Conversion of preferred shares to common stock $ - $ 9,496
Tax benefit from exercise of employee stock options $ 5,465 $ -
</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 September 30, 1999, the condensed
consolidated statements of income for the three and nine month periods ending
September 30, 1999 and 1998 and condensed consolidated statements of cash flows
for the nine month periods ending September 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 September 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 September 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):
<TABLE>
<CAPTION>
Sept. 30, Dec 31,
1999 1998
---- ----
<S> <C> <C>
Raw Materials $ 229 $ 974
Finished Goods 18,970 15,725
-------- --------
$ 19,199 $ 16,699
-------- --------
-------- --------
</TABLE>
3. BANK LINE OF CREDIT
The Company had a $5.0 million bank revolving line of credit under an agreement
with Silicon Valley Bank. Borrowings under the line were secured by accounts
receivable and other Company assets and bore interest at the bank's prime rate
(8.25% at September 30, 1999). The agreement allowed for an additional facility
of $5.0 million upon request of Polycom and payment of associated fees.
Borrowings under the line were subject to certain financial covenants and
restrictions on liquidity, indebtedness, equity distributions, financial
guarantees, business combinations, net worth, and other related items. The line
expired on October 31, 1999. There were no borrowings under the line as of
September 30, 1999.
The Company entered into a $15.0 million bank revolving line of credit under an
agreement with Bank of America on October 31, 1999. Borrowings under the line
are unsecured and bear interest at the bank's
6
<PAGE>
prime rate (8.25% at September 30, 1999) or at an offshore interbank offered
rate (IBOR) plus 0.65% (approximately 6.0% to 6.9%, depending on the term of the
borrowings at September 30, 1999). Borrowings under the line are subject to
certain financial covenants and restrictions on liquidity, indebtedness,
financial guarantees, business combinations, profitability levels, and other
related items. The line expires on October 31, 2000 but may be renewed by the
Company for an additional year so long as certain liquidity measures are met at
the time of renewal.
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 nine months ended September 30, 1999 and September
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).
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
1999 1998 1999 1998
-------------- ------------ ----------- ----------
<S> <C> <C> <C> <C>
Numerator - basic and diluted EPS
Net income $ 7,896 $ 4,767 $ 22,459 $ 8,217
-------------- ------------ ----------- ----------
-------------- ------------ ----------- ----------
Denominator - Basic EPS
Common stock outstanding 31,746 27,962 30,872 27,194
-------------- ------------ ----------- ----------
Total shares used in calculation of Basic EPS 31,746 27,962 30,872 27,194
-------------- ------------ ----------- ----------
Basic net income per share $0.25 $0.17 $0.73 $0.30
-------------- ------------ ----------- ----------
-------------- ------------ ----------- ----------
Denominator - Diluted EPS
Denominator - Basic EPS 31,746 27,962 30,872 27,194
Effect of Dilutive Securities:
Common stock options 2,424 2,467 2,394 2,603
Stock subject to repurchase 822 1,492 1,010 1,661
Warrants 0 908 282 660
-------------- ------------ ----------- ----------
Total shares used in calculation of Diluted EPS 34,992 32,829 34,558 32,118
-------------- ------------ ----------- ----------
Diluted net income per share $0.23 $0.15 $0.65 $0.26
-------------- ------------ ----------- ----------
-------------- ------------ ----------- ----------
</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 had exclusive
distribution rights and effective April 1999 3M no longer distributed 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
7
<PAGE>
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 September 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 distributed 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 were 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 has purchased some video products
from 3M. Further, existing warranty obligations 3M has concerning the sale of
these products were 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
<PAGE>
7. COMPREHENSIVE INCOME
Effective March 31, 1998, the Company adopted SFAS No. 130, "Reporting
Comprehensive Income". SFAS No. 130 establishes standards for the reporting and
display of comprehensive income and its components in a full set of general
purpose financial statements. Comprehensive income is defined as the change in
