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Plantronics, Inc. (NYSE:PLT)

Q4 2007 Earnings Call

May 01, 2007 5:00 pm ET

Executives

Greg Klaben - VP & Director of IR

Ken Kannappan - President & CEO

Barbara Scherer - SVP & CFO

Greg Tyrrell - Finance Director EMEA European Investor Relations

Analysts

John Bright - Avondale Partners

Paul Coster - J.P. Morgan

Jason Ader - Thomas Weisel Partners

Manny Recarey - Kaufman Brothers

Ted Chung - Bear Stearns

Tavis McCourt - Morgan Keegan

Daryl Armstrong - Citigroup

Rob Crystal - Goldman Sachs Asset Management

Reik Read - Robert W. Baird & Co.

TRANSCRIPT SPONSOR
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Operator

Good afternoon. My name is Catina and I will be your conference operator today. At this time I would like to welcome everyone to the Plantronics Q4 Fiscal Year 2007 Financial Results Conference Call. All lines have been placed on mute to prevent any background noise. After the speaker’s remarks, there will be a question-and-answer session. (Operator Instructions).

Thank you. I would now like to turn the call over to Greg Klaben, Vice President of Investor Relations. Mr. Greg Klaben, you may begin your conference.

Greg Klaben

Thank you operator. Joining me today to discuss our fourth quarter and fiscal 2007 finance results are Ken Kannappan, Plantronics President and CEO, and Barbara Scherer, Senor Vice President of Finance Administration and CFO, and Greg Tyrrell, Director of Finance of EMEA.

I would 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 we highlighted before, the risk factors discussion in these files are not standard boiler plate. We update these risk factors every quarter adding and dropping language and changing the order depending upon the timing and potential impact of concerns that we foresee.

We believe forecasting, our result of operations is becoming increasingly 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 Form 10-K, 10-Q, today's press release, and other SEC feelings.

Revenue for Q4 was $194.7 million, and was within previously provided guidance. The range of $190 million to $200 million. Our GAAP EPS wars $0.21 versus guidance of $0.16 to $0.21, and non-GAAP EPS was $0.28 versus guidance of $0.22 to $0.27.

Now, I’ll turn the call over to Ken.

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Ken Kannappan

Thank you Greg, and I would like to thank you all on the line for joining us. I'll start with the key takeaways from our fourth quarter fiscal 2007, and then provide business update and overview, followed by our objectives for fiscal 2008, and I will turn the call over to Barbara to go through the financial results. Following that portion of call, we will open it up for Q&A.

We believes the most important points from our results this quarter and progress we've made over the past year are as follows. First, we are entering fiscal 2008 on a stronger strategic position than we had a year ago, and we've rich product portfolio we won this year through all of our major headset product lines.

Second, our marketing programs in B2B appear to be working, as evidenced by the renewed growth in office wireless product, which increased 28% compared to Q4 last year. Third, our mobile Bluetooth portfolio is very competitive and those in the pipeline to release in fiscal 2008, will continue to offer, what we think is a compelling differentiation for the consumer.

Fourth, Altec's performance is primarily result of the product portfolio that is not efficiently sufficiently competitive, resulting in lost market share of profitability. However, we are confident in our ability to improve the portfolio and ultimately be very competitive.

Plantronics’ mission is to enhance communications and entertainment. Our strategy for doing this is to excel, inspire, simplicity and balance. The strength of our product offerings are a combination of customer insight and success in delivering those brand benefits in our product.

Let me turn to each of our product groups. In B2B, our office and contact center market, ending fiscal 2008, much stronger competitively than we were a year ago. Office wireless our best opportunity for long cycle growth and profitability, grew by $53 million or 36% in fiscal 2007 over fiscal 2006. Our research suggests we have an untapped market of new user, we describe as extremely and very interested for users based on our market research.

This segment of office workers is approximately doubled our install base. In fiscal 2008, we will focus some of our marketing spend to better address the opportunity of increasing penetration in the office segment, or continuing this program for a period of gain traction this year.

Today we announced the release some extremely existing new products with CS70N, providing a quantum leap in styling and comfort for the wireless market, together with outstanding audio performance, we believe this product will help sustain the mark, increased operations quarter-to-quarter and begin generating upgrades of our existing CS50, CS60 install base. Customer reaction has been very enthusiastic.

Let me turn to mobile. Bluetooth mobile was the fastest growing product segment of our business in fiscal 2006 to fiscal 2007. And our growth exceeded that of the market as a whole based on the strong product portfolio that we have. However, the mobile business is volatile. So these gains will be held for a while this portion remain the same. As better progress is approaching and I believe our product plans for fiscal 2008 will keep us very strong.

In addition, we are well conditioned for what maybe a large opportunity in the convergence of voice to music in a single communications device. While we continue to innovate, we are platforming our products to reduce cost and expect further improvement and profitability on mobile business.

We expect to continue transition from cordless to wireless and mobile as well and believe the revenue growth in wireless mobile is result of a more competitive progress portfolio, and distinguished product at the high end of the market.

We believe the new wireless opportunities may emerge over the next few years, as consumer shift in viewing a headset as an accessory, handsets and start to see it as a core component of their connection in listening and communication experience.

We have introduce a few products already what we refer to as a converged Bluetooth market in the ballpark 260 ballpark 590. In addition to the healthy pipeline of products with the converged Bluetooth market, gulf has important introduction with non-stereo Bluetooth, to mobile communication ready for release this fiscal year. We are excited about this products and our partners have attributed them in recent tradeshows have also demonstrated significant interest.

For the headset segment overall, I believe that we are in the best competitive position we've been in years, in B2B and in B2C. In fiscal 2007 we delivered the right product at the right quality and value point, meet the market needs in office, call center and mobile.

Let me turn now to the results for audio entertainment group. For all six business financial results were below our expectations with the quarter and for the year. Is largely result of the products portfolio that is not sufficiently competitive in what is otherwise been a very strong market.

The length of business is flexible for the following reasons. Altec's brand and their channel relationships remain strong and would allow newer, more competitive products to reach the market. We believe that we have strong competency in sound, in complexity and style, should be the core of successful execution of the right product concept.

