Logitech F2Q06 (Qtr End 09/30/06) Earnings Call Transcript

| About: Logitech International (LOGI)
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Logitech International SA (NASDAQ:LOGI)

F2Q06 Earnings Call

October 19, 2006 8:00 am ET

Executives

Joe Greenhalgh – IR

Guerrino De Luca - President and CEO

Mark Hawkins – SVP, Finance and Information Technology and CFO

Analysts

Ted Chung - Bear Stearns

John Bright - Avondale Partners

Matthew Yates - Merrill Lynch

Charles Elliot - Goldman Sachs

Mehrdad Torbati - Deutsche Bank

Manuel Recarey - Kaufman Brothers

Michael Foeth - Lombard Odier

Roger Steiner - Kepler Equity

Presentation

Operator

Good morning. My name is Cynthia and I will be your conference operator today. At this time I would like to welcome everyone to the Logitech Second Quarter Fiscal Year 2007 Earnings Conference Call. [Operator Instructions].

Now, I would like to turn today’s call over to Joe Greenhalgh, Vice President of Investor Relations. Please go ahead sir.

Joe Greenhalgh - Vice President Investor Relations

Thank you Cynthia. I would like to welcome you to Logitech Conference Call to discuss the Company's results for the quarter ended September 30 2006, the second quarter of Logitech's fiscal year 2007. The press release, a live webcast of this call and accompanying presentation slides are available online at www.logitech.com.

This conference call will include forward-looking statements that are being made under the Safe Harbor of the Securities Litigation Reform Act of 1996, including forward-looking statements with respect to future operating results.

The forward-looking statements involve risks and uncertainties that could cause actual results to differ materially from that anticipated in the statements. Factors that could cause actual results to differ materially include those set forth in Logitech's annual report on Form 20-F dated May 19, 2006 and subsequent filings available online on the SEC Edgar database and in the final paragraph of the press release reporting Q2 results issued by Logitech and available at logitech.com.

The press release also contains accompanying financial information for this call. The forward-looking statements made during this call represent the management outlook only as of today and the company undertakes no obligation to update or revise any forward-looking statements as a result of new developments or otherwise.

I would like to remind you this call is being recorded, including the question and answer portion, and will be available for replay on the Logitech website. For those of you just joining us, let me repeat that presentation slides accompanying this call are also available on our website.

Joining us today from Zurich is Guerrino De Luca, Logitech's President and Chief Executive Officer, and here in Fremont we have Mark Hawkins, Logitech's Senior Vice President of Finance and Information Technology and Chief Financial Officer.

I would now like to turn the call over to Mark.

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Mark Hawkins - SVP, Finance and Information Technology and CFO

Thanks, Joe. I will begin with an overview of our strong Q2 performance. It was an outstanding quarter with record sales and profits for Q2 and we delivered the expected substantial year-over-year and sequential improvement in gross margin that we projected following our Q1 results. Our sales grew by 19% to $502 million with growth in both retail and OEM. We had balanced double digit growth across all our retail regions reflecting excellent channel acceptance of our broad range of new products. It was our 32nd consecutive quarter of double digit sales growth.

Our comments during the call about our gross margin, operating expenses, operating income in tax and net income for Q2 FY07 will be based on our non-GAAP numbers that exclude 123R costs. This is similar to what we did in prior quarter.

Gross margin, our gross margin was an impressive 34.6%, it improved by over 300 basis points both sequentially and also compared to the prior year. Let me talk about the improvement. The improvement was primarily driven by the launch of new products that had higher margins than the products that they replaced. Our gross margin in both the cordless and corded categories delivered substantial sequential and year over year improvement. The cordless improvement was mostly related to cordless mice with higher margins -- and this is an important point, higher margins achieved across all price bands and the highest gains in the low end. The corded improvement was primarily due to significant gains in corded keyboards. We are also pleased to note that our PC speaker margins improved sequentially and year over year driving a gross margin increase in the audio category, and again we’ve talked about the audio improving in the second half, you could see this activity. Please note the growth percentages that follow in comparison to the Q2 fiscal 2006.

Our operating income, this grew by 50%. This was the second highest year over year quarterly growth that we have achieved in the last four years. Our gross profit growth at 31% significantly outpaced the 24% growth in operating expenses. Here, we were actually very please to see good scaling compared to our gross profits in terms of operating expenses and at the same time, as you know we are stepping up and making significant investments to grow this business.

Taking a closer look at our operating expenses, sales and marketing grew by 20%. This is in support of and in line with the continued double digit retail sales growth that we’re seeing. Research and development was up by 18% with the majority of the growth driven by investments in key categories such as video, audio and remotes. G&A increased by 48% due to head count increases, particularly in support of and related to the SOX 404 certification and also the implementation of Oracle 11i and the related ongoing support.

Now let’s turn to net income. Our net income grew by 47% and our net margin reached 10.6%. Earnings per share grew even stronger up by 56% to $0.28 reflecting the ongoing positive impact of our share buyback program. We’ve talked a lot about the share buyback program; we feel that’s a good thing from a company’s standpoint. You can see the effect of this in addition to the earnings effect. So let me just pause and say that this is far and away our best ever Q2 and I think most importantly as a reflection that our model is well, and operating effectively.

