Attached files

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EXCEL - IDEA: XBRL DOCUMENT - POLYCOM INCFinancial_Report.xls
EX-32.1 - CERTIFICATIONS PURSUANT TO 18 U.S.C. SECTION 1350 - POLYCOM INCdex321.htm
EX-10.5 - FORM OF AMENDED AND RESTATED PERFORMANCE SHARE AGREEMENT FOR ANDREW M. MILLER - POLYCOM INCdex105.htm
EX-10.4 - CONSULTING AGREEMENT - ROBERT C. HAGERTY AND THE COMPANY - POLYCOM INCdex104.htm
EX-10.2 - POLYCOM, INC. EXECUTIVE SEVERANCE PLAN AND SUMMARY PLAN DESCRIPTION - POLYCOM INCdex102.htm
EX-31.2 - CERTIFICATION OF THE SVP AND CFO PURSUANT TO RULES 13A-14(C) AND 15D-14(A) - POLYCOM INCdex312.htm
EX-31.1 - CERTIFICATION OF THE PRESIDENT AND CEO PURSUANT TO RULES 13A-14(C) AND 15D-14(A) - POLYCOM INCdex311.htm
EX-10.3 - AMENDED CHANGE OF CONTROL SEVERANCE AGREEMENT - ANDREW M. MILLER AND THE COMPANY - POLYCOM INCdex103.htm
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-Q

 

 

 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2010

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: 000-27978

 

 

POLYCOM, INC.

(Exact name of registrant as specified in its charter)

 

 

 

DELAWARE   94-3128324

(State or other jurisdiction of

incorporation or organization)

 

(IRS employer

identification number)

4750 WILLOW ROAD, PLEASANTON, CA   94588
(Address of principal executive offices)   (Zip Code)

(925) 924-6000

(Registrant’s telephone number, including area code)

 

 

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  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months 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 submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer   x    Accelerated filer   ¨
Non-accelerated filer   ¨  (Do not check if a smaller reporting company)    Smaller reporting company   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 in Exchange Act).    Yes  ¨    No  x

There were 85,268,495 shares of the Company’s Common Stock, par value $.0005, outstanding on July 23, 2010.

 

 

 


Table of Contents

POLYCOM, INC.

INDEX

REPORT ON FORM 10-Q

FOR THE QUARTER ENDED JUNE 30, 2010

 

PART I FINANCIAL INFORMATION

  

Item 1

   Financial Statements (unaudited):    3
   Condensed Consolidated Balance Sheets as of June 30, 2010 and December 31, 2009    3
   Condensed Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2010 and June 30, 2009    4
   Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2010 and June 30, 2009    5
   Notes to Condensed Consolidated Financial Statements    6

Item 2

   Management’s Discussion and Analysis of Financial Condition and Results of Operations    24

Item 3

   Quantitative and Qualitative Disclosures About Market Risk    40

Item 4

   Controls and Procedures    42

PART II OTHER INFORMATION

   42

Item 1—Legal Proceedings

   42

Item 1A—Risk Factors

   42

Item 2—Unregistered Sales of Equity Securities and Use of Proceeds

   64

Item 3—Defaults Upon Senior Securities

   64

Item 4—(Removed and Reserved)

   64

Item 5—Other Information

   64

Item 6—Exhibits

   64

SIGNATURES

   65


Table of Contents

PART I – FINANCIAL INFORMATION

 

Item 1. FINANCIAL STATEMENTS

POLYCOM, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

(in thousands, except share data)

 

     June 30,
2010
    December 31,
2009
 

ASSETS

    

Current assets

    

Cash and cash equivalents

   $ 248,889      $ 331,098   

Short-term investments

     208,139        123,686   

Trade receivables, net of allowance for doubtful accounts of $2,573 and $3,523 at June 30, 2010 and December 31, 2009 respectively

     133,818        132,813   

Inventories

     91,960        76,863   

Deferred taxes

     23,287        23,824   

Prepaid expenses and other current assets

     42,993        24,299   
                

Total current assets

     749,086        712,583   

Property and equipment, net

     95,990        81,252   

Long-term investments

     28,264        12,687   

Goodwill

     489,973        495,299   

Purchased intangibles, net

     35,838        46,255   

Deferred taxes

     27,432        23,943   

Other assets

     16,938        13,882   
                

Total assets

   $ 1,443,521      $ 1,385,901   
                

LIABILITIES AND STOCKHOLDERS’ EQUITY

    

Current liabilities

    

Accounts payable

   $ 94,020      $ 87,233   

Accrued payroll and related liabilities

     24,458        23,707   

Taxes payable

     —          617   

Deferred revenue

     89,720        79,504   

Other accrued liabilities

     53,821        52,360   
                

Total current liabilities

     262,019        243,421   

Non-current liabilities

    

Deferred revenue

     49,880        46,787   

Taxes payable

     22,197        27,111   

Deferred taxes

     2,308        2,702   

Other non-current liabilities

     12,137        12,027   
                

Total non-current liabilities

     86,522        88,627   
                

Total liabilities

     348,541        332,048   

Stockholders’ equity

    

Common stock, $0.0005 par value; Authorized: 175,000,000 shares; Issued and outstanding: 85,091,197 shares at June 30, 2010 and 84,485,030 shares at December 31, 2009

     40        40   

Additional paid-in capital

     1,110,285        1,066,790   

Cumulative other comprehensive income (loss)

     3,735        (962

Accumulated deficit

     (19,080     (12,015
                

Total stockholders’ equity

     1,094,980        1,053,853   
                

Total liabilities and stockholders’ equity

   $ 1,443,521      $ 1,385,901   
                

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

3


Table of Contents

POLYCOM, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

(in thousands, except per share amounts)

 

     Three Months Ended     Six Months Ended  
     June 30,
2010
   June 30,
2009
    June 30,
2010
    June 30,
2009
 

Revenues:

         

Product revenues

   $ 244,795    $ 188,419      $ 472,852      $ 371,713   

Service revenues

     49,840      42,272        97,937        84,388   
                               

Total revenues

     294,635      230,691        570,789        456,101   
                               

Cost of revenues:

         

Cost of product revenues

     99,001      80,483        191,550        158,490   

Cost of service revenues

     24,733      19,591        49,019        40,060   
                               

Total cost of revenues

     123,734      100,074        240,569        198,550   
                               

Gross profit

     170,901      130,617        330,220        257,551   
                               

Operating expenses:

         

Sales and marketing

     94,361      66,553        185,277        132,786   

Research and development

     36,240      28,075        70,145        56,528   

General and administrative

     20,205      12,728        36,187        26,317   

Amortization of purchased intangibles

     1,421      1,434        2,861        2,898   

Restructuring costs

     1,524      427        3,273        6,844   

Litigation reserves and payments

     1,235      —          1,235        —     
                               

Total operating expenses

     154,986      109,217        298,978        225,373   
                               

Operating income

     15,915      21,400        31,242        32,178   

Interest and other income (expense), net

     357      (1,077     (8,224     (1,358
                               

Income before provision for income taxes

     16,272      20,323        23,018        30,820   

Provision for income taxes

     3,668      4,998        5,003        7,470   
                               

Net income

   $ 12,604    $ 15,325      $ 18,015      $ 23,350   
                               

Basic net income per share

   $ 0.15    $ 0.18      $ 0.21      $ 0.28   
                               

Diluted net income per share

   $ 0.14    $ 0.18      $ 0.21      $ 0.28   
                               

Weighted average shares outstanding for basic net income per share calculation

     85,158      83,753        84,911        83,689   

Weighted average shares outstanding for diluted net income per share calculation

     88,244      85,054        87,804        84,652   

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

4


Table of Contents

POLYCOM, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(in thousands)

 

     Six Months Ended  
     June 30,
2010
    June 30,
2009
 

Cash flows from operating activities:

    

Net income

   $ 18,015      $ 23,350   

Adjustments to reconcile net income to net cash provided by operating activities:

    

Depreciation and amortization

     18,975        16,105   

Amortization of purchased intangibles

     9,536        9,579   

Provision for doubtful accounts

     —          247   

Provision for excess and obsolete inventories

     1,551        2,395   

Non-cash stock-based compensation

     27,612        14,088   

Excess tax benefits from stock-based compensation

     (5,931     —     

Write down of investments other than temporarily impaired

     6,530        —     

Loss on disposal of property and equipment

     141        14   

Changes in assets and liabilities, net of effects of acquisitions:

    

Trade receivables

     (1,005     14,295   

Inventories

     (16,648     8,918   

Deferred taxes

     (3,664     (1,492

Prepaid expenses and other assets

     (20,230     633   

Accounts payable

     6,787        (1,498

Taxes payable

     2,945        4,030   

Other accrued liabilities and deferred revenue

     16,266        (17,071
                

Net cash provided by operating activities

     60,880        73,593   
                

Cash flows from investing activities:

    

Purchases of property and equipment

     (33,596     (17,083

Purchases of investments

     (231,113     (268,245

Proceeds from sale and maturity of investments

     133,361        244,619   
                

Net cash used in investing activities

     (131,348     (40,709
                

Cash flows from financing activities:

    

Proceeds from issuance of common stock under employee option and stock purchase plans

     29,325        15,606   

Purchase and retirement of common stock

     (46,997     (15,375

Excess tax benefits from stock-based compensation

     5,931        —     
                

Net cash provided by (used in) financing activities

     (11,741     231   
                

Net increase (decrease) in cash and cash equivalents

     (82,209     33,115   

Cash and cash equivalents, beginning of period

     331,098        165,669   
                

Cash and cash equivalents, end of period

   $ 248,889      $ 198,784   
                

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

5


Table of Contents

POLYCOM, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. BASIS OF PRESENTATION

The accompanying unaudited financial statements, consisting of the condensed consolidated balance sheet as of June 30, 2010, the condensed consolidated statements of operations for the three and six months ended June 30, 2010 and 2009 and the condensed consolidated statements of cash flows for the six months ended June 30, 2010 and 2009, have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, these condensed consolidated financial statements do not include all of the information and footnotes typically found in the audited consolidated financial statements and footnotes thereto included in the Annual Report on Form 10-K of Polycom, Inc. and its subsidiaries (the “Company”). In the opinion of management, all adjustments (primarily consisting of normal recurring adjustments) considered necessary for a fair statement have been included.

The condensed consolidated balance sheet at December 31, 2009 has been derived from the audited consolidated financial statements as of that date but does not include all of the information and footnotes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009.

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reported period. Actual results could differ from those estimates and operating results for the six months ended June 30, 2010 and are not necessarily indicative of the results that may be expected for the year ending December 31, 2010.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Our significant accounting policies were described in Note 1 to our audited Consolidated Financial Statements included in our Annual Report on Form 10-K for the year ended December 31, 2009 (the “2009 Form 10-K”). With the exception of those discussed below, there have been no significant changes to these policies and no recent accounting pronouncements or changes in accounting pronouncements during the six months ended June 30, 2010, that are of significance or potential significance to us.

Revenue Recognition

The Company recognizes revenue when persuasive evidence of an arrangement exists, title and risk of loss has transferred, product payment is not contingent upon installation or other service obligations, the price is fixed or determinable, and collectibility is reasonably assured. In instances where final acceptance of the product or service is specified by the customer, revenue is deferred until all acceptance criteria have been met. Additionally, the Company recognizes maintenance service revenue on our hardware and software products ratably over the service period, generally one to five years.

The Company’s video communications solutions products are integrated with software that is essential to the functionality of the equipment. Additionally, the Company provides unspecified software upgrades and enhancements related to most of these products through maintenance contracts.

In October 2009, the Financial Accounting Standards Board (“FASB”) amended the accounting standards for revenue recognition to remove tangible products containing software components and non-software components that function together to deliver the product’s essential functionality from the scope of the software revenue recognition guidance.

In October 2009, the FASB also amended the accounting standards for multiple deliverable revenue arrangements to:

 

   

provide updated guidance on whether multiple deliverables exist, how the deliverables in an arrangement should be separated, and how the consideration should be allocated;

 

   

require an entity to allocate revenue in an arrangement using estimated selling price (“ESP”) of deliverables if a vendor does not first have vendor-specific objective evidence (“VSOE”) of selling price or secondly does not have third-party evidence (“TPE”) of selling price; and

 

   

eliminate the use of the residual method and require an entity to allocate revenue using the relative selling price method.

The Company elected to early adopt this accounting guidance at the beginning of its first quarter of fiscal year 2010 on a prospective basis for applicable transactions originating or materially modified after December 31, 2009. As a result, the Company’s video communications solutions products are no longer within the scope of the software revenue recognition guidance.

 

6


Table of Contents

POLYCOM, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

Multiple-element arrangements. A multiple-element arrangement includes the sale of one or more tangible product offerings with one or more associated services offerings, each of which are individually considered separate units of accounting. The determination of the Company’s units of accounting did not change with the adoption of the new revenue recognition guidance. Beginning with new or materially modified arrangements as of January 1, 2010, the Company allocates revenue to each element in a multiple-element arrangement based upon the relative selling price of each deliverable. When applying the relative selling price method, the Company determines the selling price for each deliverable using VSOE of selling price, if it exists, or TPE of selling price. If neither VSOE nor TPE of selling price exist for a deliverable, the Company uses its best estimate of selling price for that deliverable. Revenue allocated to each element is then recognized when the other revenue recognition criteria are met for each element.

VSOE is established based on the Company’s standard pricing and discounting practices for the specific product or service when sold separately. In determining VSOE, the Company requires that a substantial majority of the selling prices for a product or service fall within a reasonably narrow pricing range.

When VSOE cannot be established, the Company attempts to establish the selling price of each element based on TPE. TPE is determined based on competitor prices for similar deliverables when sold separately.

When the Company is unable to establish the selling price using VSOE or TPE, the Company uses ESP in its allocation of arrangement consideration. ESP represents the price at which the Company would transact a sale if the element were sold on a stand-alone basis. The Company determines ESP for a product by considering multiple factors including, but not limited to, geographies, market conditions, competitive landscape, and pricing practices. The determination of ESP is made based on review of historical sales price, taking into consideration the go-to-market strategy. Generally, the Company uses historical net selling prices to establish ESP. The Company regularly reviews its basis for establishing VSOE, TPE and ESP. The Company does not expect a material impact in the near term from changes in VSOE, TPE or ESP.

The adoption of the new revenue accounting guidance did not have a material impact on our revenues or results of operations for both the three and six months ended June 30, 2010. Total net revenues as reported and unaudited pro forma total net revenues that would have been reported during the three and six months ended June 30, 2010, if the transactions entered into or materially modified after December 31, 2009 were subject to previous accounting guidance, are shown in the following table (in thousands):

 

     Three
Months
Ended
June 30,
2010
   Six
Months
Ended

June 30,
2010

Net Revenues, As Reported

   $ 294,635    $ 570,789

Net Revenues, Pro Forma Basis

   $ 293,247    $ 568,072

The impact to total net revenues during the three and six months ended June 30, 2010, due to the adoption of the accounting guidance, was primarily attributable to net product revenues. Since the use of the residual method is eliminated under the new accounting standards, discounts offered by the Company are allocated to all deliverables, rather than being concentrated in the delivered element of the arrangement. This will generally result in an increase in the amount of upfront product revenue recognized and a decrease in services revenue recognized.

The new accounting standards for revenue recognition if applied in the same manner to the year ended December 31, 2009 would not have had a material impact on total net revenues for that fiscal year. The new accounting guidance for revenue recognition is not expected to have a significant effect on total net revenues after the initial period of adoption when applied to multiple-element arrangements based on current go-to-market strategies.

 

7


Table of Contents

POLYCOM, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

3. GOODWILL AND PURCHASED INTANGIBLES

The following table presents details of the Company’s goodwill by segment (in thousands):

 

     Video
Communications
Solutions
   Voice
Communications
Solutions
    Services     Total  

Balance at December 31, 2009

   $ 269,408    $ 135,204      $ 90,687      $ 495,299   

Foreign currency translation

     48      (4,245     (1,129     (5,326

Changes in fair value of assets acquired and liabilities assumed

     —        —          —          —     
                               

Balance at June 30, 2010

   $ 269,456    $ 130,959      $ 89,558      $ 489,973   
                               

The following table presents details of the Company’s total purchased intangible assets as of June 30, 2010 and December 31, 2009 (in thousands):

 

     June 30, 2010    December 31, 2009

Purchased Intangible Assets

   Gross
Value
   Accumulated
Amortization
and Impairment
    Net Value    Gross
Value
   Accumulated
Amortization
and Impairment
    Net Value

Core and developed technology

   $ 109,178    $ (87,970   $ 21,208    $ 109,178    $ (80,608   $ 28,570

Patents

     14,068      (14,068     —        14,068      (14,068     —  

Customer and partner relationships

     44,625      (34,934     9,691      44,625      (32,640     11,985

Trade name

     10,021      (5,857     4,164      10,021      (5,035     4,986

Other

     4,862      (4,087     775      4,862      (4,148     714
                                           

Total

   $ 182,754    $ (146,916   $ 35,838    $ 182,754    $ (136,499   $ 46,255
                                           

For the three and six months ended June 30, 2010, the Company recorded amortization expense related to purchased intangibles of $1.4 million and $2.9 million, respectively, which is included in “Amortization of purchased intangibles” in the condensed consolidated statement of operations. For the three and six months ended June 30, 2009, the company recorded amortization expense related to purchased intangibles of $1.4 million and $2.9 million, respectively, which is included in “Amortization of purchased intangibles” in the Condensed Consolidated Statement of Operations. The Company recorded approximately $3.3 million and $6.6 million during the three and six months ended June 30, 2010, respectively, of amortization of purchased intangibles to “Cost of product revenues” in the Condensed Consolidated Statement of Operations. The Company recorded approximately $3.4 million and $6.7 million during the three and six months ended June 30, 2009, respectively, of amortization of purchased intangibles to “Cost of product revenues” in the Condensed Consolidated Statement of Operations. Amortization of intangibles is not allocated to the Company’s segments.

The estimated future amortization expense of purchased intangible assets as of June 30, 2010 is as follows (in thousands):

 

Year ending December 31,

   Amount

Remainder of 2010

   $ 9,341

2011

     14,130

2012

     9,802

2013

     1,647
      

Total

   $ 34,920
      

Purchased intangibles include a purchased trade name intangible of $0.9 million with an indefinite life as the Company expects to generate cash flows related to this asset indefinitely. Consequently, this trade name is not amortized but is reviewed for impairment annually or sooner under certain circumstances.

4. RESTRUCTURING COSTS

The Company recorded $1.5 million and $0.4 million during the three months ended June 30, 2010 and 2009, respectively, and $3.3 million and $6.8 million during the six months ended June 30, 2010 and 2009, respectively, related to restructuring actions that are generally intended to streamline and focus the Company’s efforts and more properly align its cost structure with its projected revenue streams.

 

8


Table of Contents

POLYCOM, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

The following table summarizes the status of the Company’s restructure reserves (in thousands):

 

     Total  

Balance at December 31, 2009

   $ 5,783   

Additions to the reserve

     3,273   

Cash payments and other usage

     (5,843
        

Balance at June 30, 2010

   $ 3,213   
        

During the second quarter of 2010, the Company decided to eliminate or relocate additional positions to better align with the strategic investment plan. The Company recorded charges of approximately $1.5 million during the second quarter of 2010 as a result of these actions.

The Company committed to a restructuring plan in the third quarter of 2009 to realign and reinvest resources in the strategic growth areas of the business. The Company eliminated those positions that were not aligned with its new go-to-market structure in order to reallocate resources to growth areas. The plan included the elimination of approximately four percent of the Company’s global workforce. The Company recorded additional charges of approximately $1.7 million during the first quarter of 2010 as a result of the final notifications related to these actions.

The majority of the remaining severance-related cash expenditures are expected to be made by the end of 2010. The balance also includes approximately $0.8 million related to vacant facilities which will be paid out over the next two years unless the facility is subleased or disposed of earlier.

During the second quarter of 2009, the Company announced the elimination of approximately 20 finance and administrative positions as a result of consolidating certain function in its shared services center in Beijing, China. As a result of these actions, the Company recorded restructuring charges of $0.4 million during the three months ended June 30, 2009. During the first quarter of 2009, the Company eliminated certain positions throughout the Company amounting to approximately six percent of its global workforce and recorded restructuring charges totaling $6.4 million. This workforce reduction was designed to reduce the Company’s cost structure while maintaining flexibility to invest in the strategic growth areas of the business.

In July 2010, the Company’s management committed to a restructuring plan designed to reallocate its resources to more strategic growth areas of the business. The restructuring plan resulted in the elimination of approximately two percent of its global workforce with most of those reductions taking effect immediately, enabling the hiring of additional positions to better align with the execution of the Company’s strategic initiatives. The Company currently expects to record restructuring charges between approximately $3.5 million and $4.5 million in the third quarter of 2010 resulting from these actions, primarily related to severance and other employee termination benefits.

5. BALANCE SHEET DETAILS

Inventories are valued at the lower of cost or market with cost computed on a first-in, first-out (“FIFO”) basis. Consideration is given to obsolescence, excessive levels, deterioration and other factors in evaluating net realizable value. Inventories consist of the following (in thousands):

 

         June 30,     
2010
   December 31,
2009

Raw materials

   $ 6,634    $ 5,368

Work in process

     1,200      1,051

Finished goods

     84,126      70,444
             
   $ 91,960    $ 76,863
             

Deferred revenues consist of the following (in thousands):

 

         June 30,     
2010
   December 31,
2009

Short-term:

     

Service

   $ 85,647    $ 74,104

Product

     2,673      3,828

License

     1,400      1,572
             
   $ 89,720    $ 79,504
             

Long-term:

     

Service

   $ 39,885    $ 35,435

Product

     720      1,377

License

     9,275      9,975
             
   $ 49,880    $ 46,787
             

 

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POLYCOM, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

In February 2008, the Company, TANDBERG asa (“Tandberg”), Codian Ltd. (“Codian”) and certain of their respective affiliates entered into a settlement agreement to dismiss all litigation between the parties. Under the terms of the agreement, the Company received a lump-sum payment of $14.0 million, and will receive future patent royalties on the Codian MCU 4200 product shipped in the United States. The parties have also exchanged broad cross-licenses covering their respective business lines. The $14.0 million is being amortized to revenue over the license period of 10 years. The balance of $10.7 million at June 30, 2010 is included in Deferred License Revenue.

Other accrued liabilities consist of the following (in thousands):

 

     June 30,
2010
   December 31,
2009

Accrued expenses

   $ 14,932    $ 11,601

Accrued co-op expenses

     5,172      4,435

Restructuring and acquisition related reserves

     3,095      6,358

Warranty obligations

     9,672      9,447

Derivative liability

     7,409      5,840

Employee stock purchase plan withholding

     5,525      5,357

Other accrued liabilities

     8,016      9,322
             
   $ 53,821    $ 52,360
             

6. GUARANTEES

Warranty

The Company provides for the estimated costs of product warranties at the time revenue is recognized. The specific terms and conditions of those warranties vary depending upon the product sold. In the case of hardware manufactured by Polycom, warranties generally start from the delivery date and continue for one to three years depending on the product purchased. Software products generally carry a 90-day warranty from the date of shipment. The Company’s liability under warranties on software products is to provide a corrected copy of any portion of the software found not to be in substantial compliance with the agreed upon specifications. Factors that affect the Company’s warranty obligation include product failure rates, material usage and service delivery costs incurred in correcting product failures. The Company assesses the adequacy of its recorded warranty liabilities every quarter and makes adjustments to the liability if necessary.

Changes in the warranty obligation, which is included as a component of “Other accrued liabilities” on the condensed consolidated balance sheets, during the periods are as follows (in thousands):

 

     Three Months Ended     Six Months Ended  
     June 30,
2010
    June 30,
2009
    June 30,
2010
    June 30,
2009
 

Balance at beginning of period

   $ 9,061      $ 10,000      $ 9,447      $ 11,167   

Accruals for warranties issued during the period

     5,534        3,958        9,369        7,620   

Cost of providing warranty during the period

     (4,923     (4,718     (9,144     (9,547
                                

Balance at end of period

   $ 9,672      $ 9,240      $ 9,672      $ 9,240   
                                

 

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POLYCOM, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

Deferred Maintenance Revenue

The Company offers maintenance contracts for sale on most of its products which allow for customers to receive service and support in addition to, or subsequent to, the expiration of the contractual product warranty. The Company recognizes the maintenance revenue from these contracts over the life of the service contract.

Deferred maintenance revenue of $85.6 million and $74.1 million is short-term and is included as a component of “Deferred revenue” as of June 30, 2010 and December 31, 2009, respectively, and $39.9 million and $35.4 million is long-term and is included in “Long-term deferred revenue” as of June 30, 2010 and December 31, 2009, respectively, on the condensed consolidated balance sheets.

Changes in deferred maintenance revenue for the three and six months ended June 30, 2010 and 2009 are as follows (in thousands):

 

     Three Months Ended     Six Months Ended  
     June 30,
2010
    June 30,
2009
    June 30,
2010
    June 30,
2009
 

Balance at beginning of period

   $ 120,527      $ 96,097      $ 109,538      $ 91,971   

Additions to deferred maintenance revenue

     47,188        38,444        99,236        78,593   

Amortization of deferred maintenance revenue

     (42,183     (35,558     (83,242     (71,581
                                

Balance at end of period

   $ 125,532      $ 98,983      $ 125,532      $ 98,983   
                                

The cost of providing maintenance services for the three and six months ended June 30, 2010 was $23.7 million and $47.1 million, respectively. The cost of providing maintenance services for the three and six months ended June 30, 2009 was $18.7 million and $36.5 million, respectively.

Officer and Director Indemnifications

As permitted or required under Delaware law and to the maximum extent allowable under that law, the Company has certain obligations to indemnify its current and former officers and directors for certain events or occurrences while the officer or director is, or was serving, at the Company’s request in such capacity. The maximum potential amount of future payments the Company could be required to make under these indemnification obligations is unlimited; however, the Company has a director and officer insurance policy that mitigates the Company’s exposure and enables the Company to recover a portion of any future amounts paid. As a result of the Company’s insurance policy coverage, the Company believes the estimated fair value of these indemnification obligations is minimal.

Other Indemnifications

As is customary in the Company’s industry, as provided for in local law in the U.S. and other jurisdictions, the Company’s standard contracts provide remedies to its customers, such as defense, settlement, or payment of judgment for intellectual property claims related to the use of its products. From time to time, the Company indemnifies customers against combinations of loss, expense, or liability arising from various trigger events related to the sale and the use of its products and services. In addition, from time to time the Company also provides protection to customers against claims related to undiscovered liabilities, additional product liability or environmental obligations.

7. INVESTMENTS AND FAIR VALUE MEASUREMENTS:

The Company had cash and cash equivalents of $248.9 million and $331.1 million at June 30, 2010 and December 31, 2009, respectively. Cash and cash equivalents consist of cash in banks, as well as highly liquid investments in money market funds, time deposits, savings accounts, commercial paper, U.S. government securities, municipal securities and corporate debt securities. At June 30, 2010, the Company’s long-term investments had contractual maturities of one to two years.

 

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POLYCOM, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

In addition, the Company has short-term and long-term investments in debt and equity securities which are summarized as follows (in thousands):

 

     Cost Basis    Unrealized
Gains
   Unrealized
Losses
    Fair Value

Balances at June 30, 2010:

          

Investments—Short-term:

          

U.S. government securities

   $ 144,473    $ 53    $ (1   $ 144,525

Corporate debt securities

     48,399      33      (56     48,376

Corporate preferred equity securities

     14,789      577      (128     15,238
                            

Total investments – short-term

   $ 207,661    $ 663    $ (185   $ 208,139
                            

Investments—Long-term:

          

U.S. government securities

   $ 16,309    $ 50    $ (10 )   $ 16,349

Corporate debt securities

     11,919      10      (14 )     11,915
                            

Total investments – long-term

   $ 28,228    $ 60    $ (24 )   $ 28,264
                            

Balances at December 31, 2009:

          

Investments—Short-term:

          

U.S. government securities

   $ 64,151      12    $ (8   $ 64,155

Corporate debt securities

     19,569      7      (7     19,569

Corporate preferred equity securities

     48,698      22      (8,758     39,962
                            

Total investments – short-term

   $ 132,418    $ 41    $ (8,773   $ 123,686
                            

Investments—Long-term:

          

U.S. government securities

   $ 5,003    $ 64    $ —        $ 5,067

Corporate debt securities

     7,592      34      (6     7,620
                            

Total investments – long-term

   $ 12,595    $ 98    $ (6   $ 12,687
                            

As of June 30, 2010, the Company’s total cash and cash equivalents and investments held in the United States totaled $156.5 million with the remaining $328.8 million held outside of the United States in various foreign subsidiaries.

U.S. Government Securities

The Company’s U.S. government and agency securities are comprised of direct U.S. Treasury obligations and other U.S. government agency instruments, including mortgage backed securities which are guaranteed by the U.S. government. To ensure that our investment portfolio is sufficiently diversified, our investment policy requires that a certain percentage of our portfolio be invested in these types of securities.

