Q3 2012 Earnings Call
October 23, 2012 5:00 p.m. ET
Andy Miller - President and CEO
Eric Brown - COO and CFO
Laura Graves - VP, Investor Relations
Bill Choi - Janney Montgomery Scott
Tim Long - BMO Capital Markets
[unintelligible] - Stifel Nicolaus
Kent Schofield - Goldman Sachs
Jess Lubert - Wells Fargo Securities
Jeff Kvaall - Barclays
[Amit Pravu] - RBC Capital Markets
Tavis McCourt - Raymond James
Jason Ader - William Blair
Shebly Seyrafi - FBN Securities
[Operator instructions.] I will now turn the conference call over to Andy Miller, president and chief executive officer. Please go ahead sir.
Good afternoon everyone, this is Laura Graves, I’m vice president of investor relations, and welcome to Polycom’s third quarter 2012 earnings call. I am here today with Andy Miller, our president and CEO, and Eric Brown, 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 web browser at this time and enter Polycom's homepage, which is polycom.com, and click on the Q3 2012 earnings call link.
The Q&A session will be hosted via audio stream. For the analysts participating in the 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 the call. We welcome all others to listen into the Q&A session.
This webcast and a transcript of the prepared remarks will be maintained on Polycom's website for up to three months. We will be making forward-looking statements on this call including statements related to future and new product offerings, future trends and expectations, and guidance regarding expectations of future financial performance, which are 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 the call is valid as of today only, and we do not assume any responsibility to provide any updates to 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 materially in Polycom's SEC reports, including our most recently filed quarterly report on Form 10-Q for the quarter ended June 30, 2012. Any forward-looking statements must be considered in the context of such risks and uncertainties.
We will be presenting both GAAP and non-GAAP financial measures here today. Please refer to our reconciliation of GAAP to non-GAAP financial measures in today's earnings release, which is posted on our website.
Polycom's application of U.S. GAAP requires disclosure that availability of new products, planned features, and upgrades discussed during this call are subject to change or cancellation. Products and related specifications referenced herein are not guaranteed, and will be delivered on a when, and if, available basis.
Now, to begin our commentary on our Q3 2012 financial results, please let me turn the call over to Polycom’s president and CEO, Andy Miller. Andy?
Thank you Laura. Good afternoon everyone. Q3 was a very good and solid quarter for Polycom. We performed well, both on financial and strategic measures. Polycom reported revenue of $335 million in the third quarter of 2012. This was at the high end of our guidance of between $325 million and $335 million.
Non-GAAP earnings per share were $0.10 and above our Q3 guidance of $0.06 to $0.09. At Polycom, we have an aggressive vision to make video collaboration truly ubiquitous. To deliver on our vision, our strategy is to make video collaboration simple to use and available to everyone through open standards-based software, delivered through either private or public clouds that connect people securely across any network protocol, application, or device they wish to use.
As the leaders in open standards-based unified communications and collaboration, we are paving the way for businesses to build on their current investments and expand their deployments and usage based on software, cloud, and web video collaboration solutions.
Earlier this month, on October 8, at our strategy day event, Polycom announced the most comprehensive set of new products in our 20 plus-year history, which we believe demonstrate our industry and thought leadership and truly underscore our ability to expand our market opportunity.
This was the largest and most important launch of breakthrough solutions in Polycom’s history, as well as the history of the unified communications and collaboration industry. These breakthrough innovations, which augment our best-in-class portfolio with backward and forward compatibility take ease of use and universal access to new levels while extending and protecting investments customers have made in Polycom’s interoperable, open standards-based platform and products.
We announced what we believe will be game-changing in the industry, Polycom’s RealPresence cloud access suite. It is a new extension to the Polycom RealPresence platform that lets customers extend enterprise-grade video collaboration to users of Skype, Facebook, Google Talk, and other business video apps via a browser for B2B and B2C video collaboration with the highest quality, reliability, and security. This is a bold and visionary move for Polycom, which we expect to deliver in Q1 2013.
Second, we announced powerful RealPresence platform enhancements, which include the industry’s first open standards-based SVC scalable video codec, providing three times the high definition multipoint video capacity for greater scalability and dramatically lower total cost of ownership, superior performance, and backwards and forwards compatibility for investment protection, all available through a software update.
This provides significant value to our existing customers and new customers as well. True to our strategic of open standards and our vision to make video ubiquitous, we have made our open standards-based SVC technology available to all vendors royalty-free.
Microsoft, another founding member of the Unified Communications Interoperability Forum, alongside Polycom, is an early adopter of this new standards-based SVC technology. The licensing of H264 SVC provides a foundation that will allow the industry to deliver the type of seamless interoperability that our joint customers are asking for.
Third, we announced the superior user interface and next-generation endpoints. The new Polycom user experience, Polycom UX, delivers the industry’s best user experience, with more than 20 new user innovations and features, including a completely redesigned UI and the industry’s most lifelike HD quality, providing up to 1080p60 resolution for video or content.
