Apr 21, 2006
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Executives
Joe Greenhalgh, Vice President of Investor Relations Kristen Onken, Retiring CFO Mark Hawkins, Chief Financial Officer, Senior Vice President of Finance and Information Systems Guerrino De Luca, Chief Executive Officer, President
Analysts
Ted Chung, Bear Stearns Joel Wagonfeld, First Albany John Bright, Avondale Partners Manny Recarey, Kaufman Brothers Michael Felletz, LODH Yves Kissenpfennig, UBS Can Elbi, Cheuvreux Serge Rotzer, ZKB Jon Lopez, OTA Asset Management.
Operator
Good morning. And welcome to the Logitech Fourth Quarter and Fiscal Year 2006 Earnings Conference Call.
All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer period.
If you would like to ask a question during this time simply press “*�? then the number “1�?
on your telephone keypad. Thank you.
I would now like to turn the conference over to Joe Greenhalgh, Vice President of Investor Relations. Please go ahead, sir.
Joe Greenhalgh, Vice President of Investor Relations
Thank you, Michelle. I would like to welcome you to the Logitech conference call to discuss the Company's results for the quarter ended December 31, 2006, the fourth quarter of Logitech's fiscal year 2006.
The press release, a live webcast of this call, and the accompanying presentation slides are available online at Logitech.com. This conference call will include forward-looking statements that are being 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 includes as set forth in Logitech's annual report on Form 20F dated May 18, 2005, the subsequent filings available online on the SEC EDGAR database, and in the final paragraph of the press-release reporting fourth 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 that 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 the presentation slides accompanying the call are also available on our website.
Joining us today from Zurich is Guerrino De Luca, Logitech's President and Chief Executive Officer. Here in Fremont we have Kristen Onken, our retiring Chief Financial Officer and her successor Mark Hawkins.
I would now like to turn the call over to Kris.
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Kristen Onken, - Retiring CFO
Thank you, Joe, and thanks to all of you for joining us on our quarterly earnings teleconference. I joined Logitech at the end of fiscal 1999 and in the seven-plus years since then, our sales have grown from $448 million to $1.8 billion.
And we generated over $830 million of cash flow from operations. I am proud and grateful that I had the opportunity to contribute to the Company's sustained profitable growth.
I know I will miss the interaction with both the Logitech team and the financial community. But I am looking forward to starting my retirement at the end of this month.
During the last three weeks, I have had the opportunity to work very closely with Mark both in closing the books as well as briefing him on the key aspects of our business and financial model. He has quickly earned my confidence.
I am very comfortable with handing the reins over to him. So, it is my great pleasure to turn the call over to Mark Hawkins, Logitech's Senior Vice-President of Finance and Information Systems and Chief Financial Officer.
Mark.
Mark Hawkins, Chief Financial Officer, Senior Vice President of Finance and Information Systems
Thank you very much Kris. I am thrilled to be here, I want to say just to start out.
Having spent my previous six years at Dell and then 18 years before with Hewlett-Packard, I am look forward to applying the best of what I've learned in both places here at Logitech. I will now discuss the performance for the fourth quarter of '06 and also the full fiscal 2006.
I want to call out at the beginning that we are very pleased with our results in total. We delivered our best-ever full fiscal year and fourth quarter for sales, operating income, and net income combined with a strong balance sheet.
And we also delivered on our increased fiscal 2006 targets for the important areas of sales and operating income. The growth percentages that I am going to talk about from here forward are in reference to the same period compared to fiscal 2005.
When we look at Q4 of '06, our sales grew by 16%, or 63 million, to reach 466 million. Our retail business – let's talk about that for a minute – continued to deliver solid growth with sales increasing by 19% to 418 million driven by outstanding performance, I might add, in the audio, video and remote control area as well as, it's important to note, double-digit growth in the cordless mice.
Turning to our OEM sales, they declined by 6% primarily due to lower mice sales. If I shift now into gross margin for Q4 '06, this was at 31.9% down as expected from last year's 33.6%.
Important to call out here is that this year's gross margin includes the impact of roughly 60 basis points for a substantial reserve taken from one product in the audio category. It was a wireless headset for audio.
Excluding these one-time reserves, our underlying gross margin for the quarter would have been 32.5%, slightly higher sequentially compared to December. If I shift now to OpEx for Q4, we grew our operating expenses by only 7%.
It's important to note this is the fourth quarter in a row where we've had lower year-over-year growth and the smallest quarterly growth we've seen in years. With saying that, I am pleased to report that we did make the essential investments.
You can see that in our engineering being increased by 12%. That was heavily geared to our audio and remote controls.
But if you step way back away from it, the OpEx is in line with where we were shooting and in our model as well. And its important to see that our gross profit grew almost twice as fast as our operating expenses, which yields of course, a good operating income growth that came in by 17%.
And again I want to just call out this reach a record high for the fourth quarter. And our operating margin was at 11.8%.
So now let's shift into the net income for Q4. This grew by 27%.
Our net margin reached 11% with both benefiting I want to specifically call out, 2.8 million in other income. And let me explain a little bit about that.
That was due to a transaction timing that resulted in some related exchange rate gains. If we also shift and address the tax rate, we had an effective tax rate of 12.9%.
And this is down from last year's 15% in the prior year and also below our full-year target of 14%. And I want to recall also for our folks that we did talk about that there would be variation in our tax rate on a quarter-to-quarter basis and that’s what we're seeing here.
Now let's go ahead and step away from Q4 for a minute and go ahead and get into fiscal year 2006. Our sales grew by 21% to 1.8 billion.
If we take a little deeper level of that, we look at our sales in the retail business increased by 293 million or 23% to 1.6 billion with growth driven really by spectacular results in the audio area and then complemented nicely by very strong performance in video and our Harmony remotes. We also saw a return to growth in the OEM with sales up 11% due to very solid demand for mice.
For the FY '06 gross margin, this was at 32%, down from the 34% in prior year and still well within our target range of the 32 to 34. This decline in gross margin primarily reflected the combination of first of all significantly more retail audio sales and the product mix and also, I'd say, a return to more typical margin levels in a number of product categories as last year's gross margin was at the top of our range in several of these categories.
