Aug 10, 2018
Executives
Mike Iburg - Head of Investor Relations Joe Burton - President and Chief Executive Officer Pam Strayer - Executive Vice President and Chief Financial Officer
Analysts
Greg Burns - Sidoti & Company Mike Latimore - Northland Capital Markets David Eller - Wells Fargo Securities
Operator
Good afternoon, ladies and gentlemen. My name is Liddy and I will be your conference operator today.
At this time, I would like to welcome everyone to the Plantronics Quarter One FY 2019 Conference Call. All lines have been placed on mute to prevent any background noise.
After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions] Thank you.
It is now my pleasure to welcome our host today, Mr. Mike Iburg.
You may begin.
Mike Iburg
Thank you, Liddy. Good afternoon and welcome to Plantronics' first quarter fiscal 2019 earnings conference call.
I am Mike Iburg, Head of Investor Relations and joining me today are Joe Burton, Plantronics' President and CEO; and Pam Strayer, Plantronics' Executive Vice President and CFO. The information presented and discussed on today’s call 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 on our most recent 10-Q, 10-K and today's press release. As the acquisition of Polycom closed on July 2nd 2018, this earnings release will focus on Plantronics’ standalone results for the quarter ending June 30, 2018.
While guidance for the September quarter will be provided on a combined basis. We are providing non-GAAP guidance for the combined companies in a manner that is comparable to past period results.
Actual results will differ from this due to accounting adjustments made at the time of the acquisition of Polycom under U.S. GAAP accounting.
For example, these acquisition-related accounting adjustments are expected to temporarily reduced revenue recognized from acquired deferred revenue balances increase the value of acquired inventory, as well as add intangible assets to our balance sheet which will then be amortized over the future expected life of the assets. The specific impacts of these adjustments is unknown at this time, but will be recorded in our September quarter results when they are publicly released.
During today’s call, we will be providing historical non-GAAP metrics related to gross margin, operating expenses, operating income, net income and earnings per share. We have reconciled these measures with our U.S.
GAAP results, in our earnings press release, quarterly analyst metrics sheet and investor presentation, each of which is available, along with the recording of today’s call, on the Investor Relations section of our corporate website at investor.plantronics.com. Plantronics’ first quarter fiscal year 2019 net revenues were $221.3 million, compared to $203.9 million in the prior year quarter.
Plantronics’ GAAP diluted earnings per share for the fiscal first quarter was $0.42, compared with earnings per share of $0.57 in the prior year. Non-GAAP diluted earnings per share for the first fiscal quarter were $0.74, compared with $0.70 in the prior year.
The difference between GAAP and non-GAAP earnings per share for the first fiscal quarter of 2019 consists primarily of charges for acquisition-related fees, stock-based compensation and restructuring, all net of any associated tax impact and impacts from the changes in tax regulations. Please refer to the full GAAP to non-GAAP reconciliation in our press release for additional details.
With that, I will now turn the call over to Joe.
Joe Burton
Thanks, Mike. Good afternoon, everyone and thanks for joining us today.
I wanted to take this opportunity to provide a few remarks before we open the call for Q&A. As I sit here today, we are entering one of the most exciting periods in Plantronics’ history.
With the completion of the Polycom acquisition on July 2nd, we began a game-changing journey to transform the Unified Communications and Collaboration industry by creating a comprehensive set of intelligent communications endpoint and analytics solutions to address the markets' evolving needs. As I talk to customers and partners around the world about the acquisition, the feedback has been excellent.
Partners see the logic of bringing the two portfolios together and customers recognize the benefits of having a single vendor for their intelligent communications endpoints. I am pleased to report that the early stages of the integration are on track.
I welcome several Polycom executives onto my direct staff and look forward to building a great company together. In addition, we expect to reach the target of $75 million of annualized cost synergies by Q2 of fiscal year 2020.
Looking at our second quarter outlook on a combined company basis, we are forecasting modest year-over-year growth driven by stable revenues within the Polycom portfolio along with UC&C and Gaming growth for the Plantronics portfolio. Our outlook today includes higher gross margins, compared to the historical standalone headset business with room for further improvement as the industry-wide MLCC supply constraints and our gaming headset demand stabilizes.
