Polycom's CEO Discusses Q4 2011 Results - Earnings Call Transcript

| About: Polycom, Inc. (PLCM)


Q4 2011 Earnings Call

January 23, 2012 5:00 p.m. ET


Laura Graves - VP, Investor Relations

Andy Miller- President and CEO

Mike Kourey - Chief Financial Officer


Jim Suva – Citi

Jess Lubert – Wells Fargo Securities

Tim Long – Bank of Montreal

Jeff Kvaal – Barclays Capital

Troy Jensen – Piper Jaffrey

Kent Schofield - Goldman Sachs

Tavis McCourt - Morgan Keegan

Mark Sue – RBC Capital Markets

Sanjiv Wadhwani - Stifel Nicolaus

Jack Monti – UBS

Larry Harris – CL King

Rohit Chopra - Wedbush Securities

Jason Ader – William Blair


Ladies and gentlemen, thank you for standing by. Welcome to Polycom’s Q4 2011 quarterly conference call. [Operator instructions.] I would now like to turn the conference call over to Laura Graves, vice president of investor relations. Please go ahead ma’am.

Laura Graves

Thank you very much. Hello and welcome everyone to Polycom’s fourth quarter 2011 conference call. I’m Laura Graves, Polycom’s vice president of investor relations and here with me are Andy Miller, our president and CEO, and Mike Kourey, our chief financial officer.

As with previous quarterly calls, Polycom is again augmenting today’s voice conference call with a video webcast. If you would like to receive the full webcast, please open your browser at this time and enter Polycom’s home page, which is Polycom.com, and click on the Q4 earnings call link.

For the analysts participating in the Q&A session, leave your voice 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 the Q&A is for financial analysts. We welcome all others to listen into the Q&A session.

Please note that this entire webcast, including Q&A, will be maintained on Polycom’s website for 12 months from today. Also, a link to the call will be provided on Twitter, Facebook and LinkedIn at Polycom.

During the course of this conference call, Andy and Mike will make 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, strategic imperatives, and future business investments.

We wish to caution you that such statements and visual materials are just predications that involve risks and uncertainties and that actual events or results may 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 quarterly report on Form 10-Q for the quarter ended September 30, 2011 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 GAAP requires disclosures and the availability of new products, planned features and upgrades discussed during this call are subject to change or cancellation. In addition, we will be presenting both GAAP and non-GAAP financial measures here today. Please refer to our reconciliation of GAAP and non-GAAP financial measures in today’s earnings release, which is also posted on our website.

Now let me turn the call over to Polycom’s president and CEO, Andy Miller. Andy?

Andy Miller

Thank you Laura. I appreciate it. Good afternoon everyone. Polycom continued to execute aggressively against our strategic plan in the fourth quarter. We launched Polycom RealPresence Mobile software for the Apple iPad 2 and the leading Android devices. We launched new products that expanded our strategic alliance with Microsoft and our integration with the Microsoft Lync platform.

Last week, we announced our cloud strategy and took the next step in our growing partnership with IBM to deliver social business-based video. We announced our strategy agreement with Lenovo to deliver embedded Polycom video and voice solutions optimized for their line of laptops and tablets.

Earlier in Q4, we acquired ViVu, a video collaboration software company reinforcing Polycom’s cloud and software strategy. Financially, we generated strong operating results, both at the top and bottom line. In Q4, revenues grew 20% year over year and 7% sequentially to a record $407 million and non-GAAP operating profits grew 36% year over year. Non-GAAP operating margin expanded to 18.7%, and coupled with some tax benefits, Polycom generated a non-GAAP EPS of $0.41.

I’m delighted by these results, especially as we continue to fund long term strategic investments previously announced on our Q3 conference call. We exited the quarter with $226 million in deferred revenues, growing 41% year over year and 11% sequentially. This is the highest leverage of deferred revenue in Polycom’s history and could be attributed to the larger, more strategic deployments, as well as the services associated with sales of our RealPresence platform. Finally, we generated a record $122 million in quarterly operating cash flow in Q4. Mike will go through the financial results in detail later in this call.

Now let’s take a look at Polycom’s geographic growth dynamics. Polycom is thriving in the international markets. It is achieving major milestones in the realignment of North America. In fact, our growth rates increased in Europe and Asia-Pacific, both sequentially and year over year.

In Europe, or the EMEA theater, Polycom’s revenues grew 19% over Q3 and 28% year over year. This success, in spite of the challenging macroeconomic environment in Europe, is a testament to the value proposition delivered by Polycom’s video collaboration solutions. The hard dollar benefits of productivity and efficiency are matched by the soft dollar benefits of improved collaboration, better work relationships, and faster decision making.

As a result of these drivers, and excellent execution by the EMEA go-to-market team, we’re capturing subsequently growth in EMEA across a broad base of countries throughout the region. We experienced strong growth in major markets such as the UK, Germany, and the Nordics and delivered fast growth in the emerging EMEA markets such as Russia and the Middle East.

Let me just give you one EMEA customer example from Q4 that highlights the power of our platform in driving sales. Henkel, headquartered in Germany, is a global brands company. In the fourth quarter, as one of our larger wins, and in partnership with AT&T, Henkel significantly expanded its communications environment through Polycom telepresence and our RealPresence platform to better connect the company’s 48,000 employees around the world.

In the Asia-Pacific theater, the growth dynamics are similar. Growing 15% sequentially and 42% year over year, APAC again exhibited strong growth across a broad base of countries. In the major markets, for instance, Australia delivered strong growth and is now the number-two contributor in Asia-Pacific. China, our number-one revenue generator in Asia-Pacific again grew at record levels and represented 11% of Polycom’s global Q4 revenues.

In addition, other emerging geographies such as Vietnam and Indonesia delivered significant growth in the fourth quarter as demand for business to business video collaboration expands globally into large enterprise, government, and small to medium business alike.

For an example, in Vietnam we secured a RealPresence platform win with the Vietnam Post and Telecommunications, the country’s leading IT company. They selected Polycom because of our scalability, open interoperability, and our strategy. This key win greatly expands our presence in this country.

