Jul 20, 2006
TRANSCRIPT SPONSOR
Executives
Joe Greenhalgh – IR Guerrino De Luca - President and CEO Mark Hawkins – SVP, Finance and Information Technology and CFO
Analysts
Ted Chung - Bear Stearns John Bright - Avondale Partners Manuel Recarey - Kaufman Brothers Matthew Crakes - Merrill Lynch Mehrdad Torbati - Deutsche Bank Michael Foeth - Lombard Odier Charles Wolf - Needham & Co. Can Elbi – Cheuvreux Yves Kissenpfennig – UBS Joel Basang - AWP News Agency
Operator
Good morning my name is Angela and I will be your conference operator today. At this time I would like to welcome everyone to the Logitech First Quarter Fiscal Year 2007 Earnings Call.
(Operator Instructions) Now, I would like to turn the call over to Mr. Joe Greenhalgh, Vice President Investor Relations, Logitech.
Please go ahead sir.
Joe Greenhalgh
Thank you, Angela. I would like to welcome you to Logitech conference call to discuss the Company's results for the quarter ended June 30, 2006, the first quarter of Logitech's fiscal year 2007.
The press release, a live webcast of this call and accompanying presentation slides are available online at logitech.com. This conference call will include forward-looking statements that have been made under the Safe Harbor of the Securities Litigation Reform Act of 1996, including forward-looking statements with respect to future operating results.
The forward-looking statements involve risks and uncertainties that could cause actual results to differ materially from that anticipated in the statements. Factors that could cause actual results to differ materially include those set forth in Logitech's annual report on Form 20-F dated May 19th, 2006 and in the final paragraph of the press release reporting first quarter results issued by Logitech and available at Logitech.com.
The press release also contains accompanying financial information for this call. The forward-looking statements made during this call represent the management outlook only as of today and the company undertakes no obligation to update or revise any forward-looking statements as a result of new developments or otherwise.
I would like to remind you this call is being recorded, including the question-and-answer portion, and will be available for replay on the Logitech website. For those of you just joining us, let me repeat that presentation slides accompanying the call are also available on our website.
With us today are Guerrino De Luca, Logitech's President and Chief Executive Officer, and Mark Hawkins, Logitech's Senior Vice President of Finance and Information Technology and Chief Financial Officer. I'd now like to turn the call over to Mark.
TRANSCRIPT SPONSOR
Mark Hawkins
Thanks, Joe. I will begin with an overview of our Q1 '07 performance.
We delivered record Q1 sales and profits. Our sales grew by more than 18%, with $393 million in sales and with growths from both our retail and our OEM.
This is our 31st consecutive quarter of double-digit sales growth. There was a broad-based for our retail products with particular strength in the Americas.
As a result, I could say, we are after a really good start to achieve our financial goals for fiscal year 2007. Before we review the income statement, I want to give you an overview of the impact of the equity-based compensation, and I will discuss this during the call.
Our US GAAP results for Q1 2007 for the first time include the cost of equity-based compensation, as a result of our adoption of FAS 123R. Let me describe this in that, again this is the first time ever we are going to have about $5.1 million of cost that are reflected in our operating income.
About $4.2 million in costs will be reflected in our net income and that is net of tax benefit, and the cost impact on EPS is about $0.02. Like most companies adopting FAS 123R, we will provide non-GAAP pro forma information to ensure a meaningful apples-to-apples comparison to our prior-year.
To have an apples-to-apples view we will compare Q1 '07 non-GAAP pro forma results excluding FAS 123R with Q1 '06 GAAP results, which also exclude FAS 123R cost. Hence, and this is an important point, our comments during this call about our gross margin, our operating expenses, our operating income and net income for Q1 '07 will be based on non-GAAP pro forma numbers excluding FAS 123R cost.
We've provided a reconciliation between our GAAP and our non-GAAP pro forma results in our earnings release, as well as the earnings call slide that we posted on our website for your convenience. Now that we have covered this, let's press on and discuss gross margin.
Our gross margin was 30.9% compared to a 32.1% last year. The decline was primarily the result of channel actions we took to move several end-of-life products into retail audio and consumer gaming categories.
The three most important points that you should take away as it relates to gross margin are this: These are the key points. As I shift on to the next part of the discussion, I want to remind you that all the percentages that will follow will be in comparison to our Q1 fiscal 2006.
Our operating income grew by 15%, our OpEx grew by 13% in line with our 13% growth in gross profit. Despite the lower gross margins, operating margins are essentially unchanged compared to the prior year.
