斑馬技術公司 (ZBRA) 2005 Q4 法說會逐字稿

Good morning, and welcome to the Zebra Technologies fourth quarter and full year earnings release conference call. Joining us from Zebra Technologies are Mr. Charles Whitchurch, CFO, and Mr. Ed Kaplan, CEO of Zebra Technologies. All lines will be in a listen-only mode until after today's presentation. Instructions will be given at that time in order to ask a question. At the request of Zebra Technologies, this conference call is being tape-recorded. Should anyone have any objections, please disconnect at this time. At this time, I would like to introduce Mr. Charles Whitchurch, CFO of Zebra Technologies. Sir, you may begin.

Thank you, and good morning, everyone. Thank you for joining us today. Certain statements we will make in this call will relate to future events or circumstances and therefore will be forward-looking statements within the meaning of the Securities Litigation Reform Act of 1995. In particular, any statements we make regarding our financial forecast for the 2006 first quarter and expectations about trends in the Company's business will be forward-looking statements. The forward-looking statements involve risks, uncertainties, and other factors that could cause Zebra's actual results to differ materially from those expressed or implied by such forward-looking statements. Additional information concerning such factors is available in the press release issued today by Zebra, as well as Zebra's filings with the Securities and Exchange Commission. In particular, we direct your attention to the Company's Form 10-K for the year ended December 31st, 2004. Now I'll turn the call over to Ed, who has some prepared remarks.

Thanks, Randy. And welcome to everyone. In a year when we expected continued high growth, Zebra dealt with unexpected weakness in North America sales, an economic slow down in Western Europe, and uncharacteristic product delays. In short, we didn't meet our growth goals for 2005. It was also a year in which we continued to position Zebra for great success by spending on key strategic and value-creating activities, that extended our global competitive leadership. These activities are well-known to expand geographically, build and strengthen channel partnerships, and advance our products and technology, to serve a broader range of specialty printing applications. Because we have great confidence in the fundamental health of our industry, we were willing to trade near term profits, for long-term growth and value creation. All we have done, makes us very optimistic about Zebra's future. Our programs helped deliver record fourth quarter sales and earnings at a high end of the forecasted range. More important, they support further improvement in 2006.

Let's review the impact these programs had on our fourth quarter results. In effect, the effect of placing more Zebra representatives in high growth regions, sustain positive momentum in international sales. In Latin America, a strong team and leadership generated 22% sales growth for the quarter, and 23% for the year. Effective coordination with reseller partners in Mexico delivered more printing solutions to manufacturers, as outsourcing expanded opportunities. Our Latin America team also took the lead in winning direct store delivery and other mobile printing solutions for field force automation with our broad suite of mobile printers and wireless solutions.

Asia Pacific sales were up 9% for the quarter and exceeded 20% for the year, driven by high order rates broadly across the regions, and our considerably greater infrastructure in China. Now, with 5 sales offices, a greatly expanded team of sales representatives and sales engineers, and the leadership of an in-country managing director, our relationship with digital China, the country's largest IT products distributor, is now fully in gear and has already helped us expand 2 tier channel relationships with large IT integrators. In other parts of the region, we benefited from a stronger, more effective selling organization. A sequential rebound in AMEA sales reflected solid performance throughout most of the region. We had record sales in local currencies in the fourth quarter, reflecting the success of having placed more Zebra people in Eastern Europe and other emerging areas. Our new distribution facility opened earlier this year in the Netherlands, is operating well, and enabling faster, lower-cost product delivery.

Zebra expanded and strengthened its channel partnerships. Zebra's PartnersFirst program his its stride in 2005. Recognized as the leading industry channel program, it expanded and diversified our reseller base. During the year, we implemented tailored versions of the program for China and Latin America, and vertical specific programs for healthcare and RFID. We also set up channel programs to build our business in supplies, and most recently, with the government. Through PartnersFirst, Zebra established a relationship with McKesson Provider Technologies during the fourth quarter, a leading healthcare information technology company. McKesson greatly leverages our strategic position in the deployment of patient safety solutions, a growth area for us in 2006.

