漢威聯合 (HON) 2008 Q3 法說會逐字稿

Hello, and welcome to the Intermec's third quarter 2008 earnings conference call.

(OPERATOR INSTRUCTIONS.) I would like to remind all parties this conference is being recorded.

If you have any objections you may disconnect at this time.

I would now like to turn the call over to your host today, Mr.

Kevin McCarty, Director of Investor Relations.

Sir, you may begin.

Thank you very much and good afternoon, everyone, and welcome to Intermec's third quarter fiscal year 2008 earnings conference call.

With me on today's call is Intermec's President and Chief Executive Officer, Patrick Byrne, Chief Financial Officer, Lanny Michael, and joining us on the phone is Mike Wills, our Senior Vice President of Global Sales and Service.

In a moment, Lanny will provide a summary of our operating performance and guidance and then Pat will discuss the key trends and highlights of our business.

Subsequent to those discussions, we will begin our question and answer period.

Now let me quickly cover our safe harbor statement.

Today's discussions may include predictions, estimates, or other information that might be considered forward-looking under the Private Securities Litigation Reform Act of 1995.

Some of the statements we make today may be considered forward-looking, including but not limited to Intermec's expected financial performance, as well as Intermec's strategic and operational plans, along with additional examples that are set forth in today's earnings release.

These statements involve a number of risks and uncertainties that could cause actual results to differ materially.

Please note that these forward-looking statements reflect our opinions only as of the date of this presentation, and we undertake no obligation to revise or publicly release the results of any revision of these forward-looking statements.

For a more detailed description of the risk factors that may affect our results, please refer to our SEC filings, including our Annual Report on Form 10-K and our quarterly reports on Form 10-Q.

Copies can be obtained by visiting the SEC or our Investor Relations section of our website.

With that, it's now my pleasure to turn it over to Lanny.

Thanks, Kevin, and good afternoon.

Intermec's third quarter revenue of $234 million represented a 14% growth over prior year's third quarter.

Third quarter GAAP earnings per share were $0.18 compared to $0.07 in the comparable quarter of last year.

Operating leverage over the comparable period of 2007 was 41%.

Operating leverage is measured as incremental operating profit over the incremental revenue achieved.

Intermec's 2008 year-to-date revenue growth over the comparable period in 2007 was 12% with year-to-date operating leverage of 37% over last year.

Regionally, third quarter revenue growth rates this year over last year were as follows.

North America, our largest region, revenues grew 28%.

Europe, Middle East, and Africa grew 5%.

Latin America revenues were essentially flat and Asia-Pacific, our smallest region, declined 28%.

Reviewing our product line performance, systems and solutions revenues increased 23% over the third quarter of 2007 to $146 million.

This product line represented 62% of total revenues.

Growth in our systems and solutions revenues helped drive overall revenue growth in the quarter and year-to-date.

Printer and media revenues of $50 million representing 21% of total revenues declined slightly over the prior year's third quarter while service revenue of $39 million representing 16% of total revenues increased 5% over the prior year's third quarter.

Now looking at gross margin, total gross margin was 39.1% and compares to 37.9% a year ago representing a 120 basis point increase.

Year-to-date gross margin of 40% represents a 240 basis point improvement over the year-to-date comparable in 2007.

Third quarter product related gross margin was 38.7%, 110 basis point improvement from the year ago margin of 37.6%.

Year-to-date product gross margins improved 340 basis points to 39.6%.

Our service gross margin was 41.1% in the third quarter, an increase of 200 basis points compared to the 39.1% in prior year's third quarter.

These metrics demonstrate the progress in achieving our year-over-year gross margin improvement, one of our primary stated goals.

Transition related costs impacting gross margins in the third quarter were $1.2 million.

These related to costs in areas like overhead absorption, duplication of costs due to transition associated with the relocation of our final assembly operations to a third party contract manufacturing arrangement.

Operating expenses for the quarter including restructuring costs were $75.6 million.

Restructuring costs associated with the Company's plan to relocate the final assembly of its product lines and consolidate two US service depots amounted to $3.3 million or $.03 per share for the third quarter 2008.

The majority of these restructuring expenses relate to employee severance and retention costs.

Operating expenses combining R&D and SG&A and excluding restructuring costs were $72.3 million or 30.8% of revenues and this compares to $73.5 million or 35.7% of revenues in last year's third quarter.

On a sequential basis, our third quarter operating expenses decreased by $5.5 million from the second quarter.

R&D expense in this third quarter of $15 million includes a $1.4 million credit recorded for the reimbursement of certain costs under a foreign grant program.

Total SG&A costs of $57.3 million were relatively flat in the quarter compared to last year's third quarter but have improved by 420 basis points as a percentage of revenues year-over-year.

We are focused on the management and transition of inventories as we transition to our outsourcing initiative.

Total net inventories decreased $15 million in the third quarter.

We expect continued progress in decreasing net inventory balances in the fourth quarter.

Our cash equivalents and short-term investment position at the end of the third quarter totaled $202 million.

Net cash provided by operating activities was $16 million for the third quarter of 2008 and $38 million year to date.

This represents a cash conversion ratio of 142% in the quarter and 145% year-to-date.

Looking at our guidance for the fourth quarter, reviewing our guidance of fourth quarter fiscal 2008 reflects an economic slowdown and the fact that the U.S.

dollar has strengthened against foreign currencies.

We expect our fourth quarter revenues to be in a range of $220 million to $230 million.

Earnings per share from continuing operations are expected to be in the range of $0.14 to $0.18 per diluted share.

This EPS range is inclusive of our estimate for costs related to the final assembly and service depot relocation announced in July.

Restructuring costs in the fourth quarter are expected to be $700,000 to $1.2 million or approximately $.01 per share.

The transition related costs are expected to be about $1.5 million to $2.5 million in the fourth quarter.

Our EPS guidance assumes a diluted share count of approximately 62 million shares for the quarter.

We anticipate the effective tax rate to the full year 2008 to approximate 37%.

This concludes my formal remarks and I'll now turn the call over to Pat.

Thanks, Lanny, and good afternoon, everyone.

Intermec executed very well in the third quarter with record revenue, strong operating leverage, and cash flow from operations in excess of net income.

