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Executives

Greg Klaben - Vice President of Investor Relations

S. Kenneth Kannappan - Chief Executive Officer, President and Executive Director

Pamela J. Strayer - Acting Chief Executive Officer, Chief Financial Officer and Senior Vice President

Analysts

David M. King - Roth Capital Partners, LLC, Research Division

Gregory Burns - Sidoti & Company, LLC

Jeremy Henrard - Avondale Partners, LLC, Research Division

Michael Latimore - Northland Capital Markets, Research Division

Tavis C. McCourt - Raymond James & Associates, Inc., Research Division

Josh Goldberg

Plantronics (PLT) Q4 2013 Earnings Call May 7, 2013 5:00 PM ET

Operator

Good afternoon. My name is Jeremy, and I will be your conference operator today. At this time, I would like to welcome everyone to the Q4 Fiscal Year 2013 Conference Call. [Operator Instructions] I will now turn the call over to the Vice President of Investor Relations, Greg Klaben. Mr. Klaben, you may begin your conference.

Greg Klaben

Thanks, Jeremy. Good afternoon and thank you for joining us today. Welcome to Plantronics' call for the fourth quarter and full fiscal year 2013. Joining me today are Ken Kannappan, Plantronics' President and CEO, who's on a temporary medical leave of absence; and Pam Strayer, acting CEO and Senior Vice President and CFO.

I'd like to remind you that during the course of today's conference call, we may make certain forward-looking statements that are subject to risks and uncertainties as outlined in today's press release. As we've highlighted before, the risk factors in our press release and SEC filings are not standard boilerplate. We update these risk factors every quarter for significant changes, adding and dropping language and changing the order depending upon the timing and potential impact of the concerns that we foresee. We believe forecasting results of operations is difficult and we ask you to focus particular attention on these risk factors that could cause actual results to differ materially from those anticipated by any such statements.

For further information, please refer to the company's forms 10-Q, 10-K, today's press release and other SEC filings. For the remainder of today's call, will be providing only non-GAAP metrics related to gross margin, operating expenses, operating income, net income and EPS. We have reconciled these measures in our earnings press release and in our quarterly analyst metric sheet, both of which are available on Plantronics' website on the Investor Relations page.

Unless stated otherwise, all comparisons with the fourth quarter of fiscal 2013 financial results are of the same quarter in the prior fiscal year. Plantronics' fourth quarter fiscal 2013 net revenues were $204.2 million compared with guidance provided on January 29th of $190 million to $195 million. Plantronics' GAAP diluted earnings per share was $0.67 compared with $0.55 in the same quarter of the prior year and guidance of $0.63 to $0.67.

Non-GAAP diluted earnings per share for the fourth quarter was $0.71 compared with $0.62 in the prior-year quarter and guidance of $0.68 to $0.72. The difference between GAAP and non-GAAP EPS for the fourth quarter consists of stock-based compensation charges and restructuring and other related charges, all net of the associated tax impact, the tax benefits from the expiration of certain statute of limitation and the retroactive reinstatement of the us Federal R&D tax credit related to calendar year 2012.

With that, I'll turn the call over to Ken.

S. Kenneth Kannappan

Thanks, Greg. I'd like to first cover my health and leave of absence. I'm currently undergoing treatment to address cancer. My treatment may not always permit me to work. When I'm able to do so, I will. During my leave, Plantronics is well led by Pam, our CFO and acting CEO, and is well qualified to execute on our strategy and run day-to-day operations. Also want to disclose that I have $200,000 in stock options expiring in the next 6 months, which I intend to exercise and sell, due to their pending expiration.

During fiscal year 2013, we achieved financial records in revenues, operating income and earnings per share. Net revenues grew by 7% during the year to $762 million and earnings per share grew by 5% to $2.77. Unified Communications continues to be our company's key growth driver. Revenues from our UC product portfolio grew by 40% from the previous fiscal year to $131 million, represented 24% of our office and contact center revenues, up from 18% for fiscal year 2012.

Our innovation and breakthroughs in contextual intelligence and other product features and enhancements has spurred this growth and have allowed us to maintain a premium position in the market. Overall, OCC revenues grew by 3% for the full fiscal year to $549 million.

Our fourth quarter revenues and earnings per share also grew as we experienced some rebound in the global economy in the period, with all major geographies showing year-over-year growth. As expected, UC revenues increased in the quarter. In addition, core OCC revenues, excluding UC products, grew on a year-over-year basis for the first time in 6 quarters.

In mobile, the enforcement of the hands-free driving law in China helped us deliver strong results. While the March quarter benefited from a surge in sales since enforcement for the law commenced, we believe sales will decline from that level in the June and subsequent quarters.

