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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
[ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 1998
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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 0-27978
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POLYCOM, INC.
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(Exact name of registrant as specified in its charter)
Delaware 94-3128324
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(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
2584 Junction Avenue, San Jose, California 95134
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (408) 474-2000
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SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
NONE
SECURITIES TO BE REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, $0.0005 PAR VALUE, PER SHARE
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
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Indicated by a check mark if disclosure of delinquent filers pursuant
to Item 405 of Regulation S-K is not contained herein, and will not be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K. [ ]
The aggregate market value of the voting stock held by non-affiliates
of the Registrant was approximately $446,887,429 as of February 26, 1999. Shares
of Common Stock held by each executive officer and director and by each person
who beneficially owns more than 5% of the outstanding Common Stock have been
excluded in that such persons may under certain circumstances be deemed to be
affiliates. This determination of executive officer or affiliate status is not
necessarily a conclusive determination for other purposes.
30,043,726 shares of the Registrant's $0.0005 par value Common Stock
were outstanding as of February 26, 1999.
DOCUMENTS INCORPORATED BY REFERENCE.
Portions of the Registrant's Proxy Statement for the 1999 Annual
Meeting of Stockholders are incorporated by reference into Part III. Such Proxy
Statement will be filed within 120 days of the fiscal year covered by this
Annual Report on Form 10-K.
ITEM 1. BUSINESS
Polycom, Inc. (the "Company" or "Polycom") develops, manufactures and
markets conferencing products that facilitate meetings at a distance. With its
SoundStation product line, Polycom has established itself as the leading
provider of audioconferencing equipment designed for group use according to the
market research firm of Frost and Sullivan. SoundStation is a high-quality,
full-duplex, easy-to-use audioconferencing solution. The SoundStation products
are designed to operate with local telephone systems throughout the world and
Polycom has obtained regulatory approval for SoundStation's use in 32 countries.
Polycom's technologies permit its SoundStation products to achieve
audioconferencing communications quality that approaches handset communications
quality. Approximately 300,000 SoundStation systems had been shipped as of
December 31, 1998, and Polycom believes SoundStation is the best selling product
in the group audioconferencing market.
Polycom's innovative dataconferencing products, first introduced in
November 1995, enable real-time exchange of data and other images over ordinary
phone lines via the T.120 dataconferencing protocol standard or over the
Internet. The ShowStation IP is an easy-to-use, high-resolution dataconferencing
solution that enables groups or individuals in multiple locations to
simultaneously view, edit and annotate paper or electronic documents and data.
The WebStation, introduced in December 1998, provides an easy and affordable way
for meeting participants in any location to fully participate and collaborate in
meetings via a Java-enabled browser over the World Wide Web.
In January 1998, Polycom acquired ViaVideo Communications, Inc.
("ViaVideo") in a stock transaction accounted for as a pooling of interests.
ViaVideo was a development stage company that designed and developed
high-quality, low-cost, easy-to-use, group videoconferencing systems that
utilize advanced video and audio compression technologies along with
Internet/Web-based features. Polycom's first videoconferencing product
offering was the ViewStation 128, which commenced first customer shipments in
February 1998. The ViewStation product line established Polycom as the market
leader in the videoconferencing market in the second, third and fourth
quarters of 1998 according to TeleSpan Publishing Corporation.
In April of 1998, Polycom and Lucent Technologies announced that
Polycom would sell the Lucent Technologies multipoint conferencing unit product
(MCU) through its reseller channel. This product provides connectability for
large multipoint videoconference calls.
Polycom's products integrate advanced telecommunications, acoustic,
image capture and processing technologies. Polycom sells its products globally
through marketing and sales relationships with Lucent Technologies, MCI
Worldcom, Inc., 3M, Southwestern Bell, Ameritech, Nortel, BellSouth, Ingram
Micro, British Telecom, Siemens, Sprint, SKC Communications, GBH Distributing,
Frontier Confertech, All Communications, Viewtech, Unitel, Hibino, and Hello
Direct, which collectively represented approximately 56% of Polycom's net
product revenues in 1998, and with other resellers and OEMs. In addition,
Polycom also sells its audioconferencing and dataconferencing products through
its direct sales force.
Polycom was incorporated in December 1990 in Delaware and has two
wholly owned subsidiaries. One subsidiary is Polyspan Teleconferencing B.V., a
corporation organized under the laws of the Netherlands. The other is ViaVideo
Communications, Inc. which is located in Austin, Texas. Polycom's principal
executive offices are located at 2584 Junction Avenue, San Jose, California
95134. Its telephone number is (408) 474-2000.
INDUSTRY BACKGROUND
The telecommunications industry has experienced substantial growth in
recent years. Voice communications have expanded with the proliferation of
cellular phones and voice mail and the emergence of high-speed switching
technologies, while the data communications infrastructure has been widely
expanded through the growing use of corporate intranets and the public internet.
One of the fastest growing segments of the telecommunications market is
equipment and services for conferencing, which includes audioconferencing,
videoconferencing and dataconferencing. Dataconferencing is the sharing of data
and documents by groups in multiple locations over standard telephone lines the
proliferation of which has been enabled by the adoption of the T.120 protocol
standard and the internet. Additionally, videoconferencing technologies are
becoming easier to use with higher quality through the adoption of the H.320 and
H.323 protocol standards.
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Numerous factors are driving the growth of the conferencing market,
including the development of a global economy, the internationalization of
business organizations, the development of "extended enterprises" of companies
and their suppliers, customers and other business partners and the increasing
corporate emphasis on team projects and group and interoffice communication. As
a result, tools such as voicemail, e-mail, fax machines and the internet that
allow workers to communicate more effectively and facilitate business
interactions have become vital to improving productivity in most organizations.
To enhance the real-time exchange of information when face-to-face meetings are
not possible or practical, companies are increasingly seeking advanced
conferencing solutions to facilitate meetings at a distance.
Audioconferencing is the essential component of all conferencing. In
the audioconferencing market, key enablers such as the audio bridging services
provided by AT&T, MCI Worldcom, Sprint and other carriers are expanding the use
of audioconferencing as a medium for meetings at a distance and have increased
demand for high quality audioconferencing equipment. For instance, a fifty-point
analyst call that would not have been contemplated only a few years ago is now
commonplace in the investor community. However, despite the widespread adoption
of audioconferencing, the equipment used for audioconferencing has generally
suffered from technology and performance weaknesses. Desktop and built-in
speakerphones, which are the most widely used audioconferencing devices, often
fail to provide clear verbal information exchange as voice transmissions echo,
are distorted and are frequently clipped due to a lack of full-duplex technology
(the ability for both parties to talk and be heard simultaneously). Early
conference speakerphones designed for group use suffer from these same quality
shortcomings. Businesses and other organizations need audioconferencing
equipment that provides high-quality, full-duplex sound, is easy to install and
use and is compliant with telecommunications protocols in business centers
around the world.
Videoconferencing enhances remote meetings by permitting groups in
disparate locations to see each other and by making reactions and body language
visible. Videoconferencing is, therefore, the ideal conferencing tool for the
relationship building aspect of a remote meeting. The first videoconferencing
products were introduced in the late 1970's. Early videoconferencing products
were costly and usually required dedicated transmission facilities, specially
trained operators, and specialized rooms. Although there was broad interest in
videoconferencing as a means of eliminating travel time and expenses, most
potential users could not justify the high cost of investing in
videoconferencing technology given the level of quality and performance of the
products at that time. However, improved technology, implementation of industry
standards, lower costs, and greater connectivity and bandwidth have improved the
quality and price/performance relationship of videoconferencing and driven its
evolutionary growth.
Specifically, advances in compression technologies, which are necessary
to fit video signals into the bandwidth of telephone lines, are improving the
video quality of calls by better determining how much and which data will be
transmitted. Additionally, greater availability of and accessibility to higher
bandwidth digital lines and switched digital networks have also made
videoconferencing more convenient and enable a videoconference to be initiated
much like a traditional telephone call. Further, the adoption of standards have
helped define audio and video telephony protocols and enable interoperability of
videoconferencing systems manufactured by different suppliers. Some of the key
standards include H.320 --- standard for coding and decoding video and audio
signals transmitted over digital networks at rates between 64 Kbps and 2.048
Mbps (million bits per second); H.323 --- standard for coding and decoding video
and audio signals transmitted over LANs and other packet based networks; H.324
- --- standard for coding and decoding video and audio signals transmitted over
regular telephone lines (POTS) and; T.120 --- standard for coding and decoding
still frame, annotation, and data files over digital networks. Lastly, lower
product costs have helped justify the investment in videoconferencing for
end-users.
The videoconferencing market has evolved into two distinct segments,
group systems and desktop or personal systems. Historically, the group segment
has been divided into large and small group segments. However, with the advent
of a new generation of high performance set-top products this distinction is
blurring and the group system category is being segmented into pricing and
feature bands. The new generation of set-tops typically are priced from about
$3,000 - $4,000 for an entry level single ISDN product to around $10,000 -
15,000 for feature rich, high-bandwidth systems designed for large conference
rooms or for use in multi-point calls. The desktop or personal system market
segment is characterized by videoconferencing products designed for one-to-one
communication and typically do not have the performance, quality, features, and
capabilities to be effective in conducting business meetings involving several
people. The desktop systems are typically PC-based and require a hardware and
software component to be added
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to a personal computer. Personal videoconferencing products currently range
in price from a few hundred dollars to a few thousand dollars.
For complex information exchange, dataconferencing is the best tool for
the real-time exchange and annotation of printed or computer-generated
information such as graphics, spreadsheets, engineering diagrams or other
detailed visual data. The T.120 dataconferencing protocol is the established
industry standard although webconferencing, leveraging the power of the
Internet, high-bandwidth corporate internets, and commonly understood and used
browsers, is quickly taking hold as the emerging standard for data conferencing.
Businesses and other organizations require affordable, easy-to-use, high
resolution dataconferencing solutions that enable groups in multiple locations
to simultaneously view, edit and annotate paper or electronic documents and
data.
THE POLYCOM SOLUTION
Polycom develops, manufactures and markets conferencing products that
facilitate meetings at a distance through audio, data and videoconferencing
means. Polycom's audioconferencing product line, containing a wide range of
SoundStation and SoundPoint products, is a family of systems that provide near
handset quality communications. SoundStation products are easy to use, and
Polycom's advanced acoustic technologies minimize background echoes, word
clipping and distortion. Users can engage in natural, free-flowing discussions
without having to shout to be heard or strain to hear what others are saying.
Because of Polycom's patented full-duplex, echo cancellation technology and the
distinctive triangular design of the SoundStation products, Polycom believes
SoundStation is the best selling product in the group audioconferencing market.
The SoundStation is configurable and has been approved for use with the local
telephone systems in 32 countries. Additionally, the SoundPoint Pro, introduced
in 1998, brings the same quality of conferencing to the desktop with the full
functionality of a business phone.
Polycom's dataconferencing products, consisting of the ShowStation IP
and WebStation, enable real-time exchange of data and other images between
groups or individuals engaged in an audioconference or videoconference. The
ShowStation IP provides a cost-effective method for two or more groups or
individuals that are separated by a distance to view, edit and annotate paper
and electronic documents and data in real-time over the internet or standard
telephone lines. With Polycom's WebStation system, remote-meeting participants
anywhere in the world can join a meeting by simply browsing the Web with any
Java-enabled Web browser, or using any fully T.120 compatible dataconferencing
system. Remote participants can then collaborate in real-time and have the
ability to share presentations or documents with other meeting participants.
Both products incorporate high resolution imaging, data compression and
communications technology in a compact, easy-to-use unit.
The Company's revolutionary ViewStation group videoconferencing systems
deliver the performance and features of a high-end room videoconferencing
system, but at a fraction of the cost. Distinctively easy to set up and use, the
ViewStation product line offers high quality audio and video technology,
embedded Web based features, an integrated presentation system, a voice-tracking
camera, and a variety of other features. The ViewStation is upgradeable to H.323
IP-based videoconferencing through a software upgrade scheduled for later in
1999. In addition, an "MP" version of the product is available that provides up
to four locations to participate in a multi-point videoconference call. Using a
unique embedded system architecture, Polycom is delivering an entirely new
generation of high performance, affordable systems that it believes will
radically shift the way customers view videoconferencing and the status quo of
the industry.
PRODUCTS
Audioconferencing
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Polycom's audioconferencing products are designed to overcome the poor
audio problems associated with traditional speaker phones by providing high
quality, full-duplex, easy-to-use audio.
SOUNDSTATION. SoundStation, Polycom's first product, which was introduced in
September 1992, is a high quality, digital, full-duplex audioconferencing system
that operates over ordinary telephone lines. It provides clear, two-way voice
communications with no echoes, clipping or distortion. Users can engage in
natural, free-flowing discussions without having
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to shout to be heard or strain to hear what others are saying. SoundStation's
three built-in directional microphones pick up sound from around the room
while limiting reverberation. The unit's central sorbathane-encased,
acoustically-suspended speaker and advanced digital signal processing ("DSP")
and integrated software technology eliminate acoustic feedback while
broadcasting sound at sufficient volume and clarity to be heard up to 30 feet
away.
SoundStation has a distinctive design that Polycom believes is widely
associated with high-quality audioconferencing. SoundStation is connected via a
single cord to a power transformer that plugs into a standard electrical outlet
and a telephone cord that connects to a standard telephone outlet. Due to this
inherent simplicity, customers are able to self-install and immediately begin
using the SoundStation. The United States list price for SoundStation is $499.
SOUNDSTATION EX. SoundStation EX contains all of the technology and physical
elements of the SoundStation but also offers two connectors for additional
microphones. The microphones can extend up to 25 feet in each direction allowing
the SoundStation EX to accommodate larger conference rooms. Each extended
microphone also contains a mute button and LED mute indicator. An optional
wireless lapel microphone is available for the SoundStation EX that provides
flexibility for stand-up presenters. The United States list price for
SoundStation EX ranges from $799 to $1,299, depending on options.
Polycom also manufactures private label versions of its SoundStation
products for Lucent Technologies, 3M, Nortel and British Telecom pursuant to OEM
relationships.
SOUNDSTATION PREMIER. Incorporating the latest in DSP technology, the
SoundStation Premier is designed for larger, more demanding environments and
those requiring higher performance. Using a unique active microphone steering
algorithm in conjunction with multiple aligned microphone patterns, the
SoundStation Premier brings in every conference participant more clearly and
with less room reverberation than older systems. With other additions including
an LCD display, caller ID, and infrared remote control, the SoundStation Premier
provides a complete full duplex business conference phone solution. The United
States list price for SoundStation Premier ranges from $999 to $1,899, depending
on options.
SOUNDSTATION PREMIER EX. SoundStation Premier EX contains all of the technology
and physical elements of the SoundStation Premier but also offers two connectors
for additional microphones. The microphones can extend up to 25 feet in each
direction allowing the SoundStation Premier EX to accommodate larger conference
rooms. Each extended microphone also contains a mute button and LED mute
indicator. An optional wireless lapel microphone is available for the
SoundStation Premier EX that provides flexibility for stand-up presenters. With
the SoundStation Premier Satellite, up to 4 additional microphones, a separate
speaker module or spread spectrum wireless microphones are available to cover
larger and more complex rooms. The United States list price for SoundStation
Premier ranges from $999 to $2,199, depending on configuration and options.
SOUNDPOINT AND SOUNDPOINT PC. SoundPoint, Polycom's first desktop conference
phone adjunct product, is designed for the office environment. The SoundPoint
system is connected between the telephone line and an analog telephone set, and
provides near-handset quality full-duplex conversations. A special version of
this SoundPoint is manufactured for direct communication to Lucent's Definity
telephone sets, pursuant to the Lucent Technologies OEM relationship. The
SoundPoint PC system is similar to the basic SoundPoint system, but is designed
for desktop videoconferencing and Internet telephony applications. The
SoundPoint PC is connected to a personal computer video codec or sound card
through a standard set of audio jacks, and includes a handset when more privacy
is desired. The United States list price for SoundPoint and SoundPoint PC ranges
from $299 to $399.
SOUNDPOINT PRO. SoundPoint Pro brings Polycom's high-quality hands-free
audioconferencing to telecommuters, home offices, and small businesses, and
combines professional-quality audioconferencing and elegant styling, in a fully
featured business telephone. Available in 2-line or 3-line models, users can
conduct conference calls with up to three other remote sites at the touch of a
button, and without using outside bridging services. Features also includes
20-number programmable speed dial, integrated primary Caller ID as well as
Caller ID for Call Waiting, and 99 number caller history. The SoundPoint Pro
2-Line has a United States list price of $249, with the 3-Line model priced at
$299.
Sales of the SoundStation product line have accounted for a majority of
Polycom's net revenues through October 31, 1998, and Polycom anticipates that
such sales will continue to account for a substantial amount of its net revenues
at least through the year ending December 31, 1999. The market for Polycom's
SoundStation products is subject to technological
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change, new product introductions by Polycom or its competitors, and
continued market acceptance of the SoundStation product line. Any factor
adversely affecting the demand or supply for the SoundStation product line
could materially adversely affect Polycom's business, financial condition or
results of operations.
Dataconferencing
- ----------------
Polycom's dataconferencing products are designed to allow for the
real-time exchange of data and other images between groups or individuals
engaged in an audioconference or videoconference. By integrating
audioconferencing or videoconferencing with dataconferencing, Polycom's products
are designed to significantly enhance the productivity of workers, allowing them
to conduct meetings remotely with a level of data exchange that Polycom believes
has traditionally been possible only through a personal meeting.
SHOWSTATION IP. ShowStation IP, Polycom's first internet dataconferencing
product, is a fully integrated, easy-to-use unit that can exchange and project
data, documents and images, using corporate LAN connections or ordinary
telephone lines, between ShowStation IP's. In addition, the ShowStation IP can
exchange data, documents and images using the World Wide Web with any personal
computer that has a Java-enabled browser or T.120 dataconferencing protocol
software, such as the DataBeam software that is distributed by Polycom. Working
in tandem with the SoundStation or ViewStation, ShowStation IP provides a
cost-effective method for two or more groups or individuals that are separated
by a distance to simultaneously view, discuss, edit and annotate paper or
electronic documents and data. Multipoint dataconferences are possible with the
LAN/MULTIPOINT OPTION which allows 1 ShowStation IP to connect to as many as 9
other ShowStation IPs and 25 browsers simultaneously. ShowStation IP
incorporates advanced imaging, data compression and communications technology
utilizing over 250,000 lines of code into a compact and easy-to-use unit that
includes pen-based editing capabilities
ShowStation IP captures an image of the original document using an
integrated camera or receives data from a personal computer and displays a
high-resolution image on a flat-panel LCD display. Light is then projected
through the LCD panel and onto a screen for local viewing, without having to dim
conference room lights. Simultaneously, the image is compressed and transmitted
over the internet using the T.120 open standard protocol to other T.120
compliant participants or using HTML to Web-based browser participants where the
image is decompressed and displayed. The images can then be annotated or
highlighted in real-time by the transmitting person or any of the T.120
compliant participants using an integrated computer pen or through mouse-based
editing from remote personal computers and saved in memory for review and
printing. Pen or mouse annotations can be seen simultaneously by all parties
participating in the dataconference and each ShowStation IP can print the image
and all annotations on a printer connected via a parallel cable.