When we push on and look deeper into the operating expenses, you will note that our sales and marketing grew by 7%. As a reminder, under US GAAP, the majority of the variable costs that we incur to generate demand at the point-of-sale are booked as a reduction in gross sales, not as operating expenses.
These soft dollars grew at a very similar rate to our Q1 sales in a retail category. The key point is that our total investment in sales and marketing grew by significantly more than the 7% growth in operating expenses.
R&D was up by 15%, driven by investments in retail audio, video and remote. The G&A grew by 27%, the growth in G&A again is primarily reflected around headcount increases especially to support the SOX activity that we have going on this year, as well as our Oracle 11i implementation, and these hires again took place throughout FY06.
Now, let’s turn to net income. Our net income grew by 53% and there were three primary contributories to the net income growing faster than the operating income: These three factors contributed to the higher growth in net income versus operating income.
FYI, I want to call this out, that this is our most profitable quarter ever from a Q1 standpoint, even if we excluded the gain of the Anoto shares. This is a good sign that our model is intact and performing well.
If I move to effective tax rates as we have said before, you should expect to see effective tax rates vary quarterly. Q1 was a good example of this, with variation that resulted in a rate of 12.3%.
There is no change in our outlook. For the full year, we continue to expect our tax rate excluding equity-based compensation to be around 14%, with likely variation by quarter.
If I moved to cash, our cash position was $246 million. This was basically flat sequentially and down from $299 million last year in terms of the balance.
The decline compared to last year is primarily the result of our ongoing share repurchase program. During the last 12 months, I think most of you are aware, we repurchased $234 million on share buybacks.
Our cash flow from operations was $19 million. This was a $24 million improvement compared to last year's negative $4.9 million.
The higher operating cash flow was driven from a combination of higher income, efficient payables management and the add-back of the non-cash equity-based compensation. If I move to DSO, DSO was 67 days.
This was up from 55 days last year. This quarter was more back-end loaded, for the retail shipments in prior years, we had a big June.
As is most cases and in most years, we expect to launch most of our products relatively late in the current quarter, and so we don't anticipate significant improvement in DSO in the September quarter. If I push on to inventory, our inventory returns were five times, up from 4.8 last year.
We believe our inventory was in good shape as we entered the second quarter. As I look at share repurchases during the first quarter, on a cost split basis we repurchased 1.22 million shares for $25 million.
We currently own just less than 5% of our shares outstanding. We have roughly $37 million remaining under our current share buyback program and we expect to utilize that and also implement the previously approved $250 million repurchase program when the current program is completed.
So, our intention is to continue along with our share of repurchase. Now let's discuss the revenue by family and category starting with the retail sales, so will take a deeper look into the revenue at this point.
Retail sales with end units both grew by 20%. We achieved double-digit sales growth with stronger demand across a number of product categories.
Americas led the way with 30% growth and I want to call out that within the Americas there was growth across all categories led by outstanding performance in the video and cordless. Europe was up by 15%, Asia was up by 12%, and the video was very strong both in Europe and in Asia.
As I look at retail sales in cordless, we're very pleased report that as projected, we achieved and returned a nice rate of growth in the cordless area, had discussions with many of you and we're pleased to see this. Sales were up by 18% with units up 25%.
We feel good about the return in growth in cordless desktops as sales grew 9% and units up 14%. I would say it was a great quarter for cordless mice; sales were up by 32% with unit growth of 37%.
Most of the growth was driven by strong sales of our line of cordless mice for notebooks. All in all a really good growth story for cordless we're very pleased to see it.
As I push on to retail sales for video, this was an outstanding quarter. Sales were up by 56% with the unit growth of 53%.
This was the second straight quarter with both sales and units growing by more than 50%. Our success extended across all price points.
We experienced a continued strong demand for desktop offerings led by QuickCam, Communicate, SPX, and we more than doubled our sales of webcams for notebooks. When I look at retail sales for audio, this was a solid quarter for audio with 23% growth in sales and 35% in units.
Our speakers grew by 34% with units up by 51%. iPod, MP3 speaker sales were more than five times higher than the prior year, driven by continued strong demand for our MM50 portable speakers for iPod.
We've also experienced good growth with our X 530 PC speakers. Sales in unit shipments of our PC headsets were both up double-digit.
When I look at retail sales for corded, our sales declined by 6%, but units grew by 5%. Corded mice sales were down by 14% with units up by 1%.
It's important to call out here, as a reminder that the comparable to the prior year is particularly challenging since we had a huge quarter with our MX518 gaming mouse last year. It was a good quarter for our corded keyboards with sales up by 14%.
We experienced strong demand, in particular in the Asia Pacific for this product category. In the retail sales for gaming no surprises here, with sales down by 7% and units up by 1%, due to expected weakness in the console gaming.