UC remains our largest opportunity. We remain as confident as ever, the continued growth in the market, and our ability to maintain leadership position. We believe UC momentum is building, and based on numerous IT department surveys, a large number of enterprises have initiated adoption and deployment of the technology, and many more intend to do so. Our confidence in UC as a continued growth driver for Plantronics, remains strong, particularly as it is starting to become a transformative technology for enterprises. Enterprises are adopting UC today for 2 primary purposes. The first embraces UC as a communications tool, enhancing productivity through better and more efficient communications, reducing communications real estate footprint and other travel cost. The second use UC as a means to dramatically transform an organization, by enabling a more fluid office structure and encouraging organizational leaders to rethink office processes and culture. The traditional view of an office is changing because UC permits organizations to move beyond decades of fixed offices that are a holdover from older cultures and processes. UC enables enterprises to modify old processes, workloads and work styles, allowing organizations to become more productive and more dynamic and, ultimately, more innovative. Enterprises adopting UC promote both remote work, which can be done anywhere, and collaborative work, which takes place in an office environment, with the different office configurations to accommodate different types of collaborative work. In an office, spaces matter, and UC makes a large assortment of work environments possible. Leading-edge organizations are becoming more innovative through better structured and unstructured collaboration, as a result of cubicle and office walls coming down. In addition, we believe that this new work environment offers a competitive advantage in attracting talent who prefer a less structured workplace and more flexible work style.

For Plantronics, UC means more endpoints and an increase in the number of audio devices attached to computing devices. We estimate that more than 3% of office workers are using UC today. However, indications from IT departments suggest that many more in the process are considering moving to UC in the next 5 years.

In this changing landscape, our products can facilitate UC adoption by improving the overall user experience. Our products allow users to communicate more effectively by highlighting user availability or presence, and our software development platform allows UC vendors and software companies to refine their solutions by integrating our contextual intelligence capabilities. Our strategy is to be more than a simple end point, by adding value to workflow and productivity. Our software does more than enhance basic communications functionality. By integrating our contextual intelligence to their solutions, our partners are able to quantify incremental productivity gain. One recent example is an integration of the contextual intelligence we provided with Cisco's Finesse call center management software. This software is designed to ease contact center agent workflow and boost productivity. To achieve this integration, Cisco utilized our Spokes software developers kit to capture the data our headset sensors provide as to when an agent is wearing a headset. The software automatically logs the agents on and off when they wear a headset, and again when they take them off. Additionally, each agent's headset has a serial number, which is linked to the Finesse database. When the headset is placed on the ear, the agent is automatically put in the call queue. The result is achieving immediate availability of an agent and save time on the agent's part, an estimated 30 hours per year, making the headset itself free.

Integral to our core research and development in fiscal year 2013, we continue to invest in firmware and software engineering to enhance the broad compatibility and contextual intelligence we provide in the UC ecosystem. Our leadership in the market was recently recognized by Frost & Sullivan in March. We received their Visionary Innovation Award in recognition of our accomplishments in Unified Communication and collaboration in customer care markets.

As we do each year at this time, we've updated our 5-year market model of growth opportunities that Greg will review with you later. We plan to continue to invest to lead in UC, while also targeting our long-term, non-GAAP operating margin target of 20% to 23%. Our goals for fiscal 2014 are to deliver profitable growth, to extend our brand, to expand our consumer reach, to scale for growth and to optimize our culture. We believe these goals will allow us to continue to increase stockholder value and cash flow generation. On behalf of everyone at Plantronics, I want to thank you for your continued support. I would now like to turn the call over to Pam to discuss the fourth quarter and fiscal year results in more detail.

Pamela J. Strayer

Thanks, Ken. I want to start with an overview of financial results for the quarter and for the full fiscal year before diving into the detail.

Fourth quarter net revenues were $204.2 million, representing 15% growth over the prior year and a new record for quarterly revenues for Plantronics. Non-GAAP operating income of $41.9 million is an increase of $5.7 million or 16% versus a year-ago. Non-GAAP EPS of $0.71 is $0.09 higher, an increase of 15%.

Turning to the results for the full fiscal year. Although we faced economic headwinds in the first half of the year, a stronger global economy in the second half of the year, combined with growth in our UC revenues throughout the year, led to fiscal year '13 net revenues of $762.2 million, an increase of 7% over the prior year. Non-GAAP operating income was $160.4 million, an increase of 1%, and non-GAAP EPS of $2.77 is an increase of 5% over fiscal year '12.

Turning back to the results for the fourth quarter, I'll cover revenue in more detail. Total net revenues for the fourth quarter of $204.2 million were up $26.6 million or 15% compared to the fourth quarter last year. While all of our regions experienced healthy growth, the revenue strength in Q4 was led by our APAC region, which grew 66% overall, and more than doubled its revenue in mobile as a result of the enforcement of the hands-free driving law in China.

