Polycom, Inc. Q1 2009 Earnings Call Transcript

Apr.16.09 | About: Polycom, Inc. (PLCM)

Polycom, Inc. (NASDAQ:PLCM)

Q1 2009 Earnings Call

April 15, 2009 5:00 pm ET

Executives

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

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

Analysts

Samuel Wilson – JMP Securities

Jason Ader – William Blair & Company

Elliot Gold – TeleSpan

Jim Suva – Citigroup

John Marchetti – Cowen and Co.

Hassan Imam – Thomas Weisel Partners

Todd Kauffman – Raymond James

Tavis McCourt – Morgan Keegan

Jeff Kvaal – Barclays Capital

Bill Choi – Jeffries &Company

Operator

Welcome to the Polycom Q1 earnings conference call. (Operator Instructions) I would now like to turn the conference over to Mr. Mike Kourey, Chief Financial Officer of Polycom, Inc.

Michael Kourey

Thank you. Good afternoon everyone and welcome to Polycom’s first quarter earnings call. I am Mike Kourey, Polycom’s Chief Financial Officer and here with me is Bob Hagerty, Chairman and CEO. As with previous quarterly calls, we’re again augmenting today’s voice conference call with a web cast. If you’d like to receive the web cast please open your web browser at this time and enter Polycom’s home page, which is Polycom.com and click on the Q1 earnings call link. Then, follow the instructions provided.

For the analysts participating in the Q&A session leave your call live so that you can use your conference 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 web cast 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 legislation 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 annual report on Form 10K for the quarter ended December 31, 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 Hagerty

Thank you Mike. To begin I would like to provide a few financial highlights. Later in the call Mike will go through the operating results in greater detail. For the first quarter revenues were $225.4 million representing a 14% sequential decrease from the fourth quarter and a 13% decrease from the year-ago period. We exited Q1 with a backlog of $42.9 million, down 28% sequentially and 27% year-over-year.

Polycom’s deferred revenues grew to a record $115.2 million, up 2% sequentially and up 8% over the year-ago period. At the bottom line, non-GAAP earnings were $0.27 per diluted share, down 36% from the fourth quarter and down 25% from the year-ago period.

Despite feeling the pressure from the current economic environment in parts of our business during the first quarter we believe the core drivers of our business remain strong. In concert with these drivers we are implementing several initiatives designed to improve our top line performance and we continue to demonstrate success in managing our cost structure to drive profitability.

Let me now turn to these key drivers and initiatives. During the first quarter, video collaboration exhibited resilience and in some cases sharp growth even in the current economic environment. In fact, Telepresence was our fastest growing major product line in the first quarter and now combined with video and the supporting network infrastructure these products collectively comprised nearly 70% of Polycom’s revenue.

Our RPX and TPX Telepresence products grew to double digit, sequential and 45% year-over-year growth crossing the $10 million quarterly revenue threshold for the first time in our history. In our view, the solid growth of this product line serves as a further validation that customer organizations of all sizes and types are benefiting from their investment in solutions that have an immediate and direct hard dollar ROI.

Over the last few months we also made significant strides in improving our network infrastructure that supports our video and Telepresence offerings. In the fourth quarter of last year we launched CMA, a comprehensive, scalable video network management solution that simplifies provisioning, scheduling and improves the management and ease of use of desktop, group video and Telepresence deployments.

A key component of this solution is CMA Desktop, a tightly integrated, enterprise quality desktop video application which allows customers to scale thousands of users and supporting high definition voice video and content. In Q1 we built our leadership in innovation with the launch of Polycom’s Distributed Media Application (DMA), the industry’s first media-server virtualization product in the unified collaboration market. This product allows our customers’ IT departments to load balance key network resources saving intervention and costly resources. This product has just begun shipping in March and is already proving to be a breakthrough product.

Finally, we launched the RMX 400 conferencing platform in late February. It is an architecture that provides the industry’s first 1080p 30 frames per second bridging capability with unsurpassed port density and unparalleled capacity and scalability. As with DMA, this new product began shipping in March and is already getting great feedback from our channels and end-user customers.

Although early in its launch this best-of-industry network solution has already begun to contribute in Q1. Driving our network systems business at double digit, year-over-year growth in the quarter, we believe our leading architecture and comprehensive network solution will be a critical driver of growth in the video and Telepresence and should enable Polycom to make competitive gains in 2009.

During the quarter we also broadened our product line to address small and medium sized businesses and branch offices of larger entities which is a virtually untapped market for us. We introduced the QDX6000, a high quality video product with a price point under $4,000 designed specifically for this market. This product offers a compelling ROI and almost immediate payback which allows smaller businesses to benefit from the cost savings and the increased efficiencies afforded by unified collaboration.

Rhonda Wingate, a Senior Vice President at BT Conferencing stated, and I quote here, “There is an unmet need in the market today for a product like Polycom’s QDX6000. This product strikes the right balance of quality, performance, simplicity and affordability.” We also improved our competitive position and broadened our market reach with the U.S. Federal Government during the quarter. We announced we are the first to deliver Telepresence solutions with JITC, IPv6 and FIPS 140-2. Now although those terms may not be familiar to you suffice it to say this gives us, Polycom, the edge with U.S. Federal Government applications, particularly important with the growing budgets and the upcoming government fiscal year-end this summer.

Switching gears to voice, as I noted previously this business area is dependent on our partners’ roll outs of IP call managers and systems expansions. With the current economic downturn voice product sales continued to slow in the first quarter. However, the voice business continues to perform well competitively and remains integral to our unified collaboration solution. We expect the voice business to return to growth as the economy improves.

In fact, I would like to give you two examples of how strategic our voice business is to Polycom’s UC offering. First, note the recent introduction of our VVX1500 business media phone. This product is an excellent example of the convergence of voice, video and content right at the desktop. This desktop phone delivers an integrated collaboration device that connects directly to an IP call network, replacing the need for a voice-only device desk. According to Akiba Saeedi, Director of Unified Communications and Collaboration at IBM, same-time unified telephony users can select the VVX1500 as one of their preferred devices and are able to have high quality voice and video communication and collaboration with others using the embedded, same-time, unified telephony soft-phone.

