[November 07, 2011] LOGITECH INTERNATIONAL SA - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Tweet (Edgar Glimpses Via Acquire Media NewsEdge) 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, investment priorities, product plans, goals of targeted pricing actions, trends in consumer demand affecting our products and markets, our current or future revenue mix, our competitive position, and the impact of new product introductions and product innovation on future performance or anticipated costs and expenses. 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 should carefully review the risks described in other documents we file from time to time with the Securities and Exchange Commission, including the Quarterly Reports on Form 10-Q or Current Reports on Form 8-K that we file in fiscal year 2012 and our fiscal year 2011 Form 10-K, which was filed on May 27, 2011, which discuss our business in greater detail. 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, audio and video communication over the Internet, video security, and home-entertainment control. We have two operating 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, webcams, and lapdesks. Our tablet accessories include keyboards, keyboard cases, earphones, wireless speakers and speaker stands. Our Internet communications products include webcams, headsets, video communications services, and digital video security systems for a home or small business. Our digital music products include speakers, earphones, and custom in-ear monitors. For home entertainment systems, we offer the Harmony line of advanced remote controls, Squeezebox wireless music solutions and, in the United States, a line of Logitech products for the Google TV platform. For gaming consoles, we offer a range of gaming controllers and microphones, as well as other accessories. Our peripherals research and product management teams are organized along product lines, and are responsible for product strategy, industrial design and development, and technological innovation. Our global marketing and sales organization helps define product opportunities and bring our products to market, and is responsible for building the Logitech brand and consumer awareness of our products. This organization is comprised of retail and OEM (original equipment manufacturer) sales and marketing groups. Our retail sales and marketing activities are organized into three geographic regions: Americas (including North and South America), EMEA (Europe-Middle East-Africa), and Asia Pacific (including, among other countries, China, Taiwan, Japan, India and Australia). In addition, we recently established an organization focused on developing and selling products for enterprise markets, including peripherals for 28 -------------------------------------------------------------------------------- Table of Contents unified communications applications. This group combines product management and sales personnel for enterprise products, including our OEM sales team, into one organization. We sell our peripheral products to a network of distributors and resellers and to 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 84% of our net sales for the six months ended September 30, 2011 and 85% of our net sales for the fiscal year ended March 31, 2011. The large majority of our revenues have historically been derived from sales of our peripheral products for use by consumers. Our OEM customers include the majority of the world's largest PC manufacturers. Sales to OEM customers were 9% of our net sales for the six months ended September 30, 2011 and the fiscal year ended March 31, 2011. Our video conferencing segment encompasses the design, manufacturing and marketing of LifeSize video conferencing products, infrastructure and services for the enterprise, public sector, and other business markets. LifeSize 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 LifeSize division maintains a separate marketing and sales organization, which sells LifeSize products and services worldwide. LifeSize product development and product management organizations are separate, but coordinated with our peripherals business, particularly our webcam and video communications groups. We sell our LifeSize products and services to distributors, value-added resellers, OEMs, and, occasionally, direct enterprise customers. Sales of LifeSize products were 6% of our net sales for the fiscal year ended March 31, 2011 and 7% of our net sales for the six months ended September 30, 2011. 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 customer 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. We believe innovation and product quality are important to gaining market acceptance and maintaining market leadership. We are developing new categories of products, such as tablet accessories, expanding in emerging retail markets, such as China, Russia and Latin America, and entering new product arenas, such as hosted video conferencing as a service, and peripherals and services for UC (unified communications). 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. Our 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 markets 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. 29 -------------------------------------------------------------------------------- Table of Contents As we address the current and future market challenges we face, we plan to continue to align our resources and prioritize our investments so that we may develop promising new opportunities and seek to optimize profitability on our current product portfolio. We plan to increase our investments in emerging geographic markets and new categories, including tablet peripherals, video communications, business-to-business, digital home products, and UC. Although we primarily broaden our product lines organically, we also seek to partner with or acquire, when appropriate, companies that have products, personnel, and technologies that complement our strategic direction. We continually evaluate our product offerings and our strategic direction in light of changing consumer trends and the evolving nature of the interface between the consumer and the digital world. Summary of Financial Results Our total net sales for the six months ended September 30, 2011 of $1.1 billion were approximately the same as the total net sales for the six months ended September 30, 2010. Retail sales increased 1% and units sold increased 2%, while OEM sales and units decreased 17% and 14%. Retail sales in our Asia Pacific regions increased 25% in the six months ended September 30, 2011 compared with 2010, while weak demand in our EMEA region decreased retail sales by 6% , and inventory management actions by our direct channel partners decreased retail sales in our Americas region by 2%. If foreign currency exchange rates had been the same in six months ended September 30, 2011 and 2010, the percentage changes in our constant dollar total net sales would have been an increase of 21% in Asia Pacific, a decrease of 1% in the Americas, and a decrease of 14% in EMEA. Gaming was our best-performing retail product category during the six months ended September 30, 2011, with sales increasing 43% over the same period in 2010 based on strong sales of our steering wheels. Retail sales of keyboards and desktops increased 20%, driven by cordless keyboards and our initial launch of iPad specific keyboard products. Our weakest performing product category in the six months ended September 30, 2011 was Digital Home, as sales of our Harmony remotes declined 44%, with sales falling significantly in EMEA and the Americas. Our gross margin for the six months ended September 30, 2011 was 30.3% compared with 36.4% in the six months ended September 30, 2010. The decline in gross margin was primarily due to a $34.1 million valuation adjustment during the quarter ended June 30, 201, reflecting the lower of cost or market on our inventory of Logitech Revue and related peripherals on hand and at our suppliers, and a shift in product mix to lower-margin retail products, offset by increase LifeSize sales and the positive effect of foreign currency translation. Operating expenses increased 7% in the six months ended September 30, 2011, due to investments in our LifeSize division, B2B (business to business) and China sales and marketing, and the impact of foreign currency exchange rates. Net loss for the six months ended September 30, 2011 was $12.2 million, compared with net income of $60.7 million for the six months ended September 30, 2010. 