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Executives

Joe Greenhalgh - Investor Relations

Mark J. Hawkins - Chief Financial Officer, Senior Vice President, Finance and Information Systems

Guerrino De Luca - President, Chief Executive Officer and Director

Gerald P. Quindlen - Senior Vice President, Worldwide Sales and Marketing

Analysts

Simon Schaeffer - Goldman Sachs

Ted Chung - Bear Stearns

Matthew Yates - Merrill Lynch

Manuel J. Recarey - Kaufman Brothers

John Bright - Avondale Partners

Tavis McCourt - Morgan Keegan

Michael Foeth - Vontobel

Andrew Neff - Bear Stearns

Andy Hargreaves - Pacific Crest

Ross Argolis - Sellium Investment Management

Logitech International (LOGI) F2Q08 Earnings Call October 18, 2007 8:00 AM ET

Operator

Good morning. My name is Vonda and I will be your conference operator today. At this time, I would like to welcome everyone to the Logitech second quarter fiscal 2008 earnings conference call. (Operator Instructions) I would now like to turn the call over to Mr. Joe Greenhalgh of Investor Relations. Please go ahead, sir.

Joe Greenhalgh

Thank you, Vonda. I would like to welcome you to the Logitech conference call to discuss the company’s results for the quarter ended September 30, 2007, the second quarter of Logitech's fiscal year 2008. The press release, a live webcast of this call and accompanying presentation slides area available online at 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 25, 2007, and subsequent filings 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 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 that 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 Guerrino De Luca, Logitech's President and Chief Executive Officer; Mark Hawkins, Senior Vice President of Finance and Information Technology and Chief Financial Officer; and Gerry Quindlen, Senior Vice President, Worldwide Sales and Marketing.

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

Mark J. Hawkins

Thanks, Joe. Let me start with an overview of our record-breaking Q2 operating performance. Our sales grew by 19%, reaching an all-time high for Q2, with solid double-digit growth achieved across all retail geographies and exceptionally strong growth in OEM.

Our gross margins increased by 180 basis points compared to the prior year and equaled our all-time high. Our operating income grew 54%, setting a new record for Q2 performance. We ended the quarter with a strong cash position and we generated $103 million in cash flow from operations, an $80 million improvement over the prior year.

Our gross margins, they reached an all-time high at 36.3%, a substantial improvement over last year’s 34.5%. The gross margin improvement was achieved across all product families, primarily driven by the combination of our ongoing product cost reductions and our supply chain efficiencies.

If you look at our operating income, our operating income grew by 54%, reaching a record high for Q2. Now, during the last quarter’s call, we planned to increase the alignment between our operating expense growth and our gross profit growth and I am pleased to report that we made excellent progress during the quarter, as our gross profit grew by 25%, more than twice as fast as our operating expenses.

Now let me shift to an overview of the situation with our short-term investments. Our Q2 results through operating income as well as most of the accounts in our balance sheet are final, but we are currently unable to provide final results for our net income, or the value of our short-term investments as of September 30, 2007. Let me give you some background on what happened and what to expect.

At the start of Q3, we discovered what had begun over one year earlier as a fully protected investment in Triple A structured finance instruments composed of U.S. government backed student loans had migrated into an investment in Triple A rated instruments composed of corporate debt as well as CDOs with a value of $169 million. While these investments were still Triple A and our accounting for them in the prior quarters was correct, they were not what I had authorized when establishing the original investment parameters.

Our ownership for these securities, rather than the securities composed of U.S. government backed student loans, was the result of unauthorized actions and subsequent misrepresentations to management by our Treasurer, whose employment has been terminated.

We are in the process of reviewing the fair values of these securities, given the recent dislocation in the credit markets. This is complicated and time-consuming but there is no question that there has been significant impairment to the value of our investments.

We expect to report an impairment loss on our final Q2 income statement as an unrealized loss under other expense. We estimated that this charge will be in the range of $55 million to $75 million.

Subsequent to the end of quarter, we sold 50% of each of our securities in our portfolio at par. The sale was part of a confidential settlement agreement and as a result, we will recover one half of the loss and will report it as a gain in our Q3 income statement under other income.

We expect to finalize the amount of this loss within the next three weeks. The details will be communicated in a press release and included in our 6K filing.

Lastly, let me assure you that since uncovering the facts in early October, we have taken swift and aggressive actions to address this isolated incident and to prevent any recurrence in the future.

Now, let’s move on to the balance sheet. Our cash position excluding short-term investments was $265 million. Our cash increased by $116 million compared to the prior year. The increase versus the prior year is even more impressive when you consider that during the last 12 months, we paid off $14 million in short-term debt, spent $20 million for the acquisitions of Slim Devices, and $182 million on share repurchases, buying back our shares at an average price of $27.

Our cash flow from operations for the quarter was $103 million, and this was an increase of $80 million from the prior year. The improvement was primarily due to significant improved working capital efficiency and operating profit.

Our cash conversion cycle was 46 days. This is a 20 day reduction compared to the same quarter last year, driven by improvements in each of the three components. In fact, we achieved faster inventory turns, lower DSO, and increased EPO.

This was the fourth consecutive quarter of year-over-year improvement in our cash conversion cycle. We said we would be attentive to it; we have been and we will continue to be.

