Plantronics' CEO Discusses F3Q 2014 Results - Earnings Call Transcript

| About: Plantronics Inc. (PLT)

Call Start: 17:00

Call End: 17:34

Plantronics Inc. (NYSE:PLT)

F3Q 2014 Earnings Conference Call

January 27, 2014 5:00 AM ET


Greg Klaben – VP of IR

Ken Kannappan – President and CEO

Pam Strayer – SVP and CFO


Dave King – Roth Capital Partners

Daniel Toomey – Raymond James

Paul Chung – JPMorgan

Mike Latimore – Northland Capital Markets

Greg Burns – Sidoti & Company


Good afternoon. My name is Sharon, and I will be your Conference Operator today. At this time, I would like to welcome everyone to the Q3 FY14 conference call. (Operator Instructions)

Mr. Greg Klaben, Vice President of Investor Relations, you may begin your conference.

Greg Klaben

Thanks, Sharon, and welcome everyone to Plantronics' third quarter FY14 conference call. Joining me today are Ken Kannappan, Plantronics President and CEO, and Pam Strayer, Plantronics Senior Vice President and CFO.

Information presented and discussed today includes forward-looking statements which are made under the Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995. The risks and uncertainties related to such statements are detailed in our most recent 10-Q and 10-K in today's press release.

For the remainder of today's call, we'll be providing only non-GAAP metrics related to gross margin, operating expenses, operating income, net income and earnings per share. We have reconciled these measures in our earnings press release and in our quarterly analyst metric sheet, both of which are available on the investor relations page of our website.

Additionally, after the conclusion of today's call, the recording of the call will be available with the information on our website. Unless stated otherwise, all comparisons of the third quarter FY14 financial results are [to] the same quarter of the prior fiscal year.

Plantronics third quarter of FY14 net revenues were $212.7 million. Plantronics GAAP diluted earnings per share for the third quarter -- third fiscal quarter was $0.80 compared with $0.66 in FY13. Non-GAAP diluted earnings per share for the third quarter was $0.76 compared with $0.73 in FY13.

The difference between GAAP and non-GAAP EPS for the third quarter consists of charges for stock-based compensation and purchase accounting amortization, both net of the associated tax impact and tax benefits with the release of tax reserves, transfer pricing, tax deduction and tax credit adjustments and the impact of tax law changes. Please refer to the full reconciliation of GAAP to non-GAAP in our earnings press release.

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

Ken Kannappan

Thank you, Greg. Our third quarter was marked by strong financial results, progress in strengthening our position in key markets, and progress and support of future growth and organizational agility. Revenue growth of 8% was driven by a rebound in Unified Communications revenue combined with strong Mobile headset sales.

Operating income and EPS were above expectations, aided by stronger than expected gross margins as a result of a one-time benefit that Pam will discuss. In addition, operating expenses were below our expectations due primarily to lower-than-expected legal costs.

OCC revenues grew 5% as a result of the pickup in UC and strength in Asia Pacific and Europe. As we expected, UC rebounded from the September quarter; and the overall growth trajectory of the UC market is in line with our expectations. Our UC revenues grew by 20% over the prior-year quarter.

With three quarters of FY14 reported, we are on track to achieve UC revenue growth of slightly under 30% in fiscal year 2014. The market model in our corporate presentation by Frost & Sullivan suggests 40% average compound annual growth rate in UC. And as previously communicated, we expect to be below that rate for the next several years.

We also expect continued volatility in the UC market. Accordingly, it is entirely possible to have another down quarter although we are not expecting it in the near term. We remain confident that UC will be the primary mode of Enterprise communications and will reach mass-market adoption from the low single-digit rate of adoption today.

While it is impossible to predict with precision the growth of the market, we expect FY15 to be another good year of growth. As we do every year, we'll communicate updates to our market model when we report our Q4 results. Our market position in UC, our technology leadership and overall solution set are as strong as ever.

Turning to the Mobile product group, revenues grew 20% year over year due to strength in the stereo Bluetooth headset market combined with market share gains in both mono and stereo Bluetooth. I'm pleased with our execution in the Mobile product group, especially with the line up of products in our pipeline.

