Plantronics' CEO Discusses Q1 2012 Results - Earnings Call Transcript

Aug. 1.11 | About: Plantronics Inc. (PLT)

Plantronics (NYSE:PLT)

Q1 2012 Earnings Call

August 01, 2011 5:00 pm ET

Executives

Barbara Scherer - Chief Financial Officer, Principal Accounting Officer and Senior Vice President of Finance & Administration

Greg Klaben - Investor Relations

Kenneth Kannappan - Chief Executive Officer, President and Executive Director

Analysts

Tavis McCourt - Morgan Keegan & Company, Inc.

William Dezellem - Tieton Capital Management

Mike Latimore - Northland Securities Inc.

Gregory Burns - Sidoti & Company, LLC

Paul Coster - JP Morgan Chase & Co

Rohit Chopra - Wedbush Securities Inc.

John Bright - Avondale Partners, LLC

Operator

Good afternoon, my name is Katherine, and I will be your conference operator today. At this time, I would like to welcome everyone to the Q1 fiscal year 2012 conference call. [Operator Instructions] I would now like to turn the call over to Mr. Greg Klaben. Sir, you may begin your conference.

Greg Klaben

Thanks, Katherine. Good afternoon and welcome, everyone. Welcome to Plantronics' First Quarter 2012 Financial Results. Joining me today are Ken Kannappan, Plantronics' President and CEO; and Barbara Scherer, Senior Vice President of Finance Administration 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 of 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-K, 10-Q and today's press release and other SEC filings. We will be discussing non-GAAP measures during today's call and we have reconciled these measures in our earnings press release and in our quarterly metric sheet, both available on the Investor Relations section of the Plantronics website.

Plantronics' first quarter fiscal 2012 net revenues were $175.6 million, compared with guidance provided on May 3 of $168 million to $173 million. Plantronics' GAAP diluted earnings per share was $0.56 in the first quarter compared with $0.52 in the same quarter of the prior year. Non-GAAP diluted earnings per share for the first quarter was $0.62 compared with $0.58 in the prior year quarter, and guidance of $0.52 to $0.56.

The difference between GAAP and non-GAAP earnings per share for the first quarter include stock-based compensation charges and purchase accounting amortization, both net of the associated tax impact.

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

Kenneth Kannappan

Thank you, Greg. And thanks all of you for taking the time to listen to our call.

Fiscal 2012 started on a solid note, with healthy year-over-year growth in our Office & Contact Center, OCC business, and particularly strong growth in revenues from Unified Communications or UC products. Specifically, OCC was up 11% year-over-year or $13.4 million compared with a strong prior year June quarter. The UC subset of this business grew from $9.8 million to $18.8 million or 91%. OCC did well broadly, with every geographic region growing compared to the first quarter last year. We attribute this year-to-year growth to a slightly healthier economic climate compared with the first quarter of last year.

While our mobile business was down, this was anticipated, and we actually did a little better than expected with some additional carrier business in the U.S. As we've discussed during past calls and presentations, the most sizable opportunity ahead of us is provided by the deployment of UC. This is where I'll spend most of my time today.

UC enables the phone, PC, mobile phone, tablets and other devices to function as superior communication tools: Voice, video, instant messaging and e-mail. UC provides users far more capabilities and efficiencies, with the legacy desktop telephone. And for this and many other reasons, the majority of large and medium-sized companies are evaluating deploying or planning [ph] to deploy UC.

Adoption of UC has been broad across most vertical segments. In addition, it is typically deployed throughout an organization. While deployment of the technology is broad among different types and sizes of organizations, the actual deployment does lag the initial adoption or purchase of the license, as organizations begin with IM and presence, and later add other functionalities such as voice and video.

Given the anticipated deployment over the next several years, we believe that we are in very early stage of this opportunity. We anticipate that the rate of adoption will accelerate over the next several years. The rapid payback and high ROI of enterprise investment in UC continues to be validated. And while the obvious savings of UC include lower telephony, travel and real estate costs, it is through the increased effectiveness of employees, combined with their improved quality of life, the payoffs are most evident.

