Canon Inc (CAJ) 2004 Q3 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to Imagistics International third quarter earnings release conference, hosted by Marc Breslawsky, Chairman and Chief Executive Officer. Today’s meeting will be tape-recorded. Taping and re-broadcasting of this call are prohibited without express permission of Imagistics. After the initial remarks, there will be a question and answer session.

During this meeting, Imagistics management will make comments that constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are based on assumptions and expectations and are subject to risks and uncertainties that could cause actual results to differ materially from those projected in such forward-looking statements. Information concerning certain factors that could cause actual results to differ materially is included in the Company’s 2003 Form 10-K and other filings. The Company does not intend to update any forward-looking statement made during this meeting.

At this time, I would like to turn the meeting over to Mr. Marc Breslawsky, Chairman and Chief Executive Officer. Mr. Breslawsky, you may begin.

Thank you and good morning, ladies and gentlemen, and thanks for joining us for our third quarter earnings conference call. Sitting here with me this morning is Joe Skrzypczak, our President and Chief Operating Officer, Nat Gifford, our Vice President of Product Development and Marketing and Tim Coyne, our Chief Financial Officer.

I’ll briefly review the highlights of our third quarter results and the progress we’ve made on implementing our strategic plans . I’ll then ask Tim Coyne to cover some of the financial details. Then we’ll open up the floor for questioning.

I’ll assume that you’ve all had the opportunity to read our earnings announcement released very early this morning, along with the financial schedule that accompanied it, a copy of which is available at our investor website,-- www.igiinvestor.com (http://www.igiinvestor.com).

We reported earnings of $.38 per share, compared with $.30 per share in last year’s third quarter. This represents a 27 percent increase in quarterly earnings per share and another record for us, as a public company. Once again, we have met all First Call listed estimates.

Our net income of $6.4 million in the third quarter of this year, compared with $5.1 million in the same period of last year, an increase of 25 percent.

My remarks that are relating to revenue will exclude sales to Pitney Bowes Canada, which operates under a resale agreement at very low margins because those sales often vary greatly from quarter-to-quarter.

Our third quarter copier/MFP revenue growth of 9 percent represents our 11th consecutive quarterly increase, preserving our unbroken string of quarterly year-over-year increases in our core copier/MFP revenue since the spin-off.

The copier/MFP product line now represents 72 percent of total revenue and makes up the largest portion of our recurring revenue stream. That’s why I’m very pleased to report that in the third quarter, copier/MFP rental revenues increased 13 percent over the compatible period last year. This rate of increase is once again the highest it has been since the spin-off in 2001, driven by gains in the 35 to 60 page-per-minute segment, as well as increased print volumes. However, while we anticipate continuing success in growing the copier/MFP rental revenue, we expect this growth rate to be tempered somewhat in the coming quarter, as certain rental contracts with the Federal Government are expiring and will not be renewed.

As I have often stated in the past, the expansion of our copier/MFP revenue business is one of the most important planks in our strategic platform and it’s critical to our success. A solid copier/MFP rental space generates a steady, dependable revenue stream and stable earnings and facilitates a reliable planning and investment decision process.

As the revenue from our fax product line continues its expected decline, our overall revenue in the third quarter is flat versus last year. For the 9 months, we did achieve a 1 percent revenue growth and we continue to focus our efforts on obtaining positive revenue growth for overall 2004.

Our efforts continue to be recognized by independent research organizations. For the second year in a row, J.D. Power and Associates honored us with their prestigious Number One Copier Multifunctional Product in Overall Customer Satisfaction among Business Units award . In 2004, we were awarded sole possession of the number one spot; while you may recall that in 2003, we were tied for that number one spot. We continue to be distinguished from our peers and believe that this is not only a validation of our great strategy, but it’s also proof of the success of our commitment to provide our customers world-class products and unparalleled customer support.

In order to maintain our world-class product offerings, we recently introduced the CM3520. This multi-functional device combines black and white and color copying, network printing, flexible scanning with secure authentication, advanced file management and enhanced finishing options at an affordable price. The CM3520 prints black and white pages at 35 pages per minute and uses a single path development system to deliver high quality color at 22 pages per minute. This product is the next generation color product and will allow us to solidify our position in the important color market.

We continue to make progress in improving gross margins. In the third quarter, our gross sales margins were 48.3 percent, a 10.4 percent increase over the third quarter of 2003 and our rental margins were 72.3 percent, a 5.4 percent improvement. This quarter we again realized most of the benefits of product cost (ph) reductions, as well as a lower proportion of sales to Pitney Bowes Canada, which are at very low gross margins. We expect the sales gross margins will return to more normal historic levels in the future. However, it is important to remember that we are achieving significant gross margin improvement despite the mixed shift created by replacing our higher margin fax revenue with somewhat lower margin copier/MFP revenue.

In the third quarter, operating expenses were 13 percent above prior year. The increased spending was in sales compensation and ERP related administrative costs, as well as higher bad debts expense and operating expenses associated with the expansion of our direct distribution capability . The increase in sales compensation results from the higher level of copier/MFP revenues, as well as increased sales headcounts to support our future growth in the product line.

