Scansource Inc (SCSC) 2006 Q1 法說會逐字稿

Good afternoon. My name is Carol, and I will be your conference facilitator today. At this time, I would like to welcome everyone to the ScanSource quarterly earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer period. (OPERATOR INSTRUCTIONS). Thank you. Mr. Bryson, you may begin your conference.

Thank you. Thank you for joining us for the ScanSource conference call to discuss financial results for the quarter ended September 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 review with you the quarter's operating results and then take your questions.

This conference call contains certain comments which are forward-looking statements that involve risks and uncertainties. These 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 10-K, and quarterly reports on Form 10-Q filed with the Securities and Exchange Commission.

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

Thanks, Jeff. The Company posted record sales of 390.4 million for the quarter ended September 30, 2005, an increase of 8% over sales of 362.7 million for the September 2004 quarter. Measuring sales, based upon our product groups, shows year-over-year growth of 10% in AIDC and point-of-sale, along with a 5% year-over-year increase in communications products for the quarter ended September 30, 2005. That produced a 57/43 mix of AIDC and point-of-sale versus communications products.

Public companies with a fiscal year which begin after June, 2005 are required to implement the new accounting standard related to option expensing. For most companies, that date will be January 1st, 2006, but for ScanSource, our effective date was July 1st, 2005.

As a result, our September 2005 operating expenses, income taxes and number of shares outstanding, were affected by this new accounting requirement. The new standard is not applied retroactively to last year, so to help you understand comparable trends, we're going to try to isolate the effect of option expensing on our current-year numbers in the discussion.

Gross margin was 10.3% for the September quarter, which was at the higher end of our range of 10 to 10.3% over the past year. Operating expenses were 25 million, including the 892,000 recorded for option expensing. Without option expensing, operating expenses were 24.1 million, and 6.2% of sales, which is comparable to operating expense as a percentage of sales for each of the past four quarters.

Operating income, without option expense, increased by 11% to 15.2 million, which is 4.15% of sales. Net interest expense was 362,000 versus 197,000 for the same period last year due to higher interest rates and higher average use of the line of credit.

September 2005 quarter-end net income, without the effects of option expensing, increased 12% to 10 million, and 2.6% of sales compared to 8.9 million in the September, 2004 quarter. We were very pleased with our return on invested capital this quarter, which after including option expensing, continues to be strong at 24%. Our return numbers are a result of conscious decisions by our merchandising teams to manage inventory more carefully in an environment of slightly lower gross margins and lower sales growth in certain markets.

Balance sheet metrics and cash use were as follows -- inventory turns were 7.7 times at the end of September 2005, which is above our target of 5.5 to 6.5, and higher than the 7.3 turns posted in the June 2005 quarter. The number of days sales and receivables, DSO, was 52 at September 30, 2005 compared to 51 days posted in June 2005, due to the impact of a longer collection cycle in our international business.

Our working capital borrowings were 31.7 million at September 30, 2005, which is down approximately 4 million from the balance at June 30, 2005. We ended the quarter at a negative one day of paid-for inventory, meaning that our investment in inventory was offset by trade payables to vendors. This metric can be temporarily lower or higher due to the normal timing issues as to when the last day of a quarter ends relative to the bimonthly payments we make to our vendors.

I will now turn it over to Jeff to make on comment on each of our reporting segments.

Thanks, Rich. Our North America segment includes sales from all three 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 346.6 million, a growth rate of 5% over last year.

Our next discussion will focus on the ScanSource AIDC and POS sales unit. This unit continued to show growth, although not at the same rates as in prior quarters. If you will recall, September, 2004 North America sales were at a peak level of growth at over 30%, so we had a very tough comparable number coming in. In August, we had projected a challenging AIDC and POS environment for this quarter and our predictions were borne out. While there were no significant, large POS systems deals, our POS peripheral product lines have performed well over the last two quarters. As a group, our AIDC product lines performed at expectations. We are still optimistic for growth to improve as we look forward, so we are continuing to invest in some key areas, like our new SMB sales group and new marketing programs.

This SMB sales team consists of headcount that we hired much earlier than our usual pattern, anticipating that after a six to nine-month learning curve, this group can grow revenue to justify a reasonable return on investment. Our goal is to increase our penetration into reseller accounts, which, based on their current revenue run rates, have been classified as small by both ScanSource and our vendors. Our belief is that many of these resellers have a unique value proposition, and represent a significant growth opportunity, but have not been given the consultative sales and technical support necessary to be successful in these markets.

To address the POS market for small retailers, in October, ScanSource launched its "bring your own PC" point-of-sale bundle. We developed this bundle in partnership with Epson, ID TECH, MMF, Microsoft and Symbol. "Bring your own PC" includes all of the peripherals needed for a point-of-sale system packaged in one box, with the appropriate drivers and installation instructions. We believe this bundle will reduce the high cost of sales and support normally associated with this market.

ScanSource was named Retail Distributor of the Year by Microsoft at their worldwide partner conference recently held in Minneapolis. ScanSource was recognized for its increased sales, support of the Microsoft partner channel, reseller recruitment and commitment to the Microsoft product line by having dedicated personnel on staff. ScanSource has worked with its equipment vendors to create complete software and hardware solutions around Microsoft POS software.

