Scansource Inc (SCSC) 2011 Q4 法說會逐字稿

Welcome to the ScanSource fourth quarter and year end earnings announcements call. All lines have been placed in a listen-only mode until the question-and-answer session. Today's call is being recorded. If anyone has any objections, you may disconnect at this time.

I'll would now like to turn the call over to Mr. Rich Cleys, CFO. Sir, you may begin.

Thank you, Sarah, and thank you for joining us for the ScanSource conference call to discuss financial results for the quarter and full year ended June 30, 2011. My name is Rich Cleys and with me is Scott Benbenek, President of Worldwide Operations, and Mike Baur, our CEO. We will go over the quarters operating results and then take your questions.

This conference call contains certain comments which are forward-looking statements that involve risk and uncertainties. These statements are subject to the Safe Harbor created by the Private Securities Litigation Reform Act of 1995. The statements made in this call are made as of today's date. We may subsequently make these statements available on ScanSource's website or otherwise.

ScanSource does not assume any obligation to update the forward-looking statements provided to reflect events that occur or circumstances that exist after today's date. 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 end of 2010 filed with the Securities and Exchange Commission.

This afternoon, the Company released results for our fourth quarter and year end -- year-to-date period ended June 30, 2011. I'll start our discussion by providing overall sales and operating results for the fourth quarter. Later in the call, Mike will comment specifically on quarterly results and outlook for each of our business units.

In our fourth quarter, the Company generated worldwide net sales was of $734.9 million which increased 26% over the prior year fourth quarter, and increased 20% over the sequential third quarter respectively. Included in our quarterly sales results, our revenues of $29.6 million from the recently acquired CDC Brasil, a addition to the ScanSource family headquartered in Curitiba, Brazil. We purchased CDC on April 15, 2011 and therefore we've included the sales and expenses from that date until quarter end in the ScanSource consolidated results. CDC's operating results will be reported within our International Distribution segment.

On a geographic basis, sales originated from our North American Distribution segment increased 17%, in comparison to the prior year quarter, to $543.4 million. The International segment grew 61% from the fourth quarter of 2010 to $191.5 million. Excluding the impact of foreign exchange fluctuation and without the incremental sales from CDC Brasil, the International segment sales increased 23%.

Within our product lines we experienced a 29% increase in worldwide sales of our POS barcoding and security product categories over the prior year quarter. These product categories represented 61% of our total sales for the quarter with the remaining 39% originating from the communications products business. Our communication sales units experienced an increase of 22% in comparison to the prior year quarter.

The Company's consolidated gross margin percentage increased from 9.8% for the fourth quarter of 2010 to 10.1% for the quarter ended June 30, 2011 largely due to Brasil's higher margins and opportunistic purchases in other businesses during the quarter. Sequentially, gross margin decreased from 10.7% driven primarily by lower vendor program recognition as a percent of sales and an increase in big deals in the fourth quarter in North America that typically yield lower margins, which more than offset the benefit of Brasil's higher margins and the opportunistic purchases previously mentioned.

Operating expenses in the current quarter increased to $45.1 million compared to $35.8 million in the prior year fourth quarter. Important to note that the acquisition of CDC Brasil on April 15 resulted in an additional $4 million in incremental operating expenses for the quarter. As a percentage of net sales, our operating expense ratio remains static only decreasing 1 basis point to 6.14% of sales.

From the sequential quarter, operating expense increased $4.8 million from the $40.3 million, but decreased 44 basis points as a percent of net sales. The decrease in operating expenses ratio from the sequential quarter is primarily due to a third quarter one time SERP funding charge of $2.4 million to fund the Supplemental Executive Retirement Plan for our founder and former CEO.

In the fourth quarter, operating income was $29.2 million and increased 39% and 15% in comparable prior year and sequential quarters respectively. Expressed as a percentage of sales, operating income was 4% in the current quarter compared to 3.6% for the prior year quarter and 4.2% for the third quarter of 2011. The increase over the prior year is due to the increase of volumes in our strongest year on record.

Interest expense was $541,000 for the quarter, up from $365,000 in the prior year quarter and $429,000 from our third quarter. The additional interest was driven by increased borrowings on the Company's revolving lines of credit. The line was utilized fund the $36.2 million cash portion of the CDC purchase.

The effective tax rate was 31.7% and 33.1% for the quarters ended June 30, 2011 and 2010 respectively. Both rates reflect the normalization of the full year tax rate to 34.3% and 35.6% for the years ended June 30, 2011 and 2010 respectively. We anticipate that our approximate rate for 2012 would be in line with the 2011 full year rate at approximately 34.5%.

Our return on invested capital was 19.9% for the quarter compared to 17.8% for the prior year quarter. The increase in return on invested capital was driven by our strong operating results for the quarter.

