Scansource Inc (SCSC) 2007 Q2 法說會逐字稿

Good afternoon. My name is Rebecca and I will be your conference operator today. At this time, I would like to welcome everyone to the ScanSource Quarterly Earnings Release Conference Call. [OPERATOR INSTRUCTIONS] Thank you. I will now turn the conference over to Mr. Cleys.

Thank you, Rebecca.

Thank you for joining us for the ScanSource conference call to discuss financial results for the quarter ended December 31, 2006. My name is Rich Cleys, Chief Financial Officer of ScanSource, and with me is Mike Baur, President and CEO. We will review with you the quarter 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.

As previously announced on October 9, 2006, the company's Board of Directors appointed a special committee to conduct a review of the company's stock option grant practices and related accounting issues from the time of its initial public offering in 1994 to the present. The special committee, consisting of two independent directors, Mr. Michael J. Grainger and Mr. John P. Reilly, along with independent counsel and forensic accountants, conducted the review. On January 19, the company formed a report on Form 8-K with the SEC to announce the findings of the special committee of the Board of Directors of the company's historical stock option grant practices. The special committee recommends that management determine the impact on the company's accounting for the option grants referenced in the findings and make appropriate adjustments and required disclosures. In that regard, the company's review of accounting issues raised by the findings is ongoing. The company has preliminarily concluded, however, that the appropriate measurement date for certain grants may differ from the stated grant dates. As a result of the potential change in measurement dates, the company may record additional non-cash stock-based compensation expense related to certain of its prior stock option grants, but it is not yet able to determine the amount of such charges or the resulting tax and accounting impact of these actions or whether the financial statements for any historical periods would require restatement. Any additional non-cash stock-based compensation expense recorded will not affect the company's previously-recorded cash positions or revenues. Therefore, since we have not completed our accounting evaluation of the findings of the special committee, we are unable to report complete financial results.

Our financial discussion will be limited to sales, gross margin, certain balance sheet metrics and summary cash flow metrics since SG&A, operating income, taxes and net income may be impacted by adjustments, if any, due to the evaluation of the findings. Any number of other important factors could cause actual results to differ materially from anticipated results. For more information concerning factors that could cause actual results to differ from anticipated results, see the company's Annual Report on Form 10-K filed with the Securities and Exchange Commission. ScanSource disclaims any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise.

We'll start our discussion by providing overall sales and operating results.

The company posted sales of $473.7 million for the quarter ended December 31, 2006, an increase of 16% over sales of $408.5 million for the same quarter last year. Measuring sales based upon our product groups shows year-over-year growth of 23% in AIDC, point-of-sale and security, along with a 6% year-over-year increase in communications products for the quarter ended December 31, 2006. That produced a 63/37 mix of AIDC POS versus communications products.

Gross margin was 11.14% for the December 2006 quarter, compared to 10.24% for the same period last year. Gross margins were higher due to a favorable customer mix and an improved attainment of certain vendor incentive programs. We had a greater proportion of medium to small customer sales in our Catalyst unit. We also saw fewer large deals in our POS business. Because of this customer mix, gross margin as a percent of sales tends to be higher and we provide more value-added services to these customers. As we have said in the past, we manage to an overall ROIC target for all customers, so these value-added services to these customers will have associated SG&A costs.

Due to our previously-described ongoing accounting analysis of stock options and the potential impact on earnings, we are unable to disclose color or metrics on company operating expense, tax rate, net income and EPS. Further in this discussion, I will give a more in-depth discussion of cash flow than we normally would so as to give an impression of cash operating results.

Net interest expense was $1.6 million, compared to $300,000 for the same period last year. The majority of this increase compared to last year is primarily the result of higher debt due to the cost of acquisitions in the first quarter of fiscal 2007.

Balance sheet metrics and cash management were as follows. Inventory turns were 6.5 times at the end of December 2006, compared to 7.2 turns posted in June 2006 quarter. Turns at 6.5 are within our targets. The number of days sales in receivables, DSO, was 60 at December 2006, compared to 58 days posted in June 2006. Although lower than last quarter's 62 days sales outstanding, our DSO was higher at year-end as a result of negotiated terms on larger strategic deals. The current decrease was impacted by a lower than normal surge of sales at the end of the quarter. We anticipate that we will continue to manage DSO at the 60-day level or slightly higher as long as we generate an appropriate ROIC in our business.

We ended the quarter at a -2.5 days of paid-for inventory, meaning that our investment in inventory was more than 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 the quarter ends relative to the bimonthly payments we make to the vendors.

At this time, I will expand our discussion on cash flow. From June 30 to September 30, total debt and other borrowings had increased $75 million, from $32.2 million to $107 million. From September 30 to December 31, total debt and other borrowings decreased by $28.4 million. As we've previously disclosed, the $75 million increase from June to September was primarily due to first, the first quarter acquisitions of approximately $50 million; secondly, the net increase of approximately $38 million in working capital items of trade accounts receivable, inventories, less trade accounts payable and accrued expenses; and third, capital expenditures of approximately $600,000, the sum of which is reduced by our cash operating results.

