Logitech International F3Q06 (Qtr Ending Dec 31, 2005) Earnings Conference Call Transcript (LOGI)

| About: Logitech International (LOGI)
TRANSCRIPT SPONSOR
Research2Zero Logo
Click to enlarge

Logitech International (NASDAQ:LOGI)

Q3 2006 Earnings Conference Call

January 19th 2006, 8:00 AM.

Executives:

Joe Greenhalgh, Vice President of Investor Relations

Guerrino De Luca, President, Chief Executive Officer

Kristen Onken, Chief Financial Officer

Analyst:

Ted Chung, Bear Stearns

Manny Recarey, Kaufman Brothers

Serge Rotzer, SKD

John Bright, Avondale Partners

Charles Elliot, Goldman Sachs

Charles Wolf, Needham & Co.

Yves Kissenpfennig, UBS

Mehrdad Torbati, Deutsche Bank

Chris Gretler, Credit Suisse First Boston

Thomas Wang, Linden Advisers

Brox Pherland, Wetkel Capital

Daniel Holingo, Texas

John Elbi, Churux

Presentation

Operator

Good morning. My name is Lee and I will be your conference operator. At this time, I would like to welcome everyone to the Logitech quarter three and fiscal year 2006 earnings conference. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. (Operator Instructions) I would now like to introduce Joe Greenhalgh, Logitech's Vice President of Investor Relations.

Joe Greenhalgh, Vice President Investor Relations

Thank you, Lee. I would like to welcome you to the Logitech conference call to discuss the Company's results for the quarter ended December 31, 2005, the third quarter of Logitech's fiscal year 2006. The press release, a live webcast of this call, and accompanying presentation slides are 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 20F dated May 18, 2005 and subsequent filings available online on the SEC EDGAR database, and in the final paragraph of the press release reporting third-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.

With us today are Guerrino De Luca, Logitech's President and Chief Executive Officer, and Kristen Onken, Senior Vice President Finance and Chief Financial Officer. I would now like to turn the call over to Kris.

TRANSCRIPT SPONSOR

Research2Zero Logo

Research 2.0 combines in-depth, theme-oriented technology investment research with a lightweight business model. Our approach is to concentrate our research energy and resources into areas not well-covered by existing firms. While other analysts are attending informational meetings with company managements, we are talking to customers. While other analysts are spending a huge chunk of their time each quarter on earnings releases we are doing hands on work with technology. While other analysts are focused on what amount to trading perspectives, we are working on long-term underlying trends that drive revenue, margins and long-term company valuation.

Because we leverage technology and new distribution models rather than traditional high-cost infrastructure, we can provide unique research in a much more cost effective manner.

Individuals can purchase an annual subscription, corporations and institutions can become sponsors or consulting clients. We also deliver a good deal of our content at no charge via our email list, blog, free publications and summaries of our other research reports.

To sponsor a Seeking Alpha transcript click here.

Click to enlarge

Kristen Onken, SVP-Finance, Chief Financial Officer

Thank you, Joe, and thanks to all of you for joining us on our quarterly earnings teleconference. If my voice sounds pretty terrible, I have to confess it is terrible, and I hope you'll bear with me. I have got a bit of a cold, so for the next few minutes you'll be hearing my rather raspy voice.

We're pleased with our results, as we delivered our best Q3, as well as our best quarter ever, for sales, operating income, and net income. The growth percentages that follow are in comparison to the third quarter of 2005. Our sales grew by 19%, or $90, million to reach $574 million, exceeding the $0.5 billion quarterly sales level for the first time in our history.

Our retail business continued to deliver solid growth, with sales increasing by 19% to $517 million, driven by outstanding performance in audio, video, and remote controls. Complementing the growth in retail, our OEM sales grew by 15%, primarily reflecting robust demand for our mice.

Gross margin was 32.3%, down from last year's unusually high 34.8%, but up sequentially from 31.4% in the second quarter. The margin in Q3 this year largely reflects a return to more typical margin levels in a number of product categories and falls within our long-term target range of 32 to 34%.

The explosive growth in our retail audio sales also resulted in significantly more audio in the product mix compared with the prior year, but I am pleased to say we continued to achieve strong gross margin improvements in the category, both compared to prior year and sequentially. In fact, the improvements in audio helped us to increase our gross margin by 90 basis points sequentially, even with more retail audio in the mix than in the previous two quarters.

We grew our operating expenses by 11%, in line with the 10% growth in gross profit. Our engineering expenses increased by 17%, primarily due to investments in audio and remote controls.

Let's move to the balance sheet. Our cash position was 277 million, up by 31 million compared to the prior year. Our cash flow from operations for the quarter was 45 million, compared to 63 million last year. Our inventory was 258 million, down by $9 million from September of 2005 and up by 72 million from December 2004. Inventory turns were 6 times per year as compared to 6.8 times as of December of 2004. And we feel comfortable with our inventory level as we enter Q4. Accounts Receivable was 370 million, up from 296 million last year. Our Days Sales Outstanding was 58 days, slightly higher than the 55 days achieved in December of 2004.

Let me give you an update on our share repurchases. During the third quarter, we completed our earlier share buyback program of 250 million Swiss francs and we began repurchasing under our new 300 million Swiss franc program. During the third quarter, for the two programs combined, we repurchased 561,257 shares for approximately 31 million Swiss francs, or 24 million U.S. dollars. And we now own roughly 1% of our shares outstanding.

As a reminder, over the course of the last two previous quarters, we delivered 5.5 million shares from treasury to fulfill the conversion obligations for our convertible bonds. You can view regularly updated information on share repurchases at the Investor Relations section of our website.