In the summary, the June 2011 quarter had reported fully diluted EPS of $0.71 versus a reported fully diluted EPS of $0.52 in the June 2010 quarter. This improvement was due to better gross profit margin primarily driven by CDC's gross margin rate. Versus our April guidance of 61% a share, we benefited $0.06 a share of gross profit due to Brasil's better gross margin rates and higher company volumes and $0.01 per share of lower SG&A primarily due to lower purchase accounting costs and $0.03 a share due to better than forecasted tax rates.

Turning to the balance sheet. Inventory turned 6.1 times during the quarter compared to 6.4 and 5.5 times in the prior year and sequential quarters respectively. Increased sales volumes have increased the turns to 6.1 times from the sequential quarter turns of 5.5. As inventory balances increased during the current quarter, the Company had eight paid for inventory days on hand as of June 30, compared to 10 days at the end of the prior year fourth quarter and 18 days at the end of third quarter.

The CDC acquisition increased our days on hand by two days with a corresponding increase of two days of payables outstanding. Therefore, paid for inventory days were not impacted by CDC. We have continued to increase inventory levels of certain products in response to increased market demand, supply chain problems, and favorable vendor programs resulting in higher inventory levels at year end. In addition, we acquired $31 million worth of CDC inventory at purchase date.

Accordingly, inventory on hand at June 30 was $467.3 million versus $401.2 million at the end of the third quarter and $346.6 million at June 30, 2010. There were $73.6 million of checks written, but not cleared at June 30 included in our accounts payable balance. At June 2010, this amount was $62.7 million.

Our days sales outstanding, DSO, was 57 at June 30, 2011, up from 36 and 55 days in the sequential and comparable prior year quarters respectively. The CDC acquisition had approximately a half day increase to our overall DSO.

The Company had cash and cash equivalents on hand of $28.7 million at June 30, 2011 compared to $31.2 million at March 31, 2011 and $34.6 million on hand at the prior year end. During the quarter, the Company used $40.9 million for investing activities. These investments consisted of capital expenditures of $4.7 million, primarily relating to our investments in the new ERP system which has been discussed on previous calls and $36.2 million for the CDC Brasil acquisition.

The Company held $60.1 million of interest bearing debt at June 30, 2011, up from $30.4 million at our prior year end driven by the borrowings on the Company's revolving lines of credit. After achieving our strongest year to date results in our history, our working capital needs have significantly increased in order to maintain the appropriate level of inventories and extend the appropriate trade credit to our customers. These needs were financed from operations. The increase in our year-over- year debt can be attributed to the cash used for the CDC acquisition and for the ERP project expenditures during the year.

Additionally, the Company entered into a earn-out arrangement on the CDC Brasil acquisition. This earn-out arrangement allowed the Company to pay an initial sum at acquisition date and to fund the remaining purchase price over time with a mechanism tied to CDC's future performance. US Generally Accepted Accounting Principles require that we record this remaining purchase price or contingent consideration at its estimated fair value. On the date of purchase, we estimated the fair value of the contingent consideration at $24 million. Of that contingent consideration obligation, $2.4 million is classified as short-term, as this amount represents the estimated portion to be paid in the first earn-out payment during the September quarter.

US Generally Accepted Accounting Principles also require that we re-measure the contingent consideration at every reporting date until the obligation is paid in full. Since we're required to remeasure the earn-out at each quarter end for the next four years, the accounting for this obligation may have a material impact on our financial statements in future periods.

Mike will now provide an update on our business.

Thanks Rich. As we discussed in our call with you last quarter, we plan to be more aggressive and take market share in certain of our business units. I'm pleased to report that we achieved record quarterly sales results. Our sales teams responded by closing a more big deals and the March quarter and retaking market share in key customer accounts. We had exceptional worldwide sales results with three of our key vendors -- Motorola, Avaya, and Zebra.

As Rich discussed, we were successful in completing our acquisition of CDC Brasil during the quarter which added to our strong finish to the 2011 fiscal year for the Company. We are cognizant of the worldwide economic challenges, but continue to see good opportunities for growth in our business.

We achieved record yearly sales of $2.7 billion for fiscal 2011 and $73.5 million of net income which are records for ScanSource. I want to congratulate our 1,370 employees worldwide for an outstanding year. And, I also want to thank our 220 vendors and our over 30,000 customers for their support and business with ScanSource Inc. as we recognize that our business success is dependent on their businesses also being a successful.

Now we'll comment on each of our reporting segments. North American Distribution which includes sales into the United States and Canada, posted record sales of $543.4 million, an increase of 70% year-over-year and 18% sequentially.

For the North American discussion, we'll start with our POS and barcode units. This sales unit had very good results especially with our AIDC vendors. The sales team was able to close more large deals than last quarter and maintain good margins with our run rate business. The sales unit had strong sales results from Motorola Solutions, Intermec, Honeywell, Zebra, and NCR.

As we experienced in the last year, our POS systems business continues to be weak especially in the large deals for general retailers. However, certain of our POS components vendors are still growing and finding new customers.