We also announced patent-pending Polycom’s smart pairing technology, which enables Polycom customers to start and manage a conference right from their iPad. Our superior user experiences offered on next-generation video endpoints include the new Polycom RealPresence Group Series products and the new ultra-slim Polycom RealPresence Visual Edge executive desktop offering and Polycom RealPresence software for PCs and mobile devices.
We also announced a new portfolio of mid-market solutions including the RealPresence collaboration server 800S virtual edition. This is the industry’s first multiprotocol software MCU that runs on industry standard servers. We believe this will be a key product for us as we continue our move toward virtualization at data center public and private clouds.
The 800S, combined with our Group 300 product for huddle rooms and RealPresence Desktop and Mobile 2.0 provides a high-performance, affordable, and market-leading solution for the mid-market. We plan to be aggressive with our sales, channel, and marketing teams to enable us to take share and own the cloud, soft MCU, and small to medium enterprise markets.
We believe the solutions we announced will also allow us to win more business and take additional share in the existing market that we participate in today. In addition, cloud access opens a new addressable market opportunity for us. On a combined basis, our total addressable market is expected to grow at a compound annual growth rate of 16% to almost $12 billion by 2015.
The analyst and partner community has been highly supportive of Polycom’s strategic approach and new announcements. In Q3, Forrester Research Incorporated named Polycom a leader and top ranked in both current offerings and strategy in its new wave report on video collaboration solutions. In addition, Polycom received a strong positive rating in the Gartner Market Scope for telepresence and group video systems and was named a leader in the IDC Market Scape for worldwide enterprise videoconferencing equipment.
Feedback from both financial and industry analysts on our new product announcements has been overwhelmingly positive. Many have said that our new products are the right way to address the market, and that we have clearly laid out a path to differentiation, and that Polycom’s advanced initiatives currently surpass the individual efforts of all of its rivals including Cisco Systems.
Dimension Data, a leading global systems integrator, believes enhancements like these will accelerate the usage and adoption of video based upon faster return on investment for their clients. But even more impressive are our results. Polycom holds now more than 32% of the global market share as of the end of the second quarter of 2012 and gained nearly 8% in global video collaboration market share in the first half of 2012 alone.
I’d like to provide you with some Q3 customer wins that we believe have strategic significance to Polycom and interesting implications for the industry. Polycom has been working closely with AT&T, a Polycom managed service provider and platinum reseller, to bring the latest solutions and services to the pervasive video collaboration market.
In July, AT&T announced that it is the first service provider to support Polycom HDX desktop and conference room solutions and Polycom OTX and RPX immersive theater systems, implementing telepresence interoperability protocol to enable native single- and multi-screen interoperability with one or three screens between telepresence endpoints and from multiple endpoint brands.
As founding members of the Open Visual Communications Consortium, we are continually working together with other industry leaders to foster and propel the growth of video collaboration among our global customers.
Another service provider, Telecom Group, New Zealand’s largest telecommunications company, selected the Polycom RealPresence platform as its software infrastructure to deliver video as a service to customers through a subscription model. Telecom Group customers will have access to Polycom’s video systems including availability over tablets and mobile devices with all hosting, management, and provisioning done by Telecom Group.
A large healthcare customer has partnered with Polycom to differentiate and enhance the customer experience for their members by enabling video in their call center. This was a very competitive win over Cisco Systems and included products from our portfolio that integrate with Microsoft Lync. This deal also includes core aspects of the RealPresence cloud access suite, most notably secure, browser-based access for high-quality business to consumer video collaboration.
Deloitte, the second-largest professional services network in the world, and a member of our customer advisory council, purchased $1 million in services, along with immersive telepresence, RealPresence collaboration servers, multiple HDX video systems, and multiple CX phones, for a large Microsoft Lync voice rollout.
Well-known tire manufacturer Michelin has evolved their governance model by using an immersive telepresence to connect members of their global management team. The company is also embracing video rooms and tablets to improve productivity and collaboration. This win was a result of our partnership with Orange Business Services and CTEC.
Net, these wins in Q3 highlight our continued progress with service providers for cloud-based deployments and compelling RealPresence platform-based wins. Everything that we do at Polycom is based upon native interoperability and open standards. Our thought leadership with the upcoming Polycom RealPresence cloud access suite is a great example of that.
Now, turning to our geographic results, we saw strong results in the Americas, specifically in North America, where our sales processes have strengthened and the team is performing well. Well enough that we made some sales leadership promotions in certain regions. This strength in North America were partially offset by some late-quarter weakness in the federal space.
Our Q3 results for EMEA were better than our original expectations. Our team in Europe is executing very well in a tough macro-environment, and we are seeing opportunities in places such as Russia and the Middle East. We believe the challenges in Europe are the result of the ongoing macroeconomic situation, and we are doing as well or better than any other vendor in our space.
In China, we experienced a slowdown at the end of the quarter. We have seen increased conservatism from our China end users and partners due to the leadership and policy transition. After speaking with customers and partners, we believe this conservatism will persist through Q1 2013 and then return to normal spending levels. We are well-positioned, with over 50% market share in China.