For example, in a flexible working environment, employees would physically be in the office only when they actually need to collaborate live and in person with coworkers, customers, vendors or partners on a given day. These employees are not only more effective, but significantly more engaged. They create eco benefits of less commuting, in addition to tangible personal time benefits of fewer commuting hours and cost. Offices which weren't originally designed for live collaboration are being redesigned to enhance the effectiveness of the workspace. While employees will need to do other things when they are in the office, the primary reason they are there is to meet live and collaborate with other people. When they aren't doing that, they will still need effective spaces to concentrate, contemplate and to communicate. When employees aren't in the office, UC provides the ability to work from nearly any location, delivering an experience which closely replicates the capabilities that you have when you're in your office.

UC informs you of who's available for communications, how best to communicate with them, whether it be audio, video, e-mail or text. It also provides the capability to define subject-matter efforts, or to easily share desktops for more immersive collaboration.

Internally, we call this concept Smarter Working. It is something we've implemented in Europe, and are in the process of rolling out at our headquarters in Santa Cruz. Internal implementation of an office designed for collaboration and other key activity allows us to more effectively understand future needs in the workspace in our product development process.

The anticipated benefits with enterprise, adopting flex or Smarter Working, beyond higher productivity include reduced turnover, improved engagement, business continuity and a lower carbon footprint for the organization. In terms of what UC means to Plantronics, we continue to expect a significant contribution to our revenues and earnings over the next several years as use of headsets and other audio devices among enterprise employees increases, and we reiterate that we believe this category will be $350 million of our total revenue by fiscal 2015. Those that we reported are just over $50 million in UC revenue in fiscal 2011, and approximately $19 million in the first quarter of fiscal 2012. Between now and fiscal 2015, we expect this to grow substantially.

Our strategy for UC is to lead the market with innovative products that make Plantronics the simplest solution to deploy. Our sizable R&D investment, which is now approaching the $70 million annualized run rate, has been yielding market-leading products which are easily differentiated from our competitors in many ways including how they provide intelligence to the UC system. An example of this is with our new Savi 700 product, which effectively integrates your mobile into the UC platform, providing presence information and allowing you to virtually conference between mobile calls and UC calls.

Our investment into UC extends beyond R&D. And over the past year, we've been ramping up investment in sales and marketing, design, IT, customer service strategic partnerships and software. We also invested in a new position of Chief Technology Officer, and today announce the addition of Joe Burton, Senior Vice President of Engineering Development and Chief Technology Officer. We're pleased to have Joe aboard to leverage our UC R&D and help generate the maximum value from our planned new investment.

Even with our increasing investment ahead of the UC opportunity, we continue to generate corporate gross margins of over a long-term objective of 50% to 52%, and operating margins at the higher end of our 20% to 23% range. We made progress in several key fronts for UC's strategies during the quarter. We made further progress with our UC partners, including recently being named the Microsoft U.S. Lync Voice Device Partner of the Year by the Microsoft Voice Team. We demonstrated new integration of Plantronics' products with Cisco Communicator at Cisco Live event, earlier this month. With IBM, we announced new integration between IBM UC-squared software Sametime and Sametime Unified Telephony in a seamless unified communication experience we provide to users of their product.

Software enhances productivity for new calling capabilities for online meetings, video conferences and PC-based calls and was named an IBM Lotus 2011 Award finalists in the Enhancing Business Value through UC Solutions category. Our relationships with the other major UC vendors, including Avaya and Alcatel, as well as others, are also proceeding very well.

Turning to points on progress in UC. We are leading the UC audio solution market and we are very pleased for that our enterprise win-win [ph] and with margins that are so far better than we've expected. We introduced a number of major products during the quarter with improved wearing style and added functionality.

To conclude, we're very pleased with the overall progress in Q1, in particular, the adoption and deployment of UC compared to the year-ago quarter. UC opportunity remains very promising, and we continue to be extremely well-positioned for expected market growth.

With that, I'd like to turn the call over to Barbara to discuss our quarterly results.

Barbara Scherer

Thanks, Ken. Plantronics started its fiscal year with a solid first quarter. Net revenues came in slightly above the high end of our revenue guidance range at $175.6 million, and non-GAAP operating income was well above guidance at $39.4 million. Non-GAAP earnings per share of $0.62 also exceeded the high end of our guidance range, which was $0.52 to $0.56, with just $0.01 of the EPS outperformance attributable to the benefit of the accelerated stock repurchase program on our diluted share count.