In the Americas, we again experienced strong growth in Latin America, most notably in Brazil. In North America, our realignment and our optimization efforts discussed last quarter are well underway. We believe this region is capable of significant growth under an improved sales structure an execution plan that essentially replicates the model that we’ve been so successfully implementing in Asia-Pacific and EMEA.

Specifically, we have five key initiatives to deliver improved Americas sales performance. First, we’re building the management team to enable a higher-touch sales model. We hired David Ruggiero as president of North America sales to lead this turnaround. David has hit the ground running, and is bringing an enhanced focus and discipline to his team, which I believe will, over time, more closely align North America with the sales productivity of the other international theaters.

He’s hired area vice presidents for the northeast, south, central, and west regions. In addition, we are continuing our focus on our channel strategy and channel fulfillment with a new vice president of North America channels. David has also hired a new vice president of North America sales strategy and operations to optimize our go-to-market in this theater.

All these proven sales leaders are already on board and they bring a strong track record of delivering breakaway growth coming from companies such as Cisco, LifeSize Logitech, Hewlett Packard, and Intel.

Second, in addition to these new sales leaders, we are shifting more of our North America headcount and other resources from overhead and overlay functions to high-touch customer-facing functions. Along these lines, David has hired 24 new high-touch account managers and sales engineers as part of his realignment following the restructure in North America earlier in Q2.

Third, taking a more pipeline-driven execution methodology, we are segmenting our sales teams into major markets with an increased focus on the Fortune 500. Fourth, we are aligning our North America inside sales team with our territory account managers to provide an extended coverage model. And fifth, we are further tightening Polycom’s pipeline alignment with our strategic alliances, particularly with Microsoft, IBM, and HP.

Through this ongoing customer mapping exercise, we believe we can achieve faster sales cycles and larger deal sizes. The bottom line is that we are taking what I believe to be the right steps to elevate our performance in the Americas over the next couple of quarters.

Next, I’d like to turn a page on 2011 and move into our strategic imperatives for 2012. Our execution last year was focused on the strategic imperatives of cloud, mobility, ecosystem, network infrastructure, and our innovation engine, resulting in a record year for Polycom in which we generated 23% revenue growth and a 250 basis point improvement in non-GAAP operating margins.

Moving now to 2012, I’d like to map the strategic imperatives from 2011 into our strategic imperatives for this year. Throughout 2012, you’ll hear us consistently discussing and delivering against the following imperatives: 1) the cloud, 2) mobility, 3) our focused ecosystem of partners, 4) the proliferation of Polycom’s RealPresence platform, and 5) growth markets.

As you can see, the cloud, mobility, and ecosystem continue as major initiatives in 2012. Innovation and network infrastructure will clearly continue with the umbrella of our industry-leading RealPresence software-centric platform. Finally, you’ll note that we’ve added growth markets as a specific strategic initiative for 2012.

Next, I’d like to walk you through these strategic imperatives one at a time, starting with the cloud. As we announced just last week, Polycom has taken a significant strategic step forward with the announcement of the Polycom RealPresence Cloud. RealPresence Cloud is a carrier ready offering that enables service providers to offer cloud-delivered video as a service solutions to their customers.

This new offering is designed specifically for service providers to equipment them with the carrier-grade infrastructure, edge software and systems, and the services they need to offer businesses of all sizes subscription-based solutions for video collaboration.

Through this turnkey wholesale cloud capability, service providers can expand their reach and accelerate customer adoption through cloud-based delivery to small to medium businesses and large enterprises alike.

We believe that the Polycom RealPresence Cloud compresses the time to revenue for qualified service providers to deliver the fast-growing demand for video as a service. Powered by Polycom’s RealPresence platform, service providers can deliver the most complete and interoperable solution to harness the network effect that is emerging through business-to-business and business-to-consumer video.

In fact, RealPresence Cloud provides native interoperability with a wide array of solutions, including Microsoft Lynch 2010, IBM Sametime, and the non-standard TIP protocol and a whole host of edge systems and software solutions. Leveraging the foundation that we’ve built with OVCC, or Open Visual Communications Consortium, partners’ Polycom RealPresence Cloud is the next logical step in enabling any network, any vendor, and any video device collaboration.

With service providers already contributing 14% of global revenues in Q4 alone, we believe this important, enabling step will even further increase the ability for customers of all sectors and scale to easily adopt video as their primary mode of day-to-day communications.

Next, I’d like to touch on our second strategic imperative, mobility. Taking the same open interoperability bias, Polycom RealPresence Mobile is now available on the world’s leading pads and tablets including the Apple iPad 2, Samsung’s Galaxy, Motorola’s newly released Droid XY board. Polycom will continue to execute on the strategy of delivering the core UC infrastructure through our RealPresence platform and delivering the systems and software at the edge to make video communications secure, incredibly high-quality, and effortless regardless of work mode or location.

Our third initiative is what we refer to as focused ecosystem. Although we will continue to work closely with all of our Polycom open network partners, in 2012 we are focusing our strategic investments including sales and program resources on extending our relationships with Microsoft, IBM, HP, and Apple.

The opportunity to leverage these key relationships is proving to be significant as evidenced, for instance, by our success and growth through innovation and go-to-market alignment with Microsoft Lync. In fact, in 2011 we grew the revenues generated through our partnership with Microsoft by approximately 135% over 2010 levels.

We believe this is driven through our integration of Lync functionality with Polycom’s RealPresence platform and Lync-integrated video systems and desktop devices, coupled with the fast adoption of Lync worldwide.

An example of a Q4 customer win with Microsoft is US-based retailer Fossil for a large rollout of RealPresence platform, desktop video, and HDX room systems for use in marketing, design, and B2B with suppliers and retail locations.

Working with IBM, and largely due to our native integration with IBM Sametime, Royal Caribbean cruise lines selected Polycom for a large rollout of our RealPresence platform and RealPresence Mobile to support both on-premise and B2B video collaboration.

