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Executives

Matt Espe – Chairman and CEO

Bob Woods – SVP and CFO

Analysts

Amanda Seguin [ph] – Lehman Brothers

Woo Jin Ho – Merrill Lynch

Ananda Baruah – Banc of America

Shannon Cross – Cross Research

IKON Office Solutions Inc. (IKN) Q3 2008 Earnings Call Transcript July 24, 2008 11:00 AM ET

Operator

Greetings, ladies and gentlemen, and welcome to the IKON third quarter fiscal 2008 earnings conference call. At this time all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (Operator instructions) As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Mr. Henry Miller, Vice President of Corporate Finance for IKON Office Solutions. Thank you, Mr. Miller, you may begin.

Henry Miller

Thank you, and good morning. Before we begin, we would like to caution you that the call we're about to conduct contains forward-looking statements within the meaning of the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements are based on management's current expectations or beliefs, and are subject to a number of factors and uncertainties that could cause actual results to differ materially from those described in the forward-looking statements. The company does not intend to update any forward-looking statements made during this call.

As a reminder, today's call is being recorded at the request of IKON. This call may not be rebroadcast or replayed without the express prior written approval of IKON. Third-party transcriptions of the conference call have not been approved by IKON, and we take no responsibility for their accuracy.

The call today will be hosted by Matt Espe, IKON's Chairman and CEO; Bob Woods, Senior Vice President and Chief Financial Officer, who will also be participating on the call. At this point, I am going to turn the call over to Matt Espe, who will begin today's presentation on slide three.

Matt Espe

Good morning everyone and welcome to the IKON Office Solutions third quarter 2008 earnings conference call. Earlier this morning, we reported adjusted earnings per diluted share for the third quarter of fiscal 2008 of $0.37, which excluded a net $0.03 per share charge primarily from the loss on the early extinguishment of debt. Bob is going to provide more detail on the charts later.

Our adjusted earnings performance is at the high end of our revised outlook and a 61% improvement year-over-year. Total revenue for the quarter grew 1% to $1.1 billion, including a currency benefit of one point. Our revenue performance was driven by Managed and Professional Services, and customer service and supplies, particularly offset by 1% decline in equipment revenue.

I’m pleased to report that our operating income margin was 6% in the quarter. Our U.S. leadership team performed early in the second quarter delivered better than expected customer service and supplies revenue in gross margin, and Managed and Professional Services gross margin on continued revenue growth.

Europe again performed well growing total revenue 12% year-over-year and 7% at constant currency. Let me note that this is Europe’s eighth consecutive quarter of year-over-year revenue growth at constant currency. Additionally we had benefited from the $25 million cost and expense reduction plan we announced in January.

Now let me stress that while we are very pleased with our third quarter performance, we certainly recognize the need to continue delivering strong results. Before I discuss our revenue performance in more detail, I’ll highlight three examples of our strong third quarter execution. First, we completed our one platform migration in the U.S. We now have one common technology platform, which will leverage the increased productivity throughout the U.S... In particular, we are planning to deploy warehouse and transportation management systems over the next 18 months.

Second, we significantly reduced debt. At June 30, our corporate debt was $162 million lower than at March 31. That’s a 22% reduction. And third, we generated strong cash flow, about $90 million in cash from operations in the quarter. Bob is going to provide more detail on the balance sheet and cash flow in a few minutes.

And now I’d ask you to please turn to slide four. I’ll review equipment revenue for the quarter. In the third quarter, equipment revenue was $444 million, down 1% from the prior year. Looking at the key product segments of the U.S. equipment market, revenue declined in the black and white office segment and was partially offset by growth in color production, color office, and black and white production segments.

Color equipment revenue increased 12% with placements up 7%. Our color mix in the third quarter increased to 38% of equipment revenue, that’s up from 33% in our third quarter last year. Color office revenue grew 14% on placement growth of 10%. This continues the momentum we developed late in our second quarter. We delivered particularly strong revenue and placement growth in segment four. Additionally we are gaining traction from our efforts to simplify our go-to-market strategy with the small and medium market, generating 17% color office placement growth in June.

Color production revenue grew 6% while placements declined 8%. Our revenue growth reflected continued momentum with a Canon C7000 and C6000 products with 39 and 33 machines placed in the quarter respectively. Now the primary reason for the decline in our placements was lower sales of the Canon imagePRESS C1. Now as you will recall, this product’s availability was delayed in our first quarter of fiscal 2007, which contributed a strong sales in our second and third quarters last year. Now with that said, we continued to generate solid sales of the C1 in the third quarter of fiscal 2008.

