Scansource Inc (SCSC) 2008 Q1 法說會逐字稿

Welcome to the ScanSource quarterly earnings conference call. At this time, your lines have been placed on a listen-only mode until the question-and-answer session. The call is being recorded. If you have any objections, you may disconnect at this time. I will now turn the call over to Mr. Rich Cleys. Thank you, sir. You may begin.

Thank you, Susie. Thank you for joining us for the ScanSource conference call to discuss financial results for the quarter ended September 30, 2007. My name is Rich Cleys, Chief Financial Officer of ScanSource. With me is Mike Baur, our CEO. We will review with you the quarter's operating results and then take your questions.

This conference call contains certain comments which are forward-looking statements that involve risks and uncertainties. These statements are subject to the Safe Harbor created by the Private Securities Litigation Reform Act of 1995. Any number of important factors could cause actual results to differ materially from anticipated results. For more information concerning factors that could cause such a difference, see the Company's annual report on Form 10-K for the year ended June 30, 2007 filed with the Securities and Exchange Commission.

I will start our discussion by providing overall sales and operating results. The Company posted sales of $553.7 million for the quarter ended September 30, 2007, an increase of 12% over sales of $496.2 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 6% year-over-year increase in communications products for the quarter ended. That produced a 59/41 mix of AIDC/POS versus communications products.

Gross margin was 10.5% for the September, 2007 quarter, compared to 10.4% for the same period last year. The gross margin increase was the result of a favorable customer mix, better-than-expected international sales where gross margin percentage is higher. This quarter, we overachieved on certain vendor programs. A more normalized gross margin would have been about 10.3%.

Operating expenses were $32.8 million or 5.9% of sales compared to 6.9% for the prior year. Included in this increase in expenses were special committee expenses of $500,000, or $0.01 a share, related to the company stock option review. Further, operating expenses were favorably impacted during the quarter by $800,000 or $0.02 a share due to a reversal of an overaccrual of 2007 bonus liability. Excluding these amounts, operating expense was 6.0%.

Operating income for the September 2007 quarter increased 17.8% to $25.4 million or 4.6% of sales. Without the cost of the special committee, the increase was 20.4%. Operating income as a percent of sales, without the cost of the special committee, was 4.7%, which is improved over the prior-year quarter of 4.3%. This strong operating profit reflects stronger sales results and gross margin percent, along with the benefit of the previously mentioned bonus liability reversal.

Operating expenses will increase beginning in October for the new Mississippi warehouse. We expect our recurring expenses to increase by $500,000 per quarter, and we will incur approximately $400,000 of one-time move costs in our second quarter.

Interest expense was $1.8 million, compared to $1.7 million for the prior-year quarter.

As we discussed in the previous call, the Company has completed the process of refinancing its primary debt facility. This new credit facility increases our multinational currency line from $180 million to $250 million. In addition, we have a $50 million accordion feature which as syndicated will allow for an increase to a $300 million facility when we need it.

Interest-rate spreads will be slightly better than the previous facility.

The tax rate for the September 2007 quarter was 38%, compared with the prior-year quarter of 38.4%. This quarter, the Company adopted Accounting for Uncertainty in Income Taxes or FIN 48. The Company did not have a material change to the tax accounts and retained earnings as a result of adopting the standard.

Net income for the June 2007 quarter increased compared to the prior-year quarter to $14.7 million. Net income as a percent of sales increased 2.65%, compared to 2.5% in the prior-year quarter. Excluding special committee costs, non-GAAP net income was 2.7% of sales.

We were very pleased with our return on invested capital this quarter, which, while including special committee costs, continues to be above our targeted range at 23%. When adjusted to exclude special committee costs, the ROIC results are 24% for the first quarter of 2008.

Balance sheet metrics and cash management were as follows. Inventory turns were 7.0 times at the end of September 2007, down slightly from the 7.2 turns posted in the September 2006 quarter. However, inventory turns improved from the 6.7 times posted in the June 2007 quarter, primarily due to increased sales. Our inventory turns differ by business unit based upon ROIC by product line and the role that the individual vendors want us to play. A blended turn of 7.0 times is within our targeted range.

