HP Inc. (HPQ) Q1 2008 Earnings Report, Transcript and Summary

Good afternoon. My name is Kristen and I will be your conference operator today. At this time, I would like to welcome everyone to the Plantronics Q1 fiscal year 2008 conference call. (Operator Instructions) Mr. Klaben, you may begin your conference.

Thank you, Kristen. This is Greg Klaben, Vice President of Investor Relations with Plantronics. Joining me today to discuss our first quarter fiscal 2008 financial results are Ken Kannappan, Plantronics' President and CEO; and Barbara Scherer, Senior Vice President of Finance Administration and CFO. 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’ve highlighted before, the risk factors discussion in these filings are not standard boilerplates. We update these risk factors every quarter, adding and dropping language and changing the order depending upon the timing and potential impact of the concerns that we foresee. We believe forecasting our results 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 filings. The Plantronics mission is to enhance communications and entertainment. Our strategy for doing so is to incorporate our key product principals -- simplicity, style, and sound quality -- into products which are relevant to the respective enterprise and consumer markets. The first quarter fiscal 2008 net revenues were $206.5 million, compared with $195.1 million in the first quarter of fiscal 2007. Revenues were within our guidance of $205 million to $210 million and our GAAP diluted earnings per share increased 24% to $0.31 in the first quarter compared with $0.25 in the first quarter of fiscal 2007. Non-GAAP diluted earnings per share were $0.37 compared with $0.28 in the first quarter of fiscal 2007. Earnings per share exceeded previously provided GAAP guidance of $0.20 to $0.23 and non-GAAP guidance of $0.26 to $0.29. The difference between GAAP and non-GAAP earnings per share for the current period is the cost of equity-based compensation. Now I’ll turn the call over to Ken.