I will focus first on the core operating performance of the Company before the restructuring and transition costs.

As I discussed last quarter, this approach to outlining our results are in order to provide insights into the performance of the underlying operations.

GAAP operating profit for the third quarter was $16 million on $234 million in revenue demonstrating over 40% operating leverage compared to Q3 of last year.

This result includes the negative impact of $4.5 million of restructuring and transition related expenses.

Therefore, our core operating performance provided even stronger operating leverage created through a combination of expanding gross margins and lower spending.

Operating cash generation was strong in the quarter.

Year-to-date cash flow from operating activities of $38 million represents more than 140% cash conversion on non net income.

Moving forward, improving operating cash flow is a key part of our supply chain strategy as we lower inventories and manage accounts receivables working with our partners.

This transformation initiative positions us well for the future in free cash generation.

Revenue of $234 million or 14% growth compared to Q3 of last year.

I'm going to focus on the drivers for each region with comments on results and outlook from a market, product, and business mix perspective.

I'll be using the term run rate to describe smaller size deals and two-tier distribution business.

The message we are getting from our customers is that Intermec's solutions provide a solid return on investment that can be measured in six to nine months and enable lower supply chain and distribution costs.

These are key priorities in an economic downturn.

Improving the productivity of the mobile worker remains a priority and customers are adopting mobile solutions to both lower costs and improve their customers' experience.

There are some delays in project deployments, but there are also areas of consistent demand, for example, in consumer staples, public sector, and field mobility service applications based upon our new products and an expanded global partner program.

Now I'll go into the regional results and outlooks.

North America performance, our largest region, was very strong at 28% growth compared to last year and was broad-based, including excellent results in enterprise, as well as run rate business to two-tiered distribution.

Results were very strong in the systems and solutions business, as well as in the printer media business.

North America maintained approximately 60% channel participation compared to Q2, which means that with 28% growth, we are seeing progress in all of our go-to-market avenues.

Enterprise sales grew well with particular strength in the CN3 family of products and field mobility applications and the CK61computer and PM4 printers in public sector applications.

The CN3 family had a record quarter in North America and continues to ramp very well.

Many of the deals we saw move out of Q2 closed and shipped in Q3.

In North America, we added five new partners to our Intermec printer service program or IPSP bringing the total to 17.

We believe this program will enable us to continue to build our printer business with our partners and outgrow the market.

The broad based progress we are seeing in North America provides an aggressive model as we develop and execute innovative global sales and marketing programs to move the business forward.

Looking forward then, given the economic uncertainty, we are not expecting these very high growth rates to continue at this clip in North America.

We have seen some projects delayed.

We have grown the business in North America 19% year-to-date and we believe we are outgrowing the market.

We are well positioned going into 2009 and are engaged on a broad range of projects with our partner network and customers.

We have a strong product lineup and applications where compelling ROIs are making mobile solutions a priority for customers.

Moving now to Europe, Middle East, and Africa.

That region grew 5% compared to the prior year period and included a substantial portion of the Royal Mail hardware revenue.

We are seeing excellent progress on the project, along with our partners.

European postal opportunities continue to be a growth opportunity for Intermec and we are confident we are well positioned and engaged on the top projects.

In addition, we announced an important win with Daimler FleetBoard for onboard telematic solution using the CN3e, which combines onboard navigation, job status, barcode scanning, and two-way messaging in a single handheld device as a core contribution to their DispoPilot solution.

These are great examples of the use of Intermec solutions to improve the productivity of the mobile workforce.

Moving forward, however, we are seeing a slowdown in the EMEA business in the market demand and some postponement of projects affecting both the run rate and enterprise businesses.

And when combined with weaker local currencies, we expect this will affect the growth rates in the short term.

We are confident we have the right products, team, partners, and approach in EMEA and will be strengthening our use of the channel and two-tiered distribution in the region in order to expand our reach, lower spending, and improve sales efficiency.

We have excellent participation from our new product launch partners in EMEA and as the economy and demand recovers, we believe we are well positioned to capture the business.

Latin America was up sequentially and flat compared to last year.

We've seen important progress in building the run rate business, particularly in systems and solution with specific progress in utilities and other industrial applications, as well as retail and consumer package goods, but these were offset by a tough compare in the printer business where some large DSD deployments did not repeat.

We are broadening our business in Latin America and building our partner network in both the northern region and the southern region, the main businesses being in Mexico for the north and Brazil in the south.

We have active engagement with partners in key courier accounts, mobile in-store retail, and transportation infrastructure and we've invested in our operations in the region to support long-term growth.

For example, recently our work with Cisco in the southern region has showed how the CN3 has been integrated into their unified communications platform for retail applications.

These are examples of leveraging global partners to build a broad based business in the Latin American region to enable long-term sustainable growth.

In Asia-Pacific, we saw sequential improvements in our systems and solutions business, which is the majority of the business, mostly in the run rate.

Asia-Pacific is a small region for us, and we are evaluating means to expand our channel business and two-tiered distribution system.

We recently added 16 partners to our IPSP program in the region and believe that our new products, the CK3 and the receipt printers, will be successful.

The feedback from the APAC launch partners is very favorable and our country-specific certifications are on track.

We believe these products are well suited for the Asian market requirements and long-term growth in the region is important for the Company.

This brings me to new products.

In this period of economic uncertainty, new products are even more important for business growth.

In September, we launched and our now shipping the new CK3 in premise rugged mobile computer.

The CK3 is highly innovative with an ideal set of imaging and communications features enabling it to perform a variety of in-premise applications.

With the CK3 we launched the product, as well, with a full line of accessories along with excellent country-specific certification.

We expect these factors to drive rapid adoption.

The data capture technology in the CK3 comes from Intermec's advanced developments with linear, area or two-dimensional, and near-far imaging solutions based on the EX25.

The CK3 also includes Microsoft's latest embedded operating system, Windows Mobile 6.1, and Cisco's CCX compatible extension compliance.

The core application for the CK3 is in the warehouse and mobile in-store retail where we believe there are good long-term growth opportunities since they are some of the largest segments in the AIDC industry.

The pending technology refresh cycles provide a key opportunity for Intermec in 2009.