The number of days sales in receivable, DSO, was 61 at September 30, 2007, compared to 63 days posted at September 2006. This is consistent with our June quarter results of 60 days. As part of our analysis of receivables, we regularly review aging based upon due dates. Our September aging has been slightly better than the prior four quarters.

Paid-for inventory days were 7.2 days for the September 2007 quarter and a -5 days for the quarter ended September 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 our vendors.

Vendor payable days decreased by three days from last quarter, primarily due to vendor pricing programs.

Our interest-bearing debt was $149 million at September 30, 2007, compared to $107 million at September 30, 2006, related to higher accounts receivable of strong quarterly sales and higher ending inventory. At June 30, 2007, our interest-bearing debt was $111 million. Our cash balance increased to $11.8 million at September 30.

Mike will now give you an update on our business.

Thanks, Rich.

The September quarter turned out to be outstanding quarter across all business units and geographies. As we discussed on our conference call in August, we typically have a strong catalyst telecom quarter due to Avaya's year-end push, but we were concerned about the seasonality associated with our European POS and barcoding business.

In addition, this quarter was the first with T2 Supply's results having a prior-year comparison. I will discuss each of our business unit's sales results, but first I have some updates for you.

We are announcing today that T2 Supply and Paracon will be combined into one new business unit called ScanSource Communications. The combination of these two units will combine our industry-leading teams in video and audio conferencing and voice and data solutions, including Voice-over-IP, gateways and computer telephony products. This new sales unit will be led by Jill Phillips from our T2 Supply business unit. Jill and the teams from Paracon and T2 will offer their customers and vendors more services, more marketing programs and added scale and reach.

We also plan to add resources to expand our expertise across all existing products. We plan to selectively add additional products to our communications portfolio over time.

During the quarter, we hosted hundreds of resellers at the first IMPACT NOW event in San Diego, featuring a trade show and educational seminars designed to help our resellers grow their businesses and gain insights into Best Practices by networking with other successful resellers. The event is also designed to recruit new resellers to all of the ScanSource Inc. business units. Our next IMPACT NOW event will be on November 12 and 13 in Orlando, Florida.

Our planned move to a new distribution center in South Haven, Mississippi near Memphis was started in October. We had a very successful transition for our communications products with no disruptions to our customers or vendors, and plan to move the POS, barcoding and security products before the end of December. Our employees have done a fantastic job getting this new facility ready to go, and have completed our first phase of the move as planned.

As Rich mentioned earlier, we will have one-time costs of $400,000 in the second quarter and recurring costs of $500,000 per quarter.

Now, I will comment on each of our reporting segments. Our North America segment had a record sales quarter and includes sales from all of our technology areas -- ScanSource POS and barcoding, (inaudible) Telecom, ScanSource Communications and ScanSource Security. North America posted sales of $463.7 million, a growth rate of 8.3% over last year.

Our North America discussion will start with ScanSource POS and barcoding. We had a strong quarter in the ScanSource point-of-sale and barcoding unit with very good year-over-year growth. The areas of particular were in mobile computers, wireless, data capture devices, and barcode printers. We believe we were able to gain market share during the quarter while maintaining our gross margins as we benefited from certain vendor programs.

During the last few quarters, we've seen a significant portion of our business development and recruiting efforts shifted to small and medium resellers versus large resellers. We've accomplished this through more sales reps and more marketing dollars being invested in this area. As a result, we have benefited from higher margins, augmented by more advantageous vendor programs.

We saw fewer large deals during the quarter and have resulting higher margins and higher utilization of our value-added services. However, we believe there were some large point-of-sale deals pushed out to the December quarter. ScanSource POS and barcoding hosted their top resellers to an exclusive event in September to share ideas, educate on business topics, and network with top vendors and ScanSource executives. This partner conference reinforces our relationships with customers and provides excellent insight into growth opportunities for next year.

Next up is our Catalyst Telecom unit. Catalyst had an excellent quarter across all product lines and vendors. Typically, this quarter is strong (inaudible) Avaya's year-end. Avaya resellers had end of year incentives and promotions in place to encourage and reward business shipped by quarter end. Catalyst saw growth in the Avaya ECG business year-over-year, as well as with Juniper and Extreme, as resellers continue to develop their convergent strategy with these key product sets.