ShowStation IP also has a Multimedia option. With this additional
hardware card, a ShowStation can emulate a standard LCD projector. Users can
plug in any VGA, SVGA, or XGA source such as a laptop and project it locally on
the screen. Likewise, this feature supports NTSC, PAL, and S-Video sources, so
users can plug in devices like a VCR and project it locally. These images can
also be sent to remote participants by pressing a "Capture" button in the
ShowStation IP User Interface.
The North American list price for the ShowStation IP product ranges
from $9,999 to $12,999 depending on options, effective March 1,1999.
WEBSTATION. Designed to enhance full participation and collaboration in group
meetings, the WebStation provides an affordable and easy way to present and
collaborate with both local and remote group meeting participants via the
Web. With a simple one-cable connection to any LCD projector and a standard
local area network connection, the Polycom WebStation delivers a full range
of features that enable an LCD projector to communicate over the Internet for
sharing documents and presentations with both local and remote meeting
locations. Presenters have several options for bringing presentation
materials into a meeting using WebStation. Because WebStation integrates the
full Microsoft-Registered Trademark- Office-Registered Trademark- suite,
presenters can send PowerPoint-TM-, Word-TM-, or Excel-TM- files directly to
WebStation from their desktop computer before the meeting, then simply walk
into the meeting room where the presentation is ready and waiting. Presenters
also have the option of bringing Microsoft Office files into the meeting on a
diskette and then load them using WebStation's built-in floppy diskette
drive. With Polycom's WebStation system, remote-meeting participants anywhere
in the world can join a meeting by simply browsing the Web with any
Java-enabled Web browser, or using any fully T.120 compatible
dataconferencing system.
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Remote participants can then collaborate in real-time and even share
presentations or documents with other meeting participants. The Polycom
WebStation presentation and meeting system is available at a price of $2,999.
Polycom's future growth is dependent on net revenues generated from
sales of Polycom's dataconferencing products. Dataconferencing is an emerging
market and there can be no assurance that it will develop sufficiently to enable
Polycom to achieve broad commercial acceptance of its dataconferencing products.
Because the dataconferencing market is relatively new and evolving, and because
current and future competitors are likely to introduce competing
dataconferencing products, it is difficult to predict the rate at which demand
for Polycom's dataconferencing products will grow, if at all, or to predict the
level of future growth, if any, of the dataconferencing market. If the
dataconferencing market fails to grow, or grows more slowly than anticipated,
Polycom's business, operating results and financial condition would be
materially adversely affected. Although there are currently no products in the
dataconferencing market that offer all of the same functions and features as
Polycom's dataconferencing products, there are products that enable users to
participate in a dataconference and other products, such as multimedia
presentation products, that are not designed primarily for dataconferencing but
can be used to provide a dataconferencing solution. There can be no assurance
that the market for dataconferencing products with the functions and features of
the ShowStation and WebStation products will achieve broad commercial acceptance
or that the market for these products will grow.
Even if the market for dataconferencing products does develop, there
can be no assurance that Polycom's dataconferencing products will achieve
commercial success within such market. Due to the unique nature of these
products, Polycom believes it will be required to incur significant expenses for
sales and marketing, including advertising, to educate potential customers as to
the desirability of ShowStation and Polycom expects to incur substantially
longer sales cycles with respect to its ShowStation and WebStation products than
has been the case for the SoundStation products. In addition, the list price of
the ShowStation products, which is significantly higher than the SoundStation
product, could significantly limit consumer acceptance of the ShowStation
products. Furthermore, given the significant differences between the
SoundStation and the ShowStation and WebStation products, Polycom is developing
new distribution channels for the ShowStation and WebStation products and there
can be no assurance that Polycom will be successful selling such products
through these distribution channels. In addition, broad commercialization of
Polycom's dataconferencing products will require Polycom to overcome significant
technological and market development obstacles, many of which may not be
currently foreseen.
Polycom's new ShowStation and WebStation products are extremely complex
and because of the recent introduction of these products, Polycom has not yet
had experience with respect to the performance and reliability of these
products. If these products have performance, manufacturability, reliability or
quality problems or shortcomings, then Polycom may experience reduced orders,
higher manufacturing costs and additional warranty and service expenses which
would have a material adverse effect on Polycom's business, financial condition
and results of operations. For example, Polycom chose to stop shipments of its
ShowStation products from mid-January 1996 through the end of February 1996 to
correct software and other technical problems identified by initial customers.
Also, the new ShowStation IP product was delayed from its planned first shipment
target date in 1997 to March 1998 due to engineering design changes and certain
technical difficulties. There can be no assurance that Polycom's
dataconferencing products will be able to achieve or sustain commercial
acceptance, that sales of these products will account for a substantial part of
Polycom's net revenues or that Polycom will be able to achieve volume
manufacturing. Failure of Polycom's dataconferencing products to achieve and
sustain commercial acceptance, or of Polycom or its contract manufacturer to
achieve volume manufacturing, would have a material adverse effect on Polycom's
business, financial condition and results of operations.
Videoconferencing
- -----------------
Polycom's videoconferencing products are designed to be low-cost,
high-quality, web-enabled alternatives to the expensive videoconferencing
products in the market today.
VIEWSTATION128: The ViewStation 128 is the lowest priced member of the
ViewStation line with a U. S. list price of $5,999. ViewStation 128 features
outstanding audio and video quality, an embedded webserver, a voice tracking
camera, automatic ISDN configuration on set-up and a robust set of Web based
management, diagnostic and presentation tools.
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VIEWSTATION 512. The ViewStation 512 is a high performance product which
operates at up to 512Kbps or four ISDN lines which are multiplexed together at
up to 30 frames per second giving near TV quality video as well as increased
quality of audio using one of the standards based wide band algorithms. The
ViewStation 512 has a U.S. list price of $8,999.
VIEWSTATION V.35. The ViewStation V.35 which has a U.S. list price of $9,999
supports up to 768Kbps or half the bandwidth of a T1 line through the V.35
physical interface, a universal serial connector used to connect to a variety of
brands of multiplexers and satellite connections.
VIEWSTATION MP. The newest ViewStation incorporates the ability to make an
ad-hoc multi-way video call as conveniently as pressing the "conference" button
on any office PBX phone. The ViewStation MP can make up to a 4 way call at
single ISDN line rates of 128KBps or a three way call using 2 ISDN lines for
each of 256Kbps. The ViewStation MP has a U.S. list price of $11,999.
The ViewStation product family delivers the most powerful
videoconferencing group systems in a convenient footprint about the size of a
sheet of notebook paper. The ViewStation delivers high-quality images on small
or large display monitors and is a completely self-contained unit that sits atop
an S-Video or composite television monitor. The ViewStation is one of the first
systems to implement the H.263 video compression algorithm that delivers
enhanced video performance. Using a unique, high-performance low-delay codec
architecture, the ViewStation has a short delay and is fully interoperable with
legacy videoconferencing systems using the H.320 standard. In addition, the
H.323 software upgrade will be available in Q2 1999 providing full IP
videoconferencing. ViewStation supports full dual monitor functionality as a
standard feature, as well as VCR playback/record and a document or second room
camera. ViewStation also supports high resolution Annex D slide send and
receive.
Integrating Polycom's market-leading Acoustic Clarity Technology-TM-,
the ViewStation provides full-duplex, digital audio with noise suppression and
echo cancellation which adapts almost instantly to the changing characteristics
of the conference room to deliver crystal-clear audio. In addition, the
ViewStation supports the G.711, G.722 and G.728 audio standards. The custom
digital tabletop microphone pod uses the latest hypercardioid microphone
technology and is able to be daisy-chained to provide superb audio coverage for
even the largest conference rooms. The ViewStation also includes, as a standard
feature, a telephone connection for audio only additions to a videoconference.
Polycom's future growth is substantially dependent on net revenues
generated from sales of the ViewStation product line. There can be no assurance
that future versions of the ViewStation will be successful or that the market
for Polycom's videoconferencing products will achieve and sustain broad
commercial acceptance. Also, since this product was originally developed by
ViaVideo, the success of the integration of this company into Polycom will have
an impact on the success of the future releases of this product. There can be no
assurance that the integration will be successful. Failure of the launch and
manufacturing ramp of the ViewStation products or failure to successfully
integrate ViaVideo into Polycom would have a material adverse effect on
Polycom's business, financial condition and results of operations.
Multipoint Conferencing
- -----------------------
Polycom's multipoint conferencing product is designed to assist in
bridging multiple points on one videoconference call.
MEETINGSITE 5000. The MeetingSite 5000 product, a Multipoint Conferencing Unit
(MCU) product, is a Lucent Technologies manufactured H.320-based voice, data and
video conferencing bridge that allows up to 16 users to have worldwide,
multi-party face-to-face conferences. The MCU includes industry-leading features
such as Continuous Presence PLUS, a capability that shows multiple sites on the
same screen, and SPEEDMATCHING, which allows endpoints transporting video at
different rates of speed to carry on a video conference. The MCU supports the
emerging H.263 video standard and incorporates the H.320 Translator, allowing
H.263 endpoints to maintain their improved quality while communicating with
endpoints using the existing H.261 standard. The MCU is used by major service
providers, government organizations and commercial customers throughout the
world. It won NETWORK WORLD'S 1997 Blue Ribbon
8
for "providing the best features for network managers, conference operators
and end users." This product is custom configured for the end-user and starts
at $24,950.
TECHNOLOGY
Polycom intends to continue to invest in and leverage its core
technologies to develop and market its single-and multimedia conferencing
products and product enhancements. Polycom's core technologies include the
following:
NETWORK/INTERNET CONNECTIVITY. Polycom is actively extending its
teleconferencing products to operate over local and extended networks utilizing
standard protocols, including H.323, Ethernet LAN and TCP/IP Within the next
several years, industry analysts believe that a significant percentage of
high-quality business-oriented teleconferences will take place over
packet-switched rather than circuit-switched networks (i.e. intranets vs. the
public telephone networks). Some of the advantages of the new approach are
greater bandwidth availability, which allows for better audio and video quality,
lower transmission costs, and the ability to install and manage one network for
audio, video, and data rather than utilizing separate networks.
WEB-BASED DATA CONFERENCING. Polycom has become a leader in developing "push"
technology for sending HTML pages to Java-enabled Web browsers on demand,
allowing the secure participation of multiple sites in presentations and data
conferences. Polycom uses proprietary techniques to assure meeting security and
to provide for smooth presentation flow that is normally unaffected by limited
network bandwidth.
VIDEO COMPRESSION. Polycom continues to develop its team of video processing
experts experienced in writing, porting, and optimizing standards-based video
algorithms for use in video conferencing systems. While Polycom's systems
implement standards-based algorithms, Polycom has developed a set of compatible
but proprietary pre- and post-processing techniques that can yield a
substantially better picture than those of competitors. Polycom believes its
intellectual property in advanced video compression techniques is among the best
in the industry.
WEB-BASED CONFERENCE MANAGEMENT. Polycom has created a versatile means of
meeting and device coordination and management via integrated network control.
This can improve the reliability and accessibility of the systems, and is
especially useful to corporate users and IT organizations.
SYSTEM ARCHITECTURE. Polycom's proprietary new flexible ViewStation system
architecture allows for a wide range of very high performance but low cost
videoconferencing products. This architecture is a non-PC based embedded system
utilizing the TM-1000 series of digital processors from Philips Semiconductors.
The proprietary application-specific software developed for Polycom's systems
addresses the unique requirements of the various end-user conferencing markets
as well as international video telephony standards.
MULTIMEDIA TELECONFERENCING. Polycom has developed a series of algorithms and
techniques to integrate video from multiple sources with electronic and physical
documents and wideband and narrowband audio to support efficient conferences
from multiple sites. These methods include coordinated activities between the
ViewStation and WebStation products, allowing a conference to draw on the best
of both products in a single meeting setup.
SOFTWARE DEVELOPMENT STRATEGIES. By performing most of its software development,
including detailed video processing, in high-level language environments,
Polycom believes that it is able to develop new systems, new refinements,
achieve enhancements in picture quality and audio quality, address new
standards, and add significant user features with an agility that is unusual in
the video conferencing industry.
DIGITAL ACOUSTIC PROCESSING. Traditional speakerphone architectures employ
simple back-and-forth switching to compensate for the feedback that often occurs
when microphones and speakers are located in close proximity. This can cause
numerous problems during the course of a natural conversation, such as words or
phrases being clipped off because both ends of the call were speaking
simultaneously. Polycom has developed an arsenal of patented and proprietary
techniques and algorithms in its DSP software, which solve these problems by
creating accurate simulations of how the sound waves reflect off the walls and
obstructions in a room and using these simulations to digitally extract the
feedback before it becomes a problem.
9
By doing this, the instrument can allow both sides to talk at the same time,
restoring much of the "natural" feel to group telephone conferences.
ACOUSTICS TECHNOLOGY. The design and interaction of transducers within a
full-duplex audio device significantly impacts the effectiveness of the digital
echo canceling systems and the resulting sound quality. Working with carefully
designed algorithms and electronics, Polycom develops and designs proprietary
speaker and microphone enclosure systems that are a critical part of
high-clarity audioconferencing systems.
IMAGE PROCESSING TECHNOLOGY. Polycom has made a strong investment in the design
and implementation of imaging systems for both real-time motion video and for
high-resolution documents. XGA (768 x 1024) resolution imaging, which can show
an entire typewritten page of 10-point type, was achieved by developing a method
in which a pair of television-resolution charge coupled devices ("CCDs") are
merged to form a single high resolution image. Significant advancements in high
speed signal processing software to compensate for lens blurring, non-uniform
lighting conditions, color mixing, and natural CCD device variations were
required to achieve the target.
IMAGE COMPRESSION TECHNOLOGY. Polycom uses the standard known as JPEG (Joint
Photographic Experts Group) to compress and decompress high resolution color
images. The JPEG compressor uses progressive JPEG to minimize the transmission
time of an end-user visible image. The compressor has been tuned to work well
with complex images as well as making textual images look razor-sharp. Polycom
also uses the international standard known as Joint Bi-Level Image Group
("JBIG") to achieve rapid image transmission rates. Polycom employs certain
modes of this algorithm to enable images to be transmitted incrementally,
allowing an image to achieve legibility within a minimum time. Polycom was the
editor of, and principal contributor to, the T.126 layer of the T.120 protocol
for still-image transfer that incorporated JBIG and optimizations utilized in
ShowStation. Polycom developed a high performance implementation of this
algorithm for incorporation into DataBeam's standard T.120 toolkit to enable
throughput to be achieved even if a low-end computer is used to compress and
send images over standard telephone lines. DataBeam's T.120 toolkit has been
licensed by numerous other software and hardware providers.
COMMUNICATION STANDARDS. In addition to using existing communication and
processing standards, Polycom has been a leader in the development and adoption
of the T.120 protocol standard for dataconferencing devices. Layers of T.120
functionality are being developed and deployed by numerous major international
communications companies.
TRADE ORGANIZATIONS. In conjunction with the T.120 standardization process,
Polycom co-founded the Consortium for Audiographic Teleconferencing Standards in
order to encourage broad industry coordination and advocacy of T.120 technology,
thereby encouraging the development of the availability of desktop software and
bridging services to support Polycom's product offerings. This organization was
merged with the advocacy body for H.320, the video conferencing standard, to
become the International Multimedia Teleconferencing Consortium ("IMTC"), with
the broader goal of insuring industry-wide H.320 and T.120 interoperability,
integration and advocacy. Additionally, the Personal Conferencing Work Group
("PCWG") recently merged into the IMTC. A representative of Polycom sits on the
board of directors of this consortium, which includes companies such as AT&T,
IBM, Intel, Microsoft and PictureTel, each of which has incorporated, or
announced its intention to incorporate, various layers of the T.120 standard
into their products.
TELECOM AND DATA INTERFACES. Polycom has been aggressive in the development of
proprietary interfaces (e.g., Lucent, Northern Telecom, Intel) for faster
acceptance into some markets. Polycom has also developed a variety of telephony
interfaces, both single-function and multi-function, to facilitate the
accelerated development of its products for different markets and different
countries.
In addition to its proprietary technologies, Polycom also licenses some source
code from various suppliers to deliver certain standard features and
capabilities, such as compliance with various videoconferencing and
teleconferencing standards.
SALES AND DISTRIBUTION
Polycom markets its products primarily to businesses and organizations
of all sizes through channel networks and its direct sales organizations.
Polycom also markets its products directly to certain U.S. government
organizations through a
10
General Services Administration ("GSA") contract. Polycom sells its products
in through a group of approximately 175 resellers, including Lucent
Technologies, MCI Worldcom, 3M, Southwestern Bell, Ameritech, Nortel,
BellSouth, Ingram Micro, British Telecom, Siemens, Sprint, SKC, GBH, Frontier
Confertech, All Communications, Viewtech, Unitel, Hibino, and Hello Direct.
Many of these resellers sell a variety of conferencing products and/or
services and, with Polycom's products, offer a complete conferencing product
portfolio. One of these resellers, Hello Direct, sells a competing
audioconferencing product that it purchases from Gentner and relabels under
the Hello Direct name. In addition to working through resellers, Polycom also
sells its audio and data products directly through its internal sales force
and through a national account group. The national account managers focus on
strategic selling and the development of major account relationships, while
internal sales representatives devote time to pursuing the sales
opportunities within a signed national account. In order to minimize channel
conflict with resellers, the national account managers are compensated on a
channel-neutral basis and are responsible for resolving any channel conflict
in the field. As of December 31, 1998, Polycom had approximately 356 signed
national accounts. Polycom believes that it is important to maintain a close
working relationship with these large customers in order to meet their
demands for sales and support on a multinational basis. To complement its
sales efforts, Polycom advertises its products in trade and general business
print media as well as participating in a wide array of trade shows and
public relations activities. Polycom currently maintains North American sales
offices in the metropolitan areas of Atlanta, Boston, Bridgeport, Chicago,
Dallas, Denver, Los Angeles, New York, Phoenix, San Francisco, San Jose and
Washington, D.C..
Polycom has historically focused its international sales efforts in
regions of the world where it believes customers have begun to invest
significantly in conferencing equipment and services. These regions currently
include the United Kingdom, France, Germany, Italy, Japan, Australia and parts
of Southeast Asia. Polycom intends to significantly expand its international
distribution network. The principal international resellers of Polycom's
products currently include British Telecom, Unitel, Genedis, Eurodis Onboard,
Hibino Corporation, PTT Telecom, Siemens, CHS Latin America, Adcom and Telenor.
Additionally, in 1999, Polycom will be making additional investments in the
Europe, Middle East and Africa region in order to realize expected growth in
this region. If Polycom is not successful in expanding its resources to this
region or if the growth in this region does not materialize, it could have a
material adverse affect on Polycom's business, financial condition or results of
operations.
Polycom's net revenues from international sales represented
approximately 24%, 23% and 23% of Polycom's total net revenues in the years
ended December 31, 1998, 1997 and 1996, respectively. In 1998, volume increases
in all international regions, primarily Europe, contributed to the increase in
the international percentage. In 1997, price reductions and the $3.0 million in
domestic revenue associated with the First 3M Agreement offset unit growth in
the Company's international business. Polycom is currently investing more
resources in the Europe, Middle East and Africa region to decentralize the
marketing and administrative functions for this area. This will increase the
expenses associated with this region. Polycom has established product
distribution centers in the European and Asian markets in order to better serve
its international customers, which will increase the costs associated with such
international operations. International sales are subject to a number of risks,
including changes in foreign government regulations and telecommunications
standards, export license requirements, tariffs and taxes, other trade barriers,
fluctuations in currency exchange rates, difficulty in collecting accounts
receivable, difficulty in staffing and managing foreign operations and political
and economic instability. Sales to international resellers are usually made in
U.S. dollars in order to minimize the risks associated with fluctuating foreign
currency exchange rates. To date, a substantial majority of Polycom's
international sales have been denominated in U.S. currency, however, Polycom
expects that in the future more international sales may be denominated in local
currencies. Declines in currency exchange rates, as happened in the Asian market
in late 1997, could cause Polycom's products to become relatively more expensive
to customers in a particular country, leading to a reduction in sales or
profitability in that country. Also, current economic conditions in Asia and
Latin America may generally reduce demand for the Company's products, which
would have a material adverse effect on Polycom's business, financial condition
and results of operation. In addition, the costs associated with developing
international sales may not be offset by increased sales in the short term, or
at all. Further, Polycom has sales offices in the U. K., Germany, Finland, Hong
Kong and Singapore.
