Scansource Inc (SCSC) 2007 Q4 法說會逐字稿

Welcome, and thank you, everyone, for standing by. (OPERATOR INSTRUCTIONS). Today's conference is being recorded. If you do have any objections, you may disconnect at this time. Now I would like to turn the meeting over to Mr. Rich Cleys.

Thank you, Paula. Thank you for joining us for the ScanSource conference call to discuss financial results for the quarter ended June 30, 2007. My name is Rich Cleys, Chief Financial Officer of ScanSource, and with me is Mike Baur, 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 amended annual report filed on Form 10-KA for the year ended June 30, 2006, and the Company's annual report on Form 10-K for the year ended June 30 2007, to be filed with the Securities and Exchange Commission.

I will start our discussion by providing the overall sales and operating results. The Company posted sales of 524.3 million for the quarter ended June 30, 2007, an increase of 14% over sales of 461.1 million for the same quarter last year. Measuring sales based upon our product groups shows year-over-year growth of 16% in AIDC and point-of-sale, along with a 10% increase -- year-over-year increase in the communications product for the quarter ended June 30, 2007. That produced a 62/38 mix of AIDC POS versus communications products.

Gross margin was 10.5% for the June 2007 quarter, compared to 9.7% for the same period last year. The gross margin increase was the result of favorable product mix, including services in North America, and increased international sales, where gross margin is higher. A better comparison is the most recent marked quarterly gross margin rate, which was 10.4%.

Operating expenses were 34.3 million, or 6.5% of sales, compared to 5.6% for the prior year. Included in this increase were special committee expenses of $2 million, or $0.05 a share, related to the Company's stock option review. Excluding these costs, operating expense was 6.2%. Further operating expenses were impacted by the recognition of higher bad debt expense of approximately $1.6 million. However, bad debt expense was slightly less than the March results. March quarterly SG&A expense without special committee costs was 6.3%, which is comparable to the June result without special committee cost of 6.2%.

Operating income for the June 2007 quarter increased 9.3% to 20.7 million. Without the cost of the special committee, the increase was 19.8%. Operating income as a percent of sales without the cost of the special committee was 4.3%, which is comparable to the prior-year quarter of 4.1%. Net interest expense was 1.9 million, compared to 569,000 for the prior-year quarter. The increase for fiscal 2007 was the result of higher debt, due to acquisition costs in the September 2006 quarter, and, to a lesser extent, increased working capital for other domestic and international businesses, and the impact of increased interest rates.

As planned, the Company is in the process of refinancing its primary debt facility. We anticipate that we will close on a new bank line of credit with greater capacity with similar rates and conditions as the existing $200 million line. The new facility should be closed by September 30th. Therefore, for modeling purposes, you should anticipate using interest pricing as in the past.

The tax rate for the June 2007 quarter was 39%. The prior quarter had an unusually low tax -- the prior-year quarter had an unusually low tax rate of 28.6% as a result of excellent performance in our European business unit, due to the burn-through of our net operating loss carryforwards, also known as NOLs. The 2006 NOL benefit caused EPS to be $0.06 higher than it would have been if our historical rate of approximately 38% had been applied to the quarter's income before tax. In future periods, we see our tax rate returning to a more normal 38%.

Net income for the June 2007 quarter decreased compared to the prior-year quarter to 11.3 million. Income as a percent of sales decreased to 2.2%, compared to 2.8% in the prior-year quarter. Excluding special committee costs, non-GAAP net income was 2.4% of sales. This result is comparable to the March 2007 result of 2.4% of sales, excluding special committee costs.

In summary, for comparability purposes, fourth quarter 2007 GAAP EPS was $0.43 and was unfavorably impacted by special committee cost of $0.05 per share. The 2006 fourth quarter GAAP EPS was $0.49, but benefited by $0.06 due to the recognition of foreign NOL benefits. Therefore, on a non-GAAP basis, the fourth quarter 2007 EPS was $0.48, compared to a non-GAAP EPS of $0.43 for the same quarter in 2006.

We were very pleased with our return on invested capital this quarter, which while including special committee cost, continues to be at our targeted range of 20%. On our June 18th restatement results call, we did not have the ROIC metrics available. The comparable ROIC quarterly results are 23%, 17%, and 17% for the first, second and third quarters of fiscal 2007, respectively. When adjusted to exclude special committee costs, the ROIC results are 23%, 22%, 20% and 21% for the first, second, third and fourth quarters, respectively.