equity of a business enterprise during a period from transactions and other
events and circumstances from non-owner sources. The components of comprehensive
income are as follows:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
(in thousands) 1999 1998 1999 1998
-------------- ------------ ----------- ----------
<S> <C> <C> <C> <C>
Net income $ 7,896 $ 4,767 $ 22,459 $ 8,217
Unrealized loss on marketable securities (40) --- (40) ---
-------------- ------------ ----------- ----------
Comprehensive income $ 7,856 $ 4,767 $ 22,419 $ 8,217
-------------- ------------ ----------- ----------
-------------- ------------ ----------- ----------
</TABLE>
9
<PAGE>
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, FUTURE INTERNATIONAL SALES, EXPECTATIONS FOR THE COST OF NET
REVENUES PERCENTAGE, EXPECTED EXPENSES 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 THE SUCCESSFUL LAUNCH OF NEW PRODUCTS AND MANUFACTURING RAMP OF THE
VIEWSTATION, WEBSTATION, STREAMSTATION, MEETINGSITE AND OTHER NEW PRODUCTS;
LEVEL OF SALES TO KEY CUSTOMERS, INCLUDING LUCENT; POSSIBLE PRICE COMPETITION;
DEMAND FOR VIEWSTATION, STREAMSTATION, SHOWSTATION IP, WEBSTATION, SOUNDPOINT
PRO, MEETINGSITE AND OTHER NEW PRODUCTS; POTENTIAL DIFFICULTIES ASSOCIATED WITH
TRANSITIONING TO THE NEW MANAGEMENT INFORMATION SYSTEM; THE PROFITABILITY OF THE
DATACONFERENCING PRODUCT LINE; THE SUCCESS OF THE RECENTLY ANNOUNCED BUSINESS
RELATIONSHIPS SUCH AS REALNETWORKS, LUCENT TECHNOLOGIES AND CISCO SYSTEMS; RISKS
ASSOCIATED WITH INTERNATIONAL OPERATIONS; DEPENDENCE ON THIRD PARTY
MANUFACTURERS AND SOLE-SOURCE SUPPLIERS; DEPENDENCE ON INTELLECTUAL PROPERTY AND
OTHER PROPRIETARY RIGHTS; AND OTHER RISKS DETAILED IN THIS REPORT AND THE
COMPANY'S OTHER 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. 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 September 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
September 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"), which became the engineering and marketing organization for the
video product line. In February 1998, Polycom began customer shipments of the
ViewStation 128, its first videoconferencing product. As of September 30,
1999, Polycom's videoconferencing product line consisted principally of the
ViewStation 128, ViewStation 512, ViewStation V.35, ViewStation MP and
ViewStation 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 streaming 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 audio and
10
<PAGE>
data products through its direct sales force; however, effective November 1999,
direct sales will be moved to its VAR channel. Through September 30, 1999,
Polycom has derived a majority of its net revenues from sales of its ViewStation
and SoundStation 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 is continuing 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 September 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.
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 has purchased some video products
from 3M. Further, existing warranty obligations 3M has concerning the sale of
these products were assumed by Polycom.
11
<PAGE>
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 Nine Months Ended
Sept. 30, Sept. 30, Sept. 30, Sept. 30,
1999 1998 1999 1998
------------- ------------ ------------- ------------
<S> <C> <C> <C> <C>
Net revenues 100% 100% 100% 100%
Cost of net revenues 44% 50% 45% 50%
------------- ------------ ------------- ------------
Gross profit 56% 50% 55% 50%
------------- ------------ ------------- ------------
Operating expenses:
Sales and marketing 19% 20% 19% 21%
Research and development 10% 11% 10% 14%
General and administrative 4% 4% 4% 5%
Acquisition expenses 0% 0% 0% 0%
------------- ------------ ------------- ------------
Total operating expenses 33% 35% 33% 40%
------------- ------------ ------------- ------------
Operating income 23% 15% 22% 10%
Interest income, net 1% 1% 1% 1%
Other income/(expense), net 0% 0% 0% 0%
------------- ------------ ------------- ------------
Income before taxes 24% 16% 23% 11%
Provision for Income Taxes 9% 1% 7% 0%
------------- ------------ ------------- ------------
Net income 15% 15% 16% 11%
------------- ------------ ------------- ------------
------------- ------------ ------------- ------------
</TABLE>
NET REVENUES
Total net revenues for the three months ended September 30, 1999 were $51.0
million, an increase of $19.4 million, or 61%, as compared to the same period of
1998. For the first nine months of 1999, total net revenues were $136.1 million,
an increase of $60.4 million, or 80%, compared to the first nine 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 nine-month periods ended September
30, 1999 over the comparable periods of 1998.
