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Polycom, Inc. (NASDAQ:PLCM)

Q4 2008 Earnings Call

January 21, 2008 5:00 p.m. ET

Executives

Michael R. Kourey – Chief Financial Officer, Senior Vice President – Finance & Administration & Director

Robert C. Hagerty – Chairman of the Board, President & Chief Executive Officer

Analysts

Jason Ader – William Blair & Company

Troy Jensen - Piper Jaffray

Elliot Gold – TeleSpan

Scott Coleman – Morgan Stanley

Tavis McCourt – Morgan Keegan

Manny Recarey – Kaufman Brothers

Bill Choi – Jeffries &Company

Operator

(Call starts abruptly) This conference is being recorded Wednesday, January 21, 2009. I would now like to turn the conference over to Mike Kourey, Polycom’s CFO.

Michael R. Kourey

Thank you. Good afternoon everyone and welcome to Polycom’s fourth quarter earnings call. I’m Mike Kourey, Polycom’s Chief Financial Officer and here with me today is Bob Hagerty, Chairman and CEO. As with previous quarterly calls, we’re again augmenting today’s voice conference call with a webcast. If you’d like to receive the webcast please open your web browser at this time and enter Polycom’s home page, which is Polycom.com and click on Q4 earnings call. Then, follow the instructions provided.

For the analysts participating in the Q&A session leave your call live so that you can use your conferenddce call connection for the Q&A session at the end of our call. Please note that Q&A is for financial and market research analysts, we welcome all others to listen into the Q&A session. Please also note that this entire webcast including Q&A will be maintained on Polycom’s website for 12 months from today for your convenience and replay.

Most of you participating in this call are aware of the federal legislature regarding forward-looking statements. Accordingly, we would like to note that during the course of this conference call, Bob and I will be making forward-looking statements and present forward-looking visual materials regarding future events, anticipated future trends, future product offerings and the future performance of the company including financial guidance.

We wish to caution you that such statements and visual materials are just predictions that involve risks and uncertainties and that actual events or results could differ materially. We discuss a number of these risks in our business in detail in the company’s SEC reports including, most recently in the company’s Form 10-Q for the quarter ended September 30, 2008 and any forward-looking statements must be considered in the context of such risks and uncertainties.

Also, please note that Polycom’s application of US Generally Accepted Accounting Principles or US GAAP requires disclosure that availability of new products, planned features and upgrades discussed during this call are subject to change or cancellation. At this time, let me turn the call over to Bob Hagerty, Chairman and CEO.

Robert C. Hagerty

Thanks Mike. To begin I’d like to provide a few financial highlights. Later in the call, Mike will go through the operating results in greater detail.

First we’re pleased that in 2008, we have surpassed the $1 billion revenue mark for the first time, growing 50% for the full year and generating a record $165 million of positive operating cash flow. This success, I believe is a testament to Polycom’s world-leading collaboration solution, premier brand, and marquee customer and partner relationships.

For the fourth quarter, revenues were $263 million representing a 5% sequential decrease from the third quarter and essentially flat year-over-year. We exited Q4 with a backlog of $60.5 million, down 2% sequentially, but up 5% year-over-year.

Polycom’s deferred revenues closed the year at a record $112.5 million, up 3% sequentially and up 29% over the year ago period. At the bottom line, non-GAAP earnings were $0.42 per diluted share up 14% for the – from the third quarter of the same period as a year ago.

Next, I’d like to discuss the key demand drivers for our business that are particularly relevant during this current economic period. As market research firm Foster reported last month and I quote “companies are looking first and foremost to spend on technologies they can save money for the business and they listed unified communications and video conferencing as ways to reduce travel. Another market research firm, The Yankee Group stated following their recent 2009 enterprise predictions, and again I’m quoting, video enabled business processes will be born in 2009 and they further state video conferencing has grown steadily as a replacement for travel due to the green benefits and the lower travel cost and this year we’ll see the full emergence of this trend”.

We are finding in practice that enterprise and government agencies alike, consider business travel to be one of the most, if not the most discretionary budget line item. In fact, organizations of all sizes appear to be essentially eliminating inter-company travel and significantly reducing the number and frequency of individuals traveling for customer facing meetings.

Our solutions not only decrease the out-of-pocket cost of travel, but also substantially reduce the opportunity cost of travel, in other words a two-hour meeting takes two hours not two days.

Of course these organizations compete in globalized industries and through an extended enterprise that spans from the supply chain to the go-to-market. What appears to be the only viable way to close communications gap is through the adoption of unified collaboration solutions.

Another critical driver is the green agenda including various mandates to reduce carbon emissions over prescribed periods in certain geographies particularly Europe. Clearly another benefit of air, train, and car travel reduction is the favorable environmental impact. This is becoming a priority for the North American market as well.

Since return on investment and carbon emissions reductions are critical drivers for our business, we’ve implemented several programs to assist to organizations in optimizing their collaboration technology solutions. In fact, we’ve just rolled out a customer based ROI program that quantifies with the customer’s own data the exact benefits of specific rollout of our solutions. The program delineates distinct ROIs based on out-of-pocket benefits, opportunity cost benefits and faster business process benefits. These are important considerations for a CFO or CEO at any point, but especially beneficial in 2009.

We believe a proof point for this thesis is Polycom’s double-digit year-over-year growth in video in Q4 and our back-to-back sequential growth in network systems. We further note that the flagship of our product line the RPX and TPX Telepresence solutions experienced sequential growth in the fourth quarter. It’s also noteworthy is that the average selling prices continued to show strength in the fourth quarter.

That being said the voice – our voice business, which comprises about a third of Polycom’s revenues, appears to be more sensitive to economic environment consistent with the broader voice communication sector. As I look at each of the key product lines in voice, here are my observations and what I believe they foretell for 2009 and beyond.

First our voice conferencing product line, which is Polycom’s iconic triangular speakerphone business, remains very healthy with gross margins of around 60% on average. We are the sole source conference phone provider for essentially all of the call management and present space communications engines in the communications market. For instance, Avaya, Cisco and many others claim Polycom as the only voice conferencing solution for their customers.