In addition to IBM, we have extensive SIV based interoperability with Broad Soft, an important platform in the managed IP services environment as well as several other strategic partners. This extensibility from a voice only to an integrated UC device is only possible due to Polycom’s industry leading voice branded innovations.

Another example of the strategic nature of Polycom’s full solution offering is our recent announcement with Microsoft. Launching our new CX5000 Unified Conference Station this product line formerly known as Microsoft Roundtable will now be available only through Polycom. Working closely with Microsoft, Polycom will continue to evolve this video solution that integrates directly with their office communications 2007 platform and live meeting service.

This expansion of our strategic partnership with Microsoft is a direct extension of our joint offering in the Voice Over IP space. As Microsoft’s VP of Unified Communications, Gurdeep Singh Pall, stated in a recent interview with Information Week, “Polycom by far is the brand for conferencing. Whether it is speaker phones, video, etc. what this does is it shows that Microsoft, focused on the software platform and the best brand for conferencing for hardware gives a best of breed solution across the platform. Polycom has an incredible channel and incredible reach across geographies and great ability to support customers.”

In other words, from the conference room to the desktop and ultimately to the mobile environment Polycom’s strong value proposition, unique go-to-market strategy and innovative technology in voice serve as a foundation for our suite of unified collaboration solutions.

Next I would like to provide you with an update on Polycom’s go-to-market strategy. First, from a market reach standpoint we are getting unprecedented visibility from our hard dollar ROI of our solutions and the resilience of video collaboration in this economic environment. CEO’s, CFO’s and CIO’s alike are driving their companies and agencies to reduce discretionary spending particularly those relating to travel and to operate efficiently with staff at flat or reduced levels. Driven by this need and the quality now achievable with Polycom’s Telepresence and video collaboration solutions, our go-to-market is focused on sea level briefings, ROI calculators and a sales account structure that cultivates high touch customer relationships.

As you know, I have personally assumed interim sales management responsibility while we identify the best possible SVP of worldwide sales to take Polycom to the next level. Over the past couple of months I have been working to expand and capture a large unified collaboration opportunity, nurture our channel partner relationships and drive to gain competitively with our go-to-market. My view is that with this newly enhanced product line, our brand and our channel, Polycom’s sales team is already armed to win.

In fact, I have already received positive channel feedback regarding our product line improvements, our approach with them and our general aggressiveness in the field.

With regard to the new SVP of Worldwide sales we are actively recruiting and we have several excellent candidates. Look for an announcement in the next couple of months.

Before I turn the call over to Mike Kourey, let me give some recent examples of key customer wins. For instance, the Charles Schwab Corporation, a leading provider of financial services this quarter selected Polycom’s Telepresence solution as the RPX to deliver stability, consistency and interoperability with an immersive experience.

In Europe Daimler Trucks standardized on Polycom’s HD video solution for its board and directors. They selected Polycom to cut costs and improve efficiency while being environmentally responsible. With many of the board members and directors being geographically dispersed at various locations worldwide, the systems quickly pay for themselves when executives elect to use video instead of travel.

Shanghai Electric Power has deployed Polycom’s 1080P quality HDX solutions in its mobile command vehicles to enable emergency response teams to connect with specialized technicians located back at the home base for timely diagnosis and fixing of power failures.

U.C. Irvine Medical Center selected Polycom’s Wireless Phone solution to enable nurses, doctors and patients to communicate more effectively in their new, state of the art hospital.

Manhattan Associates, a global leader in supply chain execution, selected Polycom’s HDX, RMX and CMA to be rolled out across its U.S., India, U.K. and China offices.

Tokyo University of Agriculture and Technology adopted Polycom’s HDX, RMX and RSS solutions as the backbone of their distance learning network. This will enable teachers and students from across 18 Universities from Aikido to Okinawa to connect face-to-face to learn and collaborate. Polycom’s 1080P capabilities secured this customer and provided them with a future proof investment.

These are but a few of the examples of how Polycom’s solutions are being adapted to save money and increase efficiency while being environmentally responsible. I will keep you posted as Polycom makes progress in driving for competitive gains in the important Unified Collaboration market.

On that note let me turn the call over to Mike Kourey for a discussion of Polycom’s financials. Mike?

Michael 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 execution and financial performance which are subject to many risks and uncertainties.

Moving to a look at our results, as Bob stated earlier revenues for the first quarter were $225.4 million. This represents a sequential decrease of 14% and a 13% decrease compared to Q1 of last year. On a product line basis which includes the service elements of each product line revenues for video solutions were $156.4 million in Q1, decreasing sequentially by 11% and by 2% year-over-year. Video Solutions is comprised of our video communications and network systems product lines.

Of these product lines, video communications generated $124.3 million in revenues, decreasing sequentially by 12% and by 5% year-over-year. On a unit basis we shipped 16,529 group video systems. Importantly, note Polycom’s Telepresence grew 32% sequentially and 45% year-over-year and for the first time contributed over $10 million in revenue in the first quarter.

Network systems decreased 6% sequentially to $32.1 million but returned to double digit growth increasing 10% year-over-year. The Voice Communications business generated revenues of $69 million in Q1, representing a 21% sequential decrease from Q4 and a 31% decrease from the year-ago period.

Moving to revenue by geography in the first quarter North American revenues were down 9% sequentially and 13% year-over-year. EMEA revenues were down 23% sequentially and 17% from the year ago period. Asia revenues decreased sequentially 13% and 6% year-over-year. Latin America was down 26% sequentially and 20% year-over-year.

From a channel standpoint the revenue breakout for the first quarter was as follows: 38% through value added resellers, 50% through distributors, 7% through service providers and 5% direct.