Let's look more closely at our retail business in the third quarter, where our sales grew by 19% and unit shipments increased by 23%. We achieved a strong growth in all regions, with sales in the Americas up by 26% on a 30% growth in units, and Europe delivering a 15% growth on a 24% increase in units. The growth in the Americas and Europe was driven by audio, with a significant contribution from video, and the Americas also experienced a big impact from the success of the Harmony remotes. We continue to achieve double-digit growth in Asia, with sales up by 20%.

Turning now to our product families and starting with cordless, where our sales decreased by 6% but units were up by 11%. Our cordless mike sales declined by 10%, with units up 9%. Much of the sales decline was due to a tough comparable as Q3 of last year was our first full quarter of shipments for the world's first-ever Laser Cordless Mouse, the MX 1000. Our sales of the MX 1000 in that quarter continued to hold the record for the most sales of any product in a single quarter in the Company's history.

Another contributor to the sales decline was the inability of a supplier to provide us with a critical component for our new V400 laser mouse for notebooks. This significantly constrained sales of one of our hottest new mice, and therefore our sales growth during the quarter. But even without the V400, we still managed to grow the unit shipments of our cordless notebook mice by 71%.

Beyond these two factors, I am pleased to say that when we look at our cordless mouse category we see a very healthy business. For example, we experienced solid double-digit growth in both units and sales in the mid-range and value segments, with several new products receiving very positive market response.

Sales of our Cordless Desktops declined by 5%, while units grew by 12%. The decline in sales was primarily a function of mix shift within the overall category. We experienced strong growth in sales and units in both the high-end and in the mass market segment of the category, but our mid-range offering did not fare as well and led to the decline in sales.

Retail audio continues its record-breaking momentum. Audio has become our second-largest product family, with both sales and unit shipments more than doubling and reaching an all-time high. It was our best quarter ever for speakers, with sales growing by 144% and units by 124%.

Complementing our continued strength in PC speakers was our newest iPod speaker, the mm50, which delivered our highest sales quarter ever for a speaker. The other key driver in our audio business is PC headsets, where we enjoyed another record-breaking quarter. Fueled by the growing popularity of our Voice-over IP and hot applications like Skype, our sales of PC headsets grew by 90% and established a record high for the category for the third straight quarter.

Sales in the retail corded category declined by 5%, with units up by 1%. Corded keyboard sales increased by 6%, with units growing by 11% and were particularly strong in Asia Pacific. Sales of our corded mice declined by 12% and units fell by 5%. We saw an acceleration of growth in retail video and delivered our best quarter ever, with sales growing by 44% and units by 62%, reflecting the increasing use of video communications over the Internet. In addition to the continued success of our mass-market WebCam offerings, we also more than tripled our sales in the high-end category due to strong demand for our QuickCam fusion WebCam.

In retail gaming, our sales declined by 15% while unit shipments grow by 18%. Sales of our peripherals for game consoles declined by 15%, but units grew by 42%, with the unit growth driven by the success of our offering for the PSP platform. The decline in sales reflects both the fully anticipated transition to new console platforms as well as a difficult comparable for our wheels for the PlayStation 2.

Our wheel sales last year were exceptionally strong due to the launch of Sony's Gran Turismo 4 racing game. Without a hot new game to generate a similar level of interest, our console wheel sales declined by 14%. We could not be more pleased with the explosive growth of our Harmony remotes. These products made a solid contribution to our growth during the quarter and were responsible for nearly all of the $16 million increase we reported under the retail other category.

Let me comment now on our OEM business, where our sales increased by 15% and units grew by 18%. It was a strong quarter for mice, as our sales to PC manufacturers increased by 10%, with unit shipments growing by 14%. Before concluding my comments, I want to let you know that we have scheduled our fiscal 2007 investor meeting for May 11 in London. The agenda will feature a number of our senior executives reviewing our strategy and opportunities for fiscal 2007 and beyond, and we hope you'll be able to join us. On that note, I would like to turn the call over to Guerrino.

Guerrino De Luca, Chief Executive Officer, President

Thank you, Kris, and thanks again to all of you for joining us today. Our strong sales growth during the important holiday buying season affirms that Logitech is successfully executing our strategy to ride the wave of key consumer trends, the popularity of digital music, the pervasiveness of broadband connectivity, and the evolving role of the PC as an entertainment and communication platform.

Our results highlight one of the main benefits of our broad product portfolio, its resilience to the occasional downturn in key categories. In spite of the decline in cordless and gaming sales in the third quarter, the growth in audio, video, remotes, and OEM more than compensated, and we delivered our 29th consecutive quarter of double-digit sales growth. At the same time, we achieved a sequential improvement in gross margins returned us within our long-term target range.

Let me comment a little further on the third quarter, starting with cordless. Our desktop offering for the high end of the mass market have been well-received, but we have not had the same success in the mid-range, and that has resulted in a mix shift within the category. In addition, this year's relatively drawn-out transition to our new desktop lineup, which we highlighted in the previous two earnings calls, did not help our overall performance in the category.

We expect to return to growth in Cordless Desktop in early fiscal 2007 as a result of a variety of actions, including the introduction of new products that we define a desktop proposition for an environment characterized by increased penetration of mainstream notebooks and more media-ready PCs.

Our cordless mouse sales were impacted by the supply constraints for the V400 during our biggest retail quarter for the year, but we remain bullish about the opportunities in the category, as well as the consumer appeal and competitive strength of our offering. In fact, we expect to return to strong double-digit growth for our cordless mice sales in the current quarter.