The Avaya services business has also begun to grow nicely and be a significant contributor to the overall business. Catalyst offers a variety of Avaya-provided service offerings to resellers and has seen a significant growth in the attach rate.

During the quarter, Catalyst launched its newest vendor, Aruba, and expects product sales to ramp over the next few quarters. Aruba and Avaya are forming a strategic alliance that will provide joint solutions and programs to our resellers.

Catalyst has continued to offer its well-received convergence education and training to existing resellers and has significantly increased activities around recruitment of new voice and data resellers.

Next, I will discuss T2 and Paracon's results. As I described earlier, our other two communication units are being combined today to form ScanSource Communications. T2 Supply had another excellent quarter, led by Polycom, and Plantronics growth year-over-year and sequentially. The combination of an aggressive T2 sales and business development team, along with the industry-leading technical services team, continues to attract new customers from competition. Plus, T2 has increased their recruiting activities through a combination of trade shows and other marketing tools that has resulted in new resellers purchasing audio and video products from T2.

Paracon also had excellent success this quarter with AudioCodes, Cisco, (inaudible) Polycom and Plantronics. In addition, Paracon saw good year-over-year gains with Dialogics' gateway products and building block products.

During the last four quarters, the Paracon team did an excellent job growing through the loss of a significant vendor and had to deal with the acquisition of its other key vendor. The Paracon team is excited to be joining forces with T2 to provide more opportunity and more resources for the combined entity. We believe this move will position ScanSource Communications to expand the reach for existing vendors and possible new ones, as there is very little overlap between the two business units. By combining the sales and technical teams along with the product management teams, this new unit will achieve critical mass and scale faster.

We will now update you on our third technology area, ScanSource Security. The Security team had another record quarter as sales from Panasonic, [Alberion] and [Axis] led the way. However, our [card] printer business was not as seasonally strong as last year, that we still believe we took market share.

During this quarter, the Security team continued to add new customers through a combination of strong sales and business-development efforts, supplemented with more marketing. Answer Security hosted IP educational roadshows again this quarter to recruit new resellers and update existing customers in the opportunities ahead as IP cameras and other IP technologies become the standard in the industry. We continued to gain market share because we don't compete with our customers, and we provide consistent, accurate product shipments in a timely manner and at a competitive price.

Our second reporting segment is International Distribution. International Distribution, which includes the geographies of Europe and Latin America, posted record sales of $90 million compared to last year's quarter of $68.2 million, a growth rate of 32% over last year. If measured on a local-currency basis, our international sales growth increased by 24%. ScanSource Europe POS and barcoding had an excellent quarter, despite the seasonality that's prevalent in Europe during the September quarter. We were particularly pleased with the record sales results from our POS team in the UK and Ireland. We expect this trend to continue, as we are announcing today the addition of Metrologic data capturing collection products to our line card in the UK. Our European team has added focused resources in the point-of-sale area and expects to attract new point-of-sale resellers as we (technical difficulty) Metrologic product line.

Our barcoding business was also very start in the quarter as we saw gains across most product lines. We did see particular strength in the north of Europe during this holiday season, especially in Germany. ScanSource Europe hosted its top customers during September's Partner Conference and celebrated five years in business. This event allowed us to gain valuable feedback from customers and vendors on our business model and future strategies. We continue to receive excellent acceptance of our centralized distribution strategy and our focus on operational excellence.

ScanSource Latin America had an excellent quarter across all countries. Our business was particularly strong from our Miami-based export business to countries in Central and South America. We have benefited from the decision earlier this year to add more sales reps in the Miami location. New customer recruitment is up, and we see better coverage for our smaller customers.

In Mexico, we're pleased with results as we have transitioned from a large [deal] based business a year ago to a more consistent run-rate business with more predictable profitability. We also saw very good sales results across all product lines, including a good contribution from (inaudible) in Mexico.

We will conclude this part of the call with our expectations for the December 31, 2007 quarter. We think total revenues for the December quarter could range from $550 million to $570 million, and diluted earnings per share, excluding any impact of special committee, could range from $0.48 to $0.52 per share.