The quarter experienced the same linearity as Q1 of 2008 with 49% of revenues in the last month of the quarter. Polycom exited Q1 with $42.1 million in backlog, down by 29% sequentially and by 27% year-over-year. Polycom’s deferred revenues grew to a record $115.2 million in Q1, increasing 2% sequentially and 8% over the year-ago period. Clearly the first quarter was impacted by the economic climate which was compounded by the fact that Q1 is a quarter in which most companies set their capital budgets for the year.

Looking into Q2 our sales pipeline has improved from Q1 and bookings activity has improved from quarter-ago levels. We are also encouraged by our extensive new product roll outs that include our revitalized network systems offerings, as well as our new video products such as the QDX and DVX that extensively broaden our market reach.

Also, historically Q2 exhibits seasonal increases from first quarter levels. That being said we remain cautious about the global economic environment. In addition, we are bringing in new sales leadership that we believe will contribute to a strong second half but will likely not be impactful for Q2 revenues. As a result of this mix of factors we are guiding revenues in Q2 of flat to down 4% from Q1 levels.

Moving on to the statement of operations, non-GAAP gross margins for the first quarter were 58.9% representing a sequential decrease of 1.1 percentage points. Although the pricing environment continues to be robust in Q1, the lower revenue levels in combination with a relative mix shift towards service revenue impacted consolidated gross margins.

Breaking out our gross margin objectives by product family our network systems product line continues to have targeted gross margins in the high 60’s. Group voice and video communications products have gross margins targeted in the high 50’s to mid 60’s range while service and desktop voice are targeting low 40’s.

In the first quarter, service operated above its target range, network systems, video and group voice operated within their target ranges and desktop voice operated slightly below its target range. Of course, 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 we executed prudent cost controls during the first quarter by proactively aligning our cost structure to the current economic climate. As a result, Polycom’s operating expenses decreased sequentially by a significant $9.2 million or 8% sequentially in the first quarter. This was driven primarily by the 6% reduction in force we announced on January 6 as well as reductions in travel and the compensation cost reductions associated with the lower revenue levels.

Looking at the specific Q1 non-GAAP operating expense line items on a percent of revenue basis, sales and marketing represented 28.5% of revenues for the period, up from 26.7% in Q4. R&D closed at 11.8% of revenues, up from 10.7% in Q4. G&A was 5.2% of revenues, up from 5.1% in Q4. In total, non-GAAP operating expenses represented 45.5% of net revenues in the first quarter, up as a percent of revenues from 42.5% in the fourth quarter.

Moving to a look at the company’s operating income; Polycom generated first quarter non-GAAP operating income of $30.1 million or 13.4% of net revenues, down from 17.5% in Q4. This compares to $40.6 million in non-GAAP operating income or 15.7% of net revenues in Q1 of 2008.

As a recap of our performance against our previously stated long-term target model we are roughly at the low end of our target gross margin range of 49-63%. Sales and marketing operated 2.5 percentage points over the high end of its target range. R&D and G&A continue to operate within their target ranges.

Our non-GAAP operating margin of 13.4% is 6.4 percentage points below the low end of our target range of 20-22%. Looking forward to the second quarter we expect gross margin to remain roughly flat with Q1 levels. From an operating expense standpoint, Q2 will experience the full cost benefit of our January reduction in force as well as a few other proactive measures around travel and paid time off expanses. As a result, we anticipate operating expenses to decrease sequentially by approximately $4 million in Q2.

This translates into approximately $2.5 million in reductions in sales and marketing expense with approximately $1.5 million in engineering cost reductions. G&A may be down slightly from Q1 levels. This should yield operating margins that are up 25-150 basis points from the first quarter.

Other income and expense in Q1 resulted in a net expense of $300,000 comprised of $500,000 in interest income offset by other expenses of $800,000. 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 Q2 we expect other expense of around $700,000.

Moving to tax, you will note that our Q1 effective tax rate was 24.5%. Looking forward to the second quarter we are forecasting a 25% effective tax rate based on our mix assumptions. Of course, this 25% rate is subject to change based upon changes in geographic mix as well as changes resulting from any new U.S. or international regulations or interpretations.

Q1 non-GAAP net income was $22.5 million representing a 31% decrease from $32.7 million in non-GAAP net income in the comparable period last year. Non-GAAP diluted EPS in Q1 of $0.27 represented a decrease of 25% from Q1 of 2008. GAAP profitability for the first quarter was $8 million and $0.10 per diluted share in Q1 versus $14.2 million or $0.16 per diluted share in the comparable period last year. This represents a 44% decrease in GAAP net income and a 38% decrease in GAAP EPS year-over-year.

Moving to cash, Polycom generated $26.8 million in positive operating cash flow in Q1 representing Polycom’s 45th consecutive quarter of positive operating cash flow. These operating cash results were driven largely by our strong profitability and working capital management. Cash and investments at the end of the first quarter totaled $338.7 million. Of course the company continues to be debt free.

Moving to DSO, the company’s net trade receivables of $113.2 million resulted in a DSO of 45 days, a one day increase over Q4 but a four day improvement year-over-year. Looking forward we are maintaining our best in class DSO guidance of 40-50 days. We lowered inventories by $2.6 million sequentially to $87.1 million at the end of Q1 representing turns of 4.3. We expect inventory turns to improve slightly in the second quarter.

Regarding share count we expect Polycom’s weighted average shares from diluted EPS to grow by approximately 500,000 shares in Q2 exclusive of any stock repurchases. Note that during the first quarter we purchased approximately $5.4 million of shares under our share buyback program. Entering Q2 we have $250 million remaining in our share buyback authorization. In addition to future potential buy backs of our stock, our share count will change based on Polycom’s stock price, any acquisition activity and other factors.

Moving to headcount, Polycom had 2,537 employees at the end of Q1. As we announced earlier this quarter we implemented a restructuring plan that resulted in a 6% headcount reduction. These reductions are designed to better align resources 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 Hagerty

Thank you Mike. In summary, although we experienced challenges in the current economic environment in the first quarter we believe the core drivers of our business remain strong. Now more than ever our customers are sensitive to discretionary spending and are increasingly focused on solutions that drive hard dollar returns on investment to improve their bottom line.

