漢威聯合 (HON) 2007 Q2 法說會逐字稿

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After today's presentation, there will be an opportunity for questions and answers.

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Thank you.

Good afternoon and welcome to the Intermec Second Quarter Fiscal Year 2007 Earnings Conference Call.

At this time, all participants are in a listen-only mode.

After the presentation, we will conduct a question and answer session.

(OPERATOR INSTRUCTIONS).

At the request of Intermec, Incorporated this conference is being recorded.

It is now my pleasure to turn the meeting over to your host, Mr.

Kevin McCarty, Director of Investor Relations and Analysis for Intermec, Incorporated.

Sir, you may begin.

Great.

Thank you, Wendy, and good afternoon, everyone.

We appreciate you joining us as we discuss Intermec's second quarter fiscal year 2007 earnings release.

Joining me on the call this afternoon is Patrick Byrne, Intermec's President and Chief Executive Officer, Lanny Michael, Senior Vice President and Chief Financial Officer, and Intermec Technology's President and Chief Operating Officer, Steve Winter.

Before we begin those prepared remarks, I wish to remind investors that statements made in today's release and related statements during the course of this conference call that express the Company's or management's intentions, hopes, indications, beliefs, expectations, forecasts or predictions for the future constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.

Forward-looking statements include statements about the Company's outlook for the third quarter of fiscal year 2007 and future periods and other examples described in the forward-looking statement paragraph in today's earnings release.

These forward-looking statements reflect our opinions only as of the date of this presentation.

Our business is subject to a number of risk factors that could negatively effect our results from business operations, or cause actual results to differ materially from those projected or indicated in any forward-looking statement.

These include, for example, the risks and uncertainties described more fully in the Company's filings with the Securities and Exchange Commission including the annual report on Form 10K and quarterly reports on Form 10Q.

Copies of these filings may be obtained by contacting the Company or the SEC.

With that, I would like to turn the call over to Patrick Byrne, Intermec's President and Chief Executive Officer.

Pat?

Thanks very much, Kevin.

As many of you know, I've recently been appointed as the new CEO and President of Intermec, and I'm delighted to be joining Intermec at this time.

I believe the long-term opportunities for accelerating growth, and improving margins and return on invested capital are significant to Intermec.

The market for identification technology has strong underlying growth drivers in the global economy.

I'll spend a few minutes reviewing my background, focusing on the key areas relevant to leading Intermec.

Then, I'll outline Q2 results before turning it over to Steve Winter and Lanny Michael for further comments.

I've spent the last 24 years at HP and Agilent, most recently leading Agilent's largest businesses.

First, the wireless business unit for four years, which tests 70% of the world's cell phones, provides solutions to the entire wireless food chain, from components to functional networks, and tests advanced aerospace defense electronic systems, as well as the broad electronics industry.

Over the last two years, I led the electronic measurement group, which is a global $3.5 billion business comprised of 17 major product lines and 12,000 employees.

Over the last several years at Agilent, we built the target business model with excellent operating margins, return on invested capital, well above the cost of capital, while accelerating growth above the market rate in order to leverage this operating model.

The result was a significant improvement in profitability and free cash flow.

I'm in the process of evaluating the appropriate target business model for Intermec, but the process of transformation to deliver superior results is clearly applicable.

The core focus to improve results in a high technology, product leadership business model is through rigorous attention to gross margin expansion, new product contribution, building a world-class global supply chain, [as in a] sales and customer support distribution system that is second to none.

It takes investing in focus growth initiatives and target industries and applications where the innovation is truly differentiated and creates pricing power.

It is also important to build a truly global business approach, especially in Asia.

I outlined these factors because I believe many of them are relevant to improving the results at Intermec.

The executive team and I are in the process of evaluating the current and required organizational capabilities and operational rigor.

This will enable me to make decisions on where to focus first to improve results.

I will say some more after the questions and answers, but I wanted to start with a summary of my experience for those of you who are not familiar with my background.

Now, turning to Q2.

There are three highlights I would summarize about Q2.

First, we have made progress on issues that have limited our performance over the last several quarters, and the results in Q2 show this progress.

As I join Intermec, we will be evaluating if these issues are completely resolved or not, and take appropriate action.

Our objective is to get these behind us, so we can focus on building the target business model and accelerating profitable growth.

The issues that have limited performance in the recent past include RoHS compliance product rollovers, major product transitions and corporate cost restructuring.

As I said, I'll be evaluating the completeness of these transitions in the near future.

Steve Winter and Lanny Michael will discuss this progress in their upcoming remarks.

The second key point about Q2 is we've seen product revenues recover.

This is shown in the sequential improvement from Q1, and the adoption rate of new products.

For example, the CN3 mobile computer.

This exciting new product line is ramping to higher volumes, and the customer acceptance is strong.

Steve will review some of these new products and customer wins supporting this recovery.

Third, there are a number of developments in the business which position us for the future.

These include key customer wins, RFID adoption and the new product acceptance that I previously outlined.

As I evaluate the clarity of our strategic intent and the organizational capability to execute it, these wins will provide opportunities for future growth and improved profitability.

Steve will review these developments in his detailed discussion of Q2 results.

Thank you for joining us today, and I will summarize our future opportunities and challenges after Steve and Lanny cover more details about Q2.

I'll turn it over to Steve now.

Thank you, Pat.

Today, we recorded results for the second quarter of 2007 with revenue of $210.5 million and earnings of $0.13 per share on continuing operations.

As Pat stated, many of the factors impacting the Company's performance over the prior three quarters have subsided, and we are making progress in restoring revenue growth and improving profitability.