In North America, sales into 9 retail applications remained strong. In addition, we spent considerable time and resources during the year nurturing strategic alliances with ERP and large integration solutions providers. These relationships expanded Zebra's sphere of influence and established a robust pipeline of large deal opportunities for 2006 and beyond. Our label supplies business, particularly in North America, experienced sharp growth for the fourth quarter and the full year. We improved quality and delivery, an effective telesales model, and the West Coast production capacity. We outperformed the competition and won several long term large pieces of business with strategic accounts to tie Zebra closer to important customers. We also saw resurgence in buying by retailers, which cut back their supplies purchases during the first half of the year.

I'd like to turn our remarks to new products and technology. First RFID. During the fourth quarter, we had sequential improvements in our RFID sales, with the beginning deployments of Gen 2 EPC technology, and the next wave of companies preparing to comply with the Wal-Mart labeling mandates. Throughout the year, we had consistent growth. Zebra-manufactured Smart Labels are becoming a larger portion of our RFID business in providing a total RFID printing and coding solution. During the year, we demonstrated our leadership in RFID in many ways, including being the first to market with a complete firmware-only Gen 2 upgrade. We also expanded Zebra's RFID global footprint by obtaining radio certifications in 37 countries around the world.

Mobile printing remains a growth opportunity for Zebra. We had great first year success with our RW 420 mobile printer, optimized for [inaudible]. During the year, we also increased shipments of Zebra mobile printers for public safety, public transportation, and new retail accounts. We distanced Zebra further from the competition and attracted several large deal opportunities, by moving to a higher level of functionality in our support for high level encryption technology to ensure secure data transmission over wireless networks. We also significantly advanced our print management software, and suite of networking capabilities. During our third quarter conference call, we discussed introduction of new card and label printers. In addition to the first shipments of a new 8 by 10 digital photo printer for Kodak Picture Maker Kiosk. Initial sales of these products, particularly our S4 and metal tabletop printer have been strong. Most recently, we announced the introduction of a new series of mobile printers, the QL Plus, with advanced computing capability to support secure wireless connectivity, and print complex label formats, fonts, and graphics. We also unveiled a desktop printer, optimized for sale in China. Our product development pipeline remains full, with printers that have clear, future advantages -- feature advantages, and that are easy to sell, easy to integrate, and easy to use.

The target investments we made in 2005, and our accomplishments during the year, built a stronger Company and expanded our competitive leadership by focusing on furthering global reach, delivering new, demonstrably better products and technologies to the customers, and building stronger, broader channels. Zebra is positioned for improved sales and earnings performance in 2006. Now here's Randy to review fourth quarter results, and our guidance for the first quarter of 2006.

Thank you, Ed. I refer you to the table included with the press release for details on the breakdown of sales between various product categories in our product range. But nevertheless, I will tell you that sales of $179.3 million for the quarter were both at the upper end of our forecast range, and a new record for the Company. We grew by 2.5% in comparison to last year. As we discussed with you throughout the year, consolidated growth was negatively affected by declines in sales to key North American retailers from record levels in 2004. Despite this comparison, we had favorable unit growth in virtually all major printer categories, including mobile printer products. New printer sales represented 7% of printer products sold in the fourth quarter, and we expect new further progress on new product sales in 2006. Supply sales were up 8.7% to a record $33.6 million, and benefited significantly from the programs Ed mentioned earlier.

By region, European sales were up 1% in U.S. dollar terms, to $59.9 million, which includes the effect of a $4 million drag from unfavorable exchange rate comparisons. In local currency, European growth was 7.7% to a new record. We had strong growth in eastern and southern Europe, the Middle East, and Africa. Germany and the UK, however, were weak in the fourth quarter. Overall, however, business in Europe improved significantly over the third quarter lull, and the outlook is for further improvement in the first quarter. At current exchange rates, however, the 2005 fourth quarter and the 2006 first quarter, had the most difficult comparisons. Asia Pacific had record sales of $15.9 million, which was up 9%, with strength across the entire region, including China. This quarter, Latin America had the highest growth of any geographic region, of 22% to $12.9 million. In total, international sales were up 5% and accounted for 49.4% of total sales in the quarter.