We are fulfilling this need as evidenced by our customer adoption of Polycom’s highly differentiated RPX and TPX solutions driving a 45% growth in our Telepresence business to a record level for us. Also fueled by a wave of new infrastructure products, our network systems product line returned to double digit year-over-year growth. One of the factors offsetting this growth was our performance in the voice business which continues to be adversely affected by the economic downturn. However, the voice business continues to perform well competitively and remains integral to our Unified Collaborations solutions. We expect this business to return to growth as the economy improves.

Looking forward we expect a broad range of new products and sales execution improvements to expand our market reach and to enable us to make competitive gains in our video solutions business. Finally, as Mike and I noted previously, we have proactively aligned our cost structure to deliver margin expansion through each quarter of this year.

On that note we would like to open the call to the financial and market analysts for questions. For all others we invite you to stay on the call and 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

(Operator Instructions) Your first question comes from the line of Samuel Wilson – JMP Securities.

Samuel Wilson – JMP Securities

A clarification, you mentioned you bought back $5.4 million worth of stock. How many shares did you buy back?

Michael Kourey

Roughly consistent with the average price during the quarter. I don’t have the exact number to give right now but…

Samuel Wilson – JMP Securities

Similar to the average price?

Michael Kourey

Yes it is very similar to that.

Samuel Wilson – JMP Securities

What was the average price?

Michael Kourey

Again, I don’t have handy the exact quantity but clearly it will be in our 10Q.

Samuel Wilson – JMP Securities

I’ll get it out of the Q. On the voice business it is split up into three segments, the conference phones, wireless phones and the desktop handsets can you talk about which segments are sort of under performing the most and can you wrap into the answer is Nortel’s bankruptcy having an impact on the business right now?

Robert Hagerty

I think the way to look at it traditional wire line analog conference phone has been affected the most. Next would be wireless and the Voice Over IP speaker phones and yes I would say to some extent both of those businesses did see some decreased demand due to, I don’t know if it was the Nortel bankruptcy or just the environment of Nortel and our other OEM’s are participating in. I would say it is fairly consistent across the board with all of the OEM’s in both the wireless and the Voice Over IP conference phones. The VoIP Business was the least affected, Voice Over IP handset business was the least affected.

Michael Kourey

I did lay my fingers on that number, 381,000 shares.

Samuel Wilson – JMP Securities

My last question for you is just sort of a qualitative question. When you gave guidance three months ago you guided down from 9-13%. You are actually pretty close at minus 14% quarter-over-quarter. Just some sense of what in the quarter performed below what you had expected three months ago.

Robert Hagerty

I would say the voice business.

Operator

The next question comes from Jason Ader – William Blair & Company.

Jason Ader – William Blair & Company

From what I understand, the guidance for Q2 just so I understand, with the comment you made on better bookings and pipeline activity, your normal seasonality and obviously we had a very abnormally high negative seasonality in Q1 because of the budget cutting process, and you have some new products on the network side and the video side, I’m trying to understand why it would be down? I understand why it would be flat but why would it be down 4%? What would be driving the down environment given the kind of positive factors that you talked about?

Robert Hagerty

I think first off, I think Q1 in the video space was a new products quarter for us so we introduced a lot of new products that can tend to be…we have a lot of work to do. Get out to our channels; get our whole ecosystem geared up around the new infrastructure products. I was really happy that the infrastructure products delivered growth in Q1. So I am pretty excited about what that product line can do in Q2 as well as the Telepresence which is getting some traction and really resonating well. When we get people to demo that product they are pretty impressed. It is a “wow” product.

We also introduced 1080P. So I am feeling pretty good about the video product line and the pipe looks pretty good on the video product line. I would say if I have any concerns and why would we be a little negative first I would say probably a little conservative based on missing this quarter even though by a little bit. We don’t like to do that so I would say probably a little bit of a conservative posturing. Then the voice business. We want to see the call management infrastructure guys are really coming through this and getting things going. We did see some changes in the ITSP’s that drive the Voice Over IP but I think that has stabilized and looks like that side of the business is going to go well.

I would say at least from my sense it is a little bit of conservatism around the voice business and how fast it will recover.

Jason Ader – William Blair & Company

So if I were to break down the business, I know you don’t necessarily like to do that but you were kind enough to do the last quarter, at least talk about it qualitatively, would it be fair to model video kind of flat and voice down again?

Robert Hagerty

Yes.

Michael Kourey

That is at the margin. That is logical obviously.

Jason Ader – William Blair & Company

In terms of the timing of share gains, I guess you made a comment about the number of products putting you in a position of gaining some share there in maybe the second half and then also having a new head of sales that could help drive share gains. I understand the network side. I don’t quite understand the new head of sales because I know Bob has done a great job, you know? Why is the head of sales going to drive share gains?

Robert Hagerty

Two heads are better than one and right now there is a limit to what I can get done and the amount of travel I can do for sales purposes only. Clearly I prefer to be out on the road with channels and with sales folks visiting regions and yet there is a limit to how much I can do. I think that the right sales leader, I think I have learned a lot, and made a number of adjustments. I can tell you that for sure I am very pleased with account assignments that our channel managers are on the right channels. We have made some adjustments to put the right people in the field, that end user direct touch accounts are in good shape, probably augmenting a few things here and there but not changing a lot. So I would say new leadership with the processes we have put in place to better monitor, to get out on the field, go visit customers, go out and visit channels and touch them a bit more, I think is a plus. There is a limit to how much I can do so I am pretty excited about having somebody go do that. Although I would say once your hands are in the pot as deeply as mine are I am not going to be pulling them out all that fast. So, I am going to make sure the program has been put in place fully and are fully implemented.