Although we have experienced some reduction in direct ERP expenditures, spending for the administrative support associated with the operation of our ERP system has increased from the prior year when we were utilizing Legacy systems. Specifically, higher administrative supports costs are for additional personnel in training, overtime payments, as we continue to resolve processing inefficiencies and invoicing issues, and higher provision for bad debts to recognize the increase in the delinquency rates of our receivables.

As we have discussed before, implementing any new ERP system is an arduous task. We predicted the temporary effect that the ERP implementation would have on cash flow and working capital requirements in the form of higher accounts receivables. This was evidenced in the use of cash in the fourth quarter of 2003, and the first quarter of this year. We have made progress in reducing our accounts receivable this quarter and expect to continue making steady progress in this area as we begin to implement the collections call center and invoice adjustment process functionality in the fourth quarter.

We have expanded our direct distribution in Canada this quarter, with the acquisition of a copier dealer in London, Ontario. This solidifies our presence in the greater Toronto area and provides the base for us to support our national and major account customers throughout North America. As we have indicated before, we are continuing to seek opportunities to expand our direct sales and service capabilities in the United States, the United Kingdom and Canada. We are currently appraising several prospects and hope to close a number of transactions over the next few quarters.

We will continue to execute our unique direct sales and service and best of breed strategies and are confident that this will continue to deliver superior results. At this time, we are reiterating our previous earnings guidance of $1.48 for the year.

During the fourth quarter, and through the first half of next year, we will be implementing the final phases of our ERP project, which had provided tools we need to become more productive in the administrative functions. These improvements will enable us to begin realizing some of the efficiencies we believe are available from our ERP system. These efficiencies, coupled with a natural elimination of ERP implementation expenses as the project draws to an end, will consequentially result in lower levels of expenses. As we look forward to 2005, we expect that the comprehensive use of our ERP system will assist us in identifying and targeting additional opportunities to improve our administrative and operating efficiencies and further reduce our operating expenses in the future.

We continue to be confident that our unique business model will provide copier/MFP growth in excess of the overall market. We believe that we have reached the inflection point where growth in the copier/MFP product line will more than compensate for the decline in fax revenue and a result in accelerating revenue growth. This excludes the Canadian operation again, the Canadian Pitney Bowes operation.

Gross profit growth and the increasing rate will follow shortly thereafter. We maintain our expectations that earnings per share growth will exceed 20 percent in 2005. We take great pride in our past success and remain focused on delivering on our commitments. Thank you for the opportunity to continue to earn your confidence in the future.

Now I’d like to turn the call over to Tim for his comments on our financial results. Tim.

Thank you, Marc, and good morning, ladies and gentlemen. I will provide further comments on our third quarter results.

I’ll begin with revenue. Total revenue for the Company in the third quarter decreased 4 percent to $153.1 million. Excluding the sharp decline in sales to PB Canada, total revenue was flat versus the corresponding period in the previous year. Total revenue from the copier/MFP product line increased 9 percent in the third quarter. Copier/MFP revenue has experienced year-over-year growth for each and every full quarter since the spin-off, which is now 11 consecutive quarters. For the third quarter of 2004, the proportion of our revenues attributable to the copier/MFP product line grew to 72 percent of our total revenue, up from the 76 percent reported just 2 years ago.

Copier/MFP sales increased 8 percent, reflecting improvement in demand across all our digital copier MFP product segments. Copier/MFP rental revenues increased 13 percent compared with last year, primarily reflecting gains in our 35 to 60 page-per-minute product segments, as well as higher print volume . As Mark indicated, this is the highest increase since the spin-off and it reflects our success in growing the recurring revenue stream in this product line. We expect this growth rate to be somewhat lower in the fourth quarter, as certain government contracts are expiring and we do not expect them to be renewed.

Support services revenue for copier/MFPs were 7 percent higher than last year’s third quarter, following the increase in copier/MFP equipment sales.

Now let’s turn to the fax product line. Compared with the previous year, total facsimile revenue declined 17 percent in the quarter and 15 percent in the first 9 months. This is generally in line with our expectations. Facsimile sales were down 10 percent in the third quarter, reflecting the impact on supplies of some acceleration in the expected continuing industry-wide decline in facsimile usage, driven by technology changes, partially offset by an increase in equipment sales. The equipment sales increase reflected in part, higher sales of units out on rental, known as rental to sale conversions. We do expect facsimile equipment sales to resume their decline in the future.

Rental revenue from the facsimile product line declined 22 percent compared with the third quarter of 2003. This also reflects acceleration in the decline of the install face due in part to the impact of rental to sale conversions, coupled with lower per unit pricing. Our sales to PB Canada declined 81 percent to $1.7 million in the third quarter.

For the first 9 months of 2004, total revenue declined 1 percent to $462.9 million. Excluding sales to PB Canada, revenue of $449.5 million for the first 9 months was up 1 percent. Year-to-date, copier/MFP revenue grew 10 percent with sales up 12 percent, rentals up 10 percent, and support services up 7 percent. Over this same period, facsimile revenue declined 15 percent, sales were down 13 percent, rentals declined 16 percent and support services were down 14 percent.

Our recurring revenue stream is still strong. In the third quarter, this recurring revenue stream, consisting of rentals, supplies, sales and service revenue, represented 70 percent of our total revenues.

