Greg Klaben - VP, IR Ken Kannappan - President & CEO Pam Strayer - SVP & CFO

Dave King - Roth Capital Partners Paul Coster - JPMorgan Greg Burns - Sidoti & Company Tavis McCourt - Raymond James Jim Fitzgerald - Northland Capital Markets

Good afternoon, my name is Erin and I will be your conference operator today. At this time, I would like to welcome everyone to the Plantronics' Q3 Fiscal Year 2016 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. Greg Klaben, Vice President Investor Relations, you may begin your conference.

Thanks Erin and welcome everyone to Plantronics' third quarter fiscal year 2016 financial results conference call. Joining me today are Ken Kannappan, 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 and 10-K and today's press release. 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've 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. We've also reconciled constant currency in the investor presentation and after the conclusion of today's call the recording of the call will be available with information on our website. Plantronics' third quarter fiscal year 2016 net revenues were $225.7 million. Plantronics' GAAP diluted earnings per share for the third quarter was $0.52 compared with $0.71 in the prior year. Non-GAAP diluted earnings per share was $0.83 compared with $0.79 in the third quarter of fiscal 2015. The difference between GAAP and non-GAAP earnings per share for the third quarter consists of charges for stock-based compensation, restructuring charges and purchase accounting amortization, all of which are net of the associated tax impact and tax benefits from the release of tax reserves. Please refer to the full reconciliation of GAAP to non-GAAP in our earnings release. With that, we would like to open the call to questions.

[Operator Instructions] Your first question comes from the line of Dave King with Roth Capital Partners. Your line is open

Hi, sorry about that. Good afternoon, guys. I guess first off in terms of the restructuring, can you talk about the drivers, the rationale there? Is that more of a response to some of the macro currency pressures and realizing these are earned more of a return overall or is that more of a function of some of the pressures specifically in mono Bluetooth reducing related headcount etcetera. Color there would be helpful. Thank you.

Sure. I'll try and thanks for the question. It's really a combination, just to outline this, obviously we have seen a significant reduction in the mono Bluetooth market particularly in the U.S. We had gained a lot of market share in that business, which had masked some of that decrease. But over this past year, what we had really seen is that although we gained a tiny bit of market share, we're really about at the limit. And there were in fact some people exiting the low end of that business and that gave other people an opportunity to increase. But what we found was the retailers really did not want to have any more of the market share concentrated with us. They still wanted to have a little bit of a selection. So we think we've kind of hit somewhere near a peak in terms of our market share opportunity there. What we expect the stereo business to grow and do believe that we will come in the course of probably towards the end of this year a point that the stereo growth will exceed the mono decline. Nonetheless it doesn’t give us a growth engine on that side. So then we're looking at a fairly choppy macroeconomic environment and the FX hits being pretty substantial. We did not want to ignore that impact on our business model. We felt that we are in a really good strategic position and that we could in fact continue to be effective and industry leading with a reduction in our cost structure. So looking at both the mono Bluetooth, looking at our competitive position, looking at the impact on FX, we did want to take a step in the direction of improving our cost structure. Am I answering your question well enough?

Yeah, I think so. And maybe some follow-ups around it. In terms of then how much of this is just purely headcount versus some of the other things that you may or may not have talked about in the past in terms of SKU rationalization versus I think one of the initiatives you guys had was transitioning more the supply chain from China to Mexico. Are those -- is some of this cost savings coming out of those things as well or is this in specific response to also some of the recent…

Yeah, so this is a specific response. We are continuously reducing SKUs, but in fairness we're also continuously adding SKUs. So we do try to make sure we're doing enough housecleaning there to be cost efficient while at the same time adding innovation on the front end side. We're absolutely continuing many programs in operations including taking advantage of the incredibly low cost position and significant facility that we already have as a fixed cost in Mexico to reduce supply chain cost. This was separate from those initiatives.