Intermec is the first rugged mobile computer company to ship a Windows Mobile 6.1 platform in the CK3 and CN3.

As we stated at the time of introduction on September 10, we launched the product with 40 worldwide launch partners and the feedback has been excellent.

The price point, form factor, and functionality of the CK3 represents new addressable markets for Intermec, and we anticipate strong adoption starting in Q4 and into 2009.

The second major product launch I want to cover is the series of new rugged mobile printers.

This week we launched the new PB2 and PB3 two- and three-inch receipt printers.

They're the only mobile receipt printers in the market with long life field replaceable batteries.

These products are fully compatible with the Intermec CN3, CK3, and 700 series rugged mobile computers at launch to provide customers with a turnkey solution.

These products also represent new addressable markets for Intermec in the growing mobile printer segment for applications such as memo receipt printing, mobile route accounting, retail queue busting, and field service mobile printing.

These new products are excellent examples of expanding our market contribution through improved new product development capabilities.

Significant improvements have been made in our platform development program management certification cycle times and leveraging development partnerships.

We anticipate that these improvements will enable Intermec to continue to deliver a steady stream of highly innovative new products in the future.

I now want to focus on our transformation initiatives, which are focused on improving the profitability of the business, both through gross margin improvement and spending reductions.

These remain a key priority of the Company as we will be evaluating means to accelerate the progress during the current economic uncertainty.

On July 10, we announced plans to transfer our final assembly operation to a contract manufacturing partner, as well as consolidation of our repair depots to Charlotte and Monterey.

During the third quarter, we made significant progress on transfer of final assembly operations with approximately 25% of hardware revenue coming directly from Venture Corporation to our distribution network.

The Intermec and Venture teams have done an excellent job meeting customer demand and maintaining the highest quality and we expect continued progress towards the successful completion of the transfer.

As I outlined last quarter, we expect this transfer to take less than a year to complete from the start in July 2008.

Therefore, the progress in the third quarter, our first quarter since starting the transformation initiative, is significant.

We are on track to complete the transfer on time contributing in a significant way to enabling us to exit 2009 at our target business model of 43% gross margin for the Company.

We also made progress in our North America service center consolidation.

We've completed the transfer from Cedar Rapids to Charlotte and Monterey and we expect to complete the Everett transition on schedule during the fourth quarter.

Service levels have been excellent through the transition and cost goals are being met.

The second major transformation initiative is to shift to channel sales and two-tiered distribution.

As I outlined in the comments on North America, we have seen excellent progress building that business and it has not only delivered growth in the region, but also lower sales spending.

Selling costs as a percentage of revenue is coming down and is reflected in the lower overall percentage SG&A in Q3 compared to the prior year period.

With the slowing economic outlook, we will be evaluating means to keep SG&A spending in line with expected revenue levels by accelerating our use of the channel and two-tiered distribution, as well as managing costs and streamlining the organization.

Turning now to gross margins.

Product gross margins improved compared to Q3 of last year, but not as much as recent quarters due primarily to transition costs included in product and service cost of goods sold and the product mix in the systems and solutions business based on high enterprise shipments.

If we look at the underlying business before some of these large enterprise deals, we've seen solid progress on product gross margins in Q3 in the range of previous quarters we have reported.

Our service business delivered 5% growth compared to last year and a 200 basis point improvement in gross margins.

We're focused on improved detachment rates and contract renewals along with the depot consolidation initiative.

During the current economic environment, Intermec is focused on staying close to our customers and partners as they adjust to the new realities that they face in their businesses.

The solutions we deliver with our partners deliver a hard ROI that translates to improved operational performance for our customers.

We are focused on introducing compelling new products that can expand our contribution to the market and meet customers' requirements through innovation and we are focused on accelerating our transformation initiatives to enable our target business model of above-market growth and improved profitability.

Operating cash generation has been strong and will continue to be a priority for the Intermec team.

Along these lines, we've made significant progress so far in 2008 delivering 12% year-to-date revenue growth, 37% operating leverage, along with 145% cash conversion from net income.

Thanks for your attention.

I'd like to open it up now for the question and answer phase of the conference call.

As we outlined at the beginning, Mike Wills, our Senior VP of Global Sales and Service, will also be available during this portion of the call.

Thank you.

(OPERATOR INSTRUCTIONS.) Your first question today comes from Reik Read of Robert Baird.

Hey, good afternoon.

Pat, I think you touched on this in your comments, but maybe you can give a little bit more detail in terms of how much of -- if I look at the guidance and seasonally down, which is unusual, how much comes from macro?

How much comes from the currency, and can you talk a little bit about -- you talked about Europe seeing some declines.

What are you seeing in North America?

Well, I'll let Mike comment on that.

I think the way to think about North America, just to answer that first, is we've seen a lot of growth this year, as I said, 19% year-to-date.

We don't think that that kind of growth rate will continue, but this will look more like sequentially low single digit and flat with Q3, that sort of thing.

In terms of currency, I'll let Lanny comment on that about where we are with assumptions going into the fourth quarter for currency.

Mike, maybe you can contribute to the EMEA business outlook.

Sure, no problem.

Reik, I guess what I'll do is based on your question regarding both EMEA and North America, the assumption going into it is beginning mid-Q3, like many of the other folks that we participate with in this industry, we began to see demand signals that were clearly signaling longer selling cycle decisions and softness, just general softness in demand not exclusive to a particular piece of our business, meaning enterprise larger projects versus run rate.

It was across the board and virtually uncontained to a specific vertical market.

It was across all of our served markets, as well.

In looking at North America, we clearly this year had a lot of progress in terms of growth over prior year.

As we look at the demand signals and we look at a lot of our primary go-to-market partners, specifically, our major distribution partners and we combine the data points that we're all seeing from the demand signals from our channel partners specifically that are serving 60-plus percent of our revenue base right now in North America, the demand signals are certainly a lot softer than what we had going into Q3.

So we have to pay attention to that, and we believe that it's a prudent aspect as we kind of face the wrap-up of the year and going into next year.

We certainly aren't seeing cancellations, just broad based cancellations of projects, Reik.

But long decision cycles are the mien right now.