Let me add a few additional comments to our investment statement. Our other income declined by $2.1 million compared to the prior year. Now a lot of you will recall that tracked the stock carefully that we had a gain of $2.2 million last year with a revaluation of the Chinese Yuan, and that’s basically the delta and the other income. In terms of interest income we are up by $1.2 million compared to the prior year, as we earned higher interest on our cash balances and also you will recall that last year we had convertible debt expenses that we do not have this year.

Turning to tax rate, the tax rate for Q2 is 11.8% and as we’ve said before we do expect volatility by the quarters and we continue to expect that, but that was the rate. We now expect our tax rate excluding the equity based compensation costs to be around 13% for the full year, that’s a small improvement from our earlier target of around 14%.

Turning to cash, our cash position was $150 million plus there was another $95 million in short term investments, adding the two together leaves our cash position essentially unchanged from the prior quarter and down $10 million from the prior year. But when comparing to the prior year it’s important to note that during the last 12 months we have spent $237 million by share repurchases and we have being buying stock back on an average price of roughly $20.68. The $95 million that I reported in terms of short term investments represents an investment we made in variable rate US Government guaranteed securities that generate a higher interest income with minimal incremental risk. Our cash flow from operations for the quarter was $22 million. This was a $47 million improvement over last year’s negative $0.5 million in cash flow. The higher cash flow was driven primarily from lower inventory and the significant increase in net income. Through the first two quarters of fiscal 2007, our cash flow from operations is $72 million higher than the same period last year. We said we’d be attentive to cash and cash management, I think you are seeing that again a good reflection on the model.

Turning to inventory, inventory we ended up the quarter with roughly $4 million less in inventory than in September than even the prior year, even though we have grown the business by 19% on the top line. So as you can imagine, the inventory returns improved significantly to 53 5.1 turns compared to 4.3 last year. DSO, our DSO was at 71 days for the quarter and this is in line with the outlook we provided during the July earnings call -- this year, up just slightly sequentially. The increase is due to a combination of a slightly more back end loaded quarter that we’ve been talking about and predicted and some select term changes.

Now let me just make the key point here and that is that we expect solid sequential improvement in our DSO in Q3 due to a more linear customer ordering pattern. And let me dive deeper into this and let you know some information that is a good indicator of this and that is that our actual backlog that we have entering the quarter is substantially higher than the backlog we had last year at the same point of time. So again it reflects the strong appetite that our customers have for our product and we think that both are really well for business as well as it will help us in the DSO next quarter.

Share Repurchase, during Q2 we repurchased 1.19 million shares for $24.6 million at an average price of $20.70. We currently own just under 5% of our outstanding shares. We have roughly $12 million remaining in our current share buyback program. And we also, as all of you are aware, we talked about this in prior sessions, we have been approved to have another $258 million repurchase program that we will execute once we use up the $12 million. So share repurchase has been part of our history and will be part of our future. Let’s turn to ADR exchange. Our previously announced ADR for share exchange will be effective next Monday, October 23rd. And you know we are excited about this because we are able to offer our investors the convenience of trading all shares under NASDAQ starting next week.

We expect that this will lead to enhanced liquidity for investors trading under NASDAQ and October 28th will be the last day of trading for our ADRs. It’s important to note that the vast majority of the ADR holders for those ADR holders is really nothing that they need to do it all. ADRs held in brokerage or bank accounts will be automatically exchanged for Logitech shares on or soon after the effective date. As I exit the ADR topic, again I think the theme that I think about is one of offering our shareholders’ choices and the choice is not whether they want to trade it on the Swiss index or the NASDAQ, we give them more flexibility which we like.

Now let’s discuss the net sales by product family and starting with retail we’ll go on to the top line in a bit more detail. Our retail sales grew by 21% and units were up by 15%. We achieved balance double-digit sales across all the regions and I think that balance is a good thing. Americas led the way at 23%, Europe at 22%, and Asia 17%. And I want to call out the webcams and cordless mice really were major growth drivers in both the Americas and Europe. If I go to retail sales cordless, I am pleased about this as well our double digit sales growth in cordless was not only there but it accelerated in Q2. Sales were up 22% with units growing at 18%. We had more modest growth in our cordless desktops with the sales of 5% and units growing by 11%. It was an outstanding quarter by any measure for our cordless mice with sales growth accelerating to 40% and unit growth at 22%.

Let me talk a little more on that. The growth in Q2 is primarily driven by the launch of our MX Revolution cordless laser mouse and the VX Revolution cordless laser mouse for notebooks. Got a lot of press on this, lot of good journal articles and what not, you’ve probably read a lot about that, that really – well for us. To provide some historical perspective on our MX Revolution sales these were almost twice as high as our prior benchmark the MX1000 sales that we launched when we launched the world’s first laser mouse in the same quarter two years ago. So MX performing twice at the rate of the MX1000. We also saw continued strength in our notebook category with sales of cordless mice for notebooks nearly doubling compared to the prior period.

