Scansource Inc (SCSC) 2005 Q4 法說會逐字稿

Good afternoon. My name is Sarah and I will be your conference facilitator today. At this time I would like to welcome everyone to the quarterly earnings release conference call. All lines have been replaced on mute to prevent any background noise. [ OPERATOR INSTRUCTIONS ] Thank you, Mr. Bryson, you may begin your conference.

Thank you very much. Welcome to today's ScanSource conference call to discuss financial results for the quarter and fiscal year ended June 30, 2005. My name is Jeff Bryson, Vice President of Administration and Investor Relations. And with me today are Rich Cleys, Vice President and CFO; and Mike Baur, President and CEO. We will spend a few minutes reviewing the option salt and then take your questions.

This conference call contains certain comments which are forward-looking statements which involve risks and uncertainties. The statements are subject to the safe harbor created by the Private Securities Litigation Reform Act of 1995. Any number of important factors could cause actual results to differ materially from anticipated results. For more information concerning factors that could cause such a difference, see the Company's annual report on Form 10K and quarterly reports on Form 10Q filed with the Securities and Exchange Commission.

Rich Cleys will begin by updating you on overall sales and operating results.

Thank you Jeff. The Company posted record sales of 381.2 million for the quarter ended June 30, 2005. An increase of 14% over sales of 333.1 million for June 30, 2004. Measuring sales based upon our product groups show year-over-year growth of 16% in AIDC and point of sale along with a 12% year-over-year increase in communications products for the quarter ended June 30. That produced a 61 39 mix of AIDC point of sale versus communications products.

Gross margin was 10.3% for the fourth quarter of fiscal 2005. Slightly higher than the past three quarters. The improvement came about due to fewer larger POS deals that have lower gross margin and a more favorable product mix. Operating expenses were 23.5 million and 6.2%, which is comparable to operating expense as a percentage of sales for each of the past three quarters. Operating income increased by 2% to 15.9 million, which is 4.2% of sales.

Again, slightly higher than operating income as a percent of sales at the last three quarters. Net interest expense was 510,000 versus 132,000 for the same period last year due to higher interest rates and higher average use of the line of credit.

Our quarterly effective tax rate was 38.6%. June quarter end and net income increased 4% to 9.4 million and 2.5% of sales compared to 9 million in June, 2004. Our return on invested capital this quarter was 25%, which is within our expected range. Balance sheet metrics and cash use were as follows: Inventory turns were 7.3 times at the end of June, 2005, which is above our target range of 5.5 to 6.5 and higher than the 6.5 turns posted in the June 2004 quarter. The number of days in receivable, DSO, was 51 at June 30, 2005 compared to 47 days posted in the June, 2004 quarter. For the second quarter in a row, sales arriving later in the quarter caused DSO to be slightly higher than our historical experience.

These changes in inventory and accounts receivable metrics our reflective of our ability to flex our balance sheet to meet the needs of our customers without reducing our product fill rates or changing our credit policies while still achieving a return on invested capital goals. Our working capital borrowings were 35.7 million at June 30, 2005 compared to a 2004 balance of approximately 32.6 million.

We ended the quarter at about one day of pay for inventory, meaning that almost all of our investment in inventory was offset by trade payables to our creditors. I would now turn it over to Jeff to comment on each of our reporting segments.

Thanks, Rich. Before we begin our discussion of the North America segment, we want to share with you some recent recognition we received.

ScanSource was named the top performer from among 50 technology distributors in Computer Reseller News 20th Annual Sourcing Study. The significance of this research for us was that CRN surveyed 3,000 resellers who sell any form of technology, not just resellers specializing in a barcode, POS or communication products. These findings also are important because the measure our performance in a variety of categories not just our name recognition among the CRN reader base of 100,000 technology resellers.

ScanSource was awarded the top performer designation for overall performance among all potential product sources. ScanSource also earned top honors in the following categories related to specialty distributors. Number one in performance, loyalty, technical support, logistics, configuration and integration, automated information systems, human factors, and problem avoidance of resolution. An award like this from CRN reflects the reach that ScanSource now has in the general IP channel. This award also validates the specialty distribution model as distinct from others in the the overall technology supply chain.

Our North America segment includes sales from all 3 of our technology areas, AIDC and POS, via ScanSource, communications products through two sales units, Catalyst Telecom and Paracon, and electronic security products through ScanSource Security Distribution. North America posted sales of 330.3 million a growth rate of 10% over last year.

Our next discussion will focus on a the ScanSource sales unit. This unit had strong revenue growth over last year even though the higher end POS system business is significantly down year-over-year. Our results are consistent with other companies in this space who have also reported retail weakness and we do not believe we have lost market share. However, this quarter's AIDC business was steady across all product categories and allowed us to overcome the weakness in POS.

We continue to do a variety of sales and marketing activities to recruit resellers and similar to last quarter, the number of active buying customers is up 9% in this unit. Although we are seeing some margin pressure to program changes by vendors, we believe the vendors still value our business model for these markets and technologies. As a result we are looking closely at margins by product line and the related investments in SG&A. One way we're trying to enhance gross margins is by increasing our sales of both ScanSource and vendor provided services.

