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Logitech International S.A. (NASDAQ:LOGI)

Business Assessment for Fiscal 2012 Call

September 22, 2011, 09:00 am ET

Executives

Joe Greenhalgh – Vice President, Investor Relations

Guerrino De Luca – Chairman, Acting President & Chief Executive Officer

Erik K. Bardman – Senior Vice President, Finance & Chief Financial Officer

Analysts

Jonathan Tseng – Merrill Lynch

Christoph Gretler – Credit Suisse

Simon Schafer – Goldman Sachs

Stefan Gachter – Helvea

Andy Hargreaves – Pacific Crest Securities

Ashish Sinha – Morgan Stanley

Operator

Good day and welcome to the Logitech Fiscal Year ‘12 Business Assessment Conference Call. At this time, all participants are in a listen-only mode. We will be conducting a question-and-answer session, 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 like to introduce your host for today’s call, Mr. Joe Greenhalgh, Vice President of Investor Relations and Corporate Treasurer of Logitech. Please proceed.

Joe Greenhalgh

Welcome to the Logitech conference call to discuss the company’s Business Assessment for fiscal 2012 ending March 31, 2012. The press release and a live webcast of this call 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, 2011, and subsequent filings which are available online on the SEC EDGAR database, and in the final paragraph of the press release reporting the updated financial outlook for fiscal 2012 issued by Logitech and available at logitech.com.

The 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. 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.

Joining us today are Guerrino De Luca, acting 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 Guerrino.

Guerrino De Luca

Thank you, Joe, and thanks to all of you for joining us in such short notice. It is been less than 60 days since I resumed my CEO position on an acting basis. This has been a busy time with a number of urgent priorities. One of my top priorities was conducting an in-depth assessment of the state of our business for fiscal 2012 and beyond including a number of face-to-face discussions across all levels of our products and sales organization. I just recently completed this assessment and I felt it was important to share our findings with you today, including first and foremost our revised outlook for fiscal ‘12.

Given the current state of both the economy and our business in mature Western markets, our previous estimates were overly optimistic. We now believe that for fiscal ‘12 we can deliver revenue of roughly $2.4 billion. Operating income of approximately $90 million, which includes our previously announced $45 million operating loss in Q1, and a gross margin of around 33%, which includes the 26.1% gross margin we posted in Q1. We expect our gross margin in both Q3 and Q4 will be well above the full year average.

This new outlook is disappointing to me, particularly in light of the disappointment that preceded it. It’s important to understand that the foundation of our new outlook is an in-depth assessment of the relative strength of our product portfolio in the current economic environment. I drove this assessment, and I have personally confirmed that we have operational ownership of our revised outlook.

Of course our assessments take place against the reality of deteriorating economic conditions in mature Western markets. And there is no question that the combination of weak macro economic environments in fragile consumer confidence is having a negative impact on our two largest sales region, Europe and the Americas.

The situation in Europe is compounded by the fact that as discussed in our last earnings call, our channel partners inventory levels are higher than needed in the current environment and we are still in the process of implementing the necessary changes to pricing – to our channel pricing programs, changes that we expect to have completed by the end of the current fiscal year.

In the Americas the situation is somewhat different. Over the last several weeks, we have seen many of our channel partners express growing discomfort with the uncertain economic situation. As a result a number of them have chosen to reduce the amount of inventory they will carry, as we enter the holiday selling season, which directly impacts our sell-in to the channel.

It will be easy to blame our performance in mature Western markets solely on the economy, but that would not provide a complete picture. The fact is despite tepid economic conditions consumers are still happy to spend their money on great products. Having thoroughly reviewed our retail product portfolio there is no question in my mind that we do not have as many great products as we should.

Logitech success is always been driven by great products and there simply aren't enough of them in the current portfolio. This problem exists in varying degrees across all of our retail product categories with some such as keyboard in better shape than others. Rather than addressing each of them separately, I am going to focus on the category where I believe we have both the weakest offering in our portfolio and the most upside and that is audio and particularly digital music.

Digital music is a large and growing market and is increasingly driven by the mobile lifestyle. We have – until now largely missed this trend, focusing on PC speakers and sound quality at the expense of mobility, convenience, and coolness.

The good news is that this is very early days in the digital music category, and we have existing assets, such as our Ultimate DS brand of earphones, that we will leverage as a platform for growth.

The market is highly fragmented, presenting us with significant opportunities to displace smaller niche players as we focus our product growth development on wireless, wire-bolt, and the cloud. Given the nature of our product development cycle, there is no overnight fix for digital music or for any of our other product categories. We do have a number of great products coming this year, some recently announced, but we do not expect to realize the full impact of the product development initiatives we have put in place until fiscal 2013.