Our console gaming sales declined by 48% with units down by 28%. The weakness in this category was due to the transitions to new platforms and is likely to continue for several quarters, again we've had discussions about this.
We had a very strong quarter in PC gaming with sales up by 58%, and units up by 41%. The growth was driven by sales of our very well-received G-15 gaming keyboard.
As I press on and look at retail sales and other, sales in the retail other category grew by 71%. The growth was driven by continued success in our Harmony remotes, which grew by 122%; we're very pleased with that.
We achieved solid growth in double-digit areas of growth both in the Americas and Europe, and the Europe was ramping very nicely with strong sequential growth. OEM, sales grew by 4%, our mice sales declined and as anticipated down by 15% with units down by 7%.
The decline reflects the weak desktop PC market, as well as product transitions at major customers. It was a very good quarter for sales of embedded webcams for notebooks in the OEM category.
In conclusion, we delivered our best Q1 ever for sales and profits and a substantial improvement in cash flow from operations. We experienced strong demand in a number of product categories including video, audio, cordless and Harmony remotes and we anticipate a substantial gross margin improvement in Q2.
Our model is intact, it's performing well. Before wrapping up, let me say that we scheduled our mid-year Investor Meeting for November 2nd at the Reuters Building in New York.
We'll have more details to share with you in the coming weeks and we hope that you'll be able to join us. Now let me turn it over to Guerrino.
Guerrino De Luca
Thank you Mark. Thanks again to all of you for joining us.
I'm very pleased with our Q1 results. The fiscal year is off to a good start with strong double-digit growth in retail led by an impressive 30% growth in the Americas.
I'm also pleased that we delivered on our projected returns to growth in the cordless category with growth in both mice and desktops. We achieved this growth without the benefit of our soon-to-be-launched new products.
In spite of our anticipated decline in gross margin, we managed our operating expenses in line with gross profit and increased the operating income by 15% on a comparable basis. Even if we exclude the gain on the sale of the amount of shares we still delivered our best ever net income for Q1.
We are pleased with our Q1 results, yet as I always point out at this time of the year, the first quarter is historically the smallest contributor to our full-year performance, so we remain focused on executing our full-year plans. Last month, we held a fiscal '07 products showcase meeting with our major retail customers in Europe and the Americas.
The response from our channel partners to our fiscal 2007 product roadmaps was outstanding. The feedbacks from these corporate buyers is a key indicator that we have developed a line-up of innovative offerings that will enhance our market position throughout the remainder of the fiscal year.
Our launch plans are on track and we're excited about getting these products into the hands of our customers. So let me talk about some of what's in store for the remainder of the fiscal year, and I'll start with video.
We've experienced great growth in this category over the last four quarters and we believe the market opportunity has never been more attractive. The most recent confirmation of this attractive opportunity was Microsoft's announcement that they were entering the webcam category.
As we discussed during our investor meeting in May, we have planned for this development and we believe we are well-positioned to sustain our leadership in the fast-growing video communications market. Just this week, we announced the launch of our flagship QuickCam Ultravision Webcam, featuring a unique, appealing design and offering a true-to-life video calling experience by delivering twice the image clarity as that offered by typical webcams.
We also upgraded other members of our award-winning webcam lineup adding new technologies such as RightLight 2, a system that intelligently optimizes video settings in low light and uneven lighting conditions. Our success in the webcam category has always been driven by the combination of best-in-class hardware and software technologies that provides the user with a highly satisfying experience.
Just one example, our webcams include Logitech Video Effects software, which allows the user to personalize their onscreen appearance using avatars and face accessories. The software is especially popular among users of video-sharing web sites, as demonstrated by downloading of over 5 million video effect accessories and characters from our website.
Just last week, we announced that we have teamed up with YouTube, one of the best-known video-sharing sites to promote webcam video sharing. By providing one click access to YouTube in our software, along with easy access to video calling applications and video effects we will make the experience of video communication easier and more natural than ever before.
Let me turn to cordless. We expect the new mice and desktops launching in the coming weeks and months to sustain the growth momentum we established in the first quarter, further enabling the mass adoption of cordless.
Cordless notebook mice were a key driver of our cordless mice growth during the first quarter. We will continue to strengthen our very robust mobile cordless line up with a particularly exciting addition in the high end.
The opportunity in cordless mice extends well beyond notebooks. We are eagerly anticipating the launch of our new flagship cordless mouse, an offering that will redefine the category and leave no doubts that the mouse is gaining an even more central and sophisticated role in navigating digital information.