During the first nine months of 1999 and 1998, Polycom derived a substantial
majority of its net revenues from sales of its ViewStation and SoundStation
product families. Lucent Technologies accounted for 10% of net revenues in the
three months ended September 30, 1999 and for the first nine months of 1999. In
the three months ended September 30, 1998 and for the first nine months of 1998,
Lucent Technologies accounted for 13% and 12% 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. The Company's
future financial results would be adversely affected by a reduction in sales to
Lucent.
International net revenues for the third quarter of 1999 accounted for 35% of
total net revenues for the Company, up from 25% in the third quarter of 1998.
International net revenues for the first nine months of 1999 accounted for 31%
of total net revenues for the Company, up from 23% in the same period of 1998.
The increase in international revenue as a percentage of total net revenues for
the third quarter of 1999 compared to the third quarter of 1998 and for the nine
months ended September 30, 1999 over the nine months ended September 30, 1998
were 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
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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 is expanding 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 US 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 44% of net revenues in the three months ended
September 30, 1999 compared to 50% in the same period of 1998. For the first
nine months of 1999 the cost of net revenues percentage was 45%, compared to 50%
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 a write-down of ShowStation IP inventory and the SoundPoint
inventory to net realizable value and less revenue received under the Second
Agreement with 3M which had very low associated costs. The Company received $0.4
million in revenue under this agreement in the three months ended March 31, 1999
and $0.5 million in revenue for the three months ended September 30, 1999
compared to $1.5 million for 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 over the next few quarters can cause the
cost of net revenues percentage to fluctuate significantly. Additionally,
Polycom may reduce prices on it 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,
ViewStation 4000 and ViewStation FX products 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,
ViewStation SP 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 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.
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
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<PAGE>
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. For example, beginning in
November 1999, Polycom is moving its direct sales customers to resellers in its
VAR channel. This sales channel shift will negatively impact the Company's cost
of net revenues percentage.
SALES AND MARKETING EXPENSES
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
------------------ -----------------
SEPT. 30, SEPT. 30, INCREASE/ SEPT. 30, SEPT. 30, INCREASE/
$ IN THOUSANDS 1999 1998 (DECREASE) 1999 1998 (DECREASE)
- -------------- ---- ---- ---------- ---- ---- ----------
<S> <C> <C> <C> <C> <C> <C>
Expenses $ 9,583 $ 6,236 54 % $ 25,222 $ 15,377 64 %
% of Net Revenues 19 % 20 % (1 %) 19 % 21 % (2%)
</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 three months ended September 30, 1999 over the same
period of 1998 and the increase in expenses for the first nine months of 1999
over the comparable period of 1998 were primarily related to increased
advertising and promotional expenditures for the video and audio product.
Additionally, an increase in the investment in the worldwide 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
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
------------------ -----------------
SEPT. 30, SEPT. 30, INCREASE/ SEPT. 30, SEPT. 30, INCREASE/
$ IN THOUSANDS 1999 1998 (DECREASE) 1999 1998 (DECREASE)
- -------------- ---- ---- ---------- ---- ---- ----------
<S> <C> <C> <C> <C> <C> <C>
Expenses $ 5,182 $ 3,485 49 % $ 13,341 $ 10,410 28 %
% of Net Revenues 10 % 11 % (1 %) 10 % 14 % (4 %)
</TABLE>
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 nine
months ended September 30, 1999 over the respective comparable periods of 1998,
was offset by a reduction in dataconferencing product development. As of
September 30, 1999, all research and development costs have been expensed as
incurred.
