Logitech International S.A. (LOGI) Q3 2016 Earnings Report, Transcript and Summary

Good day and welcome to the Logitech Third Quarter Financial Results Conference Call. At this time, all participants are in a listen-only mode. We will be conducting a question-and-answer session and instructions will follow at that time. [Operator Instructions] This call is being recorded for replay purposes and may not be reproduced in whole or in part without written authorization from Logitech. I would now like to introduce your host for today’s call, Mr. Joe Greenhalgh, Vice President of Investor Relations and Corporate Treasurer at Logitech.

Welcome to the Logitech conference call to discuss the company’s financial results for the third quarter ended December 31, 2015. The press release, our prepared remarks and slides as well as a live webcast of this call are available online at logitech.com. As noted in our press release, we published our prepared remarks on our website in advance of this call. Those remarks are intended to serve in place of extended formal comments today and they will not be read on this call. During the course of this call, we may make forward-looking statements, including forward-looking statements with respect to future operating results that are being made under the Safe Harbor of the Securities Litigation Reform Act of 1995. The forward-looking statements involve risks and uncertainties that could cause actual results to differ materially from those anticipated in the statements. Factors that could cause actual results to differ materially include those set forth in Logitech’s Annual Report on Form 10-K dated June 5, 2015 and subsequent filings. The company undertakes no obligation to update or revise any forward-looking statements as a result of new developments or otherwise. Please note that today’s call will include results reported on both a GAAP and a non-GAAP basis. Non-GAAP reporting is provided to help you better understand our business. However, non-GAAP financial results are not meant to be considered in isolation or as a substitute for or superior to GAAP results. Non-GAAP measures have inherent limitations and should be used only in conjunction with Logitech’s consolidated financial statements prepared in accordance with GAAP. Our press release includes a table detailing the non-GAAP measures, together with the corresponding GAAP numbers and a reconciliation to GAAP. This information is also posted on our Investor Relations website. The slides that accompany this call are also available on our Investor Relations website. We encourage listeners to review these items. Unless noted otherwise, comparisons between periods are year-over-year and in constant currency. And all reported results and updated outlook are focused on continuing operations and do not include the performance of Lifesize, which is now reported under Discontinued Operations. This call is being recorded and will be available for replay on Logitech website. Joining us today are Bracken Darrell, President and Chief Executive Officer; and Vincent Pilette, Chief Financial Officer. I’ll now turn the call over to Bracken.

Thanks, Joe. And thanks for joining us today. We’ve made strong overall progress transforming Logitech into a design-centric growth company and excellent progress this year. We’ve grown almost 10% through our first three quarters. This quarter we had balanced growth across our three regions. We had the largest quarter ever in Asia, growing 15%, the fourth consecutive quarter of double-digit growth. In EMEA, we delivered the best growth in more than three years with sales up 10% and the Americas continue to perform, growing 7%. And we all know these regional results are only possible because we’re so focused on innovative well-designed products. That’s Logitech’s DNA. Its products like UE BOOM and MEGABOOM, CREATE for the iPad Pro, the MX Master Wireless Mouse and our ConferenceCams that drove our growth this quarter and year-to-date. Consumers love them. And we’ll continue to invest in product innovation going forward. Looking into our product categories, the overall growth category grew 17%. Excluding the tablet business, which we expect it would be down once again due to the tablet market decline, the combination of Video Collaboration, Mobile Speakers and Gaming delivered a robust 34% growth. Video Collaboration grew 62%, another powerful quarter. Cloud-based videoconferencing is growing fast and we’re well-positioned to grow right along with it. You could say that our approach to Video Collaboration reflects the neutrality of our Swiss roots, with our ConferenceCams designed to be compatible with all cloud-based services. As cloud-based video rapidly penetrates large and small enterprises, our audio/video equipment activates the cloud solution at a remarkably good value. Mobile Speakers grew 44%, reaching record high sales for a single quarter and surpassing the previous record set just last quarter. Our mobile speaker line-up is powerful, including UE BOOM 2 launched this quarter to replace UE BOOM and MEGABOOM and ROLL. We’re in a great position going forward, as the popularity of music-streaming services continues to drive overall market growth worldwide. Even The Beatles are now streaming. And we’ll continue to offer more features and benefits to our users, both new and existing through upgrades in our software. Gaming delivered its highest sales quarter ever in Q3, with growth of 19%. Our Gaming growth came from sales of PC gaming peripherals, which were up 25%. The growth is driven by our new products with particular strength in Q3 for keyboards and headsets. The tablet and other accessories category continue to be weak, as is the tablet market that drives it. The bright spot for us in Q3 was the strong sales of our CREATE keyboard for the iPad Pro. Demand exceeded supply during the quarter due to the strong initial reception. Our profit maximization category performed well in Q3 as well with sales up by 5%. We continue to gain share in all of our PC peripheral categories, while significantly outperforming the market for new PC shipments. And we feel very good about our formula for maintaining leadership and outperforming the market in each categories going forward. Now, let me turn it over to Vincent.