Recently, we announced a new value add program available to all of North America resellers. Our Partner Services Team has developed a new fee-based offering that empowers resellers and independent software vendors, ISV's, to specialize in the retail market to provide remote monitoring and proactive management services for POS applications. ScanSource's virtual technician allows resellers and ISV's to take proactive measures in analyzing potential problems and repairing hardware or software malfunctions often before in the end user even knows there's an issue.

Using virtual technician, a reseller is able to quickly determine high priority alerts such as failure of credit card settlement at close of business and can take action from the remote terminal to fix the problem, log the activity and inform the end user of the action taken preventing possible interruptions in the end user's business. ScanSource virtual technician can be set up to generate help desk tickets, pages or e-mails indicating an actual or potential problem.

We will next discuss the first of our two communication units, Catalyst. We were pleased with Catalyst sales growth over last year even though one of our challenges continues to be the execution of Avaya's go-to-market strategy. We agree with Avaya's goal to have their direct sales force concentrate on large global accounts while using the distribution channel to reach the small and medium business marketplace. We believe that their execution toward this model will continue to improve.

We are selling more Avaya converge products, especially IP Office, that require more resources during design in implementation from both the distributor and reseller than traditional voice products. We believe the VoIP will continue to need additional cost over the next year as resellers continue to sell more of these products.

One example of the way Catalyst is trying to reduce the learning curve on IP based product is its partner conference held in June called Convergence Connection 2005. Over 90% of Catalyst's top customers attended. They benefited from training on how to prepare their business for convergence and had an opportunity to network with other resellers to share best practices for selling convergence.

Catalyst has added to the value at programs that are being well-received in the Avaya marketplace. Catalyst is helping resellers reduce their investment in converged products while offering a Mobile Technology Center which is a unique program that provides a reseller with preassembled preconfigured phone systems to demonstrate their capabilities to customers in their own office, at a trade show, or at the end user's location. Catalyst has also launched Com Edge [ph] which is a free, one-day educational seminar to provide resellers with sales training targeted at closing convergence opportunities.

Catalyst Telecom has recently signed several vendors designed to fill out our convergence line card. We've extended our Polycom line offering by adding their video products which gives resellers access to PolyCom Conference Room solutions designed to make video conferencing seamless and integrated. BlueSocket is a provider of end-to-end wireless LAN products. Catalyst will be distributing BlueSocket's entire line, including access points that require no configuration, and the industry's first centralized RF sensor.

Nice is a call recording solution targeted at mid to large enterprises. This product line helps round out our contact center offering from Avaya. Kentrox routers are compatible with Avaya IP office products and provide small and medium businesses with a cost effective easy to use VoIP implementation because the routers are designed to simplify complex installations.

Our other communications sales unit is Paracon, which focuses on converged communications products from Intel and NEC. Paracon had stronger sales growth than either of the past two quarters led by a couple of larger deals. Intel continues to be our dominant vendor and many Intel sales are combined with software from Vertical Technologies formerly ArtistSoft. The Vertical-Intel combination gives resellers the ability to sell an open standards based phone system with features such as Call Center, Unified Messaging, and Advanced Call Handling which previously were unaffordable to small to medium-size businesses.

We will now take a moment to update you regarding our third and newest technology area ScanSource Security Distribution. The Security business had a record quarter with most of its revenue growth from identification product group, primarily plastic card printers. We are growing card printer sales by focusing a separate sales team on this technology.

Some of our newest card printer customers are traditional security resellers which provide incremental sales for ScanSource and our vendors. We announced the signing of Bosch as our anchor product line last quarter and had success selling Security products to several Catalyst from resellers. Some of them are new to Security and others have been in the security business all along. In the September quarter we plan to kick off a variety of marketing programs to communicate the advantages of buying from ScanSource Security Distribution and to state our value proposition.

Our second reporting segment is international distribution. International distribution which includes the geographies of Europe and Latin America posted sales of 50.9 million, compared to last year's quarter of 32.1 million, a constant currency growth rate of 54% after adjusting for 1.5 million of benefit to sales as the result of favorable foreign currency changes. We had record sales from both geographic areas and will begin our discussion by speaking to the Latin America unit.

Sales by ScanSource Latin America were driven by Mexico, with growth across many of our key AIDC and POS vendor lines. We believe the stocking of primary inventory products in country has been a significant advantage against our competitors. The other countries in which we have significant sales growth include Uruguay, Nicaragua, Paraguay, Peru, Argentina, the Caribbean Islands, the Dominican Republic and Chile. We expanded our distribution capacity and added headcount in Miami which serves as the primary export location for sales to Latin and South America. Sales in Europe were driven by several large AIDC sales and by good growth in Spain, the Nordics, France, Germany and the UK.

During the quarter we completed the acquisition of EDC, have consolidated warehouse operations in Belgium, and have a new sales operations in the Netherlands in the south of England. We see significant growth opportunities available in Germany. We are continuing to invest in our EPoS business in Europe specifically by adding business development resources for Epson and IBM.