The Americas grew 7%, driven primarily by strength in UC over the prior year. Our Europe and Africa region also had a good quarter and posted overall growth of 16%, with good growth in both OCC and mobile.

Now, I will cover key product line comparisons to Q4 last year.

OCC net revenues of $142.7 million were up roughly $12 million or 9%. Net revenues from OCC products had good growth in the Americas and in the Europe and Africa region, but were flat in Asia-Pac. UC was the major driver of worldwide OCC growth, up roughly $10 million or 36% over Q4 of the prior year, with strong double-digit growth in both the Americas and Europe and Africa region.

Revenue from core OCC also grew by about 2%, on certain of our CS line of wireless office products.

Net revenues from mobile products were up roughly $15 million and 41% growth rate compared to Q4 last year. By far, the largest contribution came from Asia-Pac where Chinese demand for the hands-free mobile devices drove strong sales in the mono-Bluetooth category.

Europe and Africa also showed strength in mobile, with strong year-over-year growth, helped by the Q4 launch of the Voyager Legend in that region.

I'll make a brief comment about our sequential results. Due to the seasonality in our business, we focus primarily on quarterly results compared to the same period in the prior year. Although the demand spike for mobile products in China created an usual situation in which mobile revenues in the March quarter exceeded those in the seasonally strong December quarter. Worldwide, revenues from mobile products grew by $5.7 million or 13% over the prior quarter, with Asia-Pac mobile revenues up $8.5 million, sequentially, and the rest of the world flat to down from the December quarter.

Non-GAAP gross margin was down 160 basis points in the fourth quarter compared to the fourth quarter of the prior year, due primarily to the strong shift in our product mix toward lower margin mobile products. The composition of our revenue was similar to the mix we would typically expect in a December quarter. Several other unusual items this quarter, when added together, caused a drag of approximately 50 basis points on our gross margin. We paid a legal settlement related to IP infringement on one of our supplier's components that is classified as COGS. In addition, we deferred revenue on sales to a customer due to concerns about collectibility. However, the related cost of goods are recorded. These factors result in a non-GAAP gross margin, for the March quarter, of 52.3%, up 10 basis points compared to the December quarter.

Non-GAAP operating expenses were $64.9 million in the fourth fiscal quarter, up $5.5 million versus the prior Q4, and dropping from 33.5% of net revenues a year ago, to 31.8% in the quarter just ended. The major drivers of the $5.5 million increase were headcount associated with R&D investments and expansion of our sales and marketing capabilities around the world. We also funded year-over-year compensation increases for associates, arising from annual merit increases and also from increases in variable compensation due to stronger performance versus our operating plans we had achieved in fiscal 2012.

Our non-GAAP operating margin was 20.5% in Q4, 10 basis points higher than in Q4 last year, on lower gross margins. For the full fiscal year, our non-GAAP operating margin was 21%, squarely within the range of our long-term operating model of 20% to 23%.

Our effective non-GAAP tax rate for the quarter was 27% compared to 26.5% in Q4 of the prior year, tax rate of 27% in the fourth quarter was higher than we were expecting due to a shift in income mix in Q4. As a result, our annual tax rate increased from an estimated 26% to 26.4%. To achieve a full year rate of 26.4%, we took a fourth quarter tax expense of 27% to make up for the lower rate recorded in the first 3 quarters of the year.

Please note that 3 quarters of the R&D tax credit that was passed by Congress in Q4 was recorded as a benefit in our GAAP financial statements, but not in our non-GAAP results as it was considered an unusual item. As a result of all these items, our Q4 non-GAAP net income of $30.5 million was 14% higher than a year ago, yielding non-GAAP EPS of $0.71, up $0.09 from last year's Q4 results.

Now, I want to say a quick word on Q4 results versus the guidance we communicated on January 29th. Although we significantly over-achieved on the revenue line relative to our guidance, several unusual events dampened the impact on EPS. The higher mix in mobile revenues, legal settlement and deferred revenue mentioned earlier lowered our gross margins from what we expected. The operating expense was higher in sales commissions and bonus expense due to the higher revenue results, and the tax rate was higher due to shift in our income to more highly taxed geographies.

Moving onto the balance sheet and cash flow highlights. We finished the fourth quarter with $426 million in cash and investments on our balance sheet and generated approximately $32 million in cash flow from operations during that period. Of the $426 million in cash and investments at quarter end, $25 million was domestic. DSO remained flat at 57 days compared to year ago and up from 51 days sequentially. In our fourth quarter, billings are typically more heavily weighted towards the second half of the quarter, which increases DSO in those quarters. Therefore, the increase in DSO from Q3 to Q4 is a seasonal pattern that is expected.