Looking at the quarter ended December 31, total debt and borrowing decreased approximately $28 million. Working capital items consisting of trade receivables, inventory, less trade accounts payable and accrued expenses decreased approximately $20 million. Capital expenditures were about $1.4 million. And finally, the remaining balance of the decrease in debt is primarily attributed to the cash operating results.

Mike will now give you an update regarding 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 three sales units, Catalyst Telecom, Paracon, and T2 Supply; and electronic security products through ScanSource Security Distribution. North America posted sales of $393 million, a growth rate of 11% over last year.

Our next discussion will focus on the ScanSource AIDC and POS sales unit. We've achieved a third successive record sales quarter in ScanSource North America. Sales were led by strong demand and market share gains in our AIDC business, particularly with Symbol, recently acquired by Motorola, Zebra and Datamax. Our POS business was weaker than the September quarter, with part of the weakness due to supply chain shortages from certain manufacturers. In addition, we had fewer large POS deals from our IBM and NCR resellers than the prior quarter.

We continue to see market share gains in AIDC due to our focus on product availability and higher inventory levels. Through the end of the quarter, we continued to maintain some duplicate inventory as we managed through the RoHS transition. We expect to continue to have this issue through the end of March.

In December, we added a new vendor to our line card, Datalogic. We've had a longstanding relationship with Datalogic in Europe and expect this partnership to offer our reseller community new opportunities for profit with hand-held bar code readers. Recently, Datalogic announced a corporate restructuring that will realign the company around three operating divisions. This realignment will integrate the PSC acquisition from a year ago into the Datalogic family. We believe this will be a positive for our PSC and Datalogic resellers.

This week, we announced our newest ScanSource vendor, Cisco Systems. Cisco's wireless solutions, including access points, controllers, network management software, security, switching and routing products, will be available to our AIDC and POS resellers immediately. We will begin working together with Cisco to get our partners trained and certified over the next two quarters. Cisco's wireless solutions will complement our mobile computing products, from Intermec handheld products and PSC Datalogic.

We will next discuss the first of our communications units, Catalyst. Catalyst had disappointing sales results after a record sales quarter in September. The December quarter is almost always seasonally down due to Avaya's fiscal year-end in September. We believe the greater-than-normal weakness was a result of supply chain disruptions, product shortages and lower sales to our largest resellers. The normal end-of-quarter surge in sales activity by our larger resellers did not materialize. We believe these purchases were deferred to the March quarter, but we can not be certain. Shortages of Avaya product contributed to our loss of market share during the quarter, especially in our SMB business where resellers can open-source products. We also lost some ECG orders to competition due to product availability. Avaya hopes to resolve its product supply issues during the March quarter.

Catalyst did have record sales results for the quarter with Extreme Networks, SpectraLink wireless handsets and Bluesocket wireless products. Record Extreme results were due to focus by the Catalyst sales team on new customer opportunities and acquiring market share. Catalyst also had strong sales results on a year-over-year basis with Juniper Networks, Polycom audio conference systems and Plantronics headsets. Key initiatives for 2007 with Catalyst include recruiting new Avaya resellers from the T2 supply base of customers, growing our mid-market ECG business and taking back market share in the SMB area. We have recently launched specific programs aimed at these three initiatives. One of the programs is targeted at the mid-market ECG or enterprise space and will focus on an intensive training and support effort around Avaya's MultiVantage Express and Communication Manager on the S8300 server. Additionally, we plan to invest in more recruiting and development resources to target the white space available to Catalyst and our resellers.

Our third communication business unit is Paracon. Paracon had a good quarter considering the distractions caused by the sale and transition of the Intel product line to Dialogic. We are excited with the product plans and commitment that Dialogic brings to the channel and to distribution in particular. Dialogic's focus on gateway products will be an excellent fit for our existing Paracon reseller network. Media gateway products allow new IT-based technologies to seamlessly integrate with legacy voice PBX's. Two of Paracon's gateway vendors, Quintum and AudioCodes, had record quarters in December due to strong sales efforts that increased our market share with those companies. Paracon's expertise at configuring and supporting gateway products is a big advantage as we target the network of Microsoft communications resellers looking for a value-added communications distributor.

We also saw good results from our network of Vertical Communications resellers, as Vertical is launching their new IP-PBX this year and will ship product next quarter.

Our newest communications business unit, T2 supply, had record results for the December quarter. T2 markets video and audio conferencing and telephony products from leading vendors such as Polycom and Plantronics. T2 gained market share this quarter, and results were led by record sales in Polycom video, audio and network products. During the quarter, the T2 team launched new Polycom high-definition video and voice products to the reseller channel and received strong interest in order. T2's combination of highly-trained, knowledgeable sales representatives who are focused on data, video and voice resellers, along with the highly-skilled technical support team, allows T2 to command gross margins appropriate to the value being delivered. We expect T2 to continue their growth as video over IP becomes a dominant technology.