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

Thank you, sir. At this time, we will begin the question-and-answer session. (OPERATOR INSTRUCTIONS). Reik Read.

It's Robert W Baird & Co. Rich, you guys talked about, in the past, with respect to the DSOs, some of the complexity in the telephony business that you're starting to see, which is really causing some of these projects to take longer. Therefore, you don't get paid as quickly. Does that also translate into a lengthening sales cycle, or are there ways that you guys are combating that?

First of all, I said that the trend that we are seeing in terms of the DSO is kind of solidified in that business, so it was Voice-over-IP and new applications that were taking more time. That has caused us to change those terms. Once you change those terms, of course, those terms are pretty much in place. But as far as the overall sales cycle goes, maybe, Mike, you want to comment on that?

Yes, I think, Reik, the overall trend by the way (inaudible) kind of levels off as you can see in that DSO area. We don't see a longer sales cycle today. I think that was the case a year ago, but it is not (technical difficulty) today.

Okay. Then Mike, last quarter, you had talked that, with respect to the catalyst business, the number of the resellers were not investing perhaps as much in the SMB area as you had seen previously. Has something changed there to cause -- because the telephony results were very good -- has something change there?

Well, I think Avaya recognizes that issue and they (technical difficulty) programs to help our SMB business. We still weren't as happy with our SMB results as our ECG, but yes, I think everyone from the reseller to Avaya to our Catalyst team are very focused on making the SMB products easier to Buy, and more importantly, easier to install and walk away from without having a lot of extra cost after the sale. So, I think the updated versions of the SMB product line are getting much, much better in that regard.

Okay. Just one question on the expenses -- Rich, I think you partially addressed this, or maybe this is the full explanation, but expenses were flat sequentially and revenue up 6%. I think you guys had talked about, last quarter, that some of these expenses for the Phase I move would start to hit this quarter. So even with that reversal, you'd almost expect expenses to be flat to up. Can you talk about if there were any other issues or any savings that you had in there?

The expenses for the move weren't very significant in the September quarter. They are going to be more significant because the move actually started in October, so as I said, those expenses will be about $400,000 for the quarter. So, the impact on the September quarter was minimal, so that reversal of the overaccrual was actually a benefit to the SG&A.

Okay. Then would the expenses, the $400,000 of one-some items, and then this $500,000 increment -- is that something that lasts for a couple of quarters and then dissipates, or is that something that you expect to be more permanent?

We would expect the warehousing costs to be more permanent.

But that's not -- is that an incremental expenditure?

Yes, yes.

Jeff Rosenberg.

William Blair & Co. Could you talk a bit -- I mean, rich, you referred to the fact that the normalized gross margin would be 10.3%, and you sort of, before you said that, you had talked about a number of different factors that affected the gross margin, some of which as I think about as things that usually fluctuate. So can you pinpoint exactly the differential between what you did and what would be "normalized"?

Well, I think, first of all, we overachieved on vendor programs, and that had a beneficial impact. That's probably worth about $0.02 a share to the quarter. Then of course, the mix of the sales, the customer mix and the size of the sales, although we had a good sales quarter, we didn't have a lot of those large deals but -- I mean, what that does is it allows our margin to blend up. Then of course, with our international growth, the international margins of course are little bit higher than those domestic margins. So those three factors all impact the gross margin.

But are any of them truly one-time? I mean, your stronger growth internationally -- you sound like you are doing things to try to boost your growth to where you're going to -- I know, mix by customer size and deal size fluctuates. Is it the vendor programs, or is that also something on -- that you don't always beat but you certainly, when you are doing well, are going to achieve some incentives? Am I missing something in terms of something that was extraordinary in the margin?

Let me try (technical difficulty) some idea. Some of the vendor programs we maxed out at some point and some of them are based on annual programs, and some are done on a quarterly basis. I would say there are definitely some one-time impacts (technical difficulty) programs that, as we grow, don't linearly increase, and so we may not see the same impact. So that's why we called it out.