I am very pleased with our spectacular performance in retail audio. Not only was this the fifth consecutive quarter where we established a new sales record for the category, it was also the third straight quarter where our sales have significantly more than doubled compared to the prior year. At the same time, we continued to improve our gross margin in the category and expect further improvements again this quarter.

I am also pleased with the acceleration of our growth in video. The strength of our results demonstrates that our refreshed and expanded line of innovative, easy-to-use and software-rich webcams has been very well-received by consumers. The opportunity in this category has never been more promising, as more and more people enthusiastically embrace the experience of live video communication. No company is better positioned than Logitech to provide both a WebCam and a headset to further enrich the experience in the months to come.

Our performance in retail gaming, our second smallest retail product family, was not as robust as we have experienced in previous quarters, but that is consistent with the state of the overall gaming environment. As we said before, the transition to new console platforms like the Xbox 360 and the PlayStation 3 has introduced significant volatility into the market. This turbulence is likely to continue for the next several quarters.

We are well-positioned to leverage future growth opportunities in the category, but it will be well into fiscal '07 before we see a return to significant growth here. I do want to mention that we have had a very strong success in the gaming category with our products for the PlayStation Portable. The stock product in the category is PlayGear Pocket, a protective case for the PSP. In just three quarters, we have already shipped over 1 million units of this very popular accessory.

We continue to be excited by the rapid growth and the positive consumer reaction that we have experienced with our Harmony remotes. As one powerful indicator of our progress, our remote sales in the third quarter were higher than our remote sales for all of fiscal 2005. We are beginning to gain traction Europe and we have only scratched the surface of what we believe we can accomplish in this category, both as it exists today and where we hope to take it in the future.

That brings me to our outlook for fiscal 2006. Based on the strong top-line growth we've achieved through the first three quarters of this year, we have increased our goal for sales. For fiscal 2006, or goal is to deliver sales growth of at least 20% compared to the prior year, up from the previous goal of 18 to 20%, and operating income growth in excess of 15%. We continue to expect our gross margin to be at the low end of our long-term target range of 32 to 34%.

Let me now turn to our preliminary comments for fiscal year 2007, which begins in April of 2006. Naturally, our first order of business is to focus on the current quarter and on achieving the targets for the current fiscal year that I have just shared with you. Once fiscal 2006 is behind us, we will discuss in more detail the expected product and operational drivers of our fiscal 2007 performance.

That said, on the sales side, we see continued double-digit growth in retail and in OEM. We anticipate a return to growth in cordless, along with continued strength in audio, video, and remotes. For fiscal 2007, our goal is to deliver 15% growth in both sales and operating income, excluding the impact on our operating income of new accounting or expensing stock-related compensation.

We just completed the best quarters in Logitech's history, delivering over $0.5 billion in sales in a single quarter for the first time ever. The resilience of our broad product portfolio combined with the strong execution by our teams has positioned us to exceed our original full-year targets for both sales and operating income.

I look forward to a successful conclusion to fiscal 2006, and at this point, I would like to open the call to your questions. Please follow the instructions of the operator.

Questions and Answers

Operator

(Operator Instructions) Our first question comes from Ted Chung with Bear Stearns.

Q - Ted Chung

Just a couple of quick questions. Regarding your fiscal year 2007 guidance of 15% revenue growth and operating income growth, by just following over 20% revenue growth in '06, should we consider that to be a conservative outlook? And what is behind that conservatism?

A - Guerrino De Luca

I think that, as I said, we expect growth across the product portfolio and growth in retail and growth in OEM. This year we have experienced an extraordinary growth in audio, in triple digits for several quarters. We do not expect that to be sustainable, so there is factored in a slowdown of audio growth relative to what we have seen in the recent quarters. Other than that, I do not believe there is conservatism in the guidance. It's in the mid-teens and this is our pace for the foreseeable future and we believe that that will be our pace next year.

Q - Ted Chung

Okay. Any updates on the CFO search?

A - Guerrino De Luca

Kris is here, although she has a cold. She's alive and kicking and will continue to be here until we find the right person. We have no particular deadline. We are definitely hoping to allow Kris to retire as she wants, sooner rather than later, but we have several candidates that we are in the final process of interviewing. I would leave it at that.

Q - Ted Chung

Okay, great. Thank you.

Operator

Your next question comes from Manny Recarey with Kaufman Brothers.

Q - Manny Recarey

Two questions. You spoke of the cordless returning to growth. Do you expect the corded segment to return to growth? I missed that, if you spoke about it.

A - Guerrino De Luca

We did not talk about the corded segment. Historically, the corded segment has been on a flat to declining trend, and we have had success and we continue to have spectacular successes in the corded segment in the gaming mice, which is a subsegment of that segment. But in general we do not expect that corded will be a contributor to growth. We do expect, as we said, that both cordless mice and Cordless Desktop will be contributors to growth in 2007, with cordless mice returning to pretty solid growth this quarter.

Q - Manny Recarey

Okay. And then the audio segment was very strong. Are you seeing any impact on Plantronics' purchase of Altec? Do you see any difference in the market due to that?

A - Guerrino De Luca

As we said, we do not believe that that acquisition changes the competitive landscape. Altec was competing in audio before, and that means that our performance, both in PC audio and iPod audio, indicates that we are in a great position to face the competition that we have in those segments.

Q - Manny Recarey

Okay, thank you very much.

Operator

Your next question comes from John Bright with Avondale Partners LLC. His line has been closed, due to no response. Your next question comes from Serge Rotzer with SKD.

Q - Serge Rotzer

I have several questions. One question is that you say that you want to improve gross profit margin, but at the end of the year we will be at a level of 32%, more or less, let's say. But next year you say 15% for growth for turnover and for EBIT. So that means that you still will have a gross profit margin at the low end of the range. Why is that?

