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Logitech International SA (NASDAQ:LOGI)

F2Q11 (Qtr End 09/30/10) Earnings Call

October 28, 2010 8:30 am ET

Executives

Joe Greenhalgh - VP, IR and Corporate Treasurer

Gerry Quindlen - President and CEO

Erik Bardman - SVP, Finance and CFO

Analysts

Alexander Peterc - Exane

Jonathan Tseng - Merrill Lynch

Ashish Sinha - Morgan Stanley

Simon Schafer - Goldman Sachs

John Bright - Avondale Partners

Andy Hargreaves - Pacific Crest

Yair Reiner - Oppenheimer & Company

Nicolas von Stackelberg - Macquarie

Operator

Welcome to the Logitech’s Second Quarter Financial Results Conference Call. At this time, all participants are in listen-only mode. We will be conducting a question-and-answer session towards the end of this conference and instructions will follow at that time. This call is being recorded for replay purposes and may not be reproduced in whole or in part without written authorization from Logitech.

I would now like to introduce your host for today’s call, Mr. Joe Greenhalgh, Vice President of Investor Relations and Corporate Treasurer at Logitech. Please proceed.

Joe Greenhalgh

Welcome to the Logitech conference call to discuss the company’s results for the second quarter ended September 30, 2010. The press release, the live webcast of this call and accompanying presentation slides are available online at Logitech.com.

This conference call will include forward-looking statements including forward-looking statements with respect to future operating results that are being made under the Safe Harbor of the Securities Litigation Reform Act of 1995. The forward-looking statements involve risks and uncertainties that could cause actual results to differ materially from those anticipated in the statements. Factors that could cause actual results to differ materially include those set forth in Logitech’s Annual Report on Form 10-K dated May 27, 2010, and subsequent filings which are available online on the SEC Edgar database and in the final paragraph of the press release reporting second quarter results issued by Logitech and available at Logitech.com.

The press release also contains accompanying financial information for this call. Forward-looking statements made during this call represent management’s 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. We’d 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 the presentation slides accompanying this call are also available on our website.

Joining us today are Gerry Quindlen, President and Chief Executive Officer, and Erik Bardman, Senior Vice President of Finance and Chief Financial Officer. I’d now like to turn the call over to Gerry.

Gerry Quindlen

I will cover the highlights of the quarter now which will be followed by a more detailed review of the financial results by Erik. Then I will return to talk about our outlook for the year before we both take your questions.

I am very pleased with our results for the quarter. We delivered double-digit growth in both sales and operating income and we achieved the highest quarterly gross margin in our history. Consumer demand for our products remains strong during the quarter with double-digit sell-through growth in all our retail regions. Our regional sales performance was led by Asia-Pacific.

Our sales in this region grew by 38% year-over-year, led by an exceptionally strong quarter for both sell-in and sell-through in China. We are still in the early stages, but we are making excellent progress toward our goal of growing China into one of our top three markets.

Remotes were once again our fastest growing retail product category with sales up by 28% and units growing more than twice as fast. We also achieved strong sales growth in pointing devices, keyboards, and Webcams. Our three product categories tied most closely to the PC platform.

We continue to build sales momentum with our LifeSize business. During Q2 LifeSize’s unit sales increased by 64% compared to the prior year and reached an all-time high for a single quarter. We are well in our way to deliver on our sales growth target of 40% to 60% in calendar 2010.

A significant highlight in the quarter was our gross margin of 37.3% the best quarterly gross margin we have ever achieved. I was particularly pleased to see that we were able to achieve this record breaking margin despite the negative impact of the weaker Euro.

Overall our gross margin is benefiting from several factors including positive consumer response to our new products and operational improvements we have made during the course of the last year. That we are focused on improving our profitability as global economic conditions gradually improved.

Finally a key non-financial highlights for the quarter was completing the many activities associated with what is arguably the most exciting launch in the company’s history. Our product portfolio for the Google TV platform. I could not be more pleased or excited about the potential of this platform holds for Logitech. Now I will talk more about in my comments following Erik.

Let me now turn the call over to Erik to review the financial highlights for the quarter.

Erik Bardman

I will start with an overview of our Q2 sales performance. Please note that the growth percentage that follow are in comparison to Q2 fiscal 2010. Our retail sales grew by 11% and were up by 15% in local currency. Units were up by 18%.

Looking at our regional sales in local currency EMEA was up by 6% and Asia-Pacific by 35% compared to a US dollar decline of 3% in EMEA and growth of 38% in Asia. Retail units were up by 13% in the Americas, by 5% in EMEA, and by 66% in Asia-Pacific.

Our overall retail average selling price in Q2 was down by 6% from the prior year and up by 4% sequentially. Sales of our retail products priced above $100 represented 17% of our retail sales in Q2, up from 15% in both the prior year and the prior quarter.

As Gerry mentioned, the Remotes category was our best performing product family in the quarter with sales up by 28% and units up by 71%. The growth was driven by multiple products with the Harmony One leading the way. Significantly stronger growth in units reflects the contribution from two of our newer Remotes. The Harmony 300, our lowest-priced remote at just $49 and the Harmony 650 priced at $99.

We were pleased with our results in the Keyboard and Desktop category with sales up by 19%. We sell double-digit growth in both sales and units in the corded and cordless categories. Growth was strongest in the low-end with sales and units both up in excess of 25%. It was a very strong quarter in Asia-Pacific with both sales and units nearly doubling.

