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LOGI > SEC Filings for LOGI > Form 10-Q on 5-Nov-2013All Recent SEC Filings

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Form 10-Q for LOGITECH INTERNATIONAL SA


5-Nov-2013

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS

You should read the following discussion in conjunction with the interim unaudited Consolidated Financial Statements and related notes.

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934. These forward-looking statements include, among other things, statements regarding our business strategy, the impact of investment prioritization decisions, product offerings, sales and marketing initiatives, addressing execution challenges, trends in consumer demand affecting our products and markets, trends in the composition of our customer base, our current or future revenue and revenue mix by product, among our lower- and higher-margin products and by geographic region, our expectations regarding the potential growth opportunities for our products in mature and emerging markets and the enterprise market, our expectations regarding trends in global economic conditions and consumer demand for PCs and mobile devices, smartphones, tablets, gaming, audio, video and video conferencing, digital home digital music and other computer devices and the interoperability of our products with such third party platforms, our expectations regarding the convergence of markets for computing devices and consumer electronics, our competitive position and the effect of pricing, product, marketing and other initiatives by us and our competitors, the impact of our restructuring plan on future costs, expenses and financial performance and the timing thereof, our estimates of future charges related to our restructuring plan, our expectations regarding the recoverability of our goodwill, goodwill impairment charge estimates and the potential for future impairment charges, the impact of our current and proposed product divestitures, changes in our planned divestitures, and the timing thereof, significant fluctuations in currency exchange rates, the impact of new product introductions and product innovation on future performance or anticipated costs and expenses and the timing thereof, cash flows, the sufficiency of our cash and cash equivalents, cash generated and available borrowings (including the availability of our uncommitted lines of credit) to fund future cash requirements, compliance with our credit facilities, our expectations regarding share repurchases and share cancellations, our expectations regarding our future working capital requirements and our anticipated capital expenditures needed to support our product development and expanded operations, our expectations regarding our future tax benefits and the adequacy of our provisions for uncertain tax positions, our expectations regarding our potential indemnification obligations, and the outcome of pending or future legal proceedings and tax audits, remediation of our material weaknesses and Logitech's ability to achieve and sustain renewed growth, profitability and future success. Forward-looking statements also include, among others, those statements including the words "anticipate," "believe," "could," "estimate," "expect," "forecast," "intend," "may," "plan," "project," "predict," "should," "will," and similar language. These forward-looking statements involve risks and uncertainties that could cause our actual performance to differ materially from that anticipated in the forward-looking statements. Factors that might cause or contribute to such differences include, but are not limited to, those discussed in the section titled "Risk Factors" in Part II, Item 1A of this quarterly report on Form 10-Q. You are cautioned not to place undue reliance on the forward-looking statements, which speak only as of the date of this Quarterly Report on Form 10-Q. We undertake no obligation to publicly release any revisions to the forward-looking statements or reflect events or circumstances after the date of this document.

Overview of Our Company

Logitech is a world leader in products that connect people to the digital experiences they care about. Spanning multiple computing, communication and entertainment platforms, we develop and market innovative hardware and software products that enable or enhance digital navigation, music and video entertainment, gaming, social networking, and audio and video communication over the Internet. We have two reporting segments: peripherals and video conferencing.

Our peripherals segment encompasses the design, manufacturing and marketing of peripherals for PCs (personal computers), tablets and other digital platforms. Our products for home and business PCs include mice, trackballs, keyboards, interactive gaming controllers, multimedia speakers, headsets and webcams. Our tablet accessory products include keyboards, keyboard cases and covers, headphones, wireless


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speakers and earphones. Our Internet communications products include webcams and headsets. Our digital music products include wireless speakers, earphones, headphones and custom in-ear monitors. For home entertainment systems, we offer the Harmony line of advanced remote controls. Our gaming products include mice, keyboards, headsets and gaming controllers. During the third quarter of fiscal year 2013, we identified a number of product categories that no longer fit with our current strategic direction. As a result, we made a strategic decision to divest our remote product category and our digital video security product line, included within our video product category. During the first quarter of fiscal year 2014, we updated our strategic focus, deciding to retain our remote product category and transition out of our digital video security product line. Since fiscal year 2013, we have been exiting other non-strategic products, such as speaker docks, and continue to evaluate non-strategic products as part of our ongoing portfolio management.