To continue our investment in RFID, ScanSource created the RFID Solutions Group, which consists of ScanSource resellers through our early adopters of RFID, and are experts in selling and supporting RFID solutions. Resellers who have not yet completed RFID certification programs can contact ScanSource to be matched up with a member of the RFID Solutions Group to help them close the sale, install equipment and support the solution. The group can provide as much assistance as the reseller needs, from providing middleware to delivering site surveys, software, hardware and installation services.

ScanSource has also developed an RFID bundle, complete with reader, printer, media role and software, allowing resellers to easily begin implementing RFID solutions for their end-user customers. The bundle consists of a Symbol RFID handheld reader, a Zebra printer and coder, a roll of RFID media and epcSolutions' RFID software. Resellers must have a working knowledge of RFID, supply chain data structures and experience implementing successful bar-coding and data-collection solutions. However, they will need no certifications or authorizations from Symbol or Zebra to purchase this bundle. Members of the Symbol and Zebra partner programs are automatically qualified.

We will next discuss the first of our two communications units, Catalyst. Catalyst had a surprisingly strong, record sales quarter. Our expectations for Catalyst were modest, knowing that our growth rate would be off an incredibly strong prior-year comparative quarter. We had a reasonably strong June quarter, and there are lingering negative effects from Avaya's changes in its go-to-market strategy. As it turned out, Catalyst was able to sell through those issues, and the Catalyst business benefited from the normal, seasonally strong September due to Avaya's fiscal year-end. One additional positive is that we are now seeing incremental sales impact from new customer signings earlier this calendar year.

Catalyst signed an agreement with Juniper Networks, a leader in secure and assured communications over a single IP network, to distribute Juniper's networking, security and applications solutions. One of the reasons that Catalyst signed Juniper was that over the past few months, Catalyst learned that many of its reseller customers wanted to be able to buy networking products from the same distributor from whom they purchased their voice equipment.

By offering Juniper's products along with Avaya's communications solutions, Polycom video products and Extreme Networks' data networking gear, Catalyst is able to offer a more competitive, converged communications solutions for its resellers is they compete against Cisco.

Juniper Networks' line of networking and security offers solutions sized for the small branch office up to the largest enterprise. Juniper markets a wide variety of routing platforms, ensuring an efficient and predictable IP infrastructure and enabling a secure, dependable user experience. Juniper also provides security technologies to reduce the risk associated with critical network services and business applications. Revenues from Juniper should begin in the December quarter.

We had a very strong sales performance from other Catalyst vendors, led by Extreme, Polycom, SpectraLink, Bogen and Plantronics.

Our other communications sales unit is Paracon, which focuses on converged communications products. Paracon's results met our expectations; however, there were no big deals in this quarter.

Paracon has recently been named the sole distributor of Vertical TeleVantage, Vertical Communications' IP-PBX and contact-center software. Paracon will become the single source for the TeleVantage software-based telephony system, which increases employee productivity and improves customer service for small and medium-sized businesses. Effective December 1, Vertical will move all of its distribution of TeleVantage through Paracon, creating a streamlined processing system which will make quoting, ordering and supporting Vertical TeleVantage solutions easier.

TeleVantage software runs on Intel's hardware and can be preloaded onto an Intel server at Paracon's systems integration facility. 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 not affordable for small to medium-sized businesses.

This quarter, Paracon also signed Zultys Technologies and will be able to sell their products to Paracon's existing phone resellers, along with resellers already familiar with Zultys. Zultys has developed a feature-rich, VoIP product portfolio to complement their line of IP-PBXs and phones. Zultys' ease of implementation, combined with an efficient, low-cost certification program, makes a reseller very competitive and profitable in terms of total cost of ownership for their customers. Zultys partnered with Paracon because they wanted to reduce the cost and complexity of their current distribution channel.

We will now take a moment to update you regarding our third and newest technology area, ScanSource Security Distribution.

Security Distribution had a good sales quarter, while adding product lines and continuing to build infrastructure. The security unit had strong card printer sales this quarter for two reasons. Seasonally, this is the time of year when end-users and government and school districts purchase identification card printers for the beginning of their fiscal years. Secondly, our security team made extra investments in inventory levels in card-printer products to take advantage of those opportunities.

This unit continues to add vendors to its line card. We added HID, Aiphone and Securitron in the access control area, and CCTV market leaders, Samsung, Tamron, Network Video Technologies and International Fiber Systems, which is a unit of General Electric. We are also partnered with two new intrusion-control providers, Adelph America and Gentex. CCTV and access control are the two market segments in which we have the best opportunity to recruit new resellers and increase market share.

We also kicked off a variety of marketing programs to communicate the advantages of buying from ScanSource Security, and raise our visibility and name recognition in this industry.

Our second reporting segment is International Distribution. International Distribution, which includes the geographies of Europe and Latin America, posted sales of 43.8 million compared to last year's quarter of 32.5 million, a growth rate of 35%. This quarter, there was virtually no impact from foreign currency translation.

Our Latin America business had a strong year-over-year growth rate and performed slightly better than expected, while still down from the prior quarter. Sales were up in most Latin America countries but were seasonally down in Mexico. We had a good year-over-year sales growth across all product lines.

The Latin America unit continues to spend on marketing programs and small trade shows and seminars in many Latin America countries. We continue to add headcount to support our growth in both the Miami and Mexico City offices.