So, if we transition now into video it was another very strong quarter for video with sales up 43% and units by 37%. It was the fourth consecutive quarter with sales growth in excess of 40%. Once again we had success across all of our price points and I want to also note that our new line of webcams that we have launched during Q2 have really obviously generated strong demand and are been very well received. Our sales of webcams for notebooks grew by more than 60%. So again nice to see the webcam business healthy.

Audio, it was a solid quarter for audio with sales up 21% and units up by 26%. Our speaker sales grew by 51% and the units grew up by 57%. If I go a little deeper into those sales for iPod, MP3 speakers were well over three times higher than the prior year. PC speakers grew by 27% and I might note also that Europe was particularly strong with the PC speaker business. Our best selling speaker you might note is the mm50 in terms of this prior period, the mm50 Portable Speaker for iPod. It was a strong quarter for the PC headsets as well as sales grew by 24% and units by 27%.

Corded, and I’m pleased that we had a strong corded business as well in this particular quarter and we grew by 13% on the revenue line and units grew up by 9% and if I go deeper here it’s important to know that this is the fastest sales growth in the corded category we had in the last five quarters. So that’s growing strong in addition to our cordless. The growth was primarily driven by our corded keyboard sales which were up by 33% with the units up by 22%. We also had growth in corded mice with sales up by 6% and units by 3%.

Okay, looking at gaming we had a similar quarter to what we saw in Q1 with sales down by 3% and units down by 6% due to the expected weakness on the console gaming. Our console gaming sales declined by 41% and units were down by 37% and we all have talked about the fact that this weakness in the category is due to significant transitions on new platforms and will likely continue in the current quarter, this is all a matter that’s in the press a lot, on the platforms and the transitions. We have had a very quarter in the PC gaming with sales growth of 63% and unit growth for 21% and again the G15 is the strong engine that’s really delivering that sustained strong demand in the PC game area.

If I go to retail sales, other sales were up by 21%, growth was driven by our Harmony remotes which grew 30%, it was a solid quarter for our remotes in the Americas and we are off to a promising start in Asia.

OEM sales, sales grew by 3%, our mice sales declined as expected I might note down by 11% with units down by 3%. The decline is really part of an ongoing product transition with one of our major customers. Separate point on the OEM is that it was our second straight strong quarter for sales of embedded webcams for note books and again we were pleased to see that business. So let me just conclude and say that it’s been -- we delivered our best ever Q2 for sales and profit. We think that this is a strong indicator of our model being well in order and operating effectively. We achieved our expected substantial sequential and year over year improvement in gross margin with our second highest quarterly gross margin in the last five years.

We entered the December quarter with a higher retail order backlog than the prior year and it was substantially higher indicating the strong demand for our new refresh product line, obviously a hungry appetite by our customers. And I want to note also that our cash amounts is up nicely year to date from the prior year’s $72 million growth – half the date rather on that so we feel good about that aspect as well. So, strong quarter and before I wrap up I want to remind you all that we have a major investor meeting that scheduled on November 2nd at the Reuters Building in New York. We hope to see you there and at this point I would like to go ahead and turn it over to Guerrino.

Guerrino De Luca - President and CEO

Thank you Mark, and thanks again to all of you for joining us today. As you can expect I’m delighted with our outstanding Q2 results. Our retail sales continue to grow at an impressive double digit grade with that across all regions. Our gross profit grew significantly faster than our operating expenses and we delivered one of our strongest quarters ever for profit growth. One of the key highlights for Q2 was delivering on our projected substantial year over year and sequential improvement in gross margin. Our ability to achieve one of our best gross margin quarters in our history is a clear indication of our success in introducing stellar products that in many cases deliver higher margins than the products they replace. The solid gross margin, a true measure of the value of our innovation not only boosts our profitability but also put that in an even stronger position and what we mean a highly competitive marketplace.

Products, I’m very pleased with the acceleration of our retail cordless mice growth to 40%. This growth largely driven by market enthusiasts for the breakthrough MX Revolution and VX Revolution mice was the highest we have delivered in the last seven quarters. Another highlight of the quarter was our successful launch of a large number of new products; the operational and logistical complexity associated with the worldwide rollout of many new products across multiple categories is significant. And our ability to manage this complexity was a major enabler in our strong top line and bottom line component. During Q2 we also implemented successfully the upgrade to our Oracle 11i ERP software. This was a major project involving multiple groups across the company over many months. We believe this upgrade provides us with a solid operational foundation to support our expected future growth.

Naturally, as pleased as we are with our Q2 results we remained focused on executing our plans during the pivotal second half of the year. And let me talk about what we see for the remainder of fiscal ‘07. There are many factors that have contributed to our achievement of eight consecutive years actually, 32 consecutive quarters of double digit year over year quarterly sales growth but none of them is as significant as the combination of consistently delivering great products that are solidly positioned in the sweet spot of consumer trends. This combination has never been more powerful or promising for Logitech than it is today. Let me talk about some of these trends, starting with IP communication. The growth of broadband is enabling a revolution in internet based communication. With the most recent example being Google’s acquisition of YouTube. The continuing success of our broad offerings of industry leading webcams validates the consumer appeal of easy-to-use video communication. In fact, this inception through the month of August there has been over 9 billion cumulative Windows Live Messenger Video session, the aggressive numbers gives you an indication of how pervasive this kind of form of communication -- has happened. Our IP communication integrative offerings go well beyond webcams. Our PC headset sales continue to register a strong double-digit growth.