Corporate Debt Securities

The Company’s corporate debt securities are comprised of publicly-traded domestic and foreign corporate debt securities. The Company does not purchase auction rate securities, and cash investments are in instruments that meet high quality credit rating standards, as specified in our investment policy guidelines. These guidelines also limit the amount of credit exposure to any one issuer or type of instrument.

Corporate Preferred Equity Securities

The Company’s corporate preferred equity securities are primarily comprised of investment-grade, non-convertible utility preferred stocks that are generally rated the equivalent of BBB or better by at least one of the major credit rating agencies. These corporate preferred equity securities were purchased as part of a capital gains capture program. This program also permitted the purchase of put options on U.S. Treasury bond futures as an interest rate hedge. The Company recently changed its strategy with respect to its capital gains capture program and has been actively liquidating these investments. During the three months ended June 30, 2010, the Company liquidated approximately $18.2 million of these investments, leaving a balance with a fair value of $15.2 million in its investment portfolio at June 30, 2010. The balance of these investments are expected to be liquidated by the end of 2010.

 

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POLYCOM, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

Unrealized Losses

The following table summarizes the fair value and gross unrealized losses of our investments, including those that are categorized as cash equivalents, with unrealized losses aggregated by type of investment instrument and length of time that individual securities have been in a continuous unrealized loss position as of June 30, 2010 and December 31, 2009 (in thousands):

 

     Less than 12 Months     12 Months or Greater    Total  
     Fair
Value
   Gross
Unrealized
Losses
    Fair
Value
   Gross
Unrealized
Losses
   Fair
Value
   Gross
Unrealized
Losses
 

June 30, 2010:

                

U.S. government securities

   $ 30,103    $ (11   $ —      $ —      $ 30,103    $ (11

Corporate debt securities

     35,559      (70     —        —        35,559      (70

Corporate preferred equity securities

     5,832      (128     —        —        5,832      (128
                                            

Total investments

   $ 71,494    $ (209   $ —      $ —      $ 71,494    $ (209
                                            

December 31, 2009:

                

U.S. government securities

   $ 17,910    $ (8   $ —      $ —      $ 17,910    $ (8

State and local governments

     1,528      (1     —        —        1,528      (1

Corporate debt securities

     31,489      (14     —        —        31,489      (14

Corporate preferred equity securities

     38,823      (8,758     —        —        38,823      (8,758
                                            

Total Investments

   $ 89,750    $ (8,781   $ —      $ —      $ 89,750    $ (8,781
                                            

The Company reviews the individual securities in its portfolio to determine whether a decline in a security’s fair value below the amortized cost basis is other than temporary. If the decline in fair value is considered to be other than temporary, the cost basis of the individual security is written down to its fair value as a new cost basis, and the amount of the write-down is accounted for as a realized loss and included in earnings. During the three months ended March 31, 2010, as a result of its change in strategy with respect to its capital gains program, the Company determined that certain corporate preferred equity securities were other-than temporarily impaired, which resulted in a write-down of approximately $6.5 million. The Company concluded that the impairment was other-than temporary based upon the Company’s decision to liquidate the securities in a relatively short period of time and an assessment of the individual holdings. During the three months ended June 30, 2010, the Company liquidated approximately $18.2 million of these investments and realized a gain of approximately $1.0 million. During the three months ended June 30, 2010, the Company determined that there were no investments in its portfolio that were other-than temporarily impaired.

Private Company Investments

For strategic reasons the Company has made various investments in private companies. The private company investments are carried at cost and written down to their estimated net realizable value when indications exist that these investments have been impaired. The cost of these investments at June 30, 2010 and December 31, 2009 was $2.5 million and $2.2 million, respectively, and are recorded in “Other assets” in our condensed consolidated balance sheets.

Fair Value Measurements

Fair value is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability. As the basis for considering such assumptions, a three-tier value hierarchy prioritizes the inputs used in measuring fair value as follows: (Level 1) observable inputs such as quoted prices in active markets; (Level 2) inputs other than the quoted prices in active markets that are observable either directly or indirectly; and (Level 3) unobservable inputs in which there is little or no market data, which require us to develop our own assumptions. This hierarchy requires us to use observable market data, when available, and to minimize the use of unobservable inputs when determining fair value. On a recurring basis, we measure certain financial assets and liabilities at fair value, including our marketable securities and foreign currency contracts.

The Company’s cash and investment instruments are classified within Level 1 or Level 2 of the fair value hierarchy because they are valued using inputs such as quoted market prices, broker or dealer quotations, or alternative pricing sources with reasonable levels of price transparency. The types of instruments valued based on quoted market prices in active markets include money market funds. Such instruments are generally classified within Level 1 of the fair value hierarchy.

 

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POLYCOM, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

The types of instruments valued based on other observable inputs include U.S. Treasury securities and other government agencies, corporate bonds, commercial paper, preferred stocks and puts on treasury bond futures. Such instruments are generally classified within Level 2 of the fair value hierarchy. Level 2 instruments are priced using quoted market prices for similar instruments or nonbinding market prices that are corroborated by observable market data. There have been no transfers between Level 1 and Level 2 during the three months ended June 30, 2010. The Company does not hold any investments classified as Level 3 as of June 30, 2010.

As of June 30, 2010, our fixed income available-for-sale securities include U.S. Treasury obligations and other government agency instruments (67%), corporate bonds (14%), commercial paper (17%) and money market funds (2%). Included in available-for- sale securities is approximately $65.7 million of cash equivalents, which consist of investments with original maturities of three months or less and include money market funds.

Our preferred equity available-for-sale securities represent preferred stocks and puts on treasury bond futures that were purchased as part of a capital gains capture program that generated capital gains to offset capital losses.

The principal market where we execute our foreign currency contracts is the retail market in an over-the-counter environment with a relatively high level of price transparency. The market participants and the Company’s counterparties are large money center banks and regional banks. The Company’s foreign currency contracts valuation inputs are based on quoted prices and quoted pricing intervals from public data sources such as spot rates, interest rate differentials and credit default rates, which do not involve management judgment. These contracts are typically classified within Level 2 of the fair value hierarchy. The fair value of the Company’s marketable securities and foreign currency contracts was determined using the following inputs at June 30, 2010 (in thousands):

 

          Fair Value Measurements at Reporting Date Using

(in thousands)

Description

   Total    Quoted Prices in Active
Markets for Identical
Assets
   Significant Other
Observable Inputs
          (Level 1)    (Level 2)

Assets:

        

Fixed Income available-for-sale
securities (a)

   $ 286,854    $ 5,018    $ 281,836

Preferred equity available-for-sale securities (a)

   $ 15,238      —      $ 15,238

Foreign currency forward contracts (b)

   $ 14,806      —      $ 14,806

Liabilities:

        

Foreign currency forward contracts (c)

   $ 7,409      —      $ 7,409

 

(a) Included in cash and cash equivalents and short and long-term investments on our consolidated balance sheet.
(b) Included in short-term derivative asset on our consolidated balance sheet.
(c) Included in short-term derivative liability on our consolidated balance sheet.

8. FOREIGN CURRENCY DERIVATIVES

The Company maintains a foreign currency risk management program that is designed to reduce the volatility of the Company’s economic value from the effects of unanticipated currency fluctuations. International operations generate both revenues and costs denominated in foreign currencies. The Company’s policy is to hedge significant foreign currency revenues and costs to improve margin visibility and reduce earnings volatility associated with unexpected changes in currency.

Non-Designated Hedges

The Company hedges its net foreign currency monetary assets and liabilities primarily resulting from foreign currency denominated revenues and expenses with foreign exchange forward contracts to reduce the risk that the Company’s earnings and cash flows will be adversely affected by changes in foreign currency exchange rates. These derivative instruments are carried at fair value with changes in the fair value recorded as interest and other income (expense), net. These derivative instruments do not subject the Company to material balance sheet risk due to exchange rate movements because gains and losses on these derivatives are intended to offset remeasurement gains and losses on the hedged assets and liabilities. The Company executes non-designated foreign exchange forward contracts primarily denominated in Euros, British Pounds and Israeli Shekels.

 

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POLYCOM, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

The following table summarizes the Company’s notional position by currency, and approximate U.S. dollar equivalent, at June 30, 2010 of the outstanding non-designated hedges (foreign currency and dollar amounts in thousands):

 

     Original Maturities
of 360 Days or Less
   Original Maturities
of Greater than 360 Days
     Foreign
Currency
   USD
Equivalent
   Positions    Foreign
Currency
   USD
Equivalent
   Positions

Euro

   8,298    $ 10,719    Buy    4,110    $ 5,768    Buy

Euro

   14,902    $ 19,346    Sell    11,100    $ 15,579    Sell

British Pound

   2,683    $ 4,238    Buy    3,019    $ 4,957    Buy

British Pound

   6,911    $ 10,429    Sell    3,300    $ 5,419    Sell

Israeli Shekel

   6,179    $ 1,650    Buy    10,443    $ 2,664    Buy

Israeli Shekel

   3,543    $ 915    Sell    —      $ —      —  

The following table shows the effect of the Company’s non-designated hedges in the condensed consolidated statement of operations for the six months ended June 30, 2010 and 2009 (in thousands):

 

Derivatives Not Designated as Hedging Instruments

  

Location of Gain or (Loss)

Recognized in Income on Derivative

   Amount of Gain or (Loss)
Recognized in Income on Derivative
 
          June 30, 2010    June 30, 2009  

Foreign exchange contracts

   Interest and other income (expense), net    $ 3,370    $ (755

Cash Flow Hedges

The Company’s foreign exchange risk management program objective is to reduce volatility in the Company’s economic value from unanticipated foreign currency fluctuations. The Company designates forward contracts as cash flow hedges of foreign currency revenues and expenses, primarily the Euro, British Pound and Israeli Shekel. All foreign exchange contracts are carried at fair value on the balance sheet and the maximum duration of foreign exchange forward contracts do not exceed thirteen months. Speculation is prohibited by policy.

To receive hedge accounting treatment under ASC 815, Derivatives and Hedging, all cash flow hedging relationships are formally designated at hedge inception, and tested both prospectively and retrospectively to ensure the forward contracts are highly effective in offsetting changes to future cash flows on the hedged transactions. The Company records effective spot to spot changes in these cash flow hedges in cumulative other comprehensive income (loss) until they are reclassified to revenue, cost of goods sold or operating expenses together with the hedged transaction. The time value on forward contracts is excluded from effectiveness testing and recorded to interest and other income (expense) over the life of the contract together with any ineffective portion of the hedge.

 

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Table of Contents

POLYCOM, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

The following tables show the effect of the Company’s derivative instruments designated as cash flow hedges in the condensed consolidated statements of operations for the six months ended June 30, 2010 and 2009 (in thousands):

 

Six Months Ended

June 30, 2010:

   Gain or  (Loss)
Recognized in
OCI—Effective
Portion
   

Location of Gain or (Loss)

Reclassified from OCI into

Income—Effective

Portion

   Gain or (Loss)
Reclassified
from OCI  into
Income—
Effective
Portion
   

Location of Gain or (Loss)

Recognized—
Ineffective Portion

and Amount Excluded
from

Effectiveness Testing

   Gain or (Loss)
Recognized—
Ineffective
Portion and
Amount
Excluded
from
Effectiveness
Testing (a)

Foreign exchange contracts

   $ 8,023      Product revenues    $ 2,743      Interest and other income (expense), net    $ 10

Foreign exchange contracts

     Cost of revenues      (136     

Foreign exchange contracts

     Sales and marketing      (740     

Foreign exchange contracts

     Research and development      252        

Foreign exchange contracts

     General and administrative      88        
                            

Total

   $ 8,023         $ 2,207         $ 10
                            

Six Months Ended

June 30, 2009:

                          

Foreign exchange contracts

   $ (1,348   Product revenues    $ 10,741      Interest and other income (expense), net    $ 158

Foreign exchange contracts

     Cost of revenues      (1,170     

Foreign exchange contracts

     Sales and marketing      (1,786     

Foreign exchange contracts

     Research and development      (2,565     

Foreign exchange contracts

     General and administrative      (1,297     
                            

Total

   $ (1,348      $ 3,923         $ 158
                            

 

(a) For the three months ended June 30, 2010, no loss or gain was recorded for the ineffective portion and a gain of less than $0.1 million was recorded for the excluded portion of the hedge. For the three months ended June 30, 2009, no loss or gain was recorded for the ineffective portion and a loss of less than $0.1 million was recorded for the excluded portion of the hedge.

As of June 30, 2010, the Company estimated all values reported in accumulated other comprehensive income (loss) will be reclassified to income within the next twelve months.

The following table summarizes the derivative-related activity in cumulative other comprehensive income (loss) (in thousands and not tax effected):

 

     Three Months Ended     Six Months Ended  
     June 30,
2010
    June 30,
2009
    June 30,
2010
    June 30,
2009
 

Beginning Balance

   $ 2,916      $ 1,954      $ (98   $ 3,567   

Net gains/losses reclassified into earnings for revenue hedges

     (3,202     (4,622     (2,743     (10,741

Net gains/losses reclassified into earnings for expense hedges

     1,480        2,987        536        6,818   

Net change in fair value of cash flow hedges

     4,524        (2,449     8,023        (1,774
                                

Ending Balance

   $ 5,718      $ (2,130   $ 5,718      $ (2,130
                                

 

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POLYCOM, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

In the event the underlying forecasted transaction does not occur, or it becomes probable that it will not occur, the related hedge gains and losses on the cash flow hedge would be immediately reclassified to interest and other income (expense) on the consolidated statement of operations. For the three and six months ended June 30, 2010, there were no such gains or losses. For the three and six months ended June 30, 2009, there were net gains of $0.4 million recognized in interest and other income (expense) relating to hedges of forecasted transactions that did not occur.

The following table summarizes the Company’s notional position by currency, and approximate U.S. dollar equivalent, at June 30, 2010 of the outstanding cash flow hedges, all of which are carried at fair value on the balance sheet (foreign currency and dollar amounts in thousands):

 

     Original Maturities
of 360 Days or Less
   Original Maturities
of Greater than 360 Days
     Foreign
Currency
   USD
Equivalent
   Positions    Foreign
Currency
   USD
Equivalent
   Positions

Euro

   3,906    $ 5,217    Buy    22,159    $ 30,144    Buy

Euro

   10,478    $ 13,707    Sell    61,164    $ 83,396    Sell

British Pound

   3,296    $ 5,080    Buy    18,451    $ 28,509    Buy

British Pound

   4,004    $ 6,124    Sell    21,923    $ 33,879    Sell

Israeli Shekel

   9,753    $ 2,561    Buy    50,770    $ 13,379    Buy

The estimates of fair value are based on applicable and commonly quoted prices and prevailing financial market information as of June 30, 2010 and 2009. See Note 7 for additional information on the fair value measurements for all financial assets and liabilities, including derivative assets and derivative liabilities that are measured at fair value in the condensed consolidated financial statements on a recurring basis.

The following table summarizes the outstanding foreign currency forward contracts that were entered into to hedge foreign currency exposures as of June 30, 2010 and December 31, 2009:

 

     As of June 30, 2010    As of December 31, 2009
          Notional Amount
(USD in thousands)
        Notional Amount
(USD in thousands)
     Number of
Contracts
   Designated    Non-Designated    Number of
Contracts
   Designated    Non-Designated

Buy EUR (Euro)

   12    $ 35,361    $ 16,488    10    $ 35,459    $ 13,129

Buy GBP (British Pound)

   12    $ 33,589    $ 9,196    11    $ 32,818    $ 6,187

Buy ILS (Israeli Shekel)

   12    $ 15,940    $ 4,313    11    $ 14,076    $ 3,862

Sell EUR (Euro)

   13    $ 97,103    $ 34,924    12    $ 90,601    $ 29,801

Sell GBP (British Pound)

   13    $ 40,002    $ 15,848    12    $ 35,686    $ 9,747

Sell ILS (Israeli Shekel)

   1    $ —      $ 915    0    $ —      $ —  
                                 

Total notional amount

      $ 221,995    $   81,684       $ 208,640    $   62,726
                                 

The following table shows the Company’s derivative instruments measured at gross fair value as reflected in the condensed consolidated balance sheet as of June 30, 2010 (in thousands):

 

     Fair Value of
Derivatives Designated
as Hedge Instruments
   Fair Value of Derivatives
Not Designated as Hedge
Instruments
     June 30,
2010
   December 31,
2009
   June 30,
2010
   December 31,
2009

Derivative assets (a):

           

Foreign exchange contracts

   $ 10,805    $ 2,413    $ 4,001    $ 1,763

Derivative liabilities (b):

           

Foreign exchange contracts

   $ 5,085    $ 2,519    $ 2,324    $ 3,321

 

(a) All derivative assets are recorded as prepaid and other current assets in the condensed consolidated balance sheets.
(b) All derivative liabilities are recorded as other accrued liabilities in the condensed consolidated balance sheets.

9. STOCKHOLDER’S EQUITY

Share Repurchase Program

From time to time, the Company’s Board of Directors has approved plans under which the Company may at its discretion purchase shares of its common stock in the open market. During the three and six months ended June 30, 2010, the Company purchased 0.6 million shares and 1.5 million shares, respectively, of common stock in the open market for cash of $20.0 million and $40.0 million, respectively. During the three and six months ended June 30, 2009, the Company purchased 0.4 million and 0.8 million shares, respectively, of common stock in the open market for cash of $7.4 million and $12.8 million, respectively. The purchase price for the shares of the Company’s stock repurchased is recorded as a reduction to stockholders’ equity. The Company allocates the purchase price of the repurchased shares as (i) a reduction to retained earnings until retained earnings are zero and then as an increase to accumulated deficit and (ii) a reduction of common stock and additional paid-in capital. As of June 30, 2010, the Company was authorized to purchase up to an additional $147.2 million of shares in the open market under the current share repurchase plan.

 

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POLYCOM, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

Comprehensive Income

The components of comprehensive income, net of tax, are as follows (in thousands):

 

     Three Months Ended     Six Months Ended  
     June 30,
2010
    June 30,
2009
    June 30,
2010
    June 30,
2009
 

Net income

   $ 12,604      $ 15,325      $ 18,015      $ 23,350   

Change in unrealized gain (loss) on investments

     401        (2,028     5,961        (3,769

Change in cumulative translation adjustment

     (4,246     2,715        (7,081     (84

Change in unrealized gain (loss) on hedging securities

     2,803        (4,084     5,817        (5,697
                                

Comprehensive income

   $ 11,562      $ 11,928      $ 22,712      $ 13,800   
                                

10. STOCK BASED EMPLOYEE BENEFIT PLANS

Stock-Based Compensation Expense

The following table summarizes stock-based compensation expense recorded for the three and six months ended June 30, 2010 and 2009 and its allocation within the condensed consolidated statement of operations (in thousands):

 

     Three Months Ended    Six Months Ended
     June 30,
2010
   June 30,
2009
   June 30,
2010
   June 30,
2009

Cost of sales – product

   $ 588    $ 421    $ 1,358    $ 969

Cost of sales – service

     959      617      2,138      1,370
                           

Stock-based compensation expense included in cost of sales

     1,547      1,038      3,496      2,339
                           

Sales and marketing

     7,272      2,611      13,563      4,511

Research and development

     2,367      1,888      5,449      3,761

General and administrative

     2,607      1,602      5,104      3,477
                           

Stock-based compensation expense included in operating expenses

     12,246      6,101      24,116      11,749
                           

Stock-based compensation related to employee equity awards and employee stock purchases

     13,793      7,139      27,612      14,088

Tax benefit

     3,102      1,763      5,838      3,399
                           

Stock-based compensation expense related to employee equity awards and employee stock purchases, net of tax

   $ 10,691    $ 5,376    $ 21,774    $ 10,689
                           

No stock-based compensation was capitalized during the three and six months ended June 30, 2010 and 2009 due to these amounts being immaterial.

Valuation Assumption

The Company did not grant any stock options during the three and six months ended June 30, 2010 and 2009. The weighted-average estimated fair value of employee stock purchase rights granted pursuant to the Employee Stock Purchase Plan during the three and six months ended June 30, 2010 was $5.89 per share and during both the three months and six months ended June 30, 2009 was $4.44 per share, respectively. The fair value of each employee stock purchase right grant is estimated on the date of grant using the Black-Scholes option valuation model and is recognized as expense using the graded vesting attribution approach using the following assumptions:

 

     Three Months Ended     Six Months Ended  
     June 30,
2010
    June 30,
2009
    June 30,
2010
    June 30,
2009
 

Expected volatility

   37.88   58.52   37.88   58.52

Risk-free interest rate

   0.17   0.39   0.17   0.39

Expected dividends

   0.0   0.0   0.0   0.0

Expected life (yrs)

   0.49      0.50      0.49      0.50   

 

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POLYCOM, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

The Company used the implied volatility for one-year traded options on the Company’s stock as the expected volatility assumption required in the Black-Scholes model. The selection of the implied volatility assumption was based upon the availability of actively traded options in the Company’s stock and the Company’s assessment that implied volatility is more representative of future stock price trends than historical volatility.

The risk-free interest rate assumption is based upon observed interest rates appropriate for the expected life of the Company’s employee stock purchases.

The dividend yield assumption is based on the Company’s history of not paying dividends and the resultant future expectation of dividend payouts.

As the stock-based compensation expense recognized in the condensed consolidated statement of operations for the three and six months ended June 30, 2010 and 2009 is based on awards ultimately expected to vest, such amounts have been reduced for estimated forfeitures. Forfeitures are estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. During the first quarter of 2010, the Company performed its annual review of assumptions, including historical experience and expectations of the future, and concluded that the forfeiture rate for restricted stock units should be reduced from 15% to 10%. The cumulative effect of the change on all unvested restricted stock units of approximately $1.0 million was recognized during the first quarter of 2010.

Performance Shares and Restricted Stock Units

The Compensation Committee of the Board of Directors may also grant performance shares and restricted stock units under the 2004 Plan to officers, to non-employee directors and to certain other employees as a component of the Company’s broad-based equity compensation program. Performance shares represent a commitment by the Company to deliver shares of Polycom common stock at a future point in time, subject to the fulfillment by the Company of pre-defined performance criteria. Such awards will be earned only if performance goals over the performance periods established by or under the direction of the Compensation Committee are met. The number of performance shares subject to vesting is determined at the end of a given performance period. Generally, if the performance criteria are deemed achieved, performance shares will vest from one to three years from the anniversary of the grant date. Restricted stock units are time-based awards that generally vest over a period of one to three years from the date of grant.

During the six months ended June 30, 2010, the Company granted 94,500 performance shares, at a weighted average fair value of $22.74 per share, which contain a performance condition based on attaining pre-defined gross margin dollar goals for calendar 2010. The performance shares will be delivered in common stock at the end of the one year vesting period based on the Company’s actual performance compared to the target performance criteria and may equal from zero percent (0%) to two hundred (200%) of the target award. The fair value of these performance shares is based on the closing market price of the Company’s common stock on the date of award.

Commencing in 2009, the Company granted performance shares which contain a market condition based on Total Shareholder Return (TSR) and which measure the Company’s relative performance against the Russell 2000 Index. The performance shares will be delivered in common stock at the end of the vesting period based on the Company’s actual performance compared to the target performance criteria and may equal from zero percent (0%) to two hundred (200%) of the target award. The fair value of a performance share with a market condition is estimated on the date of award, using a Monte Carlo simulation model to estimate the total return ranking of the Company’s stock among the Russell 2000 Index companies over each performance period. During the six months ended June 30, 2010 and 2009, the Company granted target performance shares of 463,031 and 440,115, respectively. The 2009 grants are evenly divided over three annual performance periods commencing with calendar 2009, at a weighted average fair value of $16.16 per share. The 2010 grants are evenly divided over three annual performance periods commencing with calendar 2010, at a weighted average fair value of $29.75 per share. Stock-based compensation expense for these performance shares is recognized using the graded vesting method over the three year service period.

         In addition, in 2009 the Company also granted 125,000 target performance shares, at a fair value of $23.59, which were subject to the fulfillment by the Company of certain pre-defined market share performance criteria and additionally, for a portion of the awards, attainment of pre-defined revenue goals, over multiple performance periods. On June 9, 2010, the independent members of the board of directors approved amendments to these equity awards for the remaining performance periods that commence on or after July 1, 2010. For the remaining performance periods, the performance shares will be delivered in common stock at the end of the vesting period based on the Company’s actual performance compared to the target performance criteria and may equal from zero percent (0%) to two hundred (200%) of the target award. The fair value of a performance share with a market condition is estimated on the date of award, using a Monte Carlo simulation model to estimate the total return ranking of the Company’s stock among the Russell 2000 Index companies over each performance period. As a result of these amendments, the Company will recognize incremental stock compensation expense prospectively using a graded vesting method over the remaining requisite service period totaling $3.4 million.

 

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POLYCOM, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

During the six months ended June 30, 2010 and 2009, the Company also granted 1,393,041 and 1,104,950 restricted stock units at a weighted average fair value of $24.65 and $13.74 per share, respectively. The fair value of restricted stock units is based on the closing market price of the Company’s common stock on the date of award. The awards generally vest over one or three years in equal annual installments on each anniversary of the date of grant and will be delivered in common stock at the end of each vesting period. Stock-based compensation expense for these restricted stock units is recognized using the graded vesting method.

Non-employee directors currently receive annual awards of restricted stock units. The restricted stock units vest quarterly over one year from the date of grant. The fair value of these awards is the fair market value of the Company’s common stock on the date of grant. Stock-based compensation expense for these awards is generally amortized over six months from the date of grant due to voluntary termination provisions contained in the underlying agreements.

Employee Stock Purchase Plan

During the six months ended June 30, 2010 and 2009, 339,843 and 513,946 shares were purchased at average per share prices of $19.07 and $11.94, respectively. At June 30, 2010, there were 2,403,662 shares available to be issued under the employee stock purchase plan. The stock-based compensation cost recognized in connection with the employee stock purchase plan for the three and six months ended June 30, 2010 was $1.0 million and $2.0 million, respectively, and $1.1 million and $2.1 million for the three and six months ended June 30, 2009, respectively.

11. COMPUTATION OF NET INCOME PER SHARE

Basic net income per share is computed by dividing net income by the weighted average number of common shares outstanding for the period. Diluted net income per share reflects the additional dilution from potential issuances of common stock, such as stock issuable pursuant to the exercise of outstanding stock options or the conversion of preferred stock to common stock. Potentially dilutive shares are excluded from the computation of diluted net income per share when their effect is antidilutive.

A reconciliation of the numerator and denominator of basic and diluted net income per share is provided as follows (in thousands except per share amounts):

 

     Three Months Ended    Six Months Ended
     June 30,
2010
   June 30,
2009
   June 30,
2010
   June 30,
2009

Numerator—basic and diluted net income per share:

           

Net income

   $ 12,604    $ 15,325    $ 18,105    $ 23,350
                           

Denominator—basic and diluted net income per share:

           

Weighted average shares used to compute basic net income per share

     85,158      83,753      84,911      83,689

Effect of dilutive common stock equivalents:

           

Stock options to purchase common stock

     948      373      927      215

Restricted common stock awards and performance shares

     2,138      928      1,966      748
                           

Total shares used in calculation of diluted net income per share

     88,244      85,054      87,804      84,652
                           

Basic net income per share

   $ 0.15    $ 0.18    $ 0.21    $ 0.28
                           

Diluted net income per share

   $ 0.14    $ 0.18    $ 0.21    $ 0.28

Diluted shares outstanding include the dilutive effect of in-the-money options which is calculated based on the average share price for each fiscal period using the treasury stock method. Under the treasury stock method, the amount that the employee must pay for exercising stock options, the amount of compensation cost for future services that the Company has not yet recognized, and the amount of tax benefit that would be recorded in additional paid-in capital when the award becomes deductible are assumed to be used to repurchase shares. For the three and six months ended June 30, 2010, approximately 0.8 million and 0.9 million shares, respectively, and for the three and six months ended June 30, 2009, approximately 6.0 million and 8.7 million shares, respectively, relating to potentially dilutive securities, primarily from stock options, were excluded from the denominator in the computation of diluted net income per share because their inclusion would be anti-dilutive.

12. BUSINESS SEGMENT INFORMATION

Polycom is a leading global provider of a line of high-quality, easy-to-use communications equipment that enables businesses, telecommunications service providers, and governmental and educational institutions to more effectively conduct video, voice, data and web communications. The Company’s offerings are organized along three product categories: Video Communications Solutions,

 

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POLYCOM, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

Voice Communications Solutions and Services, which are also considered its segments for reporting purposes. The segments are determined in accordance with how management views and evaluates the Company’s business and based on the criteria as outlined in the authoritative guidance. A description of the types of products and services provided by each reportable segment is as follows:

Video Communications Solutions Segment

Video Communications Solutions includes a wide range of video conferencing collaboration products from entry level to professional high definition and telepresence products to meet the needs of any meeting room, from small offices to large boardrooms and auditoriums. This segment also includes products that provide a broad range of network infrastructure hardware and software to facilitate video, voice and data conferencing and collaboration to businesses, telecommunications service providers, and governmental and educational institutions.