Turning to revenues. Our total net revenues were up $4.9 million or 3%, compared with the first fiscal quarter last year. OCC net revenues of $131 million were up $13.4 million or 11% versus a year ago, partially offset by a decline of $6.5 million in net revenues from mobile products, and $1.9 million on gaming and computer audio products.

Our 11% year-over-year revenue growth in OCC was primarily driven by UC products, which grew approximately 90% to $18.8 million from $9.8 million in Q1 last year. So $9 million of the $13.4 million year-over-year growth in OCC came from UC products.

And finally, OCC revenues grew in all major geographies, which was excellent.

The decline of 17% in mobile net revenues compared to the year-ago quarter is due to some market share loss in the U.S. and overall category weakness, partially offset by strong growth internationally. Sequentially, OCC net revenues were down $1 million or 1%, with weakness in EMEA, strength in Asia Pac and relative stability in the Americas. Sequentially, mobile net revenues were up $4.1 million or 15% compared to the March quarter, with that growth coming from our Americas region. The sequential growth in Americas was primarily from our carrier customers and was the main contributor to our overall consolidated revenues, being above our previously provided guidance range.

Geographically, our mix was 57% domestic and 43% international, compared to 61%, 39% in Q1 last year, and 55%, 45% sequentially. Non-GAAP gross margin was in line with our expectations for the quarter at 53.9%, up 0.3 point sequentially and 1.1 point versus Q1 last year.

Versus Q1 last year, the gross margin improvement was primarily due to favorable product mix, with 75% of net revenues in Q1 coming from our higher-margin OCC products versus 69% a year ago, as well as the benefit of a weaker dollar. The favorable mix and FX benefit were partly offset by higher component costs broadly.

We had a non-GAAP operating margin of 22.4% in Q1, down from 23.4% Q1 last year. The 1 point drop is due to SG&A and R&D expenses coming in at combined 2.1 percentage points of revenue higher than they did a year ago, reflecting our higher level of investment in the UC opportunity.

Relative to the March quarter, please recall that we received a one-time legal settlement of $5.1 million, which improved our non-GAAP operating margin by 3-fold percentage points. Excluding the impact of that legal settlement in Q4, our Q1 operating margin improved 2.3 points sequentially from 20.1% to 22.4%, mainly as a result of reduced SG&A expense as a percent of revenue, along with slightly higher gross margin.

Below the operating income line, we had about $0.6 million of other income in Q1, compared to $0.4 million of other expense in the year-ago quarter. The $1 million swing is from higher interest income as well as foreign currency gains in the current quarter, versus foreign currency losses in the year-ago quarter.

Last summer, we began investing some of our foreign cash into financial instruments with maturities greater than one year in order to improve their yield. This is the main reason that interest income is up a bit, but of course, rates remained very low.

Our effective non-GAAP tax rate for the quarter was 25.7% compared to 27% in the year-ago quarter. The lower rate was the result of the reinstatement of the U.S. R&D tax credit and higher foreign source income. We continue to project our full year non-GAAP effective tax rate at 26% for FY '12.

And on a GAAP basis, our Q1 tax rate was 25.1% compared to 26.9% in the prior-year quarter.

As a result of all the above, our Q1 non-GAAP net income was up approximately 3% to $29.8 million. The cumulative benefit of our share repurchase program led to a 3.3% lower diluted share count versus the year-ago quarter, which combined with our net income growth, resulted in non-GAAP EPS growth of $0.04 per share or 7%.

We remain committed to using our capital to buy back stock under the plans authorized by our Board of Directors.

On the balance sheet, we finished the quarter with $386.3 million in cash, cash equivalents and short and long-term investments after spending $110 million on repurchases of our common stock, inclusive of $100 million paid under the accelerated share repurchase program we announced in May. We generated approximately $19 million in cash flow from operations in the first quarter, and continue to have a very strong financial position, including $69 million in domestic cash and $100 million available under our line of credit.

Day sales outstanding increased to 56 days from 51 days a year ago, and increased from 54 days sequentially. Cash collections were strong and the quality of our aging continues to be excellent.