We previewed some next generation mobile products with leading buyers at the Consumer Electronics Show, which were well received by attendees. We received two CES Innovation, Design and Engineering Awards at CES. We've also won two prestigious iF design awards.

Our Gaming revenues grew by 4% year over year. Our newly-introduced RIG Gaming headset received a rating of excellent from PC Magazine and generally stellar reviews from other market influencers.

We are still an early entrant into the console space and believe we are making progress building the right partnership ecosystem for long-term success. Our investment in innovation over the past year is focused on extending the capabilities of our core parts beyond excellent communications toward solving everyday customer problems.

We formed a group within Plantronics known as PLT Labs. And the solutions they are focused on increasingly combined hardware, software and firmware to anticipate user intentions and manage connections to communicate devices intelligently.

Our capabilities in the field of wearable technology are increasingly being recognized. For example, at a recent Cisco CIO Summit, John Chambers demonstrated how our headset combined with Cisco solutions can provide a revolutionary new and improved consumer experience.

Among other features, the demonstration depicted a consumer in a retail establishment wearing the Cisco System for a specific product and utilizing in-store GPS linked to sensors in our headset and ultimately directing the consumer to the specific aisle and shelf where the product was located.

Technology is real and functional, and we've opened up the headset for development, meaning the application creators can capture a broad set of sensor data from the wear of our headset such as who you are, where you are and what you are seeing. The potential for our headset in the wearable field is broad with possibilities in fitness, commerce and gaming. We continue to invest and build our organization to support future growth and improved organizational agility.

On the operation side, we smoothly transitioned manufacturing to our new 800,000 square foot facility in Mexico with no material disruptions or complications. The grand opening ceremony was held in December, and we are on track to realize savings of several million dollars annually.

We're also making good progress on our ERP re-implementation to provide better financial reporting and management. Additionally, we've been focused on improving sales coordination for global accounts and key partners, introducing new channel marketing programs.

The objective of our infrastructure building is to be prepared to scale for growth and improve everything we do, including improving the overall customer experience and solution set, speeding innovation, improving quality, and reducing cycle times for all processes and activities. Our investments for growth, including innovation and advanced technologies, and strengthening our presence and position among strategic partners, channel partners, and end customers as the provider of choice. As we plan for FY15, we intend to grow earnings commensurate with revenue growth. With that, I'll turn the call over to Pam.

Pam Strayer

Thanks, Ken. I'll start with an overview of the quarter before getting into more detail. We exceeded revenue guidance on strong results in both Mobile and UC, with strong growth in the Europe and Africa and Asia Pacific regions. However, the global macro economic environment remains somewhat choppy. Profitability was also well above our expectations through a combination of factors which I'll cover shortly.

Second-quarter net revenues were $213 million, representing 8% growth over the prior year. Non-GAAP operating income of $44 million was an increase of 5% compared to Q3 of last year. Non-GAAP EPS of $0.76 is $0.03 higher than the prior year, an increase of 4%.

When we gave our guidance for the quarter on October 29, we expected non-GAAP EPS to be in the range of $0.60 to $0.65 per share. There are several things that contributed to our EPS this quarter and pushed us above the high end of that range.

First, we recorded a one-time adjustment to our warranty and RMA accruals, which contributed $0.05 per share to EPS. Second, revenue was higher than guidance and operating expenses were lower than guidance, driving another $0.03 per share.

Further, our non-GAAP tax rate was lower than guidance expectations, largely due to the tax benefit on the warranty adjustment, adding another $0.02 per share. Finally, we had lower-than-expected share count, driven by greater volume of stock repurchases and fewer stock option exercises during the quarter adding another $0.01 per share.

Now I'm going to cover revenue in more detail. Total net revenues for the third quarter of $212.7 million were up $15.3 million, or 8% compared to the third quarter last year. All of our regions experienced growth. The Americas grew 2%, Europe and Africa grew 16%, and Asia Pac grew 26% over the prior year.