Net inventories were up $14 million versus a year ago, and roughly flat from December, at $67 million. Inventory turned slow, from 6.1 a year ago to 5.8 in the quarter just ended, primarily resulting from a large one-time purchase of discontinued parts during the year. Occasionally, these one-time purchases are necessary to secure components for popular products, which are no longer going to be produced by our suppliers. Financial lead turns were slightly higher than 5.6 in the December quarter.

Turning to our capital expenditures. Our Q4 spending was $9.9 million or 4.9% of net revenues, bringing year-to-date capital expenditures to $39.3 million or 5.2% of net revenues. Depreciation expense on a GAAP basis for Q4 was $4.3 million and amortization expense was a couple of hundred thousand. Depreciation expense was $1 million higher than in the fourth quarter last year, most of this increase was due to accelerated depreciation of leasehold improvements related to 2 different projects.

The first relates to our lease factory sites in Tijuana, Mexico, which we plan to vacate once construction of our new manufacturing facility is completed later this year. The second project relates to the restructuring plan initiated in the fourth quarter and announced in our third quarter earnings release. The restructuring includes a move out of leased office space adjacent to our Santa Cruz facility by the end of May.

During fiscal year 2013, we generated $126 million in cash from operations. In addition, we returned $17 million to Plantronics stockholders through regular quarterly dividends, approximately $8 million more than we paid out in dividends during fiscal year 2012. We also paid out the entire $37 million previously outstanding balance on our revolving credit line, while repurchasing 752,000 shares during the year, all while maintaining fully diluted shares outstanding at roughly the same levels as which we ended fiscal year 2012.

Plantronics' balance sheet, cash flow and business model remained strong and we are happy with how the company is positioned. In summary, we had a good Q4 and fiscal year 2013. Our investments in UC will continue as we see excellent prospects for growth in that category and a large market opportunity ahead, which Greg will cover next. Our investments in mobile products have paid off as we were well positioned to take advantage of the increase in demand in China this past quarter, and we expect a higher level of mobile business to continue in China into fiscal year 2014.

Turning to the outlook. There continues to be mixed economic news. Macroeconomic environment remains uncertain. Concern has increased that we will experience a third year where the economy slows down following a more optimistic first calendar quarter. Further, the effects of federal government spending reductions, known as the sequester, are only beginning to impact the overall economy due to the manner in which these cuts are being implemented by the government, affected agencies and our contractors.

We believe total net revenues for our first fiscal quarter ending in June will be in the range of $198 million to $205 million. This forecast assumes that the initial peak sales we experienced in China, from the January 1, 2013 enforcement of the hands-free law, will recede and mobile revenues in that country will return to a run rate somewhere between the peak and normal quarterly sales prior to the enforcement of the hands-free law.

Depending on revenue mix and other factors, we believe non-GAAP operating income will be approximately $40 million to $44 million. The outlook anticipates operating expenses inclusive of litigation costs related to the lawsuit with GN Netcom. For purpose of calculating the funding of our executive and associate bonus plans, the cost related to this lawsuit will be excluded from our target and our results. We have chosen to do this so that we may continue to promote the growth of our business and reward our employees for achieving goals and objectives that benefit the company and our stockholders without penalizing employees and executives for the cost of this type of competitive litigation, which we believe to be without merit.

Please note, however, that this litigation expense does not meet our criteria for removing from our non-GAAP results. Therefore, it this included in our non-GAAP forecast below. Based on all of the above, we currently expect non-GAAP EPS to be $0.68 to $0.74 per share on average diluted shares outstanding of approximately $43.8 million. The GAAP reconciling items we expect in the coming quarters include approximately $7 million in stock-based compensation expense, accelerated depreciation and restructuring cost of about $0.12 EPS. Therefore, we expect GAAP EPS of $0.56 to $0.62 per share for the June quarter.

For fiscal year 2014, we expect capital expenditures to be between $48 million and $52 million. The plan includes capital expenditures related to our building consolidation project in Mexico, as well as the capitalization of software costs related to our Oracle R12 implementation. We expect the tax rate for fiscal year 2012 to be 26.5%. However, the actual rate will depend on a number of factors, including our income mix by geography.

Our long-standing philosophy has been to return cash in excess of our operating needs to our stockholders through quarterly dividends and through stock repurchase programs when we believe that stock repurchases will be accretive over the long term. Our management team and our Board of Directors continue to have a strong conviction on our growth prospects, business model and cash flow generation capability.

With that, I'll turn it over to Greg to discuss the long-term market model.

Greg Klaben

Thanks, Pam. At the beginning of each fiscal year, we update our total addressable market and growth expectations over the subsequent 5 years. Working with industry analyst firms Frost & Sullivan and Strategy Analytics, in addition to our own estimates, we have updated the average compound annual growth rate expected for our markets from calendar year 2012 to calendar year 2017. I'll walk you through the total addressable market now, and if you haven't already seen the new IR presentation with the slides, they are available on the IR section of our website.