The strongest growth product segment for this business unit continues to be our mobility products with scanning and printing also growing but at a slower pace. Inventory shortages continue to persist in some areas of our business due to the Japan crisis from earlier this year. We have mitigated the supply chain issues and longer lead times somewhat, by maintaining higher inventory levels.

We do expect it new products from our barcode and POS vendors this year that will drive new demand and allow our resellers to be more competitive. We recently added new vendor, Ingenico, who provides electronic payment devices and services. We are continuing to invest in value added programs like SUMO, AppSource, and our ISV program to help our channel partners prosper and grow. Our customers continue to value our services highly as evidenced by the recent Gold Award received of the Retail Solutions Providers Association annual meeting. ScanSource was voted the best distributor of the year in North America by the associations 530 members.

Next, I will update you on our ScanSource Security sales unit. This sales team also achieved record sales results after a weak March quarter. In addition, eight of our top 10 vendors showed double-digit growth sequentially and year-over-year.

The Security team took market share from competitors and realized the benefits of a key vendor reducing the number of distributors they are using. Our newest vendor, March Networks, had an outstanding first quarter with ScanSource Security, and we also saw strong growth with Sony's new distribution program. Our number of active customers also surged this quarter to record levels as we saw the benefits of more sales headcount added and more marketing events during the June quarter.

Now, for an update on Catalyst Telecom. Record sales results were delivered by the Catalyst Telecom sales team for the June quarter. These excellent results were led by very strong Avaya sales quarter with double-digit growth year-over-year, as Catalyst added new customers and Avaya resellers to take in market share. We are very pleased with the sales growth from our key vendors, Juniper, Aruba, and Extreme as we saw an increase in the volume of big deals. We also saw increase in the number of new customers recruited by Catalyst, and we have continued to hire additional salespeople to manage new accounts and provide a high level of service to our customers.

During the quarter, Catalyst increased the amount of promotional activities to encourage resellers to choose Catalyst as their distributor of choice. The Catalyst annual partner conference was held in May and was designed to educate and develop relationships with top customers and key prospects, and was the best attended ever. We also attended key vendor conferences to meet customers and better understand the opportunities that lie ahead for 2012. The September quarter is Avaya's best quarter of the year historically, and we expect this year to be no different.

Next, I will update you on ScanSource Communications. This team also delivered record results as sales grew double-digits year over-year-and sequentially. Strong sales growth was led by Polycom in all areas of voice, video, and service. ScanSource Communications team has continued to take market share from competitors, on-board existing ShoreTel resellers, and recruit new voice and video customers during the quarter.

We announced our Unified Communications, or UC, education program last quarter, which will include a web seminar series for resellers, a guide to UC solutions available now, and regional events designed to educate and create demand. The UC program is supported by our vendors, Allworx, Aruba, AudioCodes, DIALOGIC, Edgewater NET, Plantronics, Polycom, and ShoreTel. ScanSource Communications added a new vendor to our UC lineup, Revolabs and had an excellent first quarter with them. Revolabs manufactures wireless microphone systems for Unified Communications.

Our second reporting system is International Distributions. Turning to Latin America first, with the addition of Brazil through the acquisition of CDC, we had record results for the Latin American region. Our Miami based business had a good quarter with strong growth year-over-year and very close to an all time record. In the barcode POS part of our Miami business, we had excellent growth from key vendors like Motorola, Zebra, Bematech, Star Micronics, and the strongest growth in the countries of Venezuela, Guatemala, and Panama. The Panama businesses is strong due to new fiscal printer requirements in that country.

We have recently improved our field rates and inventory turns in Miami by utilizing our South Haven distribution center for shipments to customers in South America. In Miami we also had a great sales quarter from our key communications and security vendors -- Polycom, AudioCodes, Alvarion, and Samsung. We have a dedicated sales and product management team there focusing on the opportunities for these vendors.

In Mexico, we had a great sales quarter that included big deals and a strong run rate business. The strong barcode results were led by strong performances from Motorola, Zebra, Datamax, Epson and Gem. Will also had record quarter with Extreme and Polycom. Our efforts to be successful in Mexico have been challenged by pricing pressure from too many distributors in that region. We will continue to work with our key vendors to prove our value added model as we take market share and add scale to our operations in Mexico City.

In Brazil, we've completed the integration of CDC and are seeing very good results from customers and vendors. We will be educating the market on the advantages that CDC ScanSource will now bring to Brazil including better purchasing power, better inventory availability, and more resources in finance and marketing. Our CDC ScanSource team met with vendors and customers at several events during the quarter and has begun plans to add certain key vendors to the portfolio. For the June quarter, our key vendors Bematech, Motorola, Zebra, and Honeywell all had strong results.

Today in Brazil, most of our vendors utilize combination of one and two tier distribution. Our 200 employees in Brazil are excited about the new opportunities ahead for CDC ScanSource and expect to be taking market share and helping our vendors transition more business through two step distribution.