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. The increasing popularity of smaller, mobile computing devices such as tablets and smartphones with touch interfaces and the declining popularity of desktop PCs has rapidly changed the market and usage models for PC peripherals. Consumer demand for PCs is slowing in our traditional, mature markets such as North America, Western and Nordic Europe, Japan, Australia, and New Zealand, and we believe sales of our PC peripherals in mature markets will decline in fiscal year 2012 and potentially beyond. In response, we intend to increasingly differentiate our approach to PC peripheral categories and markets. We also believe our future sales growth will be significantly impacted by our ability to innovate in our core peripherals business, grow sales in emerging markets, to increase our sales of products for enterprises, to grow our LifeSize video conferencing division, and to develop sales and 30 -------------------------------------------------------------------------------- Table of Contents innovations for our emerging product categories, such as our products for tablets, digital music, and the digital home. We believe there are continued growth opportunities for our PC peripherals outside the more mature markets of the Americas and Europe. We are investing significantly in growing the number of our sales, marketing and administrative personnel in China. We are also expanding our presence and our sales in Russia, India and Latin America. We believe these markets offer high potential for us, but growing and conducting business in these markets will continue to require significant investment and management focus, and our return on investment is not certain due to, among other things, the challenges presented by potentially entrenched local competition, higher credit risks, and cultural differences that affect consumer trends in ways which may be substantially different from our current major markets. We also believe there are opportunities to sell products to consumers to help make their tablets and other mobile devices more productive and comfortable. We launched our iPad specific keyboard products during the quarter ended June 30, 2011, which contributed to the sales growth in our keyboards and desktops product family in the three and six months ended September 30, 2011. This new tablet accessories product line includes the Keyboard Case for iPad2 and the Tablet Keyboard for iPad, with additional products planned for launch in future quarters. However, consumer acceptance and demand for peripherals for use with tablets and other mobile computing devices is still unproven. We are focusing more of our efforts on creating and selling products and services to enterprises, including for use in UC. We believe the preferences of employees increasingly drive companies' choices in the information technologies they deploy to their employee base, and that this consumerization of information technology has made the business market open to embracing consumer technology and design. While our LifeSize division has extensive experience in developing and selling products for enterprises, we are still in the early stages of our B2B efforts for our peripherals and related services, and growing our enterprise business will continue to require investment in product marketing and sales channel development. Our LifeSize video conferencing segment represented 7% of our net sales for the six months ended September 30, 2011 and 6% of our net sales for the fiscal year ended March 31, 2011. On July 18, 2011, Logitech acquired Mirial S.r.l., an Italian company that is a leading provider of personal and mobile video conferencing solutions. Mirial will be integrated into the LifeSize division, and we expect that its technology will be used to enhance video connection capabilities on a variety of mobile devices and networks. While we expect sales from the LifeSize division to continue to grow faster than our overall sales, we also expect the division will require significant continuing investments in product development and sales and marketing to stimulate and support future growth. Sales of video products represented 12% of our total retail sales in the six months ended September 30, 2011 and 13% of our total retail sales in the year ended March 31, 2011. Logitech's video products category consists primarily of webcams, with a smaller, growing line-up of Logitech Alert video security systems. The long-term growth potential for webcams is unclear, as the embedded webcam experience appears to be sufficient to meet the needs of many retail consumers as the quality of embedded webcams improves. In the digital home, we invested significantly in developing and marketing our Logitech Revue and related peripherals for the Google TV platform in the United States. As a result of poor initial sales of these products, we reduced the retail price of Logitech Revue from $249 to $99 in the quarter ended September 30, 2011. This action resulted in a $34.1 million valuation adjustment to cost of goods sold in the three months ended June 30, 2011. We expect our inventory of Logitech Revue products will be fully depleted in the quarter ended December 31, 2011. We do not plan to build a successor to Logitech Revue. However, we plan to take advantage of future peripheral opportunities around the Google TV platform as such opportunities arise. 31 -------------------------------------------------------------------------------- Table of Contents Sales of our OEM mice and keyboards have historically made up the bulk of our OEM sales. OEM sales accounted for 9% of total revenues during the six months ended September 30, 2011 and the fiscal year ended March 31, 2011. In recent years, the shift away from desktop PCs adversely affected our sales of OEM mice and keyboards, 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. Our balance sheet includes goodwill of $239.6 million related to various past acquisitions which are part of our peripherals reporting unit, and $320.7 million related to our video conferencing reporting unit. We evaluate goodwill for impairment at the reporting unit level annually during our fiscal fourth quarter, and whenever events or changes in circumstances indicate that the carrying amount may exceed the fair value of the reporting unit. Events or changes in circumstances which might indicate potential impairment in goodwill include, among other key factors described in our Form 10-K, volatility in stock price, a sustained decline in market capitalization relative to net book value, and lower than projected revenue, market growth, or operating results. Based on the impairment analysis performed in fiscal year 2011, the fair value of each of our reporting units exceeded the carrying value of the reporting unit by more than 50% of the carrying value. During the quarter ended September 30, 2011 and after the quarter-end, we experienced volatility in our stock price and market capitalization. During this period, the Company's market capitalization was greater than its net book value. In September 2011, we reduced our projected fiscal year 2012 consolidated operating results, based on the current economic environment in mature western markets and the Company's current product offerings. As our consolidated operating results are projected to be profitable for fiscal year 2012, management determined there were no triggering events requiring the review of goodwill for impairment as of September 30, 2011. Management continues to evaluate and monitor all key factors impacting the carrying value of our recorded goodwill, as well as other long lived assets. Further adverse changes in the Company's expected operating results, market capitalization, business climate, or other negative events could result in a non-cash impairment charge in the future. We continue to evaluate potential acquisitions to enhance the breadth and depth of our expertise in engineering and other functional areas, our technologies and our product offerings. Most of our revenue comes from sales to our retail channels, which resell to consumers, retailers and distributors. As a result, our customers' demand for our products depends in substantial part on trends in consumer confidence and consumer spending, as well as the levels of inventory which our customers, and their customers, choose to maintain. We use sell-through data, which represents sales of our products by our retailer customers to consumers, and by our distributor customers to their customers, along with other metrics to indicate consumer demand for our products. Sell through data is subject to limitations due to collection methods and the third party nature of the data and thus may not be an entirely accurate indicator of actual consumer demand for our products. In addition, the customers supplying sell through data vary by geographic region and from period to period, but typically represent a majority of our retail sales. We also use a metric of channel inventory, which are estimates of the inventory levels of our products held by or in-transit to our retailer and distributor customers, to indicate aggregate supply of our customers to meet demand by their customers and the potential for future sales by our customers. Channel inventory includes data compiled by Logitech from data supplied by our customers, as well as our estimates of inventory in-transit to our customers. The customers supplying this data vary by geographic region and from period to period, but typically represent a majority of our retail sales. Channel inventory data is subject to limitations and possible error sources, and may not be an entirely accurate indicator of actual customer channel inventory. The data supplied by our customers may not be indicative of inventory held by our customers as a whole. Reliability of the data depends on the accuracy and timeliness of the information supplied to us by our customers, and the processes by which they collect their data, which are largely outside of our control. The data is generally based on POS (Point of Sale) electronic data, the availability and accuracy of which varies by geographic region. Where POS data is not available, the data is collected primarily through manual processes, which are subject to typical human errors, including errors in data entry, transmission or interpretation. In addition, our interpretation of the data, and our estimates of in-transit inventory may be subject to errors in assumptions, calculations or other unintentional errors. 