Now let’s talk about gross margins. Sales gross margins were 48.3 percent and increased 10.4 percentage points. This strong gross margin improvement was primarily driven by capturing most of the benefit of lower product costs, and also reflects lower inventory obsolescence charges and a decrease in sales to PB Canada, which are at low gross margins. This increase was partially offset by the continuing shift in product mix toward copier/MFP products, which carry lower gross margins than the facsimile line.

Rental gross margins of 72.3 percent improved 5.4 percentage points, compared with the third quarter last year and was primarily attributable to lower product cost. Similar to sales gross margins, rental gross margins improvement were partially offset by the continuing shift in product revenue mix from facsimile to copier/MFP.

Now we’ll discuss selling, service and administrative expenses and our ERP project costs. Selling, service and administrative expenses, or SS&A expenses, were $85.8 million in the third quarter of 2004, an increase of 13 percent from the prior year. SS&A represented 56 percent of total revenue in this quarter, compared with 47.6 percent in the prior year. This increase was due to higher sales compensation costs, resulting from the increase in copier/MFP revenue, coupled with increased sales headcount.

Higher ERP related administrative costs, as previously described by Marc , increased bad debt expense to recognize the increased delinquency rate in our accounts receivable, the inclusion in 2004 of the operating expenses associated with recent acquisitions to expand our sales and service geographic coverage and the absence of a property damage insurance recovery, recorded in 2003, related to the World Trade Center.

Expenditures for the ERP project were $5.5 million in the third quarter of 2004 compared with $6.8 million in Q3 of last year. In 2004, $3.7 million, or 68 percent, was capitalized during the third quarter, compared with $2.8 million, or 41 percent, last year, when a significant portion of the spending was for training in advance of the October 1 Oracle go-live. Total project spending through September 30th, 2004, was $73 million, of which $40 million had been capitalized, with an average expected life of 7 years.

Interest expense declined 79 percent compared with the third quarter of 2003, primarily as a result of the recognition in the third quarter of 2003 of $2.8 million of interest expense associated with the disposition of the Company’s interest rate swap agreements.

Turning to the balance sheet and cash flow items. As we have discussed before, we continue to be engaged in cleanup and stabilization efforts with a particular focus on billing, invoicing and collection issues. These issues have led to the increase in accounts receivables that we are now working hard to resolve. I can report that we have made progress in this quarter. Our accounts receivable declined by $5.2 million, in large part as a result of the programs that we initiated in the second quarter to improve the efficiency of our cash collection efforts. We are now in the process of implementing the third and final phase of the ERP projects , which includes additional collection call center and invoice issue resolution functionality that we believe will accelerate our progress in collecting accounts receivable in the fourth quarter.

During the third quarter, our inventory increased $9.2 million to support our fourth quarter product introductions, starting with the CM3520 described by Marc earlier. This inventory increase led directly to an increase in accounts payable, which was up $11.4 million.

We generated $31.8 million of cash from operations this quarter, returning to historical norms for the second consecutive quarter. We expect cash from operations to remain at roughly these normal historical levels in the future. We used the cash generated from operations to finance $13.5 million of additions to our rental asset base, to continue building our recurring revenue stream in the copier/MFP product line. In addition, we also utilized $4.9 million to continue building our infrastructure, mostly our ERP system. In the third quarter, we invested $2.5 million for acquisitions to expand the geographic coverage of our direct sales and service capabilities. We repaid $1.1 million of debt in the third quarter while continuing to execute our stock buyback program.

In the third quarter, we repurchased 225,000 shares at a total cost of $8.2 million. This represents the repurchase of 2 percent of the shares outstanding at June 30th, 2004, and since the beginning of the buyback program in 2002, we have repurchased 3.8 million shares, or 19 percent of the shares that were outstanding when Imagistics was spun-off in December, 2001.

Our balance sheet remained strong at September 30th, 2004, with total debt at $72 million, or 21 percent of total capitalization, and a cash balance of $12.3 million.

Now I’d like to turn the call back over to Marc.

Thanks, Tim. Now what I’d like to do is open the phones up for any questions. May we have the first question please, Operator?

Thank you. We will now begin the question and answer session. (OPERATOR INSTRUCTIONS) Your first question comes from Marisha Clinton with Merrill Lynch.

Good morning.

Good morning, Marisha.

Hi, Marisha.

Hi. I understand that over the past few quarters, you benefited from increased demand and sales of mid-market 35 to 45, or you guys said 35 to 60 page-per-minute digital black and white MFPs, and in fact, (indiscernible) our Dataquest numbers indicate that you’ve been able to maintain share here in the low single digits over the past few quarters. Do you see any signs of a product transition going on, particularly as some of your competitors attribute gains to the color part of the market? And then, possibly, someone else can answer this question . You recently launched a new multi-function workgroup device that does 35 pages per minute in black and white and 22 in color. I also understand that Konica, Minolta and Ricoh have similar products, that Konica and Minolta are seeing great demand. Can you comment further on the competitive landscape and your ability to maintain it and or gain share here? Nat Gifford can probably answer that part of the question.

Yes, we’re going to let Nat answer some of these questions, but we do see a tremendous opportunity in color. We’ll be launching a bunch of -- you know, we’ve launched the 3520 and should be launching more color products as we go forward during the rest of the year. This is a big opportunity for us. Obviously, color has a tremendous after -- a very good after market that we look forward to. But let me put Nat on and he can tell you about it.