The two-tenths of a percent increase in North American sales reverses a 5.3% decline in the third quarter. Sequentially, North American sales were down, largely because of a large card printer order that was shipped in third quarter, for a holiday gift card program. Lastly, sales to our largest customer, ScanSource, were 15.7% of total sales, and were up 6.8% for the quarter.

Gross margin of 50.1% was within our guidance expectations. The main source of the decline from the 52% last year, were lower average unit prices related to product mix, warranty expenses, and the negative effects of foreign exchange. Operating expenses were $51.6 million, up 15.3%, due mostly to higher payroll expenses, intellectual property work, costs related to the Paxar litigation, and consulting costs, both related to new product development and IT projects. Third quarter investment income was $3.8 million, which works out to a 2.9% return on beginning balances. Income tax expense of $13.7 million was a -- resulted in a 32.7% tax rate. During the quarter, a favorable outcome of certain tax audits and deductions from the recognition of job creation tax credits, reduced income taxes by $875,000. During 2006, we will be assuming a 34.5% effective tax rate. Net income of $28.3 million was 15.8% of sales, and equates to $0.40 per diluted share. Free cash flow was $13.6 million in the quarter, and $56.9 million for the full year. Large sales volume in December generated an unusually large receivables balance at year end, which increased DSO to 56.8 days. Inventories were unchanged with the third quarter position, with turns increasing to 5.6. Our cash position at quarter end was $544 million.

Our guidance for the first quarter is for sales in the range of 175 to $185 million, which represents a modest sequential increase in our guidance range in a quarter that is normally down sequentially. We expect earnings to be in the range of $0.35 to $0.40 a share, which includes $0.02 per share for stock option expensing. This forecast implies a gross margin of 50 to 51% and an operating expense assumption of 52 to $54 million, and an effective tax rate of 34.5%. That concludes my formal remarks. Thank you for your attention, and I'll turn the call back to Ed for some concluding comments.

Thanks, Randy. We enter 2006 well positioned for increased growth. Our work during 2005 makes us better prepared to capture business opportunities across a variety of dimensions, in a favorable business environment. The foundation of our long-term success, delivering innovative specialty printing solutions on a global basis for business improvement, remains secure. We've got great confidence in the health of our industry, and the effectiveness of our growth strategy. In RFID, compliance is now a given, with companies gaining greater confidence in the technology. Generation 2 products are showing significant performance advantages over older UHF RFID technology. Tack costs are down significantly, and ROI-driven solutions are emerging. More Zebra channel partners are selling RFID solutions more effectively. With the largest market share and product leadership, Zebra is ready to meet company needs for RFID Smart Label printing and encoding. For 2006, we will lead RFID in compliance labeling, as well as expand activity in business improvement solutions and international applications.

Geographically, we look for another strong year from international territories. Asia Pacific, Latin America, and AMEA will benefit from the placement of Zebra representatives in high growth regions. We have a much greater presence in China, and recently strengthened our leadership in the region with a new VP and GM for all Asia Pacific. In Latin America and Eastern Europe, we expect to build on our success by selectively adding to already effective teams. Because of more focused resources, our pipeline for business with strategic accounts in AMEA is building nicely as well. In North America, we are working more closely with a larger pool of end users. The number of large deal opportunities is up, including those incorporating mobile printing from customers who are attracted to Zebra's leadership in wireless, encryption, and networking capabilities.

Our work in vertical market applications is gaining momentum, particularly in field force automation and healthcare, where we are working with HIT organizations that are -- by our count, deliver the vast majority of clinical applications for patient safety. The investments in our strategy, in channel development, people, and products, are paying off and fundamental to our success. Our substantial resources give us the ability to invest in the business through challenging times, to extend global leadership and build even greater value for our stock holders. Our work in 2005 builds on our foundation of excellence, and makes us look to 2006 with optimism for higher growth and improving financial performance. Thank you for your attention. We'd be happy to answer your questions.

[OPERATOR INSTRUCTIONS] Jeff Rosenberg.

I was a little surprised by the decline sequentially in North American sales. I wondered if you could comment on if you backed out the effect of the gift card sale. Was business up sequentially in North America? And maybe a little bit of commentary on the relative strength of the channel versus your direct customers.

Yes. I'd say that the business would be up slightly, if that business wasn't included. It was a -- that's a significant contract, and most of it was shipped in the third quarter. I don't know what I could say otherwise, Jeff.