As previously noted, and shown in our outlook today, this acquisition is immediately accretive to non-GAAP EPS and as we move deeper into fiscal year 2019, cost synergies will allow for further improvement of non-GAAP operating margins and further non-GAAP EPS expansion. Our long-term outlook for the combined company aligns with our view when the deal was announced.
We expect the continued growth of UC&C providers and the integration of our portfolio to enable acceleration of our top-line, while the improved gross margin and expected synergies will lead to long-term growth on the bottom-line. Our position in our core markets remains strong and portfolio integration coupled with even more product refreshes will allow us to be even more competitive in the marketplace going forward.
Turning to the quarter just reported, both companies had solid results. Plantronics continued to see solid enterprise growth of 8%, compared to the year-over-year quarter underpinned by another strong quarter of greater than 20% growth in UC&C.
On the consumer side, Gaming had a blockbuster quarter, fueled by the Battle Royale style games such as Fortnite where collaboration is vital to playing competitively. As we saw this demand materialize, we made the decision to meet market demand and further strengthen relationships with our retail partners ahead of the upcoming holiday season.
This had a short-term negative impact on our margins, which we expect to improve going forward. Polycom’s return to growth continued in the June quarter with year-over growth in both voice and video.
We expect to provide more visibility into our historical results when we publish 12-months trailing financials for the combined company later this quarter. Thank you again for taking the time to be with us this afternoon.
And with that, let’s open the call for questions.
Operator
[Operator Instructions] Your first question comes from the line of Mr. Greg, Sidoti.
You may ask your question.
Greg Burns
Could you just discuss your view on how Cisco getting into the headset market changes the competitive landscape at all for you?
Joe Burton
Yes, hi, Greg. I’ll get started there and if Pam has anything to add, she can jump in.
Cisco announced that couple of headsets a couple of quarters ago. Cisco’s headsets are currently two or three headsets that are corded that are out and I think a cord less that is coming out and really are focused on the Cisco IP Phone market.
So, they integrate very, very closely with Cisco and frankly, so far, we have not seen them in competitive situation. So we haven’t seen them show up in big deals and clearly, it's nowhere near the breadth of the portfolio that we have.
So, really no impact on the business in the short-term and we see low to moderate impact even over time, and only in the Cisco business itself.
Greg Burns
Okay. And has there been any change in your – on the Polycom side of the business, is the relationship with Cisco now that they own BroadSoft a little bit, what's the competitive dynamic there?
And how does the combined Cisco and BroadSoft maybe impact Polycom longer term?
Joe Burton
Yes, same things. A very similar answer, Greg.
So, of course, the Cisco acquiring BroadSoft, which is BroadSoft is a unified communications as a service provider. So BroadSoft gets sold to a service provider like and AT&T or a British Telecom, they turnaround and offer that as typically a small business system to small companies.
Cisco acquired BroadSoft before we announced the Polycom transaction. So, we were well aware of it at the time we purchased Polycom.
Polycom does sell quite a few IP phones, open SIP phones against BroadSoft, RingCentral 8x8 in the entire rest of the Unified Communications-as-a-Service market. We continue to sell well against BroadSoft.
BroadSoft and Cisco have mentioned a commitment to remaining open where phones clearly from Cisco can integrate against that form, but so can phones from Polycom and other vendors as well. And we’ve seen no real change in our revenues at this time.
Greg Burns
Could you give us a sense of how big of a partner or how much revenue Polycom generates through BroadSoft on the voice revenue?
Joe Burton
We don’t break that out specifically, but let me go to a couple of things that are in the acquisition materials we put out a while back if you look deeply enough at it. Broadly, Polycom’s revenues, and I do mean broadly, but break down into kind of a third voice, third video and a third services, plus or minus a little bit.
But these are all in the materials were published back when we announced the acquisition. BroadSoft is a fraction of the voice third, but they have a broad and deep business across many different partners.