A - Kristen Onken

We haven’t projected gross profit margins precisely for fiscal '07 in our preliminary indications. We continue to believe it will fall within the range of 32 to 34. It is a bit too early to say whether this is going to be at the low end, the mid-range, or the high end of that range. We are seeing stabilization of margins from unusually high levels a year ago for many categories. We are seeing audio improvement. It is too early to tell whether this may lead to a slight improvement of margins within the range or not. So that is as far as we are in our analysis at this stage.

Q - Serge Rotzer

Okay, but this is a point for me, because improvement in audio products and more cordless devices must mean better margins.

A - Kristen Onken

Let me comment on that. Improvement in audio is one of things that we have experienced and continue to experience, and that is a great thing. On the other side, audio remains among the portfolio at the lower margin level and therefore you have to factor that in your projections.

Q - Serge Rotzer

Okay. Second question is marketing and sales costs have been quite low this quarter. Have you got any explanation for that? How you see the levels for the future?

A - Guerrino De Luca

We don't consider those quite low. I think they were consistent with our sales and promotional activities and everything we did in the Christmas quarter. So you should expect that our overall sales and marketing expenses will grow in line with gross profit.

Q - Serge Rotzer

Okay. The last question, if I may, inventory. What is in the inventory? Is it mice and desktop or what is still there? Because you say you fell happy with inventory, but anyway, 60 days is quite hard because you had about 50 days in inventory days. So what is in inventory? And second question, had you been restore some products, for example, with audio, that you had some special air freight that you had.

A - Guerrino De Luca

Let me answer the two questions. The inventory is fairly balanced across the product category; there is nothing particularly surfacing that would color it one way or another. We feel comfortable because we expect good growth in the coming quarter and the products in the inventory are very fresh. Talking about an aging that is extremely favorable for the total inventory; that's why, there's a lot of new products in the inventory and very little older things. So that that is the reason for our comfort with the current level. On the other question was…

Q - Serge Rotzer

You had a good sense of audio product. Did you have any special air freight because of that, because you would have been short in Europe for example?

A - Guerrino De Luca

I would say that our level of air freight was consistent with what we expected. I think that we did have air freight, but nothing particularly surprising. We were expecting a solid audio performance, and of course it was maybe a little bit better than what we expected, but any change was not material versus our expectations.

Q - Serge Rotzer

Okay, last question. CapEx for million users. I remember that your guidance has been a little bit about 40 million plus, quite close. Do you see another big increase or what do you say for CapEx?

A - Guerrino De Luca

Is this a forward-looking question…..?

Q - Serge Rotzer

For the quarter, for Q4. We reach already about 40 million and your guidance has been about 40 million plus, so we're already there. How much will be the CapEx in Q4 more or less at the end of the year?

A - Kristen Onken

Two of the things that happened during this particular quarter is we had, first of all, we capitalized some of our, we are upgrading our ERP system to Oracle 11i. Additionally, we've bought additional capacity in the factory for extra machinery. I think around the 40 to 43ish mark, I think we should be fine.

Q - Serge Rotzer

Okay, the little extras in Q4. No surprises in Q4?

A - Kristen Onken

Yes, no surprises.

Q - Serge Rotzer

Thank you very much.

Operator

Your next question comes from John Bright with Avondale Partners.

Q - John Bright

I apologize before. I got cut off. Two questions on the retail cordless side of the equation. I hope they weren't answered. One is the mid-range offerings in the Cordless Desktops did not fare as well as expected. Thoughts on why they did not fare as well?

A - Guerrino De Luca

I think that occasionally when you introduce a few tens or hundreds of products, some of them are not exactly meeting what you expected, so I consider that as part of life of a multiproduct vendor. Probably the upsell proposition was not as compelling and so a lot of consumers that are entering cordless right now have felt comfortable with the entry-level product, which actually grew pretty substantially, and have not felt compelled enough to move up. That is our read of the market. We are focusing on mid-range a lot moving forward, and that is one reason why we believe that our fiscal '07 Cordless Desktop sales can grow, but that as far as we can decode the signal from the markets for the time being. We have gained share on both the entry-level and high end and I think we've lost some share at the mid-range. Are you still there?

Q - John Bright

I am. Also, on the retail cordless side, for the cordless mice, you mentioned great constrain by supplier inability to provide a key component, I think, for this product.

A - Guerrino De Luca

For the V400. Just to give you a sense of what the V400 is, the V400 is the first mini laser notebook mouse in the market. So it is an extremely important product for us, and unfortunately we were significantly constrained in the supplies of this product because of the reason I mentioned in this quarter. So we did well in cordless mice with the notebooks, but we would have done significantly better with the V400. That was certainly one of the reasons of the decline of cordless. I believe that while the supply of the V400 will not completely resolve this current quarter, in general in total cordless, mice will increase solidly this quarter.

Q - John Bright

What was the component?

A - Guerrino De Luca

I cannot be more specific, if you allow me.

Q - John Bright

One last one on the retail cordless side of the equation. Did you see from a competitive standpoint Microsoft making a greater push in the market?

A - Guerrino De Luca

Microsoft is a fierce competitor as always been, and we expect it will continue to be. But I have not seen anything unusual or different than what we usually see from our most respected competitor out there.

Q - John Bright

Then two quick last ones. One on the gross margin. Great on the audio side of the equation; the gross margins held up well. Is there any specific effort that you would attribute that to?