I am also excited by the new offerings we plan in the cordless desktop space. Beyond the product and design innovations you would expect from us across all major price points, we also plan to address the increasing popularity of IP telephony by making it easier for people to use VoIP services directly with the Logitech cordless desktop.
That leads me to the audio category, where we plan to take advantage of the growing interest in acceptance of VoIP by launching a number of products for use both at and away from the PC. We will continue to innovate in the PC Speaker category with stylish high-performance offerings that meet the needs of PC users to listen to digital music at their desk or on the road with their notebook.
We will also continue to expand our line of well-received speakers for the iPod and MP3 players, and you can expect a significant addition to our Music Anywhere line, making it even easier to stream music from your PC, iPod or MP3 players to any room in your house. Turning to the Harmony remotes, where we expect to further strengthen our competitive position with several products including an innovative and attractive offering at the high end.
Given our market-leading position in the remote category in the US, our rapidly growing business in Europe and the emerging opportunities in Asia, we continue to invest in simplifying the set-up process and providing effective customer support. We believe the Harmony remote has the potential to become the universal control device for enjoying digital entertainment across the home, and we're focused on making it happen by providing consumers with the best possible user experience.
On the operational front, in addition to ensuring a successful launch of our extensive new product line-up, we're also approaching the go-light phase for the upgrade to our Oracle 11i ERP software. As you can imagine, this is a major project involving multiple groups across the company over many months, but there is always the potential for unexpected developments with any projects of this magnitude.
We are on schedule and anticipating a successful implementation. That brings me to my outlook for fiscal '07.
For fiscal '07, we continue to target 15% growth in gross sales and non-GAAP operating income compared to the prior year. As we said at the beginning of fiscal '07, we expect gross margin to be at the low end of our long-term targeted bracket of 32% to 34%, slightly higher than in fiscal '06, due to anticipated upside in the second half of the year related to new product introductions.
As Mark mentioned, we also expect to see substantial, sequential and year-over-year improvement in gross margin in Q2 as we roll out a new range of exciting new products, many with margins higher than those of the products being replaced. Our non-GAAP operating income growth target excludes the cost of equity-based compensation.
The net cost of equity-based compensation for fiscal '07 reflected in net income is expected to be between $16 million and $19 million. We had solid performance in Q1.
We are on track to achieve our financial goals for fiscal '07. We're pleased that our top line growth accelerated in the first quarter even though we had yet to launch the large majority of our new products.
We believe that the innovation and attractive designs featured in our new products will allow us to sustain this momentum during the coming year. We're focused on delivering profitable, top line growth by executing our plans to take advantage of the many opportunities before us.
At this point, I would like to open the call for your questions. Please follow the instructions of the operator.
Ted Chung - Bear Stearns
Hi, I had a quick question for you regarding your guidance. Given that your revenue growth for 1Q was 18% and you talked about new, exciting new products coming out in the second half of the year, is 15% growth being very conservative at this point?
Is there something that we are not seeing that we should be worried about?
Guerrino De Luca
I don’t think there is anything you should be worried about except the fact that the future, nobody knows it. We're very pleased with the 18% and we're very excited about Q1.
We're very excited about our products. We know that from experience that not everything that could go right, does go right so we factored that in our forward-looking guidance.
Also Q1 is a small quarter, remember. So, even though we are very pleased with our Q1, let's wait until we see the developments in the coming weeks and months.
For the time being, this is our guidance, and we confirmed it.
Ted Chung - Bear Stearns
Just on your cash conversion cycles, Mark had talked about previously that there are some opportunities to improve that. Are you continuing to see that?
Mark Hawkins
Ted, I do believe that there's opportunities to improve that. We're looking at that as I mentioned to you.
I want to begin to explore without giving any particular targets. One other things I would say, you saw in the year-on-year that we improved our cash position, partly through more efficient payables.
That is one of the beginning points. I think I said, BPO is an area that was of interest.
Clearly will continue to look at the entire cash conversion cycle but it is early days, Ted. It is something we want to look at, explore and try to optimize for the company.
Ted Chung - Bear Stearns
Great thank you.
Mark Hawkins
You bet.
Operator
Our next question comes from John Bright - Avondale Partners.
John Bright - Avondale Partners
Thank you. On the gross margin side of the equation Mark, can you talk about what the impact was?
Just elaborate on the channel actions that you took in the quarter in audio and games?
Mark Hawkins
A couple of things here, we have looked at both the audio and gaming in the channel, and felt that it was important to move these transitions to these end-of-life activities in the channel to position ourselves well for the entire year. We thought that it was in the best interest of the business to do that and we made those actions.