Black and white office revenue declined 11% with placements down 13%. These results due to continued pricing and competitive pressures, particularly in the low end segments and of course the shift to color office. We also experienced some revenue and placement of migration to black and white production as the Ricoh MP 6500 segment 4 device was replaced by the faster Ricoh MP 7000 segment 5 production device.

Black and white production revenue grew 3% with placements up 13. In light production we delivered revenue and placement growth due to use equipment, new products, specifically the Ricoh MP 7000 and 8000, and the continued strength of the Canon IR 5075. In heavy production revenue growth was driven by strong sales of the Canon IR 7150. In Europe we continue to generate strong results. Equipment revenue grew 16% year-over-year at constant current as a result of strong performance in both the UK and Germany. As reported, Europe’s equipment revenue grew 22%.

And now please turn to slide five. Customer service and supplies revenue was $347 million, up slightly from the prior year. North American customer service and supplies revenue declined 2% in the third quarter. This performance was driven by lower total page volume, a decline in analog copier machines in the field or MIF, and a decline in digital MIF.

Now within total page volume, declining pages from Analog Devices and black and white office products, were partially offset by continued strong page growth from color devices. Pages made on color devices represented about 10% of our total pages, up from 8% in the third quarter last year. Looking at customer service and supplies copier MIF in North America, analog MIF declined as expected and represents only 7% of MIF.

Digital MIF declined 1% with strong growth in color. In addition, as we expanded our service offerings from our existing customer base, some customer service and supplies MIF migrated to On-site Managed Services. So it’s important to note, total North American digital MIF, including On-site Managed Services increased 2% year-over-year.

Now in Europe, customer service and supplies revenue grew 7% at constant currency, due to an increase in color page volume and strong color placement growth. As reported, Europe's customer service and supplies revenue grew 13%.

And now please turn to slide six. Total Managed and Professional Services revenue grew 4% to $211 million. On-site Managed Services revenue, which represents about 70% of the total Managed & Professional Services, grew 6% due to continued expansion of services within existing accounts.

Off-site Managed Services revenue declined 6% due to a lower volume of activity. However, profitability improved and we continue to consider options to improve this business’s performance. Professional services revenue grew 6% in the third quarter due to growth in equipment related installation, consulting, and support and maintenance services.

I will review our outlook for the fourth quarter and, of course, all of fiscal 2008 in a few minutes. But please now turn to slide seven and Bob will discuss our third quarter results in more detail.

Bob Woods

Thank you, Matt, and good morning everyone. For the third quarter of fiscal 2008, earnings per diluted share were $0.37, excluding a net charge of $0.03 per share. This net charge was comprised of a $0.04 per share loss on the early extinguishment of debt due to the redemption of our 2012 notes and a 1% per share benefit from an adjustment to the restructuring charge that we took in the first quarter of fiscal 2008. Gross margin for the quarter was 33.7%, an increase of 50 basis points from the third quarter last year. I will review gross margins in more detail on slide eight.

Selling and administrative expenses were $292 million, down year-over-year primarily due to lower administrative expenses, which were partially offset by currency and by higher selling related compensation expenses. For the quarter, our S&A expense-to-revenue ratio was a record low of 27.8%, down from 28.1% last year and 28.2% in the second quarter. We remain on track with our plan announced in January to achieve $25 million in savings in fiscal 2008. As a result, we still expect our expense-to-revenue ratio to be approximately 28% for the full year.

Operating income grew 16% to $62 million and operating margin increased 80 basis points to 5.9% in the quarter, excluding the benefit of the restructuring charge. Interest expense, net of interest income increased $4 million year-over-year to $15 million due to the financing associated with our share repurchases activity in the first quarter of fiscal 2008.

Our effective tax rate for the third quarter was 26% as reported, down from 33% in the prior year quarter, but higher than our original expectation communicated to you in April of less than 24%. For the full fiscal year, we expect our tax rate to be approximately 34%, as reported. This expectation is subject to the outcome of a pending audit resolution, which if we are able to close this in the fourth quarter may lower our effective tax rate to as low as 31% for the full fiscal year. As we mentioned in the past, our tax rate will rise over the long-term to our anticipated structural rate of about 36%.