In the course of my review, I confirmed a number of positive findings as well. China continues to be a stand-out performer in our retail business. We have strong momentum that we expect will continue through the remainder of the year. In fact we now expect that China will be our third largest country as we exit fiscal ‘12, and we’re building a solid foundation to drive growth in the years to come. Beyond China, we’re positioning ourselves to capitalize on the long-term growth opportunities in other emerging markets such as India, Eastern Europe, and Latin America.

We have strengthened our tablet peripherals lineup in the last several weeks. We plan to continue doing so as we move through the year, focusing on peripherals designed to enhance the way people create, consume and communicate using the iPad. Our outlook for our LifeSize business remains bullish. We expect to see sequential sales growth in each of the remaining quarters of fiscal ‘12 and to continue to outpace the overall enterprise video-conferencing market growth.

We are very excited about the prospects for our B2B offerings driven by our Logitech For Business division. We believe there is a huge opportunity for Logitech with enterprise sales around the PC particularly riding the growing momentum around unified communication as a trigger for building new distribution relationships and evolving our product portfolio.

Let me wrap up by saying that, while I’m disappointed that our revised fiscal ‘12 outlook is not higher. We now have an in-depth understanding of what needs to be fixed. Our strategy remains unchanged. I am confident that the initiative we have put in place will result in reinvigorated product offerings and improved execution in our sales and marketing organization as we progressed through fiscal ‘12 into fiscal ‘13.

I look forward to providing you with progress update in the months to come. And with that Erik and I are now available to take your questions. Please follow the instructions of the operator.

Question-and-Answer Session

Operator

Thank you. (Operator Instruction) Your first question comes from the line of Jonathan Tseng from Merrill Lynch. Please proceed.

Jonathan Tseng – Merrill Lynch

Hey Guerrino and Erik. Just two questions. What in terms of the cup-in full year guidance there seems to be a fairly large cup in the EBIT guidance proportionate to revenue [cups], I just want to get a feeling for why that was so big was there kind of higher margin areas, any particular areas where you thought you should pull back expectations? I think the second question kind of linked to that, just in terms of messages you use to kind of general slowness of demand in the U.S. and Europe was there any impact from tablets or your lack of products for that market for that periphery. And you’re low expectancy, so, you missed some dollars there? Thanks very much.

Guerrino De Luca

Thank you. Why is the decline, or the reduction in operating income guidance bigger or disproportionate, with the reduction of the top-line?

Well, the first thing to say is that the, our guidance for operating income in my prior call was clearly overly optimistic. And that is the simplest answer I can give you. If the correction would have only been driven by the top line our correction on the bottom line would have been proportional to that. And it isn’t.

And the reason why this was overly optimistic, I believe, has less to do with the margin estimates, and more to do with the solidity of certain improvements, in Europe particularly, that has significant margin impact, and therefore a significant bottom line impact.

But in general I mean the easiest thing to answer this question is that we were overly optimistic in July. On the question of product, I told you this is, yes the economy is a big factor. I believe that they said in the prepared remarks, even in difficult economic times, people buy great products. The Apple products are an example of that, they are certainly not cheap.

However, there is a proportionality between the toughness of the market, and the quality of the product line that can face it. And what is happening to us is that while we have good products, we don’t have enough great dynamite products to stimulate demand in the difficult environment. This is much less to do with tablets or any category it has to do with the overall portfolio in established and new categories.

On the tablets specifically, we do have actually a pretty solid portfolio now, and we plan to increase it. So there is no relationship in my mind between our strength around the tablet and the revised guidance.

Jonathan Tseng – Merrill Lynch

Just a quick follow up. Do you kind of feel your portfolio at the moment is pretty too high end. I see things like solar keyboard, very interesting device, very high-end, and certainly, I feel, is neglected at mass market.

Guerrino De Luca

I’m glad you asked this question.

Jonathan Tseng – Merrill Lynch

Yeah.

Guerrino De Luca

I see this almost the opposite way. I think that we do not have enough attractive high-end products. And we do have – we have missed in certain categories a clear sell-up proposition. I don’t want to become too specific here because there are products that are unannounced here and but to give you a sense, it is definitely not our lack of presence in the mass and volume markets. We are incredibly strong in those markets. And proof being our strength in China, which is made up of those kinds of products. But we have brought those products across the Western market.

