Polycom, Inc. (NASDAQ:PLCM)
Q1 2012 Results Earnings Call
April 18, 2012 5:00 PM ET
Laura Graves – Vice President, Investor Relations
Andy Miller – President and CEO
Eric Brown – COO and CFO
Jess Lubert – Wells Fargo Securities
Kent Schofield – Goldman Sachs
Tavis McCourt – Raymond James
Jack Monti – UBS
Sanjiv Wadhwani – Stifel Nicolaus
Afiya – Citigroup
Rohit Chopra –Wedbush Securities
Jeff Kvaal – Barclays
[Call Starts Abruptly]
As a reminder, this conference is being recorded, Wednesday, April 18, 2012. I would now like to turn the conference over to Laura Graves. Please go ahead.
Thank you, Operator. Hello and welcome everyone to Polycom’s First Quarter 2012 Earnings Call. I’m Laura Graves, Polycom’s Vice President of Investor Relations and here with me today are Andy Miller, our President and CEO; and Eric Brown, our Chief Operating Officer and Chief Financial Officer.
As with previous quarterly calls, Polycom is 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 homepage, which is polycom.com, and click on the Q1 2012 earnings call link.
Please note that the Q&A session is for financial analyst and will be hosted via audio stream. For the participants participating in this Q&A session, please leave your voice call live, so you can use your conference call connection for the Q&A session at the end of our call. We welcome all others to listen into the Q&A session. This webcast and the transcript of the prepared remarks will be maintained on Polycom’s website for at least three months.
We will be making forward-looking statements on this call, including guidance regarding our expectation of future financial performance, which is subject to risks and uncertainties that could cause actual results to differ materially from our expectations.
Please note that any financial guidance that we provide on this call is valid as of today only and we do not assume any responsibility to provide any updates of this guidance regardless of changes which may occur in the future.
We discuss a number of the business risks that may cause our actual results to differ in detail in the company’s SEC reports, including most recently filed annual report on Form 10-K for the year ended December 31, 2011, and any forward-looking statements must be considered in the context of such risks and uncertainties.
Polycom’s application of U.S. GAAP requires disclosures, the availability of new products, planned features and upgrades discussed during this call are subject to change or cancellation. 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, at this time, I’d like to turn the call over to Polycom’s President and CEO, Andy Miller.
Thank you, Laura, and good afternoon, everyone. I’d like to start by addressing our results in Q1. We felt short of our initial expectations and are disappointed, and not having delivered against financial targets. As a management team, we have reviewed the recent trends, transactions and our results, with the following observations regarding our revenue shortfall in Q1.
Number one, geographic, we saw government spending in several key geographies including China, Australia, India and in U.S. federal civilian come in lower than expected. This was combined with an already slow growth rate in North America.
Number two, product, we believe that we are in the midst of the company and industry transition from point products to solution selling. This mindset shift affects both our customers and our sales force. We saw customers pause to consider more UC centric strategies versus point product or endpoint-only deployments. We believe this transition has many positive benefits for our company over the longer term that clearly created softness in Q1.
Number three, execution, based upon our strength in Q4 2011, we were too optimistic on Q1 growth rates. Hindsight is 20-20 and we got ahead of ourselves, and our Q4 to Q1 had a larger sequential decline that we had planned for. We overestimated the positive effect of Q4 year-end deal closure rates and we underestimated the work require to effectively ramp the North America sales team.
Our plan of action to support and enable the sales team in Q2, and the balance of the year is in these following areas.
Number one, sales execution, our plan includes more focus on net new referenceable accounts in the global 1,000, greater vertical market focus, improve field marketing and lead generation activities, added deployment of UC solutions through professional services, and improve solution selling training and productivity ramp.
We’re also be looking forward to ramp our efforts with Microsoft in joint Lync Polycom opportunities. These activities are well underway in Q2, beginning with team Polycom, our annual sales and channel partner event that just occurred in the first week of April, which kicked off our solution selling and product innovation efforts.
Number two, product, we will continue to invest in innovation to provide solutions that combine the elements of promise-based software and cloud, thereby allowing Polycom to continue to differentiate it solutions as best-in-class. To this end you can expect greater focus on the RealPresence Platform and innovative routes to the market in the second half of this year.
Number three, geographic, we will be aligning quarter carrying capacity against areas where we see opportunities. We will be limiting headcount growth in other areas where we are not seeing returns. Our marketing expenditures will center on reference selling and building pipeline for the balance of the year.
We are adapting to changes in UC market as customers are considering a broader set of use cases across their enterprises. The opportunities that we see tide to flexible delivery mode, full integration and a robust platform taking all that we have today in extended use cases of mobile and cloud. This is part of the industry transition.
Point products are becoming broader solutions, individual transactions are becoming multi-phase rollouts overtime, standalone sales opportunities become larger when they are partner enabled. Importantly, UC solutions and specifically video are moving beyond a traditional cost savings mechanism to a business process acceleration opportunity. This requires an open and interoperable UC platform.