Other costs of good sold has returned to normal historical levels, as RoHS-related product conversion costs have receded.

This and other factors led to an improvement in our gross margins.

The restructuring cast undertaken in the fourth quarter of 2006 and the first quarter of 2007 was completed ahead of schedule, and is yielding expense reductions that are in line with our previous estimates.

We are encouraged by the sequential improvement in North American sales, although we remain cautious about our recovery in North America due to concerns over general market softness.

We are pleased with the continuing strength of our international markets achieving new record-high revenue levels for the quarter in each international region.

New product introductions are contributing significantly to our recovery, and have been well received by channel partners and customers.

The CN3 continued at a record-setting pace of bookings and shipments, and the product line has been further strengthened during the quarter with the introduction of several important new products.

On a sequential basis, product and services revenues grew 17%, and earnings improved $0.20 per share, from a loss of $0.07 per share in the first quarter of 2007.

Versus the prior year, revenues declined 9% from the second quarter of 2006, when Intermec achieved its highest recorded second quarter revenue level.

On a regional basis, rest-of-world revenues increased 35% sequentially from the first quarter 2007, and 26% year-on-year versus the second quarter of 2006.

In Latin America, we saw continuing strength in our traditional base of direct-store delivery business, with long time customers like Bimbo Bakeries and Pepsi Frito.

We are also benefiting from the implementation of specific growth initiatives.

We grew our channel partner base in Latin America by over 50% in the last three years to broaden our market reach and diversify our business base.

The initiative is providing significant additional revenue growth through the channel.

We have also targeted the government sector in applications for RFID technology as expansion opportunities.

In an account that represents the conversion of both of these initiatives, Intermec partnered with the Brazilian Ministry of Sport and governmental security agencies to provide security and access control systems using RFID technology for the 2007 Pan-American games in Rio.

Intermec is supplying 200,000 RFID tags, plus RFID access control portals, portable RFID readers, and integration and professional services to ensure the safety and security of the athletes and officials.

In Asia, we are benefiting from new RFID opportunities in supply chain and transportation applications.

We secured a deal in the second quarter with China Tobacco for RFID pallet tracking in their supply chain.

The serial number of each carton is encoded in an RFID pallet tag to track the manufacturer inventory and sale of the product.

Also, in the RFID space, the Airport Authority of Hong Kong ordered, and Intermec delivered, over 550 model PF2i RFID-enabled baggage tag printers for their automated baggage sorting project.

Our printer business is also benefiting from an International Air Transportation Association recommendation to move from magnetic stripe boarding passes to two-dimensional bar codes.

In the second quarter, China's Shanghai Pudong Airport ordered, and Intermec delivered, over 800 printers to replace all of its baggage tag and boarding pass printers in the international terminal, with printers that were capable of printing the new standard two-dimensional bar codes.

The Europe, Middle East and Africa region grew 9% sequentially from Q1 2007, and we're up slightly year-on-year versus the second quarter of 2006, achieving a new high sales level for the second quarter.

We continue to see strong performance from the region resulting from the introduction of the CN3 with integrated GPS and GPRS cellular communications, and our efforts to expand our presence in the important high-growth regions of Eastern Europe and the Middle East.

In the second quarter, we closed a number of large CN3 deals in the European region.

These included Home Delivery Network, who offer the U.K.'s largest home delivering and collections service for items over 25 kilograms, handling 1.8 million parcels per year; Interlink Ireland Limited, part of GeoPost; the Parcels and Express Division of La Poste, or the French Post Office, with 35 depots handling in excess of six million parcels per year; [Tradista Transporta], a transportation and logistics company in Spain; and Bacoma, a large consumer goods company in Eastern Europe.

The German-based metro group is one of the most important international retailing companies and, today, trades in 30 countries.

They are also one of the leading drivers of RFID technology in retail supply chain applications.

Intermec has worked closely with Metro Group in the development of RFID solutions for many years.

Our systems have been through rigorous testing and trials, in both laboratory and production environments.

In the second quarter, Intermec began supplying Metro AG with an RFID portal reader system based on our IF5 and IF61 fixed readers.

By September, the Metro Group plans to have completed the rollout of approximately 130 Intermec RFID portals across Germany in the Metro cash-and-carry stores and the [Verana] Distribution Center in Ham.

Intermec also received approval from Metro for its supplier RFID [marketing] and compliance solutions, and demonstrated these solutions at the Metro Supplier Conference in May.

While North America product and services revenues decreased 21% year-on-year versus the second quarter of 2006, they increased 19% sequentially from Q1 of 2007.

We are encouraged by the sequential improvement in sales and the growing pipeline of Enterprise business and channel business as a result of our strong new product offering.

In the second quarter, we were awarded a large contract for CN3 mobile computers from Arkansas-based retailer Dillard's, one of the nation's largest fashion, apparel and home furnishing retailers.

Dillard's has more than 340 stores in 29 states.

In the industrial space, Intermec won an important field service application with Konecranes, a world-leading group of lifting businesses.

As a result of implementing the CN3, Konecranes expects to benefit from reducing the order-to-cash cycle by receiving real-time invoice information while technicians are still on site.

In the consumer goods space, Proctor & Gamble has selected and purchased quantities of Intermec CN3 for deployment in some of their U.S.

mobile work force automation initiatives.

Looking at product line performances, Systems and Solutions revenues increased 26% sequentially from Q1 2007, and declined 13% year-on-year versus the second quarter of 2006.

Printer Media revenues increased 9% on a sequential basis, but declined 8% year-on-year.