Importantly, the penetration of this solution in the roughly 25 million meeting rooms around the world is only about 15% creating a significant growth opportunity especially with the plug and play shift of Voice Over IP. The sales cycle for these products has lengthened in this environment, but with our strong brand, market position and strategic partnerships, we believe we are positioned well to capture the demand for these solutions.

The second voice product category is Polycom’s line of desktop Voice Over IP phones. In 2008, this continued to be one of Polycom’s fastest growing product lines. Driven by the significant ROI typically achieved through a transition to Voice over IP, many customers are allocating budgets to deploy this money saving solution. With Polycom’s IP telephones customers are enjoying HD voice and a level of features and functionality that we believe it’s unparalleled in the market.

As with our conference phones, we have a broad array of strategic partnership including Microsoft, Digium and many others such as AT&T and Telstra another who offer a hosted voice solution. As with voice conferencing the sales cycle has lengthened and budget priorities sometimes moving to video collaboration, however, we are pleased with the market gains we’ve made in Voice over IP and expect to leverage our Microsoft and other go-to-market relationships in 2009.

Third, our third and our final primary product line in voice addresses in trends in wireless. In fact, mobility continues to be a key priority for many organizations and Polycom’s offering includes a leading solution for voice mobility. Another relevant data point for this business is that much of the demand is derived from vertical markets such as healthcare and energy expectedly strong segments in 2009.

Working closely with our strategic and other go-to-market partners, we intend to capture these in other verticals with our leading product offerings.

In summary, while sales cycles have lengthened across much of our voice business, we believe we have taken the appropriate steps to stabilize this segment and as we look into 2009 we should be well positioned to capture the demand.

Next from a broader Polycom-wide perspective I’d like to highlight our field experience with respect to our core vertical markets. Although it may seem counterintuitive, we are experiencing success in the vertical services sector. Going back to a point I made earlier regarding fast ROI, we are finding several examples of companies that are taking cost cutting actions and as a result, adopting to Polycom solution. We find evidence of this phenomenon not just here in the US, but in each of the major geographies.

In Q4 for instance we experienced not only growth in financial services, but in the broad enterprise category as well, again evidence of the ROI demand driver. Where we did experience weakness was in government driven by the sequential decline from the strong Q3 US government fiscal year end. We also experienced budgeted tightening within the educational sector.

As we move through 2009 however we are allocating resources designed to capture the core elements of government spending packages, yielding potential opportunities for Polycom’s collaboration solution.

At this point I’d like to touch on our new product activity and what to expect in 2009. First I’m pleased to report that our new RMX network systems platform continues to perform well with double-digit sequential and very strong year-over-year growth.

Augmenting the success of the RMX, we launched our new CMA Converged Management Application in Q4 as scheduled and this platform is already becoming a strong contributor. We believe Polycom’s CMA platform not only trumps any other video network management solution on the market, but it does so with the unified desktop video client that enables all members of the organization to become empowered video collaboration participants.

No other video solutions provider can do that and as you may have seen – we announced the availability of our Distributed Media Application or DMA 7000 just yesterday. With this unique network system solution, enterprise-wide video traffic is seamlessly integrated and managed without IT or users needing to even think about individual bridge capacity or administration. This scalable solution integrates with Polycom’s RMX platform and is another industry first for Polycom.

Also in Q4, we extended our video product line to include 1080p video delivering the best quality of video experience at any bandwidth.

Of course, we have several other announcements in the pipeline regarding new video and voice product this quarter. Although I don’t plan to announce them on this call, I’d like to say that these products will continue to differentiate Polycom’s video and voice solutions from any other provider.

Further look towards continued progress in our integration with key strategic partnerships. Importantly, with our high-touch go-to-market model we are achieving a high degree of direct interaction with CIOs, CFOs, and CEOs at their levels that have never been seen before.

What we are learning is that, ROI, seamless interoperability and reducing the number of vendors are top priorities as they move into 2009. We believe Polycom provides the solution to these priorities at a level of no one else can. We have the best products, the broadest video and voice unified collaboration solutions and we are an open standard solution provider.

Next, I’d like to briefly touch upon a few of our recent customer wins. For instance, we recently announced that a large media company selected Polycom as its unified collaboration solution provider. As an example of the value proposition I outlined earlier their CIO stated that, we selected Polycom for the quality of its immersive telepresence experience, the breadth of its portfolio and because Polycom Telepresence system interoperate seamlessly with existing standards based video conferencing systems.

I’d also like to highlight that the NASDAQ OMX Group selected Polycom’s RPX Telepresence Solution to help with their merger of the OMX Nordic Stock Exchange in Sweden. Phil Marie, a Senior Vice President of Nasdaq OMX stated, Telepresence provided a cost effective way to enable his teams in the US and Sweden to communicate and collaborate across continents in real time as effectively as if they were in the same room.

Other consumer examples include Beijing based Agricultural Bank of China, who is rolling out our HDX and VSX video systems to cover 50 Tier 1 and 297 Tier 2 branches throughout China. Their purchase includes elements of Polycom’s network systems offering as – offering as well.

In Q4 A&E television networks expanded its video solution with Polycom’s RMX and CMA architectures. Cost reduction was the key driver of this infrastructure purchase, as the technology deployment will enable A&E to manage its HDX 9004 video system stretching across its U.S. and UK sites.

In the US government, we had a key DOD wins that spanned Polycom’s high definition TPX Telepresence and HDX video offerings, including recording and streaming solutions.

In healthcare, Highmark Incorporated, a leading health insurer in Pennsylvania serving 4.6 million people, recently adopted Polycom’s HDX as its video collaboration offering. Polycom video can now be found throughout their organization and it’s slated to be a key tool to support the success of their planned healthcare insurance, retail store strategy.

In Australia, Charles Stewart University selected Polycom’s SoundPoint IP desktop phone for a 5000 unit multi-campus rollout, they selected us for our voice quality ease-of-use and cross platform interoperability.

Lastly, before I turn the call over to Mike Kourey, I’d like to discuss the steps that we have taken proactively and to manage our cost structure in this economic environment while maintaining the flexibility to lead the industry in customer-centric innovation and continue to drive our go-to-market initiatives.

We reduced discretionary spending in Q4 including capturing the ROI of utilizing our own unified collaboration solutions. We have also indefinitely deferred non-essential projects and taken other steps to optimize our cost base such as increasing the percentage of research and development performed in low cost geographies and with a bias towards higher growth opportunities in the video collaboration space. Also earlier this month, we announced a restructuring plan that resulted in the reduction of our global workforce of - by 6% or approximately a 150 people.