In the broadest context after talking to our customers and partners, and in our view the key long-term demand growth drivers in the industry are as follows.
Multi-vendor integration capability in the heterogeneous environment, superior total cost of ownership, superior user experiences, which include, ease of use, high availability and supportability, flexible multi-mode delivery including on-premise cloud, SaaS and mobile. We believe we have a better solution and are better position than our competitors for this transition.
Let me now preview the new products and capabilities that we intent to deliver over the coming year that we expect will be game changing.
Number one, enhanced cloud delivery, we are vitalizing and service provider enabling our RealPresence Platform to allow customers to deploy our solutions from the cloud right away. We are engaged in large-scale service provider certifications that we will detail as we progress.
We look at this as a significant opportunity to expand the UC market giving broadband and LTE/4G penetration worldwide. We started these R&D’s investments in 2011 and in our opinion we have the most comprehensive solution to evolve and support the needs for service providers and large enterprises.
Number two, open standards and interoperability, consistent with our focus on open standards and interoperability, we believe that some of the competitors that are close but end up creating implementation islands that will not protect and preserve the customers investments. In other word’s, an architecturally disadvantaged total cost of ownership. We believe that we have the most comprehensive and complete approach in this regard, and the best total cost of ownership.
Number three, true collaboration delivered cross-platform, unlike the competition which is focused on connecting endpoints, we are focused on collaboration applications and enabling them through the cloud.
In fact, the ViVu Technology that we purchased last year allows us to provide zero footprint browser-based clients that is already integrated into enterprise social applications. We fundamentally believe that video will increasingly be part of business to consumer process and will require combination of browser and tradition endpoints.
Now, I would like to highlight some Q1 customer wins, which underscore the progress against our long-term objectives. Pertaining with our partner Microsoft we were able to upsell or could have been a simple point product sales into a comprehensive UC solution sale versus Cisco.
Alberta Health Services deploy the RealPresence Platform along with multiple RealPresence room and desktop endpoints to enable diagnostics and access to medical experts throughout their network of highly dispersed locations. This is a leading edge deployment proven that video can effectively address many of their cost challenges in healthcare today. We continue to see upsell wins in conjunction with our RealPresence Platform as well.
Experian added RealPresence Immersive room and desktop systems in Q1 following their purchase of the RealPresence Platform last quarter. This solution should enable their objective of cost reduction through an overall UC strategy deployed both internally and externally with customers.
We are also seen evidence that UC solutions are being deployed for business enablement, not simply T&E cost savings. Sony Europe, deploy their first of a multi-phase rollout that enclose the RealPresence Platform, the first installment of an eventual 150 RealPresence room system plus services.
Interoperability with Microsoft Lync is key to this win. Sony expects to use UC solutions to accelerate time-to-market for its new products, reduce design and distribution costs and transform business processes.
In China, the government education sectors continue to find value the Polycom products compared to Huawei. The Education Committee of Chaoyang District in Beijing deployed RealPresence Platform and room systems for distance learning and to connect middle and primary schools. We are proud of our team’s ability to continue to win deals over the local competition in China.
Closer to home in the U.S. the Iowa Lakes Community College System purchased the RealPresence Platform to realize their mobility strategy of extending their reach to additional students. This deployment also included RealPresence room systems proven that customer's continue to see value and combining on premise and mobile endpoints.
Now, I would like to update you on our strategic alliances. First of all, Microsoft is the most deployed of our partner alliances with execution continuing to grow steadily across R&D, marketing and sales. Customers recognize the value of native integration between Polycom and Microsoft Lync to deliver complete and interoperable standards-based end-to-end UC solution for voice, video, conferencing and collaboration across the corporate universe of customers and partners. Our partnership with Microsoft continues to deliver some of Polycom’s largest revenue opportunities each quarter.
Following Polycom's acquisition of HP Visual Collaboration Business in 2011, the two companies have aligned to create and deliver a comprehensive set of UC video solutions to customers worldwide, including RealPresence Immersive and RealPresence room systems, as well as RealPresence Cloud.
In Q1, Polycom announced HP and Polycom rich media communication solution and the HP AppSystem for Microsoft Lync. These UC solutions are built on the powerful combination of HP, Polycom and Microsoft to further deliver the promise of unified communications.
The Polycom and IBM relationship continues to show progress as integrated video solutions and social business begin to gain market acceptance. We close several deals above $1 million in Q1 in conjunction with these three key alliance partners. This strategic alliances should not only allow us to access greater deal flow in the future, but also to pursue high-value enterprise scale UC deployments.
Our strategic alliances and channel partnerships are key part of evolving and expanding our solutions, delivering capabilities and given our pure play focus on UC market we believe that we can be a more effective partner that our competitors who have multiple alliance of business. While our Q1 financial results were impacted by transitional issues. We believe that we diagnosed the major issues we are already working to make the needed changes and improvements.