So net message, within the range, audio mix impacting things, and a little bit of a normalization in terms of several categories. Looking on to our FY '06 OpEx, the thing to call out immediately is when you look at the operating expenses growing by 13%, still scaling nicely as we would like – growing at 13%, and also scaling compared to either revenue and/or gross profit.
Our net income grew by 21%. And this 21% had a nice complement from our other income related to things that we talked about on the quarterly basis also including some of the related exchange rate gains and a few other matters including our tax rate that came in for the year at 13.7% compared to the prior year at 15% compared to our target again for 14%.
And we're pleased to see that. Let me shift now to the balance sheet.
Our cash position at 245 million was down only 96 million to the prior year despite the fact that we spent $241 million repurchasing our shares during fiscal 2006. Our cash flow from operations for the quarter was a record-breaking 137 million.
Pleased to see that – up by 15% compared to last year's previous high of 119 million. For fiscal 2006, our ash flow from operations was 152 million, down from the 214 in prior year.
When I look at inventory, I think that we called out at the last call, that you could expect a significant decline sequentially in the March quarter. And that’s exactly what we delivered.
Our inventory was 197 million, down by 61 million from the December 2005. So we are actually pleased with the inventory results for this period.
You can see it in terms of the turns. They were up to 6.4 turns compared to 6.1 at this time last year and 6.0 sequentially in the prior quarter.
If we shift now to accounts receivable that was up, rather was at 290 million, up from the 229 million of last year. Our day sales outstanding was 56 days compared to 51 days achieved in 2005.
Let me now touch base, after talking about some of the assets, to our share repurchase. And couple things to call out.
In the fourth quarter we repurchased 3.975 million shares -- $464 million worth of spend. And for the full fiscal year 2006, we repurchased 6.138 million shares for 241 million.
And we now own 4.7% of our shares outstanding. By the way for everyone, I want to also remind you that on the website we do have a helpful summary regarding our repurchase in the Investor Relations section.
Now, we've completed the balance sheet. And now let's take just a little bit deeper look into Q4 '06 in terms of the business.
As we look at our retail business in the fourth quarter, we grew this by 19% on units increase of 29%. The faster unit growth was driven by product mix shift in several categories reflecting the broad appeal of our offering in the mass market segment – number one.
Number two, it is important to call out, we did not implement any significant price changes during the quarter. And we are pleased that we are continuing to execute the strategy of selling into stable price points.
If we look at it now on a regional basis, we achieved strong growth on all of our regions with sales in the Americas up by 18% on a 39% unit growth rate; and Europe delivering 20% growth on a 37% increase in units. Again audio and video were the main contributors in both regions, really a nice performance there with cordless mice making a strong showing in the Americas and Harmony remotes ramping impressively in Europe.
We continued to achieve double-digit growth in Asia with sales up by 15%. Shifting away from the region now to the product area and the product families and starting with the cordless where our sales decreased by 2%.
But units were up by 21%. I think as promised at the start of the quarter, we saw a return of double-digit growth in cordless mice.
And sales were up by 21% and units grew by 41% with a near doubling of the sales and units in the mass market segment. The overall growth in the cordless mice category was driven primarily by the success of our line of cordless mice for notebooks.
And this is including the V400. While our supplier is still ramping to meet the demands of the V400 component shortage that hurt us in December, there was improvement and we were able to ship a reasonable quantity of these, especially in Europe.
As expected, our cordless desktop declined by 17%, but units grew by 4%. With this said – and we talked about this at last quarter's call – we didn't anticipate a return to growth in this particular category until early fiscal 2007.
And this continues to be true. This is our view on this.
The decline in sales was primarily a function of mix shift within the category. And that we continue to experience strong growth in sales in units in the mass market segment of the category.
Our worldwide market share is stable. And so with this said, kind of the key points here is, we thought the growth would return in FY '07.
That continues to be our view. The mix – you can see it shifting within the categories.
That is primarily the dynamic that’s happening. We have a share that is stable and really strong growth in the mass market segment, which we see as a good sign.
If we move to the retail audio Q4, again strong performance as described with sales growing at 68% and units at 78%. Going a little deeper, our speakers the biggest audio category, increased by 77% with units growing 90%.
Complementing our continued strength in the PC speakers, it was another strong quarter for our mm50, our flagship iPOD speaker. PC headsets really are riding I'd say the wave of the voice-over-IP communications and contributed to sales growth of 61% and unit growth of 69%.
So again, audio is very strong and speakers, obviously, and the mm50 iPOD – a lot of good dynamics going on in that category. Shifting now to the retail corded, this grew by 7% with units up by 13%.
Corded mice sales increased by 6% with units growing 17% with the growth driven by the success of our mice for the PC gaming and in particular the G5 laser mouse. If we now shift to video, we saw a significant acceleration in our growth there in retail video.
And the sales were reflected by a 61% growth and then units growing at 72%. And again, this is just showing a reflection of the increased video communications over the internet dynamic, which we feel we are well positioned for.
The strongest growth came in the midrange in the mass market segments of the webcam category with sales and units roughly doubling in both of these segments. Retail gaming – when we look at that our sales declined by 26%, but our units grew by 6.
There is a bit of a story in here because when we look at the – we had a strong quarter in PC gaming with sales growing by 33% and units up by 32%. And this growth was driven, it's important to call out, by largely some of the success with our G15 gaming keyboard, which has been very, very well received by our PC gamers.
The other side of the story is that we look at the decline in gaming sales in total is really due to the transition to the new gaming console platforms, which led to a 61% drop in this sales of our peripherals for console gaming platforms and a 16% decline in units. Looking at Harmony and the remotes – just again continuing rapid growth during the quarter with sales in Europe accelerating.
These remotes made a solid contribution. And when you guys look at the other retail category, this is really the driver for the growth with a majority of the 7 million increases reported.
Let me comment on the OEM business now and with our sales they decreased by 6% in the quarter, but units grew by one. Mice sales declined by 11% with growth in video and gaming partially offsetting that.
Now let me just stop for a minute and as I kind of sum up the headlines for Q4, I think of this. Best ever Q4 sales, op inc and net income; our record Q4 cash flow; our strong balance sheet that we are exiting with; and beating the guidance in Q4 in total.
So those would be my summary headlines for Q4. Before concluding my comments I want to remind you that our fiscal 2007 investor meeting is scheduled in May – on May 11 specifically in London.
The agenda will feature a number of our senior executives reviewing our strategies and opportunities for fiscal 2007 and beyond. We are excited about this meeting.