I'll start with Slide #22 in our IR deck. We sized our total addressable market at $2 billion in calendar year 2012, growing to $3.7 billion in calendar year 2017, for an overall CAGR of approximately 13%. The Office and Contact Center market was estimated to be $950 million in 2012, growing to $2.1 billion in calendar year 2017, for a CAGR of 16% to 17%. The consumer portion was estimated to be $1.1 billion in 2012, growing to $1.6 billion for a CAGR of 7% to 8%.

The next slide, #23, shows OCC expectations in greater detail. As a reminder, OCC represented 72% of our revenue in fiscal 2013. The growth rates for UC, Office and Contact Center are all unchanged from last year, but the overall CAGR for the total addressable market for OCC is higher, 16% to 17%, as a result of the faster growing UC market becoming a larger part of the total market opportunity, and the beginning and ending years moving out 1 year. This compares to last year when we had forecast 13% to 14% OCC growth for the subsequent 5-year period. Our key driver of overall growth and the key driver for OCC market growth is Unified Communications. Our growth rate expectation for the UC market is unchanged from the model we provided last year, at 40% to 42%. The UC market is expected to grow from $237 million in 2012 to $1.3 billion in calendar year 2017.

I'd like to walk through what we've said about the UC market opportunity in the past and the revenue expectations for Plantronics.

When we first introduced the market opportunity for UC 4 years ago, in the spring of 2009, we forecast that it would be an opportunity of approximately $350 million in incremental revenue to Plantronics in calendar year 2014. On last year's fourth quarter call, when the 5-year model moved out a year to calendar year 2016, we indicated that we would not be providing guidance for specific years, but that we were confident in more than $350 million UC revenue for Plantronics in calendar year 2016. We reiterate that confidence, and we believe that the revenue opportunity for Plantronics will be much larger than $350 million in calendar year 2016. But we will not be providing specific guidance for that year. This year's model goes through calendar 2017 and indicates a UC market size of approximately $1.3 million -- $1.3 billion that year. Our expectation and assumption is that we will maintain our strong positioning in UC based on our in-depth market knowledge and leading product innovations.

If you jump to Slide 25, you can see the underlying assumptions for Unified Communications in calendar 2017. As you know, different firms have different definitions of Unified Communications. Our narrower definition of UC requires that voice capabilities have been activated and in use, and not simply licenses sold. And so the basis for our market size estimate is $84 million active voice licenses. A voice license is per person, so I'm using Lync 2013 on my Mac, my iPad and my iPhone, but it counts as one license in our model. We're estimating an attached rate of 63% for headsets to active UC voice licenses in 2017. Note that this is the expected attach rate in the year 2017, and that it is expected to grow over the next 5 years.

Today, we have a slightly lower attach rate, but expect it to grow as enterprises move form instant messaging to peer-to-peer, then to conferencing and outbound calls via UC, and adopt more soft client-only environments. The bottom line is that headsets remain the first choice for UC deployments and this has been our experience over the past few years.

The estimate for the cumulative total number of headsets sold through 2017 is 53 million, 19 million of that sold in calendar 2017, sizing the market at $1.3 billion. The ASP in the model is approximately $63, which is below ASP which we are experiencing today. The core office market, which excludes UC revenues, is expected to grow from $459 million in 2012, to $471 million in calendar year 2016. And the contact center is expected to grow from $261 million to $338 million over the next 5 years.

The next, Slide 24, covers consumer markets which represented 28% of our revenue in fiscal year 2013. The total consumer market opportunity for us in calendar year '12 was $1.1 billion and is expected to grow to $1.6 billion in calendar years 2017. Last year, we had an estimated growth, for mobile handsets, at 3% to 4% in our model, and that growth rate has been raised to 8% to 9% in this year's model over the next 5 years, as a result of stronger growth expectations for the stereo Bluetooth market. The mono Bluetooth market is expected to be flat to down over the coming 5 years. The gaming market is expected to grow to CAGR of 3% to 5%, which is the same CAGR we have previously, and a market expected to grow from $225 million to $275 million. The specialty product category is expected to grow to CAGR 4% to 5%, from $42 million to $53 million.

With that, I'd like to open the call to questions.

Question-and-Answer Session

Operator

[Operator Instructions] And your first question comes from the line of David King of Roth capital.

David M. King - Roth Capital Partners, LLC, Research Division

I guess, first off, can you quantify the benefit, Ken, from China hands-free? And then it sounds like, from your comments, Ken, that you don't expect that to continue at the same level but should be higher next quarter than it was kind of prior. I guess, can I get some context around that? Is it fair to assume that that's going to fall off of at the same rate as it did in California when the hands-free laws were enacted or is your assumption that it's going to fall off at kind of a lesser pace.