32 -------------------------------------------------------------------------------- Table of Contents Although our financial results are reported in U.S. dollars, approximately 41% of our sales for the six months ended September 30, 2011 were made in currencies other than the U.S. dollar, such as the euro, Chinese renminbi and Japanese yen. Our product costs are primarily in U.S. dollars and Chinese renminbi. Our operating expenses are incurred in U.S. dollars, Chinese renminbi, Swiss francs, euros and, to a lesser extent, 29 other currencies. To the extent that the U.S. dollar significantly increases or decreases in value relative to the currencies in which our sales and operating expenses are denominated, the reported dollar amounts of our sales and expenses may decrease or increase. Our gross margins vary with the mix of products sold, competitive activity, product life cycle, new product introductions, unit volumes, commodity and supply chain costs, foreign currency exchange rate fluctuations, geographic sales mix, and the complexity and functionality of new product introductions. Changes in consumer demand for our products affect the need for us to undertake promotional efforts, such as cooperative marketing arrangements, customer incentive programs or other pricing programs, which also alter our product gross margins. Logitech is incorporated in Switzerland but operates in various countries with differing tax laws and rates. A portion of our income before taxes and the provision for income taxes are generated outside of Switzerland. Therefore, our effective income tax rate depends on the amount of profits generated in each of the various tax jurisdictions in which we operate. For the six months ended September 30, 2011, the income tax benefit was $4.7 million based on an effective income tax rate of 27.7% of pre-tax loss. For the six months ended September 30, 2010, the income tax provision was $3.5 million based on an effective income tax rate of 5.4% of pre-tax income. The change in the effective income tax rate for the six months ended September 30, 2011 compared with the six months ended September 30, 2010 was primarily due to the mix of income and losses in the various tax jurisdictions in which the Company operates, and a discrete tax benefit of $7.2 million in the six months ended September 30, 2010 from the closure of income tax audits in certain jurisdictions. 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 the Company 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 we believe to be reasonable under the circumstances. Although these estimates are based on management's best knowledge of current events and actions that may impact the Company in the future, actual results could differ from those estimates. Management has discussed the development, selection and disclosure of these critical accounting estimates with the Audit Committee of the Board of Directors. There have been no significant changes during the six months ended September 30, 2011 to the nature of the critical accounting estimates disclosed in the Management's Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the fiscal year ended March 31, 2011. Recent Accounting Pronouncements In May 2011, the FASB (Financial Accounting Standards Board) issued ASU (Accounting Standards Update) 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs. ASU 2011-04 provides a consistent definition of fair value and ensures that the fair value measurement and disclosure requirements are similar 33 -------------------------------------------------------------------------------- Table of Contents between U.S. GAAP and International Financial Reporting Standards. ASU 2011-04 also changes certain fair value measurement principles and enhances the disclosure requirements particularly for level 3 fair value measurements. ASU 2011-04 is effective during interim and annual periods beginning after December 15, 2011. The Company will adopt ASU 2011-04 in the fourth quarter of fiscal year 2012. The Company is evaluating the impact of adopting ASU 2011-04, but currently believes there will be no significant impact on its consolidated financial statements. In June 2011, the FASB issued ASU 2011-05, Comprehensive Income (Topic 220)-Presentation of Comprehensive Income. ASU 2011-05 requires disclosure of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. ASU 2011-05 eliminates the option to present the components of other comprehensive income as part of the statement of changes in shareholders' equity. ASU 2011-05 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. The Company will adopt ASU 2011-05 in the first quarter of fiscal year 2013. The adoption of this standard will impact only the presentation format of the consolidated financial statements. In September 2011, the FASB issued ASU 2011-08, Intangibles - Goodwill and Other (Topic 350). ASU 2011-08 provides entities the option to first assess qualitatively whether it is necessary to perform the two-step goodwill impairment test. If an entity concludes, as a result of its qualitative assessment, that it is more likely than not that the fair value of a reporting unit is less than its carrying amount, the quantitative two-step goodwill impairment test is required. An entity may elect to bypass the qualitative assessment and proceed to perform the first step of the two-step goodwill impairment test. ASU 2011-08 is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. The Company will adopt ASU 2011-08 in the first quarter of fiscal year 2013. The adoption of this standard is not expected to have a material impact on the consolidated financial statements and footnote disclosures. Results of Operations Net Sales Net sales by channel for the three and six months ended September 30, 2011 and 2010 were as follows (in thousands): Three months ended Six months ended September 30, September 30, 2011 2010 Change % 2011 2010 Change % Retail $ 501,735 $ 489,721 2 % $ 896,511 $ 883,587 1 % OEM 50,261 60,850 (17 )% 99,439 119,186 (17 )% LifeSize 37,208 31,313 19 % 73,695 58,441 26 % Total net sales $ 589,204 $ 581,884 1 % $ 1,069,645 $ 1,061,214 1 % Our total net sales were approximately the same in the three and six months ended September 30, 2011 as in the three and six months ended September 30, 2010. For the fiscal quarter, growth in Asia Pacific retail sales and sales of the LifeSize division were offset by essentially flat retail sales in the EMEA region, declines in the Americas region retail sales, and declines in OEM sales in both EMEA and the Americas. For the six month period ended September 30, 2011, the increases in Asia Pacific region retail sales and LifeSize division sales were offset by declines in retail and OEM sales in both EMEA and the Americas, compared with the six month period ended September 30, 2010. 34 -------------------------------------------------------------------------------- Table of Contents The following table presents the approximate percentage of the Company's total net sales that were denominated in currencies other than the U.S. dollar in the three and six months ended September 30, 2011 and 2010: Three months ended September 30, Six months ended September 30, 2011 2010 2011 2010 Currencies other than USD 44 % 43 % 41 % 41 % If foreign currency exchange rates had been the same in three and six months ended September 30, 2011 and 2010, the percentage change in our constant dollar net sales would have been: Three months ended Six months ended September 30, 2011 September 30, 2011 Retail (1 )% (3 )% OEM (18 )% (17 )% LifeSize 19 % 26 % Total net sales (2 )% (3 )% Retail units sold increased 2% in both the three and six months ended September 30, 2011 compared with the three and six months ended September 30, 2010. Our overall retail average selling price was unchanged in the three months ended September 30, 2011 compared with 2010, and decreased 5% in the six months ended September 30, 2011 compared with 2010. Sales of our retail products priced above $100 represented approximately 15% and 16% of total retail sales in the three and six months ended September 30, 2011, compared with approximately 17% and 16% in the three and six months ended September 30, 2010. Products priced below $40 represented approximately 54% and 55% of retail sales in the three and six months ended September 30, 2011 compared with 57% and 59% in the three and six months ended September 30, 2010. Units sold to OEM customers declined 6% and 14% during the three and six months ended September 30, 2011 compared with the same periods in the prior fiscal year, primarily due to decreased sales of microphones for console singing games, which declined 98% and 96% in the three and six months ended September 30, 2011 compared with 2010. Console microphone sales are opportunistic and continue to be subject to significant variation from quarter-to-quarter and year-to-year. Sales of OEM keyboards and desktops increased 6% and 12% in dollars during the three and six months ended September 30, 2011 compared with the prior year, with units sold up 17% and 8% during those periods. Sales of mice to our OEM customers increased 2% in the three month period, and units sold grew 7% compared with the prior year period. For the six months ended September 30, 2011, sales of OEM mice decreased 5%, with units sold down 7%. LifeSize net sales represent sales of video conferencing units and related software and services. Sales increased 19% and 26% in the three and six months ended September 30, 2011 compared with the three and six months ended September 30, 2010. We experienced strong demand during the first fiscal quarter and the first six weeks of the second fiscal quarter, but concerns about potentially deteriorating economic conditions lengthened the sales cycle in both the U.S. and Europe during the last half of the second fiscal quarter. We refer to our net sales excluding the impact of foreign currency exchange rates as constant dollar sales. Constant dollar sales are a non-GAAP financial measure, which is information derived from consolidated financial information but not presented in our financial statements prepared in accordance with U.S. GAAP. Our management uses these non-GAAP measures in its financial and operational decision-making, and believes these non-GAAP measures, when considered in conjunction with the corresponding GAAP measures, facilitate a better understanding of changes in net sales. Constant dollar sales are calculated by translating prior period sales in each local currency at the current period's average exchange rate for that currency. 