The key challenge is to make sure we are picking the right products to execute. Customer understanding that Altec was not sufficiently high, while it takes time to build this expertise through an achievable objective, and should result in improving product road maps over time.

We've begun the process of understanding what people want functionally and emotionally. And the growth of this learning curve is rapidly as possible and mutinous develop customer expertise, similar to what we have in lour core headset business.

The early stages of this process to grow revenue and return to profitability, part of the belief of upgrade products will be difficult to achieve, including performance. As early efforts to improve products were launched, we expect improved performance, but also believe there will be greater uncertainty in our progress as we calibrate our computer understanding of customer desires really is.

Gain feedback the new product efforts, the network customer insights, we believe we should be able to target customer needs well where with a strong execution potentially, return to a very competitive and profitable position in the market. Leading indicators to watch the gauge to turn around this business are the success of our new product introduction.

Importantly, while the management team is spending extra cycles on strategy and oversight to improve the performance of Altec, I also want to ensure you that it is distracting us from the other nearly 90% of revenue and profitability delivered from our core headset business.

While the performance of Altec has been poor, strategic opportunity for convergence between communications and entertainment continues to be validated. We believe that successfully turning off stick around would strengthen our positioning to this opportunity.

To recap, the key piece of the executing on our mission of the enhancing communication entertainment are in place. We have a terrific set of headset products. We have what we believe is a very strong product pipeline and vision about our customers and partners really are excited.

The positive trends we see, harboring into our business few of which we've already discussed. The Opportunity in B-to-B and the conversions in corded-to-cordless the opportunity in the mobile areas as a result of converging segment, communications entertainment.

Most important corporate goal is to maximize long-term sustainable earnings per share growth. We discussed some of the major focus areas of our management team, already. And now Barbara will review the financial results in more detail.

Barbara Scherer

Thanks, Ken. Our overall financial performance was slightly better than the guidance provided due to continued momentum and strength in the Audio Communications Group segment, partially offset by lower performance than anticipated in AEG.

Our headset business continues to be strong, and we currently expect ACG revenues and profits to grow further in Q1, though AEG’s financial results for Q1 are likely to be about the same as they were in Q4.

With that said, I'll cover the Audio Communication Group segment, first. ACG revenues of $173.2 million were up 2.5% or $4 million compared to the year ago quarter. The growth was driven primarily by office wireless, which was up 28% compared to the fourth quarter a year ago.

You’ll recall that we saw growth resume in this important product category last quarter after three quarters of relatively flat sequential performance. In the December quarter that growth was really epicentered in EMEA, growth this quarter was broad geographically, and we believe the resumption of growth is due in part to our newer demand generation program.

Bluetooth grew 14% compared to a year ago, due to an improved product portfolio and increase listings at retail. Our OCC corded products were relatively flat compared to the year ago quarter. The increases were partially offset by continued decline in our mobile corded revenues as well as declines in our computer and clarity revenues.

With office wireless revenues remaining strong in the quarter, total wireless products contributed 53% of total net revenue as same as the December quarter. Contributing approximately $60 million of net revenue, wireless office headsets represented approximately 34% of ACG segment revenue and 47% of OCC.

Net revenues from Bluetooth mobile headsets contributed approximately $30 million representing 17% of total ACG revenues, in comparison to 15% or $26 million a year ago. On a full year basis, Bluetooth grew over 60% to $122 million in net revenue.

Gross margin on this product line also increased year-over-year, and in the fourth quarter compared to the same period a year ago. Our improved competitiveness in this very tough market is testament to our improved Bluetooth product portfolio, expanded customer mix, and increased account penetration over the past year.

Within ACG, international revenues remain strong, up 17% compared to the fourth quarter last year. Domestic was down 5% compared to a year ago, primarily due to the decline in mobile corded revenues.

As a result of this strong growth in EMEA and APA our domestic, international split is now 60/40, compared to 65/35 in the year-ago fourth quarter. In the U.S., sell-through was up and distributor inventories were slightly down.

Specifically, our sell-through tracking of the U.S. commercial distribution channels for the ACG segment indicates that sell-through increased approximately 4% versus the year ago quarter and 10% sequentially and that inventory in the channel decreased slightly.

Please remember that the sell-through data we are discussing here is only for a portion of our revenue as U.S. based and that this channel represents approximately 32% of total ACG segment in the March quarter.

ACG non-GAAP gross margin was up 2 points, to 45.1% compared to 43.1% in the fourth quarter year ago. Relative to the year ago quarter, gross margin was up primarily during to cost reductions and both Bluetooth and Office Wireless product, as well at margin improvements in Bluetooth, due to improvements in the product portfolio.

These improvements were somewhat offset by higher warranty costs in the quarter. And we continue to make progress in our China plant, which increased its output and reached 17% utilization, and is, on-track to breakeven in Q2.

Operating expenses on a non-GAAP basis compared to year ago quarter increased approximately $3 million or 6%, primarily due to expanded sales presence and demand generation programs, and $1 million of the increase is funding our new product development efforts.

For the full year, operating expenses were up 5.8% from $189.4 million to $200.2 million, down from 30.1% of revenue to 29.6% of revenue. We have improved overall efficiency while making the necessary investments for future growth.

As a result of all the buzz, ACG’s Q4 non-GAAP operating margin was 14.5% compared to 14.3% a year ago. And non-GAAP operating income was up $0.9 million from a year ago quarter.

For the full year, ACG non-GAAP operating income was $98.9 million, $1 million shy from last year's total. This was due to gross margin being lower by 1.7 points for the year as a whole.

Operating margin for the year, as a whole was 14.6%, 1.3 points lower than fiscal 2006, with the improvements in the ratio of expense to revenue helping offset some of the change in gross margin.

Our target model for ACG continues to be 45% to 48% gross margin and 18% to 20% percent operating margin.

In fiscal '08, we expect to increase our operating margin compared to fiscal 2007 and make progress towards our long-term target. I'm going to turn total audio entertainment group segment summary.

ACG revenue was down approximately $16 million compared to the same quarter a year ago. Our product portfolio as is mentioned has not been sufficiently competitive resulting in cumulative loss in market share and profitability.

Compared to a year ago, the portable product line was down 58% and powered line down 8%. Also included in the fourth quarter results were reversal of revenue and margin for two U.S. retail customers, we will serve on a consignment basis going forward consistent with the way we serve those accounts for ACG.

