Jul 28, 2017
Executives
Greg Klaben - VP, IR Joseph Burton - President, CEO & Director Pamela Strayer - Senior VP & CFO
Analysts
Gregory Burns - Sidoti & Company Tavis McCourt - Raymond James & Associates Nick Altman - Northland Capital Jeangul Chung - JPMorgan Chase & Co.
Operator
Good evening. My name is Lisa and I will be your conference operator today.
At this time, I would like to welcome everyone to the Plantronics First Quarter Fiscal Year 2018 Conference Call. [Operator Instructions].
It is now my pleasure to turn the call over to your host, Greg Klaben, Vice President and Investor Relations. Sir, you may begin.
Greg Klaben
Thanks, very much, Lisa. Joining me today are Joe Burton, Plantronics' President and CEO; and Pam Strayer, Plantronics' Senior Vice President and CFO.
The information presented and discussed today includes forward-looking statements which are made under the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. The risks and uncertainties related to such statements are detailed in our most recent 10-Q, 10-K and today's press release.
The complete set of prepared remarks of today's conference call are available on the Investor Relations section of our website. For the remainder of today's call, we will be providing only non-GAAP metrics related to gross margin, operating expenses, operating income, net income and earnings per share.
We have reconciled these measures in our earnings press release and in our quarterly analyst metric sheet, both of which are available on the Investor Relations page of our website. After the conclusion of today's call, the recording of the call will be available with information on our website.
Plantronics' first quarter fiscal year 2018 net revenues were $203.9 million compared with $223.1 million in the prior year. Our GAAP diluted earnings per share for the first quarter were $0.57 compared with $0.62 in the prior year.
Non-GAAP diluted earnings per share for the first fiscal quarter were $0.70 compared with $0.76 in the prior year. The difference between GAAP and non-GAAP earnings per share for the first quarter consist of charges for stock-based compensation, restructuring, asset impairments and purchase accounting amortization, all net of the associated tax impact and tax benefits from the release of tax reserves and discrete tax adjustments.
Please refer to the full GAAP to non-GAAP reconciliation in our earnings release. With that, I'll open the call for questions.
Operator
[Operator Instructions]. Your first question comes from the line of Greg Burns with Sidoti & Company.
Gregory Burns
I just wanted to talk about the weakness you saw in the Enterprise segment, in the prepared remarks you talked about a change in the UC, UCaaS vendor market. I just wanted to get some more color around what that is referring to?
And maybe just some other -- any additional color you can give around what you're seeing in the enterprise market?
Joseph Burton
Yes. This is Joe jumping in.
Thanks for the question. So for the most part in the enterprise market, we really do see a tail of 2 markets there.
As we stated in the prepared remarks, on the UC side, we saw very healthy strong growth, no problem whatsoever. We have seen some positives in decisions on more of the legacy side of the business.
So as people are beginning to adopt the Unified Communications as a service, contact center as a service a little bit more, we're actually seeing a pause while people are figuring out whether or not they're going to go on-prem with legacy telephony-style sales systems which would drive some of our core products or whether they're going to shift to the cloud a little bit more which would drive more of our USB connected products. It is something we're seeing across the industry.
We've talked to a lot of partners, talked to a lot of customers. And it does seem like a pause that we're in right now and expect to last this quarter, may be another quarter or two to some level or another.
But strong on the UC side, somewhat weak on the core side. But we do expect it to either shift or come back.
Gregory Burns
Okay. And in terms of the Soundscaping which you launched, could you just remind us what the model looks like there?
Do you have a sense of pricing ASPs? And maybe what the total addressable market for you is in that market?
Joseph Burton
I talked to a couple of pieces about and I'm going to let Pam jump in with some others. First of all, incredibly excited about the launch of Habitat Soundscaping yesterday.
Great customer feedback so far from our beta customers. Great pickup by the press, both the analysts and the AV channel press as well.
So it's been really, really nice. As far as the opportunity, the reason we choose to go into this market is, of course, we're seeing a real industry megatrend around OpenOffice seatings.
So as people are going from real estate that is private offices for people or very private cubes to the OpenOffice, where everybody kind of sits around the table, if you will. It looks great.
It's a great area to collaborate. It's a bad area to concentrate.
It really screams for an adaptive, intelligent noise canceling system that can allow people to sit out there and concentrate. My understanding is, actually the worldwide and this isn't our market.
But the -- just simply noise-dampening materials for these areas are a multibillion-dollar industry. And yet they don't get the job done.