Now we will discuss our business in Europe. Barcode POS team in Europe achieved record results in June quarter, with special recognition going to our key vendors Motorola, Intermec, Zebra, Honeywell, LXE, and Datamax. Big deals were strong in the quarter, yet we saw several deals postponed until later in this year. Sales team was able to take market share, especially in Germany, Belgium, and the Netherlands. However, we are seeing price pressure from certain local distributors who offer little value added services in sales to end users competing against their channel.

Our European distribution model continues to be very successful for customers and vendors with our in-country sales offices and central back office support -- sorry, back office support services in Belgium, including the industry's best inventory, availability, and delivery. Sales team sold to a record number of customers and continued to attract new customers through the partner towards across the UK, Poland, and Italy. In June quarter, we accelerated our promotional activities to drive demand on behalf of our vendors. Our SUMO and AppSource programs are gaining critical mass in Europe as we promote the business networking advantages of these offers.

A new vendor to Europe from the US is Pioneer POS, who is offering price competitive hospitality and retail systems first through ScanSource Europe. We expect Pioneer POS to help us gain market share in Germany and the Benelux area against local EPOS products. In the ScanSource Europe Communications business, we had record results in the UK and very good results in Germany. In the UK, we had record sales of Avaya Enterprise SME and data products as a result of taking market share from our competition. We also saw better large deal activity in strong run rate businesses as are sales and marketing teams performed at high levels. In addition, ScanSource UK was recognized as the distributor of the year by the readers of Comms Business magazine.

In ScanSource Germany, we had a very strong Avaya quarter while one of our other top Communication vendors continue to struggle in Germany and across Europe. We just started our business with Polycom in Germany, and are also doing very well with Plantronics.

So now, we'll conclude this part of our call with closing comments. We believe total revenues for the September 2011 quarter could range from $730 million to $750 million and our earnings per share could range from $0.60 to $0.64 per diluted share. At this time, we'll be glad to answer your questions.

(Operator Instructions)

Tony Kure, KeyBanc.

Hi, good afternoon guys, how are you?

Hi, Tony.

Hi, Tony.

Just to start off with the guidance. Just looking at, historically, the September quarter, as you mentioned, Mike, Avaya being a pretty strong close to their September year -- what used to be the fiscal year. Just wondering the flat guidance to the year. Is that a function of that fiscal year for Avaya no longer being as much of an influence, or is it just more caution on the broader macroeconomic environment or some combination of both? Maybe we could start with that.

Sure, John. It's Mike. Number one, we had a great quarter in June. And, so, with that, and with what's going on in the marketplace, we are certainly confident that we can continue to take market share, but we have the issue with Avaya we think still being pretty good in the quarter. But we also have, as we've gotten bigger in Europe, more seasonality risk with Europe's typical holiday vacation schedule. So, we probably got some caution in our estimates for Europe based on that. As we get bigger, we expect that we will -- in Europe, we expect that we will see more seasonality influence on our business there.

Okay. And then, as I look at, on the EPS line going down the line here, looks at that the midpoint of the guidance, $0.62 -- I think you said it was $0.60 to $0.64. So, $0.62 would imply a sequential -- and I don't have it in front of me, but from a 4% op margin in the fourth quarter, would imply a pretty healthy decline on the op margin line. Can you comment on what might be driving that?

Yes, Tony, I will take that one. From an operating profit perspective, I'd probably model to about 3.6%, 3.7%. And the reason for that is two-fold. Our gross margin -- we had strong results in our International business including Brazil in our gross margin. We don't anticipate to have that same repeated strong gross margin. So, we'd probably be closer to about a 10% gross profit overall on slightly higher volume. So, I'd say at the midpoint of 740, we'd actually be down maybe $0.01 or $0.02 in EPS just on the margin line.

On the SG&A line, there's a couple things going on that would increase our SG&A cost by about $0.03 a share. One being, we got Brazil for the entire quarter. We only had Brazil for 76 days in this last quarter. And that will be, frankly, a couple cents a share. And then we have stock compensation which impacted us starting in May and we'd have a full quarter impact of stock compensation. The third factor, other than gross profit and SG&A, is that we'll go back to a more normalized tax rate of about 34.5% and that's about $0.03. So if you take -- you say $0.71 is where we are today, about $0.02 on lower margins -- gross margins, $0.03 in SG&A, and $0.03 in tax, and that gets you about $0.63 for the midpoint.

Okay, that's helpful. That bridge is really helpful. And then, just given the weakening economic data that, obviously, everyone seems to be -- is I'm sure focused on, how are your industrial and retail customers feeling? What's the tone of their conversations? Coming off a record quarter, it sounds to me like the spending spigot is still open. What are your customers saying or what are they feeling? I know you can differentiate between market share gains and actual organic spending trends across the world.

In general, what we're seeing is that our vendors, as they've reported their numbers over the last few weeks, continued to report good numbers as well. So it's just that it's not just ScanSource taking market share only, but I do think our industry and our particular vendors have good solutions that drive good ROI with customers who have budget money. But, clearly, it's one of those scenarios where we're thrilled that we're having the results we are, knowing that everyday we turn on the news it's dire. And, our customers tend to be, as we've said many times, small and diverse.