Okay. I guess if I look at the margins that you are implying in your guidance for the December quarter, relative to kind of the normalized numbers you talked about this quarter, you are about 20 basis points below, thereabouts. I may not have quickly done it exactly right, but I don't know if that's all accounted for by the $400,000 for the distribution center. So can you kind of talk a little bit about how we should be thinking about operating margin that's in your guidance for this quarter?

Yes. Let me walk you through, from Quarter One to what I would say is a normalized quarter, and then walk you through a guidance that would be at a midpoint of $560 million. So, we reported $554 million in sales, and $0.56. The overachievement of the vendor programs is about $0.02; the bonus accrual is about $0.02. So those would reduce -- on a normalized basis, would reduce the EPS. Then of course, we have special committee which was -- if you would take that out is $0.01. So you take those three items, in the normalized quarter, would have been about $0.53. Do you follow me there? (multiple speakers)

Yes, that's good.

(technical difficulty) $0.02 of SG&A for a bonus reversal, minus $0.01 for special committee. So that would get us to about a normalized $0.53. Now, if we look at a midpoint of $560 million, we would have about $0.02 for volume increase.

We've got one-time move costs of $0.01, ongoing warehouse cost of another $0.01, the let me back into it again. Margin would take us up by $2.02 on volume, then subtract out of SG&A $0.01 for warehouse one-time, subtract another $0.01 for warehouse costs on an ongoing basis. We will have a new stock option grant this quarter that could be about $0.01. Then we will be investing in some marketing programs. For instance, in this new ScanSource Communications business, we will be investing in some marketing programs. Overall, we think we will spend about an extra $0.01 in SG&A and marketing programs. So that would take you to about a $0.51 quarter on a $560 million revenue achievement.

Okay, that's very helpful. Just one kind of detail there to the question before, the $0.01 from the permanent increase in expenses for the new distribution center, that would be leveraged over time, right, as you grow into the new facility over the long run?

Absolutely. As we grow, those are primarily fixed expenses.

Right, okay. Then, just one question on the top line and I will go away -- how should we think about the seasonality I mean in Avaya or just maybe the growth rate there? Did you see an improved -- you talked about Avaya being down year-over-year last quarter. You obviously saw a strong finish to the fiscal year but that's usually the case. So, are you feeling better about the growth there or are we still at a pretty uncertain time as it relates to what's going on with them from a corporate perspective? How does that impact Q1 -- the December quarter seasonality?

Well, when you look at last year, Jeff, we just tanked in the December quarter and we're not forecasting that. So we do feel a lot better about our December opportunity with Avaya than we did last year, for sure. We've not seen any negative impact from the private equity acquisition of Avaya. We've seen actually a lot of positive activity around programs and ideas for growth. Clearly that is what these guys are looking at, too, so we feel good about (technical difficulty). What happened in September and our ability to have a good December may be more in line with historic numbers, not as bad as last year.

Okay, thank you.

Chris Quilty.

Raymond James. Good evening, gentlemen. Just a question -- in terms of the forecast, you had mentioned you thought you had some point-of-sale products pushing out into the fourth. Are you assuming that some of those will land in the fourth quarter, in your guidance?

Yes, that's in the guidance, yes.

Okay. Historically, you've kind of given us an idea of, you are talking two or three major point-of-sale, or these larger numbers, in terms of the absolute number of activities, not necessarily the size.

Yes. I would say it's more than a couple. Yes, yes. So there's quite a few, and there were different reasons why they got delayed. There were some product availability issues on a couple of them, and there were a couple of others that just the end-user pushed it out. So we have some expectation that certainly not all of them will close but enough of them will close. That's baked into this forecast.

Are you seeing anything different? I mean, most of your vendors point to a pretty ugly North American market in the point-of-sale, AIDC business. Do you see any signs of optimism on the horizon for underlying strength of the market? Obviously, you're doing better than most of your vendors.

Well, we still believe that there are new opportunities in the market, especially when you talk about the small to medium space. Clearly, the larger deals are the ones that I think are most troublesome, but we've spent more resources in the last year beefing up our sales force so that we can focus on the smaller customers. You know, we have over 20,000 active resellers in the U.S., and we have not, in the past, had enough salespeople talking to some of those smaller customers. So we believe that's been a good investment on our part this year.