These actions underscore our commitment to cost optimization and profitability, which is a key focus for us in 2009 and beyond. As I mentioned in our last conference call we intend to execute our strategy of capturing the demand for unified collaboration and inherent ROI that can be achieved with our solution. We’ve planned to continue to support and work closely with our strategic partners such as Avaya, Cisco, IBM, Microsoft, and others to deliver an integration solution that we believe is unmatched by any other provider.

At the same time we have been driving our efficiency to execute this global plan while optimizing our cost structure yielding stability if not improvement of our operating margins for 2009. On that note, let me turn the call over to Mike Kourey for a discussion of Polycom’s financials. Mike?

Michael R. Kourey

Thank you Bob, before I get started, please note that for the financial guidance that Bob and I are giving today, Polycom is not assuming the responsibility to provide any updates regarding this financial guidance regardless of changes, adverse or otherwise which may occur in the future. Also, during this portion of the call, I remind you that we will both be making forward-looking statements including our expectations of future financial execution and performance, which are subject to many risks and uncertainties.

Moving to a look at our results, as Bob stated earlier, revenues for the fourth quarter were $263 million. This represents a sequential decrease of 5% resulting in essentially flat revenues compared to Q4 of last year. On a product line basis, which includes the service elements of each product line, revenues for video solutions were $175.9 million in Q4 declining sequentially by 1% but growing 7% year-over-year.

Video solutions is comprised of our video communications and network systems product lines. Of these product lines, video communications generated a $141.7 million in revenues, declining sequentially by 2% and growing 10% year-over-year. On a unit basis, we shipped 19,831 group video systems. Also note that Telepresence grew both sequentially and year-over-year and HD video comprised over half of Polycom video revenues in Q4 for the first time.

Network systems grew 1% sequentially to $34.2 million, a decline 4% year-over-year. The voice communications business generated revenues of $87.7 million in Q4 representing in 11% sequential decrease from Q3 and from the year ago period.

Moving to revenue by geography in the fourth quarter, North American revenues were down 12% sequentially and down 6% over the year ago period. EMEA revenues grew 11% sequentially and grew 14% year-over-year. Asia revenues grew 1% sequentially, but decreased 2% year-over-year. Latin America was down 19% sequentially and down 3% year-over-year.

From a channel standpoint, the revenue breakout for the fourth quarter is as follows, 36% through value-added resellers, 53% through distributors, 6% through service providers, and 5% direct.

In spite of the economic effects in the quarter, linearity remained relatively robust with 46% of revenues in the last month of the fourth quarter. Polycom exited Q4 with $60.5 million in backlog, down 2% sequentially but up 5% year-over-year. Polycom’s deferred revenues were a record $112.5 million in Q4, increasing 3% sequentially and growing 19% year – over the year ago period. Excluding the Codian settlement from first quarter of ‘08, Polycom’s deferred revenues grew 15% year-over-year.

Looking forward as Bob mentioned earlier, we expect the fast ROI of Telepresence and HD video to be a primary revenue driver in 2009. In addition we expect that Q1 will show strength in Canada and Japan, where March 31st is the prevalent fiscal year end.

Finally we will be launching additional new products this quarter that should begin to have a favorable impact. That being said Q1 is typically a tougher quarter seasonally. For Polycom, this has translated into sequential organic declines in most years.

In this particular Q1, we believe new budgets will take longer to finalize as companies evaluate their investments more closely in this economy. As a result we are guiding revenues to decrease sequentially by 9% to 13% in Q1 from fourth quarter levels.

Moving on to the statement of operations, non-GAAP gross margins for the fourth quarter were 60.0%, representing a sequential decrease of 0.2 percentage points. Breaking out our gross margin objectives by product family, our network systems product line continues to have targeted gross margins in the high 60s.

Group voice and video communications products have gross margins targeted in the high 50s to mid 60s range while desktop voice and service gross margins are targeted in the low 40s. For the fourth quarter, service operated above its target range, network systems, video and group voice operated within their target ranges, and desktop voice operated below its target range.

As noted above, gross margins in the future may be higher or lower and are subject to mix variations and other factors.

Switching gears to non-GAAP operating expenses for the fourth quarter Polycom’s operating expenses decreased sequentially in absolute dollars and as a percent of revenues in fourth quarter.

Looking at the specific non-GAAP operating expense line items for the fourth quarter, sales and marketing represented 26.7% of revenues for the period, down from 28.5% in the third quarter. R&D closed at 10.7% of revenues down from 11.5% in Q3. G&A was 5.1% of revenues, up from 4.9% in Q3. In total, Q4 non-GAAP operating expenses represented 42.5% of net revenues in the fourth quarter, down as a percent of revenue from 44.9% in the third quarter.

As you can see we reduced operating expenses by nearly $12 million or 10% sequentially in the fourth quarter. Please note that approximately $7 million of this reduction was driven by several sustainable cost reductions around headcount, low priority project costs, travel, and other discretionary expenses. The reduction also includes approximately $5 million in one-time management actions and other cost benefits.

Moving to a look at the company’s operating income, Polycom generated fourth quarter non-GAAP operating income of $45.9 million or 17.5% of net revenues up from 15.3% in Q3. This compares to $48.1 million in non-GAAP operating income or 18.3% of net revenues in Q4 of 2007.

As a recap of our performance against our previously stated long-term target model, we are within our target gross margin range of 59 to 63%, sales and marketing operated 0.7 percentage points over the high-end of its target range, R&D and G&A continue to operate within their target range.

Our non-GAAP operating margin of 17.5% is 2.5 percentage points below our target range of 20% to 22%. Looking forward to the first quarter, we expect a sequentially lower revenue levels to have a small impact on gross margins due to our expected product build levels. In addition, although we experience a solid pricing environment in Q4, we are planning for possible pricing pressure in the first quarter. As such, we are guiding gross margins to be down by approximately one point from fourth quarter levels.