Okay.

Marisha, hi.

Hi.

As you know, the copier market is moving much more towards a universal copier which includes color capability. This new machine that we just launched, the 3520, we believe positions us to continue to participate very well in that trend. The object here is to get one machine that will both -- will be able to do both full color as well as the black and white prints, consolidating the footprints in the office from 2 or perhaps 3 different machines today that do exclusively black and white or color or printing, down into one footprint at a cost-effective price point for the customer. We believe that the 3520 is that product. It is the next generation product. It positions us very well in the marketplace today, both from an equipment pricing standpoint, as well as the aftermarket pricing standpoint. You can also continue to expect that we will increase our product introductions of color in the future, as we move forward.

Okay. And I’m switching gears here. Can you talk about it and quantify your growth expectations for the rental revenue category in the fourth quarter, given the expected moderation associated with Federal Government contracts? And then also, when should we expect revenue within this category to resume to normalized amounts, or even increase?

We believe our rental growth rate -- we’re adding good rental contracts,very good contracts. We’ve won a lot of large orders and obviously, that number is very, very strong. But also where you gain, you lose some. You want to go forward two and then back one and so in the next quarter, it’s hard to know the exact number because still orders are coming in. But we believe the growth rate in rental revenue will be probably under about 10 percent.

Okay. And then lastly, what are you estimating for compliance associated with Sarbaness SarbanesOxley for the fourth quarter and does compliance with the Act mean that you will not perform any major system implementations before year-end, and does this effect the third and final phase of the ERP implementation? I believe you guys mentioned that you will implement this phase over the first half of next year. Can you clarify that?

You know, I’m going to let Tim talk to that but I can tell you that from an operations point of view, we just need to keep moving forward. So just as we’ve updated the Oracle software to the latest version in the third quarter, one of the issues you had was from a Sarbaness SarbanesOxley point of view, it would have been easier for us not to implement the new software, but to just focus in on the old software. From an operating point of view, that would have set us back because it would have meant -- like a call collection would have -- we would not have been able to automate that as much as we anticipate automating that process. So there’s always -- there’s never an easy decision which direction you go. But we have implemented software. We are still moving ahead with Oracle as we try to fully comply with Sarbaness SarbanesOxley. With that, I’m going to turn it over to the expert, which is Tim.

Yeah, Marisha, the interesting part about putting everything on hold for the fourth quarter is that some of the functionality that we are implementing in the fourth quarter will help us to improve our Sarbaness SarbanesOxley control work as well. So we can’t put -- from an operating standpoint, we can’t put all that stuff on hold. We are continuing to implement phase 3 of the plan. We are implementing our internal work plan to complete our compliance with Sarbanes Oxley. We are on track to get that completed by the end of the year even with the implementation work that is being done in the fourth quarter. So, we have factored that into our plan and we’re still on target for completion of the testing for compliance with Sarbanes Oxley. We have not measured our internal cost of compliance, but our external cost is in the area of $1 million at this point, and that doesn’t include all of the internal cost of the time and attention that our people have been spending dealing with Sarbanes Oxley issues.

Okay. So, with that, how should we look at SS&A costs? I believe you guys said you expected costs to trend down more so in 2005. How should we look at SS&A for the fourth quarter? What are you estimates here in the fourth quarter and into 2005?

As you know, and we’ve stated that we will begin to realize some of the impact of the Oracle system, the Sarbanes Oxley piece, in particular in the fourth quarter, won’t have a significant impact, but we don’t see any significant impact at this point for SS&A expenses in the fourth quarter.

Okay. Thank you.

Thank you. Next question, please.

Shannon Gross from Imagistics (sic) is on line with a question. Please state your question.

Hi, guys. I’m guessing it’s Shannon Cross from Cross Research.

Hi, Shannon.

Anyway, I wanted to talk a little bit about the accounts receivable balance. It improved this quarter. But, you know you took a larger bad debt reserve. I’m just curious, you know, how we should think about that, if you’re still comfortable with, you know, no potential write-offs going forward, that it will just sort of run off as, you know, again the quarters go through, probably into 2005?

Yeah, Shannon, this is Joe Skrzypczak. You know, as we’ve said all along with receivables, we expect that starting in this quarter to start seeing some improvement. We expect to see a continuous improvement as we move along. We are -- the things that we’re rolling out from an ERP perspective should help us a lot in the collection function with the call center management, screen pop-ups Things like that will be coming out in the fourth quarter. And one module that we did launch just 2 weeks ago, was a module that allowed us to adjust any type of invoice corrections that had to corrected in a very timely fashion, which we were struggling with all along. We were doing that -- went through a lot of manual effort. So, you know, my prediction is you’ll continue to see improvements as we go quarter-to-quarter.

Shannon Cross. Okay. And so no concern about a potential write-off of any of those AR?

No. The thing that we do is we -- you know, we take a look at the aging of our receivables. We discuss them with out auditors. I think you know that we’re pretty much conservative in nature and we take provisions as we deem necessary and so there’s no surprises. And that’s exactly what we’ve been doing right along.

Okay. And, Marc, we’re actually out at Canon’s Visual Solutions forum right now and the management made a comment yesterday that they’re actually seeing you guys be fairly aggressive in terms of pricing when you go after some of these rental contracts, especially, you know, the state government contracts.