Okay. Well, let me just ask another question, RFID related. In terms of your strategy to improve your retention of supply sales there, I wondered if you could talk about how that looks to you today? I'm thinking about things like -- it seems like there's a pretty competitive market out there right now for inlays, and how that affects you, as you try to sell the Smart Labels. And just in general your feeling on -- given the relative complexity of the technology at this early stage, how that's playing out and your ability to retain business.

First of all, I think Zebra is in a very good position to be successful in the Smart Label business, from a variety of perspectives. Clearly, we are manufacturing printer encoders, and a very significant share of Wal-Mart vendors have won pilots with our equipment, and selected us for utilization. So we are in contact with those people, and so they have a deep understanding of our capabilities. Clearly, we have an advantage in that, if we are running Zebra-manufactured media through our product, and guaranteeing its functionality, and can work with those very same customers, we have many advantages, and that is playing out. We also have equipped ourselves with a variety of different kinds of conversion equipment, and so we can satisfy the needs of many different kinds of customers in the marketplace. And, if you will, the inlay wars are probably helping us, certainly more than hurting us, because we're purchasers of inlays. And those companies that are the inlay providers recognize our position in the marketplace, and they're working hard to see that their inlays are put in the Smart Labels that we are producing. So I think that gives you a little better idea, perhaps.

It does. Okay. Thanks.

Chris Quilty, Raymond James.

A question for you. Ed, you had mentioned in your prepared script, that you were starting to see the next wave of Wal-Mart vendors, referring to the next 200 for the RFID initiative.

Right.

Wouldn't most of that have been felt already in the fourth quarter, or are they continuing to see waivers in rolling these deployments into the first quarter and beyond, as they did with the first wave?

You know, yes, I would have thought that. But I can tell you from the experience that we had with the 137 last year, the spillover into the first quarter was very significant. And you know Bob Cornick, who's in charge of our RFID efforts, and he said it's sort of like people studying for exams. There's those that study in advance, and there's those who have to take the make-up quiz. You know? And we have just experienced a lot of people missed the deadlines, and they probably get some grace from God, and then get into the game.

But there were -- was it more driven by the vendors' inability to prepare, or were there any supply constraints that companies like yourself, or the some of the reader manufacturers might have encountered?

There may be other -- I mean, I know what our ability was to produce, And I don't -- so I don't think that was a factor. But that doesn't mean that there weren't other elements, in terms of companies making the determination of what they needed, and getting the components together to make it happen. I mean, I would expect, yes, those are other considerations.

Okay. And are you seeing a clean upgrade from Gen 1 into Gen 2? Or I'm hearing some sporadic reports that it's becoming more of a rip and replace solution, because of non-upgradability.

Well, we've made our product upgradable. I can't speak to others.

By ripping and replacing a module. Right?

No.

Firmware upgradable?

Yes. That's right.

Okay. And have you seen anything substantial coming out of the DOD channel?

No. The word "substantial" is something that you can't associate with any RFID business.

Well, given that the theoretical deadline is less than 12 months away for full compliance -- .

Yes.

-- when might you expect some meaningful activity to -- ?

Well, our projections for our RFID business show considerable growth '05 versus '06.

What were those number, Ed?

What were they? I think I lost that slip of paper somewhere, but I do remember them as being significant. But at any rate, I'd have to be totally frank with you, that we were disappointed. We've been disappointed more than once with the projections. So it is -- this is the question. It's not if. It's when. And things are taking longer in RFID. This is not just a Zebra story. Things are taking longer in RFID than a lot of people had hoped for.

Okay. And 1 final question with regard to the core desktop business. Looks like some of your Asia Pac competitors have been going through some changes with acquisitions, and sales force layoffs, and other activity. Are you seeing any meaningful change in their competitive posture in the market?

You're talking about China?

Japan.

Oh. In Japan? Actually, I don't have information on that to be able to respond.

Okay. Fair enough. Thank you.

Philip Alling, Bear Stearns.

Ed, just wanted to get a little more color from you with respect to the comments that you've made on mobile printers, the weakness there. Could you give us some color? And is there something happening with respect to the competitive landscape there that could shed some more light on what's been going on with that particular product?

