Video conferencing company Polycom's (NASDAQ:PLCM) earnings are always likely to cause some fireworks because of the company's high-risk, high-reward nature. Some investors will balk at the mention of high risk, while others will warm to the idea of high reward. With Polycom's third-quarter results just in, it's clear that the optimists have won this round -- but not by much.
Polycom beats estimates; guidance was a bit light
A quick recap of the third-quarter earnings and fourth-quarter guidance:
- Third-quarter revenue came in flat at $335.7 million, versus analyst estimates of $334.9 million.
- Third-quarter Non-GAAP diluted EPS came in at $0.22, versus analyst estimates of $0.20.
- Fourth-quarter revenue guidance of $342 million to $352 million straddled analyst estimates of $349 million.
- Fourth-quarter non-GAAP EPS guidance of $0.21 to $0.23 also straddled analyst estimates of $0.22.
Third-quarter revenue and EPS beat estimates, but Fools should note that the midpoint of fourth-quarter revenue guidance is below the market consensus. In addition, management gave fourth-quarter guidance of non-GAAP gross margins of 59% to 59.2%, implying a decline from the 59.4% level he company tachieved in the third quarter.
What Polycom is trying to achieve with its earnings
Essentially, Polycom is competing against the unified communications operations of two giant tech companies: Cisco Systems (NASDAQ:CSCO) and China's Huawei. It also faces a number of small competitors offering cheaper, less sophisticated solutions and even Google's (NASDAQ:GOOG) Chromebox at the low end.
On top of that, there are some structural challenges, with companies increasingly favoring buying outsourced or virtualized, cloud-based infrastructure rather than dedicated hardware solutions. In addition, spending on unified communications tends to be a discretionary activity that companies undertake in expansion mode. That's somewhat at odds with the ongoing cautious spending environment.
While Polycom is finding it tough to grow its revenue line, it's been able to substantially increase margins and profitability, through a combination of cutting costs and using its cash pile to buy back shares. The plan is to increase margins in a time of sluggish top-line growth.
Polycom earnings analysis
We've covered the headline data, but the devil is in the details.
- Product revenue declined 1%, while services increased 1.8%.
- Non-GAAP gross profit increased 0.4%, with a margin of 59.4%, versus 59%.
- Non-GAAP total operating expenses as a percentage of revenue came in at 47.9%, versus 51.4%.
- Non-GAAP operating margin was 11.5%, versus 7.7%.
- Non-GAAP net income increased 50%.
- Trailing operating cash flow reached $164 million, representing 12.7% of Polycom's enterprise value (market cap minus net cash).
- Net cash and investments totaled $399 million, representing 25.6% of Polycom's market cap.
All comparisons are made on a year-on-year basis, and market cap and enterprise value figures are at the close of trading on the day of the results. Running through this extensive list helps to flesh out the investment proposition and shed light on whether Polycom is achieving its aims.
Flat revenue is never a good thing, and Fools should note the decline in product sales. Service sales tend to be higher margin, but in the long term, if a hardware-based company can't grow product sales, it will struggle to grow service sales, too. The gross margin increase is OK, but it's not enough to imply that the company has any pricing power. With companies such as Cisco and Huawei competing with it in a tough market, Polycom is likely to continue to struggle to increase gross margin.
The really impressive figure is the decrease in operating expenses as a percentage of sales, which led to an impressive increase in operating margin and net income. Clearly, the company is achieving its aim of increasing margin, but how much longer can that last?
Finally, the cash-flow figure demonstrates how cheap the stock is. By my calculation, Polycom's trailing free cash flow is around $113 million, representing around 8.8% of its current enterprise value. In other words, even with no growth, investors can expect to see the company return 8.8% of the company's value -- not bad at all. Moreover, the company holds around 25% of its market cap in cash. The stock remains an intriguing value proposition and turnaround prospect.
All told, it was a mixed set of results for Polycom. The company is increasing operating margins, but it's also struggling to generate revenue growth and pricing power. Furthermore, it operates in an industry where innovation is important -- it can't cut costs forever. The guidance was a little light as well. On balance, though, this was a positive set of results from a company facing challenges.