Thank you, Greg. Thanks for joining us today. I’ll start off with a quick business update and then I will turn the call over to Barbara to go through our financial results and then we’ll open it up to Q&A. I wanted to start with the most important points I thought occurred in the last quarter. First of all, our current product offerings continued to offer significant value and are well-positioned to take advantage of what we view as helpful conditions in the enterprise and Bluetooth mobile markets. We recently introduced the CS70N and that is receiving very solid reviews from our customers and channel partners and we believe it will continue to help our leadership position in the enterprise market. Secondly, we announced some new products during the quarter which we think should compete very well in their respective segments. We continue to believe that we have a very competitive product pipeline which will continue to offer the types of products that our business and consumers are looking for. Among the more significant product announcements were the next generation of Voyager, the Voyager 520 Bluetooth headset, which was announced and will be available next month. This product, like its very, very strong-performing predecessor, the Voyager 510, has excellent sound performance to both transmit in regular environments and windy environments. It has great receive, good communication versatility with multi-point, very intuitive, easy-to-operate design ideally suited for mobile professionals. We also inaugurated the new .Audio 480 Virtual Phone Booth of headsets for laptop, multimedia and VOIP conversation. This is the smallest, most portable computer headset in the Plantronics lineup and it delivers outstanding stereo sound and voice quality for laptop users on the go. The concept really isolates you, kind of like you are in a phone booth, with a great design for the ear bud and also provides wind noise reduction on the transmit side for people who are in a mobile café or any other type of area, so they can be engaged in Internet calling, gaming, music, movies, no matter what type of environment they are in. Third, we increased utilization in the China manufacturing plant with high quality and service levels. We also improved in other areas of transformation costs. These improvements, coupled with strong OCT revenues, contributed to the increase in gross margin within our core headset business in ACG. Important objectives for the balance of the year are to reduce transformation costs and improve supply chain management. In the first quarter, despite strong sales, our inventories increased. Going forward, inventory management remains a key objective. We have room for improvement in many other operations throughout the company over the next several years. An important one for margin improvement is our supply chain optimization and re-engineering initiative, which is now being overseen by Larry Wuerz , who joined us as Senior Vice President of Worldwide Operations after 28 years with HP. The Altec Lansing division remains in a turnaround phase and requires a significant product refresh to be competitive and return to profitability. We believe the product refresh cycle will be weighted towards the latter part of the next 18 months. We do expect to announce new products periodically during this period. Some positive signs for the division include initial sales of the IM600, now a leading portable dock and speaker system for the iPod. We also announced the Upgrader series of headphones for computers and portable electronic devices and the PT series in wireless digital surround sound speakers for flat panel TVs, which includes 2.4 gigahertz technology. We also began in-depth, very good consumer research to begin framing products for launch in the fall of 2008. Now I will turn to our product group. On the enterprise side, which consists of the office and call center market, we realized growth of 15% compared to the first quarter of last year. This is largely driven by continued strong demand of our wireless products which grew over 20% from the first quarter of last year. Last quarter I discussed our new marketing focus to penetrate what we believe is a largely untapped opportunity in the office and call center. Our sound coach provides a more immersive experience to allow people to understand the benefits of headset adoption. We’ll also continue to leverage the high levels of customer loyalty to our products or to drive purchase decisions and to upgrade existing wireless headset users to our new CS70N. Turning to mobile, the Bluetooth business was up 27% from the same quarter last year. The product portfolio we currently have remains competitive. In addition, we believe our new product pipeline is being well-received. Our biggest opportunity in the mobile headset market is being created by the rapid convergence of music and communications in the cell phone industry. While the iPhone was only recently introduced, it received obviously enormous attention as a music phone. The market for MP3-enabled cell phones is expected to reach 300 million handsets this year and 500 million by the year 2010. Close to 80% of all handsets sold are expected to be music-enabled by 2010 according to market research. We have several wireless products today which currently address this market and we have many other products that we intend to develop over the course of the next few years. One of the key strategic factors for our acquisition of Altec Lansing nearly two years ago was the convergence opportunity in the mobile market, which we believe is continuing to be validated. We continue to believe that the Altec Lansing division provides Plantronics with critical assets to capitalize on this opportunity. While we continue to work on the legacy consumer electronics market that Altec Lansing serves, we are also focused on the huge potential in mobile entertainment that we are very well-positioned for. We expect the growth of mobile entertainment, combined with product introductions, will return the division to profitability in fiscal 2009. Our non-GAAP profitability for the core headset business is just shy of our operating margin objective of 18% to 20% and we will continue to see opportunities to improve production and operational efficiencies and to add compelling value to our product offerings. As such, our focus areas for fiscal 2008 and 2009 are to: one, increase penetration in the office; two, upgrade existing customers with compelling new products; three, grow our Bluetooth market share while improving profitability; four, achieve a turnaround in the audio entertainment group; and five, improve the overall profitability of the company. I’d also like to take a moment to review our environmental initiatives. As part of a longstanding effort to lessen our environmental impact, this dedicated effort spans many years and began before the term green company really existed. The philosophy has been indoctrinated throughout our organization from product conception to packaging. Our environmental policies to develop, manufacture and market products that are safe to use and minimize the impact on the environment. Our facilities are internationally recognized for their environmental leadership and pioneering efforts. Our newest manufacturing design center in Suzhou, China, was awarded for leadership in energy and environmental design the gold certification for environmental sustainability. It was the first, and to the best of our knowledge it was the only manufacturing facility in all of China to achieve gold LEED certification levels. All Suzhou buildings feature insulated roof systems, natural light, energy-rated roof coating, insulated block walls. The building uses rainwater collection pods, storm-water irrigation, recycled condensation water in air conditioning units and a reverse osmosis system to make the water usable. This facility is also certified as ISO-14001 compliant, which means that our environmental management system can be certified by third parties. In addition, our ISO-9001 certification ensures that our products are manufactured in the most environmentally efficient means possible. In Mexico, our manufacturing plant won both the Ibero American and the Asia Pacific Quality Awards, recognizing our leadership in environmental sustainability. In Europe, we were one of the first companies to achieve full compliance. In terms of recycling, we are proactive in training employees worldwide and encouraging recycling in all of our locations. Our manufacturing facilities in China, Europe, and Mexico employ strict recycling programs and train employees on our best practices. The Mexico facility recycles over 1 million pounds of material annually. The recycling programs are a result of initiatives from our associates. A total of 57 associate-inspired programs have been implemented to date. Our product packaging keeps the environment in mind. We have everything from dies, inks, pigments, adhesives, stabilizers, and additives manufactured without using toxic or regulated heavy metals. These components are also in full reliance with the reduction of toxic packaging legislation in the United States. By 2008, we expect all Plantronics packaging will be 100% recyclable. In our Santa Cruz headquarters, we reduced carbon dioxide emissions by 465,000 pounds per year through the use of solar panels. We saved approximately 7,000 pounds of paper this year by implementing the SEC’s optional notice and access rule, which utilizes electronic delivery of shareholder material, produce printed quantities of the annual report in proxy. Both of those, of course, also saved us some money. We have switched to a source in locally grown organic produce in our employee cafeteria, which reduces the logistics imprint. We’ve implemented programs to conserve water, including the use of drought-tolerant plants in our landscaping. Our recycling program has reduced our trash pick-up here from seven times a month down to one-and-a-half. With that as a quick summary of it, I’ll turn it over to Barbara to go through the financials.