Polycom sells its products primarily through resellers. Polycom's
resellers accounted for approximately 74%, 64% and 67% of Polycom's net revenues
in 1998, 1997 and 1996, respectively. Lucent Technologies accounted for 11% and
10% of net revenues in 1998 and 1997, respectively. No other customer or
reseller accounted for more than 10% of Polycom's net revenues during the
periods. Resellers generally offer products of several different companies,
including
11
products that compete with Polycom's products. Accordingly, these resellers
may give higher priority to products of other suppliers, thus reducing their
efforts to sell Polycom's products. Agreements with resellers may be
terminated at any time. A reduction in sales effort or termination of a
distribution relationship by one or more of Polycom's resellers could have a
material adverse effect on future operating results. Use of resellers also
entails the risk that resellers will build up inventories in anticipation of
a growth in sales. If such sales growth does not occur as anticipated by
these resellers, these resellers may substantially decrease the amount of
product ordered in subsequent quarters, causing or contributing to
fluctuations in Polycom's future operating results. Furthermore, although
Polycom takes steps to reduce channel conflict, sales by Polycom's direct
sales force to potential and current customers of these resellers could have
an adverse effect on Polycom's reseller relationships. The conferencing
distribution industry has historically been characterized by rapid change,
including consolidations and financial difficulties of certain resellers and
the emergence of alternative distribution channels. In addition, there is an
increasing number of companies competing for access to these channels. The
loss or ineffectiveness of any of Polycom's major resellers could have a
material adverse effect on Polycom's operating results. There can be no
assurance that Polycom will be able to successfully sell its products through
any new channels that Polycom may be required to develop as a result of the
foregoing or any other factors. Polycom has signed numerous distribution
agreements with distributors of dataconferencing and videoconferencing
products. Polycom entered into distribution agreements with 3M in March, 1997
and June 1997, and such agreements have certain exclusivity provisions and
minimum purchase requirements. The Company's results of operations with
respect to its videoconferencing products will be dependent on the success of
3M as a reseller of such products. There can be no assurance that Polycom or
3M will be able to successfully develop a distribution network for its
ViewStation products and if no such distribution networks are developed it
would have a material adverse effect on Polycom's business, financial
condition and results of operations.
CUSTOMER SERVICE AND SUPPORT
Polycom believes that service and support are critical components of
customer satisfaction. Polycom maintains and supports products sold directly by
Polycom to its North American customers, while resellers maintain and provide
technical support to their end-user customers. Polycom operates a toll-free
Technical Service Center "hotline" to provide a full range of telephone support
to its North American resellers and to Polycom's end-user customers. If an issue
cannot be resolved remotely or through product repair and return, Polycom or its
reseller may dispatch a service engineer to the customer site. Internationally,
customer service is provided to the end-user by either Polycom or local
resellers. In 1998, Polycom contracted with Wang Global, a leading worldwide
network and desktop integration and services and solutions company, to provide
on-site technical support and installation services for Polycom's data, video
and MCU product lines.
Polycom generally warrants its products for 12 months and offers
24-month dataconferencing and 60-month audioconferencing warranties to national
accounts and federal government customers. As of December 31, 1998, Polycom's
warranty expense has not been significant; however, due to uncertainties
concerning the service and support requirements of the ShowStation IP,
WebStation, ViewStation and MCU products, Polycom may experience higher warranty
claims in the future. Polycom offers a variety of installation, maintenance and
extended warranty services that are fulfilled either directly by Polycom or by
an authorized reseller.
RESEARCH AND DEVELOPMENT
Polycom believes that its future success depends in part on its ability
to continue to enhance its existing products and to develop new products that
maintain technological competitiveness. Polycom's current development efforts
are focused on each of the audioconferencing, dataconferencing and
videoconferencing businesses. In the audioconferencing market, Polycom is
developing SoundStation and SoundStation Premier product line extensions in the
higher and the lower end of the market. In the dataconferencing market, Polycom
is devoting resources to enhancing its ShowStation and WebStation products. In
the videoconferencing market, Polycom's ViewStation product line is being
enhanced to provide an even broader array of product offerings. In general,
Polycom is focusing many of its efforts on product versions that can best
exploit the shift in the communications infrastructure to the IP network.
Polycom intends to expand upon these new product platforms through the
development of options, upgrades and future product generations. There can be no
assurance, however, that these products will be made commercially available as
expected or otherwise on a timely and cost-effective basis or that, if
introduced, these products will achieve market acceptance.
12
Furthermore, there can be no assurance that these products will not be
rendered obsolete by changing technology or new product announcements by
other companies.
Polycom believes that the structure of its development group,
particularly its software development core, represents a significant competitive
advantage for Polycom. Polycom's product development staff includes product
marketing personnel, in order to maintain channel and customer input throughout
the development process. This team structure is the basis for an integrated
process designed to enable Polycom to develop superior products with minimum
time-to-market. Additionally, the development staff focuses on Polycom's core
technologies and outsources other development tasks such as industrial design.
This structure is designed to enable Polycom to devote its key resources to
technological advancement in its primary areas of business.
Research and development expenses were approximately $13.9 million,
$16.6 million and $7.9 million for the years ended 1998, 1997 and 1996,
respectively. Polycom believes that significant investments in research and
development are required to remain competitive since technological
competitiveness is key to its future success. As a consequence, Polycom intends
to continue to make substantial investments in product and technology
development. Polycom also intends to continue to drive the adoption of various
teleconferencing industry standards which are incorporated in to its products.
The audioconferencing, dataconferencing and videoconferencing markets
are subject to rapid technological change, frequent new product introductions
and enhancements, changes in end-user requirements and evolving industry
standards. Polycom's ability to remain competitive in this market will depend in
significant part upon its ability to successfully develop, introduce and sell
new products and enhancements on a timely and cost-effective basis. The success
of Polycom in developing new and enhanced products depends upon a variety of
factors, including new product selection, timely and efficient completion of
product design, timely and efficient implementation of manufacturing, assembly
and test processes, product performance at customer locations and development of
competitive products and enhancements by competitors. Polycom is currently
engaged in the development of several new products and extensions of the
SoundStation, SoundStation Premier, SoundPoint, ShowStation IP, WebStation and
ViewStation product families, and expects to continue to invest significant
resources in new product development and enhancements to current and future
products. In addition, Polycom's introduction of its new products could result
in higher warranty claims, product returns and manufacturing, sales and
marketing and other expenses that could materially adversely affect Polycom's
business, financial condition or results of operations. There can be no
assurance that Polycom will be successful in selecting, developing,
manufacturing and marketing, or recognize a return on new products or
enhancements. The inability of Polycom to introduce new products or enhancements
on a timely and cost-effective basis that contribute significantly to net
revenues would have a material adverse effect on Polycom's business, financial
condition and results of operations. In the past, Polycom has experienced delays
from time to time in the introduction of certain of its products. For example,
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 six 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, new product or technology introductions by Polycom's
competitors could cause a decline in sales or loss of market acceptance of
Polycom's existing products or new products. Further, from time to time, Polycom
may announce new products, capabilities or technologies that have the potential
to replace Polycom's existing products or future products. There can be no
assurance that announcements of product enhancements or new product offerings by
Polycom or its competitors will not cause customers to defer or stop purchasing
Polycom's products.
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 and may also provide shared technology
resources for the development of future products. Polycom recorded the $3.0
million as revenue, $1.0 million in each of the first three quarters of 1997,
based on delivery of the items specified in this contract. The amounts were
recognized as revenue using the percentage of completion methodology.
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. 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
13
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 12, 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. 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.
COMPETITION
The market for conferencing products is highly competitive and subject
to rapid technological change, regulatory developments and emerging industry
standards. Polycom expects competition to persist and increase in the future. At
the current time, Polycom is the market leader and reputed for its product
quality, breadth of product line, and ease of use. In the audioconferencing
market segment, Polycom's major competitors include ClearOne, SoundGear, NEC,
Gentner and other companies that offer lower cost full duplex speakerphones such
as Lucent Technologies (one of Polycom's resellers) and Hello Direct (one of
Polycom's resellers). Hello Direct offers a competitive product under the Hello
Direct name through an OEM relationship with Gentner. Most of these companies
have substantially greater financial resources and production, marketing,
engineering and other capabilities than Polycom with which to develop,
manufacture, market and sell their products. In addition, all major telephony
manufacturers produce hands-free speakerphone units that are a lower cost, lower
quality alternative to Polycom's audioconferencing products.
In the dataconferencing market, Polycom's major competitors include
Microfield Graphics, Inc. and SMART Technologies, Inc. In addition, in this
market segment, PC-based communications solutions and multimedia presentation
products may be an alternative for certain applications. Also, several LCD
projector products are available from manufacturers such as In Focus Systems,
Inc., Proxima Corporation, and 3M. These products have local projection only
capabilities but may compete for basic functionality and budget dollars. 3M is
an OEM distributor for Polycom for its ShowStation IP, ViewStation and
SoundStation product lines.
In the videoconferencing market, Polycom's major competitors include
PictureTel, which dominates the group videoconferencing market from a revenue
perspective, VTEL, VCON, Intel, Sony, NEC, Tandberg, Mitsubishi, Panasonic,
Fujitsu, British Telecom, General Plesey Telecommunications and Vista
Communications Instruments. Many of these companies have substantially greater
financial resources and production, marketing, engineering and other
capabilities than Polycom with which to develop, manufacture, market and sell
their products. In addition, with advances in telecommunications standards,
connectivity, and video processing technology and the increasing market
acceptance of videoconferencing, other established or new companies may develop
or market products competitive with Polycom's videoconferencing products.
Polycom believes its ability to compete depends on such factors as
reputation, quality, customer support and service, price, features and functions
of products, ease of use, reliability, and marketing and distribution channels.
Polycom believes it competes favorably with respect to each of these factors.
However, there can be no assurance that Polycom will be able to compete
successfully in the future with respect to any of the above factors.
Polycom expects its competitors to continue to improve the performance
of their current products and to introduce new products or new technologies that
provide improved performance characteristics. New product introductions by
Polycom's competitors could cause a significant decline in sales or loss of
market acceptance of Polycom's existing products and future products. For
example, 3Com/U.S. Robotics, a former competitor, introduced an
audioconferencing product that was sold at a price substantially lower than
Polycom's list price for SoundStation. Polycom believes that the possible
effects from ongoing competition may be the reduction in the prices of its
products
14
and its other competitors' products or the introduction of additional lower
priced competitive products. Although such reduction was not in direct
response to the introduction of a lower priced audioconferencing product by
3Com/U. S. Robotics, Polycom reduced the North American list price of its
SoundStation product line by 37% in January 1997 and the International price
by 30% effective April 1997, which resulted in significantly lower gross
margins. Polycom expects this increased competitive pressure may lead to
intensified price-based competition, resulting in lower prices and gross
margins which would materially adversely affect Polycom's business, financial
condition and results of operations. There can be no assurance that Polycom
will be able to compete successfully.
MANUFACTURING
Polycom's manufacturing operations consist primarily of materials
planning and procurement, test development and manufacturing engineering.
Polycom subcontracts the manufacture of its audioconferencing and
videoconferencing 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.
Celestica is ISO 9002 approved and has British Approvals Board for
Telecommunications ("BABT") registration. Polycom's products are quality tested
by automated test equipment with final functional tests performed on equipment
and with processes developed or approved by Polycom. Polycom manufactures its
SoundPoint product through General Electronics (H.K.) Ltd., a Hong Kong based
contract manufacturer. Polycom uses Solectron's San Jose, California facility to
manufacture its ShowStation IP products and is in the process of finalizing
negotiations with a contract manufacturer for its WebStation product. Lastly,
Polycom's MCU product line is an OEM version of the Lucent Technologies
multipoint conferencing product. This product is manufactured by Lucent
Technologies in Denver, Colorado.
Polycom is located in the San Francisco Bay Area, which has in the past
and may in the future experience significant, destructive seismic activity that
could damage, destroy or disrupt Polycom's facilities or its operations. Polycom
maintains no earthquake insurance for damages or business interruptions. In the
event that Polycom or its contract manufacturers were to experience financial or
operational difficulties that are not covered by insurance, it would adversely
affect Polycom's results of operations until Polycom could establish sufficient
manufacturing supply through an alternative source, and the effect of such
reduction or interruption in supply on results of operations would be material.
Polycom believes that there are a number of alternative contract manufacturers
that could produce Polycom's products, but in the event of a reduction or
interruption of supply, for any reason, it would take a significant period of
time to qualify an alternative subcontractor and commence manufacturing, which
would have a material adverse effect on Polycom's business, financial condition
and results of operations. Also, the Company is working toward solutions to the
Company's information systems year 2000 problems. Failure to successfully
resolve these problems could have an adverse affect on Polycom's business,
financial condition or results of operations. See "Year 2000" discussion under
Management's Discussion and Analysis of Financial Condition and Results of
Operations.
Certain key components used in Polycom's products are currently
available from only one source and others are available from only a limited
number of sources. Components currently available from only one source include
certain key integrated circuits and optical elements. Polycom also obtains
certain plastic housings, metal castings and other components from suppliers
located in Hong Kong and China, and any political or economic instability in
that region in the future, or future import restrictions, may cause delays or an
inability to obtain such supplies. Polycom has no supply commitments from its
suppliers and generally purchases components on a purchase order basis either
directly or through its contract manufacturers. Polycom and Polycom's contract
manufacturers have had limited experience purchasing volume supplies of
components for its audioconferencing, dataconferencing and videoconferencing
product lines and some of the components included in these products, such as
microprocessors and other integrated circuits, have from time to time been
subject to limited allocations by suppliers, and there can be no assurance that
Polycom will not in the future be subject to component supply allocations that
would adversely affect Polycom's operating results. In the event that Polycom or
its contract manufacturers were unable to obtain sufficient supplies of
components or develop alternative sources as needed, Polycom's operating results
could be materially adversely affected. Moreover, operating results could be
materially adversely affected by receipt of a significant number of defective
components, an increase in component prices or the inability of Polycom to
obtain lower component prices in response to competitive price reductions.
Additionally, Polycom's videoconferencing products are designed based on certain
integrated circuits
15
produced by Philips and certain video equipment produced by Sony. If Polycom
could no longer obtain such integrated circuits or video equipment, Polycom
would incur substantial expense and take substantial time in redesigning its
products to be compatible with components from other manufacturers which
would have a material adverse impact on the profitability of the Company.
Additionally, both Sony and Philips are competitors of Polycom in the
videoconferencing market, which may adversely affect Polycom's ability to
obtain necessary components. Failure to obtain adequate supplies could
prevent or delay product shipments, which could materially and adversely
affect Polycom's business, financial condition or results of operations.
INTELLECTUAL PROPERTY AND OTHER PROPRIETARY RIGHTS
While Polycom relies on a combination of patent, copyright, trademark
and trade secret laws and confidentiality procedures to protect its proprietary
rights, Polycom believes that factors such as technological and creative skills
of its personnel, new product developments, frequent product enhancements, name
recognition and reliable product maintenance are more essential to establishing
and maintaining a technology leadership position. Polycom currently has eleven
United States patents issued covering the SoundStation, ShowStation and
ViewStation designs; the concept and function of the ShowStation; and certain
echo cancellation technology that expire in 2007, 2010, 2011, 2012, 2013 and
2015. In addition, Polycom currently has twelve United States patents pending;
nineteen foreign patents issued, which expire in 2001, 2002, 2003, 2007, 2008,
2010, 2012, 2013, 2016, 2017, 2021 and 2022; and twenty foreign patent
applications pending. Polycom, Polyspan, SoundStation Premier, ShowStation,
SoundPoint, SoundStation and Polycom logos are registered trademarks of Polycom,
and ViewStation, ViaVideo Communications, SoundStation Premier Satellite and
Clarity by Polycom are trademarks of Polycom, in the U.S. and various countries.
According to federal and state law, Polycom's trademark protection will continue
for as long as Polycom continues to use its trademarks in connection with the
products and services of Polycom. Polycom seeks to protect its software,
documentation and other written materials under trade secret and copyright laws,
which only afford limited protection. There can be no assurance that others will
not independently develop similar proprietary information and techniques or gain
access to Polycom's intellectual property rights or disclose such technology or
that Polycom can meaningfully protect its intellectual property rights. In
addition, there can be no assurance that any patent or registered trademark
owned by Polycom will not be invalidated, circumvented or challenged, that the
rights granted thereunder will provide competitive advantages to Polycom or that
any of Polycom's pending or future patent applications will be issued with the
scope of the claims sought by Polycom, if at all. Furthermore, there can be no
assurance that others will not develop similar products, duplicate Polycom's
products or design around the patents owned by Polycom. In addition, there can
be no assurance that foreign intellectual property laws will protect Polycom's
intellectual property rights.
Litigation may be necessary to enforce Polycom's patents and other
intellectual property rights, to protect Polycom's trade secrets, to determine
the validity of and scope of the proprietary rights of others, or to defend
against claims of infringement or invalidity. Such litigation could result in
substantial costs and diversion of resources and could have a material adverse
effect on Polycom's business, financial condition or results of operations.
There can be no assurance that infringement or invalidity claims by third
parties or claims for indemnification resulting from infringement claims will
not be asserted in the future or that such assertions, if proven to be true,
will not materially adversely affect Polycom's business, financial condition and
results of operations. If any claims or actions are asserted against Polycom,
Polycom may seek to obtain a license under a third party's intellectual property
rights. There can be no assurance, however, that a license will be available
under reasonable terms or at all. In addition, Polycom could decide to litigate
such claims, which could be extremely expensive and time consuming and could
materially adversely affect Polycom's business, financial condition or results
of operations.
ViaVideo is involved in a lawsuit alleging breach of contract, breach
of confidential relationship, misappropriation of trade secrets and other
related allegations. ViaVideo and Polycom will vigorously defend against these
claims and any related claims for damages. While litigation is inherently
uncertain, ViaVideo and Polycom believe that the ultimate resolution of these
matters beyond that provided in the consolidated balance sheet at December 31,
1998 of Polycom will not have a material adverse effect on the Company's
financial position.
Additionally, from time to time the Company is subject to a variety of
disputes or litigation in the normal course of business including suits related
to intellectual property, contract law, personal injury and employee relations.
In the
16
opinion of management, matters in which the Company is currently involved, in
the aggregate, should not have a material adverse effect on the Company's
financial statements.