Basically that's what happened, we wanted to move things along in the channel and took the appropriate actions in those two areas. I think you can step back here John and with the gaming activity that is going on, what is happening with the product transitions I think it makes a lot of sense and also in the audio with the explosive growth that we have we want to just continue to position ourselves for the entire year.
John Bright - Avondale Partners
Can you talk about the impacts on an absolute basis?
Mark Hawkins
Well, we're not going to talk about the specific impacts. I mean fundamentally, those are the two drivers that really drove the impact for the whole gross margin.
John Bright - Avondale Partners
Right, right. Guerrino, you continue to talk about your break through products redefining this segment.
Are you going to give us some timeframe on that?
Guerrino De Luca
Well, we're not going to preannounce anything here in this room there; our directors are looking at me like don't say anything, don't say anything. I have to tell you that we showed a lot of great new products across the categories and to our customers, as I mentioned.
I don’t recall such a positive feedback in all the eight years of being here. So, you will start to see some of these products, a good number of these products this quarter and the balance of it early next quarter.
John Bright - Avondale Partners
Right, and then one last one for you, Mark. On the Oracle and the SOX costs or expense increases, are these one-time or is this something that we might see a step down in G&A associated with these in the future?
Mark Hawkins
We will continue to operate within the range that we articulated in the London Investor Day in terms of the range of G&A, in terms of the model. We certainly hope that some of these expenses will transition as we go and implement, for example, in Oracle.
I think from a material standpoint I would just go back to the guidance that we're giving from a G&A standpoint.
John Bright - Avondale Partners
Thank you.
Mark Hawkins
You bet, John.
Operator
Your, next question comes from Manuel Recarey - Kaufman Brothers.
Manuel Recarey - Kaufman Brothers
Hello.
Guerrino De Luca
Hi, there.
Manuel Recarey - Kaufman Brothers
Can you talk a little bit about the audio sector? I mean looking at the number 23% is a nice year-over-year growth, but it is down fairly substantially from the previous quarter, I think it was 68%.
Is it just tougher comparisons going forward, and you expect the growth rate to be more in line for this June quarter? Or would you expect it to jump back?
Guerrino De Luca
Audio has been a very exciting business and will continue to be, we have said in the past that sustaining a triple-digit growth pace is just unthinkable and we will continue to believe that. We're very pleased with 23%.
That 23% factors in part the substantial action we took to transition the existing line-up into a new line-up across many elements of the audio line. So, audio will continue to be a major contributor of our growth, it won't be triple digits but we are fairly bullish across both the PC side of audio and the iPod side of audio.
Manuel Recarey - Kaufman Brothers
Triple-digit would be nice.
Guerrino De Luca
It has been a triple-digit but, audio as you know, is the second-largest business at this point and so it's a significant chunk of our revenue.
Manuel Recarey - Kaufman Brothers
Yes, then one more question for Mark. You had spoken about the sales of marketing, it was up only modestly on the income statement but if you include the soft dollars, it was up more.
Can you give a little bit of more color? Was it up about the same amount as gross profit or is up as much as sales?
Mark Hawkins
Let me actually speak to that Manny. When you look at the OpEx you see it growing at 7% from that standpoint.
But when I think about all the soft dollar activity that basically happens between gross ships and net ships basically, that soft dollars grew roughly in line with our retail growth rate. So you can see what's happening on the OpEx side, and then just envision soft dollars growing roughly and in line with the retail sales growth rate.
Then you can get a better view of how we are driving demand.
Manuel Recarey - Kaufman Brothers
That helps a lot. Thanks.
Mark Hawkins
You bet.
Operator
Our next question comes from Matthew Crakes - Merrill Lynch.
Matthew Crakes - Merrill Lynch
Hi, good morning and afternoon. My first question if you could give some color on why the quarter was back end loaded, and in particular if the higher level of accounts receivable reflects any selling into the channel rather than sell through?
My second question is, do you still expect OEM to grow double-digit this year? Thank you.
Guerrino De Luca
Let me tackle both questions. This quarter was more back-end loaded than last Q1, a few percentage points.
Not like a dramatic difference but a tangible difference and that's reflected in the DSOs and pipe. Why is that?
Well our customers order frequently. The performance in the late-April/early May was not as good in terms of sales out; it picked up in the second half of May and became stronger in June and that obviously drove our sales.
There is a pretty tight correlation between sales in and sales out at this point in our business; which by the way, is a healthy thing. As I talk about back-end loading, the current quarter, Q2, is much more naturally back-end loaded, it's driven much less by Q1 sales out issues, but much more by the timing of introduction of our new products.
When you introduce new products you have to fill-in a phenomenon because you have to put them up on the shelves to start selling. So, that would be more natural and that's why Mark was referring to not expecting a significant change in DSO at the end of Q2.