Thank you, Bracken; and good morning, everyone. Good afternoon for those of you in Europe. This quarter is a milestone in our transformation. We are delivering on our commitments and exceeding expectations. At the beginning of the fiscal year, we told you we would exit the OEM business in FY 2016 and we did. Working collaboratively with our customers and other stakeholders, we processed our last shipments on December 23. Ahead of plan, we smoothly exited the business without disruption or write-off. At the beginning of the year, we also told you that Lifesize was not strategic to our mission and long-term success. We took action. We restructured and divested that business into a separate independent company. Although we still own a minority stake, we have no more operational involvement. Therefore moving forward, Lifesize results will have no impact on our operating results and prior have been re-classed under Discontinued Operations. What we used to call our retail business is now our only business, the new Logitech. Our broad-based performance in Q3 and through the first three quarters of the fiscal year has positioned us to exceed our original FY 2016 financial outlook. We have consistently delivered better-than-expected sales growth and better-than-expected profitability while building the foundation for a long-term growth. Our Q3 sales grew 9% in constant currency and approximately 10% year-to-date. All three regions grew for the fourth straight quarter, demonstrating sustained momentum despite a challenging environment. As Bracken said, our strong results are based on innovative well-designed products and we will continue to invest in product innovation. R&D is up 8% year-to-date. Our strong results are also based on operational excellence, increasingly becoming part of the fabric of the new Logitech. With a sharp focus, we continue to generate cost savings that have helped to offset the impact from stronger U.S. dollar from our gross margin during FY 2016. Gross margin was 33.6%, down 170 basis points and slightly up quarter-over-quarter. As we told you at the beginning of the year, we are offsetting more than half of the currency-related decline through a combination of pricing actions, product savings and manufacturing cost efficiencies, such as packaging redesigns, using lower cost integrated circuits in some mice or using less air shipments. We are delivering on that commitment. For the year, our gross margin now, excluding Lifesize, is expected to be approximately 34%. Our long-term target of 35% remains unchanged, as we factored the exit from OEM and Lifesize into our considerations when we set a long-term business model and shared it with you at our last Analyst & Investor Day. Our rigor in managing product and supply chain cost extends to our operating expenses. We held our non-GAAP operating expenses flat in Q3 as well as on a year-to-date basis, thanks to our ongoing actions to reduce our overhead and infrastructure cost, while creating at the same time investment capacity to drive growth. Our G&A cost, which represent a portion of the total infrastructure cost, are down 6% in absolute value and represents 3.5% of revenue in the quarter, the lowest ratio in the last 10 years. As we have mentioned before, we are investing a portion of the savings to build a successful portfolio in productivity, music, Gaming and Video Collaboration, as well as adjacent growth opportunities, what we call seeds. While this trend should continue, our total operating expenses will move to what is the long-term target of 25% of revenue or less on an annual basis. Operational excellence also means strong cash generation. Here too we are delivering on our commitments and exceeding expectations. We told you we expected to have strong cash generation in the second-half and our results are ahead of plan. Our cash flow from operations was $166 million in Q3 and up 10% on a year-to-date basis. As a result, our cash conversion cycle in the quarter was just 14 days, the lowest in the company’s history. The single biggest driver of our strong cash generation was the reduction in our inventory, down by $73 million from Q2 and up only $7 million year over year. We said last quarter we expected the incremental inventory that we built in the first-half to decline to the remainder of the year. We exceeded our results through a combination of operational improvements and higher-than-expected sales. Our strong balance sheet and net cash position of $505 million enable us to act on every front. We will continue to invest in our business and look for tuck-in acquisitions. Our annual dividend and opportunistic share buyback strategy remain in place with roughly $170 million in dividends expected over the next two years and $200 million remaining on our current share repurchase program. And on that note, Bracken, I’ll pass it back to you.