Thanks, Kevin. Our consolidated earnings per share was better than the guidance we had provided in May due to continued momentum and strength in the audio communications group segment. On the other hand, the audio entertainment group results were slightly worse than anticipated due to higher-than-expected requirements for slow-moving inventory. That said, I’m going to start with a review of ACG, which achieved revenues of $185.6 million, up 13% or nearly $22 million compared to the comparable quarter last year. The growth was driven primarily by office wireless, which grew over 20% compared to a year ago, while OTC corded revenue was up a solid 10%. Growth this quarter was broad geographically, with notably strong growth of 26% in EMEA and 9% domestic growth. Bluetooth mobile was up 27% to $36 million compared to the year-ago due to the improved product portfolio, which is also garnered increased listings at retail. We believe the momentum we began to experience in the March quarter definitely carried through into the June quarter on the strength of our product portfolio and improved effectiveness of marketing programs. Within the audio communications group, as I mentioned international revenues remain strong. I had mentioned EMEA but international was up 22% compared to the first quarter last year. And that left us at a 64-36% domestic international as compared to 66-34 in the year-ago first quarter. In the U.S., sell-through was slightly down and distributor inventories were slightly up, specifically our sell-through tracking of the U.S. commercial distribution channels for the ACG segment indicates that sell-through increased approximately 6% versus the year-ago quarter and was down 5% sequentially. Sell-on was also down slightly sequentially, so we had a small pick-up in channel inventory in the quarter. Please remember that the sell-through data that I just covered is only for a portion of our revenue. It is U.S.-based commercial distributors and that channel represents approximately 36% of total ACG segment revenue in the June quarter. So on gross margin, it is great to be able to report that ACG non-GAAP gross margin was 46.6% compared to 43.3% in the June quarter last year. Relative to the year-ago quarter, that improvement was primarily due to cost reductions on both Bluetooth and office wireless products, as well as margin improvement in Bluetooth due to the overall product portfolio. We were also more efficient in manufacturing with lower variances and better utilization of fixed overhead. We continue to make progress in our China plant which increased its utilization to 26% and resulted in us crossing through break-even and actually making a small manufacturing profit one quarter ahead of our plans. These improvements were somewhat offset by higher warranty costs in the quarter. The overall result of all those factors was a 3.3 point improvement in gross margin compared to the June quarter last year. In terms of operating expenses on a non-GAAP basis compared to the year-ago quarter, our ACG expenses increased approximately $5 million or 11%. This is primarily in the sales and marketing area. We have expanded our sales presence and continue to invest in marketing and demand generation programs, and just under $1 million of the increase is funding new product development. As a percent of revenue, operating expenses decreased from 29.5% of revenue to 28.9% in the first quarter, so we feel like we are also becoming more efficient overall in the operating expense area as well. As a result of all of this above, our Q1 non-GAAP operating margin was up four points to 17.7% from 13.7% a year ago. Our target model for ACG continues to be 45% to 48% gross margin and 18% to 20% operating margins. In FY08, we expect to increase operating margins compared to fiscal 2007 as a whole and make progress towards that target, although we don’t expect to actually achieve that for the year. By increasing the utilization of our factories and reducing the transformation costs, we expect to achieve some increase in gross margin again for FY08 as a whole compared to FY07, and we believe that will be the main factor leading us to a somewhat higher operating margin in ’08 than ’07. I am now going to turn to the audio entertainment group segment summary. AEG revenue was down approximately $10 million compared to the same quarter a year ago. Our product portfolio is still not sufficiently competitive, resulting in a cumulative loss of market share and profitability, although we made some progress on the portfolio front with two new products, the IM600 an the IMB712, both of which began shipping this quarter. There’s new iPod docking systems. They received positive reviews and the IM600 in particular has been placed well and it is continuing to experience increased revenues and listings. Geographically, AEG’s net revenues were 62% domestic, 38% international