The iM600 did launch in the quarter, albeit about a month later than anticipated. This delay moved the EMEA launch down to the June quarter.

Geographically, ACG's revenues were 52% domestic, and 48% international reflecting a decrease of 2 percentage points in domestic mix sequentially. A year ago, domestic was 63% and international was 37%.

Cost reductions over the year have been very limited while net realizable prices have continued to decline. This accounts for approximately 24 points of the decline in gross margin.

With lower volumes fixed costs are higher percent of revenue and account for eights points of the decline. Provisions for potentially excess and obviously inventory while somewhat higher than in the fourth quarter year ago in dollars amounted to three points of if decline, giving the lower revenue base on which it was reported.

In the fourth quarter, we also classified within cost of goods sold certain expenses that were classified in G&A expense in the year ago quarter to conform to the ACG presentation. While the dollar cost of these expenses is approximately $400,000 that results in two points of decline compared to the year-ago quarter. As a result of all of the above, non-GAAP gross margin was negative 5.4%, compared to 32.6% for the same quarter in the previous year.

Sequentially, the decrease in net revenues was larger than the seasonal impact previously expected, which also affected gross margin. And we've set those out, factors in the press release.

ACG operating expenses were down compared to the year ago quarter and down sequentially.

Non-GAAP operating loss for AEG was $10.5 million, compared to operating income of $1.7 million a year ago. So on a consolidated basis, below the operating income line, we had $1.3 million in other income compared to $1.5 million in the year-ago quarter.

Our consolidated effective tax rate for the quarter was 15.7% on a non-GAAP basis compared to 24.5% in the year-ago quarter and to a forecasted tax rate of 18% to 21%percent in our guidance forecast.

The consolidated tax rate was significantly lower than the forecast, primarily due to the higher losses in AEG, the impairment charge in the fourth quarter, as well as a favorable distribution of taxable income given the strength and EMEA where we have a lower tax rate.

As a result of all of above, our consolidated non-GAAP net income for the quarter was $13.4 million, or 6.9% of revenues, compared to net income of $20.7 million or 10% of revenue a year ago.

So with regard to the business outlook, we are cautiously providing guidance for the first quarter and want to reemphasize the risks and uncertainties, which characterize our markets and our business.

The volatility of our business does seem to be increasing and with our book and ship business model, things can change rapidly.

The June quarter is also a difficult quarter for us to forecast, particularly I think in the ACG business, where conditions are usually strong in March and early April, and tend to weaken somewhat in the second half of April and into May and picking up in June, at this time, we have seen some of the usual decline we experienced in April bookings, but not to the extent we usually see by this point of the quarter. We also entered the quarter with a larger backlog than typical.

With respect to Bluetooth products, we have large forecasted demand from several significant customers, therefore, we believe our ACG business will grow sequentially assuming the historical pick-up in bookings recurred.

We currently anticipate that our office wireless business will be up, that OCC corded is likely to be down some, and that Bluetooth will be up, assuming the demand outlook with large Bluetooth customers remains in place and that we are able to produce sufficient volume to meet that demand. In AEG, we are anticipating revenues in the June quarter to be roughly flat compared to March.

So with those caveats and a request please consider the risk factors carefully, we are estimated a consolidated net revenue range of $205 to $210 million. We currently expect operating income to be up sequentially in ACG, and operating margin to be flat to up sequentially.

As stated in the release, we currently expect AEG's loss to be approximately the same at Q4. On a consolidated basis, this would result in a sequential increase in operating income, and higher operating margin.

It would also translate into flat to up operating income compared to Q1 of fiscal '07. We also expect or consolidated tax rate to be 24 to 25% in Q1, which dampens the sequential change in net income and EPS. The consolidated non-GAAP tax rate in the first quarter of fiscal 2007 was 23.8%, and non-GAAP EPS in Q1 of fiscal '07 was $0.28, this compares to our target non-GAAP EPS of 26 to 29 for Q1 of fiscal '08.

So, turning to the balance sheet, our cash, cash equivalents and short-term investments increased by $34.6 million sequentially and $26.6 million compared to the year-ago quarter. We ended the quarter with $103.4 million in cash, cash equivalents and short-term investments. The sequential increase reflects record cash provided by operations of approximately $45 million, offset partially by $5.3 million used for CapEx, and $6 million to pay-off the line of credit.

Overall, we believe our financial position remains adequate and in that context, our Board of Directors declared our 12th quarterly dividend in the amount of $0.05 per share. Accounts receivable decreased by almost $18 million sequentially, from $131.7 million, down to $113.8 million. Reflecting strong collections in both segments.

And sequentially, our DSO decreased by two days and it increased two days versus the year-ago quarter. We believe the net receivable balance is collectible, and that we have sufficient reserves to cover our anticipated exposure to bad debt.

On inventory, we were successful at reducing inventory by $7.7 million in the quarter, from $134 million down to $127 million. Both AEG and ACG inventories decreased, resulting in inventory turns of 3.8 compared to 4.6 in the year-ago quarter.

I do want to highlight that we expect inventory to increase in the June quarter to support higher overall volume, our outlook for Q2 and of the contingency measure, while we largely complete the transfer of consumer Bluetooth headsets to our plants in China.

We are also preparing to implement a service level improvement for customers who buy both AEG and ACG products. We will your use AEG distribution centers to service consumer retail accounts, given AEG's track record of assuring high on-time delivery to such accounts.

We will transfer distribution of business retail accounts such as Office Depot and Office Max to Plantronics. These changes will allow us to take consolidated orders from our shared customer base and pick pack and ship orders from one warehouse starting July 1.

Capital spending was $5.3 million, less than depreciation and amortization of $8.1 million in the quarter and that 8.1 does include the 800,000 impairment charge. Capital spending as the percent of revenue was 2.7%.

Before I wrap up, I just want to highlight the key initiatives underway to reduce costs and improve profitability. We have a program called Score, which is our acronym for the supply chain optimization and re-engineering program.

This is a multi-year initiative designed to increase inventory terms, improve forecast accuracy and reduce access and absolute inventory. We are on schedule to implement the first phase of this in September, which is a new forecasting tool using Oracles to monitor module.