Balance sheet metrics and cash management were as follows. Inventory turns were 6.7 times at the end of June 2007, down slightly from the 7.2 turns posted in the June 2006 quarter. However, inventory turns improved from the 6.2 times posted in the March 2007 quarter, due to better product management and reduction in non-RoHS inventory.

The number of days sales in receivables, DSO, was 60 days at June 30, 2007, compared to 59 days posted in June 2006. This is consistent with our March quarter result of 61 days. Paid-for inventory days were 2.9 days for the June 2007 quarter, and -5.9 days at the end of June 2006. 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. 2.9 paid-for inventory days at June 2007 improved when compared to the March result of 8.4 paid-for days. Vendor special pricing programs decreased payable days by eight days, versus a decrease of six days for the June 2006 period.

Our interest-bearing debt was 111.2 million at June 2007, compared to 32.2 million at June 2006, reflecting the purchase of T2 Supply and higher accounts receivable due to strong quarterly sales results. At March 31, 2007, interest-bearing debt was 132.9 million. For the quarter, cash flow from operations was +23 million, primarily due to lower inventories.

Mike will now give you an update on our business.

Thanks, Rich. As the numbers show, we had a very good fourth quarter and an excellent fiscal year across our business, as we achieved record revenues for the year of almost $2 billion. The ScanSource team did an excellent job throughout the year of building a foundation for managing growth into the future.

At the executive level, we announced the promotions of two key people, Scott Benbenek and Andrea Meade, to help us manage our growth opportunities worldwide.

Scott's new role as President of Worldwide Operations will provide more assistance to our business unit presidents and their senior management. In this role, Scott will help ensure that each business unit can continue to operate with speed of execution and focus in their specific markets, and have access to the appropriate resources from our corporate teams.

Andrea will be working with the senior executives managing the areas of information technology, our North American distribution center, which includes reverse logistics, systems integration and customer service teams, the partner services and solutions team, the OUI professional services group, and the North American technical support team. Andrea will also continue to lead our M&A activities in her corporate development role.

During the year, we made key additions to our management team with the acquisition of T2 Supply, and we added key resources in all parts of our business, with special emphasis on building additional capacity in our finance and accounting area.

As previously announced, we will be relocating our Memphis distribution center to a new facility in nearby Southaven, Mississippi. We will add about 60% more capacity, with an option for more space as needed in the future. The move to the new facility will begin in October and be completed by December. We will be incurring some additional expense in the September quarter as we prepare for this move.

We believe that our organizational structure, with separate business units with dedicated presidents and senior executives, is a key differentiator for ScanSource, and provides the optimum balance of efficient logistics and distribution excellence, along with dedicated sales and product teams who truly specialize in their technologies and markets. This combination of specialization and efficiency has been a value add to our manufacturers and our resellers.

Now I will comment on each of our reporting segments.

First, our North America segment had a record sales quarter and includes sales from all three of our technology areas -- AIDC and POS via ScanSource; communication products through three sales units, Catalyst Telecom, Paracon, and T2 Supply; and electronic and physical security products through ScanSource Security Distribution. North America posted sales of $435 million, a growth rate of 11% over last year.

Next we'll focus on the ScanSource AIDC and POS sales unit. We had a record quarter in the ScanSource North America unit, with strong year-over-year growth, especially when compared to a very strong June last year. The growth was led by very good growth in our POS business, both year-over-year and sequentially, with excellent results from IBM, NCR and [ELO]. Our AIDC business was also strong across all product lines, both year-over-year and sequentially.

We saw a balanced mix of large POS deals requiring fewer value-added services, and more small to medium deals requiring a high percentage of value-added services. We believe we gained market share as we benefited from more inside sales reps added over the last two quarters. Our product management team did an excellent job improving inventory turns without sacrificing customer service. We achieved our goal of eliminating almost all of the non-RoHS inventory that had added to our inventory level since last year.

Our partner services offerings continue to be well received, especially our VAR marketing program, which offers VARs access to ScanSource-provided resources. The typical marketing service allows our VARs to develop high-quality but low-cost demand generation tools.

During the quarter we launched our new reseller education and recruitment program called Impact Now. This multimedia campaign includes a quarterly magazine featuring programs and products to help our channel grow profitably. In addition, Impact Now includes a new industry trade show that had a successful debut in July in San Diego, and will appear next in November in Orlando, Florida. This is another example of how ScanSource can uniquely provide critical mass and efficiency marketing programs that can educate and create demand.