35 -------------------------------------------------------------------------------- Table of Contents Retail Sales by Region The following table presents the changes in retail units sold, retail sales and constant dollar retail sales by region for the three and six months ended September 30, 2011 compared with the three and six months ended September 30, 2010. Three months ended September 30, 2011 Six months ended September 30, 2011 Change in Change in Change in Change in Retail Units Change in Constant Dollar Retail Units Change in Constant Dollar Sold Retail Sales Retail Sales Sold Retail Sales Retail Sales EMEA (3 )% (1 )% (7 )% (7 )% (6 )% (14 )% Americas (6 )% (3 )% (2 )% (3 )% (2 )% (1 )% Asia Pacific 21 % 22 % 18 % 26 % 25 % 21 % Total retail sales 2 % 2 % (1 )% 2 % 1 % (3 )% Retail sales in the EMEA region have declined over the three and six months ended September 30, 2011, due to weak demand for our products across much of Western Europe, particularly in the mature markets of Southern Europe such as Italy and Spain, where the economic environment was particularly challenging. We achieved strong growth in the three and six month periods in emerging markets, particularly in Russia. In addition, the strengthening of the U.S. dollar partially offset the constant dollar sales decline. In the three months ended September 30, 2011, sales growth in the audio and gaming product families and in keyboards and desktops was offset by sales decreases in the video, digital home and pointing devices product families. The largest retail sales declines in the six month period occurred in the digital home product family, partially offset by a substantial increase in the sale of gaming products. Management believes that full implementation of the necessary operational changes related to the EMEA-specific pricing and channel management issues we experienced in the fourth quarter of fiscal year 2011 will continue through the next one or two quarters of fiscal year 2012. Retail sell-through improved 6% in the three months and 4% in the six months ended September 30, 2011 compared with the same periods in the prior fiscal year. Management believes that sales in the Americas region in the three months ended September 30, 2011 were negatively impacted by our channel partners' more cautious approach to inventory management, which reflects their overall concerns about uncertain economic conditions. Increased sales of keyboards and desktops, digital home products, audio products and gaming products were more than offset by sales declines in video and pointing devices in the three months ended September 30, 2011 compared with 2010. For the six months ended September 30, 2011, sales of keyboards and desktops and of gaming products increased, but all other product lines declined in sales. Retail sell-through in the Americas region increased 14% during both the three and six months ended September 30, 2011 compared with the prior year. Asia Pacific region's retail sales grew during the three and six months ended September 30, 2011 compared with 2010, driven primarily by sales in China, which increased 57% in the three month period and 71% in the six month period compared with the prior year. All product lines except digital home grew in the three and six months ended September 30, 2011 compared with 2010. Retail sell-through during the quarter increased 25% from the prior year, in line with the sales growth. During the six month period, retail sell-through grew 23% over the same period in the prior year. 36 -------------------------------------------------------------------------------- Table of Contents Net Retail Sales by Product Family Net retail sales by product family during the three and six months ended September 30, 2011 and 2010 were as follows (in thousands): Three months ended Six months ended September 30, September 30, 2011 2010 Change % 2011 2010 Change % Retail - Pointing Devices $ 148,386 $ 153,870 (4 )% $ 280,448 $ 285,716 (2 )% Retail - Keyboards & Desktops 109,325 94,507 16 % 203,921 169,788 20 % Retail - Audio 130,815 119,965 9 % 212,379 215,611 (1 )% Retail - Video 57,422 68,794 (17 )% 107,267 115,850 (7 )% Retail - Gaming 29,152 21,207 37 % 52,545 36,658 43 % Retail - Digital Home 26,635 31,378 (15 )% 39,951 59,964 (33 )% Total net retail sales $ 501,735 $ 489,721 2 % $ 896,511 $ 883,587 1 % Logitech's Pointing Devices product family includes our mice, trackballs and other pointing devices. Keyboards and desktops (mouse and keyboard combined) include cordless and corded keyboards and desktops, and keyboards and keyboard cases for tablets. Audio includes speakers and headset products for the PC, the home, the tablet and other mobile entertainment platforms, and wireless music systems. Our video product family is comprised of PC webcams and Alert video security systems. Gaming includes console and PC gaming peripherals. The Digital Home product family combines our advanced Harmony Remote controls and Logitech Revue with related peripherals. Net sales reflect accruals for product returns, cooperative marketing arrangements, customer incentive programs and pricing programs. Retail Pointing Devices Retail unit sales of pointing devices increased 1% in the three months and 5% in the six months ended September 30, 2011 compared with the same periods in 2010. Dollar sales of cordless mice decreased 2% in the three month period and increased 3% in the six month period compared with 2010, while units grew 9% and 16% in the same periods. The growth differential between dollar and unit sales reflects sales increases in the low- and mid-range of the product line, but sales declines of 29% and 10% in high-end cordless mice for the three and six months ended September 30, 2011, indicating the lack of a compelling up-sell proposition in the category. Traditionally, our cordless mouse portfolio has featured at least one well-differentiated, richly innovative offering on the high end, a product gap we plan to fill in the coming quarters. Dollar sales of cordless mice were strong in the Asia Pacific region and particularly in China, in both the three and six month periods, but declined in EMEA and the Americas. Unit sales of cordless mice grew in all three regions during the six months ended September 30, 2011 compared with 2010, and declined only in the Americas during the three month period. Sales of corded mice decreased 11% and 14% in the three and six months ended September 30, 2011 compared with the prior fiscal year, with dollar sales generally declining in all regions for both periods. Unit sales of corded mice declined in the EMEA and Americas regions in the three and six months ended September 30, 2011, and grew in the Asia Pacific region in both periods. Retail Keyboards and Desktops Retail unit sales of keyboards and desktops increased 5% and 9% during the three and six months ended September 30, 2011 compared with 2010. Sales of cordless keyboards more than doubled in dollars and units in both the three month and six month periods compared with the prior year, led by the Wireless Solar Keyboard K750 and the Wireless Keyboard K360. All regions achieved strong sales growth in cordless keyboards. Sales of cordless desktops increased 4% and 3% in dollars during the three and six months ended September 30, 2011 compared with 2010. We launched our iPad specific keyboard products during the quarter ended June 30, 2011, which contributed to the sales growth in the three and six month periods. This new tablet accessories product line includes the Keyboard Case for iPad2 and the Tablet Keyboard for iPad, with additional products planned for launch in future quarters. Corded keyboards and desktops sales declined 19% and 9% in dollars during the three and six months ended September 30, 2011 compared with the same periods in the prior fiscal year. 37 -------------------------------------------------------------------------------- Table of Contents Retail Audio Retail audio unit sales grew 7% in the three months, and decreased 3% in the six months ended September 30, 2011 compared with the same period in the prior year. In the three month period, dollar sales increased in all three regions, with the strongest growth in the EMEA region. In the six month period, sales growth in the Asia Pacific region was offset by declines in EMEA and the Americas. PC speaker sales increased 16% and 3% in dollars and 11% and 3% in units in the three months and six months ended September 30, 2011 compared with 2010. Sales of our digital music speakers increased 1% in dollars and 16% in units in the three months ended September 30, 2011 compared with the prior year. In the six month period, digital music speaker sales decreased 5% in dollars and 1% in units compared with 2010. Our Ultimate Ears line of products contributed to the growth in audio during the fiscal quarter and the six month period. Retail Video Retail unit sales in the Video category decreased 12% in the three months and 11% in the six months ended September 30, 2011 compared with 2010. Strong sales in the Asia Pacific region in both the quarter and six months were more than offset by declines in EMEA and the Americas. Sales of the Logitech Alert line of digital video security systems increased 4% in the three month period ended September 30, 2011, and more than tripled in the six month period compared with 2010. Logitech Alert was launched in August, 2010. Webcam sales declined 17% and 13% in dollars and 12% and 11% in units in the three and six months ended September 30, 2011 compared with the same periods