The support we are receiving for long-term growth from vendors and customers in Europe and Latin America, encourages us to continue adding resources. We will conclude this part of the call with our outlook and expectations for September 30 -- from September 3, 2005 quarter.

While the near-term sales growth outlook may be less certain than last year, we believe that our overall business model is more attractive than ever to our business partners. Technology manufacturers and resellers desire our evolving menu of the value added services. While choosing to invest in marketing activities, we expect to continue to gain operating leverage in our SG&A expenses as we achieve economies of scale. We also think that our longer-term sales opportunity is still strong since we have the ability to grow our international segment, add product lines in our existing business, and expand security distribution skills.

While acknowledging the limited visibility common to distribution, we think total revenues for the September quarter could range from 360 million to 385 million and excluding the effect of option expensing of $0.03 per share from the implementation of FAS 123R, diluted earnings per share could range from $0.65 to $0.73 per share compared to last year. At this time we'll be glad to answer your questions.

[ OPERATOR INSTRUCTIONS ]

The first question comes from Jeff Rosenberg.

Good afternoon how are you? I guess the first thing I want to ask is if you could elaborate a little bit on the margin pressures you're seeing from program changes at some of your major vendors?

Hey Jeff, it's Mike. It think in general we've always had the vendors changing programs, some yearly and some at different intervals. I think in general we believe they like our business model, they like the fundamental value proposition we are offering and they like the fact that we continue to make investments. So we think short-term we have had some pressures because of some of the changes in the program beyond what I think the manufacturers expected at the field.

In other words, if we felt margin pressure that was not their intent. They were trying to come up with a mix of program changes that would give us the right incentives that were focused on sales growth and at the same time, support our infrastructure. So in general, we are okay with most of the changes, we're still working closely with vendors on some of these.

Are you suggesting that some of these vendors are re-evaluating some of these changes if they are having an intended consequences?

Yes. Anything we have been as you expect we are in very close contact with our vendors regularly about program changes like this and saying, hey, this is what the impact was supposed to be and we all thought. Here is an impact that is harming our business and we think yours. So yes, we think there have been some tweaks to that, to some of the directions and we will continue to monitor them.

Okay and along those lines, you talk about the gross margin changes as it relates to fewer large POS deals, but if I look at the sequential improvement in gross margins, did you have that weakness in POS deals last quarter. I'm wondering sequentially what changed. Were you seeing maybe a little bit less of that shift of business from larger resellers in general as opposed to larger single transactions or maybe any commentary there in terms of, I think that with the trend is cited as an important factor in gross margins last quarter.

Yes, I think we still have the larger resellers buying lower margin deals, that's still happening. I think the reason we referenced the POS is it continues to decline at a higher rate, so we just don't see any deals happening in POS. What we used to think was not a large deal, those aren't even happening, so we continue to see that impact. But we're still receiving the benefit of those larger resellers choosing distribution, albeit at a lower margin. If you look at our margin compared to a year ago, you can see we have definitely come down from some higher margins in the past and are coming down to a much lower number now, more near the 10 to 10.3 number.

What, okay, so you're saying that sequentially the large POS system business got worse again.

Yes, it continues to decline and that is probably our biggest concern with what happened in this past quarter which is why we were concerned about our guidance then, and that's why the midpoint of our forecasts right now really makes us a little bit cautious. But it's something that we're looking at closely, trying to understand what it is that's going to change the retail POS business and right now, without a lot of clear direction from our vendors who are seeing the same thing we are, we're just a little skeptical of when that's going to return.

Okay, and against the last question I asked you is typically -- this is the one quarter where we're latest in the quarter in terms of when you're giving this guidance, and typically if it's not from you have a track record of sequential growth in this quarter and you're at the midpoint of your range and you're not looking for that. Other than the things you just said, anything you point out in terms of the tone of business and why you are a little bit more cautious even though we're well into the quarter?

Yes, I think the other key change in this forecast is the International Business. What we are projecting to grow or even be flat this quarter. We had a very good June quarter internationally, both in Latin America and in Europe. So we definitely think there will be some seasonality in our sales growth this quarter versus we did a year ago where we didn't see that. We were still ramping up but we expect International Business being down as well as POS being significantly off and continuing to decline, we're having to offset that with good steady performance in phones, although we're not expecting to have a huge jump in our Catalyst business either because we're still a little bit cautious on going to market model. You know, we had a really strong June to next September quarter in Catalyst last year and we're not predicting that this year at this stage based on what we know right now.

Okay, thanks a lot.

Ok .

Your next question comes from John Coyle.

Thank you, a good afternoon. Just a few questions.

Okay.

First, on the Catalyst business, how would you classify are characterize where Avaya is in this realignment of the channel? You gave some color last quarter. How far have they continued to progress and how far do they have to go?

John, I think from our perspective, we've had a lot of meetings with them over the last three months and we think the management team certainly made it clear to the rest of the channel as well as their internal people, that the execution didn't come off as well as everyone thought it would in the first quarter calendar year back in March quarter.