We'll next discuss the first of our communication units, Catalyst Telecom. Catalyst had a challenging quarter, as Avaya sales were down year-over-year and flat sequentially. The Catalyst team is working closely with Avaya to develop a more aggressive reseller development plan and a more aggressive reseller recruitment campaign. For the existing Avaya channel, Catalyst is investing market development funds to help generate incremental demand. We have seen better-than-average growth from our resellers who have successfully transitioned to selling convergence to their customers. Our sales from our convergence offer of Avaya, Juniper and Extreme continue to have very good growth results.

Juniper networks and Extreme Networks had record sales for the June quarter, as the combination of increased sales to Avaya resellers and the addition of new data-oriented resellers attracted by the Catalyst value proposition resulted in excellent growth year-to-year and sequentially. Although the June quarter was softer than we expected, we are anticipating sequential growth in the September quarter, which is Avaya's fiscal year-end and historically the best quarter of the year.

Our newest communications business unit, T2 Supply, just completed their first year as a ScanSource business unit and continued to post excellent results. T2 was recognized by Polycom as the distributor of the year at the recent Polycom Global Partner Conference, and continues to gain market share in North America. This award is the third in a row for the T2 Supply team. Polycom and Plantronics sales results were at all-time records for the T2 team. T2's strong executive team, experienced sales staff, and strong technical and product management teams have demonstrated capacity for managing additional products. T2 is expanding their product offerings by expanding their ADTRAN network products relationship, and adding AudioCodes' Media Gateways due to customer demand. Paracon and Catalyst also sell these products but to a different customer set from T2.

As a reminder, the September quarter will represent the first quarter for year-over-year results including T2.

Our third communications sales unit is Paracon, which focuses on converged communications products. Paracon had record sales for the quarter on a year-over-year and sequential basis. The sales team did an excellent job closing some large deals that we had expected earlier in the year. Our key vendor, Dialogic, continues to work closely with the Paracon team in adding new products and expanding our opportunities for next year. Our other key vendors, Quintum, [Invox] and AudioCodes also had excellent growth year-over-year and sequentially. Paracon's sales and product management team has been able to improve inventory turns and provide superior customer service, which has generated excellent ROIC results.

We'll now take a moment to update you regarding our third technology area, ScanSource Security Distribution. The security unit had another record quarter year-over-year and sequentially, as our business model of no sales to end users and fast, accurate product shipments from a large inventory has allowed us to gain market share.

This quarter saw growth across all product categories, with particularly large gains in video surveillance and outdoor wireless networks. Manufacturers continued to encourage resellers to try ScanSource as our sales and technical expertise have ramped up dramatically during the last fiscal year. Our efforts to educate and train resellers on the sales and technical challenges with IP-based security solutions include a Web site and seminar series called ScanSource Security IP Center. We will continue to make investments such as these to accelerate the adoption of new technologies in the security channel. During the June quarter, we added additional sales reps, business development reps and product managers as we anticipate our growth opportunities.

Our second reporting segment is international distribution. International distribution, which includes the geographies of Europe and Latin America, posted record sales of $89.2 million compared to last year's quarter of $68.5 million, a growth rate of 30%. When measured on a local currency basis, our international sales growth increased by 23%.

Europe had a record quarter year-over-year and sequentially as our team did an excellent job across the region, with particularly good growth from the UK, France and Germany, with all three growing year-over-year and sequentially. The number of active customers continues to increase, and we are seeing our largest customer give us more of their wallet share. Many of the largest customers were formerly buying direct from the manufacturers, and are now being encouraged to consider distribution as an attractive alternative with similar pricing and better customer service. As two-tier distribution becomes more acceptable, our opportunity increases across the region. As a reminder, the September quarter is seasonally weak due to the August holiday month across Europe.

The Latin American team had good performance, which was once again led by significant growth in Mexico, particularly on a sequential basis. We've been challenged over the last year with more aggressive competitors in the Latin American region, resulting in more margin pressure than in prior years. However, we believe we are maintaining market share, but at lower margins than we prefer. Our strategy is to work with our key manufacturer partners in matching our investments in recruiting and market development with an appropriate ROIC. Meanwhile, we have begun to expand our opportunities beyond AIDC and POS with specific initiatives with Mitel's communications group. Although still early, and started in Mexico only, we believe Mitel can become a key vendor for us in Latin America.