compared to 59-41 in the same quarter a year ago. Compared to the year-ago, the decrease in net revenues also affected gross margins. For example, fixed costs were almost flat compared to a year ago but as a percent of revenue were up approximately nine points. Product mix was less favorable and excess and obsolete inventory was higher due to slower-than-expected sell-through of certain products. Those factors were the primary reason for the decline in the non-GAAP gross margin compared to a year ago. The operating expenses were down compared to a year ago and down a bit sequentially although we do expect an increase in the second quarter due to the timing of certain sales and marketing programs that are expected to be launched in the second quarter. That resulted in a non-GAAP operating loss of $10.8 million compared to a loss of $5.6 million a year ago. And then on a consolidated basis below the operating income line, we had $1.3 million in other income compared to $1 million in the year-ago quarter. We had an effective tax rate on a non-GAAP basis of 24%, about the same as the 23.8% that we had a year ago, which resulted in non-GAAP net income of $17.8 million, or 8.6% of revenue compared to $13.6 million or 7% of revenue a year ago. So in terms of the business outlook, we are cautiously providing guidance for the second 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. I also want to remind you that September is a particularly difficult quarter for us to forecast, especially in the ACG business. Conditions are often relatively strong coming out of June but tend to weaken in July and weaken further in August with holiday seasons in many countries, followed with a strong pick-up in September. At this time, we have seen some of the usual decline we experience in July bookings. With respect to Bluetooth products, we have a large forecasted demand from certain customers. We currently anticipate that our mobile Bluetooth revenues will be up some sequentially, assuming that the demand outlook with those large customers remains in place. We have built up some inventory in the June quarter to meet some of that demand. In AEG, we are also anticipating revenues in the September quarter to be up somewhat compared to the June quarter. The slowdown in bookings that we usually experience in the September quarter in July and August tends to be concentrated in our office and contact center business and we are not currently expecting an increase there. So with those caveats, we are estimating a consolidated net revenue range of $206 million to $212 million and non-GAAP EPS of $0.30 to $0.35. We are currently expecting AEG’s loss to be lower in the September quarter than it was in the June quarter. We are estimating our non-GAAP tax rate to be approximately 24% in Q2, the same as Q1, and that was compared to 25% last year. And we expect equity compensation expense to reduce operating income by approximately $4 million, or about $2.6 million after tax and that would translate to a GAAP EPS range of $0.25 to $0.29. On the balance sheet, cash, equivalents, and short-term investments increased by a little over $7 million sequentially and nearly $52 million from the year-ago quarter. We ended the quarter with $110.4 million in cash, equivalents, and short-term investments and that was primarily the result of $13 million in cash from operations, offset by about $6 million in CapEx. We certainly believe our financial position remains adequate and in that context, our Board of Directors declared our 13th quarterly dividend in the amount of $0.05 per share. Our accounts receivable balance increased sequentially from $113.8 million to $121.7 million, with ACG receivables increasing by $8.4 million on higher revenues and AEG receivables remaining relatively flat. DSO was down 3 days to 53 days from 56 last June. And on inventory, as we highlighted in our guidance for the quarter, we planned to increase inventory in the June quarter to support higher overall volumes, our outlook for Q2 and as a contingency while transferring our consumer headsets to the China manufacturing facility, and to implement service level improvements with consolidated orders for our shared customers between ACG and AEG, which we can now do and have been able to do since July 1. So inventory increased by $9.6 million in the quarter. ACG inventory increased by approximately 9.3 and some of the inventory increase was due to lower Bluetooth sales than anticipated but that inventory is expected to be used in the September quarter. We currently expect to decrease inventory overall in the September quarter. Finally, capital spending was $6.3 million, less than depreciation and amortization of $7.1 million in the quarter. Capital spending as a percent of revenue was 3.1%. And with that, I’m going to wrap it up and turn it back over to our conference facilitator for the Q&A session.