Right.

I’m curious. I’ll just say it’s the first time Canon’s really mentioned your Company so I guess that’s a you know, congratulations, but I’m curious as to, you know, whether we should worry about pricing pressure in that segment eventually, you know, impacting your margins?

Well, first of all, there’s always pricing pressures as long as we’ve been in this business. That isn’t changing. The key to success is acquisition of products. Our best of breed product strategy, I believe, gives us cost advantages. So we have won a number of major state contracts. The state contracts have a lot to do with rentals, lease, purchase. They’re all different from state to state. We’ve also not won some state contracts also. We don’t win every state contract, but we are more aggressive there. We do make money on the state contracts. The margins we make on state rentals are less than they would be on commercial, as we would expect. And usually, the machines would be a lot more. It’s incremental revenue for us, and again, as long as we do a good job on the product procurement side, as long as Mr. Gifford does a good job there, we believe we can be very competitive.

The advantage again are best of breed as we go into each segment, try to pick 2 products in the segment, 1 product that has all of the features and 1 product that’s inexpensive. In some state bids, they’re just looking for the inexpensive products without the features. They all have good reliability. That’s important for us. But some could have less features than others. So we think we have a broad product line, which allows us to strategize and compete very effectively on state government bids. The issue we have, nevertheless, is federal government bids where -- the issue we have there is federal government still has provisions, today, in their contracts, where they do not favor products made in China and don’t ask me why. It makes no sense why they would care if a product were made in China or Japan, but as you know, most -- almost all of our products are made in China. So if it comes to a large federal government contract, we can’t compete today with a Canon, who does have products built in Japan or some other companies that do that. But that market today, if we had to bring in Japanese products for that market, still would be less, not very attractive for us, but you need to maintain inventories of those products and commercially, people are not interested in paying the premiums to have it manufactured in a different country.

That’s a strange, I guess, addition to a contract negotiation, but as Canon moves more of its production to China, I assume, at some point, the government will have to capitulate. And looking -- then moving on to SG&A, or SS&A, and I’m sorry if I missed those, but are you guys willing to commit that the $85 million, that’s a little over this quarter, is going to be the high-water mark and we should start seeing it decline from here, or is more of an ‘05 kind of an event?

Well, we still have work to do the rest of this year in ERP. -- there’s no doubt about that -- to finish things up. I think what you’ll see is a gradual trend throughout ‘05, a decline in SS&A.

We will definitely budget in ‘05 for declining SS&A. In the fourth quarter, we don’t anticipate a major change from the third quarter, but going forward next year, we will budget the efficiencies that we believe we would get from the ERP system.

Okay. Thank you.

You’re welcome.

Herb Hardt from Monness has a question. Please state your question.

Good morning.

Hi Herb.

Good morning.

Two questions, actually. One is, given the level of your stock, which is down a fair amount from the spring, I was surprised you only bought back 250,000 shares. I would have thought that at some point ,the real values would be recognized and be much higher so you’d probably want to be a little more aggressive down here. Is there any change in philosophy or are you -- ?

I mean, our philosophy has been that we will continuously buy back our stock with -- through cash flow. We have good cash flow. We also invested a lot of money in our rental base. We paid down our debt. I mean, we didn’t pay it down a lot, but we paid it down about $1 million from last quarter. But -- so we had a certain amount of cash. With that cash, the rental base came first. Our rental base, we did a really good job in getting rental contracts and building that and it meant that we put more money into the rental assets. But we continued to -- we basically continued to buy back stock. We don’t believe that’s going to change going forward.

Herb, this is Joe. If you -- I mean, if you look at the percentage of cash that was generated from operations and then what we did with that cash, you would see, you know, it’s a very high percentage of that cash generation went to buy back stock It was about $8 million versus paying down debt of $1 million and acquisitions of about $2.5 million. So the largest percentage of -- let’s say cash generation went into buying back stock.

Given where interest rates are, you wouldn’t let your debt drift up and be a little more aggressive?

Well, we haven’t really taken that position. We’ve been de-leveraging the Company. We still feel very comfortable where we are, and obviously, with a 21 percent debt to capitalization rate -- ratio, we do have capacity to do that. You’re right. But, you know, again, you know we’re pretty conservative fellows here and we will take one step at a time.

Herb, what we don’t forget, okay, as we look back in history is, there are a whole bunch of companies that leveraged up in this industry dramatically. Almost everybody leveraged up in this industry, went out and bought a lot of companies. It looked great for a short period of time and then the debt level ended up really, really hurting them.

Our platform has been more conservative than our competitors; there’s no doubt about that. You know, it’s not an issue for us of not -- of being able to go the bank and raising money. We can do that, obviously. We have a line that allows us to do that. But our profile, we believe, will stay at a lower risk without building this debt level up or doubling it or tripling it, again, like some of our competitors. But we have watched them and again, on a short-term basis, it’s easy to copy their formula and it might look very, very good. On a long-term basis, the risk of that blowing up is a real risk that we are not interested.

Well, I would agree, but I think they also got into trouble because they bought a lot of disparate software platforms in the process. They had a lot of problems managerially, not just from buying back their own stock. Second question --

Just one more -- one last point, Herb. Just to take a look at the trends of our buybacks . In the first quarter, we did about 150,000 shares and then the second quarter about 150,000. So we did step it up in the third quarter to, you know, 250,000, another 100,000 shares.