We will conclude this part of the call with our expectations for the September 30, 2007 quarter. We think total revenues for the September quarter could range from $525 million to $545 million, and diluted earnings per share, excluding any impact of special committee costs, could range from $0.45 per share to $0.48 per share.

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

(OPERATOR INSTRUCTIONS). Mike Marinaci, (inaudible) Capital.

I was wondering if you could explain a few movements in the balance sheet other than the items you talked about. The prepaids were up like $7.5 million sequentially. I tried looking back; I didn't see any number that was even remotely close to that. I was just wondering what that was.

We'll have to get back to you on that. The prepaids do reflect the acquisition of T2, and --

But you acquired T2 a year ago. I'm saying sequentially it went from 3 million to 10.5. You don't have an answer there?

I'll get back to you later in the call.

Also while I've got you, the goodwill and the intangibles; there seemed to be a shift there.

We finalized the acquisition of T2, and we increased the valuation of the customer list and reduced the goodwill. So what you find is an increase in the other assets for the T2 acquisition for the customer list, and then less in the goodwill category.

So what will that mean on a go-forward basis as far as amortization of those numbers?

The amortization in the current quarter is probably about $200,000 higher. On a go-forward basis, it will be slightly higher, but not appreciably higher.

Got it. Okay. That's all I had. Thank you.

Chris Quilty, Raymond James and Associates.

I was hoping you could give us a little bit more detail on the Catalyst business and some of the weakness there. And to the degree you can, a background on some of the corporate happenings with Avaya and how that may impact you.

I'll take a shot at that. We actually have had good response with Avaya relative to talking about the issues in our business together. We've been concerned, frankly, for the last two quarters about the growth with our existing resellers and what their capabilities are. As you remember, a couple of quarters ago, we had supply constraints, which caused us to not have as many orders. And it's possible we lost some orders along that process, too. Those issues with supplies have gone away, and now we're looking at what else could be our challenge in the Avaya business. So we've got this campaign, as I mentioned earlier, to start recruiting more resellers, and putting more investments in the existing resellers to help them generate new demand.

Is that all out of your pocket, or is Avaya kicking in for any of that?

No, it's shared. It's a shared cost with Avaya. And what we found is that certainly there's a whole lot of their senior management involvement in their new deal with the private equity guys, but really it hasn't impacted the business from a day-to-day basis, at least from what we can see.

In terms of the underlying demand trends for those converged products in voice over IP, and their competitive position, Avaya, relative to other vendors -- your thoughts there?

We're not hearing from our resellers that they are losing more deals now than they did a year ago. So one of our concerns is that we're not getting up to bat on enough new deals, and that maybe what we need is an improved coverage model with our resellers. In the past year we've seen our largest resellers still do very well. Our largest Avaya resellers are growing year-over-year, but we've got that mid-level reseller and some of the smaller guys who are not being as successful as they were before. So we've still got some work to do to figure out why that is.

I can't remember the timing. A year ago, or more than a year ago, you were increasing the emphasis on the SMB product category. Any update there?

I would say the SMB area has been a disappointment. The last couple of quarters we have actually declined on a year-over-year basis. So we've got some work to do there. The ECG has been much more steady, but some of the growth that we had a year ago from SMB we haven't had this year.

Flipping over to Rich's comments earlier, anything specific to point out in the higher bad debt expense?

Bad debt -- of course we've got the increase in sales year-over-year. But as you know, as we -- our business has many, many customers, and we're able to spread the risk. Over this last year we've experienced more in the way of bankruptcies than we have in the past. So our overall metrics on the receivables continue to be good; it's not going to cause us to change our underwriting policies. But this last year, we had bad debts over the whole year that were much higher than they were in the past.

Given the current headlines we're seeing out there, is it going to put you in a pickle of maybe extending terms or providing more financing for some of your resellers who may not be able to get it from other sources? Or is that a decision you would choose to make?

We're going to continue to utilize the same underwriting policy and basically the same kind of terms we have in the past. The performance of our customers is such that we won't make the same kind of decisions we've made in the past.

I think the other thing, Chris, is that we've got other partners, other customers who are doing very well and, we believe, will do well even in a tight credit environment. So if we have a partner who doesn't get the business, or can't afford to finance the business, we believe one of our other partners can get it instead.