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

Good afternoon. I wanted to ask about the drivers for the demand in the enterprise channel, particularly for some of the office products. Can you give us some color on what you think is driving that demand?

I’ll try but the truth is that fundamentally, as you know, it’s a very broad market, both geographically and in terms of type of business and it was not concentrated this quarter in terms of demand. We did think that we are continuing to see some growth within office wireless. There may have been a little bit better demand in the contact center within some of the international markets, kind of a response to generally strong global economic environment. But it’s really hard for me to pinpoint right after a quarter any specific things because it is spread so thin and so broadly.

How is the try-and-buy program progressing?

We continue to get a positive response to try-and-buy types of opportunities. Our challenge usually is identifying enough of those opportunities effectively but a lot of the real benefit actually of course comes ex-post because we continue to see a very, very high multiplier from the identification of new people and the word of mouth that that spreads.

Barbara, one question on the SG&A. The sequential step-down, I think it was about $1.4 million, can you remind me why the sequential step-down? And do you think this is a good run-rate?

No, we said that we are expecting some increase in AEG in the second quarter and we also run marketing campaigns in Europe more concentrated in -- well, the December quarter and you have to start to ramp up some for that and in the September quarter, so the -- I don’t want you to annualize out this rate but it did reflect some timing shift from Q1 to Q2 to better align marketing programs with the launch of products later in the summer getting ready for fall.

Okay, one last question then on mobile. On the mobile sales, what -- how much, if any -- well, can you talk about Apple’s iPhone introduction, the impact and what type of impact that had on mobile sales in the quarter?

We usually don’t go into very, very specific types of things like that and I do recognize that that’s gotten an awful lot of press. Obviously we were very, very pleased to be partnered, or at last have the opportunity to partner with Apple on that. Obviously there’s some level of sell-in that we would have in advance of that launch but I really don’t think we can make any specific disclosures on that. Barbara, do you want to add to that at all?

I would just say overall, it’s a really small impact at this time. I think it’s good. Music phones are a great long-term driver of our business but at this point, it is a small impact.

Thank you.

Your next question is from Paul Coster with JP Morgan.

Thank you. You are making pretty steady progress on the turnarounds, with the exception of AEG, of course. I’m sure you’ve been asked this many times but why bother turning around that segment? Why not just send it off now? Surely you’ve extracted what assets were appropriate for the convergence of communications with entertainment by now and the easy thing to do is just terminate it and we’ll see an instant benefit in terms of EPS.

Paul, that’s fair enough and I think that the option always exist to say the better decision here is to shut down that business and it is a certain thing that if we shut down that business that the losses will go away. And then the shareholders will get the benefit of the higher earnings on the stock price and hopefully that’s a good thing. What we have to weigh, Paul, is on the one hand the one-time costs of shutting down this business against the risks, if you will, of investing additional periods of time and dollars in turning around that business and the odds and the timeframe for success. We believe the business absolutely can be turned around. Why do we believe that? If we looked at a turn-around of a business, you normally have a problem. You have a problem, for example, that the business could not be made competitive. The customers are abandoning that market, that there is some industry problem, that there’s some other macro issue. We don’t have any of that. This business, this market is thriving. The opportunities for growth continue to be very, very good. Other players in the business are very profitable. We don’t lack any core competency here. We have excellent ability to produce the product. We have excellent channel access. We have a business model that is very, very acceptable to all the partners out there. We have all the technical core competencies. The problem has bee real simple. The product portfolio was not sufficiently on target from a customer perspective and that is something you can learn about and address. So we think that we’ve actually made a lot of progress in understanding that and we’ll take time to ensure to put those things in place. If we fail at some point in time, we can always make the decision that we ought to shut down that business but in all honesty, we really believe that we can succeed on this because we don’t think --

I believe you can as well in time, and the question though now is, the second question is, is it worth it though? Because yes, you can make it profitable again in time but does it matter strategically anymore since you’ve already extracted the know-how necessary to address the convergent market?

I believe it still has value in short because -- let me just put it to you this way; if we look at -- let’s just take an iPhone as an example. What products might you want to use with an iPhone? Well, you might want to use a headset with an iPhone. You might want to use a headphone with an iPhone. You might want to use a speaker phone with an iPhone. You might want to use a set of speakers with an iPhone and you might want to have some combination of those various functionalities in some of the products that you select. The fact of the matter is that the competencies at Altec in making a lot of the speakers are actually excellent and for us to be able to offer the same breadth of products is definitely enhanced keeping that organization intact. So we do think it extends the breadth of our product offering and gives us an additional profit opportunity. We do recognize that there is time required and there is investment required. We do believe we can turn it around but even if we fail, we think that the only risk for the Plantronics shareholder is some period of time with lower earnings and some investment lost because we could ultimately obviously restore that P&L.

Fair enough. Okay, my last question is really to Barbara. You mentioned the business is more volatile than it has been in the past. I don’t really see that. In some ways, it should be more diversified than previously, so what is it you are referring to, please?