in 2010. The long-term growth potential for webcams is unclear, as the embedded webcam experience appears to be sufficient to meet the needs of many retail consumers. We plan to enhance our product line-up by enabling experiences that cannot be easily achieved with an embedded webcam. Retail Gaming Retail unit sales of our gaming peripherals decreased 2% and 4% in the three and six months ended September 30, 2011 compared with the same period in 2010, while dollar sales grew 37% and 43% in those periods. All regions achieved sales growth in gaming peripherals in both the three and six month periods, particularly in Asia Pacific where dollar sales doubled in both the three and six months. The world-wide dollar sales growth in gaming peripherals was driven by our steering wheels for PC and console games. Steering wheels have higher selling prices than our other gaming products, which is the main factor in the variation between sales growth and unit decline in the gaming category. PC gaming sales increased 42% in dollars and 1% in units in the three months ended September 30, 2011 compared with 2010. In the six month period, PC gaming sales increased 46% in dollars and decreased 1% in units. Console gaming sales increased 19% and 39% in dollars and decreased 27% and 21% in units in the three and six months ended September 30, 2011 compared with 2010. Retail Digital Home Retail unit sales in our digital home category, which includes Harmony remotes, Logitech Revue, and our Google TV peripherals, increased 31% during the quarter ended September 30, 2011 and decreased 17% in the six months ended September 30, 2011 compared with the same periods in the prior fiscal year. Sales of Harmony remotes decreased 40% and 44% in the three and six month periods, with sales falling significantly in both the Americas and EMEA. Unit sales of Harmony remotes increased 4% in the fiscal quarter and decreased 29% in the six months ended September 30, 2011 compared with the same periods in 2010. The differential between dollar sales and unit sales was due to a significant shift to lower price points, particularly in the three month period, when sales in the low end of the category increased by 61%. The Harmony One, launched in January 2008, was the highest seller during the six months ended September 30, 2011. In order to address the decline in Harmony sales and the trend to lower-price products during the last few quarters, management intends to strengthen the product line-up in the upcoming quarters. As part of this effort, we introduced the Logitech Harmony Link in September 2011, which is a small WiFi device that transforms an iPad, iPhone or Android Smartphone into a full-featured remote control. Sales of Logitech Revue and related peripherals partly offset the sales decline in Harmony remotes during the three and six months ended September 30, 2011 compared with 2010. 38 -------------------------------------------------------------------------------- Table of Contents Gross Profit Gross profit for the three and six months ended September 30, 2011 and 2010 was as follows (in thousands): Three months ended Six months ended September 30, September 30, 2011 2010 Change % 2011 2010 Change % Net sales $ 589,204 $ 581,884 1 % $ 1,069,645 $ 1,061,214 1 % Cost of goods sold 390,783 364,950 7 % 745,617 675,251 10 % Gross profit $ 198,421 $ 216,934 (9 )% $ 324,028 $ 385,963 (16 )% Gross margin 33.7 % 37.3 % (10 )% 30.3 % 36.4 % (17 )% Gross profit consists of net sales, less cost of goods sold which includes materials, direct labor and related overhead costs, costs of manufacturing facilities, costs of purchasing components from outside suppliers, distribution costs, write-down of inventories and amortization of intangible assets. The decline in gross margin for the three months ended September 30, 2011 compared with 2010 was primarily the result of product mix, partially offset by the increase in LifeSize sales and a positive effect from foreign currency translation. Gross margin declined in the six months ended September 30, 2011 compared with the prior year primarily due to the $34.1 million valuation adjustment to cost of goods sold during the quarter ended June 30, 2011, reflecting the lower of cost or market on our inventory of Logitech Revue and related peripherals on hand and at our suppliers. A shift in product mix to lower-margin retail products also contributed to the lower margin. These negative impacts were partially offset by increased LifeSize sales and the positive effect of foreign currency translation. Operating Expenses Operating expenses for the three and six months ended September 30, 2011 and 2010 were as follows (in thousands): Three months ended Six months ended September 30, September 30, 2011 2010 Change % 2011 2010 Change % Marketing and selling $ 107,446 $ 97,412 10 % $ 207,239 $ 188,889 10 % % of net sales 18 % 17 % 19 % 18 % Research and development 39,491 40,927 (4 )% 79,472 79,316 0 % % of net sales 7 % 7 % 7 % 7 % General and administrative 27,989 27,420 2 % 58,854 54,780 7 % % of net sales 5 % 5 % 6 % 5 % Total operating expenses $ 174,926 $ 165,759 6 % $ 345,565 $ 322,985 7 % Over three-quarters of the increase in total operating expenses in the three months ended September 30, 2011, and nearly two-thirds of the increase in the six months ended September 30, 2011 compared with the same periods in the prior fiscal year were due to investments in the growth of our LifeSize division. We refer to our operating expenses excluding the impact of foreign currency exchange rates as constant dollar operating expenses. Constant dollar operating expenses are a non-GAAP financial measure, which is information derived from consolidated financial information but not presented in our financial statements prepared in accordance with U.S. GAAP. Our management uses these non-GAAP measures in its financial and operational decision-making, and believes these non-GAAP measures, when considered in conjunction with the corresponding GAAP measures, facilitate a better understanding of changes in 39 -------------------------------------------------------------------------------- Table of Contents operating expenses. Constant dollar operating expenses are calculated by translating prior period operating expenses in each local currency at the current period's average exchange rate for that currency. Marketing and Selling Marketing and selling expense consists of personnel and related overhead costs, corporate and product marketing, promotions, advertising, trade shows, customer and technical support and facilities costs. Marketing and selling expenses increased 10% in the three and six months ended September 30, 2011 compared with the same periods in the prior fiscal year primarily due to additional sales and marketing headcount for LifeSize, B2B, China and EMEA. Bonus reductions and decreases in travel and entertainment expense more than offset a slight increase in stock compensation costs due to the use of RSUs (restricted stock units) instead of stock options. Settlement of a customer bankruptcy suit also increased expenses in the six months ended September 30, 2011 compared with 2010. The impact of foreign currency exchange rates also caused marketing and selling expenses to increase. If foreign currency exchange rates had been the same in the three months ended September 30, 2011 and 2010, the percentage increase in constant dollar marketing and selling expense would have been 6% instead of 10%. If foreign currency exchange rates had been the same in the six months ended September 30, 2011 and 2010, the percentage increase in constant dollar marketing and selling expense would have been 5% instead of 10%. Research and Development Research and development expense consists of personnel and related overhead costs, contractors and outside consultants, supplies and materials, equipment depreciation and facilities costs, all associated with the design and development of new products and enhancements of existing products. The changes in research and development expense for the three and six months ended September 30, 2011 compared with 2010 were primarily due to personnel additions in our LifeSize division and B2B products, offset by reductions in bonus expense. Research and development expense for our peripherals division declined more than the change in retail peripherals sales. The impact of foreign currency exchange rates also caused research and development expenses to increase. If foreign currency exchange rates had been the same in the three months ended September 30, 2011 and 2010, the percentage decrease in constant dollar research and development expense would have been 7% instead of 4%. If foreign currency exchange rates had been the same in the six months ended September 30, 2011 and 2010, the percentage change in constant dollar research and development expense would have been a decrease of 4% instead of 0%. General and Administrative General and administrative expense consists primarily of personnel and related overhead and facilities costs for the finance, information systems, executive, human resources and legal functions. General and administrative expense increased due to higher personnel-related expenses, severance expense related to the former Chief Executive Officer, recruiting fees and increased litigation expenses. These increases were offset by lower stock compensation due to the Chief Executive Officer's departure, decreases in bonus expense and lower travel and entertainment expense. The impact of foreign currency exchange rates also caused general and administrative expenses to increase. If foreign currency exchange rates had been the same in the three months ended September 30, 2011 and 2010, the percentage change in constant dollar general and administrative expense would have been a decrease of 3% instead of an increase of 2%. If foreign currency exchange rates had been the same in the six months ended September 30, 2011 and 2010, the percentage increase in constant dollar general and administrative expense would have been 2% instead of 7%. 