So the ability to bring in an additional active intelligent acoustic system to help manage that, we see as a great opportunity going forward. Now you asked about the model.
This is indeed a two-step distribution model or it's gets sold through distribution and sold and installed primarily through the AV channel. We announced partnerships yesterday with AVI-SPL, probably the largest global installer for this kind of product along with SKC Communications, a terrific partner here in America and a long-time Plantronics partner, other channel partners to come.
They install it. They get sold as a service.
So over time, it has very attractive margins. I think because we price it by the foot, but it depends very, very much on the exact configuration of the building.
I think we haven't announced direct pricing per foot, since it actually goes through the channel and they decide. Anything else to that, Pam.
Pamela Strayer
Yes, I'll just add a couple of things. As you said, Joe has said, we're pricing this in terms of cost per square foot a square meter in the office space.
The model is set up such that the first year, the cost to the customer as far as the hardware cost to install the speakers and microphone as well as the first year subscription on the SaaS service. That first year is going to be less profitable on client accounts then following years, as you can imagine because we've got a large hardware component to cover.
So in the first year, the gross margin is going to be below our average corporate margin. When we get to year 2 and following year, it's all SaaS services.
It's all software. The only incremental cost is some AWS service fee.
So overall, after you get past that first year, the gross margins on the SaaS revenues are going to be in the high 90s like you would expect for a SaaS offering. So it's a nice business model for us.
And that tells you a little bit about how we're going into market.
Joseph Burton
The one part that's great Pam, is that addresses our profitability being okay upfront and much better over time with the subscription market. The other thing we're already hearing from people is that, the ROI for the end customer on this is very good.
Being able to move into that OpenOffice environment and still have people collaborate in, concentrate, is terrific. And the early feedback from the channel partners and in fact, some of the news coverage yesterday, was that they see this as an attractive and positive stream.
So we have an industry megatrend, profitability for us, profitability for the channel and a good ROI for the customers. We believe that should be a winning combination over time.
Gregory Burns
Okay. And one more.
The restructuring, how much in cost savings do you expect to realize from the restructuring you announced?
Pamela Strayer
So the cost savings of the restructuring is expected to be about $15 million annualized. What I -- I will talk a little bit about our OpEx cost on this.
And we've done several restructurings over the last year or so. We've really been working to transform the company over time and take costs out of the business, but also invest in long term growth initiative.
So while we're taking cost out of the company, we're going to -- we're staying committed to our profitability goals over the long term to get to 20% to 23%. Our margins are down right now, for a couple of reasons.
But one of the primary reason being the GN litigation and annual proceeds associated with that. Other than that, if you look at our OpEx trends over the long term, they've been flat to down as we've been really focused on controlling costs over time.
And with the long term -- the investment in our long term growth initiatives, we're at a point now where Q2 of FY '18 we've got a SaaS offering that's less than a year old. The Soundscaping offering that's being launched this quarter, really great long term growth initiatives for the company.
Also, very profitable growth initiatives for the company. And we've done that through these restructurings and we've done that by keeping costs flat.
So I think it's a nice story for the long term growth of the company as well as the cost discipline of Plantronics over the last year or so.
Operator
Your next question comes from the line of Dave King with Roth Capital Partners.
Unidentified Analyst
This is Phil Qantas [ph] on for Dave. First off, can you the talk about what might be driving the comfort around to present up for a catch-up period for Enterprise demand?
And to what extent, if at all have you seen that in the second quarter thus far?
Joseph Burton
A couple of pieces on that, that the -- and by the way you were cut out for just a second. You were, I believe asking about the rationale for at least a modest catch-up period when some of the vendor stuff sorts out?
Unidentified Analyst
Yes, correct. And if -- yes and if you...
Joseph Burton
And have we seen it so far?
Unidentified Analyst
Exactly.
Joseph Burton
So on the first one, frankly, the reason we put in the comment about a small catch-up period and it's never 100% in and all it wants. Frankly, over the last 10, 15 years of being in the business, other times we've seen positives around vendors.
We do see a minor resurgence when all that starts out. We have not materially seen that yet this quarter.
Nothing you should be -- that should be read into that. But frankly, when we see the business being off due to vendor confusion, when the vendor confusion clears up, you do see a partial resurgence for a little while.
Unidentified Analyst
Okay, great. That was helpful.
In terms of outlook for the consumer to be flat to down for the year, can you talk about the puts and takes as to what's driving that? Assumingly strength in gaming or some end market declines for mono Bluetooth?