From an operating expense standpoint, even net of the one-time benefits in Q4, we expect OpEx to decrease sequentially by approximately $2.5 million in Q1. Although we expect sales and marketing spend to be roughly consistent with Q4, we expect R&D and G&A expense is to decrease roughly by about $1million or so each. Based on our revenue and gross margin guidance, this should yield an operating margin of approximately 12.2% to 13.7%.

Other income and expense for the fourth quarter resulted in a net expense of $2.1 million comprised of $1.2 million in interest income, offset by other expenses of $3.3 million. Interest income continues to be impacted by the lower interest rate environment. Other expense was driven by foreign exchange, hedging expense and losses on translation of foreign currencies in the period. Looking forward to Q1 we expect other expense, of $700,000.

Moving to tax, you will note that our Q4 effective tax rate was 19.8% bringing our full year tax rate to 23.9%. We accomplished this improved rate through various discrete items, our geographic mix of profits, the reinstatement of the R&D tax credit, and a new lower tax rate in both Singapore and Thailand.

Looking forward to the first quarter, we are forecasting a 25% effective tax rate based on our mix assumption. Of course this 25% rate is subject to change based upon changes in geographic mix as well as changes resulting from any new US or international regulations or interpretations.

Q4 non-GAAP net income was $35.2 million, representing a 9% decrease from $38.5 million in non-GAAP net income in the comparable period last year. Non-GAAP diluted EPS in Q4 of $0.42 was flat with Q4 of 2007. GAAP profitability for the quarter was $25.7 million or $0.30 per diluted share in Q4 of ’08 versus $22.8 million or $0.25 per diluted share in the comparable period last year. This represents a 13% increase in GAAP net income and a 20% increase in GAAP EPS year-over-year.

Before moving to the balance sheet, I’d like to note that all the results that I just discussed include the impact of the Nortel bankruptcy filing. Although their filing occurred after December 31, we’ve included the impact in our Q4 ’08 results. Briefly the impact is as follows; a $2.6 million reduction in revenues and a corresponding $2.6 million in gross profit and pretax profit.

In other words, our Q4 ’08 revenue would have been $265.6 million had it not been for the filing. The Q1 ’09 impacted the Nortel bankruptcy which is already incorporated into the guidance that I have given today is not significant.

Moving to cash, Polycom generated $50.5 million in positive operating cash flow in Q4 representing Polycom’s 44th consecutive quarter of positive operating cash flow. These excellent operating cash results were driven largely by our strong profitability and working capital management. Cash and investments at the end of the fourth quarter totaled $324.5 million, of course the company continues to be debt free.

Before turning to DSO, I’d like to briefly highlight our full year performance in 2008. For the year Polycom delivered record revenues of $1.1 billion, an increase of 15% over the prior year. Non-GAAP net income for the year was a record $130.4 million, an increase of 1% over 2007. In addition in 2008 Polycom generated a record $166.6 million in positive cash flow, a growth of 11% from 2007 operating cash flow.

Moving to DSO, the company’s net trade receivables of $126.5 million resulted in a DSO of 44 days, consistent with Q3 and a four-day improvement year-over-year. Looking forward, we are continuing our best-in-class DSO guidance of 40 to 50 days.

Inventories decreased $2.4 million sequentially to $89.7 million at the end of Q4 representing turns of 4.7. We expect to maintain inventory at approximately this turns level in the future. Regarding expected share count, we expect Polycom’s weighted average shares per diluted EPS to grow by approximately 500,000 shares in Q1 exclusive of stock repurchases. Note that during the fourth quarter we did not purchase any shares under our share buyback program.

Entering Q1 we have $220 million remaining in our share buyback authorization and we do plan to be active with repurchases this quarter. In addition to these future potential buyback of our stock, our share count will change based upon Polycom’s stock price, any acquisition activity and other factors.

Moving to headcount, Polycom had 2,648 employees at the end of the fourth quarter. As we announced earlier this month, we implemented a restructuring plan that resulted in a 6% headcount reduction. These reductions are designed to better align resources with the company’s growth opportunities and to optimize our cost structure in 2009.

As a final note on the financials, we have presented both non-GAAP and GAAP financial measures here today. Please refer to our reconciliation of non-GAAP to GAAP financial measures in the tables entitled GAAP to non-GAAP reconciliation in today’s earnings release. At this time let me turn the call back over to Bob Hagerty for closing comments.

Robert C. Hagerty

Thanks Mike. In summary, we are pleased to have surpassed the $1 billion revenue mark in 2008. As the largest company in unified collaboration industry Polycom generated year-over-year growth in our video solutions business illustrating the resilience of our fast ROI video offering.

With our voice business showing more sensitivity to the economic environment, Polycom proactively took action in Q4 to reduce our operating cost structure and as we announced earlier this month, we’ve implemented a restructuring plan designed to optimize our cost structure as we move into 2009.

With our rapid pace of innovation and the full breadth of our offering, we believe Polycom is best positioned in the industry to deliver our customers the cost saving benefits of video adoption. Our strategic partnerships with Avaya, Cisco, IBM, Microsoft and others, enable us to provide integrated solutions that capture the full benefits of unified collaboration. These partnerships differentiate Polycom as the solutions provider of choice for companies who describe our collaboration solution as the strategic technology investment.

In spite of the challenging environment, through our leading solutions and go-to-market strategy and of course our improved cost structure, we expect to continue to gain strength competitively in 2009, and to deliver solid operating results.

On that note we’d like to open the call to financial and market analysts for questions. For all others, we invite you to stay on the call and to listen in. Of course, as we discussed earlier in the call, many of the statements we have made and will make during the Q&A period are forward-looking statements which are subject to many risks and uncertainties. Is the conference call operator available at this time?

Question-and-Answer Session

Operator

Yes, thank you. (Operator Instructions). And our first question comes from the line of Jason Ader with William Blair & Company. Please proceed with your question.

Jason Ader – William Blair & Company

Thank you. Hey guys. Wanted to ask just a few questions about there is some granularity on the guidance, in particular from a segment perspective, do you expect the video and voice business to be down about the same sequentially or is one going to be hit harder than the other? I know in Q4 obviously voice was down a lot more significantly?

Michael R. Kourey

I think going forward in Q1 here we would expect that voice would decline by more than video.

Jason Ader – William Blair & Company

Okay, on a percentage basis?

Michael R. Kourey

That’s correct.