We completed our first conference from pilot this month. This system utilizes statistical data mining to help improve accuracy, which helps to focus management on exceptions. Our implementation of it will also enable us to compare forecast from multiple independent data sources, in addition to the statistically suggested vested forecast.

In the fall, we will also implement another module, which will enable us to increase the level of vendor-managed inventory, which will reduce our inventory. Second major program is transformation cost reduction, which involves utilizing our manufacturing facilities more fully as well at reducing the ratio of transformation costs to material.

Our key areas of focus in this initiative are the utilization of our China plant, improvement in direct labor productivity, and reduction of logistics costs. Related to reduction of transformation costs, we increasing use of platforms from which we can produce multiple generation of products.

We are measuring re-used, down to the development team level. And we are using a design for excellence approach, which exclusively considers the assembly and related costs for higher per count, ease of packaging, and other factors to help development teams make the right trade-off confident of achieving their objectives.

We also have a new executive incentive plan that will be filed on an 8-K tomorrow. Our compensation committee has completed its work on this, and we have implemented a new incentive plan designed to further enhance the length between pay and performance across the entire executive team in a consistent matter.

Under the new plan, half of the total cash bone is target for the fiscal year will be paid according to annual corporate performance. The metrics on which the portion will be judged are GAAP, EPS, and asset utilization. With a 75% weight on GAAP, EPS, and 25% laid on asset utilization. Given the results of fiscal 2007, the targets to earn an annual bonus were not achieved, and accordingly, no annual executive bonus payments will be made.

And with that, I thank you for your patience. I will turn it back to our conference facilitator for the Q&A session.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from John Bright with Avondale Partners.

John Bright - Avondale Partners

Thank you, and good afternoon, Ken and Barbara. Ken, you know, you deliver a strong quarter here on the office side of the equation, the office wireless side of the equation. We've now got the mobile Bluetooth returning to grow some cost improvements taking place in the strong basis there.

And now we're reworking Altec, can you give me a better sense of the multi year plan you are talking about to expand your brand distribution and some of the operational improvement you are looking at as well as the product refresh?

Ken Kannappan

Just to be clear, John, those last three questions were referring only to Altec?

John Bright - Avondale Partners

That's correct.

Ken Kannappan

Okay. So in terms of the, lets me just start with the product side, the company has been involved in this market for some time and they have, you know, got a set of research out on the business, having said that, the level of insight in terms of the use of the products, particularly some of the new emerging segments, such as with iPods and other MP3 players was somewhat limited.

And a lot of the feedback they had was from channel partners and what is what I would call shorter cycle rather than deep insight in terms of what it is it the consumers are really doing with the products and trying to experience both from a functional perspective, as well from a emotional perspective.

And so the key thing here is trying to really make sure we nail the target, and we looked at some of the new product, like the iM 600, it’s been achieved with some success, with really by your kind of loading the feature set or on to the product, which doesn't allow you to get to the right gross margin.

So first and for most is really making sure we kind of die deep and truly understanding from an end user level that we've done the homework, and we understand what they really want, because I think we have excellent competencies to execute on that once we get there.

We believe that we are going to be making progress during the course of this year, kind of tied to those new products, but at the same time, you know, it’s very easy to say okay, what was wrong here, but to really get what was right, we will probably have to get closer over a couple of gem.

We expect it will be close to a year and a half before we are pretty much aligned with customer requirement and really able to kind of achieve something much closer to the target model. But during the course of that time, it should also be fairly easy to make some sequential progress in cost reduction and in better design per cost.

We believe we should be able to expand the very strong design capability that we have with Plantronics during the latter part of this year to begin to execute for Altec. So then really it was very high degree of confidence. You know once we know where the target is, so we can execute to it very, very well.

So while it's going to take some time, we think the ultimate risk of not being successful here is we have actually, fairly low. In terms of distribution, there are a number of places around the world where we have fairly strong distribution infrastructure and that we can compliment Altec's capabilities and we think those are some pretty good opportunities.

And then there are specific areas where we are expanding the product line in what I call converged areas. One of those for example is headphones, which are pretty easy opportunities to combine some of our competency with their brand.

John Bright - Avondale Partners

On the, I'll shift over now to the wireless side of the equation, or the office wireless side of the equation. Very strong quarter on the office wireless side of the equation, a core competency of Plantronics, what is rejuvenated? You have got some new products in place; have pulled additional levers that you think might have helped you to rejuvenate this particular market segment that you might see using also on the Altec side?

Ken Kannappan

No, I think it's different marketing in to be candid, I think that in Altec's case, the markets are really quite vibrant, very good and we just haven't been competing successfully for our share of them, and once we have the target down, I think we can execute very, very well combined with that knowledge.

On the Plantronics side of things, it's been quite different; we've been competing well for market share and our tail end tend to grow the overall market. I think we, as we've been doing a lot of marketing experiments over the last few years, we were seeing things, working and things that weren't working, I don’t want to kind of get away all the formula, but maximum level, what we are trying to do obviously is kind of more of the things that we are working.

I do want to say that we've always believed the pattern of growth on this was probably not going to be a steady pattern, but what we are seeing is very positive word of mouth, and I'll tell you this. The single most encouraging thing that we have out there is that people's expectations of what they will get and how much they will like a wireless headset. It's substantially below what they actual experience when they try one, so our key challenge is to narrow that gap.

John Bright - Avondale Partners

Last one, Barbara, from a financial standpoint, the balance sheet looks, continues to improve and strong cash generation, you are now debt free. What, when you look forward, you are payment dividend uses of your cash as you generate looking forward?

Barbara Scherer

So I think you are probably really asking when are we going to do a share buyback again? And we have done share buybacks consistently over the years. At this point, I think we need to improve the performance at Altec a bit further, and we also need to build up our domestic cash balances, our overall cash is still heavily weighted towards international, which can't actually be used for share repurchase.

But as we move forward with our recovery plan and get some of the improvements in inventory management, which we expect through this score initiative, we'll start to further build up our cash reserves and be in a position when it's kind of right opportunistically to buyback stock again at some point.

John Bright - Avondale Partners

Thank you.

Barbara Scherer

You're welcome.

Ken Kannappan

Thank you.