It's the average and what we're seeing in every one of our accounts.

Okay.

Thanks for that color.

Reik, this is Lanny.

I just will comment on the currency on a relative order of magnitude.

As you know, in -- our primary currency exposure in terms of revenue dollars is in EMEA and that is the euro and the British pound.

And roughly speaking, in the fourth quarter we're anticipating a range of 10 to 15% lower than what we have been seeing coming into the fourth quarter.

It's not the same for each of the currencies, but on a relative order of magnitude, that's the frame of the range.

Okay.

Thank you for that.

And then again, Pat, you kind of addressed this on the call, but what is your ability to protect against the downside here and how quickly can you take costs out?

And I guess maybe thinking about it in '09 time frame, if we were to go into an environment where you're down, say, 3 to 5% in revenues, what do operating margins wind up looking like?

What's the sensitivity there?

Yes, so the key thing that we're focused on is accelerating -- we have transformation initiatives in place to improve operating profit.

So we have a supply chain initiative that will -- is specifically designed to improve gross margins and as I outlined 43% at the exit of 2009.

We're on a good track on that and what we'll be doing is really looking every quarter how do we accelerate that to make sure that we capture those gross margins.

And then in terms of operating expenses, two comments.

One of them is that currency will help here and there's several million dollars per quarter of lower spending based upon lower foreign currencies.

The other part of it is the channel transformation.

Our selling expenses are a significant portion of our SG&A, and as we execute that plan in North America and in other regions, we'll be able to reduce our selling expenses to keep SG&A in line with our revenue levels.

So if you think about the target business model as 33% expenses and 43% gross margin, we believe that's still a valid business model.

So if I go back -- those are -- that's good color, but if you go back to what I was asking in terms of if you're down 3 to 5%, are those initiatives enough to still hold operating margins steady or could you actually see some improvement in that case?

I think the -- could you just repeat the question one more time so I make sure I understand it?

Yes.

Just from a volume standpoint, if you were to go down, if the environment were to get a little bit weaker and we were to go down 3 to 5% in terms of revenue growth, can you still hold the operating margin in 2009 the same as it is in 2008 or could you even improve that?

Yes, so I think that the operating margin -- I tried to outline that in the numbers that I outlined with both currency and SG&A spending, as well as product gross margins is that the -- we're on the path of our target business model, and so we believe that we can execute that in 2009 according to the plan that we've got.

Okay.

Thank you very much.

Thank you.

Your next question comes from Tavis McCourt of Morgan Keegan.

Hi.

Thanks, and nice quarter.

Couple things.

I wonder if you could quantify, maybe if not exactly, I guess talk about a little bit the impact this quarter of Royal Mail on revenues and gross margin and if there's anything in Q4 related to that contract specifically.

And then as you look about -- look at the timing of similar deals in Europe for next year, what should we be thinking about in terms of the timing of those deals?

Is there anything that's predictable in that sense?

The majority of the Royal Mail hardware revenue shipped in Q3, and it wasn't all of it, but it was a substantial portion of it.

And so that's what I was commenting on earlier about that if you were to take out some of these -- [sort of before] these large enterprise deals, you start to see the same gross margin improvements that we've seen in prior quarters.

We modeled the enterprise business into our guidance going forward.

In terms of 2009, we -- the feedback we're getting is that these postal programs are -- remain priorities and we believe in the next six months there will be trials and then we'll start to see revenue later on in 2009.

And I'm sorry.

You said trials in the next few months?

Yes, in the next six months.

And then revenue later on in 2009.

Okay.

And then in terms of the next quarter's guidance, is there any typical seasonal uptick in SG&A or I guess there has been historically, but I'm wondering is that all driven by sales commissions?

Yes, a large portion of the sequential increase in SG&A spending is driven by sales commissions because Q4 is typically a very high revenue quarter.

And a question for Mike here, I guess.

The North American business this quarter was exceptional and that obviously wasn't impacted by Royal Mail, very different story from your competitor that reported this morning.

How much of, I guess that would be market share gain, but how much of that is you guys executing on this two-tier distribution versus maybe just some big enterprise deals hitting this quarter versus last quarter?

Well, Tavis, it's a combination of both, and I don't mean to be elusive on the answer.

It's not intended to be that way.

It was truly a combination of both sides of our business throughout the entire year.

And we announced the program in terms of this two-tiered distribution and commitment to it and continued to metric that transition throughout the entire year and show progress against it.

We didn't break that pattern in Q3.

We continued to see solid growth there, both in the number of partners that are participating.

We have over 1,100 global channel partners online and in supporting Intermec product lines, a considerable amount of those here in North America.

So adding to those ranks, especially in some vertical markets that our products fit into that our partners can take these products, add some value-added solutions to it, is helping give us the uplift so that the run rate business as Pat has defined it in his prepared comments continued to see solid traction in Q3.

The other thing that we signaled in our Q2 review, and Pat also included in his comments earlier, is that many of those projects that were delayed that we had counted on in our earlier forecast for Q2 actually closed in our enterprise side of our business in Q3.

So we didn't have any large deals on -- in contrast of like a Royal Mail in North America -- that contributed to the performance in Q3, but we saw substantial, substantial progress in both sides of the business in North America.

Okay.

Thanks a lot.

Stacy, are you still there?

This is the coordinator.

Are you ready for the next question?

We sure are.

Thank you very much, Stacy.

Thank you.

Chris Quilty from Raymond James, your line is open.

Thanks, gentlemen.

Don't want to harp on that same point, but maybe to just come at the question a different way, back in the second quarter you had, I think you said at the time, eight large deals that failed to close.

I presume a large number of those, five or six of those, probably were part of what shipped here in the current quarter.

But can you give us a status of how many you have won, how many were contributing?

And I think in the past, Pat, you've kind of given us a sense of how much of the quarter's revenues were derived from large enterprise and was it unusually large this quarter?

And simply because of Royal Mail or just in general?

Well, I would -- I'm going to let Mike add into this.

I don't think we've said that it was eight deals, but I do think it was a handful of deals that we outlined.

Mike outlined what is the case, which is the run rate business.

The two-tiered distribution broad based business had a strong Q3, and the year-to-date performance of 19% growth in North America is really across all the product lines, all the go-to-market channels.