Thanks, Vincent. We’re really excited about our momentum as we entered the last quarter of fiscal year 2016. In the past three years, we’ve transformed Logitech. We’re performing across all three regions and across our corporate portfolio, and we have the strongest portfolio ever. The strategy is working. That brings me to our outlook. We started the year with an outlook for fiscal year 2016 non-GAAP operating income of $150 million, and constant currency retail sales growth of 7%. Given our momentum and strong performance through the first three quarters of the year, we’ve increased our outlook for fiscal year 2016 non-GAAP operating income to $170 million. And for constant currency retail sales growth to between 7% and 9%. And with that, Vincent and I are available now to take your questions. Please follow the instructions of the operator.

[Operator Instructions] And we’ll pause for just a moment to compile the Q&A roster. Your first question comes from the line of Joern Iffert from UBS. Please go ahead.

Yes, good morning, gentlemen. Thanks for taking my question. The first one would be, can you please help us a bit to understand what is your plan for launching new product categories for fiscal year 2017? So shall we expect one, two or three? And will it be a modification of existing categories or can we also expect totally new categories? And the second question would be the competitive environment. Have you realized any changes here in terms of new players coming in, old players exiting? An update here would be appreciated. And then, you have highlighted that 50% of the FX hits are offset already in fiscal year 2016. Can we assume, when you annualize it there should be support coming from the average selling price increases and cost savings done in 2016, that we should see the other 50% benefit in 2017? Thanks very much.

Okay. I got three questions there. Let me take two and I’m going to hand one off to Vincent. Although, you can add color to anything you like, Vincent. First, you’re in - you asked, what’s our plan for entering new categories as we go into next fiscal year. And as we normally say and I’ll say it again, we don’t disclose what we’re going to go into in terms of new categories. What I will say is you can expect a lot of innovation through our existing categories and we have seed projects in place that are - that continue to mature. And when that we feel like we’ve got a really compelling offering, you can expect that we will bring those out. Second, in terms of competitive environment, we are - we operate across many different categories and we have lots of different competitors, and they’re always changing. We are vigilant about everybody who might enter the space or has. And it makes this a really exciting business. And I think as we go into new things you’re going to see more of it. But the key for us is we really believe that if we invest in technology and continue to develop our design-skills we can compete with anybody we might be - we might see enter our categories. And that’s our fundamental game-plan for new and existing categories. I’m going to hand the FX question off to Vincent.

On the currency, just to remind everyone, when in March of last year we got hit by currency. We explained the flow-through and the significant impact it had on our gross margin. We committed to recover at least a third of it in FY 2016. We’re doing better than expected at this point in time. We also said at the time that in the long run we would expect to fully recover on the currency. I’m not going to exactly guide FY 2017 now. We will do that at our Analyst Day. And of course, it will also depend where currency will land between now and March, right? But we definitely in the long run expect to fully recover. And that’s why we are holding our business model today at 35% gross margin or more.

All right, thank you very much. And if [indiscernible] quickly follow-up on the competitive situation, so your market share has been at least maintained and some peripheral focus of Apple or Nest hasn’t really shaken up anything so far.