Operator

Your next question comes from Paul Coster with J.P. Morgan.

Paul Coster - J.P. Morgan

Yes, thank you. Ken, I wonder if you are in a position to talk about the competitive landscape in the ACG segment in particular, how the Bluetooth world is evolving, and what do you see in the contact center and professional side of the business as well, please?

Ken Kannappan

Sure. Well, first of all, I would say that the markets from our perspective continue to be competitive overall within the Bluetooth market, one of our key goals has been to become the leading independent brand in that market and we think we've made a tremendous amount of progress there, as well as, in establishing ourselves as a leader in what I would call the premium spaces, in particular the Discovery 665, and that’s some of this is measured of course by revenues and market share.

Some of this also measured by a word, press coverage and so forth, which has been uniformly blowing about that product, and we think it's enhancing our inventory. We are finding that repeat customers are becoming increasingly conscious that the performance of the Plantronics products is considerably better than the other products out there, and we think that bodes well for the long term.

Having said that, as I started out, it's still a price competitive market, and it's, our strategy to improve profitability in addition to strengthen the position, comes down doing a more effective job of cost reduction, platforming and supply chain and that’s really where we think we can make further progress from where we see today.

On the contact center and office side, we don't think we've seen a dramatic change in competitive type conditions, we do believe having said that, that this products that we announce today is going to be by far best of calls product, it is going to be an extremely successful one in the market.

Paul Coster - J.P. Morgan

Okay. Barbara, I guess we have been asking several quarters now, when you're going to issue long-term business model objective again like I said, the world has changed a bit as you've been going through this operational turn-around.

Are you closer to being able to talk about what kind of margin structure we should be looking for long-term? Or is it still a little way off?

Barbara Scherer

Actually, we're confirming the business model that we've had, which is 15% to 18% overall with 18% to 20% operating margin target for ACG, and 5% to 10% for AEG, and the kind of growth rate target from an industry perspective so, would be it’s about 16% for the headset industry taking into account, you know, very slow growth in the contact center, 10% to 15% growth in office, about 20% for mobile, etcetera.

That blends out to around 16%, and on the consumer audio side, it's about a $1 billion market growing at about 12% rate, so it blends, we believe, without any changes in market share to about a 15% overall top-line growth target on a secular basis.

So, we think the 15 to 18 is still the right target, with respect to this coming fiscal year, we expect to make some progress towards the ACG target, but not get to that 18 to 20 and obviously, we’re going to have losses all year for AEG, so we’re not even close to that model, but we believe that we can get within that range in the second half of fiscal '09.

Paul Coster - J.P. Morgan

Okay, then I stand corrected, but I'm happy, I asked the question anyway, because that was helpful. The margin, the gross margin outlook, is that something you are prepared to comment on as well?

Barbara Scherer

Yeah, so the ACG target is 45%to 48%. We've been getting of late close to it, I mean, we actually hit it in the fourth quarter it, not yet for the year as a whole. And on AEG, the target remains 30% to 35%. And that's going to take a couple of years to get, targeting back in that range second half of fiscal '09.

Paul Coster - J.P. Morgan

Great. Thank you very much.

Barbara Scherer

You're welcome, Paul.

Operator

Your next question comes from Jason Ader with Thomas Weisel.

Jason Ader - Thomas Weisel Partners

Thank you. On the Bluetooth side of the business, what's been happening on your ASPs? That's the first question.

The second question is a year ago, I believe it was about a year ago, you talked about your contacts inner business based on the economy slowing down? And I think in retrospect, certainly the economy didn't really slow down a lot in '06, but it looks like obviously in Q1 of '07 it has slowed down. So maybe you can give us some color on the impact of the economy so far this year on your contact center business.

Ken Kannappan

Okay. Well, first of all, as it turns out, we don't have Bluetooth ASP data with us. So you know, we can try to follow up with you on that subsequently, but let me just say, as a broad point, we have not seen a dramatic transition in the price point since our last call.

Most of the consumer price points have been relatively more stable particularly in the U.SF. We've seen a little bit of a drift-down in Europe. But nothing indicating that the pace of productions is increasing. If anything, I would say the pace is probably been slowing over that short period.

Jason Ader - Thomas Weisel Partners

And is your mix shifted at all in terms of the high end versus lower end products?

Ken Kannappan

Yeah, well, I mean, clearly the 665 has done very well for us, and for our market share, there is better and has been building having said that, the bulk of the volume in the market is still at the lower price points, so our overall unit volume is still heavily weighted, so given that disparity at the, I'm sure it's risen some, but keep in mind that the bulk of our volume is still going to be at the explorer price point. I think the second question you asked was about economic cycle and the influence on the contact center?

Jason Ader - Thomas Weisel Partners

Yes.

Ken Kannappan

So we have not seen a significant impact on the contact center business from the cycle, it's only just as a little bit difficult for us to ascertain because while clearly the office is graduating more so to wireless products than the contact center is, we do sell corded products into both contact centers as well as into office.

We've continued to see growth internationally in contact centers, and we continue to see what we view to be extremely flat market conditions in the more developed markets.

All of the markets are improving their efficiency in the use of this equipment which we've been stretching out utilize this product it tends to have the time been a greater impact on us than the overall economic cycle. So quick answers we've not seen a negative effect on the contact center business in Q1 as a result of the cycle.

Jason Ader - Thomas Weisel Partners

That business is still 5% type of growth business?

Ken Kannappan

Well, actually I think it's probably even flatter than that. You know, our long term growth rate that we've got in there are in 2 to 4% range, and really, very, very close to 0% in the most developed market if you’re in the largest market such as United States.

Of course, Europe is getting a lift in part from currency, translation which kind of artificially is growing that share of the market and there is some real growth in some of the outsource regions which will continue.

Jason Ader - Thomas Weisel Partners

Okay. Thank you very much.

Operator

Your next question comes from Manny Recarey with Kaufman Brothers.

Ken Kannappan

Hi, Manny.

Manny Recarey - Kaufman Brothers

Good afternoon Barbara and Ken. Three questions. The first one is the, you gave some color on the outlook for the ACG business for revenue. Is it, what kind of gives you the confidence, is it just the new product that you put out or is it changes in the overall market or competitive environment that has given you the confidence for this quarter?