The following are key product line comparisons to Q3 last year. OCC net revenues of $146.6 million were up roughly $7.2 million and 5%. UC was the driver for the growth, while core OCC was generally flat compared to the prior year quarter. UC revenues of $43.2 million were up $7.2 million, or 20% over Q3 of the prior year.

Net revenues for Mobile products were up $8.7 million and 20% compared to a year ago. This increased the mix of Mobile revenues to roughly 25% of our total revenues compared to 22% in Q3 of the prior year. Our growth in Mobile products was driven primarily by strong sales of our Voyager Legend and BackBeat GO 2 products.

Non-GAAP gross margin is better than expected being flat compared to last year's 52.2% even with the higher mix of Mobile revenue. Our gross margin this quarter benefited from the one-time adjustment related to the correction of our [counting] for product warranty and returns. This adjustment involved improved gross margins by 130 basis points. Excluding this adjustment, gross margins would have been 50.9%, with a decrease driven primarily by product mix.

Non-GAAP operating expenses were $67.1 million, up $5.8 million but below our high-end expectations by about $1 million, primarily as a result of lower-than-anticipated legal expenses. The discovery phase of our GN lawsuit started later in the quarter than expected, but it has begun now; and we expect higher legal expenses for the fourth quarter.

As a percentage of revenue, operating expenses were 31.5%, up 50 basis points from the prior year of 31.0%. The major drivers of the increase were higher headcount, annual merit increases and higher variable compensation. Additionally, product launches drove higher marketing expenses compared with last year.

Our non-GAAP operating margin was 20.7%, down from 21.1% in the prior year. Our effective non-GAAP tax rate for the quarter was 25.1%.

As a result of all of these items, our Q3 non-GAAP net income of $33.1 million was 6% higher than a year ago, yielding non-GAAP EPS of $0.76, up $0.03 from last year's Q3 results and better than our guidance. The warranty adjustment was a one-time correction in Q3, which improved EPS by approximately $0.05 per share.

Now on to balance sheet and cash flow highlights. We finished the quarter with $429 million in cash and investments on our balance sheet and generated over $34 million in cash flow from operations during the period. Of the $429 million in cash and investments at quarter end, $27 million was domestic. We used $29.4 million to repurchase shares during the quarter.

DSO was 56 days, up from 51 days at the end of Q3 of the prior year. The increase was due to slow customer payments, primarily by one of our largest distributors who paid slowly due to the holiday schedule this year. We expect our customers to return to normal aging levels at the end of this quarter.

Net inventories were flat versus a year ago. Inventory turns are up to 6.2 compared to 5.7 in Q3 of last year.

Turning to our capital expenditures, our Q3 investment was $10.4 million, or 4.9% of net revenue. The largest single item in Q3 related to capitalized cost of our Oracle R12 implementation.

In addition, we invested in furniture and equipment for our new manufacturing facility in Tijuana, Mexico, and building improvements at our corporate headquarters in Santa Cruz.

We are making good progress in investing in our infrastructure to scale for future growth. Our building consolidation in Mexico is complete, and our new ERP system is on track and expected to go live in Q1 of FY15.

This new system will be instrumental in supporting global processes, improving global data and analytics, and reducing our cost of maintenance on the system.

Depreciation expense on a GAAP basis for Q3 was $3.7 million and was down from $4.1 million in the third quarter last year. We're forecasting to spend approximately $12 million in capital expenditures next quarte,r for an annual total of about $50 million for the full fiscal year.

Turning to the outlook. We believe total net revenues for our fourth fiscal quarter ending in March will be in the range of $200 million to $210 million. This forecast assumes gross margin to be similar to this quarter's gross margins. Our product mix will shift back to lower Mobile revenues, and we will not have the one-time benefit we reported in Q3.

Depending on revenue mix and other factors, we believe our non-GAAP operating income will be approximately $36 million to $40 million. This resulted in operating margin which is just below our long-term targeted range.

Our guidance expect that we will spend roughly $1 million on the GN lawsuit in Q4. As a reminder, we are including GN litigation costs as part of our non-GAAP results based on our policy for non-GAAP reporting. The GN lawsuit has recently entered the discovery phase, and the impact to operating income from the associated legal expenses is particularly difficult to forecast. Actual expenses can vary significantly from our forecast.

