Logitech International S.A. (LOGN) Earnings Call Transcript & Summary

I think we're going to go ahead and get started. Stephen Ju with the UBS Internet Equity Research team. I'm joined on stage by Chuck Boynton, the CFO of Logitech. So welcome, and thanks for joining us.

Thank you. It's great to be here.

So, let's get started with your most recent quarter first. Can you talk about the drivers of the results by category as well as what's baked into your near-term outlook for your various segments, gaming, video conferencing and personal workspace?

Absolutely, yes. We posted results that were better than we expected in our September quarter, driven largely by overperformance and what we call personal workplace solutions. Think of that as the heritage of who we are as a company. Keyboards, Mice, Webcams, et cetera. It was overall a really good quarter. That business, we saw year-over-year growth in pointing devices, think of that as mice and in tablets. If you recall, our business had been declining year-over-year. Our revenues grew 70-plus percent during COVID and then they've come off their highs, but are still 40-ish percent above where they were pre-COVID. And while we're still posting declines year-over-year, the rate of change is slowing. And so, if you think about in Q4 last year, we were down 22% year-over-year. Q1, we were down 16% and in Q2, we were down 8% year-over-year, which was better than we expected. So while we're not happy that it was a decline year-over-year, the rate of change is slowing, and we maybe, are starting to see on the horizon a bottom. We haven't called it yet, but we're starting to maybe see based on the rate of change that we may be hitting that kind of asset to the bottom. We also had a pretty strong quarter in gaming in certain key categories with some new products coming out. In our video business, the kind of the third leg of our stool was kind of sideways. It wasn't better or worse than expectations. It's still a great business doing about $150-some million a quarter in revenue. It's still a good business, but it's been, I would say, we're not yet seeing the inflection point. And if you look at the geographic mix, Europe was quite strong. We actually saw year-over-year growth in Europe and which I think was surprising to a lot of people because other companies have not posted such great results in Europe and constant currency was down mildly. U.S. was kind of in line with expectations and then Asia is still struggling a bit down kind of high teens year-over-year. And then as we look forward into Q3 and Q4, our December and March quarters, we see margins compressing a little bit from where we posted 42% gross margins in Q2. We see margins going down a little bit in Q3 and Q4 at the lower end of our long-term financial model, which is 39% to 44%. And we see on the category basis, December is our biggest quarter. So certainly, the consumer categories like gamers and creators should do quite well and followed by personal replaced solutions. And then finally, I think enterprise video and headsets will be sort of somewhat in line with the prior quarter given we don't quite see the same peak in the December quarter.

The European strength is a little bit counterintuitive, do you have any color to share there in terms of what might be driving that?

A lot of it is easier comps. I think a year ago, Russia is no longer in the baseline from prior years. So there was a little easier comp without the Russia business a year ago. And then I think it was still maybe a bit more of a tenuous market. I'll also call out really strong execution by our local sales organization. They really have done a great job. And so, I do think it's a little bit of easy comps and hard work and good results.

I want to put you on a spot a little bit here because I think there were some questions on the gross margin guidance for the third quarter. So, I mean, 39% to 44% for the third quarter seems pretty conservative, given what seemed like a pretty nice jump in the second quarter. And there's also the easing of what the promotional environment sounds like. So, can you add some color there in terms of what's being factored into the guidance?

Certainly. We're really proud of our margins, both gross margin and operating margins. This is a great business. It really is. The 39% to 44% is our long-term financial model. The guidance or the outlook we provided for Q3 and Q4 was approximately 38% to 39%, just to be clear. And if you think about why would that go down from Q2 at 42%, well, 42% in Q2, there was a little bit of onetime benefits in there. We brought down chain inventory, brought down on-hand inventory. That created some reserve releases, which were kind of onetime in nature. If you look into Q3, the December quarter, it's our peak quarter. So on one hand, we should do better with a tailwind of more overhead absorption into a larger base. That should help us out. On the part that's the headwind is the big quarter is gaming primarily, and gaming has the lowest margins of our stack. And so, overall, with the higher mix of gaming and in a more promotional environment, that overall, we think, will bring margins down a little bit from where we were in Q2. And then, Q4 has a little bit of the opposite, where it's our tough quarter. It's our lowest revenue quarter of the year, in the March quarter and so you have less overhead being absorbed. But then again, you have higher enterprise mix so, it should be a benefit there. And so net-net, we see approximately 38% to 39% is a good base. And I think that might be sort of the low watermark. If you think about where we're going in the long-term model is 39% to 44%, I think we'll be in the low end of that range throughout next year.