Sorry your second question was?
Matthew Crakes - Merrill Lynch
On the OEM price expectation for this year.
Guerrino De Luca
We do expect OEM to grow to double-digits. Let me sort of comment on what's happening here, I think Mark eluded to it.
We're seeing a soft general desktop PC market; you know that, we know that. That somewhat impacted our OEM, especially because we have a significant market share in mice.
So our performance in that business is closely related to the market. However, there is also an additional thing which is interesting: a major customer we are transitioning from a mouse offering to a desktop offering.
We are in the middle of that transition; the desktop offering is not entirely ramped up at this point. From revenue and gross profit perspective it is actually a very positive change, as you can imagine.
You replace a mouse with the desktop, there is obviously more value getting in. That is going to be a driver of our growth in the remainder of fiscal '07,.
To answer specifically, we do continue to expect double-digit growth.
Matthew Crakes - Merrill Lynch
Can I just one follow-up question? Have you seen any rising impact from higher wage costs in China?
Mark Hawkins
Matt, we have looked at this before we talked to people and what not, and of course, wages go up everywhere, to a degree. There has been no significant effect on that at all on our business.
Very small, de minimus effect.
Matthew Crakes - Merrill Lynch
Thank you, guys.
Operator
Our next question comes from Mehrdad Torbati - Deutsche Bank.
Mehrdad Torbati - Deutsche Bank
Hi Mark, hi Gary. I just had a question on active DSOs.
You're saying that you're not going to see any significant improvement in DSOs due to the product announcement at the end of the quarter? Now, going back to the first quarter, if you were to normalize the quarter in terms of sell in or sell out, sales evenly in a quarter, what do you think your DSOs would have been at the end of the quarter?
Mark Hawkins
What you are really asking about, Mehrdad, is trying to normalize for the ramp of a big June and trying to step back at the terms, fundamentally. I think it's the gist of your question.
From a Logitech standpoint, a couple of things are going on that we discussed in London. One is, certainly there is emerging market activity that is having some impact on the regional mix, if you will, of DSO which has a weighted average total effect.
But the biggest thing that drove the change, basically, was in fact the big ramp in June. So if you normalize that, I think you might see some movement in DSO, but the biggest explanation, far and away, the number one is in fact the big June.
Without quantitatively giving it to you, I am telling you the big bar far and away was the June ramp.
Guerrino De Luca
Let me qualify, let me add to what Mike is saying. We are not providing a guidance on DSO, if that is the question.
That is what it is. It is higher than it’s physiological level due to the back-end loading, but we are not telling you what it is projected to be moving forward.
Mehrdad Torbati - Deutsche Bank
You were trying to explain the potential improvement in cash conversion cycles ahead of you. You have referred more to payables as a source of improvement.
Do you see DSOs as a source of improvement in the short term as well? Let’s talk about Q3, Q4 when you would not be having a back-end loaded quarter.
Mark Hawkins
The think I believe is that the cash conversion cycle in aggregate, there is an opportunity there for us. That is what we want to explore more deeply and more fully.
I think the first port of call you can see is looking at what is happening with DPO and we are just beginning to look at that. If you look at this quarter’s cash, and if you look at this quarter’s cash position, there is a $24 million improvement period-on-period and the payables was a contributor to that.
So we're just beginning these days of really starting to dig in and look at this. I believe that the cash conversion cycle is an opportunity and we will continue to look at that over time and we will begin to unfold this over time; but I would rather deliver some good progress for you as opposed to guide you to a specific number in this respect.
But we do believe that there is an opportunity.
Mehrdad Torbati - Deutsche Bank
Could you please give further comment on what you said early, the emerging market activity is lengthening your DSOs. Is it coming from China?
What kind of profile do you have there?
Mark Hawkins
Think about it more in terms of things like Eastern Europe, Latin America; activities like that.
Mehrdad Torbati - Deutsche Bank
Thanks so much.
Mark Hawkins
You're welcome, Mehrdad.
Operator
Our next question comes from Michael Foeth - Lombard Odier.
Michael Foeth - Lombard Odier
Hi, can you hear me?
Guerrino De Luca
Yes.
Michael Foeth - Lombard Odier
Good morning. I have one question on the other operating income, apart from the Anoto contribution what was in there?
Could you maybe tell us if we should expect more positive contributions in coming quarters on that side?
Mark Hawkins
The other thing that was in there, we had some foreign exchange gains as well. There was favorability year-on-year from that standpoint.
We had interest income, it was up year-on-year was one of the explanation that I gave as well. So if you think about the differences between operating income and net income, again the contributory factors were the Anoto, which we called out.
