So much for the power of positive thinking. A few weeks ago, Polycom (NASDAQ:PLCM) warned investors to anticipate lower earnings than Wall Street expected. But the sting of the soothsaying seemed to have passed yesterday. Investors bought shares with abandon, in hopes that Polycom had perhaps exaggerated its difficulties -- only to unload those same shares after the news broke.

Good news, with some bad
The news wasn't all bad. Operationally, Polycom expanded partnerships with Avaya (NYSE:AV), Cisco (NASDAQ:CSCO), IBM (NYSE:IBM), Microsoft (NASDAQ:MSFT), Nortel (NYSE:NT), Alcatel-Lucent (NYSE:ALU), and 3Com, and expanded its high-definition product line (which management expects to help drive growth in Q4).

Numbers-wise, Polycom came within a single fiber-optic strand of analysts' revised sales target, and it maxed out its own predicted earnings, reporting $0.21 per share. That was no small feat, because Polycom complicated the task of hitting its per-share number with stock dilution. Compared to this time last year, Polycom's share count is up 4.5% -- despite the firm spending $50 million (about 2% of market cap) to buy back shares.

Bad news, with a little good
Turning now to the bad news, in last year's Q3, Polycom split its sales 71% toward higher-margin video products, and 29% toward lower-margin voice. Q3 2007 saw the mix downshift to 61/39, which helped shave 200 basis points off the firm's gross margin, reducing it to 60.2%. (On the plus side, by holding down the percentage of R&D and administrative costs, Polycom was able to recapture that lost margin, and even increase its operating margin by about four basis points.)

Out-and-out bad news
As you can see, I'm pretty ambivalent on most of what Polycom had to say yesterday. For the most part, it was neither wonderful nor horrible. One thing that seems clearly bad, though, is the situation with free cash flow -- important to me because, as I explained on Tuesday, this is the metric by which I value the company. With accounts receivable up 62% year over year, and inventories up 57% -- both much faster than sales are growing -- I suppose it was inevitable that free cash flow would suffer. Still, the magnitude of the decline, with FCF down 19% to $70.6 million so far this year, was a bit of a shock.

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