Our sales in the Video category were up by 18% with units up by 28%. We achieved sales and unit growth in both the high end and the low end of the major Webcam price points with particular strength in the high end.

Sales in the high end benefited from strong demand for our HD Pro Webcam C910 which features full HD 1080p video recording as well as HD 720p video calling. We achieved sales and unit growth in Webcams across all three regions. Our recently launched Logitech Alert line of digital video security systems also made a notable contribution to our growth in the video category during the quarter.

Sales in the Pointing Devices category were up by 18% with units up by 26%. Growth was driven entirely by our cordless mice with sales up by 34% and units by 61%. We achieved triple digit sales growth in both the high end and the low end of the major cordless mice price points.

Sales in the high end benefited from the continued strength of our two high performance MX offerings featuring Darkfield Laser Tracking for use on virtually any service, while sales in the low end were led by two of our attractively priced wireless mice for notebooks, the M215 and the M305. It was an exceptionally strong quarter for cordless mice sales in Asia Pacific where sales more than doubling and units nearly tripling.

Sales in our Audio category were essentially flat down by 1%. Decline was mostly driven by the Speaker category where sales fell by 7% primarily due to weakness in EMEA. We achieved strong growth in PC headsets as well as in our Squeezebox family of streaming video products.

Turning now to OEM where sales were up by 10%. Growth was led primarily by our OEM keyboards with sales and units both up by more than 50% as well as our microphones for console singing games.

Let me now shift to gross margin. Our Q2 gross margin improved by 680 basis points compared to the prior year and by 200 basis points sequentially. The year-over-year increase in our gross margin was achieved despite a stronger U.S dollar and was driven by a number of factors. With favorable product mix shifts, having the most significant impact followed next by operational efficiencies in our supply chain, and then by the contribution from LifeSize.

As an example of product mix shifts, we achieved strong double-digit growth in pointing devices and video two of our highest margin retail categories. Our sales were flat in audio and comparatively low margin category. We also achieved significant year-over-year gross margin gains in two fast growing categories Remotes and keyboards.

Turning now to operating expenses. Our operating expenses were up by 33%, the prior year’s expenses do not include LifeSize which is the single largest driver of the year-over-year increase in Q2. Excluding LifeSize our operating expenses grew at a double-digit rate but still much slower than our growth in gross profit as we focused on steadily rebuilding operating leverage over time.

The increased spend reflects both the significant improvements in the operating environment over the last 12 months and our renewed emphasis on driving top-line growth. We are investing in a number of areas and activities, including but not limited to Google TV that ensure we are positioned to drive profitable, double-digit growth in the quarters to come.

Let us move to the balance sheet starting with cash. Our quarter-ending cash position was $308 million. The cash was down by $10 million from the June quarter and down by $217 million compared to the prior year. Looking at the decline in our cash compared to the prior year, it is important to note that we use $382 million for acquisition of LifeSize in December of 2009 and another $126 million for share repurchases during the last 12 months.

Our cash flow from operations in Q2 was a negative $1 million a decrease of $59 million compared to the same quarter last year. The primary driver of the year-over-year decline was the sequential increase in inventory this Q2 compared to just a 2% sequential increase in Q2 of the prior year.

Note that the absence of significant sequential inventory growth in Q2 of last year was highly unusual and reflected the combination of our channel partners’ ongoing efforts to reduce their weeks of supply and are putting a place to inventory at a time when there were still a high degree of economic uncertainty.

The 23% sequential increase in inventory in Q2 of this year was similar to the increases we experienced in FY ‘09 in prior years especially in light of the increase for Google TV related products. Our cash conversion cycle in Q2 was 41 days, eight days higher than the same quarter last year primarily due to the inventory dynamic I just mentioned.

Our inventory increased by $103 million or 43% compared to the prior year and it was up by $63 million compared to the June quarter. Inventory turns were 4.3% down from 5.8% in the prior year. The increase versus the prior year was driven by three factors, the inclusion of LifeSize and Google TV related products; the improved demand environment and our decision to establish an inventory buffer for the holiday shopping season.

The combination of LifeSize and Google TV in Q2 of this year added roughly $23 million more in inventory and 10 percentage points of the inventory growth compared to the prior year. The demand environment has clearly improved during the last 12 months. Given our channel partners relatively low inventory levels by historical standards, we chose to carry somewhat more inventory entering the current quarter so that we are prepared to help them take advantage of any upside during the quarter.

Our DSO was 47 days unchanged from the prior year. We did not repurchase any shares during Q2. We own approximately 7.7% of our shares outstanding. We have a $250 million Board approved program that we have not yet utilized.

Before concluding my comments, I want to remind you that our next Analyst and Investor Day scheduled for November 9 in New York. We hope that you will be able to join us. That concludes my comments. Let me now turn the call back to Gerry.

Gerry Quindlen

I want to comment now on our improved outlook going forward. As you saw in our press release we have increased our full fiscal year outlook for sales, gross margin and operating income.

Let me start by giving you an overview of the reasons for our increased confidence as we enter the second half of the year before I summarize the changes to our outlook. Starting with sales, the driving factor in our improved outlook for the remainder of the year is the launch of our line of products designed to create the best Google TV experience for the millions of U.S. households within HDMI-ready TV.

We are committed to driving a successful launch and a strong adoption rate for this new platform which we believe has the potential to provide us with yet another sizable and growing installed base to generate incremental sales over an extended period of time.