Inventory -- our inventory was essentially flat, up by only 2%, or $5 million compared to the September of the prior year. Inventory turns were significantly improved at 5.8 compared to 5.1 turns last year.

DSO -- our DSO was 64 days for the quarter, a reduction of seven days compared to the prior year.

Let me turn to share repurchases. During Q2, we repurchased 1.53 million shares for $41.6 million at an average of $27.23. We own just over 5% of our outstanding shares. We had roughly $80 million remaining on our current repurchase program and another $250 million ready to take effect when this current one is completed.

Please note that the growth percentages that follow are in comparison to Q2 of ’07. Now, let’s discuss net sales by product family, starting with retail.

Our retail sales grew by 16% with units up by 10%. Excluding video, which demonstrated modest improvement but still declined, our retail sales grew by 26%, demonstrating the robust health in the rest of our portfolio.

It was a strong quarter in both the Americas and Asia with growth of 17% and we are pleased to note that we returned to double-digit growth in EMEA with sales up by 15%. The growth in retail was primarily driven by our PC speaker, keyboards, and remotes.

Let’s go on to pointing devices. We delivered double-digit sales growth in retail pointing devices. Sales were up by 14%, with units up by 13%. It was a solid quarter for cordless mice, with sales growing by 14% and units by 31%. We experienced very strong growth in the low-end of the category in both sales and units. The low-end strength was driven by our notebook mice led by our V220 cordless optical mouse.

We saw continued strength in the notebook category with sales of cordless mice for notebooks growing 46% with units up by 67%, and I want to note here that we were quite pleased with the initial reception of our VX Nano cordless laser mouse for notebooks.

Our 3DConnexion offering made another solid contribution to growth in the category where their sales were up by 43%.

If I turn to audio, it was a great quarter for audio, with sales growing 38% and units up by 13%. Our speaker sales grew by 51% and units were up by 44% with the majority of the growth coming from PC speakers.

Sales from our iPod MP3 speakers were up by 8% with strong initial reception to our Pure-Fi Anywhere iPod speakers. It was the best quarter every for our PC speakers, with sales growth accelerating to 66% and units up by 48%.

We achieved 50% growth across all major PC speaker price bands, which we think is a very good sign.

Our growth in audio also benefited from the sales of our slim devices streaming media products, which we acquired in Q3 of 2007.

Our keyboards and desktops -- we also enjoyed our best quarter ever in keyboards and desktop category, with sales up by 35% and units by 29%. Standalone keyboard sales increased by 57%. We had another strong contribution from Alto, our portable notebook stand with an integrated keyboard. We also continued to be pleased with the sales of our high-end cordless keyboard, the diNovo Edge.

Desktop sales also grew double digits with sales up by 21% and units by 26%. Now, we continue to experience strong demand in the mid-range of the cordless desktop category and I want to say we are quite pleased with the initial response to our innovative cordless desktop wave, which made a significant contribution to the growth in this category.

Let’s press on to video. Our webcam sales declined by 27% with units down by 25%. Despite the decline, we did see signs of improvement. Sales were up 36% sequentially. While sales were down in EMEA, the decline was significantly less than what we experienced in Q1. We continued to experience very strong growth in sales and units in the high end of the category, led by the QuickCam Pro 9000 and the QuickCam Pro for Notebooks, which both feature the high quality Carl Zeiss lenses.

On to gaming, gaming sales increased 16% with units down by 8%. Now, our console gaming sales declined by 36% with units down by 40%. This is really a function of the sales of our PS3 peripherals were not large enough to really offset the year-over-year decline in the sales related to the prior generation consoles, particularly the PS2.

It was, however, a great quarter for PC gaming, where sales were up by 48% and units by 26%. We achieved growth in multiple categories led by steering wheels. Our PC wheel sales more than tripled, led by the G25 and the MOMO Racing Wheels.

Remotes -- we were pleased to see the return to strong growth in remotes with sales up by 47% and units by 21%. We had solid double-digit growth in the Americas and we bounced back in EMEA after a weak Q1 with sales more than doubling compared to the prior year. The Harmony 1000 made a major contribution in both regions.

OEM sales -- it was the best quarter ever in OEM, with sales growth of 40% and units up by 11%. The majority of this growth was in the console gaming category, driven by microphones for singing games for PlayStation and the Wii. Keyboards also made a significant contribution to the growth with sales nearly tripling and our OEM mice sales were also up by 6%.

Let me conclude with the following points -- it was our best Q2 ever for sales and operating profits, thanks to double-digit growth across the majority of our retail product portfolio and outstanding performance in OEM. Gross margin was up substantially over the prior year, reflecting ongoing product cost reductions and supply chain efficiencies.

We achieved 54% growth in operating income and we generated dramatically higher cash flow from operations compared to the prior year.

Before concluding my comments, I want to remind you that we’ve scheduled our mid-year investor meeting for November 1st at the Reuter Building in New York and the agenda will feature a number of our senior executives, and we do hope you will be able to join us.

Let me now turn the call over to Guerrino.

Guerrino De Luca

Thank you, Mark. Thanks again to all of you for joining us today. I am delighted with our outstanding operating results in Q2. We returned to strong double-digit sales growth with good growth across all retail regions and a spectacular quarter in OEM. Our gross profit grew over twice as fast as our operating expenses and we achieved record Q2 operating income.