During the quarter, we also added some security products and dedicated security salespeople to support our Latin America security sales strategy. We believe there is a good opportunity for our security business to expand into Latin America, and expect to begin to see results in the upcoming quarter.

As expected, Europe was seasonally down from the June quarter, but still grew nicely from the September 2004 comparable number. Due to strong sales growth in Germany, we are continuing to invest in headcount resources there. Other areas of strong Europe sales growth were the Nordics, Netherlands, France and Eastern Europe. Our biggest obstacle to better growth and profits is the high number of mixed-model distributors across Europe. Our gross margins continue to be lower than we need, due to this competition with low-value, low-cost distributors. However, we still believe the opportunity for profitable sales growth in Europe continues to justify the investments we are making.

We will conclude this part of the call with our expectations for December 31, 2005 quarter.

We think total revenues for the December quarter could range from 385 million to 405 million, and excluding the effect of option expensing of $0.05 per share, diluted earnings per share could range from $0.73 to $0.78 per share.

At this time, we will be glad to answer your questions.

Thank you. (OPERATOR INSTRUCTIONS). Kate Read.

I guess they mean Reik Read. The question I would have, is just on Europe, can you guys comment, Jeff, off of the comments that you just made there? You're still seeing some low-value add type distributors. To what extent are the vendors continuing to try to embrace some degree of vendor consolidation? And then also comment to what extent the resellers in the European Community are embracing central distribution.

I'll try that Reik. This is Mike. In general, one of the things that we found out is that we're really the only pan-European distributor our vendors have to choose from. So they've been somewhat hampered by -- once they go down the path of preferring or finding a way to consolidate some of the business to a pan-European model, which they believe by the way is the way to go -- at least most of the vendors -- that they want to make sure that they are prepared for that. And so, we've kind of introduced this model to Europe.

And at the same time, the resellers have told us that they really like the fact that we can fulfill their demand even across country borders, from a central logistics facility, with one company you deal with for credit across borders. Very few of these mixed-model European distributors really have an investment in the distribution side of their business. They are very small companies, and most of their profits come from their end-user business. So as a result, they're not out there doing marketing programs like we are, creating RFID initiatives, and so the vendors are telling us to be patient, keep making those investments, as we try to move to this pan-European distribution model.

What needs to be the catalyst there? I mean it sounds like you've been enduring that for quite some time where the vendors are saying be patient, continue to make investments. I mean, is there an expectation or is there a driver out there that will cause them to try to consolidate that market a little further?

Well, we are hoping that some of our recent conversations with a couple of our key vendors will be the catalyst for that. So, a couple of our key vendors have said -- as they are developing their plans right now, for 2006, that next year will give them the chance to start doing some of this rationalization of the channels. Clearly, it takes a little bit longer when almost every one of our vendors that we do business with over there are U.S.-based companies. So we have to meet with the U.S. executive teams and then have them communicate to the European teams, the strategy, and so there's a normal amount of translation that's got to happen.

So I would say, we're not losing our patience; our challenge would be to improve our profitability there if some of this consolidation doesn't happen. And part of the way we would do that would be by reducing some of our SG&A investments. So as we continue to see growth in Europe, we may not add headcount at the same pace we've been adding.

And what about the opportunities beyond the barcoding side of things? You guys have mentioned point-of-sale in the past. How close are you to having some opportunities there with some of the key vendors that you are working with?

Well, the point-of-sale vendors are probably even more behind from a pan-European strategy, so today we're working with, for example, IBM and Epson in the UK already. And so as those vendors look at how they're going to grow and penetrate some of the SMB space, we hope they will see that one of the things that ScanSource has brought to the U.S. market is this ability to support lots of resellers who are focused on the SMB space, and clearly Europe is much more fragmented from a retailer perspective than the U.S., and so many more of the opportunities are small to medium opportunities.

So I think again, we probably, when we first got there, we spent the first two years focused almost exclusively on AIDC vendors, and have just this year been focused on the POS guys. But we expect that our successes with Epson and IBM will continue to improve next year.

Jeff Rosenberg.

Good afternoon. First question I wanted to ask -- I mean, my numbers are suggesting that your ScanSource business in North America was pretty much flat sequentially, and if that's about right, I just wanted to explore if you could comment on whether or not your large systems POS business was indeed down significantly in the quarter, sequentially and you made it up elsewhere? Or I was trying to kind of get the gist of what you were saying in your prepared remarks about whether that was where the weakness was or because you said things went as expected; I wasn't quite sure what that meant.

Yes, I think, Jeff, that we still are seeing very little demand in the large POS deal space, which has historically been in general retail -- whereas, we still see some decent business in the PC-based POS systems that are focused more on hospitality, and through some of our smaller vendors, we're still seeing okay POS business. So, we're trying to separate our large systems deals from our point-of-sale peripheral-based deals, which typically go to either hospitality type space, for example, or to small and medium-sized retailers. So, to get back to your first point, so yes, sequentially, we did not see a lot of growth in the core business, but we also felt like we didn't lose any market share.

Amid (ph) those larger vendors where you said you weren't really sure how much worse it could get, did that indeed get worse in September versus June from that area where you cited the specific weakness in August?

Yes, yes.

Okay, so you did see some sequential growth if you back out those large systems vendors; you still were growing a little bit in your --

Correct.

-- AIDC vendors and elsewhere?

Yes, the POS deals that continue to haunt the industry of are they going to happen, just continued not to happen. So that business continues to decline.