In India, we are seeing a slowdown in spending due to government constraints and the weak local currency. From a product category standpoint, we saw 4% year over year growth in [the UC] platform, as customers continued to recognize and value our fully open, interoperable UC&C architecture solution as the best-in-class in its ability to deliver multi-vendor and hybrid solutions.
As I travel and meet with customers and partners all over the world, it’s obvious to me that businesses are looking to use video collaboration in a variety of ways like never before. More than two years in the making, we believe our new solutions will accelerate mass adoption of video collaboration and fuel new growth opportunities for Polycom and our partners by removing the impediments that have hindered the penetration of video.
We believe they open new markets and position Polycom as the clear leader in the unified communications and collaboration market, which we expect to grow to approximately $12 billion in 2015. Polycom is leading the transition to new models that include software and cloud-based delivery of enterprise grade video collaboration to anyone, anywhere, on any device.
The new solutions we are bringing to market extend customers’ investments, provide significant incremental value, and are both backward and forward compatible. An investment in Polycom is a safe investment and one that we believe will grow in value as we bring new solutions to market today, tomorrow, and into the future.
I’d now like to turn the call over to Eric to review our detailed Q3 results and guidance for Q4. Eric?
Thank you Andy. For financial reporting purposes, the results of our enterprise wireless solutions business, or EWS, are considered discontinued operations for all periods presented. Accordingly, results discussed on this call are based on our continuing operations only, and exclude the EWS results unless otherwise indicated.
Polycom generated revenues of $335 million in Q3 2012, which was above consensus and at the high end of our guidance range of $325 million to $335 million. Q3 non-GAAP earnings per share were $0.10, above consensus and our guidance range of $0.06 to $0.09. We had strong performance in both the top line and bottom line, and managed our operating expenses.
Looking at revenue from continuing operations by geography, Americas revenues were down 5% compared to the same period last year. As Andy noted, North America sales processes have strengthened and the team is performing well. North America enterprise performed well, and more than offset some weakness in U.S. Fed at the very end of the quarter.
EMEA revenues were down 8% compared to last year, largely as the result of the ongoing macroeconomic situation in Europe. This was, however, slightly better than what we expected going into the quarter, and we believe this is the result of the well-seasoned team that we have in place, and their execution.
The following countries had positive year over year growth for us in EMEA: the U.K., Russia, France, and the Benelux region. Asia-Pacific revenues were down 4% compared to last year. Specifically within China, we are seeing reduced government spending and elongated sales cycles. China, together with India, performed below our expectations for the quarter.
Q3 revenue from continuing operations by product category, including the services attached to each, was as follows. UC Group Systems, which includes immersive telepresence, group video, and group voice systems, was down 8% year over year to $226 million, or 67% of revenues in Q3. UC Personal Devices, which includes all desktop video devices and desktop voice, was down 3% year over year to $46 million, representing 14% of revenues in Q3. UC Platform revenue, which includes the Polycom RealPresence platform, grew 4% year over year to $64 million, comprising 19% of revenues in Q3.
Q3 revenue mix was 74% product and 26% services. Year over year, product revenue was down 13%. Services revenue was up 25%, driven in part by the Halo acquisition at the end of July last year. Organic services revenue growth was 19% year over year.
From a channel standpoint, the revenue breakdown for the third quarter is as follows: 27% through value-added resellers, 62% through distributors, 10% through service providers, and 1% direct. Please note that approximately 6 percentage points of our distribution business in Q3 was driven by the ITSPs and other service providers fulfilled through distribution, making service provider revenue 16% of the Q3 total.
Now I’d like to provide information on deal metrics. The following is based on information reported by the field. Please note that this information is not complete in terms of our total transaction volume and is based on a bookings view of transactions closed in our Salesforce.com system, not GAAP revenue. This is intended to provide the basis for a representative view of the quarter.
We had a total of 660 transactions greater than $100,000 this quarter, compared to 592 in Q3 last year. We had a total of 14 transactions greater than $1 million this quarter, compared to 17 in Q3 last year. Midsized transactions in the $250,000 to $500,000 range were 132, compared to 122 in Q3 last year. In terms of linearity, we recorded 49% of revenues in the third month of the quarter, compared to 52% in Q3 last year.
Moving to the P&L, non-GAAP gross profit margins for the third quarter were 60.0%, down 1.4 percentage points from Q3 last year, primarily as a result of mix impact from the managed service business we acquired from HP in 2011. There was no change in the competitive pricing environment in Q3 versus Q2.
Q3 non-GAAP operating expense line items were as follows. Sales and marketing expense represented 32.2% of revenues for the period, up from 29.1% in Q3 last year. R&D expense was 14.5% of revenues, up compared to 13.0% in Q3 last year. And G&A was 6.1% of revenues versus 4.6% in Q3 last year.
These increased percentages are a function of lower total revenue versus prior periods, and the semi-fixed investment we are making for the engineering and marketing launch of our new product portfolio. Q3 non-GAAP operating income was $24 million, or 7.2%, of net revenues. This compared to $52 million in non-GAAP operating income, or 14.7% of net revenues in Q3 of 2011.