DEPENDENCE ON THIRD-PARTY LICENSES
Polycom incorporates into its ShowStation products software licensed
from third parties, including certain communications software which is licensed
from DataBeam Corporation ("Databeam"), digitizer and pen software which is
licensed from Scriptel Corporation ("Scriptel") and Windows software from
Microsoft Corporation ("Microsoft"). The DataBeam license agreement will
terminate in March 2001 if either party has given notice at least 90 days prior
to that time of its desire to terminate the agreement. Polycom also has
licensing agreements with various suppliers for software incorporated into its
ViewStation products. For example, Polycom licenses certain video communications
source code from RADVision, Omnitel, Adtran and EBSNet, Inc.; certain video
algorithm protocols from REAL Networks and VideoServer; development source code
from Digital Equipment Corporation and Philips Semiconductor; camera tracking
technology from Brown University; and audio algorithms from Lucent Technologies.
There can be no assurance that these third-party software licenses will continue
to be available to Polycom on commercially reasonable terms, if at all. The
termination or impairment of these software licenses could result in delays or
reductions in new product introductions or product shipments until equivalent
software could be developed, licensed and integrated, which would materially
adversely affect Polycom's business, financial condition or results of
operations.
EMPLOYEES
As of December 31, 1998, Polycom employed a total of 243 persons,
including 93 in sales, marketing and customer support, 69 in product
development, 35 in manufacturing and 46 in finance and administration. Of these,
ten employees were located in the U.K., three were located in Singapore, three
were located in China and the remainder were located in the United States. None
of Polycom's employees is represented by a labor union. Polycom has experienced
no work stoppages and believes its relationship with its employees is good.
Polycom believes that its future success will depend in part on its
continued ability to hire, assimilate and retain qualified personnel.
Competition for such personnel is intense, and there can be no assurance that
Polycom will be successful in attracting or retaining such personnel. The loss
of any key employee, the failure of any key employee to perform in his or her
current position or Polycom's inability to attract and retain skilled employees,
as needed, could materially adversely affect Polycom's business, financial
condition or results of operations. Continued development and commercialization
of Polycom's videoconferencing products also depends substantially upon the
continued efforts of its engineering and marketing personnel, and there can be
no assurance that such individuals will continue to remain employed by Polycom.
The loss of the services of any executive officer or other key technical or
management personnel involved with Polycom's videoconferencing products for any
reason could have a material adverse effect on the business, financial condition
or results of operations of Polycom.
ITEM 2. PROPERTIES
Polycom's headquarters are located in a 52,000 square foot facility in
San Jose, California pursuant to a lease which expires in December 1999. This
facility accommodates corporate administration, research and development,
marketing, sales and customer support. Polycom's videoconferencing engineering
and marketing operations are located in a 23,000 square foot facility in Austin,
Texas pursuant to a sublease which expires in December 1999. The Company also
leases 19,890 square feet of a building in Livermore, California which is used
as the Company's North American and Latin American distribution center and
repair center. This lease expires on May 31, 2000. In addition, the Company
utilizes space at its manufacturing contractor in Thailand and its United
Kingdom distribution contractor in the United Kingdom to provide an Asian and
European distribution and repair center, respectively. Further, Polycom leases,
on a short-term basis, sales office space in the metropolitan areas of Chicago
(Illinois), Oxnard (California), the U. K., Germany, Finland, Hong Kong and
Singapore. Polycom believes that its current facilities are adequate to meet its
needs for the foreseeable future. Polycom believes that suitable additional or
alternative space will be available in the future on commercially reasonable
terms as needed.
17
ITEM 3. 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
December 31, 1998, will not have a material adverse effect on the Company's
financial position.
On October 2, 1997, Datapoint Corporation filed a complaint against
Intel Corporation for infringement of two U.S. patents related to
videoconferencing network technology in the U.S. District Court in Dallas,
Texas. On November 25, 1997, the complaint was amended to include several
additional defendants, and Datapoint also filed a motion for certification of
the action as a class action. No ruling occurred relative to the motion for
class action certification. Although neither Polycom nor its subsidiary ViaVideo
had been served as a defendant in any Datapoint complaints, both Polycom and
ViaVideo were named as putative class members in the Datapoint motion for class
action certification along with over 500 other companies. During the third
quarter of 1998, the Company was notified that this case was dismissed by
stipulation and an order entered by the court to that effect.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not Applicable.
18
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK
PRICE RANGE OF COMMON STOCK
The Company's Common Stock is quoted on the Nasdaq National Market
("Nasdaq") under the symbol "PLCM." Prior to its initial public offering on
April 29, 1996, there was no public market for the Company's Common Stock.
The following table sets forth the high and low sales prices for the Common
Stock as reported by Nasdaq for the periods indicated. These prices do not
include retail mark-ups, markdowns or commissions.
HIGH LOW
---- ---
FISCAL YEAR 1997
First Quarter 5 11/16 3 1/2
Second Quarter 5 3/8 2 3/4
Third Quarter 5 7/8 4 3/8
Fourth Quarter 6 5/8 4 7/8
FISCAL YEAR 1998
First Quarter 12 1/4 4 3/4
Second Quarter 17 5/8 10 3/8
Third Quarter 18 7 1/16
Fourth Quarter 23 1/8 8 5/8
FISCAL YEAR 1999
First Quarter (through February 26, 1999) 27 1/8 17 7/8
On February 26, 1999, the last sale price reported on the Nasdaq
National Market for the Company's Common Stock was $20.25 per share. As of
such date, there were approximately 315 stockholders of record who held
shares of the Company's Common Stock, as shown on the records of Polycom's
transfer agent for such shares.
DIVIDEND POLICY
The Company has never declared or paid any dividends on its capital
stock and does not intend to pay any dividends in the foreseeable future. The
Company currently intends to retain its earnings, if any, for the growth and
development of its business. Any future determination to pay cash dividends
will be at the discretion of the Company's Board of Directors and will depend
upon the earnings of the Company, its financial condition, capital
requirements and such other factors as the Company's Board of Directors may
deem relevant.
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The following selected consolidated financial data should be read in
conjunction with the Company's audited consolidated financial statements and
related notes thereto and with Management's Discussion and Analysis of
Financial Condition and Results of Operations, which are included elsewhere
in this Form 10-K. The consolidated statement operations data for the years
ended December 31, 1998, 1997 and 1996 and the consolidated balance sheet
data at December 31, 1998 and 1997, are derived from, and are qualified by
reference to, the consolidated financial statements which have been audited
by PricewaterhouseCoopers LLP and are included in this Form 10-K. The
consolidated statement of operations data for the years ended December 31,
1995 and 1994 and the consolidated balance sheet data at December 31, 1996,
1995 and 1994 are derived from audited consolidated financial statements which
have also been audited by PricewaterhouseCoopers LLP.
19
SELECTED CONSOLIDATED FINANCIAL DATA
December 31,
----------------------------------------------------------
(in thousands, except per share data) 1998 1997 1996 1995 1994
- ----------------------------------------------------------------------------------------------------------------
Operating Data:
Net revenues $111,696 $ 46,630 $37,032 $24,944 $15,025
Costs and expenses:
Cost of net revenues 55,054 25,255 17,698 10,859 6,211
Sales and marketing 21,893 13,106 9,095 7,073 5,307
Research and development 13,862 16,560 7,893 6,852 5,527
General and administrative 5,130 6,781 2,198 1,819 1,140
Acquisition costs 185 597 -- -- --
-------- --------- ------- -------- -------
Operating income (loss) 15,572 (15,669) 148 (1,659) (3,160)
Interest, net and other income (expense) 936 1,165 1,086 69 202
-------- --------- ------- -------- -------
Income (loss) before taxes 16,508 (14,504) 1,234 (1,590) (2,958)
Taxes 1,749 171 108 12 5
-------- --------- ------- -------- -------
Net income (loss) $ 14,759 $ (14,675) $ 1,126 $(1,602) $(2,963)
-------- --------- ------- -------- -------
-------- --------- ------- -------- -------
Basic net income (loss) per share $ 0.54 $ (0.73) $ 0.08 $ (0.60) $ (1.25)
Diluted net income (loss) per share $ 0.46 $ (0.73) $ 0.06 $ (0.60) $ (1.25)
Weighted average shares outstanding for basic EPS 27,486 20,169 13,478 2,650 2,371
Weighted average shares outstanding for diluted EPS 32,394 20,169 19,815 2,650 2,371
December 31,
---------------------------------------------------------
(in thousands) 1998 1997 1996 1995 1994
- ----------------------------------------------------------------------------------------------------------------
Consolidated Balance Sheet Data:
Cash, cash equivalents and short-term investments $23,031 $17,670 $21,354 $ 6,261 $ 5,792
Working capital 45,631 21,404 29,524 7,829 5,442
Total assets 76,954 43,529 39,510 18,000 10,778
Notes payable, less current portion -- -- -- 1,178 757
Convertible redeemable preferred stock -- -- -- 22,360 17,380
Convertible preferred stock -- 9,496 1,975 -- --
Total stockholders' equity (deficit) 53,054 26,283 32,861 (12,640) (11,088)
ITEM 7. 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,
SHOWSTATION IP, WEBSTATION, MEETINGSITE AND OTHER NEW PRODUCTS; THE MARKET
ACCEPTANCE OF VIEWSTATION, SHOWSTATION IP, WEBSTATION, SOUNDPOINT PRO,
MEETINGSITE AND OTHER NEW
20
PRODUCTS; THE SUCCESS OF 3M IN ESTABLISHING AND MAINTAINING CHANNELS FOR THE
VIEWSTATION PRODUCT LINE AND SHOWSTATION IP PRODUCTS; SALES OF THE SOUNDPOINT
PRODUCT GIVEN THE INTRODUCTION OF THE SOUNDPOINT PRO; THE ONGOING SUCCESS OF
THE 3M ROYALTY RELATIONSHIP; THE PROFITABILITY OR EVEN POSITIVE GROSS MARGIN
OF THE DATACONFERENCING PRODUCT LINE; DEPENDENCE ON NEW PRODUCTS;
TECHNOLOGICAL CHANGE; UNCERTAINTIES RELATING TO THE INTEGRATION OF OPERATIONS
OF VIAVIDEO COMMUNICATIONS, INC.; EFFECTS OF THE ACQUISITION ON EXISTING
BUSINESS PARTNERSHIPS; DEPENDENCE ON THIRD PARTY DISTRIBUTORS; RISKS
ASSOCIATED WITH INTERNATIONAL OPERATIONS; DEPENDENCE ON RESEARCH AND
DEVELOPMENT; EXISTING AND NEW COMPETITION; DEPENDENCE ON THIRD PARTY
MANUFACTURERS 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 CURRENT REPORT ON
FORMS 8-K FILED WITH THE COMMISSION JANUARY 16, 1998 AND JULY 22, 1998,
QUARTERLY REPORT ON FORMS 10-Q FILED WITH THE COMMISSION MAY 19, 1998 FOR THE
PERIOD ENDED MARCH 31, 1998 AND AUGUST 19, 1998 FOR THE PERIOD ENDED JUNE 30,
1998 AND NOVEMBER 16, 1998 FOR THE PERIOD ENDED SEPTEMBER 30, 1998. 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 December 31, 1998, Polycom's
audioconferencing product line consisted principally of the SoundStation,
SoundStation EX, SoundStation Premier, SoundStation Premier EX, SoundPoint
and SoundPoint Pro. Polycom began shipping its first dataconferencing
product, ShowStation, in November 1995. In March 1998, Polycom began
shipments of its next generation ShowStation, the ShowStation IP. As of
December 31, 1998, Polycom's dataconferencing product line consisted
principally of the ShowStation IP and WebStation. On January 2, 1998, the
Company completed the acquisition of ViaVideo Communications, Inc.,
("ViaVideo"), a development stage company that designed and developed high
quality, low cost, easy-to-use, group videoconferencing systems that utilize
advanced video and audio compression technologies along with
Internet/Web-based features. In February 1998, Polycom began customer
shipments of the ViewStation 128, its first videoconferencing product. As of
December 31, 1998, 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.
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 December 31, 1998, 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
21
1995 and generated net income in fiscal 1996. The Company incurred a
quarterly operating loss in each quarter of 1997 as a result of investments
in the next generation dataconferencing product, the videoconferencing
product line and the sales and marketing function. The Company intends to
continue to invest significantly in research and development, 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 and may also provide shared
technology resources for the development of future products. Polycom recorded
the $3.0 million as revenue, $1.0 million in each of the first three quarters
of 1997, based on delivery of the items specified in this contract. The
amounts were recognized as revenue using the percentage of completion
methodology. 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.
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 12, 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. In the three months ended March 31, 1998 and the
three months ended June 30, 1998, the Company received, and recognized as
revenue, $1.5 million and $1.0 million, respectively, under this agreement,
using the percentage of completion methodology.
On July 21, 1998, the Company announced that Robert C. Hagerty,
previously Polycom's president and COO, was appointed the role of president
and CEO. Brian L. Hinman, formerly chairman and CEO, continues as Chairman of
the Board of Directors.
22
RESULTS OF OPERATIONS FOR THE THREE YEARS ENDED DECEMBER 31, 1998
The following table sets forth, as a percentage of net revenues,
consolidated statement of operations data for the periods indicated.
Years Ended December 31,
----------------------------
1998 1997 1996
---- ---- ----
Net revenues 100% 100% 100%
Cost of net revenues 49% 54% 48%
----------------------------
Gross profit 51% 46% 52%
Operating expenses:
Sales and marketing 20% 28% 25%
Research and development 12% 36% 21%
General and administrative 5% 15% 6%
Acquisition costs 0% 1% 0%
----------------------------
Total operating expenses 37% 80% 52%
----------------------------
Operating income (loss) 14% (34%) 0%
Interest income, net 1% 3% 2%
Litigation settlement income, net 0% 0% 1%
Other expense, net 0% 0% 0%
----------------------------
Income (loss) before provision for income taxes 15% (31%) 3%
Provision for income taxes 2% 0% 0%
----------------------------
Net income (loss) 13% (31%) 3%
----------------------------
----------------------------
NET REVENUES
Total net revenues for 1998 were $111.7 million, an increase of
$65.1 million, or 140%, compared to 1997. This increase was due in large part
to revenues from the videoconferencing products which were not part of the
prior year revenue stream. Additionally, audioconferencing product line sales
volume increases, primarily in North America, also contributed to the revenue
growth. Further, in 1998 the Company recorded $2.5 million in revenue
relating to the Second Agreement with 3M. This 1998 3M revenue compares with
the $3.0 million in 1997 revenue associated with the First Agreement with 3M.
Total net revenues for 1997 were $46.6 million, an increase of $9.6
million, or 26%, compared to 1996. This increase was due to unit volume
increases of the SoundStation over the same period in 1996, the introduction
of the new Premier and SoundPoint product lines in 1997 and revenue in 1997
associated with the First Agreement with 3M. These increases were partially
offset by price reductions for the SoundStation product line and ShowStation
unit volume decreases.
During 1998, 1997 and 1996, Polycom derived a substantial majority
of its net revenues from sales of its SoundStation and ViewStation product
families. One customer accounted for 11% and 10% of net revenues in 1998 and
1997, respectively. No other customer or reseller accounted for more than 10%
of Polycom's net revenues during the periods.
International net revenues accounted for 24%, 23%, and 23% of total
net revenues for 1998, 1997, and 1996, respectively. See Note 14 of Notes to
Consolidated Financial Statements for business segment information. In 1998,
volume increases in all international regions, primarily Europe, contributed
to the increase in the percentage of international revenue. In 1997, price
reductions and the $3.0 million in domestic revenue associated with the First
3M Agreement offset unit growth in the Company's international business. 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
23
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 49% of net revenues
in 1998 compared to 54% in 1997. This improvement in cost over 1997 is
attributable to a more favorable product mix, royalty revenues with no
associated costs, favorable material price improvements and favorable
manufacturing variances related to increased production levels. When
comparing 1997 to 1996, the cost of net revenues represented 54% of net
revenues in 1997 versus 48% in 1996. The increase in cost of net revenues
percentage is primarily attributable to the 37% SoundStation price reduction
implemented in North America in January 1997 and the 30% SoundStation price
reduction implemented in the international regions in April 1997. Also, the
costs associated with transitioning the SoundStation and Premier product
manufacturing to Celestica, formerly IMS, in Thailand and the introduction of
a lower margin audio product contributed to the higher 1997 cost of net
revenues percentage. These increases were offset by the revenue received
under the First Agreement with 3M, which had very low associated costs.
Forecasting future gross margin percentages is difficult. Polycom
expects that the overall cost of net revenues percentage will remain at
current levels in 1999; 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 each quarter 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 in 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 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.
24
SALES AND MARKETING EXPENSES
Increase (Decrease)
Year End December 31, From Prior Year
------------------------------- -------------------
Dollars in Thousands 1998 1997 1996 1998 1997
-------------------- ------------------------------- -------------------
Expenses $21,893 $13,106 $9,095 67% 44%
% of Net Revenues 20% 28% 25% (8%) 3%
The increase in sales and marketing expenses in absolute dollars in
1998 over 1997 was primarily related to increased investment in the
videoconferencing sales effort. As mentioned previously, the Company only
began selling the ViewStation products in 1998 and, consequently, had little
sales and marketing expense in 1997 associated with these products.
Additionally, increases in the audioconferencing sales efforts in 1998 have
also contributed to the overall increase over 1997. When comparing 1997 to
1996, the sales and marketing expense increase was related to the launch of
Polycom's dataconferencing and videoconferencing products.
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
Increase (Decrease)
Year End December 31, From Prior Year
-------------------------------- -------------------
Dollars in Thousands 1998 1997 1996 1998 1997
-------------------- -------------------------------- -------------------
Expenses $ 13,862 $ 16,560 $ 7,893 (16%) 110%
% of Net Revenues 12% 36% 21% (24%) 15%
Research and development expenses consist primarily of compensation
costs, consulting fees, an allocation of overhead expense, supplies and
depreciation. The expense decrease in 1998 when compared to 1997 was
primarily attributable to higher development expenses for the ShowStation IP
and ViewStation products in 1997 which resulted in the initial launch of
these products in early 1998. For the remainder of 1998, the development
charges for these products normalized. These decreases were offset somewhat
by increases related to the audioconferencing product line. The increase in
dollar amount in research and development expenses in 1997 over 1996 was
primarily attributable to increased staffing and associated support required
to expand and enhance Polycom's dataconferencing and videoconferencing
product lines. As of December 31, 1998, 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 in the future.
25
GENERAL AND ADMINISTRATIVE EXPENSES
Increase (Decrease)
Year End December 31, From Prior Year
-------------------------------- -------------------
Dollars in Thousands 1998 1997 1996 1998 1997
-------------------- -------------------------------- -------------------
Expenses $ 5,130 $ 6,781 $ 2,198 (24%) 209%
% of Net Revenues 5% 15% 6% (10%) 9%
General and administrative expenses consist primarily of compensation
costs, an allocation of overhead expense, and outside legal and accounting
expenses. The decrease in general and administrative expenses in 1998 when
compared to 1997 is due to lower legal expenses associated with the VTEL and
Datapoint lawsuits. This decrease was offset by increases related to
increased staffing and infrastructure to support the Company's growth.
Additionally, during the third quarter of 1998, the Company reversed a
contingency reserve associated with the Datapoint litigation which was
resolved favorably during the quarter. The increase in dollar amount in 1997
over 1996 was primarily due to increased staffing, including the hiring of a
president at the beginning of 1997, to support Polycom'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.
ACQUISITION EXPENSES
The Company incurred expenses totaling $0.2 million and $0.6 million
in 1998 and 1997, respectively, related to the acquisition of ViaVideo. A
significant portion of these charges was for outside legal, accounting and
consulting services. Management does not anticipate any further material
ViaVideo acquisition related expenses; however, there can be no assurances
that other expenses related to acquisition activity will not be incurred or,
if incurred, will not be material.