And then, on the telecom side of things, it looks like you were up about double-digits sequentially, so it's a nice kind of seasonal finish there. What's your feeling on how much of a step back you might take in the December quarter there, and how steady do you think that might be able to hold? What's your best guess now?

Well, backed into our forecast is the idea that if Catalyst has some traditional -- I don't want to use the word "weakness" but not as strong a quarter as September -- we think that weakness would be offset by the growth from international, as they pick back up from a seasonally slow quarter in September. So we think that's built into our forecast when you look at the midpoint of the forecast.

Okay, and then I just wanted to ask about Juniper, is that a vendor that has much of a relationship in terms of trying to work together with Avaya? And then also, do they have a strong position in the enterprise side that they are trying to penetrate and you're just stepping in as a channel partner? Or are they more of a service provider networking company, that is selling to service provider companies and then you're really trying to help them with more of an enterprise strategy? I am not as familiar with how their business breaks down, where they are strong or not.

Well, they definitely have announced a strategic relationship with Avaya, and that really drove the relationship with Catalyst, is that, if you add the products from Juniper along with the products from Extreme, another partner of Avaya's, along with Avaya's enterprise products, that solution set is very competitive in the marketplace against the Ciscos of the world. So this really was able to give Avaya's solution a stronger competitive position against Cisco, and as a result, they needed to have a way to reach the resellers for Avaya who would sell this product. And of course, they look at us as the key way to reach the Avaya resellers, and then Juniper of course is working with the Avaya direct sales teams as well to make sure that that product sold to their large enterprise accounts. So it is a strategic enterprise-level relationship for Avaya.

So have you heard that as an objection from resellers, as you've been trying to recruit them -- that they needed to really focus on their networking guy when they were thinking about their telephony solution, and so this is really --?

Yes, it was a gap; it was a gap in the product line, so they were having to go to Cisco.

Okay, so maybe the last question I'll ask is a follow-on to that. If we go back a year ago, you had talked about how Avaya really had a target for you to go out and invest in recruiting incremental resellers, and I'm wondering if maybe this is a reason why -- well how has that progress been over the last three or four quarters, in terms of the number of resellers you've been able to attract, that they were targeting?

I think we've exceeded the targets. I think the challenge that we face -- and it's traditional in a space like this, or frankly in any part of our specialty technologies, is the ramp-up time for a new reseller is generally six to nine months. It takes awhile for -- it's one thing to recruit them and sign them; it's another thing to develop them. And I think that's a big part of the role we end up playing, along with the vendor -- is providing the resources to develop the expertise of that reseller in this particular technology. So, we're starting to see some fruits of those recruiting efforts that started nine to 12 months ago, and I think that was a contributing factor to our September results for Catalyst.

Chris Quilty.

Can you give us an update on what you're seeing out there competitively from other distributors?

In which business unit?

if you can take them each, one at a time.

I think in the bar-code business, the POS and AIDC, we obviously have continued to see competitors change their strategies over the last year. There have been impacts from larger, broad line distributors trying to get into this market, as we all know.

We believe that, based on our discussions with the vendors, they still value the investments we make in building the market, and they prefer us to continue to make those investments, which is why they continue to see a value-added model that requires this level of SG&A as still appropriate for these technologies in these markets.

So, no real change in the strategy, meaning that we haven't seen a vendor say "we really prefer a low-value, broad line type distributor." That is not what we're hearing. So we are pleased with that.

And I think that's the same answer in the Catalyst and Paracon space. You know, if you recall, Catalyst has had over the last couple of years, a couple of attempts by some of the lower-value distributors to break into the market, and to date, I think the vendors and the resellers continue to say they really need someone who understands these technologies, where the business unit is focused only on these technologies -- so there's not a distraction -- and if we can't make the sale, then we will sell some of the product that is not relevant. So I think the vendors continue to say, "we like the model and we're not willing to go destroy the model." And so that gives us confidence to continue to invest in business-building programs, as we've done.

And then security, it's probably still too early to call that one. We hope the value-added model is the one that the vendors will go to, but it's a new area for us.

Isn't it true also that in the security space, you really have captured distribution? You know, I think of -- I'm trying to get the lineage here -- Pittway was acquired by Honeywell and (multiple speakers) so they were the largest equipment manufacturer and distributor --

Correct. Yes, you are right. There are some obvious conflicts in that model, that are built in, that we hope to take advantage of. And so, those are a barrier, potentially at first, but we think the reseller community will appreciate the independence of our offer. And we're not the only company that has recognized that an independent distributor has value in security business. So there are some other guys that have opened up in the last year or so trying to do the same thing, to go after that captured manufacturer/distribution model.

Just to clarify on your comments earlier about Europe, where you said you're trying to sort of break the mold of the mixed model, sort of master VAR type of VARs that existed a decade ago here in the U.S. Isn't it true that they are generally going to be distributing products at a much higher margin? And I thought Jeff actually said the opposite; maybe I just misunderstood.

No, the point was, they don't have a high margin for the distribution side of the business. Because they don't have a large investment there, all of their SG&A is focused primarily on the end-user business where they have a higher gross margin and net margin. So as a result, they don't invest in the distribution side that we compete with. As a result, they have a lower gross margin and they put pressure on our margin. So, yes, you kind of misunderstood that one, Chris. But that is a model that was similar in the U.S., though. Mixed-model guys were not trying to recruit resellers, but they would provide fulfillment at a very low cost, because it was easy for them to do that. But they didn't have business-development people or marketing programs to recruit new resellers; that's the point.