Now you touched on inventory levels. So, I was wondering if you can add some more color on the current state of your owned as well as the channel inventory?

Certainly. All our operations team has done a really nice job bringing down inventory levels. Now, during the pandemic, we took a bet and it paid off. We built inventory and bought ahead ICs and that, the supply execution by our team really paid huge dividends. We saw revenue growth of 70-plus percent during the pandemic. Other companies had revenues declining because they couldn't source parts. Now, on the back side of this, the supply chain issues have eased up, so we don't see the constraints. However, our on-and-inventory levels are still a little bit too high. So if you look at a year ago, we were about 3.2 inventory turns. This last quarter, we were at 4.6%. I think the long-term model should be between 5 and 6 tons, maybe above 6 occasionally, maybe below 5 occasionally. But I think we ought to be in a point where we're able to consistently deliver on an annualized basis between 5 and 6 tons, and that will generate a little more free cash. On the channel side, our sales organization has done a really nice job, and we have this sort of religion around both on-hand and channel inventory, thinking about it from a lens of return on invested capital. If you think about how do you improve your ROIC, well, you can improve your profits for sure, we want to do that, but you can also reduce invested capital. That's good for us. It's good for the channel, if we reduce channel inventory. And so our view, our thesis is if we keep channel inventories low, then we can do a better job in pricing with the channel to have that. They don't need to earn as much money if they have less inventory. And so that part, we brought inventory down materially in Q1. We had planned in Q2 of channel inventory being flat, but it actually came down because sales out was stronger than we had expected. And now, we don't know where December is going to land. The reports that I've read about last week with Amazon and a lot of the retailers were, it appears that last week was a very strong week, both in Europe and the U.S. on the heels of Black Friday and all the promotion events. I'm not talking about our results specifically, but it looks and what I've read and seen on TV and read in the newspaper and an article that there's a general consensus that the consumer is showing up. And so, that could mean that our inventory levels, our channel inventory levels are already lower at the end of the year than we expect, and that, that would bode well for Q1 or sorry, for the March quarter. It won't really impact our December quarter too much, but it would have a positive benefit, if that is true, and that happens, it could benefit our March quarter. So we can talk more about the green environment, but I want to sort of give you the color on the current market.

So, as far as you can tell, Christmas is still heating up.

Of course, the last week is 1 week and the next 3 weeks are super important. So, I think we're cautiously optimistic. And what we're reading in the newspapers is accurate, then we're off to a good start.

Is your SG&A savings program fully executed at this point? Or are you starting to think about increasing marketing budgets over some time frame?

Yes. We don't have plans to increase marketing budgets. We had outlined the model. If you go back at our Analyst Day, we outlined the model of OpEx is 25% of revenue. And at the time, revenues were forecast to be below $4 billion. And so we said, well, we won't go below $1 billion in OpEx because there's a base and we want to protect our investments in sales and marketing, protect our investments in R&D because that's really the future growth of the company that drives future revenue growth and future margin expansion. So we want to protect those. And so, we said we'll stay at $1 billion as a floor. But as we saw the business performing better, it will be a little bit above $1 billion this year. And our target is roughly 25%. So, as revenues grow, we'll increase our OpEx a little bit, but effectively, we'll be quite disciplined and so the cost programs are largely all executed. Now, will we shift money between different departments? For sure. We'll always be looking at optimizing our investments. But I think overall, I'm really pleased with the cost cutting that we've done. And that business model has translated into really good operating margins. Last quarter, we delivered 17% operating margins which is near the high end of our published range of 14% to 17%. And so, yes, I would think long term as kind of 25% are a TAD less. And as revenues grow, maybe we can see a little bit of expansion there. But for the most part, I would say, at or below 25%.