OTHER INCOME AND EXPENSE AND PROVISION FOR INCOME TAXES
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
$0.9 million, $1.2 million and $0.8 million for 1998, 1997, and 1996,
respectively. The fluctuations in interest income, net are due primarily to
changes in average cash balances throughout the year.
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 1998, 1997 and 1996, Polycom's
provision for income taxes was $1.7 million, $0.2 million and $0.1 million,
respectively. The provision for income taxes in 1997 and 1996 were primarily
for federal alternative minimum and certain foreign taxes.
As of December 31, 1998, Polycom had approximately $7.3 million in
federal net operating loss carryforwards and $0.4 million in federal tax
credit carryforwards as well as other deferred tax assets arising from timing
differences. Polycom has established a valuation allowance against a portion
of these deferred tax assets due to the uncertainty surrounding the
realization of such assets given the company's only recent return to
profitability, the strong competition from PictureTel, the largest competitor
in the videoconferencing market, and the lack of backlog in the sales cycle.
Management evaluates on a quarterly basis the recoverability of the deferred
tax assets and the level of the valuation allowance and, accordingly, the
26
valuation allowance may change based upon the Company's financial performance
and market condition. At such time as it is determined that it is more likely
than not that deferred tax assets are realizable, the valuation allowance
will be appropriately reduced. See Note 12 of Notes to Consolidated Financial
Statements.
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 compliant. The costs associated
with this effort may be incremental to the Company and also represent a
reallocation of existing resources. In addition, the Company has initiated a
project to replace its current internal business information system. While
this effort will also address the Year 2000 issues of the legacy system, this
internal system implementation effort is principally being conducted to
improve operating efficiencies.
Polycom takes seriously the potential issues that could arise due to
the Year 2000 impact on internal systems, facilities, and its suppliers. In
connection with the Year 2000 initiative, the Company is working to assure
that its internal systems, facilities, and suppliers are Year 2000 compliant
in advance of January 1, 2000. The schedule for this program and percentage
of tasks complete are as follows:
% Scheduled
Year 2000 Initiative Phases Complete Completion
--------------------------- -------- ----------
Conduct inventory 100% 10/1/98
Survey suppliers 100% 2/15/99
Assess Year 2000 compliance 75% 3/31/99
Develop action & contingency plans 12% 5/30/99
Assess need to implement contingencies 0% 6/30/99
Complete upgrades & replacements 0% 10/15/99
The results of our assessments to date are that 100% of Polycom
product are Year 2000 Compliant. Of the inventoried internal systems, 42% are
Year 2000 Compliant, 26% require an upgrade, 7% require replacement, and 25%
require completion of the assessment.
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.
27
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 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 FOR THE THREE YEARS ENDED DECEMBER 31, 1998
As of December 31, 1998, Polycom's principal sources of liquidity
included cash and cash equivalents of $17.5 million and short-term
investments of $5.5 million. Additionally, the Company established 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 December 31,
1998, Polycom was in compliance with these covenants. See Note 9 of Notes to
Consolidated Financial Statements.
Polycom used cash in operating activities totaling $0.5 million,
$8.7 million, and $2.5 million for the years ended 1998, 1997, and 1996,
respectively. The improvement in cash from operating activities in 1998 over
1997 was due primarily to the improvement in net income before non-cash
items and a smaller increase in accounts payable and accrued liabilities,
offset somewhat by the growth in receivables and inventory. When
comparing 1997 to 1996, the decline in cash from operating activities was due
to the net loss before considering non-cash items compared to net income in
1996, offset somewhat by the increase in accounts payable and accrued
liabilities.
The total net change in cash and cash equivalents for 1998 was an
increase of $5.1 million. The primary sources of cash were $11.9 million
proceeds from issuance of stock, mainly from the purchase of stock worth $7.6
million by 3M. The primary uses of cash during 1998 were purchases of
property, plant and equipment of $5.4 million and cash used in operating
activities of $0.5 million. The use of cash in operating activities was
primarily the result of higher accounts receivable, due to a larger portion
of revenue realized at the end of the year and higher inventory levels. This
was offset somewhat by a positive net income before considering non-cash
expenses such as depreciation and higher accounts payable and accrued
liabilities.
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. See Notes 8 and 9 of the Notes to Consolidated Financial Statements.
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
28
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.
RECENT ACCOUNTING PRONOUNCEMENTS
In March 1998, American Institute of Certified Public Accountants
issued Statement of Position ("SOP") No. 98-1, "Software for Internal Use,"
which provides guidance on accounting for the cost of computer software
developed or obtained for internal use. SOP No. 98-1 is effective for
financial statements for fiscal years beginning after December 15, 1998. The
Company does not expect that the adoption of SOP No. 98-1 will have a
material impact on its consolidated financial statements.
In June 1998, the FASB issued SFAS No. 133, "Accounting for
Derivative Instruments and Hedging Activities" ("SFAS 133"). The Company is
required to adopt SFAS 133 in fiscal 2000. SFAS 133 established methods of
accounting for derivative financial instruments and hedging activities
related to those instruments as well as other hedging activities. The Company
has not yet determined what the effect SFAS 133 will be on the operations and
financial position of the Company.
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, Polycom believes that the 37% price
reduction in the North American list price of its SoundStation product line,
effective December 1996 for resellers and January 1997 for end-user
customers, and the 30% price reduction for SoundStation products sold
internationally effective April 1997, negatively impacted Polycom's net
revenues and profitability in 1997. Additionally, the Company lowered the
price of the ShowStation IP 23% effective March 1999 due to market acceptance
issues for this product. 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. In addition, costs
related to the merger with ViaVideo, and its integration into Polycom, and
expense growth related to the activities of the combined entities could
negatively impact future profitability. Further, costs related to the
introduction of the new ShowStation IP, ViewStation, SoundStation Satellite,
WebStation, MeetingSite and SoundPoint Pro products 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
29
the Company's balance sheet as of December 31, 1998, are difficult to predict
at this time. Further, Polycom's limited operating history and limited
resources, among other factors, make the prediction of future operating
results difficult, if not impossible.
In the past Polycom has experienced delays from time to time in the
introduction of certain new products and enhancements and 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 and changes in general economic conditions. In
addition, competitive pressure on pricing or demand levels in a given quarter
could adversely affect Polycom's operating results for such period, and such
price pressure over an extended period could materially adversely affect
Polycom's long-term profitability. Polycom's ability to maintain or increase
net revenues will depend upon its ability to increase unit sales volumes of
the 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, 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, ViewStation V.35, ViewStation MP and WebStation
shipments, in the fourth quarter of 1998. 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 supplier 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
30
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 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.
The Company has several distribution and marketing agreements with 3M
whereby 3M purchases video and data products from Polycom and provides a
royalty revenue stream for Polycom. If 3M is unsuccessful in the
videoconferencing and dataconferencing equipment business, it would
significantly reduce the amount of product they purchase from Polycom and the
royalty revenue stream associated with it. This could materially adversely
affect 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 will make 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 (DSO) 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
December 31, 1998, 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
31
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.
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.
32
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 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.
33
ITEM 7A. 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:
As of December 31, 1998:
Expected Maturity
1999 2000 2001 Total
---- ---- ---- -----
(in thousands, except interest rates)
ASSETS
Cash and cash equivalents 17,548 --- --- 17,548
Average interest rates 3.16% --- --- 3.16%
Investments 5,483 --- --- 5,483
Average interest rates 5.33% --- --- 5.33%
LIABILITIES
Bank line of credit --- --- --- ---
Average interest rates 7.75% --- --- 7.75%
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.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements required by Item 8 and the financial
statement schedules required by Item 14(d) are included following Item 14
hereof. The supplemental data called for by Item 8 is not applicable to the
Company.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
34
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
(a) DIRECTORS - The information required by this item is included in the
Company's Proxy Statement for the 1999 Annual Meeting of Stockholders and
is incorporated herein by reference.
(b) EXECUTIVE OFFICERS - The executive officers of the Company, and their ages,
as of March 12, 1999 are as follows:
NAME AGE POSITION
---- --- --------
Brian L. Hinman* 37 Chairman of the Board of Directors
Robert C. Hagerty* 47 President, Chief Executive Officer and
Director
Michael R. Kourey* 39 Senior Vice President, Finance and
Administration, Chief Financial Officer,
Secretary and Director
Dale A. Bastian 45 Senior Vice President, Worldwide Sales and
Service
Ardeshir Falaki 40 Senior Vice President and General Manager,
Dataconferencing Products
Alan D. Hagedorn 51 Senior Vice President, Manufacturing
Craig B. Malloy 37 Senior Vice President and General Manager,
Videoconferencing Products
Rose M. Rambo 48 Senior Vice President and General Manager,
Audioconferencing Products
- ------------------------
* Member of the Board of Directors.
BRIAN L. HINMAN is a founder of the Company and serves as the
Chairman of the Board of Directors. Also, until July 1998, Mr. Hinman served
as the Chief Executive Officer. Mr. Hinman co-founded PictureTel Corporation,
a leading manufacturer of videoconferencing equipment, in August 1984. At
PictureTel, he served as the Vice President of Engineering from August 1984
until January 1991 and as a member of the Board of Directors from August 1984
to December 1989. He is a co-founder and director of the International
Multimedia Teleconferencing Consortium, Inc. which is dedicated to the
International Telecommunications Union standards of H.320 and T.120 for video
and dataconferencing. Mr. Hinman holds eight U.S. patents in the conferencing
field. Mr. Hinman also holds a B.S.E.E. from the University of Maryland and
an S.M.E.E. from Massachusetts Institute of Technology.
ROBERT C. HAGERTY joined the Company in January 1997 as President
and Chief Operating Officer and as a member of the Board of Directors. In
July 1998, Mr. Hagerty was appointed the role of President and Chief
Executive Officer. Prior to joining Polycom, Mr. Hagerty served as president
of Stylus Assets, Ltd., a developer of software and hardware products for
fax, document management and Internet communications. He also held several
key management positions with Logitech, including Operating Committee Member
to the Office of the President, and Senior Vice President/General Manager of
Logitech's retail division and worldwide operations. In addition, Mr.
Hagerty's career history includes positions as Vice President, High
Performance Products for Conner Peripherals, Director of Manufacturing
Operations and General Manager for Signal Corporation, and Operations Manager
for Digital Equipment Corporation. Mr. Hagerty holds a B.S. in Operations
Research and Industrial Engineering from the University of Massachusetts, and
an M.A. in Management from St. Mary's College of California.
MICHAEL R. KOUREY joined Polycom in July 1991 and served as the
Company's Senior Vice President, Finance and Operations until January 1995.
He assumed the additional roles of Secretary and Treasurer in June 1993.
Since January 1995, Mr. Kourey has served as Senior Vice President, Finance
and Administration and Chief Financial Officer of the company. In January 1999,
Mr. Kourey became a member of the Board of Directors. Prior to joining
Polycom, he was Vice President, Operations of Verilink, a leading supplier of
T1 telecommunications equipment. He brings over 18 years experience in
high-technology finance and manufacturing management to Polycom. Mr. Kourey
holds a B.S. in Managerial Economics from the University of California,
Davis, and an M.B.A. from the University of Santa Clara.
DALE A. BASTIAN joined the Company in July 1997 as Senior Vice
President, Worldwide Sales and Service. Before joining Polycom, Mr. Bastian
served as Vice President, Sales and Marketing for Allen Telecom Group.
35
Previously, Mr. Bastian also held posts as Vice President of Sales for Rose
Communications and Digital Sound Corporation, as well as sales management
positions with Commterm Corporation, Code-A-Phone Corporation and Sony
Corporation. He brings over 17 years of sales experience in the
telecommunications to his position at Polycom. Mr. Bastian holds a B.B.A. in
Management from Ohio University.
ARDERSHIR FALAKI joined the Company in April 1996, as Vice
President, Dataconferencing Engineering. In January 1998 he was promoted to
Senior Vice President and General Manager, Dataconferencing Products. Mr.
Falaki was formerly Director of Performance Systems for PictureTel
Corporation, a leading videoconferencing provider. Previously, he held a
variety of key engineering, sales and marketing positions at PictureTel.
Before joining PictureTel, Mr. Falaki served in various engineering positions
at Siemens Energy and Automation, Inc. Mr. Falaki brings over 8 years of
conferencing development experience to Polycom. Mr. Falaki holds a B.S.E.E.
from Northeastern University and participated in graduate studies in
electrical engineering and physics at the University of Massachusetts,
Dartmouth.
ALAN D. HAGEDORN joined the Company in September 1996 as the Senior
Vice President, Manufacturing. Mr. Hagedorn was formerly Vice President of
Manufacturing for Amati Communications, Inc., a leading developer of advanced
transmission equipment. Prior to that, he served as Vice President of
Manufacturing for Network Computing Devices, Inc. and has held senior
manufacturing positions with companies including PRIAM, Inc. and Anicon, Inc.
Mr. Hagedorn brings over 25 years of experience in high tech manufacturing to
his position at Polycom. Mr. Hagedorn holds a B.A. in Management from
California State University, Fullerton.
CRAIG B. MALLOY joined the Company in January 1998 as Senior Vice
President and General Manager, Videoconferencing Products. Mr. Malloy
co-founded ViaVideo Communications, Inc. in 1996. Prior to founding ViaVideo,
Mr. Malloy served in various marketing management roles at VTEL, including
Manager of Product Marketing and Director of Commercial Analysis. Mr. Malloy
also held marketing and manufacturing management positions with Baxter
Healthcare and Pfizer-Shiley, and served as a lieutenant in the U.S. Navy.
Mr. Malloy holds a B.S. degree in Political Science from the United States
Naval Academy and a M.B.A. degree from the University of California, Los
Angeles.
ROSE M. RAMBO joined the Company in January 1998 as Senior Vice
President and General Manager, Audioconferencing Products. Ms. Rambo comes to
Polycom from Siemens Corporation, where she most recently served as Director
of Siemens' small and medium switching business unit in the U.S. During her
tenure at Siemens, Ms. Rambo also held a number of other key positions,
including Director of Product Management and Brand Manager, among others. Ms.
Rambo brings nearly 20 years of experience in the telecommunications industry
to her position with Polycom. Ms. Rambo holds a Bachelor of Arts degree from
Oberlin College, and a Master of Science in Industrial Administration from
Carnegie Mellon University.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is included under the caption
"Executive Compensation and Related Information" in the Proxy Statement for
the Company's 1999 Annual Meeting of Stockholders and is incorporated herein
by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERSHIP AND MANAGEMENT
The information required by this item is included under the captions
"Ownership of Securities" in the Proxy Statement for the Company's 1999
Annual Meeting of Stockholders and is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is included under the captions
"Certain Transactions" in the Proxy Statement for the Company's 1999 Annual
Meeting of Stockholders and is incorporated herein by reference.
36
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 10-K.
(a) The following documents are filed as part of this Report:
1. Financial Statements. (see Item 8 above)
Polycom, Inc. Consolidated Financial Statements as of December 31,
1998 and 1997 and for each of the three years in the period ended
December 31, 1998.
2. Financial Statement Schedule. (see Item 8 above) The following
Financial Statement Schedule of the Registration is filed as part of
this Report:
Schedule II - Valuation and Qualifying Accounts.
Schedules not listed above have been omitted because the information
required to be set forth therein is not applicable or is shown in the
financial statements or notes thereto.
3. Exhibits.
The following Exhibits are filed as part of, or incorporated
by reference into, this Report:
EXHIBIT NO. DESCRIPTION
----------- -----------
2.1 Agreement and Plan of Reorganization,
dated as of June 11, 1997, by and among
Polycom, Inc., Venice Acquisition and
ViaVideo Communications, Inc. (which is
incorporated herein by reference to
Exhibit 2.1 to Form 8-K filed by the
Registrant with the Commission on August
13, 1997).
2.2 Amendment No. 1 to the Agreement and Plan
of Reorganization, dated as of September
2, 1997, by and among the Registrant,
Venice Acquisition Corporation and
ViaVideo Communications, Inc. (which is
incorporated herein by reference to
Exhibit 2.2 to Form 8-K filed by the
Registrant with the Commission on January
16, 1998).
3.1 Amended and Restated Certificate of
Incorporation of Polycom, Inc. (which is
incorporated herein by reference to
Exhibit A to the Registrant's Definitive
Proxy Statement on Schedule 14A filed with
the Securities and Exchange Commission on
April 21, 1998).
3.2 Amended and Restated Bylaws of Polycom,
Inc. (which is incorporated herein by
reference to Exhibit 3.4 to the
Registrant's 1996 S-1).
4.1 Reference is made to Exhibits 3.1 and 3.2.
4.2 Specimen Common Stock certificate (which
is incorporated herein by reference to
Exhibit 4.2 to the Registrant's 1996 S-1).
4.3 Amended and Restated Investor Rights
Agreement, dated May 17, 1995, among the
Registrant and the Investors named therein
(which is incorporated herein by reference
to Exhibit 4.3 to the Registrant's 1996
S-1).
4.4 Preferred Shares Rights Agreement dated as
of July 15, 1998, between Polycom, Inc.
and BankBoston N.A., including the
Certificate of Designation, the form of
Rights Certificate and the Summary of
Rights Attached thereto as Exhibits A, B
and C, respectively (which is incorporated
herein by reference to Exhibit 1 to the
Registrant's Form 8-A filed with the
Securities and Exchange Commission on July
22, 1998).
10.1 Form of Indemnification Agreement entered
into between the Registrant and each of
its directors and officers (which is
incorporated herein by reference to
Exhibit 10.1 to the Registrant's 1996
S-1).
37
EXHIBIT NO. DESCRIPTION
----------- -----------
10.2 The Registrant's 1991 Stock Option Plan
and forms of agreements thereunder (which
is incorporated herein by reference to
Exhibit 10.2 to the Registrant's 1996
S-1).
10.3 The Registrant's 1996 Stock Incentive Plan
and forms of agreements thereunder as
amended and restated March 5, 1997 (which
is incorporated herein by reference to
Exhibit 10.3 to the Registrant's 1996 S-1
and Exhibit 99.1 to the Registrant's
registration statement on Form S-8
registration No. 333-43059).
10.4 The Registrant's Employee Stock Purchase
Plan and forms of agreements thereunder
(which is incorporated herein by reference
to Exhibit 10.4 to the Registrant's 1996
S-1).
10.5 Lease Agreement by and between the
Registrant and Orchard Investment Company
Number 701 dated June 24, 1993, as
amended, regarding the space located at
2584 Junction Avenue (which is
incorporated herein by reference to
Exhibit 10.5 to the Registrant's 1996
S-1).
10.6 Amended and Restated Development, Volume
Purchase and Distribution Agreement, dated
December 22, 1995, by and between
PictureTel Corporation and Polycom, Inc.
(which is incorporated herein by reference
to Exhibit 10.6 to the Registrant's 1996
S-1).
10.7(1) Sublicense Agreement, dated March 31,
1994, by and between DataBeam Corporation
and Polycom, Inc. (which is incorporated
herein by reference to Exhibit 10.7 to the
Registrant's 1996 S-1).
10.8(1) Amended and Restated General Distribution
Agreement, dated February 14, 1996, by and
between DataBeam Corporation and Polycom,
Inc. (which is incorporated herein by
reference to Exhibit 10.8 to the
Registrant's 1996 S-1).
10.9(1) Volume Purchase Agreement, dated March 1,
1994, as amended, by and between Scriptel
Corporation and Polycom, Inc. (which is
incorporated herein by reference to
Exhibit 10.10 to the Registrant's 1996
S-1).