Then on the same line there, if you look at the foreign exchange. Separate from that you have the interest income and the tax improvement.
Those are some of the accelerators that helped drive good operating income to an even higher net income.
Michael Foeth - Lombard Odier
Okay. But no expectations for the future?
Mark Hawkins
Well we never give guidance on things like foreign exchange and things of that nature, but that also are the actual dynamics that were happening.
Michael Foeth - Lombard Odier
My second question would be on the console gaming, can you explain what the drivers are, what will drive growth again there and what timeframe we should look at in terms of turning momentum in console gaming?
Guerrino De Luca
By far the largest driver of our console gaming business is the PlayStation. And as you know the PlayStation is undergoing a major transition and Sony is telling the world that perhaps before the end of this calendar year they will introduce PlayStation3 in some markets.
I'm being cautioned here, I don’t want to speak for Sony. We are very close to Sony; as you know, we have a long-standing relationship with them as there are a lot of things that we were working on with them.
Some of which will appear at the launch of PlayStation 3, some of which will lag a little bit. But fundamentally the PlayStation 3 introduction will be the great catalyst of our growth.
This is why we are saying that it is hard to expect the return to growth before the end of fiscal '07. At that point we will become very bullish on our console gaming business again.
Other platforms, we have been doing very well with PSP , but it is a much smaller platform. We expect PSP to continue to be a driver and we have never and don't expect we will have a substantial business on Xbox.
So, that is not kind on the radar screen, we have a unique product there, Harmony remotes specifically there for Xbox. We will have a couple of other retail products that work with Xbox, but Microsoft policies are such that doesn't make it either possible or attractive to do a lot around that platform.
Historically, we are talking a 10:1 ratio for us in terms of the importance of the PlayStation. So, we are all eagerly anticipating that introduction and that should lift our gaming business, particularly console gaming.
As I am on gaming, I was very pleased to see the growth of PC gaming and I would not underestimate the opportunity in that space, due particularly to the introduction of Vista. Vista is many things, but it certainly is a much more suitable platform for PC gaming; we defined the reference game pad, which means that every game will work with the same game pad.
It has never been the case for the PC. So, that should continue to drive PC gaming.
Also the success of the online gaming, gaming keyboards and gaming mice. So, I'm definitely bullish on that side of the business.
Michael Foeth - Lombard Odier
Great. Just a last one, I just want to get confirmation that the 130 basis points on the gross margin, it was really only due to the timing effect of audio console sets?
Guerrino De Luca
Absolutely, we believe that the impact of audio and console gaming end-of-life activities in the channel was very significant. We are not quantifying that, but it was very significant.
You should look more at what we said about our margin going forward. We said that we expect substantial, sequential improvement in Q2, and we also confirmed that we will see overall year margins to be slightly ahead of last year.
Mark Hawkins
Exactly. That's why I think we should really just refer to the three takeaway points that we gave, and Guerrino covered.
Michael Foeth - Lombard Odier
So you're going to be back in that bracket?
Guerrino De Luca
Yes, absolutely.
Michael Foeth - Lombard Odier
In Q2 as well?
Guerrino De Luca
We said substantial. It's up to you to - We can't make the meaning of substantial.
Michael Foeth - Lombard Odier
Okay, thanks a lot.
Operator
Your next question comes from Charles Wolf - Needham & Co.
Charles Wolf - Needham & Co.
I just wanted to do a follow up on the issue of the console gaming arena. When should the year-over-year growth turn positive once PlayStation 3 is introduced?
Guerrino De Luca
Hi, Charlie. Let me speculate.
If Sony launches as announced, I believe that Q4 might be a good time to look for it. Our fiscal Q4.
Charles Wolf - Needham & Co.
Thanks a lot.
Operator
Our next question comes from Can Elbi – Cheuvreux.
Can Elbi – Cheuvreux
Hi, I just want to follow up as well. I believe your allowance for customer programs and returns grew 3X versus net sales in fiscal ’06 versus fiscal ’05.
So with these directional changes, can you give us a sense of how that did in fiscal Q1?
Mark Hawkins
John, first of all hello. Thanks for the question.
We actually don’t get down into that level of detail in terms of specifics. I think the key point for you is understanding again the bigger context of what we are doing from a gross margin and sales standpoint.
We don’t typically comp them at that level.
Guerrino De Luca
This is a gross to net kind of item.
Can Elbi – Cheuvreux
I was trying to understand the dynamics between gross DSOs and net DSOs, that is why I was trying to get my hands around that.