Jason Ader – William Blair & Company

All right, okay. And then from a geographic perspective, EMEA seemed like it has held up pretty well. What’s the outlook for EMEA in Q1 and beyond? I think there’s some fear that we sort – I think shoot at drop as EMEA at some point for – for tech companies. What – what’s your, what commentary can you provide on EMEA right now?

Michael R. Kourey

I’ll start and then Bob if you like to add it to that I think that, the outlook for EMEA is reasonable. I think there are couple drivers there, one is, they have been very strong adopters of Telepresence and video more broadly, driven by the cost element that’s travel savings and opportunity cost associated with travel, but also they do have at this point frankly a keener focus on some of the green initiatives, from a just pure geographic standpoint and some of the mandates over there. So I think we look forward here in the Q1 we expect that they might also do better than average for the company.

Robert C. Hagerty

Yeah, I would reiterate that, I think particular weakness in the UK, they’ve got a lot currency fluctuations, but strength other places. I mean, I think there is a lot of focus on green and there are globalized businesses there that are continuing to expand into Asia for example. So we are seeing some good worldwide demand being sourced originally and in Europe and expanding out, and of course the Middle East even with the all the client continues to expand economically. So that is of course in our European number as well.

Jason Ader – William Blair & Company

Okay, and then last question, if you combine the 6% risk, announced in January together with the 3% in October I believe it was and I think there was some other minor restructurings that happened in 2008, what’s the total headcount cut on a percentage basis, let's sayfrom beginning of’08 till today?

Michael R. Kourey

Well there is an offset to that as well Jason. I mean, that’s been very targeted. That has not been kind of an indiscriminate of headcount by department or something. So those risk that you mentioned were targeted risk for strategic and execution reasons. So if you look at what happened with headcount, we actually of course added a fair amount of headcount in some key areas as well. So I would think that is more strategic alignment not that there was an objective to get a particular percentage. Although of course the January 6th announcement that we have made not only of course that bias, that strategic bias as far as where we would make those reductions around certain geographies and product lines, that kind of things, but also did help us of course that cost structure objectives.

Robert C. Hagerty

So I think if you look at our headcount at the beginning of ’08 and at the end of ’08, what you would notice about it strikingly that there is more headcount in Asia, than we started. So that was certainly one consistent factor throughout the year is that Asia and all facets of the Asia operation did increase. And then there was a shift, as you should be able to see in the percentages to more of a hi-tech sales force. And so there was more adds in that direct touch or high touch where we influence customers by talking to end-users more deeply than we had in the past. And I think those are two key trends that to keep in mind as we - as you look at our total operation in terms of headcount.

Jason Ader – William Blair & Company

Okay and the 5 million one-time management actions and other cost benefits, could you elaborate on what that means?

Michael R. Kourey

Sure, they were from a management action standpoint, about half of that was associated with kind of a - think of it like a shutdown but it was a – it wasn’t necessarily outlined with the exact same time, it was more done to support the business, but there was some incremental pay time off taken by the staff that comprised about half of it. The other roughly half of it was just some accrual reversals associated with some end of year true-ups and some of the fringe costs and other areas. So that would the results.

Jason Ader – William Blair & Company

Okay, thanks guys.

Michael R. Kourey

Thanks Jason.

Operator

Our next question comes from the line of Troy Jensen with Piper Jaffray. Please proceed with your question.

Troy Jensen - Piper Jaffray

Good afternoon gentlemen. A quick question for Michael. On the Nortel exposure, could you give us any color with respect to, how big they are for you? I know they sell speakerphones, Wi-Fi phones, and kind of a video channel, but any other color on how…

Michael R. Kourey

I think you’ve got it. I mean that’s the primary…

Robert C. Hagerty

Yeah, I think that we don’t breakout our partners in specific, as you know but it’s a fair question because of the unusual events that happened here. First of all there is absolute transparency on obviously what I just covered, which was a $2.6 million impact and there was dead hit to our top and bottom line well pre-tax bottom line last quarter, Q4 that got booked in Q4 even though the filing was on the 14th of January. So, that should give you a rough feel. I won’t disclose the exact payment terms, but actually they’ve been a very good payer, leading up into that, certainly they got - in recent past years, we managed that account. So, you can kind of think of it turns on the business and that I will give you a rough idea. By definition based on the exposure that should give you a rough idea of what the percent is.

Troy Jensen - Piper Jaffray

Okay so just thinking through that a little bit is that the receivable exposure you had and our terms there roughly 45 days about half a quarter of revenues?

Robert C. Hagerty

I couldn’t confirm or deny that kind of thinking, but we have various terms of different partners, but it’s that kind of thinking that would get you to the rough idea. And I’m not trying to be dodgy it’s just we do not breakout partners at the direction of the partners.

Troy Jensen - Piper Jaffray

Understood, that's fine. And then, just another Michael then maybe one for Bob. Channel inventories, I know you guys tied on the inventories inhibited six weeks but I mean what’s you sense on how much the absolute level of inventory has decreased here and maybe the last quarter or two?

Michael R. Kourey

Bob can answer this. I mean, as far as channel inventories, it really depends on the country, it depends on the product line, you have to remember if you thinking about the two tier distribution which I think are something like 53% this quarter they are the ones that really carry the stock for the most part, most of the other channels don’t. So if you look what they cover, they carry what they need to so they can do a big chunk of their value-add of course, they have several value adds, but one is to being able to fulfill orders quickly and have the right flow have it have already gone through customs and those kinds of things. So net-net, I guess it’s a long-winded way of saying that there is ebbs and flows but frankly things remain quite stable quarter-to-quarter, including the fourth quarter.

Troy Jensen - Piper Jaffray & Company

Okay. Great understood. And then just quickly for Mike, or excuse me for Bob, RMX 2000, 4000, it’s doing well here and growing do you think that’s the products really hard now and really ready to take on Codian head-to-head?