We've got over 30,000 customers now, adding the Brazil acquisition. And these are small to medium, but mostly small enterprises. And they typically find a way to sell a solution to the customer, whether it's manufacture, healthcare, you name it. They find a way to sell products. And so I think we are fortunate in that we are spread across so many vertical markets, and, now, spread across multiple geographies that we're still able to see the benefits of that. But, clearly, we, like everybody else, are constantly looking at the news and wish we could just turn it off. But our vendors continue, Tony, to report good numbers, too. So we're not the only guys doing it.

I guess to extend that logic then, Zebra talked about retail -- big box retailers not, being a little more cautious. So your underweights to those big box retailers then is maybe working in your favor relative to Zebra? Would that be a fair assessment?

Yes, absolutely. We're rarely involved in deals at tier one retailers. Correct. Our channel doesn't sell to the Wal-Marts and the big guys. You're exactly right, Tony.

Okay. And then just wanted to follow-up, the big deals that you mentioned that some got delayed in Europe in the fourth quarter. They got delayed into the next fiscal year. Do you think that hits in the first quarter or is that more -- are these delays more characterized by middle of -- into the next calendar year?

I think that's also in our forecast right now, and so that's why the forecast is what it is, because we don't know. So we've -- all we've heard is those deals were not lost to competition. The resellers are telling us that the end user still has budget money, but they don't know if it'll be in the September quarter or December quarter. Frankly, we've learned, in most cases, not to even talk about them a lot because they could just go away or be there for a long time. So implied in our forecast is our confidence in whether were going to get those or not.

Okay, I'll stop there. Thanks.

Thanks.

Chris Quilty, Raymond James.

Good evening, gentlemen.

Hi Chris.

First, just some clean up, I missed a couple numbers. I think you gave specific revenues for CDC, and if you gave International revenues I didn't hear it.

CDC we said was $29.6 million in the quarter.

Okay. And International?

International was $191.5.

Great. While I've got you, Rich, there were a lot of puts and takes on the balance sheet in terms of accounts payable and goodwill moved. I assume, and you talked to many of those items, but changes in goodwill due to the accounting associated with CDC?

Yes. Goodwill and intangibles, yes.

Okay. And were there any other items in terms of opportunistic buys or planning of payment that would be reflected in the quarter-end report?

Included in our inventory to the extent that we've got opportunistic buys that we haven't liquidated yet, we're going to have that inventory on hand. So, that's part of our inventory increase.

Okay. And generally when you do that, that contributes to a higher margin in those quarters when you sell?

Yes.

Okay, And again, reflected in your first quarter guidance?

Right. And the 10%, yes.

Okay. So you did mention you saw some uptick in large deals in the AIDC POS, but it's not tier one retail. So where were those transactions happening?

So they were more on the, Chris, they're more on the AIDC side of the house. And in the case of one particular deal that we didn't talk about, but I'll mention, we had a self scanning deal in Europe that actually came through in the quarter.

Okay.

So there are some pieces of retail, but unlike where we were, say a couple years ago, we just don't see those large deals anymore in retail.

Got you. So a macro question here on Europe. We're 2 or 3 weeks into a panic stage here. When this happened in 2008, there was a pretty immediate closing of the spigot on all capital spending. You haven't seen any of that or heard any feedback yet from your channel partners that, that same thing is starting to happen in the European market?

Right. I think what we would say is, since we're sitting here on August 18, we've updated our forecast as of yesterday, basically. And so, essentially were saying, as of yesterday, we feel pretty good about being flat in our total forecast. And, in that, if you just move the numbers around, it implies that Europe is down a little bit, but we think that's seasonal.

Okay. And, the downtick that you're forecasting in the Brazilian gross margins, is that related to product mix or some other factor?

It's primarily product mix. They had really good product mix quarter. So, that helped them a lot.

Okay, got it. And, in terms of the security business, can you just give us maybe a little bit more of a general update there on -- you've been seeing some more favorable trends, vendors moving towards -- limiting the number of distributors that they have. Is that something that could accelerate in the current market environment or do you feel you're static for the time being?

I think we are seeing movement there, and it's not multiple vendors at a time, but we're certainly seeing that and that was one highlight, I think, of the quarter is now that a vendor like Sony has decided to do that we're seeing the benefit. And Sony, frankly, was one of those vendors that had, I think, 30 distributors. So they made the decision that, as they wanted to compete in the marketplace and, frankly, part of it is as these security vendors in video surveillance are looking at a cost model that's different than the old model -- meaning the new IP-based cameras are more expensive to manufacture -- the vendors need to find a way to lower their cost to market. One way is to reduce their distribution costs. It's clearly they're seeing that having 30 distributors versus 3 or 4, they can get leverage and reduce their selling cost. And I think that model is something that we're out there talking a lot about and it's starting to resonate. So we don't think there's going to be this huge rush in the next quarter or so, but we do see momentum there.