Other income and expense in Q3 was a net expense of approximately $0.2 million, comprised of $0.2 million of net interest income and approximately $0.4 million of other expenses, including the impact of foreign currency, equipment disposals, and nonincome-related taxes in certain geographies.
Our Q3 non-GAAP effective tax rate was 28%, and our GAAP effective tax rate for continuing operations was 18.7%. The Q3 rates reflect a higher mix of U.S. profits. Q3 GAAP diluted EPS from continuing operations was a loss per share of $0.08 compared to income per share of $0.11 in Q3 last year. Q3 non-GAAP diluted EPS was $0.10, down compared to $0.23 in Q3 last year but above consensus and our Q3 guidance of $0.06 to $0.09.
Turning to the balance sheet, we exited the third quarter with cash and investments of $628 million. We have the equivalent of approximately $3.60 per share in cash and investments. Polycom’s deferred revenues grew to $244 million in the third quarter, up 2% sequentially and 22% versus last year. Deferred revenue grew on a year over year basis as a result of an increase in software maintenance agreements associated with UC Group and UC platform products.
We purchased $30 million of common stock under our share repurchase program in Q3, and as of September 30, we have $28 million remaining in our repurchase authorization.
Moving to accounts receivable, we ended the quarter with total A/R of $190 million, resulting in a DSO of 51 days, which is down from 54 days in Q2 and up slightly versus 50 days in Q3 last year.
Inventory turns in Q3 were 5.2x, compared to 5.6x in Q2 and Q3 last year. We generated $48 million in operating cash flow in the quarter. On a trailing 12-month basis, our operating cash flow was $243 million. With approximately $3.60 in cash per share as of the end of Q3, our current enterprise value is approximately 4.25x our trailing 12 month operating cash flow.
Moving to headcount, Polycom had 3,733 employees at the end of Q3, essentially flat from the end of Q2. By expense area, we had the following number of employees: cost of goods, 754; sales and marketing, 1,282; research and development, 1,112; and G&A , 585. This excludes approximately 217 employees that are part of the EWS business.
We just announced an update on the EWS divestiture. Rather than pursuing costly and uncertain litigation, we have reached the following settlement with the purchaser. The agreed terms are a sales price of $53 million cash up front, subject to adjustments for cash, debt, and working capital as set forth in the purchase agreement and an EBITDA based burnout of up to $57 million over the next four years. The targeted close date is on or before mid-December 2012.
Moving on to Q4 guidance, the following key assumptions are reflected in our Q4 guidance. We just announced a very broad-ranging set of new products that will supplement and extend our existing portfolio. We will continue to invest in product development and sales and marketing activities at current dollar levels as we expect to bring these products to market in Q4 2012 and the early part of 2013.
North America is performing well. However, we experienced a slowdown in China in Q3 and we believe this will persist through Q1 2013. Our position in China is excellent, with over 50% market share, but we see some slowdown due to the leadership and policy transition.
Based upon the above factors, our Q4 guidance for continuing operations is as follows. Revenue ranging from $345 million to $355 million with the key variable being levels in APAC. Non-GAAP gross profit margins ranging from 60.0% to 60.4% of revenues. Total non-GAAP operating expenses ranging from 50.5% to 49.9% of revenues. Non-GAAP operating income ranging from 9.5% to 10.5% of revenues. A GAAP tax rate of 21% and a non-GAAP tax rate of 21%. Share count of an estimated 179 million diluted shares, exclusive of share repurchases. GAAP EPS ranging from a loss of $0.03 to a loss of $0.01 per share and non-GAAP EPS ranging from $0.14 to $0.16.
We are holding our Q4 non-GAAP EPS guidance midpoint consistent with current Q4 consensus EPS while adjusting our revenue assumptions for the reasons just discussed.
Now let me turn the call back over to Andy for closing comments.
Thank you Eric. As I said before, Polycom is executing well and growing market share. We believe that our recently announced product launches are significant as we extend our reach with software, cloud, and web-based solutions. As we enter Q4, we are coming off the largest and most important launch of breakthrough solutions in Polycom’s history, as well as the history of the unified communications and collaboration industry.
We are introducing a series of new products that will create new addressable market space for Polycom. Specifically in SMB, where our portfolio is compelling it will be sold through our existing channels. We expect to exit 2012 very well-positioned versus our competitors and with greater addressable market opportunity in the more rapidly growing cloud and software segments of the unified communications and collaboration market.
In Q1 next year, we will be launching cloud access, which will allow us to enter the video collaboration as a service space, and we will create an additional $2 billion of new TAM. We fully intend to lead in cloud-based enablement in the UC&C market. We have strength in many areas, including North America, and we are holding our Q4 non-GAAP EPS guidance at current consensus.
In summary, I’d like to thank the shareholders, customers, partners, and employees of Polycom for their continued support and excitement. We have never before been more proud of an organization and the solutions that we are bringing to market. I firmly believe that no company can match the solutions and best user experiences that Polycom offers.