Ken Kannappan

It's not…

Manny Recarey - Kaufman Brothers

The second question would be on wireless, that is typically lower gross margin than the wired business, but as that grows as a percentage of the total, is it move to China going to be offsetting that or is it still going to be a little bit of a drag just from a product mix and the gross margin?

And the last question will be on the AEG business, is the way to think of is that the way you reach operating profitability would be more towards just driving the topline as opposed to taking cost out of the business?

Ken Kannappan

So you've asked several questions, and we’re going to try to remember them all and respond. If we miss one, just remind us. Let me kind of start with the question about why we think the ACG business is going to growing, and I believe this is primarily related to wireless revenue. Let me make a comment on this. It's not that we have perfect visibility in our market, we've made that point a couple of times, and people don't plan a wireless headset purchase months in advance kind of to rollout.

Forecast as to what's really going to happen, some of the things that we try to do are we try to make sure that the information we do have is as free of noise as possible so it provides a good signal. What we do in order to try to achieve that is we try to eliminate as much possible inventory by our channel partners in the field so that when they get orders, hopefully this provides us a pretty good indication because they need to flow those through to us in the form of orders.

So we can track a run rate. We tend to measure these run rates overtime and its seasonality and other things so that we can extrapolate from those run rates somewhat incredibly as to what they have indicated towards the past about the business. We always overlay any known other dynamics related to what information we receive from partners. Their level of business outlook, order activity we overlay it with infecting the other known new products or other issues we think will effect the flow of business.

Overall, at this point in time, given the indications we have from our customers and the order of activity to-date, we think we are providing a reasonable estimation in the current quarter. But we have been wrong before and sometimes certain changes do happen in the market.

But again, information we have now we believe we’re being very reasonable. I think the second question, and I knew what Barbara talked I think the second question that I'm going to try to cover is the one on Altec, where you asked, is this going to be driving the topline.

And the answer is no, but we actually have to drive the topline clearly they were impacted by several things this quarter. One of them was much lower level of aggregate revenues, which obviously impact fixed cost, and regardless, you can only make so much profit on the lower level of revenue.

So clearly, need to have a more competitive product lines with a better share of a very good market. With a better product line and better share of good market, we think that will help in that respect and secondarily should also improve the gross margin both by having better value to cost ratio which will allow us to reduce the amount of marketing promotion funds, and other things that are required to support the product.

In addition to that, there's an awful lot of other opportunities for us to reduce costs in the architecture and platform and other products, similar to what we've done in the Plantronics business on the Bluetooth headset, quite obviously, it's a different set of products, but that's a significant opportunity and it's being pursued, so those are all areas that we can work in addition to purely revenue growth. Barbara, can you hit the other part of that question?

Barbara Scherer

Yes. Our guidance forecast of 205 to 210 as indicated almost all of that growth is expected in ACG. And so call that $10 million plus, and yes, it's true that wireless office is lower than corded office, but it is, has a very good gross margin and Bluetooth has an improving gross margin so when we are looking at the quarter sequentially, that level of anticipated revenue growth in ACG does drop down incremental operating profit in comparison to the fourth quarter.

So, if you look at the standard margin, the mix would be less robust than the Q4 mix, but there are also improvements we were making in and transformation costs, and some of those dampen some of that mix effect, but overall, it's, it is a good gross margin business, it's growing $10 million plus is a good level of growth, and we expect it to provide incremental operating income compared to the fourth quarter.

Manny Recarey - Kaufman Brothers

Okay. Thanks, and good job remembering all the questions.

Barbara Scherer

Thanks, Manny.

Operator

Your next question comes from Ted Chung with Bear Stearns.

Ted Chung - Bear Stearns

Thank you. Just a quick question. Your VP of Operations, Terry Walter’s resigned end of February. Have you found a replacement for him? And what was the cause behind that?

Ken Kannappan

I think the question is on Terry Walters? The short story is that Terry retired from Plantronics. He had given us full notice and we have conducted a search of internal and external candidates and believe that we're in good shape with respect to that process.

Ted Chung - Bear Stearns

And just quick clarification, what was the breakdown within the AEG group in terms revenue split?

Barbara Scherer

Let me come right back to you on that. I'll get my hands on the number. Do you have another question?

Ted Chung - Bear Stearns

No, that was it.

Barbara Scherer

Okay.

Ken Kannappan

Great, thanks.

Operator

Your next questions come from Tavis McCourt with Morgan Keegan.

Tavis McCourt - Morgan Keegan

Hi, Barbara and Ken couple of quick questions forgive me if you went through this during the earning season shuffle here to conference call but, looks like the guidance revenues were up sequentially.

It looks like your guiding gross margins on both divisions, flattish to maybe modestly up on ACG, but earnings expectations are flat. Is there an increase in OpEx there and if so what are the cause of that increase?

Barbara Scherer

There is going to be some increase in OpEx but the tax rate is also going up sequentially and both non-GAAP and GAAP, and that is actually making a pretty big difference, we expect the operating income itself to increase on a, in ACG and on a therefore consolidated base, because what we say, we expect AEG to be about the same.

But the tax rate non-GAAP was 15.7% in Q4 and we're for casting between 24% and 25% and one of the reasons, there are a number of reasons, but we're also changing the way that we do the tax provision to something called the forecasted method from the discrete method, which we've been using last year, and this is in connection with preparing for FIN.48, and under the forecasted method.

You look at your entire year and all the factors that you expect to influence your tax rate during the year, and then you actually provide at that rate each quarter as opposed to looking at all the elements just discretely within the quarter by itself. So we basically got a 10-point pick-up on the tax rate there1

Tavis McCourt - Morgan Keegan

Okay. So you got to build in your expectation of Altec Lansing becoming less diluted in the back half of the year to the tax rate?

Barbara Scherer

That, and we have only three quarters of the R&D tax credit in the FO8 tax rate because it's due to expire 12, 31. And last year, we actually had five quarters of benefits, because it was reinstated. We had a solar energy credit last year, we don't have that anymore this year, so there are a few items like that.

Tavis McCourt - Morgan Keegan

And for those of us that are building separate models for AEG and ACG, where do you get the tax rate to be assuming that at some point AEG becomes kind of neutral to earnings?