Service revenues increased 7.3% sequentially from Q1 2007, and increased 4.1% year-on-year versus the second quarter of 2006.

Moving on to an analysis of gross margins, in the May 2007 earnings call, we stated that we expected incremental improvement in gross margins throughout the remainder of the year, driven by additional reductions in other costs of goods sold to bring them in line with historical run rates, savings and purchases of materials, as well as improving margin contribution from increasing new product volumes, higher service and media margins, and decreased price erosion.

The predicted incremental improvement in gross margins did occur in the second quarter with each of the factors I just mentioned contributing to the recovery.

Also, we expected, in May, the build-up in lower margin Enterprise business to historical levels should and has partially offset the expected improvement.

Gross margins increased 260 basis points sequentially to 38.6% in the second quarter of 2007, from 36% in the first quarter of 2007.

On a year-on-year basis, gross margins decreased 190 basis points from 40.5% in the second quarter of 2006.

Looking at a product line basis, product margins increased 110 basis points sequentially to 36% in the second quarter of 2007, from 34.9% in the first quarter of 2007.

On a year-on-year basis, gross margins decreased -- or excuse me.

On a year-on-year basis, product gross margins decreased 350 basis points, versus 39.5% in the second quarter of 2006.

The entire year-on-year decline in product margins was in Systems and Solutions which did improve sequentially.

Printer and media margins improved sequentially and year-on-year.

Service margins increased from 45.1% in the second quarter of 2006 to a high of 49.2% in the second quarter of 2007.

Several important product introductions were completed in the second quarter.

We introduced the rugged CX -- excuse me -- CK31ex mobile computer, which integrates the industry's only near/far area imager.

With the CK31ex, users can scan 1D, 2D composite and postal codes, capture images for proof of delivery, and wirelessly connect corporate networks, eliminating the need for multiple devices and readying operations for the futures.

Customers such as the diversified chemical company, Kamera, in the Netherlands, specialty meats producer, Johnsonville Sausage, and packaging and forest suppliers, Temple-Inland, have seen the benefits of this revolutionary new scanning technology, and improved workflow productivity, improvement information management, and lower costs.

New orders were generated from the introduction of the CK32IS mobile computer, which is certified to meet the highest safety ratings from UL, ATEX and other international organizations.

The CK32IS is designed from inception to provide double-fault, intrinsically safe computing in even the most hazardous environments everywhere in the world.

The easy coder PF2i RFID baggage tag printer, designed for meeting the demands of airline and transportation applications where space is limited and down-time is not an option, was introduced in Q2, and generated key wins in the airline industry, as previously discussed.

And the Intermec IF61 Enterprise RFID reader was proven in Metro AG's demanding performance and testing environment, and selected for a large deployment.

The IF61 contains a powerful combination of the Intel Celeron processor, and up to 1 gig of optional memory, capable of running complex applications.

I would now like to turn it over to Lanny for further comment on financial matters.

Thank you, Steve.

Before I provide some financial comments, I should point out that all of the financial information that we're discussing is on a GAAP basis.

Our operating expenses related to sales, general and administrative, came in at $68.8 million, resulting in a decrease of approximately 12%, or $9.7 million lower compared to the prior year second quarter.

During the quarter, SG&A benefited from other operating gains of about $2 million.

Excluding this benefit, the operating expense approximated $70.8 million for the second quarter of this year.

As expected, operating expenses have reflected the cost reduction initiatives implemented in 2006.

Earnings from continuing operations before income tax were $12.5 million, compared to the prior year period of $18.1 million.

The second quarter of 2006 includes a $2.3 million pre-tax gain, or approximately $0.02 per share, from the sale of the Savi investment.

Earnings per share from continuing operations were $0.13 for the second quarter of this year.

This compares to the prior year second quarter of $0.16, excluding the one-time investment gain in that period.

During the quarter, regarding discontinued operations, we reached an arbitration settlement with the purchasers of our [Sensinay Glam] operation, and recognized an after-tax charge of $1.3 million, or approximately $0.02 per share, related to discontinued operations.

Intermec's fully diluted EPS, after the impact of discontinued operations, were $0.11 for the second quarter this year, compared to $0.16 in the same period 2006.

The Company's net inventory balance decreased by approximately $17 million during this quarter.

The decrease was aided by higher sales and inventory management majors that have resulted in better equilibrium between production, purchase and increased demand.

Looking at our liquidity position, total cash and short-term investments at the end of the second quarter was approximately $189 million.

This reflects an increase in cash of approximately $16 million in the second quarter of the year, which is primarily attributable to operating profit contribution and a net decrease in inventory.

Our net interest income was lower in the second quarter, versus the prior year second quarter comparison, due to larger average cash balances primarily associated with our $100 million share buyback which was completed during the second half of fiscal 2006.

Diluted shares at the end of the second quarter were approximately $61.1 million, and the basic shares approximated $60.3 million.

The Company's effective tax rate for the second quarter of 2007 was approximately 37%.

This was consistent with the prior year's quarter.

And finally, we'd like to provide our outlook for our third quarter 2007.

Historically, our third quarter revenues are generally flat when sequentially compared to our second quarter performance.

Europe's revenues tend to tighten a bit, while North America revenues typically pick up on a sequential basis.

We expect the upcoming third quarter will follow a similar pattern.

We believe third quarter revenues will be in the range of $203 million to $213 million, and diluted earnings per share from continuing operations are expected to be in the range of $0.06 to $0.12 for the third quarter of 2007.

That concludes our prepared commentary.

I'll now turn the call back to Pat for some final comments.

Thanks very much, Lanny.