Our brand, portfolio management, product definition and engineering teams in our peripherals segment are responsible for product strategy, technological innovation, product design and development, and bringing our products to market. Our peripherals business groups are organized by the following product categories: Pointing Devices, PC Keyboards & Desktops, Tablet Accessories, Audio PC, Audio-Wearables & Wireless, Video, PC Gaming and Remotes. Our global marketing organization is responsible for developing and building the Logitech brand, consumer insights, public relations and social media, and digital marketing. Our regional retail sales and marketing activities are organized into three geographic areas: Americas (including North and South America), EMEA (Europe, Middle East, Africa) and Asia Pacific (including, among other countries, China, Taiwan, Japan and Australia).

We sell our peripherals products to a network of distributors, retailers and OEMs. Our worldwide retail network includes wholesale distributors, consumer electronics retailers, mass merchandisers, specialty electronics stores, computer and telecommunications stores, value-added resellers and online merchants. Sales of peripherals to our retail channels were 87% and 86% of our net sales for the six months ended September 30, 2013 and 2012. The large majority of our revenues have historically been derived from sales of our peripherals products for use by consumers. Our OEM customers include several of the world's largest PC manufacturers. Sales to OEM customers were 7% of our net sales for each of the six months ended September 30, 2013 and 2012.

Our video conferencing segment encompasses the design, manufacturing and marketing of video conferencing products, infrastructure and services for the enterprise, public sector, and other small to medium business markets. Video conferencing products include scalable HD (high-definition) video communication endpoints, HD video conferencing systems with integrated monitors, video bridges and other infrastructure software and hardware to support large-scale video deployments, and services to support these products. The video conferencing segment maintains a separate marketing and sales organization, which sells LifeSize products and services worldwide. Video conferencing product development and product management organizations are separate, but coordinated with our peripherals business, particularly our Consumer Computing Platform group. We sell our LifeSize products and services to distributors, value-added resellers, OEMs, and occasionally, direct enterprise customers. Sales of LifeSize products were 6% and 7% of our net sales in the six months ended September 30, 2013 and 2012. During fiscal year 2013, we recorded a non-cash goodwill impairment charge of $214.5 million related to our video conferencing segment.

We seek to fulfill the increasing demand for interfaces between people and the expanding digital world across multiple platforms and user environments. The interface evolves as platforms, user models and our target markets evolve. As access to digital information has expanded, we have extended our focus to mobile devices, the digital home, and the enterprise as access points to the Internet and the digital world. All of these platforms require interfaces that are customized according to how the devices are used. We believe that continued investment in product research and development is critical to creating the innovation required to strengthen our competitive advantage and to drive future sales growth. We are committed to identifying and meeting current and future consumer trends with new and improved product technologies, partnering with others where our strengths are complementary, as well as leveraging the value of the Logitech and LifeSize brands from a competitive, channel partner and consumer experience perspective.


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We believe innovation and product quality are important to gaining market acceptance and maintaining market leadership.

We have been expanding the categories of products we sell and entering new markets, such as the markets for mobile device accessories. As we do so, we are confronting new competitors, many of which have more experience in the categories or markets and have greater marketing resources and brand name recognition than we have. In addition, because of the continuing convergence of the markets for computing devices and consumer electronics, we expect greater competition in the future from well-established consumer electronics companies in our new categories as well as future ones we might enter. Many of these companies have greater financial, technical, sales, marketing and other resources than we have.

The peripherals and video conferencing industries are intensely competitive. The peripherals industry is characterized by platform evolution, short product life cycles, continual performance enhancements, and rapid adoption of technological and product advancements by competitors in our retail markets, and price sensitivity in the OEM market. We experience aggressive price competition and other promotional activities from our primary competitors and from less-established brands, including brands owned by some retail customers known as house brands, in response to declining consumer demand in both mature retail and OEM markets. We may also encounter more competition if any of our competitors in one or more categories decide to enter other categories in which we currently operate.