We'll now take a moment to update you regarding our third technology area, ScanSource Security Distribution. ScanSource Security had another excellent quarter, led by record sales and security products from Panasonic video surveillance solutions and Tropos Wi-Fi mesh networks. Card printer product sales were also strong, although lower from the seasonally strong September back-to-school quarter. ScanSource Security continued to invest in people and programs during the quarter, as we believe our distribution strategy is resonating with our manufacturer partners and customers. The number of active resellers continues to grow due to strong execution by the sales team and some channel shift by certain manufacturers.

ScanSource Security will be rolling out several marketing programs in the March quarter. One is a joint education and recruiting effort by the ScanSource POS sales team and the security team called Secure Store Advantage. This program will provide a certification program for sales and technical reps along with monthly web-based training and access to a bundled security solution. Through Secure Store Advantage, resellers will be educated on opportunities with electronic article surveillance, EAS, video surveillance, access control and digital video recording technology.

As new security products are being designed to work on the network, we have seen the need to begin a series of workshops called IP Center, where we will help the reseller community more easily transition to security over IP. Through this year-long series of network basics and network video workshops, we expect to help our resellers take a leadership role in understanding and delivering IP-based solutions. Finally, we plan to have a larger presence at the premier security trade show, ISC West, to be held March 28-30 in Las Vegas. Last year, we determined that this show generated a high number of reseller leads and allowed us to significantly raise the awareness of ScanSource Security.

Our second reporting segment is international distribution. International distribution, which includes the geographies of Europe and Latin America, posted record sales of $80.3 million compared to last year's quarter of $55.3 million, a growth rate of 45%, and without the effect of foreign exchange, our growth rate was 37%. ScanSource Latin America had record sales results in the seasonally strong December quarter. The sales were led by the market share gains in Mexico, Central America, Puerto Rico, Chile and Colombia. The Latin America team continues to get great support from Symbol Motorola, Zebra, Elo and Star. However, we are still seeing significant margin pressure from non-value-added distributors in Miami and Mexico.

During the quarter, ScanSource Mexico announced a distribution agreement with Mitel for their IT communications solutions. ScanSource Mexico is adding dedicated and technical resources -- sales and technical resources -- to support this opportunity with Mitel. We believe this partnership can drive incremental business for both companies in Mexico. This agreement allows ScanSource Mexico to offer Mitel hardware, software and accessories to Mitel's growing stable of channel partners in Mexico.

ScanSource Europe also achieved record sales results this quarter. The strong performance was led by AIDC vendors Symbol Motorola, Intermec and Zebra as we continue to add new customers to our business across Europe. Customer growth was seen in the northern and southern areas of Europe. Our UK and Ireland business grew at a record rate, especially with support from IBM, Elo and Epsom. Increased marketing and trade shows helped us reach new customers and continued investment in inventory allows us to win new customers. As we discussed last quarter, we still have higher inventory levels than normal due to the RoHS transition, and we expect that to continue through March.

We will conclude this part of the call with our expectations for the March 31, 2007 quarter. We think total revenues for the March quarter could range from $468 million to $488 million and gross margin could range from 10.25% to 10.4%.

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

[OPERATOR INSTRUCTIONS]. And your first question comes from David [Sternman].

Good afternoon, guys. How are you? Just trying to get a sense here -- I had been under the impression three or four quarters ago that it started to look like you were seeing a lot of gross margin pressure and looking at a new baseline in gross margins closer to the 9 to 10% range, and then we're seeing some good gross margins frankly in the last few quarters and I know you've talked about a lack of large deal size and maybe it's a little bit of a mix shift back towards ADC and POS, but can you spend just a couple minutes talking to us again about where you see the gross margins stabilizing, all other kind of business trends being equal? In terms of standard sales mix and kind of a standard split between large deal sizes and smaller deal sizes? What are you still targeting from a gross margin perspective?

Yes, David. This is Rich. We think that a more normalized gross margin would be on a lower end of a range of sales towards 10.4%. On a high end of the range of sales, 10.25%. This quarter's margin of 11.1% was excellent, but there were some things that we believe to be somewhat anomalies to this quarter.

Okay. And just an unrelated question. Looking at the communications vertical, and you pointed to a couple of challenges that took place in the quarter and steps you're going to take to alleviate that. Can you comment a little bit on what we should expect in calendar '07, kind of what you're seeing in the communications vertical on kind of a broad demand level. Is there a deceleration going on there overall or do you really think these are just some vendor-specific issues to tackle?

