Polycom Outperforms, Shares Surged

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Yesterday, after market close, Polycom Inc. (NasdaqGS:PLCM - News) declared outstanding financial results for the fourth quarter of 2011. Polycom’s latest software-centric business model has significantly raised its overall market opportunity. Despite facing competitive pressure from Cisco Systems Inc. (NasdaqGS:CSCO - News), the company’s RealPresence software businesses grew 45% in the previous quarter. Polycom, the most vital partner of Microsoft Corp. (NasdaqGS:MSFT - News), provides hardware for Microsoft’s video chat and VoIP software, Lync, which can be used to replace traditional phone systems.

We believe the massive success of Lync has also helped Polycom to expand its top line. Management expects strong growth in 2012 from the emerging markets. In synergy with these positive factors, the stock price of Polycom raised by an enormous $2.58 (14%) in the after market trade on NASDAQ to $21.

GAAP net income in the fourth quarter was $49.6 million or 28 cents per share compared with a net income of $33.1 million or 19 cents per share in the prior-year quarter. However, adjusted (excluding special items) EPS in the reported quarter was 30 cents, miles above the Zacks Consensus Estimate of 21 cents.

Total revenue in the fourth quarter of 2011 was a little over $407 million, up 20% year over year, surpassing the Zacks Consensus Estimate of $402 million. The year-over-year increase in revenue is mainly due to growing sales in the international markets. 

Geographic Distribution of Sales

In the fourth quarter of 2011, the American region generated approximately $193.8 million of revenue, up 7% year over year. Europe, Middle East, and Africa generated $109.7 million, up 28% year over year. Asia Pacific region accounted for the remaining $103.5 million, up 42% year over year.

Margins

Gross margin in the reported quarter was 60% compared with 59.8% in the year-ago quarter. Operating expenses in the fourth quarter were $199.9 million, up 19.3% year over year. Quarterly operating margin was 10.8% compared with 10.5% in the year-ago quarter. Management expects the company’s operating margin to be in the range of 18%-20% in 2012.

Balance Sheet

At the end of fiscal 2011, Polycom had nearly $591.6 million of cash & investments and no outstanding debt on its balance sheet compared with $535.7 million of cash & investments and no outstanding debt at the end of fiscal 2010.

Cash Flow

During fiscal 2011, cash flow from operations was $299.6 million compared with $143.4 million in fiscal 2010. Free cash flow (cash flow from operation less capital expenditure) in fiscal 2011 was $230.3 million compared with nearly $74.1 million in fiscal 2010.

Emerging Markets Hold the Key

Polycom expressed its high hope for the emerging markets, such as Brazil, Russia, India, and China, the Commonwealth of Independent States, the Middle East, and Africa. Most of these countries are offering new opportunities, while the developed North American region is mainly providing sales from the company’s existing client base. Polycom is realigning its market and sales force in this region to resolve the poor execution.

However Competition Looms Large

The uniform collaborative communications market is fiercely competitive resulting in cut-throat pricing strategy. Ciscobecame a major player after its acquisition of Tandberg TV. New players such as Logitech International S.A. (NasdaqGS:LOGI - News) and Microsoft, despite being a partner of Polycom, make the competitive landscape more intense.

Logitech entered into video conferencing market through the purchase of LifeSize Communications Inc. Further, Logitech acquired Italian firm Mirial, a leading videoconferencing solution provider to offer video-calling on tablets and other mobile handhelds. Microsoft decided to acquire Skype, a leading developer of free video-calling software for PCs and other digital devices. Acquisition of Skype will enable Microsoft to offer videoconferencing from desktop computers.

Our Recommendation

As of now, Polycom remains the only pure play unified collaborative solutions provider. The company stands to gain as enterprises, governments, and educational institutions increasingly recognize the productivity-enhancing benefits of video conferencing. We thus maintain our long-term Outperform recommendation on Polycom.  On the other hand, intensely competitive nature of the videoconferencing market is the major cause of concern. As a result, Polycom holds a short-term Zacks #3 Rank (Hold) on the stock.

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