There were a number of major highlights in the quarter. We delivered a significant year-over-year improvement in gross margin for the fifth quarter in a row. This improvement achieved despite aggressive promotional activities in multiple retail product categories, reflected consistently excellent performance by our product and operations teams, and continued to provide us with a strong source of flexibility and competitive advantage.

I was quite pleased with our ability to realign our operating expenses growth and our gross profit growth. We’ve been diligent in managing our headcount additions and discretionary spending while continuing to make the investments needed to drive future growth. It is clear that our strategy is paying off.

Our Q2 performance demonstrated robust demand for our products across the majority of our retail portfolio. Our line of Harmony remotes returned to strong growth with sales more than doubling in EMEA. We delivered accelerated growth in speakers and keyboards and we made progress in webcams.

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 of a strong top line growth and a strong bottom line performance.

Let me briefly comment on the issue with our short-term investments. As you can imagine, I am very disappointed that the unauthorized action and misrepresentation of a single individual had such a negative impact. Painful as it is, it is important to remember that this was completely unrelated to our operating activities and in no way detracts from what is a spectacular wireless. The close to five times year-over-year increase of our cash flow from operations is a powerful indicator of that.

We understand what happened with our short-term investments and I fully support Mark in his swift and decisive handling of the situation.

Naturally, as pleased as we are with our Q2 results, we remain focused on executing our plans during the pivotal second half of the year. Let me talk about what we see for the remainder of fiscal 2008.

We generated impressive momentum during Q2 and we see many signs that lead us to believe that we can build on that momentum moving forward. Let me comment on several of those signs, starting with the webcam category.

We believe the progress we made in webcams during Q2 is an early indicator that our three pillar strategy to reignite webcam market growth with a focus on product, partnerships and consumer marketing activities is beginning to bear fruit. As you heard from Mark, two of our newest webcams, the QuickCam Pro 9000 and the QuickCam Pro for Notebooks, are doing quite well and drove strong growth in the high-end of the category.

We also launched several new entry level webcams in EMEA at the end of the quarter that will strengthen our offerings in that segment during the rest of the year. We are still on track to announce a significant new partnership this quarter that we believe will broaden consumer awareness and expand the potential user base for video communication.

Our market share in EMEA continues to look relatively stable while in the Americas, our share has rebounded the same levels that we saw prior to Microsoft’s entry in the category.

We believe the market share data confirms that our in-store marketing activities are having a growing impact.

We remain enthusiastic about the opportunities in the webcam space and we expect a return to double-digit growth in this category in Q4 of this fiscal year.

It was a great quarter for our recently expanded line of cordless mice for notebooks. We were very pleased with the initial demand for several of our new products, including the V220 on the low end and the VX Nano on the high end. We’ve entered the holiday season with our strongest ever offering of notebook mice, which positions us well, given the rapid growth in the notebook category.

Q2 was our best quarter ever in keyboards, with growth accelerating to the highest level we’ve seen in over five years. We’re extremely pleased with the market response to our new Wave comfort keyboard, which made a significant contribution to our growth during the quarter. We said at the start of the year that we expected the keyboard category to be one of our fastest growing and we see continued momentum ahead.

We are very pleased with the outstanding growth in our audio sales. The growth engine in the category for the first two quarters in the year has been PC speakers, where our sales have grown by 65% on a year-to-date basis. Our PC speakers line has never been stronger, with products at all key price points and offering an attractive value proposition to the consumer.

We also expect to build on the modest momentum we established with [PC] speakers in Q2 throughout the remainder of the year.

Moving to remotes, we are very pleased to see the return to strong growth in the category in EMEA during Q2. The actions we discussed during last quarter’s call are paying off and we expect good growth from our remote sales in the region during the remainder of the year.

The market in the U.S. remains vibrant and the opportunity in this category is substantial across all geographies. We continue to be focused on improving every aspect of the user experience to further increase our already high level of customer satisfaction while significantly expanding the potential universe of Harmony users.

Turning to gaming, we are pleased with our performance in PC gaming and expect continued growth in the category. The picture is a little different on the console side. While we have yet to establish momentum in retail console gaming, we have seen explosive sales growth in OEM, driven by our microphones for singing games. In fact, if you look at retail and OEM combined, our console gaming sales increased by 88% through the first half of the year.

The OEM opportunity remains significant in the near-term and we believe that the situation in retail will improve during the remainder of the year.

Let me talk about our Asia-Pacific region. The moderate growth in this region has been a topic of discussion at various times and most recently in relation to management changes in Japan.

I am quite pleased with the momentum we’ve been building across the entire region. I believe that the steps we’ve taken have established a foundation that will result in accelerated growth in the region during the remainder of the current fiscal year.

And that brings me to my outlook for fiscal 2008. In the near-term, we see several positive signs. Our retail booking through the first two weeks of the quarter are well ahead of the same period last year. We also believe that channel inventory levels are quite reasonable for this time of the year.

For the full fiscal year, we continue to target 15% growth in sales. We have increased our operating income growth target from 15% to 20%. We have also increased our expectation for gross margin and look for it to be above the high end of our long-term target range of 32% to 34%.

Before moving to the Q&A, let me comment on our announced leadership transition. Effective January 1st, I will assume the role of Chairman of Logitech's Board. Succeeding me will be Gerry Quindlen, who is currently our Senior Vice President of Worldwide Sales and Marketing. Our company co-found, Daniel Borel, will remain a member of the Board of Directors.