From time to time, we may seek to partner with or acquire, when appropriate, companies that have products, personnel, and technologies that complement our strategic direction. We continually review our product offerings and our strategic direction in light of our profitability targets, competitive conditions, changing consumer trends, and the evolving nature of the interface between the consumer and the digital world.

Revision of Financial Statements for the Three and Six Months ended September 30, 2012

In the first quarter of fiscal year 2014, we identified errors related to the accounting for our product warranty liability and amortization expense of certain intangible assets. The errors impacted prior reporting periods, starting prior to fiscal year 2009. While these errors were not material to any previously issued annual or quarterly consolidated financial statements, management concluded that correcting the cumulative errors and related tax effects, which amounted to $19.1 million, in the first quarter of fiscal year 2014, would be material to the consolidated financial statements for the three months ended June 30, 2013 and to the expected results of operations for the fiscal year ending March 31, 2014.

We evaluated the cumulative impact of the errors on prior periods under the guidance in ASC 250-10 relating to SEC SAB No. 99, Materiality. We also evaluated the impact of correcting the errors through an adjustment to our financial statements and concluded, based on the guidance within ASC 250-10 relating to SAB No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements, to revise our previously issued financial statements to reflect the impact of the correction of these errors when we file subsequent reports on Form 10-Q and Form 10-K. Accordingly, we revised our consolidated financial statements for the quarter ended June 30, 2012 to correct these errors. In addition, as a result of the decision to revise our previously issued consolidated financial statements to correct for the errors described above, we corrected other immaterial errors that were previously uncorrected. We filed a Form 10-K/A to revise our financial statements for the years ended March 31, 2011, 2012 and 2013 to correct for the same errors. As a result, we have also revised our financial statements for the three and six months ended September 30, 2012 from what we previously reported.

The revised financial statements corrected the following errors:

(1) - Warranty accrual - We determined that our prior warranty model did not accurately estimate warranty costs and liabilities. The inherent flaws in the prior model involved use of generic assumptions, incomplete warranty cost data and inter-regional methodological differences. This error impacted prior reporting periods, starting prior to fiscal year 2009, and impacted deferred tax asset classification between current and non-current assets.


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(2) - Amortization of intangibles - We determined that $4.2 million in intangible assets originating from a November 2009 acquisition were never amortized. The impact of this adjustment was $2.0 million in amortization expense not properly recorded during the periods from the quarter ended December 31, 2009 through the end of fiscal year 2013.

(3) - Other adjustments - We also corrected a number of other immaterial errors, including the cumulative translation adjustment related to the purchase of treasury shares, and an adjustment affecting the amount of property, plant and equipment purchased during the first quarter of fiscal year 2013.

The adjustments made as a result of the revisions to the historical financial statements are more fully discussed in Note 2, Revision of Previously Issued Financial Statements, to the Consolidated Financial Statements.

Summary of Financial Results

Our total net sales for the six months ended September 30, 2013 decreased 1%, compared with the six months ended September 30, 2012, due to a decrease of 2% in OEM sales and a decrease of 16% in video conferencing sales, offset in part by an increase of 1% in retail sales.

Retail sales during the six months ended September 30, 2013 increased 1% and retail units sold decreased 5%, compared with the six months ended September 30, 2012. We experienced an increase of 9% in the Americas and a decrease of 7% in the EMEA regions. Sales in Asia Pacific region remained constant. If foreign currency exchange rates had been the same in the six months ended September 30, 2013 and 2012, the percentage changes in our constant dollar retail sales would have been a decrease of 1% for total retail sales, an increase of 9% in the Americas, an increase of 4% in the Asia Pacific, and a decrease of 9% in the EMEA regions. Sales incentive spending (including pricing discounts) during the six months ended September 30, 2013, compared with the six months ended September 30, 2012, increased by 4% during this period. Sales returns expense during the six months ended September 30, 2013, compared with the six months ended September 30, 2012, decreased by 13% due to lower channel inventory return rate and lower channel inventory level during this period.

OEM net sales decreased 2% and units sold remained constant in the six months ended September 30, 2013, compared with the preceding fiscal year. The decline was primarily due to overall weak market conditions for sale of new desktop PCs.