Net inventories are down $20.5 million versus June of last year, and up $1.2 million from March. Non-GAAP inventory turns improved from $4.1 million a year ago to $5.6 million in the quarter just ended. This performance reflects the continued strong focus on working capital management throughout our operations.

Turning to CapEx. Our Q1 spending was $3.9 million or 2.2% of revenue, and our CapEx plan for this fiscal year remains $18 million to $20 million. Depreciation and amortization expense was $3.5 million in the quarter, down from $4 million in the first quarter last year, and our full year estimate remains $15 million to $16 million.

So turning now to the business outlook. Seasonally, our September quarter is typically marked by declining orders in July and August, followed by a healthy rise in September. This quarter, the early weeks have been a bit stronger than normal. Our guidance range incorporates the benefit we've seen to date and return to the normal seasonal pattern for the balance of the quarter in a range around that pattern. In our second quarter, we believe total net revenues will be in the range of $172 million to $177 million, reflecting double-digit OCC growth and low-single-digit growth in mobile compared to the second quarter last year. Depending on the revenue mix and other factors, we believe non-GAAP operating income will be approximately $37 million to $40 million, or 21.5% to 22.5% of revenues.

The outlook anticipates OpEx levels at 32% to 33% of net revenues, slightly above those seen in Q1. Based on all of the above, we currently expect non-GAAP EPS from continuing operations to be $0.58 to $0.63 on average diluted shares outstanding of approximately 47 million to 47.5 million.

The key assumption on the share count is that the accelerated share repurchase program will not be completed in Q2, which means that we do not take delivery of additional shares. If it is completed in Q2, we will take delivery of additional shares, though the amount cannot be estimated at this time or the timing of receipt, and that we have not included the benefit of any such deliveries in our forecast. The GAAP charges we expect in the coming quarter include approximately $4.6 million in equity compensation expense and $0.1 million in purchase accounting amortization, bringing total estimated GAAP charges to $4.7 million pretax in Q2 and $3.3 million or $0.07 EPS after tax. We thus expect GAAP EPS on continuing operations of $0.51 to $0.56.

With that, I'll turn it back over to Katherine, our conference facilitator, for the Q&A session.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Paul Coster.

Paul Coster - JP Morgan Chase & Co

Questions. First of all, in talking about the outlook, and obviously, things seem pretty positive at the moment, is there any nuance still around the regions? Obviously, many have anticipated EMEA to start softening a little bit, but it sounds like that's not the case for you.

Kenneth Kannappan

Well, there have been regional variations. I would say, that relative to your question, EMEA, like anyone else, our business in southern part of Europe has been affected by the economic events. But having said that, within the central and northern part of Europe, business has been quite strong and, of course, within that region, for us it includes the emerging market areas, which are continuing to grow very well.

Paul Coster - JP Morgan Chase & Co

Okay. You talked of UC being a $350-million opportunity for you by 2015. I know it's always been very difficult in terms of definitions here, but can you talk about the residual OCC business? Does it cannibalize that to some extent? I imagine so. But what sort of sticks around inside OCC? And what's the sort of anticipated growth prospects or decline prospects, the ramp of the OCC business?

Kenneth Kannappan

Sure. Let me answer a little bit, then Barbara may add on. But first, let me just speak directly to the cannibalization. So if you say that out there, we have installed things that customers just take a global average, perhaps, that's around 7% or something like that of a corporation. Then if they adopt UC, and if it's a 100% headset, which of course, won't always be the case, there will be phones and other things, but let's just assume that for a second -- then, if 7% of those people are already using headsets, and that 7% are not incremental end users for us, and to that degree, you could say some portion of it is cannibalized. Of course, the UC implementation may accelerate that replacement, which is still some level of benefit for us. We think, therefore, that the bulk of the UC revenues are incremental, rather than cannibalized, but there is a piece that could be determined to be cannibalized. I think that in terms of the next part of the question, I think that in terms of the OCC growth, the vast bulk of it is, in fact, driven by UC. We don't expect that the actual -- the rest of the OCC revenues would decline, but the vast bulk of the growth does go into UC. Barbara, do you want to comment?