I have always believed that Logitech should not have the same CEO for more than 10 years. With this in mind, our Board of Directors, led by our current Chairman, conducted a thorough process for selecting my successor and I could not be more pleased that it will be Gerry.

As we continue our long-term double-digit growth path, Gerry has the right experience to allow the company to scale effectively and gain more momentum in consumer driven marketing.

Gerry and I share the same vision for Logitech and I am sure we will establish a strong partnership in our new future roles. I have a great model for it; my partnership with Logitech's co-found and current Chairman, Daniel Borel.

I am proud that Gerry will transition in this new role with a very strong executive management team that knows and respects him and that has proven excellence in product development, finance, operations, marketing and sales.

Lastly, let me add that I am very pleased that my new role will keep me actively engaged with Logitech, as it is my hope to be associated with Logitech for the rest of my business career. In the meantime, as you expect from me, I am fully involved in the company’s activities as we focus on executing our plans in what is always our largest and most pivotal quarter of the year.

At this point, I would like to open the call to your questions. Please follow the instructions of the operator.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Simon Schaeffer with Goldman Sachs.

Simon Schaeffer - Goldman Sachs

Good afternoon. Thanks very much. I wanted to ask a question on the excess cash situation, just about what happened this quarter. I was wondering how the company looked at -- what we perceive to be somewhat of an excessive capitalization again in terms of excess cash and perhaps some of the challenges that you incurred again highlighting that excess capitalization. Thank you.

Guerrino De Luca

I think Mark may comment on this one but let me say something; I understand your question. It is true that our cash management traditionally, always and in the future will be focused on total conservativeness and that’s why we were completely blindsided by what happened here, which has nothing to do with our philosophy of cash management. It has nothing to do with the policies we have and I think Mark explained it enough, enough of what happened.

The truth is we have always said that the best use of cash is potentially buying companies, potentially making acquisitions, and we have made them and will continue to make them, and buying back our stock, which is a great investment and a great way to return money to our shareholders.

This incident, as regrettable as it is, doesn’t change that philosophy.

Operator

Your next question comes from the line of Ted Chung with Bear Stearns.

Ted Chung - Bear Stearns

Great, thank you. Just a quick question; with this short-term investment, has there been any impact on the previous earnings or results?

Mark J. Hawkins

Ted, let me just describe that; the answer is no. These investments were Triple A and were liquid and trading at par during the prior periods. It was only during this period and Q2 when the issue of liquidity was discovered and the problem was discovered and worked through, so there are no issues. The prior period accounting is correct.

Ted Chung - Bear Stearns

Okay, let me ask it in a different way; was there a much higher return for these investments that might have boosted your earnings from prior quarters?

Mark J. Hawkins

Actually, there was a de minimis effect in the return on these investments, so that -- actually, the yield was de minimis.

Ted Chung - Bear Stearns

Okay, great. And what type of controls have you implemented since then that would assure us that this type of event will not happen?

Mark J. Hawkins

Ted, the number one action that we’ve taken and the most important action was we’ve changed personnel, number one, full stop. There are other things that we could speak of that are more than the time we have here but there are other things that have been done and are begin deployed as we speak. But the number one most important significant thing has happened.

Ted Chung - Bear Stearns

Thank you.

Operator

Your next question comes from the line of Matthew Yates with Merrill Lynch.

Matthew Yates - Merrill Lynch

Good afternoon, guys. My first question, and I know we’ve talked about this before in the past but can we go through it one more time, please? On the effect of a weaker dollar on your company, both in terms of the translation on the sales growth and also the transaction on your gross margin, please.

Mark J. Hawkins

Matthew, this is a question that I am happy to cover. A couple of things here; one is that we look at the entire circumstance with foreign exchange and we’ve always called out that we never made any claim in terms this having a negative or positive effect on our company throughout the history, even when the currency goes one way or the other.

It is not the primary driver of our performance. The primary driver of our performance is more associated with the mix of the product in gross margin. That has a much bigger effect from that standpoint.

We think it is really well over-simplified to stand back and try to discern this effect, given all the pricing, natural product introductions that we make, and also the fact that we are very global in terms of where we manufacture and where we sell, so there is really no comment to be made on this one from that standpoint.

Guerrino De Luca

Let me add on something here; this is a recurring theme and evidently, we have not been good enough in explaining it but it is -- look at the amount of products that we introduced in the last three months. All these products have been priced under the current currency scenario and all of these products are just part of our revenue, so obviously the European consumer is taking advantage of the strong Euro and should be, way more than Logitech.

I don’t know if that’s clear but that’s where we come from.

Matthew Yates - Merrill Lynch

Okay, thank you for that. Just a couple of follow-ups, if I can; this one’s for Mark on the working capital over the last few quarters. As you say, you’ve really raised the importance internally of that. At this point, do you have a feel as to how much more you could do on that side?

Mark J. Hawkins

Matthew, we see no reason, no structural reason why we cannot continue to improve. We are really pleased to see the results. A 20-day improvement year-on-year from the prior year’s period is really a healthy improvement. I wouldn’t have you expect that same rate of improvement but we see no structural reason why we can’t get more. I don’t guide on this but we are going to continue to be attentive and I know you and I’ve talked. This has been a focus for some time and you can expect us to continue to be attentive to this, and no structural reasons why we can’t further improve.