Now, let me turn the call over to Eric for detail financial results.
Thank you, Andy. Polycom generated revenues in the first quarter of $367 million falling short of our expectations. While we are disappointed by the product revenue being down year-over-year, we still grew overall revenue inclusive of services by 7% year-over-year compared to Q1.
Looking at revenue by geography in Q1, we have growth across all theaters. Americas revenues were up 2% compared to last year, EMEA revenues were up 16% compared to last year, and Asia-Pacific revenues were up 7% compared to last year.
Moving to revenue by product category, including the services attached to each, the revenues for UC group systems, which includes all immersive telepresence, group video and group voice systems grew 5% year-over-year to $240 million or approximately 66% of revenues in Q1.
UC personal devices, which includes all desktop video devices, desktop voice and wireless land products grew 8% year-over-year to $67 million, representing 18% of revenues in Q1. The percentage of total revenue attributable to UC personal devices was up 2 points compared to last quarter. This product category includes lower margin voice products.
Polycom's revenues for UC platform formerly referred to as network infrastructure grew 12% year-over-year to $60 million, comprising 16% of revenues in Q1. UC platform includes Polycom RealPresence Platform.
From channel standpoint, the revenue breakdown for the first quarter is as follows: 27% through value-added resellers, 62% through distributors, 8% through service providers and 3% direct.
Please note, that approximately 5 percentage points of our distribution business in Q1 was driven by the ITSPs and other service providers fulfilled through distribution, making the service provider revenue 13% of total in the first quarter.
Now, I’d like to provide some information on deal metrics. The information is based on information reported by our field. Please note that this is not complete in terms of our total transaction volume and is based on our booking deal of transactions closed in our salesforce.com system not GAAP revenue. This is intended to provide the basis for a representative view period-to-period on our sales trends.
We had a total of 614 transactions greater than $100,000 this quarter, compared to 524 in Q1 last year. We had a total of 22 transactions greater than $1 million this quarter, compared to $9 in Q1 last year. Mid-sized transactions in the $250,000 to $500,000 range were down year-over-year, seven of the $1 million and above transactions were influenced by our strategic alliances partners, Microsoft, HP and IBM.
Polycom's deferred revenues grew to $239 million in the first quarter, growing 6% sequentially and 34% versus last year. We shipped 50% of revenues in the third month of the quarter.
Moving to the statement of operations, non-GAAP gross profit margins for the first quarter were 60.2%, down 90 basis points from Q1 last year. Margins this quarter were impacted by higher than expected mix of UC personal devices versus UC group systems and UC platform.
Polycom’s non-GAAP operating expenses decrease sequentially in absolute dollars, but increase as a percent of net revenues with non-GAAP operating expenses representing 46.4% of net revenues in Q1, up from 44.5% in Q1 last year and 42.5% of net revenues in Q4.
Q1 non-GAAP operating expense line items were as follows: sales and marketing represented 28.8% of revenues for the period, up from 27.8% in Q1 last year. R&D closed at 12.9% of revenues, up from 12.2% in Q1 last year, and G&A was 4.7% of revenues, up from 4.5% in Q1 last year.
Q1 non-GAAP operating income decreased 12% year-over-year to $51 million, or 13.8% of net revenues. This compares to $57 in non-GAAP operating income or 16.6% of net revenues in Q1 of 2011.
Other income and expense in Q1 was a net expense of approximately $1.8 million, comprised of $0.3 million of net interest income and approximately $2.1 million of net other expense, including the impact of foreign currency losses and non-income related taxes.
Our Q1 non-GAAP effective tax rate was 18.8%, and our GAAP tax rate was 17.1%. This was driven by international profit mix. Q1 GAAP diluted EPS was $0.08, compared to $0.19 in Q1 last year. Q1 non-GAAP diluted EPS was $0.22, down slightly, compared to $0.24 in Q1 last year.
Please note that the EPS data for both current and historical periods reflect the two for one stock split that took effect on July 1, 2011.
Turning to the balance sheet, we exited the first quarter with cash and investments of $680 million and Polycom continues to be debt free. We have the equivalent of approximately $3.50 per share in cash and investments. We did not purchase any shares under our share repurchase program in Q1. However, we continue to believe that share repurchase is an effective way return value to shareholders. We have $7 million to $8 million remaining in purchase authorization.
Moving to accounts receivable, we entered the quarter with AR of $211 million resulting in a DSO of 52 days, a higher mix of international sales impacted this metric in Q1.
Non-GAAP inventory turns at the end of the first quarter were 4.8 turns, compared 5.9 in Q4 and 4.6 in Q1 last year. Q1 turns were lower than expected due to the revenue shortfall on the quarter.
We generated $32 million in positive operating cash flow in the quarter. This is lower than expected, primarily due to lower profits and higher inventory levels.
On a trailing 12 month basis our operating cash flow was $286 million, up 70%, compared to the 12-month period ending Q1 2011. With approximately $3.50 in cash per share as of the end of Q1, this implies that our enterprise value is approximately 6.5 times our trailing 12-month operating cash flow.