40 -------------------------------------------------------------------------------- Table of Contents Interest Income, Net Interest income and expense for the three and six months ended September 30, 2011 and 2010 were as follows (in thousands): Three months ended Six months ended September 30, September 30, 2011 2010 Change % 2011 2010 Change % Interest income $ 601 $ 650 (8 )% $ 1,291 $ 1,173 10 % Interest expense - (15 ) 100 % - (17 ) 100 % Interest income, net $ 601 $ 635 (5 )% $ 1,291 $ 1,156 12 % The changes in interest income for the three and six months ended September 30, 2011 compared with the same period in the prior fiscal year resulted from lower invested balances, partially offset by higher interest rates. Other Income, Net Other income and expense for the three and six months ended September 30, 2011 and 2010 were as follows (in thousands): Three months ended Six months ended September 30, September 30, 2011 2010 Change % 2011 2010 Change % Foreign currency exchange losses, net $ (1,053 ) $ (1,421 ) (26 )% $ (713 ) $ (1,061 ) (33 )% Gain on sale of property and plant - - 0 % 4,904 838 485 % Investment loss related to deferred compensation plan (716 ) (611 ) 17 % (528 ) (176 ) 200 % Other, net 6 238 (97 )% (235 ) 401 (159 )% Other income (expense), net $ (1,763 ) $ (1,794 ) (2 )% $ 3,428 $ 2 171300 % Foreign currency exchange gains or losses relate to balances denominated in currencies other than the functional currency of a particular subsidiary, to the sale of currencies, and to gains or losses recognized on foreign exchange forward contracts. The decline in foreign currency exchange losses in the three and six months ended September 30, 2011 compared with 2010 resulted primarily from lower losses on foreign exchange swap contracts. The gain on sale of building for the six months ended September 30, 2011 relates to the sale of an unused manufacturing facility in China. The gain on sale of building in the same period in 2010 relates to the sale of our building in Romanel, Switzerland. Investment income for the three and six months ended September 30, 2011 represents earnings and realized and unrealized losses on trading investments related to a deferred compensation plan offered by one of our subsidiaries. Investment income for the three and six months ended September 30, 2010 represents changes in the cash surrender value of Company-owned life insurance contracts, related to the same management deferred compensation plan. In December 2010, the Company surrendered the life insurance contracts for cash, and invested the proceeds in a portfolio of mutual funds, which are classified as trading investments. 41 -------------------------------------------------------------------------------- Table of Contents Provision for Income Taxes The provision for income taxes and effective tax rates for the three and six months ended September 30, 2011 and 2010 were as follows (in thousands): Three months ended Six months ended September 30, September 30, 2011 2010 Change 2011 2010 Change Provision for (benefit from) income taxes $ 4,888 $ 8,856 (45 )% $ (4,657 ) $ 3,454 (235 )%Effective income tax rate 21.9 % 17.7 % 27.7 % 5.4 % The provision for income taxes consists of income and withholding taxes. Logitech operates in multiple jurisdictions and its profits are taxed pursuant to the tax laws of these jurisdictions. The Company's effective income tax rate may be affected by changes in or interpretations of tax laws in any given jurisdiction, utilization of net operating loss and tax credit carryforwards, changes in geographical mix of income and expense, and changes in management's assessment of matters such as the ability to realize deferred tax assets. The change in the effective income tax rate for the three months ended September 30, 2011 compared with the three months ended September 30, 2010 is primarily due to the mix of income and losses in the various tax jurisdictions in which the Company operates. The change in the effective income tax rate for the six months ended September 30, 2011 compared with the six months ended September 30, 2010 is primarily due discrete tax benefits of $7.2 million in the six months ended September 30, 2010 from the closure of income tax audits in certain jurisdictions. Current deferred tax assets increased from $27.0 million as of March 31, 2011 to $42.9 million as of September 30, 2011. The increase is primarily due to the tax benefit from operating losses generated in the six month period ended September 30, 2011. As of September 30 and March 31, 2011, the total amount of unrecognized tax benefits and related accrued interest and penalties due to uncertain tax positions was $136.9 million and $138.1 million, of which $116.6 million and $118.2 million would affect the effective income tax rate if recognized. The decline in the income tax liability associated with uncertain tax benefits is primarily due to the expiration of statutes of limitations, offset by the impact of foreign currency exchange rates and the accrual of interest expense. The Company continues to recognize interest and penalties related to unrecognized tax positions in income tax expense. As of September 30, 2011, accrued interest and penalties related to uncertain tax positions increased to $8.3 million from $8.0 million as of March 31, 2011. The Company files Swiss and foreign tax returns. For all these tax returns, the Company is generally not subject to tax examinations for years prior to 1999. The U.S. Internal Revenue Service has completed its field examinations of tax returns for the Company's U.S. subsidiary for fiscal years 2006 and 2007, and has issued NOPAs (notices of proposed adjustment) related to international tax issues for those years. The Company disagrees with the NOPAs and is contesting through the administrative process for the U.S. Internal Revenue Service claims regarding 2006 and 2007. The Company believes the outcome of this examination is not expected to have a material adverse effect on the consolidated operating results. In addition, the U.S. Internal Revenue Service is in the process of examining the Company's U.S. subsidiary for fiscal years 2008 and 2009. The Company is also under examination in other tax jurisdictions. At this time it is not possible to estimate the potential impact that these examinations may have on income tax expense. If the examinations are resolved unfavorably, there is a possibility they may have a material impact on our results of operations. Although the Company has adequately provided for uncertain tax positions, the provisions on these positions may change as revised estimates are made or the underlying matters are settled or otherwise resolved. Although the timing of the resolution or closure on audits is highly uncertain, the Company does 42 -------------------------------------------------------------------------------- Table of Contents not believe it is reasonably possible that the unrecognized tax benefits would materially change in the next twelve months. Liquidity and Capital Resources Cash Balances, Available Borrowings, and Capital Resources At September 30, 2011, our working capital was $555.1 million, compared with $450.4 million at September 30, 2010. The increase in working capital over the prior year was due to higher cash balances and lower current liabilities. During the six months ended September 30, 2011, operating activities provided net cash of $1.6 million. Our largest sources of operating cash flows were net income after adding non-cash expenses of depreciation, amortization, inventory valuation adjustment and share-based compensation expense, and increased accounts payable balances compared with March 31, 2011. These sources of operating cash flows were offset by increases in accounts receivable and inventory compared with March 31, 2011. Net cash used in investing activities was $34.8 million. We invested $20.9 million in capital expenditures for tooling, computer hardware and software, equipment, and leasehold improvements, which was partially offset by proceeds of $4.9 million from the sale of one of our buildings in the three months ended June 30, 2011. We also acquired Mirial S.r.l. for a total consideration of $18.8 million net of cash acquired of $1.4 million . Net cash used by financing activities was $63.5 million. We repurchased $73.1 million of shares under our share buyback program, which was partially offset by proceeds of $9.8 million from employee stock purchases and the exercise of stock options. At September 30, 2011, we had cash and cash equivalents of $379.5 million, comprised of bank demand deposits and short-term time deposits. Cash and cash equivalents are carried at cost, which is equivalent to fair value. The Company has credit lines with several European and Asian banks totaling $148.4 million as of September 30, 2011. As is common for businesses in European and Asian countries, these credit lines are uncommitted and unsecured. Despite the lack of formal commitments from the banks, we believe that these lines of credit will continue to be made available because of our long-standing relationships with these banks and our current financial condition. At September 30, 2011, there were no outstanding borrowings under these lines of credit. There are no financial covenants under these facilities. The Company has historically financed its operating and capital requirements primarily through cash flow from operations and, to a lesser extent, from capital markets and bank borrowings. Our normal liquidity for the next 12 months and our longer-term capital resource requirements are provided from three sources: cash flow generated from operations, cash and cash equivalents on hand, and borrowings, as needed, under our credit facilities. Cash Flow from Operating Activities The following table presents selected financial information and statistics as of September 30, 2011 and 2010 (dollars in thousands): September 30, 2011 2010 Accounts receivable, net $ 294,691 $ 304,998 Inventories 325,053 343,021 Working capital 555,111 450,420Days sales in accounts receivable (DSO) (1) 45 days 47 days Inventory turnover (ITO) (2) 4.8x 4.3x Net cash provided by operating activities $ 1,634 $ 4,890 -------------------------------------------------------------------------------- (1) DSO is determined using ending accounts receivable as of the most recent quarter-end and net sales for the most recent quarter. (2) ITO is determined using ending inventories and annualized cost of goods sold (based on the most recent quarterly cost of goods sold). 