A - Guerrino De Luca

For sure, certainly we have introduced a lot of cost reduction in our products, both in the products themselves and packaging and other components of the logistics of moving speakers throughout the world, and that has benefited dramatically. And we expect to continue both on the product as well as on the supply chain to make improvements on speakers. And there is also benefit out of the iPod speaker, which tends to be higher margins, and obviously helps the mix.

Q - John Bright

Kris, any thoughts on stock option expense expectations for fiscal year '07?

A - Kristen Onken

Yes, certainly you have seen, John, that our trend on that has been going down. Just to give you a flavor for what it is going to be for this particular quarter, it is going to close to about $4 million. That is a little bit, about 20% less than it was last year at this time. But I think right now what we're looking at is on the year-to-date basis, our stock option expensing is about $11 million. So I think what you should find is A, the absolute value has been going down as well as the percentage of our net income; that has also been going down. And there is nothing to suspect that that trend will change. There are many factors, of course, that get involved with the valuation of the stock options, but for the most part things that we have control over are going to indicate that we're going to continue to bring those numbers down.

Q - John Bright

Thank you.

Operator

Your next question comes from Charles Elliot with Goldman Sachs.

Q - Charles Elliot

Have you got any estimate of the impact on sales and operating profits from the supplier problem on the V400? For example, would cordless mice sales have been up without this problem?

A - Guerrino De Luca

It is very hard to answer this question. We have been amazed occasionally by the performance of our top mice, but this would be really speculative, so I can't answer this question. Maybe, maybe not. Remember, just to add one thing to the comment. One additional reason for the decline in cordless mice was the incredible performance of the MX1000 last year. And that, of course, would certainly have been mitigated by the V400 this year, but not entirely.

Q - Charles Elliot

So it's partly just a tough comp?

A - Guerrino De Luca

Yes, both, tough comp and disappointment on this particular product that is pretty hot. I actually use one, to make you envious that you couldn't buy one, I use it. Anyway.

Q - Charles Elliot

Just to follow up on another question, can I confirm that the full-year CapEx, capital spending this whole fiscal year, including the last quarter, will be $40 million?

A - Kristen Onken

No, I'm sorry. It's going to be closer to around 50.

Q - Charles Elliot

Closer to 50?

A - Kristen Onken

Yes. I'm sorry about that, yes. It's 43 year-to-date.

Q - Charles Elliot

Thanks very much.

Operator

Your next question comes from Charles Wolf with Needham.

Q - Charles Wolf

I had two questions. Kris, can you give us any guidance on the option expense for 2007? That is the first question. And Guerrino, you mentioned that the gaming console business should begin to accelerate in 2007. Can you be more specific on that forecast?

A - Kristen Onken

Charlie, let me just go over the examples one more time. For the first, let me just vie you an indication of where it looks today and that might help you make a projection out for 2007. First three quarters of this fiscal year, our stock option expense is $11.1 million, or about 9%. Okay? There is no reason to expect, one of the things I need to point out again is the dollar value as well as the percent of our net income are both lower than they were in the previous year, and that was lower than it was in the year before that. So there is no reason to expect that this percentage will do anything other than continue to decline, aside from the obvious wild variables that might happen to the Black-Scholes method of accounting for these. But for the most part, I see these coming down.

Q - Charles Wolf

Okay, thanks.

A - Guerrino De Luca

Let me take the second part of your question, Charlie. As I said, our gaming performance is very impacted by the life of the platforms for which we develop. This year is the year in which Xbox 360 will increase its installed base. That increase will begin to stimulate aftermarket sales for important parts of our portfolio. PlayStation 3 will be introduced and we will have both attached product sales as well as installed base sales there, but the transition to PlayStation 3 may impact a little bit our sales on PlayStation 2. So net-net, I would expect that our growth in gaming will resume in the second half of the fiscal year, rather than sooner.

Q - Charles Wolf

Okay, thanks a lot, Guerrino.

Operator

Your next question comes from Yves Kissenpfennig with UBS.

Q - Yves Kissenpfennig

I just had two short questions. Firstly, when I look at the pricing across your various product categories, they seems to either be stable, if not deteriorating. And I was wondering if that was really your response to market conditions or whether that was just more or less based on various shifts within the product categories. Then my second question would be to the gross margin within the audio. I was hoping you could give us a little bit more data in terms of what kind of sequential increase you're seeing and what steps you're taking to improve that further.

A - Guerrino De Luca

On the pricing, you have seen that our growth in units has been higher than our growth in revenue; therefore, our ASP has slightly declined on a year-over-year basis. It improved a little bit sequentially. That does not mean the pricing of individual products have been suffering. Actually, I would say that, as usual, the price landscape has been quite stable. However, when demand moves to lower ASPs, that is what happens with that metric. So I would say that the competitive landscape is as intense as it has ever been, both in our existing, normal, traditional categories as well as in the categories we're entering new. And we are acting and from pricing perspective as a competitor that wants to grow and gain share. That said, if I look at the portfolio pricing, I have not seen any special deterioration by product. You do see, and you see it in the number, that demand tends to, has moved to slightly lower ASP in general. I would say that that is within the normal fluctuation of these things, and over the years, you follow that, these things go up and down quite frequently. The second question is on the more details on the audio margin. We do not, as you know, provide margin indication by productline. It's a significant competitive matter, and I would not go beyond the comment we made with Kris, that over the course of the last several quarters we've seen good improvement and we expect those improvements to continue. But also we said that audio remains on the low end of the margin within the portfolio.

Q - Yves Kissenpfennig

Maybe just a follow-up question. Do you expect, shall we say, within 12 to 18 months that you could ever get the audio margins to be somewhat comparable to some of the margins in your other product categories, such as cordless or video, for instance?