We hope you can join us. And on that note, let me go ahead and turn it over to Guerrino.
Guerrino De Luca, Chief Executive Officer, President
Thank you Mark. Thanks again to all of you for joining us today.
Before I begin my remarks, I would like to extend my sincere appreciation to Kris Onken for the tremendous contribution she made over the years at Logitech. We were looking for a truly world-class replacement to a world-class CFO.
We have found him. And I am delighted that Mark has joined us in this key role.
So on to my comments on the results and the outlook. As you can imagine, I am very pleased with the Company's performance in fiscal 2006 and with its record-breaking performance in each of the four quarters.
Fiscal 2006 was Logitech's best year ever and our eighth consecutive year of double-digit growth. In spite of the decline in gross margin largely driven by the retail product mix, we managed our operating expenses in line with gross profit, increased our operating income by 16%, our net income by 21%, sustained our net margin of 10.1% of sales, and delivered again our increased full year targets both for sales and operating income.
Let me talk about our gross margin in the fourth quarter, which was negatively impacted by reserves taken for one audio product, as you have heard, our wireless headphone for iPOD. This product was eagerly anticipated by our customers when we began shipments in the June quarter.
The initial response from the channel and consumers was very positive and we ramped up production accordingly to meet demand. Apple's subsequent launch of the nano and consumers' favorable reaction to its small form factor negatively impacted the market for our headphones since they couldn't be used without the addition of a rather large adaptor.
So during this quarter, it became clear that we needed to take action and we increased our reserves accordingly. So this was obviously expensive but the good news is that we have learned a lesson about the ecosystem for iPOD peripherals.
Our iPOD speakers continue to do very well. We have a number of new iPOD-related products coming later this year.
We will clearly proactively manage both our product development and our inventory planning with the knowledge that this platform is subject to rapid and potentially disruptive change. The notable fact is that without these specific charges, our gross margin in Q4 marked an un-seasonal sequential increase over Q3.
As a final point on Q4, let me also say I was quite pleased with our operational performance that led to the record-breaking $137 million in cash flow from operations during the quarter. There were a number of retail product highlights during the year led by the spectacular performance in speakers.
Our speaker sales more than doubled in the fiscal '06 driven by the combination of a substantial increase in PC speakers and a solid contribution from our iPOD speakers. Another star in the audio category was PC headsets with sales nearly doubling due to the rapidly expanding appeal of internet communication.
The success of these two product categories helped make retail audio our second largest business. Speaking of internet communication, it was also a great year for retail video with sales up 36% and units up 53% driven by the increasing penetration of video conversation.
As the market leader, we did our part to help increase this penetration through the introduction of innovative new video products for desktop PCs and notebooks along with the Logitech video effects software, a key differentiator available only with Logitech webcams. I am also very pleased with the explosive sales growth of our Harmony remotes.
Our sales in this category roughly tripled compared to the prior year and are now nearly as large as the PC gaming category. In a relatively short period of time, the Harmony remotes have taken the number one position in US retail for both the advanced remote control market and the total remote control market.
During the second half of the year, we also started to build momentum in Europe. Let me talk about cordless where our sales were essentially flat.
The two main categories of this segment are cordless mice and cordless desktop. Our cordless mice sales grew by 8% for the year with units up by an impressive 21%.
Our growth in cordless mice, specifically in the all-important second half of the year, was constrained by our supplier's inability to satisfy our component demand for the V400. Even with this constraint, I am still quite pleased with the sales growth delivered by our line of cordless mice for notebooks.
You have seen the 9% decline in cordless desktop sales. The market itself continues to grow, particularly in the mass market segment, and we had very strong success in this segment, compelling evidence that the massive optional cordless is happening and we are participating as the market leader.
We continue to expect a return to growth in the category as we roll in a stronger innovative offering in the mid range and the high end in the first half of fiscal 2007. Turning now to our operational performance, one of the main highlights of 2006 was the successful move in June of last year to our new manufacturing facility in China.
We completed the move on time, within budget, and most importantly with zero disruption to our ability to ship product to our customers. The new plants gives us increased capacity and flexibility and leaves us well-positioned to accommodate our expected future growth.
My comments on fiscal 2006 wouldn't be complete without also mentioning the addition of three new senior executives to complement our strong management team. They come from senior positions held in much larger companies and will be key contributors to help Logitech scale as we grow.
In addition to Mark, Gerry Quindlen joined the Company as Senior Vice-President of Sales and marketing after a successful career at Kodak. Joe Sullivan, who joined us last year from Carrier Corporation a subsidiary of United Technologies, has recently been promoted to Senior Vice-President of Worldwide Operations, succeeding Company veteran Erh-Hsun Chang, who will be presented for election to the Logitech board of directors at our annual shareholder meeting in June.
We enter fiscal '07 focused on two key priorities – capturing the attractive growth opportunities before us; and improving our profitability. Our main growth drivers in fiscal '06 were audio, video, and Harmony remotes.
We expect these categories to retain their momentum in fiscal '07. In audio we see a continued strong growth opportunity due to the popularity of digital music and the increasing penetration of internet voice communication.
Our product lineup for the New Year will include a number of innovative and attractive speakers targeted to the PC platform as well as the iPOD and MP3 space. We also plan to broaden and enrich our user-friendly wireless music offerings enabling the streamings of music on your PC, iPOD, or MP3 players to any room in the house.
We are thrilled by the growing penetration of internet communication. As leaders in both webcams and PC headsets, we are uniquely positioned to provide consumers with an appealing lineup of standalone and integrated products that both simplify and enhance the user experience.
The new products we expect to launch this year will recognize and address the unique needs of different users be they in the home or on the go. Increased complexity and richness of home entertainment systems in the livingroom translate into a huge opportunity for our Harmony remotes.
The impressive initial success of our offerings in the United States and most recently in Europe provides strong evidence that these remotes are becoming widely acknowledged as the answer to this complexity. We believe our sustained investment to simplify the setup process and provide effective customer support gives the Harmony remote the potential to become the universal remote control device for enjoying digital entertainment across the home.
Turning now to cordless where we continue to expect a return to growth in fiscal '07. As the unit growth figures in our fourth quarter results demonstrate, the mass adoption of cordless has begun.