So in order for that model to change, you have to go out to those resellers who don't carry inventory, who are currently getting it from a competitor, convince them in large enough quantity to switch to your model, and eventually that sort of breaks the back of the master VAR, who is trying to do a side business of selling equipment to his competitors?

Yes, I think two things are there. One is that we're not a competitor; number two is our fill rates on the inventory alone will be better than the mixed-model guy, because the mixed-model guy will always prefer to give the available inventory to his end-user sales force first, when he's offered the choice. Because he makes a higher margin on it. So we think yes, that's what will change that model if the manufacturers don't force it. So our point is, in the U.S., the manufacturers finally said "we agree; we need a two-tier only strategy, and we're going to ask the mixed-model guys to choose -- are you a distributor or a reseller -- and we are hearing that that is some of the plans for next year by some of our key AIDC manufacturers.

Fair to assume, though, that Europe is still less than corporate average EBIT margins?

Yes, yes.

Improving? Or static?

Yes, improving. I think volume alone improves it to some extent. We have to then be careful if we are asked to continue to invest in people in a new country, or extra marketing programs, if we don't see a reasonable return. So we're having to be a little cautious to add more spending to that model, if we can't improve the profitability.

Got it. Final question -- RFID; I agree with the comments you've said and earlier comments that, for your customers at the VAR integrator level, that it's a really more of a best-case scenario back-end of '06, maybe more likely '07, that they become intimately involved in the deployment. But are you currently seeing a drag in terms of SG&A outlays, in order to prep and train and do all those other things, and how material would it be?

Well, we won't talk about the materiality for competitive reasons, but I would say clearly, there is some of that built into our SG&A. And if we weren't investing in RFID, however, we would make that same investment somewhere else. So it's not like we would not make an investment. As we've always said, we try to make sure that our operating margins are at a reasonable point, and above a certain level, it's an opportunity for us to invest in a growth business.

Now, having said that, RFID -- we think we have a reasonably modest investment. A big part of the cost we've kind of digested now, meaning that we chose to create an RFID lab in Memphis; we created a lot of educational materials. So really, it's more people cost right now, from a go-forward standpoint, Chris.

Okay, very good. And am I correct in that this is the first time since I can remember that you guys actually raised guidance? What gave you the confidence to actually raise estimates? I was shocked.

Well, frankly, we had a great quarter, from our standpoint. And I feel like we learned some things in this quarter, that gave us the confidence that we see strength in several areas across our business. And as you know from following us for a long time, our business has a lot of moving parts to it. And we felt like there were enough parts moving in a positive direction that we could give this kind of a forecast.

Great! Well, keep up the good work.

Ajit Pai.

Yes, good evening, gentlemen. Congratulations on a very solid quarter. A couple of quick questions. The first one would be, just looking at the security business right now, I'm not sure whether I missed it, but I don't think you mentioned as a percentage of revenues, whether it was material or not right now.

And the second question on the same line would be, in the security business, after you've entered it and been operating for a while now, can you tell us what your biggest challenges have been over there and what kind of progress you expect to make over there in the next couple of quarters, in terms of penetrating the industry further?

Ajit, this is Jeff. From a competitive standpoint, we will not disclose the security revenue right now. We're bundling those in with the bar-code point-of-sale revenue, because that's where the card-printer business -- that's where its roots are. But at some point when it's material enough that we are required to disclose it, then we will start to disaggregate it for the purpose of this call. So we're still very much in the early stage on the revenue side.

Yes, I agree. And the strategy there, Ajit, is to identify some key vendors -- as we've said -- that are willing to help change the model somewhat in the security business, from a distribution standpoint. So we chose early on Bosch as a key vendor and we're starting to fill some of the gaps around Bosch with other vendors, because what we've learned over the last -- it's been almost a year now, not quite, but almost a year in this business, that there are literally 3, 400 manufacturers. And the resellers in this market tend to sell multiple manufacturers, many more times than our telephony, bar-code and POS guys. So, whereas we might see our other resellers in our other businesses -- they will lock into one or two key vendors, and then fill in with some real, real small peripheral companies, in this market, we're learning that some of these guys will sell products from 15, 20, 30 vendors. So that was a real surprise to us.

So we're having to fill in the gaps with some other products so that we give the reseller a compelling reason to come to us, not just for one item or two out of a 15-item solution. So we've got to at least get half of those products that they need to buy, or they won't consider us.

Is it fair to assume that the AIDC and POS markets are actually slightly softer, if you exclude the security business?

Not any more than we have already indicated.

Not any more.

No, no.

But you're not seeing any less additional incremental deterioration in those markets? They seem relatively stable, a few large sort of customers over there pushing out some of the deployments, but on the peripheral side, you've indicated that demand continues to be fairly healthy and growth continues to be fairly healthy?

That's correct; that's correct. And yes, I think the retail piece is, when you look at the general retail, the specialty retail, which is where our historic, large deals have come from, that's the area that really has continued to be weak.

Okay. And then just looking at the current sort of fed environment, watching interest rates rise, etc., has there been any tightening or you haven't found it necessary to tighten any of your trade controls on the vendors that you've been supplying your equipment to?