Now, let's come out to the big picture. I mean, what you were saying earlier about how much bigger you are versus pre-pandemic that was striking to me. So, I mean, obviously, the pandemic created a surge in gaming, video conferencing and content creator type activities. But despite the tougher comparisons and the challenges recently, it seems like the biggest takeaway here is that consumers and enterprises who may not have been customers of Logitech before, they're not here, right? So, what steps are you taking to not only retain all of these users, but in fact, grow your share of P.I.E?

That's a really good question. We participate in roughly kind of 15 categories. We have #1 market share in roughly 11 of those 15 categories. So, we are really proud of being the category captain in some really important categories. We have plans to grow in some of the categories like in video, enterprise video, the market has been a little challenging. And so, the way we look at it, we have top share in video, but the market is really not moving. We have launched 2 new NPIs that should help gain additional revenue growth, hopefully, and potentially some share. One is a rally bar for the small conference room that's been released. It's a great product. It's a smaller footprint for a smaller room. And the second one is a really cool new product called Site that is for the large conference room that provides meeting equality for those that are in the back of the conference room. And I'm sure we can all relate to being on a Zoom call where you're remote and you're dialed in to a Zoom meeting, which has 15 or 20 people in the room and the camera picks up the folks in the front of the room quite well, but those in the back are really second-class citizens. And our new product is a tower like the size of a tennis ball can. It sits in the back of the room, has cameras and that will render those in the back of the room with equal prominence to those that are in front of the room and creates a much better meeting experience. A lot of our enterprise customers are really excited about this product. I don't believe it's yet fully certified on Zoom and Teams, but it should be imminently and the initial feedback from our customer base is incredibly strong. So I think we'll find share expansion there. And the other categories, we've released lots of new NPIs, 50 to 70 a year. And that's really helping to maintain and grow share. So you think about what brings the customer back year after year, new products, in gaming, in time for the holidays, we've got a whole bunch of new products on the gaming side to help extend our lead and to help grow share. And then in the traditional webcam, mice, keyboards, tablets, we're always revamping that line, and that's helped keep the product line fresh and keep customers coming back to upgrade.

Now, I think on the last conference call, you talked about potentially the second half of '24 returning to year-over-year growth, right? So setting aside the considerations of easing comparisons, et cetera, can you elaborate on what's kind of being baked into that thought process either from a product perspective or a category perspective or otherwise?

Yes. We haven't really called the bottom and called growth. I think some investors are quite excited about what next year is going to look like. We're a bit more cautious on what next year will look like. The first thing of the data I mentioned of, if you look at the last 3 quarters, 22% decline down to 16%, down to 8%. So that slope, if you draw that line, it feels like the bottom is out on the horizon. We haven't called the bottom yet, but it looks like we're headed there. Now, our March quarter is generally going to be an easier versus a year ago, but we do plan to reduce channel inventory in the March quarter. So, it's possible that there's growth on sales out, but sales in might be flat or down. We haven't provided that level of granularity in our annual outlook. But as you look out to next year, for us to get back to growth, I think we need the consumer to show up and to be strong, the economy to be fairly resilient globally and video to come back. Now we haven't provided an outlook for next year. We'll do that. We're likely going to have an Analyst Day in mid-May this year. So we'll see. We haven't finalized the plans for that. But likely in mid-May next year, we'll do some Investor Day and kind of talk more about our longer-term views. But for now, I think we're being a little more cautious on our views into next year given the uncertainty.

You talked about operating margins earlier but narrowing down the discussion a little bit to the gross margin. So as you think about medium to longer term, how various categories are going to grow at different levels. I mean, how do you think your gross margins will trend in sort of the similar time frame?