At the end of the quarter, actual shares outstanding were 94 million shares, a 24% reduction year-over-year driven by our share repurchase program. For the third quarter, our weighted average fully diluted shares were also 94 million. For fiscal 2008, we expect average fully diluted shares to range from 99 to 100 million shares.

Now please turn to slide eight, and I will review our gross profit margin. Gross profit margin in the third quarter increased to 33.7% from 33.2% a year ago, primarily driven by improvements in Managed and Professional Services and in equipment. And these were partially offset by a lower customer service and supplies margin.

Our equipment margin improved 70 basis points to 25.1%, driven by higher average selling prices and a higher mix of used equipment. We realized higher average selling prices as we moved to an increased mix of color production machines and our strong performance in the high end of business color.

Customer service and supplies margin decreased primarily due to North America, where cost declines did not keep pace with revenue. Managed and Professional Services margin improved, primarily due to strong professional services revenue on lower fixed cost, continued contract profitability growth in On-site Managed Services, and lower cost in our Off-site Managed Services business.

Now please turn to slide nine and I will discuss our cash flow. For the first nine months of fiscal 2008, we generated $148 million of cash from operations compared to $16 million in the comparable period of fiscal 2007. As Matt said, we generated about $90 million of cash from operations in the third quarter or 60% of our year-to-date cash from operations.

During the first nine months of this year, we generated $18 million in net working capital improvement from inventory and accounts payable. Accounts receivable used $11 million of cash. Other, which is the net of the remaining non-cash items and changes in other assets and liabilities, was $16 million, an improvement year-over-year due to lower bonus payments in fiscal 2008 and the timing of payments related to other liabilities versus the prior year such as the timing of payroll disbursements.

Net capital expenditures were $35 million in the first nine months of fiscal 2008, resulting in free cash flow of $112 million, which was an improvement of $129 million year-over-year. We now expect free cash flow to range from $130 million to $150 million for fiscal 2008.

Now please turn to slide ten, and I will cover our balance sheet. As Matt mentioned earlier, we reduced corporate debt by $162 million or 22% in the quarter, significantly reducing our debt-to-capital ratio to 36% at June 30 from 41% at March 31. The primary driver of our debt reduction was the redemption of our 2012 notes. In May, we redeemed 50 million of these notes and at the end of June we redeemed the remaining 100 million.

In addition, $14 million of our 2008 notes matured and were retired in June. We focused on debt reduction this quarter because we could call the 2012 notes at par through June 30, and eliminating this relatively expensive debt was preferable to today’s low returns on available cash. Our debt reduction activity was a primary reason cash decreased $97 million in the third quarter to $107 million.

Going forward, we plan to continue to repurchase shares within the covenants of our existing debt agreements. However, we do not expect to resume this activity until fiscal 2009 when we have increased our capacity under our existing debt covenants. Inventory remained relatively stable ending the quarter at $278 million compared with $288 million at September 30 of last year. Accounts payable increased to $273 million at June 30 from $264 million at September 30.

Now please turn to slide 11, and I will turn the call over to Matt to discuss our outlook for the fourth quarter and for the full fiscal 2008.

Matt Espe

Thanks, Bob. Let me start with the fourth quarter. Given our seasonally lower customer service and supplies and Off-site Managed Services revenue, as well as higher lease rates, our outlook for the fourth quarter diluted earnings per share is a range of $0.25 to $0.30. I’ll note that we’ve widened the range our EPS guidance because now one penny of earnings equals less than $1 million of net income due to the reduction in our share count over the last year. For the fiscal year 2008, we expected adjusted diluted earnings per share to range from $1 to $1.05. This equates to 10% to 15% growth year-to-year and higher in our previous outlook of $0.92 to $0.98.

As you recall, Bob mentioned a pending tax audit, which if favorably closed could increase earnings per share up to an additional $0.05. In addition for fiscal 2008, we continue to expect total revenue to be flat year-over-year, our expense-to-revenue ratio to be about 28%, and our operating income margin to be about 5%. This is consistent with the guidance provided during our Investor Conference in May.

In closing, I want to personally thank our employees for their hard work and commitment to help us deliver another quarter of better than expected results. We’re proud of the 6% operating margin in our third quarter execution. We completed the one platform migration here in the U.S... We continue to perform well in Europe. We significantly reduced debt and generated strong cash flow.

This management team remains focused on our strategic priorities of improving sales productivity, increasing placements of color machines, drawing our annuity streams, improving working capital, and reducing costs and expenses, and of course continuing to generate strong earnings growth.

At this time, we’ll be happy to take your questions.