Barbara Scherer

Yes, so maybe, if you think about OCC in total, we estimated the global OCC market in calendar 2010 at $850 million, and our projection for calendar '15 is $1.7 billion. So that's a 15% compound annual growth rate. And clearly, the biggest part of that is Office, which we're estimating will grow in the 15% to 20%, which is the part that's really driven by UC. But it's not all of the revenue growth. So OCC is 15% over that period.

Paul Coster - JP Morgan Chase & Co

Okay. In context, some of this business would be replacement and some, incremental growth, as a function of increased headcount in that function, globally?

Kenneth Kannappan

Yes. I mean, again, it's emerging markets is really where we're seeing the pickup. A lot of those economies have seen a growth in: A, consumer categories that results in contact centers, but; B, the more contact centers for financial services for, of course, mobile and the domestic B2B infrastructure operations. So that's all very encouraging. I mean, it used to be that most of that business was really outsource contact centers for developed markets, but the bigger growth, lately, is that for domestic economies.

Paul Coster - JP Morgan Chase & Co

Our last question, just being a little bit pessimistic at the moment, just looking at macro landscape. In the event that we see a cyclical slowdown, or were we to see a slowdown, how does UC sort of perform in that context? I mean, I imagine that budget's always -- would be constrained, and that would be difficult for everyone. But does UC sort of thrive on the slowdown environment? Or do you think it also gets delayed significantly?

Kenneth Kannappan

Well, I think as a secular trend it continues to thrive. Now, there's several things that we can argue about UC in a context of an economy and how businesses will actually deal with it. One is, it saves money. The second one is, it actually enables you to save even more money on brick-and-mortar and other types of investments. Now, as always, timing has to work. If no one is going to take your facility, you don't actually save any money by shutting the facility. So it has to -- it always has to line up with your lease and your real estate facilities plan. I think that it nonetheless represents a management activity. Because in order to get the most out of your UC investment, you need to get people to collaborate, you need to change the way people are working, you need to change management practices, you need to do other things. And if, as an example, management is busy figuring out how to do cost cuts or other things like that, that is another management activity that can delay activity and progress on this type of thing. So I don't want to know that I necessarily know how it will go. But I think the fundamental secular trend is very much in place and is going to move forward. Could it get delayed by a recession? Of course, it could get delayed by a recession. But I don't think it will change the fundamental economics of the equation.

Operator

Your next question comes from the line of Tavis McCourt with Morgan Keegan.

Tavis McCourt - Morgan Keegan & Company, Inc.

I have a couple of questions. As it relates to the share buyback, Barbara, how much of the cash balance, currently, is in the U.S.? And obviously, it's kind of unknowable what the -- what you also mainly get from the forward purchases. But how should we be modeling how aggressively you buy back stock after that? Is there any kind of formula you're using in terms of time or price to purchase the remaining shares?

Barbara Scherer

So the first part of the question, how much of the cash is domestic, the easiest way to answer that is, say, $59 million of the cash and cash equivalents in short-term investments is domestic. And that would be out of the $330 million -- the long-term investments on the balance sheet are all international. So, $59 million. In terms of the pace, we'd like to go relatively quickly. We talked about trying to do it within approximately a year. It does depend -- it's not an exact formula, and having multiple programs in the market at the same time is not straightforward. So it does depend on the pace at which Goldman completes this current program for us, which is, by contract, up to them. It needs to complete -- by the contract, by January 9. But it could complete as early as August 9.

Tavis McCourt - Morgan Keegan & Company, Inc.

Got you. Now a couple of operational questions. You mentioned you thought you lost some share in the U.S. on the mobile side. Is there a strategy to get that back? Or do you think you're somewhat unsustainably high share prior to that? And kind of what is your outlook, I guess, longer-term for the mobile business? And kind of why you're in the...

Barbara Scherer

First of all, and in terms of -- we do still have the largest share in the U.S. by a decent margin. And we have -- most of our incremental investment has been for UC, but we are also investing in refreshing those product lines as well. And so, let me turn it back over to Ken for more.