Our product portfolio for this new platform currently includes the Logitech Revue, a compact, plug-and-play companion box that incorporates our Harmony remote control technology and comes with the Logitech Keyboard Controller also part of the portfolio are the Logitech TV Cam with Vid HD service for HD video calling from the living room. The Logitech Mini Controller as well as several iPhone, iPad, and Android applications design for the Google TV platform.

With this initial line of products which we will substantially expand over time. Logitech will help redefine the user experience in the digital living room. It is important to remember that we are at a very beginning of this exciting opportunity. Our products started shipping in the U.S just last week. They are currently available at Best Buy, Amazon and through our own website as well as through the DISH Network.

As we move into the March quarter we plan to significantly expand our retail distribution to include more of our channel partners in the U.S. We also expect that Google TV platform will become available in Europe during calendar 2011.

While it is obviously premature to draw any firm conclusions. We are very pleased with the initial enthusiasm we have seen from consumers and with the extensive coverage in the technology and general media. We look forward to learning much more about consumer’s response to this promising new category in the coming months.

I want to reiterate something that we said last quarter mainly that we plan to invest the gross profit we generate from sales of our Google TV product this fiscal year into consumer-focus marketing activities to create additional awareness that we expect will ultimately lead to future sales.

We therefore expect sales of our products for Google TV to be operating income neutral this fiscal year, as we focus on building the foundation to make this a long term source of profitable growth. Thus our increased outlook for operating income in FY 11 is driven by improvements in our core business and by the growing impact of LifeSize.

Let me now turn to LifeSize. Just last week we announced the major addition to our LifeSize product portfolio, the LifeSize Bridge 2200, the first bridge developed and manufactured by LifeSize. This product enables organizations to take a building-block approach, scaling videoconferencing deployments as needed.

They are providing the best high definition experience available on the market. Based on a modular architecture, the LifeSize Bridge empowers companies to purchase the appropriate number of bridges to accommodate their current needs with the ability to easily add capacity as their HD videoconferencing needs grow.

As you would expect from the LifeSize offering, the LifeSize Bridge offers disruptive price performance. In fact, the Bridge 2200 can deliver 720p60 and 1080p30 HD quality at less than one-third the cost of other solutions in the market today and it is just the beginning.

We will continue to expand our LifeSize portfolio of products and services in the coming months with additional disruptive price performance offerings designed to make video communication easy and acceptable to anyone anywhere with the biggest opportunities in the SMB and small enterprise space.

Let me focus now on our retail business. During the September quarter we launched majority of our new products for fiscal 2011. We are excited about this year’s product roadmap and I am very pleased with the initial response we received from consumers and all our channel partners. We expect these products to make a significant contribution to achieving our increased sales and profitability goals this fiscal year.

Let me highlight several of our innovative offerings starting with the Audio category and the Logitech Wireless Speaker Z515. The Z515 delivers great sound from a laptop, iPad, iPhone or smartphone without the hassle of course. The speaker uses 2.4 Gigahertz technology to deliver wireless audio up to 50 feet away delivering full stereo sound and plenty of bass. The Z515 also includes a rechargeable battery that can power the speaker for up to 10 hours.

Moving to the Keyboard category, we launched the Logitech Wireless Illuminated Keyboard K800. The K800 features include smart backlighting and motion sensing. The backlighting automatically adjusts based on the amount of light in the room using ambient light sensors. While the motion sensors detect movements as the users’ hands approach to turn the backlighting on or to turn it off as the hands move away conserving battery light from backlighting is not needed.

There is the latest addition to the Video category, Logitech Alert Digital Video Security, a complete HD digital video security system. The Logitech Alert master system comes with a smart HD camera, powerful PC and web software, and free remote viewing on a PC, Mac or smartphone.

The camera includes the 2 Gigabyte MicroSD card for storage, eliminating the needs for the PC to be on while recording video when motion is detected. Consistent with our vision to bring HD video to anyone anywhere, we are excited to be able to bring a completely new video security solutions consumers and small businesses which offers HD video quality and motion-triggered live viewing and recording at attractive price points.

Let me shift now to the demand environment. As was the case following Q1 our increased sales outlook is not predicated on an improvement in overall consumer demand for our products. As mentioned earlier it primarily reflects the impact of the introduction of our line of Google TV products. If the overall demand environment improves in the second half that could represent upside to our outlook.

Let me comment briefly on gross margin and operating expenses. We have been extremely pleased with our strong gross margin performance during the first half of fiscal 2011 and 36.4%; our first half gross margin was well above the high end of our long-term range and was achieved despite a relatively weak Euro for most of the period.

Our confidence in delivering a similar gross margin during the remainder of the fiscal year reflects positive developments in our core PC-related business, independent of the contribution from LifeSize.

Looking forward we are confident that LifeSize will become increasingly accretive to our gross margin as it becomes a bigger piece of our overall business. Even our recent performance as well as our increased gross margin outlook for fiscal 2011 we are reevaluating our long-term gross margin range and you can expect to hear more from us on the subject at our upcoming Analyst and Investor events on November the 9th.

Let me now discuss operating expenses for the rest of the year before summarizing the changes in our outlook. As Erik said LifeSize was the biggest contributor to the year-over-year growth in our operating expenses during Q2. Investing in LifeSize to achieve its long-term growth potential will continue to be one of our top priorities.