One more thing. With regard to that, in our forecasts we have included more provision for bad debt because of the experience over the last year. So in that EPS number that we've given you, if you look at the midpoint of 5.35, our EPS target of 5.35 is $0.47. And that includes a healthy provision for bad debt.

If you also can maybe give us a sense -- you implied in your statements that you're going to have some facility costs in the fiscal second quarter for moving out of Memphis. Can you give us sort of an order of magnitude sense there, so when we go ahead and update the models out for Q2 we can kind of get that in the right range?

We've got a lot of interference there. I think your question was in the second fiscal quarter, what do we think we're going to have from an expense from the new facility. Is that right?

That's it.

Rich, do you have that number?

From an expense point of view, our second quarter we're actually going to be carrying the old facility costs. So we'll have depreciation and the debt carry of the old facility for that quarter, as well as that will be the first quarter where we have -- where we have the full facility costs. I think that our costs on that new facility will be in the range of 4 to 500 a quarter. But that, of course, gives us a lot more capacity for growth.

Were you guys busting at the seams at the old Memphis?

We were -- we're about over 85% capacity on an average basis, which really restricts your ability to move product in and out efficiently. So it's probably costing us more than it should at our existing facility because we can't be as flexible with inventory locations and our workforce.

If I can, one final question. The Cisco wireless LAN product that you picked up back a while ago -- are you making any traction with that?

We believe we are doing quite well there. The only challenge we've got is getting our resellers educated and certified. For our resellers to become successful in competing in -- for particular deals where there are some existing Cisco partners bidding against them, they have to be certified and achieve these levels of specialization to receive the appropriate discounts to be more competitive. So that's been something that, we think, has been slower than we originally thought, was getting our channel educated and certified. But Cisco has done a great job of helping us defray the cost of doing that. We've just got to get our resellers to give us their technical people and their salespeople time out to get this done.

Got it.

I've got the answer to Mike's question earlier. The prepaid expenses for the current year include what amounts to a tax receivable for payment of federal taxes of about 4.5 million. In the current year we do have some service contracts that are prepaid for T2; about $1 million of that. And then we also have some prepaid marketing expenses. So that's why the influx on that account. So effectively, we've got a receivable for the federal government on our books right now.

Reik Read, Robert W. Baird & Co.

With respect to the Avaya business, it seems like if I go back in the last couple of quarters, you guys have talked about increasingly using your balance sheet to help in that area. And I'm wondering, with the weakness that you're seeing there -- and I guess this goes more to just total communications, not just Avaya -- but do you envision having to use your balance sheet more? And as you're doing that, how are you getting compensated? Is this -- you're getting a better close rate so, therefore, better growth, or is there a better margin associated with it? Where do you get the ROI on it?

This is something that we sit down with Avaya and have the discussions about what is the -- number one, what's the optimum level of inventory to have so that we can provide the right service levels. As I said earlier, a lot of this past year up until the last quarter we had supply issues. So we were actually -- weirdly enough, we had some specific items that we were out of stock on, but we had other items that we were heavy on because we couldn't ship a complete system. So our inventory and our balance sheet investment was higher than it should have been up until recently. And we had hoped that growth would -- in the June quarter would get us out of that scenario. So we still got higher inventory levels than we would prefer to have to satisfy our customers.

Having said that, our DSOs that we've talked about have stretched out probably more in our Catalyst business than in some of our others, because they typically are larger deals, more complex installations. As the IP technologies have started to become more and more prevalent, it's been interesting to note that there's actually a higher initial cost from the reseller in getting these systems up and running. And until they become more familiar with the technology, it takes them longer to get them installed and get paid, which means they are slower paying to us. We think all that now is in the background. And on a go-forward basis, we see that -- we believe that we're going to be able to reduce our investment in that business, and we're doing that in conjunction with Avaya.

To go back on the Avaya point, to make sure I understood that correctly. You feel that that bad mix in inventory that you had previously is now squared away?

I would say it's not quite there, but we're in the process of doing that. That's really where we are. Once we got through the supply issues through the March quarter, we really didn't have the June quarter from a sales perspective that we had anticipated. So we're still carrying more inventory in the September quarter. So we're really assuming and anticipating a strong September.

Just to clarify what you said before, Mike, you don't anticipate necessarily having to use your balance sheet more to win deals; it's a matter of getting more coverage out of your current group?

That's correct. That's right. It's not a competitive situation as much as it is making sure that our existing channel can be successful.