So BroadSoft would be some sliver of that third, not the majority of it and not outside of that particular third. So, hopefully, that helps you begin zeroing in on the potential impact and frankly, based on the way that market works, we do not see those revenues drying up in any abrupt way.
Greg Burns
Okay, great. I’ll jump back in the queue.
Thanks.
Pam Strayer
Okay, Greg.
Joe Burton
Thanks, Greg. Operator next question.
Operator
And your next question comes from the line of Mr. Mike Latimore from Northland.
You may ask your question.
Mike Latimore
On the enterprise and UC deals, are you seeing a diverse set of deals? Or is it a concentration in a few?
Joe Burton
It’s a great question. Part of the – part of the growth we've been seeing around Unified Communications over, frankly the last couple of years with the last several quarters, in particular, is the business has become broad indeed.
We're not seeing the – we are not seeing a lumpy market where one or two deals make or break the quarter. We are really seeing a consistent, all three geographies, all company sizes, solid demand for UC across the business at this point.
So no particular lumpy deals.
Mike Latimore
Okay. You haven't given the guidance for the full year, but could you talk a little bit about how you see Polycom over the next six months or for the next twelve months?
Do you see the growth being stable or enough of a factor there or maybe a slight decline and any challenges you see there?
Joe Burton
Well, it’s - so once again, I’ll start and Pam can jump in. But, as you said, we have not announced full year guidance or updated any models.
We are also being appropriately cautious on Polycom. Given that of course we did great diligence.
We have literally as of today owned it for about 35 days, technically, and then, all the way under the covers. So, I think, Pam will probably go through guidance for the coming quarter here in a little bit.
But we expect to see Polycom be a flat to modest grower with little bit stronger on the Plantronics' side, probably.
Mike Latimore
Okay.
Pam Strayer
Yes, I guess, I just jump in there and maybe add that, on the Polycom side, we expect to see a continuing trend that we saw during diligence. They are getting growth from their voice business.
They had growth in their video endpoints business. But that’s being offset by their legacy video infrastructure business which is going to continue to decline as we expected.
Joe Burton
Yes, which was a choice Polycom made and how they position the portfolio and frankly matched our market thesis so well. That’s part of the reason that we came together.
So really, we are – so far we are expecting very much what we were expecting when we announced the deal.
Mike Latimore
Okay. So, does it mean that there would be any further Polycom products that would be decommissioned over the next couple of quarters?
Joe Burton
Well, clearly, we neither announce cancellations nor announce new products on a call like this. However, there is certainly nothing substantial planned.
Polycom has a great product portfolio. It’s part of a – a big part of why we purchased them.
Obviously, they’ll have product refreshes, old versions of products that are going away, but no big change in the Polycom strategy. We thought it was untied on target and that’s why we came together.
Mike Latimore
Owned it, yes. Thanks a lot.
Nice quarter.
Joe Burton
Yes, thanks, Mike. Operator, next question.
Operator
Thank you. Your next question comes from the line of Mr.
David Eller from Wells Fargo. You may ask your question.
David Eller
Yes, thank you for taking my questions. I think you mentioned in the script, maybe you saw Polycom voice and video growth in the June quarter.
Did I hear that correctly? And, kind of any thoughts on profitability, whether it be EBITDA or operating income for the June quarter as well?
Joe Burton
So, we did mention that we saw at least – that we did see a continued growth in Polycom like the last couple of quarters. But, have we broken anything out on profitability, Pam, going backwards?
Pam Strayer
Yes, no, we haven’t. I would say, because Polycom was still a private company.
In the June quarter, we are not releasing a lot of data here. I guess, I would just say in terms of profitability, you talked a little bit about the growth trends and those were similar in the June quarter.
In terms of profitability, I’d just say, it’s in line with what our expectations were. There is no surprises there and you know, we are still confident in our ability to integrate and reduce costs overall for the combined company.
David Eller
Okay. Another housekeeping question.
Any change you can give us kind of the cash and debt balance of Polycom as of June 30?
Pam Strayer
No, no, we are not going to be releasing that information.