I think they made significant improvements in June and we're just being in a cautious here for September. We like to think that what we're seeing so far is good trend lines towards the way things will shake out. As we said all along, if we look at this thing over Avaya's fiscal year we felt like the impact to Catalyst would be negligible. So far during this fiscal year, there has been an impact, and we're not sure we will make it up between now and September 30. There might be in the quarter before we can see the business working the way it was a year ago.

Okay. And then your comment regarding the services requirement, install requirements for voice over IP and the added costs there, are you implying that there is no way to pass on those costs to the resellers and then ultimately onto the customer, and as a result the margins there are being -- until the resellers ramp, we're going to be compressed?

Yes, I think that's correct. The think we've got about a year or so already under our belt. I think there's probably another year's worth of experience and real world applications that our customers, resellers, and frankly our sales has to experience and also something that Avaya is having to learn.

So combination of the manufacturer, the distributor, and the reseller all having to learn some new skills as well as just getting comfortable with the difference in how you configure, install and train on IP solutions has got a drag on everyone's margins in the whole supply chain. I think a year from now we will be able to say we've got this under our belt now and things are clicking along.

I think the general feeling before now have been if your selling IP solutions, they look more data submissions so they should be easier, more commodity like and what we're finding is just the opposite because you've got the more open standards and more product that can work with each other versus a proprietary product, there is more room for error. So it has added an additional complexity that ultimately will resolve but it may be a year from now.

Okay, good. Just turned to the AIDC part of your business, are you seeing vis-a-vis three months ago any increased activity on the part of Tech Data or Ingram Micro or Synex?

We continue to see activity, meaning that some vendors have decided to work with those guys. I think from our value proposition to our customers and what we're seeing in terms of revenue from our customers, we don't believe we're losing market share.

How about on RFID, I know you've dropped a press release recently, where would you say on that progression? I know you said your not really expecting any revenue below 6, how is that tracking?

Right now we're doing a lot of education. We just had our first class are resellers go through our new RFID lab up in Memphis last week. I think they felt like it was a great learning experience, I think there was a lot more complexity than they realized it was going to take. Looking at revenues, we're probably looking now at mid to late calendar year '06 where I would have hoped we would see some better opportunities in the first half of calendar '06, I think it's going to be more second half, just because some of the lateness in some of the standards in some of the solutions being developed.

Along the same lines, the security division, I'm assuming you've started to ship Bosch products in the June quarter?

Yes, we got product in the quarter.

And how would you say the impression there is, just with that relationship and also with building on the rest of the line? Since the majority of the revenues so far is coming from the card side, security business.

Yes, I would compare it to when we went to Europe. Internally we're impatient and frustrated. We recognize that in this case the manufacturers are having to look it up as kind of a new kind of animal. A company like ours did not exist in the security nor did it in Europe and we're over there so we're having to work at the pace of our vendors. And we believe the customers like what we're doing, think we're giving some traction.

Our challenge now is to continue to fill out the line car with some peripheral vendors that will complement our Bosch solution. We're not going to have 400 or 500 vendors like some distributors, probably more like 50 to 75. We still have some vendors to add. We feel like we are able to continue to make those investments based on the profitability of the overall company.

How many vendors do you have presently in security?

It's about 18.

Okay, and just turning a real quick to the balance sheet, I noticed that inventory turns were up beyond your target if you could give a little bit of color as to why that was, and also you let the cash position grow, are you sweeping it towards anything?

As far as the inventory position goes, with our sales -- more sales in the second half, we had been managing our inventory level down. To hit our ROIC goals and overall with the second half sales, it actually was outside of our target range for the turns, a little bit better.

To your second question, the cash, what's happening in our business is that cash was generated domestically. We actually have no domestic revolver. The credit line that we have is International and at the end of the quarter, the timing was such that it didn't make sense to move that cash overseas for a short-term pay-down.

Okay, great. Final question on guidance, the lower than expected guidance, is it fair to say it's primarily attributable to the lack of the larger POS deals? And in the expectation that will continue as well?

Yes, I think the POS business continues to slow. We don't know how low it can go. That is absolutely our concern, and we've got some seasonality internationally that we did not experience last year.

Okay, great, I will leave at that.

Thanks.

Thanks, John.

Your next question comes from Reik Read.

Hey, good afternoon. Can you guys talk a little bit more about the plan for operating expenditures as you get into the first and second quarter and I guess I'm looking at some of the things you talked about, RFID, new Security marketing initiatives, you've got some software initiatives. It sounds like you need some additional spending for those things. Jeff, in your remarks you talked about the opportunity for additional leverage. Can you just talk about what the spending plan is and where do you expect to get the leverage or why you expect to get the leverage? Particularly since -- given the revenue uncertainty?

Well I'll start and I'll let Rich jump in, or Jeff. This is Mike. Number one , I think we are going to be very careful to spend a lot of money domestically in POS. So anything I've got going there will probably shift around a little bit. We're trying to really grow our POS business in Europe and Latin America. We think those opportunities are good so we're probably going to reassess from the spending we're doing there from the marketing side. I'll let maybe Rich or Jeff jump in about the other.