It is the lack of strong attractiveness of certain high-end products and the lack of a strong sell-up proposition across the product portfolio that hits us. I do not buy the notion that consumers in a difficult environment buy for $20 and don’t buy for $40. They buy nothing or they buy the most attractive product they can get for the money. And that is where we have to do better.

Jonathan Tseng – Merrill Lynch

Thanks very much.

Operator

Your next question comes from the line of Chris Gretler from Credit Suisse. Please proceed.

Christoph Gretler – Credit Suisse

Yes. Hi, good afternoon or good morning.

Guerrino De Luca

Hi, Gret.

Christoph Gretler – Credit Suisse

Hi, Guerrino. I have two questions. The first is may be a bit unfair at this point of time. But I was just wondering if you could evaluate in order of achievability of your midterm targets in light of the change in your business condition? And also in order the product mix comment you made that you actually now have come to the conclusion or you no need to come to the conclusion or not about whether there are any structural changes noted to the business model? That would be the first question.

And the second is, I remember you were basically talking about reallocating some resources internally. Are you thinking in light of what and all is going on, you need to accelerate that in some form or the other?

Guerrino De Luca

Okay, the first question. I don’t think this is unfair, I think this is a very fair set fair set of questions. So let me answer, try to answer the three of them; about achievability of our goals. Those of you that know me know that I don’t like to give goals that I can’t make. I think we have disappointed too many times in the recent past for me to venture into some creative, aggressive targeting for the company. I think we will make these goals. And I think this will be the last bad news for a long time for Logitech.

And the reason I believe that is that I now have a much more in-depth understanding of where we stand product-wise and commercially, commercial network-wise. And I did not have that full understanding as I took over two months ago.

On the changes of the business model, it is absolutely clear to me that the company must be given the chance to actually prove that under the tough conditions we’re in, but under a stronger product portfolio and go-to-market strategy, we can resume the growth we are used to. In order to do that, there will not be dramatic cutting, restructuring, it is not in the plans. We will watch every penny, this has never been a company that spends a lot of money, and we will be extremely careful in where we put our money. And that’s where the reallocation matters.

We are going to accelerate putting the money into the best opportunities. And don’t get me wrong, the best opportunities are not only what we frequently talk about in China or LifeSize. Some of the best opportunities are within the portfolio that you are familiar with. When I mentioned before the sell-up proposition and better high-end, this is a tremendous opportunity for us. When I mentioned digital music, this is a tremendous opportunity for us. And this is where, increasingly, we’ll put our R&D resources as well as our commercial resources. So I think this answers both your reallocation question and the changes in business model. I’m not sure that I understand fully what you mean by changes in the business model. But this is going to continue to be a product company that will win if its portfolio is better than the wins that go against it from an economy point of view.

Christoph Gretler – Credit Suisse

Okay, pretty clear. Thanks.

Operator

Your next question comes from the line of Simon Schafer from Goldman Sachs. Please proceed.

Simon Schafer – Goldman Sachs

Yes, thanks so much. Actually I was wondering on the portfolio, sort of a follow-up question, what percentage of the portfolio you perhaps thought, if any, had some more structural challenges, and that perhaps require some sort of more drastic overhaul and how long that may take to fix? I understand the issue perhaps of what you mean of missing out on the expensive sell-up propositions. But I guess if any, is there a percentage of the portfolio that you perhaps think needs a much more drastic overhaul that may take some time?

Guerrino De Luca

Well, that’s a tricky question, Simon, because every children is built differently, every product line has its different situation in terms of market potential, natural market potential as well as structural issues within the portfolio. So unless we could spend three days about all this, it is very difficult for me to answer in detail. I would say that the core categories, the keyboard is probably the category in the best shape. Somebody mentioned an expensive solar keyboard as a potential issue. In fact, it is one of the best-selling products we have. And it proves again the case that relatively high price points, we’re talking $69 or $69 here are not the issue in a difficult environment. It is attractive product, attractive enough products that have an issue.

The mouse portfolio needs a better – more works on the sell-up proposition. We’ve been very aggressive in the entry level and we won. Now, we have not given the consumers that shop the shelf enough good reason to give us $40 instead of $20. I’m being overly simplistic. By providing an up-sell proposition that is attractive enough at that price point.

On speakers and WebCams, the situation is slightly different. While I believe that mouse and keyboards in Western mature markets have still growth potential, it is more difficult to grow in PC speakers and Webcams. And this is where we need to structure the product line for margins and profitability and we need to capture the opportunities that do exist. This is both a very large market, it’s not that they go away overnight. They do exist but our product line needs to be better aligned against that. I will leave this overview of our product portfolio at that. I mentioned our four largest product lines. There is another angle here that maybe answers your question.

