Richardson Electronics Ltd (RELL) 2005 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the second-quarter earnings release. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Instructions will be given at that time. (Operator Instructions). As a reminder, this conference is being recorded. I'd not like to turn the conference over to our host, Chief Executive Officer, Mr. Ed Richardson. Please go ahead.

Good morning. I have Bruce Johnson with me, President; and Dario Sacomani, Chief Financial Officer; and Greg Peloquin, Executive VP and Manager of the RF and Wireless Group. Bruce will cover some highlights of the quarter for you, and Dario will go over the P&L and the balance sheet. And Greg is here to answer some questions on the RF and wireless group as well.

Well, sales wise, we were really pleased with the quarter. It was a record quarter at 151.4 million. Unfortunately, it was also a record quarter in expenses. However, we accomplished a lot. I think the biggest milestone in the quarter is we finally have PeopleSoft up and running. We went live early in December after three years and about $12 million worth of expenditures on programming. During the quarter, we brought in over 250 people who were trained on the system. And we really -- we think we've done it right. So far, it's working very well. Part of the reason why it took so long for us to implement PeopleSoft is we have an excellent system called Robinette, that we've had for some 20 years. And from a sales and marketing side, we don't think there's a better system in the industry. So we chose to bridge between Robinette and PeopleSoft, which was a very complicated thing to do. But it's working extremely well and everyone's happy and we're up and running. So we think it's been money well spent. And certainly, it gives us a system now that can take us to $1 billion over the next few years. That's what we're attempting to do.

At the same time, we completed an acquisition of a company in China called Evergreen, and Bruce will tell you about that. We've been working on that one for about six months. And we also completed a joint venture with a group of engineers from T.I. in Texas, which we think will get us some technology for video compression that will allow us to increase our sales for the Security Systems Division as well as the Display Systems Group. And Bruce will also tell you about that.

So, in the second quarter, again, sales were a record 151.4 million, up 18 percent from the prior year's second quarter. And encouragingly, all four SBUs in all four geographic areas of the world were up from the prior year. It was the 10th consecutive quarter of year-over-year growth. Net earnings were 10 cents versus 15 in the prior year's second quarter. And again, this had to do with the incremental expenses from PeopleSoft. Also, our ongoing project with Sarbanes-Oxley and all the consultants and whatnot to try to comply with the Sarbanes-Oxley. But we're getting there.

By SBU, sales and gross margin versus the prior year. The RF and wireless group was up 17 percent to $67.4 million. More importantly, they raised their gross margin a full point to 23.3 percent. The Passive and the Internet group was up 29 percent in the quarter. Network access was up 19 percent. The infrastructure group was up 12 percent. And Asia, as far as geographic areas, again, let the growth. They were up 25 percent. And then there, more importantly, is they raised their gross margin almost 3 full points. So that's really encouraging. Asia has always been the lowest gross margin for us of any geographic area.

The Industrial Power Group was up about 12 percent, and at 31.3 million. They again achieved the Company's goal for gross margin. They were about 30 percent at 30.4 percent. It was led by growth in the power components side of the business, which is really the growth area of this business -- was up 22 percent. And there, they were able to increase margin from 26.9 to 27.5, which is encouraging.

The tube business, which we keep being told is going to disappear one of these years. I think 25 years ago, they told me the tube business would be gone in five years. And here we are 25 years later and we're showing a 7 percent increase. Certainly, the highest margin business that we have in the Industrial Power Group. At 20.6 million in the quarter in sales.

Asia, again, was the leader in growth for the Industrial Power Group. They were up 33 percent. The Security Systems Division was up 5 percent to 27.4 million. And they also increased their gross margin as we got more and more of the private-label products into new digital systems with a focus around digital video recorders. So their margin increased from 25.5 percent to 26.7. In the private-label portion of the business, again, which is the digital video recorders and associated equipment, was up 19 percent. And of course, that's why the margin is up.

Canada led the way as far as regions. They were up 16 percent in the quarter for the Security Systems Division.

Display Systems Group was really the star in the quarter. We really have some nice orders working, which Bruce will tell you about; the New York Stock Exchange order, which we've talked about a lot. But DSG's business was up 58 percent in the quarter to 23.6 million. They had some margin reduction in the quarter; was down about 2.5 points, basically to deal with the medical monitors. As we talked with you in the past about our suppliers in the grade scale monitor business, have chosen to cut prices about 50 percent during the last year, and that's affected our business. At the same time, our overall business was up for medical monitors 70 percent. So the units were selling, obviously, and more than doubled to do that. However, margin was down to 21.4 percent on those products.