Matthew Yates - Merrill Lynch

And just one more, if I can; you talked about the benefit of some supply chain efficiencies on the gross margin. Can you just elaborate a little bit more on that?

Mark J. Hawkins

I sure can. One of the things that is kind of a virtuous cycle, Matthew, when you really get into the cash conversion and we start working on the inventory turnover is when you have less inventory, you have less supply chain cost. And there is an incredible virtual impact all the way through the warehouses and what not, and that’s one of the direct effects of that virtuous cycle.

Matthew Yates - Merrill Lynch

Can I squeeze in one more? When I look at your sales guidance for this year, are you assuming normal seasonality?

Mark J. Hawkins

Again, we don’t guide by quarter from that standpoint. Looking forward, I think the best thing is just to think about our overall guidance that Guerrino talked about. I understand your point there, Matthew but I’ll just have to pass on that.

Guerrino De Luca

Let me add something here, a forward-looking statement and I have the privilege to make it. If you look at the first half of this year, we are roughly 14.5% growth, so our goal -- not our guidance, our goal for the target for the year is 15%. I think that there is no expectation on anything dramatic to happen to help us get there.

Matthew Yates - Merrill Lynch

Okay, thank you very much, guys.

Mark J. Hawkins

Matthew, one other last point on the supply chain; I do want to call out just the outstanding performance of our logistics team in every aspect of their execution is helping, in addition to them helping to drive the inventory turns, which provides that virtuous cycle in supply chain. So both of those we should call out.

Operator

Your next question comes from the line of Manuel Recarey with Kaufman Brothers.

Manuel J. Recarey - Kaufman Brothers

Thanks and great quarter. I have a question on guidance, if I can ask it another way; as you look out into the second half of the year, do you -- how do you feel or what is your view on consumer spending, considering the strong growth that you had in the August quarter? Do you feel that, especially here in the U.S., that the issues in the housing market and so forth is going to have an impact on consumer spending?

Guerrino De Luca

Historically, our performance has been rather uncorrelated with the consumer sentiment and consumer spending. As you very well know, the majority of our products are sold at what I continue to call below the check-with-your-spouse threshold. People don’t have to consult to buy a mouse or a webcam. They don’t have to have a family reunion to do it. And usually, these kinds of purchases -- and remember, we are the premium vendor in that space, the premium vendor in the affordable category -- usually what happens in difficult times, consumers tend to redirect their purchases and therefore they may do without some higher ticket item, one that doesn’t come well through a family reunion. And people look at one another and say no, maybe not this time.

But when it comes to buying a joystick or speaker for your iPod, it is just a pleasure to do it and you buy it at the highest level possible because it is actually affordable. And this kind of dynamic we’ve seen in the past.

Now, will things change in the future? Will this country’s economy completely collapse? I certainly don’t think so but I would say that there is no underlying, dramatic relationship between consumer sentiment in general in this country or otherwise and our performance.

Just as an add-on, in this quarter that was not particularly happy for the consumer in this country, our AMR growth was 17% and so that should indicate where things are going.

Manuel J. Recarey - Kaufman Brothers

Okay, thanks. And another question maybe for Mark; could you just give a little bit more color -- is it product mix the reason why revenue is up 19% and units were up 10%?

Mark J. Hawkins

I think product mix is really the factor. When you look at our pricing, our pricing is largely stable, Manny. I think you have a good insight around our model. We are just getting nice receptions for some high-end products. You know, our Harmony 1000, just a great high-end product. The customers love it and are buying that. You look at our diNovo Edge high-end keyboard as another example that people are putting their money out for.

I think you’ve got the exact right angle, which is we’re just getting nice reception for some of our products.

Guerrino De Luca

To be clear, our strategy is not necessarily to make that happen. Our strategy is not to say we are happy with the high-end and we don’t care about anything else. One of the most interesting aspects of the results in this quarter has been the spectacular performance of cordless notebook mice, in which we had a dramatic growth in revenue, like 45% -- I don’t have the number in front of me right now, and 20 points more growth in units. And we are very happy with that.

We are taking advantage of the opportunities where they come and our product line performs in different ways and different seasons, but this is an absolutely high priority of ours. We are as interested in having Logitech present at the entry level as we are in having our high end products to be so exciting for our consumers.

Manuel J. Recarey - Kaufman Brothers

Great. Thanks very much.

Operator

Your next question comes from the line of John Bright with Avondale Partners.

John Bright - Avondale Partners

Thank you. Mark, on the impairment, do I understand this correctly -- it’s $55 million to $75 million in Q2 on the books, and then you will see a gain of approximately half of that in Q3?

Mark J. Hawkins

That is exactly correct, John. You can expect that. In fact, the money is in the bank for the other half at this point. It is just in the Q3 period, so you can absolutely expect that.

John Bright - Avondale Partners

All right. Can you talk about the linearity of the quarter, Mark, from a sales perspective?

Mark J. Hawkins

The linearity for Q2, again Q2 is a back-end loaded quarter. We had a little bit more than half of our retail business ends in the last month of the quarter and that’s Q2-ish and that’s kind of what happens, John.

John Bright - Avondale Partners

It was nothing different than historical patterns?

Mark J. Hawkins

No, no.