Robert C. Hagerty

Well, it is Tandberg and yeah I think the product line is in phenomenal shape. I think you can’t overlook the DMA. DMA is unique. And there is nobody with a DMA or a software solution out there. And you think about the way people are going to use video over the coming years. I mean there there is a huge a huge chunk that is scheduled. That’s covered under our CMA Management solution. It’s got a very good scheduler and of course we integrate with Microsoft Outlook and we have a strong integration with IBM. So then the next way to look at it is as the emergence of desktop comes on, the way we built DMA and the way we built our solution is to be able to deal with conferences as they happen. In yesterday’s world you took a scheduled conference and you had to find the ports, allocate the ports, and it required a lot of IT resources to do that. Under the DMA solution, not only do you not have to worry about scheduling on a particular set of media servers or bridges, but you then take and you can not care about your network. So you can distribute your bridging around your organization, so it’s closed and optimizing your pipes for a least cost but when it needs to route it can route easily and seamlessly and the conferences just occur. So it’s a very important solution. It’s really the convergence of some of the work we did in audio with InnoVox platform and of course with the RMX. So not only as RMX strong and getting stronger, but the DMA and the CMA overlay which controls that total solution and really that is a three part solution DMA, CMA and RMX. And when you deploy that within your enterprise or agency, you get a really powerful optimization. And I’ll belabor it just a little bit, when we looked at the way audio conferencing work in big service providers, one of the things that we were able to observe and digest and develop code and algorithms for, was the way to optimize the use of the media server to get the maximum utilization out of a media server. And so with that combined with the RMX and our ability to do 1080p, on the RMX and other things, it becomes a extraordinarily powerful solution coming at it kind of a from a different angle. So yeah, I think we are in a strong position to take on the competition both from all sides really, from the RADVision and clearly from Tandberg.

Troy Jensen - Piper Jaffray & Company

Got it. Good luck in all ’09 gentlemen.

Robert C. Hagerty

All right. Thank you, Troy.

Operator

Our next question comes from the line of Elliot Gold with TeleSpan. Please proceed with your question.

Elliot Gold – TeleSpan Publishing Company

Thank you. I am going to limit my questions to few. I’m just going to have to admit that my system crashed about halfway through and I have lost the bunch of notes and if Laura can send me the deck or some much that I would have appreciate it.

Robert C. Hagerty

You bet.

Elliot Gold – TeleSpan Publishing Company

Thanks a lot. What I was typing in, Mike was you were giving the group video and I didn’t hear the desktop. Do you have the group units?

Michael R. Kourey

So the group is 19,831. We did not give desktop seats and the reasons for following. Now with the CMA platform, there is integrated with that network management that media network management tool that is included desktop video capability that's very high quality, that completely integrated and kind of the seat numbers becoming a little artificial and meaningless, although we are still selling the PBX software. So at this juncture, I mean they are actually a very large number but because that's kind of the new way of thinking, it would be a discontinuous compared to last year the sequential period. So, we are not including it. The CMA has been actually very successful for all the reasons that Bob touched on as he was also also talking about the seamless scalability of the new DMA platform, but breaking out a discrete number seats just no longer the best way to do that

Elliot Gold - TeleSpan Publishing Company

Okay. Understand.

Michael R. Kourey

Yeah.

Elliot Gold - TeleSpan Publishing Company

Can you give any idea, of quantifying or relative growth in the telepresence “group system” quarter-over-quarter?

Michael R. Kourey

Yeah we had a very nice growth in telepresence. It did grow sequentially, it grew quite a bit year-over-year, we don’t give the exact numbers, but it was multiples of double-digit growth year-over-year growth in this most recent period.

Elliot Gold - TeleSpan Publishing Company

Okay. And then one last question, I will pass to next person. When you did the cuts, can you talk the cuts in Colorado, the old Buoyant group or even the core group, can you comment on and I’ll pass.

Michael R. Kourey

There are cuts in all organizations and more in some locations and in others. There are a lot of moving parts to it. I’d rather not get into it specifically, how many were in Westminster or Boulder (inaudible) or this location or another, but it is a hard think for us to do and we don’t like it. We are not happy about it. These are good folks and these are really difficult economic times or even though we have a very strong product line that continues to do very well. In spite of the economy, we did feel like we needed to make a proactive move there, and get ourselves aligned properly. And the voice business now clearly has seen some toughest sort of economics then we see in the video space. So, they had maybe a little rougher time on a percentage basis.

Elliot Gold - TeleSpan Publishing Company

Thanks a lot, appreciated.

Michael R. Kourey

Thank you Elliot.

Operator

Our next question comes from the line of Scott Coleman with Morgan Stanley. Please proceed with your question.

Scott Coleman - Morgan Stanley

Hi thanks, good afternoon.

Michael R. Kourey

Hi Scott.

Scott Coleman - Morgan Stanley

A couple of questions on my end, first in terms of the cost reduction and the heads you have taken out. This quarter your pro forma operating expenses were $112 million, slightly higher than they were in Q4 of ’07, what should we think about as the dollar impact of what is now, I guess about a 9% reduction as well as some shifts to various areas where you want to focus?

Michael R. Kourey

Well I think as we said in the prepared comments, we anticipate about a $2.5 million sequential reduction in OpEx in Q1 over Q4. So I would definitely model that into your your thinking.

Scott Coleman - Morgan Stanley

And but as we go through the year this nets you out about if I annualize that about a $10 million savings of the Q4 run rate, is that the right way to think about it?

Michael R. Kourey

No, because as we talked about in the prepared comments, there was a chunk of expenses that were one time in nature about $5 million roughly speaking in Q4. And so the savings you can think of is more like $7.5 million.

Scott Coleman - Morgan Stanley

Okay.

Michael R. Kourey

You see what I mean so it’s making out for that five as well as another 2.5

Scott Coleman - Morgan Stanley

Okay.

Michael R. Kourey

On a quarterly basis.

Scott Coleman - Morgan Stanley

Okay, that’s helpful thanks Mike.

Michael R. Kourey

Okay.

Scott Coleman - Morgan Stanley

And then I think you mentioned during your prepared remarks in your comments on gross margin that you have expected a more challenging pricing environment in Q1?

Unidentified Company Representative

Yeah

Elliot Gold - TeleSpan Publishing Company

I’m wondering if you could give us a little bit more detail on that. Is it specific product areas? Is it as demand softens from a macro perspective? Do you think the competition will use price more as a way to capture market share?