The custom displays was really where the growth is; and of course, this is the New York Stock Exchange order, the target order, and some others that Bruce will tell you about. The custom displays, which are made at Pixelink in Boston was up 169 percent in the quarter. And the margin there was up about 4 full points as well. Specialty displays also did well. They were up 87 percent in the quarter. So overall, DSG is really on fire at the moment.

By geographic area, North America did extremely well. They were up 21 percent to 79.8 million. And margin there was just about flat. The U.S. was up 24 percent at 59.4 million. And again, this was all carried by the Display Systems Group, who in North America was up 65 percent in the quarter.

Europe was up 7 percent, led by Germany, which is a nice change. Germany was up 45 percent in the quarter, and had nice margin. They were 29.4 percent. And in Germany, this had, again, to do with the Display Systems Group, who was up 99 percent in the quarter, although the business is small there. England was up about 17 percent. And in England, the growth was due primarily to the RF and wireless group that was up 77 percent in the quarter.

Asia-Pacific, again, was the largest growth area geographically for us in the world, again led by China. Asia-Pacific in total was up 26 percent. More importantly, they increased margin over 2 full points in the quarter. And China was up 87 percent. So the word that we've been hearing out there about China cooling off is certainly not affecting our business.

Southeast Asia was up about 50 percent, which was encouraging. And their margin was up a full point as well. And that was primarily due to sales of RFWC, or the RF and wireless products, which was up 96 percent in Southeast Asia.

And finally, Latin America has turned around. Latin America in the quarter was up 9 percent. Our business there is small. We do about $5 million. But their margin was up substantially. The margin increased from 24.4 percent last year to 28.7 percent this year. It was led by sales in Colombia. They were up 41 percent, which was really unusual for us. And most of the increase in Colombia, again, was RF and wireless business.

So overall, we're really pleased with the top line and the sales. We know we've got incremental expenses in the quarter, but we think we accomplished a lot. And now I'll turn it over to Dario to tell you more details on the P&L and the balance sheet.

Thanks, Ed. Well Ed talked about the sales. 151.4 million, were up 18 percent from the prior year. And gross margins at 24.5. So about 30 basis points of expansion from the prior year, which is good.

With respect to SG&A for the quarter, we're at 21.2 percent of sales versus last year at 19.9 percent of sales. But as we talked about in the last quarter's call, we expected to be higher than last year's percent of sales, in the 20.5 percent range, due to the incremental expenses associated with, as Ed mentioned, the PeopleSoft implementation, which was successful; and the Sarbanes-Oxley compliance programs. But the actual cost for these items did exceed our estimates, primarily due to incremental PeopleSoft cost of training, network expansion, and system testing. We do anticipate a drop in the PeopleSoft cost in Q3.

Other expense increases included legal costs, which were associated with our joint venture and our acquisition, as well as some additional sales engineers and support of higher sales. Our cost base will be reduced in line with the current sales level. And you can anticipate that in Q3 of '05, we'll have SG&A around 21 to 21.5 percent of sales.

Other expenses are at 2.6 million. That's up 225K from Q2. Interest was actually 2.2 million, which is down from 2.6 million as a result of the equity offering, offset by interest on incremental borrowing to fund working capital requirements. The remainder of other expenses was actually up 600K, just due to foreign exchange realized losses.

We expect total interest and other expenses to be slightly down at about 2.5 million for Q3 of '05. Tax rate, 27.1. 17.5 million shares, which includes the 3 million shares from the offering.

If we turn to the balance sheet, cash was up about 400K, with currency actually driving about a million 1 of that increase. Accounts receivable is up 9.2 million. That's primarily associated with the fact that the linearity in the quarter -- we had a big November. But our DSO is at 58, or flat with Q2 of '04. Inventories up 14.2 from the year end. Our days in the quarter are at 85 versus the prior year at 86, and the prior quarter at 89.

As discussed last quarter, our Q1 '05 inventory increase was primarily associated with exclusive supplier agreements. And we expect the days to continue to improve throughout the fiscal year. A couple of points on that -- I mean the exclusive agreements have gone a long way to helping our wireless group increase their margins by 100 basis points. So it's actually paid off for us putting in that inventory for the exclusive agreements. And also, we didn't aggressively improve the inventory position in Q2 of '05, just to cover for any unforeseen PeopleSoft issues, which, fortunately, we didn't have any.

Property, plant and equipment is up 2.7. That reflects CapEx of 4.7 million for the year-to-date, 2.4 million for Q2. That's offset by depreciation of 2.4 million year-to-date and 1.2 million in Q2. About a million -- $1.2 million in each quarter of that CapEx was associated with PeopleSoft.