Voice Communications Solutions Segment

Voice Communications Solutions includes a wide range of voice communications products that enhance business communications in the conference room, on the desktop and in mobile applications.

Services Segment

Service is comprised of a wide range of service and support offerings to resellers and directly to some end-user customers. The Company’s service offerings include: maintenance programs; integration services consisting of consulting, education, design and project management services; consulting services consisting of planning and needs analysis for end-users; design services, such as room design and custom solutions; and project management, installation and training.

Segment Revenue and Contribution Margin

Segment contribution margin includes all product line segment revenues less the related cost of sales, direct marketing and direct engineering expenses. Management allocates corporate manufacturing costs and some infrastructure costs such as facilities and information technology costs in determining segment contribution margin. Contribution margin is used, in part, to evaluate the performance of, and allocate resources to, each of the segments. Certain operating expenses are not allocated to segments because they are separately managed at the corporate level. These unallocated costs include sales costs, marketing costs other than direct marketing, general and administrative costs, such as legal and accounting, stock-based compensation expenses, acquisition-related integration costs, amortization and impairment of purchased intangible assets, restructuring costs, interest and other income (expense), net.

Segment Data

The results of the reportable segments are derived directly from Polycom’s management reporting system. The results are based on Polycom’s method of internal reporting and are not necessarily in conformity with accounting principles generally accepted in the United States. Management measures the performance of each segment based on several metrics, including contribution margin.

Asset data, with the exception of inventory, is not reviewed by management at the segment level. All of the products and services within the respective segments are generally considered similar in nature, and therefore a separate disclosure of similar classes of products and services below the segment level is not presented.

 

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POLYCOM, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

Financial information for each reportable segment is as follows as of and for the three and six months ended June 30, 2010 and 2009 (in thousands):

 

     Video
Communications
Solutions
   Voice
Communications
Solutions
   Services    Total

For the three months ended June 30, 2010:

           

Revenue

   $ 154,236    $ 90,559    $ 49,840    $ 294,635

Contribution margin

     72,816      40,185      21,789      134,790

As of June 30, 2010: Inventories

     47,493      29,830      14,637      91,960

For the three months ended June 30, 2009:

           

Revenue

   $ 126,820    $ 61,599    $ 42,272    $ 230,691

Contribution margin

     59,024      22,750      20,539      102,313

As of June 30, 2009: Inventories

     37,285      25,526      15,606      78,417

For the six months ended June 30, 2010

           

Revenue

   $ 302,561    $ 170,291    $ 97,937    $ 570,789

Contribution margin

     143,407      75,885      42,938      262,230

For the six months ended June 30, 2009

           

Revenue

   $ 248,677    $ 123,036    $ 84,388    $ 456,101

Contribution margin

     115,546      46,158      40,046      201,750

The reconciliation of segment information to Polycom consolidated totals is as follows (in thousands):

 

     Three Months Ended     Six Months Ended  
     June 30,
2010
    June 30,
2009
    June 30,
2010
    June 30,
2009
 

Segment contribution margin

   $ 134,790      $ 102,313      $ 262,230      $ 201,750   

Corporate and unallocated costs

     (97,478     (68,491     (189,099     (138,875

Stock-based compensation

     (13,793     (7,139     (27,612     (14,088

Effect of stock-based compensation cost on warranty expense

     (112     (74     (233     (186

Amortization of purchased intangibles

     (4,733     (4,782     (9,536     (9,579

Restructuring costs

     (1,524     (427     (3,273     (6,844

Litigation reserves and payments

     (1,235     —          (1,235     —     

Interest and other income (expense), net

     357        (1,077     (8,224     (1,358
                                

Income before provision for income taxes

   $ 16,272      $ 20,323      $ 23,018      $ 30,820   
                                

13. INCOME TAXES

The Company’s overall effective tax rate for the three and six months ended June 30, 2010 was 22.5% and 21.7%, respectively, which resulted in a provision for income taxes of $3.7 million and $5.0 million, respectively. The effective tax rate for the three and six months ended June 30, 2009 was 24.6% and 24.2%, respectively, which resulted in a provision for income taxes of $5.0 million and $7.5 million, respectively. The decrease in the effective tax rate for the three and six months ended June 30, 2010 as compared to the same periods in 2009 was primarily related to a relative increase in foreign earnings in 2010 which are subject to lower tax rates, partially offset by the benefit of the federal research and development tax credit which is reflected in the tax rate in 2009, but not included in the 2010 tax rate due to the expiration of the federal research tax credit for amounts paid or incurred after December 31, 2009. Also offsetting the benefit of the increase in foreign earnings in 2010 as compared to 2009 was a relative increase in non-deductible stock compensation in 2010 as compared to 2009.

During the three and six months ended June 30, 2010, tax related reserves decreased by $1.4 million and $5.4 million, respectively. The decrease for the three months ended June 30, 2010 was primarily related to releases of $0.2 million due to the lapse of the statutes of limitation in certain jurisdictions, $0.8 million due to payments made for the settlement of a California Franchise Tax Board audit, and $0.4 million due to movements in foreign exchange rates. The decrease for the six months ended June 30, 2010 was primarily due to the release of $3.4 million related to the cost sharing among legal entities of stock-based compensation which was released as an adjustment to stockholders’ equity, releases of $0.9 million due to the lapse of statutes of limitation in certain jurisdictions, $0.8 million due to payments made for the settlement of a California Franchise Tax Board audit, and $0.7 million due to movements in foreign exchange rates, partially offset by additional reserves of $0.4 million during the period.

 

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POLYCOM, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

In the three months ended June 30, 2009, we released $9.8 million in tax related reserves to additional paid in capital due to the lapse of statutes of limitation in the U.S., and $0.1 million in tax reserves due to the lapse of a statute of limitation in a foreign jurisdiction. Offsetting the reserve releases was an increase to the tax reserves of $0.8 million related to movement in foreign exchange rates during the quarter. In the six months ended June 30, 2009, an additional reserve release of $0.9 million was recorded in the first quarter related to statute expirations.

As of June 30, 2010, the Company has $39.0 million of unrecognized tax benefits compared to $45.8 million at June 30, 2009. The Company anticipates that except for $1.4 million in uncertain tax positions that may be reduced related to the lapse of various statutes of limitation, there will be no material changes in uncertain tax positions in the next 12 months.

The Company recognizes interest and/or penalties related to income tax matters in income tax expense. As of June 30, 2010 and 2009, the Company had approximately $3.4 million and $4.0 million, respectively, of accrued interest and penalties related to uncertain tax positions.

 

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Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

YOU SHOULD READ THE FOLLOWING DISCUSSION AND ANALYSIS IN CONJUNCTION WITH OUR CONDENSED CONSOLIDATED FINANCIAL STATEMENTS AND RELATED NOTES. EXCEPT FOR HISTORICAL INFORMATION, THE FOLLOWING DISCUSSION CONTAINS FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF SECTION 27A OF THE SECURITIES ACT OF 1933 AND SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934. WHEN USED IN THIS REPORT, THE WORDS “MAY,” “BELIEVE,” “COULD,” “ANTICIPATE,” “WOULD,” “MIGHT,” “PLAN,” “EXPECT,” “WILL,” “INTEND,” “POTENTIAL,” AND SIMILAR EXPRESSIONS OR THE NEGATIVE OF THESE TERMS ARE INTENDED TO IDENTIFY FORWARD-LOOKING STATEMENTS. THESE FORWARD-LOOKING STATEMENTS, INCLUDING, AMONG OTHER THINGS, STATEMENTS REGARDING OUR ANTICIPATED PRODUCTS, CUSTOMER AND GEOGRAPHIC REVENUE LEVELS AND MIX, GROSS MARGINS, OPERATING COSTS AND EXPENSES AND OUR CHANNEL INVENTORY LEVELS, INVOLVE RISKS AND UNCERTAINTIES. OUR ACTUAL RESULTS MAY DIFFER SIGNIFICANTLY FROM THOSE PROJECTED IN THE FORWARD-LOOKING STATEMENTS. FACTORS THAT MIGHT CAUSE FUTURE RESULTS TO DIFFER MATERIALLY FROM THOSE DISCUSSED IN THE FORWARD-LOOKING STATEMENTS INCLUDE, BUT ARE NOT LIMITED TO, THOSE DISCUSSED IN “RISK FACTORS” IN THIS DOCUMENT, AS WELL AS OTHER INFORMATION FOUND IN THE DOCUMENTS WE FILE FROM TIME TO TIME WITH THE SECURITIES AND EXCHANGE COMMISSION, INCLUDING THE ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 2009.

Overview

We are a leading provider of high-quality, easy-to-use unified communications (UC) solutions that enable enterprise, government, education, and healthcare customers to collaborate more effectively. Our solutions are built on architectures that enable unified video, voice, and content collaboration. Polycom uses open standards and removes distance and organizational barriers to enable dispersed work teams to easily meet and collaborate via the video or voice communications devices they choose, bringing people together efficiently and increasing productivity. Our business operates in three segments: Video Communications Solutions, Voice Communications Solutions, and Services.

Important drivers for the adoption of Polycom UC solutions include:

 

   

the return on investment (ROI) achieved through productivity gains resulting from faster decision-making and the reduction in travel costs,

 

   

significant improvement in quality of customer experience through our immersive telepresence and high definition video and voice solutions,

 

   

ease of connectivity through business-to-business and emerging cloud-based solutions,

 

   

the need for business continuity solutions, and

 

   

environmental or “green” benefits of using Polycom’s solutions.

Based on these drivers and Polycom’s increasingly unique position as a large independent collaboration solutions provider, we launched a strategic investment plan in the fourth quarter of 2009 intended to capture a strong position in the growing UC collaboration market. We believe Polycom has the opportunity to serve in a pivotal role in the broader communications ecosystem to provide an integrated collaboration solution, regardless of which call management or presence-based solution a particular customer has adopted. We are now executing on five core strategic initiatives to capture the collaboration market opportunity and to optimize our position as the partner of choice for global communications providers and as the provider of choice for our customers. These initiatives include:

 

   

enhancements to our go-to-market capability;

 

   

building our strategic partnerships with companies such as Avaya, Broadsoft, Hewlett-Packard, IBM, Juniper, Microsoft and Siemens;

 

   

focusing on service providers’ enhanced sell-through, as well as developing specific products and services to support their growing offerings in the managed and hosted space;

 

   

further innovation surrounding our telepresence products and other solutions; and

 

   

expansion of our professional services practice.

 

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Table of Contents

Revenues for the three and six months ended June 30, 2010 were $294.6 million and $570.8 million, respectively, as compared to $230.7 million and $456.1 million for the three and six months ended June 30, 2009, respectively. The increase in revenues primarily reflects an increase in sales volumes of our voice communications and video communication solutions products, and to a lesser extent an increase in service revenues. Global economic conditions negatively impacted our revenues in 2009, particularly in our Voice Communications Solutions segment. Our revenues increased sequentially across many of our product lines and geographies and we also experienced strong year-over-year growth in both the second quarter and first half of 2010 across all our product lines and geographies. Despite the recent signs of stabilization, we continue to be cautious about our future outlook in light of the global economic climate.

During the six months ended June 30, 2010, we generated approximately $60.9 million in cash flow from operating activities, which after the impact of investing and financing activities described in further detail under “Liquidity and Capital Resources,” resulted in an $82.2 million net decrease in our total cash and cash equivalents.

Our Video Communications Solutions, Voice Communications Solutions and Services segments accounted for 52%, 31% and 17%, respectively, of our revenues during the three months ended June 30, 2010, compared with 55%, 27% and 18%, respectively, of our revenues in the three months ended June 30, 2009. Our Video Communications Solutions, Voice Communications Solutions and Services segments accounted for 53%, 30% and 17%, respectively, of our revenues during the six months ended June 30, 2010, compared with 55%, 27% and 18%, respectively, of our revenues in the six months ended June 30, 2009. See Note 12 of Notes to Condensed Consolidated Financial Statements for further information on our segments, including a summary of our segment revenues, segment contribution margin and segment inventory.

The discussion of results of operations at the consolidated level is followed by a discussion of results of operations by segment for the three and six months ended June 30, 2010 and 2009.

Results of Operations for the Three and Six Months Ended June 30, 2010 and 2009

The following table sets forth, as a percentage of revenues, condensed consolidated statements of operations data for the periods indicated.

 

     Three Months Ended     Six Months Ended  
     June 30,
2010
    June 30,
2009
    June 30,
2010
    June 30,
2009
 

Revenues:

        

Product revenues

   83   82   83   81

Service revenues

   17   18   17   19
                        

Total revenues

   100   100   100   100

Cost of revenues:

        

Cost of product revenues as a % of product revenues

   40   43   41   43

Cost of service revenues as a % of service revenues

   50   46   50   47
                        

Total cost of revenues

   42   43   42   44
                        

Gross profit

   58   57   58   56
                        

Operating expenses:

        

Sales and marketing

   32   29   32   29

Research and development

   12   12   12   12

General and administrative

   7   6   6   6

Amortization of purchased intangibles

   1   1   1   1

Restructuring costs

   1   0   1   1

Litigation reserves and payments

   0   0   0   0
                        

Total operating expenses

   53   48   52   49
                        

Operating income

   5   9   6   7

Interest and other income (expense), net

   0   0   (2 )%    0
                        

Income before provision for income taxes

   5   9   4   7

Provision for income taxes

   1   2   1   2
                        

Net income

   4   7   3   5
                        

Revenues

 

     Three Months Ended          Six Months Ended       

$ in thousands

   June 30,
2010
   June 30,
2009
   Increase     June 30,
2010
   June 30,
2009
   Increase  

Video Communications Solutions

   $ 154,236    $ 126,820    22   $ 302,561    $ 248,677    22

Voice Communications Solutions

   $ 90,559    $ 61,599    47   $ 170,291    $ 123,036    38

Services

   $ 49,840    $ 42,272    18   $ 97,937    $ 84,388    16
                                        

Total Revenues

   $ 294,635    $ 230,691    28   $ 570,789    $ 456,101    25
                                        

Total revenues for the three months ended June 30, 2010 were $294.6 million, an increase of $63.9 million, or 28%, over the same period in 2009. Total revenues for the six months ended June 30, 2010 were $570.8 million, an increase of $114.7 million, or

 

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25% over the same period in 2009. The increase in revenues in both the three and six month periods primarily reflects an increase in sales volumes of our voice communications products and our video communications solutions, and to a lesser extent an increase in service revenues.

Video Communications Solutions segment revenues include revenues from sales of our video communications and network systems product lines. Revenue from video communications products increased to $127.4 million for the three months ended June 30, 2010 from $105.1 million in the year ago period, a 21% increase. Revenue from video communications products increased to $245.6 million for the six months ended June 30, 2010 from $206.6 million in the year ago period, a 19% increase. The revenue increase in the three and six month periods was primarily due to an increase in sales volumes of our HDX® product family and new video communications products, such as our Polycom® CX5000 unified conference station, QDX 6000™ video conferencing system and VVX™ 1500 business media phone, partially offset by decreases in sales volumes of our VSX® product family due to the transition to HD products. While we experienced strong revenue growth in our immersive telepresence products both sequentially and year-over-year in the second quarter of 2010, revenues from our immersive telepresence products in the first six months of 2010 were down year-over-year as revenue recognized in any given period will fluctuate depending on a number of factors, including the size and timing of orders, customer request dates and timing of product acceptance where contractually required. Revenues from our network systems products for the three months ended June 30, 2010 were $26.8 million, up 23% from revenues of $21.8 million in the comparable 2009 period. Network systems product revenues for the six months ended June 30, 2010 were $56.9 million, up 35% from revenues of $42.1 million in the comparable 2009 period. The revenue increase is primarily due to increases in our video network systems revenues, which were driven primarily by the introduction of new products and enhancements to existing products. While we experienced strong year-over-year revenue growth in our network systems products, our network systems product revenues declined sequentially in the second quarter of this year following a seasonally down first quarter. During the third quarter of 2010, we have taken a number of actions surrounding our sales compensation incentives, increased technical support for our sales force and training and marketing around the capabilities of our network systems product portfolio, which are aimed at driving increased network system revenues.

Voice Communications Solutions product revenues increased in both the three and six months as compared to the comparable year ago periods primarily due to increased sales volumes of our voice communications products, including our Voice-over-IP, circuit-switched, wireless and installed voice product lines. Revenues from our Voice Communications Solutions declined year-over-year from the fourth quarter of 2008 through the second quarter of 2009. We believe these declines were primarily a result of the global economic climate and that this business is now improving as the economy improves. In the third quarter of 2009, we experienced sequential growth for the first time since the second quarter of 2008. We have continued to experience sequential growth since that time, including 14% sequential growth in the most recent quarter.

Services revenues increased in the both the three and six month periods as compared to the comparable year ago periods primarily due to increases in video-related services, and to a lesser extent, increased network systems-related services, partially offset by a decrease in voice-related services.

International revenues, defined as revenues outside of the U.S. and Canada, accounted for 51% and 46% of total revenues for the three month periods ended June 30, 2010 and 2009, respectively, and 50% and 47% for the six months ended June 30, 2010 and 2009, respectively. On a regional basis, North America, EMEA, Asia Pacific and Latin America accounted for 49%, 25%, 22% and 4%, respectively, of our total revenues for the three months ended June 30, 2010 and 50%, 25%, 21% and 4%, respectively, of our total revenues for the six months ended June 30, 2010. North America, EMEA, Asia Pacific and Latin America revenues increased 16%, 33%, 50% and 66%, respectively, in the three months ended June 30, 2010, over the comparable 2009 period. North America, EMEA, Asia Pacific and Latin America revenues increased 16%, 25%, 44% and 77%, respectively, in the six months ended June 30, 2010, over the comparable 2009 period. Revenue increases across these geographic regions were across all three of our segments, except for North America which experienced decreases in video communications solutions product revenues during the three months ended June 30, 2010 as compared to the comparable 2009 period.

During the three months ended June 30, 2010, one channel partner accounted for 13% of our total net revenues, 10% of our Video Communications Solutions segment revenues and 19% of our Voice Communications Solutions segment revenues. In addition, during the three months ended June 30, 2010, a second channel partner accounted for 10% of our Voice Communications Solutions segment revenues. During the six months ended June 30, 2010, one channel partner accounted for 13% of our total net revenues, 12% of our Video Communications Solutions segment revenues and 18% of our Voice Communications Solutions segment revenues. No one customer accounted for more than 10% of our Services segment revenues during the three and six months ended June 30, 2010. During the three months ended June 30, 2009, one channel partner accounted for 11% of our total net revenues, 11% of our Video Communications Solutions segment revenues and 16% of our Voice Communications Solutions segment revenues. During the six months ended June 30, 2009, one channel partner accounted for 10% of our total net revenues, 11% of our Video Communications Solutions segment revenues and 13% of our Voice Communications Solutions segment revenues. No one customer accounted for more than 10% of our Services segment revenues during the three and six months ended June 30, 2009. We believe it is unlikely that the loss of any of our channel partners would have a long term material adverse effect on our consolidated net revenues or segment net revenues as we believe end-users would likely purchase our products from a different channel partner. However, a loss of any one of these channel partners could have a material adverse impact during the transition period.

 

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We typically ship products within a short time after we receive an order and, therefore, we do not consider backlog to be a good indicator of future revenues as it represents only a small portion of our current quarter’s revenue. As of June 30, 2010, we had $64.2 million of order backlog as compared to $52.1 million at June 30, 2009. We include in backlog open product orders which we expect to ship or service orders which we expect to bill and for which we expect to record revenue in the following quarter. Once billed, unrecorded service revenue is included in deferred revenue until earned. We believe that the current level of backlog will continue to fluctuate primarily as a result of the level and timing of orders received and customer delivery dates requested outside of the quarter. The level of backlog at any given time is also dependent in part on our ability to forecast revenue mix and plan our manufacturing accordingly and ongoing service deferrals as service revenues increase as a percent of total revenue. In addition, orders from our channel partners are based in part on the level of demand from end-user customers. Any decline or uncertainty in end-user demand could negatively impact end-user orders, which in turn could negatively affect orders from our channel partners in any given quarter. As a result, our backlog could decline from its current levels.

Cost of Revenues and Gross Margins

 

     Three Months Ended           Six Months Ended        

$ in thousands

   June 30,
2010
    June 30,
2009
    Increase/
(Decrease)
    June 30,
2010
    June 30,
2009
    Increase/
(Decrease)
 

Product Cost of Revenues

   $ 99,001      $ 80,483      23   $ 191,550      $ 158,490      21

% of Product Revenues

     40     43   (3 )pts      41     43   (2 )pts 

Product Gross Margins

     60     57   3 pts      59     57   2 pts 

Service Cost of Revenues

   $ 24,733      $ 19,591      26   $ 49,019      $ 40,060      22

% of Service Revenues

     50     46   4 pts      50     47   3 pts 

Service Gross Margins

     50     54   (4 )pts      50     53   (3 )pts 

Total Cost of Revenues

   $ 123,734      $ 100,074      24   $ 240,569      $ 198,550      21

% of Total Revenues

     42     43   (1 )pt      42     44   (2 )pts 

Total Gross Margins

     58     57   1 pt      58     56   2 pts 

Cost of Product Revenues and Product Gross Margins

Cost of product revenues consists primarily of contract manufacturer costs, including material and direct labor, our manufacturing organization, tooling depreciation, warranty expense, freight expense, royalty payments, amortization and impairment of certain intangible assets, stock-based compensation costs and an allocation of overhead expenses, including facilities and IT costs. Generally, Video Communications Solutions segment products have a higher gross margin than products in our Voice Communications Solutions segment.

Overall, product gross margins increased by 3 percentage points and 2 percentage points, respectively, in the three and six months ended June 30, 2010 as compared to the comparable periods in 2009 due to increases in gross margins in both our Video Communications Solutions and Voice Communications Solutions segments. The increase in the Video Communications Solutions segment gross margins was due to an increase in both video communications and network systems gross margins. The increase in the Voice Communications Solutions segment gross margins was due primarily to an improved product mix and increased revenues. The increase in total product gross margins was also due in part to a decrease in past license fee claims, of which we incurred approximately $1.1 million in the six months ended June 30, 2009 as compared to zero in the six months ended June 30, 2010. These costs were not allocated to our segments. Cost of product revenues and product gross margins included a $0.6 million and $0.4 million charge for stock-based compensation in the three months ended June 30, 2010 and 2009, respectively, and $1.4 million and $1.0 million for stock-based compensation in the six months ended June 30, 2010 and 2009, respectively. Stock-based compensation is not allocated to our segments.

We expect product gross margins to improve slightly in the near term, but margins could be higher or lower depending on mix variations and other factors.

Forecasting future product gross margin percentages is difficult, and there are a number of risks related to our ability to maintain or improve our current gross margin levels. Uncertainties surrounding revenue levels, including future potential discounts as a result of the economy or in response to the strengthening of the U.S. dollar in our international markets, and related production level variances, competition, changes in technology, changes in product mix, variability of stock-based compensation costs, and the potential of resulting royalties to third parties, manufacturing efficiencies of subcontractors, manufacturing and purchased price

 

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variances, warranty and product recall costs and timing of sales over the next few quarters can cause our cost of revenues percentage to vary significantly. In addition, we may experience higher prices on components that are included in our products. In order to control expenses in any given quarter, we have taken actions to reduce costs such as imposing travel restrictions, postponing salary increases, requesting employees to use paid time off or implementing other cost control measures. Such actions may not be able to be implemented in a timely manner or may not be successful in completely offsetting the impact of lower than anticipated revenues. These actions are not necessarily sustainable in the long term, and we have begun to increase spending in order to maintain and build the business in future periods, which among other factors may negatively impact our gross margins, particularly the reinstatement of merit increases in the third quarter of 2010, and bonus programs, which we began to phase in during the second quarter of 2010 and will be fully phased in during the third quarter of 2010.

Cost of Service Revenues and Service Gross Margins

Cost of service revenues consists primarily of material and direct labor, including stock-based compensation costs, depreciation, and an allocation of overhead expenses, including facilities and IT costs. Generally, services have a lower gross margin than our consolidated product gross margins.

Overall, service gross margins decreased in the three and six months ended June 30, 2010 over the comparable periods in 2009 primarily as a result of a mix shift toward lower gross margin service offerings and increased costs, including higher video network operation center charges from third parties and headcount additions to support our go-to-market and professional services strategic initiatives. Cost of service revenues and service gross margins included a $1.0 million and $0.6 million charge for stock-based compensation in the three months ended June 30, 2010 and 2009, respectively, and $2.1 million and $1.4 million for stock-based compensation in the six months ended June 30, 2010 and 2009, respectively.

Forecasting future service gross margin percentages is difficult, and there are a number of risks related to our ability to maintain or improve our current gross margin levels. Uncertainties surrounding revenue levels, including future potential discounts as a result of the economy or in response to the strengthening of the U.S. dollar in our international markets, and related attach rates for new service as well as maintenance renewal rates, the utilization of our professional services personnel as we develop our professional services practice and expand our offerings as part of our strategic investment plan, our ability to achieve greater efficiencies in the installations of our RPX™ telepresence product, increasing costs for freight and repair costs, and the timing of sales can cause our cost of services revenues percentage to vary from quarter to quarter. In order to control expenses in any given quarter, we have taken actions to reduce costs such as imposing travel restrictions, postponing salary increases, requesting employees to use paid time off or implementing other cost control measures. Such actions may not be able to be implemented in a timely manner or may not be successful in completely offsetting the impact of lower than anticipated revenues. These actions are not necessarily sustainable in the long term, and we have begun to increase spending in order to maintain and build the business in future periods, which among other factors may negatively impact our gross margins, particularly the reinstatement of merit increases in the third quarter of 2010, and bonus programs, which we began to phase in during the second quarter of 2010 and will be fully phased in during the third quarter of 2010.

Sales and Marketing Expenses

 

$ in thousands

   Three Months Ended           Six Months Ended     Increase  
   June 30,
2010
    June 30,
2009
    Increase     June 30,
2010
    June 30,
2009
   

Expenses

   $ 94,361      $ 66,553      42   $ 185,277      $ 132,786      40

% of Revenues

     32     29   3 pts      32     29   3 pts 

Sales and marketing expenses consist primarily of salaries and commissions for our sales force, stock-based compensation costs, advertising and promotional expenses, product marketing expenses, and an allocation of overhead expenses, including facilities and IT costs. Sales and marketing expenses, except for direct marketing expenses, are not allocated to our segments.

The increase in sales and marketing expenses in absolute dollars for the three and six months ended June 30, 2010, as compared to the comparable periods in 2009, was due primarily to increased headcount resulting in increased compensation costs, higher travel and entertainment expenses, as well as increased recruitment and training costs. Depreciation and facilities allocations also increased as a result of headcount increases, as well as the expansion of our demonstration center capabilities. Spending on marketing programs also increased in both the three and six month periods. Sales and marketing expenses also increased as a result of increased stock-based compensation charges, which were $7.3 million and $2.6 million in the three month periods ended June 30, 2010 and 2009, respectively, and $13.6 million and $4.5 million in the six month periods ended June 30, 2010 and 2009, respectively.

 

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We expect our sales and marketing expenses to continue to increase in absolute dollars in the near term as a result of incurring costs to recruit and hire new sales and marketing personnel, and expenses will also likely increase in the future as revenues increase. We will also make additional investments in sales and marketing as a result of our strategic investment plan to support our key initiatives surrounding enhancing our go-to-market capability, increasing our strategic partnerships and focusing on service provider’s enhanced sell-through, as well as developing specific products and services to support their growing offerings in the managed and hosted space, in order to extend our market reach and grow our business.

Forecasting sales and marketing expenses as a percentage of revenue is highly dependent on expected revenue levels and could vary significantly depending on actual revenues achieved in any given quarter. Marketing expenses will also fluctuate depending upon the timing and extent of marketing programs as we market new products and also depending upon the timing of trade shows. Sales and marketing expenses may also fluctuate due to increased international expenses and the impact of changes in foreign currency exchange rates. In order to control operating expenses in any given quarter, we have taken actions to reduce costs such as delaying or limiting the scope of marketing programs and other projects, imposing travel restrictions, postponing salary increases, requesting employees to use paid time off or implementing other cost control measures. Such actions may not be implemented in a timely manner or may not be successful in completely offsetting the impact of lower than anticipated revenues. These actions are not necessarily sustainable in the long term, and we have begun to increase spending in order to maintain and build the business in future periods, which among other factors may negatively impact our operating margins, particularly the reinstatement of merit increases in the third quarter of 2010, and bonus programs, which we began to phase in during the second quarter of 2010 and will be fully phased in during the third quarter of 2010.