Kenneth Kannappan

Sure. I mean, Barbara largely covered it. I do think that we have -- when the downturn hit, we prioritized the UC opportunity. And that left us a little bit more vulnerable with our consumer portfolio. As financial positions improved, we've increased those investments. I believe we have an opportunity on a structural basis to regain some ground, as we bring a greater set of competitive products to market. I think that we've also gained some ground internationally, so that's balanced a little bit some of the domestic issues. And one of the things that happened is that, the growth of the stereo[ph] market took off, and we have not invested in that as much. And so that's a future opportunity for us.

Tavis McCourt - Morgan Keegan & Company, Inc.

Got you. And as it relates to UC, Ken, obviously, these things are going to have to pick up quarter-to-quarter. But is there anything, in kind of the tenure of business you see now that would lead you to believe that we shouldn't continue to see sequential growth from current levels?

Kenneth Kannappan

No. We continue to think that the market is growing, and that the sector trends are in place, and that we're positioned well to compete.

Tavis McCourt - Morgan Keegan & Company, Inc.

Great. And final question, you did mention strength in the first few weeks of July. I think on the last call, you mentioned some weakness in late April. I'm wondering, kind of how long that weakness lasted? And then on the July strength, you mentioned, was that broad-based or OCC-specific?

Kenneth Kannappan

Sure. So first, the strength that we've had more recently has been in the OCC area. Secondly, if we're talking about last quarter, it actually did firm shortly after our conference call. You may recall that at the time of the call, we just finished some severe storms in the Southeast -- that we had the late Easter, we had the royal wedding. And those are things we've considered. But, particularly the storms' a little hard to quantify exactly. We did see a firming of the business, and then again, it strengthened above kind of the normal seasonal level towards the end of June, which led to some of the excess performance that we had, relative to the plan.

Operator

Your next question comes from the line of Rohit Chopra with Wedbush.

Rohit Chopra - Wedbush Securities Inc.

Just a few questions here. I just wanted to get a sense, Ken, what products within UC are actually doing well? Is it the -- is it particularly the Savi line? Or is it Blackwire? Maybe you could elaborate on that? And we'll just start with that question.

Kenneth Kannappan

Sure, I mean, I think they're all doing well, first of all. But secondly, if you're to say -- if you measure it by revenue, of course, the Savi are the heavier contributors, they're the higher-priced products, number 1. And number 2, a significant portion of UC, at this point in time, is still what I would call phone-centric, which means that only people are using headsets, who are heavy users, who would've bought a headset even prior, as opposed to ubiquitous softphone only installations where I'm rolling out a headset to everyone, as our only device, and that's what leads to the broader Blackwire installation. So in terms of units, we're still selling more Blackwire. But in terms of revenues, it's more Savi. Both lines, I think, are competing well in the market.

Barbara Scherer

And also, both lines are growing.

Rohit Chopra - Wedbush Securities Inc.

Okay. And then, let me ask you this question. You've mentioned Alcatel as a partner in the past, and I think, even on this call. Are they -- I know they're not 10%. But are they material enough, as a partner? Are they material?

Kenneth Kannappan

Yes, they are material. But I just want to explain, when you say 10%, it's kind of like a revenue reporting thing. With all of our partners in the UC ecosystem, we're not selling to them. We're selling to end customers through our channel, who are buying their UC solutions and deploying our products with them. So that will never show up in any of them, Cisco, Microsoft, Avaya, Alcatel, IBM, as a 10% revenue from us under our existing business model.

Rohit Chopra - Wedbush Securities Inc.

Right. And I think you know where I was going with that. I was just trying to understand if they're material, and there is some disruption as Alcatel sells off the enterprise division. I just wanted to get a sense of how it could impact you. So...

Kenneth Kannappan

Well, those sorts of things can affect the timing of deployments for end customers, and then it can affect us.

Rohit Chopra - Wedbush Securities Inc.

Okay. And the last question. I just wanted to get a sense on the verticals. You used to do a lot of work for the federal government, and I think you used to be called -- there was something in other specialty products that I think you used to do stuff for the Army, and stuff like that. So can you just talk to us a little bit about how the verticals are doing? Or maybe, which verticals are doing well? Is financial services doing well? Is the government doing well? Just give us a sense of how that plays out in the quarter?