Finally, HP is adopting Polycom’s RealPresence platform to connect Microsoft Lync, Halo Telepresence, and Polycom Video to improve global employee collaboration and go-to-market. This is clearly a hallmark reference win with HP as they deploy the full line of Polycom solutions.

Our fourth strategic imperative is the proliferation of Polycom’s RealPresence platform, which grew an outstanding 30% sequentially and 45% year over year in Q4. Representing a vehicle for the company’s industry-leading innovations, Polycom’s RealPresence is the platform through which delivery of best-in-class industry solutions and immersive telepresence, room systems, desktop, and mobile video.

Enabled through our world-class global R&D team that’s over 1,100-strong, Polycom is leading the industry through our customer-centric innovations. We will continue to invest in this team to extend our technology leadership, building upon our extensive software base and our portfolio of over 700 patents issued and pending worldwide.

Finally, our fifth strategic imperative is to execute on the growth market opportunity. For Polycom, this specifically refers to the fast-growing geographies of the BRIC nations, the Middle East, and Africa, and CIS countries. These markets all represent significant growth opportunities for Polycom and we are investing in our go-to-market and R&D resources to maximize our share of these important markets in 2012 and beyond.

Now, before I turn the call over to Mike, I’d like to provide you with some deal size metrics that we believe highlight how mission critical and widespread adoption is becoming with our customer base. In 2011, our number of $250,000-$500,000 size transactions grew by 32% year over year, and our $500,000-$1 million transactions grew year over year by 31%. Polycom’s transactions over $1 million jumped 38% over 2010.

As video communications become middle critical and the usage extends to desktop and mobile, adoption is becoming far more widespread. We’re also seeing that B2B video has become a significant driver for our business, and I believe we’re only at the early stages of seeing this positive impact.

In a world of anytime, anywhere video communication, Polycom’s open, standards-driven approach to delivery is proving to be a recognized differentiator by our partners, our customers, and is enabling exciting customer wins worldwide.

Let me summarize by saying that we believe Polycom, as the $1.5 billion video collaboration leader, is strategically positioned in this fast-growing market. We have the team, the innovations, the partners, the go-to-market engine to capitalize on this opportunity. We expect to execute on our cloud, mobility, and partnering strategies with focus and a relentless drive to delight our customers while growing both our top and bottom line.

Now, I’ll turn the call over to Mike for a discussion of Polycom’s financial results. Mike?

Mike Kourey

Thank you Andy. Before I get started, please note that for the financial guidance that we are giving here today, Polycom is not assuming the responsibility to provide any updated 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 be making forward looking statements including guidance regarding our expectations of future financial execution and performance, which are subject to risks and uncertainties that could cause actual results to differ materially from our expectations.

Moving to a look at our results, as Andy stated earlier, Polycom generated record revenues in the fourth quarter of $407 million. This represents a sequential increase of 7% and a growth of 20% over Q4 of last year.

Looking at revenues by geography in Q4, Americas revenues were down 2% sequentially but grew 7% over the year ago period. EMEA revenues grew by 19% sequentially and 28% year over year, and Asia-Pacific revenues grew 15% sequentially and a significant 42% year over year.

Moving to revenue by product line, including the services attached to each, Polycom’s RealPresence platform, or UC Network Infrastructure Solutions, grew a significant 30% sequentially and 45% year over year to $80 million, or 20% for revenues, in Q4.

Revenues for UC Group Systems, which includes all immersive telepresence, group video, and group voice systems, increased 6% sequentially and 18% year over year to $260 million or 64% of revenues in Q4.

UC Personal Devices, which includes all desktop video devices, desktop voice, and wireless land products, were down 6% sequentially but were up 5% year over year to $67 million, representing 16% of revenues in Q4.

From a channel standpoint, the revenue breakout for the fourth quarter is as follows: 29% through value-added resellers, 60% through distributors, 9% through service providers, and 2% direct. Note that 5 percentage points of our distribution business in Q4 was driven by the ITSPs and other service providers who fulfill through distribution, making the total service provider percentage 14% in the fourth quarter.

We shipped 50% of revenues in the last month of the quarter. Polycom’s deferred revenues grew to $226 million in the fourth quarter, growing a significant 11% sequentially and 41% over the year ago period.

Moving to the statement of operations, non-GAAP gross margins for the fourth quarter were 61.2%, up 10 basis points from Q3, and the same as the comparable period last year. Although we are not changing Polycom’s gross margin model at this time, we do expect a gradual increase in consolidated gross margins over time as Polycom’s RealPresence platform and our software at the edge gain momentum through our branded mobile and embedded applications.

Polycom’s non-GAAP operating expenses increased sequentially in absolute dollars but decreased as a percentage of net revenues with non-GAAP operating expenses representing 42.5% of net revenues in Q4, down from 45% of net revenues in the third quarter.

Looking at the specific Q4 non-GAAP operating expense line items on a percentage of revenues basis, sales and marketing represented 26.2% of revenues for the period, down from 27.7% in Q3. R&D closed at 12.2% of revenues, down from 12.9% in Q3. G&A was 4.1% of revenues, down from 4.4% in Q3.

Moving down the income statement, fourth quarter non-GAAP operating income grew 24% sequentially and 36% year over year to $76 million, or 18.7% of net revenues. This compares to $56 million in non-GAAP operating income, or 16.5% of net revenues, in Q4 of 2010, a 220-basis point improvement in operating margin.

As a recap of our performance against our long term target model, we operated slightly above the midpoint of our target gross margin range of 59-63%. Sales and marketing operated 20 basis points over its target range of 24-26%, and R&D operated 20 basis points over its target range of 10-12%. G&A was at the low end of its target range, which is 4-5%.

Other income and expense in Q4 resulted in net other income of approximately $1.2 million, comprised of $200,000 of net interest income and approximately $1 million of net other income. Net other income was primarily driven by a refund of non-income-related taxes, which were partially offset by other non-operating expenses. Looking forward to Q1, we expect a net other expense of approximately $1.3 million.