Pamela J. Strayer

Yes. So, sorry, first of all, just to be clear, we did a hit peak in Q4 and we expect revenues from the China hands-free law to go down from there, not up. So, to quantify it, we don't really provide details at that level. I would just say, take a look at Asia-Pac region overall, and the growth there, year-to-year, is primarily driven by the mobile hands-free law.

S. Kenneth Kannappan

I'll just give a little bit of comment on the outlook. These hands-free laws typically have had a 3-month peak. And we were not entirely sure how that would play in China given that there was a little less advanced notice that the enforcement was really going to be serious at the beginning of January. Now we did have some increase in the December quarter prior to that, but not at the level that said, yes, this is definitely going to really be enforced and people are going to follow it. We had a huge spike in that quarter and we have already seen the sell-through rates have declined significantly. At this point, it's still too early to say whether they settle out at the type of run rate that we've seen in developed markets or not. There are some dynamics that are different in China. So, we're not 100% sure. It'll take more time for us to know. But, in all of these hands-free laws, what we've seen is that there is some enduring benefits. One of them is that the run rate forever stays higher, and the second one is that headsets, as a category, become much more broadly accepted and it's not just limited to use in the mobile environment. It winds up pervading how people view headsets for use in the office as well, and that's very significant long-term benefit for us.

David M. King - Roth Capital Partners, LLC, Research Division

And then maybe switching gears a bit. Forgive the background noise. Looks like growth in traditional OCC business is accelerating. I guess, can you talk about what's really driving that? Is that better trends on the unemployment front? Is that specific regions around the world that might be driving that? Is that mainly from new wireless line? Just any color on that will be really helpful.

S. Kenneth Kannappan

Sure. First of all, I think that the OCC business had been beaten down, really, on the traditional side, for some time. So, I think that it had gotten relatively close to a trough level. Now I don't want to say that we have necessarily concluded that this is a rebound that's here to stay. I mean, I think that the economic environment remains volatile. I mean there's good news 1 day and bad news another day. And in the case of Europe, sometime we think, my gosh, it's just got to be at the bottom, and then lo and behold other bad news comes out. In the case of U.S., I think we've been feeling that there's been a recovery underway, but at the same time we still have this looming issue of the sequester, which is all those cuts are supposed to be in place by October 1, and how those start to reel in, we don't know for sure. So, I think that we're somewhat cautiously optimistic that we've got a lot more upside than downside in the OCC market, and at the same time, both Americas and Europe had good quarters there. Europe a little bit more than we suspected that we would have, and so I think we're hopeful. But we're not sure, at this point in time, that the labor market is that robust, that we can bet on. I do think that the housing market has improved in the U.S., and the improvement in mobility is another positive from the standpoint for replacement rates.

Operator

Your next question comes from the line of Greg Burns of Sidoti & company.

Gregory Burns - Sidoti & Company, LLC

Just another question in regards to China. Did you have any supply constraints in the quarter and are you changing anything in your supply chain to meet the increased demand going forward?

S. Kenneth Kannappan

Well, first of all, everyone had supply constraints in China during the quarter. Because the truth is almost everyone was taken by surprise with the level of enforcement that occurred at the beginning of the year. And so products were sold out from all vendors. I mean, really, anybody who could supply initially was going to get some sales. I think we've managed to turn it actually better than most and so we got most of our products sold through. I think there were some that arrived at the end of the quarter, with large shipments, and are now trying to get those to work off. But I think we did a nice job on it. I think that at the end of the day, one of the things that make supply chains, in Bluetooth, somewhat inflexible is that the reality is you're dependent upon the silicon, and the silicon has got a lead time as well as a fab time that is very large relative to shipping a lot more products inside a quarter. And since you don't want to be stuck with silicon at the same time that's going to go become fish in a year, you don't operate with a huge inventory of that sort of product. So, in a short cycle, sudden spike type of thing, supply chains aren't going to be able to react. Having said that, I think, overall, we did a good job in meeting supply chain. I think really best in class in the industry.

Gregory Burns - Sidoti & Company, LLC

Okay. And, GN Netcom, talked about -- called out, specifically, a very large UC deal. I think 70,000 headsets or so. Is there any kind of color you could give us around maybe the size of deals or the pipeline? Just kind of give us an idea of just qualitatively what the deal flow looks like.

S. Kenneth Kannappan

Well, I tried to do that during the call and, obviously, we don't tend to go as specific as they tend to do. We continue to see good UC demand. Obviously, we had good results in UC and are continuing to forecast, and up overall business outlook, which reflects these investments in UC. But we don't talk about, ordinarily, specific deals and transactions.

Gregory Burns - Sidoti & Company, LLC

Lastly, Pam, in terms of the litigation expense for GN, can you quantify how big that's going to be next quarter and maybe how many quarters you expect that the recur?