With penetration rates relatively low, we believe there is lots of runway left. We also believe that the penetration of Bluetooth technology into the PC install base is starting to approach critical mass providing an attractive opportunity for Bluetooth enabled mice in desktops, especially at the high-end.
The increasing popularity of notebooks has created a substantial and growing market opportunity for cordless mice. Our mobile cordless mouse lineup is already robust and we plan to improve it further during the year.
Speaking of cordless mice, I am pleased to tell you we still see opportunities for significant innovation. While I won't offer any detail at this stage, I will say that in reviewing our cordless mice roadmap for fiscal '07, I am very excited about our potential to once again redefine the cordless mouse category.
I am also excited by the new offerings we plan in the cordless desktop space. Beyond the product innovations you'd expect from us, we also plan to launch cordless desktops that address both the increasing penetration of notebooks as well as the popularity of voice and video Internet communication.
We enter the new fiscal year focused on improving our profitability. Our product development teams are looking at every aspect of product costs from components to the size of the retail package to identify potential improvements.
Many of the products we plan to launch later this fiscal year, particularly in the speaker and cordless categories, are expected to carry better margins than the products they replace. That brings me to my outlook for fiscal '07.
On the sales side, we see continued double-digit growth both in retail and OEM. In fiscal '07, we expect both sales and operating income to grow 15% compared to the prior year.
Gross margin is expected to be at the low end of our long-term targeted bracket of 32% to 34%, but slightly higher than in fiscal 2006 due to anticipated upside in the second half of the year related to new product introductions. Our fiscal '07 targets exclude the cost of equity-based compensation, which will be included in operating results beginning in the June quarter.
The net cost of equity-based compensation for fiscal '07 reflected in net income is expected to be between $16 million and $19 million. Fiscal '06 was the best in our history.
Even with a 200 basis-point drop in gross margin, we demonstrated the adaptability of our business model by growing our operating expenses slower than our gross margin, limiting the decline in operating margin to only 50 basis points while preserving our net margin of 10.1% of sales. We enter fiscal 2007 well-positioned for sustained growth and profitability with an innovating and appealing product roadmap targeted at substantial growth categories, a proven ability to scale our operations as needed, and a strong and experienced management team focused on delivering against our full year targets.
At this point I'd like to open the call to your questions. Please follow the instructions of the Operator.
Operator
Operator Instructions
Q - Ted Chung
Hi good morning. I just have a couple of questions.
First, can you discuss in more detail regarding the desktop weakness. You mentioned that the penetration rate is still fairly low.
Is there a specific trend towards mass market that could potentially help you grow the market further in terms of additional features and so forth?
A - Guerrino De Luca
Let me tell you what -- to try to explain what is happening -- or what we think is happening. We have dug into this category pretty substantially.
There is clearly unit market growth substantially out there. And it takes place at the entry level because that is where newcomers to the categories tend to buy.
And we have grown our units. We are doing well there.
Prices are lower in that space. Fine, but we participate.
What has not worked this year, which is what usually works for us and we believe will continue to work, is the fact that we were unsuccessful in stimulating enough of the newcomers to trade up to our midrange. So a lot of people stayed with the entry level, which is great.
We keep share and we plant another seed for future repurchase. But of course, we suffered on the revenue side.
So what we want to do is address the appeal of the midrange. And it will happen through the introduction of new products in the first half of fiscal of '07.
We believe that on one side we'll continue to take advantage of the mass adoption of cordless, which is where all these entry level sales are taking place, and on the other will give us more revenue growth because of the trade-up. In addition, I mentioned Bluetooth as a promising higher-end extender of the category.
You should read by that that our Bluetooth offering at the very high end will become more substantial.
Q - Ted Chung
Okay, just on the gross margin your guidance towards the low end of your target range. It seems to be conservative given the growth in your video categories than other categories.
Can you explain more on that?
A - Guerrino De Luca
Well you know they said, our gross margin we said, and we repeat it -- and we'll never tire to repeat it -- will fall in the bracket. We'll continue to be in that bracket.
We see -- we are very pleased with the growth of video. The growth of video for the year was 36%.
We are now providing guidance for category-by-category next year when we believe video is going to be a good participant to the growth. And video is a great margin category.
So that is great. But, once again it is the combination of categories and price points within the categories that makes the margin.
We prefer to guide where we are today with some slight improvement because we see products coming at better margins than the products they replace. That we can say.
And so that’s where we stand today.
Q - Ted Chung
And just finally, for your fiscal '07 tax rate, would you still expect 14%?
A - Mark Hawkins
Yeah, let me address that Guerrino, if I may. 14% is the range that we're looking at Ted.
Even with some of the stock option expensing and some of the other regulatory activities that are going on, we think that the 14% makes sense. We think it's sustainable.
There will be some variation by quarter, it is important to note. In total we think that it's going to be within the range within 1% of the range.
So 14 is our target.
Q - Ted Chung
And just one last question. Would you be breaking out the stock options impact by line item or?
A - Mark Hawkins
Could you repeat that, Ted.
Q - Ted Chung
Are you planning to break out the stock option expense when you report your earnings or?
A - Mark Hawkins
Yeah, we will in fact. That's correct.
Going forward, what we will obviously comply with the requirements in terms of external reporting. But we will provide a pro forma that also shows with and without that.
Okay?
Q - Ted Chung
Thank you.
A - Mark Hawkins
You got that.
Operator
Your next question comes from Joel Wagonfeld with First Albany.
Q - Joel Wagonfeld
Thank you. Two quick questions.
Number one, I apologize if I missed it. Could you comment on the supply constraints?
Are those completely gone on the V400? And are there any constraints for any other products?
And then, that's first question.
A - Guerrino De Luca
Well the answer is no, they are not entirely gone. We believe that they will be gone this quarter.
But even though we were able to ship a substantial amount of V400 in the past quarter, we were not completely in a position to meet full demand. We believe that we will be out of that particular constraint in the current quarter.
As far as general constraints, I can't say that there is anything major at this time.
Q - Joel Wagonfeld
Just on the stock option expense for fiscal '07 was a little bit higher than what we had been anticipating. Can you comment on your thoughts about trying to manage that down or why that would be up potentially year-over-year?
A - Mark Hawkins
Let me speak to that a little bit. If you look at, just in terms of year-over-year Joel one, in FY '05, we pro-forma-ed it at 18.5 million or 12% of our net.