In addition, last quarter we introduced several innovative new products, including the Logitech Easy Call Desktop, the world’s first combination speakerphone, headset, mouse, and keyboard, which provide a complete solution for Internet calling and navigating the PC, as well as the Logitech QuickCall USB Speakerphone for Internet calling, and the Logitech Cordless Internet Headset, which makes using Skype on the computer as easy as using an ordinary cordless telephone. The next trend we are exploiting is the explosive popularity of digital music, which continues to be one of our major gross drivers. Our stylish, high-performance product in the PC speaker category address the needs of PC users to listen to digital music at their desk or on the road with a notebook, and our expanded line of speakers for the iPod and MP3 players continues to meet with strong market acceptance. For the ultimate listening freedom we recently announced the Logitech FreePulse Wireless headphones for iPod and MP3 players.

Our second generation wireless headphones deliver greatly, style, comfort, durability, and performance. And today to further our momentum in digital music we have acquired slim devices and pioneer in the development of music systems to take advantage of the whole network. Products from slim devices such as the acclaimed sweatbox and the recently announced transporter enable people to enjoy high-quality digital music in multiple rooms of their home regardless of whether the music is streaming directly from the Internet or from the PC, Mac or storage device on their network. We purchased a privately-held company based in Mountain View California for $20 million in cash plus a possible performance-based payment tied to reaching certain future revenue guidance. The acquisition of slim devices allows us to build on our foundation of innovation in digital music at home entertainment controlled with emerging markets. Slim devices bring expertise in both network based music delivery and high-quality digital audio streaming and a committed community of developers.

This acquisition will immediately broaden our product offering for multi-room music systems and build our capability to network-based streaming technology. We also complement our existing technology and human interface strength as well as our own offering which includes the recently introduced Wireless DJ Music System, a product for streaming any PC-based music, your stereo or power speakers without (inaudible). The acquisition of slim devices follow the same rational that we successfully applied for QuickCam, Labtec, and Harmony over the past several years. We are adding a small company with great products, great technology and a great team to Logitech in an emerging market that we expect to experience substantial growth and to whom we can add unique value. Let me continue to review the key trends underlying our product strategy and our exciting prospects by turning to navigation.

Transforming the experience of navigating and manipulating the vast amount of digital context on a person’ s computer or on the web, remains the central opportunity for us 25 years after the first mouse. What we accomplished it with the MX and VX Revolutionize mice means specifically to reflect the revolutions being enable for PC navigation is just one element in a strategy and a sense of significant innovation opportunities in this space that we’ll unfold in the coming months. Another trend out there, the growing complexity and richness of home entertainment assistance in the living room is a perfect match for our market leading line of Harmony advanced universal remote controls. The most recent addition to our lineup the flagship Harmony 1000 which we’ll begin to ship this quarter, which is a colored touch sensitive screen and sets new standards for ease of use. Beyond the product themselves our most significant competitive differentiator is the world’s largest audio/video control database. This database now includes over 5,000 unique brands of devices and over 175,000 unit devices and we also continue to add thousands of new devices to the database each week which extends our lead with this valuable asset.

We have given it a relatively low profile recently but increasingly widespread appeal of console and PC based gaming is a trend that will become much more visible in the near future. Earlier this month we announced the first of our products for the PlayStation 3, the Logitech ChillStream Controller. We believe we are uniquely positioned to leverage the opportunity for third party PlayStation3 peripheral and we are eagerly anticipating the launch of the deciding platform. We also believe the expanded centralized Windows Vista will reignite the market for PC gaming which as you have heard, is growing substantially this quarter. As the leaders of PC gaming controllers we will be ready from the start. Another way we have began starting the immigration from desktop computers to laptops. These trends present us with attractive opportunity to include retail and OEM. We continue to add to our broad line of retail notebook peripherals which includes mice, webcams, headsets and speakers.

As one indicator of our success in the notebook category during Q2 the growth rate of our retail notebook peripheral sales was over four times higher than the growth rate of our total retail sales. There is more to come this fiscal year is an innovative addition to our offerings that brings the comfort and experience of using a desktop PC, the notebooks. I wouldn’t want to conclude my comments on key trends without mentioning one of the most important roles and that the consumer will need the tech support and go wiring it every where.

The consumer’s interest in easy to use innovative wireless products is growing in every one of the market that we play in. We’ve long been the leaders in cordless mice and keyboards with the recently announced Logitech diNovo Edge keyboard been the most recent example of our ability to work for a cutting edge plan of refine design and great re-innovation in the cordless category, but our portfolio today includes a wide range of other cordless devices. The Harmony radio frequency and IR remotes, wireless music distribution systems, wireless headphones for iPod and MP3 players and wireless gaming controls, the wireless devices and our opportunity to benefit from it, that would be great.