Sales of video conferencing products, which were 7% of total net sales in the six months ended September 30, 2013, decreased by 16% in the six months ended September 30, 2013, compared with the six months ended September 30, 2012, due to a combination of a changing industry landscape caused by a shift to less expensive, cloud-based video conferencing solutions, an evolving LifeSize product line and challenges in execution.

Our gross margin for the six months ended September 30, 2013 improved to 34.8%, compared with 33.6% for the six months ended September 30, 2012. The improvement in gross margin for the six months ended September 30, 2013, compared with the same period of the prior fiscal year, primarily resulted from cost improvements in some of our PC-related categories and from actions we took during fiscal year 2013 to streamline our product portfolio. The improvement also resulted from negative factors affecting our gross margin during the same period of the prior fiscal year which did not exist during the six months ended September 30, 2013, including $4.5 million in pricing actions related to the simplification of our product portfolio in the Americas and EMEA regions, $3.0 million in costs related to product development efforts that were discontinued as a result of the April 2012 restructuring, and a provision for a patent dispute. The improvement was offset in part by a $5.2 million write-off of video conferencing discontinued products resulting from the restructuring of our video conferencing reporting segment during the quarter ended September 30, 2013.


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Operating expenses for the six months ended September 30, 2013 were 33.1% of net sales, compared with 37.0% in the same period of the prior fiscal year. The decrease in total operating expenses as a percentage of net sales was primarily due to a decrease of $20.8 million in restructuring charges combined with a $17.1 million decrease in market and selling expense due to a decline in marketing spend activity.

Net income for the six months ended September 30, 2013 was $15.4 million, compared with net income of $3.4 million in the six months ended September 30, 2012. This improvement primarily resulted from a decrease of $20.8 million in restructuring charges and a decrease in market and selling expense, offset in part by a shift from a $38.0 million benefit from income taxes during the six months ended September 30, 2012 to a $2.3 million provision for income taxes during the six months ended September 30, 2013.

Trends in Our Business

Our sales of PC peripherals for use by consumers in the Americas and Europe have historically made up the large majority of our revenues. In the last several years, the PC market has changed dramatically and there continues to be significant weakness in the global market for new PCs. This weakness had a negative impact on our net sales in all of our PC-related categories. We believe that this weakness reflects the growing popularity of tablets and smartphones as mobile computing devices.

We believe Logitech's future growth will be determined by our ability to rapidly create innovative products across multiple digital platforms, especially accessories for mobility-related products, including tablets, smartphones and other mobile devices, and for digital music, including wireless speakers and wearables such as earphones, to limit and offset the decline in our PC peripherals. We pursue growth opportunities in emerging markets, mobility-related products, products for digital music and enterprise markets. The following discussion represents key trends specific to each of our two operating segments, peripherals and video conferencing.

Trends Specific to our Peripherals Segment

Mature and Emerging Markets. In our traditional, mature markets, such as North America, Western and Northern Europe, Japan, and Australia, although the installed base of PC users is large, consumer demand for new PCs has declined in recent years, and we believe it will continue to decline in future years. As a consequence, consumer demand for PC peripherals is slowing, or in some case declining. While we continue to pursue growth opportunities in select PC peripherals product lines in mature markets, we believe there are growth opportunities for our PC peripherals outside the mature markets. We have invested significantly in growing the number of our sales, marketing and administrative personnel in China, our largest target emerging market, with the result that China was our second-largest country in retail sales for the six months ended September 30, 2013. We are also expanding our presence in other emerging markets.

Enterprise Market. We are continuing our efforts to create and sell products and services to enterprises. We believe the preferences of employees increasingly drive companies' choices in the information technologies they deploy to their employee base. Growing our enterprise peripherals business will continue to require investment in selected business-specific products, targeted product marketing, and sales channel development.