Moving to headcount, Polycom had 3,868 employees at the end of Q1, up 1% from the end of Q4. By expense area, we have the following number of employees. In cost of goods 814, sales and marketing 1,386, research and development 1,106, and G&A 562.
Moving on to Q2 guidance and outlook. The following assumptions are reflected in our Q2 guidance. First, looking back at Q1, we were somewhat optimistic in terms of the rate which we would be able to transition certain elements of our operating model in Q1, while we are operating predictably in EMEA we have additional work in North America and Asia-Pacific, this is reflected in our worldwide Q2 revenue guidance.
Secondly, in Q1 we experienced the higher than expected mix of UC personal devices versus UC group systems and UC Platform. Overtime, we do expect the gradual increase in consolidated gross profit margins as we increase the mix of UC Platform and software, and cloud-based delivery.
Third, we have taken action to reduce the operating expense ramp in Q2 versus our original assumptions to better align expenses with revenue. However, we have already incurred cost early in Q2 for our worldwide sales and partner event team Polycom, which will result in a slight sequential increase in Q2 expense when compared to Q1. On a perspective basis, we are holding headcount flat with the exception of previously planned addition of quarter carrying capacity, sales support functions and mission-critical roles in R&D.
Fourth, our Q2 EPS guidance reflects a non-GAAP operating income margin of 12.8% to 13.9% for Q2. This is below the 18% target that we had previously forecasted for each quarter of fiscal 2012. We do not expect to reach 18% in either Q3 or Q4 of this year due to the various transitions that we are working through.
However, on a long-term basis, we still expect to expand non-GAAP operating margins to 20%. Within this long-term P&L model solution, we previously provided a set of target ranges of gross profit margins and individual operating expense line items.
While, we expect to expand gross profit margins as we increasingly transition our mix of business from hardware to higher-margin software, services and cloud models. We are no longer prescribing a specific range of cost of goods, sales and marketing, R&D and G&A. We fully intent to reach 20%, but the precise mix of revenue enhance the underlying operating expense elements versus cost of goods levels may fluctuate.
Breaking on the Q2 guidance we expect the following, revenue ranging from $367 to $377 million with the key variable being progress in North America. Non-GAAP gross profit margins ranging from 60.3% to 60.5% of revenue.
Total non-GAAP operating expenses ranging from 46.6% to 47.5% of revenues. Non-GAAP operating income ranging from 12.8% to 13.9% of revenues. A GAAP tax rate of 18% to 19% and non-GAAP tax rate of 20% to 21%.
Share count of an estimated $182 million diluted shares exclusive of stock purchases. GAAP EPS ranging from $0.03 to $0.05 and non-GAAP EPS ranging from $0.20 to $0.22.
Now I’d like to provide my perspective on operations, after my first two months of Polycom, I see opportunities to improve our worldwide operations, having successfully manage enterprise technology companies through transitions to create both margin and multiple expansion, I’m confident that we can and will transform our Polycom products, processes and sells and channel ecosystem to the following opportunities.
We can make improvements in our sales and channel-related systems that will provide highly automated and socially useable information flow and free up more time for selling versus processing. We can create better and more proactive support for the sales team through idea desk function to optimize margins and provide attributable insight into competitive versus noncompetitive situations.
And in sales, we can focus on industry verticals, reference selling of large enterprise accounts and creating tighter collaboration with our channel and alliance partners to deliver higher value solutions for our customers.
We can also be more agile to Polycom. I’ve already seen multiple opportunities for best profit margin expansion on existing business through product mix, logistics and discount management. I'm driving tempo across the Board to allow us to convert hypothetical opportunities to hard dollar benefits.
And now, I’d like to turn call back over to Andy.
Thank you, Eric. We believe that we are in period of transition and this represents evolving business requirements and opportunities. We acknowledge the challenges that we faced in Q1 which from our perspective were due to a combination of execution, product, geographic and to a lesser extent market.
We have plans in place to address the outcomes that we own, execute to our financial goals, delivering best-in-class product and to competing effectively. We believe the market evolution toward open standards with platform supported multiple delivery models is a long-term opportunity for us as leading pure play UC vendor.
In the balance of this year, we intend to focus on a number of tactical programs, which are as follows. Number one, improve North America sales execution. Here we are pursuing a variety of recruiting, training, pipeline management and partner enabling programs.
Secondly, solutions go-to-market model, this is in part related to the channel partner in Polycom sales training but more importantly emphasizes architecture and integration and industry case studies as we saw more complex solutions to a higher level IT budget holder.
Three, focus on platform. More than every, I'm convinced that our open standards approach with our RealPresence Platform and native integration with key standards is a significant differentiator. We believe that drive and adoption here positions us at a new level in our customer base versus standalone endpoint sales.