I am very excited about some of the feedback we have had some of the channel programs. We had a very good meeting in Europe and a very good meeting in the U.S. with the technical side of our channels. I think it went extraordinarily well and we got some great feedback and some very good, not only feedback i.e. the meetings went great but very excited about the platform, very excited about the architecture and oh by the way here are some things you could do to even improve your position better which we have taken to heart. We have gone back in the labs and making a few changes there as with our go-to-market. So I would say the back and forward communication is as good as it has been in years and I’m very excited about it. I think it is just icing on the cake to get a senior professional sales manager in here who can really take this thing to the next level.

Michael Kourey

Obviously in the second quarter with those moves with a new head there is bound to be some level of disruption. That would be expected. That goes into our guidance.

Jason Ader – William Blair & Company

The last question kind of on the same topic, how difficult is it to have the confidence and ability to start gaining share when you have cut a fair amount of the headcount and your primary competitor I don’t think has cut anybody and so they are kind of operating with you could argue more resources out there than you are just given the cuts that you have made from an OpEx standpoint.

Robert Hagerty

That is a good point and I think we are very aware of where our competitors are and where we have strength and where we have weakness. We have done some things in terms of the support structures, not so much in the account structures although there has been some, it happened in the December/January timeframe. I think we know where they are. I think one of the moves that you make in a situation like this is we are an ecosystem player. We have always been an ecosystem play. I would say more than ever I am excited about the ecosystem because the ecosystem is an equalizer. We have great channels. We have great partnerships. We have to kind of dust off some of those relationships and we have got to re-embrace those relationships and make them really hum. I think that is our opportunity and that is a leverage play. So I think that the ecosystem could equalize for us and we have got to be excellent at that. We are making improvements every day in our approach to the channel.

Jason Ader – William Blair & Company

So kind of back to basics basically?

Robert Hagerty

Yes, I would say back to the I think you said at one time the old Polycom. So we are definitely going back to the way we operate. It is not an old model but I would say the model that we were in I am sharpening it up quite a bit. Cleaning it up, spraying it off, spraying some lube on it and getting it running top speed.

Operator

The next question comes from Elliot Gold – TeleSpan.

Elliot Gold – TeleSpan

There were some things that you said rather rapidly and I wanted to make sure I got them right. You said that the higher end video systems that would be the HD and Telepresence, 70%? Is that right?

Michael Kourey

That is correct. Nearly 70%.

Elliot Gold – TeleSpan

You said I believe total group system count was 15,529? Did I get that right5?

Michael Kourey

16,529.

Elliot Gold – TeleSpan

Then you said Telepresence had grown 32% sequentially and 45% year-over-year?

Michael Kourey

That is correct.

Robert Hagerty

Belated Happy Birthday.

Elliot Gold – TeleSpan

She got to you too?

Robert Hagerty

That date is the new 30. I won’t say what that date is.

Operator

The next question comes from Jim Suva – Citigroup.

Jim Suva – Citigroup

For the voice side of the business can you talk about when you think we may potentially see some stabilization there? I know a lot of it depends upon the economy but at some point I would assume you internally are kind of looking at hey maybe the worst of times have passed us?

Michael Kourey

I think we have taken a conservative posture in this guidance. I would suggest that we will see. I think so. I think a bottom maybe have been made but you have to be careful when you look at this to understand we are a global company and while I feel positive about what is happening in the U.S. economy I think there are still things going on globally that can impact that number. So we will just have to see. I would say if you are looking particularly at the U.S. I would probably be with you in saying it is starting to stabilize and bottom. I am not so convinced internationally we are through all this yet.

Jim Suva – Citigroup

Switching topics a little bit to your hiring plans, it sounded like from your prepared comments you actually may be looking at beefing up or adding a little bit more strength because you are pulled a little thin right now. Would that entail actually bringing in several people or several teams? At one time it sounded like you were just talking about like one sales person and then another time you talk about needing some additional help.

Michael Kourey

I think just to be clear what we are talking about very specifically is bringing in a new Senior Vice President of Worldwide sales. With that individual there may be at the margin some additional resources that would be brought in but the guidance we gave around cost, for instance, incorporates all of that. So no, there is no intent here to bring in new teams per se. It is a new SVP of Worldwide and possibly a little surrounding support for that.

Jim Suva – Citigroup

As a follow-up to that when you said bringing them in, we are already into the month of April into the quarter so I guess on a run rate basis should we look at a slight step up there for the SG&A line?

Michael Kourey

Actually it is as we said in, or as I said in my prepared comments, we expect sales and marketing to be down sequentially by $2.5 million net.

Jim Suva – Citigroup

I was referring to beyond the March quarter because they are not hired yet.

Michael Kourey

I am guiding for the June quarter. Do you mean the September quarter?

Jim Suva – Citigroup

Yes.

Michael Kourey

For the September and December quarters we only guide one quarter out. However, what Bob did say in his comments is that our intent is to have improvements each quarter in the operating margin and so yes really I think it is very dependent on revenue growth rates later in the year. We have not guided to that yet. We would make adjustments at that time. Do keep in mind that our intent is to see some operating margin improvements in these future quarters.

Operator

The next question comes from John Marchetti – Cowen and Co.

John Marchetti – Cowen and Co.

Just curious, last quarter you talked a little bit about some expected pricing pressure in terms of the way you gave guidance for the March quarter. Just curious sort of how that played out for you in the quarter relative to the expectations of the guidance that you gave back in January?

Robert Hagerty

It actually turned out pretty well. The pricing environment still is fairly robust. In fact, that wasn’t the major driver of the gross margin decrease of just over a point. It was related more to the fact that there were lower revenue levels which means fixed overheads on the manufacturing side are more sensitive obviously on the lower base. Then also the shift mix to service away from product where in aggregate that is a lower margin business. I am very happy with the service business. It makes for sticky, long-term critical strategic partnerships with our customers but nonetheless it is a lower gross margin area. So those were the two core drivers. The pricing environment was good.

John Marchetti – Cowen and Co.