Now, we would like to switch to the audio portion of our call for questions and answers. 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 are subject to many risks and uncertainties.
Is the conference call operator available at this time please?
Certainly. [Operator instructions.] Our first question comes from the line of Bill Choi with Janney Montgomery Scott. Please go ahead.
Bill Choi - Janney Montgomery Scott
I first wanted to see your explanation on the disconnect between the growth rates on UC group and work infrastructure. Typically there’s some level of semblance and selling together. How much of the discrepancy there in the growth rate is due to Halo managed services? And on the UC group side, if there’s anything with the mix between audio versus video. That’s my first question, and then I have a follow up.
As it relates to the Halo managed service, the group system and the platform does not play into that, so there’s no connection between the two. Clearly what we’re seeing in the market is a greater penetration and request for the RealPresence platform as it relates to the network platform and interoperability engine to drive backward and forward compatibility. So we’re seeing some great stickiness for the platform that we offer.
On the endpoints, I think what we’re seeing is a little bit of holdback from customers pre-announcement. I believe now that we’ve made that clear as it relates to HDX and the new group systems, we’ll see that return to a more normal level. Eric?
The only thing I would add on is that the thing that we track most closely is UC platform since that is the core of our advantage. And again, with the group series launch, the 300, 500, and 700 moving through Q4, we expect to recover that and then early next year we’ll be augmenting with the executive desktop. So we feel the product portfolio is perfectly addressing the next wave of needs there.
Bill Choi - Janney Montgomery Scott
Any sense of audio versus video within the group systems, the dynamic on a sequential basis?
Well, the majority of our voice, it would report in the personal line. And so just to calibrate, make sure we’re on the same page, personal was down 3% year over year, group is down 8% year over year. So the personal space and VOIP phones actually did reasonably well. The particular softness that we saw was on the conference room systems, the endpoints. That falls into the UC group category.
Our next question comes from the line of Tim Long with BMO Capital Markets. Please go ahead.
Tim Long - BMO Capital Markets
Just a few on the new product set coming. First of all, could you talk a little bit about what you think this will do to the business model? It sounds like a little bit more software and systems related sales. So should we expect to see a changing margin profile? And then secondly, if you could just talk about the risks. I guess you said maybe there was a little bit of impact before the announcement. But do you think there’s a risk of either cannibalization or a holding off on products in Q4 and into Q1 in anticipation of the new products coming? And I guess associated with that, if you could just update us on where you think the channel and the sales force is as far as ability to sell this new stuff.
Let me answer your second question first, and then I’ll go into the margin and business model. We have spent an inordinate amount of time with our sales team, our partners, and our carrier providers as it relates to training and certification on the new products. We made it very clear that the HDX is the flagship, and it will continue to be, of our group conferencing line, augmented by the group 300, 500, and 700.
So we expect little to no cannibalization. I think we’ve made it very clear where each one of those products play, and I think in the early two weeks since we’ve launched this we’ve seen some very positive clarity from our VARs and from our distributors. So we feel that the risk in that is minimal. We did a lot of work proactively to make sure that would be that way, and provided great clarity in terms of availability of products, the availability date, such as the group 300, 500, and 700, and the 800S virtual edition in the quarter.
So we feel very good about that, and as we talked about on the call, the one area that we probably didn’t foresee - I’m not sure if anyone did - two quarters back, was some of the continued softness in China that we feel is temporary.
As it relates to margin, I’ll turn it over to Eric. We talked a lot about strategy today in terms of how we see the operating model profile play out.
I’m going to list out software products that we announced at strategy day. So software product number one is the 800S virtual edition. Software product number two is the mixed mode SVC AVC option that we are providing for the RealPresence platform. And software SKU number three is the cloud access product.
And we will be positioning these and marketing these like you would expect of an enterprise software product. They will have a high margin, both up front and the maintenance pricing, while still to be determined, you can expect that it will be more at the 20% of list range versus the typical 10% maintenance pricing that we have on pure standalone hardware products.
The second important point about business model is that cloud access allows us to directly enter the video collaboration as a service market, or VCaaS. And at a wholesale dollar level that is a $2 billion market as of 2012. It has a high CAGR, 25%-plus.
And that gives us access to very high new incremental TAM. So three software products upcoming. We can sell them to the existing installed base, 800S, SVC/AVC mixed mode, and cloud access software. They extend the value of existing customers of the RealPresence platform.
Our next question comes from the line of Sanjiv Wadhwani with Stifel Nicolaus. Please go ahead.
[unintelligible] - Stifel Nicolaus
This is [unintelligible] calling in for Sanjiv Wadhwani. I had more of a high-level type of question. With the Q3 results, just wanted to get a sense for if you feel that we’ve kind of hit the bottom and Q4 and Q1 are going to take off. And the second part of my question is that the new products that you announced at the strategy day, are those going to start contributing to the top line beginning in Q1?