Research and Development Expenses

 

     Three Months Ended           Six Months Ended        

$ in thousands

   June 30,
2010
    June 30,
2009
    Increase     June 30,
2010
    June 30,
2009
    Increase  

Expenses

   $ 36,240      $ 28,075      29   $ 70,145      $ 56,528      24

% of Revenues

     12     12   —          12     12   —     

Research and development expenses are expensed as incurred and consist primarily of compensation costs, including stock-based compensation costs, outside services, expensed materials, depreciation and an allocation of overhead expenses, including facilities and IT costs.

Research and development expenses increased in absolute dollars for the three and six months ended June 30, 2010 as compared to the comparable periods in 2009, while remaining flat as a percentage of revenues in both the three and six nine month periods. The increase in absolute dollars in the three months ended June 30, 2010 as compared to the comparable period in 2009 is primarily due to increased headcount, primarily in our Video Communications Solutions segment, and increased development expenses in support of our strategic investment plan. Research and development expenses also increased as a result of increased stock-based compensation charges, which were $2.4 million and $1.9 million in the three month periods ended June 30, 2010 and 2009, respectively, and $5.4 million and $3.8 million in the six months ended June 30, 2010 and 2009, respectively.

We are currently investing research and development resources to enhance and upgrade the products that comprise our collaboration communications solutions, which encompass products and services in all three segments, including enhancements to our existing network systems products, products that address the high definition video conferencing market, including our immersive telepresence products, and additional voice-over-IP products. We anticipate committing a greater proportion of our research and development expenses toward enhancing the integration and interoperability of our entire video solutions product suite. We are also investing more heavily in research and development as a result of increased business opportunities with strategic partners and service provider customers as a result of our key strategic initiatives in these areas, as well as in key vertical markets such as the U.S. federal government.

         We believe that technological leadership is critical to our future success, and we are committed to continuing a significant level of research and development to develop new technologies and products to combat competitive pressures. Also, continued investment in new product initiatives will require significant research and development spending. We expect that research and development expenses in absolute dollars will increase in the near term, but will fluctuate depending on the timing and number of development activities in any given quarter. Research and development expenses as a percentage of revenue is highly dependent on expected revenue levels and could vary significantly depending on actual revenues achieved in any given quarter. In order to control operating expenses in any given quarter, we have taken actions to reduce costs such as delaying or limiting the scope of engineering projects, imposing travel restrictions, postponing salary increases, requesting employees to use paid time off or implementing other cost control measures. Such actions may not be implemented in a timely manner or may not be successful in completely offsetting the impact of lower than anticipated revenues. These actions are not necessarily sustainable in the long term, and we have begun to increase spending in order to maintain and build the business in future periods, which among other factors may negatively impact our operating margins, particularly the reinstatement of merit increases in the third quarter of 2010, and bonus programs, which we began to phase in during the second quarter of 2010 and will be fully phased in during the third quarter of 2010.

 

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General and Administrative Expenses

 

     Three Months Ended           Six Months Ended     Increase  

$ in thousands

   June 30,
2010
    June 30,
2009
    Increase     June 30,
2010
    June 30,
2009
   

Expenses

   $ 20,205      $ 12,728      59   $ 36,187      $ 26,317      38

% of Revenues

     7     6   1 pt      6     6   —     

General and administrative expenses consist primarily of compensation costs, including stock-based compensation costs, professional service fees, allocation of overhead expenses, including facilities and IT costs, patent litigation costs, and bad debt expense. General and administrative expenses are not allocated to our segments.

General and administrative expenses increased in absolute dollars for the three and six months ended June 30, 2010 as compared to the comparable periods in 2009. The primary driver of the increase in both the three and six month periods was related to severance, legal and other costs associated with the CEO transition that occurred in May 2010. This also drove an increase in general and administrative expenses as a percentage of revenues during the three months ended June 30, 2010. The remaining increase in general and administrative expenses in absolute dollars in the three and six months ended June 30, 2010 over the comparable periods in the prior year was primarily due to increased legal fees and other outside services, and to a lesser extent, increases in headcount and headcount-related expenses. General and administrative expenses also increased as a result of increased stock-based compensation charges, which were $2.6 million and $1.6 million in the three month periods ended June 30, 2010 and 2009, respectively, and $5.1 million and $3.5 million in the six month periods ended June 30, 2010 and 2009, respectively.

Significant future charges due to costs associated with litigation or uncollectibility of our receivables could increase our general and administrative expenses and negatively affect our profitability in the quarter in which they are recorded. Additionally, predicting the timing of litigation and bad debt expense associated with uncollectible receivables is difficult. Future general and administrative expense increases or decreases in absolute dollars are difficult to predict due to the lack of visibility of certain costs, including legal costs associated with defending claims against us, as well as legal costs associated with asserting and enforcing our intellectual property portfolio and other factors.

We believe that our general and administrative expenses will increase in absolute dollar amounts in the near term, but could fluctuate as we make investments in enhancements to our financial and operating systems and other costs related to supporting a larger company, increased costs associated with regulatory requirements, and our continued investments in international regions. General and administrative expenses will also increase as a result of additional investments required to support our key strategic initiatives, including adding additional infrastructure to support our increased go-to-market capability and focus on service providers. In order to control operating expenses in any given quarter, we have taken actions to reduce costs such as delaying or limiting the scope of administrative projects, imposing travel restrictions, postponing salary increases, requesting employees to use paid time off or implementing other cost control measures. Such actions may not be implemented in a timely manner or may not be successful in completely offsetting the impact of lower than anticipated revenues. These actions are not necessarily sustainable in the long term, and we have begun to increase spending in order to maintain and build the business in future periods, which among other factors may negatively impact our operating margins, particularly the reinstatement of merit increases in the third quarter of 2010, and bonus programs, which we began to phase in during the second quarter of 2010 and will be fully phased in during the third quarter of 2010.

Amortization of Purchased Intangibles

In both the three months ended June 30, 2010 and 2009, and the six months ended June 30, 2010 and 2009, we recorded $1.4 million and $2.9 million, respectively, for amortization of purchased intangibles related to the Voyant, DSTMedia, Destiny and SpectraLink acquisitions. Purchased intangible assets are being amortized to expense over their estimated useful lives, which range from several months to eight years.

Restructuring

During the three months ended June 30, 2010 and 2009, we recorded $1.5 million and $0.4 million, respectively, and during the six months ended June 30, 2010 and 2009, we recorded $3.3 million and $6.8 million, respectively, related to restructuring actions that resulted from the elimination or relocation of various positions as part of restructuring plans approved by management. These actions are generally intended to streamline and focus our efforts and more properly align our cost structure with our projected revenue streams.

 

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During the second quarter of 2010, management decided to eliminate or relocate additional positions to better align with the strategic investment plan. We recorded charges of approximately $1.5 million during the second quarter of 2010 as a result of these actions.

Management committed to a restructuring plan in the third quarter of 2009 to realign and reinvest resources in the strategic growth areas of the business. We eliminated those positions that were not aligned with the go-to-market structure under our new sales leadership in order to reallocate resources to growth areas. The plan included the elimination of approximately four percent of our global workforce. We recorded additional charges of approximately $1.7 million during the first quarter of 2010 as a result of the final notifications related to these actions.

The majority of the remaining severance-related cash expenditures are expected to be made by the end of 2010. The balance also includes approximately $0.8 million related to vacant facilities which will be paid out over the next two years unless the facility is subleased or disposed of earlier.

During the second quarter of 2009, we announced the elimination of approximately 20 finance and administrative positions as a result of consolidating certain function in our shared services center in Beijing, China. As a result of these actions, we recorded restructuring charges of $0.4 million during the three months ended June 30, 2009. During the first quarter of 2009, management eliminated certain positions throughout the company amounting to approximately six percent of our global workforce and recorded restricting charges totaling $6.4 million. This workforce reduction was designed to reduce our cost structure while maintaining flexibility to invest in the strategic growth areas of the business.

See Note 4 of Notes to Condensed Consolidated Financial Statements for further information on restructuring costs.

In July 2010, management committed to a restructuring plan designed to reallocate our resources to more strategic growth areas of the business. The restructuring plan resulted in the elimination of approximately two percent of our global workforce with most of those reductions taking effect immediately, enabling the hiring of additional positions to better align with the execution of our strategic initiatives. We currently expect to record restructuring charges between approximately $3.5 million and $4.5 million in the third quarter of 2010 resulting from these actions, primarily related to severance and other employee termination benefits.

In the future, we may take additional restructuring actions in order to reallocate resources to more strategic growth areas of the business, gain operating efficiencies or reduce our operating expenses, while simultaneously implementing additional cost containment measures and expense control programs. Such restructuring actions are subject to significant risks, including delays in implementing expense control programs or workforce reductions and the failure to meet operational targets due to the loss of employees or a decrease in employee morale, all of which would impair our ability to achieve anticipated cost reductions. If we do not achieve the anticipated cost reductions, our business could be harmed.

Litigation Reserves and Payments

During the three and six months ended June 30, 2010, we recorded a reserve totaling $1.2 million related to the settlement of a legal matter during the period. There were no such expenses in the three and six months ended June 30, 2009.

Interest and Other Income (Expense), Net

Interest and other income (expense), net, consists primarily of interest earned on our cash, cash equivalents and investments less bank charges resulting from the use of our bank accounts, gains and losses on investments, non-income related taxes and fees and foreign exchange related gains and losses.

Interest and other income (expense), net, increased in the three months ended June 30, 2010 to a net gain of $0.4 million compared to a net expense of $1.1 million for the same period in the prior year primarily due to gains realized on investments in 2010 versus losses realized in 2009, and to a lesser extent, lower foreign exchange losses in 2010 than 2009. These increases were partially offset by an increase in non-income related taxes and fees in 2010 compared to 2009.

Interest and other income (expense) was a net expense of $8.2 million and $1.4 million during the six months ended June 30, 2010 and 2009, respectively. Interest and other income (expense), net, decreased in the six months ended June 30, 2010 compared to the same period in the prior year primarily due to losses recognized related to investments that we considered to be other than temporarily impaired, the write-off of a non-trade note receivable and, to a lesser extent, lower interest income due to lower average investment returns. There were no such impairment losses or non-trade note receivable write-offs in the first six months of 2009.

See Note 7 of Notes to Condensed Consolidated Financial Statements for further discussion on the accounting for our investments.

         Interest and other income (expense), net, will fluctuate due to changes in interest rates and returns on our cash and investments, any future impairment of investments, foreign currency rate fluctuations on un-hedged exposures, fluctuations in costs associated with our hedging program and timing of non-income related taxes and license fees. The cash balance could also decrease depending upon the amount of cash used in any future acquisitions, our stock repurchase activity and other factors, which would also impact our interest income.

 

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Provision for Income Taxes

Our overall effective tax rate for the three and six months ended June 30, 2010 was 22.5% and 21.7%, respectively, which resulted in a provision for income taxes of $3.7 million and $5.0 million, respectively. The effective tax rate for the three and six months ended June 30, 2009 was 24.6% and 24.2%, respectively, which resulted in a provision for income taxes of $5.0 million and $7.5 million, respectively. The decrease in the effective tax rate for the three and six months ended June 30, 2010 as compared to the same periods in 2009 was primarily related to a relative increase in foreign earnings in 2010 which are subject to lower tax rates, partially offset by the benefit of the federal research and development tax credit which is reflected in the tax rate in 2009, but not included in the 2010 tax rate due to the expiration of the federal research tax credit for amounts paid or incurred after December 31, 2009. Also offsetting the benefit of the increase in foreign earnings in 2010 as compared to 2009 was a relative increase in non-deductible stock compensation in 2010 as compared to 2009.

During the three and six months ended June 30, 2010, tax related reserves decreased by $1.4 million and $5.4 million, respectively. The decrease for the three months ended June 30, 2010 was primarily related to releases of $0.2 million due to the lapse of the statutes of limitation in certain jurisdictions, $0.8 million due to payments made for the settlement of a California Franchise Tax Board audit, and $0.4 million due to movements in foreign exchange rates. The decrease for the six months ended June 30, 2010 was primarily due to the release of $3.4 million related to the cost sharing among legal entities of stock-based compensation which was released as an adjustment to stockholders’ equity, releases of $0.9 million due to the lapse of statutes of limitation in certain jurisdictions, $0.8 million due to payments made for the settlement of a California Franchise Tax Board audit, and $0.7 million due to movements in foreign exchange rates, partially offset by additional reserves of $0.4 million during the period.

In the three months ended June 30, 2009, we released $9.8 million in tax related reserves to additional paid in capital due to the lapse of statutes of limitation in the U.S., and $0.1 million in tax reserves due to the lapse of a statute of limitation in a foreign jurisdiction. Offsetting the reserve releases was an increase to the tax reserves of $0.8 million related to movement in foreign exchange rates during the quarter. In the six months ended June 30, 2009, an additional reserve release of $0.9 million was recorded in the first quarter related to statute expirations.

As of June 30, 2010, we have $39.0 million of unrecognized tax benefits compared to $45.8 million at June 30, 2009. We anticipate that except for $1.4 million in uncertain tax positions that may be reduced related to the lapse of various statutes of limitation, there will be no material changes in uncertain tax positions in the next 12 months.

We recognize interest and/or penalties related to income tax matters in income tax expense. As of June 30, 2010 and 2009, we had approximately $3.4 million and $4.0 million, respectively, of accrued interest and penalties related to uncertain tax positions.

We are also subject to the periodic examination of our income tax returns by the Internal Revenue Service (IRS) and other tax authorities, and in some cases we have received additional tax assessments. Currently, certain tax years are under audit by the relevant tax authorities, including an examination of our U.S. federal tax returns for the calendar years 2006 and 2007 by the IRS. The timing of the resolution of income tax examinations is highly uncertain and the amounts ultimately paid, if any, upon resolution of the issues raised by the taxing authorities may differ materially from the amounts accrued for each year. While it is reasonably possible that some issues in the IRS examination could be resolved within the next 12 months, based on the current facts and circumstances, we cannot estimate the timing of such resolution or the range of potential changes as it relates to the unrecognized tax benefits that are recorded as part of our financial statements. We do not expect any material settlements in the next 12 months, but the outcome of the examinations is inherently uncertain.

Segment Information

A description of our products and services, as well as selected financial data, for each segment can be found in Note 12 to Condensed Consolidated Financial Statements. Future changes to our organizational structure or business may result in changes to the reportable segments disclosed. The discussions below include the results of each of our segments for the three and six months ended June 30, 2010 and 2009.

Segment contribution margin includes all segment revenues less the related cost of sales, direct marketing and direct engineering expenses. Management allocates corporate manufacturing costs and some infrastructure costs such as facilities and IT costs in determining segment contribution margin. Contribution margin is used, in part, to evaluate the performance of, and to allocate resources to, each of the segments. Certain operating expenses are not allocated to segments because they are separately managed at the corporate level. These unallocated costs include sales costs, marketing costs other than direct marketing, stock-based compensation costs, general and administrative costs, such as legal and accounting costs, acquisition-related integration costs, amortization and impairment of purchased intangible assets, purchased in-process research and development costs, restructuring costs, interest income, net, and other expense, net.

 

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Video Communications Solutions

 

     Three Months Ended           Six Months Ended        

$ in thousands

   June 30,
2010
    June 30,
2009
    Increase     June 30,
2010
    June 30,
2009
    Increase  

Revenue

   $ 154,236      $ 126,820      22   $ 302,561      $ 248,677      22

Contribution margin

   $ 72,816      $ 59,024      23   $ 143,407      $ 115,546      24

Contribution margin as % of Video Communications Solutions revenues

     47     47   —          47     46   1 pt 

Video Communications Solutions segment revenues include revenues from sales of our video communications and network systems product lines. Revenues from our Video Communications Solutions segment increased by 22% in both the three and six month periods ended June 30, 2010 as compared to the comparable 2009 periods.

Revenue from video communications products, which consists primarily of our HDX® and VSX® product families, increased by 21% to $127.4 million for the three months ended June 30, 2010 from $105.0 million in the comparable year ago period, and by 19% to $245.6 million for the six months ended June 30, 2010 from $206.6 million in the comparable year ago period. The revenue increase in both the three and six month periods was primarily due to an increase in sales volumes of our HDX product family and new video communications products, such as our Polycom® CX5000 unified conference station, QDX 6000™ video conferencing system and VVX™ 1500 business media phone, partially offset by lower sales volumes of our VSX product family. With the increasing adoption of high definition (HD), our HD products comprised an increasing percentage of the group video units sold. For the first six months of 2010, over 80% of our video communication product revenues were derived from our high definition HDX products versus our standard definition VSX products. While we experienced strong revenue growth in our immersive telepresence products both sequentially and year-over-year in the second quarter of 2010, revenues from our immersive telepresence products in the first six months of 2010 were down year-over-year as revenue recognized in any given period will fluctuate depending on a number of factors, including the size and timing of orders, customer request dates and timing of product acceptance where contractually required.

Revenues from our network systems products for the three months ended June 30, 2010 were $26.8 million, up 23% from revenues of $21.7 million in the comparable 2009 period. Network systems product revenues for the six months ended June 30, 2010 were $56.9 million, up 35% from revenues of $42.1 million in the comparable 2009 period. The revenue increase in both the three and six month periods is primarily due to increases in our video network systems revenues, which were driven primarily by the introduction of new products and enhancements to existing products. Total unit sales of our video network system products increased in the three and six months ended June 30, 2010 as compared to the same periods in 2009, and we continued to see a mix shift toward our newer RMX product lines away from our MGC products, with RMX units comprising the vast majority of video network system units shipped during the first six months of 2010. While we experienced strong year-over-year revenue growth in our network systems products, our network systems product revenues declined sequentially in the second quarter of this year, following a seasonally down first quarter. During the third quarter of 2010, we have taken a number of actions surrounding our sales compensation incentives, increased technical support for our sales force and training and marketing around the capabilities of our network systems product portfolio, which are aimed at driving increased network system revenues.

International revenues, defined as revenues outside of the U.S. and Canada, accounted for 62% and 54% of our Video Communications Solutions segment revenues for the three months ended June 30, 2010 and 2009, respectively, and 62% and 55% of our Video Communications Solutions segment revenues for the six months ended June 30, 2010 and 2009, respectively. During the three months ended June 30, 2010 and 2009, one channel partner accounted for 10% and 11%, respectively, of our total net revenues for our Video Communications Solutions segment, and 11% in each of the six month periods ended June 30, 2010 and 2009. We believe it is unlikely that the loss of any one channel partner would have a long term material adverse effect on consolidated revenues as we believe end-users would likely purchase our products from a different channel partner. However, a loss of any one of these channel partners could have a material adverse impact during the transition period.

The contribution margin as a percentage of Video Communications Solutions segment revenues was 47% for both the three and six months ended June 30, 2010 as compared to 47% and 46% in the three and six months ended June 30, 2009, respectively. During both the three and six months ended June 30, 2010, the change in contribution margin was the result of an increase in gross margins and to a lesser extent, direct marketing expenses decreasing as a percentage of revenues and in absolute dollars, which were substantially offset by an increase in engineering spending. The increase in gross margins was due to an increase in both video communications and network systems gross margins. Engineering expenses increased in absolute dollars and as a percentage of revenues due to increased spending in support of our strategic initiatives.

Direct marketing and engineering spending in the Video Communications Solutions segment will fluctuate depending upon the timing of new product launches and marketing programs.

 

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Voice Communications Solutions

 

     Three Months Ended           Six Months Ended        

$ in thousands

   June 30,
2010
    June 30,
2009
    Increase     June 30,
2010
    June 30,
2009
    Increase  

Revenue

   $ 90,559      $ 61,599      47   $ 170,291      $ 123,036      38

Contribution margin

   $ 40,185      $ 22,750      77   $ 75,885      $ 46,158      64

Contribution margin as % of Voice Communications Solutions revenues

     44     37   7 pts      45     37   8 pts 

Revenues from our Voice Communications Solutions segment for the three and six months ended June 30, 2010 increased 47% and 38%, respectively, over the comparable 2009 periods, primarily due to increased sales volumes of our voice communications products, including our Voice-over-IP, circuit-switched, wireless and installed voice product lines. Revenues from our Voice Communications Solutions declined year-over-year from the fourth quarter of 2008 through the second quarter of 2009. We believe these declines were primarily a result of the global economic climate and that this business is now improving as the economy improves. In the third quarter of 2009, we experienced sequential growth for the first time since the second quarter of 2008. We have continued to experience sequential growth since that time, including 14% sequential growth in the three months ended June 30, 2010. Our voice communications products do not provide the same return on investment profile that we believe our video communications solutions products provide to customers who have curtailed travel and other related expenditures in a down economy, making our voice products more susceptible to economic downturns, such as we experienced in 2009

International revenues, defined as revenues outside of the U.S. and Canada, accounted for 37% and 36% of our Voice Communications Solutions segment revenues in the three and six months ended June 30, 2010, respectively, as compared to 36% in both the three and six months ended June 30, 2009. In the three and six months ended June 30, 2010, one channel partner accounted for 19% and 18%, respectively, of our Voice Communications Solutions segment revenues. In addition, during the three months ended June 30, 2010, a second channel partner accounted for 10% of our Voice Communications Solutions segment revenues. During the three and six months ended June 30, 2009, one channel partner accounted for 16% and 13%, respectively, of our Voice Communications Solutions segment revenues. We believe it is unlikely that the loss of any one channel partner would have a long term material adverse effect on consolidated revenues as we believe end-users would likely purchase our products from a different channel partner. However, a loss of any one of these channel partners could have a material adverse impact during the transition period.

The contribution margin as a percentage of Voice Communications Solutions segment revenues for the three months ended June 30, 2010 was 44% as compared to 37% in the comparable 2009 period, an increase of 7 percentage points. The contribution margin as a percentage of Voice Communications Solutions segment revenues for the six months ended June 30, 2010 was 45% as compared to 37% in the comparable 2009 period, an increase of 8 percentage points. The increase in contribution margin in both the three and six month periods was primarily due to both engineering and direct marketing expenses decreasing as a percentage of revenues and an increase in gross margins. Gross margins increased due to an improved product mix and increased revenues. Operating expenses were up slightly in absolute dollars compared to the year ago period, with slightly higher engineering expenses offset by lower direct marketing expenses.

Direct marketing and engineering spending in the Voice Communications Solutions segment will fluctuate depending upon the timing of new product launches and marketing programs.

Services

 

     Three Months Ended           Six Months Ended        

$ in thousands

   June 30,
2010
    June 30,
2009
    Increase/
(Decrease)
    June 30,
2010
    June 30,
2009
    Increase  

Revenue

   $ 49,840      $ 42,272      18   $ 97,937      $ 84,388      16

Contribution margin

   $ 21,789      $ 20,539      6   $ 42,938      $ 40,046      7

Contribution margin as % of Services revenues

     44     49   (5 )pts      44     47   (3 )pts 

Revenues from our Services segment for the three and six months ended June 30, 2010 increased by 18% and 16%, respectively, over the comparable 2009 periods. The revenue increase in both the three and six month periods was due primarily to increases in video-related services, and to a lesser extent, increased network systems-related services, partially offset by a decrease in voice-related services.

 

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International revenues, defined as revenues outside of the U.S. and Canada, accounted for 42% of total Services revenues for both the three and six months ended June 30, 2010, and 37% for both the three and six months ended June 30, 2009. No one customer accounted for more than 10% of our total revenues for our Services segment for the three and six months ended June 30, 2010 or 2009.

Overall, the Services segment contribution margin as a percentage of Service segment revenues decreased by 5 percentage points for the three months ended June 30, 2010, as compared to the same period in 2009, and by 3 percentage points for the six months ended June 30, 2010, as compared to the same period in 2009. The decrease was primarily due to a mix shift toward lower gross margin services offerings and increased costs, including higher video network operation center charges from third parties and headcount additions to support our go-to-market and professional services strategic initiatives.

Liquidity and Capital Resources

As of June 30, 2010, our principal sources of liquidity included cash and cash equivalents of $284.9 million, short-term investments of $208.1 million and long-term investments of $28.3 million. Substantially all of our short-term and long-term investments are comprised of U.S. government securities, corporate debt securities and corporate preferred equity securities. See Note 7 of Notes to our Condensed Consolidated Financial Statements.

Our total cash and cash equivalents and investments held outside of the United States in various foreign subsidiaries totaled $328.8 million as of June 30, 2010, and the remaining $156.5 million was held in the United States. If we would need to access our cash and cash equivalents and investments held outside of the United States in order to fund acquisitions, share repurchases or our working capital needs, we may be subject to additional U.S. income taxes (subject to an adjustment for foreign tax credits) and foreign withholding taxes.

We generated cash from operating activities totaling $60.9 million in the six months ended June 30, 2010, compared to $73.6 million in the comparable period of 2009. The decrease in cash provided from operating activities for the six months ended June 30, 2010 was due primarily to increased trade receivables, prepaid expenses and other assets, inventories and deferred taxes and smaller decrease in taxes payable. Partially offsetting these negative effects were an increase in accounts payable, other accrued liabilities and increased net income and non-cash expenses.

The total net change in cash and cash equivalents for the six months ended June 30, 2010 was a decrease of $82.2 million. The primary sources of cash were $60.9 million from operating activities and $29.3 million associated with the exercise of stock options and purchases under the employee stock purchase plan. The primary uses of cash during this period were $97.8 million for purchases of investments, net of sales and maturities, $33.6 million for purchases of property and equipment and $47.0 million for purchases of our common stock. The positive cash from operating activities was primarily the result of net income, adjusted for non-cash expenses and other items (such as depreciation, amortization, the provision for doubtful accounts, inventory write-downs for excess and obsolescence, and non-cash stock based compensation), and increases in accounts payable, other accrued liabilities and taxes payable. Partially offsetting the positive effect of these items were increases in trade receivables, inventories, deferred taxes and prepaid expenses and other assets.

Our days sales outstanding, or DSO, metric was 41 days at June 30, 2010 and 44 days at June 30, 2009. We expect that DSO will remain in the 40 to 50 day range but could vary as a result of a number of factors such as fluctuations in revenue linearity, an increase in international receivables, which typically have longer payment terms, and increases in receivables from service providers and government entities, which have customarily longer payment terms. DSO could be negatively impacted in the current economic environment if our partners experience difficulty in financing purchases, which results in delays in payment to us.

Inventory turns were 5.4 turns at June 30, 2010 as compared to 5.1 turns at June 30, 2009. We believe inventory turns will fluctuate depending on our ability to reduce lead times, as well as changes in product mix and a greater mix of ocean freight versus air freight to reduce freight costs. Our inventory turns may also decrease in the future as a result of the flexibility required to respond to the increased demands of our growing business.

Cash used for purchases of property and equipment increased significantly in the first half of 2010 to $33.6 million as compared to $17.1 million in the first half of 2009. We expect that our capital expenditures will increase in the remainder of 2010 as compared to 2009 due to the investments we are making as a result of our strategic investment plan, including upgrading our Enterprise Resource Planning (ERP) systems and adding and expanding our demonstration centers.

We enter into foreign currency forward contracts, which typically mature in one month, to hedge our exposure to foreign currency fluctuations of foreign currency-denominated receivables, payables, and cash balances. We record on the balance sheet at each reporting period the fair value of our foreign currency forward contracts and record any fair value adjustments in results of operations. Gains and losses associated with currency rate changes on contracts are recorded as other income (expense), offsetting transaction gains and losses on the related assets and liabilities. Additionally, our hedging costs can vary depending upon the size of our hedge program, whether we are purchasing or selling foreign currency relative to the U.S. dollar and interest rates spreads between the U.S. and other foreign markets.

 

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Additionally, we also have a hedging program that uses foreign currency forward contracts to hedge a portion of anticipated revenues and operating expenses denominated in the Euro and British Pound as well as operating expenses denominated in Israeli Shekels. At each reporting period, we record the fair value of our unrealized forward contracts on the balance sheet with related unrealized gains and losses as a component of cumulative other comprehensive income, a separate element of stockholders’ equity. Realized gains and losses associated with the effective portion of the foreign currency forward contracts are recorded within revenue or operating expense, depending upon the underlying exposure being hedged. Any excluded and ineffective portions of a hedging instrument would be recorded as other income (expense).

From time to time, the Board of Directors has approved plans to purchase shares of our common stock in the open market. During the six months ended June 30, 2010, we purchased approximately 1.5 million shares of our common stock in the open market for cash of $40.0 million. As of June 30, 2010, we were authorized to purchase up to an additional $147.2 million under the share repurchase plan, which was originally approved in 2008. We continue to closely monitor our repurchase program, and as a result, our stock repurchase activity could vary from period to period. See Note 9 of Notes to our Condensed Consolidated Financial Statements for a discussion of the accounting for our common stock repurchases and the resultant accumulated deficit included in stockholder’s equity in our Condensed Consolidated Balance Sheet.

During the third quarter of 2010, we plan to launch a program under which we will be providing direct financing to Internet Telephony Service Providers (ITSPs) as part of a broader initiative to expand and grow our revenues from ITSPs. While we do not expect this initial financing program to be material, we may decide to broaden our programs and provide increased lease financing offerings in the future.