More importantly, what's going on in stereo? Any color on that would be greatly appreciated.
Joseph Burton
Maybe I can talk about the macro trends and Pam can talk about the number since that's her part. She gets it.
Macro trends side. A couple of things we said in the past are, while consumer Bluetooth stereo as a broad market is booming, up many, many percent year-over-year, multibillion-dollar industry, we don't compete in that entire market.
We compete in the niches of the market, where Plantronics precision audio, miniaturization and human factors can actually command the premium. So first of all, never look at that multibillion-dollar market if something we're going for.
We're going for a smaller part of that. Frankly, because we're not going to compete on brands.
You're not going to see Super Bowl commercials. You probably not going to see celebrity rap stars on Plantronics' products.
We have to compete where the technology helps us, number one. Number two, frankly, over the last year, we've decided to focus greatly on profitability.
We have some older products that were -- we had some older products that we would have had to severely discount and had profit. Profit was top line to be in the market.
We chose to selectively place those products, where we could still make a buck, while our new, more profitable, more refresh products are coming online. So in essence, the reason for flat to down is, we're not going to buy business.
We're being cautious. And as the new products come online, we think we'll have a profitable nice consumer business that really interacts well with our B2B business because it primarily takes care of those people outside of the work hours, the rest of their 16-hour day, plus the gaming products that are just a terrific world product line for us.
Pamela Strayer
Yes. Yes and so I can talk a little bit about the gross margins on consumer.
We started talking in Q4 about the fact that we were going to focus on consumer profitability and really be more strategic in how we place our products, what products we put in the market, what channels we use. We're really still quite early in that process.
So if you look at consumer margins year-over-year, they're pretty flat year-over-year. The trends of increasing consumer revenues at the expense of gross margins have stopped.
But it is going to take a little bit of time for us to work through our portfolio. And as Joe said, the best way to improve the consumer margins is to introduce new products into the market.
So that's going to take a little bit of time. Having said that, we're making major changes today, part of the sale the Clarity business was a view to try and improve profitability of consumer.
We look very carefully at the channels that we're utilizing today and are trimming those so that we can improve profitability. But it will take a little bit more time.
We're not giving direct guidance on where we expect that to end up for the year because this a bit of a work in progress, but we know that we can improve things dramatically in profitability region.
Unidentified Analyst
Great. That was great color.
Just one last one for me. In terms of operating margins, do you still expect those to ebb 50 to 100 basis points for the year?
Pamela Strayer
So what we're looking at for operating margin this year, obviously, you can see from the results, with revenues missing, we did manage to hit the low end of our profitability targets which is fantastic. That took a lot of cost discipline during the quarter.
And -- but with top line being off, we have kind of backed up our top line growth expectation. Operating margin, we're still going to focus on very hard to try and get to a 20% operating margin, excluding GN litigation fees.
What I will -- I'm not sure we'll get there, but what I will commit to is that we really improve our profitability year-over-year when you remove those GN fees. In our prepared remarks, you see we started talking a little bit about what our results were excluding GN.
We do expect that these are significant costs going into our OpEx which we expect to go away by Q4 of this year. And so it gives you a little bit better viewpoint into how we're actually doing in profitability terms of the company and what we're likely to look like when we come through this trial at the end of the fiscal year.
Operator
Your next question comes from Tavis McCourt with Raymond James.
Tavis McCourt
It's Tavis. A couple of questions, I think you answered my first one, but so just to confirm is the trial date been set for the GN litigation?
Joseph Burton
Yes, absolutely. That's out there in the public.
It's in the middle of October. It's expected to be a few weeks and then we'll be on the backside of this thing.
Tavis McCourt
And then, requesting do you have the -- what the litigation expense was last year off hand fiscal '17?
Pamela Strayer
Yes. So in Q1 of fiscal year '17, we booked roughly $5 million in litigation fine.
And on top of that, we had legal fees of about $2.2 million.
Tavis McCourt
Yes. So last year, $7.2 million all in.
Pamela Strayer
Yes, $7.2 million all in, last year. This Q1, it was a little over $3 million.
Joseph Burton
Yes. And no volume, but the actual ongoing fees ramping a bit as we move towards the trial.
Tavis McCourt
Yes. And then Joe, can you talk a little bit about what's going on with the GSA, that they mentioned in the 10-Q.
Is that -- are you selling through that platform now? Or is that an appeal?