Question-and-Answer Session

Operator

(Operator instructions) Our first question today is coming from the line of Carol Sabbagha with Lehman Brothers. Please go ahead with your question, ma’am.

Amanda Seguin – Lehman Brothers

Actually, Amanda Seguin [ph] on for Carol. First, just a question on the economy in the U.S. and then Europe, kind of what you saw in the quarter and as the quarter progressed versus the prior quarter, if there was any change there?

Matt Espe

Hi, Amanda, it’s Matt.

Amanda Seguin – Lehman Brothers

Hi.

Matt Espe

There really wasn’t a degradation in the economy sequentially quarter-over-quarter, as we’ve said. The environment remains challenging, continues to remain challenging. We certainly didn’t see it any easier. I think we saw – we have seen some additional challenges. And I guess that sort of manifests itself in longer deal cycles at the very high end. But that’s about it. I mean, nothing significantly different sequentially and nothing significantly different than we would sort of anticipate it coming into the year.

Amanda Seguin – Lehman Brothers

Okay. And then one more follow-up. On the Konica Minolta Danke deal, just wondering if that’s changed, if there’s any update on your relationship with Konica there and the machines in the IKON channel?

Matt Espe

Nope. Konica, we like the 350 and the 550, the equipment is terrific and the relationship is intact.

Amanda Seguin – Lehman Brothers

Okay, great. Thanks for the question.

Matt Espe

You bet.

Operator

Thank you. Our next question is coming from the line of Woo Jin Ho with Merrill Lynch. Please proceed with your question.

Woo Jin Ho – Merrill Lynch

Thanks. Matt, you continue to see good momentum in Europe, 7% on a constant currency basis in the quarter. How do you see the European business developing in light of the softening economy? And I understand you – it is challenging in the U.S., but it seems as if some of it maybe bleeding overseas. And how much – what are some of the European assumptions are there embedded into your FY ’09 guidance that you gave on analyst day?

Matt Espe

Well, we are not going to really comment on ’09 at this point. We’ll have more information, Woo Jin, in our fourth quarter call. But just to – we’ve got a very stable, very senior leadership team, very experienced leadership team in Europe that our business model there has been very stable as well. We’ve had solid execution in Germany for quite a long time. We’ve got solid execution in the UK in the past several quarters. We’ve got a relatively small share in a relatively large market. So we’re cautiously optimistic for the balance of this year and into next year.

Woo Jin Ho – Merrill Lynch

Okay, great. One market question in terms of the light color production space, can you discuss the opportunities in the light color production market, especially given the increase in competition from – or forthcoming competition from Xerox as well as Konica, Minolta, also expanding its own distribution capacity? Now do you view this space to be a growing market segment and is this a share where you can – or is this a market where you can sustain your share?

Matt Espe

Well, Xerox is a very serious player in color production at light, mid and heavy. They have got great products. We obviously are taking advantage of very strong introductions with C7000 and 6000. We’ve had a very strong run with Konica Minolta through several iterations of their product lines. We view production color mid, light and heavy as an opportunity for us. As we think about increased competition from Danke connection, there is a requirement for investments in order to be effective in the mid-market that makes it tough to enter. So we’ve invested in color production. We’ve invested in color specialist, production specialists and graphic arts reps in order to take advantage of the product technology we have. And so it’s not a market that’s just easy to get in even if you have the products. It requires investment and focus. We’re also excited by the way at the potential launch – or the launch rather, Ricoh’s C900 coming out in September or October. So as we think about ’09, we step into ’09 with a very strong color production portfolio, clearly the strongest we’ve had in quite a while.

Woo Jin Ho – Merrill Lynch

Okay. And then a couple more. Number one, update on the graphic arts segment, any placements there this quarter? And lastly on the customer services margin, nice uptick on a sequentially basis, how sustainable is that going forward?

Matt Espe

In terms of color production, we still see the majority of our placements in in-plant applications. The pipeline in pay for print and commercial printing continues to build. I mean, we’re seeing success there, but if you are asking on a percentage basis, still – the mix still favors in-plant. And your question on customer services margins sustainability–?

Woo Jin Ho – Merrill Lynch

Yes.

Matt Espe

Reasonably sustainable. I’ll kick it over to Bob to make an additional comment.

Bob Woods

If you look typically in our third quarter, it’s our best margin quarter in customer service. So we expected the uptick. If you look at it, the margin tends to weaken somewhat as you get into the fourth quarter because it’s a slower period of time, the July to September quarter. But in terms of the – if you look at the big picture on the margin, it requires what we do well, which is continued focus on cost and order for us to maintain our margins.