Barbara Scherer

So, sort of a longer term picture?

Tavis McCourt - Morgan Keegan

Yeah, I mean, my understanding is one of the reasons tax rates have been low is the net losses at AEG, if that's correct, where would the tax rate be or where will the tax be is that approaches more of a breakeven type profitability?

Ken Kannappan

Right. So, it wouldn’t move up, you can use the 24 to 25 obviously for the whole fiscal '08, and then probably like to do a little, I actually like to refer to a document that I have on that that but I don't have handy right here, but I think it will move up a point or two and out here but I can…

Tavis McCourt - Morgan Keegan

Okay, but not going to the mid 30s or anything like that?

Barbara Scherer

No.

Tavis McCourt - Morgan Keegan

Okay.

Barbara Scherer

Then I just wants to come back to the other question, which was on portable versus powered, so portable was $9.5 million in the quarter down from $22.3 a year ago. Powered was $15 million compared to basically $16 million a year ago. Other was 2.6 versus 4.4 a year ago. And those are all gross before reserves contract item.

Tavis McCourt - Morgan Keegan

And then another clarification on the guidance, Barbara. You mentioned inventories and DSO's up sequentially, I think what is the driver of that?

Barbara Scherer

So, on inventor, the key driver is, there's actually several key drivers. One is the volume that we're anticipating for this quarter, but also volumes that we’re anticipating for the September quarter.

The September quarter includes key retail reset points, and you need to bring in some of the inventory even in the June quarter to get ready for that. We're also putting some inventory, sort of safety stock and contingency as we're transferring production of consumer Bluetooth to China, so we're putting some just in case inventory in place.

We're also getting ready to be able to service our, the customers that we share with AEG would like to give us a consolidated order, and have it pick packed and shipped out of a single warehouse right, and get their Altec products and their Plantronics headset products all in one shipment.

And we're getting ready to support that, we’ll actually be able to start doing that effective July 1, but it means putting some ACG inventory finished goods into some of the AEG warehouses, and moving some Altec inventory into Plamex to get ready to do that. So those are the key factors.

Tavis McCourt - Morgan Keegan

Got you. And Ken, as a happy CS70 user, what is the kind of primary improvement that, on the CS70 in that was announced today relative to the CS07?

Ken Kannappan

Yeah, so for a lot of the CS50, CS60 users they operate in help desks and other very loud environments. And it may be that you've got a private office and the CS70 works very well for you.

But for those nosier applications, the CS70N with the noise canceling performance represents the great upgrade opportunity, and so there is just a lot of those sorts of environment where you really have not had this type of performance or with a noise canceling product.

But having said that, hopefully you like to design, hopefully you find it comfortable, because in general, we are getting very, very good remarks for that. Coupled that with first class noise canceling performance, and you have an idea of what we think the CS70N offers.

Tavis McCourt - Morgan Keegan

And then the noise canceling performance was not available on the 50 or 55 either?

Ken Kannappan

No. Those are noise canceling products, but we believe the CS70 platform represents a greater level of comfort over the years, and has a more attractive style.

Barbara Scherer

Yes I would summarize it like this, relative to the CS50, it's more comfortable and attractive, relative to the CS70, it has noise canceling.

Tavis McCourt - Morgan Keegan

Got you. Great summer. Thanks a lot.

Operator

Your next question comes from Daryl Armstrong with Citigroup.

Daryl Armstrong - Citigroup

Thank you very much. A couple of things, first of all, in terms of the Altec business, clearly a big part of the turn around is a function of your belief that you will be able to sink your product portfolio with customer requirements and process in the marketplace.

Given the fact that we are talking fairly far into the future, well left to occurrence, what gives you the levels of confidence that we aren't shooting for a moving target? That the product platform and development that you are anticipating to development a few years down the line, will stink with what the mark is requesting at that time.

Ken Kannappan

You know, Daryl, just to be clear on this, no one bats a thousand on new product, maybe if you've got some exception, but in general, out here in corporate America a few are batting a thousand on a new product. Having said that the more you understand the customers needs, certainly this needs of course don't even change.

Some of them change because the ecosystem changes and the and the opportunities change, life-styles change, that kind of stuff, but certain the core functional need tend not to change as much. Some of the emotional needs design trend, other things; tend to be a little bit more fluid.

For some of the technical possibilities should realize functional desires can absolutely, evolve within that becomes clear. So we are at a early stage of learning on this new market, what the basic level needs are. If you look at the drop-off that Barbara noted in the portable category and compare it with the drop off in the power category, the power drop off was pretty small.

The portable drop off was much larger, so it is an early category. There wasn't enough effort to go up that learning curve, really absorb and under what needs to be done. It is something we understand how to do. Now we are not experts on the headset side of the business, on the music listener, but it is something that we know how to do and we know what has been done and its some thing that can be achieved.

Does that mean we will necessarily get there right away? No, because there is a moving target, competition will come along, the will get better too, but we have a large gap and we can surely close that gap over time. But the other advantage I think we have is I don't think anybody can do a bur job than we can once we have that target in place of delivering great design, great sound, and great eagle ease of use.

Daryl Armstrong – Citigroup

Right. And then just one last follow-up. Clearly, it seems like you have a fairly well thought out strategy in terms of turnaround, the Altec business, but as you surely will acknowledge, there's been a lot of commentary from your investor base to maybe at least consider a plan B. Given the level of confidence that you have in your existing plan, should it be safe to assume there's no plan B in the near, in immediate term horizon that you are going to take this turnaround plan to all the way to completion?

Ken Kannappan

Well, our let me just say this, our job is to try to increase shareholder value, and try to make good decisions each point of the way. We are all unhappy that Altec performance has been as good as we wanted it to be. We had what we think was a well thought-out strategy; we still think the strategy has been validated. The execution platform is clearly off.

Then if the question is, at this point in time do we believe and kind we kind of look in the mirror and can we review with our board, everybody believes that we have actually, we have a credible plan that is going to add more shareholder value than the alternative.

And we have to be able to answer that question honestly at each step of the way, and if we get off track, or even if we get on track, if there's something that makes more sense to the shareholders, we ought to be clear and conscious of it, and make sure we're doing the right thing.