Pamela J. Strayer

Yes. So, we expect expenditure to occur throughout much of fiscal year 2014. We're not quantifying that in our forecast. We're not going to going that level right now.

Operator

Your next question comes from the line of John Bright of Avondale Partners.

Jeremy Henrard - Avondale Partners, LLC, Research Division

This is Jeremy Henrard in for John Bright. I want to ask you about UC. The sequential growth looks like it was a little bit lower than in prior quarters, and I was just wondering how should we think about that. Is there some seasonality or are there other factors there?

S. Kenneth Kannappan

There's always been a certain amount of unevenness in the pace of growth. I think that, for sure, there was the launch of Lync 2013 in the March timeframe. I don't know that I want to say that, that resulted in a lower sequential growth. I actually think perhaps more of it was reflected in a pretty good December quarter that made a higher base relative to the sequential pick up. So, I still think, if you look at it year-over-year and you look at that quarter in relation to the last 8 or 10 quarters, it looks like a pretty good quarter, and the overall momentum in the market still seems positive.

Jeremy Henrard - Avondale Partners, LLC, Research Division

And next question on guidance. Traditional Office and Contact Center returned to growth. How would you characterize that in June? How should we think about that?

Pamela J. Strayer

Well, in preparing our guidance, we still expect UC growth to be strong. Total OCC to be flat to up, but core OCC we're kind of expecting to be flat to down. It's really hard to know given the economic situation.

Operator

Your next question comes from the line of Mike Latimore from Northland Capital.

Michael Latimore - Northland Capital Markets, Research Division

In terms of the government business, have you seen any change in demand from the government sector recently?

S. Kenneth Kannappan

So, if you are referring to sequester, the answer is we haven't really seen the sequester impact yet. We're just anticipating that it's the kind of thing that people have now reacted, the fact that it's in place, that they have to have plans in place in October. One, in that the impacts could start to reach, more likely, in the September quarter or following than they will right away. But it's certainly on people's minds and it's on the minds of the industries that feed into that sector. When we talk government, of course, it's broader than that in that State and local remain a fairly challenged market for us, has been challenged for some time, hasn't gotten necessarily any better.

Michael Latimore - Northland Capital Markets, Research Division

Okay. And then how about -- in China, in the OCC market, I know it's not that big of a segment for you, but just I'm thinking, kind of enterprise OCC in China. Have you seen any kind of increased interest there after we're kind of a few quarters, now, away from the government change there?

S. Kenneth Kannappan

Well, I think that the change in government was a positive in that there's a certain amount of business activity that waits as you have the kind of leadership change and you're trying to figure out but decisions are going to be made. I think they got a little affected, then, by the kind of global economic questions. But, at this point in time, I think that the overall situation, at least from a government perspective, in China, is positive.

Michael Latimore - Northland Capital Markets, Research Division

Okay. I guess just the last question would be, your UC growth rate has kind of been in the mid-30s, mid-40% range for each quarter in fiscal 2013. Is that kind of the right way to think about it going forward or how do we think about the growth rate there?

Greg Klaben

That is -- in our long-term model, we did just over 40% fiscal year '13 over '12. We're forecasting where the market growth is expected to be roughly that 40% to 42%. So, we're expecting that type of growth over the next 5 years at a compound annual growth rate.

Operator

Your next question comes from the line of Tavis McCourt of Raymond James.

Tavis C. McCourt - Raymond James & Associates, Inc., Research Division

I had a question on the -- some of the new numbers on the slide show, the 2017 estimates for the UC business. And what I'm wondering is, I think some of the assumptions there, one of them is 63% headset adoption. How does that compare to what you're seeing today? And then the other one is, I think, there's -- it says 19 million UC audio devices sold, and if you kind of do the ASP on that it's like a $70 ASP or so. I presume that's a much lower ASP than today. So, kind of walk us through what leads to those assumptions.

S. Kenneth Kannappan

Sure. So, Tavis, on the headset adoption rate, we are seeing attach rates similar to that, today, related to Microsoft Lync. We're expecting the attach rate to grow overall today, through 2017, as a result of there being more softphone deployments, and that's what we're seeing as well as what Frost & Sullivan is expecting as well. So, we do expect headset adoption to grow. It is the primary device of choice which is being deployed when UC with voice gets rolled out. In terms of the audio devices sold, the ASP that's -- you get back into in the model, it's actually just not too far below what we're seeing today in ASP. So, we are expecting an ASP decline or that the market forecast is for an ASP decline.

Tavis C. McCourt - Raymond James & Associates, Inc., Research Division

Great. And then, Ken, I guess in terms of when you look longer term into UC, are there new product categories that this opens up for you beyond headset as well or are you kind of head down, no pun intended, focused on just the headset opportunity at this point?