Well, as you -- this is Mike. As you know, we deal with really a small number of vendors in this space, and our experience has been that our customers have different opportunities for buying in different quarters, and in this particular case, it was exacerbated by some product shortages in the Catalyst business group. In general, the overall trends we see are very positive. There still is a large move towards voice over IP technology. The market studies we've seen indicate that that business trend -- to move to voice over IP -- is not over yet but any stretch. And we see that there's opportunity as well in our new business unit, T2. They've done a great job of also focusing on IP-based products, including video. And so we feel very good about the communications segment for us over next year.

Okay.

Over '07.

Alright. I appreciate it. Thank you.

Your next question comes from the line of Jeff Rosenberg.

Hi. Could you talk a little bit about the competitive environment in the communications space? I mean, you talked about picking up some business in the small and medium-sized business, but then, at the higher end, losing some due to product shortages. Is that all a function of these temporary issues in the supply chain or are there some changes in terms of how your customers or your customers' customers are buying? Any color there in terms of how the shift in the channel is flowing your way?

Yes, I think we've found that we felt like there were some temporary issues here in the quarter. We hate it whenever our customers can't get product when they need it, and when that happens, they will try to find product through other distributors, and when that happens, of course, then they get a chance to experience another distributor, which we don't want to have happen. So we would had rather not had shortages. We do believe that, on a level playing field, in any particular quarter, we'll win customers against our competitors. But it can lead to a little more competitive environment out there than we would have like. But in general, as I think you know, Jeff, we have a strong position with Avaya. They've been very supportive of us. They tried to do everything they could in the quarter to make sure that we didn't lose any significant orders. So we felt like we've had some issues there, but that in general, they'll be resolved this quarter.

Okay. But as it relates to some of the big customers that are out there that buy through the channel, like a service provider type larger orders, I mean, that's all a function of product availability, or is that business really getting more difficult to retain?

No, I don't think there's any more pressure on our ability to retain relationship and business with those guys. We just saw some temporary cases where, on the SMB side, we did lose some market share. We felt like SMB is a place that we have to work closer with Avaya and, frankly, with our sales teams to make sure we're not losing it either to another distributor or to a competitor of Avaya. And so that's an SMB statement. ECG, I think we feel very good about our market share with our key customers, whether it's service providers or large resellers, and we think we're in good shape there with them.

Okay. And then on the profitability side, and it's kind of an unusual conversation because we always tend to de-emphasize the gross margin relative to the operating margin, but you can't speak to the operating margin. But given it looks like on a gross profit dollar basis, you guys had some upside this quarter, and historically, when you see that, you've usually attempted to try to increase spending on some areas that you're seeing growth and that sort of thing. Can you talk qualitatively whether you're spending for -- whether it be for the security business or to help T2 build out their footprint, if any of that increased during the quarter, and then conversely, given it looks like you're projecting that gross profit dollars might take a step back in the March quarter, are you -- is that discretionary to the extent that you feel like you can manage through that decline in gross margins to minimize the effect on the operating margin line?

I think we're making investments today in three key areas. International, because we still see strong growth there as evidenced again this quarter. Security, so we continue to invest there and seen gross margins to where they are this quarter, and our sense is that we're not going to overinvest, but we still see investments in security. And then thirdly, you're right. We see an opportunities within the communication business, whether it's T2's opportunities in video or, frankly, to make sure that we continue to invest alongside Avaya in our communication business with them. We still believe there's opportunity there as well because they have a dominant place in the marketplace. And so I think those three areas, we see continued investment. And clearly, if we can have stronger gross margins again, that's clearly a signal to us to make investments.

Can you talk about the flexibility there? In other words, this quarter you had some strong gross profits and maybe you were able to spend some money and take advantage of that, but based upon your forecast you're looking at, gross profit may be, on a sequential basis, coming down a few million bucks. I mean, is there an ability that you see to be able to smooth that out at the operating margin line, or are you kind of more building your infrastructure, if you will, for some of these -- some of the marketing for some of these programs?

Yes, I think some of it is marketing programs that we can execute on quickly, and some of it will be head count, will be people. That takes a little longer to deploy. But I think there's clearly some short-term programs that we would like to take effect in the March quarter, take advantage of this.

Okay. Alright. Thanks.

Your next question comes from the line of Reik Read.

Hi. Good afternoon, guys. Mike, it sounds like from your comments that the single biggest issue was the lack of supply on the communications side and it seems like you guys have been talking about this type of an issue for a number of quarters and maybe they're not related, but it seems to be the same kind of thing where there are some supply issues that kind of creep up. What's given you the confidence at this point that this kind of unwinds quickly in terms of this quarter?