Fair enough. Next question, regarding the bad debt. Is this a -- when it goes beyond 90 days, you automatically increase the reserve even though it might be with someone who just is -- not gotten all the information so therefore has decided not to pay you or is this things that are just written off, period?

No. it’s the number of -- it’s not things that are just written off. It’s basically, we follow a formula --

That’s the question.

We basically take a look at the aging. We look at things that are over, let’s say, 210 days old and we say, “Well, that’s -- you know, we should reserve 100 percent of that,” and there are cases when we do collect some of that money. And then we look at different buckets that we have, aging buckets within our receivables and provide accordingly. It’s a formula that we feel very comfortable with, ourauditors feel comfortable with and, you know, we think it’s the right, prudent thing to do for the Company.

Can you tell us what the number was this quarter versus a year ago?

As far as bad debt deficient?

Right.

Tim, do you have that?

The -- Herb, are you looking for the provision or the balance in the allowance?

The actual provision, what you did this quarter versus --

That’s on the cash flow statement.

Yes, it’s on the cash flow statement. We provided for $4 million of bad debt which is -- versus $1.2 million provision in the third quarter of last year. On a year-to-date basis, we’re at 10 -- we provided $10.4 million for bad debts versus $5.7 through the 9 months of last year. So we were roughly at the same level in the third quarter as we were in the second quarter.

Okay. Thank you.

Thank you, Herb. Next question, please.

Margo Mertoff from Snider Capital is on line with a question. Please state your question.

Yes. Thank you. Again, on the SS&A lines , can you quantify the different factors more closely? Like, you know, what’s the non-recurring -- what are non-recurring costs of, you know, getting the system up and the other factors that you mentioned, so we get an idea of, you know, how it’s going to look going forward. I mean, for example, the headcount, can you talk about the different factors involved and try to quantify them a little bit for us?

Well, in general terms, I think, you know Tim’s given some highlights as far as what we’re spending in direct ERP expenses. I think this quarter, we spent about $1.7 million in direct expenses. We know that we’ve brought on at least an additional 100 administrative staff to supplement this ERP go-live. And we know that those are type of expenses that we should be able to take out. In addition, we knew that we would probably have billing errors initially going out, which would result in delinquent type receivables and thus, based on the formula we’ve previously described, would make additional provisions associated with that, and as Tim just highlighted, what those dollar amounts were.

So, I guess what I’m saying is that we knew that our operating expenses would go up to probably this level, but we also recognize that they have to come down as we become in a more stable environment in the Oracle world, and we’re seeing that. We’re seeing that in the way of new modules being launched that will provide additional efficiencies where we can do things a lot faster than what we were able to do when we first launched Oracle. So, rather than giving you a hard number, saying, you know, SG&A is going to be down X dollars in the first quarter, and the second quarter, and the third quarter of next year, I think what you should look forward to is a continuous improvement quarter-afterquarter as we move throughout 2005.

So you would be heading back down. I don’t have my model in front of me, but didn’t you use to run recently at 52 percent type of number. And so, it should be getting back to that at least in -- ?

Yes, I think we have to go back to our more historical levels, but, even so, you know, our goal should always be to look for even additional efficiencies that we can drive into the Company. And, you know, what we’ve always said publicly is that our job is to, you know, once we get through Oracle, is to look for those continuous improvements and see the SG&A, as a percent of revenue, improve quarter-after-quarter. But we still have to wrap up the rest of this Oracle project this year.

Okay. You also talked about some more salesman for the copier/MFP. Now have you -- is your sales force now in place or are there further costs?

Yes, the sales force is in place. We’ve added about 100 people over the year to the sales organization, and it’s in place. We think we’re at a good number now. We’re not looking to grow that sales organization. We think we have it pretty much at the right level. So, yes, I mean, that’s going after revenue -- that’s a cost in going after revenue. Again, one thing you get is, you can see our rental base has grown at a very good rate. We expensed all the commissions and salaries related to rental expense right up front. So there you’re putting the expense before the revenue. It’s conservative. Perhaps it could be done a different way, but we’ve always done it like that, but now revenue is growing more dramatically, so I think that shows up also.

Margo, I would just supplement Marc’s comments. What the additional headcount comment also refers to, the additional headcount in sales that came from acquisitions.

Okay. Okay. And you’ve had, this year, really good improvement in gross margins that wasn’t really fully expected in cost of sales and cost or rentals. Now, I think you’d said something about this, but can you just -- is that pretty much a sustainable improvement here? I mean, if we, you know, model, should we be looking at -- ?

Well, yes, we were very pleased in the third quarter of the improvements that we saw. But some of the improvements also came from -- when we do a rental to sale conversion on a facsimile unit, many of those units are nearly or fully depreciated which yields as a pretty good -- obviously, a pretty good margin. So when we do have some customers that say, “Look, you know, we’ve had your fax machines. We’ve rented them for X number of years,” but now it’s time to just, you know, buy them out. We do offer that option to our customers, and obviously, that will result in an improvement in margins. In addition, we had very low sales to Pitney Bowes Canada --

Right.