That brings me to my outlook for the remainder of fiscal ’07. We have increased our target for the current fiscal year ending March 31st 2007. We now expect sales to grow by 17% up from our previous target of 15% and non GAAP operating income to grow between 20% and 25% up from our initial target of 15%. Gross margin is now expected to be above the mid point of our long-term range of 32% to 34% and upward revision of our earlier estimate of being in the low end of that, this means that we expect that our gross margin in the second half fiscal ‘07 will be higher than the 33% we delivered in the first half of the year and of course significantly higher than in the second half of prior year. The impact of the slim devices acquisition will now increase fiscal 07 target is expected to be immaterial. Our non GAAP operating income gross target excludes the cost of equity based compensation and we continue to expect the net cost of equity based competition fiscal 07 reflects that the net income to be between $16 and $19 million.

One of our key goals for fiscal 07 is to sustain a revenue growth while increasing our profitability and taking advantage of the leverage opportunities of our business model. The results throughout the first half of the year and particularly our gross margin improvement in Q2 provide compelling evidence that we are on track to achieve this goal. Our strong top and bottom line performance combine with our expectations of continued strength in second half of the year had allowed us to increase our full year target. With strong demand from our channel partners for new premium peripherals for the PC, the line up of new video and audio devices for internet communication of must have with digital music prevented the last holiday season with our strongest portfolio ever and a high degree of cost. And at this point I like to open the calls to your questions, please follow the instructions of the operator.

Question-and-Answer Session

Operator

Thank you ladies and gentleman, [Operator Instructions]. Your first question comes from Ted Chung with Bear Stearns.

Ted Chung - Bear Stearns

Yes, hi I have a quick question regarding the cash convergent cycle. In the previously indicate as you work focused on improving that and we were just wondering how the progress is going on that aspect of it.

Mark Hawkins

Hey Ted, this is Mark, how you are doing?

Ted Chung - Bear Stearns

Good and how are you?

Mark Hawkins

Good, we actually have made some progress on that. I think if you look at the cash convergent cycle in total, we are looking at it to improving about -- it looks to be -- it was about 71 days last year, its 66 days this year for this quarter. So we have made some improvement on that and will be continuing to attend to that.

Ted Chung - Bear Stearns

Okay, great and just, can you update us on how your sales strategy is going in the China markets.

Mark Hawkins

Okay, Guerrino --

Guerrino De Luca

Yeah, the Chinese market as you know, all the developing countries markets have a structure which is different from the markets in which we operate in the west. We are very successful where market that’s saturated with the platforms we target. So that explains why our growth in Western Europe and Eastern Europe and Americas region is always sustained. Where everybody suffers when PC makers and cell phone manufactures we actually benefit. China is not there yet and what our strategy in China is to continue to maintain a high profile and a premium brand position, we want to be the aspirational brand and as the market broadens and as more people have PCs at home etc, that will bring China in line with the growth rate or even faster that we see in the developing world right now. So China is doing well, structurally we have cleaned up and significantly simplified our go to market channel structure and we are waiting for China to become the nature of the market that benefits most of our products.

Ted Chung - Bear Stearns

Great, thank you.

Operator

Your next question comes from John Bright with Avondale Partners.

John Bright - Avondale Partners

Thank you, good morning, first Mark on the corded sales upside, what you attribute the better than expected performance, at least versus my expectations on the course that I know you mentioned keyboards but is there a particular driver behind this?

Mark Hawkins

It’s really John the keyboards, I don’t think there is a lot more behind that other than we just (audio gap) it has strong performance there and that’s been the singular driver.

John Bright - Avondale Partners

Yeah. Okay, and then on the gross margin side, performed much better and you attribute that to driving down some costs or some costs in this generation of products lower than the last generation of products, can you elaborate on what those might be?

Mark Hawkins

Well, a couple of different things here, one of the things that we looked at really -- the biggest message I would say John, for the gross margin improvement how to do with the replacement of new products basically. So the cordless we had some strong performance which contributed to the substantial sequential year on year improvement. In gross margin we also had in the corded and in the audio, those three categories in particular let the way with replacement products that fundamentally allowed us to raise the gross margin. Of course, you would expect there is always cost reduction projects and things of that nature that you know, our aps teams and our collected team do but the biggest headliners where those three drivers.

John Bright - Avondale Partners

Okay, and then I also noted you talked about the significant investments in the Oracle 11 and SOX driving the G&A, is that something that we might expect to step down from in the future?

Mark Hawkins

Yeah, two points here John, one is for SOX, there is both these initial certification which we are going through, and then obviously there is a sustaining amount of that that’s going to happen in the future so that -- I would not expect the SOX investment to come down substantially. Secondly, in relation to Oracle, we have made the investments for Oracle to get that live as Guerrino called out and now the opportunity is to really optimize that and harness that productivity, so and in the near term I would not expect any major change there.

John Bright - Avondale Partners

Okay, and then let me, the last question. Microsoft did in there, with their webcam market during this -- this reporting quarter, we don’t expect any major signs from them at least now, your thoughts still the same have them baked into your guidance or you are seeing them in the market making any presence Guerrino?