Okay. Okay. Yeah definitely helps. And then maybe going back to the mono versus stereo comments, so in terms of looking at that revenue now, how much of the business is tied to mono versus stereo? And then it sounds like Ken from your comments that the stereo business is still tracking fairly well. Maybe can you just talk about the health of that recent performance of some of the BackBeat products, just any color to give us some comfort there would be great.

Sure, so great, there were a few questions there and I'll try to remember them all, but if I miss something, just let me know. So first of all the stereo business has clearly grown as a portion of the total consumer business and at this point in time, actually the mono business is less than half of our total consumer business, now there is a little bit that’s gaming as well. We had a terrific response to some of our portfolio this year, but more to the point, the portfolio -- and we had growth in stereo obviously, but more to the point, the portfolio that we showed at the Consumer Electronics Show or CES in Las Vegas, was really extremely well received. I think that one of the concerns that we’ve had as Plantronics is we're known and we are a communication brand and the depth of the value add that we can provide in communications is truly unparallel. As we were moving into this stereo space, we knew that some of these products were consumption first or music first types of products where communications would be secondary. And so we were worried about our permission to play in these segments and the reception that we would get from some of the key channels. And very clearly what we heard at the CES Show was, your products have been fantastic. Our sales reps are already telling us that these are the best products. The return rates are lower. Word of mouth is very positive, very positive reviews on the websites. So we may not be able to compete with the marketing brands or the budgets of some of our competitors, but the authenticity of the experience is very, very high and the enthusiasm we had for the specific models we showed that were launched over the course of the year was very, very high. So we feel very good about our potential and the ability to compete in that segment. Now, again you asked a number of questions and I am not sure if I remembered them all. So if I missed one please tell me.

No, no, I think you covered it. You gave me some color on the health of the business and then also just the response in new products and I asked about BackBeat in particular, but I think that sort of talks about new products, so it helps. Just one more and then I’ll step back, in terms of the guidance now for next quarter, sequential guidance if I call it the midpoint of $205 million, it looks like that’s -- you guys are expecting that to be up 2% year-over-year, if I look at that correctly versus down 2.5% in the most -- in the quarter you just reported, I guess how does that break down in terms of enterprise including UC versus consumer then also maybe to the prior point, how are you thinking about the near term outlook for stereo versus mono in that consumer segment?

So on guidance for Q4 we are expecting an increase of 2%. Most of that is going to be driven by the enterprise business and UC in particular. Year-over-year for Q4, we’re expecting a little bit of a decline in consumer driven primarily by the declines in the mono Bluetooth market. So UC will be the primary growth driver there offsetting declines in mono Bluetooth.

So I’ll just talk briefly, on the consumer side clearly we will expect some good progress on the stereo side of the business, but not in terms of this quarter because we don’t really have the benefit of the new launches this quarter.

Okay. Okay. That's great color. Thanks Ken and Pam and good luck with the rest of the fiscal year.

Thank you.

Thank you.

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

Yes, thank you very much for taking my questions. So gross margins came in slightly south of our expectations. I wonder if you can talk to us about the puts and takes in December quarter, but also the guidance, the guidance, I’m finding it quite hard to work with from a pro forma EPS perspective unless I take down our gross margins quite significantly in the back end of this fiscal year, is that a correct thing to do and why? Thank you.

So first I’ll talk about the gross margin changes year-over-year in our Q3 results. They did come down by over 300 basis points. 120 basis points of that was due to currency impacts and we also had 70 points from some customer mix and product mix. There was also about 100 – sorry, about 80 points from some pricing changes that we made in order to stay competitive in our international geographies.

And so going forward into 4Q?