S. Kenneth Kannappan

Well, first of all, in our minds, we've not been focused just on the headset opportunity. We've been focused on our value-add. Now, there's no question that the authenticity of the brand is built upon the strength of our headset business. But we view that as a leverage to add a lot more value in the contextual intelligence solutions that we can bring, and those integrate with a lot of different other software and applications to deliver far more value than is possible through just a headset. I think, that as you look at some of those software value-add, it does naturally carry us even further outside some of that dependency upon the headset as a base. So, we're definitely exploring a variety of long-term growth opportunities.

Tavis C. McCourt - Raymond James & Associates, Inc., Research Division

And when you look kind of at the target model to get to the operating margins, is it a similar mix of R&D and SG&A as we see today or does the business get more R&D intensive over time?

S. Kenneth Kannappan

Well, I think that, that's a good question. So, as we -- let me just say this. This model is based upon the growth of our existing businesses in a very reasonable manner. Some of the evolution of the business that is feasible, into greater software value-add, could result in slightly higher levels of gross margin and R&D. But, for right now, we've not attempted to do that level of work.

Operator

[Operator Instructions] Your next question comes from the line of Josh Goldberg of G2 Investment Partners.

Josh Goldberg

I guess I wanted to ask just two quick ones. One was, you mentioned on the call that the R&D tax credit was actually not included in your non-GAAP number, is that correct?

Pamela J. Strayer

Yes. So, the Q4 benefit is included in our Q4 results, but there's a retroactive benefit that we got from results in the first 3 quarters of the year and 1 quarter in last year, and we would have had to record all of that benefit in Q4, which we did, but we put it in GAAP-only charges. We didn't put it in our non-GAAP results.

Tavis C. McCourt - Raymond James & Associates, Inc., Research Division

Roughly how much was that?

Pamela J. Strayer

I don't know, off the top of my head, to be honest.

Greg Klaben

I'll get back to you, Josh, on that.

Tavis C. McCourt - Raymond James & Associates, Inc., Research Division

A few other tech companies actually include it in their non-GAAP number, that's why I was wondering. And did you say how much of your expenses will be increased in the first quarter because of the litigation with GN Netcom?

Pamela J. Strayer

No. We're not disclosing or forecasting that right now.

Tavis C. McCourt - Raymond James & Associates, Inc., Research Division

Okay. In terms of just the presentation on your website, it says that your Office and Contact Center growth rate, industry growth rate, it'll be about 16% to 17%. Seems a little bit faster growth than what you guys have been doing recently. And this quarter, the March quarter, is really the first quarter where you saw some pretty healthy OCC growth, 9% now, obviously, UC being a part of it. Do you feel confident that you're entering a stage where you're going to have double-digit OCC growth? I mean, if the market expectations are 16% to 17% for you guys to be at least at a 10% growth rate for total OCC seems pretty achievable. I just want to get your sense on that.

S. Kenneth Kannappan

Well, we always like to be conservative. So, when you ask me for confidence, I always like to find something negative. But bear in mind that the last several years, we have been dealing with a downward draft in our OCC business, not primarily due to cannibalization, but due primarily to the fact that the labor market has gotten worse. So, labor participation rates globally are way down, and this is certainly true in Europe, this is even true in the U.S., which has got, supposedly, the best recovery going, and mobility is down. So, we've been having this UC growth that's largely been masked by the deterioration in our additional business. That stops deteriorating. We get more growth. That starts to rebound and we believe it should, and I'm not trying to predict global economic states, then we get a boost upon that. So, I think that when we look at the numbers, they look positive. The other thing, which Greg kind of outlined in the model, is that the UC business, which is growing faster, just naturally becomes a larger portion of our total revenue stream.

Josh Goldberg

Sure. The last one I meant, in terms of the increase in the double-digit growth. I mean, basically, your non-UC business turned positive for the first time in 7 quarters, which was a great start to this calendar year. So, if the market is expecting this type of growth and you're clearly leading in UC, of about 40% top line growth, what would hold you back from -- I mean, you did a 15% top line growth this quarter, double-digit, it just seems like you're back on track on that type of growth rate. Besides the fact of the global economic slowdown, is there anything else that might be a headwind to your ability to continue to grow at these 10% to 15% growth rates?

S. Kenneth Kannappan

Well, I do hope you guys remember that we said this March quarter was a spike for China Mobile. Don't hold that one against us, that is a spike. But, nonetheless, if you exclude that...

Josh Goldberg

You're still double-digits for the year -- for the quarter, year-over-year.

S. Kenneth Kannappan

Okay.

Operator

There are no further questions at this time. Mr. Klaben, I turn the call back over to you.

Greg Klaben

Great. Thanks, everyone, for joining us today. If you have any follow-up questions afterwards, Pam and I will be available. Thanks.

Operator

This concludes today's conference call. You may now disconnect.

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