Looking at the rest of our business we will continue to prioritize our spending and categories, geographies and markets including Google TV, China and other emerging markets that provide us with the highest potential long-term return. Even with these investments excluding LifeSize you should expect that we will continue to grow our operating expenses at a slower rate than our gross profit during the remainder of the fiscal year.

Finally, let me summarize on improved financial outlook. For fiscal 2011, we have raised our sales outlook from the previous range of $2.35 billion to the new range of $2.35 billion to $2.4 billion. We have increased the target for operating income from the previous range of $160 million to $170 million to the new range of $170 million to $180 million. We now expect gross margin to be approximately 36% for the year, up from the previous range of 34% to 35%. We continue to expect our tax rate to be approximately 16%.

I want to wrap up by saying that I am very pleased by our performance in the first two quarters of fiscal 2011. We enter the second half with strong momentum focused on sustaining double digit growth in our core business by simultaneously developing the LifeSize and Google TV opportunities.

Since the start of the fiscal year, we have increased our outlook for sales by as much as $100 million; the outlook for operating income by $13 million to $20 million and for gross margin by 200 basis points. Our improved outlook reflects the combination of our strong first half performance and the many attractive growth opportunities for us. I am confident that we are well positioned to achieve our increased targets.

With that Erik and I are now available to take your questions. Please follow the instructions of the operator.

Question-and-Answer Session

Operator

(Operator Instructions)

Our first question will come from the line of Alexander Peterc with Exane.

Alexander Peterc - Exane

I’d just like to clarify with respect to your guidance upgrade, can you tell us if your previous guidance already including any of the goal to be impacted at all or not? Secondly, just from a housekeeping perspective, are you going to report the Google TV revenues separately? Thanks.

Gerry Quindlen

To your first question in terms of what was previously in our guidance, we had talked about this last quarter there was no revenue or sales baked into our guidance previously. We did talk about the fact that because we have been working from an R&D perspective on Google TV in previous quarters that have been included, but there was no sale. Our upgrading guidance now does include everything that's Google TV related. Could you actually…

Erik Bardman

How are we going to report it?

Gerry Quindlen

What we’re going to be doing is you’ll see it in our Digital Home Group which is the same place where we report our Harmony remote controls today.

Operator

Our next question will come from the line of Jonathan Tseng with Merrill Lynch.

Jonathan Tseng - Merrill Lynch

First question just on the gross margins here, you talked about getting supply chain improvements there, does that mean the gross margin is sustainable at these levels at the mixed stage where it is or – so would you be within your 32% to 34% gross margin range anymore?

Gerry Quindlen

Say again?

Jonathan Tseng - Merrill Lynch

It's kind of the question you're getting in H1 2008.

Gerry Quindlen

Yeah, so obviously we’re very pleased with the gross margin performance and a number of the changes that we've made that I referred to as things that we did over the past year to improve profitability are sustainable. Let me give you a couple of examples of things that we did that we’re continuing to work on and will be sustainable going forward.

During the past year, one of the things we looked at was for example are the number of SKUs that we offered and particularly when we worked with our partners to reset the channel levels, one of the things we looked at was we had too many low performing SKUs, SKUs that we’re generating relatively low sell-through volumes. Frankly, we went back and systematically cleaned a lot of those out. They help us in a lot of way. They help us in supply chain cost. They reduced the amount of write-offs that we might have for when retailers choose to discontinue those SKUs. When retailers do choose to discontinue those SKUs there is a lot of promotional activities, all those things hit gross margin. In cleaning a lot of those non-productive SKUs out, we’ve seen a lot of benefits and that they’re sustainable.

Another thing that we did and we did a lot of things this is just a couple of them. We really revamped our sales programs to our partners and we change them to really focus on really driving more sell-through and incenting more linear purchases from us. We’re seeing benefits not only in gross margin. One of the reasons you’re seeing improved performance on DSO and on cash conversion cycle is that we are more linear and that too is largely sustainable.

The last thing I’ll say is we’ll be talking a lot more about our gross margin in our business model in general at the Investor Day in a couple of weeks. We’ll be addressing that question and where we see it going specifically.

Jonathan Tseng - Merrill Lynch

On the demand side could you reconcile what you’re saying in terms of better demand you’ll see the stock of the inventory and getting it better in Q4 you ready for that. The fact that year-over-year growth rates appear to be slowing in EMEA and the U.S. Now obviously that there is a funny part commenting, if I match my focus say 24 months ago the growth trend is still improving, but you reconcile kind of getting ready for a better holiday season and seeing growth rates slowing?

Gerry Quindlen

Yeah, let me just clarify. If you look at the sell through growth rate in Europe it was actually very good. It improved 22% year-on-year and I believe it is up sequentially versus Q1. I could say in Europe and AMR we did see in September demand happened very late and I’ll talk about each of them individually.

In the case of Europe, I was very pleased with the sell through growth we saw, but Europe for the September quarter is always our most back-ended quarter, July and August fairly low months and so we saw it's a September driven quarter and this year the demand materialized even later than normal and as a result frankly we weren’t able to replenish a lot of our customers because some of the demand happened too late. The good news there is in the first two weeks of Q3 we've actually seen our shipments up substantially versus prior year. I like the momentum that we’re carrying into Q3.