Yeah, we're forecasting some additional pricing impacts in Q4, but our gross margins for our guidance is somewhere between 51% and 52%. So that gives you some idea, I don’t know if that was in the range that you were looking at, but that’s what…

No, it is, and so it means that you're approaching expenses a little bit higher than - you doing this restructuring, is it not going to impact OpEx. I might have missed something there but…

No, let me clarify that, yeah let me clarify that. So due to the timing of our restructuring activities that are happening during Q4, we’re not going to see all of the savings in Q4 that we would expect. So there is a quarter-over-quarter increase in our expectation of operating expense and some of that has to do with variable compensation. In Q3 we saw a benefit of about $2 million from reducing our variable compensation as a catch-up adjustment reducing Q1 and Q2 accruals, but we’re not going to see that benefit again.

Okay…

Also, sorry, the bigger impact there going from Q3 to Q4 is really the 14th week, due to the way our fiscal year calendar falls, we have an unusual 14th week in our Q4 this year. It's typically 13 weeks. So that adds about -- that will add over $4 million in operating expense just in the 14th week.

Got it, that’s helpful. Just going back to revenues for a moment, the fiscal third quarter, I know you don’t break out UC from corded and wireless office systems anymore, but just directionally where was the growth and where was there no growth -- was UC up double-digits year-on-year or are you just not in a position to share that data anymore?

Well we can give you a little bit of color on this. So the UC business on a constant currency base I think it was up about 8% for the year, which is a little bit lower than we had a hoped, but nonetheless positive. The big decline was in the mono Bluetooth business in the U.S., which was off about $8 million year-over-year.

Okay. That makes sense. And then so thinking a little bit further out and you have introduced a whole bunch of new capabilities on your contact center headsets [indiscernible] I think particularly to Enterprise IT in terms of the metadata that can be collected from these headsets now. And you've also seen Microsoft introduce Skype for business. It kind of feels like things should be fairly good in the enterprise at the moment in terms of the reasons to buy Plantronics headsets anyway, but I suspect there is cyclical headroom just to the extent you can give us color here? What is the outlook for 2017?

All right. So everything you said is correct Paul. Let me kind of give you what the concerns are and what the pros are. We're certainly hearing a very good response to our new portfolio and I would say globally. At the same time, it's early January that we've assembled this forecast and it's been at best a choppy start to the year from a macroeconomic standpoint. I would say some sectors of both global and U.S. economy have been very affected. And so just talking U.S. economy, very clearly the oil and gas industry has taken a significant hit and that for us is a very, very good sector of the market. We've seen some hits also from the defense contractors aerospace sector and I would say the U.S. exporters such as ourselves who are affected by the dollar, some of course are able to price in dollars overseas, but those who have to price in local currency, this has been a significant impact for them. So I think some of those sectors of the economy have been affected and I think others have been concerned by macroeconomic events. We usually find that this is still early in the quarter to really understand what we’re going to see in the course of the year. And so we’ll pick up more of that intelligence as we go to Enterprise connect and get more feedback. But so far what we’ve heard has been relatively positive, but it's in my mind there is a certain tentativeness just because of macroeconomic concerns, the downgrading of expected GDP growth rates. From a global basis, we actually saw a pretty good quarter from constant a currency standpoint from Europe. I think that the -- never minding the translation, I think that there is actually some room for hope that the position is getting better. On the other hand some of the emerging markets have been very hard hit and some of them were hit before and it's gotten worse. So if I look at areas such as Russia, Brazil, South Africa, China having slowed down, very clearly the oil producing regions and as well as big companies within countries, if you look at Pemex or something like that, Petrobras, which are oil companies in diversified economies these are also weak. So we've got some of those on the negative side. So I think we feel very, very good about the portfolio, the value proposition it provides and what the reaction we're hearing and at the same time, if I looked out longer, I think that there is a risk of macroeconomic headwinds on the negative.

Thank you, Ken.

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

Good afternoon. In terms of the gross margin and some of the bear comments you mentioned competitive pricing on the enterprise side impacting the gross margin. So I was just wondering if you could give a little bit more color. I think what Pam was saying, it sounded like just dealing with the FX advantages of some of your competitors, but I don't know if there might be anything more going on in the market I think.