Great. You had mentioned in your comments, Mike, that the point-of-sale business had done quite well. And we had seen prior to that, I think, in a couple of quarters where maybe some of those deals weren't being won. Now you've get news out of the retailers that they seem a little bit like the results are a little bit weaker than what people were hoping. As you kind of look forward, is there concern on your part that maybe some of that CapEx that they were willing to spend this particular quarter is going to start to go away? Do you have any insight on that?

I really don't have any insight on that at this point. We're just glad that we've got some of these deals closed that had been in the pipeline for a while. We still think there's a reasonable pipeline of deals still out there. So you just never know. We haven't been able to predict this POS business for the last two years.

Rich, one quick question on the interest expense. Sequentially it was almost $300,000 higher, with lower debt balances. Can you talk about what happened there?

Lower debt balance at the end of the period. (multiple speakers) pay interest on average debt. So we've got the average debt issue. So on an average basis, it was higher during the quarter. We also had -- in our quarter we had a slight rate increase, too.

Jeff Rosenberg, William Blair & Company.

Just to kind of hone in on your guidance, high-end of your EPS guidance of $0.48 is flat sequentially, but you're looking for some revenue growth in the quarter of flat to up 4% sequentially. Can you talk a little bit about your expectations for margins? Is it fair to assume that operating margins are expected to tick down, and why? Is there another below-the-line operating margin line number that's responsible for the difference there?

I'll take that. What we're looking for in this upcoming quarter is maybe not quite as favorable a product mix, so a little tick down on the gross margin, maybe more towards what we saw in March. And then, as far as SG&A goes, we are making investments in headcount in our sales staff. We have also anticipated some needs for our move. And then, as I mentioned before, in our forecast we have a provision that's slightly higher than what we've had in prior periods, which we thought was prudent based upon our experience -- provision for bad debt; I'm sorry.

But the provision for bad debt (inaudible) I thought you were saying a minute ago that that's not any higher than it's been the last quarter or two, even though I know it's -- because it's been running high? Right?

The fourth quarter was actually slightly below the third quarter. So what we have provided in the first quarter is more in line with the higher periods prior to the fourth quarter. So when we look at the operating profit, we came in at about 4.3 adjusted. We'd probably take that down a little bit based on product mix and then investments in SG&A headcount, and the move.

And just on the other hand, gross margins in particular, but operating margins, too, have been running higher year-over-year. And yet I thought about your business in terms of incremental growth coming particularly in the core business from larger customers who don't need as much of your value-added service, so therefore, perhaps good growth, but lower gross margin. What's offsetting that? Where are you really being able to see that improvement in gross margin on a year-over-year basis, and is that sustainable over a longer period of time?

We're showing good results in our security business. The T2 acquisition has been a very good acquisition for us. So both of those domestic businesses help to blend up our margins. And then, of course, with our international business growing, the international business also has better gross margins. So, as to the second question about sustainability, we think that as these businesses continue to grow for us, that the margins should be better than what you saw maybe a year ago on a gross margin basis.

Because on an operating margin basis, if you adjust for historically 123R expenses, you're at the high-end of your historical range and you've been staying there. So historically, there's been usually a tendency for that to stay within a relatively narrow range, but to trend back down. But you feel like the way your business is coming together now, that you can keep these margins 20, 30 basis points above where they have been historically?

I think, Jeff, on the -- if you think about our SG&A for a minute, we do have some higher SG&A in these new business units. But we've also continued to get operating leverage that we really haven't talked about. And we believe that our productivity improvements in our corporate support teams, whether it's our distribution center or other support areas, we think we've gained leverage over the last year that's showing up now on an operating earnings basis.

If I think about your sales growth from a higher level, this quarter if you back out T2, and if you look at the first quarter, there's no longer that issue; you're kind of growing at a high single-digit growth rate, which is below the growth rate you achieved for the whole year, I think, below what you think you're capable of. Is that really all about just these issues with Avaya and trying to get better performance there? Or are there other opportunities you see in the near to intermediate-term to improve revenue growth as you look out over the next -- the whole fiscal year?

We're not going to give guidance out fiscal year, but --

I'm just looking like directionally. Where do you think are the areas that are dragging you down a little bit, and what your outlook is for trying to improve that performance, just qualitatively?