In the case of AMR we were down from about 17% in Q1 to about 12%. AMR was similar to Europe in that demand lastly the quarter started up quite strong in terms of demand and then we did see some mid quarter softness and what we saw was very consistent with what I saw a lot of U.S. retailers reporting and a lot of our tech companies reporting which is the back-to-school seemed to happen very late. The good news is that September picked up substantially. We exited the quarter from a demand standpoint with very good demand that we carried into Q3, so I’m cautiously optimistic that will stay there and that will have a good Christmas season, and I like the momentum I see so far in Q3.

Jonathan Tseng - Merrill Lynch

Gerry, just one last one you're carrying quite a lots of Google TV inventory on the books now, is there a risk of visiting double (inaudible) holiday season for various reasons, is there a risk of write-down or risk that all are covered on that front?

Gerry Quindlen

Johnny just actually to answer that question for you. We feel very comfortable with the level of inventory we’ve got related to Google TV. The thing I would also caution everybody with is the products only been shipping for about a week. In the very early days, we feel very good about the launch of the program the launch of the platform overall. We feel that we’ve got the right level of inventory related to that and then obviously as we see sales develop over the course of this quarter and into the fourth quarter, we’ll be able to vary it is needed.

Operator

Your next question will come from the line of Ashish Sinha with Morgan Stanley.

Ashish Sinha - Morgan Stanley

Just a couple of quick ones, I was trying to understand what’s changed in your guidance for the full year since last time around, obviously looking at revenues you’ve added the revenues from Google TV’s. However, looking at profits and looking at the gross margin, if I assume a 1% increase in your gross margin and that 1% increase basically coming from better supply chain management.

I would have thought that all of those gross profits would have been falling to your operating profit lines. Given your $2.3 billion to $2.35 billion of top-line guidance that would imply roughly $23 million of operating profit, but you are increasing your operating profit guidance just by $10 million. Just wanted to understand where 13 odd million of profits growth is it reinvestment in the business or are there some OpEx associated with that gross margin increase. Then secondly on Google TV are you assuming that Google TV there is an ecosystem and drives sales of some other peripherals as well or is it the increased in revenue guidance is just the Revue box. Thank you.

Gerry Quindlen

Let me, thank you for your question Ashish. Let me start with the second question first. The increase in our outlook and our view of Google TV going forward includes the impact of both the Revue box which is the companion box plus the controller that comes with it and peripherals like TV Cam the Mini Controller that will have it launched. Going forward as we mentioned in our remarks we will have a much broader ecosystem of peripherals over time.

This is just the beginning and the real focus initially is on expanding the platform and getting it out there and getting consumers familiar with the potential for Google TV how its different and what they’ll be able to do with it over time which is a good segue into the first part of your question which, so as we increase both our top-line our gross margin and our operating income we’re also implicitly increasing our assumption about what we will invest this year particularly around Google TV.

It’s not limited to Google TV but we are increasing our investments in some variable spending or primarily around Google TV to build the awareness. Because we’re taken a very long-term view of it and it has huge potential and there is an education job that needs to be done to help consumers really understand what it is the potential for it and why it’s so exciting for them.

Operator

Our next question will come from the line of Simon Schafer with Goldman Sachs.

Simon Schafer - Goldman Sachs

It’s Simon Schafer from Goldman. I wanted to ask a follow-up question on your commentary on the sell-in specifically in Europe because it looks that’s actually done in the sell-in basis year-over-year. Is that just Gerry as you said some consumer maybe uncertainty throughout the summer months a normal seasonality and then secondly it looks is in the other regions the sell-in is still outpacing that a sell-through on a year-over-year basis. I know there is an element of restocking and so on which is clearly required, is there any sense as to how you think that’s going to be tracking going forward a comment on both would be useful. Thanks.

Gerry Quindlen

Let me take that it’s probably easy, if I take the regions one by one, I actually start with the America. You look at the Americas and the percentage changes with 19% in sell-in and 12% sell-through growth. In my view and our view in the Americas in Q2 you are starting to see the alignment we’ve been talking about.

There is still seven point gap between them from a percentage standpoint, but as we’ve been saying all along as we start to get to Q2 when the reset particularly in the America channel reset was largely over. You would start to see the growth rates align and well they are not perfectly aligned.

We do think that you will see this kind of a small spread between sell-in and sell-through there could be quarters going forward in the Americas where our sell-through grows slightly faster than sell-in. In our view we’re largely where we said we would be that the two are aligned.

In the case of Europe we did have sell-in growth it grew 6% in local currency terms and the 22% is also of sell-through is also in local currency terms. The gap there was really driven by the lateness of demand materializing as I said in response to Johnny’s question. I’m encouraged by the fact that we’ve seen shipments in the first few weeks of the quarter substantially above last year as we replenished customers given that the sell-through materialized at the end of the quarter.

In the case of Asia Pacific remember the Asia Pacific is the one what we said the channel reset really was over after Q3. If you go back and look at the specifics of Asia Pacific a year ago, I believe sell-through was roughly flat and sell-in was down close to 30%.

If I look at the current quarter the absolute levels of sell-in, sell-through are largely aligned. Once we get past Q3 with Asia Pacific you’ll start to see the growth rates coming together kind of like what you’re seeing with the Americas in the current quarter. That’s how we see it going forward.

Simon Schafer - Goldman Sachs

Then my second question would be I heard you say that you wanted to invest the gross profit from the Google TV related revenue upside in other marketing activity, does that just mean that your marketing spend stays relatively elevated as a percentage of sales? I’m trying to understand as to when you may be able to go back to your sort of historical operating margin model in the team. One element of that would be that somewhat higher marketing spend as you redeploy gross profit from Google TV into that segment?