A - Guerrino De Luca

We have indicated that our bracket for margin is 32 and 34%, and every one of those points is reachable. It will depend on the mix of the portfolio. So there is no reason to think that with a sustained growth in audio we will not be able to fall within or even at that the higher end of that bracket. That is as far as I will go in my comments.

Q - Yves Kissenpfennig

Okay, thank you very much.

Operator

Your next question comes from Mehrdad Torbati with Deutsche Bank.

Q - Mehrdad Torbati

I have a question on your working capital, your operating cash flows. Could you comment on type of cash flow from inventory?

A - Kristen Onken

I'm sorry, your voice is breaking up and we cannot hear you. Could you repeat that?

Q - Mehrdad Torbati

Sorry. I was just trying to get a feeling about working capital development in the fourth quarter. Do you expect these ratios to come down and to what levels? And what would your target inventory turn be next year in terms of overall cash conversion cycle. Do you see any improvement ahead?

A - Kristen Onken

Yes. Let me address that. We have a pretty rigorous program in place now to ensure that the inventory levels and the Accounts Receivable levels will be at an acceptable point as we enter into our Q1. What I am expecting is that our inventory turns should be pretty similar to what they were last year at this time, or as of March 31. I feel pretty confident we're going to be able to accomplish that. Receivables might be slightly higher, but nothing alarming, so I have a feeling the working capital should be fine.

Q - Mehrdad Torbati

So we see the normal seasonality in the fourth quarter in terms of…?

A - Kristen Onken

That's right.

Q - Mehrdad Torbati

And this would be sustainable in the next fiscal year?

A - Kristen Onken

As you know, our cash flow by quarter is unique. It is a very seasonal activity, so cash flow in Q4, we won't be able to repeat that, obviously, in Q1. But certainly in the following Q4 there is no reason to expect why we can't do that as well.

Q - Mehrdad Torbati

Okay, to just get a feeling because of the strong growth ahead if there is any reason to carry more inventory next year?

A - Kristen Onken

That's a good point. We began that, as you remember, in response to some customer demand, particularly here in the United States. But I don't necessarily see that tugging at us too much more than we have already done in the past. So it should be seeking that.

Q - Mehrdad Torbati

My second question is regarding gross margins. I'm sorry if I'm coming back to this question, despite several questions around it. You mentioned that the gross margin improvement in the third quarter was a reflection of improvements of the audio segment. And at the same time, you had a negative impact due to a higher share of the audio segment in the overall mix. If you strip out the negative impact of higher share of audio within the sales mix, what was the actual improvement you achieved through sale effects and the programs you put in place to improve the speaker gross margins?

A - Guerrino De Luca

Okay, let me restate what we said and answer specifically to your question. We said that audio gross margin has improved sequentially year-over-year. We said that that improvement is a contributor to the sequential improvement of gross margins, particularly with audio arithmetically at the low end of the margin range, even though improving, that means that all other categories, or I would say virtually all other categories, also improved sequentially. So I don't know if that answers the question.

Q - Mehrdad Torbati

You are basically saying that the gross margin improvement is not entirely due to….?

A - Guerrino De Luca

Absolutely. It is not entirely due to the improvement in the other category, absolutely.

Q - Mehrdad Torbati

Other categories improved gross margin?

A - Guerrino De Luca

Virtually every category sequentially improved.

Q - Mehrdad Torbati

Okay, thank you very much. There's no further questions.

Operator

Your next question comes from Chris Gretler with Credit Suisse.

Q - Chris Gretler

I have one question with respect to the restocking pattern of retailers after the Christmas season, whether you would want to make a comment about what you see on that. Secondly, whether you would make any comments about your satisfaction level on the mobile phone headset part of the business. And then also I have another question lastly on the retail gross margin. For the audio business, would you make a comment year-over-year what was the increase you have seen in that part of the business?

A - Guerrino De Luca

Your questions, let me take your questions. In terms of the channel inventory restocking level post Christmas etc., I can tell you a couple of indicators for the current quarter. We've factored our Q4 with a higher backlog and orderbook than stocking Q4 last year. And we have seen substantially higher new bookings in the first two weeks of the quarter. So these are indicators that the channel inventory out there is in a healthy position. Restocking does not happen in big cycles. It happens in small cycles. The retailers throughout the world have learned to order less and more frequently, and that is a good thing for everybody. So those indicators should confirm that the channel out there is in a healthy shape. Second question was on our degree of satisfaction with mobile home phone headsets. It is a category that has not picked up for us. We continue to penetrate channels in Europe particularly. It is a marginal part of our audio business. It's not certainly the main growth driver of audio at this point. And your specific question on retail audio, as we said, our margins in audio have been improving. Audio remains at the low end of the spectrum of our gross margin in the product portfolio, but it has been constantly improving. But we do not provide details gross margin indication by productline and we will not do that for audio.

Q - Chris Gretler

Okay, thank you. Very helpful.

Operator

Your next question comes from Thomas Wang with Linden Advisers.

Q - Thomas Wang

Just a couple quick questions. One, I seem to have noticed more rebate promotions starting in late December and continuing to the present time. I was just wondering if you could talk about your philosophy regarding these rebate programs and how you manage them. Then on a different note, Apple seems to be moving more towards the direction of peripherals and I was just wondering what your plans are regarding their moving more heavily into peripherals and accessories.