Moving to tax, you’ll note that our Q4 non-GAAP effective tax rate was 4.3%. This was driven by the strong international profit mix in 2011, the year-end true up of the taxes as well that profit mix, and other items. Looking forward to the first quarter and beyond, we are continuing to forecast a 23% effective tax rate based on our geographic mix assumptions and other factors. Of course, our tax 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 of $74 million increased 53% from Q3, and grew by 71% from $43 million in the comparable period last year. Non-GAAP diluted EPS was $0.41 in Q4, up 58% from $0.26 in Q3, and growing by 71% from $0.24 in the year ago period. In Q4 of 2011, $0.08 was attributable to the favorable tax rate.

GAAP EPS for the quarter was $0.28 per diluted share in Q4, compared to $0.19 per diluted share in the same period last year. Note that the EPS data for both current and historical periods reflect the two-for-one stock split that we took July 1.

Looking forward to Q1, we expect to continue the benefit from our success in the Asia-Pacific and EMEA theaters, and from our ongoing strength in the emerging markets. We’ll continue to make improvements in North America over the next couple of quarters, and we anticipate some early results in sales productivity during Q1 through the initiatives that Andy described earlier. Although, through winning at the network core, we expect to benefit from continued UC network buildouts and the pull created by the powerful open collaboration open network.

Even with these substantial drivers, however, we believe it is important to be thoughtful with regard to Q4 to Q1 sequential seasonality and our ongoing North America sales realignment initiatives. As such, we are guiding first quarter revenues to be down approximately 2% from fourth quarter levels.

Driven by the solid market dynamics and our mix expectations, we anticipate first quarter gross margins to be up 10-20 basis points from Q4 levels. Of course, gross margins in the future may be higher or lower, and are subject to mix variations and other factors.

Moving to operating expenses in Q1, we expect to make some targeted go-to-market investments, particularly in the Asia-Pacific. In R&D, we are maintaining roughly consistent investment levels and with G&A, we’re making a few investments in some systems areas as we scale our business to the next level.

Specifically, we expect sales and marketing expenses as a percentage of revenues to increase by approximately 60-70 basis points, R&D to decrease by approximately 10 basis points from fourth quarter levels on an expense revenue basis, and G&A to increase by approximately 30 basis points as a percentage of revenue from fourth quarter levels. As a result, we expect non-GAAP operating margin of 18.0% in Q1.

Before turning to the balance sheet, I’d like to briefly highlight our full year 2011 operating performance. For the year, Polycom delivered record revenues of $1.5 billion, and growth of 23% over 2010.

Moving to margins, Polycom’s 2011 non-GAAP gross margins improved 90 basis points over 2010, and our full year non-GAAP operating margin improved 250 basis points. We also generated $300 million in operating cash flow in 2011, a growth of 109% over the prior year.

Turning to the balance sheet for the quarter, we generated a record $122 million in positive operating cash flow in Q4. These operating cash results was driven by our growing profitability and strong working capital management.

We exited the fourth quarter with cash and investments of $592 million, and the company continues to be debt-free. Moving to DSO, even with the strong international revenue mix, the company’s net trade receivables of $220 million resulted in a DSO of 49 days.

Looking forward to Q1, we expect to continue to experience a strong international mix, with a resulting DSO of approximately 50 days. Of course, DSO will fluctuate based upon international mix, linearity, and other factors.

Non-GAAP inventory turns at the end of the fourth quarter were 5.9 turns, up from 5.3 in Q3. We continue to be within our target range of 5-6 turns.

Regarding share count, we expect Polycom’s weighted average shares per diluted EPS to grow by approximately 1.5 million shares in Q1, exclusive of stock repurchases. This is driven by the stock price and other factors. During the fourth quarter, we purchased $20 million in shares under our share repurchase program.

Looking forward, we have $78 million remaining in our share buyback authorization. Of course, in addition to the future potential buybacks 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 3,839 employees at the end of Q4, down 1% from the end of Q3. The net decrease was primarily driven by restructuring activities in the quarter, which were partially offset by additions in strategic areas of the business.

At this time, let me turn the call back over to Andy Miller for closing comments.

Andy Miller

Thank you Mike. In summary, 2011 closed strong with full year revenues of $1.5 billion, driven by particular strength in the sales of Polycom’s RealPresence platform and broad geographic growth. Enabled by Polycom’s innovations, we experienced unprecedented demand for our secure, interoperable, unified collaboration solutions by both the enterprise and service provider customers.

Leveraging our industry leading technology and powerful network of strategic partners, Polycom’s cloud, mobility, and software driven infrastructure strategy is beginning to yield and we look forward to another year of solid growth in 2012.

On that note, we would like to open the call to the financial analysts for questions. For all others, we invite you to stay on the call to listen in. As we discussed earlier in the call, many of the statements we’ve made and will make during the Q&A period are forward looking statements, which are subject to many risks and uncertainties. Each analyst will be limited to one question and one follow up.

Is the conference call operator available at this time?

Question-and-Answer Session


Certainly. [Operator instructions.] And our first question comes from Jim Suva with Citi. Please go ahead.

Jim Suva - Citi

When we look at your operating margin goal, I think there was a lot of skepticism if you could meet the 18% for Q1 as the year progresses. It sounds like you’re kind of putting a stake in the ground and telling everybody you feel very confident in that. When we think about that 18% and all the efforts you’re doing about North America and the turnaround there, is it fair to assume that we should expect, as the year progresses, you to build upon that? Or are there some things, seasonality or cost realignment, that could cause that to fluctuate? Because it seems like to me kind of Q1 would be the softest quarter and you’d build upon that. But I just want to see if that’s accurate.

Mike Kourey

Yeah, as we had guided in the prior quarter, we expect to be in the 18-20 range all year long, in each quarter, beginning with 18.0 this quarter.