We are specifically referring to the mobile business, which is large and it is very volatile in terms of how many bundles you are in, how successful those bundles are, which could be completely independent of anything to do specifically with the headset. It could be the phones itself which drives the success of the bundle. And the office business, the office wireless business is quite a bit different in terms of the demand characteristics than the contact center business was and is. One, it’s a very new market, it’s a new technology and it does tend to run almost -- it will sort of catch fire a bit maybe in a particular geography or some large corporate accounts and then maybe go through a period of digestion. So it is much harder to estimate certainly based on historical trends and it is a much --it is a very, very diverse business in terms of end customers, so it is harder to get a handle on some sort of external factors. Maybe Ken wants to add to that as well.

Paul, I just want to say that in all honesty, we kind of have the dream also that as our business got more diverse, and we look at contact center used to be 80%, 85%, 95% of our business and it is down in the 20% range, that it would make us less volatile but certainly the opposite has happened. On the one hand, the hard facts are we get the daily orders and shipments and all that kind of stuff, we are absolutely seeing it so take it from us a fact that it is true. I think Barbara definitely hit a lot of the reasons why. The other part of the contact center business to bear in mind is it always has a large replacement flow element to it into the substantial installed base and so now we are just kind of dealing with more new demand, which tends to have a more volatile pattern.

Thank you.

Your next question is from Jason Ader with Thomas Weisal.

Thank you. Barbara, maybe you could address this on the margin side. Just looking at the progression here, it looks like the Bluetooth gross margins at this point are running in the mid-teens. I know you haven’t broken that out for us but first of all, is that about right and second of all, where do you think they can go over time as you get China up to full utilization?

That is about right, Jason, and we really think that they kind of are likely to be in that 15% to 20% range, maybe closer to 15. It really depends on the mix of products that you have at the high and low ends. You have to have products at the low-end in order to cover the price points but the higher value-add products are definitely more profitable, so it kind of depends on the mix that we can achieve in the market. But we don’t think they are likely to go beyond that.

So how do we think about once China gets the full utilization, is that going to continue to benefit the gross margins? How do I think about that?

It does continue to benefit them, yes. It’s lowering our cost per unit.

Okay, but if the Bluetooth gross margins are kind of mid-teens today and you expect them to stay in the mid-teens, so how do I think -- where does China benefit? Which line item or which part of the product set does it benefit?

Well, by mid-teens, I’m sorry, I didn’t mean 15. I was actually thinking kind of in the 10 to 15, so low-double-digit.

Okay, so there’s still -- so that the delta there is just China, basically getting that up and running?

Well, there’s other things we are going to do. Bear in mind that we -- you have to get more efficient because the market is also going to get more competitive so we need to gain relative ground here if we are going to be able to realize any on the bottom line.

So part of it is just costs will continue to come down and you have to be there in order to compete.

Yes, definitely.

All right and then just from an operating margins perspective, it looks like you are guidance operating margin down a little bit slightly next quarter. Is that just a function of product mix?

Definitely on mix. I would say that we’ve seen some greater pricing competition looming as well.

And on the op-ex side, there’s no significant changes to expect there next quarter?

Not significant. I mean, I do expect operating expenses to be up in Q2 but not --

Typical seasonal patterns.

Yes, but not -- you know, just not significant.

Both R&D and SG&A should be up sequentially?

Yes.

All right. Thanks, guys.

Your next question is from Tavis McCourt with Morgan Keegan.

Ken, you just mentioned you are expecting some degree of higher pricing competition. I wonder if you could talk about where you are seeing that, which product line?

Well, we’ve seen some with the Bluetooth products generally and we’ve also seen our largest competitor on the B-to-B side appearing to reduce prices more than they had.

And then the corded headsets for the call center were it looked like pretty strong, significantly better than they were last quarter. Any idea what was driving that?

Again, I think that there was actually a little bit better market in the contact center but don’t have any feeling that we changed our fundamental long-term growth rates for the contact center market, which we haven’t.

Okay and then in terms of stereo Bluetooth, I know you guys have had at least one product out there for a little while before there were really any phones out there that were compatible with it, or too many. We are starting to see a lot more stereo Bluetooth phones come to market. What is in your opinion the outlook for that market in terms of when do you think the timing of that becoming a real headset or headphone opportunity?