This is Rich Cleys. In terms of the customers that -- I think you are asking a question on -- a customer question.

No, not vendors; I'm sorry -- the customers.

Yes, we're still offering essentially the same credit terms that we have in the past. We have ready access to capital that's still relatively cheap for us. So offering credit to our customers along with all of our solutions is part of our value-add. So we haven't looked to tighten up because of interest rates at all.

And at the same time, Ajit, I think the health of the reseller community continues to be something we monitor. We've not seen any degradation over the last few quarters, so we think there's really no news there. We've seen some consolidation with some of our partners, specifically in the telephony space, but overall, we've not seen a reason to tighten credit because their financial positions are worsening at this time.

Okay. And then, when you are looking at your tax rate, just given that the international mix is increasing, do you think that the current tax rate is the one that we should use for the rest of the year, or do you think that we should start modeling something slightly lower than that for the rest of the year?

I would think if you're looking at your tax rate, overall, you should be looking at a model that's similar to what we have on the net, after the stock options. If you're looking at it from a pre-stock-option, that rate is a little bit better than what we've experienced in prior years.

Okay.

So if it's including all these stock-option expensing, if you were somewhere between 37 and 38, that would probably make sense.

Okay. And then the last question is about -- you know, Solution City turned around and being used now for quite a while. Could you give us some metrics as to what percent, like what kind of traction are you seeing there, number of hits; some way to track the number, what kind of progress and how many folks have been using it this year relative to last year?

I don't have any statistics in front of me, but we continue to develop it and invest. Solution City has now become more than just a trade show or a web site. At our recent gathering of our vendors, which we just had this week, we call it Future Path, and once a year we gather all of our vendors together and talk about strategies for next year. The number one request by our vendors was that we continue to invest on a vertical market basis. And we've found no better way to do that than through our Solution City strategy. So, they are asking us to take specific markets, and within, for example, retail, segment it even tighter into hospitality, specialty retail, quick service, and develop strategies to spend less money in a shotgun manner and find a way to better identify fewer customers who really care about these particular products. So, Solution City really is an example of what we really call our vertical market strategy. And, it continues to be very successful, and it gives us an easy way to organize all of our marketing efforts now around vertical markets. So, the trade shows are one piece.

The Web site is -- the biggest use of the Web sites and the highest number of hit are places where we have white papers and strategies for penetrating a vertical market. And we have literally thousands of customers downloading those documents on a monthly basis.

Okay. Thank you so much, gentlemen, and congratulations again on a very solid quarter.

Peter Barry.

I'm struggling here trying to reconcile what looks to be a very stable gross margin performance, both year-to-year and sequentially with the segment mix, as well as the geographical mix -- that is, a very strong European performance. Can you help me out in that regard?

I think in terms of the European performance, remember, this is the seasonal quarter where that might be down. So I think that overall international revenues as a percent to our total is slightly less than it would have been a quarter ago. I don't know if that helps you.

It was up 35%, year to year, though. Right?

Year to year. But sequentially, as a percent of total sales, it will be down. Two points.

It was 11% this quarter, 13% last quarter in terms of the percentage of the whole.

And with a 57/43 split, wouldn't that imply some -- given the fact -- I assume this is correct -- I've been saying it for a while -- telephony is less profitable a business for you than AIDC/POS?

From a mature margin standpoint, here in North America, those two businesses have looked pretty similar now for a while.

So much for that theory!

That's all right.

And this type of margin performance, the 10.3% gross margin, sustainable do you think over the year?

I think what we would be looking for, it would be somewhere between 10 to 10.3. That's a range that we think is somewhat sustainable at this point.

Mike, I wanted to visit the vendor situation. You've said for some time now that vendor margins have been under some pressure. Is that correct, and is that still correct?

I think it certainly depends on which vendors we're talking about, right? Whether it was our strong telephony vendors, or whether it was the bar-code/POS guys. So we talked about it in contrast generally to their use of the channel, and how they were going to try to reach new markets. And so, even if they have margin pressure, the dilemma is, what is their cost to reach the markets that we reach for them?

Having said that, they constantly want us to improve our efficiencies, so that we can deliver products at a lower cost over time, however, continue to recruit new customers. And it's that recruiting of new customers that's still very expensive, even in our efficient, value-added model. I think that's the dilemma. The vendors can't do it cheaper than we can.

Again, I'm trying to equate the broad-line strategy with the vendor margin pressures. Is there any inconsistency there, in your mind?

Well, no, because I think again they want a distributor to do low-cost fulfillment, which is what broad line guys are very good at, but there's an "and", and it's to go out there and recruit new customers and support them. And I think we've been able to show we can do both of those, and so why do you need another model which only does one-half of that.

So as long as we can show that we're not overcharging for the pure fulfillment customers, then I believe the vendors are happy with our model.

Any RFID revenues to speak of, Jeff?

Not material, but we are certainly closing some business. It's kind of been shocking to me. What's happened is that the cost of the tags have plummeted in the last year, so that some of the older opportunities that are still in a closed loop system, or closed system, now become possible. Because the tag price has come down so dramatically.

So we're selling not the new Gen 2 stuff yet, we're selling some older technology, using the low-cost tags, into some decent-sized deals, yes. But it's not material yet.

Just a couple more for me. Would you expect the Q2 mix of 57/43 to close back to the more traditional 60/40 as the year unfolds?