Kenneth Kannappan

Sure. Just to clarify, what you're referring to there in that specials product area, was not the extent of our business with government. That was specialized products that we do for government, and the vast bulk of the revenues are, largely, ordinary products that we do for federal and state government -- in the states and cities, for that matter, and internationally. And for sure, within the verticals, the state and local area has been hit some by this budget crisis. And I would extend that to cities and municipalities as well. Similarly, we've certainly seen some effect in some of the regions that I've already talked about from their governments, and sometimes that's a larger share of GDP than we're used to here in the U.S. So those have been negative. That said, some of the quasi-government areas, for example, education, which is very often government-supported, has actually remained fairly robust for us. They tended to be adopters of UC. They see a lot of the benefits for the way they're trying to operate. And broadly speaking, and this is not quite as government-related, but in some markets it is, healthcare has also held up fairly well. In general, the prime contractors have also held up pretty well because, again, they're driven by the technology and the productivity. Federal government, again, that was running fairly well. It certainly eased off a little bit at this point in time. But the good news is that the private sector spending has more than made up for that. Because in general, what we're seeing is that corporations have got good balance sheets, good expense control, and are investing for productivity.

Operator

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

John Bright - Avondale Partners, LLC

Ken, on the new customer front. The opportunity for UC, $350 million by FY '15. We're in FY '12 now. That really lends itself to a pretty big ramp. How would you characterize the customers today? Are you hitting singles and doubles? Or are you hitting some home runs? What kind of home runs still remain out there?

Barbara Scherer

First, Ken, let me tell you, this is calendar '15, not fiscal '15. It's calendar '15, which basically amounts to FY '16. It's still coming quickly, but it's not quite that quickly.

Kenneth Kannappan

So I would say that we are having probably more singles. But having said that, there are a number of doubles, and I would say that most of the true home runs have been what I would just describe as agonizingly slow from my perspective, in terms of the pace of the deployment, certainly slower than they had originally planned. But they're still moving forward. So it's just going to happen over more time than we had expected.

John Bright - Avondale Partners, LLC

Okay. Is it improving your visibility, as anticipated?

Kenneth Kannappan

Yes. Our visibility is definitely getting better, but by several things. One, just the aggregate revenue flows are becoming larger, making it much easier for us to plan inventory and all that type of levels. And secondly, we're getting a better flavor for how -- what really happens in these deployments, when people really take it in. And so our whole planning visibility has been improving.

John Bright - Avondale Partners, LLC

Last one, it's on competition. They say success, I think, breeds imitation, but in this case, maybe it's competition. Logitech is licensing GN's products. They're having a transition over there right now, but they're looking to focus on the B2B side of things, more the enterprise side. And UC seems to be coming more in focus for them. Are you seeing them in the marketplace today? And what do you make of that competitive threat?

Kenneth Kannappan

Well, I mean, we're really feeling very comfortable with our position, as I said. We're very, very pleased with our win rate overall. We're very pleased with the extension [ph] we have. We think our product portfolio is well ahead of our competition. And so we feel good about where we're at. I think that's a fairly recent transaction, and so at this point in time, we haven't seen it significantly in the market. That may change in the future, but again, I think we feel very good about where we're at.

Operator

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

Gregory Burns - Sidoti & Company, LLC

Sure, taking a question. Most of them have already answered, but I just wanted to touch on some of the UC vendors, and maybe you could talk about which ones are performing maybe better than you? Are they expected? Or worse? Which ones are having the most beneficial impact for you guys?

Kenneth Kannappan

Well, of course, these are all close partners. And I'm not going to be talking about them specifically. But I will tell you, I'll make maybe a couple of comments that will hopefully be helpful, and then if it's not, you can let me know what you're looking for. I would say that from our perspective, there is a difference between those that are oriented most towards softphones, and those that are oriented most towards hardphones. Those are most softphone-oriented, the ultimate potential is greater headset adoption. Having said that, it's also a slightly slower deployment cycle. That's the bigger change for people to take in, to change and the infrastructure that they have in place. It's greater change to workflow management practices, all that type of stuff. Those who are more hardphone-oriented, it's a faster adoption cycle, which is a nearer term lift, which is a plus. But the ultimate adoption breadth will probably take longer, although we expect it even there as well. Is that helpful?