Sure, let me comment on a little bit. That's probably the smallest of all the factors in terms of gross margin and what I would say there is there is kind of two elements of it. One is we sometimes sell in dollars, but we're really in local currency competition and so that's part of it. And the other part of it is there were some even on the enterprise areas where we had little bit of price competition in Europe. The much bigger effect on the pricing was on the consumer side, and then product mix and FX. So this was a fairly small one.

Okay. And in terms of the OpEx, I guess you gave some color on what to expect in fiscal '17 so up year-over-year, is the first quarter kind of the high water point and then you get some benefits from the restructuring or how should we think about that year-over-year increase in fiscal '17?

So I believe the year-over-year increase I was referring to was actually looking at Q4 guidance. If we look at the full year FY’17, we're going to have cost increases. We've taken $15 million to $16 million out of our annual cost. But one of the big challenges we have is variable compensation is going to come back to 100% for much lower than that this year and that's a big chunk $15 million or more in cost that are going to be coming back as a result of bonuses. We'll also have…

Depending of course on our performance relative to the plan, which is not yet been set for next year.

Sure right. The plan is not yet finalized. We also have merit increases in healthcare cost and other things in there that traditionally go up year-over-year.

Okay. So the guidance is for the first quarter of '17 to be up sequentially from the fourth quarter of this year and then that's kind of the run rate including all the restructuring benefits?

So we haven't actually set guidance for Q1 of next year. All we provided is guidance for Q4, which admittedly is not giving you a perfect understanding of this cost reduction action because obviously it's occurring February 1. Not all of it will take effect for the whole of this quarter. So the full effect of that benefit will be in the next quarter, but we've not yet come up with guidance for the June quarter at this time.

Okay. I am just looking at your prepared remarks and it says we expect Q1 fiscal '17 operating expenses to increase slightly over the fourth quarter. Is that not the case?

That is the case, yes.

Okay.

But again a lot of that is the variable incentive compensation coming back. We haven't put together an actual detail expense as yet for the June quarter.

Okay. And in terms of the accrual reversals this quarter, what was the total amount in terms of dollars and the impact on EPS?

Well, the way I would think about it is that there was a benefit of $2 million in Q3 operating expenses as a result of the adjustment.

Okay. Thank you.

[Operator Instructions] Your next question comes from the line of Tavis McCourt with Raymond James. Your line is open.

Hey, thanks for taking my questions. I wanted to dig a little bit deeper into the gross margins in the quarter and the guidance. So to what degree and I think you went over kind of the currency issues and pricing changes and mix, but are you seeing these issues across both categories or is this consumer-only or is it enterprise-only?

So let me talk partly to it and then I'll let Pam give you more correct and detailed information. First of all, some of this absolutely cuts across all categories. So foreign exchange cuts across all categories. The lower volumes in the plant, which affects our fixed absorption maybe due primarily to the drop-off in the mono Bluetooth business, but that affects our total business and it affects our total gross margins. Some of the higher logistics cost we had were due to the consumer side of the business where we had much greater volume. On the mix side we had product mix issues that are really kind of very specific to particular products. It was probably a little bit more on the consumer side than it was on the business side and more of the pricing was probably on the consumer side than on the business side, but that's kind of the flavor I would give you. Pam, do you want to correct anything?

No, I won't correct anything. I will add one thing though. The discount or the pricing impact to enterprise was all international -- into international pricing. So the pricing impacts were much more significant on consumer globally, but when you think about the enterprise, it was internal pressures.

Great. And I have a couple of other questions. And then on the consumer business, so if I take a step back and look at the last four quarters, it's actually getting better right, like so it was declining year-over-year much worst four quarters ago. It appears to be getting better. From your guidance next quarter it seems like low to mid single digit decline, but I want to make sure I am reading that right because it seems like you're focusing more on this call than perhaps you have on the last couple of calls. Are we kind of nearing the points where I think you mentioned mono was getting close to 50% of revenues where we might see a flattish or an up quarter in the next four to eight quarters or am I looking at something wrong in the model here?

