Richardson Electronics Ltd (RELL) 2005 Q3 法說會逐字稿

Ladies and gentlemen, thank you very much for standing by. Welcome to the third quarter earnings release conference call. At this time, all participation lines are in a listen-only mode. Later there will be an opportunity for questions and answers with instructions given at that time. Should you require assistance during the call, please press star followed by zero, and a conference specialist will assist you off-line. As a reminder, today's conference call is being recorded for replay.

I would now like to turn the call over to our host, Mr. Ed Richardson. Please go ahead.

Thank you. Good morning. I have Bruce Johnson with us, President, and he'll discuss some of the highlights of the quarter and the bookings. Dario Sacomani, who is Chief Financial Officer, to discuss the balance sheet and the profit and loss statement. And Greg Peloquin, who is Executive Vice President of the RF and Wireless Group, he will be here to answer questions in reference to the RF and Wireless area of the business.

As you know, we released earnings last night. The press release and the earnings are also on our website, which is www.rell.com.

The good news is the third quarter continued to be record sales for us for the third quarter of the year at 141.7 million. It was up about 11% from the prior year's third quarter. And although the sales increase has declined somewhat for the first nine months, we were up about 15%, so we're happy with that. The real area that we need to work on, of course, is expenses, and we'll talk about the actions we've taken there.

All four strategic business units and all four geographic areas of the world were up from the prior year, which was good. It was the 11th consecutive quarter of year-over-year growth.

We're really a business in transition. We're transitioning from our roots as a component supplier. First, as you know, from vacuum tubes and then to semiconductors and related components. The strategy that it's being received and letting the business grow rapidly that we call engineered solutions. It's a much different business model.

The components business, which is the roots of the business, requires local stock and local currency to be successful, especially for the aftermarket portion of the business. So over the years we've developed 70 offices worldwide, about 35 of those carry inventory, and then the infrastructure to support local stock and local currency, and the engineering talent to service the technical needs of the customers. As we move more and more to an engineered solutions model, the business becomes project based, requires less inventory, certainly on a local basis, we have a lot more visibility as these projects are in a design phase for 12 to 18 months, so we have the opportunity to cut out a lot of the expensive infrastructure, especially internationally as the business transitions.

Unfortunately, in the interim, still about 50% of our business is components, and it's paying a lot of the bills as we develop the engineered solutions strategy, so we find ourselves in between with two infrastructures to support the strategy of the business, one to support the components business and another to support the engineered solutions strategy, which is certainly our future.

And what we saw happen in the second quarter was the expenses in the business have outpaced the sales and earnings. And so we took a hard look at that and we made some very difficult decisions in the third quarter, and we made quite a number of cuts. In total, we reduced the work force about 78 people. We took a position that to study every one of the business plans worldwide by salesman and sales area, any of those plans that were under 70% of their budget we looked hard at, and as a result, we actually cut about 35 sales engineers worldwide.

We did make a decision not to make any cuts in Asia, as we'll tell you about here shortly. Asia was up 30% in the quarter. China was up 87%, and is certainly the fastest growing area for us in the world. Most of the sales people there are on their numbers, so we didn't touch Asia at all. A majority of the cuts were done in Europe, Latin America, and the U.S.

As a result, we took a total pretax charge of $4.2 million and reported yesterday a net loss of $0.12 versus earnings of $0.07 a share in the prior year's third quarter. If you back those numbers out, about $0.17 a share was due to the restructuring, and on a pro forma basis if you eliminated the $0.17 a share we would have had positive earnings in the quarter of about $0.05 a share. Obviously, far less than where we'd like to be, but we thought it was necessary to make the hard decisions and make these cuts in the quarter. That's done, and the expenses have been reduced accordingly.

In the total charge, about 2.2 million was severance. There was about 900,000 with inventory for discontinued and deemphasized product lines. There was about 800,000 that had to do with a freight reclassification, about 300,000 for bad debt, and an additional tax provision of about 200,000. So, again, the number was a net loss of $0.12 versus $0.07 a year ago.

I guess the most encouraging portion of the quarter was the increase in product margin. Certainly shows that our strategy is working. The product margin was 26.5% in the quarter, and this is purely the cost of goods sold, subtracted from the selling price, but it is a very clear indicator of what the improvement in the business is. A year ago the product margin was 26%.

When you include the effects of the restructuring charge, which included this freight charge and also inventory provisions, the gross margin was 23.8% versus 24.8 a year ago. When you look at it by a strategic business unit, we attempted to go in and do a pro forma gross margin number to give you an accurate comparison taking out the inventory write-downs and this freight issue.

The RF and Wireless Group was up 17% in sales to 65.3 million, and the pro forma gross margin was 23%. The infrastructure portion of the business was up about 24% in the quarter. The network access business was up about 21%. Geographically, Asia led the growth for the RF and Wireless Group. They were up 42%, again, a lot of this has to do with China, with sales in Asia at 24.1 million for RF and Wireless.