Michael R. Kourey

Yeah, I think it’s possible. We did with the possible qualifier by that for intentionally. I think that even though we saw robust price environment. And that was clear with our Q4 results, just in this kind of environment with this more ambiguous timelines, I’m getting the CapEx budget for ’09 completed by enterprise throughout the world, all the 12/31s anyway, you just have to anticipate that there maybe some of that influence. And so we really put a lot of thought into this process here in this guidance. And one of the things that we thought, it would be prudent, its just its insinuative, its prudent, not a tremendous amount of evidence, a little bit here and there when we have some head-to-head competitive fights on larger deals. There is the basic value prop of our unique solution, but sometimes price enters into that discussion as well. And so we have seen a little bit of evidence of that obviously, on blend nothing noticeable. But we do want to anticipate that it could be a little more noticeable in the first quarter hence the guidance, one of the contributors to gross margin.

Elliot Gold - TeleSpan Publishing Company

Okay, Thanks. May be one last one from me. Bob, you walked through the three components of the voice business and perhaps I missed it but talked about lengthening sale cycles, but which of these three do you think has the most economic sensitivity and also if you could help us understand, the relative sizes of the three voice businesses today and that would be great?

Robert C. Hagerty

We were not really breaking out the relative size of our business from speaker phones to VoIP phones to wireless phones. Maybe I will ask Mike to give a little bit of color on that later to give you relative. But I guess I would say, it is interesting that VoIP is the area I would say had the highest growth, and yet has got a long sales cycle. So our conference phones are somewhat discretionary, the old circuits switch but they moved to VoIP. So I guess the aggregate VoIP has seen that people have lengthened it, because the ROI is not as clear as video. So I think when we look at voice I would put the conference phones and the VoIP in one category in that they can be somewhat discretionary and there is cost savings. There is clearly costs savings for doing it but it is not as rapid in ROI as you would see in a video solution. And then on the wireless because its in verticals and those verticals are very dependent on that solution, it has a very strong ROI, I kind of categorize the wireless more or less in the same category, maybe not quite the same category as video, but certainly of the three probably the strongest value proposition. It is used in hospitals, it is used for shop floor management, and if the phones are broken or old, the operations is still going to continue and you need to replace them or expand that operation. Does it help or hopefully it does.

Elliot Gold - TeleSpan Publishing Company

Hey guys’ thanks for clarification, I appreciate it

Unidentified Company Representative

Thank you Scott.

Operator

Our next question comes from the line of Tavis McCourt with Morgan Keegan. Please proceed with your questions.

Tavis McCourt-Morgan Keegan & Company

Hi guys, first a clarification. Mike can you repeat the year-over-year growth in Americas and EMEA?

Michael R. Kourey

Sure. Let me pull that out so in the Americas, the year-over-year or for North America, excuse me, q-to-q was 12% year-over-year was minus 6, minus 12 q-to-q, minus 6 year-over-year and I am sorry the other one.

Tavis McCourt-Morgan Keegan & Company

And then EMEA.

Michael R. Kourey

EMEA

Tavis McCourt-Morgan Keegan & Company

Yeah, yes.

Michael R. Kourey

11% sequential, 14% year-over-year, both being growth.

Tavis McCourt-Morgan Keegan & Company

Great and then, I mean it sounds like Q1 in terms of the cost level is what we should thinking about as kind of a base level and then you experience kind of normal seasonal cost fluctuations from that level. Is that the case or is there some additional benefit that goes into Q2?

Michael R. Kourey

No I think the way you stated it is roughly accurate. I think that that’s a base level that would want to use in your modeling. We are going to obviously be watching our cost structure very carefully as the year unfolds. We obviously are very hopeful with our value prop as Q2, Q3 and Q4 roll around that Bob made it clear that he is looking for some results in the operating margin area, at least stability if not better. And so as you model that would guide your thinking. We are very focus on the margin. We have plenty of spend here to make the strategic executions organically that we need to make around go to market looking at customer and servicing the customer and of course R&D.

Tavis McCourt-Morgan Keegan & Company

And are there any other product launches that are coming up this quarter that would cause an impact to existing product sales as customers wait for those or are they smaller in nature than that.

Unidentified Company Representative

I think that they are some very strategically important. I think that the way we've introduced them you would have only minor effects in terms of people waiting. I mean I sure the rumor mills are great and people know about what we bated here and there but I don't think that's affected the revenue trends too much. And we have tightened up from certainly from announcement to shipment so when we are announcing a rollout a lot closer into the delivery, certainly within the quarter, we’re going to keep those things very close. So clearly there are betas and some people are affected and people know about the beta and they are looking at it but I think that's less soo. But I’m very excited about the solutions that we are bringing in this quarter. The ones we announced already are pretty powerful and ones that are coming up I think equally so.

Tavis McCourt-Morgan Keegan & Company

And in terms of Nortel, now that the bankruptcy filing is out, is it somewhat business as usual again and they continue to do the reselling management.

Unidentified Company Representative

Yeah absolutely, that's a great partnership. Frankly once the filings are done, it actually creates a lot of stability in the minds of the end user customers and frankly in our mind as well post filings. So post filing business is going on full steam ahead.

Tavis McCourt-Morgan Keegan & Company

Gotcha, and then I don’t know to what degree you are willing to talk about this but its obviousl, it’s a pretty strange here in terms of lack of visibility across all of technology but in terms of your guys pay packages and the target bonuses that board is setting for you. Can you talk about whether your targets are going to be based on revenue growth or EBIT growth or kind of what will it be based on this year given the uncertain environment.

Michael R. Kourey

So that's comp committee discussion that is pretty consistent with last year I would say in terms of pretty much we have always focused on revenue growth and profit so those are two keys components. I expect there will be other things they will point us at, but those are the two and then of course at various levels to the initiatives and things people are focussed on.

Tavis McCourt-Morgan Keegan & Company

Okay, thanks a lot.

Michael R. Kourey

Thank you Tavis.

Operator

Our next question comes from the line of Manny Recarey with Kaufman Brothers. Please proceed with your questions.

Manny Recarey - Kaufman Brothers

Thanks, good afternoon guys.

Michael R. Kourey

Hi Manny.

Manny Recarey - Kaufman Brothers

Mike can you repeat the operating margin forecast for the first quarter was 12.5 to 13.7%

Michael R. Kourey

12.2 to 13.7.