Okay, a follow-up on that -- a couple of years back when [Cymbal] made a big push to move the vast, vast majority of their business to indirect, we saw a trend where they pushed the big VARs on to you, who consumed less services. You had a bit of a drag on your gross margins. Would you assume, as you make this counter-push into more of the smaller types of accounts, that you're going to seeing a turn-about where gross margins might walk up over time?

Well, I think I would say differently, that maybe it will lessen the decline of gross margins. I think we all believe that there's a decline that's inherent in this business over time, and if we can -- if a particular business -- you know, what we're talking about here is ScanSource POS and barcoding, of course, the more mature, 15-year-old North American business. That business unit, we do believe there is a long-term declining margin trend, but if we can slow down that trend, that would be our plan. Our challenge then is making sure that we see that fast enough to add some investments so we can maximize it, and that has been one of our challenge, is on the SG&A line, is knowing when to make those investments.

Okay. Is there some particular program or activity you can put in place to help your resellers target smaller, more difficult-to-reach end customers?

Well, I think we have got to have more resources focused on those customers because they are not as sophisticated. They need more sales time from our salespeople; they need more technical support, more pre-sale, probably even more pre-sale than post-sale, to be honest. So we're having to look at the utilization of those kind of services and make sure that we are providing those services to people who buy from us.

One of the challenges in our business model is we provide some services to customers who buy a little bit from us and maybe more from our competitor, so we're having to really look and analyze that.

Okay. A separate question, picking up Metrologic in the UK -- if I remember correctly, Metrologic had their own distribution in Europe. So is there something larger that you think may change there, or is this just a UK-only program?

Well, Metrologic does have distributors. They do have local warehouses and country managers, but they do have distributors and have had for a while. They are generally pretty small and regionally focused. If you recall, too, when we bought ABC back in 2002, they actually had a Metrologic relationship and then we parted ways with them. We're glad to be back with them. I think they've got new management at the top, as you guys know; they've got new ideas for how to generate growth beyond just their point-of-sale scanning, low-end scanning products. I think they see our success across Europe as an opportunity for them. We certainly see that a lot of these small to medium point-of-sale resellers have a very strong following with Metrologic. We've started to sell (inaudible) printers to many of them in the UK but not having the Metrologic scanner was a real negative for us. So we believe this will help us, and we think Metrologic is supporting this strategy across Europe, and we do believe that it will spread across Europe over time.

Okay. How about the Cisco product line which you've had for a couple of quarters now?

Yes, our wireless business is doing well. Some of the challenges there is understanding the complexity of how a reseller can become certified to get the best discounts. Because of the large channel that Cisco already has, the dilemma is making sure that you can acquire products at the most favorable discounts, based on specialization, such as wireless and retail. So we're having to get our customers trained and certified, which is taking a lot longer, frankly, than we like and that Cisco likes, so that would be one of the limiting factors right now -- is until they get certified, they are not eligible for addition discounts, which won't really allow them to make enough margins selling Cisco.

Oh, there's no margin anyways! (LAUGHTER)

There is some out there. We liked their specific, specialized programs, but you've got to get everybody ready for them. But the generic (technical difficulty) guy who is selling the hardware is a different story, yes.

Okay. Final question -- I hate to beat a dead horse here but just to make sure -- $500,000 a quarter for the warehouses and an incremental $400,000 in the December quarter, so it's actually $900,000 --?

Total warehouse costs, 4900,000, of which $500,000 will recur quarter after quarter.

I got it; I just wanted to make sure.

[Andy Yeung]

Thomas Weisel Partners. Congratulations on a very strong quarter.

Given the slowdown in the U.S. economy, your December quarter seems to suggest (inaudible) acceleration sales growth on a year-over-year basis. So, besides of the postponed POS orders, is the strength coming from your company's specific sales efforts, or is it more a quarter strength in end-markets?