Well, so I think what you just said is reasonable, but let me just say also part of the reason we only forecast one quarter is that our accuracy is not very perfect. So you're asking me for when we'll get to that inflection point where the drop off in the mono category stops hurting us more than the gains in the stereo and we don't know for sure ourselves just to be clear. In all honesty we were surprised that the mono Bluetooth category's decline accelerated this year in the U.S. We were certainly prepared for some decline, but it actually went down much faster than we had expected. So we don't know for sure how much growth the stereo category will have. We don't know for sure how much decline the mono category would have. That means that it was pretty hard for us to estimate for sure where the crossover will be. Having said that, we do think it's kind of reasonable that within a year as we started to get the traction on all of our new product launches, that we will be at or around that zone.

Great. And I did have a question on something you should be able to forecast, which is the operating expenses. So if I want to get this right, so part of the increase in the operating expenses in the fiscal fourth quarter was $5 million or $6 million from the added week in the quarter, which makes total sense. Theoretically that should go away in the first quarter of '17 and that would be a bigger number than whatever variable bonuses would be coming in from doing the math right. So I am trying to figure out, are those logical steps correct and if so what am I missing here? Is it…

You made one error and that is the variable compensation coming back into Q1, is much larger than the $5 million impact of the 14th week.

Let me explain one thing. So there were two elements that kind of -- that in Pam’s comment about the $2 million credit in Q3 I believe, one is that we had a credit for reversal of prior quarter's accrued compensation. But the other one is our accrual for that period was well below a 100% accrual. So when we go back to a regular quarter, we would be assuming we're on plan accruing on the basis of a 100%. So that’s why those numbers didn’t quite add up.

No, yeah I understood all that. I had heard Pam say earlier $15 million annual number, and so I was dividing by 4, but may be that $15 million wasn’t inclusive of all the variable cost.

Yeah, that was about -- that was a quarterly number and includes AIP as well as merit increases and healthcare. So…

There is a few other small numbers, a year ago we had I think a litigation receipt that reduced our OpEx. We don’t have that this year. There is a few other little things.

All right, I got. Thanks.

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

Hi, this is Jim Fitzgerald sitting in for Mike Latimore. Most of my questions have been answered, but I just have a few quick ones here. Going to Skype for business, I know that was touched on once earlier, but have you seen any delays or accelerations in your UC business that’s a result of that offering? And then I guess I would have the same question for Cisco [Swirk] if you've seen any delays or accelerations in the UC business because of that.

So I think that we’re encouraged by the new products from our partners. I think that it always takes a certain amount of time having said that for the market to trial, accept them for any issues in the offerings to get smoothed out by the customer base. And so it's just not been the case that we typically get an instant lift off from new offerings. However I do think that there is if anything continued growing enthusiasm. I continue to wish that it took off a little bit more like a rocket ship and less like a barge, but at the end of the day, are we confident that there is growth? Yes, these offerings are better, faster, cheaper than existing solutions. They can meaningfully help organizations operate better, more flexibly, embrace mobility in their workforces, do it at lower cost. Some of the new offerings extend the cost savings opportunities to corporations while extending the capabilities and better supporting both cloud and hybrid architectures that people are very interested in. So I think we feel positive about that, but again I’ve learned that it doesn’t always mean that we’re going to get an instant acceleration of business. I would say one other thing. I think that Microsoft is also very interested in converting a lot of the people who've adopted their UC solutions currently primarily for IM and presence into using more of the license and that would also be encouraging.

Okay. Great and then what do you guys expect for GN litigation expense in 4Q? I think for 3Q you had expected it to be something like $1.6 million?

The current forecast is somewhere between $1 million and $2 million in expense in Q4.

Okay. Great. Thank you, guys.

There are no further questions at this time. I'll turn the call back over to you, Mr. Klaben.

Thanks Erin. Thanks everyone for joining us today. If you have any additional follow-up questions, we'll be around this afternoon.

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