Yes, our market shares continue to be intact. In fact, we’re growing market shares in virtually all of our categories around the world. And we’re continuing to invest very aggressively, as Vincent mentioned, up 8% year over year in innovation and we’re going to keep doing that.

Thanks very much.

Thank you.

Your next question comes from the line of Tavis McCourt from Raymond James. Please go ahead.

Hi, Tavis.

Hey, guys. Hey, thanks for taking my question, Bracken. First, a couple housekeeping items for Vincent, so the discontinued ops was about $20 million net loss year to date. Is that similar to what the non-GAAP EBIT impact is of Lifesize as well or is there some kind of tax benefit where there is a material difference there? And then, the other housekeeping one, Vincent, was I don’t think there were any stock buybacks in the quarter. Were there any circumstances that were - that led to that?

Yes, so Discontinued Operations, which is Lifesize, Lifesize in the first-half of the year had an operating loss on a non-GAAP basis of about $10 million. We explained at the last earnings call that we restructured that business on October 1, which was part of the restructuring charge of $5 million to $7 million that we booked last quarter for that restructuring. That plan called for breakeven results on the non-GAAP basis for Lifesize in the second-half. When you move into Discontinued Operations, we move the non-GAAP operating loss plus the restructuring, plus the stock-based compensation, which leads to you minus $20 million that you have seen. So minus $10 million was the answer. And breakeven for the second-half was the projection. Also note that we expect a gain on the GAAP basis. We’ll exclude it from our non-GAAP of $15 million to $20 million non-cash gain for closing the Lifesize deal here on December 28, which is part of our Q4 quarter. And that will be offsetting that discontinued operation of minus $20 million on the year-to-date basis. And then, the second question is around buyback. We put our buyback on hold, when we were discussing the term sheet with the investors that we’re taking operational control of Lifesize. It started right at the beginning of the quarter when the window opened that happened. And so we had to close it and we unfortunately only closed that deal at the end of December and so could not buy during the quarter. Moving forward, in the absence of any material information that we would have we will continue and resume the buyback.

Got you. And then, you’ll still own a minority portion of Lifesize, correct? So if there are profits or losses in a given quarter, we’ll see that below the operating line, is that the right way to think about it?

We have no operational control. The accounting method will be the cost method, so we will evaluate the value of that stake. If there is an impairment on an annual basis of that investment, it will be below the line. We’ll not consolidate the results on the quarterly basis for Lifesize operational results.

Great. And then, Bracken, my question for you is - another really strong performance in the profit maximization categories. And as I’m looking at the numbers here, it looks like it’s not just ASP increases, but the volumes are actually reasonably steady and obviously the PC numbers have not been as a category. And so, what I’m wondering is, I wonder if you could talk about kind of market growth that you see in these categories versus market share gains that Logitech has had. You mentioned you’ve been gaining share in most categories. Is this the market holding in better than the overall PC category or is this just the impact of Logitech taking share? Thanks.

I’d say three things, three response to that. First one is, even though the PC - the PC market continues to decline 11% this quarter, if you look in front of you, most of you - if you’re in your offices probably have a PC. So the PC usage actually is not declining like that at all. And so as a result, people are still using PCs. And PC peripherals are still pretty interesting to upgrade your experience with. And so, I think that’s one of the things that’s continued to keep our PC peripherals business pretty healthy. The second thing is that, yes, there is weakness in different categories in the PC peripheral space but we’re gaining share. We’re continuing to innovate. We don’t intend to let up and I think that formula can continue for quite some time, if not, forever. Did I answer your question there, Tavis?

Yes, thanks, Bracken.

Great. Thank you, Tavis.

Thank you.

Your next question comes from the line of Andrew Humphrey from Morgan Stanley. Please go ahead.

Hi, Andrew.