A majority of those deals, more than a majority of those deals, closed in Q3 and represented revenue.

So, Mike, I'll let you add on to that about what the picture looked like.

I think the key focus here, Chris, is the year-to-date performance.

It's 28% growth in Q3, but combined with Q1 and Q2, 19% growth is substantial progress in a region that isn't growing as fast as that.

And so we're clearly outgrowing the marketplace.

Well, Chris, just to add some additional color to Pat's comments directed at your question, the carryover from Q2 to Q3 was in the magnitude of, as you framed it, eight to ten projects, projects, you know, as we had articulated were in the $500,000 to $1 million and up kind of range that, you know, we had expected to close in the pipeline.

The bottom line is all but one of them--and again, I'm doing this by memory now, but I believe all but one of them closed in the quarter, which is pretty normal, except for the actual selling cycle and closing cycle.

The one that did not close is one of these that fell prey to a customer just concerned about the business environment and just took their funding and pointed it in a different direction.

The project isn't dead.

In essence, it's just shelved for another day.

But to Pat's earlier point, to offset the gains that we saw on the strategic account side of our business, we saw equal gains and ongoing traction with our channel partners, as well, as we transitioned into Q3.

So, I hope that answered your question and gave you a little bit more color to it, Chris.

Yes, it does.

Also, a follow up on the OpEx, a fairly dramatic $5.5 million sequential decline there.

And clearly, I don't think that pace is sustainable.

Was there any particular large items in the quarter that accounted for the drop?

Chris, this is Lanny.

Year-over-year is your question.

Well, let me just--.

Well, it said on a sequential basis, OpEx decreased by $5.5 million I think is what you said in the conference -- in the speech.

Let me just pull my comments here first, Chris.

The OpEx was $72.3 million, and this compares to $73.5 million in the third quarter of last year.

And you're right, it was $5.5 million down from the second quarter.

Well, there are a couple of things that occurred.

You may recall, in the second quarter of this year we did have an unusual event from the Cedar Rapids flood as one placeholder.

This quarter, we did have a credit against our R&D of about $1.4 million, and that's about half of that delta.

And then, if you look at, you know, just spending, some of--this is total OpEx now--we had slightly higher spend rate on R&D in the second quarter than we did the third quarter of this year by the order of magnitude of a couple million.

Okay.

And that's real close to delta.

Okay.

And you're currently still supporting sort of a dual sales channel through the indirect and your sort of internal sales.

At what point does that transition cross over and you start to see real savings on the sales and marketing side?

We'll start to see that in early 2009.

Okay.

And a question on the CK3.

Given the fact that it's sort of targeted at a little bit different application or end market than you've traditionally focused on, are there any changes you need to make to your--who your channel partners are or how you go to market with the product?

Well, Mike, why don't you go ahead and join in on that?

I think a substantial portion of the partners that I've spoken to about this product are in these markets.

And so, you know, we don't have 100% market share in our channel partner, so these represent a substantial portion of the existing partners.

I think there are some new partner recruiting that the sales and marketing team is doing.

Mike, I'll turn it to you.

Yes, Chris, you know, to Pat's point, a good portion of our existing--as I mentioned before, we have over 1,100, on a global basis, partners out there in various different business models -- a good portion of them have a practice in in-premise, so it automatically becomes attractive to them in terms of some of their key customers that they're serving.

However, as I mentioned to you earlier, we are working with our top three global distributors in identifying--because this is an in-premise tool targeted at a very familiar vertical market for us, which is warehousing and distribution stores, but also it's a logical product that you may find in store operations, merchandising type environments, and retail as well.

So, we're working with our distributors in terms of enlisting and recruiting additional partners that may not be carrying the Intermec banner right now to help us gain traction with the CK3 launch.

Got it.

And since I have you, Mike, printer consumables we haven't talked about in a while, but that's often been sort of a canary in the coalmine on demand.

Have you seen any big changes there?

Right, it normally is an early demand signal in terms of the supply chain, certainly.

We saw some signs.

However, interestingly, kind of lost in the data we were also winning back some larger contracts.

So, in the surface, our media part of our business was actually growing in a low-single digit during that time period.

But, as you look at just core demand rates of existing customers, there's some traceability there, Chris, that, as it has in the past, the media consumables business continues to signal, in the supply chain customers that participate there, the movement of goods that the demand was getting soft before it started to show up on the hardware and the CapEx side of the business.

Okay.

And I forgot, one final question.

I think last week the Justice Department approved the new RFID patent consortium.

Can you give us your thoughts on that?

It's probably a little bit too early to comment on it, Chris.

I thought you were going to go a different direction with that on the passive RFID award.

But, in terms of the patent consortium comments, it's probably a little early for us to give some formal rebuttal to.

Okay.

How about the former issue, then?

Yeah, we're, obviously, happy to be selected among others to be one of a handful of providers to this contract.

We are a subcontractor to a couple identified primes in there.

The size, of course, is yet to be determined in terms of the overall demand rate, but the potential is there certainly, and we've enjoyed a lot of great years of AIT-like contracts that have served us well.

So, obviously we have a lot of ambition with this.

Great.

Thanks a lot.

Our next question comes from Andrew Abrams of Avian Securities.

Hi, guys.

I wonder if you could give me a little color on the offshore progression, and is it possible for you guys to push that timeframe forward and increase the speed at which that transition is going, especially given a weaker environment?

Or, is this something that's relative fixed in your mind and in your partner's mind and will not be flexible in terms of being able to move it forward?

This is Pat.

This is one of our key priorities as a company.

We're making substantial progress.

We've hit all the quarter milestones in terms of getting the products built at Venture.

And so, as I had mentioned that we outlined a one-year transition.

We are evaluating means to ensure that we stay on track and any means that we can to accelerate that, clearly that helps our gross margins.

We'll start to see the benefit in early 2009, but we've got to get it all completed in order to see the full benefit, so that'll be a key focus going forward to see what can we do to deliver on our gross margins and enhance them.

Also, I'm not sure if you're going to be able to give color here, because it's pretty far deep into your distribution channel, but the smaller VARs tend to last longer in a weak environment in the channel, or at least that's what I've sensed.