Accounts Payable is up 3.3. That represents days payable of approximately 27 versus year end at 26, and long-term debt, including the current portion at 127.4, down 10.4. It's actually down 13.4 excluding currency. But that really represents the application of the currencies from the equity offering less the working capital requirements.

The balance sheet performance really translates into net debt requirement in the quarter of 2 million in Q2 '05, on sequential sales of 9.3 percent. And we would expect our working capital metrics to continue to improve through the year. With that, I'll pass it over to Bruce for some highlights.

Thank you, Dario. I'm going to go through the bookings trend, and comparing this year versus last year, and also give you some highlights by SBU and geography.

The Company overall was up 11.7 percent over the prior quarter. RWC came in about 1 percent over the prior quarter. We signed an exclusive worldwide distribution agreement with a company called Flactis (ph), which is a designer and manufacture of antennas for the telecommunications, electronics and military markets. We also expanded our existing agreement with Anaren, which is a world leader of Passive products, and now which is global.

This week, we received the first-draft presentation from our retail wireless consultants of their proposed sales and marketing launch of our wireless line of self signal enhancer products. And activity is now underway for a planned rollout in the first calendar quarter.

In IPG, the quarter was up 11.7 percent over the prior year. As Ed had mentioned, we acquired the assets of a leading distributor of power components in China by the name of Evergreen Trading Co. They're a very similar company to Richardson. They emphasize engineered solutions offering technical services and design assistance. And the acquisition, which was strategically very important for us, now establishes a base infrastructure and selling organization that will enable us to more aggressively expand our IPG business throughout China. And that ultimately will have a positive impact on the overall gross margin since IPG represents our highest gross margin SBU.

Security systems are up 5.3 percent over the prior year. Again, as Ed had mentioned, we closed on a joint venture with Lightspeed Labs, which will provide SSD with the engineering resources and expertise they need to develop network video technology applications for large national accounts, such as retail in hospitality chains for both their security as well as their display solution needs. In essence, we'll be able to use (technical difficulty) -- SBUs will be able to use their services. The bottom line is that their technology facilitates video compression that enables multiple systems or stores, utilize one system to transmit their data over the Internet.

Display systems had a fabulous -- not only a billing quarter but a bookings quarter as well, up 63.7 percent over the prior year. And as Ed had mentioned, our medical and custom display business units both led and both achieved new record sales. Our medical team second-quarter revenue came in. And sales of almost $10 million, which represents an increase of 70 percent over the prior year.

The other good news is that DSG's backlog continues to increase. As we discussed on previous quarterly calls, we were successful in working with the New York Stock Exchange in designing and manufacturing an engineered solutions touch screen display for their trading floor. We received their first $2 million release in June. The second $2.5 million release in November. We expect another release sometime in this quarter. And we anticipate the billings this year will amount to somewhere between 9 and $10 million for the year.

In geography, North America, very strong; came in 22 percent over the prior year. Europe, 5.3 percent; Asia-Pac, what is it, about 1 percent, primarily impacted by Korea. And Latin America, primarily due to a large order last year and the fact that it's a relatively small geography declined about 19.2 percent. I also want to make comment on the fact that in November, Asia achieved their largest billing month ever of almost $16 million. So things continue to go very well there.

And just an added comment on PeopleSoft. Both Ed and Dario have talked about this. But a little bit more details. First of all, the supply chain implementation was very, very complex in that it simultaneously involved 34 global locations, all of our global locations. And this has proceeded throughout the quarter. Every month throughout the quarter, for extensive planning, training, testing to assure that their day-to-day purchasing inventory, manufacturing, barcoding, and EDI would not be adversely impacted by the global rollout. And within days, the system was able to reach normal daily transaction volumes with minimal disruption. And I might add that we installed this with what we call a big bang approach, which was total global at one time. But we had good redundancy of backup as opposed to doing this in sort of more of an evolutionary and a slower manner, and it was a flawless execution.

The next step will involve a reconfiguration of our organization and internal operations to support our evolution into a global supply chain operating MO, encompassing purchasing, inventory, logistics, and manufacturing. And our objective will be to improve our gross margin; reduce our total supply chain management; operating expenses as a percent of sales; and improve our overall service to our customers. Now back to Ed.

Thanks, Bruce. Well, again, we were pleased with the top line, especially in the quarter. And as I'm sure you realize now, we think we've accomplished a lot. It is really going to facilitate the growth of the Company going forward.