Okay. And can you remind us in terms of geographic presence where you're at now and where you might be able to expand?

In Security, Chris?

Yes.

So, we're doing some Security out of Miami right now and a little bit in Mexico. It's not in a big way yet. I referenced that we did add some people to focus on that in Miami. We have no Security business in Brazil and no Security business in Europe.

And to go into Brazil, do you have to apply for licenses and crazy stuff like that or is it can you just move products in and move products specialists in and create something?

I don't know the answer to that yet, to be honest. We have not discussed in detail. Early days, I want to keep those guys focused.

Okay. So the more likely opportunity there is the push to Europe?

Could be. That would be where we've got the most knowledge of that market and we've got a mature business. I think what we're seeing is, we have been somewhat hesitant because we want to make sure we knew the model well here. And, unlike in our barcode business, there's just so many vendors, and we have struggled finding the right vendor to kind of hang on their coattails to move into a geography. If you recall, we went to Europe on the coattails of [Symbol]. And we'd like to find that vendor that will drag us into that geography. That's what I'm looking for. Haven't found it yet.

Okay. Great, thank you guys.

Thanks Chris. Appreciate it.

Andrew Abrams, Avian Securities.

Hi, I just wanted to talk a little bit about margins on a general basis. Last quarter you mentioned that the larger number of vendors that some of your customers had were pressuring a little bit on your margins, and it seems from your conversation so far that, that's now kind of easing a little bit in terms of the number of vendors that each of those -- the number of distributors that each of those vendors have. Is that going to help you going forward or are there other offsets that kind of behold gross margins at this level for a while?

I think what we've got built into our forecast is some gross margin degradation in some of our units, and I'm backing out the CDC impact, right? So CDC is helping our margins as we've said in general, even though we won't get as much help this quarter as last, as Rich indicated. But I think in general what we find over time, in our more mature businesses we have a margin that degrades over time. New products help it go up and there's some new products being announced in our markets, even in the US, that could help us.

We also find that, as vendors reduce the number of distributors -- to the first part of your question -- that tends to help us, we tend to have to do more to justify that extra margin. So, in most cases, we don't see, in our more mature businesses, an uptick in gross margin. We generally are trying to leverage our SG&A as we grow our volume and still deliver very strong operating numbers and very strong ROIC. That's probably where we focus more of our time, and we use the gross margin kind of as a barometer as to what we need to invest in on an SG&A basis. Now, the only exception to that is we're selling more services now, and as we sell more services and we've been talking about for a few years, they're starting to become more meaningful to our gross margin.

Got it, okay. So as that percentage moves up, it's going to help you even some of the more mature markets.

Absolutely right.

And, just a -- how many days was CDC in the quarter? I think you mentioned it, but I didn't catch it.

76 days.

76 days. And revs were $29.6 million for the 76 days.

Yes.

And what kind of CDC growth do you look for? We have a 1-quarter static number that we can work off now, but what do you guys look at over the next 4 to 8 quarters?

We haven't published anything it. And, of course, as you know from the way we've structured the deal, we believe in paying for performance. And so, we've got the right incentives in there for these guys to do very well -- the owners -- if they can continue to manage growth. And so I think we've got the right incentive system out there that they can grow at a rapid rate. Now having said that, one of the things that probably they were challenged with before we acquired them was access to capital, capital's expensive in Brazil.

And so we've got relationships with most of the same vendors, and so I believe we'll be able to help them from inventory availability, more available credit, even though we are not going to make the credit terms any different, but we're going to make more capital available. So, I think, as any distributor grows rapidly, meaning, 20% plus, they've got to have a ready supply of capital or they tend to not take some of the opportunities that the vendors would want them to take such as big deals that we talk about a lot. That would not be something that they would have taken a lot of in the past, if they had scarce capital, right? So that's kind of the thinking that we're on is we've go to first educate and provide them this foundation for growth and then we'll see where the numbers come in.

Got you. And their incentives are revenue based or are they net income based?

It's an earn-out, so it would be earnings based.

Got you. Thanks very much.

Keith Housum, Northcoast Research.

Thanks, guys. Thanks for taking my call. Rich, can you just let us know what the depreciation and amortization was for the quarter?

The depreciation and amortization? Let me just get that for you, for the quarter. Total depreciation and amortization is about $2.3 million.

$2.3 million. Okay, great. And then, I'm just trying to reconcile the SG&A increase a little bit more. And you mentioned that there's going to be a full quarter of stock compensation expense versus a partial in the current quarter that just completed. Can you just fill us in a little bit more on your thoughts there and what the potential impact may be?

I think I said stock compensation -- what I said is when I was going from the 71 to the 63 for the midpoint guidance, I said stock compensation would cost an extra $0.01 a share.

Okay.

So that would be the impact on our quarter incremental to our last quarter.

Got you. And then, as the earnings in Brazil improve, how should we look at that in terms of potential increase in the earn-out?