Guerrino De Luca

We see that everywhere they have launched their products and the impact they had is in line with our expectation, would be that the market opportunity in video has never been more attractive, we’ve seen our results this quarter. We believe that Microsoft actually may help drive the market grow even faster as we can on our own, in fact we’ve been alone in this country for a very long time. What we have seen so far is fundamentally consistent with our expectations, I think we are well positioned to sustain a leadership in this fast growing market and we are used to compete with Microsoft, so nothing has changed and of course the guidance factor that any impact of their entry into webcam entry on your Windows Live relationship.

Guerrino De Luca

Actually the pricing, it may seem we are the preferred communication partners for Windows Live, don’t ask me why.

John Bright - Avondale Partners

Okay, gentlemen congratulations on a strong quarter.

Guerrino De Luca

Thank you

Operator

Your next question comes from Matthew Yates with Merrill Lynch

Matthew Yates - Merrill Lynch

Hi, good afternoon couple of questions please, I just want to dig in to the full year guidance -- of the invested that you talked about how the gross margin on new products usually peak sometime after their introduction just wondered therefore if you felt the Q2 margin with sustainable through the rest of the year.

Guerrino De Luca

Hey Mat, well let me address this one, first of all let me reiterate what Mark said that new products of higher margin the products they replace and this is not because we decided to all of a sudden you know, cut the cost of the old products to make the new. I think margin is a clear indication of the -- it’s a clear metric of innovation; margin is the delta between the perceived value and the cost. I think that is never more than in this Christmas season we have introduced an objective in our product line substantial innovation across the border. And the list of dramatically innovative products that could have been called revolution goes way well beyond the revolution life. So in that sense that’s what the margin improvement is all about, we have guided for an improvement in the second half over the first half. Margin is driven by many factors, across product plans that’s why we are saying what we are saying in terms of the second half and we also wanted to make sure that we can utilize the competitive advantage of such a great margin to do anything we need to do to compete effectively. Our primary target is to increase gross profit dollars. And that is in the maniacal session of the company and we’ve shown this quarter what that means and that’s why we are aiming at. No particular percentage will replace gross profit growth and that’s what we are going for.

Matthew Yates - Merrill Lynch

Okay, and just a second one if I may, I think you have recently launched a number of products across different categories, that have higher price points than you previously had. I just wondered if you had seen some evidence of consumers trading up to a higher price model from you.

Guerrino De Luca

Well, it’s a bit too early to tell, certainly our ESP has increased and so that’s an indication that people had to move higher up. But ESP are also on average driven by combination of mixed issues by product line and within product line. I would say that our pricing strategy has not changed but certainly we believe that -- for certain products line in certain categories, measuring the innovation we can bring -- the proceed value justifying the price. There is no fundamental you know, going away from being the premium brand affordable pricing. But we certainly opportunistically take advantage of what of the proceed value that our products bring.

Matthew Yates - Merrill Lynch

Okay and just one quick last question, the other business is down sequentially. Does that in line with your expectations, or is there any comment you can make that?

Guerrino De Luca

There is no particular things to say other than, I mean this has to do with all the ups and downs of any business, for example, how many had a solid 30% growth, we expect this growth to be substantially higher in Q3 so, it has to do with product cycles and that’s also part of your business model for having significant resilience across elements of the portfolio.

Matthew Yates - Merrill Lynch

Okay, thanks guys.

Operator

You are next question comes from Charles Elliot with Goldman Sachs.

Charles Elliot - Goldman Sachs

Hi Guerrino and Mark, congratulations, just two questions from me. First I would just like to check on the tax rate when we are calculating this at around 13%. Do we take of pre tax profits plus stock option expenses or --?

Mark Hawkins

Let me just speak to that, the tax rate that we were talking about 13% is pre 123R, that is correct, so if you want to factor in the effective 123R there is a bit of tax shield there as you know, and so the guidance -- the target rather is specifically as pre 123R.

Charles Elliot - Goldman Sachs

So that’s prior to -- can you just spell that in terms of --

Mark Hawkins

Yeah, Charles let me make it even clear here. Basically, you know, we talked about the target at 13%, that is basically, if you take it close to a point of tax shield if you will for the 123R stock comp so effectively on a post 123R it would be closer to 12%. Again it will be a plus or minus sign, but that’s the target.

Charles Elliot - Goldman Sachs

Got you, thank you.

Mark Hawkins

You are welcome

Charles Elliot - Goldman Sachs

This is more big one but do you have an estimate what percentage of your sales is Bluetooth or could you just make a comment on how Bluetooth is impacting across your product range and across the rising demand?

Guerrino De Luca

Well I don’t have updates with me, and we don’t take that angle. Bluetooth is one of the many wireless technologies we are using and you can see it both in wireless music system and in cordless desktops, we don’t have that cut, I would say that Bluetooth is -- at this point it’s a better advantage for us we have learned a lot in Bluetooth over the course of the last year. It provides the high end customers additional features and functionalities that are not available with other wireless technologies from us at this point. I will say it’s one of the many ingredients that we built our recipes with Charles, if not, it’s neither the most important one or nor an irrelevant one.