Fourth, scaling partnerships, we're now starting to see traction in the field with our Microsoft alliance. We believe the long-term opportunity is tangible with Microsoft representing a substantial, addressable, installed base in the global 5000.
And fifth, cloud, mobile and hybrid delivery models, we are securing true points with respect to cloud mobile. The customer examples that I’ve started earlier underscore this. Mobility in particular is driving more dialogue as company seek to better enable distributed work environments.
We look to secure more wins in this area through future development efforts to extend video centric UC use cases from internal networks to external networks i.e. business-to-business and ultimately business-to-consumer.
According to industry analysts, the overall UC market remains a long-term 14% to 18% growth market supporting the fundamental value proposition for UC solutions. We believe that our long-term strategy of adhering to open standards with multiple delivery models is valid and well supportive of our product roadmap. We received enthusiastic support to this vision from our worldwide partners and customers and our team Polycom event earlier this month.
Now, we would like to open the call to questions. Each analyst will be limited to one question and one follow-up. As we discussed earlier in the call, many of the statements that we've made and will make during the Q&A period are forward-looking statements, which is subject to many risks and uncertainties. We’ll now switch over to the audio portion of our call for Q&A.
Is the conference call operator available at this time?
Yeah, sir. (Operator Instruction) Our first question comes from the line of Jess Lubert with Wells Fargo Securities. Please go ahead, sir.
Jess Lubert – Wells Fargo Securities
Thank you for taking my question. I’m going to try and squeeze two in here, if you don’t mind. First, I was hoping you could discuss whether we saw any thawing in the business towards the end of the period and help us better understand what leads you to believe the positive you saw in the March quarter was a transitional industry event rather than share loss to other players and alternative delivery models?
And then secondly, you alluded to the adoption of new software-based video delivery platforms, given the adoption of these platforms, I was hoping you could help us understand how you believe deployment of software-based product is likely to impact the demand and price of traditional room-based offerings?
Let’s start off. This is Andy. So I’ll take the first part which was, from a linearity perspective, what did we see specifically in the third month of the first quarter. Clearly, we from a linearity perspective as Eric talked about, we saw 50% of our business occur in month three. So we saw a healthy flow of business in the third month of March.
Clearly, the laws of physics as relates to every quarter, we do not achieve what we have expected. We also talked clearly about improving linearity to both our high touch and our channel model as well. Eric, do you have any comments on linearity?
No. Other than -- if we had actually hit the targets, we would have done actually a bit more than 50%. So it’s fair to say it was slightly more back-end loaded. The other comment that we did make is, it wasn’t a question of couple of large transactions following out right at the end of Q1 going into Q2 that was not either case in terms of the short fall for the first quarter.
I’ll take your part B as a whole question as it relates to the adoption of video delivery platforms. Clearly, as we talked about, we’re seeing a pause, in terms of UC buyers looking at not at just traditional endpoints but a more holistic solution which does incorporate as we talked about browser-based solutions, mobile solutions, and a combination of managed hybrid and cloud-based solutions. So we’re seeing quite a bit of consternation and thought process in terms of a broader UC play rather than just standalone video.
I think Microsoft Lync is a great example of a more holistic UC deployment and our focus as we talked about training and we talked about roadmap is about having our team to be able to have a conversation with the CIO in terms of not just end points but the migration of end point to ultimately software-based and cloud. And clearly, we have to get better effect and that’s part of the – this elongated transition process that we spoke of today.
Jess Lubert – Wells Fargo Securities
Can you talk a little bit about what that means for the room-based system market and or are you seeing evidence of price deflation there?
Well, I’ll let Eric talk in a second about ASPs. As relates to the room-based systems, I believe and I believe that our partners would have tested this that it is not cannibalized room-based systems. It actually augments room-based systems. I think the Microsoft, the CX7000 that we brought to market, I think, validates that as it relates to the place and time and purpose of room-based systems.
So I believe the browser-based and software based is more for personal endpoints and more for small group conferencing. That steal the market for room systems, has the opportunity to expand as these software and hardware pieces play together.
This is Eric. In terms of pricing for the room systems other than one or two transactions which were larger in size, overall, the price points were quite stable year-over-year.
Jess Lubert – Wells Fargo Securities
The next question comes from the line of Kent Schofield with Goldman Sachs. Please proceed.
Kent Schofield – Goldman Sachs
Thank you. As you talk about doing initial – additional work in North America and Asia-Pac to improve execution. Can you just begin to add a little bit and to the extent that there is different things that need to be done in the different regions, it would be great to get some detail there?
Well, clearly, every region – this is Andy. Every region is different in terms of what is required in terms of better tools and arrows in the quiver. Clearly, in North America that is off of just on two key areas, one is a greater penetration into competitively held Fortune 500 accounts where we need to expand our market region brought into, what I call net new logos or accounts that are either competitively held or in some type of mixed or hybrid manner.
So we need to do a better job in terms of expanding our footprint and that is why we’ve added the net new 32 high touch sales reps. That’s why we focused on really strong partnership with HP, Microsoft and IBM to be able to get that reach in to those customers.