The Industrial Power Group was up 8% to 29.7 million. Their gross margin was actually 31% with the -- on a pro forma basis. In addition, IPG could have shipped about $1 million more of power grid tubes if we'd had product in the quarter. We have our largest supplier of power grid tubes involved in relocating a factory, and they've been slow on shipping products, so we had about $1 million worth of backlog that we could have shipped in the quarter and hopefully we can get that out in the fourth quarter. That also has an impact on the business because, as you know our two businesses, the most profitable portion of the business and runs 30% plus in gross margin.

The Security Systems division was up about 1.4%. Their margin was up nicely on a pro forma basis. Their gross margin was 27.1%. The primary improvement there was the engineered solutions or private label portion of the business that was up 14%, and the margin on that business is about 30% plus. So we saw nice growth in that area.

Canada continues to be the star performer for the Security Systems division. The sales were up 19% in Canada and the gross margin increased from 27.5% to 30%. So nice improvement for Security as part of margins concerned.

The Display Systems Group, they were up 16%. Not as much as we had expected, although still good performance. On a pro forma basis, their margin was 23%. We did ship about $2 million of the New York Stock Exchange order in the quarter, but we expected to ship about $2.5 million more. That release didn't come through at the end of the quarter. Will be shipped in the fourth quarter. So we should see some good sales improvement for the Display Systems Group.

Our Pixelink operation near Boston is really doing well. Of course, they're building the NYSE product, but their sales were up 90% in the quarter. Geographically, North America in total was up about 7%. Their margin was just about flat at 25.9. Canada was up 16%, and their margin was up in total primarily due to Security. Their margin increased from 27.7 to 29.9. In Europe, sales were up 7% to 31.1 million, and gross margin increased to 30.3 from 29.1.

Scandinavia was up 27%, and that was primarily RF and Wireless. The RF and Wireless business in Scandinavia was up 29%. Spain was up 17%, which was good, and there again, that was because of RF and Wireless sales in Spain, and the RF and Wireless business in Spain was up 60%.

Asia, sales were up 30%. Again, led by China which was up 87% in the quarter. That primarily had to do with RF and Wireless, which was up 92% in China. Korea was up 55% in the quarter. And, again, that was driven by RF and Wireless, which was up 62% in Korea.

In Latin America, finally we have hit the bottom and started to recover. Latin America was up about 2% in the quarter. They were led by Brazil, which was up 22%, and again, that was primarily RF and Wireless products that were sold in Brazil, they were up 33% in the quarter.

So that sort of covers the highlights, and with that, I will turn it over to Dario to talk about the P&L and the balance sheet.

I'll try to summarize real quick. Ed discussed the sales at 141.7, which is up 11% from the prior year. Gross margin at 23.8 included the 900K of incremental inventory reserves, which related to the deemphasized businesses associated with the restructuring initiative, and it also included 800K worth of previously capitalized freight, which we will now be reporting as a period expense. So when you adjust that, this would put the corporate GM at about 25% for the quarter.

Ed gave you, for your models, by business unit, the GMs excluding inventory and freight charges to try to attain the normalized operating performance by SBU, so I won't go through it again.

With respect to SG&A for the quarter, we're at 34 million, about 24% of sales which, again, includes the severance infringes of about 2.2 million and a preference payment from a bankruptcy proceeding of about 300K. That puts operating SG&A at about 31.5 or 22.2% of sales. We were expecting approximately $150 million of sales in the quarter, which would have put our SG&A as a percent of sales in the 21% range compared to the prior year at 21.2.

Our restructuring initiatives should give us more head room as we go forward, and we're expecting SG&A in Q4 of '05 to be 30.6 million. Simple reconciliation to that, we had 34 million in the quarter, minus the severance and other preference, plus we're anticipating about $1.6 million worth of savings from our restructuring initiative. Add back an incremental fee for SOX and you're at about -- of 700K, you're at about 30.6 million for SG&A in the fourth quarter.

Other expenses were at 2.4, that was down 500K from Q3 of '04. Interest was 2.2 million, which was down from 2.6 as a result of our equity offering completed in Q1 '05. We expect total interest and other expenses to be flat at 2.4 for Q4 '05. The tax rate is at 25% on the loss. Expect a normal rate on profit to be 36%. And with 17.3 million shares outstanding gets us to the reported $0.12.

Turning to the balance sheet, cash is up 5.8, currency was driving about 1.3 million of that. Accounts receivable are up 3.8 million with DSOs relatively flat at 61 versus last quarter at 58. Inventory is up 14.8 million with days at 90 versus the prior year at 88.5 days, and the prior quarter at 85 days. As discussed last quarter, our Q1 inventory increase was primarily associated with exclusive supplier agreements. We did expect improvement in Q3 '05, but the lower than expected sales in February drove our days to increase. We'll be managing it closely in Q4 '05 and anticipate improvement.

Fluctuations in other current assets and non-current assets we talked about in Q1 '05 were primarily associated with the reclassification of our deferred tax assets. PP&E is up $3 million and that reflects CapEx of 6.5 million year-to-date, offset by depreciation of 3.7 million.