Well, I think that the supply issues we had over the last year related to this were somewhat different. They were related to manufacturing supply issues, and we still saw a small number of those kind of what we call shortages in the quarter. So during the December quarter, the shortages we saw compared to nine months before were dramatically improved, but we still saw some, but with good progress and with, I would say, us receiving a good feeling that they'll be resolved completely during this quarter. Separately from that, Avaya went through some changes in how they distribute product outside of the factory. And so they have some central distribution partners who, once it's produced, actually then configure and ship product to their partners like us. And so they had some supply chain disruptions, as they called them on their call on Tuesday, relative to their distribution capability, not their manufacturing. So these things all happened right in the quarter. This new distribution partner Avaya was using was brought online in October, and so it was really a shock to us that they did such a poor job providing product to us. And so, we did a lot -- it was distracting, to be honest. And so some of our customers ended up having to delay installations and we lost a little bit of business because they had to go find it somewhere because they had to meet a customer request. After meeting with Avaya -- and I was meeting with them just last week -- we feel good that they are well aware of the issues and that they have good plans in place to solve it.

So it's one of these where they know that they've made some mistakes and they have plans underway. Are you seeing that improvement yet or is that still something that's on the come and you just like to plan?

I think the latter. I think we like to plan. Got to see it happen. So that's why we're not sure how well we'll do in Catalyst this quarter and a lot of that will be relative to how well Avaya does at fixing these problems. But we've got confidence in their plan.

Okay. And I take it also from your comments that, absent the POS market, you guys feel pretty good about how the North America bar code market seems to be performing at this point. It kind of came in at or above expectations.

Yes, I think that's correct. And I think the POS business would have been better, but we also had some shortages there. So that drove us nuts. And we would have had better performance. Although we didn't still have as many large deals as we had previously, it would have been a better quarter if we hadn't had product shortages in POS.

And can you just talk a little bit about the general retail environment? Do you see the retail/POS area making some strides back or is it still kind of a squishy environment?

Well, I think from a short-term perspective, it's still very -- I'm going to call it flaky, not squishy. I can't figure it out. The one big positive was they just had the national retail show two weeks ago in New York and, by all indications, it was the most attended show in about five or six years. There were a lot of new companies there talking about new technology. I think the retailers had an overall sense -- this is from vendors talking to me -- overall sense that they were willing to invest in some new technology. So the vendors walked away from that show telling us that it was the best show they've had in a long time. So that gives us some sense that maybe sometime this year, we're going to see a steady demand from the retail sector, but right now, we'll say it's still a little bit flaky.

And just one question back on the telephony side. I want to get some clarifications on your comments because I'm not sure I've heard them correctly. Did you say that the -- you saw good sales in the SMB area and it was some of the larger customers that were weak, or did I misinterpret that?

Yes, I think I would say that you're right. The larger customers delayed some purchasing and we assume that's going to happen this quarter. Secondly, SMB -- we lost some market share, and part of that was due to lack of inventory.

And what's the -- what's your best sense for what the factors are in the delayed orders from the larger guys?

We don't know. I mean, we talked to them. They told us that their pipelines were strong. They just say, "We don't need anymore product right now." Typically, the December quarter is the weakest quarter with Avaya. The resellers always have a -- they have a lot of incentives, if you remember over the years. There's resellers to the dealer to close out their fiscal year with Avaya strongly. And so typically, there's some business that ends up in September that might have been in December. And then in some years, we've had some business that might be in the March quarter move into December. And we didn't see that happen this time.

Okay.

So it's still a little bit of wait and see.

Yes. Thanks for the comments.

Your next question comes from the line of Tavis McCourt.

Hi, guys. First an operational question. You mentioned a new relationship in Mexico with Mitel. Is that a complete shift on their part going to a two-tier model, or is it more of an opportunistic opportunity on your part?

This is a change in Mitel's distribution strategy. Today they have a number of partners that they sell to directly from Mitel, and they were looking for better logistics in customer service, along with a reduced cost structure for Mitel, and so they're handing off other aspects of the relationship, such as recruiting new resellers, providing technical support to the existing channel, and also just in general providing a better relationship and customer service to their existing channel.

And I forget. Is that a vendor that Catalyst has worked with historically in the U.S., or is that a new relationship for you guys?

It is new. It's new to our company.

Great. And then, Rich, can you make any comments on kind of the timing of the accounting review, now that the options review I guess is over. Should we get full results for the March quarter or are we looking more like the June quarter?

Well, I would answer it like this. First of all, I don't know how long it will take, but if I look at other companies, it takes -- once you get the results from the special committee or the legalistic review, it takes anywhere from one to three months to usually work through this to come up with restatements if you've got the restatements. So based upon what other companies would do, that's kind of what I'm looking at.

Gotcha. And you have the book overdraft number for the quarter?

No. I don't have that separate. We include that in accounts payable.

Okay. Alright. Thanks.

Your next question comes from the line of Mike [Marinacci].

Hi, Rich. How are you doing? I just wondered if you had the accounts receivable allowance? And then on T2, can you give us the revenues they generated?

Well, on both of those, we don't disclose T2 separately. We have said in the past at the time that we acquired them, their prior 12 months were, I believe, about 77 million, but we're not disclosing T2 as a separate entity in our segment reporting.

Okay. So what are we supposed to take from the record results posted by our T2 supply sales teams that was quoted in the press release?