Looking at it in FY '06, we anticipated it at a14.9 million impact on our FY '06 or around 8% net. Then in FY '07, I think we have projected a $16 million to $19 million range, again with a similar percent impact on our net.
If you look at the bigger picture, it is actually coming down substantially from '05 to the projection in the business for '07, even though we have a bigger business and we've added 400 professionals in total for the year. So that’s, those are some of the dynamics Joel that are going on.
Q - Joel Wagonfeld
Is that just less use of options or restricted stock? Or any details on how you are doing that?
A - Mark Hawkins
I think in total the bigger picture is looking on a multi-year period, yeah we are reducing the total number of options issued, consistent by the way with what’s happening in the broader marketplace. Obviously we view these as important.
And we are doing the appropriate amount competitively but we’re bringing those down much like the rest of the marketplace.
Q - Joel Wagonfeld
Great. Thanks very much.
Operator
Your next question comes from John Bright with Avondale Partners.
Q - John Bright
Thank you. Good morning.
Allow me to, hello Guerrino. Hello Kris and Mark.
Allow me Kris to again extend my congratulations to you. It's been enjoyable working with you.
Mark, welcome aboard.
A - Mark Hawkins
Thank you.
A - Kristen Onken
Thank you very much John.
Q - John Bright
You're welcome. First question, in the press release I think you talk about you expect product and marketing initiatives – you related your cordless desktops and mice – trying to drive the cordless category to solid growth.
Can you detail some of the expectations there?
A - Guerrino De Luca
We said that we would return to growth in the first half for desktops in the first half of fiscal '07. And I don't think we want to say more than that.
And I profoundly believe that the market is there, that the dynamics haven't changed. There is massive option, which means consumers are entering the category at the lowest possible price points.
Fortunately they are buying our products, which is good. It means that we have an appealing entry level.
What we would like to see is a little more trade-up. And for example, in webcams, the situation is very similar.
And yet we have been able to actually trade up a lot of the entry level customers to midrange. So the same dynamic has to be and can be recreated on desktops.
Q - John Bright
What action do you take to help encourage the consumers to trade up?
A - Guerrino De Luca
In this particular case it's a product issue. So that’s why we talk about the first half.
We usually, as you know, introduce our main products in the September quarter. And that’s when we expect to address that particular element.
Q - John Bright
You mentioned significant innovation in your prepared remarks for cordless mice and looking to redefine the potential.
A - Guerrino De Luca
Yes. Did I whet your appetite?
Q - John Bright
Yes, you did. Do you have a timeframe that you want to talk about?
A - Guerrino De Luca
It is going to be before Christmas.
Q - John Bright
Before Christmas?
A - Guerrino De Luca
Yeah.
Q - John Bright
Okay, and video continues to be a very strong performer. Great publish that you had on YouTube.com, by the way, for the animation features associated with that.
Is there anything in particular you are doing on your side of the equation to try and drive that awareness further?
A - Guerrino De Luca
You know, one of the most powerful elements of this kind of the vio marketing or consumer-driven marketing is that you just don't touch it. It took us weeks before some journalist convinced us to get in touch with us this young woman that who was posting those beautiful videos on YouTube and our mandate to our PR people that wanted to jump on it was to just don't touch it.
It is happening so beautifully. And I believe that more of these things will happen, especially with the video sect, which was the driver of the excitement for that particular posting.
So I believe at this point that the category had legs. The awareness is starting to happen, especially across a certain age group.
And we will have to continue to deliver fun products for these people to use. And believe me, we have plans for that.
Q - John Bright
Okay, two other questions on the revenue side – or one on the margin side, you are talking about better margins expected for some of the audio speakers. What leads you to give that type of guidance?
A - Guerrino De Luca
Well as you know, we have pretty elaborate product development cycle and process that has targets and feature sets and cost targets. And from the way we see things developing at this stage, we are excited about what we will be capable of doing, particularly in the cordless and in the speakers categories.
So it's projected cost of future products that replace existing products or complement existing products. And that’s what makes us make that statement.
Q - John Bright
Okay, on the Harmony remote sales, when did you introduce those initially into Europe?
A - Guerrino De Luca
We started actually very early with very, very occasional sales. The true sort of structured approach started maybe five months ago or so five to six months ago.
Q - John Bright
So we're thinking the December timeframe?
A - Guerrino De Luca
Yes. Well, actually slightly before that.
On the ramp to Christmas in the October November timeframe.
Q - John Bright
Okay and then lastly, on the tax rate. Mark, I didn't understand.
I didn't get that. I apologize.
Why was the tax rate lower in this quarter?
A - Mark Hawkins
A couple of things. One, John the geographic mix obviously has an impact on us.
And then secondly, we had some actual favorable tax rulings that also went on a favorable side. So couple dynamics that provided a really nice quarter on the tax rate.
I think the key thing that I would underscore with you that is important is it's a very – the fiscal year target. Okay we did again agree on variation by quarter.
You are going to see that going forward as well. The fiscal year target of 14% plus or minus one is really sustainable.
It's not dependent on net operating losses and whatnot. It is more of a structural strong tax rate.
Q - John Bright
Okay thank you.
A - Mark Hawkins
You are welcome.
Operator
Your next question comes from Manny Recarey with Kaufman Brothers.
Q - Manny Recarey
Good morning. Or good afternoon, I guess, wherever you are.
A couple of questions. The gross margin, if you exclude the reserve, you said would be 32.5%, which would be a sequential increase as you pointed out.
In historically, the margin goes down from December to March. Can you give a little more color on how you were able to achieve that.
Was it just product mix? What was driving that?
A - Guerrino De Luca
It is as we said on the downside, it is product mix. And I believe that the tremendous growth of webcams had something to do with it.
Q - Manny Recarey
Okay but on the audio side those margins continued to improve as well though.
A - Guerrino De Luca
Year-over-year they did, absolutely.
Q - Manny Recarey
Okay then looking at the sales and marketing line, that only grew 2% while the top line grew 16% year-over-year. Can you give a little bit more color on how you were able to achieve that?
A - Mark Hawkins
A couple things I'd say here. One is, when you step back – I am going to build the full points here.