I think in terms of our overall spend, if you look at the trend on our SG&A line, I feel pretty good about the controls we have in place to control our spending. We continue to invest in our international business, we're investing in our security business in some of the new vendors that we have, especially in the communications business, so I feel pretty good about our ability to achieve those operating margins, of about 4% and continue to look at our ROIC and achieve those goals.

And so I guess I'm hearing what you guys are sitting are there are other opportunities to draw down certain programs in favor of the marketing spend and so on and so forth?

Yes.

Ok.

Yes, we always believe that something we can't do on a day's notice but certainly within a quarter we can make some adjustments that are reasonable. The one thing that is obviously harder to change, as you know, Reik, is headcount so we always watch that very carefully. And I would say any headcount increases are probably going to these new opportunities that Rich just mentioned, like security and maybe to support some of our new vendors in communication areas.

Secondly for me, can you just talk a little bit more about NEC and give us an update there in terms of how that business is progressing?

I would say we are disappointed in I think they would be also. We continue to look at does a two-tier model really work for NEC? They're challenging themselves with how do we make sure that their value added model that Paracon is capable of delivering is one that NEC can leverage. So I think we're still having a little bit of what is the role Paracon is supposed to play in the overall NEC channel.

Clearly we are bringing in 100% incremental business to NEC, but our model really doesn't sing, as you guys know, until we get significant revenues and we have not seen that yet. So that's another area where we would not continue to make investments and until we see some changes.

Okay, great, thank you Mike.

Your next question comes from Ajit Pai.

Good evening, gentlemen.

Good evening.

Couple of quick questions. First when you're looking at your international and security business could you give us a sort of rough indication of where the operating margins in those businesses are in security, whether it's [INAUDIBLE] international, whether it's a need to expand sequentially year-over-year?

As far as the security business, we don't disclose those margins for competitive reasons. Overall, the international margins are a little less as we're still in the investment mode than what we would see here but on an operating margin basis, we are positive internationally.

Right.

Those are not mature margins yet, Ajit.

I think from memory, I think there were at sort of in the low -- about 140, 150 basis points. Is it still in that range?

That would be a reasonable estimate.

And when looking at the Security products as a percentage of sales, at what point do you think it will become a material percentage of sales based on your current forecast? By material, it would be somewhere between 5 and 10% of overall revenues.

Well, I think we went into this expecting this to be a three-year project. Our goal is to, over the first three years, really prove our business model and make sure that that works. Having said that, internally we want it to be faster than that.

Okay.

But we are willing to give it three years.

Three years, and then looking at the virtual technician product that you talked about, is it just a selling tool, or are you actually recognizing revenues or an ROIC that you can attribute to the product?

We actually expect to get some fee income from this. It's a service that we believe is really valuable, that we don't have to give away and that lowers the cost of support for our resellers. So it's brand new and we've still got to work out how it's actually going to be sold and how meaningful it will become, but we clearly believe this is a value add that our customers will pay for and possibly some of our vendors if they want to incorporate this in their solution.

Some of your vendors have products that aren't directly competing but are going to have some of the functionality that is like this. Example, the MSS platform that Symbol has, I think Intermec is collaborating with someone else for some products here. Is this an independent in-house development that you have that is completely multi-vendor or are you working in partnership with some of your vendors right now?

We clearly have educated our vendors on what we're doing over the last year. It's been about a year-long project in we have developed is in-house along with a local company. But our goal is is to not overlap with the vendor so one thing you said is true. Ours will be multi-vendor, some of our vendors will not be.

Number two, most of our vendors have products like this targeted at large enterprise. Ours is targeted at the small to medium customer who primarily is buying through our reseller channel and it's even more focused -- where primarily looking at supporting a point of sale application, is where a lot of our customers have a lot of cost, where as I think the solutions from our vendors like Intermec and Symbol is targeted at the mobile device area.

Absolutely.

I think we have two different strategies that definitely can compliment but shouldn't compete.

Okay, and then looking at your AIDC and point of sale resellers, given that the market is slowing and particularly in point of sale retail, you don't know when it will come back. How are you screening the credit quality of your resellers over there and have you seen a deterioration in the credit quality over there of the facilities you are providing them?

Number one , they have to buy something before we have a credit problem. Overall, for that business, I haven't seen a deterioration in the credit quality overall. So we're still ready for and we have the ability to grant credit to those customers if those orders are coming in.

But clearly it is a concern. They can only go so long without significant revenue, so we will have to be very diligent in that.

Okay, moving on to your point of sale, you talked about investing a lot in that business and trying to get a market. Do you think it really makes sense when customers are not spending and are getting more cautious to actually spend marketing dollars at a time like this rather than when they have the money and our trying to figure out what to spend it on?

We agree, I may have misspoken. We're going to decrease our spending on POS in North America, we're going to increase it internationally where we do see spending happening. Yes, we agree. We won't spend dollars chasing a market that doesn't want to buy our product.

Okay, and then looking at your salaries and options, you did mention that the $0.03 in option impact, is that going to change the way you grant options today? And also in salary increases, because you do have international businesses, when you in your fiscal year or is it going to be at the calendar year-end?

Typically, historically our options are granted at the calendar year-end, and our Board has certainly taken all these issues into consideration as we determine what we'll do this year. So we haven't made any decisions yet, to be honest. Looking at what options we have there.