43 -------------------------------------------------------------------------------- Table of Contents Net cash provided by operating activities was $1.6 million for the six months ended September 30, 2011 compared with $4.9 million for the same period in the prior year. The decline in operating cash flows was primarily due to the net loss of $12.2 million in the six months ended September 30, 2011 compared with net income of $60.7 million in the six months ended September 30, 2010 and a decrease in accrued liabilities, offset by the $34.1 million inventory valuation adjustment and a lower increase in accounts receivable in the six months ended September 30, 2011 compared with the increase during the six months ended September 30, 2010. DSO for the quarter was two days lower than the same period in the prior year, due to lower receivables as of September 30, 2011 and higher sales in the three months ended September 30, 2011. Typical payment terms require customers to pay for product sales generally within 30 to 60 days. However, terms may vary by customer type, by country and by selling season. Extended payment terms are sometimes offered to a limited number of customers during the second and third fiscal quarters. The Company does not modify payment terms on existing receivables, but may offer discounts for early payment. Inventory turns for the six months ended September 30, 2011 were higher than the same period in the prior year, due to lower inventory as of September 30, 2011 and higher sales in the three months ended September 30, 2011. Cash Flow from Investing Activities Cash flows from investing activities during the six months ended September 30, 2011 and 2010 were as follows (in thousands): Six months ended September 30, 2011 2010 Purchases of property, plant and equipment $ (20,921 ) $ (25,419 ) Acquisitions, net of cash acquired (18,814 ) (7,300 ) Proceeds from sale of property and plant 4,904 2,688 Purchases of trading investments (4,536 ) - Proceeds from sales of trading investments 4,522 - Net cash used in investing activities $ (34,845 ) $ (30,031 ) Our capital expenditures during the six months ended September 30, 2011 and 2010 were principally for normal expenditures for tooling, computer hardware and software, equipment, and leasehold improvements. In the six months ended September 30, 2011, the Company acquired Mirial S.r.l. for a total consideration of $18.8 million (€13.0 million), net of cash acquired of $1.4 million (€1.0 million). Proceeds from the sale of property, plant and equipment were related to the sale of an unused manufacturing facility in China in the three months ended June 30, 2011 and the sale of our building in Romanel, Switzerland in the three months ended June 30, 2010. 44 -------------------------------------------------------------------------------- Table of Contents The purchases and sales of trading investments in the six months ended September 30, 2011 represent mutual fund activity directed by participants in a deferred compensation plan offered by one of the Company's subsidiaries. The mutual funds are held by a Rabbi Trust. In the six months ended September 30, 2010, the deferred compensation plan was invested in life insurance contracts. Cash Flow from Financing Activities The following table presents information on our cash flows from financing activities during the six months ended September 30, 2011 and 2010 (in thousands): Six months ended September 30, 2011 2010 Purchases of treasury shares $ (73,134 ) $ - Proceeds from sale of shares upon exercise of options and purchase rights 9,764 16,570 Tax withholdings related to net share settlements of restricted stock units (185 ) (223 ) Excess tax benefits from share-based compensation 30 676 Net cash provided by (used in) financing activities $ (63,525 ) $ 17,023 Six months ended September 30, 2011 2010 Number of shares repurchased 7,609 - Value of shares repurchased $ (73,134 ) $ - Average price per share $ (9.61 ) n/a During the six months ended September 30, 2011, we repurchased 7.6 million shares for $73.1 million under the Company's September 2008 buyback program. No share repurchases were made in the six months ended September 30, 2010. Cash of $9.8 million and $16.6 million was provided during the six months ended September 30, 2011 and 2010 by the sale of shares upon exercise of options and purchase rights pursuant to the Company's stock plans. The payment of tax withholdings related to net share settlements of RSUs (restricted stock units) required the $0.2 million in cash in the six month periods ended September 30, 2011 and 2010. Tax benefits recognized on the exercise of share-based payment awards provided less than $0.1 million and $0.7 million in the six months ended September 30, 2011 and 2010. Cash Outlook Our principal sources of liquidity are our cash and cash equivalents, cash flow generated from operations and, to a lesser extent, capital markets and borrowings under our bank lines of credit. Over the past several years, we have generated positive cash flow from our operating activities, including cash from operations of $156.6 million in fiscal year 2011. In the six months ended September 30, 2011, although our operating cash flows have been negatively affected by a decrease in demand for our products and by uncertainty regarding future global economic conditions, the levels of our cash and cash equivalents and our working capital remain strong. Our future working capital requirements and capital expenditures may increase to support investment in product innovations and growth opportunities, to repurchase our stock, or to acquire or invest in complementary businesses, products, services, and technologies. Additional financing may not be available at all or on terms favorable to us. In September 2008, our Board of Directors approved a new share buyback program, which authorizes the Company to invest up to $250 million to purchase its own shares. As of September 30, 2011, the approved amount remaining under the September 2008 program was $177.0 million. 45 -------------------------------------------------------------------------------- Table of Contents In connection with the acquisition of LifeSize Communications, Inc. in December 2009, Logitech agreed to establish a cash retention and incentive plan for certain LifeSize employees, linked to the achievement of LifeSize performance targets. The duration of the plan's performance period is two years, from January 1, 2010 to December 31, 2011. The total available cash incentive is $9.0 million over the two year performance period. Approximately $7.9 million is accrued as of September 30, 2011. On October 12, 2010, the legislature of the U.S. state of California enacted a fiscal budget bill which extended the suspension of net operating losses for tax years beginning on or after January 1, 2008 through January 1, 2012. The legislation also affects the methodology used by corporate taxpayers to apportion income to California and modifies the large corporate underpayment penalty effective for our fiscal years ending March 31, 2011 and 2012. Although the Company has significant operations in California, we believe these changes will not have a material impact on our results of operations, cash flows or financial condition. During the second quarter of fiscal year 2012, the U.S. Internal Revenue Service completed its field examinations of tax returns for the Company's U.S. subsidiary for fiscal years 2006 and 2007, and issued NOPAs (notices of proposed adjustment) related to international tax issues for those years. The Company disagrees with the NOPAs and is contesting through the administrative process for the U.S. Internal Revenue Service claims regarding 2006 and 2007. In addition, the U.S. Internal Revenue Service is in the process of examining the Company's U.S. subsidiary for fiscal years 2008 and 2009. The Company is also under examination in other tax jurisdictions. As of September 30, 2011, we are not able to estimate the potential impact that these examinations may have on income tax expense. If the examinations are resolved unfavorably, there is a possibility they may have a material impact on our results of operations. Other contractual obligations and commitments of the Company which require cash are described in the following sections. Based upon our available cash balances and credit lines, and the trend of our historical cash flow generation, we believe we have sufficient liquidity to fund operations for at least the next 12 months. Contractual Obligations and Commitments As of September 30, 2011, the Company's outstanding contractual obligations and commitments included: (i) facilities leased under operating lease commitments, (ii) purchase commitments and obligations, (iii) long-term liabilities