When you look at total OpEx as a percent revenue, really came in, in total, in line with what we see on an historical basis for Q4 – if you go back for several years in the 20.2% range, we made the overarching theme is we made the investments that we really feel we need to, to grow going forward. You can see that with some of the engineering investments and whatnot.
We were able to spend where we needed to and not where we didn't, basically. So I think there is a lot of puts and takes to it.
But I think that is the answer. Fundamentally we are within the range of where we want to be both in our business model that we've called out to you before.
Historically in total OpEx, we made the essential investments that we needed to. And we were able to also make those puts and takes trade-offs that we feel just allow us to get a little bit of leverage being a bigger business.
So I think that is some of the key thoughts that I would share with you.
A - Guerrino De Luca
Let me add something. Mark cannot yet take credit for this – this last quarter.
But I think he will continue to take an aggressive view there. The important thing here is that A, we didn't sacrifice anything.
B, this shows a tremendous adaptability of the business model. Let's face it.
The Company can absorb a 200-basis-point decline in gross margin and basically show only a 50-point decline in operating margin, continuing to grow R&D dramatically – explosively, I would say in audio and remote controls. That’s kind a powerful, I believe.
So very, very happy about that. I am sure that Mark will contribute that.
Q - Manny Recarey
Guerrino I understand what you are saying. Looking at it on a quarterly basis going forward with the different line items on the operating expenses there will be some variability.
Would it be a fair assumption to expect sales and marketing to increase more on a year-over-year basis than they did the March quarter?
A - Guerrino De Luca
I would say that 7% is quite tight. I would say that the overall envelop should increase, as we said, in line with the gross profit.
What does that in line mean the same one point less? That's very hard to predict.
That is the class of things that we're looking at.
A - Mark Hawkins
Exactly. We still believe we support the model and the overall aggregate level of investment.
You are going to see variation from quarter-to-quarter as you would expect as different product introduction cycles happen and whatnot.
Q - Manny Recarey
Okay thank you.
A - Mark Hawkins
You are welcome.
Operator
Your next question comes from Michael Felletz (phonetic) with LODH.
Q - Michael Felletz
Yes. I have three questions actually.
First one would be that one-off impact on the gross margin – 60 basis points for those reserves. Is that really one-off limited to Q4?
Or do you feel that you will have to take more? Actually If I understand correctly, you produced too much and will have to discard these products?
A - Mark Hawkins
Michael this is definitely one of these one-off events in this particular case. You always have certain kinds of adjustments and reserves and whatnot.
But this is very specific to one particular product in the wireless audio category. It was significant.
And really give transparency to all of you, we wanted you to understand the underlying gross margin rate with and without this event. So that is why we called it out.
We really see this as a significant isolated event. Obviously we will continue to have the normal kinds of – what you would expect with excess and obsolete and things of that nature.
But this was a specific one.
Q - Michael Felletz
Okay thanks. Second question would be concerning the corded products.
Actually last year, if I recollect correctly in your investor day you talked about a declining market for corded products, but you actually sold gross. Are you expecting still expecting this market to decline in 2007?
Or is there more growth?
A - Guerrino De Luca
We won't apologize for growth. We will not apologize for growth.
I think that we were underestimating the tremendous response to the G15 keyboard, which was a substantial driver of corded growth. We do not believe that, from a secular perspective, corded mice and keyboard have higher potential than any other category in the portfolio.
We will take growth. And we'll continue to pursue it.
Remember this distinction of cordless and corded equipment that was chosen for us many years ago and that has driven a lot of our kind of approach to the market may not be the only distinction. There are other distinctions, for example, like desktop and notebook that may be intriguing.
In a way I might not be surprised to see a growth in corded, for example, driven by more product for the notebook. So we look at our categories with a very open mind.
And as I mentioned, sure we don't believe that corded product mice and keyboard have the same potential as Harmony or webcams. But their debt may be proclaimed a little bit prematurely.
Q - Michael Felletz
Okay thanks. And my final question would be on financials.
Could you tell us what your net cash use for share transaction was? And I mean that is purchased shares and the proceeds from sale of shares net of tax.
Do you have that number? I think last year it was 88 million.
A - Mark Hawkins
Michael go ahead and explain that one more time in terms of the question. I can tell you a lot about the share repurchase.
Q - Michael Felletz
The purchase of the dollar amount used for share purchases and the dollar proceeds from sale of shares upon exercise of options.
A - Mark Hawkins
Okay so let me tell you yes. I think I can address some of that here.
Certainly – let me just kind reorient a little bit. Let me reiterate a little bit about the share repurchase program.
We will keep taking this one step at a time. We purchased for the year let's just start with that 6.138 million shares okay.
And that was for spend of $241 million. Let's stop at that.
Now you want to go down to a deeper level and understand the following. Go ahead and share with me what you are looking for.
Q - Michael Felletz
Normally you show that in your filings the proceeds of sales from shares that you sell upon exercise of share options by your employees.
A - Mark Hawkins
We actually don't have that at this point. So I am just going to have to tell you we don't have that at this point.
Q - Michael Felletz
Alright, fine. That will be all from my side then.
Do you plan any further share buyback programs given that one is nearly over?
A - Mark Hawkins
Let me speak to that. First of all, we have – use the facts.
We have remaining authority to repurchase shares within the program that has been approved by our board. Secondly I would call out the fact that our board has historically obviously encouraged us to do share buyback.
Obviously it will be for the board to entertain that going forward. They are the ones to make that decision.
Certainly we are a Company with a history of share buyback. And you can see what we did in Q4.
Q - Michael Felletz
Thanks.
A - Mark Hawkins
You are welcome.
A - Guerrino De Luca
Mike believe it or not, I have found the number that was being asked about. If I understand the question, it's how many shares did you use because of the exercise of options and employee stock purchase programs.
Is that correct? Was that the question?
I assume that was. Mark said that we purchased 6.1 million shares, roughly.
And then we stopped upon exercise of option on the SPP something like 3.5 million. So the net in this case is roughly 2.6 million in favor of what we repurchased.
Remember that we also used shares to cover the conversion of the convertible bond. And that was for about 5.4 million shares.
So net, net we have – there was a negative net of 2.4 million between conversion of the convertible and covering the conversion of the convertible and covering stock options. The ratio of stock options that were purchased is roughly 50%.
Next question.
Operator
Your next question comes from Yves Kissenpfennig with UBS.