John Bright - Avondale Partners

Okay, and then Guerrino, the partnership for webcams, you are talking about announcing that before the end of the year. Is this something that could benefit our webcam sales in this holiday season, or should we think about this more as a 2008 calendar benefit?

Guerrino De Luca

It’s hard to answer this one. I think if I remember when we did major things with webcams a couple of years ago or four years, it may take some time for the consumer to get there. So it is hard to anticipate. We have a very, very aggressive marketing strategy around this and you will see it happening and I won’t discuss it in detail but it is very hard to predict how fast this will impact.

I am more excited about this partnership for it’s long-term value than I am to stimulate short-term sales. I think we have a lot of weapons to do so, including our products, but I am certainly -- the reason I am enthusiastic with this category is that I believe that there is fuel that can be put in the engine and this fuel will actually reaccelerate the engine.

Don’t ask me to be too specific as to when exactly, but I’m sure it will.

John Bright - Avondale Partners

Gerry, congrats on the promotion. Strategically, Logitech has, from an acquisition front, been a bolt-on acquisition type of company. Philosophically, do you see any change in that thought process in your new role?

Gerald P. Quindlen

I don’t. We’ve done a good job in the acquisitions that we’ve made and as Guerrino said, it’s been a part of our strategy in the past and it will be going forward, and so no. I’d say no.

John Bright - Avondale Partners

All right. Thank you. Congrats on a solid quarter, gentlemen.

Operator

Your next question comes from the line of Tavis McCourt with Morgan Keegan.

Tavis McCourt - Morgan Keegan

Let me wish my congratulations as well on a good quarter. Mark, not to beat a dead horse on the gross margins, but I was wondering at least qualitatively, if you could talk about -- you guys are probably operating around 300 to 400 basis points above where your long-term range is. How much of that is just sales mix, kind of the strength being at the higher end of the product line? How much of that is just being at a very low cost component environment right now? And what would it take -- I mean, why aren’t gross margins just going to stay in the mid 30s? What would it take to get gross margins back down to the 32%, 34% range?

Mark J. Hawkins

Well, a couple of things, Tavis; one is that certainly innovation has been driving this fundamental performance, if you will. We can see that with new product replacements. When you compare that year on year and that’s been kind of a consistent theme from that standpoint.

I think the other thing is the mix does have an effect and we talk about that and just in understanding our model, but it is important to note that the product replacements year on year have fundamentally created a different level of performance.

We are also just getting, as I was trying to call out, the virtuous cycle of supply chain and logistics with the cash conversion cycle, which we’re pleased about, and it just really starts to work into a powerful momentum, if you will.

These are fundamentally the drivers. Now, when you come back and you say what is our guidance going to be, the range has been historically 32% to 34% -- you know, we’re not prepared to talk about guidance beyond that other than what you’ve heard from Guerrino for this year. We constantly reassess what is the range that one should expect going forward, but I want to make one point, Tavis, that’s very important. We see the fact that these gross margins are where they are at as incredibly powerful from a flexibility standpoint in terms of allowing us to do the things we need to do in the market to achieve the goals we want to achieve.

So we couldn’t be more pleased at this virtuous cycle. We couldn’t be more pleased at the record-breaking gross margins and the virtuous cash cycle that we are seeing.

Tavis McCourt - Morgan Keegan

And in terms of -- I mean, it looks like a lot of the strength this quarter came from PC speakers and OEM, which has traditionally been two of your lower gross margin product lines. It the gross margin improvement within those lines or is it really just across the board?

Mark J. Hawkins

This is another element that is nice to speak about. We again are seeing across-the-board improvement but these two areas, certainly we’re seeing improvement on, and the PC speakers in particular is just a really strong performance. Our product generation, our engineering team has just done a fabulous job and then our supply chain team takes it to a -- operations team take it to another level. Both of those have improved, specifically the PC speakers in particular significantly. Hope that helps.

Tavis McCourt - Morgan Keegan

And in terms of PC speakers, Mark, it seems like you’ve seen a big reacceleration there. I’ve got to believe you are substantially outgrowing that market at that point. Is there anything dramatic going on in that market that has enabled you to do that? Has somebody left the market? Have you gained shelf space or is it really just the new products having greater sell-through then the old?

Guerrino De Luca

No, nobody has left the market and there’s been no discontinuity there. In fact, we see a lot of players. This is the most fragmented market in which we play and so you may see a lot of smaller players losing share.

We have a particularly strong presence. We are the leading brand by far in Europe and that’s what drives a lot of that growth, but no, I don’t think there is any structural change.

The truth is that we are designing, we have designed a speaker line which is totally focused on digital music and gaming for the PC. And we believe we are the only one that has got the formula right in that space. You have a lot of speaker players that play across many categories and they fundamentally provide sound. We provide sound for the digital world on the PC in gaming and music. It’s different and I think the consumers see it.

Just as an example, we have the first PC speaker designed specifically for gaming. It is call G51. If you’re a gamer, you should buy it. I strongly recommend it. It has everything that a gamer needs around speakers. You may say what is that? Well, we can talk for about an hour about the features that this thing has for gamers. No one does that.

So this approach that is very focused around the PC and the digital lifestyle of gamers and music enthusiasts is paying off big time.

Tavis McCourt - Morgan Keegan

I wish I had time to be a gamer, and then my last question was on slim devices. You kind of called it out as contributing to revenues this quarter. Can you just qualitatively speak about where you are and distribution of that product right now? When it becomes more worldwide distribution, is there still product upgrades or improvements you are looking to make to the product before you really go global with that distribution?