I would, because of international, Peter. So if international picks up, remember, it's only POS and bar-code, yes.

And finally, and Rich, this is probably for you. FAS 123 -- has it necessitated you to sort of revisit your operating margin targets in any meaningful way?

Well, if you look at our results on the pro forma, on that Page 7 of the release, that operating profit is over 4%. In the past, we've kind of looked at 4% as being the right level of investment.

We are able to -- we've been able to absorb, at least this quarter, the stock option expensing within a reasonable operating margin, and I would expect that we should continue to be able to do that.

But once pro forma sort of fades into the background as this matures, and these are in fact the numbers, is 4% still a valid target for you?

I would look at modeling 4% to be a reasonable thing.

Post options expense?

Maybe slightly less than that. If you have stock option expense excluded, you would be better than 4%.

Thank you very much.

Kevin Starke.

Good evening, gentlemen. I was wondering, looking at Westcon's results, it seems as if you're gaining share on them. Is that your sense as well? And if you could speak to whether you are either gaining or maintaining share against other bar-code and point-of-sale wholesalers, that would be interesting to hear, too.

Well, Kevin, this is Mike; in the telephony space, we have competed with Voda One, the Westcon business unit, for a long time, and we believe that we have continued to gain share over time, yes.

Our real strategy over the last year, though, has been to find new customers and build those guys, because, frankly, the business that is remaining at the other distributors is business that at some level might not be profitable. So, we clearly don't try to bring revenue in unless it meets our profitability standards.

And then on the bar-code/POS side, I think we continue to see that we have about the same number of competitors, and we see share shifting maybe among those guys. And we continue to believe that we're maintaining our dominant share when we talk to the vendors.

Thanks. You mentioned the "bring your own PC" bundle; was that a driver in the first quarter?

It's really just getting started. It's one that we are teeing up as an example of how we're going to have to go out and find business where the growth is in POS, which is in the small to medium space, and drive new demand there to offset those large POS system deals that I can't count on ever coming back. I mean, I'm hoping they will but we've got to find ways to grow our business absent that business coming back. And if it does come back, then we will have some great results.

You mentioned the vendors that were participating in that bundle and the ones that were participating in the RFID thing as well. Is the choice of vendor dictated by you, or the vendors are the ones that come up with these things? or how do you choose, for example, Symbol and Zebra in an RFID bundle?

Well, it's certainly a collaborative effort. We sit down and do a planning session with our product management team on a yearly and then a quarterly basis. And we try to come out with some large programs that we need multiple vendors to participate, and we certainly start with the concept of which vendors fit legitimately, and then we go down the path of saying, does it make sense to have more than one vendor in a bundle? Clearly, we do so much marketing programs and we've just given you two of them, that we try to have something for every vendor. Because we want to make sure that our marketing fits all of our vendors' needs. And in this particular case, we highlighted these vendors, but there is another program we're running where we have probably the other five guys that view themselves as competitors.

Where we can, we like the idea of having something very specific that has complementary vendors, and it's very easy for our customers to make a decision.

I wanted to follow up on Chris Quilty's question about guiding up for the December quarter. Speaking from painful experience, you haven't tended to have the greatest visibility, particularly about, say, the last two weeks of the quarter. Has something changed in your incentives to resellers, or your accounting, that gives you confidence about kind of the closing weeks of the quarter?

Well, Kevin, one thing maybe just to go back to -- and you all have heard us say this so many times, this is not a surprise -- but really this is really our first time to comment on this quarter, so in a sense, we're not taking guidance up or down. This is just our first opportunity to speak to it, and I know you guys have other demands that are made of you that require you to go ahead and go out more quarters than that. So, I guess I would just say, we've set this quarter's expectations to give you as good a read on our business as we've done every other quarter. I mean, we're just doing our very best to give you as much data as we feel confident with right now.

That's a very fair point. Okay, I'm done. Thank you.

You have a follow-up question from Ajit Pai.

Yes, could you give us some sort of color as to whether the Datalogic that hasn't typically been one of your vendors, now that they've acquired PSC, is there a possibility that you'd be getting access to those products as well?

It's Mike, Ajit. Yes, we've certainly talked to them about it. And just to remind everybody, so in Europe, we currently distribute Datalogic; they're one of our top vendors. They have not had a brand strategy or presence of any significance in the U.S. What they have told us over the last few days is that they are going to leave their PSC business, especially in the U.S., stand-alone and expect the channels and the products to remain separate.

So we don't see any change coming in the near future with the strategy they have. So in the U.S., today, ScanSource does not distribute Datalogic, and we don't expect that to change here in the short-term. We do expect that our PSC business, which has been very good now, and with the Datalogic resources, we hope that one will increase.

Okay, thank you so much.

Sir, you have no further questions -- I'm sorry, we have one more question. From Steven Lucboreo (ph).

Yes, thank you. With regards to security, Mike, can you just generally speak to -- you've been, as you've mentioned, executing on that strategy now for some time. Can you just talk to the size of the opportunity? Is it fair to say that what you thought it may have represented in the sense of the size of opportunity, 12 months back, is indeed the case? Is it larger, smaller?

And along those lines, can you just also refresh me on the Bosch relationship? Has it changed in any way, relative to how it was first inc.'ed or formed?

Yes, I think from my perspective, the opportunity is at least as big as we thought it was. So we've got no hesitation now; we believe this is a strong opportunity for our Company, and for our strategy.