The second part is specifically in North America, all around the complacency of a high touch model with channel distribution and most importantly, the education of just what I talked about a moment ago, moving from that endpoint competitive discussion to a more holistic solution discussion including cloud, mobility, browser-based software technology. So it’s running around education and looking at how we expand our sales force into the net new logos and competitively held accounts.
As relates to Asia Pacific, I think we’ve got very good strategy clearly in China. We have 51.3% market share against likes of Cisco and Huawei. We definitely saw a pause in terms of government spending but we don’t see that as a long-term issue, it’s more cyclical.
Thank you. The next question comes from Tavis McCourt with Raymond James. Please proceed.
Tavis McCourt – Raymond James
Thanks Andy. Two quick ones. One, I was wondering if you could discuss a little bit the sales force churn in the U.S. What impact that may have had and to what degree do you think that is behind the company? And then secondly on the cloud strategy, you outlined last quarter, I think it was more of Polycom building its own cloud initially and then letting service providers and resellers utilize that. Is that still your working strategy or are you open to other business models there?
So let me take this. So as far as the -- in other word churn, clearly, we take all of our execution very responsible we fall in our sword. As it relates to North America, we added to 32 net new high touch sales team and clearly, it was -- I take full responsibility for expecting too fast as the productivity ramped. As it relates to churn and some of the things that we’ve heard of media is actually one director, VP level that actually departed from our business that was responsible for the education and healthcare market, who actually went to a very Polycom friendly channel partners.
So we’ve actually seen very little churn in the North American market. The challenge is what I said before which is how do we get this 32 net new high touch headcount at this speed and at the same time transition the sales team from more point product to solution based and clearly, that took us longer than we like to see and expected. I think we’ve done more forensics literally city by city, region by region, and I put very focused plans in place.
As it relates to cloud, our strategy has not changed from Q4. It’s only accelerated. Our focus is, has always been, how do we help accelerate the carrier, bring out video-as-a-service. And our focus has been around the word enablement. How do we create and stand up a cloud under the build-operate transfer model.
In other words, build the cloud, not a retail cloud but a cloud with product time technology and allow the carrier to utilize that cloud up and until the point where they’ve gone through their certifications, processes, billing and go-to-market structure and then take that cloud oval.
So we will not compete with the carrier and a retail cloud. We will continue our focus on our enablement to operate, transfer and bring out some very significant carrier opportunities as video-as-a-service in 2012.
Thank you. The next question comes from the line of Jack Monti with UBS. Please proceed.
Jack Monti – UBS
Yeah. Thanks for taking the question. I guess, I want to, kind of, touch upon the growth, the thoughts about growth. I mean, obviously that company is growing below market into taking some actions to improve that and I guess, if you could give us any idea or any your thought process of how soon the company could start growing again with the market. Is this something that takes one to two quarters or two to three quarters or any type of detail on how long you think the fix is here? Thank you.
This is Eric. I’ll take that question. The market we believe is growing at a composite rate of roughly 14% to 18%. Different sub components of the market are growing at different rates. We did note that we saw for example, stronger than expected mix in voice-related products in this past quarter versus our original model.
As we look at the first half of the year with Q1 actuals and Q2 guidance, we’re effectively flat with what we were in the prior year and so the notion of having enough of ramp in the second half of this year to get to that composite market growth rate is a bit challenging because we’re off to a slower than expected start.
I think what we’re doing now is the right thing in terms of position the product portfolio. The things that we do like that we see is number one, strength in infrastructure, which we’re now referring to as UC platform.
UC platform is very sticky. It’s driving 501 sales and it’s bringing with it elevated service and maintenance levels as well. So we expect to see that to start to turn from the infrastructure side outward as we look to the year and the back half.
Thank you. Our next question comes from the line of Sanjiv Wadhwani with Stifel Nicolaus. Please proceed.
Sanjiv Wadhwani – Stifel Nicolaus
Thanks so much. I’ll try to sneak in two quick questions also. So Annie, when you’ve done your forensics for what happened in Q1 and you’ve sort of laid out three main issues can you parse through, which one had a bigger impact on the mix in Q1?
And then second question I had was, when you look at the U.S. market under transitions and the changes that they are making here. Is there something that we should expect, we’ll continue through the course of the year. Is there a light at the end of the tunnel in the quarter or two, any time that we can put arms around? Thanks.
Okay. Thanks. So in terms of the issues, in terms of prioritization, and we talked about some of the government spending challenges that we saw across the globe, we talked about the pause around point product to solution and then frankly our execution issues around two optimistic growth rates.
So clearly, we have a very, very specific plan around the sales execution area. It has everything to do with professional services, training, enhancing productivity ways, deeper penetration with Microsoft. As I said before, our focus on North America on Fortune 500, across the globe on Global 1000 and accountability for every employee at Polycom. So I believe we have the right process in place based upon the forensics that we’ve done.