Non-GAAP tax rate is expected to be 27%. Based on all of the above, we currently expect non-GAAP EPS to be $0.62 to $0.68 per share on average diluted shares outstanding of approximately 43 million.

The GAAP reconciling items we expect in the fourth quarter include approximately $6 million in stock-based compensation expense and purchase accounting amortization before tax. Therefore, we expect GAAP EPS of $0.52 to $0.58 per share for the March quarter.

Our operating margins were better than expected in Q3; and as we plan for FY15, we will be targeting operating margins within the 20% to 23% range.

Our investments in product and processes continue to distinguish Plantronics among its peers in the market and in the price premium we are able to maintain in certain product groups.

As Ken mentioned, one of the foremost priorities is to invest for long-term growth while maintaining a level of profitability within our targeted range. We believe we can do this while maintaining a level of profitability which is above the technology industry average.

With that, I'll turn it back to the Operator for Q&A.

Question-and-Answer Session


(Operator Instructions) Your first question comes from Dave King from Roth Capital. Your line is open.

Dave King – Roth Capital Partners

Hello. I guess, first off, Ken, do you see growth this quarter, I guess, for the the second straight quarter is coming and decelerating a bit? I'm wondering if you could just talk about what may be going on there. Is there anything in terms of contract getting pushed out? Anything you want to allude to? Or anything you want to talk about in terms of what may be happening in the industry that, you know – versus that three percentage-ish kind of rate plus that you talked about before?

Ken Kannappan

Yes. You know I don’t think that we had net contrasting pushed out at the quarter. I think that reflected the largely speaking the growth rate in the industry. It is and has been always a little bit bumpy. There are a lot of companies that we believe are in the pipeline that have not yet moved forward. We continue to think that pipeline builds but it’s a market that is not unfortunately a rocket ship.

It’s the kind of system that makes sense – is far more perspective, flexible, greater performance and yet people have working communication system so they don't have to change right away and there’s some work and effort in doing that as we have talked about. So you know we’re very sure about the future because really there is no effective alternative for people. The legacy systems aren't going to get continued investment but the pace at which it happens is still to be determined.

Dave King – Roth Capital Partners

Okay. Thank you. That’s helpful. And then, Pam, in terms of gross margin, if you could kind of back out the 130 basis point gain that you had and then understanding that a lot of the contraction year over year was due to mix, looks like there was some other things that may have been driving it a little bit more than that. Anything that you can touch on whether it’s in certain segments more so than others that might be driving some of the remaining contraction there? I guess that would be helpful.

Pam Strayer

Yes. So, product mix itself contributed 130 basis – sorry 110 basis points decline year over year. Now, really those two things, the warranty was just an offset by product mix are by far the largest. You know we did take an E&O charge of this quarter. That was roughly 50 basis points impact to the gross margin but that was the highlight.

Dave King – Roth Capital Partners

Okay. Now, and then as we think about, you know, charters on a go-forward basis, you know, given that you’ve had some for a few quarters, how should we think about that also, you know, as you think about that charge or gain you got this quarter? You know was that – I mean I may have missed it in your comments you’ve had – was that driven by some of the stuff you recognize invested you were able to recover? And then, how should – I guess just how should we think about that on a go-forward basis quick?

Pam Strayer

On E&O charges going forward, I would still estimate roughly $500,000 to $750,000 per quarter is what we expect to be in the normal range. We're not there yet. But I will say that we've done an awful lot of work on all of the processes around E&O, things that contribute to E&O, and we expect that number to be coming down next quarter.

Dave King – Roth Capital Partners

Got it. Thanks so much. Great quarter, guys.


Your next question comes from Daniel Toomey from Raymond James. Your line is open.

Daniel Toomey – Raymond James

Yes. Thank you. You've answered part of my question, but as far as Mobile, the growth rate, looks like that's also decelerating and wondering if you had any comments for us about your forecast for growth in the Mobile part?