Having said that, yes, I think we've learned that we have to add a lot more vendors to fill out some of the holes, either where the resellers expect us to plug a vendor in, even if they are buying on Bosch. So, unlike with Avaya or with some of our other vendors, where as I said earlier, the reseller can pick one vendor and pretty much go with that, we are not finding that to be the case here. And we thought that was the case. I would say that's definitely a change in our view as something we've learned over the last couple of quarters.

So now we've got to get these other guys on board, and Jeff highlighted some of the vendors we've signed in the last quarter, and we expect to sign some more between now and the end of the year. And I think, knowing that, we still believe we have a very strong opportunity here, yes.

And to the Bosch question, I believe I'm trying to get at there is, I don't believe it was an exclusive arrangement initially; has the relationship changed in any way as time has gone on?

Yes, correct. It was never exclusive. I guess the words we used were that it was an anchor product line. And I think as I was just saying, we probably found we have to plug in a few more holes because their product line is not as complete as we thought it might, for most of the resellers. So I think that's the only significant change.

We still believe that Bosch has a strong portfolio, and we expect to do very well with Bosch.

Okay, great. And can you just -- any comments on NCR as an opportunity going forward? Obviously, I recognize it takes time to work on these relationships, as you've obviously been doing so, but just given some of the leadership changes there, I'm just curious if there's a different outlook, looking forward.

Well, we know the CEO there, now! So that's a change, and that's a positive.

I would say in general, NCR has got some pretty strong positions in the marketplace, relative to point of service and self-service technology, that we're pretty excited about. The challenge would be, how do you take those kind of projects and move them through a channel. But I think some of the things they are doing in their retail group relative to point of service are some opportunities that are fairly open for us and where NCR doesn't have a lot of competition today.

So, looking at their traditional cash register business, if we call it that, that business certainly is suffering. But if that doesn't change, we think there might be some new opportunities with NCR. So we feel good about that.

And back to Chris Quilty's line of question with regards to European consolidation opportunities, and your reference to the fact that the vendors there are more proactive in terms of pushing along that strategy this upcoming year, what if anything has changed? I mean, that sounds like a very similar message or spirit of opportunity, in terms of what it represented 12 or even eighteen months back. What changed along those lines to feel more confident that that may take place, looking forward?

Well, clearly, some of it is just because of conversations that my team and I have had with the management teams. And that they have said, we would like to bring some of these same programs.

If you recall, over the last three years, the U.S. really has finally put in place -- the U.S. vendors -- have really only just put in place these new partner programs. You have the Partner Select from Symbol, Partners First from Zebra; Hand Held has got a program for their resellers. So many of our large vendors really have just executed those for a year or so in the U.S. And so now they've seen the results and they are saying, "let's take this model and articulate it to Europe, do some translation, let's do some customization," and that's why we feel good about it -- is that they like what they did in the U.S., and they say alright, we now have a framework that we can take to Europe and say, "guys, this is the model; this is what we were talking about, and this is why it will work incrementally for you." And it won't just be about, let's shift all the business to two-tier distribution. It will be about growing the business. And I think the success that vendors have had with these programs in the U.S. give them the confidence to tell us "we promised you it's coming, and here's why, because we actually have a program that we're going to localize to Europe next year."

Great, thanks for taking my questions.

Andrew Abrams.

I was wondering if you could help me a little bit more on the retail side of your business.

You characterized the large deals as still difficult. Have you seen any improvement on the volume out of small VARs? I mean, is there any movement at all on either the large or the small segment that you see across the board in retail? Or is it just still all declining the same way it was before?

Yes. This is Mike, Andy. So, the smaller customers definitely are growing to our resellers who are targeted at the smaller retailers, and so that's why we added additional headcount to our SMB team.

We also referenced that many of our POS peripheral product lines -- and I'll just give you a couple of names, so Epson, Elo, companies like that -- are doing very well with us. So their business is growing well, even in the environment that we're seeing where the larger system sales are not happening the way they were a year ago. And really, I guess that's the point is September of '04 was the last quarter where we had strong POS systems sales into general retail.

And if you look at a customer, a smaller VAR for example that you've had throughout that entire period, September to September, other than new programs that you've done with them, do you see their business declining, flat or up, if you look on it kind of on a steady-state basis, without any other attachments to their business? I know that's a hard thing to define.

It's a good question. I would say -- I would characterize it as the smaller guys typically only grow even in a good year, 5 to 10%. They don't normally have the capital and the resources -- the headcount, for example -- to grow much faster than that. So if those guys can continue to grow at those kind of levels, even in a tough environment, that's why our business can still be real study. We have thousands of those guys; that's why we can still grow somewhat, even in a tougher market for our big guys.

It's the big guys that we have to worry about, because they are the ones that when they lose these big deals, they don't have, generally, a huge base of smaller business. What they depend on historically is a lot of services revenue, that comes in as an annuity to maintain -- to cover their cost. And so any of those resellers who don't have some kind of annuity business in a downturn like this, you know are in trouble. (multiple speakers) the big guys.

Right; I appreciate that. Thank you.

Sir, we have no further questions.

Okay, thank you very much.

Thank you for joining us on the call. Our next conference call to discuss December 31 earnings should be around January the 26th.

Thank you for participating in today's teleconference. You may now disconnect. Thank you, sir.