At June 30, 2010, we had open purchase orders related to our contract manufacturers and other contractual obligations of approximately $248.0 million primarily related to inventory purchases. We also currently have commitments that consist of obligations under our operating leases. In the event that we decide to cease using a facility and seek to sublease such facility or terminate a lease obligation through a lease buyout or other means, we may incur a material cash outflow at the time of such transaction, which will negatively impact our operating results and overall cash flows. In addition, if facilities rental rates decrease or if it takes longer than expected to sublease these facilities, we could incur a significant further charge to operations and our operating and overall cash flows could be negatively impacted in the period that these changes or events occur.

These purchase commitments and lease obligations are reflected in our Consolidated Financial Statements once goods or services have been received or at such time that we are obligated to make payments related to these goods, services or leases. In addition, our bank has issued letters of credit totaling approximately $1.4 million to secure the leases on some of our offices.

The table set forth below shows, as of June 30, 2010, the future minimum lease payments due under our current lease obligations. Total estimated sublease income for 2010 to 2012 is approximately $0.2 million and is netted in the amounts below. In addition to these minimum lease payments, we are contractually obligated under the majority of our operating leases to pay certain operating expenses during the term of the lease such as maintenance, taxes and insurance. Our contractual obligations as of June 30, 2010 are as follows (in thousands):

 

     Net Minimum
Lease Payments
   Projected
Annual
Operating
Costs
   Other
Long -Term
Liabilities
   Purchase
Commitments

Remainder of 2010

   $ 8,440    $ 1,890    $ —      $ 242,563

2011

     18,652      3,984      1,446      4,089

2012

     15,748      3,292      1,817      1,300

2013

     9,923      1,855      694      —  

2014

     8,471      1,529      1,112      —  

Thereafter

     21,629      3,960      7,068      —  
                           

Total payments

   $ 82,863    $ 16,510    $ 12,137    $ 247,952
                           

As discussed in Note 13 of the Notes to Condensed Consolidated Financial Statements, at June 30, 2010, we have unrecognized tax benefits, including related interest, totaling $42.4 million. Payments we make for income taxes may increase during 2010 as our available net operating losses and research tax credits are depleted.

We believe that our available cash, cash equivalents and investments will be sufficient to meet our operating expenses and capital requirements for the next 12 months and beyond based on our current business plans. However, we may require or desire

 

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additional funds to support our operating expenses and capital requirements or for other purposes, such as acquisitions, and may seek to raise such additional funds through public or private equity financing, debt financing or from other sources. We cannot assure you that additional financing will be available at all or that, if available, such financing will be obtainable on terms favorable to us and would not be dilutive. Our future liquidity and cash requirements will depend on numerous factors, including the introduction of new products and potential acquisitions of related businesses or technology.

Off-Balance Sheet Arrangements

As of June 30, 2010, we did not have any off-balance-sheet arrangements, as defined in Item 303(a)(4)(ii) of SEC

Regulation S-K.

Critical Accounting Policies and Estimates

Our Condensed Consolidated Financial Statements have been prepared in accordance with accounting principles generally accepted in the United States of America. We review the accounting policies used in reporting our financial results on a regular basis. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our process used to develop estimates, including those related to product returns, accounts receivable, inventories, investments, intangible assets, income taxes, warranty obligations, restructuring, contingencies and litigation. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates due to actual outcomes being different from those on which we based our assumptions. These estimates and judgments are reviewed by management on an ongoing basis and by the Audit Committee at the end of each quarter prior to the public release of our financial results.

Our significant accounting policies were described in Note 1 to our audited Consolidated Financial Statements included in our Annual Report on Form 10-K for the year ended December 31, 2009. With the exception of those discussed in Note 2 of our Condensed Consolidated Financial Statements, there have been no significant changes to these policies or recent accounting pronouncements or changes in accounting pronouncements that are of potential significance to us during the six months ended June 30, 2010.

We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our Condensed Consolidated Financial Statements.

Revenue Recognition and Product Returns

We recognize revenue when persuasive evidence of an arrangement exists, title and risk of loss has transferred, product payment is not contingent upon installation or other service obligations, the price is fixed or determinable, and collectibility is reasonably assured. In instances where final acceptance of the product or service is specified by the customer, revenue is deferred until all acceptance criteria have been met. Additionally, we recognize maintenance service revenue on our hardware and software products ratably over the service period, generally one to five years.

Our video communications solutions products are integrated with software that is essential to the functionality of the equipment. Additionally, the Company provides unspecified software upgrades and enhancements related to most of these products through maintenance contracts.

In October 2009, the Financial Accounting Standards Board (“FASB”) amended the accounting standards for revenue recognition to remove tangible products containing software components and non-software components that function together to deliver the product’s essential functionality from the scope of the software revenue recognition guidance.

In October 2009, the FASB also amended the accounting standards for multiple deliverable revenue arrangements to:

 

   

provide updated guidance on whether multiple deliverables exist, how the deliverables in an arrangement should be separated, and how the consideration should be allocated;

 

   

require an entity to allocate revenue in an arrangement using estimated selling price (“ESP”) of deliverables if a vendor does not first have vendor-specific objective evidence (“VSOE”) of selling price or secondly does not have third-party evidence (“TPE”) of selling price; and

 

   

eliminate the use of the residual method and require an entity to allocate revenue using the relative selling price method.

 

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We elected to early adopt this accounting guidance at the beginning of our first quarter of fiscal year 2010 on a prospective basis for applicable transactions originating or materially modified after December 31, 2009. As a result, our video communications solutions products are no longer within the scope of the software revenue recognition guidance.

A multiple-element arrangement includes the sale of one or more tangible product offerings with one or more associated services offerings, each of which are individually considered separate units of accounting. The determination of our units of accounting did not change with the adoption of the new revenue recognition guidance. Beginning with new or materially modified arrangements as of January 1, 2010, we allocate revenue to each element in a multiple-element arrangement based upon the relative selling price of each deliverable. When applying the relative selling price method, we determine the selling price for each deliverable using VSOE of selling price, if it exists, or TPE of selling price. If neither VSOE nor TPE of selling price exist for a deliverable, we use our best estimate of selling price for that deliverable. Revenue allocated to each element is then recognized when the other revenue recognition criteria are met for each element.

The adoption of the new revenue accounting guidance, which resulted in an increase in revenues during the first half of 2010 of $2.7 million, did not have a material impact on our revenues or results of operations for the six months ended June 30, 2010.

We accrue for sales returns and other allowances as a reduction to revenues upon shipment based upon our contractual obligations and historical experience.

Channel Partner Programs and Incentives

We record estimated reductions to revenues for channel partner programs and incentive offerings including special pricing agreements, promotions and other volume-based incentives. If market conditions were to decline or competition were to increase further, we may take future actions to increase channel partner incentive offerings, possibly resulting in an incremental reduction of revenues at the time the incentive is offered. The Company accrues for co-op marketing funds as a marketing expense if we receive an identifiable benefit in exchange and can reasonably estimate the fair value of the identifiable benefit received; otherwise, it is recorded as a reduction to revenues.

Warranty

We provide for the estimated cost of product warranties at the time revenue is recognized. Our warranty obligation is affected by estimated product failure rates, material usage and service delivery costs incurred in correcting a product failure. Should actual product failure rates, material usage or service delivery costs differ from our estimates, revision of the estimated warranty liability would be required.

Allowance for Doubtful Accounts

We maintain an allowance for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. We review our allowance for doubtful accounts quarterly by assessing individual accounts receivable over a specific aging and amount, and all other balances on a pooled basis based on historical collection experience. If the financial condition of our customers were to deteriorate, adversely affecting their ability to make payments, additional allowances would be required. Delinquent account balances are written off after management has determined that the likelihood of collection is not probable.

Excess and Obsolete Inventory

We record write downs for excess and obsolete inventory equal to the difference between the cost of inventory and the estimated fair value based upon assumptions about future product life-cycles, product demand and market conditions. If actual product life cycles, product demand and market conditions are less favorable than those projected by management, additional inventory write-downs may be required. At the point of the loss recognition, a new, lower-cost basis for that inventory is established, and subsequent changes in facts and circumstances do not result in the restoration of or increase in that newly established cost basis.

Stock-based Compensation Expense

         Our share-based compensation programs consist of grants of share-based awards to employees and non-employee directors, including stock options, restricted stock, restricted stock units and performance shares, as well as our employee stock purchase plan. We measure and recognize compensation expense for all share-based payment awards made to employees and directors based on estimated fair values. The estimated fair value of these awards, including the effect of estimated forfeitures, is recognized as expense over the requisite service period, which is generally the vesting period. The fair value of stock option awards is estimated at the grant date using the Black-Scholes option valuation model. The fair value of restricted stock units is based on the market value of our common stock on the date of grant. The fair value of performance shares is based on the market price of our stock on the date of grant and assumes that the performance criteria will be met and the target payout level will be achieved. Compensation cost is adjusted for subsequent changes in the probable outcome of performance-related conditions until the award vests. The fair value of a performance share with a market condition is estimated on the date of award, using a Monte Carlo simulation model to estimate the total return

 

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ranking of our stock among the Russell 2000 Index companies over each performance period. Changes in the underlying factors and assumptions utilized may result in significant variability in the stock-based compensation costs we record, which makes such amounts difficult to accurately predict.

Deferred and Refundable Taxes

We estimate our actual current tax expense together with our temporary differences resulting from differing treatment of items, such as deferred revenue, for tax and accounting purposes. These temporary differences result in deferred tax assets and liabilities. We must then assess the likelihood that our deferred tax assets will be recovered from future taxable income and to the extent we believe that recovery is not likely, we must establish a valuation allowance against these tax assets. Significant management judgment is required in determining our provision for income taxes, our deferred tax assets and liabilities and any valuation allowance recorded against our net deferred tax assets. To the extent we establish a valuation allowance in a period, we must include and expense the allowance within the tax provision in the consolidated statement of operations. As of June 30, 2010, we have $48.4 million in net deferred tax assets. Included in the net deferred tax asset balance is a $1.4 million valuation allowance related to net operating losses generated in Denmark.

We recognize and measure benefits for uncertain tax positions using a two-step approach. The first step is to evaluate the tax position taken or expected to be taken in a tax return by determining if the weight of available evidence indicates that it is more likely than not that the tax position will be sustained upon audit, including resolution of any related appeals or litigation processes. For tax positions that are more likely than not to be sustained upon audit, the second step is to measure the tax benefit as the largest amount that is more than 50% likely to be realized upon settlement. Significant judgment is required to evaluate uncertain tax positions. We evaluate our uncertain tax positions on a quarterly basis. Our evaluations are based upon a number of factors, including changes in facts or circumstances, changes in tax law, correspondence with tax authorities during the course of audits and effective settlement of audit issues. Changes in the recognition or measurement of uncertain tax positions could result in material increases or decreases in our income tax expense in the period in which we make the change, which could have a material impact on our effective tax rate and operating results.

Fair Value

Fair value is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability. As the basis for considering such assumptions, a three-tier value hierarchy prioritizes the inputs used in measuring fair value as follows: (Level 1) observable inputs such as quoted prices in active markets; (Level 2) inputs other than the quoted prices in active markets that are observable either directly or indirectly; and (Level 3) unobservable inputs in which there is little or no market data, which require us to develop our own assumptions. This hierarchy requires us to use observable market data, when available, and to minimize the use of unobservable inputs when determining fair value. On a recurring basis, we measure certain financial assets and liabilities at fair value, including our marketable securities and foreign currency contracts.

The Company’s cash and investment instruments are classified within Level 1 or Level 2 of the fair value hierarchy because they are valued using inputs such as quoted market prices, broker or dealer quotations, or alternative pricing sources with reasonable levels of price transparency. The types of instruments valued based on quoted market prices in active markets include money market funds. Such instruments are generally classified within Level 1 of the fair value hierarchy.

The types of instruments valued based on other observable inputs include U.S. Treasury securities and other government agencies, corporate bonds, commercial paper, preferred stocks and puts on treasury bond futures. Such instruments are generally classified within Level 2 of the fair value hierarchy.

As of June 30, 2010, our fixed income available-for-sale securities include U.S. Treasury obligations and other government agency instruments, corporate bonds, commercial paper, municipal securities and money market funds. Included in available-for-sale securities is cash equivalents, which consist of investments with maturities of three months or less and include money market funds.

Our preferred equity available-for-sale securities represent preferred stocks that were purchased as part of a capital gains capture program. We recently changed our strategy with respect to our capital gains capture program and we plan to liquidate the remainder of these investments by the end of 2010.

The principal market where we execute our foreign currency contracts is the retail market in an over-the-counter environment with a relatively high level of price transparency. The market participants and the Company’s counterparties are large money center banks and regional banks. The Company’s foreign currency contracts valuation inputs are based on quoted prices and quoted pricing intervals from public data sources (specifically, spot exchange rates, LIBOR rates and credit default rates) and do not involve management judgment. These contracts are typically classified within Level 2 of the fair value hierarchy. For the fair value of the Company’s marketable securities and foreign currency contracts see Note 7 of Notes to Consolidated Financial Statements.

 

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Goodwill and Purchased Intangibles

We assess the impairment of goodwill and other indefinite lived intangibles at least annually unless impairment indicators exist sooner. We assess the impairment whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Some factors we consider important that could trigger an impairment review include the following:

 

   

significant underperformance relative to projected future operating results;

 

   

significant changes in the manner of our use of the acquired assets or the strategy for our overall business; and

 

   

significant negative industry or economic trends.

If we determine that the carrying value of goodwill and other indefinite lived intangibles may not be recoverable based upon the existence of one or more of the above indicators of impairment, we would measure any impairment based on a projected discounted cash flow method using a discount rate determined by us to be commensurate with the risk inherent in our current business model.

In the fourth quarter of 2009, we completed our annual goodwill impairment test. The assessment of goodwill impairment was conducted by determining and comparing the fair value of each of our reporting units to the reporting unit’s carrying value as of that date. Based on the results of these impairment tests, which indicated that the estimated fair values of each of our reporting units substantially exceed its carrying value, we determined that our goodwill assets were not impaired as of December 31, 2009.

We assess our purchased intangibles for impairment on an ongoing basis. The assessment of purchased intangibles impairment is conducted by first estimating the undiscounted expected future cash flows to be generated from the use and eventual disposition of the purchased intangibles and comparing this amount with the carrying value of these assets. If the undiscounted cash flows are less than the carrying amounts, impairment exists, and future cash flows are discounted at an appropriate rate and compared to the carrying amounts of the purchased intangibles to determine the amount of the impairment. Screening for and assessing whether impairment indicators exist or if events or changes in circumstances have occurred, including market conditions, operating fundamentals, competition and general economic conditions, requires significant judgment. Additionally, changes in the high-technology industry occur frequently and quickly. Therefore, there can be no assurance that a charge to operations will not occur as a result of future goodwill and purchased intangible impairment tests.

Non-marketable Securities

We periodically make strategic investments in companies whose stock is not currently traded on any stock exchange and for which no quoted price exists. The cost method of accounting is used to account for these investments as we hold a non-material ownership percentage. We review these investments for impairment when events or changes in circumstances indicate that the carrying amount of the assets might not be recoverable. Examples of events or changes in circumstances that may indicate to us that an impairment exists may be a significant decrease in the market value of the company, poor or deteriorating market conditions in the public and private equity capital markets, significant adverse changes in legal factors or within the business climate the company operates, and current period operating or cash flow losses combined with a history of operating or cash flow losses or projections and forecasts that demonstrate continuing losses associated with the company’s future business plans. Impairment indicators identified during the reporting period could result in a significant write down in the carrying value of the investment if we believe an investment has experienced a decline in value that is other than temporary. For example, to date, due to these and other factors, we have recorded cumulative charges against earnings totaling $21.5 million associated with the impairment of these investments, including $7.4 million in the second quarter of 2007. At June 30, 2010 and December 31, 2009, our strategic investments had a carrying value of $2.5 million and $2.2 million, respectively.

Derivative Instruments

The accounting for changes in the fair value of a derivative depends on the intended use of the derivative and the resulting designation. For derivative instruments designated as a fair value hedge, the gain or loss is recognized in earnings in the period of change together with the offsetting loss or gain on the hedged item attributed to the risk being hedged. For a derivative instrument designated as a cash flow hedge, the effective portion of the derivative’s gain or loss is initially reported as a component of accumulated other comprehensive income (loss) and subsequently reclassified into earnings when the hedged exposure affects earnings. The ineffective portion of the gain or loss is reported in earnings immediately. For derivative instruments that are not designated as cash flow hedges, changes in fair value are recognized in earnings in the period of change. We do not hold or issue derivative financial instruments for speculative trading purposes. We enter into derivatives only with counterparties that are among the largest U.S. banks, ranked by assets, in order to minimize our credit risk.

 

Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Interest Rate Risk

Our exposure to market risk for changes in interest rates relates primarily to our investment portfolio. We generally invest excess cash in marketable debt instruments of the U.S. government and its agencies and high-quality corporate debt securities, and by

 

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policy, limit the amount of credit exposure to any one issuer. We have also invested in corporate preferred equity securities as part of a capital gains capture program. These corporate preferred equity securities are primarily comprised of investment-grade, non-convertible utility preferred stocks that are generally rated the equivalent of BBB or better by at least one of the major credit rating agencies. While an active market exists for these securities, preferred equity securities are not as actively traded as common stock equity securities. Further, while we have the ability to hold these investments, as part of our recent change in strategy with respect to our capital gains capture program, we have decided to liquidate these investments over the next several months. If we sell these securities within a short period of time, we could incur significant losses. At June 30, 2010, the fair value of these corporate preferred equity securities is $15.2 million. We recognized losses in the first quarter of 2010 totaling $6.5 million related to investments in corporate preferred equity securities that we considered to be other than temporarily impaired based upon our decision to liquidate the securities in a relatively short period of time and an assessment of the individual holdings. During the three months ended June 30, 2010, the Company liquidated approximately $18.2 million of these investments and realized a gain of approximately $1.0 million.

The estimated fair value of our cash and cash equivalents approximates the principal amounts reflected in our Consolidated Balance Sheets based on the short maturities of these financial instruments. Short-term and long-term investments consist of U.S. government obligations and foreign and domestic public corporate debt securities and corporate preferred equity securities. The valuation of our investment portfolio is subject to uncertainties that are difficult to predict, particularly in light of the recent credit market instability. If the current market conditions deteriorate further, or the anticipated recovery in market values does not occur, we may realize losses on the sale of our investments or we may incur further temporary impairment charges requiring us to record additional unrealized losses in accumulated other comprehensive loss. We could also incur additional other-than-temporary impairment charges resulting in realized losses in our statement of operations which would reduce net income. We consider various factors in determining whether we should recognize an impairment charge, including the length of time and extent to which the fair value has been less than our cost basis, the financial condition and near-term prospects of the security or issuer, and our intent and ability to hold the investment for a period of time sufficient to allow any anticipated recovery in the market value. Further, if we sell our investments prior to their maturity, we may incur a charge to operations in the period the sale takes place.

A sensitivity analysis was performed on our investment portfolio as of June 30, 2010. The modeling technique used measures the change in fair values arising from hypothetical parallel shifts in the yield curve of various magnitudes. This methodology assumes a more immediate change in interest rates to reflect the current economic environment.

The following table presents the hypothetical fair values of our securities, excluding cash and cash equivalents, held at June 30, 2010 that are sensitive to changes in interest rates. The modeling technique used measures the change in fair values arising from immediate parallel shifts in the yield curve of plus or minus 50 basis points (BPS), 100 BPS and 150 BPS (in thousands):

 

-150 BPS

 

-100 BPS

 

-50 BPS

   Fair Value
6/30/2010
   +50 BPS    +100 BPS    +150 BPS

$237,626

  $237,218   $236,811    $236,403    $235,996    $235,588    $235,181

Foreign Currency Exchange Rate Risk

While the majority of our sales are denominated in United States dollars, we also sell our products and services in certain European regions in Euros and in British Pounds, which has increased our foreign currency exchange rate fluctuation risk.

While we do not hedge for speculative purposes, as a result of our exposure to foreign currency exchange rate fluctuations, we enter into forward exchange contracts to hedge our foreign currency exposure to the Euro, British Pound and Israeli Shekel relative to the United States Dollar. We mitigate bank counterparty risk related to our foreign currency hedging program through our policy that requires the Company to execute hedge contracts with banks that meet certain credit ratings criteria.

As of June 30, 2010, we had outstanding forward exchange contracts to sell 6.6 million Euros at 1.31, sell 4.2 million British Pounds at 1.46, and buy 2.6 million Israeli Shekels at 3.58. These forward exchange contracts hedge our net position of foreign currency-denominated receivables, payables and cash balances and typically mature in 360 days or less. As of June 30, 2010, we also had net outstanding foreign exchange contracts to sell 7.0 million Euros at 1.40 and sell 0.3 million British Pounds at 1.64 and buy 10.4 million Israeli Shekels at 3.92. These forward exchange contracts, carried at fair value, typically have maturities of more than 360 days.

We also have a cash flow hedging program under which we hedge a portion of anticipated revenues and operating expenses denominated in the Euro, British Pound and Israeli Shekels. As of June 30, 2010, we had net outstanding foreign exchange contracts to sell 6.6 million Euros at 1.29 and 0.7 million British Pounds at 1.47 and to buy 9.8 million Israeli Shekels at 3.81. These forward exchange contracts, carried at fair value, typically have maturities of less than 360 days. As of June 30, 2010, we also had net outstanding foreign exchange contracts to sell 39.0 million Euros at 1.37 and 3.5 million British Pounds at 1.55 and buy 50.8 million Israeli Shekels at 3.79. These forward exchange contracts, carried at fair value, typically have maturities of more than 360 days.

 

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Based on our overall currency rate exposure as of June 30, 2010, a near-term 10% appreciation or depreciation in the United States Dollar, relative to our foreign local currencies, would have a positive or negative impact of less than $1.0 million on our results of operations if unhedged. We may also decide to expand the type of products we sell in foreign currencies or may, for specific customer situations, choose to sell in foreign currencies in our other regions, thereby further increasing our foreign exchange risk. See Note 8 of Notes to Condensed Consolidated Financial Statements for further information on our foreign exchange derivatives.

 

Item 4. CONTROLS AND PROCEDURES

Evaluation of disclosure controls and procedures.

Our management evaluated, with the participation of our Chief Executive Officer and our Chief Financial Officer, the effectiveness of our disclosure controls and procedures as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on this evaluation, our Chief Executive Officer and our Chief Financial Officer have concluded that our disclosure controls and procedures are effective to ensure that information we are required to disclose in reports that we file or submit under the Securities Exchange Act of 1934 (i) is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms, and (ii) is accumulated and communicated to Polycom’s management, including our Chief Executive Officer and our Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. Our disclosure controls and procedures are designed to provide reasonable assurance that such information is accumulated and communicated to our management. Our disclosure controls and procedures include components of our internal control over financial reporting. Management’s assessment of the effectiveness of our internal control over financial reporting is expressed at the level of reasonable assurance because a control system, no matter how well designed and operated, can provide only reasonable, but not absolute, assurance that the control system’s objectives will be met.

Changes in internal control over financial reporting.

There was no change in our internal control over financial reporting that occurred during the quarter ended June 30, 2010 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II OTHER INFORMATION

 

Item 1. LEGAL PROCEEDINGS

From time to time, we are involved in claims and legal proceedings that arise in the ordinary course of business. We expect that the number and significance of these matters will increase as our business expands. In particular, we expect to face an increasing number of patent and other intellectual property claims as the number of products and competitors in Polycom’s industry grows and the functionality of video, voice, data and web conferencing products overlap. Any claims or proceedings against us, whether meritorious or not, could be time consuming, result in costly litigation, require significant amounts of management time, result in the diversion of significant operational resources, or require us to enter into royalty or licensing agreements which, if required, may not be available on terms favorable to us or at all. If management believes that a loss arising from these matters is probable and can be reasonably estimated, we record the amount of the loss. As additional information becomes available, any potential liability related to these matters is assessed and the estimates revised. Based on currently available information, management does not believe that the ultimate outcomes of these unresolved matters, individually and in the aggregate, are likely to have a material adverse effect on the Company’s financial position, liquidity or results of operations. However, litigation is subject to inherent uncertainties, and our view of these matters may change in the future. Were an unfavorable outcome to occur, there exists the possibility of a material adverse impact on our financial position and results of operations or liquidity for the period in which the unfavorable outcome occurs or becomes probable, and potentially in future periods.

 

ITEM 1A. RISK FACTORS

YOU SHOULD CAREFULLY CONSIDER THE RISKS DESCRIBED BELOW BEFORE MAKING AN INVESTMENT DECISION. THE RISKS DESCRIBED BELOW ARE NOT THE ONLY ONES WE FACE. ADDITIONAL RISKS THAT WE ARE NOT PRESENTLY AWARE OF OR THAT WE CURRENTLY BELIEVE ARE IMMATERIAL MAY ALSO IMPAIR OUR BUSINESS OPERATIONS. OUR BUSINESS COULD BE HARMED BY ANY OR ALL OF THESE RISKS. THE TRADING PRICE OF OUR COMMON STOCK COULD DECLINE SIGNIFICANTLY DUE TO ANY OF THESE RISKS, AND YOU MAY LOSE ALL OR PART OF YOUR INVESTMENT. IN ASSESSING THESE RISKS, YOU SHOULD ALSO REFER TO THE OTHER INFORMATION CONTAINED OR INCORPORATED BY REFERENCE IN OUR ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 2009, INCLUDING OUR CONSOLIDATED FINANCIAL STATEMENTS AND RELATED NOTES.

Global economic conditions adversely affected our business in 2009 and could again adversely affect our revenues and harm our business.

Adverse economic conditions worldwide have contributed to slowdowns in the communications and networking industries and have caused a negative impact on the specific segments and markets in which we operate. As our business has grown, we have become

 

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increasingly exposed to adverse changes in general economic conditions, which can result in reductions in capital expenditures by end-user customers for our products, longer sales cycles, the deferral or delay of purchase commitments for our products and increased competition. These factors have adversely impacted our operating results in prior periods, including most recently in the fiscal year ended December 31, 2009. Despite some recent signs of stabilization and our growth in revenues in the first six months of 2010, global economic concerns like the recent sovereign debt crisis continue to create uncertainty and unpredictability and cause us to continue to be cautious about our future outlook. A global economic downturn would negatively impact technology spending for our products and services and may materially adversely affect our business, operating results and financial condition. Further, global economic conditions have resulted in a tightening in the credit markets, low liquidity levels in many financial markets, and extreme volatility in credit, equity, foreign currency and fixed income markets.

These adverse economic conditions negatively impact our business, particularly our future revenue potential, losses on investments and the collectability of our accounts receivable, by causing the inability of our customers to obtain credit to finance purchases of our products and services, customer or partner insolvencies or bankruptcies, decreased customer confidence to make purchasing decisions resulting in delays in their purchasing decisions, decreased customer demand or demand for lower-end products, and decreased customer ability to pay their obligations when they become due to us. For example, our partner Nortel’s bankruptcy filing in January 2009 negatively impacted our revenues as our level of business with Nortel has been materially lower than that of historical levels.

We believe our voice communications products are more susceptible to general economic conditions than our other products, which led to longer sales cycles for our voice products and negative year-over-year growth of revenues in the voice product line in 2009. In particular, while we believe that our video product lines may be better able to sustain the impact of current economic conditions and recessionary and other factors, our voice products do not provide the same return on investment profile that we believe our video products provide to customers who are curtailing travel and other related expenditures in a down economy, making our voice products more susceptible in periods of economic downturn. Further, although we believe our video communications products offer a rapid return on investment, tightened corporate budgets and capital expenditures in this economic environment will likely continue to negatively impact our video communications product revenues, as was the case in 2009.

If we fail to compete successfully domestically and internationally, our business and results of operations would be significantly harmed.

Competition that we face in our markets is intense and, given the recently completed acquisition of Tandberg by Cisco Systems, it will likely intensify and place increased pressure on average selling prices for our products. Potentially lower average selling prices for our products will correspondingly have a negative impact on our revenues and gross margins. The principal competitive factors in the markets in which we presently compete and may compete in the future include the ability to:

 

   

provide and sell a broad range of products and services that are responsive to changing technology and changing customer requirements and our ability to bring such products to market more rapidly than our competitors do;

 

   

appropriately and competitively price our products and solutions;

 

   

introduce new products and solutions;

 

   

reduce production costs;

 

   

provide value-added features and functionality;

 

   

successfully integrate our products with, and operate our products on, existing customer platforms;

 

   

gain market presence and brand recognition; and

 

   

extend credit to our partners.

         We may not be able to compete successfully against our current or future competitors. We expect our 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 our current or future competitors, or our delay in bringing new products to market to compete with competitive products, could cause a significant decline in sales or loss of market acceptance of our existing products and future products. We believe that the possible effects from ongoing competition may be a reduction in the prices of our

 

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products and our competitors’ products, the introduction of additional lower priced competitive products or the introduction of new products or product platforms that render our existing products or technologies obsolete. For example, video network systems product revenues declined on a sequential quarter basis in the first and second quarters of 2008, and again most recently in the first and second quarters of 2010, and could decline again in the future. Revenues relating to new product offerings may also be unpredictable. For instance, although we initially saw strong sales of our Polycom CX5000 Unified Conference Station in 2009, there can be no assurance that revenue will remain at those levels or grow in future quarters.