In reference to guidance, normally, in our third quarter is down 3 to 4 percent compared to the second quarter. Because of the Christmas holidays, we basically end up with a two-week December. Yet, we're continuing to experience record levels of sales. November was probably the strongest month in our history -- not probably, it was. And that continued into December. So we really feel that the third quarter is going to be better than normal, and may come close to equaling the second quarter. We're not far enough along, but certainly will be better than the normal 3 to 4 percent decline.

In the fourth quarter, normally, our business is up 9 to 10 percent over the third quarter. And at this juncture, we'll just sort of forecast that that will occur again. And I think that probably gives you guidance for this year. And with that, Marla, I think we'll open it for questions.

Thank you. (Operator Instructions). Bill Benton with William Blair.

Hey, guys. One question. I know, Ed, you said you thought that this quarter, the third quarter here, could be maybe down less than you would normally experience. What is the traditional pattern in the current quarter in terms of sales? If you can kind of help out. Month-to-month, are you usually kind of a -- is it pretty linear this quarter? Or is it more back-end loaded historically? Or is front end loaded?

No, it's normally back-end loaded because December turns out to be a two-week month. So December's usually very light. What we're seeing so far is -- of course we're only halfway through December. But so far it's strong. It looks more like November. But it will drop off. I mean after today, things normally really drop off. And then the last month of the quarter is the strongest month by far.

Okay. And, as I look at kind of the bookings figures, I guess overall, I mean I think most of this is turns business anyway, so I don't think you're pulling much out of backlog. But on the RF and wireless area, it looked like the bookings -- I think you said, Bruce, were up 1 percent, and the sales were up considerably more. Is that something that is concerning to you? And are you seeing any sort of softening in any of the regions?

Greg?

Sure. Bill, what we saw was a softening in Korea when you compare it to prior year. But there's a couple of things. It wasn't one thing that put those numbers to the 1 percent growth. Part of it was we received two exclusive agreements a year ago, and we booked a lot of the business that we disengaged with the current other channels. So we're now seeing that in terms of revenue.

But the biggest thing is Korea for us, Asia being flat. It was our largest growth (inaudible) in both bookings and billings when we compare it from quarter-to-quarter. In addition to that, we booked a majority of the tube (ph) positions business, which I've talked to many of you about before. And when Ed talked about the increase in Passive and interconnectors, a large content of that in that system for us. And we're seeing the revenue from that in Q1 and Q2 this year where we booked it last year as a large project. So those three things comparatively are why we're seeing small bookings.

But Bill, a number of things that we see in calendar year Q1 and Q2 with North America, with Cingular announcing the implementation of 3G and it's squeezing capital by 17 percent; and contracts with Ericsson and Lucent to put this 3G infrastructure in place, we'll participate in that. Because as you know, 95 percent of my business is infrastructure. Europe has announced implementation of UPS in the second and third quarter of calendar year next year. Those contracts are with Ericsson and Siemens. And we have a major program going on with Siemens for infrastructure amplifiers.

And then Korea has come back to us -- and Ed mentioned the billing for us with bookings are real strong in December as Korea puts a number of upgrades into their CDMA 2000 or 3G system.

So we see it comparatively, those are the reasons that it happened. But we don't have any real concerns internally that that's a trend. We really think Q3 will be strong in terms of bookings.

Okay. And then, just in terms of maybe getting into some of that -- how much -- what percent of your business would you say is turns business? And could you maybe offer what percentage of the business -- I know your gross margin improved. Was there less component sales this quarter on a percentage basis than in total?

It was about the same it's been. About 70 percent of my business is turns business today. And the balance of it is project-based business, where we have more visibility in terms of bookings. But it's about 70 percent.

Okay. And the components?

What percentage is components there?

Of that?

No, not just on the turns side. Just components in general. I mean the gross margin was up, and so I didn't know if the components maybe in Asia -- maybe eased a little bit.

Well, you know, component sales are still about 60 percent of my business. The other 40 percent is engineering solutions type products. But then with the increase in exclusive agreements, our component sales have increased. And as Bruce mentioned, our margin has increased quite well. In fact, one of a largest RF and wireless suppliers may come in as exclusive. And our gross margin is up 3 points with them, and we'll do close to $70 million with them. So the concept is working.

Okay. And then two other questions. One for Dario. I guess operating expenses -- you expect -- I guess I'm trying to get a sense for when you expect maybe some of the two-timer type expenses maybe to come down in terms of -- maybe offer some magnitude on the PeopleSoft side and the Sarbanes-Oxley side. Are they tailing off? Are they going to like drop off? Just if you can give some color around that. And the second question maybe, which is maybe again back toward Greg or whoever would like to answer that, is kind of where we're at on the compensator in terms of distribution development.