They had a great quarter.

Okay. So something north of 77 annualized.

Yes, I mean -- this is Mike. The reason is for competitive reasons, we don't want to give out any information we don't have to. And we still feel like we can give you guys enough sense of how we're doing without breaking that out. So we'll try to work with you on that.

Alright. And I'm sorry, Rich, the --

And as far as the reserve goes, we have not disclosed the bad debt reserve with these numbers.

Okay. So we have to wait until --

We'll have to wait until the full disclosure is complete, but there's -- I can't give you that number right now.

Okay. And I think I calculated the 4X impact on the top line of about 4.5 million. Does that sound about right?

The difference between -- I'll just have to give you the percentages right now.

I worked it out. It's 4.5.

45 versus 37. I'd have to go back and calculate.

I was able to handle that one.

Okay.

Alright. I guess that's it then.

Your next question comes from the line of Ajit Pai.

Good evening. A couple of quick questions. The first one is just about your securities business. Could you give us some color as to -- I might have missed it if you provided it -- but what percentage of revenues it is right now and how rapidly it's growing?

Hi, Ajit. It's Mike. We still have that lumped into our ScanSource bar code and POS business. Again, just for competitive reasons. However, I can tell you that it's not significant enough yet for us to break it out, although we plan to. Their growth rates are very strong. They're coming off of a small base as we've discussed in the past. We have not made any acquisitions in this space, but we do like the business we're doing and the vendors are starting to really support us there. So that's built into that growth rate you saw with the AIDC and POS.

Right. And so that growth rate that you saw -- did you mention 20 or 22%? I missed that.

I believe the total was 23%.

23. Okay. And then just looking at the sort of large reseller that's selling to the point of sale, and I think largely driven by retail. I think it's now been almost two years since that sort of business has been sort of sluggish in early '05. What do you think is going on in that space? What do you think the drivers are that's going to change their current behavior?

Well, I think the things we talked about a year ago where we saw some improvement was that a lot of the retailers installed systems at Y2K and so these things are getting to be six and seven years old, and at some point, they were going to have to do some significant replacements. I think we may have seen some of that. I think what else happened is you had some new players come on the scene. In the last two years, Dell has become a much bigger player in retail, and so that may have affected some of the purchasing that would have gone through our resellers selling IBM or NCR. Maybe they're selling some of the peripherals today, but not the CPU because Dell's selling that directly. So I think that's happened. I think the other thing that's happened is -- and we talked about this a few quarters ago -- there was significant consolidation among a lot of the retail software companies in the past year with SAP and Oracle coming into the space, and so some of those companies that had their own software -- they used to buy hardware and software from and now it's part of SAP or Oracle, they no longer are selling hardware. So we've actually had some of our better POS resellers frankly get out of the hardware business. So there's been some disruption in who our customers are in that space.

Right. Okay, thanks. Do you attribute some of the sort of sluggishness in that business to your customer base, partially to broader conditions, partially to your transition in terms of software/hardware mix, and then partially to also new entrants that you don't cover. Is that fair?

Yes. That's exactly right.

Okay. And then, if you're just looking at the receivables. I think you did mention that you don't know how much the reserve is. But qualitatively, at this point in the cycle, are you seeing any kind of deterioration in the receivables quality? Are you seeing any sort of modesty [inaudible] from any folks or do you think that it's just -- even if there is a little up and down, it's just noise at this stage?

I think -- the way I can answer that -- well, first of all, we do know what the receivable reserve is. We just can't disclose it right now. But as far as the quality of the receivables, I'd say our underwriting criteria for our customers remains consistent and our reserving is consistent and the overall profile right now is fairly consistent with the past, so --

Yes, I think the only thing else I would add to that, Ajit, is that we have seen some consolidation as well among our communication resellers. There's been some private equity come into that space and consolidating some of those key players. So I think there were some pretty good resellers that found a good opportunity to market their business. And so that has led probably some other companies in that space -- some other resellers -- who are under some financial pressure to do some different things. So I think, as a rule, though, we feel good about the overall health of the channel and, as we've disclosed before, we have no customer larger than I think 5%. It rotates between 5 and 6% in any quarter. So we have our risk spread across a large number of resellers.

Okay. Thank you so much.

Your next question comes from the line of Chris Quilty.

Good evening, gentlemen. Rich, I just missed it. Can you give me the numbers for international revenue? I've got the growth rate at 45.

International is 80.3 million and growth rate is exchange-adjusted 37.

Okay.

Percent.

And touching back on the AIDC point-of-sale business, obviously a lot of that growth was coming from international. Did you say that the point-of-sale business was down year-over-year or it was just significantly weaker than the overall AIDC business?

Yes -- this is Mike. I think I characterized it as weaker than it has been, partly due to shortages and partly due to the flakiness of the market, but not necessarily down.

Okay. Got it. And just as reminder, do you have distribution agreements with Avaya, NCR, IBM in any of the international markets?