-- which also improves our margin. I think the third quarter was a little bit higher than what we would normally expect. I think what you saw in the second quarter is a much more normalized rate.

Okay. And just on the receivables, if I remember, they used to be running more like $70 million, didn’t they? I don’t have my stuff in front of me but --

Yeah. That -- they’re -- I think it was like $72, $73 million at the end of September of last year.

Okay.

And, obviously we -- I think we spoke about changing our billing cycles for facsimile which would have an increase, a permanent increase, in receivables because we put the facsimile and the billing for copiers on the same cycle which would have a one-time adjustment. And the estimates that we had were in the $10 to $15 million range. In addition, we have acquired a few companies along the way since September, which also adds to our receivables. But our goal is to get our DSO down. That’s the best way to look at it is, , you know, what is our DSO today and it’s way too high. We need to improve our DSO on a go-forward basis and this quarter, we saw an improvement. But it’s still way too high and we should see continuous improvements in the future.

Okay. Well, what was it this quarter and what is a realistic goal?

I think our actually DSOs this quarter was around 78 days which is way too high for a company like this. I think you should see us probably in that mid 50s down in the future some time.

Okay. Great. Thanks a lot.

You’re welcome.

Dan Robertson from Druma Asset Management is on line with a question. Please state your question.

Good morning.

Good morning, Dan.

I just had a couple of questions. In terms of the rental CapEx, it looks like your rental CapEx was actually up quite a bit in the quarter, but you’re saying that you’re expecting that rentals in the next quarter are going to be lower and I’m just wondering what the relationship between that growth in CapEx -- you know, they’re still -- it looks like the highest level since September ‘02, in terms of rental CapEx.

You’re absolutely right, Dan. The rental -- what we said was the growth rate -- we felt -- you know, this quarter we had, you know, a 13 percent growth rate in rental. That’s pretty high. We’ve said that that growth rate would be tempered to probably something just south of 10 percent in the fourth quarter. And that’s not really a reflection of our business, but really some of the contracts that we have in our portfolio with the Federal government. As we’ve said, you know, it’s going to be -- it would be impossible for us to re-bid those with products that we have that are produced in China. And, actually, it just would not be acceptable all. It would be against the law to do that, so we feel that there will be -- and we know that there will be a number of contracts in our portfolio that we just won’t have the opportunity to renew, but still, sustain a good growth rate. And as you pointed out in the CapEx number, the rental additions is one of the high --that’s a great indicator for us as to, you know, future business and what’s happening with our reoccurring revenue stream. We like seeing that.

Okay. Thanks. And the other thing is on these bad debt reserves. I mean, it looks like compared to what you were doing last year, that the expense on this has been, you know, considerably higher in the last couple of quarters. Somewhere -- I mean, it looks like as much as sort of $.10 to $.20 a share almost in expense and I’m wondering, you know, as you’re invoicing improves with the ERP implementation success, what -- could we -- I mean, is it possible that those could unwind at some point in the future?

In theory, yes; -- in theory, yes. I mean, you know, again, we’re conservative. As we see things age, we want to make the appropriate provisions. But you’re right. As invoicing becomes, let’s say, much more reliable or, let’s say, issues that with an invoice are corrected in a much more timely fashion through some of the modules that we’ve recently rolled out, you would think the agings would improve and thus, you would not need to make as many provisions as we have made this year.

Okay. And the other thing is on the SS&A line with sales compensation for the quarter, would you be able to break that out and give us a sense of how much that was becauseit sounds like that was a pretty big number?

We normally don’t break those out, Dan.

Okay. Thank you.

Lloyd Beetman from Bernstein Investment Research is on line with a question. Please state your question.

Hi, there, folks.

Good morning, Lloyd.

Hi, Lloyd.

Let’s see. In, gee, SS&A again, the bad debt expense and also, some of the other expenses that boosted SS&A in this quarter, now I know in past quarters, you folks have talked about sales compensation expense and some other expenses that didn’t really seem to reconcile as they should have. And now that you’ve gotten through phase two, I was wondering, was there, let’s say, any catch-up on both, let’s say, sales compensation, on bad debt expense that, let’s say, inflated the third quarter number more than it should have been?

If you’re referring to sales compensation expenses, I think we have said in the past that, as we rolled out Oracle, we had to pay our sales reps on estimated earnings versus actual calculations coming out of Oracle. And we felt that some of those numbers were probably a little bit higher than normal. We know they were higher than normal. At the risk of not losing our sales force, we felt it was prudent to, you know, make those type of conservative estimates and pay them. Our hope and belief is that as we go live with a sales compensation module through Oracle, that the calculations will be a lot more precise and we will not be paying or overpaying, let’s say, in this case, sales reps, and thus, we’ll have a benefit to our selling and marketing expenses.

Okay. And on the bad debt provision, in -- hearing calls from all kinds of companies, whether it’s manufacturers, whether it’s financial service companies, the trend seems to be that credit quality is improving overall within the U.S. So I was just wondering, this increase in bad debt expense, is this -- do you see this within a particular sector, specifically, becauseI find it interesting that you folks are kind of moving in a different direction here?