Well, first of all, our product range includes a variety of different types of mobile printers that are each suited for -- or best suited for particular applications. The most recent introductions are the QL Plus and the RW series of products. And the RW series of products is -- are projected -- are directed into the route accounting, the direct store delivery marketplace. And that's a new position for Zebra, that particular market area. And we've been quite pleased with the progress we've been able to make with the penetration. Concerning the products, one of the things that some companies are looking to upgrade and improve is in the area of the encryption of data, and we have offered a next generation of capability in that regard. And that's being received very favorably.

Is there anything you can say with respect to the competitive offerings in mobile printers? Has that changed at all in the past 2 quarters?

Well, yes. I think there are more people are becoming aware of opportunities in the mobile space. And so there are -- there is more competition in the space than there has been in the past. We seem to be holding our own in that regard, and it's great to be in a market where you've got a really nice back win. But I think we're doing well versus the competitors that have come into the space. And by having more competition, it's healthy. And new innovative ideas come to bear, hopefully, frequently from us. But I don't think that Zebra's position in particular -- I don't think it has been affected too much by the competitive forces, at least to date.

Just with respect to sort of the domestic and international growth that you've reported, what is your sense about what the split likely will be between your international and domestic revenue a year from now?

Well, I think that our international business will continue to grow faster than our domestic business, overall. So I'd expect that those ratios will click in that direction. We're not that far from doing more international business versus domestic business. In this last quarter, it was actually quite close.

Right. And just a final question from me just on the collections. Normally, up in the fourth quarter, could maybe Randy give a little color in terms of sort of what the outlook is there, as far as collections going forward?

You're talking about receivables now. Right?

Yes.

Yes. Well, we had large shipments in December in comparison to December of the previous year. So that's going to have a naturally -- it's going to inflate your DSO a little bit, distort it a little bit. So our normal target for DSO is in the range of below 53 to 55 days, is what I would normally expect. So we would -- I would like to see that come down from where it currently is, which is a little over that range right now. But the health of the receivables portfolio is quite excellent. Our experience historically, has been very, very good. We really stay on top of it. We have a strong credit organization, and we manage the receivables portfolio, I think in an extraordinarily strong way. So it's -- I'm not concerned about it at all. It will come down, and I would expect it would be down in the normal range by the end of the second quarter. I mean, excluding extraordinarily large sales in March, that in comparison to March of the previous year. You always have that issue. But no, I'm not concerned about the DSO.

Thanks, Randy.

Reik Read, Robert W. Baird.

Good morning. You guys mentioned as part of your comments, that the seasonality that you see in the first quarter is typically flat to down. And you guys are bucking that trend a little bit here, and you listed a couple of thing that might be contributing to that, larger deals, some benefits in Europe, maybe a little bit of RFID. Can you just prioritize for us what the biggest source of the upside is, with respect to those things that you had mentioned?

We had a lot of product introductions in the fourth quarter -- important product introductions in the fourth quarter. That would be the biggest reason for that, what you call bucking the trend optimism.

Okay. And so I guess I'm taking from that comment -- I think you guys had said you had 7% new products this quarter. I think that was off of 8% last quarter. Typically, you would see 20 to 30%. You're suggesting that you'll start to get back there a little bit more quickly?

That curve is going to go up over the course of '06. It will go up substantially.

Okay. And any change in the retail environment? You've noted weakness there for the last couple of quarters. Is that changing at all?

We are -- we're the victim of -- I guess I'd say we're the victim of not having enough retail customers. So either we could make things -- essentially the volatility of the individual accounts is significant. And the way that it works is, if just 1 of those accounts is not in a buy cycle, we are affected. We are doing things over the course of '06 to improve in that regard. But that has been a big part of the story actually in '05, is the volatility of that business. I really hesitate to call it weakness in retail, as much as it is the inner section of buying cycles. Because there's a lot of demand, particularly demand for some of the mobile products that we're offering. It's just a question of when people are doing their rollouts of those products and those applications. That's the environment that we operate in. And I guess we'd rather have that business and have it volatile, than not have it at all.

[inaudible] stock portfolio with [inaudible] of 1.5.