We have a relationship with IBM in Europe. Currently, it's limited to only two countries.

Okay. And is that something you're looking to expand at some point in the future?

Yes, it is. We've been working at that for a while. We're hoping that IBM will be able to allow us to sell across Europe, so we've been trying to do that. And we also sell IBM in some limited areas of Latin America, but not across Latin America.

Okay. And would you consider at some point picking up some of the European vendors?

Yes, we would. We would certainly talk to them because we'd like to grow our POS business internationally comparable to the way it is in the U.S., and I would say we're still behind in that opportunity, and we still see that as pretty good ground for us to grow.

Is the European business also -- can you give us any comments on -- years ago, when you greenfielded that, it was operating margins well below the North American. Have you achieved the type of scale now where that business is getting closer to or equal to the North American business?

Well, what we've done, Chris, is that we have the opportunity to have it approach the U.S. operating margins, but because of the growth opportunity, we continue to make significant investments in that business. So I think that's the opportunity for us is not to frankly miss any of the growth opportunity ahead of us. So I would say that we do have the scale now to where, if we felt like we were going to -- we needed to maximize operating margins, we could do that.

Alright. And from your earlier discussion about the security business and continuing to invest, it's fair to assume that business is still in the red at this point?

I don't know that that's the case, because for us, again it leverages all the infrastructure here in the States with the back room, with management, even to some extent. So their real specific corporate expenses are pretty low proportional to their business. I mean, we probably, like any business, would have some head count ahead of time but -- commensurate with the opportunity. But I would say -- I would not say make that assumption.

Okay. And in the AIDC point-of-sale business, I think you mentioned in your script that you didn't see the year-end surge that you might typically expect and there's -- I remember in the past couple years, you guys actually took down revenue guidance going into the lack couple weeks of December, only to see a big surge of business. Is the lack of a surge -- to you, does it provide any indication of what to expect going forward into calendar '07?

Well, I think the lack of surge was pretty specific in two areas. One, some point-of-sale business due to some shortages, and then more, I think, bigger question is about the Catalyst surge. So we didn't see the Catalyst surge that we normally would, and everything that we know today would suggest that it's not -- that business is not gone, it's just delayed. And so we believe we'll still pick up that business. It's just a question of is it going to happen now in the March quarter or it somehow going to be later than that? We don't anticipate that we lost that business.

Okay. And just given the fact that you gave us the 6% overall growth rate in that business with a decent chunk coming from T2, probably fair to assume Catalyst was down year-over-year?

That would be fair to assume.

Okay.

You bet.

And final question just for Rich. Given your statement that you're probably looking at another month to three months of accounting work here, are you in the process now of talking with your lenders about a further extension or waiver?

Yes. We've had those discussions and early indications are good.

Great. Alright. Thank you, gentlemen.

Your next question comes from the line of Kevin Starke.

Rich, following on Chris's question, what's your status vis-à-vis the NASD?

We -- the NASD -- we had a hearing on January 11.

Okay.

And that hearing -- the results of that hearing -- their results will be 30 to 45 days from that date, so we're waiting on those results.

Okay. Avaya said that their indirect channel grew 11.5%. I'm just wondering where some of that business that you missed went to. Do you have any sense of that?

Well, I think there's two answers there. One is because their business grew, I think it grew as a percentage. I think their direct business was down, so I think it was just some shift in how the business ended up being recorded. But I think, from us, we would have lost some business in SMB and that goes to four, five distributors in the U.S for SMB products. And so those -- our customers, our Avaya customers, can buy SMB products from any distributor they want on a transaction basis, whereas the ECG business, you have to make a commitment to the distributor on an annual basis. And the SMB business, as a reminder from long time ago, and then I mentioned this [inaudible] it's about 25% of our business in Catalyst.

Is there anything behind the shortages that you can enlighten us about, and are there any commonalities between the shortages on the POS side -- the point-of-sale side and the telecom side?

No. There's nothing at all related. It's bizarre. They just all happened in the same quarter. Kind of frustrating.

If I recall correctly, Datalogic was exclusive with Bluestar before. Are they now exclusive with you?

No. They've added us and they're no longer exclusive.

Okay.

One comment back to your shortages. I would still -- I would venture to guess one thing that is common across the last six months has been this whole RoHS transition. It's affected every manufacturer we have, and some shortages have been directly linked to their transition in components and new product transitions. And that's been a bigger deal than everybody thought six months ago.

Got it. Now, I regard ScanSource as one of the better managed companies that I follow, but the fact of the matter is, your stock really hasn't gone anywhere in three years. If you look at where it was trading in January '04, it's pretty much where it is now. And I'm wondering if you could reflect for us any discussions, impatience, whatever, that you and your Board talk about in relation to that situation.