A - Guerrino De Luca

On the first part of the question, our rebate and promotional activities have not changed in nature and color over the past several quarters, so what you see today in the channels is the usual promotional behavior that you have seen historically. We have not either stimulated or observed any special form of rebates or promotions that we had not experienced in the past. So the level of promotional pressure out there is consistent with history. On the peripheral question for Apple, Apple does sell a lot of peripherals. In fact, Apple does sell today a lot of our peripherals, our iPod speakers, the mm50, sells in the Apple stores. Our wireless headphones for the iPod sells in the Apple store. And we expect that our newly introduced Cordless Desktop for the Mac will sell in the Apple store. So Apple is focusing on peripherals mostly through third-party products that are sold on their website and on their stores and we participate in that. We do not expect, even though with Apple you might never know, that Apple will just go itself into develop peripherals. They might and we will see how we can complement that. For the time being, the wealth of the peripheral markets around the iPod, particularly, is something that we are participating in.

Q - Thomas Wang

Thank you.

Operator

Your next question comes from Brox Pherland (ph)with Wetkel Capital (ph).

Q - Brox Pherland

I was just curious to get a sense of the foreign currency impact on the quarter and any specific geographic impact that you thought might be either ahead or behind plan.

A - Kristen Onken

Typically we don't comment on the impact of foreign exchange. There's so many other variables that come into play, particularly when you have global pricing like we do. So the answer is there is no impact that we think is worth discussing.

Q - Brox Pherland

Okay. And just geographically, the areas that seem to be particularly strong in video and audio, are those broad-based in terms of both U.S. and international or is there an opportunity to expand some of those opportunities internationally?

A - Guerrino De Luca

Actually, audio and video have been very strong in both regions, in both Europe and the U.S. So remote controls have been very strong in the U.S.; it is beginning to gain traction in Europe, so that is an area that there's obviously further growth opportunities there. The Company has always been very, very balanced geographically, so we do enjoy access to channel for new product categories very broadly, so that has been part of the fabric. We do not expect that to change in the future.

Q - Brox Pherland

Great, thank you.

Operator

Your next comes from Daniel Holingo (ph) with Texas.

Q - Daniel Holingo

I have three questions. First, you commented on the global pricing. Maybe you can explain to us why there is a discrepancy between the growth in America, the units and sales, and the growth in Europe. It seems like Europe has a much bigger discrepancy between units and sales in terms of global pricing philosophy. And then could you remind us what the DSOs were end of March 2004 and if this is the target for the end of March of this year? And then more a general philosophical question for Guerrino. Your business model in terms of operating leverage, we see that your forecast is going forward no operating leverage in the system. Do you still continue to invest it in top-line growth? And when and if do we see some margin impact on your fantastic positioning in the peripheral era?

A - Guerrino De Luca

I'll let Kris deal with the DSO question first and then I will talk about….

A - Kristen Onken

Our DSOs last March were 51 days. I am expecting that they are going to come in a little bit higher this year than they did last year. One of the things that is important to note is we're moving out into different areas, such as Eastern Europe or Latin America. So the increase in days is not going to be substantial. It will be still within the same range as it was last year. But the 51 days last year is going to be difficult thing for us to beat and I don't think we are going to do that.

Q - Daniel Holingo

If you say it such, is it one day? Is it five days?

A - Kristen Onken

A couple of days.

Q - Daniel Holingo

Okay, maybe you can comment on global pricing also.

A - Guerrino De Luca

Let me be the philosopher of the answer here. On pricing, yes, we do global pricing. Global pricing is not a science. Global pricing is an art, and we don't change price to our customers every day. So there are facts and currency changes that do impact the delta pricing between Europe and the U.S. That said, you shouldn't read much into the delta between units and revenue growth in Europe and the U.S. when it comes to currency. It means, for example, that in Europe we were even more successful than in the U.S. in certain mass-market offerings, and that obviously draws the average pricing lower. I would really affirm what Kris said. Our pricing, we price our products frequently and therefore that, because we introduce new products frequently and therefore those new prices factor into the fluctuation of currency a lot. So I would leave it at that in terms of currency comment. In terms of operating leverage in longer-term, we said and I continue to repeat that our goal is to achieve 12% operating margin and 10% net margin. We are flirting with those figures and we certainly want to reach them, and at this point we're certainly at shooting distance. Our preliminary guidance for 2007 suggests that our margin does not change, and that is where we at this point compared to 2006, that is where we stand today. Our goal is to create growth of gross profit. That is the main focus for us. We want to take advantage of the incredible opportunity that exists out there across the portfolio. And therefore, we will invest in R&D and sales and marketing to get there. We believe strongly in the sustainability of our business and in the business proposition that we offer to the consumer, and because we do so, we will continue to invest to make this company bigger. Obviously, we want to be as profitable as possible and we will not miss any opportunity to provide things on the bottom line. But for the time being, our long-term business model of 12% operating margin is sustained and we don't see any reason to change it.

Q - Daniel Holingo

Maybe an additional question to that. If you start expensing your options, your flirting with your targets becomes more distant. Do you foresee any adjustment to that mid-term target or do you see some potential to go up again, even with expensing of options?

A - Guerrino De Luca

Let me clarify, and we said it and I want to repeat it that our guidance excludes the impact of expensing of stock options, so let's stay clear. And we will continue to look at the stock options on a pro forma basis, because we believe it, we know it is non-cash expense and we think that we want to provide a fair comparable to the investor and shareholder. That said, the percentage impact of expensing stock option is going down. It has been going down significantly over the past several years, and as Kris mentioned, we don't expect that trend to stop in fiscal '07. But all the guidance on the business model excludes the non-cash element of stock options.

Q - Daniel Holingo

Thank you.

Operator

Your next question comes from John Elbi, Churux.