for income taxes payable, and (iv) defined benefit pension plan and non-retirement post-employment benefit obligations. The following summarizes our contractual obligations and commitments at September 30, 2011 (in thousands): September 30, 2011 Operating leases $ 97,897 Purchase commitments - inventory 132,590 Purchase obligations - operating expenses 58,290 Purchase obligations - capital expenditures 13,894 Income taxes payable - non-current 130,892 Obligation for management deferred compensation 13,256 Pension and post-employment obligations 30,594 Other long-term liabilities 14,725 Total contractual obligations and commitments $ 492,138 46 -------------------------------------------------------------------------------- Table of Contents Operating Leases The Company leases facilities under operating leases, certain of which require it to pay property taxes, insurance and maintenance costs. Operating leases for facilities are generally renewable at the Company's option and usually include escalation clauses linked to inflation. The remaining terms on our non-cancelable operating leases expire in various years through 2028. Our asset retirement obligations on these leases as of September 30, 2011 were $1.7 million. The increase in operating lease commitments to $97.9 million as of September 30, 2011 compared with $72.6 million as of March 31, 2011 was due to approximately $35 million related to new facilities for our Americas operations in Northern California, and approximately $13 million for an expansion of our LifeSize headquarters in Austin, Texas. Purchase Commitments At September 30, 2011, we have fixed purchase commitments of $132.6 million for inventory purchases made in the normal course of business to original design manufacturers, contract manufacturers and other suppliers, which are expected to be fulfilled by December 31, 2011. We also had commitments of $58.3 million for consulting services, marketing arrangements, advertising, outsourced customer services, information technology maintenance and support services, and other services. Fixed purchase commitments for capital expenditures amounted to $13.9 million at September 30, 2011, and primarily relate to commitments for tooling, computer hardware and leasehold improvements. We expect to continue making capital expenditures in the future to support product development activities and ongoing and expanded operations. Although open purchase commitments are considered enforceable and legally binding, the terms generally allow us the option to reschedule and adjust our requirements based on business needs prior to delivery of goods or performance of services. Income Taxes Payable At September 30, 2011, we had $130.9 million in non-current income taxes payable, including interest and penalties, related to our income tax liability for recognized uncertain tax positions, compared with $132.0 million in non-current income taxes payable as of March 31, 2011. The Company files Swiss and foreign tax returns. For all these tax returns, the Company is generally not subject to tax examinations for years prior to 1999. The U.S. Internal Revenue Service has completed its field examinations of tax returns for the Company's U.S. subsidiary for fiscal years 2006 and 2007, and has issued NOPAs (notices of proposed adjustment) related to international tax issues for those years. The Company disagrees with the NOPAs and is contesting through the administrative process for the U.S. Internal Revenue Service claims regarding 2006 and 2007. The Company believes the outcome of this examination is not expected to have a material adverse effect on our consolidated operating results. In addition, the U.S. Internal Revenue Service is in the process of examining the Company's U.S. subsidiary for fiscal years 2008 and 2009. The Company is also under examination in other tax jurisdictions. At this time it is not possible to estimate the potential impact that these examinations may have on income tax expense. If the examinations are resolved unfavorably, there is a possibility they may have a material impact on our results of operations. Although the Company has adequately provided for uncertain tax positions, the provisions on these positions may change as revised estimates are made or the underlying matters are settled or otherwise resolved. Although the timing of the resolution or closure on audits is highly uncertain, the Company does not believe it is reasonably possible that the unrecognized tax benefits would materially change in the next twelve months. 47 -------------------------------------------------------------------------------- Table of Contents Obligation for Deferred Compensation At September 30, 2011, we had $13.3 million in liabilities related to a deferred compensation plan offered by one of the Company's subsidiaries. For more information, please refer to our Annual Report on Form 10-K for the fiscal year ended March 31, 2011. Pension and Post-Employment Obligations At September 30, 2011, we had $30.6 million in non-current liabilities related to our defined benefit pension plans and non-retirement post-employment benefit obligations. See Note 4 - Employee Benefit Plans for more information. Other Contractual Obligations and Commitments For further detail about our contractual obligations and commitments, please refer to our Annual Report on Form 10-K for the fiscal year ended March 31, 2011. Off-Balance Sheet Arrangements The Company has not entered into any transactions with unconsolidated entities whereby we have financial guarantees, subordinated retained interests, derivative instruments or other contingent arrangements that expose us to material continuing risks, contingent liabilities, or any other obligation under a variable interest in an unconsolidated entity that provides financing, liquidity, market risk or credit risk support to the Company. Guarantees Logitech International S.A., the parent holding company, has guaranteed payment of the purchase obligations of various subsidiaries from certain component suppliers. These guarantees generally have an unlimited term. The maximum potential future payment under the guarantee arrangements is limited to $30.0 million. At September 30, 2011, there were no purchase obligations outstanding for which the parent holding company was required to guarantee payment. Logitech Europe S.A., a subsidiary of the parent holding company, has guaranteed the purchase obligations of another Logitech subsidiary and third-party contract manufacturers under three guarantee agreements. Two of these guarantees do not specify a maximum amount. The third guarantee is limited to $7.0 million. As of September 30, 2011, $5.4 million of guaranteed purchase obligations were outstanding under these guarantees. Logitech International S.A. and Logitech Europe S.A. have guaranteed certain contingent liabilities of various subsidiaries related to transactions occurring in the normal course of business. The maximum amount of the guarantees was $83.8 million as of September 30, 2011. As of September 30, 2011, $15.5 million of guaranteed liabilities were subject to these guarantees. Indemnifications Logitech indemnifies some of its suppliers and customers for losses arising from matters such as intellectual property rights and safety defects, subject to certain restrictions. The scope of these indemnities varies, but in some instances, includes indemnification for damages and expenses, including reasonable attorneys' fees. In addition, we have entered into indemnification agreements with our officers and directors, and the bylaws of our subsidiaries contain similar indemnification obligations to our agents. No amounts have been accrued for indemnification provisions as of September 30, 2011. We do not believe, based on historical experience and information currently available, that it is probable that any amounts will be required to be paid under these indemnification arrangements. 48 -------------------------------------------------------------------------------- Table of Contents Legal Proceedings On May 23, 2011, a class action complaint was filed against Logitech and certain of its officers. This action was filed in the United States District Court for the Southern District of New York on behalf of individuals who purchased Logitech shares between October 28, 2010 and April 1, 2011. The action was transferred to the United States District Court for the Northern District of California on July 28, 2011. The complaint relates to Logitech's disclosure on March 31, 2011 that its results for fiscal year 2011 would fall below expectations and seeks unspecified monetary damages and other relief against the defendants. On July 15, 2011, a complaint was filed against Logitech and two of its subsidiaries in the United States District Court for the Central District of California by Universal Electronics, Inc. (UEI). The complaint alleges that Logitech's Harmony remotes, Logitech Revue for Google TV and other products for the digital home infringe one or more of the seventeen UEI patents asserted in the action, and seeks unspecified monetary damages and other relief against the defendants. In addition, the Company is involved in a number of lawsuits and claims relating to commercial matters that arise in the normal course of business. The Company believes these lawsuits and claims are without merit and intends to vigorously defend against them. However, there can be no assurances that its defenses will be successful, or that any judgment or settlement in any of these lawsuits would not have a material adverse impact on the Company's business, financial condition, cash flows and results of operations. The Company's accruals for lawsuits and claims as of September 30, 2011 were not material. [ Back To TMCnet.com's Homepage ]