Gerry Quindlen

Sure. Yeah, and I totally understand the question. The first thing I’ll say is that we’re going to be talking a lot more about what's at the heart of your question in two weeks at the Investor Day and just the business model and how we see it evolving, not just operating margins but obviously the whole thing.

More specifically, the significant portion of any operating expense that additional operating expense is going to Google TV and the focus of that is really on driving awareness and obviously creating demand, but educating consumers on letting different about that product. We’re also though increasing our investments in the second half of the year on Harmony for example and even in China where we’re very, very pleased with the growth we’re seeing and actually outpacing the plan we built. We’re also making some incremental investments there.

In the case of Google TV specifically, it's important just to put in perspective we've invested heavily in R&D for example well ahead the revenue. We’re only now in this current quarter Q3 going to start to see revenues from Google TV. We've been spending on marketing activities in Q1 and Q2 and we can spend heavily on engineering activities since really Q4 of last year with no revenues.

As the platform builds, we'll start to get scaling. We’re going to continue to invest in it, but up till now we had no revenue and only expense. Going forward you’ll start to see the revenue build. We won't have to maintain the same rate of investments, but we will continue to invest to build that awareness at a reasonable rate.

Simon Schafer - Goldman Sachs

How did that translate your ability to go back to the long term model?

Gerry Quindlen

The best answer to give you there is we'll be talking about that in depth in two weeks, at AID.

Operator

Our next question will come from the line of John Bright with Avondale Partners.

John Bright - Avondale Partners

Couple of questions for Erik and then Gerry a question for you. First Erik, on the gross margin, it looks like you're becoming more optimistic on the gross margin possibly changing the long term range associated with it, can you talk about LifeSize gross margins, how are they trending and then also if you would talk about your expectations for Google TV’s gross margins?

Erik Bardman

As it relates to LifeSize there is a couple of things we’re not specifically about LifeSize individual gross margins. As we talked about before and since we did the acquisition there is a structurally higher gross margin in that industry and you can see gross margins of anywhere from 55% to 70% depending on the product and depending on the size of the player in the industry and LifeSize is well within that range.

We'll continue to be accretive. They're a small percentage of our sales today but growing very rapidly. As you heard Gerry say in his remarks earlier, we’re very happy with where LifeSize is. They will continue to be accretive going forward and especially as they grow more quickly.

To your question about what do we anticipate in terms of Google TV gross margins, there is really two pieces to that I would say. When you think about our initial companion box, Logitech Revue, we do anticipate that that will have a structurally lower gross margin than the long term range that we've talked about before of 32% to 34%. We do anticipate that.

However, as Gerry mentioned we're really focused on building out the peripherals for the entire ecosystem, with the TV Cam, with the enhanced controllers that we've got available today, as well as when we started to see things to develop in terms of applications and other things for the platform, we see that there is a very rich opportunity for peripherals and all of those peripherals we anticipate will have a gross margin very similar maybe even in some cases even higher than the gross margin we've got today for our PC peripheral business. It's going to be hard when you think about gross margin as it relates to Google TV.

Gerry Quindlen

John, just an add-on to that, I would also just say that to me adding on the LifeSize piece plus the moving parts with Google TV doesn’t really substantially change what we've been doing for years. If you think about it we've been talking to you for years about the fact that mice and Webcams have higher gross margins than audio and OEM. We manage the portfolio of products and categories and we’re comfortable doing that and we've done it effectively for many, many years.

Now we have more moving parts. We have LifeSize which is very accretive gross margin. We have Revue box which initially – which certainly we'll have lower margins and then the peripherals we expected to have a range of gross margins, some could be higher than our 32, 34, some could be lower, and in general they probably can be consistent with PC peripherals that we've been managing for years. We've added to that portfolio of gross margins that we've been managing pretty effectively for a number of years.

John Bright - Avondale Partners

Erik, on the inventory side of the discussion, could you characterize the inventory or is it to fair to characterize the increase in inventories primarily Google TV related but beyond that which segment of the inventory are you probably most optimistic about heading into this holiday season?

Erik Bardman

Just a little bit to talk about it when you look at the inventory build and also to give you a sense of it in terms of how we look at it sequentially, we do always see an increase in inventory as we go from the end of Q1 to the end of Q2 because you know we’re building for our highest value quarter of the year in Q3.

As Gerry mentioned and I talked about in our prepared remarks as well is we wanted to put a little bit of additional buffer. It’s not in any one specific place; it’s more related to making sure that we’re in a good position to serve our customers if we do see an uptick in consumer demand. Let me be really clear, we haven’t baked into our guidance and what we told you today, a large uptick in consumer demand, we just want to be in a really good service position, if that would have happened.

The other thing I would say too, when we look at levels of inventory, there is really two metrics that we’re focused on internally. First is the age of the inventory, okay, and we feel our inventory is very healthy today in terms of the aging and part of the reason for that is we’re just coming off of our product refresh cycle, which happens over the summer months and into the early fall. We’ve got new products in our warehouses ready to go for our customers. We feel very well positioned. If that additional higher demand that we’re preparing for could happen does not materialize, we feel well positioned that because of the freshness of the inventory we will handle that as we go into the end of Q3 and into Q4.