As you can see, the business performance has improved in Q2, and we will be focusing to continue this improvement into the second half.

I want to thank Larry Brady for these results and his leadership of Intermec as Chairman, President and CEO for the last six years.

His leadership has positioned the Company to focus on the opportunities in the automated identification and data capture industry.

Now, looking to the future, I wanted to outline key principles that we'll be using to focus the Company on improving results and shareholder returns.

First, we have to have a focused and clear strategic intent that is compelling and differentiated compared to the competitors, and delivers on a target business model in line with our technology leadership.

This target business model will be used to guide business choices, operational disciplines, and customer value delivery.

Second, the role of the leadership team is to build the organizational capabilities that deliver consistently to that strategic intent, so that we can execute better in the future.

These organizational capabilities are the source of sustainable competitive advantage, and will be tested by our ability to execute in a superior manner.

Finally, we'll be setting higher performance standards, and holding ourselves accountable to performance levels that are consistent with our technology leadership and dedicated team.

In the future, I'll be outlining the specific objectives related to these higher levels of performance.

But, it is fair to say that they will center on margin expansion, capital utilization improvements and growth in the business through the business cycle.

I strongly believe that we can improve the performance of the Company through these steps and position the Company for long-term profitable growth by building and leveraging the operating model of a high technology company.

I'll turn now back to Kevin for the next steps in our conference call.

Great.

Thanks, Pat.

Wendy, at this time, we'd like to open up our call for our question and answer period please.

Thank you.

(OPERATOR INSTRUCTIONS).

Reik Read, Robert W.

Baird.

Hey, good afternoon.

Steve, in your comments, you talked about North America and maybe a little bit of concern with respect to some softness.

And I guess I just want to understand that in a little bit more detail because, when you talk to the resellers, they seem reasonably happy.

You see Zebra's sellout results were plus 15%.

So, it seems like North America's at least pretty reasonable.

It's a seasonably up quarter.

So, can you help us out with this softness comment there?

Sure.

North America improved nicely sequentially.

However, it's the first quarter in which we saw a sequential improvement.

And so, we're a bit cautious as a result of that.

We did see a recovery in Enterprise business, but it's not yet at historical levels.

We also have seen improvement in some of our product lines in North America but, again, they're not fully yet to historical levels.

So, we're just a bit cautious about our recovery in North America.

The other thing is there is some concern about how robust the North American demand for product line is right now.

We're seeing growth rate potential at the low end of what has been traditional for the market.

It's not a particularly robust growth mode.

So, we're just a bit cautious as a result of those things.

Is this a quarter where, historically speaking, you really need September to come through to make it a pretty good quarter?

Is it a little bit more backend loaded?

It's not anymore backend loaded than other quarters.

However, one of the factors that occurs in the third quarter is that Europe slows down.

Europe has been our growth engine, and that's just a seasonal fact.

They do tend to accelerate their activity in September, but the summer time can be busy months for us in the direct store delivery market, which tended to offset that and kind of mediate that back loading.

With a little bit of caution about North America, we're just making sure that we're not overestimating what the recovery will be.

Okay.

And then, with respect to profitability, in your comments you had cited a number of factors why you ought to see some improvement.

And as you look forward, I think most of those factors are very much intact.

And certainly, the CN3 ramping, less discounting on the 700 Series, you've got this portable label printer out there that ought to be a big improvement for margins.

Can you kind of walk us through are those things all intact?

Are there offsets to them?

And how do you see the next three to four quarters progressing with respect to margins, in a general sense?

Yes, we stated we expect incremental improvement.

When we look at the CN3, it is now at a solid production rate and, therefore, our ability to negotiate cost savings on that is improving.

And we would expect to continue to see cost improvements on that product each quarter going forward.

We are also working to stabilize the volume of 700 sales.

It's still a vital new product.

And we are upgrading that product to Windows Mobile 5, which is an important upgrade to keep the channel focused on selling the product.

And that's being released this quarter.

So, stabilizing the sales of that high margin product will benefit us.

We continue to improve our margins in the Media area.

You can see Service margins are being held at the high, or reaching new historical highs.

We think the second quarter was exceptionally high for Service, but we expect it to be in the 45% range, which it's been achieving.

And in the Printer area, we continue to work on cost savings opportunities and introduce new products that are generating good revenue for us, like this PF2i, which is really taking off in the bag tag area and the boarding pass area.

It's producing some nice growth for us.

Okay, great.

And then, just one housekeeping question for Lanny.

The receivables reserve increased from last quarter.

Last quarter it was 7.8, this quarter it's 9.4.

Can you give us a sense for what's behind that?

Well, our reserve methodology is applied to upticks in our business, and we did see an uptick in overall business volume in the quarter.

So, it's reflective of that.

Okay, great.

Thank you.

Philip Alling, Bear Stearns.

Thanks very much.

Patrick, I was wanting to get a sense from you, if at this point, you've been able to identify what you think, longer-term, the operating margin potential of this business is, and really what you think the top-line growth should be going forward.

And perhaps, you could maybe even address what you think the cash flow generation capability of this business model would be on a normalized basis.

Well, that's exactly what I'm working on figuring out.

So, I'm not prepared to talk about it.

I do think that the margins can be improved.

They need to be improved.

The high technology portfolio of this Company, the gross margins need to be consistent with the high technology portfolio.

So, the key focus is on gross margin improvement, and that's where that I'll be focused.

I'm not prepared yet to state what the target business model is.

The target business model would be the gross margins, the expenses and the operating profit.

So, that's work in progress.

That's what I'm going to be focused on.