Woo Jin Ho – Merrill Lynch

Thank you.

Operator

Thank you. Our next question is coming from the line of Ananda Baruah with Banc of America. Please proceed with your question.

Ananda Baruah – Banc of America

Very nice. Thanks guys for taking my question. Just wondering if you could comment maybe on the pricing environment both in the U.S. and Europe? And then if you could just talk to what you are seeing across your different verticals in both of the regions, are you seeing – I get the overall demand environment feels pretty stable this quarter relative to last quarter, but is there anything you are seeing – are you seeing any shifts I guess across any of your important verticals as far as demand trends go?

Matt Espe

Yes, Ananda, it’s Matt. The pricing environment continues to be tough. And most of the pricing pressure we see is in black and white at the low end. And it comes from kind of tier two manufacturers. We haven’t seen – as we expand our footprint in color production, we see a little price there. It’s expected. I think we are more than holding on in terms of price performance along with revenue performance in color production and black and white production frankly. We’ve got very strong product portfolios in both color and black and white production. We’re seeing the real benefit of that. In terms of vertical performance, nothing changing there. I mean, we haven’t seen any degradation in any specific vertical, any degradation in any geography, so – or customer segment. I mean, we are certainly happy with the increased focus that the U.S. team is placing on the mid market. I think the office color portfolio expansions by both Canon and Ricoh in the last 18 months are helping us there significantly. So we are happy with the progress we are seeing in our focus on the mid market. We are probably taking a little bit of share there. But in terms of segment performance on a demand basis, no real changes.

Ananda Baruah – Banc of America

Are you seeing the – maybe the more risk of pricing from the two tier guys have any impact from a share shift perspective? I mean, I guess you just mentioned that you think you might be taking some share in mid-market. But is it just a case of they pricing a bit more aggressively because things are going tougher and kind of two tier distribution but they are taking share, or is there – are you seeing any bleed-over effect from a share perspective?

Matt Espe

Well, we are seeing some – you know, what we see is more segment one and two boxes in black and white. So the very low end office black and white continues to go to the retail channel and continues to go from copier technology to printer technology. And that’s sort of where we are seeing – where the price pressure is. If you look at our performance visa [ph] the market for copiers through the copier channel, we are probably holding share there even in black and white. But what I’m talking about is, saying like A4 copiers – you’re seeing actually some improvement in functionalities clearly at much lower price points by the tier two guys. And you are seeing that kind of shift from copier distribution to retail. We don’t play there. There is not a value there. And while we watch it, it doesn’t concerns from a model perspective. And we were talking about the mid-market. We just – under Jeff Hickling’s leadership with Mark Bottini, I mean, we’ve really – and are re-orienting ourselves on the mid-market, as we discussed at the Investor Conference and we are beginning to see traction there. And that’s enabled somewhat by the stronger office color portfolio we’ve seen, the new products by Canon, Ricoh and office color.

Ananda Baruah – Banc of America

Got it. And just a quick question on the operating margin, roughly 6% operating margin this quarter, so – I mean, is this sort of – if I look back historically, it’s been your seasonally strongest quarter for operating margins. And I suppose that’s the reason for kind of the implied guidance in the sequential downtick, so that makes sense. But let me say it does kind of feel like you might be a little bit ahead of your internal plan, either that or you guys had some – a bit of conservatism baked into your original forecast, which I don’t think anybody would blame you for in this environment. But I guess the question is, as we move forward here, kind of if there is a potential for you to begin to move more kind of in ’09 step [ph] maybe into your long-term financial model of about 6% operating margins as opposed to the 5% to 5.5%. So it does feel that you guys might be a little bit ahead of schedule right here.

Matt Espe

Well, I think you said it. I mean, our third quarter tends to be our strongest. Bob commented on the relative performance and the customer service margins and how you’d expect a little bit of drop-off in the fourth quarter. Our model – you know, the sequential quarterly performance seems to track that way. Again we are not going to discuss ’09 guidance at this point, but we are sticking with – we are sticking generally with the guidance that we shared at the Investor Conference and we’ll talk more about that at the end of our call next quarter.

Ananda Baruah – Banc of America

Okay, great. Thanks a lot.

Matt Espe

Thanks, Ananda.

Operator

Thank you. Our next question is coming from the line of Shannon Cross with Cross Research. Please proceed with your question.