And is there any way for you guys to see into that channel a little bit in terms of where the strength came from from larger size VARs or smaller size VARs?

Yes, Pat, I'll take that.

Yes, sure.

Andrew, I think your observation holds here with the performance--the overall performance in Q3.

We certainly saw a broader participation from a larger number, clearly represented by the smaller capitalized private VARs out there who are either just now picking up the Intermec product line or are expanding their overall consumption of, and participation, of the Intermec product line as opposed to, you know, the steady run of our larger partners that we've had years and years and years of history with.

So whether that will continue to hold I think will be dictated by the economic factors in each one of the vertical markets and the solutions that they bring to the market.

Great.

Also, on Royal Mail phase two -- obviously, you've been particularly successful in phase one.

What can you talk about in terms of the risk to you getting phase two?

Is there any different risk here than there was before?

How much of a leg up does phase one give you in phase two?

And is it possible for you to scale phase two a little bit relative to one?

Well, let me outline that.

So, the--as we had outlined, the phase one is 25,000 CN3s.

We believe that phase two is more than twice that in terms of number of units.

We believe that that will be--based on the insight that we have, we believe that that will be piloted in 2009, by the first part--you know, the first half of 2009.

Obviously, it depends upon the success of the current deployment, and that is really dependent on a number of factors that aren't just Intermec, but really the rest of the partner network and Royal Mail's program.

The program is going very well at Royal Mail, and I believe that our position is very strong going into the second phase, because it isn't just that the product has done very well--and the product has done very well during the pilot phase as well as this deployment -- but also the local expertise we're able to provide with our partners to deliver the solution so that Royal Mail has capability for their mobile workers, because that's really what it's all about.

It isn't just about a piece of hardware; it's about getting a revenue stream for Royal Mail.

So, I think we have a very strong position.

Obviously, this will be competitive, and we're very focused on that engagement.

Great.

Thank you very much.

I appreciate it.

Thank you.

Our next question comes from Ajit Pai of Thomas Weisel Partners.

Yeah, good afternoon.

Good afternoon, Ajit.

A couple of quick questions.

The first one is, when you look at your strategic alliances -- that's with Cisco, Microsoft, SAP, IBM and Oracle--can you describe, like, how much--you know, not just providing the overall solutions, but how much pull that these relationships provide?

And the sales that actually come through this channel, are they going through directly from Intermec, or are they going through, you know, the indirect channel?

Well, I think the relationship with Microsoft--and I'll let Mike jump into this on the Cisco side.

The relationship with Microsoft is -- we have very close development partnerships with Microsoft related to the use of Windows Mobile in our platform.

It's one of the reasons, for example, that the CK3 has superior battery life, is because of the way that we've worked with Microsoft on power management.

It's a real competitive advantage for us.

With our relationships with the ERP suppliers, these are oftentimes already installed ERP deployments, and so really what we need to do is be working with our value-added resellers to ensure that the deployment we have, the mobile technology plus their software and solutions, works inside the ERP deployments.

So, I think that's more of a --

Yes, but a consultant, an ERP and Oracle consultant that actually goes and provides a solution to a customer, not on the -- directly on the ERP side, but the actual implementers out there.

That's not part of your channel, then, today?

Well, they're--Ajit, they influence our channel, okay, and to the degree that we're actually working with a certified partner that sells -- and as you know, some of these partners have models where they actually incorporate and have the capability and willingness and desire to package up and sell hardware versus an ISV-type partner who wants to participate on the consulting side but leave the hardware and service to somebody else, we embrace both of these sales models.

And Cisco--so, I'll speak to the other half of the question.

Cisco has been a very strong alliance partner of ours, and your timing of your question is perfect, especially with the launch of the CK3 in an in-premise type application environment.

They are going to be a critical partner of ours going forward.

And I can give you strong evidence of that just this past year on a couple of large in-premise opportunities, one in which we were very public with in the first quarter with Army Air Force Exchange.

Those store environments -- that was a partner-led solution cell with Cisco.

And where a customer is leaning heavily on Cisco expertise and Cisco infrastructure, it is very much a partner-led type environment.

Now, your other part of your question about fulfillment, almost entirely we fulfill indirectly, either through a Cisco partner or through distribution.

Got it.

Then, just looking at the Asian business, I think the commentary that was provided today -- you talked about it being down 28% year-over-year, but you also mentioned that, on a sequential basis, the business was actually up.

So, could you give us some color as to what's changing over there and what kind of potential you see in Asia right now?

Well, I'll comment on that, and then perhaps Mike can as well.

The key thing -- if you look at the 28% decline compared to last year -- now, we're talking about small numbers here, so it's a few million dollars.

Nonetheless, it's 28% in a region where the economies are growing, so clearly this is going to get more focus moving forward.

And in fact, Mike and I are reviewing this critically.

And the key thing is the run rate business, which is two-tiered distribution and, through the channel partners, is building sequentially.

But, the key comparison, if you look at it compared to last year, was that there was some larger deployments that hit last -- a year ago in Q3, and those did not repeat, and so it ends up being lumpy.

And so, that's my comment, is that the sequential run rate business is improving.

That's very important for us.

As I had mentioned, that's one of the dynamics happening in Latin America.

We intend to grow our international business, and that is going to come through the same -- especially in these developing areas.

As I outlined in Latin America, where we're building a broader based run rate business through the channel, reaching more applications and industries.

That same dynamic opportunity is available for us in Asia, and we saw progress in Q3 compared to Q2, just as we have in Latin America.

The compares end up being flat and minus 28%, but the underlying strategy is taking hold.

Got it.

And then, when you're looking at the impact of currency, I think you talked a little bit about it helping on the cost side but, you know, reducing your sales a little bit.

But looking at how you're pricing your product right now and the competitive dynamics in those markets, are you altering your pricing strategy in Europe just given what's happened with currency?

And then, in these emerging markets, which tend to typically be a little more price sensitive, are you planning a different product line?

Are you planning to price the products differently than you do in the developed world?

Yeah, let me talk about Europe, and then I'll talk about these other ones.

In Europe, we have -- we're actually just evaluating now what does the pricing look like in local currency.