Clearly, on the product side, I believe that we have as I have talked about not only the current but also products forthcoming in 2012 to allow customer to have best-in-breed positioning both in terms of noble, cloud, premise and software.
And then as Eric talked about in terms of aligning quarter care and capacity against areas where we see opportunities and learning head count growth in terms of other areas, would that be much more surgical and specific versus shopped on. So while we don’t have time today to go through my entire companywide improvement plan, those are really the three key areas.
As relates to changes, we are in a fast moving high growth competitive EC market. One of the great joys is frankly we’re in a market with two major competitors and it’s up to us as a company, it has great leadership team, a great balance sheet, great set of technology, assets that are very different for our competition to execute.
So I think that – be naive for me to say that we’re through all the changes. I think in this market we have to focus on Germany and phase value is that the only thing that is constant is change but with that said I believe we have the right leadership team, the right leadership team in sales, the right process in place through remediate the challenges of Q1 and yeah, there will be continued changes like in any company as we move forward but I would like to thank the major areas that we are focusing on the right ones and are solid in nature.
Thank you. The next question comes from the line of Jim Suva with Citigroup. Please proceed.
Afiya – Citigroup
Sorry, gentlemen, this is [Afiya] behalf of Jim. Good question what about some of your customers saying a potentially deal where you have a lot of competition what are they saying in terms of your product portfolio relative to your competition. Because I’m trying to reconcile still, your growth forecast applying some sequential rates for the reminder of this year following the post -- following your Q2 guidance and looking at sort of what your market expectations are for industry growth. So where are we seeing Polycom deals not closing relative to some of your competition, from a product feature functionality people to provide some more guidance on that, that would be great. And then two, if you could give us a little bit….
Go ahead. I’m sorry. You are going to say in your second half.
Afiya – Citigroup
Sorry. I was trying to understand if you could give a little bit more on what happened in Asia Pac. I can understand there were some government spending but was that the only factor that happened in China or rest of your Asia Pac as well as India and if you can provide some more clarity on what happened there and why the sales growth there on a year-on-year basis slow down so dramatically?
Yeah. So I want to take -- I want to give a quick overview, I’m going to turn over Eric. One that we don’t have the forensics because Cisco reports after us, we don’t have the market research on Q1 to be able to go back and look at market share gains or losses. And clearly things were change on a quarterly basis, based upon product transition and market challenges.
What we do know is if we look at our win loss rate against our largest competitor, we actually trying very well but the issue is not with the loss rate. The issue is the ability for us to be in more places with more customers. In other words, how do we move into accounts where you don’t play today, specifically in the global 100.
And you’re addressing that with global accounts team and the team that focused on net new logos as I talked about so I believe that customers already (inaudible) specifically around open standards, interoperability, the deployment of social media -- I’m sorry --social media, cloud and mobility model. So Eric will talk about that one in a second.
As relates to Asia Pacific, we had some very large wins in Q4 both are Australia and in China and I think that’s clearly the part of this following – and I swear around that we are over zealous and too optimistic about growth rates globally but also in Asia Pacific based upon China, Australia. So we did see the set out in the government spending, which we didn’t see in lieu of new year, clearly, it was over zealous which Eric is helping the company to post correct.
Yeah. I would add on to the question of new growth versus the market as a good one. And that the important thing is here it’s not a quarter-by-quarter measurement, it’s an overall long term trend and -- earlier we talk about when we get to the market growth rates quarter-by-quarter not necessarily in fact if you look at the first half, taking midpoint of our guidance, it’s roughly flat versus last year.
We do expect to do better in the back half of the year, and we do see that we are competing very effectively as we roll up our internal view of win loss ratios, we find no real net change quarter-over-quarter, that is Q1 compared to Q4. So we feel that we are competing well and invariably, when we’re in larger deals in architecture multimer delivery is being discussed that’s what we have advantage.
We’ve probably not seen enough transactions, and as we look at our deal stats, well as we are up year-over-year on the large deals, we find that we are down year-over-year on the midsize transactions. So we have an issue of flow that we’re looking to address vis-à-vis the expansion of selling capacity in the field.
Next question please?
Certainly, the next question comes from the line of Rohit Chopra with Wedbush Securities. Please proceed.
Rohit Chopra –Wedbush Securities
Thank you. Hey, just want to ask you question about some your competition you mentioned to but how you compete against your largest competitors and their ability to bundle, and then can you talk a little bit about, maybe the competition you are seeing from the smaller players, does that -- should anybody be worried about that and I specifically you could be a via -- it could be a fact that video got built into the IBM peer systems platform. I just want to understand why competition isn’t -- you are talking about win loss ratios but why isn’t it a factor?
Let me check the first part of that as relates to our largest competitor. Clearly, they have the opportunity to bundle and package this technology into the main line network infrastructure, which clearly and sometimes is an advantage for them.