Competition that we face in certain of our international markets is different than that we face in North America. We have noted additional competitors and increased pricing pressures in China, India and other parts of Asia. If we are unable to compete effectively in these regions in terms of price, technology, product offerings or marketing strategies, our overall financial results may suffer.

Competition in each of our markets is intense, particularly in light of increased consolidation in our industry, and our inability to compete effectively in any of these markets could negatively affect our results of operations.

We face significant competition in the video communications solutions industry. For our video conferencing end points, our major competitors include Cisco Systems, who acquired Tandberg in April 2010, Hewlett-Packard and a number of other companies including Aethra (which is being acquired by RADVISION), Huawei, LifeSize (which was acquired by Logitech in December 2009), as well as various smaller or new industry entrants. We face competition for sales of our RPX and TPX telepresence solutions and related services from Cisco Systems, Hewlett-Packard, Tandberg, Teleris and others. Some of these companies have substantial financial resources and production, marketing, engineering and other capabilities with which to develop, manufacture, market and sell their products, which may result in our having to increase our spending on marketing, and we may not be able to effectively compete against these companies due to their size.

Direct competition for telepresence product sales against larger competitors like Cisco Systems and Hewlett-Packard may also result in increased downward pressure on our product prices, as well as cause us to invest more in sales and marketing in order to compete effectively. Sales of our RPX and TPX products were lower in 2009 than in 2008, which we believe may have been caused by increased competition from companies with greater resources than us, as well as new competitive products entering the marketplace, which trend may continue in future quarters, potentially adversely affecting our revenues from such product lines.

In addition, with the increasing market acceptance of video communications solutions, other established or new companies may develop or market products competitive with our video conferencing products, including companies with greater financial and other resources, greater brand recognition or greater access to top-level executives than we have, or may partner with companies which have more substantial resources and production, sales, marketing, engineering and other capabilities with which to develop, manufacture, market and sell their products and to bring their products to market or respond to changing technologies more rapidly than we can, or that may be more adept in responding to rapidly changing market conditions or changing technologies than we are. These factors could negatively impact our video revenues as customers assess such new technologies or wait to make purchases until sales prices for such next generation products fall. Conversely, new product adoption may grow at such rates that we are unable to keep up with increasing demand due to our size, resources, need to establish new partnerships, or other factors. Also, strategic partnerships and acquisitions are regularly being formed and announced by our competitors, which may increase competition and result in increased downward pressure on our product prices.

For instance, in April 2010, Cisco Systems completed its acquisition of Tandberg, which could have an adverse effect on our business and our future results of operations, possibly materially. We will now have to compete with a larger combined company with significantly greater financial and sales and marketing resources than ours, an extensive channel network and with a newly acquired expanded video communications solutions product line. This new product line may be sold in conjunction with Cisco Systems’ proprietary network equipment and technology as a complete solution, making it more difficult for us to compete against them or to ascertain pricing on competitive products. In addition, Cisco Systems may use its dominance in network equipment to foreclose competition in the telepresence and/or videoconferencing equipment market. Cisco Systems may make it more difficult, more expensive, or otherwise less attractive to choose our telepresence and/or videoconferencing products in a Cisco Systems network environment. Cisco Systems may also preclude our competitive products from being fully interoperable with Cisco Systems endpoints, video infrastructure and/or network products. Similarly, Hewlett-Packard’s recently announced partnership with Vidyo to offer conference room and desktop video endpoints that run on enterprise networks will result in increased competition for such video communications offerings and, accordingly, could adversely impact our revenues for such product lines and our revenues from Hewlett-Packard.

Further, the acquisition of privately-held LifeSize by Logitech in December 2009 will likely result in increased competition and pricing pressure for our video communications solutions products, which could also negatively impact our future results of operations, as the newly-combined entity will have greater financial resources, deeper mass market sales channels and greater pricing flexibility than LifeSize did as a standalone entity. Further, LifeSize recently announced a partnership with Alcatel-Lucent under which they will integrate, co-sell and co-market their video communications and telepresence solutions. LifeSize could secure

 

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additional partnerships, including partnerships with companies that we already have established partnerships with, in order to compete with Polycom’s Open Collaboration Network strategy, which provides an open and interoperable collaboration solution that gives customers greater flexibility and investment protection for their UC environment.

We have lost group video conferencing sales opportunities to our competitors, including Tandberg, and also to LifeSize and competitors in China who sell at lower price points than we do. We expect to continue to face stiff competition, and our competitors may gain market share from us, due in part to their strategic relationships and their latest product offerings. We also believe we will face increasing competition from alternative video communications solutions that employ new technologies or new combinations of technologies. Further, the commoditization of certain video conferencing products could lead to the availability of alternative, lower-cost video conferencing products than ours and, accordingly, drive down our sales prices and negatively impact our revenues.

Our video communications solutions network systems products experience significant direct competition from Cisco Systems, which acquired Tandberg in April 2010, Huawei, and various smaller or new industry entrants. Tandberg’s acquisition of Codian strengthened their infrastructure product offerings and continues to result in increased competition from Tandberg against our total video communications solutions offering, and has negatively impacted our video communications solutions revenues, as well as our market position with respect to video conferencing and network systems offerings. For example, while we gained market share in the first quarter of 2010 despite the seasonal sequential decline, our network systems product revenues also declined sequentially in the second quarter of 2010 due in part to increased competition. Further, we launched our next generation video network system platform (RMX 2000®) in 2007 and introduced enhancements to that platform in 2009 with the introduction of our RMX 2000 V4.0 and RMX 4000, and we intend to continue to launch new network systems product offerings, including enhancements to existing products, in the future. These new product offerings may be delayed or may not have as much of a positive impact on our video communications solutions revenues as we anticipate. As a result, we may continue to lose market share with respect to our video communications solutions network systems products, as we have experienced in previous quarters.

The market for voice communications equipment, including voice conferencing and desktop equipment, and wireless voice devices is highly competitive and also subject to rapid technological change, regulatory developments and emerging industry standards. We expect competition to persist and increase in the future in this area. Further, we believe that the market for voice communication products may be more sensitive to economic conditions than our video communications solutions products as we have seen in 2009. In voice communications solutions, our major conference phone competitors include ClearOne Communications, Konftel, Mitel, Yamaha and other companies that offer lower cost, full-duplex speakerphones. Furthermore, all major telephony manufacturers produce hands-free speakerphone units that cost less than our voice communications products. Our major VoIP desktop competitors include Aastra, LG Nortel, Linksys, a division of Cisco Systems, Snom and Thompson, in addition to several low cost manufacturers in Asia and Europe that are emerging.

We also sell a range of high definition VoIP devices from personal speakerphones to executive desktop devices enabling integration with Microsoft Office Communications Server 2007. Some of these products directly compete with products offered by LG Nortel. In addition, there are PBX and IP Call Manager manufacturers that compete with standards based IP products including Alcatel-Lucent, Avaya, Cisco Systems, Mitel, and Siemens.

A significant portion of our VoIP desktop product revenues come from Internet Telephony Service Providers (or ITSPs) that use a hosted call server platform from one business partner. If that partner were to be acquired by a competitor, or if potential customers for our VoIP desktop products use or move to other platforms, our VoIP desktop revenues could suffer, possibly materially. Our VoIP product sales may also be negatively impacted by the anticipated, increased market traction of sales by Skype to business consumers. With respect to our wireless product lines, our competitors include Aastra, Hitachi Cable and Linksys for small business and entry-level products. Our KIRK wireless products compete with offerings from DECT providers such as Aastra, Alcatel-Lucent, Ericsson and Siemens.

Our SpectraLink wireless products compete with proprietary and Wi-Fi-based products from Ascom, Cisco Systems, Motorola, Siemens and Vocera. The overall market in the wireless segment is highly competitive, and many of such competitors may have greater financial, technical, research and development, and marketing resources than we do. In addition, mature DECT standard-based products previously marketed by large telecom companies in markets outside the U.S. are being introduced in the U.S., which may be lower-priced than our SpectraLink and KIRK offerings. Enterprise adoption of standards for wireless LAN and VoIP may lead to the commoditization of wireless telephone technology and the availability of low-cost alternative products. Other purchasers may prefer to buy their wireless telephone systems from a single source provider of wireless local area networks, or LANs, such as Cisco Systems, who provides wireless infrastructure and wireless telephones.

         For our services business, we do not currently experience any significant competition from any third party maintenance and support companies, although many of our competitors in our various product lines offer strong service offerings, particularly in overseas markets. We also may not be as well-situated as these competitors to scale and to compete as effectively in our services business, particularly in the international arena. Third party maintenance companies may become a threat to our service base in the future, as the industry grows and as they look at our products as potential third party service revenue streams, in addition to trying to provide one service solution to their customers. In addition, as we expand our professional services offerings, we may compete more directly with system integrators.

 

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It is possible that we will see increased competition in all of our product lines to the extent that one or more of our competitors join together either through mutual agreement or acquisitions to form new partnerships to compete against us, such as the recently completed acquisition of Tandberg by Cisco Systems. Rumored or actual consolidation of our partners and competitors can cause uncertainty and disruption to our business and can cause our stock price to fluctuate. Also, these competitors, either on a stand-alone basis or on a combined basis, could have more substantial financial resources and production, sales, marketing, engineering and other capabilities with which to develop, manufacture, market and sell their products. Further, the economic downturn may incent partners of ours with whom we do not currently compete to become competitors of ours as a means of growing their business in a difficult economic environment.

Our plans to invest in our business for further growth have caused, and may continue to cause, a negative impact on our profitability and may not ultimately lead to our intended results.

In the fourth quarter of 2009, we announced a strategic investment plan that included several key initiatives designed to capture growth in the unified collaboration market in which we operate. These include enhancements to our go-to-market capability; building strategic partnerships with companies such as Avaya, Hewlett-Packard, IBM, Microsoft and others; focusing on service providers’ enhanced sell-through, as well as developing specific products and services to support their growing offerings in the managed and hosted space; increased innovation surrounding our immersive telepresence products and other solutions; and expansion of our professional services practice. Over the next few quarters, we plan to significantly increase our spending levels in sales and marketing and, to a lesser extent, research and development and general and administrative areas, to support these key initiatives. This increased investment level has lowered profits in the short-term and is designed to yield increased growth in both our revenues and profitability in the future.

The results of these investments are expected, in the short-term, to limit our profitability and could negatively impact our stock price. Further, these investments may not result in the revenue and profitability growth that these investments are designed to yield. We may have also underestimated the required investment that each of these initiatives requires in order for us to achieve the anticipated results.

Our quarterly operating results fluctuate significantly and are not necessarily a good indicator of future performance.

Our quarterly operating results have fluctuated in the past and may vary significantly in the future as a result of a number of factors, many of which are out of our control or can be difficult to predict. These factors include, but are not limited to:

 

   

the impact of global economic conditions, including the restricted credit environment impacting the credit of our partners and end user customers, and the spread of these conditions and recessionary factors to other countries, which has impacted, and may continue to impact, our global financial performance in future quarters;

 

   

fluctuations in demand for our products and services, principally due to (i) the changing global economic environment, (ii) increased competition as we have seen in Asia, particularly in China and India, across all product lines and globally with respect to video communications solutions product lines, (iii) the development of new partnerships, such as the one recently announced between Hewlett-Packard and Vidyo, and the impact of consolidation in our industry, such as the recently completed acquisition of Tandberg by Cisco Systems, (iv) increased competition from larger companies like Cisco Systems, particularly as a result of the Tandberg acquisition, and Hewlett-Packard and (v) the introduction by our competitors of new products that may be considered more technologically advanced than the products that we offer and that are introduced in the market more rapidly than we can offer them;

 

   

the timing and extent of additional investments we make to support our recently announced strategic initiatives may not result in the revenue and profitability growth that these investments are intended to yield;

 

   

changes to our global organization, particularly with respect to CEO transition activity and the corresponding reorganization of our global sales organization, which creates distraction for our sales force and our channel partners, may lead to employee attrition in the sales organization and may materially impact our future revenues and profitability during the transition period;

 

   

slowing sales by our channel partners to their customers, which places further pressure on our channel partners to minimize inventory levels and reduce purchases of our products;

 

   

changes to our channel partner programs, contracts and strategy that could result in a reduction in the number of channel partners, could adversely impact our revenues and gross margins as we realign our discount and rebate programs for our channels, or could cause more of our channel partners to add our competitors’ products to their portfolio;

 

   

the impairment of investments, including the preferred equity securities and corporate debt in our investment portfolio, as well as our strategic investments or other assets;

 

   

the impact of the volatility of the U.S. dollar, and recently of the Euro and British Pound, which could result in delays in purchasing our products or lower average selling prices to offset the volatility, affecting both revenues and gross margins;

 

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the prices and performance of our products and those of our existing or potential new competitors, which can change rapidly due to technological innovations;

 

   

the timing, size and mix of the orders for our products;

 

   

the negative impact of the growth of our VoIP product sales on sales of our circuit-switched products and whether VoIP product sales will serve as an effective driver for sales of our IP-based video communications solutions, as we anticipate;

 

   

the level and mix of inventory that we hold to meet future demand, including the impact of our efforts to decrease inventory and improve inventory turns, which could negatively impact our gross margins as a result of under absorption of our manufacturing costs in any given period;

 

   

changes in effective tax rates which are difficult to predict due to, among other things, the timing and geographical mix of our earnings, the outcome of current or future tax audits and potential new rules and regulations;

 

   

changes in the underlying factors and assumptions regarding a number of highly complex and subjective variables used in the option-pricing model to determine stock-based compensation which may result in significant variability in the stock-based compensation costs we record, making such amounts difficult to accurately predict;

 

   

fluctuations in the level of international sales and our exposure to the impact of international currency fluctuations on both revenues and expenses;

 

   

dependence on third party manufacturers, which includes outside development manufacturers, and the associated manufacturing costs;

 

   

the impact of increasing costs of freight and components used in the manufacturing of our products and the potential negative impact on our gross margins;

 

   

the magnitude of any costs that we must incur in the event of a product recall or of costs associated with product warranty claims;

 

   

the impact of seasonality on our various product lines and geographic regions; and

 

   

adverse outcomes in intellectual property litigation and other matters and the costs associated with asserting and enforcing our intellectual property portfolio.

As a result of these and potentially other factors, we believe that period-to-period comparisons of our historical results of operations are not necessarily a good predictor of our future performance. If our future operating results are below the expectations of stock market securities analysts or investors, our stock price will likely decline.

We face risks associated with developing and marketing our products, including new product development and new product lines that require a more direct-touch sales model.

Our success depends on our ability to assimilate new technologies in our products and to properly train our channel partners, sales force and end-user customers in the use of those products.

The markets for video communications solutions and voice communications solutions products are characterized by rapidly changing technology, such as the recent demand for high definition video technology and lower cost video infrastructure products, evolving industry standards and frequent new product introductions. The success of our new products depends on several factors, including proper new product definition, product cost, timely completion and introduction of new products, proper positioning of new products in relation to our total product portfolio and their relative pricing, our ability to price our products competitively while maintaining favorable product margins, differentiation of new products from those of our competitors, and market acceptance of these products. Other factors that may affect our success include properly addressing the complexities associated with compatibility issues, channel partner and sales force training, technical and sales support, and field support.

Further, as our product portfolio expanded and as we entered into product lines that require a more direct-touch sales model and more complex negotiations, such as our RPX and TPX product lines, we made key strategic investments in additional sales and marketing personnel in 2008 and 2009 and are doing so again in 2010 as part of our strategic initiative to invest in our go-to-market capabilities.

It will take time for us to hire additional key sales and marketing talent in such numbers that we believe are required to compete effectively both domestically and internationally and then further time for such new personnel to receive training and to become familiar with our product lines and services.

 

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In addition, we plan to make additional investments in developing our immersive telepresence products and other product innovation as part of our recently announced key strategic initiatives. Ultimately, it is possible that our increased investments in this area may not yield the financial results that we plan to achieve from such investments as quickly as anticipated, or at all. In addition, in our high end video communications solutions, such as telepresence, that typically require direct high touch sales involvement with potential customers, we compete directly with large, multi-national corporations, such as Cisco Systems and Hewlett-Packard, who have substantially greater financial, technical and executive resources than we do, as well as greater name recognition and market presence with many potential customers.

We continually need to educate and train our channel partners to avoid any confusion as to desirability of new product offerings compared to our existing product offerings. During the last few years, we launched several new product offerings, and there is a risk that these new products could cause confusion among our channel partners and end-users, thereby causing them to delay purchases of any product until they determine if these products are more desirable products than our other products.

We recently introduced our RMX 4000, RMX 2000 and RMX 1000 conferencing platforms, which provide the next generation of conferencing infrastructure and had a negative impact on the sales of our MGC media servers, and the HDX® 4000, our high definition executive desktop product, which had a negative impact on sales of our existing executive desktop product. Further we believe that the anticipation of the announcement of our HDX® 8000 video conferencing product, our high definition video conferencing product for small- to medium-sized conference rooms, temporarily delayed sales of our HDX® 9000 video conferencing product, our high definition video conferencing product intended for larger conference room settings, in the third quarter of 2007.

Similar delays in future purchases could adversely affect our revenues, gross margins and operating results in the period of the delay. In addition, the introduction of new products such as the HDX® 7000 video conferencing product for smaller conference rooms and the Polycom CX5000 Unified Conferencing Station may have an unintended negative impact on sales of and corresponding revenues associated with other video conferencing products such as our VSX and other HDX and telepresence offerings. We and our channel partners must also effectively educate our potential end-user customers about the benefits of video conferencing and the products that we offer and the features available over those of our competitors.

The shift in communications from circuit-switched to IP-based technologies over time may require us to add new channel partners, enter new markets and gain new core technological competencies. We are attempting to address these needs and the need to develop new products through our internal development efforts, through joint developments with other companies and through acquisitions. We may not identify successful new product opportunities and develop and bring products to market in a timely manner. Further, as we introduce new products that can or will render existing products obsolete, these product transition cycles may not go smoothly, causing an increased risk of inventory obsolescence and relationship issues with our end-user customers and channel partners. The failure of our new product development efforts, any inability to service or maintain the necessary third-party interoperability licenses, our inability to properly manage product transitions or to anticipate new product demand, or our inability to enter new markets would harm our business and results of operations.

We may experience delays in product introductions and availability, and our products may contain defects which could seriously harm our results of operations.

We have experienced delays in the introduction of certain new products and enhancements in the past, such as the delays experienced with the introduction of our HDX 9000 in the fourth quarter of 2007. The delays in product release dates that we experienced in the past were due to factors such as unforeseen technology issues, manufacturing ramping issues and other factors, which we believe negatively impacted our sales revenue in the relevant periods. Any of these or other factors may occur again and delay our future product releases. In addition, we have occasionally terminated new product development efforts prior to any introduction of the new product.

Our product development groups are dispersed among California, Colorado, Georgia, Massachusetts and Texas in the United States, as well as in China, Denmark, India and Israel. Our need to manage large and geographically dispersed product development groups in our product lines results in certain inefficiencies and increased product development costs and creates an increased risk of delays in new product introductions.

We produce highly complex communications equipment, which includes both hardware and software and incorporates new technologies and component parts from different suppliers. Resolving product defect and technology and quality issues could cause delays in new product introduction. Component part shortages, such as those we experienced in the fourth quarter of 2009 and the first half of 2010, could also cause delays in product delivery to our customers and lead to increased costs as we are required to expedite shipping to meet our product order requests. Further, some defects may not be detected or cured prior to a new product launch, or may be detected after a product has already been launched and may be incurable or result in a product recall. For example, in the past we have encountered defects with the lithium ion batteries in our wireless products. The occurrence of any of these events has resulted and could in the future result in the failure of a partial or entire product line or a temporary or permanent withdrawal of a product from the market. We may also have to invest significant capital and other resources to correct these problems, including product reengineering expenses and inventory, warranty and replacement costs. These problems might also result in claims against us by our customers or others.

 

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Any delays in the future for new product offerings currently under development, any product shipment delays or any product quality issues, product defect issues or product recalls could adversely affect the market acceptance of these products (and correspondingly result in loss of market share), our ability to compete effectively in the market, and our reputation and the satisfaction of our customers, and therefore could lead to decreased product sales and could seriously harm our results of operations. We may also experience cancellation of orders, difficulty in collecting accounts receivable, increased service and warranty costs in excess of our estimates, diversion of resources and increased insurance costs and other losses to our business or to end-user customers.

Product obsolescence and excess inventory can negatively affect our results of operations.

We operate in a high technology industry which is subject to rapid and frequent technology and market demand changes. These changes can often render existing or developing technologies obsolete. In addition, the introduction of new products and any related actions to discontinue existing products can cause existing inventory to become obsolete. These obsolescence issues, or any failure by us to properly anticipate product life cycles, can require write-downs in inventory value when it is determined that the recorded value of existing inventory is greater than its fair market value. Further, as customers transition to our HDX video conferencing endpoints from our VSX video conferencing endpoints or to our RMX platform from our MGC network systems products, we may experience additional write-downs in inventory value of these products in the future, as has happened in the past. Also, the pace of change in technology development and in the release of new products has increased and is expected to continue to increase. If sales of one of these products has an unplanned negative effect on sales of another of our products, it could significantly increase the inventory levels of the negatively impacted product. For each of our products, the potential exists for new products to render existing products obsolete, cause inventories of existing products to increase, cause us to discontinue a product or reduce the demand for existing products.

We face risks related to the adoption rate of new technologies.

We have invested significant resources developing products that are dependent on the adoption rate of new technologies. For example, our SoundStation® IP and SoundPoint® IP products are dependent on the roll out of voice-over-IP, or VoIP, technologies. In addition, VoIP products are traditionally sold through service providers. We may not be successful in expanding our current service provider network or maintaining a successful service provider network or one that we can successfully leverage beyond our current value added reseller model. The success of our HDX 4000, VSX 3000 and CMA Desktop software application products depends on the increased use of desktop video collaboration technologies. The success of our Polycom Video Border Patrol™ (VBP™) security and Network Address Translation (NAT)/firewall traversal solutions will depend on market acceptance and the effect of current and potential competitors and competitive products. Further, as we see the adoption rate of new technologies increase, product sales of our legacy products may be negatively impacted. Due to the SpectraLink acquisition, we face risks related to our ability to respond to rapid technological changes within the on-premises wireless telephone industry. The wireless communications industry is characterized by rapid technological change, short product life cycles, and evolving industry standards. Further, a lower than anticipated rate of acceptance of 802.11 wireless networks within the enterprise environment may impede the growth of our wireless handset sales.

In addition, we develop new products or product enhancements based upon anticipated demand for new features and functionality, such as next generation high definition video resolution technology and scalable video codec (SVC) capabilities. We may not be able to sell certain of our products in significant volumes and our business may be harmed if the use of new technologies that our future products are based on does not occur; if the development of suitable sales channels does not occur, or occurs more slowly than expected; if our products that incorporate new technologies are not priced competitively or are not readily adopted; or if the adoption rates of such new technologies do not drive demand for our other products as we anticipate. For example, although we believe increased sales of group and desktop video communications solutions will drive increased demand for video infrastructure products, such increased demand may not occur or we may not benefit to the same extent as our competitors. We also may not be successful in creating demand in our installed customer base, such as customers who have our legacy SoundStation products, for products that we develop that incorporate new technologies or features.

We may not successfully execute on our product requirements because of errors in defining product marketing requirements, planning or timing, technical hurdles that we fail to overcome in a timely fashion, or a lack of appropriate resources. Due to the competitive nature of our business, any failure by us to meet any of these challenges could render our products or technologies obsolete or noncompetitive and thereby materially and adversely affect our business, reputation, and operating results.

In May 2010, the Company co-founded the Unified Communications Interoperability Forum (UCIF), a non-profit alliance of worldwide technology leaders working together to deliver open unified communication (UC) solutions. The UCIF will utilize existing standards and define new standards to eliminate the gaps between current protocols and broad-based interoperability. Developing and maintaining the UCIF requires a significant investment of time and resources and we may not ultimately realize the intended benefits.

 

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Lower than expected market acceptance of our products, price competition and other price changes would negatively impact our business.

If the market does not accept our products, particularly our new product offerings which we are relying on for future revenues, our profitability would be harmed. Further, new products typically have lower gross margins for a period of time after their introduction. We have recently launched a number of new products and new products are becoming an increasing percentage of our revenues. For example, our HD video products, which generate higher gross profit dollars than our other non-HD video products due to higher average selling prices, may result in a lower overall gross margin percentage for an extended period of time after their introduction depending upon the mix of new products sold during the period.

Our profitability could also be negatively affected in the future as a result of continuing competitive price pressures in the sale of video and voice conferencing equipment and video infrastructure products, which could cause us to reduce the prices for any of these products or discontinue one product with the intent of simplifying our product offering and enhancing sales of a similar product. For example, we believe that the sequential declines in video network systems product revenues that we experienced in the first and second quarters of 2008 and again in the second quarter of 2010 are due in part to increased competitive pressures. Further, we have reduced prices in the past in order to expand the market for our products, and in the future, we may further reduce prices, introduce new products that carry lower margins in order to expand the market or stimulate demand for our products, or discontinue existing products as a means of stimulating growth in a similar product.

In addition, we anticipate that our gross margins may become more difficult to predict due to these types of changes, the wide range of margins associated with each of our product lines, and shifts in the mix of products sold. Our video network systems products typically have higher gross margins than our other product lines. Therefore, our overall gross margins could decrease if we experience decreases in our video network systems product sales. Further, if our video network systems sales suffer, there may be a correspondingly negative impact on our services business, which relies in part on video network systems sales for its success.

Finally, if we do not fully anticipate, understand and fulfill the needs of end-user customers in the vertical markets that we serve, we may not be able to fully capitalize on product sales into those vertical markets and our revenues may, accordingly, fail to grow as anticipated or may be adversely impacted. We face similar risks as we expand and focus our business on the small-to-medium business and service provider markets.

Failure to adequately service and support our product offerings could harm our results of operations.

Our products are becoming increasingly more complex and are incorporating more complex technologies, such as those included in our video network systems products, our new video product offerings and our software products. This has increased the need for enhanced product warranty and service capabilities. If we cannot adequately develop and train our internal support organization or maintain our relationship with our outside technical support provider, it could adversely affect our business.

In addition, sales of our telepresence product line are more complex sales transactions than our other product lines, and the end-user customer in such transactions typically purchases an enhanced level of support service from us so that it can ensure that this significant investment can be fully operational and satisfy the end-user’s requirements. This requires an enhanced level of support and project management from the Company in terms of resources and technical knowledge of an end-user customer’s telecommunication network. As this type of service is relatively new for us, our inability to provide the proper level of support on a cost beneficial basis may cause damage to our reputation in this new emerging market and may, as a result, harm our business and results of operations.

Impairment of our goodwill or other assets would negatively affect our results of operations.

We have acquired several businesses, which together resulted in goodwill valued at approximately $490.0 million and other purchased intangible assets valued at approximately $35.8 million as of June 30, 2010. This represents a significant portion of the assets recorded on our balance sheet. Goodwill and indefinite lived intangible assets are reviewed for impairment at least annually or sooner under certain circumstances. Other intangible assets that are deemed to have finite useful lives will continue to be amortized over their useful lives but must be reviewed for impairment when events or changes in circumstances indicate that the carrying amount of these assets may not be recoverable. Screening for and assessing whether impairment indicators exist, or if events or changes in circumstances have occurred, including market conditions, operating fundamentals, competition and general economic conditions, requires significant judgment. Therefore, we cannot assure you that a charge to operations will not occur as a result of future goodwill and intangible asset impairment tests. The decreases in revenue and stock price that have occurred and may occur in the future as a result of global economic factors make such an impairment more likely to result. If impairment is deemed to exist, we would write down the recorded value of these intangible assets to their fair values, as we did in the fourth quarter of 2007 when we wrote down certain intangible assets associated with our acquisition of Voyant in the amount of $3.6 million. If and when these write-downs do occur, they could harm our business and results of operations.

 

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In addition, we have made investments in private companies which we classify as “Other assets” on our balance sheet. The value of these investments is influenced by many factors, including the operating effectiveness of these companies, the overall health of these companies’ industries, the strength of the private equity markets and general market conditions. To date, due to these and other factors, we have recorded cumulative charges against earnings totaling $21.5 million associated with the impairment of such investments. As of June 30, 2010, our investments in private companies are valued at $2.5 million. We may make additional investments in private companies which would be subject to similar impairment risks, and these impairment risks may cause us to write down the recorded value of any such investments. Further, we cannot assure you that future inventory, investment, license, fixed asset or other asset write-downs will not happen. If future write-downs do occur, they could harm our business and results of operations.