Well, again, we provide provisions in AR, based on aging of invoices and some of the provisions, let’s say, are a result of things that are self-inflicted because we’ve gone to Oracle and we’ve had difficulty in generating some of the invoices, getting readings corrected, and what happens is, those invoices begin to age. And it’s -- our policy is to provide for those invoices as they age. So I wouldn’t say it has anything to do with the credit quality of our customer. We have a great customer base. As you know, we deal a lot with the Fortune 1000 accounts. They pay timely, but they do expect an invoice to be 100 percent accurate. We’ve had instances where in Oracle -- you know, one of the things we thought was going to be a benefit but, in some cases, did not turn out to be a benefit, is we used to generate one separate invoice for facsimile and then one separate invoice for copiers.

And under Oracle, we said, “Well, why don’t we just make one invoice for a customer?” Well, with some of our large accounts, they basically said, “Oh, whoa, wait a second. You know, we have a PO for fax and we have a purchase order for copiers and, you know, we want separate invoices. We don’t want a consolidated invoice.” And as crazy as that may sound, we’ve had instances where customers said, “We’re just not going to pay it that way,” and so what we do is we have administrative staff deconsolidating those invoices for that particular customer. So, some of the things that have happened in our invoicing have been, let’s say, self-inflicted through the implementation of Oracle and has no reflection on the market or the quality of our customers’ credit, notone iota there.

Okay. So, and essentially, if I could put words into your mouth now, so then --

It’s been done before.

Sorry about that. So then from here on, as you now move through this whole Oracle process, you would expect this to moderate, if not, let’s say, go back to a more normal type of situation?

Yes, exactly. .

Okay. That’s fine. Thanks very much.

You’re welcome.

Daniel Demaz from Chilton Investment Company is on line with a question. Please state your question.

Thank you. Good morning. I was wondering, you made a comment that you source all of your products from China now, but previously, you had supplied the federal contracts with non-Chinese copiers. Can you just give me a little bit better understanding of how you’ve shifted the sourcing of your product over time and how that’s worked out and what that’s involved?

Sure. It really is one of the big home runs for us, shifting, and we’ve been doing it over years. We felt -- we’ll have some product from Japan now It’s not 100 percent, but it’s probably 95 percent comes from China anyway .

The good news on that is, as you look through the years, our margins have improved dramatically. That’s been driven by major reductions in cost. So we make higher profits now on everything we sell commercially, or even to state governments, by having manufacturing in China. And we’re not the only ones who have that. Most of our competitors have product made in China also. But -- so we used to do a lot of government business, typically, at very low margins. And that business gradually goes away, unless the government -- and they have been working on changing the rules, but, you know, anything to get through the federal government system takes typically years to do because they know they’re paying a premium for this also without -- and you don’t create American jobs by buying product made in Japan versus China. It doesn’t create any American jobs, but it’s something we have to live through.

So the big plus here is improved margins, which are tremendous for us. The negative is occasionally, as contracts become due, we cannot bid on those contracts. Again, sometimes we’re able to renew older machines for a longer period of time, but that’s what we try to do. That’s typically our strategy. But most of the old machines we have in there are the analog, old analog machines. So if the government has money, they pay a much higher price and as you know, this is a favorable surplus in the government now. I guess they have the money to pay more. I’m only kidding.

How much of your business is with the Federal government?

How big of it?

How much of your business is with the Federal government?

It’s not a huge portion of our business.

Less than 10 percent?

We don’t -- we’ve never broken out federal or state, but it’s not a big number.

Okay. And also, with regard to the spending on the ERP system, you mentioned that you have spent $73 million on the system to date; $40 million of that is capitalized over the 7 year life. The $73 million, when did you begin spending the money on that and how much of that has been in this year?

This is Tim Coyne. We began spending in 2001, actually. And this year, of the total, $14 million was spent in the first 9 months of this year.

We break that all out in the Qs, I believe , where we show what we expense and what’s been capitalized on the ERP system.

Great. Same ratio of capitalization, I would assume the same?

It varies from quarter to quarter. You know, as Joe said, last year we were doing mostly all training. When you do training, if it’s - you got quality accounting or else when you do training, you can’t capitalize that and we expensed that last year. So right now, we’re not doing mostly training.

Okay. And then the final question, when you true-up the commissions for the sales people to the actual, if you have overpaid, will there be some reduction in the commission rate until that overpayment is balanced out?

I think we have to look at everything and make a determination on where we are, if we’ve had massive overpayments, you know, so we could true-up some of it.

Our goal is really to look at individual by individual and take a look at it.

Okay. So you don’t expect that to be any kind of material change in -- ?

Well, I mean, perhaps it will be. We would expect the -- as the system goes on Oracle, that we would take money on compensation.

And is the system -- is the project on schedule? Is it taking quite some time?

No, it from our original schedule, it’s behind, but I guess so is every other Oracle implementation from every other company.

Well, what was the original schedule and how far are you behind?

I

I think we’re about 7 months behind.

7 months behind. That will be finished in the first quarter of ‘05?

Yes, I think we’ll be -- have most of it done in the first half of ‘05.

First half ‘05. Okay. Great. Thank you very much.

Thank you. Are there any other questions?

There are no further questions at this time.

Well, thank you all for joining us on the call. I’d like to thank you all for the support you have given our Company and we look forward to continuing to communicate with you as we move forward. Thank you very much.

Thank you for participating in today’s conference call. You may now disconnect.