We’ve always had difficulty not so much assessing I think where the opportunities are or even what people might want. It’s predicting the timing for the take-off of the market that has been a challenge. Actually, honestly with 515 we were probably too early. Maybe that holds true with the Pulsar too. That can certainly happen. In this case, I think the accessory attach rates for music phones, for music has been lower than broadly than we had hoped they would be at this time. We still believe they will take off. We still think that over time there is going to be more and more music content, whether it is side-loaded or whether it is through the operating system in a more elegant manner. But be it as it may, we do expect the devices are going to get used more and more and that that will boost the accessory attach rate. But the answer to your question is no, we are not seeing huge volumes today and honestly, do I expect them right away? No, I think it is going to take more time but with the bulk of phones going in that direction, I still think the end market is clear.

I was trying to aim it more what does your product launch strategy look like given those dynamics? Are you guys going to try to establish a brand before that market becomes reality or will you wait for the data to start telling you the demand is real before you start launching new products there?

Well, we are still trying to create the right product. I think you want to be in position. We won’t spend a lot of marketing dollars. One because it is a consumer brand space and two because it is just so earlier relative to the market volume.

Right. And then remind me, the target or the goal on AEG profitability. You mentioned ’09. Were you speaking in the December quarter in ’09 you would expect to be profitable or do you think that is a reasonable expectation for the full year fiscal ’09?

Well, specifically it’s for the second-half fiscal ’09 to get into the target range, which is 5% to 10% operating profit. That should mean that we are profitable for the whole year as well but not in the target range that we are striving to achieve.

It sounds like from your comments here you would expect this to have been the peak dilution quarter.

We think that in terms of operating losses, we’re at the worst place and that the operating performance will improve.

Thanks a lot, appreciate it.

Your next question is from Ingrid Ebeling with JMP Securities.

Thank you. Good quarter. Can you talk a little bit about any changes that you’ve seen in the competitive environment for the Bluetooth product line? With Bluetooth up about 36% this quarter, I heard some comments that you said sales in the Bluetooth were lower than expected. Could you give a little bit more color around that?

Sure, I’ll try. First of all, as Barbara mentioned earlier, our actual sales tend to be volatile in this business and we continue to expect them to be volatile and that actually makes it very difficult for us to correctly project -- well, one, forecast to you and for the investment community generally; and then two, on an internal basis exactly what our production volumes ought to be. The reality is we have to submit to lead times for components well in advance of understanding where the end market demand is going to be, so it always leaves us with some of the issues. There’s a lot of things we are working on to try to improve that situation but that’s where we’ve been. So on the one hand, we were off but frankly within what I would call the normal bounds of our error levels. I didn’t think it was particularly sharper. In terms of competition, you know I have to say it remains in my mind a very, very competitive market across the board. Competition in terms of price certainly but also competition in terms of brand and bundling from the large players with significant clout and global reach. Competition in terms of technology, competition in terms of design innovation, competition really across the board. Having said all those things, we actually do believe that we have net net and managing to gain market share while improving our profitability and improving our business model and processes. There’s still many things we need to work on because this is a very dynamic market and while it is in the early days, the music phone is going to being changing the game, so it is very important to be well-positioned and executing for that opportunity.

Okay, great. Thanks. Could you give us a little bit more color about the initial reception of the IM600 and I think it was the V712 thus far?

Sure. The IM600 represents a product that installs the need for the person who wants to be able to go effectively from room to room in their home, so they want to be able to listen to music while they are working out and then while they are making breakfast and this and that and the next thing, and so it’s just got a great level of convenience in the home environment. The other product is not a significant revenue product. It was in all honesty more of something where you are showing it in conjunction with the video capability and it is early and it was very well-received for its performance but it is a little bit more expensive so it is a little bit less mainstream.

Okay, great. Thank you.

Your next question is from Manny Recarey with Kaufman Brothers.

Good afternoon. Two questions for you, Barbara; can you just repeat the fiscal ’08 commentary you made about the ACG business and the -- hitting their margin objectives? I missed some of that.

Yes, so I was basically saying that our operating margin target remains 18% to 20% for ACG and we are planning to make progress toward that target in fiscal ’08 compared to fiscal ’07 but our plans don’t actually call for us to get to that level. Obviously we did very well in Q1, though we’ve got the full year to go through and we do think on balance that we’ll be able to earn a higher gross margin in ACG this year than last year, and that that will contribute to a higher operating margin for ’08 in its entirety as compared to ’07.

Okay, thanks. And then for the guidance for the September, if you take the low-end of it where revenue is about flat sequentially but EPS is I think about $0.07 or so less, is the way to think about that is that most of the delta is in the SG&A between some of the shifting and costs that you mentioned from the June and September quarter and then the additional spending for some of the marketing in EMEA?