Or is that having any impact at all?
Joseph Burton
The impact thus far has been minimal. What was actually out there factually was a proposed debarment.
It's proposed. There's not a debarment.
So we have continued to sell as usual so far. Probably a little bit of an impact, but not much.
In the previous quarter, we have submitted all of our responses to the GSA and are awaiting a final outcome. But we're confident.
Tavis McCourt
Okay. And then, requesting on the guidance for September specifically, it should -- is this a full quarter without Clarity?
And does it include a full quarter of the cost getting pull out the operation? Or will it be December before their full quarter impacts?
Pamela Strayer
Yes. Tavis, that's a good question.
So the revenue guidance for the next quarter excludes Clarity entirely, so there's no clarity's revenues flowing through. There's also no Clarity expenses.
We made a clean break from Clarity at the end of June.
Tavis McCourt
And the other cost actions that you announced in June have -- will the full impact of those be felt in that quarter as well? In the September quarter?
Pamela Strayer
Yes.
Tavis McCourt
Cool. And then last one for you Joe.
On -- you mentioned consumer product refreshes this year. Will you be refreshing the entire product line?
Or just one of the products?
Joseph Burton
Straight down the middle with those Tavis. It will indeed not be the entire product line, although we have substantial refreshes, some already announced and a few yet to come, across our mono product line that continues to perform very well.
Very solid refreshes on the stereo side. Just a fantastic gaming lineup, including our exclusive with Dolby around their Atmos technology for this Christmas.
I actually think it's the strongest consumer line up we've ever had. Continuing to be a little bit cautious there, given the last couple of quarters.
But we feel very good about the products we're going in within and the profitability with them.
Tavis McCourt
Okay. And the last question is on capital spending for the year.
Should we think about it as pretty flattish compared to last year?
Pamela Strayer
Yes. Absolutely.
We're really focused on reducing our capital expenditures in order to manage our depreciation expense. The business really doesn't require a lot of capital.
We made some major investments in the past that we think were good investments. But there were in facilities and some internal IT systems and the like.
But we don't see anything like that on the horizon. And so we're keeping capital expenditures down between 2% and 3% of revenue for the year.
Operator
Your next question comes from Mike Latimore with Northland Capital.
Nick Altman
This is actually Nick Altman on for Mike. You guys mentioned, you've received some positive feedback from the Soundscaping data.
Can you tell us how many beta customers there were?
Joseph Burton
So thanks for joining this Nick, for Mike. So we actually held ourselves to a good size handful of beta customers for Soundscaping and really focused on making sure we had a diverse group by both geographic location, by industry that they're in.
And actually, most importantly for this product, by the style of architecture of the building. We need buildings with drop ceilings, buildings with the open warehouse pipes, high ceilings, low ceilings, different shapes of rooms.
So we actually went out and found a good handful of customers across the globe to provide us a good set of all of that. And continued holding the product and tuning until we really thought we had something that was differentiated for all of those.
Nick Altman
Got it. Okay.
Can you guys tell us like what would be the typical order size for an enterprise customer?
Joseph Burton
Look, I think, typical order size is really hard to say. Pam talked about it for the following reason.
Pam talked about this being a per square foot or per square meter type of product. Certainly, if you get down to a space of under 1,000 square feet, if you think of 1,000 square feet as may be a typical floor of an American home, if you will.
If you start getting down much under that, it doesn't make a bunch of sense, to have a Soundscaping sitting over two desks. But literally, it's an incredibly scalable solution.
You can have multiple zones of it in a building. So it actually makes an incredible amount of sense anywhere from a couple of thousand square feet to a couple of million square feet.
So I don't mean to put you off with that. But certainly, some of our beta customers you ask about were, what I would call small- to medium-size enterprises, similar to Plantronics itself.
Others were multimillion square foot, very large multinational institutions. This should -- they roll it out everywhere.
You get wildly different size orders from them. I'd like them both, but I'll take the second one if I had might there.
Nick Altman
Got it. Got it.
Good. Okay.
And then just to clarify, you guys said in the first year about 90% SaaS and then 10% hardware?
Pamela Strayer
No, no. Let me clarify that.
In the first year, it's more of the opposite. The hardware costs are upfront.
So we're getting revenues to cover the hardware which is going to be a much, much larger portion than the SaaS revenues in the first year. So gross margins will be lower.
When you get to the second year, then the revenues will be at 80 or higher gross margins because it's a SaaS offering.