What's your other questions -- were around?

Well, I just said in terms of sort of, like, annual cash flow generation capability--.

--Right--.

--And so forth.

So, that--.

--Right, right.

So, those will come from the work that we're doing now to model what the target business model, what the investment capital and, therefore, what the free cash flow should be.

Okay.

There was a fair amount of commentary on the call with respect to RFID products and so forth.

And there has been some issues in the past with respect to visibility for investors in terms of the RFID royalty revenues and so forth.

Any expectation that there would be improved visibility for investors with respect to that revenue stream?

With regard to RFID, we intend to report the revenue when it reaches its level of materiality.

With regard to royalty income, we cannot, and would not, separately break that out because it would basically violate confidentiality agreements that we have in place.

But, it would be folded into, in the future, any material disclosure of RFID revenue.

A question for Lanny.

With respect to the comment you made about other operating gains benefiting SG&A, could you give us a little more color on that?

And then, presumably, we should be looking at sort of a quarterly run rate on OpEx, there of sort of low $70 million type range.

Is that what presumably is implied in your guidance?

To the question, the items that we benefited from don't truly classify or qualify as non-recurring because, otherwise, they would have a different connotation in the accounting presentation.

But, they were items that were related to some insurance proceeds and a property sale that, obviously, don't happen to reoccur on any sort of a normalized basis.

So, we broke those out so that, in fact, you could get a perspective of our expense level, at approximately the $70.8 level.

As we commented in our earlier discussions, both today and previous quarters, our cost reduction initiatives are substantially behind us.

And we saw the run rate of those -- excuse me, the operating effect of those on SG&A expenses, both in the first quarter -- and we're confident that the level of expenses that we are currently at is appropriate for our business model, and we've incorporated our thoughts of what SG&A costs might be relative to prospective revenue generation for the third and fourth quarter -- but, in the case of the third quarter -- in our guidance.

Okay.

And just one final question from me.

And that's just with respect to the -- what was the impact of currency, in particularly on your European revenues in the quarter?

Currency in terms of the P&L impact was relatively de minimis.

We have -- obviously, there's a -- with the uptick in European business volume in the quarter, we did see a fair amount of currency play on the top-line revenue side.

We don't disclose specifically what it is, but it was commensurate with the activity in the exchange rate difference we're seeing.

Okay.

Well, that's all I have for now.

Thanks much.

Neil Miller, Fidelity.

[313].

Hello?

Yes.

Please go ahead, Neil.

Yes, there was one trade magazine that suggested that China was kind of blocking over EPC and involvement, and maybe wanting to be independent.

And I'm just kind of wondering whether your perception of these awards in China are sanctioned by the government, and whether we could -- they're on board with your standards or the industry's standards in RFID, I guess.

Sure.

The wins that we're having are EBC global standard product.

Most of them, at this point in time, are closed loop applications driven by the customer.

So, China Tobacco, for example, for their supply chain, they're managing the entire implementation and processes.

So, arguments over government standards are not an issue.

In the long-term, we don't see the outcome of that argument being significant in the business one way or the other.

I mean, it may require us to add particular standards, compliance, to our products, but it won't materially impact our ability to provide product in China.

Thanks so much.

You bet.

Kevin Starke, Weeden & Company.

On the foreign exchange issue, I would note that your predecessors have routinely disclosed that information, and your competitors have done likewise.

I would invite you to revisit that policy.

But, my question is about guidance.

You have indicated that you expect the gross margin to improve quarter-on-quarter.

And the high end of the revenue guidance is up versus the second quarter, but the EPS guidance is down sequentially.

You would think that at the high end of the revenue guidance, there would be positive operating leverage that would translate into EPS guidance, and I'm -- given what you said about gross margin, I'm wondering why that isn't the case.

To your point, our actual revenue in the second quarter was above our guidance that we gave, yes, for the quarter.

When we look at our transparency of both revenue, as well as the operating leverage and whatnot, we are being mindful of both the recovery momentum in North America and what the margin impact on that might be.

And as Steve, I think, commented, that we're very pleased with some of the high level margin performance, for example, that we saw in the Service business, which certainly complements our overall margins.

But, there is some risk that some of that might moderate.

And we think that if you factor out some of the one-time impact of some of the benefits in the -- certainly in the second quarter, that the two on the revenue side and the EPS side are proportionally in line with each other.

Okay, thank you.

Ajit Pai, Thomas Weisel Partners.

Yes.

First, on the margins again, I think the past three years, when you're going from the second to the third quarter, typically you've had a margin decline.

Could you give us some sort of color as to what was driving sort of that shift?

And also, I think you talked about Service margin targets being 45%, but you came in at 49% this quarter.

Do you expect them to go back down, and what drove the increase this quarter?

And why do you expect it to be 45% going forward?

Ajit, this is Steve.

With regard to the second to third quarter margin decline for the last three years, that was typically driven by revenue mix.

Our European revenues, which typically are at higher margins, moderated in the third quarter, and was typically replaced by lower margin DSD business that tended to swell in the summertime.

So, that was a seasonal impact.

We don't expect that to be significant this quarter, but that's what has happened in the last couple of years.

And I'm sorry.

Could you repeat the second question?

Yes.

On the Service gross margins, I think you talked about it being closer to 49%, but your target being 45%.

Yes, 45% is what we've been achieving, or thereabouts.

If you look at the first quarter, we did about 41%, and then we did 49% in the second quarter.

We think some of that is basically spillover from the first quarter when we weren't able to convert some of the activity of the billings.

And we weren't able to convert some of the Service renewals to billings.