Gregory Burns - Sidoti & Company, LLC

Yes, it is. And just one follow-up on that, I guess. Are you seeing more, maybe like, messaging and data type applications being the lead-in, and then voice control comes behind it? Or...

Kenneth Kannappan

Yes, we're definitely -- I mean, sorry, I didn't mean to cut you off. But absolutely, we are seeing that in a number of installations, people are doing the voice, at some lag after the other applications.

Operator

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

Mike Latimore - Northland Securities Inc.

Just on the -- just back to the recent strength you've seen last few weeks. Is that both in your more traditional OCC business, as well as UC? Or is it primarily in UC?

Kenneth Kannappan

Really across-the-board.

Mike Latimore - Northland Securities Inc.

Okay. And then you talked about -- you're comfortable with the win rates in your -- in the UC category. Would you say the win rates are higher, lower? Same as your kind of standard products?

Kenneth Kannappan

Well, it's very hard for us to evaluate. Let me just kind of explain this really quickly. When we look at our traditional revenues, we have one competitor that reports usually X weeks after us, we're able to measure how we've done. In the case of UC: one, they don't provide that data; but two, it's also much harder, because it's not a whole market. It's a piece of a market to judge that type of thing. So again, we think we're doing well, but we don't have all of the data to be 100% sure on that measurement. And so if I were trying to compare percentages, hazarding a guess as to how much different that percentage might be, I just really wouldn't want to publicly state that type of thing without having data to back it up.

Mike Latimore - Northland Securities Inc.

Sure, okay. And then just on the government vertical. I know you use a lot of color around it. Do you have just a kind of percent of revenues where that is today?

Kenneth Kannappan

Well, we do have some percent of revenue stuff, but we've not publicly disclosed it and I don't think we're going to do that right now.

Mike Latimore - Northland Securities Inc.

And then you talked about, I think it was North American carriers, were purchasing a little bit more in the mobile category. Any particular color around that? Was it just to fill in inventory? Or were there some new product initiatives on their end that caused that purchase?

Kenneth Kannappan

The main thing, actually, it was no longer depletion of inventory. That lower category rates, there've been some reduction, actually, of category shelf space that they're focusing on other things. And they've -- as the revenue rates were declining, they had to work off some inventories. That was largely completed, and so we were in balance. That was the main of it.

Operator

Your next question comes from the line of Bill Dezellem with Tieton Capital.

William Dezellem - Tieton Capital Management

We had a couple of questions. The first one was relative to your operating expenses, being at the, I guess, as a percentage of revenues in higher, higher end of the range. Would you help us understand your perspective on that, and where you're looking to go from here?

Barbara Scherer

Yes so, first of all, our increase in operating expenses is primarily all around investing for the UC opportunity. And when you look back, we really stepped up our OpEx to about the level it is now in Q3 of last year. And it's been relatively flat since then. And I believe it will continue to be in this, kind of, call it $56 million to $58 million a quarter over the balance of this year. And when we -- after we made that increase, and we also increased our operating model to 20% to 23% operating margin, and our expense levels today are consistent with the range and consistent with our beliefs in the UC opportunity.

William Dezellem - Tieton Capital Management

And yet your gross margin is above the range, and so you're in -- you're kind of in that middle of the zone, or the lower end of the zone. I guess that's where I was, in part, going. Is that the whole operating income is within the model, but maybe I'm just misunderstanding, but it seems like the gross margin is above and the operating expenses are below.

Barbara Scherer

Right. The main thing we focus on is the operating margin, and the operating margins at 22.4%, which is near the high-end of our range of 20% to 23%. We are investing for the UC opportunity, which is expected to have a strong ramp over the next several years, and that is requiring investment in front of that. So yes, it's a little -- the model is a little tilted to that direction right now.

William Dezellem - Tieton Capital Management

Barbara, I need to apologize because I was thinking about your guidance being in the -- on a GAAP model, but in fact, you are talking about the non-GAAP operating margin, correct?

Barbara Scherer

Right.

Operator

I would now like to turn the call over back to Greg Klaben.

Greg Klaben

Thanks, everyone, for joining us today. If you do have any follow-up questions, you can reach Ken, Barbara, or myself after the call.

Operator

Ladies and gentlemen, this concludes today's conference call. You may now disconnect.

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