Q - Yves Kissenpfennig
I have two short questions actually. First, you continuously mention your product launch upcoming in the first half of fiscal '07.
I was wondering will you be concentrating most of that in the second quarter? Or will you be staggering it a little more unlike you've done in the past?
A - Guerrino De Luca
Well we will have products this quarter. But the fundamental bulk will come in Q2.
Q - Yves Kissenpfennig
Okay and then my second question was to the OEM business that seems to be neglected at the moment. I was wondering--
A - Guerrino De Luca
Not by us. Not by us.
Not by us.
Q - Yves Kissenpfennig
I know. By the analysts, it seems.
But anyway you mentioned double-digit growth also in your OEM business. And I was wondering that include any potential sales to the PlayStation 3?
Are you working with Sony together on something along those lines.
A - Guerrino De Luca
We may or may not we working with Sony along this line. The guidance does not include that.
Q - Yves Kissenpfennig
Okay.
A - Guerrino De Luca
This guidance has to do with some major transition that is happening at a major customer that we cannot name, whose transition was responsible for the decline of OEM in this Q4. And this transition is basically replacing a mouse with a desktop at a major customer.
So you will see moving forward at some point in time in fiscal '07, that the – we will have less mouse sales and significantly more desktop sales if this program is successful. And that is what fundamentally leads us to believe that OEM is going to grow in fiscal '07.
Q - Yves Kissenpfennig
Great. Thank you.
A - Guerrino De Luca
You are welcome.
Operator
Your next question comes from Can Elbi with Cheuvreux.
Q - Can Elbi
Hi guys can you hear me?
A
Yeah.
Q - Can Elbi
Kris, if you're still there, from my side as well, thanks for all the help during the last six, seven years. All the best in the future.
A - Kristen Onken
Thanks, Can. It's been a pleasure.
Q - Can Elbi
I just have two questions left, I guess. One, Guerrino I understand your comments with respect to cordless desktop and the fact that you have not been able to entice people to trade up.
And I guess that's had an impact on your ASPs in cordless desktop, which I think was down 12% in fiscal '06. But that still doesn't answer, I think, our question with respect to unit growth.
Because, if you look at cordless mice unit growth in fiscal '06, I think it was around 21% versus only 5% for desktop. So there must be something going on in terms of the unit growth area as well.
So I’m just trying to understand where any there any structural issues there with respect to the emergence of notebooks. Or also, probably at the same time, the fact that maybe consumer penetration into the PC desktop space has already reached some mature levels.
I have another question afterwards.
A - Guerrino De Luca
Yeah, I think it's a fair question. I believe from the data we have in and believe me Can we have analyzed this across all possible dimensions.
We see a material growth at the entry level, particularly in Europe and the most of the average spread growth. So in Europe you see the market declining as a whole with a substantial growth of entry level.
And then the United States you see the market growing. But the European market is larger than the US market for the time being.
Okay, that is the dynamic we are facing. We are participating in the high-volume growth in Europe.
And we believe that, that’s an indication of the contrary of what you may think which is, that penetration is not high. And therefore, they the lot of consumers that have never bought it and they just want the cheap one because if you had bought it in the past, why would you want the entry level one.
There is no reason. Mostly these products continue to work for a long time.
So that’s what makes us believe that there is an ongoing entry-level penetration. And I believe strongly to that what may be more tactical things that we are looking at channel-by-channel.
But you know it's too detailed and to be discussed on a call like this. And then you get into competitive issues that I don't want to disclose.
That the fundamental issue is trade-up. I believe now we have asked ourselves the question about notebooks big time.
And what we notice is that A, if there is a unit growth in Europe pretty substantial in a market where notebook penetration is even higher than in the United States, that doesn't, doesn’t call for a substantial notebook impact on that even though there must be some. So I will, we will actually target certain keyboards and desktops next year specifically to the notebook market to prove what is in there.
But we are, we believe, and without arrogance, that we are the experts in the category. And believe me, we are just dissecting this and I can tell you that our projection now before the category to return to growth.
Q - Can Elbi
Okay, just maybe the second question and this was asked. But I just want to maybe rephrase it a little bit because I was still not convinced by the answer, without being arrogant.
But if I look at marketing and selling in fiscal Q4, as it was pointed out, it was up only 2% whereas retail sales were I think up to 19%. And obviously retail sales and the growth in retail sales somehow drive marketing and selling.
So I am just trying to understand how much discretion you have in marketing and selling and whether you can really push it out at discretion if you need to. Guerrino on many occasions pointed out to the fact that gross profit growth and OpEx growth would be in line.
They are certainly not in line in fiscal Q4. So I am just trying to understand how much discretion there is in marketing and selling and whether you can really push it out if you want to.
A - Guerrino De Luca
We have substantial discretion. As you said something which is interesting to remark.
You said that the sales and marketing costs are driven by sales. It's true.
The other way around is also true. That sales and marketing expenses drive sales.
That’s what we would like to see, right? And if you look at our guidance for revenue for the year, we actually went slightly higher than what we had expected.
So sales are there. And as Mark said, why do you spend money if you have sales?
This is remember also that there is a component of expenses that you don't see in the operating expense, a component of the marketing expense that has to do with soft dollars and other promotional channel eternally incentives that you don't see you see it in gross to net and therefore you see it in margins. So we have ample margin of using the right tactic at the right time.
So I continue to insist that this is not like we didn't cut anything. We didn't kill anybody.
We didn't actually our payable are even unfortunately too low. So we were just doing what the model allows us to do and are actually very, very happy that that is the flexibility that the model shows.
Q - Can Elbi
Okay, maybe just one quick add-on and then I'll let you go. The retail ASPs, playing the devil's advocate again, I think retail ASPs and you have constantly told us that it's an obviously an issue of mix.
But as retail ASPs, I think, were down 3% from Q3 and now down 8% in Q4. Is it still only a mix issue?
Or were there some pricing initiatives because in your presentation there is a sentence saying there were no significant pricing actions. So I just want to understand what significant is.
A - Guerrino De Luca
Well, I don't think we can be more literal than that. Did we reduce some prices in some products in some geographies?
Yes. Do we always do that?
Yes. Were they significant?
No.
Q - Can Elbi
Okay, thank you.
Operator
Your next question comes from Serge Rotzer with ZKB.
Q - Serge Rotzer
Yes, hi every body. You mentioned already that you want to launch a new desktop, kind of voice-over-IP video desktop.