If people are concerned about the fate of the PC and you know I’ve heard and read even this morning the reason why Logitech is lowering its outlook is the PC is dead. What a naive and simplistic statement to make. The PC is actually up alive and running in two of the three largest markets in the world, the business market worldwide and the emerging markets worldwide. So this is and we are taking advantage of emerging.

And as I mentioned, we are going to increasingly take advantage of the installed base of PCs in business markets, which is largely unpenetrated by us and we are going to do much better there. So the real issue of the PC, if you want to put it, is in the develop market and the consumer market in the develop markets. It’s – we make maybe 40% to 45% of our revenue there, which means that we make more than 55% of revenue elsewhere and that is something that’s probably missed occasionally. So this is the revenue that we are – we want to nurture and this is where the comments on the product portfolios do apply. In this particular Western develop markets for PC peripherals, we have to do better with sell-up and attractive products. Some categories will grow and some will not.

Simon Schafer – Goldman Sachs

That’s right, (Inaudible).

Guerrino De Luca

Okay. Thank you.

Simon Schafer – Goldman Sachs

Thank you. And my second question would be actually just on this issue of sell-up proposition which, when you go back in time, that’s obviously your real profit pool and your excess margin that you’ve been able to earn in the past very successfully. Is the scope for sell-up much lower in China whereby that initial growth comes at an operating margin discount? And I guess the – maybe I should clarify my question that I understand that the underlying product cap here of course is necessarily lower margin.

But in the initial penetration phase, perhaps there is less of a sell-up proposition that exists in such a nascent market? So I just wonder how you feel about profitability into that region and in the more sort of intermediate term i.e., in the next couple of years? Thanks.

Guerrino De Luca

Well, I would say that this is another concern that has been raised in the past, Simon and probably by you and others. All the figures I have show me that our contribution margin at the level of the regional operations in China are substantially strong. And there is noting to be ashamed with. And I’m not discussing this number. This is something we discussed but it’s certainly not a source of concern at all and we are indeed not particularly focusing on the sell-up proposition yet imagine when we do. Because we will. China is changing and approaching that maturity very fast.

And in fact, amazingly enough, we were discussing just yesterday with the team responsible for China, how we can begin to bring more sell-up opportunities in China. So I said many times it is still true today that entry level products do not have necessarily a lower percentage gross margin than midrange or high-end. However, the reason the sell-up is important, is that if I have to sell one product to one person, I definitely prefer that person to give me $40 versus $20. And that is where the up-sell proposition matters. Even you closed $40 come at a slightly lower gross margin percent, it will certainly bring much more gross profit for the company.

Simon Schafer – Goldman Sachs

Understood. Thanks so much.

Guerrino De Luca

Thank you.

Simon Schafer – Goldman Sachs

Thank you.

Operator

Your next question comes from the line of Stefan Gachter from Helvea. Please proceed.

Stefan Gachter – Helvea

Yes. Hi, thanks for thanking my question. I just wondering if you could give us an update on your share buyback program? And also I mean during the last conference call, Eric said you guys would still like to stick to 20% of operating cash and I believe that 20% is kind of a high number and somehow also limits your capability of buying back more versus [own] shares. Yes, that would be my question.

Guerrino De Luca

Sure, Stefan. Happy to answer your question. A couple of things that I’d say. On the share buyback program, just you know very specifically is, we always repurchase shares when our window is open, our window is currently closed, it’s always closed; when it is closed for Logitech insiders, so it’s closed now. It will open again for us after we report our Q2 earnings on October 27.

And as we’ve said very consistently, the way we look at share buyback is consistent with the way we look at our use of cash overall. First and foremost, it’s about how we fund the working capital in the business. And then we’re going to be opportunistic. Whether it be share buyback or acquisitions that things that help drive growth for the Company in acquisition side and share buyback, when it’s a combination of factors, particularly to your question about, what’s the right level of cash for the company. It’s something we’re always evaluating. We’ve provided that long-term range of trialing 12 month sales you mentioned 15% to 20% as a guideline. But at any one point in time we’re going to evaluate what we see forward, what are the needs for the business, those types of things.

The last thing, I would share with you as well, at our recent AGM, we did receive approval from our shareholders to go above 10% ownership of our shares. We had entered our last round of buyback it is just under 10%. And we also announced our intention over time, to open up a second trading line, which would allow us to repurchase shares that with future shareholder approval, we would be able to cancel, which would be very beneficial for our shareholders from that perspective. So, that’s just to give you a little bit of update and answer your question.