Yes, it's a really good question. I think overall, on the video side, enterprise video and headsets, those are above company average margin. And I think those will stay roughly consistent. The competitors, it's a big category, and there's lots of competitors for sure. Big markets that are profitable attract competition, and there's good competition. I think overall, in that video space, I think margins are fairly stable. The industry participants have acted responsible. Enterprises are not that price sensitive. If you think about video gear, what they're spending on furniture likely costs more than what they spend on the video technology in that given conference room. So it's not really a pricing issue. It's really more, is it the right technology. And I think we have the best technology, and so I think that's what's helping us to be #1 in that market. In the other categories, I think in PWS, the team has done a really good job on margin expansion. They've done a great job on lowering costs. Certainly, supply chain costs have come down with freight and logistics for everyone. We've also done a good job in kind of design for manufacturing and bringing costs out that are negotiated supply chain and our brand value, the brand equity is quite high. And so, I think on the margin side for PWS broadly, I think that's fairly stable. And gaming is the one that has a bit more volatility. And gaming is really below the gamers and creator space. There's like 4 or 5 subcategories. The flagship for us is PC gaming, which the margins are quite good. They're below company average, but they're quite good. And then the other end of the spectrum is console headsets where margins are challenged. Now, there are some new products coming out, and I think that can help to create differentiation and potentially help improve margins. But generally, in the gaming space, it's a lot more price sensitive. People buy when they're promoted and they don't buy as much when they're not promoted. And so, I think their brand is really important. We have taken a lot of the old brands like ASTRO and Blue Microphone, and we've bundled those underneath the Logi G brand that our customers love and revere. I think that can help on the brand equity side to grow or protect margins.

Now, let's switch gears a little bit to the prospects for AR, VR over the medium term. So how do you currently split your R&D budget to make sure that you remain in a strong position in this category?

We have a number of different R&D organizations. We have more software engineers than we have hardware engineers. We've got a really phenomenal hardware engineering team. A large group in Lucerne, Switzerland, where our corporate headquarters are, a very large group in Taiwan and then a group in the U.S. as well. And so they're always innovating. Our interim CEO, Guy Gecht, did just such a phenomenal job. He is a great partner. I really like working with him. He's brought a lot of new ideas of how do we accelerate time to market. And our view is that if we can accelerate time to market for new products, we'll have more time to do more fundamental research. So, we take a view, and I don't want to get into kind of our secret sauce in how we do our engineering and design work because I think we're world class at this. The design that we do is phenomenal, but we have a separate design organization that does the design work, and they are world class. We have the hardware engineering organization that does invest significant money in new technologies like AI, AR, VR, all these new technologies and then they have a group that is sustaining. And the whole battle for all tech companies, not just us, is the tiering the now tends to move budgets towards sustaining engineering. You have to be very disciplined to move engineers off of legacy product projects on to new projects. And that's not a logic issue. That's a company-wide issue. It's why many times large companies stop innovating because they get consumed with dealing with the current products and market. And I'm really happy with the work that our head of software, hardware design, they've been very disciplined about making sure we're protecting those investments in new technology because that's the lifeblood of any company. And I look at generally tech companies, and we're no different. If you don't spend money in R&D, you get commoditized and margins start to fall. Revenues fall, margins fall. If you're investing appropriately in R&D, you should have stability in margins or growth in margins. And so we're very conscious on how do we allocate and allocate resources.

Sony, I believe, recently introduced some new gaming line products. I mean, this is probably not a new dynamic, right? But how do you assess the prospects for the first-party manufacturers to increasingly access your end markets?

Yes. We're very close to Sony. They're a great company. They've got really great products and these are big markets. These are big multibillion-dollar markets and big markets attract lots of different competitors. And you've seen Microsoft and Sony and many companies, they'll get into categories, they'll come out of categories. I'd say, I welcome the competition because I like our odds of competing and doing better and it's validation. When others enter markets, it validates the market that we're in. But I would say Sony is a really good partner, and we like them a lot. And if they want to introduce products that are in our backyard, that's great. I think we're happy to compete with them, and if they want to partner with us deeper, we're happy to do that too. But they're a great company and a good partner of ours.

And yet another one among things to worry about, think about for video conferencing. I mean, should we be worrying about our prospects for greater camera integration into screens?

I don't think so. I mean, if you think about the market that Dell has as an example, selling glass into the conference room, that's a huge business for them. If they start to integrate cameras and they got to have the software teams because I would say, the hard part in video and the part that we excel at is the software part that makes that stuff work really well. I think with Dell, my guess is they're a lot better off selling great monitors in the conference room because when you put the camera in, they are great, well, like the microphones, what about the speakers? The speaker placement and the microphone placement? It's probably a lot more complex than it might seem. Now, in a small conference room, would an integrated solution make sense? Sure, you could have a monitor that has a camera like your laptop. But great cameras need to be large to capture a lot of light to render the individual with the right color and the right kind of clarity. And so, I think when you embed the camera into the screen, you lose more flexibility. You want the camera above or below. If the camera is up high, and it's up how you're looking down on people. If it's low, and the monitor is low. So I don't think the market wants them integrated. And I don't think that, that's a big threat. But if they come out with it, it's a huge market. So people will buy whatever you create because the market is so big, there's room for lots of people. But what will be industry-leading and what will have the highest share? I don't think the integrated camera is necessarily the best form factor for a conference room video.