Is the customer able to use this desktop by if the PC is turned off?
A - Guerrino De Luca
Sorry, could you repeat the question. I am not sure I understand the question.
Can you repeat it?
Q - Serge Rotzer
Can a customer use this new desktop, this IP desktop by switching or turning off the PC? Or can you replace a normal phone with this desktop?
A - Guerrino De Luca
That's interesting. You are asking a product feature question.
That may be a great feature for, well you may look for a job in a phone marketing department. I can't answer this question, we don’t want to talk about feature of unannounced products.
Q - Serge Rotzer
Okay, we will see. The second question is, is there a certain reason, you are in such a hurry to buy back shares before Q4 – before…
A - Guerrino De Luca
I don't know. What do you think?
Q - Serge Rotzer
I think yes. That's just a guess.
Because you are full of net financial and a lot of shares. Are you screening the market actively for acquisitions?
A - Guerrino De Luca
I think that we saw that the price at which level that we consider is a very, very attractive investment opportunity. Remember we buy back shares because it's a good investment.
Let me tell you that the $160 million plus that we spent in Q3, in Q4 sorry, was a great investment. So yes, there is a reason.
Of course, there is. We thought it was very attractive.
Q - Serge Rotzer
Okay, we will see how in the long-term, it is up for follow-up. Thank you very much.
A - Guerrino De Luca
Thank you very much. Operator, we'll take the last call if we have one.
Operator
Your final question comes from Jon Lopez with OTA Asset Management.
Q - Jon Lopez
Thanks so much for taking the question. I appreciate it.
I just wanted to revisit the gross margin topic. And I apologize because I know you have covered it several ways.
But if I look on a year-on-year basis, excluding the inventory provision that you took, your gross margin is down on the order of about 100 basis points. And yet the retail video business was up about 61% year-on-year.
And your OEM business, as you noted was down year-on-year. And my sense of those are both reasonably favorable from a gross margin perspective.
Can you give a little more clarity on a year-on-year basis as to what caused that contraction?
A - Guerrino De Luca
The majority of the contraction is due to the substantial audio impact year-over-year – 61%, I would say 68%growth in Q4. That is what drove the majority of it.
As as Mark said, I am sorry to steel the stage, as Mark said we a number of our product lines went to more typical margins. That’s why we give a range of 32 to 34.
So it is fundamentally, if you want to look for one culprit – if you want to call it a culprit is audio.
Q - Jon Lopez
Okay, great. The second question relates to your capital spending.
You guys had initially guided to 40 million, I believe in CapEx. And then you had spent about 40 through the first three fiscal quarters.
Then I think you talked about something like 50. And the actual looks like it is about 60.
So your capital spending last year was up about 64% year-on-year and another 47% this year. So two questions.
The first one is, what is the – what are you spending on? And do you have any initial plans for fiscal '07 from a CapEx perspective?
A - Mark Hawkins
Let me take that Jon. A couple of things.
One is just – actually we spent 54 million this year, just to kind of see that and that gives you a sense of where we're at. Secondly, when you look at that, I think you can see in FY '07, you can expect a range – it will be somewhere close to that also in FY '07.
A couple of key things that have driven that historically – obviously computer and software activity; tooling; plant and building activity; certainly Oracle as well in this particular year; and some 10 million for the factory – the rest of the factory as far as in China. So I think the net message for you is 54 million is where we landed this year.
Expect a similar range in FY '07.
Q - Jon Lopez
Okay. And just a last question on that topic.
And this may be my lack of understanding on specifically what you are spending on but. Your quarterly depreciation in fiscal Q1 was about 7 million.
And that actually declined through the course of this year to 6.4 million in the most recent quarter, if I have the numbers right. And that comes obviously as your CapEx, as we've just discussed, is increased fairly meaningfully.
So, what is the – why are you not – why is the quarterly depreciation not trending higher given the higher level of CapEx? Or is it going to in some future period?
A - Mark Hawkins
Yeah, I think a couple things. One of the things we should look at is even the mix within asset lives I think is some of the key things.
You think about tooling being like a year or whatnot. And then you look at things like factories more in the long-term in terms of 10 to 20 years.
So I think you've got to look at the mix actually within asset lives. John I think it's a good question.
But that’s the dynamic there. And by the way do want to underscore one point.
We actually see capital investment is a good thing, as a good growing business where we going to, we are pleased to be able to generate the cash flow we're doing and at the same time make the investments in our future.
Q - Jon Lopez
Absolutely. I am sorry, just the very last question on this topic.
My assumption is that the majority of the depreciation is probably run through the COGS line. If I have that incorrect, please correct me.
But as you contemplate the gross margin range you've laid out for next fiscal year, are you contemplating a higher level of depreciation commensurate with the increase in the CapEx? Or is that am I thinking about that incorrectly?
A - Mark Hawkins
Yeah. A couple things I'd say.
One is you are correct. I think the majority of the CapEx would show up in the COGS area.
So I think that’s a sound assumption. And I want you to think about our gross margin in general comprehends all the integration of our capital expense plans.
So that would be very safe to say.
Q - Jon Lopez
Terrific. Thanks very much for the help.
I appreciate it.
Guerrino De Luca, Chief Executive Officer, President
Thank you everybody. Thank you for participating.
I want to close on a comment about the future. As you've seen, we've reached $1.8 billion in sales in fiscal '06.
Our goal for fiscal '07 keeps us very well on track to reach our $3 billion goal. And our focus on profitability is designed to increase our operating margins on our way to that sales goal.
So as we celebrate our 25th anniversary, you know it's our 25th anniversary this year -- the Company is stronger than ever, young and yet experienced with a blend of veteran employees and new experienced additions. Mark is one example.
Over the last twelve months more than 400 new professionals joined Logitech's payroll in engineering, operations, marketing, and staff functions. We are prepared to capture the tremendous opportunity coming our way.
Convergence is happening. And our interface devices will be at the center of the user experience.
Our fiscal '07 portfolio, which you will begin to see unroll this summer – I am very happy that I have made you eager to do so – will demonstrate once again what innovation can do to our category. Thank you for your participation everybody.
Operator
Ladies and gentlemen, this concludes today's Logitech fourth quarter and fiscal year 2006 earnings conference call. You may now disconnect.
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