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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
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
------------------ -----------------
SEPT. 30, SEPT. 30, INCREASE/ SEPT. 30, SEPT. 30, INCREASE/
$ IN THOUSANDS 1999 1998 (DECREASE) 1999 1998 (DECREASE)
- -------------- ---- ---- ---------- ---- ---- ----------
<S> <C> <C> <C> <C> <C> <C>
Expenses $ 2,083 $ 1,363 53 % $ 5,506 $ 3,765 46 %
% of Net Revenues 4 % 4 % 0 % 4 % 5 % (1 %)
</TABLE>
General and administrative expenses consist primarily of compensation costs, an
allocation of overhead expense, bed debt write-offs and outside legal and
accounting expenses. The increase in general and administrative expenses in the
three and nine months ended September 30, 1999 over the respective comparable
periods of 1998 is due to increased staffing and infrastructure costs to support
the Company's growth including the conversion of the management information
system. 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. Additionally, potential write-offs associated
with bad debt are difficult to predict and material write-offs could negatively
affect the profitability in the quarter they are realized.
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 $0.5 million and $0.2 million for
the three months ended September 30, 1999 and 1998, respectively. For the first
nine months of 1999, the interest income, net amount was $1.1 million compared
to $0.7 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 September 30, 1999,
income tax expense was $4.3 million compared to $0.2 million for the same period
of 1998. For the first nine months of 1999, income tax expense was $9.4 million
compared $0.4 million for the first nine months of 1998. The increases in income
taxes for the three month and nine 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 September 30, 1999, Polycom had approximately $7.1 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
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<PAGE>
such. The Company reversed $6.3 million of this allowance in the first nine
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 three 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 were
completed on 11/1/99. 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 initiated and completed a project
to replace its prior internal business information system. While this effort
also addressed the Year 2000 issues of the legacy system, this internal system
implementation effort was principally 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 100% 5/30/99
Assess need to implement contingencies 100% 6/30/99
Complete upgrades & replacements 100% 11/1/99
</TABLE>
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, 100% are Year 2000 Compliant.
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 $100,000) 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 was 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.
As mentioned above, Polycom has completed efforts on a business systems
replacement project. The new system, which will make the Company's business
computer systems fully Year 2000 compliant, was completed at the beginning of
November, 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.
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<PAGE>
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 September 30, 1999, Polycom's principal sources of liquidity included cash
and cash equivalents of $38.2 million and investments of $22.9 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 September 30, 1999, Polycom was in compliance with these covenants. On
October 31, 1999, the line of credit with Silicon Valley Bank expired and
Polycom entered into a $15.0 million line of credit agreement with Bank of
America.
Polycom generated cash from operating activities totaling $24.7 million in
the first nine months of 1999 compared to a use of cash of $1.8 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, the timing of liabilities
and lower inventory increases. 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 nine months of
1999 was an increase of $20.7 million. The primary sources of cash were $24.7
million from operating activities, $15.0 million proceeds from an exercise of
warrants by 3M, and $3.7 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 nine months of 1999 were net purchases
of investments of $17.5 million and purchases of property, plant and equipment
of $5.5 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 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.
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<PAGE>
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 businesses or technology.
OTHER FACTORS AFFECTING FUTURE OPERATIONS
CHANNEL SALES AND INVENTORY. Polycom sells a significant amount of its products
to distributors and resellers which maintain their own inventory of products for
sale to end-users. A substantial percentage of the total products sold during a
particular quarter consist of distributor stocking orders. Polycom typically
provides special incentives for distributors to purchase the minimum or more
than the minimum quantities required under their agreements with Polycom. 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.
Many of Polycom's distributors and 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. The loss
of distributors or resellers could have a material adverse effect on the
Company's business and results of operations.
CHANNEL AND CUSTOMER ORDERS. 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. Additionally, orders from the Company's reseller
customers are based on the level of demand from Polycom end users. The
uncertainty of such end user demand means that any quarter could be
significantly negatively impacted by lower end-user orders which could
negatively affect orders the Company receives from its resellers.
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.
UNCERTAINTY OF FUTURE REVENUES AND RESULTS. As a result of several factors,
including reliance on channel sales and the timing of orders and shipments
during each quarter, 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,
18
<PAGE>
product mix and, therefore, profitability is difficult, if not impossible, to
predict. Due to these 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;
similar price reductions and demand issues could occur for this and other
products 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.