Difficulties in integrating our acquisitions or executing divestitures could adversely impact our business.

Difficulties in integrating past or potential future acquisitions could adversely affect our business.

We have completed a number of acquisitions during our operating history. The process of integrating acquired companies into our operations requires significant resources and is time consuming, expensive and disruptive to our business.

Failure to achieve the anticipated benefits of any acquisitions, to retain key personnel, or to successfully integrate the operations of these companies could harm our business, results of operations and cash flows. We may not realize the benefits we anticipate from our acquisitions because of the following significant challenges:

 

   

incorporating the acquired company’s technology and products into our current and future product lines;

 

   

potential deterioration of the acquired company’s product sales and corresponding revenues due to integration activities and management distraction;

 

   

potentially creating confusion in the marketplace by ineffectively distinguishing or marketing the product offerings of the newly acquired company with our existing product lines;

 

   

potentially incompatible cultural differences between the two companies;

 

   

geographic dispersion of operations;

 

   

interruption of manufacturing operations as we transition an acquired company’s manufacturing to our outsourced manufacturing model;

 

   

generating marketing demand for an expanded product line;

 

   

distraction of the existing and acquired sales force during the integration of the companies;

 

   

the difficulty in leveraging the acquired company’s and our combined technologies and capabilities across all product lines and customer bases; and

 

   

our inability to retain previous customers or employees of an acquired company.

Further, future acquisition agreements may incorporate earn-out provisions in them that entitle the former shareholders of the acquired companies to receive additional consideration upon the satisfaction of certain predetermined criteria. It is possible that disputes over unpaid earn-out amounts may result in litigation to the Company, which could be costly and cause management distraction.

We have spent and will continue to spend significant resources identifying and acquiring businesses. The efficient and effective integration of our acquired businesses into our organization is critical to our growth. Any of our acquisitions involve numerous risks, including difficulties in integrating the operations, technologies and products of the acquired companies, the diversion of our management’s attention from other business concerns, particularly when dealing with the integration of large and complex organizations such as SpectraLink, and the potential loss of key employees of the acquired companies. Failure to achieve the anticipated benefits of these and any future acquisitions or to successfully integrate the operations of the companies we acquire could also harm our business, results of operations and cash flows. Additionally, we cannot assure you that we will not incur material charges in future quarters to reflect additional costs associated with acquisitions or any future acquisitions we may make.

 

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Our failure to successfully implement restructuring plans related to vacant and redundant facilities could adversely impact our business.

We have in the past, and may in the future, as part of acquiring a company or as part of restructuring actions taken to streamline the business, identify redundant facilities. If we identify redundant facilities, we would develop a plan to exit as part of the integration of the businesses or as part of the implementation of the restructuring plan. For example, as of June 30, 2010 we have a remaining liability in the amount of $0.8 million related to facilities we vacated in connection with our acquisition of SpectraLink. This reserve is net of estimated sublease income we expect to generate. Our estimate of sublease income is based on current comparable rates for leases in the respective markets. If actual sublease income is lower than our estimates for any reason, if it takes us longer than we estimated to sublease these facilities, or if the associated cost of subleasing or terminating our lease obligations for these facilities is greater than we estimated, we would incur additional charges to operations which would harm our business, results of operations and cash flows. To the extent that any such cash outflows or additional costs exceed the amount of our recorded liability related to the sublease or termination of these lease obligations, we could incur a charge to operations which would harm our business and adversely impact our results of operations.

Our failure to effectively execute a divestiture of a product line could adversely impact our business.

If we divest any of our product lines in the future, such divestitures may not be executed effectively, which could adversely impact our customer relationships or cause other adverse effects during a transition.

We experience seasonal demand for our products and services, which may adversely impact our results of operations during certain periods.

Sales of some of our products have experienced seasonal fluctuations which have affected sequential growth rates for these products, particularly in our first and third quarters. For example, there is generally a slowdown for sales of our products in the European region in the third quarter of each year and sales to government entities typically slow in our fourth quarter and to a greater extent in our first quarter. In addition, sales of our video conferencing products have historically declined in the first quarter of the year compared to the fourth quarter of the prior year. Seasonal fluctuations could negatively affect our business, which could cause our operating results to fall short of anticipated results for such quarters.

Our operating results are hard to predict as a significant amount of our sales may occur at the end of a quarter and certain of our service provider contracts include contractual acceptance provisions.

The timing of our channel partner orders and product shipments and our inability to reduce expenses quickly can result in harm to our operating results.

Our quarterly revenues and operating results depend in large part upon the volume and timing of channel partner orders received during a given quarter and the percentage of each order that we are able to ship and recognize as revenue during each quarter, each of which is extremely difficult to forecast. For example, in the third and fourth quarters of 2008, we experienced delays in orders from our channel partners, particularly in the last few weeks of the quarter, that we believe were attributable to global economic factors. We are also experiencing longer sales cycles in connection with our high end video conferencing solutions sales and our voice solutions products, which could also increase the level of unpredictability and fluctuation in the timing of orders. Further, depending upon the complexity of these solutions, such as telepresence and some video network systems products, and the underlying contractual terms, revenue may not be recognized until the product has been accepted by the end-user, resulting in further revenue unpredictability. Moreover, a significant portion of our orders in a given quarter are shipped in the last month of that quarter and sometimes in the last few weeks of the quarter.

While our product backlog has increased in recent years, we typically ship products shortly after receipt of an order. In addition, we believe that backlog levels will continue to fluctuate due to many factors such as the ability of our sales force to generate orders linearly throughout the quarter, our ability to forecast revenue mix and plan our manufacturing capacity, customer request dates, timing of product acceptance where contractually required and ongoing service deferrals as service revenues increase as a percent of total revenue. In addition, orders from our channel partners are based on the level of demand from end-user customers. Any decline or uncertainty in end-user demand could significantly negatively impact end-user orders, which could in turn negatively affect orders from our channel partners in any given quarter. As a result, our backlog could decline significantly in future quarters, as we saw in the first quarter of 2009, and we do not believe backlog is a good indicator of future operating results. Any degradation in linearity levels or any failure or delay in the closing of orders during the last part of a quarter would materially harm our operating results. Furthermore, we may be unable to ship products in the period we receive the order due to these or other factors, which could have an adverse impact on our operating results.

 

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Our expectations for both short and long-term future revenues are based almost exclusively on our own estimate of future demand and not on firm channel partner orders. Our expense levels are based largely on these estimates. In addition, a significant portion of our product orders are received in the last month of a quarter, typically the last few weeks of that quarter; thus, the unpredictability of the receipt of these orders could negatively impact our future results. Further, our products are typically categorized as capital equipment and, due to the current unfavorable economic and credit environment, budgets for capital equipment purchases may continue to be delayed, reduced or eliminated for 2010, causing continued unpredictability for 2010. Accordingly, if for any reason orders and revenues do not meet our expectations in a particular period, we will be limited in our ability to reduce expenses quickly, and any significant shortfall in demand for our products in relation to our expectations would have an adverse impact on our operating results.

Delays in receiving contractual acceptance will cause delays in our ability to recognize revenue and may impact our quarterly revenues, depending upon the timing and shipment of orders under such contracts.

Certain of our sales contracts include product acceptance provisions which vary depending upon the type of product and individual terms of the contract. In addition, acceptance criteria may be required in other contracts in the future, depending upon the size and complexity of the sale and the type of products ordered. As we increase our focus on growing our service provider business, it is likely that an increased amount of our revenue will be subject to such contractual acceptance terms. Accordingly, we defer revenue until the underlying acceptance criteria in any given contract have been met. Depending upon the acceptance terms, the timing of the receipt and subsequent shipment of an order may result in acceptance delays, may reduce the predictability of our revenues, and, consequently, may adversely impact our revenues and results of operations in any particular quarter.

We face risks related to our dependence on channel partners to sell our products.

To avoid confusion by our channel partners regarding our product offerings, we need to continually devote significant resources to educating and training them.

When we take any significant actions regarding our product offerings, or acquire new product offerings, it is important to educate and train our channel partners to avoid any confusion on the desirability of the new product offering in relation to our existing product offerings. For instance, integrating acquired product offerings with ours has created confusion among our channel partners in the past and may continue to do so in the future. We will need to continue to devote significant resources to educate and train our channel partners about our product offerings. We have launched our HDX video conferencing products and our RMX conferencing platform, all of which continue to require significant resources and training to educate our channels. Channel confusion could also occur if we do not adequately train or educate the channel on our product families, especially in the cases where we simplify our product offerings by discontinuing one product in order to stimulate growth of a similar product. Ongoing confusion may lead to delays in ordering our products, which would negatively affect our revenues.

Conflicts and competition with our channel partners and strategic partners could hurt sales of our products.

We have various original equipment manufacturer (OEM) agreements with major telecommunications equipment manufacturers, such as Avaya and Cisco Systems, whereby we manufacture our products to work with the equipment of the OEM. These relationships can create conflicts with our other channel partners who directly compete with our OEM partners, or could create conflicts among our OEM partners who compete with each other, which could adversely affect revenues from these other channel partners or our OEM partners. Conflicts among our OEM partners could also make continued partnering with these OEM partners increasingly difficult, or our OEM partners, including large competitors such as Cisco Systems, who recently acquired Tandberg and now directly competes with us across our line of video communications solutions products, may decide to enter into a new OEM partnership with a company other than us or develop products of their own, or acquire such products through acquisition, that compete with ours in the future, which could adversely affect our revenues and results of operations. Because many of our channel partners also sell equipment that competes with our products, these channel partners could devote more attention to these other products which could harm our business. Further, as we move to a more direct-touch sales model, we may alienate some of our channel partners or cause a shift in product sales from our traditional channel model as these traditional relationships evolve over time. Due to these and other factors, channel conflicts could arise which cause channel partners to devote resources to other non-Polycom communications equipment, or to offer new products from our new and existing competitors, which would negatively affect our business or results of operations. Further, consolidation among our channel partners or strategic partners may adversely impact our business as we expect short-term distraction and a potential negative impact on our revenues during the integration of the two companies.

We licensed from Microsoft the right to distribute our re-branded Polycom CX5000 Unified Conference Station in the second quarter of 2009. The Polycom CX5000 solution contributed to our sequential growth in video communications solutions product revenues in the second quarter of 2009. While we experienced strong sales in the initial quarters of the product launch, such results may not be necessarily indicative of future product sales. Additionally, in the future, Microsoft could decide to enter into similar distribution agreements for this product with companies other than us which could adversely affect our revenues in future periods.

 

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As part of our recently announced key strategic initiatives, we are building strategic partnerships with such companies as Avaya, Broadsoft, Hewlett-Packard, IBM, Juniper, Microsoft and Siemens; however, defining and developing these partnerships is expensive and time consuming and may not come to fruition or yield the desired results, impacting our ability to effectively compete in the video communications market and to take advantage of anticipated future market growth. For example, our prototypical home telepresence solution, as demonstrated in January 2010 as part of IBM’s Connected Home initiative, may not result ultimately in our ability to capture successfully the opportunities presented in the home videoconferencing market. Further, as we enter into agreements with these strategic partners to enable us to continue to expand our relationships with these partners, we may undertake additional obligations which could trigger unintended penalty or other provisions in the event that we fail to fully perform our contractual commitments or could result in additional costs beyond those that we have planned for in order to meet these contractual obligations. We also recently launched our Polycom UC Intelligent Core initiative, which is intended to drive increased product sales of our video communications network products, which may not ultimately yield the revenues or product adoption results that we intend.

Some of our current and future products are directly competitive with the products sold by both our channel and strategic partners. For example, we have an agreement with Cisco Systems under which we ship SoundStation IP conference phones for resale by Cisco Systems. Cisco Systems, through their recent of acquisition of Tandberg, sells a video infrastructure product which is in direct competition with our video network systems offerings and video conferencing products that are in direct competition with our video conferencing solutions. We also compete with Cisco Systems in the WLAN space. We also recently entered into an agreement with Hewlett-Packard under which our complete portfolio of voice and video solutions will be sold and delivered through Hewlett-Packard. Hewlett-Packard also sells a telepresence product (named HP Halo) that is in direct competition with our telepresence product offerings and has entered into a new relationship with Vidyo to expand the HP Halo portfolio to include conference room and desktop endpoints that run on enterprise networks. As a consequence of conflicts such as these, there is the potential for our channel and strategic partners to compete head-to-head with us and to significantly reduce or eliminate their orders of our products or design our technology out of their products. Further, some of our products are reliant on strategic partnerships with call servers providers and wireless network systems providers. These partnerships result in interoperable features between products to deliver a total solution to our mutual end-user customers. Competition with our partners in all of the markets in which we operate is likely to increase, potentially resulting in strains on our existing relationships with these companies. As an example, we are now competing in the voice-over-IP handset arena through service providers, which may cause our relationships with our IP PBX strategic partners to erode. In addition, due to increasing competition with us for sales of video conferencing equipment, Cisco Systems may decide to terminate its relationship with us to resell our SoundStation IP conference phones or eliminate the interoperability of its wireless access points with our SpectraLink 8000 wireless telephones. Further, our strategic partners may acquire businesses that are competitive with us. Any such strain or acquisition could limit the potential contribution of our strategic relationships to our business, restrict our ability to form strategic relationships with these companies in the future and create additional competitive pressures on us, including downward pressure on our average selling prices, which would result in a decrease in both revenues and gross margins, any of which could harm our business.

We are subject to risks associated with our channel partners’ product inventories and product sell-through.

We sell a significant amount of our products to channel partners who maintain their own inventory of our products for sale to dealers and end-users. If these channel partners are unable to sell an adequate amount of their inventory of our products in a given quarter to dealers and end-users or if channel partners decide to decrease their inventories for any reason, such as a recurrence or continuation of global economic uncertainty and downturn in technology spending, the volume of our sales to these channel partners and our revenues would be negatively affected. For example, in the first quarter of 2009, we generally saw our channel partners decrease their inventory levels in response to lower sales to dealers and end-users, which negatively affected our revenues during the quarter. In addition, if channel partners decide to purchase more inventory due to product availability or other reasons, than is required to satisfy end-user demand or if end-user demand does not keep pace with the additional inventory purchases, channel inventory could grow in any particular quarter, which could adversely affect product revenues in the subsequent quarter. In addition, we also face the risk that some of our channel partners have inventory levels in excess of future anticipated sales. If such sales do not occur in the time frame anticipated by these channel partners for any reason, these channel partners may substantially decrease the amount of product they order from us in subsequent periods, or product returns may exceed historical or predicted levels, which would harm our business. Moreover, if we choose to eliminate or reduce special cost or stocking incentive programs, quarterly revenues may fail to meet our expectations or be lower than historical levels. In addition, we accrue for sales returns and other allowances as a reduction to revenues upon shipment based upon our contractual obligations and historical experience, and the underlying reserve requirements will fluctuate from quarter to quarter based upon the volume and mix of revenues to our channel partners.

Our revenue estimates associated with products stocked by some of our channel partners are based largely on end-user sales reports that our channel partners provide to us on a monthly basis. To date, we believe this data has been generally accurate. To the extent that this sales-out and channel inventory data is inaccurate or not received timely, we may not be able to make revenue estimates for future periods.

 

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Potential changes to our channel partner programs or channel partner contracts may not be favorably received and as a result our channel partner relationships and results of operations may be adversely impacted.

Our channel partners are eligible to participate in various incentive programs, depending upon their contractual arrangements with us. As part of these arrangements, we have the right to make changes in our programs and launch new programs as business conditions warrant. Further, from time to time, we may make changes to our channel partner contracts. These changes could upset our channel partners to the extent that they could add competitive products to their portfolios, delay advertising or sales of our products, or shift more emphasis to selling our competitors products, if not appropriately handled. There can be no assurance that our channel partners will be receptive to future changes or that we will receive the positive benefits that we are anticipating in making any program and contractual changes.

Consolidation of our channel partners and strategic partners may result in changes to our overall business relationships, less favorable contractual terms and disruption to our business.

We have seen consolidation among certain of our existing channel partners and strategic partners. In such instances, we may experience changes to our overall business and operational relationships due to dealing with a larger combined entity. Further, our ability to maintain such relationships on favorable contractual terms may be limited. For instance, the combined entity may be successful in negotiating the most favorable contractual terms out of each of their respective contracts, including terms such as credit and acceptance, which are less favorable than those in our existing contracts with each channel partner. Depending on the extent of these changes and other disruption caused to the combined businesses during the integration period, the timing and extent of revenue from these channel partners may be adversely affected.

We are subject to risks associated with the success of the businesses of our channel partners.

Many of our channel partners that carry multiple Polycom products, and from whom we derive significant revenues, are thinly capitalized. Although we perform ongoing evaluations of the creditworthiness of our channel partners, the failure of these businesses to establish and sustain profitability, obtain financing or adequately fund capital expenditures could have a significant negative effect on our future revenue levels and profitability and our ability to collect our receivables. As we have grown our revenues and our customer base, our exposure to credit risk has increased. In addition, global economic uncertainty and recessionary factors, a downturn in technology spending in the United States and other countries, and the financial services crisis have restricted the availability of capital, which may delay our collections from our channel partners beyond our historical experience or may cause companies to file for bankruptcy, jeopardizing the collectability of our revenues from such channel partners and negatively impacting our future results as they reorganize or go out of business. For example, our partner Nortel filed for bankruptcy protection in the first quarter of 2009, one of our Asian distributors filed for bankruptcy in the third quarter of 2008 and one of our large European distributors filed for bankruptcy in the fourth quarter of 2007. Since filing bankruptcy, our level of business with Nortel has been materially lower than that of historical levels and the recent acquisition by Avaya of Nortel’s enterprise solutions business could have a further negative impact on revenues.

Our channel partner contracts are typically short-term and early termination of these contracts may harm our results of operations.

We do not typically enter into long-term contracts with our channel partners, and we cannot be certain as to future order levels from our channel partners. When we do enter into a long-term contract, the contract is generally terminable at the convenience of the channel partner. In the event of an early termination by one of our major channel partners, we believe that the end-user customer would likely purchase from another one of our channel partners. If this did not occur and we were unable to rapidly replace that revenue source, its loss would harm our results of operations.

If revenues from sales to our service provider customers decrease significantly from prior periods, or if the intended results of our strategic initiative focused around service providers do not come to fruition, our results of operations may suffer materially.

Service providers constitute some of the larger end-user customers of our network systems products, and we experience significant quarterly variability in the timing and amount of these orders. The revenues for network systems products from service providers are subject to more variability than network systems product revenues from our channel partners. Further, we recently announced a focus on service providers’ to provide enhanced sell-through, as well as developing specific products and services to support their growing offerings in the managed and hosted space. The loss of any one of these service provider customers for our network systems products, or our failure to adequately maintain or grow the level of network systems-related product sales to service providers or to execute properly on our service provider strategic initiative, could have a materially adverse impact on our consolidated revenues and profitability. For example, in 2008 our revenues for our voice network systems products, which are sold primarily to service provider customers, decreased by 66% compared to 2007.

 

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We face risks related to our international operations and sales.

International sales and expenses represent a significant portion of our revenues and operating expenses and risks inherent in international operations could harm our business.

International sales and expenses represent a significant portion of our revenues and operating expenses, and we anticipate that international sales will continue to increase and to account for a significant portion of our revenues for the foreseeable future and that international operating expenses will continue to increase. International sales and expenses are subject to certain inherent risks, including the following:

 

   

adverse economic conditions in international markets, including the current credit crisis and global recession;

 

   

potential foreign currency exchange rate fluctuations, including the recent volatility of the U.S. dollar, and the impact of our underlying hedging programs;

 

   

environmental and trade protection measures and other legal and regulatory requirements, some of which may affect our ability to import our products, to export our products from, or sell our products in various countries;

 

   

unexpected changes in regulatory requirements and tariffs;

 

   

difficulties in staffing and managing foreign operations;

 

   

difficulties in competing effectively for international sales against international competitors;

 

   

longer payment cycles;

 

   

problems in collecting accounts receivable;

 

   

potentially adverse tax consequences;

 

   

the near and long-term impact of the instability in the Middle East or other hostilities;

 

   

disruptions in business due to natural disasters, quarantines or other disruptions associated with infectious diseases or other events beyond our control; and

 

   

adverse economic impact of terrorist attacks and incidents and any military response to those attacks.

International revenues may fluctuate as a percentage of total revenues in the future as we introduce new products. These fluctuations are primarily the result of our practice of introducing new products in North America first and the additional time and costs required for product homologation and regulatory approvals of new products in international markets. To the extent we are unable to expand international sales in a timely and cost-effective manner, our business could be harmed. We cannot assure you that we will be able to maintain or increase international market demand for our products.

Although to date, a substantial majority of our international sales have been denominated in U.S. currency, we expect that a growing number of sales will be denominated in non-U.S. currencies as more international customers request billing in their currency. We maintain local currency pricing in the European Union and the United Kingdom whereby we price and invoice our products and services in Euros and British Pounds. In addition, some of our competitors currently invoice in foreign currency, which could be a disadvantage to us in those markets where we do not. Further, with the recent credit crisis and volatility of the U.S. dollar against other currencies in the second half of 2008 and again in 2010, our products have become more expensive for our partners whose purchases are denominated in U.S. dollars, which may further disadvantage us relative to our competitors or negatively impact our margins. Our international operating expenses are denominated in foreign currency. As a result of these factors, we expect our business will be significantly more vulnerable to currency fluctuations, which could adversely impact our results of operations. These currency fluctuations would be recorded in Interest and Other Income (Expense) in our Consolidated Statements of Operations. We will continue to evaluate whether to, and are likely to decide to, expand the type of products we sell in selected foreign currencies in addition to the Euro and British Pound or may, for specific customer situations, choose to sell our products in foreign currencies, thereby further increasing our foreign exchange risk.

While we do not hedge for speculative purposes, as a result of our increased exposure to currency fluctuations, such as we have seen in the Euro and British Pound in 2010, we typically engage in currency hedging activities to mitigate currency fluctuation exposure. As a result, our hedging costs can vary depending upon the size of our hedge program, whether we are purchasing or selling foreign currency relative to the U.S. dollar and interest rates spreads between the U.S. and other foreign markets. As a result, Interest and Other Income (Expense) has become less predictable and more difficult to forecast. Due to the denomination of our European product sales in Euros and of our United Kingdom product sales in British Pounds, we have increased our hedging activity. The impact in any given quarter of our hedging programs is dependent upon a number of factors, including the actual level of foreign currency denominated revenues, the percentage of actual revenues covered by our hedge contracts, the exchange rate in our underlying hedge contracts and the actual exchange rate during the quarter. For example, as a result of our cash flow hedging program, in the third and fourth quarters of 2009, we reduced operating income by $0.6 million and $2.2 million, respectively, as compared to increasing operating income in the first and second quarters of 2009 and the first and second quarters of 2010 by $2.3 million, $1.6 million, $0.5 million, and $1.7 million, respectively.

In addition, significant adverse changes in currency exchange rates could cause our products to become relatively more expensive to customers in a particular country, leading to a reduction in revenue or profitability in that country, as discounts may be temporarily or permanently affected.

 

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Difficulties we may encounter managing a substantially larger business could adversely affect our operating results.

If we fail to successfully attract and retain highly qualified management personnel, our business will be harmed.

Our future success will depend in part on our continued ability to hire, assimilate and retain highly qualified senior executives and other key management personnel. Beginning with the appointment of Andrew Miller as our President and Chief Executive Officer in May 2010, we have begun a transition in certain of our executive positions, including the departures of our Senior Vice President, Human Resources and Senior Vice President and General Manager, Polycom Global Services. In addition, we have not as yet replaced the head of our Voice Communications Solutions division who left the company in November 2009, and Mr. Miller fills that role on an interim basis. Future changes to the Company’s executive leadership team, including new executive hires or departures, or other organization changes implemented by our new Chief Executive Officer, could cause disruption to the business and have an impact on our ability to execute successfully in future periods while these operational areas are in transition. Further, as a result of our increased focus on service providers and small-to-medium businesses, we will likely need to hire additional personnel with expertise in these areas or make organizational changes to better align our resources around these markets. Competition for qualified executive and other management personnel is intense, and we may not be successful in attracting or retaining such personnel, which could harm our business.

Further, since July 2009, we have made a number of changes in our global sales organization, including most recently in connection with Mr. Miller’s transition from his prior role as EVP, Global Field Operations. Such changes may create a distraction for our sales force and our channel partners and divert management’s attention from other ongoing business concerns, may lead to employee attrition in the sales organization and, accordingly, may materially impact our future revenues and profitability during the transition period. Such transitions may also be disruptive to the affected function and our business on a longer term basis than we expect, particularly as the sales team, many of whom have not worked together previously, learns to work together effectively. Further, we may not experience the operating efficiencies in product planning, research, and development or sales productivity that any reorganization within the sales organization is intended to achieve. In addition, the success of the planned expansion of our sales force as part of our recently announced strategic initiative around increasing our go-to-market capability is also dependent upon their ability to achieve certain productivity levels in an acceptable timeframe, and any inability to do so could be disruptive to our business and have a material adverse impact on our operating results.

We have experienced significant growth in our business and operations due to internal expansion and business acquisitions, and if we do not appropriately manage this growth and any future growth, our operating results will be negatively affected.

Our business has grown in recent years through both internal expansion and business acquisitions, including our acquisitions of SpectraLink and Destiny in 2007, and we recently announced several key strategic initiatives that we are undertaking to further grow our business, including enhancing our go-to-market capability, increasing our strategic partnerships, focusing on service providers’ enhanced sell-through, as well as developing specific products and services to support their growing offerings in the managed and hosted space, increased innovation in our immersive telepresence products and expansion of our professional services practice. The Company’s execution against its strategic initiatives may cause strain on our organizational resources and may not ultimately result in the return on investment that is anticipated, particularly with respect to the heavy investment in go-to-market resources. Further, continued growth in general, which may include growth through business acquisitions, may continue to cause a significant strain on our infrastructure, internal systems and managerial resources. To manage our growth effectively, we must continue to improve and expand our infrastructure, including information technology and financial operating and administrative systems and controls, and continue managing headcount, capital and processes in an efficient manner. In addition, we must continue to evolve our processes to take advantage of automation tools as the size of our business grows, or the processes that we developed when we were a smaller company may not be sustainable and could cause harm to our business. Our productivity and the quality of our products may be adversely affected if we do not integrate and train our new employees quickly and effectively and coordinate among our executive, engineering, finance, marketing, sales, operations and customer support organizations, all of which add to the complexity of our organization and increase our operating expenses. We also may be less able to predict and effectively control our operating expenses due to the growth and increasing complexity of our business. In addition, our information technology systems may not grow at a sufficient rate to keep up with the processing and information demands placed on them by a much larger company. The efforts to continue to expand our information technology systems or our inability to do so could harm our business. For instance, we are in the

 

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process of upgrading our Enterprise Resource Planning (ERP) systems to meet the growing demands of our business, which upgrade efforts were slowed toward the end of 2008 and early 2009 due to a decrease in Company spending during the period of economic downturn. The initial phase of our upgrade to our ERP systems was completed in July 2010 and will continue to be implemented in phases through 2011. The fact that such ERP upgrades were delayed, or may not be effectively completed as planned, could cause harm to our ongoing business operations. Further, revenues may not grow at a sufficient rate to absorb the costs associated with a larger overall headcount.

Our future growth may require significant additional resources given that, as we increase our business operations in complexity and scale, we may have insufficient management capabilities and internal bandwidth to manage our growth and business effectively. We cannot assure you that resources will be available when we need them or that we will have sufficient capital to fund these potential resource needs. Also, as we assess our resources following our acquisitions, we will likely determine that redundancy in certain areas will require consolidation of these resources, such as the associated restructuring activities we completed during 2008 and 2009. We have in the past, and we may again in the future, implement restructuring plans to eliminate or relocate positions in order to reallocate resources to more strategic growth areas of the business or to reduce our operating costs. Such restructuring actions result in significant cash payments and charges to operations, such as the $15.9 million we recorded for restructuring costs in 2009. Any organizational disruptions associated with restructuring activities would require increased management attention and financial expenditures, or we may discover we terminated the wrong personnel or cut too deeply, which may impact our operations. If we are unable to manage our growth effectively, if we experience a shortfall in resources or if we must take additional restructuring charges, our results of operations will be harmed.

Further, in 2009, we opened a Shared Services Center (“SSC”) in Beijing, China, to perform certain accounting, order entry and other functions previously performed in regional headquarter locations and we may expand our SSC operations in the future. These efforts to globalize these shared functions into one location may not yield the intended benefits and could result in higher turnover than planned and could have an adverse affect on these functions during the transition. In addition, if the controls we put in place with respect to the SSC fail to operate effectively, our business and results of operations could be harmed.

Because of our operations in Israel, we are subject to risks associated with the military and political environment in Israel and the Middle East region.