The other question I had, just on the operating expense side. You came in at 51.5 million in your forecasting to go sequentially up 52 to 54. Can you just talk about what are the components of that increase at this point? And can you talk a little bit about what you might be expecting for legal expenses with respect to Paxar?

Well I think I'll comment a little bit on that. I think with respect to the legal expenses, given that the trial date has been moved off to January, 2007, we would expect in the near term that legal expenses would be somewhat lower than we've experienced recently. They would probably tend to go up later in the year, as the trial date gets closer. As it relates to the sequential increase or the guidance range that we provided for operating expenses, this is based principally on payroll increases. We're scheduled for annual merit increases and that kind of thing. So it's the normal cycle of OpEx that we're putting into the guidance range.

Okay. Great. Thank you.

Ajit Pai.

This is Andy Young standing in for Ajit. Just a couple questions regarding the retail verticals. It seems the vertical has been weak for several quarters now, and you mentioned that it's probably due to the buying cycle.

Yes.

Do you see the buying cycle become more favorable next year, or when do you expect it to become more favorable?

I think with the -- if I look at the complement of companies that we are currently selling, I wouldn't expect a substantial shift in either direction. Matter of fact, it might have a little bit of a downward bias. On the other hand, there are new opportunities for us from additional companies, that are looking very interesting. So overall, we will probably see an increase.

And that's quite a spike in terms of selling and marketing expenses. [inaudible] I think you were targeting retail verticals or some other verticals.

I'm not sure I understood what you were saying. But there was something about sales and marketing.

Yes. Marketing expenses.

Right. If you were to break down our expectations for spending in '06, I would expect the largest increases to be in the area of sales and marketing expenses. And those will come predominantly from international sales and marketing, but a little bit in terms of North America-based sales and marketing.

Okay. And in terms of other vertical, do you see -- do you back out retail vertical? It seems even in this quarter you have some growth in the nonretail verticals. Which vertical is going faster? Is that government or some other industry?

Well, if you look at Zebra's business, we have a strong part of our business is in the area of manufacturing, warehouse, distribution applications. Now, there's other applications or other verticals besides that, but those areas are very important overall to Zebra's business. And, yes, we are anticipating some growth in that space.

Great. Thank you very much.

David Sterman, Jesup & Lamont.

My questions are answered.

Hello?

Yes. I'm sorry. Thank you. My questions were answered.

Mark Roberts.

Ed, when you look at the overall environment, can you reiterate again what you feel like a sustainable, long-term revenue growth rate is for the Company? Kind of what you all are targeting internally?

Could I do that again? Does that mean I did it before?

I thought in previous calls occasionally, you've mentioned kind of the types of growth ranges you would -- ?

I think the thing for you to do is, to just really just take a look at what the historical compounded rate is, and pick your period. Randy, do you have -- ?

Well, yes.

Historical information?

Yes. We've spoken before about the belief that we have. And I guess this is validated both, from internal work that we've done, internal experience that we've had, internal studies that we've done, and also third party market studies provided by people like Venture Development and others, that indicate that the bar code thermal printer market is expected to grow in the range of 10 to 12% a year for the next 3 or 4 years. Now, we would expect, first of all, it's not going to be every year. And we would expect, given our strategic position, our financial strength, and the other things we bring to the table, we'd be able to gain some share, and supplement that with some strategic acquisitions, again highly unpredictable in terms of timing. But our view is that -- or our aspiration, is to grow the overall topline of the Company in the high-teens to as much as 20% a year. So these are the numbers we've spoken to people about in the past, and I don't think there's anything that's materially changed in the last quarter or so, that would change that.

Okay. And you mentioned earlier that there at least several people asked questions about increase in competition for the RFID segment of the business. Are you seeing -- it wasn't clear to me. Are you seeing the number of competitors increase, or the players that are in the space are just being a little more aggressive?

Number of competitors, well again we do -- I don't know the answer to that question. I think we certainly see the same cast of characters we've always referred to, the Sato's, Datamax's, the Toshiba's, and some of the smaller Taiwan-based Chinese competitors. There are a large number of companies that compete in the card space, and you know who those are. So I would say that the portfolio of competitors has not materially increased, in terms of their overall number, and anybody that does come into the market is typically pretty small in terms of their impact, with very limited product range, and very limited in terms of their regional presence. So you'll see them pop up in specific regions of the world, mostly in Asia Pacific, and to a lesser extent, in Europe. We haven't seen any U.S.-based competitor -- new U.S.-based competitors emerge over the last 12 months, that I'm aware of.