Polycom believes that profitability could 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. For
example, during the third quarter of 1999, the Company recorded a charge for
excess and obsolete inventory concerns for the ShowStation IP and SoundPoint
product line which negatively impacted the Company's cost of net revenues
percentage. 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 4000, ViewStation FX, ViewStation SP, 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 and changes in general economic conditions. For
example, beginning in November 1999, Polycom is moving its direct sales
customers to resellers in its VAR channel. This sales channel shift will
negatively impact the Company's cost of net revenues percentage. 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 volumes of existing products, introduce and sell new
products or reduce its costs as a percentage of net revenues.
19
<PAGE>
PRODUCT INTRODUCTIONS. Polycom's revenue growth since the beginning of 1998 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, such as the recently announced ViewStation 4000
and ViewStation FX, 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 these or any new product introductions in 1999 or 2000 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 such as Lucent Technologies 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. Because many of the Company's distributors
also sell equipment that compete 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 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-
20
<PAGE>
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.
MANAGEMENT INFORMATION SYSTEM TRANSITION. The Company is currently transitioning
to a new enterprise resource planning system which affects almost every facet of
its business operations. This conversion is expected to bring new process
efficiencies which should improve the Company's business operations. However,
typically, these conversions negatively affect a Company's ability to conduct
business initially due to problems such as historical data conversion errors,
the learning curve associated with the new system, delays in implementation or
unforeseen technical problems during conversion. If such problems arise during
this transition, the Company could experience, for a period of time, delays in
or lack of shipping, an inability to support its existing customer base, delays
in paying vendors, delays in collecting from customers, an inability to place or
receive product orders or other operational problems. If this were to occur, the
Company's profitability or financial position could be negatively impacted.
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. In addition, increased international competition has forced
companies in the conferencing market to provide a complete service and
support package. Polycom 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 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 during the third quarter of 1999 for
the ShowStation IP and the Soundpoint products when the Company recorded $1.3
million in excess and obsolescence charges and for the original ShowStation
product in the third quarter of 1998 when Polycom wrote-down an additional $1.5
million
21
<PAGE>
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. No revenue was recorded on this transaction
and it had no impact on net income. The trade credits were classified as a
prepaid asset at their net realizable value which approximated the value of the
inventory. During the third quarter of 1999, the Company backed out of the
contract due to non-performance on the part of the barter company. Therefore,
the SoundPoint inventory was received back into inventory and the prepaid asset
associated with the trade credits was reversed.
STOCK PRICE FLUCUATIONS. 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.
22
<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 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 September 30, 1999:
<TABLE>
<CAPTION>
Expected Maturity
1999 2000 2001 Total
---- ---- ---- -----
(in thousands, except interest rates)
<S> <C> <C> <C> <C>
ASSETS
Cash and cash equivalents $ 38,245 --- --- $ 38,245
Average interest rates 2.74% --- --- 2.74%
Investments --- $ 18,677 $ 4,238 $ 22,915
Average interest rates --- 4.59% 4.24% 4.52%
LIABILITIES
Bank line of credit --- --- --- ---
Average interest rates 8.25% --- --- 8.25%
</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.
23
<PAGE>
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
Not Applicable
Item 5. OTHER INFORMATION
Not Applicable
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
<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: November 16, 1999 POLYCOM, INC.
/s/ Michael R. Kourey
--------------------------------
Michael R. Kourey
Accounting 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> JUL-01-1999
<PERIOD-END> SEP-30-1999
<CASH> 38,245
<SECURITIES> 15,859
<RECEIVABLES> 39,994
<ALLOWANCES> 1,056
<INVENTORY> 19,199
<CURRENT-ASSETS> 117,983
<PP&E> 20,738
<DEPRECIATION> 11,550
<TOTAL-ASSETS> 137,968
<CURRENT-LIABILITIES> 38,343
<BONDS> 0
0
0
<COMMON> 18
<OTHER-SE> 99,607
<TOTAL-LIABILITY-AND-EQUITY> 137,968
<SALES> 50,989
<TOTAL-REVENUES> 50,989
<CGS> 22,433
<TOTAL-COSTS> 22,433
<OTHER-EXPENSES> 16,360
<LOSS-PROVISION> 48
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 12,148
<INCOME-TAX> 4,252
<INCOME-CONTINUING> 7,896
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 7,896
<EPS-BASIC> 0.25
<EPS-DILUTED> 0.23
</TABLE>