Andy Miller

I would just add, I think with the 18.7% performance in Q4, and our commitment of 18.0% in Q1, I think we have put a stake in the ground, and I think, not only have we continued to invest in the areas where we feel necessary, but that we can comfortably operate consistently in that range.

Jim Suva - Citi

Right. But more specifically, kind of, when we think about as the year progresses, is there anything abnormal as far as the linearity goes as we progress throughout the year? Just because you’re going through so many changes. Or should we just think upon that stake is just building upon each quarter such we progress.

Mike Kourey

We’re clearly not giving full year guidance here today. We don’t do that as you know. We just have this quarterly guidance that we have given, the range for operating margins for 2012. So there’s nothing unusual that we’re pointing out, no.


Our next question comes from Jess Lubert with Wells Fargo Securities. Please go ahead.

Jess Lubert – Wells Fargo Securities

First, I was hoping you could help us understand how much of the business that slipped from Q3 actually closed in Q4. And then it looks like North America was a little weaker than I would have expected during a December quarter. So I was hoping you could provide us with some additional details regarding the state of your North American business. To what degree did the restructuring drive the sequential weakness in the region? Were you surprised by this weakness? And how long do you think it is likely to take for this business to get back on track? And do you expect North America to be flat up or down sequentially in the March period?

Andy Miller

Let me work with Mike on that. Let me first start off with, we made a commitment that there were transactions in Q3 that would move into Q4. We actually closed with eight of the ten transactions. Two of them have slipped out. Nothing to do with Polycom. Just to do with macroeconomic issues into 2012. So we were very pleased in terms of our close rate from Q3 to Q4. As it relates to the restructuring in North America, this is an evolution of the movement of building out a team based upon the requirements of today’s innovative model, such as enterprise software sales, interoperability. As I’ve talked about on the call before, large deals, between $500,000 and over $1 million. So this is less of a restructure and more of an evolution of North America. Not only by the talent that we’ve brought in, but by the approach that we’ve taken. So, no, it was not a surprise in terms of the results in North America in Q4. I believe that we now have the building blocks in place, and as I talked on the call, I think we’ll see quarter-by-quarter improvement of those results, not only in terms of deal size, but in terms of profitability and in terms of revenue growth in that specific theater.

Mike Kourey

And specifically as to guidance here in Q1, Jess, we don’t break out by theater, by product line, our forward guidance. We give consolidated numbers. Obviously, as we talked about, the work that we’re doing in North America, we’re in the midst of, and we’ve got the leadership team on board and making great progress. But we’re not breaking out the theater-by-theater guidance at this time.


Our next question comes from Tim Long with Bank of Montreal. Please go ahead.

Tim Long – Bank of Montreal

Just onto the growth markets for a little bit. Could you talk just a little bit about what the pipeline looks like there? Obviously much higher growth rate. Is it, you know, just a much lower penetration? How should we think about the difference in growth there and the other more-established geographies next year? And then related to that, Mike, if you could just talk about the typical margin profile for some of these deals? Is there more pressure on the growth margin line, but you make up for it on the opex line? Or is there a lot of opex pressure because you’re just building it out? If you could just break that down for us that would be great.

Andy Miller

First, let me take the emerging markets, which we talked about, or BRIC - Brazil, India, China, Russia. Also, CIS, the Middle East, and Africa. We try to have a consistent pipeline at Polycom of 2.5 prospects for each executed customer. We actually see that pipeline higher in the emerging market areas. Traditionally the more greenfield opportunities, not coming off a legacy base, but deploying collaborative communications sort of for the first time. So we see a very healthy, consistent pipeline, traditionally either at or above the traditional norm. We see that continuing very nicely as we go forward into the year.

Mike Kourey

We don’t break out the particular contribution margins by specific sub-geography, but as you’ve noted, clearly if you look at Asia-Pacific, where you have a lot of those growth dynamics, and certainly the “I” and the “C” of BRIC, India and China, are in there, as well as places like Indonesia. We’ve been actually quite profitable there. The Asia-Pacific theater has been our highest contribution margin theater, and it has the best growth rate typically as well, as it did year over year this quarter. So that’s where that stands.


Our next question comes from Jeff Kvaal with Barclays Capital. Please go ahead.

Jeff Kvaal – Barclays Capital

Gentlemen, I was wondering if you could spend a little bit more time on North America again. Would you consider the relative revenue sluggishness for you a function of not being able to get to the deals? Is demand a little soft? Are you rebuilding your pipeline? How should we consider that? And then also, would you mind giving us the HP contribution this quarter again please?

Andy Miller

Sure. So let me start off with North America. As we talked about on the call a little bit earlier, we talked about, you know, the first step is bringing in the team that can evolve North America to the next level. We think David and the team he’s built out has been excellent.

One of the most important was the conversion of a channel-led team to the evolution of more high-touch, and specifically to your question, what we’ve found with our competition, specifically Cisco, is we need to be present from a high-touch perspective, collaborating with the partner, but not to be channel-led. So as we talked about, the 32 additions in North America, plus the conversion of channel to high-touch, specifically in key NFL cities will give us that opportunity.

Where we play against Cisco we have a very high win rate, because of the solution that I discussed. But where we weren’t there, or we were led only by channel, we did not have the win rate that, frankly, we wanted as a company.

So this transformation, or evolution, is all around the right team, the right number of account managers from a high-touch perspective, collaborating with our partners, the right focus in terms of how we work and leverage the pipeline, with Microsoft, HP, and IBM. And I believe we’re starting to see that in Q4.

The reason that we’re being slightly conservative in Q1 is we want to see that built back up, but we’re seeing all the metrics in the right direction, and the team is absolutely the right team. They are the best team in the business to be doing this, and I think as this goes in place, over the coming quarters, we’ll be able to see a transformation to that, as we said on the call earlier, like EMEA and Asia-Pacific in terms of performance.