I’ll take the first part of that. In regards to “the bottom” it would be a bit presumptuous for us to attempt to do that in the midst of the overall environment, but we’re in the midst of what we think is going to be a very promising new product cycle. And so we have new hardware endpoints, new software products, and breakthrough new technology with cloud access.
The products themselves are becoming available starting this quarter. In fact, we’ve already received the first orders for the new group series. And I think that as we ramp up, we have a chance to push ahead, in what is still, admittedly, a challenging marketplace. But we can’t, again, with any kind of precision call the bottom as being here or not.
We have an adage at Polycom that we are here to make the news, not report the news. So we take a serious ownership of driving the market, and I believe that software and cloud allow customers now to have a choice in terms of public, private, or hybrid.
So again, as Eric said, it’s not our call to call the bottom of any market. However, we feel better than ever as it relates to our Q3 results, our Q4 focus in terms of holding our EPS guidance, despite some softness in China, and just our relentless focus on this new product cycle.
As it relates to the new products, Eric has gone through the availability, the gross margin perspective. As it relates to new markets, we’ve also talked about the TAM. I think it’s important to understand three specific areas. One, on soft MCU, with the virtual edition 800S, we are going right after that market, and we will own that market.
Secondly, as it relates to the small to medium enterprise, which has never been a market for Polycom for the most part, we now have group 300 and the 800S virtual edition to really own the SME and the mid-market. And thirdly, cloud access has received accolades as absolutely the best innovative collaboration solution brought to market to date, and we believe that we will play and lead that market as well.
So I believe that the new products will provide great new TAM, great new opportunity. I can tell you, being in the field almost every day, I can see the sales people, the customer, and the partners having this portfolio to go after any and all competitors is, I think, brilliant in terms of opportunity. So we’ll leave it at that, and move to the next question.
Our next question comes from the line of Kent Schofield with Goldman Sachs. Please go ahead.
Kent Schofield - Goldman Sachs
First off, could you talk a little bit about puts and takes on North American strength in Q3 and kind of your expectations for Q4? And sort of in this context, because obviously as you discussed, you have some improving execution from your sales force, but then there’s a difficult spending environment out there as well. And then maybe on the margin, what’s happening with some of that federal business? Did it slip into Q4, and that’s what you’re looking forward to in terms of some of the North American strength?
We look at North America in three areas, the traditional enterprise, the state and local, or public sector, and then the federal marketplace. Clearly there are macro challenges that exist in all three. However, we saw some very good results and resilience in the traditional North America enterprise market. In the federal space, we saw a good federal result with the exception of U.S. Army as we got into the latter part of the quarter, which I think is clearly stated by many other tech companies as well.
I won’t speak to what did or what did not slip into Q4, but I believe that from a balanced view that we will have a solid quarter in North America across all three areas, enterprise, public sector, and federal in Q4.
Kent Schofield - Goldman Sachs
And then looking at the network infrastructure side versus the UC group system side in terms of the growth rates we’ve seen over the last few quarters, I’m wondering is there a disproportionate number of larger deals on the UC network side that has an impact there?
UC network, we also refer to that as UC platform. It’s the RealPresence platform sales. And that is typically at the center of larger scale deployments, where people are looking to take video collaboration enterprise-wide as opposed to it just being a division or a department implementation. So as we look at the large deals, generally speaking the attach rate for UC platform was very high, and this is where we think we have the most competitive advantage versus anyone else in the space based on its performance, open standards, and interop. So that is definitely a driver in the larger transactions.
Our next question comes from the line of Jess Lubert with Wells Fargo Securities. Please go ahead.
Jess Lubert - Wells Fargo Securities
First, for Andy, I was hoping you could give us an update on Microsoft Lync, what type of traction you’re seeing there. It looks like the UC personal business was up sequentially and I’d love to better understand how much of the strength there is voice pull-through from Lync and what you’re seeing on the video side.
And then second, for Eric, I was hoping you could give us an update on how we should be thinking about the buyback going forward given the proceeds of the enterprise wireless sale that were supposed to be used to fund the increase in the authorization, and it seems like the terms have changed a bit now.
You’re right, we saw some very good traction in terms of personal devices, of which the CX series, that are the purpose-build devices for Microsoft Lync. You saw Microsoft’s recent announcement that the Lync business was up some 40% quarter-over-quarter. And I believe that as Lync continues to gain traction, that is in a very positive interest for Polycom, because of the attach rates of CX to Lync.
Also, the attach rates of the RealPresence platform to Microsoft Lync as being an interoperability engine, providing connectivity outside of Lync to other either call control or enterprise software applications.
So seeing some very good momentum in terms of not only relationship with Lync, but as well as on the CX series attach rates to Lync. And I’ll turn it over to Eric for the buyback.
The buyback that we executed in Q3, just to start with that, was $30 million of shares repurchased. We exited the quarter with $28 million of authorization still remaining. And the EWS transaction, which is expected to close no later than the middle of December, at close we will receive $53 million of cash up front, and that cash will immediately be available to increase the share repurchase authorization that we have. So it will be additive to the $28 million that we have today.