Mark Hawkins
I appreciate that. Hopefully Guerrino, really helped you with the DSO, articulated a little bit more and elaborating some of the key takeaways on that.
Again the biggest driver from that standpoint, just to be clear, is the fact that we had a big June which we're really happy about, to be honest with you. Secondly, there is some regional mix activity including Eastern Europe, Latin America that is out there and some of the regional mix affects us.
Some term changes but those are down the [prado bar] in terms of dissecting the actual, what is happening with DSO.
Can Elbi – Cheuvreux
Okay, and maybe just one quick refinement on gross margin you made certain comments on year-over-year comparisons. Do your comments also pertain to a quarter-over-quarter comparison?
So I mean if I'm looking at this 160 basis points clean quarter-over-quarter decline, including about 60 basis points that you claimed was there last quarter, is that also due to these actions that you took or would there be anything else there on a quarter-over-quarter basis?
Mark Hawkins
No, there wouldn't be anything else there.
Can Elbi – Cheuvreux
Okay, thanks a lot.
Mark Hawkins
You bet.
Operator
Your next question comes from Yves Kissenpfennig - UBS.
Yves Kissenpfennig – UBS
Yes, hi Mark and Guerrino. I also had a question to your gross margins.
You are talking about the gross margin being weak in Q1 due to the channel actions in audio and remote, and you see net growth –
Guerrino De Luca
I'm sorry, in audio and gaming.
Yves Kissenpfennig – UBS
In gaming, I'm sorry, yes. You seem pretty confident near-term and you keep saying that the product introductions are going to push the gross margin back up.
Could you maybe be a little more specific as to is it just these two areas, or what other areas do you really expect to be relevant from the gross profit margin perspective?
Mark Hawkins
Let me take a shot at that and then maybe Guerrino can add in. A couple of things here: One is, I think you've characterized well.
First of all, if you look at what's happened currently we have taken the appropriate actions we felt was appropriate to move some things through the channel and hence we did that in the console and also in the audio area. If you push beyond that, and have that not been there in the current quarter, then you start to look at the fact that we have been introducing new products already.
A number of recent announcements that are happening. Thirdly, we began to shift more into new products throughout the year, as we even talked about what you can expect from a DSO standpoint because historically we have a big wave of products coming out.
So, new product introductions has been a consistent part of our plan; it is something we talked about back in London. We're beginning to execute on that and seeing that happen.
We have taken the right actions now to position ourselves for the long term and to stay on track for the guidance. So, I would be very clear and crisp, and say, yes, moving these through to the console and moving through the audio has helped us and also looking at the product mix in the introductions, it is helping us.
We actually feel that we are well on track to achieve our commitments in the gross margin area.
Guerrino De Luca
More specifically in terms of new products, as you know, you have followed Logitech for a long time, when we introduce new products, their gross margins tend to be lower than it will be in the few months, through the life cycle. However, in this particular case, this is more than compensated by the fact that several new products are replacing older products, and these new products at introduction will have better margins than those that they replace.
That is particularly true in audio. This is as much color as I can give you on our sort of bullishness on the sequential improvement and our overall fiscal year margin.
Yves Kissenpfennig – UBS
No, that's great. Thanks a lot.
Guerrino De Luca
You're welcome. We will be taking one more question.
Operator
Yes sir. Your last question comes from Joel Basang - AWP News Agency.
Joel Basang - AWP News Agency
I just wanted to ask about your mid-term goals, still confirms the $3 billion to reach by 2010?
Guerrino De Luca
Thank you for the question. That’s way beyond what we usually provide as formal targeting.
So it is way beyond fiscal '07, but we are very confident that we can sustain double-digit growth for the foreseeable future. So if you apply that statement to at a simple compound growth opportunity for the company, the answer to your question is yes.
We see that $3 billion as just one milestone we look that, as we build Logitech for the very long term.
Joel Basang - AWP News Agency
Thank you very much.
Guerrino De Luca
Let me give you just a couple of observations before we close the call. Thank you very much for your participation.
I believe it was tangible, how excited I am about this year’s product portfolio. I think we are entering the holiday season with our strongest line-up ever.
Let me also share what I saw last week when we completed a strategic review of our product roadmap for fiscal '08. Here I am going really to the future.
Fiscal '08, as you know starts next April. As thrilled as I am about this year's product, I must say that I am very impressed with next year’s plan for continued market-leading innovation.
I strongly believe that our ability to innovate has long been one of our primary competitive strengths, and that our fiscal '08 products will just widen the competitive gap even further. As has been the case for a long time at Logitech, the best is yet to come.
So thank you very much for your participation today.
Operator
Ladies and gentlemen, this concludes today's conference call. You may now disconnect.
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