On that with the services side, I know in the past it has always been running from a gross margin perspective well above sort of its target range, down a little bit sort of this quarter. Are we getting…do you anticipate it coming all the way back down to that target range? Is that something we should be overly concerned about? Is that something maybe down the line you are going to have to look at to revise relative to your target?

Robert Hagerty

I would say more of the latter.

John Marchetti – Cowen and Co.

Lastly, just looking at the backlog, obviously a big drop here in Q1. Just wondering sort of what went into that? Obviously you had a pretty similar linearity as you did last quarter so I’m curious as to the big drop in backlog there and maybe what we should think of that as we look into Q2 and beyond?

Robert Hagerty

I think if you look at where our backlog ended we are at about 19% of the current quarter revenues. Our target, as we have said in the past, is roughly 20% or so. We have been operating a little above that as you know. Clearly you would expect to see the backlog increase with revenue increases from here. You might see it go back to 20% or a little better. So that is the kind of outcome that might be realistic over the next couple of quarters. But a lot of that frankly is just related to the lower revenue levels during this last tough quarter that we had with the environment and the budget setting. From here, it is appoint ender, our kind of target range, but that is about where it is at.

John Marchetti – Cowen and Co.

Lastly, if you could just give us a little bit of color on what you are seeing from a geographic perspective? I know Europe was actually pretty strong for you in Q4. This quarter obviously a little bit weaker. You had talked about some weakness in the U.K. and that others were looking pretty stable. If you could just give us some color there and then I will jump back into the queue.

Robert Hagerty

In general I think the quarter worldwide was pretty slow in January. I think there was a lot of, I don’t know if you would call it confusion or designed delay, where people were extending the sales cycle. I think we talked about it in the last earnings call. What we saw was levels being bumped up. So what a senior finance director could sign for last quarter they could no longer sign for, you needed a CFO. So we saw that happen consistently globally. That really played out in January and then started to clean up in February and got I would say closer to normal in March.

Then I would say the weakness we saw was global weakness in particular on that budget and trying to recover for that lost time. But I would say Eastern Europe, Russia and Middle East to some extent got pretty soft.

Operator

The next question comes from Hassan Imam – Thomas Weisel Partners.

Hassan Imam – Thomas Weisel Partners

On the OpEx line, are these levels do you think sustainable as we go through the year? I know you had commented on that but as we look to Q2 or the second half of the year with the new sales person and kind of accelerated sales effort do you think we could see a ramp up in the sales and marketing line?

Michael Kourey

I think it really depends on the revenue profile as the year plays out. That has a lot to do with the economy and obviously a lot of the sales execution improvements that Bob touched on. As far as overall, the objective is as the situation improves we expect to see operating margin improvements so there is not a bias to certainly add back costs with the revenue increases but to the extent that strategically and operationally it makes sense to make some additions in customer facing areas that is possible but again it is not something that we are prepared to guide on. In general, we believe we have a right-sized organization and we are looking to see margin improvement as the quarters roll out here. Some of these additions we talked about like the SVP of Worldwide certainly that is a very senior individual but on the size of the company that in and of itself doesn’t drive any significant changes in cost structure.

Hassan Imam – Thomas Weisel Partners

The competitive situations are kind of well known. I was going to ask if you have seen any incremental activity from any of your main competitors. For example with Cisco with the new mid to lower end product?

Robert Hagerty

Sure, I can talk a bit about that. I think that what we have seen is that they have come out with a 1300 I think is what you are talking about. It is a device that fits somewhere between their large system and their single or two-seater. So it takes a six seater and limits the camera to two of the six at any one moment. So, I wouldn’t say that it greatly enhances, obviously the are in the space, they are strong in the space, and we continue to see them and compete with them but I wouldn’t say that activity is particularly troublesome.

Michael Kourey

Let me add this. If you look at it, where our product line competes with its price point is with our Telepresence product line, the high end Telepresence products in that RPX/TPX category. That category ironically in Q1 grew the fastest of any major product line in the business. It was I believe 32% sequentially and 45% year-over-year. Yes Cisco does a fine job and as you may also know they are a very close partner of ours in other areas of the business. We happen to compete in this area so it is just good competition. We are actually doing very well in that end of the line which is the RPX/TPX Telepresence products. We are happy that we are having some good victories. So there are various examples of where we have done a good job there.

Operator

The next question comes from Todd Kauffman – Raymond James.

Todd Kauffman – Raymond James

Just as a follow-up to that last question it sounds like you are doing quite well at the very, very high end as it relates to the market share you have lost in recent times, and you just explained not in the high end, what would be the reason or the factors contributing to some of the recent share loss if not at the high end?

Robert Hagerty

I think if you kind of break that into two parts, infrastructure and we have done a lot of work in the infrastructure world. We have got a new product line or enhancements to a product line that really get us into a better competitive position and I think it is a strong product line where we were in transition from our MGC product line which was the leading product line in the world and as we wrapped up the new technology to move to HD it didn’t go quite as swiftly as we would have liked but we are in a very, very strong position now and the architecture is fully baked and our organization knows how to enhance it and grow it and scale it. So I am very comfortable with where we are with infrastructure. Then I would say I don’t think we were as adept, as we focused more on the high end of the business I think we weren’t as crisp as we could have been particularly around channels and our ecosystem. So the ecosystem needed more attention which is what we are giving now which would drive the higher volume and lower priced side of the business.

Operator

The next question comes from Tavis McCourt – Morgan Keegan.

Tavis McCourt – Morgan Keegan

First, in terms of the VoIP business itself, is that entirely book and ship or do you have some level of visibility into that business? Kind of on that topic, are you seeing partners carry less channel inventory than they have historically? Any change in what you are seeing there the last quarter or two?

Robert Hagerty

I think that the channels adjust their inventory levels to the volume they are seeing. We are seeing that happens. I think the channel inventories are in the place they are supposed to be given the volume they are doing. So, yes I think there were some adjustments. They are carrying less than they would last year but they are running at a lower volume and that is appropriate for the amount of volume they are carrying.

Michael Kourey

It has a magnifying effect on the downside and frankly later in the recovery on the upside that is how the math works.