Okay.

How we grant them and with the other types of vehicles might be.

Okay, last question would be on your tax rate. Is that going to stay in the the current range as we look through next year, around 38% overall, or do you expect some of the other businesses grow and if you invest more that it might change?

I would be fairly comfortable with the rate that we have right now going forward.

Okay, thank you so much.

Thanks.

Your next question comes from Josh Goldberg.

Hey guys, quick couple of questions. First on the guidance, when you talk about the range of 360 to a record 384, to take even the midpoint of that, are you expecting that both segments are going to be down quarter-over-quarter or just Telecom stay up since one of your big vendors? And I have a follow-up.

Josh, this is Mike. I think you've got it about right. And think the Catalyst business probably has some upside to it, but we're not planning a lot right now until we see kind of how this quarter develops. This is the fiscal year and for Avaya, we've had the struggles for three-quarters on. Then getting that go to market model right where the direct guys are taking certain deals that are new to them and the indirect channels are taking different deals. If that mix comes out right we will be pleasantly surprised. But we're not banking on it.

So I think at the midpoint of our range, yes, there is some slight uptick in Catalyst and definitely down in the overall POS market. That implies the overall business being down if you're a steady state in the U.S.

Because most of your international is barcode at this point.

Yes, there is no phone revenue in international.

Okay. And Mike, if you can, could you talk a little bit more in terms of margin pressure? I think you said you are seeing some resellers starting to buy product at a lower margin and you were seeing your gross margins coming down from more like 11 a year ago, to closer to 10. As we look out this year, do you think gross margins stay at 10 or could they even trend lower now, as more and more of these resellers by the lower margin products?

I think what's happened in the last year is we've seen the shift by some of our manufacturers of some of the larger resellers to distribution as a choice for the reseller, they weren't forced to buy from distribution. One of the things when that happens is we don't get the same margin opportunity that we had, which we're okay with because we provide less services to those larger resellers. So I would say a big bulk of that shift happened a couple of quarters ago and it's now with us but we don't see a lot of the continuing right now.

In other words it's not a major vendor program underway to change that, to increase that right now and we hope none of that goes away. We think it will stay where it is, lower gross margins, we should have lower SG&A so that's why we still can model to a good operating margin for the Company and that's kind of what you see in our guidance at the midpoint.

Okay, great, thanks.

Thanks, Josh.

Your next question comes from Chris Quilty.

Good afternoon, gentlemen, can you hear me okay?

Yes.

I know you don't give specific records on barcode versus point of sale, but given what you said about point of sale business being down, looks like it's fair to assume that your barcode business is up pretty strong and I'm imagining all verticals outside of retail must also be up pretty strong for the number to be where it was.

I'd say that's pretty fair approximation. It is hard to break it out as you know as to when an order comes in, for example, for a scanner where did that end up, because we don't collect end user data for all of our products, but yes, I think that assumption is fair. Chris, remember too that benefits when International is up because that's almost entirely in that business segment, so it also benefits from international growing faster than the Company average.

Right, and is there or do you have a license or a capability to take the NCR and IBM and whatever other products and distribute those in Europe, or do you have any limitations on your ability to push POS products there?

It's one of the things we're focused on right now is how do we increase our business in Europe in POS. So a couple of answers, we do have a relationship with IBM, not with NCR, in Europe. Our relationship with IBM has been, until recently, only in the UK so most of the point of sale vendors, unlike the AIDC vendors, the point of sale vendors are still predominantly country driven. Meaning they have not necessarily accepted the idea that there is a value to a pan-European distribution model.

So we're still doing a lot of education and bubbling with those vendors. And IBM is really just now starting to produce -- they to develop in a rolling out a program allows us to sell across countries but that is brand new. So I think that's the opportunity is that in the marketplace, we have a vendors, the same as we have in the U.S. who at some point would think well embrace us. We don't have NCR yet today, but that would certainly be another opportunity.

However, in Europe, there are other vendors in POS that we don't have relationships with you in U.S.

[INAUDIBLE]

Correct. There can be some other players that we need to be working with in Europe that we don't have a relationships with yet.

Okay. Switching gears over to the Catalyst Telecom piece, I know you had talked in recent quarters that Avaya was going to emphasize the SMB product line. Have you actually seen that happen?

Yes, I think we continue to see they have good product. The problem has always been that that is such a small piece of business to start off with and trying to grow that, you put any kind of growth rate on it, you have to grow it substantially to make a big impact on our overall Catalyst business. Meaning the ECG enterprise business had been so much of our business historically, it's always been about 75% of our revenue, was the non-SMB, right?

So to get SMB to become a real growth driver, its got to be singing, and part of the challenge has been the IP Office implementation costs, the time it takes to roll them out, and frankly, they've continued to improve IP Office over the last two years, meaning that we've had to go through these upgrade cycles because the early versions of that product were not that successful.

Today they've got a really good product, we're having to find in some cases new customers to sell it because a lot of the guys selling the ECG stuff, if they see the average ticket price for SMB is lower and I have a higher support costs per dollar, why do they want to do it? So we're having to frankly find some new customers for SMB that are not traditional ECG guys.