Yes, hey, Bill. I think that you know, with respect to PeopleSoft, that's going to drop off significantly. I think quarter-on-quarter, between the legal expenses associated with the joint venture and the PeopleSoft costs, we're probably going to see it drop like 600K from Q2 to Q3. The SOX costs, which was about, oh, 270K, 300K in the quarter, Q2, probably continues in Q3, and then starts tailing off in Q4. We're going to finish all of our assessments internally in Q3 and then pretty much pass over the package to our auditors for Q4. So our internal costs in Q4 for SOX should drop off.

Okay, okay. And then the compensator?

Yes, the update on that, Bill, is Brightstar has given us as of yesterday their rollout plan for January to introduce the product into their customer base. We have received the proposal from the consultants in terms of rolling this out. And we are rolling out the strategy in January, and it includes both a retail and a direct strategy. So we're excited about it, and we really think we have our hands around all the issues that come up with dealing with retail. And that was our biggest concern, that we were going to try to become (inaudible) price into the retail market and we were going to come up with some laws that would jeopardize the maximization of revenue for this product. So we're a lot more confident now going into this and we're rolling it out next month.

Okay. Okay, great, guys. Thanks.

Rob Damron with 21st Century Research.

First of all, question on the Asia-Pacific business. Really nice improvement in the gross margin in that segment. And I know that's been one of your lower margin businesses here recently. And it is just nice to see that move higher. What is happening differently? Are you able to get some more additional engineered solutions business in Asia? Or what's driving that gross margin higher?

Well, we've really done a good job I think in organizing over there. We have a lab we've opened in Shanghai in the past few months. I was just there a month ago. We've got an excellent manager running that laboratory. We took our Korea regional sales manager -- and Korea represents our third-largest geography -- we put him in charge totally in our ES business throughout all of Asia. We've hired engineered solutions people in at least most of the countries and where they're dedicated, focused primarily on this. And from an organizational standpoint, we look very, very good. I think the prognosis for that business is excellent.

Also, something else we've done -- we have now operating under Greg -- something called component engineered solutions, which is a little different than the compensator amplifiers and pallets. And that has really been sort of up and running only for about the last three or four months. And we've already got a listing of about $50 million of potential products and components. And that's being led by one of our best business unit managers here in LaFox.

Okay. Well that's clearly a nice improvement. I also want to talk about the margin in the display business. It looks like you have two offsetting factors going on, one with the medical monitors and then one with the higher margin, for example New York Stock Exchange type of orders. Which of those two drivers should we expect to be stronger, I guess, going forward? I mean if you have more medical monitor type sales, that may drive their margin down or vice versa with the New York Stock Exchange kind of orders. So how should we think about margin in that (inaudible) business going forward?

Rob, one comment. I think Bruce covered it, but I'm not sure that it was clear. On the New York Stock Exchange order through the second quarter, we've only shipped about 3 million out of what we have released. So we expect in the balance of the fiscal year, another 6 or 7 million to go out. And that's nice margin business. After that, Bruce has more details on the mix than I.

And the -- well, medical obviously -- the major issue in DSG has to do with the medical business. And I think Ed mentioned this in his opening comments. We have one major vendor there that we sell a great amount of their product into the market. And they sort of led the effort in terms of reduction of the resale price of about 40 percent -- 40 to 50 percent, where they dropped in margin of about 5 percentage points. And what's amazing is we've been able to excel as far as sales are concerned, which means we're selling about double the number of units. But we're selling those units right now at about a 5 point less than margin. And that's being addressed as we speak with the vendor. And we're looking for some other contingencies as well from that standpoint.

Okay. And then just one last question for Dario. Just the tax rate a bit lower this quarter. How should we view the tax rate for the balance of the year?

I'd say year-to-date rates at around 30. I'd hold it there.

Okay. Alright, thank you.

Bob Schenosky with Jefferies Co.

Yes, thank you. Actually, it's Monica Mohn (ph) for Bob. I just had a follow-up question on the cell (ph) enhancer product. Can you give us any update on the in-home product, and sort of how development on that is going?

Yes, the in-home is just one of the number of four compensating products using that same technology that we're introducing. And we're just completing the final design. We'll be doing testing in the month of January, and that product will be available at the end of February. That's the schedule within our engineering design center here in Elgin. So the RB unit is available in January. And the ring (ph) unit will also be available in the middle of February. So our products will be in terms of the design completed by the end of February.

And then just one last follow-up on the cost side, Dario. You mentioned before the cost for Sarbanes. Can you break out the cost in the quarter for the PeopleSoft implementation and also for the legal side related to the J.V.?