Jess Lubert - Wells Fargo Securities
Andy, just to follow up on Microsoft, would it be fair to assume that the Microsoft business grew sequentially, and could that show up as a 10% customer in 2013?
It is fair to say that it definitely grew sequentially, no question about it. We measure Microsoft as influence revenue, because we sell through a separate channel, so we track that. And it could be a RealPresence platform or CX series devices. So it’s fair to say that based upon the metrics of Lync sequential growth, that yes in fact that business should be sequentially up in 2013 as well. That is correct.
Our next question comes from the line of Jeff Kvaall with Barclays. Please go ahead.
Jeff Kvaall - Barclays
Eric, this is a question that I wanted to get back to from the analyst day. You had suggested earlier in the year that after you’d gotten through some product launches that you would revisit what your opex structure could look like, or what the spending levels are like. Could you, perhaps, enlighten us a little bit about what you see the trajectories are? Is there a period now where you can pull back a little bit on R&D spending or would just move that into sales and marketing? That would be helpful. Thank you.
In regards to the Q4 guidance, we referred to opex as being semi-fixed investments. And in the short term they’re fixed, and in the midterm they’re a bit more variable. So certainly in Q4 and for the very early portion of next year we’d view the R&D investment as being fixed, because A) we have Q4 products bringing to market, we have Q1 2013 products to bring to market, and we have other things such as federal certification. So that is kind of the short term outlook.
Beyond that, I won’t get into 2013 guidance right now, but the expectation is that we’re going to drive overall P&L into higher gross profit margin services and software. We expect to create P&L leverage in that manner, i.e. in terms of gross profit margin expansion, and less so through R&D optimization by way of example. We kind of characterized going after 3 to 5 points in terms of gross profit margin long term, versus 1 to 2 points on R&D. So that’s kind of the sense of the opportunity that we see looking into a mid to long term time horizon.
Jeff Kvaall - Barclays
And then my follow up could be for either one, but as the cloud access business model gains traction, can you help us understand how that’s going to be reflected on your income statement? Is this going to be a solution sale model in the same way that your endpoint sales have been in the past? Will it be more recurring revenue and then ramp slowly, although perhaps at a higher margin? That would be helpful too.
To be clear, RealPresence cloud access suite is an on-premise sale. It is software. And the requirement for deploying cloud access is that you are an existing Polycom customer with the RealPresence platform. So it will fall squarely into the UC platform reporting segment versus personal versus group. And again, we haven’t determined pricing on the product, but think of it as more traditional enterprise software with a higher annual maintenance load. We’ve talked about a 20% annual maintenance versus 10% that we have on pure hardware products today. Final pricing is still to be determined, so I’m not in a position to get into that right now.
Our next question comes from the line of Mark Sue with RBC Capital Markets. Please go ahead.
[Amit Pravu] - RBC Capital Markets
This is [Amit Pravu] on behalf of Mark Sue. Two questions if I may. First, going back to the [unintelligible] collaboration as a service, could you discuss how your customers have received the launch of [unintelligible]? And are you seeing a pause from your customers in the interim?
I’ll take the first part of it. I would say, number one, of all the multitude of new products that we announced at strategy day, the one that received the most interest due to its breakthrough innovation was cloud access, so the feedback from all quarters was positive. Customers, partners, industry analysts, sell side analysts. Now, the thing that I want to come back to is what I said earlier. To deploy cloud access, you need to have an existing RealPresence platform installation. So there’s no notion of cannibalization or tradeoff. This is additive to an existing RealPresence platform purchase. And so that’s a very important distinction that I’d like to make here.
And I would just add on one more that I think is important for everyone, is that we have been selling our RealPresence platform to tier one, tier two, tier three and ITSPs for quite a period of time. In fact, over the last two years. And many of those carriers, we’ve enabled them to light up video as a service in a private or public cloud. What cloud access does is it allows them to simply have a platform on top of that existing platform but adds the word collaboration. So we look at this as video collaboration as a service. We’re not only providing video, but we’re providing all the collaborative elements on top of that, whether it’s content sharing, white boarding, media, etc.
So not only is it a simple software upgrade, but more importantly it really distinguishes ourself from the other video as a service players, whether it’s WebEx, whether it’s GoToMeeting, whether it’s Adobe Connect, or others, because of this unique interoperability, the ability to bring in, off of a presence engine, that consumer or business based application. So very significant to existing customers that have already enabled video as a service to actually make that additive in terms of collaboration simply through software.
Our next question comes from the line of Tavis McCourt with Raymond James. Please go ahead.
Tavis McCourt - Raymond James
Andy, you mentioned China weakness a couple of times, and I’m wondering if you have enough visibility to know if that was in-market weakness or any of the competitors getting more aggressive with pricing or product. And then secondly, a product-related question. You built SVC into the group endpoints, and I’m wondering, for a customer to benefit from that, do they need to buy and upgrade the RealPresence server as well? Or can you get the benefits of SVC just by upgrading your endpoints?