Okay, and if I remember correctly, your Avaya contract typically rolls into September. Do you anticipate any major changes to the agreement?

I sure hope not. Right now, with all the other problems we've had this year, with the Avaya is going to give us a break this year.

Okay, and final question, with the stock option expensing, can you give us an idea of how you're going to delineate the forest in the future, given a think there's going to be varying interpretations of whether we count or ignore that stock option expense for first call reporting purposes.

Yes, Reik, I think in terms of our guidance -- Chris, I'm sorry -- in terms of our guidance going forward for the next year, we'll probably delineate how much of our guidance is stock option expensing. And then as we reported in the 10Q, and the earnings release, we will probably do the same.

Great, that'll give us the ability to back it out. Thanks.

You bet.

Your next question comes from Andrew Abrams [ph].

Hi, just a few short ones. I'm trying to get some color on the POS business. Is the expectations, not just yours but across the industry, is this a function of last year's good second and third quarter and were people just overly optimistic about thinking that this was going to continue through this year? Or was that a particularly large build in we satisfy an awful lot of that POS business and without a really strong retail environment you won't see a recurrence of that. Can you give a little color on that?

Yes, we'll try.

I know it's hard.

Less to our was looking at that today, frankly, and when you look at last year, we really had a peek back in the June and September quarters and we were talking throughout last year about product refresh from some of the analysts and research guys who looked at the retail industry. If there was a product refresh cycle, it was pretty doggone short. So we were surprised, I think everybody was. And one of the things we have seen since December is the lack of large roll-outs.

The business we have gotten, retailers are breaking it up into smaller chunks. So if we are giving retail business, obviously we're getting some, it's just no large deals. They're saying well we'll just take a certain percentage of it right now, let us get that implemented, it's like no one's making any big decisions and the decisions that historically they would make and they would take 1,000 terminals at one time, they're saying, we'll take 200 and then we'll call you back when we're ready for the other 200.

I guess the answer is we don't know for sure but we do you think it was a peak last year that's been declining since the September quarter.

Okay, about margin pressure, generally in your earlier comments, do you think this is a function of the increased competitive nature of the business in the last year or so, or is this general business conditions putting pressure on the manufacturers? Is there a way that you can categorize that a little bit from your perspective?

I think we have two things going on. I think one is the mix of our customers changed over the last four to six quarters so we've definitely picked up some larger resellers, which was a plan by the manufacturers. They felt like we could serve those customers better and the customers appreciated that option. Number two, as manufacturers look at their program changes, as we call them, which sometimes equates to an annual change in the way we get paid, but they certainly look at how they can lower the overall cost in the channel.

So we have really no manufacturer that comes to us saying, we need improve our margins at your expense. They generally come to us saying, if we do this, we think it's going to cost you less because we're going to reduce some element of the cost in the whole supply chain so you can live with less gross margin because your operating should be the same. So they come to us with the right idea, but it's always the execution of those programs have some starts and stops and never comes out the way you graph it on a white board.

So I would say the methodology and mentality of our vendors is always we don't want to harm distribution, we're just trying to figure out how do we get a more efficient supply chain over time without hurting anybody in the channel up.

Okay, and last, would you expect any inventory increase as you build up Bosch line since a lot of that came toward the end of the quarter, demos in that kind of stuff, is there going to be any impact there or is this to be a wash?

I don't think you'll see anything material there to our overall inventory number. They're working very very well with us on that. It's interesting because Bosch and some of the other security guys, they're not used to distributors keeping much inventory. So they're excited about the fact that we're willing to take on some of that function. So it will not be material to our overall inventory number at this time.

Your next question comes from Gary Schnierow.

Hi guys.

Hi, Gary.

I know you said it's hard to break out the barcode from the POS piece, but can you -- historically, can you give us what it's been historically? Is it more 50/50, 75/25? Can you give us anything directionally?

I would have always said when pressed to give a number, 50/50, I see we have in our top vendor listing, about half of our top vendors if you look at our top 6 to 8 vendors, are POS companies. So clearly they are a key part of our business and when we don't have a POS system being sold, we also don't have a scanner being sold and some other sometimes Mobile Data Collection products. So the other part of that system being sold drags through some barcode, it might drag through one of the low-end label printers, so that's why it's tougher to characterize it as just POS are AIDC.

Okay, great, that's it for me. Thank you.

Thanks, Gary.

The next question comes from Seth Wonder [ph].

Hi guys, just one quick question the September guidance obviously is a lot lower than it normally is on a quarter-to-quarter basis. Can you just refresh for is given the call is a little bit later this year than most, with the linearity of a typical September quarter and then I guess on that basis so we have a sense for how conservative you guys are being, in this quarter's guidance versus your historical guidance programs?

I think most of our quarters, we have a large month in the quarter. It doesn't necessarily have to be the last month of the quarter but in September quarter that is typically the case so there is some uncertainty even when you're sitting here in the the middle of August. But again I think the biggest thing that is different this year is the significance of Europe in International and its seasonality on our ability to predict and then the fact that this POS trend now has popped up on our dashboard as well.