10.10(1) Volume Purchase Agreement, dated March 29,
1996, by and between Scriptel Corporation
and Polycom, Inc. (which is incorporated
herein by reference to Exhibit 10.11 to
the Registrant's 1996 S-1).
10.11 Stock Pledge Agreement and Note Secured by
Stock Pledge Agreement, each dated June 9,
1995, by and between Polycom, Inc. and
Patrick P. Day (which is incorporated
herein by reference to Exhibit 10.1 to the
Registrant's Form 10-Q dated May 14,
1997).
10.12 Series D Preferred Stock Purchase
Agreement and Amended and Restated
Investor Rights Agreement dated May 17,
1995 (which is incorporated herein by
reference to Exhibit 10.13 to the
Registrant's 1996 S-1).
10.13(1) Joint Marketing and Development Agreement
and Stock Warrant Agreement, each dated
March 28, 1997, by and between Polycom,
Inc. and Minnesota Mining and
Manufacturing Company (which is
incorporated herein by reference to
Exhibit 10.2 to the Registrant's Form 10-Q
dated May 14, 1997).
10.14(1) Joint Marketing and Development Agreement,
dated June 10, 1997, by and between
Polycom, Inc. and Minnesota Mining and
Manufacturing Company, as amended on June
10, 1997 (which is incorporated herein by
reference to Exhibit 10.1 to the
Registrant's Form 10-Q dated August 13,
1997).
10.15 Lease Agreement by and between the
Registrant and The Joseph and Eda Pell
Revocable Trust, dated May 12, 1997,
regarding the space located at Arroyo
Business Center in Livermore, California
(which is incorporated herein by
reference to Exhibit 10.15 to the
Registrant's Form 10-K dated March 13,
1998.)
10.16 Stock Pledge Agreement and Note Secured by
Stock Pledge Agreement, each dated March
17, 1997 (which is incorporated herein by
reference to Exhibit 10.1 to the
Registrant's Form 10-Q dated May 14,
1997).
10.17 ViaVideo Communications, Inc. 1996 Stock
Option/Stock Issuance Plan and related
38
EXHIBIT NO. DESCRIPTION
----------- -----------
agreements (which is incorporated by
reference to Exhibit 4.2 to the
Registrant's Registration Statement on
Form S-8, Registration No. 333-45351).
21.1 Subsidiaries of the Registrant (which is
filed herein).
23.1 Consent of Independent Accountants (filed
herein on page S-4).
24.1 Power of Attorney (filed herein on page
41).
27.1 Financial Data Schedule (filed herein).
(1) Confidential treatment requested as to certain
portions of these documents.
(b) REPORTS ON FORM 8-K.
Not applicable.
(c) EXHIBITS.
See Item 14(a)(3) above.
(d) FINANCIAL STATEMENT SCHEDULES.
See Items 8 and 14(a)(2) above.
39
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the
Securities Exchange Act of 1934, as amended, the Registrant has duly caused
this Report to be signed on its behalf by the undersigned, thereunto duly
authorized, in the City of San Jose, State of California, on this 12th day of
March, 1999.
POLYCOM, INC.
/s/ Robert C. Hagerty /s/ Michael R. Kourey
- --------------------------- -------------------------------------------
Robert C. Hagerty Michael R. Kourey
Chief Executive Officer and Vice President, Finance and Administration,
President Chief Financial Officer and Secretary
40
POWER OF ATTORNEY
- -----------------
KNOW ALL PERSONS BY THESE PRESENTS:
That the undersigned officers and directors of Polycom, Inc., a
Delaware corporation, do hereby constitute and appoint Robert C. Hagerty and
Michael R. Kourey, and each of them, the lawful attorneys-in-fact, each with
full power of substitution, for him in any and all capacities, to sign any
amendments to this report on Form 10-K and to file the same, with exhibits
thereto and other documents in connection therewith, with the Securities and
Exchange Commission, hereby ratifying and confirming all that each of said
attorneys-in-fact or their substitute or substitutes may do or cause to be
done by virtue hereof.
IN WITNESS WHEREOF, each of the undersigned has executed this Power
of Attorney as of the date indicated.
Pursuant to the requirements of the Securities Exchange Act of 1934,
as amended, this Report has been signed below by the following persons in the
capacities and on the dates indicated.
SIGNATURE TITLE DATE
- --------- ----- ----
/s/ Brian L. Hinman Chairman of the Board March 12, 1999
- ------------------------------------
Brian L. Hinman
/s/ Robert C. Hagerty Chief Executive Officer, President March 12, 1999
- ------------------------------------ and Director (Principal Executive Officer)
Robert C. Hagerty
/s/ Michael R. Kourey Vice President, Finance and March 12, 1999
- ------------------------------------ Administration, Chief Financial
Michael R. Kourey Officer, Secretary and Director (Principal
Financial and Accounting Officer)
/s/ Bandel Carano Director March 12, 1999
- ------------------------------------
Bandel Carano
/s/ Stanley J. Meresman Director March 12, 1999
- ------------------------------------
Stanley J. Meresman
/s/ John P. Morgridge Director March 12, 1999
- ------------------------------------
John P. Morgridge
/s/ James R. Swartz Director March 12, 1999
- ------------------------------------
James R. Swartz
41
POLYCOM, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE
----
Report of PricewaterhouseCoopers LLP, Independent Accountants F-2
Consolidated Balance Sheets F-3
Consolidated Statements of Operations F-4
Consolidated Statement of Stockholders' Equity/(Deficit) F-5
Consolidated Statements of Cash Flows F-6
Notes to Consolidated Financial Statements F-7
F-1
REPORT OF INDEPENDENT ACCOUNTANTS
January 20, 1999, except for Note 16
which is as of March 2, 1999
To the Board of Directors of Polycom, Inc. and Polycom, Inc. Stockholders,
In our opinion, the accompanying consolidated balance sheets and the
related consolidated statements of operations and stockholders' equity
(deficit) and of cash flows present fairly, in all material respects, the
financial position of Polycom, Inc. and its subsidiaries at December 31, 1998
and 1997, and results of their operations and their cash flows for each of
the three years in the period ended December 31, 1998, in conformity with
generally accepted accounting principles. These financial statements are the
responsibility of the Company's management; our responsibility is to express
an opinion on these financial statements based on our audits. We conducted
our audits of these statements in accordance with generally accepted auditing
standards which require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management,
and evaluating the overall financial statement presentation. We believe that
our audits provide a reasonable basis for the opinion expressed above.
PricewaterhouseCoopers LLP
San Jose, California
F-2
POLYCOM, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share data)
December 31,
1998 1997
--------- ----------
ASSETS
Current assets:
Cash and cash equivalents $ 17,548 $ 12,486
Short-term investments 5,483 5,184
Accounts receivable, net of allowance for doubtful accounts of $838 and $438
in 1998 and 1997, respectively 25,011 8,135
Inventories 16,699 9,915
Deferred and refundable taxes 2,594 --
Prepaid expenses and other current assets 2,196 2,930
------------ ------------
Total current assets 69,531 38,650
Fixed assets, net 6,727 4,528
Deposits and other assets 696 351
------------ ------------
Total assets $ 76,954 $ 43,529
------------ ------------
------------ ------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Line of credit $ -- $ 625
Accounts payable 12,412 11,552
Accrued payroll and related liabilities 3,472 1,061
Taxes payable 1,405 113
Other accrued liabilities 6,611 3,895
------------ ------------
Total current liabilities 23,900 17,246
------------ ------------
Commitments and contingencies (Note 8) -- --
Stockholders' equity (deficit):
Preferred stock, $0.001 par value:
Authorized: 5,000,000 shares in 1998 and 18,095,690 shares in 1997
Issued and outstanding: none in 1998 and 1997 -- --
Convertible preferred stock, $0.001 par value:
Authorized: none in 1998 and 7,102,104 shares in 1997
Issued and outstanding: none in 1998 and 5,809,094 shares in 1997 -- 5
Common stock, $0.0005 par value:
Authorized: 50,000,000 shares
Issued and outstanding: 29,772,702 shares in 1998 and 22,077,260 in 1997 18 12
Additional paid-in capital 64,590 52,603
Notes receivable from stockholders -- (24)
Accumulated deficit (11,554) (26,313)
------------ ------------
Total stockholders' equity (deficit) 53,054 26,283
------------ ------------
Total liabilities and stockholders' equity (deficit) $ 76,954 $ 43,529
------------ ------------
------------ ------------
The accompanying notes are an integral part of these
consolidated financial statements
F-3
POLYCOM, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
Year ended December 31,
--------------------------------------------------
1998 1997 1996
--------------- -------------- -------------
Net revenues $ 111,696 $ 46,630 $ 37,032
Cost of net revenues 55,054 25,255 17,698
--------- --------- --------
Gross profit 56,642 21,375 19,334
Operating expenses:
Sales and marketing 21,893 13,106 9,095
Research and development 13,862 16,560 7,893
General and administrative 5,130 6,781 2,198
Acquisition costs 185 597 --
--------- --------- --------
Total operating expenses 41,070 37,044 19,186
--------- --------- --------
Operating income (loss) 15,572 (15,669) 148
Interest income, net 945 1,153 791
Litigation settlement income, net -- -- 303
Other income (expense) (9) 12 (8)
--------- --------- --------
Income (loss) from continuing operations
before provision for income taxes 16,508 (14,504) 1,234
Provision for income taxes 1,749 171 108
--------- --------- --------
Net income (loss) $ 14,759 $ (14,675) $ 1,126
--------- --------- --------
--------- --------- --------
Basic net income (loss) per share $ 0.54 $ (0.73) $ 0.08
--------- --------- --------
--------- --------- --------
Diluted net income (loss) per share $ 0.46 $ (0.73) $ 0.06
--------- --------- --------
--------- --------- --------
Shares used in Basic per share calculation 27,486 20,169 13,478
Shares used in Diluted per share calculation 32,394 20,169 19,815
The accompanying notes are an integral part of these
consolidated financial statements
F-4
POLYCOM, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (DEFICIT)
(in thousands, except share data)
Preferred Stock Common Stock
------------------------------- -----------------------------
Shares Amount Shares Amount
------------------------------- -----------------------------
Balances, January 1, 1996 --- $ --- 3,670,046 $ 2
Issuance of preferred stock 2,320,021 2 --- ---
Conversion of promissory note into preferred stock 70,367 --- --- ---
Issuance of common stock through: --- --- --- ---
Initial public offering, net of issuance costs --- --- 2,500,000 2
Conversion of preferred shares --- --- 13,069,857 6
Exercise of stock options under stock option plan --- --- 138,738 ---
Exercise of warrants --- --- 22,500 ---
Issuance of stock --- --- 2,556,793 2
Conversion of promissory note into stock --- --- 36,131 ---
Payment of stockholder notes receivable --- --- --- ---
Repurchase of common stock --- --- (257,083) ---
Net income --- --- --- ---
-------------- ------------- ----------- ----------
Balances, December 31, 1996 2,390,388 2 21,736,982 12
Issuance of preferred stock 3,418,706 3 --- ---
Exercise of stock options under stock option plan --- --- 361,378 ---
Shares purchased under Employee Stock Purchase Plan --- --- 92,731 ---
Repurchase of common stock --- --- (113,831) ---
Interest on stockholder notes --- --- --- ---
Payment of stockholder notes receivable --- --- --- ---
Valuation of warrants --- --- --- ---
Valuation of options granted to outside consultants --- --- --- ---
Net loss --- --- --- ---
-------------- ------------- ----------- ----------
Balances, December 31, 1997 5,809,094 5 22,077,260 12
Conversion of preferred stock into common stock (5,809,094) (5) 5,809,094 5
Issuance of common stock --- --- 1,020,476 1
Exercise of stock options under stock option plan --- --- 785,902 ---
Shares purchased under Employee Stock Purchase Plan --- --- 79,970 ---
Cost of Stockholders' Rights Plan --- --- --- ---
Payment of stockholder notes receivable --- --- --- ---
Valuation of options granted to outside consultants --- --- --- ---
Tax benefit from stock option activity --- --- --- ---
Net income --- --- --- ---
-------------- ------------- ----------- ----------
Balances, December 31, 1998 --- $ --- 29,772,702 $ 18
-------------- ------------- ----------- ----------
-------------- ------------- ----------- ----------
Notes
Additional Receivables
Paid-In From Accumulated
Capital Stockholders Deficit Total
----------- ------------ ------------- -----------
Balances, January 1, 1996 $ 285 $ (163) $ (12,764) $ (12,640)
Issuance of preferred stock 1,932 --- --- 1,934
Conversion of promissory note into preferred stock 41 --- --- 41
Issuance of common stock through: --- --- --- ---
Initial public offering, net of issuance costs 19,927 --- --- 19,929
Conversion of preferred shares 22,354 --- --- 22,360
Exercise of stock options under stock option plan 68 (17) --- 51
Exercise of warrants --- --- --- ---
Issuance of stock (1) --- --- 1
Conversion of promissory note into stock 21 --- --- 21
Payment of stockholder notes receivable --- 151 --- 151
Repurchase of common stock (113) --- --- (113)
Net income --- --- 1,126 1,126
------------ ------------ ------------- ------------
Balances, December 31, 1996 44,514 (29) (11,638) 32,861
Issuance of preferred stock 7,518 --- --- 7,521
Exercise of stock options under stock option plan 127 --- --- 127
Shares purchased under Employee Stock Purchase Plan 396 --- --- 396
Repurchase of common stock (18) --- --- (18)
Interest on stockholder notes --- (8) --- (8)
Payment of stockholder notes receivable --- 13 --- 13
Valuation of warrants 40 --- --- 40
Valuation of options granted to outside consultants 26 --- --- 26
Net loss --- --- (14,675) (14,675)
------------ ------------ ------------- ------------
Balances, December 31, 1997 52,603 (24) (26,313) 26,283
Conversion of preferred stock into common stock --- --- --- ---
Issuance of common stock 7,629 --- --- 7,630
Exercise of stock options under stock option plan 1,647 --- --- 1,647
Shares purchased under Employee Stock Purchase Plan 495 --- --- 495
Cost of Stockholders' Rights Plan (26) --- --- (26)
Payment of stockholder notes receivable --- 24 --- 24
Valuation of options granted to outside consultants 121 --- --- 121
Tax benefit from stock option activity 2,121 --- --- 2,121
Net income --- --- 14,759 14,759
------------ ------------ ------------- ------------
Balances, December 31, 1998 $ 64,590 $ --- $ (11,554) $ 53,054
------------ ------------ ------------- ------------
------------ ------------ ------------- ------------
The accompanying notes are an integral part of these
consolidated financial statements
F-5
POLYCOM, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Year Ended December 31,
--------------------------------------------
1998 1997 1996
------------- -------------- ---------------
Cash flows from operating activities:
Net income (loss) $ 14,759 $ (14,675) $ 1,126
Adjustments to reconcile net income (loss) to net cash used in
operating activities:
Depreciation and amortization 3,293 2,019 1,517
Provision for doubtful accounts 400 --- 1
Provision for excess and obsolete inventories 2,715 1,265 560
Value of stock options granted to outside consultants 121 26 ---
Loss on asset dispositions 6 308 ---
Value of warrants --- 40 ---
Other non-cash expenses --- 8 ---
Changes in assets and liabilities:
Accounts receivable (17,276) (1,891) (3,218)
Inventories (9,499) (3,722) (2,710)
Deferred taxes (2,594) --- ---
Prepaid expenses and other current assets 734 (1,813) (782)
Deposits and other assets (345) (251) (9)
Accounts payable 860 7,145 617
Accrued liabilities 6,306 2,857 427
------------- -------------- ------------
Net cash used in operating activities (520) (8,684) (2,471)
------------- -------------- ------------
Cash flows from investing activities:
Acquisition of fixed assets (5,412) (3,606) (1,776)
Proceeds from sale of fixed assets 27 --- ---
Purchase of short-term investments (9,686) (7,154) (9,964)
Proceeds from sale of short-term investments 9,387 12,071 2,585
------------- -------------- ------------
Net cash provided by (used in) investing activities (5,684) 1,311 (9,155)
------------- -------------- ------------
Cash flows from financing activities:
Proceeds from issuance of common stock, net of repurchases and
issuance costs 11,867 505 19,868
Proceeds from issuance of preferred stock, net of issuance costs --- 7,521 1,934
Proceeds from issuance of notes payable --- --- 4,314
Repayment of notes payable and capital lease obligation --- --- (6,977)
Repayment of stockholder notes receivable, net 24 5 151
Proceeds from line of credit borrowings 9,601 2,558 50
Repayment of line of credit borrowings (10,226) (1,983) ---
------------- -------------- ------------
Net cash provided by financing activities 11,266 8,606 19,340
------------- -------------- ------------
Net increase in cash and cash equivalents 5,062 1,233 7,714
Cash and cash equivalents, beginning of period 12,486 11,253 3,539
------------- -------------- ------------
Cash and cash equivalents, end of period $ 17,548 $ 12,486 $ 11,253
------------- -------------- ------------
------------- -------------- ------------
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the period for interest $ 16 $ 28 $ 141
Income taxes paid $ 399 $ 183 $ 40
Advertising barter trade credits $ 770 $ --- $ ---
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING:
Capital leases $ 113 $ 20 $ ---
Common and preferred stock issued for notes receivable $ --- $ --- $ 80
Conversion of preferred shares to common stock $ 9,496 $ --- $ 22,360
The accompanying notes are an integral part of these
consolidated financial statements
F-6
POLYCOM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. FORMATION AND BUSINESS OF THE COMPANY:
Polycom, Inc. and subsidiaries (the "Company"), a Delaware
corporation, is engaged in the development, manufacturing and
marketing of teleconferencing equipment. The Company's products are
distributed and serviced globally. The Company sells its products
through its direct sales force and maintains marketing and sales
relationships with major telecommunications carriers, value-added
resellers, telecommunications suppliers, catalog distributors, and
telecommunications specialists.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
FISCAL YEAR:
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 year. For
convenience of presentation, the accompanying consolidated
financial statements have been shown as ending on December 31 of
each applicable period. Due to timing, 1998 is a 53 week fiscal
year. Consequently, the first quarter of 1998 had 14 weeks rather
than the usual 13 weeks.
RECLASSIFICATIONS:
Certain financial statements items in prior year's financial
statements have been reclassified to conform to current year's
format.
PRINCIPLES OF CONSOLIDATION:
The consolidated financial statements include the accounts of the
Company and its wholly owned subsidiaries. All significant
intercompany balances and transactions have been eliminated.
USE OF ESTIMATES:
The preparation of financial statements in conformity with
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 reporting
period. Actual results could differ from those estimates.
CASH AND CASH EQUIVALENTS:
The Company considers all highly liquid investments with original
or remaining maturities 90 days or less at the time of purchase to
be cash equivalents.
SHORT-TERM INVESTMENTS:
Short-term investments are classified as available for sale and are
carried at fair value. Unrealized holding gains and losses on such
securities are reported net of related taxes as a separate
component of stockholders' equity. Realized gains and losses on
sales of all such securities are reported in earnings and computed
using the specific identification cost method.
INVENTORIES:
Inventories are stated at the lower of cost or market. Cost is
determined on a standard cost basis which approximates the
first-in, first-out ("FIFO") method. Appropriate consideration is
given to obsolescence, excessive levels, deterioration and other
factors in evaluating net realizable value.