Mike Kourey

And then on the HPVC, we don’t break that out separately of course as we had talked about. We gave one-time guidance back when we announced the deal in July, and obviously it’s been a great relationship including the recent win with HP proper that Andy described. But I will say this, in that we have previously given the guidance for Q4, it was in the kind of range that we gave for Q4, which is in that high-teens area, all in product and services. And then as we had said originally, we expect that to grow roughly pro rata with the rest of our business in 2012 and we’re currently in that stance as well. So that’s the answer to that one.


Our next question comes from Troy Jensen with Piper Jaffray. Please go ahead.

Troy Jensen – Piper Jaffrey

I want to hit North America just one more time. Just asked differently here, did your win ratio change in North America?

Andy Miller

The win ratio in Q4 was consistent with Q3 in terms of the transactions that we were in competition from a high-touch perspective, so we saw no difference in terms of the win ratio in North America, nor the pipeline evolution or close rates.


Our next question comes from Kent Schofield with Goldman Sachs. Please go ahead.

Kent Schofield - Goldman Sachs

I was wondering if you could touch on the services sides of things. It looked a little bit stronger than I think some of us were looking for, and to the extent that HP impacted that.

Mike Kourey

HP impacted that to a bit. Minority point there, in that it continues to be a strong business for us. But that wouldn’t really be the main issue. The main point here is we’re continuing to have some really good success in our maintenance revenues around the various contracts from elite services on down, globally. And so that’s been a driver. It also is a key driver for the increase in deferred revenues. As you saw in the quarter, up 11% sequentially. And so sequential there by definition we had HP in the prior quarter for two months and four days, and we had it for the entire quarter here. So that was the minority point. It’s primarily maintenance contracts on new ship and renewals.

Andy Miller

I think the final point, Mike, is it’s very important to understand that we talked a lot today about large deal size. We talked about large deployments like the China Unicom, with over 10,000 end points. The reality is what we’re focused on is to create bundled and service packages around deployments of Microsoft Lync, IBM Sametime, consultative deployments, certification, education. So all those, as the deals get bigger, the service deployments become more complex, and we’re going to start seeing that increased service revenue around these more complex and large deployments also affecting gross margins. So I think that’s all for the good.


We do have a follow up question from Troy Jensen. Please go ahead.

Troy Jensen - Piper Jaffray

So I guess my follow up question was just around the product gross margins. I understand that APAC was up a lot, which is probably lower-ASP products, but network infrastructure systems were also up a lot. So can you just talk about maybe just the product gross margins for a little bit?

Mike Kourey

Good question, Troy. The product GMs were off a bit sequentially as you saw, and that had to do with - Andy highlighted some of the business that we did and the larger deals in some of those transactions as has always been the case, will always be the case. There is some competition where price is an element, one of the elements of the competition that we deal with there. The other piece is the mix was obviously heavier to places like the Asia-Pacific and some of the emerging geographies, and that has some of the lower-end products built into the mix. So those are two of the drivers that would offset the richness of the mix from an overall network infrastructure standpoint.

Andy Miller

I would just add, Mike, that in the emerging markets, Troy, the ASPs in the high-growth areas, you saw the revenue increase, and that’s all for the good for our company and our shareholders. On the large transactions, as Mike talked about, specifically as you get to the $500,000 and $1 million deals, we did see some price competition and we were able to take advantage of that in closing the transaction and building out that core stickiness with the RealPresence platform. And finally, from gross margin perspective, I think we have an excellent plan in place at the company in terms of gross margin improvements across the board. So all in all, those were kind of the two things that we saw in the quarter about gross margin, but as Mike said, in terms of as we look forward to Q1 and beyond, we intend to participate in that range and think that we have a very good program in place in terms of increase in our gross margin.

Mike Kourey

And as we guided, we do expect gross margins this quarter to increase by 10-20 basis points sequentially.


Our next question comes from Tavis McCourt with Morgan Keegan. Please go ahead.

Tavis McCourt - Morgan Keegan

My question is really around the network infrastructure. This quarter obviously extremely strong. How much of that was driven by service provider versus enterprise? And was there anything unique in terms of this quarter that we should keep in mind as we go forward that would impact the run rate? And then the follow up is Andy, you now kind of have dual cloud strategy, where on one hand you’re actually managing the cloud and basically white-labeling that to carriers, if I understand correctly, and then also attempting to sell equipment into the carriers. When you target a carrier, how do you explain that? And which do you prefer? And which are they preferring? And how do the economics differ for you in those two different scenarios?

Andy Miller

On the first piece, around the RealPresence platform, in terms of percentage of service provider or what we call high-touch, Mike talked about that 14% of our business came through the service provider or the carrier market. So some of those were fulfilled by carriers such as AT&T, Verizon, and British Telecom.

But I think what we saw in the quarter, and we expect that to continue going forward, is a very good trend. You know, we introduced the RealPresence platform, which is a combined solution of our RMX, CMA, and DMA technologies into one architected solution. So we’re starting to see the brand attachment of that. We’ve got the sales force trained in terms of how to sell that as a solution versus a [unintelligible] product.

So I think we’re just seeing the trajectory of good education and customer awareness in terms of the RealPresence platform. And I think we’ll continue to see that sequentially as we go forward.

As it relates to the cloud, our focus has been very simple. Our focus has been to enable carriers to stand up video as a service. Our competitor, I think, has a mixed message. On one hand, they have a retail site that sells directly. On the other hand, they sell equipment to service providers.

We are very clear. What we want to do is we want to help service providers enable a cloud strategy, sell product solutions and services to them to enable that. The reason that we took this approach, our first approach of this wholesale approach, is to be able to enable them to be able to stand up these clouds very quickly.

Once they stand up the cloud using our white label wholesale approach, we intend for the service provider to then carry that forward. So this is more of a temporary situation in terms of getting the carriers up to speed as quickly as possible, and then over time morph that to the carrier for them to take that forward.

So again, our approach is very simple. It’s to enable the carrier, through our products, our services, and our solutions, to offer video as a service. Our intention is not to be in retail and not to compete against the carrier in any way.


Our next question comes from Mark Sue with RBC Capital Markets. Please go ahead.