It's a little hard to quantify because it's spread throughout travel and consulting and etc. But you know it's in the range of about, what did I say, 700K between legal and PeopleSoft.

Does that answer your question?

Yes. Thank you.

And we do have a follow-up question from the line of Bill Benton with William Blair. Please go ahead.

Hey, guys. Just Dario, you said the tax rate at 30 percent -- I'm not sure why it was lower, and why -- I guess it's staying lower?

There was one big statute of limitation that told in the second quarter associated with some prior reserves we had for an issue in France like seven years ago, which the statute told we didn't need the reserve. And I don't expect to be 27 percent going forward.

Okay, okay. And then, I guess on the working capital side, inventories, you said that you expect to kind of improve a little bit more going forward. Where do you think you can take the days inventory I guess by year end? I guess where are you targeting that to?

Well, you know, we ended last year at 77. And I'd like to try to get back to either 77 or 80.

Anything in the business right now that would prohibit you from -- making it more difficult to get to those kind of levels?

Nothing in particular. I mean we're going to have to make sure that we fund the acquisition with respect to inventory. But it's nothing that we shouldn't be able to overcome and get our working capital back down to like 80. The only other thing we've got to deal with is some incremental Industrial Power Group products. Again, I don't think overall we're not going to be able to get to about 80.

Okay. Okay, great, guys. Thanks.

Zach Zinger (ph) with KeyBanc Capital.

Hi, guys. It's Walt Liptak. How's it going? The first question I've got is for Dario. Can you -- it's not perfectly clear to me what the incremental expenses were for PeopleSoft and Sarbanes-Oxley. And I'm sorry about this. But how much did you spend on PeopleSoft during the quarter?

Like I said, it's a little hard to estimate since it's spread between travel. We had like 250 people trained. And I would say that between PeopleSoft and the incremental legal expenses, it was about 700K. And like I said when Bill asked the question, I would say overall between all the issues, it's about 600K that won't repeat in Q3.

Okay. Before we go there, though, so 700K for legal and People Soft. For Sarbanes-Oxley, what's the incremental cost?

Incremental from when?

Incremental year-over-year. You weren't spending on Sarbanes-Oxley last year?

Not at all. Not at all. We had like 40K last quarter. Last year's quarter. That was about it.

Okay. Well how much was there this quarter?

There was about 270, 300.

Okay. So in total, we've got $1 million worth of incremental expenses.

Correct.

Okay. Next quarter, what does it look like?

Like I said, I would expect it to drop. I would expect 600 of those to drop in the third quarter.

Okay.

Primarily, like I said with Bill, it's going to be primarily associated with PeopleSoft because PeopleSoft is in. It's operating well. And Sarbanes continues into Q3 and then should start dropping off in Q4.

Okay. I apologize for going over this a second time, but okay. And then in the -- so in the third quarter, of that million, we're down 400,000.

Correct.

Okay, in fourth quarter?

Correct. Oh, fourth quarter? I don't know. I would guess it's probably in the range of 200K. Another 200K drop.

Okay, fine. You mentioned a couple of other items that you didn't quantify like network expansion.

Yes?

Is that included in PeopleSoft?

Correct.

Okay,. And then you also included sales engineers as an incremental expense. Is that included in PeopleSoft or in Sarbanes-Oxley?

No, that was just to support higher sales. That wasn't the big chunk of "incremental."

Okay. How much money was spent on sales engineers that was incremental?

Well, we hired probably 30 people in the quarter.

Okay. What's the average cost per person?

It depends where you add them. If we keep adding them in China, it's pretty low. That's why I said it's not a lot.

Okay. Can you give me like a parameter? You know, is it $10,000, a half $1 million?

Well, if it's in China, you're talking about 15. And if it's in the U.S., you're probably talking about somewhere in the range of 75.

Okay. That's not perfectly clear to me, but I can ask you questions about that off-line. And then the second question -- set of questions I had was for Bruce. And we've got a big PeopleSoft installation. What do we get? You mentioned higher gross margin, lower SG&A and better service to customers. What kind of gross margin impact you know in basis points? And how long does it take to star seeing some of the benefits?

Well, we -- internally, our target is which we've reviewed with the board as well is a 2 point reduction -- I'm sorry, 2 point improvement -- in product margin; a difference between cost and resale of products that we buy and so forth. And as it relates to the supply chain management system as a percent of sales, we don't know yet. We've got a -- this becomes a recruiting issue. Because we're going to bring into the Company a supply chain management guru, someone with a great deal of experience in this area globally. And the vision will come out and the planning will come out as a part of that process right now -- as he starts working with our own people.