John Bright - Avondale Partners

Last question for you Erik, you mentioned in your prepared remarks, that you didn’t repurchase any shares in the last quarter. Give us your philosophy on when you want to buyback shares.

Erik Bardman

John it’s very consistent with what you’ve heard us say in the past and we’ll continue to do going forward. Our first priority in terms of where we use our working capital is going to be investing to grow the business. It’s actually very helpful to think about it. If you think about a year ago versus today, so a year ago, as we’re dealing with the downturn as a lot of other businesses were with the contraction environment versus where we are today with sales over the first half growing 29%, we’re in an investment mode for the business.

We’re growing the top-line. We’re going to see growth in receivables. We talked about the investments we’re making in inventory and Google TV, and other places, that’s going to continue to be the first priority in terms of where we put working capital. Beyond that what we’re going to be focused on as we've done in the past is that we'll be opportunistically making acquisitions as well as opportunistically buying back shares, so, no change in philosophy in terms of how we think about that.

John Bright - Avondale Partners

Finally, Gerry for you, I've heard from the PC makers that they're focusing in 2011 calendar on all-in-one PC, desktop PCs, what's your thought about an all-in-one desktop PC that might come with the higher end mouse and keyboard and its potential impact on after market peripheral sales?

Gerry Quindlen

We have in discussions John as we do every year and they're talking to us about a lot of things, not just all-in-one PCs but I can't give any specifics, but we’re certainly looking at that opportunity a lot of that we won't say, and we'll be talking about and we'll discuss our roadmap in future calls.

Operator

Our next question will come from the line of Andy Hargreaves with Pacific Crest.

Andy Hargreaves - Pacific Crest

Can you comment at all about the tax rate of cameras and diNovo Mini on any of the Google TV pre-orders or early orders?

Gerry Quindlen

No, I can't comment on that Andy. I can say that I've been very pleased with the – some of the commentary people who tried the TV Cam which we provided along with the Revue box and we've gotten terrific feedback on it. I will say that that's a new application for consumers. Consumers obviously understand that you can do video calling from your PC that's been around for a decade.

Creating that new paradigm with consumers that hey, you can now talk to any PC and then the other Google TV that has TV Cam is in new paradigm and then we have to educate them on that and that will take time. I don't expect that we’re going to see any instantaneous surge in tax rate with the build that. It's part of the reason we've talked about investing in marketing expenses.

The quality is pretty spectacular and as consumers become aware of that and the convenience, the comfort of sitting in your living room doing a call and you get a much wider picture through the TV Cam we provide and its HD quality, we think consumers are going to respond to it. Time will talk.

Andy Hargreaves - Pacific Crest

Just to clarify absent the change in guidance from Google TV, the revenue guidance would have been unchanged, is that correct?

Gerry Quindlen

Majority of it is Google TV. We'll just leave it at that.

Andy Hargreaves - Pacific Crest

Another question on the gross margin, can you be more specific at all on a sequential basis, we don't see there was a big change there but the mix at least from a percentage standpoint, the product mix didn’t change a whole lot, can you comment on what the changes were quarter to quarter?

Erik Bardman

Yeah, on a sequential basis the primary driver was the stronger euro. As you heard us talk about it's been consistent. As we've got multiple drivers there, the thing that we felt very good about in the ensuing quarters prior to this and when you look at on the year-over-year basis has been the favorable product mix we’d be able to drive when we talk a little bit and Gerry even gave you some examples as to some of the operational efficiencies as well as the accretion that we get from LifeSize as they continued to grow.

Gerry Quindlen

Andy just to put in perspective I know you asked sequential and Erik answered on a year-over-year basis, the negative impact from euro was largely offset by the accretive impact of LifeSize so those two were roughly comparable and netted each other out. The real improvement year-on-year was really driven by operational improvements mix and really that was the core business.

Andy Hargreaves - Pacific Crest

Lastly just you commented on the – some of the changes to the marketing programs, just from an accounting standpoint, do any of those changes result in dollar shifting from contra revenue account into operating expense?

Erik Bardman

No.

Operator

Your next question will come from the line of Yair Reiner with Oppenheimer & Company.

Yair Reiner - Oppenheimer & Company

First, during your Investor Day last year you talked about couple of strategic kind of focuses for you, one of them was China, we see making good progress there and TV. You also mentioned something around small touch devices and ways of making those more, more friendly and interactive.

As far as I know we've yet to see anything any kind of significant peripheral activity around the iPad or the iPhone or Android devices. Is that something we could still look forward to this year or if not when and what might be we looking forward to?

Gerry Quindlen

The first thing, just around specifically, let me talk about the iPad specifically and then tablets more broadly. It is important to keep in mind that the iPad launched during the first quarter of our fiscal year so at that point our product roadmap had been finalized for many months.

Now, we currently have as I mentioned in my remarks, we currently have a great wireless speaker could of Z515, which is doing very well and which works with the iPad, the iPhone and we have Bluetooth keyboard that works with the iPad and the iPhone, excuse me the iPad.

We have a number of peripherals on our roadmap for fiscal ‘12, not only for the iPad, but for the emerging tablet category. The thing to keep in mind about tablet category is, today it’s primarily the iPad. There has been a number of announcements, Samsung and the Galaxy, there are a number of announcements of products coming, and they use different operating systems, some will have USB, some won't, so we’re working with all of those folks.