Andy, this is Mike. I think the biggest difference is, if you recall, the year-over-year comparison opportunity for us is pretty good, meaning last December was lousy. It was primarily in our catalysts business unit. We were talking earlier. We don't believe we're going to have as strong a decline. Normally there's a decline from the September quarter to December in our Catalyst business. Last year was a surprisingly large decline. It was much worse than historic. So we believe that will be better this year. Then we believe we are continuing to grow in Europe and in Latin America. Those are still new growth opportunities for us, the way we look at it. And we also believe the addition of T2 a year ago continues to help us feel good about the quarter. So yes, the underlying economic issues in the country really are not affecting us at this point because we have these other opportunities ahead of us. Frankly, we feel a little bit better about the communication business year-over-year.

Good. Back to your international sales growth, you mentioned that you see quick opportunities in Europe and Latin America. Is that due to your geographic expansions, or new product offering, or more due to the underlying economic strength in those countries and currencies?

Well, I think it really is the evolution of the indirect channel. We started in those countries, those geographies five years ago, bringing in a business model that was different, one that had a lot of scale and that had capabilities such as more inventory in the marketplace from a centralized source, a model were the distributor no longer competes with the reseller for end-user business. So I think it's our business model and the acceptance of it is allowing us to continue to grow even five years into it. Those markets from some of our vendors' perspective, if you listen to their calls, are all doing pretty well. I think the international business, separate the currency impact, is still doing better than North America for all of our vendors.

Okay, great. In terms of North America POS and the retail vertical, what do you see there in terms of the underlying demand trend?

In North America?

Yes.

I would say that we are probably seeing a premature business right now, and we're having to use opportunities to take market share by (technical difficulty) programs, and we've added some vendors in the last year, to be honest. With the addition of Cisco wireless in the U.S. for our ScanSource team, that was strong. We had Aruba just recently in Catalyst. So we picked up some pretty strong brand names that will help us complete some of our solution sets, and we think that's going to help us in North America next quarter and next year.

Great. Just one more question about operating margins -- you seem to have year-over-year expansion in operating margins for the last two quarters. I know you guys are going to have more expenses in the next couple of quarters due to the expansions in (technical difficulty) the new distribution center. But in terms of more long-term normalized operating margins, how should we see it going forward?

I mean, I think, in general, I will comment and let Rich give the specifics. But in general, we don't anticipate expanding operating margins, so there are some things that have happened one time, and there are some that have happened over the last few quarters,. I will see if Rich can talk to that. But in general, as we've said many times on our conference calls, we would see additional profitability as a sign to invest in our businesses. That's one of the signs that we're seeing now. Go ahead, Rich.

Yes, I think, in terms of the operating margin, one of the benefits that we've had probably over the last year to 18 months is we have seen our gross margin go to 10.3, 10.4, 10.5. That has been the influence of our international business, and it has been the influence of security business, T2, these newer technologies that allow us, in the earlier stages, to get more gross margin. Those businesses do need value-added investments, and we make those investments.

The challenge for us is the timing of investments and the SG&A investment in our businesses that have been with us for a longer time, like the communications -- some of the communication businesses, and certainly the AIDC and POS.

The investments we're making in the warehouse, we view the warehouse investment as being something that should give us some capacity for a number of years, so that's more of a step. But we continue to invest in marketing and programs.

So overall, we've seen our overall operating margin at 4%, a little bit more than 4%. Right now, I would look at an operating model of a margin of 4%, 4.1%, because of course we have bigger debt numbers, so we've got to cover some of the interest costs that we've incurred that we didn't have to two or three years ago. So does that answer your question, Andy, or was that --?

Yes, that was perfect. Thank you very much. That's all for me.

Cregg Watner.

It's Cregg Watner at Elm Ridge. Just a clarification -- did you say Telecom was up 6%? Was that the number?

Our telecommunication business was up 6%, year-over-year, yes.

Okay. Are you expecting, then, the Catalyst business to decline next quarter or kind of stay flat? I am cognizant of what you were saying earlier, that last year was a challenging December. But I was just kind of running through the math of how you would get up low single digits sequentially with the decline in the Catalyst business.

Yes, so if you go back and look a few years, it does seasonally decline in December. It's not quite as much now either because we have the T2 acquisition that's in our numbers, but before T2 came along, the December quarter was always down from (multiple speakers) quarter, right. So if you try to forecast the 560, I wouldn't be surprised if you are still showing a decline in the Catalyst business, yes. (multiple speakers)

Sequential from September but (multiple speakers) year-over-year, good growth.