Hi, there. Thanks for taking the question and congratulations on the quarter. Maybe just one follow-up on the guidance upgrade, from what you’re saying if non-GAAP operating loss for Lifesize in the first-half was $10 million and you’re budgeting breakeven for the second-half, that’s just to me, that about a half of the upgrade from $150 million to $170 million is kind of organic and like-for-like, so just a confirmation there. And the other question I had was around working capital. Clearly, you saw a substantial benefit from winding up inventory on the OEM business over the quarter. How much of the inflow that you saw there was actually OEM-related. And I think looking into Q4 I think you’ve also said you aim to work on receivables between now and the end of the year. So can we expect to be like another strong operating cash performance in your fourth quarter?

Yes, let me handle those two questions, and let me start with the cash flow from operations. So we generated $166 million in the quarter. Normally, I guide - also we’ve done the formal guidance before you modeling that we generate cash flow from operations - sorry, at around one-time non-GAAP net income. We’ve done that in Q3, which is about half of the cash flow from operations. The other half is coming from the inventory reductions. From the OEM side, our OEM inventory was around $18 million decrease on the year over year basis. So that’s for - the first question was - can you remind me the first question was, Andrew?

Just around the guidance increase and kind of reconcile how much was like-for-like, if you like, versus - versus Lifesize related.

Yes, so I forgot the question. Simple answer, the answer is, yes, you’re correct. So half of the guidance increase is from Lifesize, the other half is from our over-delivery year to date.

Great. Thank you.

Thank you.

[Operator Instructions] Your next question comes from the line of Andreas Mueller from Zürcher Kantonalbank. Please go ahead.

Hi, Andreas.

Yes, hello, thanks for taking my question. The Circle product was not mentioned in the prepared remarks. Can you give us an update on the product and how well is it selling and what was the share in the Video Collaboration category? That’s the first question. And that last one was - is actually, what was the operating margin for OEM in the last quarter and would you expect to incur still some costs for OEM as well in the fourth quarter or is the chapter basically closed there?

Yes, I’ll answer the first one. And I’ll let Vincent answer the second one. The Circle camera launched in October in a very selected number of countries and accounts, and we’re very excited about it. I think if you haven’t - if those of you on the call haven’t bought one, we’d be happy to offer a discount if we can do that from a - probably we can’t. But you certainly could buy one and I think you’ll find the experiences really remarkable. I know both of us who around this table where we’re having this call check ours probably 10 times a day. It’s way too early to judge how it’s doing. It’s we’re getting distribution in the places we expected. It’s we’re getting merchandising in the way we expected. And we’re continuing to look at the whole market and figure out what role we’re going to play in it. But we’re really excited about the in-home camera market. The opportunity for us to get in and offer a differentiated product that - also delivers on the core experience of an in-home camera. And we’re doubling down on it and excited about it. So I’ll give you an update going forward, but so far it’s getting into the place as we expected and people are buying. And I’m getting continuous feedback that people love the product.

Okay.

On the OEM side, so we mentioned in last March that we were running Lifesize and OEM breakeven on a combined basis. Lifesize lost about $10 million in the first-half with breakeven projected for second-half. On the OEM side, we tried to hold breakeven as well, as we’re decreasing the cost, decreasing the inventory and holding breakeven. In this last quarter because the better-than-expected sales, we’re able to fully flush all of the inventory. We got a benefit from a reserve release of about $5 million. And so OEM is slightly positive on a year-to-date basis, offsetting basically the Lifesize first-half decline. And then moving forward, there is no more inventory, there is no more risk and there is no more expected revenue and/or return or the things in our P&L for OEM.

Okay. Thank you.

Thanks, Andreas.

Thank you. It appears there are no further questions. At this time, I’ll turn the conference back over to Mr. Darrell for closing remarks.

Thanks to all of you. We have very strong momentum going into our Q4. And we really look forward to updating you on our progress. And I hope that we’ll see many of you at our strategy - Analyst & Investor Day in Zürich on March 2. Thanks a lot for joining today. And we’ll talk to you again soon.

Thank you.

This concludes today’s conference call. You may now disconnect.