So, we caught up on those Service renewals and billings in the second quarter.

And so, if you look at the two quarters together, you're at, basically, about a 44%, 45% margin.

That's what we would expect on a go-forward basis.

Okay.

And then, one more question about -- just looking at Europe and the fact that it grew 9% sequentially, but just slightly year-over-year despite the currency sort of tailwinds, could you give us some color as to what challenges you're facing out there, and why that's going to change on a go-forward basis?

Sure.

Europe, last year, was the highest recorded revenue we'd ever achieved in the second quarter.

It was a big quarter for us because of the build-up before the RoHS transition.

So, it was an unusually high quarter for us.

We're actually quite pleased that we actually exceeded that level in this quarter.

So, for us, we feel that's quite a victory.

In Europe, actually, we are seeing accelerating business.

We're pretty confident about the growth potential for Europe.

Eastern Europe and the Middle East are providing great opportunities for us to expand.

Our win ratio on competitive deals is in good shape.

So, we think the fundamentals are in pretty good shape in Europe.

Right.

And then, just looking at your direct versus indirect strategy while penetrating international, could you give us some color as to which one you're focused on much more over there, both in Europe, as well as in Asia?

Yes.

In Asia, currently, we are 100% indirect.

And it would be our intention over time to modify that slightly, so that we can do a better job on Enterprise accounts.

But, currently, they're 100% distribution.

In Europe, our model is probably closer to what we'll ultimately achieve for the Corporation, which is about a 75% to 80% indirect, and 20% to 25% direct.

And that's a model that we'll probably stick with going forward.

The reason for that is there's just a certain number of Enterprise customers that you want to have a direct relationship with, not only because of the knowledge that they provide you with, but because that's the way they require to work with you.

And so, we have to maintain that relationship.

So, just a follow-up to that.

Usually, when you work with the large Enterprises, I think your margins in that business on the gross side are typically lower, I think the discounting is higher.

(Inaudible.)

Also, when you work with distribution, typically, also you're sacrificing some margin.

So, in the next phases, international right now, particularly Asia, is the fastest growing business you have right now, is that trend going to be positive for margins, or is it going to be dampening for margins?

It'll be positive for margins.

Our distribution business is some of the highest margin business that we have.

On the gross margin side, as well?

Yes.

Oh, okay.

Yes.

Thank you so much.

Christoph O'Donnell, Morgan Keegan.

My questions have been answered.

But, one last one is where are you with the rollout on North American carriers for the CN3, getting certification there?

I did see the AT&T release in May, but just some color on the other carriers.

Sure.

We've got AT&T, Sprint, Verizon, several of the other smaller ones.

We're pretty much fully certified and compliant at this point.

And all of that work was completed in Q2.

Great, thanks.

(OPERATOR INSTRUCTIONS).

Chris Quilty, Raymond James.

Good evening, gentlemen.

Good evening.

Good evening, Chris.

Hey, Chris.

I just wanted to follow-up with regards to the guidance for the back half of the year here.

If I circle back to about six months ago, you had expressed some optimism based upon the fact that you had a number of large Enterprise accounts that delayed implementations in the back half of last year when the CN3 began to roll.

And could you give us a sense of what kind of visibility you have on the Enterprise business in the back half of the year?

Has it improved or decreased?

And what kind of retention rate did you actually come out of that period last year, where you had to put many of these customers on hold?

Sure.

Let me try to answer that.

We are seeing an increasing pipeline of activity in the Enterprise space.

If we look at quoted activity and pipeline analysis, we're in better shape going into the second half, from a pipeline basis, than we were in the second half of last year.

Of course, you've got to convert that all to shipments, and that's the challenge that we'll work on over the next few quarters.

But, if you look at North America -- but, we saw a substantial uptick in Enterprise business between Q1 and Q2, although it's not fully back to our traditional levels.

The pipeline looks better.

But, again, it's converting that.

If I look at were we fully successful in converting deferred Enterprise customers from last year, certainly we lost a few customers during that process.

When we look at most of the key relationships, though, the ones that we are heavily focused on in the DSD space and the Consumer Goods space, other spaces, we've done a pretty good job of retaining those customers.

And they are typically the ones that are buying and rolling out the CN3.

We don't have a specific metric for you on that, that I can quote.

But, generally, our Enterprise customers have stuck with us through the process.

Okay.

And in the past, Steve, you've given us some color by a vertical market of areas where you're seeing strength and weaknesses?

Sure.

By verticals, we're a little weak in the public sector right now.

It's mostly a timing issue associated with the buying pattern.

We have very good upside looking in the public sector going into the second half.

There's also a product refresh going on there.

A lot of the new products are being added to contract vehicles right now.

So, some of that's just deferral until those products get on those contracts.

But, again, we expect to recover in the third and fourth quarter.

In the Industrial space, that is a market which will pace our recovery, to a large degree, because of the CK31ex and the SR61ex, which will be coming out this quarter.

That's the way in which we are going to recover competitiveness in the scanning area, which has hurt us, the near/far scanning area.

And in fact, give us a competitive advantage with the EX25 engine.

So, we're very anxious to see how that product takes off in the channel.

That's where most of the business will occur.

And we'll be monitoring that closely in the third and fourth quarter.

So, we think that's a recovering market for us.

In the Consumer Packaged Goods space, the CN3 is wowing them.

And we are coming out in the Fall with another version of the CN3 called the CN3E, which stands for extended, which adds a larger keypad for our direct store delivery customers.

That's getting a lot of interest, and we expect that to convert quite a few customers.

So, we think the CPG space is in good stead.