Tavis McCourt – Morgan Keegan

I’m trying to get, do you think the end markets there really shrunk by low 30% or how big was the magnifying impact of the channel inventories do you think?

Michael Kourey

Because we keep a very balanced channel that the channels frankly buy what they need to carry and to fulfill our customer turnaround requirements. I don’t think it is a significant effect. I wouldn’t quote that here because it is different by country, by channel and by channel type. There is some level of it. No, I think that did magnify it a bit but the primary issue is the end market demand was down, associated with a lot of our OEM partners and frankly the roll outs of new call managers, PBX’s and that kind of thing and less Greenfield activity in this environment and those kinds of issues which of course will ultimately recover but in the near term that has been the issue and that will likely be the issue in Q2. As far as is it all book and ship on turns? Mostly. Not entirely. We do have some elements of the business where we have design wins around our Voice Over IP platform associated with partners like Broad Soft with service providers and some other providers of ours. In those cases we have greater visibility so there is some good forecasts that underpins our expectations. Frankly that is in our guidance for this quarter.

Robert Hagerty

I think that the VoIP market has got an extraordinary ROI. It just happens to be less than the ROI you get out of video. I think that people are on a discretionary basis delaying a VoIP move that they would otherwise be executing on. But I will tell you there is no question VoIP will take over. VoIP is the direction everybody is moving in. We all move in. So I am very comfortable about the strategic nature of the investments we have made and the product lines we are in. I think this is just a transition as people pause and do the things they have to do, one of which is video to save costs. The other of which is a longer-term ROI but clearly VoIP has a better ROI than staying with what you are currently using.

Tavis McCourt – Morgan Keegan

In terms of the backlog number you reported is that pretty representative of your revenue mix or is that predominately video?

Michael Kourey

It has elements from all of our business areas in there. There is video networking and voice in that number.

Tavis McCourt – Morgan Keegan

If you could just describe obviously a lot of new products and enhancements to the network product line over the last few months. How much is there pent up demand for this versus you have to go out and teach the channels and so forth the real benefits of it? How should we expect that to ramp? I know it is a relatively long sale cycle business but on the flip side I would imagine some of your customers have seen this coming for quite a while?

Robert Hagerty

Well it is a longer cycle sale as you say but there is a compelling argument if you are in the Greenfield space or if you have been doing an additive product then this is the product you want to be adding. If it is scalability, the fact it does flexible ports, it does the virtualization of the media servers. So it is a very compelling argument. We are doing a lot of work to train channels and train our own sales people, position the product properly and get it out in front of the end user customers. So I think it is a product line in the beginnings of getting legs. I was really pleased that we had early wins that helped propel some year-over-year growth in this business. I think we have got a lot of moving parts. I would say if there is anything I feel good about it is our network systems business and our Telepresence business and I am feeling more and more comfortable that we are getting our relationship and our inner workings with channels going to get the video product line moving through. I think the video product line already is a very strong product line as is the voice product line. It just needs a little more time to get revved up and working properly.

Tavis McCourt – Morgan Keegan

I was wondering if you could comment on the original big verticals for this technology, kind of the state and local governments, the SK small verticals, the Federal government, there is obviously a lot of budget conscious states out there and local municipalities and on the flip side a lot of federal money coming. What are you seeing from your channel partners that serve those verticals?

Robert Hagerty

I think federal has been strong and federal looks to be a good area. I think there is some shifting going around from what may have been spent two years ago to newer agencies and additions to other agencies. Without a doubt the federal government is one of the best users of video in the world. They understand it. They use it extensively. So as they increase their spending either with oversight programs they are moving down to the states or with their own internal spend it is a positive for us. I view that as a strength. I think healthcare continues to be a good place. Education clearly is another strong point to the extent that more money is coming in the stimulus package to go into education and gives a big focus at a federal level to stimulate. I am not an expert in this field so I couldn’t tell you, we do know that state and local governments are constrained but there is federal funds flowing in. The net of that I’m not sure I know. I know we are still writing grants. We are still working closely with them and there still seems to be really good demand. So health and education, gems, government education and medical seems like a good space to be.

Michael Kourey

Blended for Q1 and public funding did better than private funding so to speak.

Operator

The next question comes from Jeff Kvaal – Barclays Capital.

Jeff Kvaal – Barclays Capital

I was wondering if you could characterize the drivers on the operating margin improvement through the year. To what extent is that driven by higher revenue trajectory and where does gross margin…

Michael Kourey

I think again the specific guidance is only on Q2. Where that comes from is cost; operating cost. Gross margin we guided to be approximately flat and revenues flat to down 4%. So that is purely a cost exercise for Q2. Beyond Q2 one would anticipate that to the extent there is an improvement from an economic standpoint and/or our sales improvements and enhancements that Bob touched on it would clearly we would anticipate to see some revenue benefits as a result of those. With that then the revenue growth would be driving operating margin enhancement. So the immediate term, cost and in the back half of the year, the goal clearly would be for revenue growth.

Jeff Kvaal – Barclays Capital

These gross margin assumptions were in the right range right now?

Michael Kourey

Yes. 59-63, we were 1/10th under that this quarter. Our goal clearly with revenue improvements to see that drift back up a bit. Obviously we feel better when it has a six in front of it.

Operator

The next question comes from Bill Choi – Jeffries &Company.

Bill Choi – Jeffries &Company

Just curious, given the very strong performance on total presence is this a segment that you think could still grow sequentially or is that where perhaps you might have gotten some revenue out of bookings sequentially?

Michael Kourey

We just don’t guide by sub-product line. I think it is difficult to say. We are very pleased with our product line there. We believe we have the best offering in the business for our customers. We are getting some nice wins as a result of that. We would not be prepared to go on record of the specifics of each particular product area. But that is one to watch clearly as well as the broad video line and we expect some benefits there as well as network frankly. As Bob alluded to earlier not only is network enhancements good for the network systems line of revenues but the infrastructure line and oftentimes the sale is made from the core out and it has every opportunity to be helpful for us in pulling along a better share of the video as well. Some of that will be Telepresence. I wouldn’t want to break it down today.