F - 7
POLYCOM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FIXED ASSETS:
Fixed assets are stated at cost less accumulated depreciation and
amortization. Depreciation is provided on a straight-line basis
over the estimated useful lives of the assets, which is one to
three years. Tooling equipment is stated at cost less accumulated
depreciation. Tooling equipment is depreciated over the estimated
life of the product which is up to three years. Amortization of
leasehold improvements is computed using the straight-line method
over the shorter of the remaining lease term or the estimated
useful life of the related assets, typically three to five years.
Disposals of capital equipment are recorded by removing the costs
and accumulated depreciation from the accounts. Gains or losses are
included in the results of operations.
CARRYING VALUE OF LONG-LIVED ASSETS:
The Company writes down the carrying value of long-lived assets to
fair market value if the carrying value is considered to be
impaired. The value is considered to be impaired if the carrying
amount exceeds the undiscounted future net cash flows generated by
the assets.
REVENUE RECOGNITION:
The Company recognizes revenue from gross product sales, less a
provision for estimated future customer returns, upon shipment to
the reseller or end-user customer, upon fulfillment of acceptance
terms, if any, and when no significant contractual obligations
remain outstanding. During 1998, the Company recognized $2.5
million in revenue related to certain deliverables detailed in the
Second Agreement with 3M. During 1997, the Company recognized $3.0
million in revenue related to certain deliverables detailed in the
First Agreement with 3M. The amounts recognized as revenue from
these agreements approximate the amounts that would have been
recognized using the percentage of completion methodology.
RESEARCH AND DEVELOPMENT EXPENDITURES:
Research and development expenditures are charged to operations as
incurred.
ADVERTISING:
The Company expenses the production costs of advertising as the
expenses are incurred. The production costs of advertising consist
primarily of magazine advertisements, agency fees and other direct
production costs. The advertising expense for the years ended
December 31, 1998, 1997 and 1996 was $5,221,000, $1,835,000 and
$1,570,000, respectively. Advertising barter trade credits are
reflected in prepaid assets and stated at a net book value of
$770,000 as of December 31, 1998.
INCOME TAXES:
Income taxes are accounted for under Statement of Financial
Accounting Standards No. 109 ("SFAS No. 109"), "Accounting for
Income Taxes". Under SFAS No. 109, deferred tax assets and
liabilities are recognized for the future tax consequences
attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their
respective tax basis. Deferred tax assets and liabilities are
measured using enacted tax rates expected to apply to taxable
income in the years in which those temporary differences are
expected to be recovered or settled. Valuation allowances are
established when necessary to reduce deferred tax assets to the
amount expected to be realized.
TRANSLATION OF FOREIGN CURRENCIES:
The Company's foreign consolidated subsidiary is considered to be an
extension of the U.S. operation and the functional currency is the U.S.
dollar. Accordingly, monetary assets and liabilities are translated at
year-
F - 8
POLYCOM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
end exchange rates while nonmonetary items are translated at
historical rates. Income and expense accounts are translated at the
average rates in effect during the year, except for depreciation
and cost of revenue which are translated at historical rates.
Foreign exchange gains and losses have not been significant to date
and have been recorded in results of operations.
COMPUTATION OF NET INCOME/(LOSS) PER SHARE:
The Company calculates Net Income/(Loss) Per Share using the
guidelines in Statement of Financial Accounting Standards No. 128
("SFAS No. 128"), "Earnings Per Share". SFAS No. 128 requires net
income (loss) per share to be presented under two calculations,
Basic EPS and Diluted EPS. Basic net income (loss) per share is
computed using the weighted average number of common shares
outstanding during the periods represented. Diluted net income
(loss) per share is computed using common and dilutive common
equivalent shares outstanding during the periods represented.
Common equivalent shares (including shares issued under the Stock
Option Plan which are subject to repurchase) are excluded from the
computation of fully diluted net loss per share when their effect is
antidilutive.
FAIR VALUE OF FINANCIAL INSTRUMENTS:
Carrying amounts of certain of the Company's financial instruments
including cash and cash equivalents, accounts receivable, accounts
payable and other accrued liabilities approximate fair value due to
their short maturities. Estimated fair values for short-term
investments, which are separately disclosed elsewhere, are based on
quoted market prices for the same or similar instruments.
STOCK BASED COMPENSATION:
Statement of Financial Accounting Standards No. 123 ("SFAS No.
123"), "Accounting for Stock-Based Compensation," encourages, but
does not require, companies to record compensation cost for
stock-based compensation plans at fair value. The Company has
chosen to continue to account for employee stock options using the
intrinsic value method prescribed by APB Opinion No. 25,
"Accounting for Stock Issued to Employees." Accordingly,
compensation cost for stock options is measured as the excess, if
any, of the quoted market price of the Company's stock at the date
of the grant over the amount an employee must pay to acquire the
stock.
ACQUISITION OF VIAVIDEO COMMUNICATIONS, INC.:
On January 2, 1998, the Company completed the acquisition of
ViaVideo Communications, Inc., ("ViaVideo") whereby a wholly owned
subsidiary of Polycom, Inc. was merged with and into ViaVideo.
ViaVideo was a development stage company that designed and
developed high quality, low cost, easy to use, group
videoconferencing systems that utilize advanced video and audio
compression technologies along with Internet/Web-based features.
Approximately 8.7 million shares of Polycom common stock were
exchanged for all of the issued and outstanding capital stock of
ViaVideo. In addition, outstanding stock options to purchase
ViaVideo common stock were converted into options to purchase
approximately 1.1 million shares of Polycom common stock. The
transaction was treated as a pooling of interests for financial
reporting purposes and, consequently, all prior period figures have
been restated as if the combined entity existed for all periods
presented. All intercompany transactions between the two companies
have been eliminated in consolidation. Polycom and ViaVideo had the
same fiscal year end of December 31 and activity from the start of
the current fiscal period to the merger date was not material.
Further, there were no adjustments required to conform accounting
policies between the two companies.
F - 9
POLYCOM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table reconciles of Polycom's previously reported
revenue and earnings in 1997 and 1996 to the restated amounts ($ in
thousands):
1997 1996
-------------- -------------
Revenue:
Polycom previously reported $ 46,630 $ 37,032
ViaVideo -- --
-------------- -------------
Restated revenue $ 46,630 $ 37,032
-------------- -------------
-------------- -------------
Net income (loss):
Polycom previously reported $ (1,068) $ 1,483
ViaVideo (13,607) (357)
-------------- -------------
Restated net income (loss) $(14,675) $ 1,126
-------------- -------------
-------------- -------------
Basic net income (loss) per share:
Polycom previously reported $ (0.06) $ 0.11
ViaVideo (0.67) (0.03)
-------------- -------------
Restated basic net income (loss) per share $ (0.73) $ 0.08
-------------- -------------
-------------- -------------
Diluted net income (loss) per share:
Polycom previously reported $ (0.06) $ 0.08
ViaVideo (0.67) (0.02)
-------------- -------------
Restated diluted net income (loss) per share $ (0.73) $ 0.06
-------------- -------------
-------------- -------------
COMPREHENSIVE INCOME:
Effective January 1, 1998, the Company adopted the provisions of
Statement of Financial Accounting Standards No. 130, ("SFAS No.
130"), "Reporting Comprehensive Income". SFAS No. 130 establishes
standards for reporting comprehensive income and its components in
financial statements. Comprehensive income, as defined, includes
all changes in equity (net assets) during a period from non-owner
sources. To date, the Company has not had any transactions that are
required to be reported in comprehensive income (loss) as compared
to its reported net income (loss).
SEGMENT INFORMATION:
In June 1997, the Financial Accounting Standards Board ("FASB")
issued Statement of Financial Accounting Standards No. 131, ("SFAS
No. 131"), "Disclosures about Segments of an Enterprise and Related
Information". This statement establishes standards for the way
companies report information about operating segments in annual
financial statements. It also establishes standards for related
disclosures about products and services, geographical areas and
major customers. In accordance with provisions of SFAS No. 131, the
Company had determined that it does not have separately reportable
operating segments.
RECENT PRONOUNCEMENTS:
In March 1998, American Institute of Certified Public Accountants
issued Statement of Position ("SOP") No. 98-1, "Software for
Internal Use," which provides guidance on accounting for the cost
of computer software developed or obtained for internal use. SOP
No. 98-1 is effective for financial statements for fiscal years
beginning after December 15, 1998. The Company does not expect that
the adoption of SOP No. 98-1 will have a material impact on its
consolidated financial statements.
In June 1998, the FASB issued of Statement of Financial Accounting Standards
No. 133, ("SFAS No. 133"), "Accounting for Derivative Instruments and
Hedging Activities" . The Company is required to adopt SFAS No. 133 in
fiscal 2000. SFAS No. 133 established methods of accounting for derivative
financial instruments and
F - 10
POLYCOM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
hedging activities related to those instruments as well as other hedging
activities. The Company has not yet determined what the effect of SFAS
No. 133 will be on the operations and financial position of the Company.
3. SHORT-TERM INVESTMENTS:
Short-term investments at December 31, 1998 and 1997 comprise (in
thousands):
Fair Cost
Value Basis
-------------- --------------
US government securities $ 2,611 $ 2,611
Foreign government securities 504 504
Corporate debt securities 2,368 2,368
-------------- --------------
Balances at December 31, 1998 $ 5,483 $ 5,483
-------------- --------------
-------------- --------------
US government securities $ 1,492 $ 1,492
Corporate debt securities 3,692 3,692
-------------- --------------
Balances at December 31, 1997 $ 5,184 $ 5,184
-------------- --------------
-------------- --------------
All short-term investments as of December 31, 1998 and 1997 mature within
one year. During 1998 and 1997, there were no realized gains or losses on
the disposal of short-term investments.
4. INVENTORIES:
Inventories consist of the following (in thousands)
December 31,
-----------------------------------
1998 1997
---------------- ---------------
Raw materials $ 974 $ 2,526
Finished goods 15,725 7,389
---------------- ---------------
Total inventories $ 16,699 $ 9,915
---------------- ---------------
---------------- ---------------
5. FIXED ASSETS:
Fixed assets, net, consist of the following (in thousands):
December 31,
---------------------------------
1998 1997
------------ ------------
Computer equipment and software $ 6,393 $ 4,338
Equipment, furniture and fixtures 3,866 2,161
Tooling equipment 4,700 3,237
Leasehold improvements 567 517
------------ ------------
$15,526 $10,253
Less accumulated depreciation and amortization 8,799 5,725
------------ ------------
$ 6,727 $ 4,528
------------ ------------
------------ ------------
F - 11
POLYCOM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
6. OTHER ACCRUED LIABILITIES:
Other accrued liabilities consist of the following (in thousands):
December 31,
---------------------------------
1998 1997
------------ ------------
Accrued expenses and legal fees $ 3,127 $ 3,029
Warranty reserve 1,719 406
Sales tax payable 567 57
Employee stock purchase plan withholding 391 160
Other accrued liabilities 807 243
------------ ------------
$ 6,611 $ 3,895
------------ ------------
------------ ------------
7. BUSINESS RISKS AND CREDIT CONCENTRATION:
The Company sells a limited number of products which serve the conferencing
equipment market. A substantial majority of the Company's net revenues are
derived from sales of the SoundStation and ViewStation products. Any factor
adversely affecting demand or supply for the SoundStation and ViewStation
products could materially adversely affect the Company's business and
financial performance. Although the Company will begin volume shipments of
the new WebStation product in 1999, the market for dataconferencing products
is only beginning to emerge, and there can be no assurance that it will
develop sufficiently to enable the Company to achieve broad commercial
acceptance of its dataconferencing products. There can be no assurance that
Polycom will succeed in this market.
Currently, the Company subcontracts the manufacturing of its
audioconferencing and videoconferencing product lines through one
subcontractor in Asia. The ShowStation IP product is manufactured by one
U.S. subcontractor. The Company believes that there are a number of
alternative contract manufacturers that could produce the Company's
products, but in the event of a reduction or interruption of supply, it
could take a significant period of time to qualify an alternative
subcontractor and commence manufacturing. The effect of such reduction or
interruption in supply on results of operations would be material.
Additionally, the Asian economy has gone through some recent problems which,
as yet, have not had a material impact on the supply of Polycom product from
the subcontractor used in this region. However, should the economic problems
in Asia persist, it could create an interruption in supply which could
materially adversely affect the results of operations.
The Company's cash and cash equivalents are maintained with two
international investment management companies and two commercial banks and
their international affiliates, and are invested in the form of demand
deposit accounts, money market accounts, corporate debt securities and
government securities. Deposits in these institutions may exceed the amount
of insurance provided on such deposits.
The Company markets its products to distributors and end-users throughout
the world. Management performs ongoing credit evaluations of the Company's
customers and maintains an allowance for potential credit losses, but
historically has not experienced any significant losses related to
individual customers or group of customers in any particular geographic
area. The expansion of Polycom's product offerings may increase the
Company's credit risk as customers place larger orders for the new products.
There can be no assurance that the Company's credit loss experience will
remain at or near historic levels.
F - 12
POLYCOM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
8. COMMITMENTS AND CONTINGENCIES:
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 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 consolidated balance sheet as of
December 31, 1998, will not have a material adverse effect on the Company's
financial position.
On October 2, 1997, Datapoint Corporation filed a complaint against Intel
Corporation for infringement of two U.S. patents related to
videoconferencing network technology in the U.S. District Court in Dallas,
Texas. On November 25, 1997, the complaint was amended to include several
additional defendants, and Datapoint also filed a motion for certification
of the action as a class action. No ruling occurred relative to the motion
for class action certification. Although neither Polycom nor its subsidiary
ViaVideo had been served as a defendant in any Datapoint complaints, both
Polycom and ViaVideo were named as putative class members in the Datapoint
motion for class action certification along with over 500 other companies.
During the third quarter of 1998, the Company was notified that this case
was dismissed by stipulation and an order entered by the court to that
effect.
STANDBY LETTER OF CREDIT:
The Company has $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.
During May 1997, a bank issued a standby letter of credit to one of
ViaVideo's major suppliers for $335,000. The letter of credit expired in
April 1998 and was secured by ViaVideo's certificate of deposit for a
similar amount deposited with the bank.
During August 1997, a bank issued a standby letter of credit to one of
ViaVideo's major suppliers for $75,000. The letter of credit expired in July
1998 and was secured by ViaVideo's certificate of deposit for a similar
amount deposited with the bank.
LICENSE AGREEMENT:
The Company entered into an agreement to license software to be incorporated
into its dataconferencing products. Under the agreement, the Company is
obligated to pay annual minimum license fees, ranging from $15,000 to
$35,000 through the year 2001 and the Company may cancel the agreement at
any time, provided the Company has paid a minimum of $200,000 in connection
with the agreement. As of December 31, 1998, the Company had paid $275,000
of the minimum license fees. In February 1999, the Company re-negotiated
F - 13
POLYCOM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
the terms of the contract and paid a lump sum figure of $195,000. Under the
terms of this new contract, the Company has no further obligation regarding
any fees associated with this licensed software.
LEASES:
The Company leases certain office facilities and equipment under
noncancelable operating leases expiring between 1999 and 2002. Future
minimum lease payments are as follows (in thousands):
Leases
-------------------
YEAR ENDING DECEMBER 31,
1999 $ 1,923
2000 291
2001 123
2002 56
-------------------
Minimum future lease payments $ 2,393
-------------------
-------------------
In December 1998, the Company extended its headquarters office lease
agreement for one year. This lease is due to expire in December 1999. Under
the terms of the lease, the Company is responsible for related maintenance,
taxes and insurance.
In January 1998, the Company leased 23,000 square feet of office space in
Austin, Texas for its video engineering and marketing operations. The lease
expires in December 1999. Under the terms of the lease, the Company is
responsible for related maintenance, taxes and insurance.
In May 1997, the Company entered into a three year operating lease for its
U.S. distribution and repair center in Livermore, California. The lease
associated with this building will expire on May 31, 2000 and allows for
earlier termination by the Company.
Rent expense for the years ended December 31, 1998, 1997 and 1996 was
$1,159,000, $666,000 and $483,000, respectively.
9. CREDIT ARRANGEMENTS:
The Company has available a revolving line of credit with a bank for the
lesser of $5,000,000 or the sum of 80% of eligible domestic trade accounts
receivable and 50% of foreign trade accounts receivable, as defined, less
the sum of the aggregate outstanding face amount of all letters of credit
issued under the line. The line of credit expires in October 1999. The
agreement allows for an additional facility of $5.0 million and for the
borrowing to convert to a term loan for any outstanding amount 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. Borrowings under the line of credit bear interest at the
lender's current prime rate (7.75% at December 31, 1998 and 8.5% at December
31, 1997). The weighted average interest rates for the years ended December
31, 1998, 1997 and 1996 were 8.4%, 9.3% and 9.5%, respectively.
As of December 31, 1997, ViaVideo Communications had a bank credit agreement
which provided for a revolving line of credit of up to $750,000. The
outstanding balance on the line of credit at December 31, 1997 was $625,000
with an interest rate equal to the bank's prime rate plus 0.75% (9.25% at
December 31, 1997). The line was collateralized by substantially all of the
assets of ViaVideo. The outstanding balance was paid in full during 1998 and
the line was closed.
All borrowings are collateralized by substantially all assets of the
Company. The Company must meet certain financial ratios, as well as maintain
minimum tangible net worth and quarterly maximum cumulative losses. The
agreements also require that the Company provide certain financial
information to the lender on a periodic basis and restrict the Company from
paying any cash dividends without the bank's consent.
F - 14
POLYCOM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
10. STOCKHOLDERS' EQUITY:
PREFERRED STOCK:
In March 1996, the Company authorized 18,095,690 shares of preferred stock.
In May 1998, the Company reduced the authorized shares of preferred stock to
5,000,000. As of December 31, 1997, the Company had 7,102,104 authorized
shares of convertible preferred stock, of which, 5,809,094 shares were
outstanding. During 1998, the outstanding convertible preferred shares were
converted to common stock before the merger between Polycom and ViaVideo
Communications.
COMMON STOCK:
As of December 31, 1998, 1,118,595 shares of common stock, stemming from
the founder stock of ViaVideo Communications, Inc., were outstanding but
subject to repurchase.
STOCK OPTION PLAN:
In 1996, the Board of Directors reserved 3,125,000 shares of common stock
under its 1996 Stock Option Plan (the "Plan") for issuance to employees and
directors of the Company. In 1997, an additional 1,000,000 shares were
reserved through a shareholder vote. The Plan supersedes the 1991 Stock
Option Plan.
In 1996, ViaVideo Communications, Inc. reserved 887,763 shares of common
stock under the 1996 ViaVideo Communications, Inc. Stock Option Plan
("ViaVideo Plan") for issuance to employees of ViaVideo. In 1997, an
additional 710,210 shares were reserved through a shareholder vote. The
ViaVideo Plan was assumed by Polycom pursuant to the Merger Agreement on
January 2, 1998. All remaining option shares available for grant and
subsequent cancellations of option shares under the ViaVideo Plan expired or
will expire as no additional option shares can be granted from the ViaVideo
Plan subsequent to the merger.
Under the terms of the Plan, the 1991 Stock Option Plan and the ViaVideo
Plan, options may be granted at prices not lower than fair market value at
date of grant as determined by the Board of Directors. The options granted
under the ViaVideo Plan and the 1991 Stock Option Plan are immediately
exercisable, expire in ten years from the date of grant, and the unvested
shares issued upon exercise of the options are generally subject to a right
of repurchase by the Company upon termination of employment with the
Company. Options granted under the Plan expire ten years from the date of
grant and generally are only exercisable upon vesting.