Q - John Elbi

I just want to come back to questions that have already been asked numerous times. I just want to get some more clarification. Number one, when I think one of the main disappointments at the numbers reported this morning I guess was on the retail cordless side. In terms of basically the weakness that is there and the problem that you said was pertinent to the midrange, should we assume that was mainly pertinent to Europe, i.e. you losing share in the midrange in desktops, was that mainly in Europe?

A - Guerrino De Luca

The first question is you are talking about retail desktops, not retail cordless in general. So yes, the answer is I said we had weaknesses in the midrange. We have lost some share. We have lost some share across geographies and I would leave it at that.

Q - John Elbi

Okay. The second question is in terms of the gross margin. I am just still trying to understand the moving parts and I still think there's probably a missing piece there because if I look at the comments you had made back in November, you were talking about supply chain costs going down as if the second half because of lower transportation costs. The retail/OEM mix has become better on a sequential basis. Units are upon a sequential basis. Then obviously it seems like this negative retail mix shift is masking all of these positive effects, so is there something else that is getting missed here in terms of a negative impact?

A - Guerrino De Luca

First of all, let me make the statement that we have brought our gross margins within our range. We were exceeding that range in the comparables a year ago, so we cannot explain too much the change between something that wasn't sustainably high and something that is more typical. That said, yes, we have seen improvement in supply chain costs and logistics, but we have also introduced a bunch of new products with significantly more technology content than the product they replace. We did that because that is the way it works in this business. So those two elements tend to work together to reach the mix that we have announced. I repeat, we have seen sequential improvement from Q2 to Q3 and that is due by improvement across all product categories and including and particularly in audio. Audio is mainly at the lower end of the margin and being a higher proportion of the mix, you do your calculation and you see that evidently there has been improvements across the portfolio, not just in audio.

Q - John Elbi

On the other hand, I think the issue in the market is that you are stating, you are backing up your 32 to 34% range, but obviously in fiscal Q3, which is normally your highest gross margin quarter in a normal year, if you only have 32.3 it just basically implies that the other quarters could be below that range. So I guess it just becomes giving the Company or giving you the benefit of the doubt of you still being in that range even outside the fiscal Q3 quarters. I guess that is what I was trying to get to.

A - Guerrino De Luca

I appreciate it and I understand that there is a lot of moving parts to gross margin and it is very difficult to predict exactly what will happen. I can only repeat what I said. We expect to end the year within the range actually of the low end of the range as we said a quarter ago. We expect to be in the range in fiscal '07. That is as far as I can go up. The Company is not passively looking at the passage of time. The Company is acting on product cost, on logistics, on competitive positioning of our product. And so we drive a lot of variables within the product margin. They just don't happen to us like that. And that is what leads me to make the guidance and the target that I mentioned.

Q - John Elbi

Maybe just one last short question. In terms of this 11.1 million non-cash expense that you just stated in terms of stock option expensing, can you break that down into COGS versus OpEx so we can maybe start to put that into our models?

A - Kristen Onken

I can't do that yet. You're probably going to be getting a little more flavor on that at the Investor Day on May 11. At this point, I can't do that.

Q - John Elbi

So there's no way, you're not trying to incorporate that into our model then?

A - Kristen Onken

No, not this point. Again, remember, we're going to be giving you pro forma as well, so your model should be just fine. You'll probably have to have a second pro forma model or second with stock option model.

Q - John Elbi

Okay, thanks a lot.

Operator

Your final question comes from John Bright with Avondale Partners LLC.

Q - John Bright

One follow-up question. On the share repurchase, did you see the share repurchase, that you, I think, purchased 561,000 shares. Kris, Guerrino, thoughts on being more aggressive with the share repurchase.

A - Kristen Onken

We're going to continue our share repurchase, obviously, when our window opens tomorrow, so I'd just encourage you to watch on our website. One other thing I might remind you of, something you already know, Q4 is a very cash rich quarter for Logitech. So I will allow you to connect the dots.

A - Guerrino De Luca

All right. Thank you for your questions and let me conclude with a short remark by mentioning that 2006 is Logitech's 25th Anniversary. The industry has changed dramatically over these 25 years. What is great to see is that throughout all these transformations that focus on the user has become the dominant theme. So Logitech was and is at the forefront of this trend, so our last-inch offer is less peripheral than ever. In fact, it has become the most central part of the user experience. Today we have not only confirmed and even increased our financial target for this year, but also provided further proof of the solidity of our business proposition. And looking forward, growth opportunities abound across the whole portfolio and the Company is as ready as ever to execute and capture them. So we intend to celebrate our 25th Anniversary this year by proving once again our innovation, design, and quality can delight our users and propel Logitech to sustained profitable growth. Thank you for your participation today.

Operator

Ladies and gentlemen, again, thank you for participating in the Logitech quarter three and fiscal year 2006 earnings conference. This does conclude the presentation. You may now disconnect.

TRANSCRIPT SPONSOR

Research2Zero Logo

Research 2.0 combines in-depth, theme-oriented technology investment research with a lightweight business model. Our approach is to concentrate our research energy and resources into areas not well-covered by existing firms. While other analysts are attending informational meetings with company managements, we are talking to customers. While other analysts are spending a huge chunk of their time each quarter on earnings releases we are doing hands on work with technology. While other analysts are focused on what amount to trading perspectives, we are working on long-term underlying trends that drive revenue, margins and long-term company valuation.

Because we leverage technology and new distribution models rather than traditional high-cost infrastructure, we can provide unique research in a much more cost effective manner.

Individuals can purchase an annual subscription, corporations and institutions can become sponsors or consulting clients. We also deliver a good deal of our content at no charge via our email list, blog, free publications and summaries of our other research reports.

To sponsor a Seeking Alpha transcript click here.

Click to enlarge

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!