No. I don't have any specific comments about that. In think in general, we feel good about the business plan long-term. We entered the security marketplace October of '04 as an opportunity to really grow our business in a new direction. We also, at the same time, have had more competition in our space. Several of our manufacturers in the last two years have signed companies like Ingram Micro, Tech Data, Avmet and others, and so we've had to work our way through additional competition. So we believe we've got still some technology areas that are growing maybe mid to high single digits, and our opportunity over the history of our company has been to convince manufacturers that we can be a better distributor than others and also to convince them that the can be comfortable shifting more business to the channel in general. And having said that, we still have quite a few vendors that still do a huge amount of their business directly to end-users. And we believe that some of those manufacturers are prepared to take a look at that again -- and they do this every year -- try to decide can the channel play a bigger role than in the past, and that's what keeps us excited about our business prospects is that market [inaudible] growing and many of our manufacturers have not totally shifted business yet to the channel. So --

So you are reflecting for us right now what your Board sees as the sort of way forward in terms of enhancing shareholder value?

Yes. And also, as we said, we want to make sure that we don't enter markets and lose a lot of money at the same time. We want to be -- we've been somewhat conservative there in the way we approached Europe and Latin America and we believe that was a good decision as well. We think the opportunity ahead of us is pretty strong.

Thank you.

Your next question comes from the line of Greg [Watner].

Good evening, guys. I guess I'm confused as to why we're talking about kind of shortages when inventories were up 11% sequentially on a down 5% revenue quarter, sequentially. I mean, what are we holding in inventory?

Well, when they have shortages, what happens is you may be short one particular product. So in the case of an Avaya system -- Avaya system may go out with about 50 to 60 items on the order, but if we're short one item, let's take a circuit pack, we typically will not ship any of the order. We won't ship partial. The customer can't use it without all the components. So we're sitting there holding 95% of the revenue of that order waiting on that last 5% to come in. That's what happens.

Just a question on your AR. I haven't seen -- I was just kind of going back and looking at the last, say, 20 quarters. I've never seen it down, let alone down the magnitude it was down. Is there something that went on there? Did you guys factor some receivables or --

No. It's really a matter of not getting that end-of-quarter surge on sales. So if you look at the span of collection activity, this is not surprising to me.

Okay. And can you give us the non-operating expenses due to the investigation?

We cannot disclose that at this time.

Was it a material number?

I can't really comment on it. It's -- well, I can say, again, if you look at other companies, they are seven-digit numbers. Seven-digit numbers that they do for these special investigations.

Okay. So you're not out of line with that. Okay. And one final question. Has the investigation spread at all? Is it -- are we still talking about options or -- Bryson seems to be the guy that the investigation fingered, but he was the CFO, so the question is are you looking at the rest of the accounting?

The scope of the investigation remains the same as it was originally. So the situation now is we've got to take the results of the special committee's findings and analyze those results and determine the impact, if any, to the financial statements current and prior.

Right. But you also said it won't impact cash or revenue. Is that -- I mean, is that a consistent statement with saying that the scope is the same?

I think -- the fact that it -- yes.

Okay. Alright. Thank you.

You have a follow-up question from Ajit.

Yes, just in terms of color of the new folks -- the new [inaudible] that have entered the landscape in POS and then also some color on the competitive environment for your manufacturers in the AIDC space, are you seeing any low-cost Asian manufacturers taking share over there? And also, like Micros and Fujitsu, are you sort of seeing them greater in the POS market, and are you considering sort of distributing to them as well?

Well, we -- the latter question about distributing other companies' products, we're always talking to companies about what their needs are in the channel and what we can provide, and typically, companies are going through different stages of whether they're providing customer service and logistics directly to their resellers like Micros does and Fujitsu does, or whether they have even considered two-set distribution. So I would say that we are always having those kinds of conversations. No difference. And I think in general, we have seen more distributors come into our space. We've also seen the distributors, in some cases, exit our space. Most recently, TechData decided not to continue to compete in the point-of-sale space. They're staying in the AIDC part of their business but they have closed down their POS business. It took them about three or four years, and so that's what we have to be faced with sometimes. These guys have to come in and see that it does require a value-added model and it does require a significant investment and you have to have scale.

But in terms of manufacturers whose products have been distributed, are you seeing anyone new, any kind of trends, some low-cost folks from Taiwan, etc. or things from that perspective are fairly static?

And that's a good question. Sorry, I forgot about that one. Yes, we did. We saw a low-cost bar code printer company enter the space last year, and frankly, it did not go that well for them. They've had a hard time competing in the space just on price. Seems like the products that our resellers are selling in these spaces are in vertical markets where the end-users require robust, rugged products and they have some specific brand preferences in many cases, and we've not seen any significant market share by any of the low-cost offshore brands. Have not.

Okay. Thank you so much.

At this time, you have no further questions.

Okay. Thank you for joining us. Our next conference call to discuss the March 31 quarter is expected to be held on Thursday, April 26. Thank you very much.

This concludes today's conference call. You may now disconnect.