Ken Kannappan

Well, you know, actually we thought it was a really good year in Mobile. The category has declined this year, and outside of China had declined for a couple of years, as well. And so, growing the revenues in the face of that is a pretty good result in terms of the mono segment and we had a pretty significant lift in market share.

You know I think that within the stereo area, which is growing, we had a good entrance into the stereo area. We've got some other good products there that we think can expand the segment that we're in. So we feel very good about how we're executing.

That said, I do think the mono category, absent new hands-free laws, is unlikely to see significant category growth, and that's certainly going to limit the growth that we're likely to have in that part of the market. Overall, we still expect to grow primarily due to the opportunities outside of mono.

Daniel Toomey – Raymond James

Okay, thanks. And the two new products that you had commented received good reception, has sell through continued to be good through the quarter and into current quarter?

Ken Kannappan

Well just to be clear, those two new products are not products that have launched yet, but products rather that we were previewing. And relative to your other question, I don't have complete sell through data post Christmas. We get some data weekly, we get some data at the end of the month. I would say that generally speaking, yes, we had good sell through data for the Bluetooth business.

Daniel Toomey – Raymond James

Okay, thank you.


Your next question comes from Paul Coster from JPMorgan. Your line is open.

Paul Chang – JPMorgan

Thanks for taking my question. This is actually Paul Chang for Paul Coster. Most of my questions have been answered, but can you comment on if you see new competitors in the UC space? And also on a second question, can you comment on headcount turnover or job mobility in the Contact Center of space and what you're seeing there?

Ken Kannappan

Sure, so first of all in terms of new competitors, we -- the primary competitor that we have remains GN Netcom, Jabra. There are actually many other competitors that we see from time to time. Those include certainly Sennheiser, certainly Microsoft from the hardware side of the business. There are other smaller players that are in the business.

We certainly expect that those will be in the business at some point in time, we haven't actually seen a product from them in this part of the business as yet. But so I would say, I don't think there's been a significant change in competitors to this point. I think there was a second question that you asked me and I'm trying to remember what it was.

Paul Chang – JPMorgan

Right. Just on headcount turnover or job mobility in the Contact Center space.

Ken Kannappan

Sure, so I think that in terms of overall headcount turnover, we think that the tone, and this is not specific to context there, we think the tone has slightly improved. The housing market definitely firmed some, that was one barrier to labor mobility, at least in the US.

I think we've finally had a little bit of an upturn in Southern Europe, or at least stabilization. I think the US economy, the UK economy have both improved some and those are encouraging in terms of the potential for overall turnover. Now, I do think it's been clear that the labor market participation has declined and that that is the primary reason the unemployment rate has gone down. So it's not directly helping us.

There was some improvement in the quits number which is more directly related and encouraging. Now, we don't get that by Contact Center versus other market segments, but my general feeling is with the tone of that market has also improved a little bit.

Paul Chang – JPMorgan

Okay, great. Thanks.


Your next question comes from Mike Latimore from Northland Capital. Your line is open.

Mike Latimore – Northland Capital Markets

Yes. Thanks a lot. In the past you've given some general color on segment revenue in the following quarter. Do you think Office and Contact Center would grow, Mobile would be down? Generally how do you think about some of the…


Ken Kannappan

Sure. I mean Mobile of course is a seasonally weaker quarter in the March quarter compared to the December quarter. That said, we still expect to have what we would consider to be a good quarter in Mobile, as well as a good quarter in Office and Contact Center. So -- and that's all implicit of what we've already put out in the forecast.

But ordinarily and at times we've certainly seen a slightly larger drop from the seasonally strong December quarter to the March quarter. So yes we have a -- we're expecting good prospects in both areas.

Pam Strayer

I will add that for Mobile in Q4 our forecast assumes a year-over-year decline. If you recall Q4 last year was when the China hands-free law went into effect and we had unusually high Mobile quarter, at that quarter.

Ken Kannappan

Yes, that's it's spike. So, you look at the business in part without the spike.

Mike Latimore – Northland Capital Markets

Right, right, okay. And then you talked about generally 20% to 23% target margins, that would be I believe -- I think achievable in fiscal 2015. I wonder is that true, a clarification question there? And second does that include legal expenses?