We’ve got a lot of products on the roadmap and I know I keep saying this, but we will be talking specifically about the opportunity we see in tablets broadly not just the iPad and how we plan to address that, we'll have an extensive session on that at the Investor Day in New York in two weeks.

Yair Reiner - Oppenheimer & Company

Erik, I understood the comments you made about the freshness of the inventory, is there nevertheless inventory days level that you should try to hit exiting this quarter and at what level should we be about a bit concerned? Thank you.

Erik Bardman

The best way to think about it the way we approach this is, this is a very appropriate investment on our part in terms of that and talked about how we are working with our customers be prepared for if there was an uptick in demand. We also feel very comfortable that we have good operational visibility within our business. If we were to see two different scenarios, one scenario being that demand is really picking up and we’re serving that because we have our own factory there are some things we can do within a quarter that give us some flexibility.

On the flip side, if some of that were not materialized, we've got some plans and things that we can do to make sure that we end the quarter at the right place, the appropriate level. Like I said because the inventory is still fresh, we feel very comfortable that that sell-through can then pull into Q4 if that's necessary.

Gerry Quindlen

Just to reemphasize the last point that Erik made the reason he talked about the aging statistics which is one of the key things we look at and it's very, very fresh and help the inventory is that gives us a comfort level that if that upside demand that we’re going to put a buffer aside for it doesn’t materialize, we’re very confident that we'll be able to sell in Q4 and we won't be discounting it taking gross margin hits because it's aged. That's why we’re very comfortable with where we are.

Operator

Our final question will come from the line of Nicolas von Stackelberg with Macquarie.

Nicolas von Stackelberg - Macquarie

Couple of housekeeping, one, first of all, could you quantify the impact of FX changes on your gross margin and specifically I notice that depreciation was down quarter-over-quarter. Was that driven by FX changes that would be my first question?

Erik Bardman

Yeah so, to your first question, we don’t disclose specifically FX impacts to gross margin, but as you may have heard us talk about a little bit previously is on a sequential basis it was the largest driver, was the stronger euro. On a year-over-year basis, we were hurt a little bit by FX, but that was primarily offset by accretion from LifeSize and so, the main gains that we saw year-over-year which were significant was everything related to favorable product mix as well as the operational efficiencies. That leads us to the point where with our current full year guidance for gross margin we anticipate to be about 36%, which would be a record for a full year basis for the company.

Nicolas von Stackelberg - Macquarie

My next question would be on net working capital, I mean you clearly invested to get ready for a strong Christmas sales period, how do you feel about cash flow sequentially, specifically from net working capital changes?

Gerry Quindlen

Before Erik goes just to be clear about the inventory, we invested to give ourselves flexibility if demand picks up substantially, just want to be clear on that. We just thought it was an investment worth taking, because nobody knows what consumers are going to do this holiday shopping season. If you look at what we saw this quarter, the demand was solid, but it occurred very, very late. We’re cautiously optimistic we put ourselves in a position to serve our customers with additional product if demand is stronger than kind of what we’re thinking right now. Erik you can take.

Erik Bardman

Yes, to your question about net working capital little bit sequentially and how we think about it is, when you look at our business traditionally is, Q1 and Q2 are typically low cash flow generation or even cash – net cash investment quarters with our biggest net cash generating quarters have been this current quarter Q3 and then Q4 because of the timing of the volume.

In an overall basis, that's no different. We feel comfortable that we’re positioned well and as Gerry talked about we had a number of key investments we wanted to make sure from a timing perspective, Google TV, some of the other things that we’re doing with Harmony and obviously as we continue to invest in LifeSize are all things that are big priorities for us, but overall it fits well in terms of how we produce cash in the past and what we anticipate Q3 be in a solid cash flow production quarter.

Nicolas von Stackelberg - Macquarie

Just in two lines, for you what are the key differentiating factors of Google TV versus competing offers?

Gerry Quindlen

There is a number of offerings in the market has been there for a while. I would say that they're primarily streaming devices, some of them do more than that, but they're primarily streaming devices that allow you to stream, movie, user TV shows to your big screen TV. Google TV is really we continue to say is primarily a platform. It certainly allows you to stream, but it does a whole lot more than that. It really enables the full web and it does so very, very seamlessly. It enables brand new activities and experiences like video calling from a living room. None of these other platforms go nearly that far.

Finally, and this is one of the key things is that Google TV is an open platform and there is an entire development community out there that will be enriching the platform. We'll talk about Version 1.0 here. They will be enriching the platform with tailored applications optimized for the biggest screen in your house.

You may have seen from yesterday that Google seeded 10,000 Google TV devices with development community and that's too unleashed their creative juices and get them working on all the great apps that will enrich the platform. It really is a platform as opposed to a number of devices that are offered today which stream and do it very well by the way, but they're more narrow and limited in what they do. It's really a much broader platform and that's why we’re so excited about it.

Nicolas von Stackelberg - Macquarie

Lastly, what happened in audio, I mean there was not a great performance this year and what are you going to do about it?

Gerry Quindlen

In audio very briefly it was primarily some softness in speakers and it was concentrated. It was largely in Europe. The number of audios and many things the way we classify it, it includes our line of Ultimate Ears headphones they're doing great, it includes PC headsets or voice access as we call doing great. It includes our streaming media devices, also doing very, very well. Speakers were a bit soft and it was primarily in Europe nothing that concerns us.

Operator

Ladies and gentlemen, this concludes our conference call for today. You may all now disconnect. Good day everyone.

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