No, there would be some effect from that but it is really driven more by the revenue mix shift that we would be anticipating if we came in at the low-end because we do think that the AEG business should be up some, even at the low-end, and we do think that Bluetooth is going to be up some. If that scenario materializes, the OCC business is down and the margin difference between OCC and AEG is very large, and so we’d have a lower gross margin and we would have somewhat higher op-ex as well.

Okay. Thanks very much.

Your next question is from Ted Chung with Bear Stearns.

Thank you. Just following up on that question, typically your OCC business actually increases sequentially in the September quarter. Is there any particular reason why you are expecting that business to decline?

No, actually last year Q1 to Q2 it was up about $1 million, and two years before that it was up just under $2 million. We have had Q1 to Q2s that decline. When it has been up, it generally hasn’t been up very strongly and then the bookings pattern is challenging, as we mentioned. You get this kind of summer slowdown in Europe and so you really don’t want to count on it being up, given what we know to be the historic booking pattern. You do have to count on a strong September and you have to count on having the right mix of product and inventory to ship in September. So it’s a lot of things to count on going right in terms of a low-end of a guidance forecast.

Is there any impact from an inventory adjustment within the channel or any of that being considered?

There’s always some of that but having said that, in all honesty I think it tends to balance out. This is not primarily driven by expected inventory. I do think that --

Very little. You know, I had mentioned that but really the channel inventory was up really slightly in the U.S. It was actually down we believe in the U.K., which is our largest market in Europe, so --

Another thing to look at, by the way, is September quarters sometimes in relation to the March run-rate. Suffice to say that with all the data we have, we actually think we are providing a reasonable estimate, not unduly we hope aggressive or conservative. We just think we are being reasonable.

Okay, great. Thank you.

We have time for one final question and your last question will be from Reik Read with Robert W. Baird.

Good afternoon. Ken, as part of your comments, you had talked about your largest competitor being a little bit more aggressive on price. Can you talk about -- is that in the Bluetooth segment, the office wireless segment or is that both?

It’s both. I mean, we’ve seen some pretty sharp price promotions around the globe from them this quarter, some of them recent. So I think we are just kind of conscious that they are competing on price and taking it down to lower levels than where they were previously.

Okay, and then just going back to the transition costs and operations that you guys just talked about, you talked before -- you have a new operations chief. Can you give us some thoughts in terms of maybe what he has found that he would like to improve and maybe some timeframe in terms of what he is proposing at this point to get things moving in the direction that you want?

First of all, I am thrilled with Larry. He has gotten up to speed very, very quickly and understands the issues well and is working very well with the team. Having said that, and I do think there are some areas that he’s identified preliminarily. He has only been on board for a matter of weeks and I really don’t think I want to string him out on a limb when he’s not finished his assessment on some of these things. But we have quite a number of opportunities identified even before he joined where we think he can help us a great deal in leading to the successful execution on those items and those are already in our plans.

Yes, but he is -- it sounds like you had identified a number of those things and he is agreeing that he is on board with those and he is not making any major changes.

He’s also come up with some additional ideas which I think are good too. I’m just saying I don’t want to go into all of that at this point.

Okay, and --

Again, he’s only been on board a fairly small period of time.

Sure. And then just lastly, Barbara, you had talked about higher warranty, as you had last quarter. It sounds like that is really related to some of the mix shifts that you are seeing with respect to some of the wireless products. Is that something where you expect to continue and it will be relatively stable going forward, or will that continue to pick up on a sequential basis?

You are right. It is primarily related to wireless, not only because of the product mix shift but also some of the channels, so on the Bluetooth we are getting more into some of the retail channels, which actually overall retail is more profitable than carrier in terms of percentages. But return rates tend to be a lot higher at retail. It’s not as much of an assisted sale and consumers can just become don’t wanters after the fact, and Bluetooth pairing is still kind of in its early days in terms of people understanding how to do that, so there -- we certainly don’t believe it is just going to continue to rise. There are definitely things that we can do in terms of the packaging, the messaging, the ease of use of the products, the actual experience of how you set up and install and use the products, so we have a whole set of ideas how to reduce and control this. Sequentially I really don’t expect it to be up but for the year. Are we likely to be higher than we were a year ago? Yes, I think so, given the product set and the channels we are selling through.

Okay, great. Thank you very much.

Thank you for joining us today. We look forward to seeing you at upcoming investor events and there will be replay available of this call, as well as a webcast replay via our website. Thank you.

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