Under fair value accounting we've got a liability on the books. There will be an impact for time value of money and change in estimates that could impact our P&L, but the earn-out is simply going to be based on a multiple of earnings. So, from a cash basis, the cash that'll go to them will be a portion of the earnings based on the earn-out, but the accounting will be under this fair value accounting. So you'll see some non-cash volatility in the P&L.

Okay. And, over what time period is that going to be paid out?

We'll have a payout in this current quarter, and then over the next 4 years we have earn-out and the payment for the full year will be at the same time each year. So, September quarter of each year there'll be a payment. Over the next 4 years -- 5 payments, starting this quarter, going over the next 4 years.

Okay. And then final question, you had mentioned there are supply chain issues. Have those been resolved?

We're anticipating there's still some supply chain issues. And, I think the way we're going at it is, it's unclear when they're going to be resolved, so we've taken the tack of adding some more inventory because what's happening on these supply chain issues, it really lengthens the lead times. And so we're watching it, of course, carefully. But we decided to take on some extra inventory in certain cases so that our customers don't -- aren't sensitive to the issues. But, they tell us they're resolved. I think there's always a lag time between time they're resolved and then we actually can see free flowing inventory.

Got you. Okay, thanks guys.

Ajit Pai, Stifel Nicolaus.

Good afternoon, and congratulations on very solid quarter.

Thank you, Ajit.

A couple of quick questions. We'll approach that for Brazil a little later. But first, in the markets where you already are, looking at the credit environment and looking at your receivables right now, you folks did an exceptional job in 2008 when you had a pretty sudden drop in credit in managing your receivables and getting it down and generating cash to get into a very solid net cash position very quickly over 4 to 6 quarters. In the current environment, how much of a differentiator has it been to your customers for your ability to manage credit for them when the banks are not being cooperative? How much does that help you?

And then secondly, on a go-forward basis, are you, yourselves, getting more cautious right now the way you did back in the middle of '08 in reducing that or are you still fairly comfortable with continuing to invest in your receivables. And then, any -- when you're looking at a market like Brazil, how do you think about it where the cost of capital is materially different, the credit availability is much less and the rates are much higher? You mentioned that you don't plan to lend over there in the way that you have in the developed markets, or the terms are not going to be any different. Are the terms that you provide here are still very competitive over there for you to gain more market share there?

Let me take the first part, Ajit, in terms of what our customers are realizing right now. So, we have not changed our approach at this stage in the marketplace. And, as we look at a value add, we continue to tout the fact that we have a team of professionals, some of them former bankers who make up our accounts receivable team, our credit team here in the States as well as Europe and Latin America now. And, we do think that we have been able to gain share while managing our AR extremely well. So I would say our sales teams view it as a sales advantage to have the team and the processes and the skills we have. So, absolutely that helps us in our markets today. And I'll let Rich answer the part about the availability of credit and also the cost of capital in Brazil.

Yes, Ajit. As far as the availability of capital to our customers and whether they'll be looking to us for more, we're going to use the same underwriting criteria that we've been using all along, and we've been able to underwrite our customers as we've come out of the last recession. So, coming out of the last 18 months or so, a lot of our customers have had limited access to banking capital and we've been able to manage through that with them. As Mike says, we've got a very talented team throughout the Company that works on the underwriting and the credit management with the customers.

So, we've been able to manage through that credit crunch for these customers over the last 18 months and I expect that we will continue to manage through that. As far as overall Brazil, they've managed -- if we look at their DSO, as I mentioned, the addition of their receivable for ScanSource only had a half day impact to our DSO. They manage their receivables very well and we plan to continue to manage those receivables well, but the thing that we'll do down there, as larger deals come into play and more customers come into play, hopefully we'll be able to help these guys with some of the things that we do in credit to expand their business even more, but not do it by taking undue risk.

So, you'll be providing expertise more than anything else?

We provide expertise and sometimes we build relationships with third party providers that maybe don't exist today that allow our customers to expand their purchasing power, but we don't necessarily have to keep it on our balance sheet.

Got it. And then just looking at your balance sheet as well, is it fair to assume that the long-term portion of contingent consideration and both the current portion and the long-term are primarily to do with Brazil?

Yes.

Got it.

They are to do with Brazil, yes.

And then, in the last -- in 2008, you were fairly quick to turn off the spigot and manage your receivables far more aggressively. Are you feeling that caution right now? Or you still think that the environment is such that you don't really have to start generating a ton of cash out of your receivables, you can keep receivables at current levels?

Ajit, I don't think we turned off the spigot in terms of credit. The underwriting was really the same back then. It was just about the volumes went down, and when the volumes go down, you collect more than you're adding to the receivables.

Okay. So that's all that it was.

(multiple speakers) way our business works is it generates cash flow if the sales are down.

Got it. Okay, thank you.

Chris Quilty, Raymond James.

Hi, you guys. Just 2 quick follow-ups on the supply chain issues. Is it related to any certain products, either in Communications or AIDC POS?