David Eller
Okay. And then, kind of turning to tariffs, could you talk a little bit just about on a combined basis, can you give us an idea after the deal, how much your products is manufactured in China?
How much in Mexico? And any other thoughts you have on potential for tariffs?
Joe Burton
One thing I would say is, we really source our products quite globally. We have a substantial amount of the Plantronics products of course being sourced to Mexico.
We do have some in China, but some in many other countries around the world as well. Any thoughts on the overall exposure to tariffs Pam?
Pam Strayer
Yes, we are looking at this. Obviously, the impact is going to depend on the final list of products, the specific rates and implementation timing, which I think is all open at this point.
We are watching it carefully and to prepare for it, we are looking at alternatives in our supply chain. I think we are in a good position because we have a manufacturing facility in Mexico.
It does allow us to potentially reduce some of the impact to us by utilizing more of that manufacturing facility there. So, no guidance there right now.
We are going to continue to watch it.
David Eller
And then, if you could just talk about other inflationary pressures outside of tariffs, whether it be kind of input cost, transportation, logistics, foreign exchange, any other of those factors that might affects the model going forward?
Pam Strayer
Sure, so, let me just jolt down a couple of notes just for a minute. So, there is a couple of dynamics going on in the market.
There is the MLCC cost, there are capacitor costs that are increasing, that’s impacted Plantronics a little bit in this June quarter. It’s also going to be impacting Polycom going forward.
So that’s something that’s going to weigh a bit on our gross margins as a combined company going forward. In this past quarter, FX for Plantronics was a bit favorable, but I think going forward that’s expected to stabilize a bit more.
So, I am not expecting significant FX impacts going forward. We do need a little bit of time to get Polycom on our normal hedge program.
They are currently not hedged like we are and so we need a little time to get that in place to protect ourselves from FX. Those are the big things off the top of my head in terms of trends across.
Joe Burton
I think that, just FX and the well-known MLCC shortage that’s hitting virtually everybody in the consumer electronics industry.
David Eller
And then, last question from me, kind of one of the prior questions was kind of about the September and December quarter. Could you give us any other insight into on the consumer gaming business, you talked about strength kind of recently, do you think any of that could be pull forward from kind of Q3, Q4 quarters and then, on the Polycom side, are there any anomalies or one-time items from the prior year that we should be kind of thinking through as we model out those next two quarters?
Joe Burton
Starting with the gaming question, you might imagine that everyone in the industry continues to watch for the shape of the curve around this gaming phenomenon. Certainly, everyone seems to believe including us that this is not a pull forward.
That the gaming demand is likely to remain strong, certainly for the next couple of quarters as a minimum. Clearly, others in the gaming business have recently announced and said at the same time.
So I don’t expect that we had our Christmas quarter, this quarter, I think this is actual additional demand. So gaming should look good over the next couple of quarters.
Like everybody else, we are really trying to peer into the tea leaves and figure out what happens post holiday season. But that’s a couple of quarters down the road.
On the Polycom side, no particularly anomalies. They do not have strong seasonality.
In other words, they stay pretty linear. They don’t have a particular quarter that’s wildly stronger than others.
And there were neither any unusual positive or negative effects over the last quarter nor are there any particular ones anticipated over the next couple of quarters.
David Eller
All right. Thanks for taking the questions.
Joe Burton
Yes, you bet, David.
Mike Iburg
Operator, next question.
Operator
And a follow-up question coming from the line of Mr. Greg Burns from Sidoti.
Please as your question.
Greg Burns
I just wanted to get a sense of what’s your view on the cash flow is going to be for this year, particularly, where the cost of the synergy is going to be, the cash costs and what's your view on CapEx for this year?
Pam Strayer
Yes, Greg, let me try to answer your questions there. On CapEx, I’ll take that one first.
I think as a combined company, we are going to end up still in a similar situation where it’s going to be a low percent of revenue than on capital expenditures. My expectation will be somewhere between $30 million and $40 million in CapEx for the year.
Your other question was about cash flow. And, the forecast for that…
Greg Burns
The cash cost.