There were some price movements competitively earlier in the year, and so we're very carefully looking at run rate and distribution business for pricing, obviously, with the significant currency.

Part of it, as well, is being able to just manage the street pricing of the products, because part of the sales through the distribution network, and some of it is good for the price [exception] process.

So, we have the ability, on a deal-by-deal basis, working with our value added resellers to evaluate what the price structure looks like.

But, clearly, what the pricing looks like, what the margin protection plan is in Europe is an important dynamic because of this sequential change that Lanny outlined.

In the international markets, one of the key things that you can see from our product strategy is that the CK3 is a, for example, is a very competitive product from a price point of view and functionality.

So are these receipt printers.

I believe that that is going to be very important, combined with our distribution strategy, to build a broad-based run rate business internationally, is getting the right price point, the right form factors, the right set of functionality in these areas.

As we look to leverage our development partnership through -- I think we can expand the contributions we can make to these kinds of products, especially in Asia, moving forward.

Got it.

Thank you.

Your next question comes from Richard Davis of Richard W.

Davis and Company.

Yes, could you comment a little bit about the military awards?

Yeah, Mike, why don't you take care of that?

Richard, I guess just for clarification, can you be a little bit more specific, because all year long, as you know, we've been enjoying progress on the AIT contract and its multiple year state.

So, which -- are you specifically talking about the passive RFID award?

I was concerned with the one that was just recently announced.

Okay.

PBUSE, Mike.

Okay.

Okay.

Well, that is a -- Richard, that's a continuation.

Again, it's a little leverage, honestly, off of AIT.

It's a leverage and continuation of a product line, primarily our in-premise terminals and printers associated with the AIT affiliation.

We had some participation in Q3 in terms of revenue.

It will roll, obviously, into Q4, as well.

And at this point right now, steady signals are, completing the demand associated with this particular contract order with PBUSE in Q1 of 2009.

Now, in -- if I back off to more of a 50,000-foot level, our government sector -- and when I say government, it's almost exclusively federal government -- has been a nice contribution growth engine for us this year in North America, where that is almost exclusively captured.

And probably the last feather in our cap is, due to that affiliation, Richard, it was -- it created a stage for us to leverage our position into this passive RFID award, as well.

We haven't even begun, obviously, to see any of the first fruits of that effort.

It probably won't even be a material contribution in Q4.

But we expect, through these handful of prime contractors, that both our consumables on the RFID side -- meaning our tags -- as well as our readers and printers will handsomely be rewarded as far as participation as being included in this passive RFID approach.

And again, it's another multi-year contract award.

Thank you.

Yep.

Thank you.

Our next question comes from Glenn Primack of Broadview Advisors.

Hi.

It's actually Rick Lane.

I had two quick questions.

One, I'm just curious about working capital needs for the -- looking out let's say over the next 12 months in light of shifting, you know, more business to the channel, but, at the same time, obviously a slowing top line.

And then, I'll ask the second one after you're done.

Well, this is Lanny.

Let me frame maybe a response in that light -- in a different way.

You know, we -- we're not a capital-intensive company in terms of CapEx type of spending.

And we--as we commented in our call today, you know, one of our objectives is to try to get a relatively high cash conversion on our net income.

Now, Pat mentioned in his qualitative review a number of the supply chain initiatives and what that will do for our working capital vis-a-vis our inventory and also the managing of our accounts receivable through our channel partners.

And his comment there was that we anticipate that those initiatives will assist us in our working capital efforts, meaning that we should generate cash--working capital in the sense of additional cash flow from those initiatives.

So, said another way, we feel like our working capital position is strong, and in light of an uncertain economy and whatnot, we feel good about where we're at from a liquidity standpoint.

And looking out to 2009, as we mentioned, we would anticipate these initiatives should assist in softening any blow we might see from the economic cycle on top line revenue and its impact on cash and assist us in that regard.

Yeah, I should have mentioned that third element, which is the supply chain issue.

But--so, in the context of, let's say, a top line of--you know, a modest top line of 2% to 3% growth maybe for '09, would working capital be a contributor to cash generation, or would you still--?

Yeah, I would expect--this is Pat.

I would expect that we would continue to improve our working capital.

Our inventory is going down as a result of our supply chain efforts as well as careful management of accounts receivable.

So that's our plan, and our expectation is that we would continue to see strong working capital management so that we can generate positive cash flow from operations.

Yes, The third component -- this is Lanny -- I would comment on that we've seen this year, and with profitability we would also continue to--or expect to see a continuation of cash generation from deferred tax assets.

Okay.

And then, the second question relates to the printer business with the new PB2 and 3, with respect to, you know, going more through the channel and more of the outsourcing and all of that.

Historically, it would be a gross exaggeration to say that printers have been an ugly stepsister.

That wouldn't be totally fair, but it hasn't grown like the rest of the product business.

Is there more of a strategic focus?

I mean, do you think you can get a bigger part of whatever the addressable market is?

Yes, this is Pat.

I--you know, the printer business, it's no--you know, it's no secret that the printer business has not grown for several years.

As I had mentioned, the printer business is doing well in North America, where we've put the most focus on the enhanced two-tier distribution and channel business.

Comparing it to a year ago, as we had outlined, it's about flat.

And I had outlined that in Latin America, because of DSD business not repeating, that's one of the things that detracted from its growth rate.

We believe that with the introduction of new products and focused sales and marketing programs, that we can grow this business.

It's a significant addressable market.

The mobile printer business is growing as a segment, and we believe we can grow that.

And in some cases, we are growing faster than the competitors are.

But, overall, we're not satisfied with the growth rates that we've had in the past, but we have a focused team and we believe that that business can grow, and we expect it to.

Is it possible, then--because there's, obviously, a catch up in terms of market share and what you think would be your "fair share" of that market vis-a-vis the rest of your product business in that space.

Is it conceivable that, for a stretch of two, three, four years, that that could actually grow faster than the rest of your product business?

I think that the key thing to think about is that, you know, we aren't a standalone printer company.

We're providing mobile solutions to these turnkey combinations that we're outlining.

We believe that getting those products to attach together and work together and go through the same distribution network will start to accelerate the printer growth rates.