Chris, I can't say that specifically, meaning I heard it more from our AIDC POS guys, but I want to be careful not to throw any vendors under the bus. But, we did hear it some in Communications, a little more in AIDC. But, I'm not sure why. We didn't get to the real root cause because, frankly, I wasn't sure our people knew it that well.

Okay. And the last time I remember something like this I think it was the [rohas] when that whole thing happened back years ago. You guys were able to bring on a lot more inventory than your competitors. You actually gained a lot of market share if I remember. Is there a possibility of doing something like that again?

We're certainly making sure that if there's an opportunity, we're going to take advantage of it, as we normally do. And, I think that's what we send a message to our guys, even earlier than the Japan crisis because we were worried that, if you think back a year ago, we had severe shortages before Japan. And so those shortages started then even as we came out of the recession the factories came online too slow to meet demand. And so, we kind of saw a surge in inventory last June through September. And then we got to December, we still felt like the factories themselves -- forget Japan for a minute -- still weren't believing the forecasts from their sales people. So we were telling our guys, even in January, let's keep the inventory levels higher, and then when Japan hit we said we better add a little more. So we've been cautiously high on the inventory side still for the last year.

Okay.

Because of that fact. If you don't have it, you can't sell it. So we would rather err on that side, knowing that we do a damn good job managing obsolescence and current inventory and we can have a real high focus on that at ScanSource.

Got you. And final question for Rich on the CDC accounting. As it stands now, it sounds like the only P&L which impact of the accounting would show up in the non-operating line. Is that correct?

No, the way that the accounting works is the adjustment to the contingent consideration, the fair value adjustment, goes through SG&A. So, there will be a -- if all else stays the same, if all our risk stays the same, if our forecasts stay the same, there'll be a time value of money factor that goes through SG&A under fair value accounting. So, we actually have something baked in this current forecast for that. Albeit not a big, big number, but there could be volatility because of, not the time value of money, as much as forecasting and estimates.

Got you. So, presumably if there's a really big impact in a particular quarter, you'll call that out for us?

Yes.

But is it also fair to assume, if CDC has a really good quarter, and presumably that would cause an uptick in SG&A, most of it should be accounted for by the better actual operating performance that flows through the P&L, so it all neutralizes?

Yes, there would be a better operating performance for that quarter, but the uptick could be beyond the quarter.

Got you.

So there could be more volatility because there's more than one quarter's adjustment you're making.

Got it, alright. That's why I didn't go the CPA route. Thank you.

Ajit Pai, Stifel Nicolaus.

Yes, hello. Looking at the Security business and your experiences over the past several years, and you've talked about some vendors trying to reduce the number distributors, et cetera. But, right now, when you're looking at that business and the growth that you've had the past 5 to 7 years since you started focusing on that business going forward, what do you see as the biggest drivers of growth of that business? Is it new vendors? Is it penetrating new markets? Is it getting greater share from existing vendors? Could you just give us some color as to when it really becomes a material driver of ScanSource, and, in this broader macro environment, how you see that business growing?

Yes, I think I would answer 2 ways. One is, the rest of our business keeps growing so well, it's hard for the Security business to keep up. They're growing faster than our average, but the rest of the business is doing quite well, as we've indicated. So, that makes it tougher for them to become significant material without a major change in that business. So, you're right.

The thing that would change the profile of the Security business for us would be, not necessarily getting into a new part of it. We're primarily focused on video surveillance products, access control, and the ID products, which are the card printer products. We, at the very beginning of our entry into Security, thought we would be more in the traditional burglar alarm business, but we have since learned that -- and fire safety -- we've since learned that, that part of the business is not attractive to our business model, the normal channels we sell to, et cetera. So, we've got a very clear focus on the part of Security we want.

I think what we still find frustrating is there's huge inefficiency in the distribution and sales channels for the Security products in the United States. And until the vendors really decide they want to have fewer distributors like a few of these vendors have done, our reliance has been more on some of the newer players. So, one of our top vendors is Axis Communications and they're not a traditional security vendor. So they've come with new technology, without having the baggage of the old channel, and they only have 3 distributors. So they're a company, a vendor that's chosen ScanSource and only a few other distributors and that's why we're doing so well with them.

So we would hope that these traditional security vendors will see what Axis and Sony are doing and follow the path. But I would say the only other thing that would change that, Ajit, would be if we were to make an acquisition in security space, right, which we haven't done, which we typically have done in all our other technologies and geographies to get critical mass is we've made an acquisition and we haven't done that in this space.

And what's held you back?

It's the models that are -- the business models out there do not look like the ones we run today. So, it would be a lot of stuff you'd have to throw away.

Got it. Okay, thank you so much.

Appreciate it.

And currently, we are showing no further questions.

Okay. Thank you for joining us. Our next conference call to discuss our September 30 quarterly earnings is expected to be on October 27, 2011. Thank you.

Thank you. That does conclude today's conference. Thank you all for participating. You may disconnect your lines at this time.