Guerrino De Luca

The answer to both question is yes, in the sense that we are seeing a gradual increase of our presence. We are way, way not where we will be, both in EMEA and in the U.S. And this is a new category. It requires a careful understanding of the selling proposition at the point of sale, if you will allow me that sort of marketing speech, and that is what we are working on.

We are very pleased with the momentum. We are very pleased with how this is rolling out but we are way not there yet, and that to me is -- in a way, I am very enthusiastic across the product portfolio. You know how strongly I believe that Harmony is an incredible potential and how excited I am about our mice and keyboards -- that is amazing and beyond and I don’t want to just forget any line. But this is like the next little seed and we are carefully growing it.

You asked whether there is going to be improvement; you bet. There will be improvements in the product offerings and making it even more appealing to the consumer but that’s another story and I’m not prepared to discuss it in details right now.

Tavis McCourt - Morgan Keegan

Great. Thanks a lot and not a bad 10-year run, Guerrino. Congratulations.

Guerrino De Luca

Wait for the next 10. Thank you.

Operator

Your next question comes from the line of Michael Foeth with Vontobel.

Michael Foeth - Vontobel

Good afternoon, good morning. I have three questions; first of all, I would like to congratulate Gerry for his promotion. I was wondering who is going to succeed him in sales and marketing, because I guess that’s an important job as well?

Gerald P. Quindlen

We are in the process of undertaking that and we’ll be announcing that within probably the next quarter. Thank you for the comment on the promotion. I will continue to do that role. We’ve announced essentially a transition today, so this is effective January 1, so I will continue to be the SVP sales and marketing for Q3.

Michael Foeth - Vontobel

Great. Second question, a follow-up on the measures -- maybe that’s a question for Mark -- on the measures that you are implementing to prevent those kinds of issues that you’ve seen here in Q2 with the short-term investments. I mean, obviously changing personnel is not really preventing things from happening again in the future. I guess you need other measures there in place. What do you have in mind?

Mark J. Hawkins

Michael, there’s a variety of things that we will be doing. There are things that we have done that are more detailed and more involved than we want to get to on this conference already today. But we feel like the most important thing we did is address the personnel issue and that’s critical.

But you can be assured that there are things that have already been done and in fact will continue to be done to continue to drive improvement.

Michael Foeth - Vontobel

Okay, thanks. And my last question would be with respect to the webcam market in Europe. What kind of promotional activities have you initiated yet and what results are you seeing on that? What can we expect for the current quarter, not in terms of numbers but where things are evolving?

Guerrino De Luca

As you’ll recall in Q1, Europe saw a dramatic decline of webcams year over year and while we had a decline this quarter, it was significantly less, so we are seeing the same kind of dynamic that we saw in the United States one quarter before. It is a much better sequential performance, a much lower decline year over year. That’s an indication that things are moving in the right direction.

Promotionally and marketing wise at the point of sale, you’ll see more -- you have seen and you will see more emphasis on usage than on competitiveness, if you want, more emphasis on what you can do with this as opposed to this is a better webcam than the other guy’s webcam.

We said that we would do that and it is paying off. But I think the most significant thing you will see in the coming few months is the marketing implication of the partnership that we’ll announce. And as I am not prepared to talk about that in detail, I won’t be able to explain the details of that but it is obvious that both online and offline, in the cyberworld and in the real world, we will take advantage of that.

Michael Foeth - Vontobel

Okay, I look forward to that. Thanks a lot.

Operator

Your next question comes from the line of Andrew Neff with Bear Stearns.

Andrew Neff - Bear Stearns

Just to go over the issues that you talked about with the investment, can you just give us a sense of what was the -- I mean, if you didn’t get any earnings out of it, if you didn’t get -- what was the thinking behind this? What was going on here? Why do this?

Guerrino De Luca

Thank you very much. I’ll take it over for Mark, who is anxious to answer this because this is such a fundamental point. The answer is we have no idea. The answer is -- and that’s why we are completely -- that’s why we didn’t see it before because the yields were just imperceptibly better than what you would have gotten from a total secured government-backed asset and security. So it was just marginal. And sometimes people are carried away with this marginal one, two, three basis points and they just do what they think is right.

The point here is that Mark authorized an investment, which was absolutely, totally secured and we were absolutely certain, on the basis of the yields alone, that that’s what was going on. In reality, our Treasurer decided that he wanted to do better, not only just acted without authorization and B, never told anybody -- actually, the contrary; told everybody that what we owned was exactly what we thought we would own.

And by the way, the assets we own today, as impaired as they are, were and are Triple A rated. You know what happens in this market these days and so how much you want to rely on ratings. I am not qualified to discuss that. I’m not the expert but that’s the story. The story is there was absolutely marginal benefit but maybe good enough for a Treasurer to be happy about it.

But that’s the key point for us. You know how conservative we are in cash management. We’ve been accused to be over-conservative in cash management. I don’t think we’ve ever been over-conservative. Fundamentally, fundamentally this is our philosophy and this was a profound violation of our philosophy.

Whether the gain could have been higher or smaller, I don’t even care. This is not the way we manage our cash and we were misled and somebody acted without authorization and without our knowledge. That’s the gist of it. It’s isolated. It’s circumscribe. It’s what it is. We have to move on.