The other thing that we can't forget in September is Europe. Last year we didn't grow from the June quarter to the September quarter in Europe, and we are forecasting that again this year. So once we get past this seasonally tougher quarter for Europe, I think then we'll see -- assuming everything else comes back into play normally, we think we can have growth. Can't forget, though, if I just look out a quarter, that -- beyond September that the quarter following Avaya's fiscal year-end is always the toughest one for Catalyst. So we've just got to keep that in mind, too.

But I think our European -- we're talking about where is our growth opportunity? I think it's really two key areas. Europe continues to have opportunity that we haven't tapped into yet. We still don't have all of our vendors on board with a Pan-European strategy, nor are they all on board with a two-tier strategy. So we think the opportunity there is still significant. We also believe our security business is really just starting to gain some momentum and critical mass, and that hopefully over the next year we'll see some substantial growth there as well.

Is that big enough to noticeably contribute from our point of view in terms of if it grows at what you hope it to, is it going to add enough to the growth rate that we would notice that improvement in the growth rate because of security? I know you don't want to tell us exactly what it is. But how material is it relative to its ability to contribute to the whole?

I think we still may be a couple quarters away from that. But I do believe that that is a potential for next year, yes.

[Tom Yuhl], Jefferies Asset Management.

I was wondering, as you move from the Memphis facility to the new facility, are you experiencing or expensing costs today related to that transition? Or once you move to the new facility, will then -- will you begin expensing the transition and the depreciation that's associated with that facility after you make the transition?

I think right now we do have a little bit of headcount in anticipation, but I think the expenses are going to start as we move into the new facility, which is really starting in earnest in October. So we will have some expenses as we get towards the end of the quarter preparing for it. But the expenses of the move itself will primarily be in the December quarter.

As far as the expenses of the facility itself, we don't really officially enter into the facility, start working in the facility until October. So that's when we'll start picking up some of the lease cost. And as I mentioned earlier, the December quarter we're going to have overlap. So we'll have our own facility that we'll continue to have debt load on, and the depreciation and some of the utilities, and then we'll have the new facility starting up in that same quarter.

I assume that you'll have a little bit excess capacity when you move to the new facility. Is there a way to compare the cost of the old facility to the new facility? What's the delta there until you totally fill it up and get back up to capacity?

I don't think we'd really want to disclose that, for competitive reasons.

I'm just trying to figure out the cash flow in the quarter. Can you say what the sequential change was in the overdraft?

Let me get back to you on that. But again, the overdraft is simply the way that our bank account works. It's checks that have not cleared. And that's a normal situation for us. I'll get back to you later on the call as to what exactly that number is. From a cash flow perspective quarter-over-quarter, we had a good quarter in terms of positive cash flow; good decrease, frankly, in the inventory, which was something that was planned.

And the decline in the inventory is basically all RoHS related and Avaya related? I was looking back; I haven't seen your inventory decline as far back as I have financials. But is that -- was that the main reason, or is there anything else going on there?

We don't break it out by vendor, but we did mention the non-RoHS inventory that we had in March that we had planned to get rid of by June. So that was a big part of it. In addition, we had some just better product management from our teams across the board. We put more focus on it. With our June 30 fiscal year-end, it gives us a chance here every year to make sure we clean up any surplus we might have.

(OPERATOR INSTRUCTIONS). Ajit Pai, Thomas Weisel Partners.

A few quick questions. The first one would be just the sort of hard numbers in terms of percentage for AIDC and point-of-sale as a percentage of sales. And then the telecom business as a percentage of sales. And then I'll move on to the next.

The split between AIDC and communications for the quarter, 62% AIDC and point-of-sale, which includes the security business, and then 38% would be communications.

Within that AIDC point-of-sale, if I heard you right a few minutes ago in answer to the last question or the one before that, I think you had mentioned that the security business is going to become material in the next couple of quarters. But material, typically, folks talk about the 10% of sales benchmark. Is that what you're beginning to approach right now?

I think the question wasn't a material question; it was do we think -- when will it start to impact the growth rate.

(inaudible) overall. Yes.

So I really wasn't saying that it was material from your definition, but more (multiple speakers) it was starting to have an impact on our growth rate. So, yes; we do think that's going to happen over the next couple quarters. Yes.

(inaudible). What about becoming material as a percentage of revenues? If you had to guesstimate when that would be, how far out do you think that would be?

A lot of people want to know that answer. I'm not willing to put my neck out on that one yet.