But frankly, we've got to see the delivery of printer growth rates before I start to say it's going to grow as fast as the computer business has.

Well, and I guess that the way you presented that, too, it's conceivable that because it's part of the turnkey and the project business per se, you know, experiences slowdowns like as you'd expect in a tougher economy.

Actually, that would suggest it could actually be a little bit more cyclical than your--the rest of your product business.

Well, it has been cyclical.

As I've outlined, you know, our goal is to go through two-tiered distribution and build a run rate business, and we're seeing some good progress there.

But, there's also a project aspect.

That's some of the things that's drove the year-on-year decline in Latin America, as I've outlined.

But, North America is a good example of building a consistent business performance.

And likewise, are you comfortable--are you getting to where you think you need to be from a profitability standpoint on the printers?

Yes, they're consistent with the Company results and, in some cases, better.

Okay.

Great.

Thank you very much.

Thanks, Rick.

Thank you.

Our next question comes from Jeremy Grant of the Stanford Group.

Hey, guys.

Afternoon, Jeremy.

Congratulations on a very solid quarter.

I've got a couple questions.

I've been juggling three other earnings calls as well, so forgive me if these have been asked already.

Just don't ask the questions for the other companies.

I'm trying to keep them straight.

The--you know, I guess the first question was, you know, color on the quarter.

Obviously, you know, really solid number, coming in well ahead of guidance.

You know, looking through--you know, what I've heard so far, it sounds like North America much stronger, as well as a lot coming from UK Royal Mail.

Are those sort of the two big drivers that really made you guys beat them this quarter?

Yes.

If you look at--North America drove the growth.

I mean, it's a big--it's our largest region, and it grew 28%.

That's the headline.

And of course, Europe grew with 5%, and Royal Mail contributed to that growth.

So, I think that's a good summary.

And what--I think the key thing there is that it shows real progress in a tough competitive environment to grow North America 19% year-to-date, and that really demonstrates our progress on building this channel-focused business model.

Yes, definitely.

Can you give a little more color on Royal Mail in terms of the initial order?

Where does that stand?

How complete are you in that first phase?

Well, the--you know, the revenue's got hardware and the revenue's got service in it.

And so the service revenue, you know, starts after you're deployed and you're supporting the products.

The substantial portion of the hardware revenue has been shipped in Q3, and the project is on track with our partners being deployed and commissioned according to the schedule that Royal Mail and the partners have right now.

Okay, great.

And then shifting back to the US, there were some questions before about DoD.

Am I correct that AIT--the next AIT contract comes up for bid this coming year?

That's right, Jeremy.

This is Mike.

It's mid-2009.

As they have in the past, they've signaled, obviously, a willingness to issue continuances as they go through the responses to the RFP based on the participating companies.

So, at this point, we're really not anticipating any major change to the engagement level we have right now with DoD through the AIT contract throughout 2009.

Okay.

And, you know, talking about--I know there were questions about the passive RFID award.

There's obviously been some other good US government awards coming.

You know, how much--are you guys able to give a breakdown of how much the government's sort of increased demand for your products this year has been driving the rebound in North America versus the, I guess, commercial sector?

Yes, we--obviously, from everything we've talked about in every one of our quarter breakouts, the federal government business obviously has grown for us this year.

We don't break it out at that point, once you get down into the regions and the sub-regions kind of line item.

But, just suffice it to say it's also been a participant in the overall growth in North America.

Okay, appreciate it.

Thanks a lot.

Yes, and the--this is Pat.

It's an important portion of our business and, as I've outlined, 19% growth year-to-date, with North America.

It's participated in helping us build the business.

Great.

Great.

Thank you.

Thank you.

Our last question comes from Reik Read of Robert Baird.

I just wanted to clarify a quick thing on the European postal side of things.

You guys had talked about some pilot activity occurring in early '09 and perhaps more rollouts in late '09.

Was that just in reference to phase two of Royal Mail, or is there--are there some other opportunities with--and I think you guys have talked in the past about France, Spain, Italy.

Right.

Can you talk about those, as well?

Yeah.

So, this is Pat.

Mike can comment on this some, as well.

As I was trying to outline, the--both the phase two of Royal Mail, as I outlined, pilot--think about it as pilot in the first half and deployment in the second half.

Again, these things can shift, but that's the best outline we've got.

And then, the other--some of the other areas, like Italian post and Saudi post and Spanish post, are also in these planned pilot phases.

And it's an important part of their initiatives to improve productivity during, you know, a deregulation phase that they're facing.

Those things are--those things really haven't materially changed in the last quarter.

Okay.

And then, if I can just ask one more question on the channel, with all the work you've been doing there--or I guess it's maybe more broad, that the company is.

What's the status of the sales force given all the changes that you've made?

Do you have the correct number of people, the right people?

How effective is the training at this point?

It's a great question, Reik, and it's a key issue, obviously, in the transformation of where you deploy your resources and how you equip them, et cetera.

You know, it--we're in that phase right now, as we've seen progress for several quarters now.

And I hate to boil it down to the basics, but it's walking the talk.

You know, you commit yourself to a purposeful sense of direction, and you measure yourself, the progress there.

Our channel partners are participating.

At this point, we are now redirecting our direct resources on those key--as, you know, I've covered openly, publicly before, those key tier one accounts within our targeted vertical markets.

And we're going through that process right now of evaluating and examining that list of key tier one accounts that meet the attributes that we're looking for and making sure that we've got the right number of resources, to the first part of your question, and then, secondly, addressing some of the existing and known skill gaps.

And the skill gap issue is not just on the direct strategic account capture side, Reik.

It's also on the channel management side, how--you know, how we interface and support and collaborate as an organization with a growing number of channel partners.

So we're beginning to do the needs analysis and address those, and we'll continue to address those throughout 2009.

And in many ways, Reik, it's a never-ending process, right?

I mean, you have to continue to tweak and modify as you continue to see the right results.

Okay, great.

Thanks for the extra time tonight.

Appreciate it.

And at this time, there are no further questions.

Great.

Thanks, Stacy.

And we appreciate everybody joining us, again, this afternoon.

This will conclude our call for today, and have a great evening.

This concludes today's conference.

You may disconnect at this time.