Tablets, Smartphones and Other Mobile Devices. The increasing popularity of smaller, mobile computing devices, such as tablets and smartphones with touch interfaces, have created new markets and usage models for peripherals and accessories. Logitech has begun to offer products to enhance the use of mobile devices. For example, we are experiencing strong demand for our tablet keyboards. We introduced the Logitech Ultrathin Keyboard mini, a slim protective keyboard cover designed to enhance the iPad mini experience during the fourth quarter of fiscal year 2013. Demand for the Logitech Ultrathin Keyboard mini


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has continued to be very positive. The tablet accessories category is one of the primary strategic categories of our business. We continue to expand and leverage on our success in this category through the recent introduction of innovative products such as the Logitech Keyboard Folio and Folio mini, the Logitech FabricSkin Keyboard Folio for iPad and iPad mini, the Logitech Wired Keyboard for iPad, and the Logitech Ultrathin Keyboard Folio for Samsung Galaxy Tablet.

Digital Music. We believe that digital music, the seamless consumption of digital audio content on mobile devices, presents a growth opportunity for Logitech, based on our history of successful earphone and speaker products. Many consumers listen to music as a pervasive entertainment activity, fueled by the growth in smartphones, tablets, music services and Internet radio. We believe we have a solid foundation of audio solutions to satisfy consumers' needs for music consumption, including earphones and digital music speakers. We continue to invest and introduce innovative new products in this category such as UE BOOM, a wireless speaker offering 360-degree stereo sound announced in late May 2013.

OEM Business. Sales of our OEM mice and keyboards have historically made up the bulk of our OEM sales. In recent years, there has been a dramatic shift away from desktop PCs and there continues to be significant weakness in the global market for PCs, which has adversely affected our sales of OEM mice and keyboards, all of which are sold with name-brand desktop PCs. We expect this trend to continue and for OEM sales to comprise a smaller percentage of our total revenues in the future.

Trends in Other Peripherals Product Categories. Some of our other peripherals product categories are experiencing significant market challenges. As the quality of PC-embedded webcams improves along with the increasing popularity of tablets and smartphones with embedded webcams, we expect future sales of our PC-connected webcams in mature consumer markets to continue declining. During the third quarter of fiscal year 2013, we identified a number of product categories that no longer fit with our current strategic direction. As a result, we made a strategic decision to divest our entire Retail-Remotes product category and our digital video security product line included in our Retail-Video product category. During the first quarter fiscal year 2014, we updated our strategic focus deciding to retain our Retail-Remote product category. We will continue to evaluate our product offerings and will exit those which no longer support our strategic direction.

Trends Specific to our Video Conferencing Segment

The trend among businesses and institutions to use video conferencing offers a long-term growth opportunity for Logitech. However, the overall video conferencing industry has experienced a slowdown in recent quarters. In addition, there has been an increase in the competitive environment in fiscal year 2013. This resulted in a $214.5 million non-cash goodwill impairment charge in the fiscal year ended March 31, 2013. During the fourth quarter of fiscal year 2013 and the second quarter fiscal year 2014, we implemented restructuring plans affecting our video conferencing operating segment to align its organization to it strategic priorities of increasing focus on a tighter range of products, expanding cloud-based video conferencing services and improving profitability. We believe the growth in our video conferencing segment depends in part on our ability to increase sales to enterprises with existing installed bases of equipment supplied by our competitors, and to enterprises that may purchase such competitor equipment in the future. We believe the ability of our LifeSize products to interoperate with the equipment of other telecommunications, video conferencing or telepresence equipment suppliers to be a key factor in purchasing decisions by current or prospective LifeSize customers. In addition, LifeSize has broadened its product portfolio to include infrastructure, cloud services and other offerings which require different approaches to developing customer solutions. We also are seeking to offer LifeSize products designed to enhance the use of mobile devices in video conferencing applications.


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Critical Accounting Estimates

The preparation of financial statements and related disclosures in conformity with U.S. GAAP (generally accepted accounting principles in the United States of America) requires us to make judgments, estimates and assumptions that affect reported amounts of assets, liabilities, net sales and expenses, and the disclosure of contingent assets and liabilities.

We consider an accounting estimate critical if it: (i) requires management to make judgments and estimates about matters that are inherently uncertain; and
(ii) is important to an understanding of Logitech's financial condition and operating results.

We base our estimates on historical experience and on various other assumptions . . .

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