Okay. Just looking at RFID, you know, there's been so much disappointment, all of that. And you were pretty active in sort of trying to enable the market with Solution City, etcetera. Are you seeing any kind of greater interest, any kind of trends that you would like to share with us as far as that's concerned?

It is interesting that it is growing. We don't break it out as a segment. But the RFID business actually -- we did a lot of training, got a lot of people educated. What's happened is the compliance business that everyone was focused on from Wal-Mart and the DOD just really hasn't materialized in any significant way. But, because the technology got better, and the price of tags and equipment came down substantially over the last year and a half, we have seen a lot of more traditional closed-loop RFID sales actually happen. So, I think, for 2006, we probably had a number of around 7 million or so in sales, if I just had to pick a number for you. And I would say that that's probably doubled in size in the last year.

Mostly driven by the closed-loop systems?

That's correct.

Very broadly, you play in two of the most significant geographies in terms of sales; you play in both the Americas as well as in Europe. Is there any plan or anything imminent about entering Asia?

Nothing planned or imminent. We continue to have conversations with our manufacturers who play a role over there, and they continue to ask us to consider using our model. Our challenge is it's just tough to find an entry point where we can achieve enough critical mass in a timely fashion. We probably, if we were to go over there, we need to have some type of acquisition to get us started. It would be tough for us to leverage our management team in the U.S. or in Europe because of the distance and the time zones. So I would say it's not on our near-term horizon.

One additional question. In terms of competitive dynamics, you have had some of your significantly larger electronics distributors, etcetera, sort of try and get more active in your space. And their typical margin structure has been lower. Are you watching greater competition from them, are you watching the same level of competition, or are you watching the competition intensify?

I would say it's not intensifying. I would say in some cases, a few of the guys have lost some interest in our business. We've seen some of the larger broad line distributors exit some parts of our business.

Could you share which ones?

Last year Tech Data got out of the point-of-sale business. That was one. And so we've seen -- what we've really seen over time, since really 12, 13 years ago, was that the manufacturers want a value-added model. And if any distributor enters the business and doesn't invest in a value-added model, then they will quickly not receive the support from the manufacturers and, frankly, the resellers. But we've always said that even if a larger distributor enters our space, that if they are required to make the same value-added investments that we make, then we're not worried about competing with them.

Mike Marinaci, (inaudible) Capital.

Rich, just two quick ones. I was wondering if you found the book overdraft number. And then I was wondering if you had the percentage allowance, or the allowance for the AR.

The AR allowance percentage will be in the 10-K that will be filed next week. But basically, I can tell you that the AR allowance continues to be at the same kind of metric that you've seen in the past. As far as the overdraft goes, the overdraft at June, which was a book overdraft, is about 46 million, which is down about $1 million from the prior period. But one way to take a look at that is, if you look at that figure, that amounts to less than eight days of receivable collections. And as you know, the way our bank line works, as those checks clear, it gets charged against the line. But everyday we're collecting receivables, too.

You don't have the AR allowance number handy? Is that correct?

No, I don't.

Chris Quilty, Raymond James and Associates.

Just a follow-up question. International growth, as always, very impressive. Can you give us a sense of what you think the breakdown of that growth is, underlying market, foreign exchange, and sort of core growth of the market? And maybe tied to that, are you seeing stronger growth or stronger prospects in Europe or the U.S. for the related AIDC point-of-sale business?

We don't break out the growth rates for Europe separately. We have them combined, as you know, internationally. So I won't do that. But (inaudible) give you the -- our sense is -- that we would want to leave you with is that we're continuing to grow faster than the market, which is obvious. We continue to see certain vendors create new programs which favor two-tier distribution. Over the last two and a half years, in addition to Symbol -- which is now Motorola, which really started the bandwagon -- Intermec, Zebra and, I would say, most recently Hand Held Products, have really stepped up in driving new programs that favor two-tier distribution over mixed model distribution, which has been the model of choice in Europe up until now. So we still have other vendors. Another vendor that's done a great job with allowing us to sell on a Pan-European basis is Elo, where as we've got several of our point-of-sale vendors where we're still restricted to selling in one or two countries only. So we believe the growth opportunity still is substantial in Europe, probably more than we originally thought. And so our challenge is to continue to be somewhat patient, but create the model that the vendors will prefer.

At this time we have no further questions.

Thank you for joining us. Our next conference call to discuss the September 30th quarterly earnings is expected to be on October 25th.

Thank you.

This does conclude today's conference call. You may disconnect at this time.