Shannon Cross – Cross Research

Hi, good morning.

Matt Espe

Hi, Shannon.

Shannon Cross – Cross Research

Couple of questions. Just starting – can you talk a little bit about the competitive environment in the services business as you go out and do some of these bids, the sweep bids and that, you know, with the HP getting a bit more aggressive, Lexmark is probably desperate from a desperation standpoint I would say? And then they are also obviously playing their queue. I’m just curious at sort of what pricing, what it looks like in terms of how savvy customers are becoming in terms of getting all of you to price against each other and then what people are looking for and what sort of drives their decision-making?

Matt Espe

Well, let me try to answer that. That’s a very good question. For many of our customers, this is now round two or three of outsource agreement, certainly round two. So to your point, the customers are more savvy. But what we are seeing is, we continue to see extremely high retention rates because the switching costs are high. And we’ve been able to leverage fairly strong product portfolios with very strong workflow solutions at our customer base. As a result, you just tend to get embedded into clerical workflow. So the switching costs are a little bit higher. So it makes it very difficult even for companies – strong companies like Canon – or I’m sorry, Xerox and HP to come in and knock us out. When it’s a brand new Greenfield, if you will, it’s a little tougher, but we have very strong references. So it’s – we think we are very well positioned because we’ve got a very broad and diverse product range and we’ve got great leverage with very strong workflow solutions, and we’ve got great process experience in a number of verticals. Our product line – the equipment lineup is stronger for mid-market than a couple of manufacturers you mentioned. Our experience is broader and deeper, and our ability to sort of refresh the offering during the course of a managed service agreement is very good. And we’ve got a very, very good track record of delivering on precisely what we commit to. And that brings some sustainability as well.

Shannon Cross – Cross Research

Okay. And then a question with regard to your strategy and your product lineup. Obviously Canon and Ricoh play an extremely large role. You’ve got some of the Konica Minolta. You also brought in some of the Konica Minolta printers I believe that you are branding. Just sort of how do you think about the trade-off between branded and unbranded and Kyocera Mita, right, that you brought in at the low end?

Matt Espe

Yes, we are still – it’s a good question, Shannon. I mean, we are committed to solid branding, meaning we believe there is real value in lining up with the Canon and Ricoh brands. We see co-branding as a niche opportunity where we are able to differentiate that offering a little bit. I would not see – we don’t have a strategic direction away from lining up with very, very strong brands towards co-branding. Our priority is positioning strong brands and we use co-branding on a niche basis where we see fit and where I said where we think we can differentiate the offering a little bit.

Shannon Cross – Cross Research

Okay. And then just a final question with regard your fuel costs. I’m just curious with companies like yours and others, which obviously have a significant services fleet out there driving around burning $4 gallon gas.

Matt Espe

Yes.

Shannon Cross – Cross Research

How do you sort of manage that and are you – just productivity is offsetting the cost there? How should we think about petroleum cost?

Matt Espe

Well, it obviously presents a little upward pressure. That’s why crisp execution and implementation on one platform is critical because it gives us the ability to take some of that structure out. Bob, you want to comment on that?

Bob Woods

Yes. You are certainly right. We are affected by fuel costs. Our approach is we have to find ways to offset it. We have a very good freight management team and that has looked at rerouting routes in order to optimize the amount of time on the road. We have seen some in our service force obviously. Those costs are higher. And the way we approach it with each of those units is, where the costs are higher, we go through and find other ways to reduce to find an offset. And we’ll keep doing that as long as we have the increases that everybody is facing.

Shannon Cross – Cross Research

Okay. And then just one last question. Remind me again on the currency side, how we should sort of think about your willingness of your partners to be aggressive on pricing and how is currency played into your model?

Matt Espe

Well, we haven’t seen any pricing increases from our vendors at all with or without the currency impact. Obviously they are Japanese and you got the – the impact that gets handled somewhere. But as we say frequently, they have to compete in the U.S., in the U.S. market, in the U.S. pricing environment, we have to compete throughout Europe in the European pricing environment. And so far that’s what we’ve seen them do.

Shannon Cross – Cross Research

Okay, great. Thank you very much.

Matt Espe

Thanks, Shannon.

Operator

Gentlemen, there are no further questions at this time.

Matt Espe

All right. Thank you very much. Thanks everybody for your questions and have a great day.

Operator

Ladies and gentlemen, this concludes today’s teleconference. You may disconnect your lines at this time. Thank you for your participation.

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