Bill Choi – Jeffries &Company

On the 70% you had mentioned, was that again just of the end points being HD and Telepresence? 70% of the end point revenue? What was that referring to?

Michael Kourey

70% of the end point revenue.

Bill Choi – Jeffries &Company

So in that case obviously we do see some meaningful decline in the standard def video. It was holding up really well all through last year and then took a tick down. I’m curious how you look at what is happening in standard def? Is it maybe there is traditional [birth] for like education guys who were late to the HD shift? Is that moving on? Finally, how are you doing overall on kind of the account conversion since you have a huge installed base of the SD? Are you getting the volumes and the units? The group systems seems to be a little bit weaker.

Robert Hagerty

I think what is going on is we have price points now in HD that are comparable to standard definition. People are understanding that the HD systems run more efficiently at the lower bandwidths. So in other words if you were to compare a maybe moderately for higher priced or even lower priced product like a QDX it will give you better video at the same bandwidth you are currently running. So as a result unless there is something specific about the way the implementation happens like it is a set top box and the implementation is for a set top box then you generally speaking would see people move to HD.

Bill Choi – Jeffries &Company

Any comment on just account conversion?

Robert Hagerty

I think people will be generally moving over to HD. I don’t think…if we have an account and we are working that account and they are currently buying standard def, converting them to HD generally in the next buy they are buying in the HD product line. Although I would say that the current standard definition product is a bargain and it has phenomenal video. We can deliver a heck of a lot better video with the HD and so I think it is a blend of people looking at applications and where they want to use it. But I would say the standard def is moving more into specific applications where it is particular to that particular product line but for a general case use people are buying QDX or HDX.

Michael Kourey

Is your question also are we holding the account in the transition from standard def to HD or is it up for grabs competitively?

Bill Choi – Jeffries &Company

Right, competitively.

Robert Hagerty

I think every deal is contingent…in the industry right now there is a lot of contention for deals. I think that people generally speaking where with the new forget end points for a moment, I don’t think that is as big an issue because we clearly have a very strong HD video end point offering, but I think with the new network solution we are starting to really shore up and grow accounts not only our existing accounts but even competitive accounts.

Bill Choi – Jeffries &Company

Could you say whether the win rate is higher on existing accounts versus Greenfield accounts?

Michael Kourey

Yes absolutely.

Robert Hagerty

The existing accounts or existing customers are always easier than new accounts and new accounts are always easier than competitive accounts.

Michael Kourey

I think we have answered the question. I guess we covered a lot. The reality is clearly converting your own customer is our highest win rate. We have had the gap though in the network area to be candid. That has created an opportunity for some of our competition to take that conversion from standard def to HD away from the Polycom account. If you look at our situation today, now with release 4.0 of the RMX2000 platform as well as of course the CMA media server and the DMA virtualization product now we have an opportunity to not only secure those accounts but do better in contesting Greenfield and have a real opportunity in making that upgrade in our competitor’s standard def accounts. That is quite new. We are hopeful about it. We hope to validate it with proof here in the next quarter.

Robert Hagerty

Let me just go into that a little bit more. If you go point for point, our management system is we think far superior particularly with the integrated desktop. Some of the ways we integrate to Microsoft OCS. If you go to our bridge out scales it is 1080p and our other competitors aren’t. It has more ports. Our other competitors can’t flex their ports. If you go to DMA nobody has DMA. So you can’t virtualize all the bridging. Then we have our storage and streaming product covers the full bandwidth from standard definition all the way to the 1080p. I think it is a strong story. A very strong story. I think we are very proud of what we have accomplished in the last several months to get those launched. We look forward to filling out the road map and continuing to expand this product line.

Bill Choi – Jeffries &Company

When you look at your units, units are definitely weak. Would you say that when you just look at pure units, are you holding up your market share?

Michael Kourey

We’ll see.

Robert Hagerty

Through 2008 yes. In terms of specifically Q1? I don’t know.

Michael Kourey

We will know soon. That day will be forthcoming.

Operator

We have a follow-up question from the line of Jim Suva – Citigroup.

Jim Suva – Citigroup

I got several emails on this from investors. They are having trouble and maybe you can help clarify and answer it, figuring out you talked about an increase in bookings and improvement in visibility a little bit but the guidance is flat to down 4% quarter-over-quarter. Yet you have a lot of new products launching and it sounds all exciting. They are having a little trouble accepting the bookings yet the guidance being down plus seasonal strength coming at us. Could you maybe take another crack at that?

Robert Hagerty

I think that the video product line is going to be stronger. The voice product line we are guiding conservatively. I think the overall guidance is something we are trying to be prudent about.

Michael Kourey

The pipeline is better than it was in the quarter-ago period. The bookings to date are better than they were in the quarter-ago period but we are still obviously very early in the quarter so that is part of the answer. So there is uncertainty around that and we are a bit concerned or we remain cautious is probably a better way to say it around this economic environment. Even though there are obviously some inklings of potential improvement here in the states but worldwide that is certainly not understood. So I think that is part of it. Then we also have in addition to the economic issue we have this sales leadership that is going to be coming in and there is, as we noted in our most recent risk factors, some level of distraction associated with those kinds of moves. So we have to plan for that. If that is smoother than anticipated, if it goes more quickly than anticipated, if the economy stabilizes then I think the questions from some of the folks make an awful lot of sense. But we just need to set an expectation that would contemplate things not going optimistically, remaining cautious and that is the stance of our guidance.

Operator

Sir there are no further questions at this time.

Robert Hagerty

Thank you very much for your attention today and your continued support of Polycom. We look forward to capturing the demand for unified collaboration as a cost savings and a productivity solution our core markets worldwide. We will see you again next time. Thank you very much.

Michael Kourey

Goodbye everybody.

Operator

Ladies and gentlemen that does conclude the conference call for today.

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