We are not naïve to that. We are very focused on -- they can show that we compete in accounts that appreciate and recognized open standards, interoperability, not proprietary devices and mobile core different yards to market in cloud. So we do well but we actually have to get better and making sure that we understand the accounts the CIO is open to what I just talked about versus one stop shop and packaging and bundling.
And I think we are getting better with that. But we are in the front of the CIO that can appreciate a story that’s interoperable, open standard, that is agnostic to the enterprise software application and that actually participates in the call control where they will be hosted on premise to a Microsoft Lync. I think we have a very, very good opportunity and there is a great invest marketplace for that.
On clearly, the wire RADVision is an opportunity I think for us to differentiate ourselves in terms of not only a strong relationship with Microsoft and the Lync side but also gives us frankly a very good opportunity to participate in a channel that has been clearly disrupted between the via OEM, the life size -- acquisition of RADVision. So I think there is continued market transition that opportunity in that environment as well.
We see very little some of the aforementioned smaller pars as it relates to IBM. We have a very strong relationship with native integration and to same time and actually that relationship is getting stronger each day.
So very cognizant of Cisco’s ability to packaging bundle and I’m clearly we have to do a better job around differentiating there and I think the other to keep our eye, we are not naïve to software -- shall we say late stage luxury companies.
However, as Eric talked about and I talked about the innovative products that are forthcoming from our company in terms of the browser based, software, I think will give us a very substantial advantage of any of those companies that were not mentioned by name. Eric.
No. I will just add on that we’re finding -- we’ve got a lot of really good feedback from our team Polycom event earlier this month. It’s that there is no one preferred mode of delivery. In fact, what we’re seeing this motion of hybrid delivering mode, mix delivering mode, recurring more and more frequently.
And we think that what will be important is ultimately taking everything from the very high end systems board room, caliber, telepresence systems overly down to pure software clients and at the extreme browser based, there are footprint clients and figure not how to connect all this together, because there is no single solution stack or use case scenario that, they will see in mid and large sized enterprise.
And so again at the corporate, we are doing is design of the UC platform, so it is extensible to all these use cases and fed rates of these end points. Some of the small companies that provide on-demand services, they simply have no connectivity option or plan to get into room systems, traditional desktops, boardrooms et cetera and that’s a very important point.
Next question, please?
Certainly, our last question comes from the line of Jeff Kvaal with Barclays. Please proceed.
Jeff Kvaal – Barclays
Great. Thanks very much. I was wondering if I could grow two in there really, I think one maybe for you Eric a little bit and that’s on the operating margin side, you are still giving us a long-term 20% operating margin target, I’m wondering what kind of plan do you have overtime to get there to revenue driven, is that something you will manage to on the OpEx line how should we think about that? And then Andy, for you, I heard a little bit your last talked, I think Polycom about the service provider partnerships that you’ve forged over the last two, two plus years. Could you give us an update there and should we think that, they we really just don’t have as much momentum say as you do with Lync?
Let me have Eric go first and I will take (inaudible).
Okay. So we need to move from where we are in 13%, 14% up margin to 20% overtime and how we are going to get there is a -- it’s going to be growth in revenue but most importantly it’s going to be mix of revenue going forward.
So traditionally with headlines of businesses at different levels of margin, which are purely hardware based and what we are in the process of deploying and you hear more about this in the second half of the year is partially different revenue models and different margin profile that will be more service based.
Some of these maybe net revenue base for example which should have very high gross profit margins and so it’s going to be mix of services, cloud and software in a combination thereof that we’ll drive gross profit margin or net margin against OpEx intent to lever. To be clear about the OpEx assumptions, looking to control, match with revenue, but we will make investments in quarter caring capacity because we see the opportunity in -- through the end of 2012 in terms of going after more enterprise solution sales. We have an advantage. We are wining deals head-to-head as we noted. We are not seeing enough deals.
So this is a coverage issue not a competition issue. So product mix will be key and I do want to point out that’s one of the reasons we have exclusively remove the percent of revenue targets line item by line item because out in the long term one can be as precise in term of what the final mix will be in terms of cloud services software and traditional hardware.
Let me just finish up that Q&A on the carriers question. We started off by year and half ago with the OVCC which was the Open Visual Communications Consortium, which was over 30 of the largest service provider as worldwide. That has moved into unfortunately we are not able to discuss it today, several major worldwide carriers certifying the Polycom Technology to be able to not only reserve but use in the cloud and that is a key element of something material and marketing moving as relates to our cloud strategy.
We also now in the process of developing a five significant carriers to as I said before to fundamentally handhold with Polycom, a build operate trans flow mentality to be able to move into video as a service in the cloud in 2012 the back half. So while we may have been more low key about it at the last quarter, it’s only because we are already to certification and as I said before the carrier piece does take time but it is very, very important parcel software in cloud on a go-forward strategy.
So with that said, I would like to thank everyone for their participation on this Q&A. I would like to thank you for your time and your support, and your continue support to Polycom and we look forward to speaking with you out again next quarter. Thank you.
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