Okay. Okay. Can you quantify -- I'm sorry, can you quantify the SG&A reduction? And the timeframe I guess (multiple speakers) --?

(multiple speakers) as to what it is. We think we know what it is, but I don't want to go on record with it right now. But it's going to go down.

Okay. Okay. Thanks a lot. Congratulations on the revenue and the gross margin improvement.

Myron Mantraknoc (ph) with Eagle Rock.

Hi. Of the -- I missed part of the conference call. Of the -- would you review again how much of the costs related to PeopleSoft and Sarbanes-Oxley in aggregate? And how much of that is nonrecurring in the coming quarter and the following quarter?

In total, for PeopleSoft and SOX and everything we had going, it was probably in the range of about a million. And I would expect that we'll still carry over another 400K into Q3. So we should see a drop of about 600K in Q3 compared to Q2.

Okay. Now, it sounds like -- can you hear me? It sounds like those expenses are fairly predictable. Is that true?

Going forward? I think they are now that the implementation of PeopleSoft is over.

Okay. I just question how much of this quarter's costs -- these type of costs were predictable and were included in your guidance -- original guidance?

We originally included about 500K in our original guidance for everything.

So you underestimated by 500,000? Is that what you're saying?

Yes.

So how confident can we be about going forward -- that your estimates for 400,000 in the third quarter?

Well, you know, again, if I characterize the increase in the second quarter, it was all about going live with PeopleSoft. I mean that was the one -- we had trainings scheduled in locations, and we were going to try to do the training in the local locations. This is an example of what we did. And we weren't getting as much focus from the people in the local locations because they still had to do their current job. So we made the decision to bring everybody in to central locations to make sure that everybody was well trained. In addition to that, during the testing process, we experienced some problems with network bandwidth as an example. And so what we did is we did a new network with AT&T, installed new routers in the new network. And unfortunately, for the quarter, that represented a dual network charge for the quarter. But again, like I said, so those are the kind of things that surprised us in the second quarter that I would say were associated with insurance that we took out on making sure that PeopleSoft goes live without any issues or disruption to the operations. And I think now that that's in place, it should be much more predictable going forward.

Okay. So if there's only 500,000 sort of incremental expense that you hadn't forecast, what was the other -- what was the source of the other expense that caused you to fall short?

Well, for example, like we talked about, we did -- in this quarter, we did joint venture and we did an acquisition, so we had some incremental legal expenses which we don't anticipate to reoccur.

Okay. Got you. Thank you. Well, now, is there anything in this coming quarter that's hard to predict? I guess you -- maybe you have some consulting fees or something? Is there anything else that's going to be difficult for you then to forecast?

I don't foreseen anything on the horizon that I know of today that we know we're going to implement that could lead us to a surprise in the third quarter.

Yes. And then, I guess what this is leading up to is we're wondering why didn't you bother to revise guidance sort of in the mid-quarter whenever you learned that you're going to fall significantly short -- you had sort of underestimated some of these costs?

Well, I mean we didn't really -- we didn't realize until late in the quarter. It was late in November when we did our day in a life testing, the last two weeks before we went live with PeopleSoft on December 5th. And it was a lot of items uncovered during those day in a life sessions where we'd realized we needed to take incremental precautions for the implementation. So it was pretty late in the quarter.

So a lot of these surprising costs were very late in November?

Yes, we didn't go live until December 5th. And we did significant day in a life testing to two weeks before we went live. So two or three weeks before the quarter ended, we organized the training. We did the network. It was pretty late in the quarter.

Okay. Well, I guess as a practice, you would have -- if you had caught it sooner, you would have put out a press release or revised guidance, I assume, right?

We don't normally preannounce.

Okay.

If we had had it in the mid-quarter and we were aware of it, yes, we would have reduced guidance. This was -- frankly we didn't know until after the quarter was over that these incremental expenses were even involved and what the scope of them was.

The other thing I want to just point out is that we are pretty unaccelerated reporting period here with respect to the press release just because of the holidays. We normally get another week, so --

Now, does this PeopleSoft implementation -- are your auditors now at the point where they're satisfied that your internal controls are up to their standards?

With respect to PeopleSoft?

With respect to everything. You know, accounting.

No, they're not going to do their final 404 testing until our Q4.

Okay. And the PeopleSoft implementation actually will be part of that testing, I assume?

Yes, and it should be beneficial to us. There's a lot more inherent controls in PeopleSoft than what we had in the previous legacy system. So it should be beneficial.

Okay. That's all I have for now. Thank you.