Okay. Thank you.

Andrew Abrams.

I have a question concerning your RFID. Obviously, you're not going to give us any numbers, but I thought maybe you could give us a little bit of color in terms of, number 1, how it breaks out between commercial and government. And maybe '05 would be a good starting point. And then '06 breakout, and relative to where you would have thought that would have been a year ago, meaning how much DOD business has pulled back, or been held back versus commercial.

The absolute -- I mean, the commercial side of RFID is -- versus DOD, it's almost all commercial. You have a series of different pilots that we're participating in on the government side, but there's very, very small amount of business in that area. I think things will change a little bit in '06. Well, I know that the projections are on a relative growth basis, from the government number being a very small number. So there's quite a lot of growth from a percentage basis. But on a dollar basis, still, when you would look at '06 numbers, at least our expectations are that government will be very -- will be small in '06.

Okay. And if you could give us a little bit of color on the weakness in the retail sector, and how it breaks out customer by customer? I don't mean specific customers, but I'm talking about more large to small than anything else. Is this a large phenomena as we've heard from some of the manufacturers? Or is it small, or is it across the board? There's no differentiation between the 2.

Well, given our channel structure, the only people we sell on a direct basis, are large accounts. Large, whether it's retail or manufacturing, or in any of the verticals that we operate in. So the breakdowns that we get in realtime are not very reliable, so I really can't tell you. I really can't answer that question for you, other than to tell you that, in the space that we're -- where we do have the information, in the large account space, as I mentioned earlier in the conversation, it is generally a situation of rollout of programs within those companies.

Okay. So I assume the ScanSource business is a good indicator on the smaller side as to what the flow through there is, even from old products and new products together, so -- ?

Yes. You have a piece of channel business that is flowing through ScanSource. And we reported to you here that ScanSource represents 15% of our business. So 85% of it is not in that sample. And what you have is the ScanSource numbers are predominantly North America-based numbers. I mean ScanSource does have some amount of business outside the United States, but by and large, those numbers, the 15%, represent mostly U.S. business. So -- and half of our business is outside the United States. And the half that is outside the United States doesn't have -- well, we don't have good breakdown by verticals, that would allow me to respond to changes on a quarterly basis. Even on an annual basis, it's difficult for us. But certainly on a quarterly basis, we have just no ability to respond to that.

Thank you.

It's truly one of the weaknesses of the model.

Well, that kind of color is helpful, though. At least we know what our basis is, that we're working off of. Just in terms of the expenses, 1 last question. You've stated in the last couple quarters that the expense level that you've established within a certain amount here, is going to continue, regardless of basically where the revenue rate had changed to. And I think on the last call you indicated that there was -- at some point there is the possibility that those expenses will come down, if the revenues don't materialize as expected. Is this an '06 phenomena, where you will go through most of the year, if that's the case? Or is this on a quarter by quarter basis, that those kind of changes could occur some point in the 2006 year?

Well, let me give you a little bit of clarity on that anyway. When I made those remarks about sustaining our operating expense level, I was really referring to Q3 and Q4 of '05. That in essence we had put plans in place for the year, and I felt that it was better for us to continue to not stop certain efforts in the middle of the year, complete various projects that -- and get the value from those projects. And so the spillover -- I would allow that spillover into Q3 and Q4. We have now created budgets for '06, and we've looked at our -- we've very carefully analyzed our spending levels, and what our growth expectations are for the year. And we have put together a budget where we have proper alignment between those operating expenses and the revenues that we're anticipating.

Terrific. Well thank you very much. I appreciate the help.

Marshall Levine.

My question's been answered. Thank you.

Chuck Thomas.

Just a couple quick follow-up questions. So based on that last answer, is kind of the channel build-out part of the operating expenses, completed both internationally, and then addressing the vertical markets?