Mark Sue – RBC Capital Markets

Andy, can you help us understand how customers are feeling about video in an uncertain macro-environment, and how you might be thinking about the growth rate for 2012. Just kind of like your market growth rate on your working assumptions would be great.

Andy Miller

I think that we demonstrated in Q4, specifically with the growth rates around the RealPresence platform, that unified communications, this collaborative solution, is very important. That the total cost of ownership, the productivity tool, and using this as a business continuity, even in a macroeconomic challenged environment, is not discretionary. It is a very critical element of that technology. If you look at the growth rates in the customer examples that we used in Asia and in Europe - and I don’t want to minimize North America. North America had a good quarter, and I believe wholeheartedly that we’re doing the right things to get that improved over the next several quarters. So I think it’s continued to be, and I believe - and I’m in the field probably more than any other technology CEO, understanding what customers are saying. And I hear over and over again that this is a very critical element of their unified communication plan. Mike?

Mike Kourey

No, I think that’s well said.


Our next question comes from Sanjiv Wadhwani with Stifel Nicolaus. Please go ahead.

Sanjiv Wadhwani - Stifel Nicolaus

Two quick questions. First, just to confirm, with sort of the RealPresence/infrastructure piece now 20% of revenues, is that sort of a new run rate we can assume going forward as a percentage of revenue, because it’s sort of hovered around 15-16% for a while. Big spike up in Q4. So just trying to get a feel for whether 20% is sort of the new normal, somewhere around that range. And then second quarter 2010, on the North American restructuring, just qualitatively, do you feel you’re sort of ahead of what you thought you would be coming out of quarter 4, in line with where you thought you would be? Any color on that would be helpful. Thanks.

Andy Miller

I’m going to take the second part of it first, with is North American, as you said, restructuring. I like to call it evolution. Then I’ll turn it over to Mike about the 20% range. I actually feel that we are actually ahead of schedule. And the reason being is the five areas that I mentioned earlier. David now has his team built out and on board. Not only the four vice presidents, the head of channels, the head of strategy.

So we talked in Q3 about David going out and finding the best talent that we can have, and as you know, it’s about an 8-12 week stage in terms of identifying the talent to actually onboarding. They’re now on board. They’re up to speed. They’re building out their teams. The 32 headcount have been added in terms of high-touch. We have the head of North America strategy, the head of North America channel, have all been on board now.

So I’m actually very pleased about the talent that we’ve been able to bring on board to the company, and I believe we’re actually ahead of schedule in terms of the onboarding and the beginning of that next stage of evolution.

Mike Kourey

As far as the percentage of revenues, we’re not giving a forecast by product line or as a result what percentage of revenues each particular of the three key elements will be. But clearly if you look at history, if you roll back the tape by three years to Q4 ’08, it was around 13 and change percentage of revenues. It now closed out, Q4, at just around 20% of revenues.

So we’re pleased with the investments we’ve been making, and with really winning at the core. And that is a key part of our strategy. It’s one of the five imperatives for the year, this RealPresence platform. So yes, it’s a key focus area. These metrics do sawtooth to some degree. So we can’t commit quarter by quarter exactly where it will end up. But yeah, we believe it’s a very important and strategically one of the most key elements of our strategy. So we would expect it to continue to perform well.


Our next question comes from Jack Monti with UBS. Please go ahead.

Jack Monti – UBS

I was curious if you could comment on the US federal revenues in the quarter. I know we discussed strong order trends last quarter, and I was curious if those were up this quarter. And then also, I was curious if you could comment on how you’re thinking about currency and foreign exchange impacting revenues over the near term.

Mike Kourey

On US Federal, typically, as you know, Q3 is the fiscal year end, and that’s typically the peak quarter for US Federal. This year was no different from that. From an FX standpoint - and Andy of course can tag on when I’m done here - on the FX side of things, very little impact on the quarter. We have kind of a laddered hedged strategy that we use for both balance sheet hedges and cash flow hedges, and it doesn’t change anything, but it certainly smooths it and gives us a lot of forecasting capability. And with that laddered hedge that we do over four quarters, it really smooths things out and so it had minimal impact in the period.


Our next question comes from Larry Harris with CL King. Please go ahead.

Larry Harris – CL King

I was intrigued by the comments with respect to the deferred revenue increase in the quarter, that the RealPresence platform contributed to the increase in deferred revenues. I was under the understanding that deferred revenues were largely driven by service sales. With the contribution of RealPresence, can you quantify that in terms of the deferred revenue contribution? And could that be a good source of deferred revenue increase or cash flow generation going forward if RealPresence continues to perform well?

Mike Kourey

Yeah, I’m not sure how that came across, so I apologize if there’s any confusion. No, the driver for deferred revenue, the primary driver, is in fact around the maintenance revenues associated with services for a single-year, multiyear first attach as well as renewal. So that is the primary driver.

Now, the reality though is - I mean you do touch on something, which is, as RealPresence becomes a higher percent, the platform becomes a higher percentage of sales, to the extent that occurs, and as it has occurred here of late, there is a higher services element involved in that product line, by definition. Because it’s core network infrastructure. So yes, it does have that second order effect. So I think the answer is yes and yes. But primary yes. It is absolutely around maintenance revenues both attached and renewal.


Our next question comes from Rohit Chopra with Wedbush Securities. Please go ahead.

Rohit Chopra - Wedbush Securities

I may have missed this. I just want to get a sense of what the contribution was by the top partners, which you’ve listed before, and maybe qualitatively, you could talk to us about how Microsoft did in the quarter. I understand they did well for the year, but how they did for the quarter.

Mike Kourey

We actually don’t break out partner revenues, by partner. We haven’t done that at least - actually, I’m not sure if we ever did it, but it’s certainly been at least 10 years or longer. So I’m not sure about that one. As far as Microsoft in the quarter, any color you’d like to give? We give it for the year, but any color you want to give?