Stefan Gachter – Helvea

But you can not add [more] color of when you would go for that second line? I mean that’s the question that many investors of course now have?

Guerrino De Luca

I’m not going to talk in the operational details right now, that’s our intention and we’ll update you as we make progress on that.

Erik K. Bardman

Let me comment on this, because I understand the nature of the question. I’m convinced that share buyback and with intention of canceling is a very beneficial way to return the money to the shareholders, as long as the money is not needed to create a stronger company moving forward. And there is always going to be this kind of conflict and tension you have to manage. If you’re asking whether we are announcing here today that starting the 27th of October we’re going to do that, we’re not in a position to do it. We are not commenting on that point, you’ll have to wait and see.

Stefan Gachter – Helvea

Okay. Thanks a lot.

Operator

Your next question comes from the line of Andy Hargreaves from Pacific Crest. Please proceed.

Andy Hargreaves – Pacific Crest Securities

Hi, thanks. First, Guerrino, you seem to be acting not very interim right now and a lot more long-term. Is that the way you’re thinking? And has there been any change to that from the board level?

Guerrino De Luca

I wonder, what would I sound like if I acted very interim right. I understand your question. We want the Board and I are looking actively to find the right leadership for Logitech. This doesn’t subtract 1-inch from my commitment to the company for as long as it takes. It may take short, medium and long period of time. I am here. I intend to stay here for the rest of my professional of life, as I said many times, not necessarily as the CEO, but hopefully as the Chairman, if the Board or shareholders still want to hear about me. But now I’m acting as the CEO. And I would even takeaway that from board interim of acting, because I am acting as I think the good CEO would act in the interest of the company in the short, medium and long-term. That’s all that matters to me. I don’t have a deadline; we will see.

Andy Hargreaves – Pacific Crest Securities

Okay. And I apologize if I miss this, but is there any change to the LifeSize outlook in embedded in the new guidance?

Guerrino De Luca

No, there is no change. The LifeSize outlook, in fact in my prepared remark, I lifted LifeSize as one of things that doing well in the company. And I said that we expect that to continue to grow, and outgrow the videoconferencing market, which is growing, which is good news and I expect to see solid growth year-over-year and I – we’ve said that we expect to see sequential growth in each of the coming quarter.

Andy Hargreaves – Pacific Crest Securities

Okay. Thank you.

Operator

And your last question comes from the line of Ashish Sinha from Morgan Stanley.

Ashish Sinha – Morgan Stanley

Hi, just a very quick question, if I may. How should we be thinking about cash conversion and the working capital I mean the background is that your balance sheet still remains I believe quite strong despite the $73 million buyback in August? So in your revised guidance, are you assuming using your cash buys to support the channel inventory or I mean somehow work with your channel partners?

Guerrino De Luca

Well the way – I’m not sure I fully understand it. So I leave it up to Erik who is certainly much more familiar with the detail of this. But let me comment on the channel. We do not support our channel partner from that perspective financially. We do not. Our European channel is higher than we would like it to see it, in particular because the market conditions are horrible and our product line isn’t strong enough, as I said. So instead of taking six months to just get to the level in which we believe it’s running at a normal pace, it will take may be another three months and that’s embedded in the revised outlook or targets.

But there is no particular engagement from a balance sheet perspective in that sort of realignment with the channel. Same is true for the U.S. In the case of the U.S., our channel is pretty healthy. Our channel inventory is healthy, what is not healthy is the extremely high concern of our customers about their own total inventory, which includes higher ticket item that don’t move fast enough. And of course when it comes to their balance sheet and therefore their available cash to buy, they are increasingly being cautious. So, but there is no engagement at the balance sheet level to mitigate and or so of these issues. Right.

Erik K. Bardman

Yeah. And Ashish I think to add to the very first part of your question, as you said, our cash conversion cycle is very solid, cash balance is strong. We have no debt on the balance sheet. So, from that perspective, the flexibility we have in terms of how our balance sheet can work for us help us focus on the right growth opportunities is there. No changes. And, we’ll obviously when we get to the end of Q2, we’ll update you specifically about where we’re at. But from a cash and balance sheet perspective, we’ve got the flexibility needed to make the decisions and invest where we need to.

Ashish Sinha – Morgan Stanley

Great. Thank you.

Guerrino De Luca

Okay. I understand this was the final call – the final question. I thank you all for being here at such a short notice. My commitment is that you will not have this kind of calls for a long time in the future. Thank you very much.

Operator

That concludes our conference call for today. You may now disconnect. Thank you. Have a great day.

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