Right, right. Okay. One last thing -- the overdraft was what?

The outstanding checks at September were $14.7 million. You can compare that to June, where it was $45.7 million.

Okay, thank you very much. I appreciate it.

[Mike Mirianoschi].

[Ragna Rock]. congratulations on the quarter, Rich.

Do you have the cash flow from operations number?

Cash flow from operations is about $24 million of usage. The primary driver on that is inventories, then we also, because of the warehouse, had about $2 million more of CapEx than we normally would have.

Okay, but so the CapEx was more like 44 million or something?

For the quarter, it would be more like $2.5 million.

Okay. Then remind me if I'm not forgetting something, but the sequential decrease in other expenses of $500,000, on the higher outstanding debt, was there something in June that made that number higher?

The decrease in --?

Other expenses. In the June quarter, it was 2.1. This quarter, it was 1.7 or whatever.

Other expense is influenced by foreign exchange, where we had better coverage on our foreign exchange.

Do you have a ballpark number as to how much that affected it? I mean, what should we be thinking about for other expenses, net, on a quarterly basis?

When we do our planning and our forecasting, we assume that exchange rates will stay flat, so I would -- when I do my modeling, I would assume very little in the other expenses line. Of course, interest is a separate story, both interest income and interest expense.

Okay, but for the net number, the interest expense, interest income, Other Income number -- I mean, is a going to be more closer, north of $2 million, or are we going to see $1.7 million?

Well, this last quarter, we were at 41.8 million, net, on interest. I don't see that number being driven up significantly. We've got some opportunity in terms of the way we manage our cash. We are starting the quarter with inventories at a little bit higher level than certainly we started last quarter, so overall, our average debt, which is the way we manage it, I don't see the average debt as having a degradation to it.

Okay. Just one more thing -- did you have the AR allowance number, dollar number?

(technical difficulty) the earnings release?

No, the balance sheet offset.

Well, the AR allowance number as not appreciably changed.

So still around 13.3, or something?

It's probably a little more than that. We've got more provided there. We are very comfortable with our AR number.

I got it.

I just don't have it right in front of me right now.

It will be in the Q.

A little over 414 million.

Kevin Starke.

Weeden & Company. Mike, Datatech released results today as well, and they mentioned that they were conducting fairly substantial layoffs in the United States. Have you heard if any of those are in Voda1 or if they might otherwise benefit you?

No, I didn't hear that. That's interesting. The only thing I've heard about those guys is that they were looking at consolidating some of their business units because (multiple speakers) separate units but no, I haven't heard that.

Looking at the guidance, is there anything in play here that could cause you to come in in the middle of the revenues range but come in toward the high end of the EPS range? Anything that might be conspiring to lift operating margins in the quarters that follow?

That's a two-pronged question there.

Yes. I mean, I'm not asking for guidance, but it does seem that you keep doing better than your expectations. I'm wondering if that is something that might prove sustainable despite your efforts.

(LAUGHTER). Yes, I don't think I want to go on record as saying I'm (inaudible) do that, but you know, I think our challenge is always, we are in markets where sometimes distributors aren't willing to make the investments, so they don't get the long-term benefit. As you know, we are a long-term player in all of our markets, so we see an opportunity where we should go and make some investments that would reduce operating margins from 4.7 or 4.5 to 4.2 or 4.3. We would certainly be interested in that, because we're trying to build a long-term franchise here that we think is a value-added business that vendors will appreciate.

So there's nothing that I'm seeing today that we would be talking to you about, but I mean we certainly are aware that there are some opportunities for us to grow, even in the markets we've been in for along time, if we can do a few things better for our customers in vendors.

You know, the example is there is still a very inefficient supply chain in our oldest business, and there's a huge amount of cost that could come out that supply chain. We've always looked at ways to help our vendors do that. So, I will leave it at that.

All right. Good enough. Thank you.

(OPERATOR INSTRUCTIONS)

Okay, well, thank you very much. Thanks for joining us. Our next conference call to discuss the December 31 quarterly earnings results is expected to be on January 24. Thank you.

Thank you.

Thank you. At this time, you may disconnect; the call has ended.