Charles Elliot - Goldman Sachs

Got it, good thanks.

Operator

Your next question comes from Mehrdad Torbati with Deutsche Bank.

Mehrdad Torbati - Deutsche Bank

Hi everyone, thanks for taking my questions, I have couple of questions. First one is on your guidance, I mean you are a guiding, an opening profit of at least 20% higher than last year, it gets you to around $239 million. If you take a step back here that’s around 40% higher than the fiscal ’05, is there any reason why your operating cash flow this year should not be 40% higher than what you generated in 2005? Are there any structural reasons why you know, your DSOs should be any different and what you are enjoying the past or, what is the optimal level of DSOs you should be having or reaching soon? And the second question relates to the geographic breakdown of your sales, can you be here a bit more specific on Americas, how did US sales grow, how did South American sales grow, in Asia Pacific can you make a breakdown the based on different geographies in Asia Pacific and that will be the questions, thank you.

Guerrino De Luca

Mehrdad let me address your second question, by disappointing you we don’t provide revenue beyond the level of regional aggregation that Mark mentioned. As far as the ideal, the optimal level of DSO cash flow, I’ll let Mark answer, although I’m sure you will be disappointed by the answer also.

Mark Hawkins

Yeah, on the cash flow, let me just say a couple of things here, one is that as you know we don’t typically guide on the particular elements of the cash conversion cycle, we don’t set forward looking targets on that, so that’s one thing to kind of call out also just in general I think there is a main point to look at is our business model, looking at the guidance that Guerrino had talked about but in terms of operating income, net income what you should expect there. And then also know that we will be attentive to our cash conversion cycle but we do not guide going forward. Let me do make sure to call out one thing here in Mehrdad that I think might be useful to you, whereby we don’t go in more detail we do have a mix for the geographies that I want to make sure you do know that in this quarter we achieved 48% of our total sales in Europe, 35% in the Americas, 17% in Asia. So we do go at that level, but we never you know, disclose it at a lower level than that. So I think from that standpoint and that would be both retail and OEM together.

So that’s what we can share. As far as the DSO, in terms of what we share with that I think the big message with the DSO we talked about is that you should expect that to go down sequentially. That’s the overarching point. The ordering pattern has been a major factor and we’re strongly related to new product introductions and I already told you about the backlog and how it stands at the beginning of the quarter. So you should expect to see a decline sequentially. But in terms of let me just leave it at that and hopefully I just -- at least address some of your question.

Mehrdad Torbati - Deutsche Bank

But when you are saying that the DSOs are coming down sequentially or seasonally in Q3, DSOs always come down sequentially, right. Well my question is more on a long-term basis, you generated $119 million offering cash flow in fiscal ’05, and your operating profit is 40% higher this year according to your guidance. To what extent is your operating cash flow is going to be higher than fiscal ’05, what type of operating cash flow growth can we expect in this business?

Mark Hawkins

Yeah, that’s something that we don’t give guidance on and so I really I can’t speak to that, to be honest with you.

Mehrdad Torbati - Deutsche Bank

Okay.

Guerrino De Luca

Mehrdad let me try to help you a little bit. There is nothing that has structurally changed from fiscal ‘05 to fiscal ‘07. We have been -- maybe there is a few turns with some of our customers there, but they are longer than they were in fiscal ‘05 but it’s not so enormously significant. We have taken some inventory position to guarantee customer satisfaction and use our competitive advantage which is derived due to fact that we have a lot of cash and that is maybe having a marginal impact, but fundamentally the business is a cash generating business. There is no fundamental change from then other than the two points --

Mehrdad Torbati - Deutsche Bank

Okay, well the reason I am asking that is that your offering cash flow last year was down 20% and you have done a great job in the first half of this year to improve some of the metrics. I just want to know where you are going to end up for the full year in terms of cash flow generation.

Guerrino De Luca

I understand that, but we don’t share that okay, I’m sorry, about that.

Mark Hawkins

Mehrdad, we don’t guide on that, but I do think you pulled out the right point which is to take a look at the first half and look at the north of $70 million growth in cash flow. And I think that’s probably been perceived favorable in the market today.

Mehrdad Torbati - Deutsche Bank

Okay, thank you.

Operator

Your next question comes from Manuel Recarey with Kaufman Brothers.

Manuel Recarey - Kaufman Brothers

Thanks and congratulations on a good quarter. If I just go to gross margin, again the outlook, what kind of gives you the confidence at this time you know, that it’s going to be able to remain strong and as I understand it you know, Logitech continue to always introduce new products and typically at the higher price point so what is different this time?