Warren Clifford of Clifford Capital.

My question has been answered. Thank you.

Mark LaRochelle (ph) with Lumis Sales (ph).

Yes, this is Diana Montesis (ph) with Lumis Sales. Hi, how are you? Just a question about the Evergreen acquisition. Has -- or a couple about it. Has it actually closed? And can you tell us what the revenue of Evergreen was? And how are you going to pay? Is it cash or equity? And what can you tell us about the cost?

Sure. It is closed, and we've been working on it for six or seven months. There was actually a regulation in China that prohibited the acquisition of distributors. This company is more of an engineering firm. But because of that, we waited until that regulation changed, and then closed the acquisition within two or three days after the regulation the Chinese government changed. The company is small. They're a group of about 12 engineers. And it was really accessing the engineering talent for the power semiconductor and Power Passive portion of the business in China. They're probably 4 or $5 million in revenue -- something of that nature.

But we really think that we can take our resources and theirs and get 1 and 1 to equal 3. It's basically an addition of engineers. The cost -- this is sort of our typical structure where a portion of it is what we call an earn-out, or it's done on future earnings over a period of time. In each case, what you're really buying is people in these acquisitions. And so we'd want the management to stay with us. And we've worked out a program where they participate in the earnings going forward. The initial payment for the company was small. We paid $400,000 -- was the initial payment on the company.

Great. Thank you.

David Behr (ph) with Provident Advisors.

Thank you. I'd like to, if you don't mind, follow up a little bit more on the so (ph) amplifier rollout. I know Brightstar is going to take a small amount of units with 2000 something like that, early in the year. I just wondered if you could give us a sense of how the rest of the rollout is looking at this point -- maybe an update on the SEC testing. You mentioned that your retail consultant gave you a better plan. So maybe get some thoughts on the likelihood of getting into a major distributor, like the Best Buys or the RadioShacks and maybe your thoughts on how the consumer model just rolls out?

Greg, you want to address that?

The product has been SEC approved. It was SEC approved in June. The design and everything has been completed for nearly six months now. And as you know, we've already shipped 300,000 units to a different customer base the last three years. So the product is ready to go. Again, we're a technology company building engineered solutions. And building a product for retail was new to us. So we're partnering with the Brightstar for the distribution channel. They're just completing their forecast. They forecast numbers for you other than total available market data. So those numbers are huge. So but -- again, we're using that in terms of bringing us to the consumer market. We are in contact and in discussions with people like Brightstar and RadioShack to bring it to market. And we're confident that it'll be in their stores this spring. And the third version of the rollout will be direct channel through Web sales and directly to our logistics channels to supports the Web-based customer base.

That's the program that will roll out those three channels. And again, it's active -- I can't stress enough the fact that we needed to get a consultant in here to let us know the barriers and the walls that we'd come across in terms of retail. And we're just that much more confident going in that we'll do the right thing and get the proper margin, which the whole idea here is to meet our five-year objective of 30 percent margin, that will meet all of those variables also.

Yes, it's my sense that to achieve your margins, the price point has to be roughly in the range of $250. I'm just sort of curious, if it looks like the volumes are going to be very, very large for this unit, are you able to reengineer it and bring the cost point down while still maintaining margins?

Yes, in fact, this is a product is a fifth generation. It's one-half of the original cost from four years ago, and it's one-half of the component content. On a daily basis, we're redesigning it. We'll have our sixth generation product in the spring, which will be reduced in cost. But the labor content on this and manufacturing this is literally zero. So we're working with again, as we presumed the model with our component suppliers, to build e-seek (ph) or multichip modules that will take the component content out of the product and make it more cost-effective. And again, the quantities greatly change when you have a product that's an accessory for under $100 to a product that retails for under 200. There's a big separation there. But yes, we continue and have been continuing to take the cost out of the product.

Thank you.

(Operator Instructions). And there are no additional questions at this time, Mr. Richardson. Please continue.

Oh, okay, Mara. Well, thank you very much. And we want to wish all of you a Merry Christmas and a happy, healthy, and prosperous new year. And we are around the rest of the day. If you have any questions, give us a call. Thank you very much.

Thank you. Ladies and gentlemen, this conference will be available for replay after 12.30 PM today, running through Wednesday, March 23rd, 2005 at midnight. You may access the AT&T Teleconference Replay System at anytime by dialing toll-free 1-800-475-6701, and entering the access code 761015. That number again toll-free is 1-800-475-6701, and entering the access code 761015. That does conclude our conference for today. Thank you for your participation and for using AT&T Executive Teleconference. You may now disconnect.