Right now, if we look at as an example, alternatives has been surfaced, we don't think that we would realize more shareholder value by selling that business at its current performance level or shutting it down. We think we can clearly with support of that team and with their learning curves and with our execution competency turn that business around, and not only does it become profitable, but augments to total ability we have to execute the strategy, which is the direction we think customers are going.

If something happens that makes us feel that we can't, that's no longer realizable, we shouldn't be close minded. We shouldn't ever pour good money after bad and we got to be positive in the shareholder value. Right now, we really do believe that this is extremely achievable overtime, and that overtime the uncertainty and risks are disclosed and are diminished as we get a better understanding of what it is that really needs to be executed there.

Daryl Armstrong - Citigroup

Thank you very much.

Operator

Your next question comes from Rob Crystal with Goldman Sachs Asset Management.

Rob Crystal - Goldman Sachs Asset Management

I guess, following up on the last question, just sort of, I guess you’re confidence in turning around the Altec business is pretty high. So, I guess coming back to the buyback, why wouldn't you be buying back stock today, given sort of, it doesn’t seem like cash needs are particularly high and, you generate a lot of cash last fiscal year and historically have generated lot of cash? Thanks.

Ken Kannappan

Rob there is couple of points on this. First of all, while our confidence is high the Altec turnaround as -- it's high as a function of time. We know we can eventually get it, it doesn’t mean we know we can get it right away, as fully our aim is going to improve as we understand the first products what's right, what’s wrong, how can we improve them. So, that's the first point.

The second point is that, although, we talked about the improved performance in the Bluetooth part, but also acknowledged it to be volatile and wanting a little bit more of timeline it. The third point is that Barbara outlined is actually most of the cash we have on the book is international cash, not domestic cash.

We don't feel like we need to be hasty about this sort of things. To be sure there's some opportunity costs, if you know downstream the stock prices is higher, but we think it's probably more important and that there is more value for our shareholders and making sure that we realize the operating leverage and the improved intranets performance than what we will realize by buying X number of shares at a slightly lower price.

So we just don't wants to compound the situation with financial activities at this point.

Rob Crystal - Goldman Sachs Asset Management

Thank you very much. Good luck.

Ken Kannappan

Thank you.

Operator

Your next question comes from Reik Read with Robert W. Baird & Company.

Reik Read - Robert W. Baird & Co.

Hi, good afternoon. Can you guys just talk a little bit more about the Bluetooth pricing? And Ken, I just wanted to clarify the pricing is still down, but I think what you were saying is that the pace is little bit more steady, i.e., there's always price pressure there just not -- you’re not seeing acceleration of that price pressure?

Ken Kannappan

Yeah. But the question was framed to me as, I think, from January to April, just to be clear on that. So what I indicated was that we haven’t seen a lots of dramatic price drops in the U.S. market. There was a little bit more in Europe.

Some of these price points, I think were also proving somewhat more stable, and we've clearly seen a category of customers actually gravitate up for having a poor experience, so they turnoff from the category, or do they try at better products.

Some of them we know turnoff from the category, some of them try better products and that winds-up being a Plantronics and they've got a pretty good experience. So as we also said, we didn't bring the data on the Bluetooth pricing with us, and we can get back to you.

But in general, I would say, I believe the pace has moderated, but also bear in mind, that's not the season where you typically see the greatest price decrease.

Reik Read - Robert W. Baird & Co.

Okay. And then, just on Altec can you talk about would the fixes that you’re planning at this point, both on the marketing side and updating the products, is there a bump in incremental spending here, or is this simply refocusing kind of existing dollars?

Barbara Scherer

There's really not much increase expected on the OpEx side. It's really how we -- the effectiveness of the spent there, so increases would be very small.

Reik Read - Robert W. Baird & Co.

Okay. And then Barbara, I think it’s part of your comments, you said one of the programs that you have in place right now is really focused on cost reductions, irrespective of what you’re doing with the new products.

Can you give us a sense, of -- there's presumably constant price pressure in this segment as well. What is your ability to stay ahead of some of that price pressure with some of the cost reduction initiatives that you have?

Barbara Scherer

Specifically, you’re talking cost reduction in the AEG segment?

Reik Read - Robert W. Baird & Co.

Correct.

Barbara Scherer

Right. So, a large part of the issue that they’ve had there is committing to inventory and having an on-order position that has really limited the ability to get any cost reduction after that point.

So part of it is designing for costs at the outside, understanding where prices are likely to go, but they are also, just like we are and we're working together on transformation costs broadly speaking for the AEG business, and we are confident there are both component costs and transformation costs, reductions that we can make with new products, primarily, not so much with the existing products.

Ken Kannappan

Just wanted to add one explanation in case it wasn't clear. What Barbara is trying to say upfront is that if the initial order quantity turns out to be such a large percentage of the total volume, you don't really have a great opportunity to do further things, and that's the situation with the total revenue expectation being so much lower than originally expected. You don't really have the opportunity to go back and work on significant cost reductions, because almost all of the material everything else is in essence already committed.

Reik Read - Robert W. Baird & Co.

Okay. And then just one last question, Barbara, you had said warranty costs were up and was one of the offsets on a gross margin, can you just tell us what that was? Or what that was related to?

Barbara Scherer

It’s primarily a result of I would say kind of a growing wireless and consumer mix that tend to have somewhat higher return rates, and the wireless office products also have a higher cost. Higher selling price and it is a lower margin than quoted.

So a high margin, but a high cost you and then the ability to repair that or if it's just, you know, buyers remorse thing, you don't get, you get an unit back that you need to expect to warranty, so I think it is a little bit of a mixed shift over time that is slightly affecting the warranty cost.

Ken Kannappan

We have shifted from repairing products to simply replacing them and that's also effective.

Barbara Scherer

Yeah.

Reik Read - Robert W. Baird & Co.

Okay. Great. Thank you, guys.

Barbara Scherer

You're welcome.

Operator

At this time, there are no further questions.

Greg Klaben

I'd like to thank everyone for joining our call, as always, we are available for any additional questions if you have them. Thank you again very much.

Operator

Thank you for participating in today's conference. You may now disconnect.

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Source: Plantronics F4Q07 (3/31/07) Earnings Call Transcript

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