So I guess over the last couple of September course, is September, 38, 39% are we talking a much higher percentage of the quarterly bookings?

We have never aggregated specific monthly contributions to any individual quarter, we'd rather now do that.

Okay, and then just when understand, I guess Europe is about -- what was Europe as a percent to the September quarter anticipated and last year?

In a projected basis we rarely ever disaggregate our projections into those components, but we know for this particular quarter just posted, International was about 13% of the total.

And what percentage of that is Europe?

We have not said for competitive reasons.

Okay thank you.

Thanks.

Your final question comes from Jerrod Berlin [ph].

Yes, hi. I'm kind of new to the Company, so please tell me if these questions is not appropriate for this forum, but I was wondering with the margins deteriorating in listing to the call, I guess there's kind of a couple of different factors impacting margins. One is kind of a mixed shift where you have larger resellers at your servicing, and then something going on with the mix of products. Could you just flush that out a little bit for me and then what should we expect the margins to do both gross and operating margins over the next 12 to 18 months?

I will take a shot and then if any of the other guys want to chime in. This is Mike. In general, if you look at our overall business model, we've never been as focused on gross margin as maybe other companies have. We always looked at ROIC and operating margin as really what we have to model to predict gross margin has always been a barometer as what kind of value added services we provide group that's really the hallmark of our business service is no matter if it's 11, 12, or 10, it's a signal to us we need to be providing more or less SG&A to support that business.

So we always move SG&A and if you look at our model sometimes we miss it by a quarter. But generally over the long term our SG&A moves in tandem with our gross margins so that our operating margins have been in a range of 3.6, 3.7, 3.8 up to 4.2, 4.3 for years and years and years. So that gives us the confidence that even if gross margin changes due to some things that we don't prefer like manufacturers changing our discounts, we can go into our SG&A line and pull out the cost and not provide those any longer and still have an ROIC and an operating margin that we're comfortable with.

So we think as we look at the forecast we will have a good quarter financially based on our ROIC and operating metrics.

And then in terms of on the manufacturer front changes, I guess, you mentioned a couple of times where there are different changes in the way they're thinking about the channel and they're kind of execution issues. Could you detail what's going on with Avaya and how should we think about that relationship going forward?

Their fiscal year starts October 1. Last October they decided to roll out a new change in what they call their go-to-market plan. That just meant that larger customers and users were going to buy from their direct sales force. They were buying from the channel. The offset to that was [ audio drops ] so that the channel would pick up that business on the low end. The net effect of that would be zero. That was what we started out and what has happened is the larger customers pay direct to the Company on the smaller [ audio drops ] lost business in the first two quarters in the March quarter [ audio drops ] kind of came to grips with that around April. And I think since then, we've seen a marked improvement [ audio drops ] Avaya understands.

Excuse me, Mr. Bryson. Hello?

Yes, Ma'am.

Yes, this is the operator. There is some typing in the background and you're fading in and out. We can barely hear you.

It's not here, it must be one of our callers phones. I don't know where I left off if you guys couldn't hear me. You want me to keep talking about Avaya or do you want me to go back and start again?

No I was kind of with you up to how the resellers lost out on customers up until April but we're getting the promised compensatory smaller customers but now Avaya has kind of fix that more less?

That's right. Later acknowledged that was a goof and had predicted that sales force to give up the accounts they should have. We think that's happening but we don't think it will happen in aggregate by the end of September.

Thank you so much.

You bet, thanks.

Your next question is a follow-up question from Ajit Pai.

Yes, did you have any new vendors that you would like to share with this that you got during the quarter?

Yes, we did pick up some in our communication area, Kentrox which has a router product, these are the ones we mentioned in the narrative, NICE, BlueSocket, and probably the most significant one was we added Polycom Video which we did not have, we just had the Polycom audio products and I think that's going to be a very significant opportunity for us.

Okay, in the last thing is you talked a lot about margins and margin pressures, et cetera in today's call. Today you actually sort of this quarter is probably the best gross and operating margins you've had in four quarters. So could you give us some color as to when you're talking about margins, but when you're looking forward over the next couple of quarters, do you expect the trend that you talked about today to begin to impact things? Were you expecting to sort of stay where they are right now, which is materially below where you were last year in June.

I would say where we are now is where we are modeling going forward. We don't expect any significant change in that unless we have significant changes in specific products that might bring higher margins. International typically brings us higher gross margins so as that improves, you might see a change. But I would say fundamentally, we've adjusted our SG&A to where we believe it's appropriate for those margins we're getting notwithstanding a vendor making a major change in our programs for next year, which we're not expecting.

Right, but looking at it broadly in this quarter you just announced in this quarter that you're increasing your investments in certain areas. At the same time you're seeing a slowdown the point of sale side, so is that something that is been incorporated into your thinking when you were looking at flat margins going forward?

Yes, that is incorporated.

Okay, thanks so much.

At this time there are no further questions.

Okay, thank you for attending our call today. Our next scheduled call will be to discuss the September 30 results on October the 27th. Thanks a lot.

This concludes today's conference call, you may now disconnect.