And in the Retail space, the CN3 has opened up some opportunities for us.

Quite frankly, we had a good year in 2004 and '05, and 2006 was an okay, but not a great year for us in Retail.

With the combination of the CN3 in Retail and the addition of portable label printers this Fall, we expect that space to be a growth space for us.

Great.

And Transportation?

Yes, I knew I had forgotten one thing.

Transportation Logistics is just a very good market for us.

It's very robust, especially in Europe, and, in fact, all over the world.

It's just the best market right now, in our opinion, for growth and for the fit of our products.

And are you getting the GPS models out there for the Transportation market?

Oh, yes.

Yes, it's been shipping since March, I believe, and a lot of interest in the GPS stuff.

In fact, almost everything is going into that market.

They're buying GPS whether they have the application now or not.

Okay.

And you mentioned earlier in the script, with regard to gross margins, one of the factors being reduced price erosion.

Can you comment on that?

Yes.

Part of the price erosion occurred because we were basically trying to shore up our position in the short-term with the 700 and discounting, while we waited for the CN3 to come out.

We expect that to moderate because of two factors.

One, we have upgraded the 700 with Windows Mobile 5, and we think that will boost its competitiveness in the markets that we would compete with it, and which is mostly in our installed base where there's some loyalty to the product, and in our channel.

And the other thing is we expect the CN3 to benefit both from price reductions and continuous evolution of product extensions as we continue to evolve that product, like coming out with the CN3E, which is the stretch version.

Okay.

And there haven't been any issues with RoHS inventories flooding the market?

I know last quarter, ScanSource kind of hinted on their conference call that they were going to force some of their vendors to disgorge the RoHS stuff that they were sitting on.

Yes.

We've been monitoring inventories pretty closely from our distributors, and looking at the return rates and their point of sales output.

And we did see some of our distributors lower inventories in the quarter.

Our returns were at normal rates.

But, we believe we're in good shape.

The inventory levels that we have right now in the distribution, it looks like we're in good shape.

But, we continue to monitor that closely.

Great.

Thanks a lot, gentlemen.

You bet.

Thank you.

Eli Lustgarten, Longbow Securities.

Good afternoon.

Hi, Eli.

A quick question, for clarification.

During the commentary, I think you talked about a $2 million operating gain in SG&A, then you talked about going from $68.8 to $70.8.

That sounds like it's a one-time gain.

Was it pre-tax, after-tax?

What was that?

Yes, we commented that there was -- operating expenses were at 68.8 million.

Um-hmm.

And they benefited approximately $2 million at an operating expense level.

Um-hmm.

So, that's pre-tax.

Okay.

And gain is sort of a loose word here.

But, I mean, the point, I guess, is they were a credit to our operating expenses from -- I commented already earlier in the call that they were from insurance proceeds and a sale of a property.

We classified them as operating because they are from the operating end of the Company, but we don't really look at them as something that's going to reoccur every quarter.

Okay.

And so, we wanted to disclose that, so that you could get a perspective that, without that benefit, the operating expenses were $70.8 million.

Yes.

So, that's about $0.02 a share, and that sort of explains the difference in guidance almost with the volume levels, doesn't it?

To a great degree, yes.

Yes.

Yes.

And so, that's what occurred there.

Now, secondly, you talked about volume in the quarter being better than guidance, which it obviously was.

Was that new product driven?

Was that the North American Enterprise market coming back?

What caused -- what do you identify as giving you that upside surprise in volume versus what your guidance was?

Well, again, we continue to be cautious about North America.

And so, when we gave guidance, North America was at a fairly low volume for us.

So, we guided based on recovery, but we saw a substantial sequential improvement.

I think it was 19% quarter-on-quarter.

Um-hmm.

So, we benefited there.

But, you look at the international growth rates, they exceeded our expectation, as well.

Every one of the regions internationally grew sequentially and year-on-year.

So, that benefited us.

The international economies are pretty robust right now.

Um-hmm.

So, with the public market, I think you're saying, being somewhat weak, is there any reason why the North American market should be any weaker in the third quarter than the second quarter?

I think you're assuming it gets a little bit better in your guidance, but is--?

--Yes, it gets a little better, and it offsets some of the decline that we typically see seasonally in Europe, just because of the--.

--Yes--.

--Summertime slowdown.

Great.

And then, finally, is there any negotiation going on in North American airports as you see in Hong Kong or so, with some of your systems?

The biggest interest is internationally, and the reason is, internationally, the airports are typically run by a governmental agency and they own the gates.

Um-hmm.

And therefore, they own all the infrastructure.

In the U.S., the airports own the infrastructure and, therefore, you've got to negotiate with the airports and -- or excuse me, the airlines.

Airlines.

I'm sorry.

The airlines own the gates, and the airlines own the infrastructure.

And you negotiate with them.

And U.S.

carriers are not real strong right now, so it's not a robust market for us.

But, internationally, the airports are converting quickly.

Okay.

Thank you.

Will Potter, AG Asset Management.

Thanks.

My questions have been answered.

Thanks, Will.

Okay, great.

Reik Read, Robert W.

Baird.

I just want to go back to the expense question.

You guys had talked about -- and I think it was last quarter, following the completion of the restructuring -- that the target operating expenditures would be kind of $69 to $71 million per quarter, for each quarter this year.

Is that still the case, even though you're winding up at the high end?

And I guess I'm asking with respect to the guidance.

It almost seems like you're forecasting above that range right now.

And if that's the case, can you tell us why?