Manny Recarey - Kaufman Brothers

Okay. Now is the way to kind of think about that the first quarter because you are focusing on the cost-cutting measures that hopefully would be the kind of the trough of the year and then the idea is that as we go throughout the year you try to expand that not necessarily getting up to your target range but at least continuing to focus on the cost-cutting side?

Michael R Kourey

Yeah I mean we're clearly focused on the margin in this improved cost structure. But our number one focus is on the customer and delivering our ROI value proposition which is landing with our end users. Frankly, including the financial services and many sectors so, that's where we are focusing our efforts delivering the best integrated solution for the customer and coupled with that, we've optimized our cost structure. So yes, our absolute objective and end goal would be that this would be trough and that we would be able to grow from here obviously driving the top line. And Bob I think was pretty clear, and you can add you right here about the thoughts on operating margin, but there is a real focus this year on delivering operating margin as well.

Manny Recarey - Kaufman Brothers

Okay. And then one last question on the network systems, do you guys feel what that you’ve been gaining share for the last two quarters? Or has the overall market began to grow a little bit as well?

Unidentified Company Representative

I think we near a better strategic position, it’s a long decision for people to make about their infrastructure. I would say that with some of the changes with people buying other people, it certainly disrupted the natural flow. Therefore probably most of 2008. And at the end of 2008 and now we are starting to build lot of momentum around our solution, how it is differentiated, how it is a better solution, and so we are pretty excited about that and I expect that we will fair very well with that product line.

Manny Recarey - Kaufman Brothers

Okay, thanks.

Unidentified Company Representative

Yep

Unidentified Company Representative

Thank you Manny.

Operator

Our next question comes from the line of Bill Choi with Jefferies & Company. Please proceed with your question.

Bill Choi - Jefferies & Company

Thanks. Hi, guys. Can you here me?

Unidentified Company Representative

Yes.

Unidentified Company Representative

Yes.

Bill Choi - Jefferies & Company

Great, I want just delve in to the gross margin outlook a little further. Obviously there are several factors going on here on the product side alone, you have ASP benefits of shifting to more HD, my guess is here ASP on the group video systems are up over 3% sequentially. How much of that is due to overall pricing increases that got instituted in September that stuck versus the shift to obviously higher HD products and kind of where you think we are in the ASP growth as a result of mix shift change for the HD.

Unidentified Company Representative

Well first of all, yeah clearly there was the 3% price increase in September. Some of the benefits that we saw in the fourth quarter was as a result of that. So we had partial impact as you can imagine. Even with the environment some of that stuck, meaning that with many of our deals that in fact has stuck and its been a benefit to the company broadly. In addition there was a mix shift toward HD, which was a benefit so if you had to rank order those two it would be mix first, price increase second.

Bill Choi - Jefferies & Company

Okay, that’s helpful. And just in looking at anticipating obviously pricing potentially getting tougher, have you seen anything out of Cisco, in this regard we start to see a lot of the larger capitalized companies using finance aggressively on things like PCs and stuff, but how do you look at Cisco and their ability to essentially subsidize and build the base with telepresence on a tough economic year, because it’s ultimately good for them and there (inaudible) grabbing business anything?

Unidentified Company Representative

So we continue to see that Cisco continues to use a variety of selling tools that are quite favorable for them. We believe we have equally strong selling approaches that we’re employing. So I haven’t see a market shift in the way they do it and so I’d say I haven’t seen a delta, I saw them using a very customer friendly approach i.e., long trial cycles and other such mechanisms right from the beginning, we continue to see that today. So I don't think that will change we haven't seen a change materially in late '08 so I don't expect to see it in '09. But I think we're in a pretty good financial shape, we've got we generate $15 million of positive operating cash flow. We've got a very, very strong balance sheet, so I think we're in good shape from that standpoint, plus I think our value proposition in telepresence is quite strong. We are quite differentiated from the rest of the market with our RPS product line. So I think we have a really strong position to come in and sell what we what we have to offer in our solution.

Unidentified Company Representative

And it was one of our very fastest growing product lines in the fourth quarter, which is the good testament and frankly we’ve had some head-to-head competition with the major players in the Telepresence space. And we’ve done very well and some of those – you will be hearing about through announcements in the coming weeks.

Bill Choi - Jefferies & Company

Okay one last component here just on the services gross margins, obviously you guys saw a very strong gross margin in Q4. As you guide lower on overall products, how should we think about this, the ability to sustain these mid-50s type of gross margins in services.

Unidentified Company Representative

I think, that remains to be seen to some degree and obviously in the guidance I hedge that down somewhat. I don’t know unbelievably strong, but the margins have been, let’s put it this way, significantly over the long-term target model on service growth for quite sometime. So it’s a full 12, 13 points over the long-term target model. I mean obviously maybe the model needs looking at, but the reality is they’ve done a very good job with our cost structure and their global deployment. We have a highest touch service model for unified collaboration of any company in the world bar none, and we have been able to exploit that quite well to the benefit of our customer, having both staff and product near the customer or at the customer ready to help the customer proactively around network design at the front end all the way through managing the network for them at the back end. In some cases we have staff they will live active, work everyday within the customer shop. So we are very pleased with that margin model, we would like to do a lot of more of that product area of service and we plan to.

Unidentified Company Representative

Included higher value added aspects of professional service or services, is something we are definitely continuing to expand. And the other thing I think is exciting about the service area is that we have got the largest install base I believe bar none and video in the market and certainly in triangular speakerphones, but with that we have got a very strong pipeline of software upgrades and the ability to keep people at a high rate of renewal on contracts because of that software component that we are bringing as well. So I think it’s a good win, both because we continue to bring out higher value service offerings that are synergistic with our channels and then good software improvements to keep people very interested and maintaining the systems that are out there.

Bill Choi - Jefferies & Company

Okay, thanks.

Unidentified Company Representative

Thank you.

Operator

So, we have no further questions from the list provided of analyst

Michael R. Kourey

Well thank you for following Polycom as we ended 2009. We look forward to capturing demand for unified collaboration as costs saving and productivity solutions in core markets worldwide. We will see you next time. Thank you.

Unidentified Company Representative

Bye, bye everybody.

Operator

Ladies and Gentlemen, that does conclude the conference.

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Source: Polycom, Inc Q4 2008 Earnings Call Transcript
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