Joseph Burton
Yes. Just got to pay for that hardware core charge in the first year.
We're making sure it's profitable. But really, then the overall profitability ramps as the years go forward.
Operator
[Operator Instructions]. Your next question comes from Paul Coster with JPMorgan Chase.
Jeangul Chung
It's Paul Chung on for Coster. So just wanted to follow on UC.
As you see kind of accelerated, how does that really impact your legacy core business? Is there any cannibalization risk?
And sometimes classification for UC can be a bit gray, what defines part of UC from a Plantronics perspective?
Joseph Burton
I'll talk about some of that and let Pam talk to the specific numbers or if there's anything to add from a margin perspective or whatever. Plantronics actually has an award-winning, we think best-in-class portfolio, both in UC and in the traditional core business.
Certainly, as UC rams like it has this quarter and we've been saying it would for years, what that really means is much more of our USB-type connected products. The black wire line.
The savvy wireless line. The Voyager UC line.
All terrific products. This is actually a great trend for us because when you move to UC which tends to have a soft phone involved, things like Microsoft Skype or the similar offerings from Cisco, Avaya or the new born in the cloud guys like 8x8 and RingCentral.
The attach rate to headset tends to be higher. So net-net, this is a great trend for us.
At some point as that occurs, if there are less legacy telephones being put on desks. And we're really not seeing that in a big way yet.
We said for a while. We expected our core business to be kind of 0% to 2% growth, pretty down flat.
Sometimes down a point or two, sometimes up a point or two. Right now, we're down a couple of points or two because we've seen a pause in the desk phones going on the desk.
Some of those will come back. Some of them won't.
But even if there's a transition, we're extraordinarily well positioned. In fact, if there was a tsunami of transition, we'd love that.
Anything about margins, I think they're still pretty much...
Jeangul Chung
Joe, just a follow-up on that. So you've mentioned some barriers to higher adoptions and judging by solid fiscal year '17 extending into this quarter, some of those barriers or hurdles have subsided whether it's the connection issues, Microsoft Lync upgrades.
But what do you see as the main barriers or hurdles now moving forward?
Joseph Burton
Well, it's a funny thing. When we actually unpack what's going on in the market, we had a record UC quarter.
So UC is going very, very well. But we have the legacy business that is still a very healthy business.
It's very profitable. We still sell a ton of it.
But it's often where it was. What that really implies and at least from our checks in the market, we don't think this is unique to us.
We think this is an industry phenomena. Some people are really getting on the UC bandwagon.
Some people that it's time to upgrade the traditional telephony, are just tapping the breaks and trying to decide, am I going to go legacy telephony one more time. Am I going to move to UC?
And if I do move, to which one? Some of them are making the move.
That's why we have record revenues in UC. Some of them are in that break tapping.
But right now, U.S. what the barriers are.
Frankly, it's curse of choice. Too many good things out there.
Microsoft has a great offering. Cisco has a great offering.
I mean, Avaya, the born in the cloud guys, it's a little bit of evaluation for is not lack of good choices. So some of them are making the job.
We got the record profits. Or I mean, revenues and some of them are trying to figure it out.
But obviously, they'll figure it out and they'll start buying. They're going to have funds.
Jeangul Chung
Okay. And so record revenues, should I assume that higher double-digits year-on-year growth?
Pamela Strayer
I mean, in terms of growth rates year-over-year, it's about mid-teens.
Jeangul Chung
Mid-teens. Okay.
Pamela Strayer
Similar to what we've been seeing. Yes.
Jeangul Chung
Got you. And then switching to consumer.
How has the mono Bluetooth market doing? Has that kind of stabilized?
Or what was the costs or the weakness there?
Pamela Strayer
Yes, so the mono Bluetooth market in Q1, we did experience a year-over-year decline in our mono Bluetooth revenues. It's similar to what we were expecting, maybe even a little bit better than we were expecting in Q1.
Our mono Bluetooth portfolio is still pretty strong. We're still gaining market share.
Margins are still good in that business. So everything in mono is overall very, very positive, except the category itself is declining.
Operator
And there are no additional questions at this time. I will now turn the call back over to Mr.
Greg Klaben.
Greg Klaben
Thanks, very much, Lisa and thanks, everyone. We appreciate you joining us today.
If you have any follow-up questions we'll be available afterwards. Thanks, again.
Operator
Ladies and gentlemen, this does conclude today's conference call. Thank you for your participation.
You may now disconnect.