Let me take the first one. I’m intimately involved and have spent quite a bit of time in China. So we have a 53.7% market share in China. I know for a fact that we have not lost share. So this is not an issue in terms of Polycom losing share to a competitor. This is, as we said, very thoughtfully, on the call, all in relation to the government transition and policy transition that is taking place in China, that is causing a pause.
Having spent quite a bit of time with the team in China, and our partners, which frankly between our sales team and our partners we have over 1,400 sellers in China, they believe, and I believe, that this is a temporary issue as we work through procurement cycles as it relates to this transition. And as we said on the call, we’ll pick that up to more normal levels in Q2 of 2013.
But very clearly, not losing share. Have great share. Have an excellent distinguishable product lineup in China, and feel very, very comfortable and confident.
As it relates to SVC, this is a software upgrade. It’s provided in the endpoint. As we talked about on the virtual edition 800S, it runs on an X86 platform. It has, as Eric talked about, SVC/AVC, which is very unique. Multiprotocol. So we’ve had quite a bit of customer interest in terms of upgrading their platform or utilizing the 800S virtual edition product form an SVC/AVC standpoint.
So we feel very comfortable and confident in terms of the backward-forward compatibility of that product and technology. Frankly, it’s best in class and best in industry.
Just to clarify, from an 800S perspective, it’s a brand new purchase. So clearly that’s new software revenue to us. And for the SVC/AVC mix mode for the RealPresence platform, that is an additional incremental purchase for everyone. It is not free under maintenance. It’s a separately priced SKU for which we’ll collect new software license revenue.
Next question please. We have time for two more questions.
Our next question comes from the line of Jason Ader with William Blair. Please go ahead.
Jason Ader - William Blair
I know the endpoint products business was weak in Q3, and I guess you attributed that to people waiting for the new products. But the reality is that business has really struggled all year across not just Polycom but the whole industry. Would you attribute this to unit weakness, or ASP declines? And then second part of the question is what gives you confidence that the ASPs want a road for the room systems market in 2013 and beyond, just given the trends?
I’d be happy to address that question. I would say that as we look at the hardware endpoints in the [unintelligible], which is HDX, the ASP trends are constant quarter-over-quarter. So that’s the first comment. So this is more of a unit demand versus a price point issue.
As we look out to the next several years, we see growth in terms of conference room endpoint systems. The reason being that there’s been a lot of discussion around software clients for endpoints, and the form factor, what you get with a hardware endpoint connected to, you know, a 70-inch plasma is just infinitely better than what you get for a software client on a 14-inch laptop screen.
So we see demand returning. We attribute the pause at this point in time to people considering how exactly do they want to roll out enterprise video in a wholesale fashion. And before they make investments in the dedicated room systems, they want to make sure that they have the Lync strategy mapped out. They have questions about SVC. And they have questions about what should the mix of software clients.
It’s fair to say that we see much more growth ahead on software clients. There’s been a lot written about that. But software clients, to be used effectively to be federated, will have to attach to UC platform technology.
And so we see ourselves making money not only off selling endpoints, the new group series, but also selling RealPresence to [unintelligible] software clients, reliance on Windows 7 environments, OSX, IOS, and Android. This really plays into the BYOD trends.
So we’ll see more growth in the software client in terms of units, much lower ASPs there for software, but all of these hardware and software endpoints attaching to UC platform technology, where we think we have a very compelling advantage and offering.
We have time for one more question please.
Our last question comes from the line of Shebly Seyrafi with FBN. Please go ahead.
Shebly Seyrafi - FBN Securities
So looking at your guidance, you’re guiding, I believe, below consensus on revenue by around $10 million on EPS and line for the fourth quarter. And I’m wondering, you talked about weakness in federal, and Asia. I’m wondering, can you split out that $10 million between federal, Asia, and possibility other buckets?
The September quarter is the big federal quarter, right? It’s the end of the federal year, and that’s where you see the budget flush analogous to enterprise budget flush in the December quarter. So we’re expecting federal to come down. The adjustments to the guidance, the $10 million or so that you’re referring to, the majority or substantially all of that is in China for the reasons that we articulated. Otherwise, we think we’re doing well in North America enterprise and EMEA.
Shebly Seyrafi - FBN Securities
And separately, you talked about increasing your software presence with the 800 SVE mix mode and cloud access. How would you think about your software percentage of revenue now? Is it all just UC platform at 19%? And how do you see your software percentage increasing over the next few years?
I think everything that we sell today is powered by software firmware, and I think what we’re talking about here is with the three new pure software products is a fully abstracted model in the case of the 800S, something that could be run and virtualized in a data center. So it’s the next level up. Cloud access also fits that description, as does the SVC/AVC mode upgrade over time.
In terms of giving a pure software percentage again, we’re just not in a position to give that right now. We are on the cusp of launching these products. We need to get some more data points, but we think they’ll be additive and most importantly accretive to our overall gross profit margin versus where we are today.
So in closing, I’d like to thank everybody for their continued support of Polycom. And we look forward to speaking with everyone real soon. Again, thank you, and have a great day.