Andrew Neff - Bear Stearns

If I could just ask two other things on that; one, and Mark, you addressed this before, but is there a level of review of your other -- have you gone through your other investments -- you’ve got a lot of cash elsewhere -- so that you know this is contained here?

And second, just if you could talk about incentives; were there incentives for the Treasurer’s office to -- based on profits or things like that?

Mark J. Hawkins

Let me speak to a few things. The first thing is in terms of our investments, our investments in Logitech are in short-term bank deposits and that has been confirmed. That’s what we do. Again, it’s been conservative, that’s where we’re at and the only other thing that’s been authorized is government-backed security, specifically that investment with the contingence that it be government-backed, principal guaranteed securities. So there is nothing else other than short-term bank deposits, cash at major world class banks.

In terms of incentives, there is nobody that makes commission on this. There are no incentives from that standpoint, so that is very, very clear from that standpoint. This was an event exactly as described by Guerrino. It was unauthorized. It was misrepresented and mis -- actually internally reported and the issue has been dealt with, it’s been isolate. It’s been fully addressed and more. So that’s where we’re at.

Guerrino De Luca

I think you ask a very interesting question about incentives. Just to be clear, the entire company, the management of the company, the only incentive that we have is on top line and bottom line for the entire company, so you can understand that’s the -- that’s the I could put together and we’ll continue there.

Andrew Neff - Bear Stearns

Thank you.

Operator

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

Andy Hargreaves - Pacific Crest

Just on the webcam market, I suppose, you guys are gaining share here and kind of steady in Europe. Can you just give us your thoughts on why the market isn’t growing? And then, as part of that, is this new partnership going to be an entirely new application that we haven’t thought of or that doesn’t exist right now, or is it just a new partnership for something that already does exist.

Guerrino De Luca

First of all, your first comment, we are -- our share is stable in Europe. We are not gaining share. Our share has rebounded in the U.S., which I think is the best news. It has rebounded at the level it was before Microsoft entered the category, so I couldn’t be more pleased.

Microsoft is still playing, by the way, and Microsoft evidently both Logitech and Microsoft took share from other players, which by the way was what we had anticipated at the beginning. I am very happy to see that happen.

In terms of the partnership, I am sorry. I cannot answer your question. I can only tell you that this partnership will enable us to address a significantly large community that has not experienced the full benefit of video. That is all I can say.

Andy Hargreaves - Pacific Crest

And then just one other question on the remote market, you had mentioned kind of an interest in the OEM opportunity there. Could you give us any update or how you are thinking about that?

Guerrino De Luca

My thinking hasn’t changed. We are very interested in that opportunity. I think that over time, you will see us as a player in that space, which we fundamentally haven’t touched, but stay tuned.

Andy Hargreaves - Pacific Crest

Thanks.

Operator

Your next question comes from the line of Ross Argolis from Sellium Investment Management.

Ross Argolis - Sellium Investment Management

Yes, a quick question on the investment securities. I’m not going to ask you who, but did you basically get a counter-party to absorb half the loss in the third quarter and that’s why you are getting out at par in the -- not the third quarter, in the next quarter?

Mark J. Hawkins

Ross, there was an agreement that’s confidential in nature that was struck where half the investment was sold at par. Unfortunately, I really can’t speak to any details behind that due to the confidential nature of it, but I think the economic implications of what has been done, you accurately understand, which is we have in the bank half that investment right now in our short-term cash deposits. It’s there. It was at par, so half of the exposure is gone. That’s all I can say. I wish I could say more but you can imagine the sensitivity of this.

Ross Argolis - Sellium Investment Management

Thank you.

Guerrino De Luca

We’ll take the last question.

Operator

Your last question comes from the line of Matthew Yates with Merrill Lynch.

Matthew Yates - Merrill Lynch

Thanks for taking the follow-up. It was about the management transition and Guerrino, could you say if the board interviewed anyone externally for the post, or was the plan always an internal candidate?

Guerrino De Luca

The details of this is confidential. We will not discuss them. I can tell you that the board went through a very broad and deep assessment across the board. The process has taken a long time. As I told the board years ago, I didn’t think anybody should run this company for more than 10 years. You can imagine that this has taken a long time.

I don’t have many experiences of executive transitions. I’ve never been a former CEO but I believe from everything I’ve seen and from everything I’ve been told that this has been the most structured, the most well-done process that any board has gone through. It’s not for me to say but I’m telling you because I think that that is the case and I couldn’t be happier than we got to choose Gerry. You will get to know him. He is dynamite and I am very happy to be associated with it for the long-term.

So, which actually leads me to a conclusion that I wanted to share with you. First of all, thanks for being on the call. Ten years ago, when I took over this job at Logitech, the company had a very strong vision and a tremendous potential. Ten years later, Logitech is five times bigger, 20 times more profitable, and yet has the same strong vision and the same tremendous potential.

I look forward to working with Gerry to help him accomplish in the coming years what Daniel Borel helped me accomplish in the past 10, and I could not be more excited at this prospect and at our opportunities.

Thank you for joining us today. Have a good day.

Operator

This concludes today’s Logitech second quarter fiscal 2008 earnings conference call. You may now disconnect.

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Source: Logitech F2Q08 (Qtr End 9/30/07) Earnings Call Transcript
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