Ken Kannappan

So, let me answer the first part and then I'll let Pam talk about the part with the legal. So yes, we do expect to be north of the 20% on our true business basis which is how we are managing the business. Whether or not the legal drops us below that, can you comment on that?

Pam Strayer

Well I would say that right now our forecast for legal expenses would again bring us down to the low end of the range, but we plan to be between 20% and 23% next year. Now it's anybody's guess how much we end up spending on legal, so that's very difficult to forecast.

Ken Kannappan

So, probably including the legal, we're going to be getting very close to the bottom end of that range.

Mike Latimore – Northland Capital Markets

Okay, great. And then last question for me, you talk in the past about some R&D and sales and marketing investments to support, particularly the R&D side to support UC initiatives. How do you generally think about that? Is that something that you're finishing up in the fourth quarter here, and then you start curtailing from there, or where are you in that investment pattern?

Ken Kannappan

We're really in a very good place. We've done a lot of work over the past years. We think our portfolio is well ahead competitively. We think that our investments in the ecosystem have again put us well ahead of everyone. We think we're really driving innovation in the industry.

We have opportunities to further innovate to drive long-term growth in the business but these are not things that we have to do. We're also working pretty significant project to improve our efficiency and our platforming, R&D investments to allow us to be faster and more effective per dollar that we spend.

So we're expecting if you look going forward to be able to leverage the fact that we're ahead, leverage some improvements and still have some pretty good innovation investments. These are not quick things. These take probably a couple of years, but I would expect over the course of that it's more likely that we will see our R&D expenditures, particularly over the second year, begin to decline a little bit as a percentage of revenues, and maybe not decline so much as a percentage of revenues in the coming year.

Mike Latimore – Northland Capital Markets

Great, thanks.


Your last question comes from Greg Burns from Sidoti & Company. Your line is open.

Greg Burns – Sidoti &Company

Afternoon. Question on PLT labs, could you give us an update on the kind of interest you're seeing from the developer community, and when we might see a commercial headset with some of the new capabilities being rolled out?

Ken Kannappan

Sure. Well first of all, we had a hackathon just before the Consumer Electronic Show, which was about three days long. And we showed our concept and one headset at that time and people were writing applications on it. And ultimately the leader of that team was on a panel at the end of the hackathon.

We've gone to a number of these wearable technology conferences, have been recognized as the leading innovator at a number of these and had people write applications for it. But it's less about independent applications, not that there can't be some great ideas there, and more about the integration with key partners into some of their applications.

And that's part of the reason I gave the example of Cisco, because it's a key partner for us and we have other key partners integrating or looking to integrate with our products as well. And some of these new products will be able to leverage all the integrations that have already occurred. They create additional capabilities for things beyond that.

So we have things that are already out there. We expect with more capabilities that people will do more. We have in our minds the UC Voyager Legend is a product out there out there already was significant sensors, significant contextual intelligence that provide APIs to communicated and software that is taking advantage of that. With these new capabilities, it's always -- take some time to productize that and so it will be some time before we put it out there, I'm not providing a date at this point in time. But this is a continuous process that we're embarked on.

Greg Burns – Sidoti &Company

Okay, thanks. And in terms of UC sales, in any given quarter could you give us a sense of how much are greenfield or new deals as opposed to cultivating more season deals and getting further penetration? Are you seeing some of your older deals then come back and take more headsets as they mature?

Ken Kannappan

So, the answer to the question is, it's almost all greenfield. There are absolutely early adopters who are replacing or they took all corded and some people want cordless and that kind of stuff. Having said that, this UC market is really amazing.

Let's remember that it's only been a few years that we've been selling these headsets. And therefore there weren't really, if you look at our revenues three years ago, there's not that much out there to replace. Almost nobody replaces within two years. So you don't really have a big pool of replacement revenues to go to.

Greg Burns – Sidoti &Company

Okay, thank you.


We have no further questions at this time.

Greg Klaben

Thanks again for joining us today. We'll be available after the call if you have additional questions.


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

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