Well, to your point, we did make comments earlier in the year that with the cost reductive initiatives that were substantially enacted at the end of last year, our target was to get our run rate, if you will, our operating cost levels, in that $69 to $71 million level.

In that regard, we were looking at it from somewhat of a holistic level, from a take all the expenses and divide it by four, and what's kind of the trend there.

But, certainly, as revenue growth picks up, there will be some incremental pressure on operating expenses, not the least of which is -- for example, even this quarter, we saw incrementally higher sales commissions that are in the selling costs.

So, there are variables like that that will fluctuate.

But, to your point, the approximately less than $71 million is right in line with where we think the operating expenses should be for the quarter, given the other natures of the business.

We don't believe we have a spending issue.

That's not really what we're focusing the go-forward on as much as we are, as Pat mentioned, on gross margin and operating margin improvement.

So, it's a volume-driven issue, rather than any incremental investments that you didn't conceive of last quarter?

That's correct.

And we think SG&A costs are adequately reflected in our third quarter guidance, and that's in line with previous kind of comments we have provided.

Okay.

And then, one last question.

Steve, you had talked about Transportation Logistics being a very strong market.

Maybe this is what you meant by this, but can you talk a little bit about the postal opportunity in Europe with the CN3?

I know you talked about one in your opening remarks.

But, it just seems like there's quite a bit of opportunity there.

Yes, we are tracking a lot of opportunities in Europe in Postal and Transportation Logistics.

And we are seeing some of those convert.

A lot of them are still in the decision process.

And so, they'll probably be reflected more in the fourth quarter guidance than they are in the third quarter guidance.

But, we did convert Interlink, which was an important one for us in establishing a beachhead in GeoPost, which is the largest parcel delivery service in Europe and the largest post office with French Post.

So, we're encouraged by our progress there, and there is a large number of projects that we're tracking.

Okay, great.

Thank you.

Ajit Pai, Thomas Weisel Partners.

Yes, two questions.

The first is just a clarification on the property that results in the one-time sort of expense reversal.

Can you give us some color as to what property that was?

Well, it's a fairly de minimis item, Ajit.

I mean, it was in the hundreds of thousands of dollars of gain, and it was just a property that was in our--.

--But, did that contribute to the cash flow, is what you're asking.

Well, it might not have been a gain, does it contribute significantly to the $70 million of cash flow?

No.

No, it didn't.

Okay (inaudible).

The second is just looking at competitive dynamics.

I think you had one of your largest competitor get acquired by Motorola.

And for a while, there was some price pressure a while ago.

So, can you give some color as to whether the pricing environment in the industry right now is fairly static, and whether you've seen any fundamental changes in the competitive dynamics?

And second, are there any new competitors that you are facing out of Asia?

So, when you refer to pricing, you're talking about product pricing?

Product pricing, yes, and discounting patterns.

Yes.

We are not seeing unusual activity for our market place at this point in time.

I think a lot of the very aggressive pricing has kind of settled out.

And so, we would consider the environment today to be a normal environment for us, from a pricing and discounting perspective.

With regard to competitors, we haven't seen any significant change in the complexion of our competitive environment.

We don't see Asian incursion -- suppliers from Asia being an issue for us right now.

And what about sort of new players, like the VeriChips of the world, on the -- like, companies like Pay, are they getting into your space more actively, the VeriFones of the world?

We never see them as a competitor in our traditional environments.

Sometimes, they are partners, if you're talking about -- VeriSign is in a very different market.

No, we're talking VeriFone, which makes--.

--Oh--.

--The handheld devices that could be used for credit card transactions, etc.

They're in a very different market.

Very different.

So, you're not seeing any overlap there right now?

No, none at all.

Okay.

Thank you.

Thanks a lot, Ajit.

Kevin Starke, Weeden & Company.

You're eight months away from a debt maturity, and I was wondering if I could ask you your specific plans about what you intend to do with that, or at least if you could share your -- as the new team at Intermec, kind of give us your sense of what the properties of leverage would be at a company like Intermec or companies, in general.

Sure.

I'll comment on that.

We have no specific targeted transaction to refinance or replace that debt issuance at this point.

In other words, that we're ready to talk about.

But, we do have an analysis and a discussion underway relative to your second point, and that is the appropriate capital structure of the company including, prospectively, any refinancing or other type of financing that would go on the balance sheet.

Secondly -- well, not conjunct necessarily to your specific point, we are in the process of finalizing negotiations on a replacement bank facility to our existing $50 million revolver that matures at the end of September.

And we would envision that that facility could also be used for short-term working capital on a very flexible basis for liquidity, as well.

So, that is one component that we do have in place.

And as part of our on-boarding with Pat and our establishing the strategy, capital structure will be part of that.

Do you regard Intermec, maybe other companies it the space, as somewhat under-leveraged?

A loaded question, I know.

Well, I mean, I would answer it this way.

Instead of saying do I have a view, or do we have a view--.

--Yes--.

--What the leverage of Intermec should be, I think, from my perspective, we want to be mindful to have cash balances that are appropriate for giving us both operating and tactical flexibility.

But, that said, it's also going to be tied into our operating model going forward, in terms of cash generation.

And as Pat said, we'll comment more on that later.

And it is a timeframe, from an interest rate environment, that one probably would evaluate with the appropriate level of leverage versus equity of a company.

But, I'm not going to comment on what I think the specific model or level should be for Intermec at this point.

Okay, thank you.

At this time, I show no further questions, sir.

I'll turn the meeting back over to you for any closing comments.

Great.

Thank you, Wendy.

Once again, we appreciate everyone joining us on our call this afternoon.

And that will conclude the call for today.

Have a great night.