Pam Strayer
Oh, sorry, the cash cost, yes, thanks. The cash cost on synergies, it’s really hard to know how much it’s going to take by the end of the – we are working on detailed plans now to underpin the synergies that we are going after with an integration that size, some of those costs can be significant and I think some of the benchmarks we’ve looked at suggest that you could spend pretty much dollar-for-dollar to get the $75 million runrate synergies.
I don’t have a forecast for that right now. Once we’ve been working as a combined company for a while longer, I’ll be able to give you more insight into what those cost will be.
But we are just starting on our detailed plans.
Greg Burns
Okay. And, what percent of the consumer business is gaming?
Pam Strayer
It has grown certainly over time and right now, it’s gotten to be about 25% - 20% to 30% of total – of consumer revenues with gaming.
Greg Burns
Okay. And, any update on what’s going on with – in the stereo market.
Has your competitive positioning there improved at all? Is that growing, declining?
What’s going on there?
Joe Burton
I think as we stated a couple of earnings calls ago, we were in the process of refreshing our stereo portfolio to both have a more attractive competitive set of products and also to improve margins. As we begin to tilt towards the holiday load in here for the second half of the year, we’ve completed our refresh now.
We have a fully refreshed set of our back beat products ready to go for the holiday season and we are very optimistic, but yet cautious. So, we will see what the next quarter has to show for us, but we think we have a much improved hand at this point.
Greg Burns
Okay. And then, looking at the gaming margins, how much lower are they relative to the rest of the consumer segment?
And when you roll that down to the operating margin line, have you changed your view on your target model of 20% to 23%? Or is that still achievable?
Pam Strayer
Yes, so, a couple of questions there. On our target model, we will - as a combined company, we are going to take a fresh look at what that long-term operating model is going to be.
I’d expect it to change in some way. But I don’t have that prepared right now.
I’d like to operate, again, as a combined company for a couple quarters before I lock essential long-term operating model. The gaming margins, if you exclude airfreight and some of the royalties on it the gaming margins overall, well it did increase year-over-year.
But the airfreight added over a 100 basis points to the cost of the headsets and some of the royalties attached to gaming also brought down margins. So, we were estimating the total gaming impact to be about 270 basis points on our gross margins.
And that includes, the additional expedited costs, but also the product mix shift towards gaming headsets which do tend to be lower margin than enterprise. But, right in line with other consumer headsets when you exclude royalties and freight.
Joe Burton
Yes, I think that’s what makes it a little bit tough this quarter, Pam. It is actually our gaming portfolio has very reasonable margins that our fully mixed model supports quite nicely.
We are a little bit of victim of our own success when we sold dramatically more gaming headsets than we had anticipated this quarter and then had to airship a bunch of them, which really brought the profitability down a bit. However, we thought that was crucial to maintain our relationship with the various resellers and be positioned well for the holiday season.
Greg Burns
Okay, great. And then, lastly, in your headset business, what percent of that business is tied to contact centers?
Joe Burton
We have – couple of things I’d say about that. It’s always been impossible to really tell how much of it is tied to contact centers.
What we really know with some level of detail is what percent of it is our core business that hooks to telephones and what percent is the newer UC business which tends to hook to a – which tends to hook to a PC, tablet or smartphone over a more modern connection like Bluetooth or USB. The breakdown between the two of those is approximate parity, meaning our core business has been in slow decline for a number of years.
While the UC business has been growing 20% year-over-year for a number of quarters now to the point where those two businesses are about the same size. But as far as what percent of it is precisely in the contact center?
Impossible to tell, but it is becoming proportionately smaller as you see continues to really take off.
Greg Burns
Okay, thank you.
Joe Burton
Yes.
Mike Iburg
Thanks, Greg.
Operator
Okay, thank you. I will hand over the call again to Mr.
Mike Iburg for closing remarks.
Mike Iburg
Thank you, Liddy. Thank you for joining us today for Plantronics’ First Quarter Fiscal 2019 Earnings Conference Call.
We look forward to reviewing our second quarter results on our next call. Thank you.
Operator
This concludes today's conference call. Thank you for participating.
You may now disconnect.