No. I wouldn't say it's completed at all. I mean, this is -- for us, this is a very ongoing thing. We are expanding our channel in actually all 4 regions of the world. There is perhaps more emphasis on channel development outside the United States. And that perhaps there is more investment outside the United States. We're increasing our selling organization in all of those regions, and we think that we've got the products that we need to be successful in those markets.

So I should kind of look at this quarter's sales and marketing as maybe being on the high end of what I'd normally expect, but as far as a percentage of revenue goes, not really expect it to come down that much. Is that correct?

I actually don't have in front of me a breakdown to be able to look at that.

Well, I'll follow-up. Now, in the past, you said that, excluding delayed deliveries into 3 tier 1 retailers, going back to the third quarter, that the excluding this shortfall that North American sales would have increased by 10% last quarter. I think my notes are correct.

No, no, no. Your notes are incorrect. We said that they would have increased sequentially. We did not wrap a number around that.

Okay. Can you give me some clarity onto the activity in those 3 tier 1 accounts, what sales would have looked like without their lumpiness? And I also think that somewhere in my notes that I have that you expect those programs to continue. Can you -- ?

What I would tell you, is that if you would take out the lumps, okay? Those large accounts, and just put that on the side. And what you're essentially left with is predominantly channel business, you would have seen much more consistent growth.

Consistent implying what?

Well, consistent. You would -- you would have seen, if you would have looked quarter to quarter to quarter, you would have seen growth in channel business, as opposed to what you did see, which was our overall business was relatively flat over the course of the year. Which essentially means that, if you take out the stuff that was bouncing around, it had a negative effect on the total. The channel business was very -- it had growth.

Right. The channel.

And recognize that's a big chunk of our business.

Okay. Just 2 last quick follow-ups. Just doing a little math here, ScanSource, 15% of total revenue? So 30% of North American revenue?

Well, ScanSource is both -- principally domestic. Not exclusively. But yes, it would be approximately that. Somewhat less. ScanSource has operations outside the U.S.

Okay. And then 1 last one if I may. Looking at -- again, going back into notes and looking at prior commentary on growth expectations, underlying market growth of 10 to 12% -- and this is a number that we haven't seen on your revenue line in a while. Over what sort of time frame would you expect this to be reflected in your revenue growth?

Well, I would expect it relatively soon. Again, we had actually expected it in 2005. And again, we stated earlier in our initial comments, that we were disappointed in the growth performance in 2005. And this was particularly related to the issue that Ed was just talking about. This is the drop-off in some of these key account retailers, where we had record sales in 2004, and substantially less than that in 2005. It really dragged down the overall results in North America, in particular. So that was a huge issue for us. So we would expect to get back on a more normal growth track, as early as this year.

Okay, I mean, because I look at the midpoint of Q1 guidance for year-over-year, and I'm looking at what, 5.5, 5.8% topline growth.

Right.

Thank you.

What I'd suggest for you is to either give Randy or Doug a call, and we'll share with you some of the market research information relative to the sector, or some of the sectors of the business where we operate. And we will also give you some of the historical growth rates for the Company in total, in the various parts of our business.

Thank you very much.

Jeff Rosenberg, William Blair.

Randy, does the 52 to $54 million operating expense number, does that include operations expense?

Yes, it does.

That would be what?

The options expense is reflected principally in the operating expense area, and there's cost of sales, as well.

Okay. And is that a number that you think will be pretty consistent, quarter to quarter?

Yes, it would be around $2 million a quarter. It works out -- for us, it works out to about $0.02 a share.

Right.

And we will be restating prior years, or in this case, 2005. Things like options expense, as well. Last question. Last question. One more question. Do I hear another question?

I'm done.

You have a follow-up question.

This is the last one, though. Okay? Because we've been on for an hour. Okay?

Philip Alling, Bear Stearns.

Thanks for letting me squeeze this last one in here. Just was wondering whether there's any change in appetite with respect to M&A? Certainly that's figured prominently in some of the growth discussions that we had in the past. So was wondering if you could just comment on that?

We are actively pursuing acquisition candidates.

That's it, Ed? Okay. Thanks very much.

You got it.

Okay. Thank you all for your participation today. Just as reminder, our next conference call will be at 10:00 in the morning Central time, on April 26th. We'll look forward to hearing from you then. Thanks for your participation.

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