Guerrino De Luca

First of all, the dramatic jump in gross margin that we had anticipated and predicted and shared with you is driven by what we thought and the market is now proving being a dramatic innovation injection in the private portfolio, that is a critical point and we believe that what we have seen in terms of responsiveness in products we have introduced the majority of our product line up at this point and we have a few coming but it’s fundamentally done, and so we expect that to help sustain gross margins. There was a comment made by one of your colleagues before in the call that I would like to address which is, we have said and continue to say that normally during their lifecycle products gross margin improve, and so they at the lowest when we introduce them and they tend to improve over the majority of their lifecycle. It is the case this year too, the difference is that the products we introduced this year at the beginning of their lifecycle are better margined than the most of the products they replaced, so there is a very nice combination here, so we would certainly see some improvement in front of cost in some of the newly introduced product and therefore a tendency it might just to sustain at least. But again there is mixed issues and there is a willingness that as I said to use the flexibility that a higher margin gives us to drive growth. And we want to make sure this to all of you that for gross profit dollar growth is the priority of the company.

Manuel Recarey - Kaufman Brothers

Okay, if I can just ask one more question, the audio segments that has nice growth 23% in the first fiscal quarter, 21% in this quarter, so that down sale is substantially from the growth in the fiscal ‘06 has that reached a level where you know the 20%, 25% is kind of a more realistic gross rate for that segment?

Guerrino De Luca

Absolutely we don’t share goals for -- by product segment, I can tell you that there is nothing bad with 20%, 25% gross. We will see the impact of some rate in products for the iPod coming in. We have made an acquisition that eventually would be very efficient material this year but over time pretty substantial hopefully to the audio business, so it’s very hard to say it’s been the best of audio, I don’t think so.

Manuel Recarey - Kaufman Brothers

Okay, thank you.

Operator

Your next question comes from Michael Foeth from LODH.

Michael Foeth - Lombard Odier

Yes, hello gentlemen congratulations from my side also. I would have some question on the OEM side, when are you actually expecting this product transition at one of your major customers to be over and grow starting again. And also on that I believe that you had guided for 10% gross in the OEM segment does that still valid, that will be do it, the first two questions and then a follow-up.

Joe Greenhalgh

We expect OEM to grow substantially in the second half and therefore we expect to reach the double digit for the year, so therefore we expect the transition to be completed in the quarter we are in now.

Michael Foeth - Lombard Odier

Okay, good news and can you tell us who are your biggest customers are for embedded camera – embedded webcams, is that something you can disclose?

Joe Greenhalgh

We cannot.

Michael Foeth - Lombard Odier

Okay, thanks then.

Operator

Your next question comes from Roger Steiner with Kepler Equity.

Roger Steiner - Kepler Equity

Good morning, and congratulation also from my side, I would have two questions the first one is on channel inventory, one of you could shed some light on your thoughts on channel inventory with the new revolution product range sort of to get a feel on what you think was the opportunity on the quarter and the second one would be on your sales gross guidance I mean, you just outlined that you expect OEM to grow double-digit again, your sales gross overall was over 18% in the first half and your guidance for 70% for the full year so where do you expect that to come from?

Mark Hawkins

Okay, let me address the channel inventory and then we can have Guerrino touch on the sales growth there. On the channel inventory, I just will say broadly speaking maybe overall inventory looks healthy around the world on the channel side. We looked at that and I think you can see probably some evidence just when you hear our backlog is substantially higher year-on-year in September. It probably gives you a good feeling for very strong appetite for the product itself. But beyond that we certainly don’t go, Roger, to our product level. We don’t go into a lot of specificity in the channel inventory, but at a broad level it actually looks good and the backlog is really solid data point to be thinking about. On the sales growth side, Guerrino, I don’t know if you want to touch on that.

Guerrino De Luca

Yeah, well you know we have begun to see the initial sales out data for the -- is doing normally well, that’s all I can say. And in terms of what to expect for the second half, remember we are -- the second half of the year is actually 60% growth revenue. We’ve increased our guidance for the top line, we have increased our guidance for a top line, but the bottom line we’ll stick to it and that’s all we have to say.

Roger Steiner - Kepler Equity

Okay, thank you.

Guerrino De Luca

Now lets take one more question, thank you.

Operator

Your final question comes from Thomas (inaudible).

Unidentified Analyst

Yeah, hello, just wanted to ask a question on the OEM, going back to the question asked before on double-digit growth. I don’t know if you break that down on the product chart, could you give us some indication on that?

Guerrino De Luca

I can give you a flavor of that. We expect gross to be driven by cordless desktop, which is the product we’re in transition at with, our major customer in OEM. And we expect continued growth with video modules, we expect that the traditional weakness of the mouse business both for this transition, a big customers, they will buy mice and keyboards so that’s a good thing but of course when you measure it, mice declines and desktop growth and also a generic weakness of the desktop PC market, which everybody knows about and which gives us this tremendous opportunity in laptop market and notebook --

Unidentified Analyst

Thank you.

Joe Greenhalgh

So with that let me conclude this call by thanking you all for joining us and I want to make one more observation. The vision of being the interface between people and technology that was the foundation of Logitech 25 years ago, has never seen more relevant, pervasive and far reaching than today. If you look at our broad product line, you will not fail to notice how from our Harmony, to our webcam to our digital music systems we have developed a vision into a uniquely compelling portfolio of exciting products for the consumer. And with our growing presence in the digital home, I think we are just at the beginning of the rise. Thank you very much.

Operator

Thank you ladies and gentlemen this concludes today’s conference. You may now disconnect.

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