Andy Miller

I think the trajectory of Microsoft Lync has evolved now to a point where we’re moving from the early adopters and the pilot stages to real deployments, and of size as well. So as Mike says, we don’t break it out specifically, but the trajectory between the sales team’s linkage, our ability to now deploy, a linked Polycom solution, and a clear differentiation of a linked Polycom solution compared to that of a competitor’s call-controlled solution, has evolved very nicely with the right growth rates. So I’m very pleased and opportunistic about the opportunities in 2012 upon the relationship and the growth trajectory of the Polycom linked solution.


Our next question comes from Jason Ader with William Blair. Please go ahead.

Jason Ader – William Blair

Andy, can you talk about how the US was structured differently than the other geographies? And was that just sort of a vestige of the past or, you know, what was your, when you were head of sales, was there something that you saw and thought you could work through? Any color on, you mentioned the US being structured differently.

Andy Miller

I think the Asia Pacific team and the EMEA team were always much more focused on high-touch versus channel. In the US there’s quite a large number of, from a distribution perspective, and value-added resellers, compared to the other two theaters, so in my previous role, a year and a half ago, from a sales perspective, when I came on board it was all around to, frankly stabilize the environment and bring in talent that could help not only that stability, but in terms of moving North America forward. And I believe it did that.

Now, the next generation is to evolve, as the industry has changed. If you go back and look even a year ago, now we’re working with Microsoft Lync on enterprise software sales. We’re working on transactions that were typically $250k and below. Now, over a million dollars. The competition has changed quite substantially.

So this evolution, Jason, is to emulate, as I said before, a more EMEA, APAC-like, which is frankly very high-touch focused and to bring in the talents, like David, from Cisco, to be able to really compete head-on with that company and to be able to really truly partner with IBM, Microsoft, and Hewlett Packard on enterprise software.

So as I said before, there’s several stages to every company’s growth. There’s several stages to every new management team coming on board. And this is just that. I believe that we have the right team in place now, the right number of high-touch versus channel, the right strategic partnerships. And now, frankly, it’s just a matter of execution. You’ve got the team teed up and as we said in the call, we’re going to need a couple of quarters, as we’ve always said, to get that trajectory in the right place.

But all signs are very positive, and again, my focus is to have a very balanced company: the Americas, EMEA, and Asia-Pacific, and I believe that we’ve taken all the right steps to do that.


Our last question comes from Bill Joy with Janney Capital Markets. Please go ahead.

Bill Joy - Janney Capital Markets

Actually, I guess it’s more of a follow up question. You guys had provided the top seven strategic partner percentage on a quarterly basis. I don’t think you provided that. That still would be helpful. And I guess given that you’re working closely with Microsoft and some of these partners, they’ve been pulling demand of the personal devices segment and that was down. And I just want to better understand, from a product perspective, what might be having more pressure.

And then on the RPP, obviously quite impressive there, but just given how you lumped it under RPP, it’s really tough for us to get an understanding of the moving dynamics and just trying again here. Can you provide any color here between the new managed services type of business model that’s impacting RPP versus the traditional MCU portion, or, alternatively, maybe some color about the traditional product segment, RMX, CMA, and DMA. Thanks.

Mike Kourey

So let me start it. So, first of all, yeah, I’m sorry. I thought the question earlier was by partner, which we have not done. You’re right. As we discussed last quarter, we said that we would no longer - it was 26% if I’m not mistaken, for the top seven - we said we would no longer be breaking that out in 2012, simply because over time, we would expect all of our partnerships to be contributing more and more to sales.

So over time, it could be a very high percentage and I’m just not sure how meaningful that is. And, by the way, the rotation of who the top 7 are, that would be kind of like trying to rebalance the Dow Jones Industrial Average. So we are not doing that. But we are very devoted to all these partners, but with a real investment focus on the ones Andy highlighted in the call.

The partners are continuing to do very well. Microsoft is real highlight, but there are others that are doing very well. So expect the contributions to, if anything, increase to a higher and higher percentage over time. So that’s that part of it.

As far as the RealPresence platform goes, the product line is doing very well. So we’re not breaking out within those categories, sub-elements of this much was attached to services, this much product, in various and sundry ways. But the product line - the RMX, DMA, CMA - is doing very well as a product category. So that’s some color that hopefully is helpful to you.

Andy Miller

And let me add one other point that I hope will provide clarification for you. When we talk about the carriers, the 14% of revenue, a majority of that is what we call sell-through, and that’s the carrier acting as a channel to sell our technology. We are in the early stages of selling to the carrier. Selling to the carrier is to allow the carrier to stand up a cloud-based service.

So a majority of the RealPresence platform, what was previously RMX, CMA and DMA, have been sold to enterprise customers for enterprise customer deployments. And they go through a distributor or through a carrier, but that’s all on the sell-through. So what we hope to see, and what we plan to see, as we stand up these clouds and enable this white label offering and then, post-that, deployments of cloud services, a much greater propensity of sell to the carriers. But for today, most of those are enterprise-deployed applications.

And, the key part of this RealPresence platform, the DMA completely differentiates us from our largest competitor in terms of providing virtualization in a distributor architecture perspective. So the DMA is a clear, very important part of the RealPresence platform. The CMA, as we talked about before, provides that entire mobile solution. A CMA license required for each mobile solution deployed is a very key and important part of the RealPresence platform.

So CMA, DMA continue to be very important in working with the RMX, which is now the RealPresence platform. They are deployed to large enterprise customers, either through resellers, distributors, or carriers. And then we will begin, as we start what we just announced last week, the cloud deployment, selling equipment to carriers to deploy cloud-based solutions. So hopefully that cleared some of that up.

Mike Kourey

Yeah, and I’ll even put an exclamation point on it. As far as the product elements go here, we gave our fully blended, that includes the services elements, for the quarter in RealPresence, up 30 sequentially, and I believe it’s 45 year over year including services. That’s very indicative, plus, as to how we did on just the product.

Andy Miller

Good. So I’d like to thank everyone. And in closing, I’d like to thank you again for your continued support of Polycom. And have a great afternoon. Thank you.

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