The research and development and manufacturing facilities for our network systems products and many of the suppliers for such products are located in Israel. Political, economic and military conditions in Israel and the Middle East region directly affect our network systems group’s operations. A number of armed conflicts have taken place and continue to take place between Israel and its geographic neighbors. As a result, certain of our employees have been called to active military duty, and additional employees may be called to serve in the future. Current and future armed conflicts or political instability in the region may impair our ability to produce and sell our network systems products and could disrupt research or developmental activities. This instability could have an adverse impact on our results of operations. Further, the military action in Iraq or other countries in the region perceived as a threat by the United States government could result in additional unrest or cause Israel to be attacked, which would adversely affect our results of operations and harm our business.

We have limited supply sources for some key components of our products and services and for the outside development and manufacture of certain of our products, and our operations could be harmed by supply or service interruptions, component defects or unavailability of these components or products.

Some key components used in our products are currently available from only one source and others are available from only a limited number of sources, including some key integrated circuits and optical elements. Because of such limited sources for component parts, we may have little or no ability to procure these parts on favorable pricing terms. We also obtain certain plastic housings, metal castings, batteries, and other components from suppliers located in China and certain Southeast Asia countries, and any political or economic instability in that region in the future, natural disasters, quarantines or other disruptions associated with infectious diseases, or future import restrictions, may cause delays or an inability to obtain these supplies. Further, we have suppliers in Israel and the military action in Iraq or war with other Middle Eastern countries perceived as a threat by the United States government may cause delays or an inability to obtain supplies for our network systems products.

         We have no raw material supply commitments from our suppliers and generally purchase components on a purchase order basis either directly or through our contract manufacturers. Some of the components included in our products, such as microprocessors and other integrated circuits, have from time to time been subject to limited allocations by suppliers. In addition, companies with limited or uncertain financial resources manufacture some of these components. Further, we do not always have direct control over the supply chain, as many of our component parts are procured for us by our contract manufacturers. In the event that we, or our contract manufacturers, are unable to obtain sufficient supplies of components, develop alternative sources as needed, or companies with limited financial resources go out of business, our operating results could be seriously harmed. During the fourth quarter of 2009 and the first half of 2010, we experienced material shortages from several key component suppliers which delayed our manufacturing output for certain of our voice, video and network system products. Some of these shortages will continue into the second half of 2010 and possibly longer. In addition, we may incur additional costs to resolve these supply shortages, which would negatively impact our gross margins, as we have seen in recent quarters.

Moreover, we have strategic relationships with third parties to develop and manufacture certain products for us. The loss of any such strategic relationship due to competitive reasons, our inability to resolve any contractual disputes that may arise between us, the financial instability of a strategic partner or their inability to obtain any financing necessary to adequately fund their operations, particularly in light of the current economic environment, or other factors, could have a negative impact on our ability to produce and sell certain products and product lines and, consequently, may adversely affect our revenues and results of operations.

 

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In the case of the video network operations center (VNOC) services we provide to users of our telepresence products, we are dependent upon third party suppliers for such services. In the event that any such supplier is acquired by a competitor or faces financial difficulty, such event creates a risk of VNOC service discontinuity for our customers while we search for a replacement provider and may materially adversely affect our ability to sell our telepresence products.

Further, the business failure or financial instability of any supplier of these components or services or of any product manufacturer could adversely affect our cash flows if we were to expend funds in some manner to ensure the continued supply of those components or products.

Additionally, our HDX video conferencing and network system products are designed based on digital signal processors and integrated circuits produced by Texas Instruments and cameras produced by JVC. Our VSX video conferencing products are designed based on integrated circuits produced by Equator Technologies, a subsidiary of Pixelworks Inc., and cameras produced by Sony. If we could no longer obtain integrated circuits or cameras from these suppliers, we would incur substantial expense and take substantial time in redesigning our products to be compatible with components from other manufacturers, and we cannot assure you that we would be successful in obtaining these components from alternative sources in a timely or cost-effective manner. Additionally, Sony competes with us in the video communications industry, which may adversely affect our ability to obtain necessary components. The failure to obtain adequate supplies of vital components could prevent or delay product shipments, which could harm our business. We also rely on the introduction schedules of some key components in the development or launch of new products. Any delays in the availability of these key components could harm our business.

Finally, our operating results would be seriously harmed by receipt of a significant number of defective components or components that fail to fully comply with environmental or other regulatory requirements, an increase in component prices, such as the price increases for components as a result of increased transportation and manufacturing costs of our suppliers, or our inability to obtain lower component prices in response to competitive price reductions.

Manufacturing disruption or capacity constraints or failure of our information technology systems would harm our business.

We subcontract the manufacture of our voice products, including our wireless products, and video product lines to Celestica, a third-party contract manufacturer. We use Celestica’s facilities in Thailand, China and Singapore, and should there be any disruption in services due to natural disaster, terrorist acts, quarantines or other disruptions associated with infectious diseases, or other similar events, or economic or political difficulties in any of these countries or Asia or any other reason, such disruption would harm our business and results of operations. While we have begun to develop secondary manufacturing sources for certain products, Celestica’s facilities are currently the manufacturer for substantially all of these products, which means we are essentially sole-sourced for the manufacturing of such products, and if Celestica experiences an interruption in operations, suffers from capacity constraints, which may include constraints based on production demands from us as we grow our business, or is otherwise unable to meet our current or future production requirements we would experience a delay or inability to ship our products, which would have an immediate negative impact on our revenues. Moreover, any incapacitation of any of our or our subcontractors’ manufacturing sites due to destruction, natural disaster or similar events could result in a loss of product inventory. Further, we could experience a failure of our ERP systems or other information technology systems that occurs toward the end of a financial quarter or that lasts for a significant duration, either of which events could adversely impact our ability to process orders and ship product in any given quarter. As a result of any of the foregoing, we may not be able to meet demand for our products, which could negatively affect revenues in the quarter of the disruption or longer depending upon the magnitude of the event, and could harm our reputation. In addition, operating in the international environment exposes us 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 harm our business and results of operations.

The majority of the DECT wireless products are manufactured in Horsens, Denmark. Any event that may disrupt or indefinitely discontinue the facilities’ capacity to manufacture, assemble and repair our DECT wireless products could impair our ability to generate revenue, fulfill orders and attain financial goals for these products.

Finally, certain of our thinly capitalized subcontractors may fail or be detrimentally harmed in the current economic downturn, which could have a materially adverse impact on our results of operations.

 

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We face risks relating to changes in rules and regulations of the FCC and other regulatory agencies.

The wireless communications industry is regulated by the FCC in the United States and similar government agencies in other countries and is subject to changing political, economic, and regulatory influences. Regulatory changes, including changes in the allocation of available frequency spectrum, or changing free un-licensed to fee based spectrum licensing, could significantly impact our wireless operations in the United States and internationally. For example, foreign countries which adopt the 802.11 standard could provide future markets for our SpectraLink 8000 products. However, countries’ certification and approval processes for 802.11 compatible products such as SpectraLink 8000 are typically time consuming and potentially costly. If we have difficulty or experience delays in obtaining certification and approval by foreign countries for our SpectraLink 8000 wireless telephone product, then we and/or our distributor channels may not be able to gain access to the markets in these countries in a timely fashion, if at all, which would limit international growth of our SpectraLink 8000 product line.

If we have insufficient proprietary rights or if we fail to protect those rights we have, our business would be materially impaired.

We rely on third-party license agreements and termination or impairment of these agreements may cause delays or reductions in product introductions or shipments which would harm our business.

We have licensing agreements with various suppliers for software incorporated into our products. For example, we license video communications source code from ADTRAN, Aricent, Delcom, RADVISION, Simtrol, Skelmir, SNMP, Software House, Texas Instruments, Inc., and UB Video Inc., video algorithm protocols from DSP and ATT/Lucent, Windows software from Microsoft, development source code from Avaya, In Focus Systems Inc., Nokia, Vocal Technologies Ltd., Wind River, Ingenient and Avistar, audio algorithms from Telchemy, D2 Technologies, Ericsson, Sipro, GIPS, Telogy and Voiceage, and communication software from Spirit. In addition, certain of our products are developed and manufactured based largely or solely on third-party technology. These third-party software licenses and arrangements may not continue to be available to us on commercially reasonable or competitive terms, if at all. The termination or impairment of these licenses could result in delays or reductions in new product introductions or current product shipments until equivalent software could be developed, licensed and integrated, if at all possible, which would harm our business and results of operations. Further, if we are unable to obtain necessary technology licenses on commercially reasonable or competitive terms, we could be prohibited from marketing our products, could be forced to market products without certain features, or could incur substantial costs to redesign our products, defend legal actions, or pay damages. In addition, some of our products may include “open source” software. Our ability to commercialize products or technologies incorporating open source software may be restricted because, among other factors, open source license terms may be unclear and may result in unanticipated obligations regarding our product offerings.

We rely on patents, trademarks, copyrights and trade secrets to protect our proprietary rights which may not be sufficient to protect our intellectual property.

We rely on a combination of patent, copyright, trademark and trade secret laws and confidentiality procedures to protect our proprietary rights. Others may independently develop similar proprietary information and techniques or gain access to our intellectual property rights or disclose such technology. In addition, we cannot assure you that any patent or registered trademark owned by us will not be invalidated, circumvented or challenged in the U.S. or foreign countries or that the rights granted thereunder will provide competitive advantages to us or that any of our pending or future patent applications will be issued with the scope of the claims sought by us, if at all. Furthermore, others may develop similar products, duplicate our products or design around our patents. In addition, foreign intellectual property laws may not protect our intellectual property rights. Litigation may be necessary to enforce our patents and other intellectual property rights, to protect our trade secrets, to determine the validity of and scope of the proprietary rights of others, or to defend against claims of infringement or invalidity. Litigation could result in substantial costs and diversion of resources which could harm our business, and we could ultimately be unsuccessful in protecting our intellectual property rights. Further, our intellectual property protection controls across our global operations may not be adequate to fully protect us from the theft or misappropriation of our intellectual property, which could adversely harm our business.

We face intellectual property infringement claims and other litigation claims that might be costly to resolve and, if resolved adversely, may harm our operating results or financial condition.

We are a party to lawsuits (patent-related and otherwise) in the normal course of our business. The results of, and costs associated with, complex litigation matters are difficult to predict, and the uncertainty associated with substantial unresolved lawsuits could harm our business, financial condition and reputation. Negative developments with respect to pending lawsuits could cause our stock price to decline, and an unfavorable resolution of any particular lawsuit could have an adverse and possibly material effect on our business and results of operations. In addition, we may become involved in matters such as regulatory investigations or other governmental or private legal proceedings, which could result in requests for information from us that could be distracting, expensive and time consuming for us while we comply with such requests, and, if public, may also cause our stock price to be negatively impacted.

 

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We expect that the number and significance of claims and legal proceedings that assert patent infringement claims or other intellectual property rights covering our products, either directly against us or against our customers, will increase as our business expands. In particular, we expect to face an increasing number of patent and copyright claims as the number of products and competitors in our industry grows and the functionality of video, voice, data and web conferencing products overlap. Any claims or proceedings against us, whether meritorious or not, could be time consuming, result in costly litigation, require significant amounts of management time, result in the diversion of significant operational resources, or require us to enter into royalty or licensing agreements or pay amounts to third parties pursuant to contractual indemnity provisions. Royalty or licensing agreements, if required, may not be available on terms favorable to us or at all. An unfavorable outcome in any such claim or proceeding could have a material adverse impact on our financial position and results of operations for the period in which the unfavorable outcome occurs, and potentially in future periods. Further, any settlement announced by us may expose us to further claims against us by third parties seeking monetary or other damages which, even if unsuccessful, would divert management attention from the business and cause us to incur costs, possibly material, to defend such matters.

If we fail to manage our exposure to the volatility and economic uncertainty in the global financial marketplace successfully, our operating results could be adversely impacted.

We are exposed to financial risk associated with the global financial markets, which includes volatility in interest rates, uncertainty in the credit markets and the recent instability in the foreign currency exchange market.

Our exposure to market rate risk for changes in interest rates relates primarily to our investment portfolio. The primary objectives of our investment activities are to preserve principal, maintain adequate liquidity and portfolio diversification while at the same time maximizing yields without significantly increasing risk. To achieve these objectives, a majority of our marketable investments include debt instruments of the U.S. government and its agencies, investment-grade corporate debt securities, bank certificates of deposit, corporate preferred equity securities that are primarily investment-grade rated and money market instruments denominated in U.S. dollars.

The valuation of our investment portfolio is subject to uncertainties that are difficult to predict. Factors that may impact its valuation include changes to credit ratings of the securities, interest rate changes, the ongoing strength and quality of the global credit market and liquidity. All of the securities in our investment portfolio are investment-grade rated, but the instability of the credit market could impact those ratings and our decision to hold these securities, if they do not meet our minimum credit rating requirements. If we should decide to sell such securities, we may suffer losses in principal value that have significantly declined in value due to the declining credit rating of the securities and the ongoing strength, quality and liquidity of the preferred equity’s market and the global financial markets as a whole. If the carrying value of our investments exceeds the fair value, and the decline in fair value is deemed to be other-than-temporary, we will be required to write down the value of our investments. For example, in the first quarter of 2010, we recognized losses totaling $6.5 million for investments we considered to be other than temporarily impaired, $3.0 million of which we actually realized during the second quarter of 2010. With the current instability in the financial markets, we could incur significant realized or other than temporary impairment losses associated with certain of our investments which would reduce our net income. We may also incur further temporary impairment charges requiring us to record additional unrealized loss in accumulated other comprehensive income. In addition, the recent decrease in interest rates has adversely impacted the return we receive on our investments.

A significant portion of our net revenue and expenses are transacted in U.S. dollars. However, some of these activities are conducted in other currencies, primarily currencies in Europe and Asia. As a response to the risks of changes in value of foreign currency denominated transactions, we may enter into foreign currency forward contracts or other instruments, the majority of which have a maturity date greater than one year. Our foreign currency forward contracts reduce, but do not eliminate, the impact of currency exchange rate movements. For example, we do not execute forward contracts in all currencies in which we conduct business or hedge the full amount of each exposure identified. The translation of these foreign currency denominated transactions will impact net revenues, operating expenses and net income as a result of fluctuations in the U.S. dollar against foreign currencies. Accordingly, such amounts denominated in foreign currencies may fluctuate in value and produce significant earnings and cash flow volatility. For example, as a result of our cash flow hedging program, in the third and fourth quarters of 2009, we reduced operating income by $0.6 million and $2.2 million, respectively, as compared to increasing operating income in the first and second quarters of 2009 and the first and second quarters of 2010 by $2.3 million, $1.6 million, $0.5 million, and $1.7 million, respectively.

Loss of government contracts or failure to obtain required government certifications could have a material adverse effect on our business.

         We sell our products indirectly and provide services to governmental entities in accordance with certain regulated contractual arrangements. While reporting and compliance with government contracts is both our responsibility and the responsibility of our partner, our or our partner’s lack of reporting or compliance could have an impact on the sales of our products to government agencies. Further, the United States Federal government has certain certification and product requirements for products sold to them. If we are unable to meet applicable certification or other requirements within the timeframes specified by the United States Federal government, or if our competitors have certifications for competitive products for which we are not yet certified, our revenues and results of operations would be adversely impacted.

 

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We are required to evaluate our internal control over financial reporting under Section 404 of the Sarbanes-Oxley Act of 2002 and any adverse results from such evaluation could result in a loss of investor confidence in our financial reports and have an adverse effect on our stock price.

Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002 (Section 404), we are required to furnish a report by our management on our internal control over financial reporting. Such report contains, among other matters, an assessment of the effectiveness of our internal control over financial reporting as of the end of our fiscal year, including a statement as to whether or not our internal control over financial reporting is effective. This assessment must include disclosure of any material weaknesses in our internal control over financial reporting identified by management. While we were able to assert in our Annual Report on Form 10-K for the fiscal year ended December 31, 2009, that our internal control over financial reporting was effective as of December 31, 2009, we must continue to monitor and assess our internal control over financial reporting. In addition, our control framework may suffer if we are unable to adapt our control framework appropriately as we continue to grow our business. For instance, in 2009 we opened a Shared Services Center (“SSC”) in Beijing, China, to perform certain accounting, order entry and other functions previously performed in regional headquarter locations. If the controls we put in place with respect to the SSC fail to operate effectively, our control framework could suffer or be considered ineffective. If we are unable to assert in any future reporting period that our internal control over financial reporting is effective (or if our independent registered public accounting firm is unable to express an opinion on the effectiveness of our internal controls), we could lose investor confidence in the accuracy and completeness of our financial reports, which would have an adverse effect on our stock price.

Changes in existing financial accounting standards or practices may adversely affect our results of operations.

Changes in existing accounting rules or practices, new accounting pronouncements, or varying interpretations of current accounting pronouncements could have a significant adverse effect on our results of operations or the manner in which we conduct our business. Further, such changes could potentially affect our reporting of transactions completed before such changes are effective. For example, in December 2007, the FASB issued Accounting Standard, or ASC, Topic 805, Business Combinations, or ASC 805, which changed the accounting for business combinations including the measurement of acquirer shares issued in consideration for a business combination, the recognition of contingent consideration, the accounting for pre-acquisition gain and loss contingencies, the recognition of capitalized in-process research and development, the accounting for acquisition related restructuring liabilities, the treatment of acquisition related transaction costs and the recognition of changes in the acquirer’s income tax valuation allowance. ASC 805 is effective for financial statements issued for fiscal years beginning after December 15, 2008. We believe that ASC 805 will result in the recognition of certain types of expenses in our results of operations that we would have capitalized pursuant to previous accounting standards and may also impact our financial statements in other ways upon the completion of any future acquisitions.

Changes in our tax rates could adversely affect our future results.

We are a U.S. based multinational company subject to tax in multiple U.S. and foreign tax jurisdictions. Unanticipated changes in our tax rates could affect our future results of operations. Our future effective tax rates, which are difficult to predict, could be unfavorably affected by changes in, or interpretation of, tax rules and regulations in the jurisdictions in which we do business, by unanticipated decreases in the amount of revenue or earnings in countries with low statutory tax rates, by lapses of the availability of the U.S. research and development tax credit, or by changes in the valuation of our deferred tax assets and liabilities. Further, the accounting for stock compensation expense in accordance with ASC 718 and uncertain tax positions in accordance with AS 740 could result in more unpredictability and variability to our future effective tax rates.

The Company is also subject to the periodic examination of its income tax returns by the Internal Revenue Service, such as we are currently undergoing, and other tax authorities, and in some cases, we have received additional tax assessments. The Company regularly assesses the likelihood of adverse outcomes resulting from these examinations to determine the adequacy of its provision for income taxes. We may underestimate the outcome of such examinations which, if significant, would have a material adverse effect on the Company’s net income and financial condition.

Business interruptions could adversely affect our operations.

Our operations are vulnerable to interruption by fire, earthquake, or other natural disaster, quarantines or other disruptions associated with infectious diseases, national catastrophe, terrorist activities, war, ongoing disturbances in the Middle East, an attack on Israel, disruptions in our computing and communications infrastructure due to power loss, telecommunications failure, human error, physical or electronic security breaches and computer viruses (which could leave us vulnerable to loss of our intellectual property and disruption of our business activities), and other events beyond our control. In 2008, we launched a business continuity program that is based on enterprise risk assessment which addresses the impact of natural, technological, man-made and geopolitical disasters on the Company’s critical business functions. This plan helps facilitate the continuation of critical business activities in the event of a disaster but may not prove to be sufficient. In addition, our business interruption insurance may not be sufficient to compensate us for losses that may occur, and any losses or damages incurred by us could have a material adverse effect on our business and results of operations.

 

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Our cash flow could fluctuate due to the potential difficulty of collecting our receivables and managing our inventories.

Over the past few years, we initiated significant investments in EMEA and Asia to expand our business in these regions. In EMEA and Asia, as with other international regions, credit terms are typically longer than in the United States. Therefore, as Europe, Asia and other international regions grow as a percentage of our revenues, accounts receivable balances will likely increase as compared to previous years. Although from time to time we have been able to largely offset the effects of these influences through additional incentives offered to channel partners at the end of each quarter in the form of prepay discounts, these additional incentives have lowered our profitability. In addition, the recent economic crisis, economic uncertainty or a downturn in technology spending in the United States and other countries has restricted the availability of capital, which may delay our collections from our channel partners beyond our historical experience or may cause companies to file for bankruptcy. For example, our partner Nortel filed for bankruptcy in the first quarter of 2009, one of Asian distributors filed for bankruptcy in the third quarter of 2008, and one of our large European distributors filed for bankruptcy in the fourth quarter of 2007. Either a delay in collections or bankruptcy would harm our cash flow and days sales outstanding performance.

In addition, as we manage our business and focus on shorter shipment lead times for certain of our products and implement freight cost reduction programs, our inventory levels may increase, resulting in decreased inventory turns that could negatively impact our cash flow. We believe inventory turns will continue to fluctuate depending upon our ability to reduce lead times, as well as due to changes in anticipated product demand and product mix and a greater mix of ocean freight versus air freight to reduce freight costs. For instance, in the first quarter of 2008, our inventory levels increased significantly from the December 31, 2007 levels as a result of these factors.

Our stock price fluctuates as a result of the conduct of our business and stock market fluctuations and may be extremely volatile.

The market price of our common stock has from time to time experienced significant fluctuations. The market price of our common stock may be significantly affected by a variety of factors, including:

 

   

statements or changes in opinions, ratings or earnings estimates made by brokerage firms or industry analysts relating to the market in which we do business, including competitors, partners, suppliers or telecommunications industry leaders or relating to us specifically;

 

   

our recently announced plans to invest heavily in our business for future growth, which we expect, in the short-term, to affect our profitability;

 

   

the announcement of new products, product enhancements or acquisitions by us or by or of our competitors, such as the recent acquisition of Tandberg, previously our largest independent competitor, by Cisco Systems;

 

   

technological innovations by us or our competitors;

 

   

quarterly variations in our results of operations;

 

   

general market conditions or market conditions specific to technology industries; and

 

   

domestic and international macroeconomic factors.

In addition, the stock market continues to experience significant price and volume fluctuations related to general economic, political and market conditions. These fluctuations have had a substantial effect on the market prices for many high technology companies like us and are often unrelated to the operating performance of the specific companies. As with the stock of many other public companies, the market price of our common stock has been particularly volatile during the recent period of upheaval in the capital markets and world economy. This excessive volatility in our stock price is unpredictable and may continue for an indefinite period of time.

 

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Item 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

Share Repurchase Program

The following table provides a month-to-month summary of the stock purchase activity during the quarter ended June 30, 2010:

 

Period

   Total
Number of
Shares
Purchased(1)(2)
   Average Price Paid
per Share(1)(2)
   Total Number of
Shares Purchased
as Part of Publicly
Announced Plan(2)
   Approximate
Dollar Value of Shares
that May
Yet  be
Purchased
Under the Plan(2)

4/1/10 to 4/30/10

   568    $ 33.54    —      $ 167,165,000

5/1/10 to 5/31/10

   638,567    $ 31.77    629,054    $ 147,173,000

6/1/10 to 6/30/10

   451    $ 30.37    —      $ 147,173,000
                   

Total

   639,586    $ 31.77    629,054   
                   

 

(1) Includes 10,532 of shares repurchased in April through June 2010 to satisfy tax withholding obligations as a result of the vesting of performance shares and restricted stock units.
(2) In May 2008, the Company’s Board of Directors approved a share repurchase plan under which the Company at its discretion may purchase shares in the open market from time to time with an aggregate value of up to $300.0 million (“the 2008 share repurchase plan”). As of June 30, 2010, the Company was authorized to purchase up to an additional $147.2 million of shares in the open market under the 2008 share repurchase plan. These shares of common stock have been retired and reclassified as authorized and unissued shares. The 2008 share repurchase plan does not have an expiration date but is limited by the dollar amount authorized.

 

Item 3. DEFAULTS UPON SENIOR SECURITIES

Not Applicable.

 

Item 4. (REMOVED AND RESERVED)

 

Item 5. OTHER INFORMATION

Costs Associated with Exit or Disposal Activities

In July 2010, management committed to a restructuring plan designed to reallocate our resources to more strategic growth areas of the business. The restructuring plan resulted in the elimination of approximately two percent of our global workforce with most of those reductions taking effect immediately, enabling the hiring of additional positions to better align with the execution of our strategic initiatives. We currently expect to record restructuring charges and make cash expenditures between approximately $3.5 million and $4.5 million in the third quarter of 2010 resulting from these actions, primarily related to severance and other employee termination benefits.

 

Item 6. EXHIBITS

 

Exhibit
No.
 

Description

    3.1   Amended and Restated Bylaws of Polycom, Inc. (which is incorporated herein by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K filed with the Commission on June 15, 2010).
  10.1*   Polycom, Inc. 2004 Equity Incentive Plan (May 27, 2010 Restatement) (which is incorporated herein by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with the Commission on June 2, 2010).
  10.2(1)*   Polycom, Inc. Executive Severance Plan and Summary Plan Description, as amended and restated effective May 10, 2010.
  10.3(1)*   Amended Change of Control Severance Agreement, effective as of May 10, 2010, by and between Andrew M. Miller and the Company.
  10.4(1)*   Consulting Agreement, made and entered into as of May 10, 2010, by and between Robert C. Hagerty and the Company.
  10.5(1)*   Form of Amended and Restated Performance Share Agreement for Andrew M. Miller.
  31.1(1)   Certification of the President and Chief Executive Officer Pursuant to Securities Exchange Act Rules 13a-14(c) and 15d-14(a).
  31.2(1)   Certification of the Senior Vice President, Finance and Administration and Chief Financial Officer pursuant to Securities Exchange Act Rules 13a-14(c) and 15d-14(a).
  32.1(1)   Certifications pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101**   The following materials from Registrant’s Quarterly Report on Form 10-Q for the quarter ended June, 2010, formatted in Extensible Business Reporting Language (XBRL) includes: (i) Condensed Consolidated Balance Sheets at June 30, 2010 and December 31, 2009, (ii) Condensed Consolidated Statements of Income for the Three and Six Months Ended June 30, 2010 and 2009, (iii) Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2010 and 2009, and (iv) Notes to Condensed Consolidated Financial Statements, tagged as blocks of text.

 

 * Indicates management contract or compensatory plan or arrangement.
 ** XBRL information is furnished and not filed or a part of a registration statement or prospectus for purposes of sections 11 or 12 of the Securities Exchange Act of 1933, as amended, is deemed not filed for purposes of section 18 of the Securities Exchange Act of 1934, as amended, and otherwise is not subject to liability under these sections.
(1) Filed herewith.

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

Dated: July 30, 2010

 

POLYCOM, INC.

/s/    ANDREW M. MILLER        

Andrew M. Miller
President and Chief Executive Officer
(Principal Executive Officer)

/s/    MICHAEL R. KOUREY        

Michael R. Kourey

Executive Vice President, Finance and Administration,

and Chief Financial Officer

(Principal Financial Officer)

/s/    LAURA J. DURR        

Laura J. Durr
Vice President and Worldwide Controller
(Principal Accounting Officer)

 

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EXHIBIT INDEX

 

Exhibit
No.
 

Description

    3.1   Amended and Restated Bylaws of Polycom, Inc. (which is incorporated herein by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K filed with the Commission on June 15, 2010).
  10.1*   Polycom, Inc. 2004 Equity Incentive Plan (May 27, 2010 Restatement) (which is incorporated herein by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with the Commission on June 2, 2010).
  10.2(1)*   Polycom, Inc. Executive Severance Plan and Summary Plan Description, as amended and restated effective May 10, 2010.
  10.3(1)*   Amended Change of Control Severance Agreement, effective as of May 10, 2010, by and between Andrew M. Miller and the Company.
  10.4(1)*   Consulting Agreement, made and entered into as of May 10, 2010, by and between Robert C. Hagerty and the Company.
  10.5(1)*   Form of Amended and Restated Performance Share Agreement for Andrew M. Miller.
  31.1(1)   Certification of the President and Chief Executive Officer Pursuant to Securities Exchange Act Rules 13a-14(c) and 15d-14(a).
  31.2(1)   Certification of the Senior Vice President, Finance and Administration and Chief Financial Officer pursuant to Securities Exchange Act Rules 13a-14(c) and 15d-14(a).
  32.1(1)   Certifications pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101**   The following materials from Registrant’s Quarterly Report on Form 10-Q for the quarter ended June, 2010, formatted in Extensible Business Reporting Language (XBRL) includes: (i) Condensed Consolidated Balance Sheets at June 30, 2010 and December 31, 2009, (ii) Condensed Consolidated Statements of Income for the Three and Six Months Ended June 30, 2010 and 2009, (iii) Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2010 and 2009, and (iv) Notes to Condensed Consolidated Financial Statements, tagged as blocks of text.

 

 * Indicates management contract or compensatory plan or arrangement.
 ** XBRL information is furnished and not filed or a part of a registration statement or prospectus for purposes of sections 11 or 12 of the Securities Exchange Act of 1933, as amended, is deemed not filed for purposes of section 18 of the Securities Exchange Act of 1934, as amended, and otherwise is not subject to liability under these sections.
(1) Filed herewith.

 

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