Options granted under the Plan and the 1991 Stock Option Plan normally vest
at 20% after completing one year of service to the Company and the remaining
amount equally over 48 months until fully vested after five years. Options
granted under the ViaVideo Plan normally vest monthly for each month of
service to the Company until fully vested after four years. For new options
granted under the Plan beginning in December 1998, the options will vest at
25% after completing one year of service to the Company and the remaining
amount equally over 36 months until fully vested after four years. While
there are several option grants with vesting schedules different than those
described, generally vesting of options is consistent within each of the
plans.
F - 15
POLYCOM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Activity under the Plan is as follows (in thousands, except share and per
share data):
Outstanding Options
Shares ------------------------------------------------------------------
Available Number Exercise Aggregate Weighted Avg
for Grant of Shares Price Price Exercise Price
-----------------------------------------------------------------------------------
Balances, January 1, 1996 22,484 800,875 $ 0.15-$ 4.75 973 $ 1.21
Options reserved 3,248,835
Options granted (1,035,829) 1,035,829 $ 4.75-$ 9.00 7,049 $ 6.81
Options exercised -- (138,738) $ 0.15-$ 7.20 (68) $ 0.49
Options canceled 202,803 (202,803) $ 0.15-$ 9.00 (705) $ 3.48
--------------------------------- ----------
Balances, December 31, 1996 2,438,293 1,495,163 $ 0.15-$ 9.00 7,249 $ 4.85
Options reserved 1,710,210
Options granted (3,879,967) 3,879,967 $ 0.08-$ 6.06 11,661 $ 3.01
Options exercised -- (361,378) $ 0.08-$ 4.75 (127) $ 0.35
Options canceled 814,035 (814,035) $ 0.08-$ 9.00 (4,429) $ 5.44
Shares repurchased 12,091 -- --
--------------------------------- ----------
Balances, December 31, 1997 1,094,662 4,199,717 $ 0.08-$ 9.00 14,354 $ 3.42
Options reserved --
Options granted (960,750) 960,750 $ 7.88-$ 20.56 13,450 $14.00
Options exercised -- (785,902) $ 0.08-$ 9.00 (1,647) $ 2.10
Options canceled 380,210 (380,210) $ 0.15-$ 15.13 (1,921) $ 5.05
Options expired (227,768) -- $ 0.08-$ 2.56 --
--------------------------------- ----------
Balances, December 31, 1998 286,354 3,994,355 $ 0.08-$ 20.56 24,236 $ 6.07
--------------------------------- ----------
--------------------------------- ----------
As of December 31, 1998, 1997 and 1996, 1,610,590, 1,809,378, 609,890
outstanding options were exercisable at an aggregate average exercise price
of $2.67, $1.57 and $2.09, respectively. Of these options that were
exercisable, 721,029, 1,214,119 and 411,663 were unvested and, therefore,
subject to repurchase as of December 31, 1998, 1997 and 1996, respectively.
In addition, as of December 31, 1998, 146,852 shares of common stock
acquired under the Plan were subject to repurchase.
In March 1997, the Company implemented an option cancellation and regrant
program for employees (other than executive officers) holding stock options
with exercise prices per share in excess of $4.50. Outstanding options
covering an aggregate of 223,200 shares with exercise prices in excess of
$4.50 per share were canceled and new options for the same number of shares
were granted with an exercise price of $4.375 per share. The new options
vest over a five-year period beginning on March 5, 1997.
Consistent with the provisions of SFAS No. 123, the Company's net income or
loss and basic and diluted net income or loss per share would have been
adjusted to the pro forma amounts indicated below (IN THOUSANDS, EXCEPT PER
SHARE AMOUNTS):
1998 1997 1996
-------------------------------
Net income/(loss) - as reported $14,759 $(14,675) $1,126
Net income/(loss) - pro forma $ 9,621 $(18,928) $ 166
Basic net income/(loss) per share - as reported $ 0.54 $ (0.73) $ 0.08
Basic net income/(loss) per share - pro forma $ 0.35 $ (0.94) $ 0.01
Diluted net income/(loss) per share - as reported $ 0.46 $ (0.73) $ 0.06
Diluted net income/(loss) per share - pro forma $ 0.30 $ (0.94) $ 0.01
The impact on pro forma net income (loss) per share and net income (loss) in
the table above may not be indicative of the effect in future years as
options vest over several years and the Company continues to grant stock
options to new employees. This policy may or may not continue.
F - 16
POLYCOM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The fair value of each option grant is estimated on the date of grant using
the multiple options approach with the Black-Scholes model with the
following weighted average assumptions:
Risk-free interest rate 5.20% - 5.57%
Expected life (yrs) 0.5
Expected dividends --
Expected volatility 0.6 - 0.8
The weighted average expected life was calculated based on the vesting
period and an aggregate exercise behavior. This exercise behavior was based
on historical exercise patterns. The risk-free interest rate was calculated
in accordance with the grant date and expected life.
The options outstanding and currently exercisable by exercise price at
December 31, 1998 are as follows:
Options Outstanding Options Currently Exercisable
------------------------------------------------- -----------------------------------
Weighted
Average Weighted Weighted
Range of Remaining Average Average
Exercise Number Contractual Exercise Number Exercise
Price Outstanding Life (Yrs) Price Exercisable Price
------------------- --------------- ---------------- ---------------- ------------------ ----------------
$ 0.08 - $ 0.15 330,424 7.98 $ 0.09 330,424 $0.09
$ 0.21 - $ 0.34 363,114 7.97 $ 0.22 363,114 $0.22
$ 1.00 - $ 2.22 96,119 8.11 $ 2.06 96,119 $2.06
$ 2.53 - $ 6.25 2,071,786 8.37 $ 4.46 668,678 $4.06
$ 6.38 - $15.13 881,287 9.06 $11.11 152,255 $8.43
$16.38 - $20.56 251,625 9.83 $19.49 -- --
--------------- ------------------
3,994,355 8.54 $ 6.07 1,610,590 $2.67
--------------- ------------------
--------------- ------------------
The Company has also estimated the fair value of purchase rights issued
under the Employee Stock Purchase Plan. Rights under this plan were also
evaluated using the Black-Scholes option-pricing model. The Company's plan
is described in Note 11. Purchase periods occur twice yearly and each
effectively contains a 6-month option.
January 1998 July 1998
--------------- ----------------
Risk Free Interest Rate 5.20% 5.20%
Expected Life 6 months 6 months
Volatility 0.8 0.8
Dividend Yield --- ---
The weighted average fair value of purchase rights granted pursuant to the
Employee Stock Purchase Plan in 1998 and 1997 was $2.38 and $2.04,
respectively.
WARRANTS:
In connection with a joint marketing and development agreement, dated March
28, 1997, for the ShowStation IP, Polycom granted 3M warrants to purchase up
to 2,000,000 shares of the Company's common stock at an exercise price of
$7.50 per share. The warrants were due to expire in March 1999 and were
exercised on March 1, 1999. The warrants were valued at approximately
$40,000 using the Black-Scholes model.
F - 17
POLYCOM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
PREFERRED SHARE PURCHASE RIGHTS PLAN:
On July 15, 1998, pursuant to a Preferred Shares Rights Agreement between
Polycom, Inc. and BankBoston N.A., as Rights Agent, the Company's Board of
Directors declared a dividend of one right to purchase one one-thousandth of
a share of the Company's Series A Preferred Stock for each outstanding share
of Common Stock, par value of $0.0005 per share, of the Company. The
dividend is payable on July 31, 1998 to stockholders of record as of the
close of business on that day. Each Right entitles the registered holder to
purchase from the Company one one-thousandth of a share of Series A
Preferred at an exercise price of $90.00, subject to adjustment. The Rights
become exercisable (the "Distribution Date") upon the earlier of: (i)
fifteen days following the first date a public announcement by the Company
or an Acquiring Person that an Acquiring Person has become such (the "Shares
Acquisition Date") and (ii) fifteen days (or such later date as may be
determined by the Board of Directors) following the commencement of, or
announcement of an intention to make, a tender offer or exchange offer, the
consummation of which would result in a person or group becoming an
Acquiring Person. A person or group of affiliated or associated persons that
beneficially owns, or has the right to acquire beneficial ownership of, 20%
or more of the outstanding Common Shares is referred to as an "Acquiring
Person." The Rights will expire on the earliest of (i) July 15, 2008 (the
"Final Expiration Date") or (ii) redemption or exchange of the Rights as
described below.
Unless the Rights are earlier redeemed, in the event that a person becomes
an Acquiring Person (a "Triggering Event"), each holder of a Right which has
not theretofore been exercised (other than Rights beneficially owned by the
Acquiring Person or any affiliate of the Acquiring Person, which will
thereafter be void) will thereafter have the right to receive, upon
exercise, Common Shares having a value equal to two times the Purchase
Price. The Company may instead substitute cash, assets or other securities
for the Common Shares for which the Rights would have been exercisable.
Similarly, unless the Rights are earlier redeemed, in the event that, after
a Triggering Event, (i) the Company is acquired in a merger or other
business combination transaction, or (ii) 50% or more of the Company's
assets or earning power are sold (other than in transactions in the ordinary
course of business), proper provision must be made so that each holder of a
Right which has not theretofore been exercised (other than Rights
beneficially owned by the Acquiring Person or any affiliate of the Acquiring
Person, which will thereafter be void) will thereafter have the right to
receive, upon exercise, shares of common stock of the acquiring company
having a value equal to two times the Purchase Price.
At any time after a Triggering Event and prior to the acquisition by any
person or entity of beneficial ownership of 50% or more of the Company's
outstanding Common Shares, the Board of Directors of the Company may
exchange the Rights (other than Rights owned by the Acquiring Person), in
whole or in part, at an exchange ratio of one Common Share per Right.
At any time on or prior to the close of business on the earlier of (i) the
Shares Acquisition Date and (ii) the Final Expiration Date of the Rights,
the Company may redeem the Rights in whole, but not in part, at a price of
$0.005 per Right.
11. EMPLOYEE BENEFITS PLANS:
401 (k) PLAN:
The Company has a 401 (k) Plan (the "401(k) Plan"), which covers
substantially all employees. Each eligible employee may elect to contribute
to the 401(k) Plan, through payroll deductions, up to 20% of their
compensation, subject to current statutory limitations. The Company, at the
discretion of the Board of Directors, may make matching contributions to the
401(k) Plan but has not done so since the inception of the 401(k) Plan.
F - 18
POLYCOM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
EMPLOYEE STOCK PURCHASE PLAN:
Under the 1997 Employee Qualified Stock Purchase Plan, the Company can grant
stock purchase rights to all eligible employees during offering periods of
up to a maximum of 24 months with purchase dates approximately every six
months (beginning each February and August). The Company has reserved
500,000 shares of common stock for issuance under the plan. Shares are
purchased through employees' payroll deductions at purchase prices equal to
85% of the lesser of the fair market value of the Company's common stock at
either the date of the employee's entrance to the offering period or the
purchase date. No participant may purchase more than 1,500 shares or $25,000
worth of common stock in any one calendar year.
12. INCOME TAXES:
The Company's tax provision differs from the provision computed using
statutory increased tax rates as follow (in thousands):
Year Ended December 31,
-----------------------------------------------
1998 1997 1996
------------ ------------- --------------
Federal tax at statutory rate $ 5,778 $(4,931) $ 419
Permanent difference due to non-deductible differences 83 117 23
State taxes, net of federal benefit 1,007 (51) 93
Alternative Minimum Tax -- 38 63
Change in Valuation Allowance (3,863) 6,094 (40)
Current NOL and Credit Utilization (1,256) (837) (450)
Other -- (259) 0
------------ ------------- --------------
Tax provision $ 1,749 $ 171 $ 108
------------ ------------- --------------
------------ ------------- --------------
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets are presented below (in thousands):
1998 1997 1996
------------------ -------------- ---------------
Fixed assets, principally due to differences $ 1,998 $ 552 $ 141
Other accrued liabilities 5,123 3,627 1,127
Capitalized research expenditures 246 334 419
Net operating loss carryforwards 2,553 4,746 2,312
Tax credit carryforwards 353 2,283 1,210
Other 0 0 239
Valuation allowance (7,679) (11,542) (5448)
------------------ -------------- ---------------
Net deferred tax asset $ 2,594 $ -- $ --
------------------ -------------- ---------------
------------------ -------------- ---------------
For 1998, the Company has established a valuation allowance against a
portion of these deferred tax assets due to uncertainty surrounding the
realization of such assets given the Company's only recent return to
profitability, the strong competition from PictureTel, the largest
competitor in the videoconferencing market, and the lack of backlog in
the sales cycle. For 1997 and 1996, due to the uncertainty surrounding
the realization of certain deferred tax assets, including net operating
loss and credit carryforwards, the Company determined a valuation
allowance is appropriate.
As of December 31, 1998, the Company has federal tax net operating loss
carryforwards for tax purposes of approximately $7,295,000 and federal tax
credit carryforwards of $353,000. These net operating loss carryforwards
expire in the years 2007 through 2015 and the tax credit carryforwards
expire in the years 2007 through 2021.
F - 19
POLYCOM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The future utilization of the Company's net operating loss and credit
carryforwards are subject to a certain limitation due to changes in
ownership that occurred in 1998.
13. NOTES RECEIVABLE FROM STOCKHOLDERS:
During 1996 and 1995, the Company issued five notes receivable for purchases
of common stock under its stock option plan totaling $17,000 and $154,000,
respectively. No notes were issued in 1998 or 1997. The loans bore interest
ranging from 5.98% to 7.33% per annum and were to mature from July 2004 to
July 2005. The entire balance of these notes was paid in full in 1998. As of
December 31, 1997, the remaining aggregate balance of these notes was
$24,000.
14. BUSINESS SEGMENT INFORMATION:
The Company operates in one business segment and markets its products in the
United States and in foreign countries through resellers and its own direct
sales organization.
The Company's export net revenues are all denominated in U.S. dollars and
are summarized as follows (in thousands):
Year Ended December 31,
--------------------------------------------
1998 1997 1996
-------------- --------------- -------------
United States $ 84,027 $35,293 $27,779
Canada 927 545 696
----------- ------------ ----------
North America 84,954 35,838 28,475
Europe, Middle East & Africa 15,578 5,446 5,159
Asia 8,138 4,148 2,852
Caribbean & Latin America 3,026 1,198 546
----------- ------------ ----------
Total International 26,742 10,792 8,557
----------- ------------ ----------
$111,696 $46,630 $37,032
----------- ------------ ----------
----------- ------------ ----------
Individual customers who comprise 10% or more of the Company's net revenues
are as follows:
Customers: 1998 1997 1996
-------------- --------------- -------------
A 11% 10% ---
F - 20
POLYCOM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
15. EARNINGS PER SHARE (EPS) DISCLOSURES:
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).
Year Ended December 31,
-----------------------------------
1998 1997 1996
-----------------------------------
Numerator - basic and diluted EPS
Net income (loss) $14,759 $ (14,675) $ 1,126
-----------------------------------
-----------------------------------
Denominator - Basic EPS
Common stock outstanding 27,486 20,169 13,478
-----------------------------------
-----------------------------------
Total Shares used in calculation of Basic EPS 27,486 20,169 13,478
-----------------------------------
Basic net income (loss) per share $ 0.54 $ (0.73) $ 0.08
-----------------------------------
-----------------------------------
Denominator - Diluted EPS
Denominator - Basic EPS 27,486 20,169 13,478
Effect of Dilutive Securities:
Common stock options 2,564 -- 593
Shares subject to repurchase 1,572 -- 1,296
Convertible warrants and preferred 772 -- 3,997
Preferred shares of ViaVideo Communications -- -- 451
-----------------------------------
Total Shares used in calculation of Diluted EPS 32,394 20,169 19,815
-----------------------------------
Diluted net income (loss) per share $ 0.46 $ (0.73) $ 0.06
-----------------------------------
-----------------------------------
Stock options to purchase 4,199,717 shares of common stock at prices ranging
from $0.08 to $9.00 and 5,809,094 shares preferred stock were outstanding at
December 31, 1997 but were not included in the computation of diluted net
income (loss) per share as they were antidilutive.
Associated with the first joint marketing and development agreement with
Minnesota, Mining and Manufacturing Company ("3M"), 3M was granted 2,000,000
warrants to purchase common stock at $7.50 per share. These warrants were
antidilutive at December 31, 1997 and, therefore, were not considered in the
Diluted EPS figure.
16. SUBSEQUENT EVENT:
3M EXERCISE OF WARRANTS
On March 1, 1999, 3M exercised its warrants for 2,000,000 shares of Polycom,
Inc. common stock for $7.50 per share for a total consideration of $15.0
million. The warrants were associated with the First Agreement with 3M. As a
result of the purchase, 3M owns approximately 9% of outstanding Polycom
common stock.
F - 21
POLYCOM, INC.
INDEX TO FINANCIAL STATEMENT SCHEDULE
PAGE
Report of PricewaterhouseCoopers LLP, Independent Accountants on
Financial Statement Schedule S-2
Schedule II - Valuation and Qualifying Accounts. S-3
Consent of Independent Accountants S-4
S-1
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Polycom, Inc. Stockholders,
Our report on the consolidated financial statements of Polycom, Inc.
and subsidiaries is included on page F-2 of this Form 10-K. In connection
with our audits of such financial statements, we have also audited the
related consolidated financial statement schedule in this Form 10-K.
In our opinion, the consolidated financial statement schedule
referred to above, when considered in relation to the basic consolidated
financial statements taken as a whole, presents fairly, in all material
respects, the information required to be included therein.
PricewaterhouseCoopers LLP
San Jose, California
January 20, 1999
S-2
SCHEDULE II
POLYCOM, INC.
VALUATION AND QUALIFYING ACCOUNTS
(In thousands)
BALANCE AT BALANCE AT
BEGINNING END OF
DESCRIPTION OF PERIOD ADDITIONS DEDUCTIONS (a) PERIOD
----------- --------- --------- ---------- ----------
Year ended December 31, 1998
Allowance for Doubtful Accounts $ 438 $ 400 $ 0 $ 838
Provision for Obsolete Inventory $ 1,982 $2,715 $(3,092) $ 1,605
Tax Valuation Allowance $11,542 $ 0 $(3,863) $ 7,679
Year ended December 31, 1997
Allowance for Doubtful Accounts $ 443 $ 0 $ (5) $ 438
Provision for Obsolete Inventory $ 721 $1,265 $ (4) $ 1,982
Tax Valuation Allowance $ 5,448 $6,094 $ 0 $11,542
Year ended December 31, 1996
Allowance for Doubtful Accounts $ 448 $ 1 $ (6) $ 443
Provision for Obsolete Inventory $ 345 $ 560 $ (184) $ 721
Tax Valuation Allowance $ 5,488 $ 0 $ (40) $ 5,448
(a) Uncollectible accounts written-off or disposal of unusable or damaged
raw materials.
S-3
CONSENT OF INDEPENDENT ACCOUNTANTS
We consent to the incorporation by reference in the Registration
Statements of Polycom, Inc. on Forms S-8 (Registration file Nos. 333-45351
and 333-43059) of our reports dated January 20, 1999 on our audits of the
consolidated financial statements of Polycom, Inc. and subsidiaries as of
December 31, 1998 and 1997, and for each of the three years in the period
ended December 31, 1998 and on our audit of the consolidated financial
statement schedule, both of which reports are included in this annual report
on Form 10-K.
PricewaterhouseCoopers LLP
San Jose, California
March 12, 1999
S-4