Switching gears a little bit. You have $1 billion in cash, and you have been returning cash to shareholders. Should we expect your current capital allocation strategy to continue?

Yes, our stated capital allocation priority is, one, we're going to protect the dividend. We pay an annual dividend. We're very proud of that. We've been increasing that every year for 10, I'm not sure how many years, but many, many years. So, we will continue to do that. Then after we pay the dividend and grow the dividend, we then want to buy companies, invest in CapEx and grow. We have not been very active in the M&A side as of late, but that's partially because we have an interim CEO, and we're not going to be doing M&A deals with an interim CEO. Our new CEO starts on Monday. And so, I would expect this to be -- we're not going to suddenly start doing deals overnight. It will probably take a year, it could be 2 before we're more active. But there's a lot of opportunity out there for us to grow. And then the excess capital we return to shareholders via buybacks. Now, on the M&A side, I want to just highlight a couple of things there. We're really good at M&A. We have done some -- if you look at our categories like gaming with ASTRO or our video conferencing businesses, those are all businesses that grew out of M&A. And we would not be a $4 billion revenue company today without doing significant M&A. So one, we're quite good at it. And of course, there's a lot of risk in M&A, not everything has worked out perfectly, but I think we're quite good at this. And we have something unique. We've got a brand that everyone knows and reveres, a great brand. We have a great supply chain organization and how we manufacture and create the upstream part of our business. We're really good at that. And we have a global distribution network that is at scale. And other companies don't necessarily have the same scale we have. So there's an opportunity for us to buy companies, plug them into our supply base, get lower costs, plug them into our distribution network and be able to work with the likes of the retailers and e-tailers and the multitier channels around the world. But if it's something unique and special here that makes M&A a little lower risk and more beneficial than maybe some companies out there.

And you touched on this earlier, you have a new CEO in a matter of days now, I think, right? So with new leaders, come new ideas, new directions. So anything you can share in terms of what we can expect?

Yes, Hanneke Faber starts on Monday and we're super excited to work with her. We've been talking a lot, and she's just a very dynamic leader. She's going to fit right in. She's already been working incredibly hard with us. I'll be leaving for Switzerland on Saturday. The whole team will be with her all of next week. She's going to bring so much to the table for us. A couple of things that we're talking about in the conferences earlier today is she ran a $15 billion or $12 billion, $15 billion business at Unilever just recently. We have aspirations to grow, we're at $4 billion in revenue today. And this idea of bringing global scale. I think we, as a company, have a lot of room to mature and how we think about things and how we scale. I think she'll bring many things, but that ability to scale as an organization, and she's really in tune with who is the customer and being very in touch with identifying with who the customer is, and helping us along that journey of being better in touch with our customers and what they want and what they need in the future.

We have only about a minute or so left. So that's fast forward in time about a year. We're once again sitting here at the UBS Tech Conference and it's November, December 2024. What do you think we'll be talking about in terms of what you've accomplished in the trailing 12 months?

Well, first of all, I'm so excited you're having this conference because the first time I attended the old Credit Suisse Tech Conference was in 1999 back when it was the kind of, if you were invited, you were a company in the Silicon Valley, everyone wanted to be here, and I was afraid you were going to cancel it now that UBS had acquired Credit Suisse. So, first of all, I'm thrilled you're having the conference again next year. It's a great conference. And I hope that we're talking about revenue growth, strong margins, great end markets, video growing and video performing quite well. I'm a little more cautiously optimistic, but I hope what we're talking about is all the pandemic kind of decline is behind us and we're back to growth, and we're talking about future markets and ideas of how we can continue to grow with that long-term financial model rate.

So with that, we'll wrap it up. Chuck, thanks so much for your time.

Thank you so much. It was a great conversation. I really appreciate it.

Thank you.