Accounts payable is up 4 million. This represents days payable of approximately 29 versus year end at 26, and last quarter at 27. We talked about other accrued liabilities that dropped in Q1, primarily associated with the payouts of year-end incentives and 401(k) matching. Net debt less cash at 111.4 versus year end 2004 at 120.9, so we're down 9.5 net debt, represents the application of proceeds from the equity offering less working capital requirements.

With that, I will turn it over to Bruce for highlights.

Thank you, Dario. I'm going to cover the bookings comparing the quarter of this year versus the quarter of last year, and then give you highlights on each one of the SBUs.

First of all, the booking trend for the quarter and total Richardson was pretty much flat with the previous year. RF Wireless was -- came in down about 3.2%, but last year we had two large non-repeatable bookings, one in China for about $4.1 million, the other in the U.S.A. for $3 million, totaling $7.1 million. If you back those two bookings out, our WC bookings would have increased by 5% in the quarter.

Also, our new call Capture, that's our private label name, a wireless cell enhancer product line launch is progressing well through a retail strategy which we have successfully developed with an experienced wireless retail consultant. And sales continue to increase and Greg will give you a more comprehensive update later in the call.

In the Industrial Products Group, IPG, bookings came in 3.6% over the prior year. Their microwave business that primarily serves the semiconductor equipment market continues strong with a quarterly book-to-bill of 1.14. And we forecast this positive trend to continue as we are seeing renewed strength in this market and we've already achieved many new design wins for engineered solutions products and programs. And as such, we have several products awaiting first article test completion. Also, within that group, the passive components portion of the business also continues strong with revenue growth of 18% and a book-to-bill of 1.12.

Turning to Security Systems, bookings for Security Systems are up 5.5% in the quarter, and as Ed has mentioned, the good news in this SBU is that our highly profitable engineered solutions private label business continues to increase.

Display Systems in bookings for the quarter came in 4.8% below the prior year, but as we've mentioned on previous calls, this is a highly project-oriented business that will fluctuate quarter to quarter. For example, in the previous quarter, bookings increased 64% over the previous year. As Ed had mentioned, another large order release is pending for the New York Stock Exchange for our custom display monitors, which we expected to book in the quarter, but will now book in this quarter and that's about $2.5 million.

We've also, and this is hot off the press, have just recently consummated a large partnership agreement with a major vendor to provide all of their customers with our engineered solutions touch and privacy screen displays, and we expect sales to begin materializing in the first quarter.

Turning to geography. North America came in flat. Europe was down about 5.6%. Asia Pacific was down about 2.4%, but as I explained previously, due primarily to one large $4 million order. Ed had mentioned Latin America on the rebound in billings also on bookings, they came in 66.8% over the prior year. And for the total Company overall, the booking number as I mentioned previously was flat.

I'll turn this back over.

Okay. Thanks, Bruce. Greg, you want to give us an update on your progress in the signal enhancer family of products?

Sure. As Bruce mentioned, the strategy of redesigning this product from an OEM application and developing a retail strategy, is moving forward as planned. We are finalized our regional retail launch, which is on schedule, which I'll touch on in a second. And sales of this product continue to increase on a monthly basis as more and more customers approve this technology and are educated that this technology is available.

As many of you already know, we have a for sale approach to bringing this to the retail market. We've now exceeded from an OEM level the 400,000 unit mark, so currently there's over 400,000 units of our product in the field. This unit is connected to a hands-free kit that is sold through a system through a telematics company to Mercedes-Benz, BMW, and Range Rover. But they are in the process of approving our wireless version, our new design that will be going into other lower cost consumer automobiles.

Our direct sales channel will be launched through a complete media plan on April 11th. We have a new consumer-friendly website, if you will, that now takes two to three steps to order the product through our new marketed cell Capture trademark product line.

What's really exciting next week is our specialty retail strategy, which is focusing on the regional service providers. There's a show next week. We're going to be launching this product to that specific market. It's the Rural Cellular Association Show. There's over 100 of these. And that market really benefits Richardson's product because that's where our product excels. These are the regional service providers that handle the cellular services in remote areas and regional areas.

We are partnering with Brightstar. As many of you know, we have that partnership in progress. They have doubled their backlog with us in terms of the initial stocking order.

Finally, the consumer retail market, a press release will go out and launched on April 11th will be our regional retail marketing strategy where we're focusing on specific regions. We now have approved in 20 retail locations in the Midwest area, 11 different retailers, and that announcement will be going out and launched through a media campaign and available in these retail stores April 11th. Again, a press release with all the details of that naming the retail outlets, et cetera will be put in progress.

So overall we're happy with the progress. Again, this is a different market for us, different strategy. But in working with these consultants we're comfortable with the progress, and we are on schedule with this strategy.

Thanks, Greg. One other item we should mention, in the third quarter we successfully exchanged $44.6 million of our convertible debentures. We exchanged them for a new bond that extends the maturity out about five years at just about the same terms and conditions as the original bond, and that leaves 22.3 million of the original issue still open, which actually matures in June of '06 and December of '06. So we're pleased to have that out of our way and gives us another five years or so. They actually mature in 2011, that's 2011.

All right. Well, in reference to guidance, we were concerned that February showed as much softness as it did. Certainly, when you go through a restructuring and in this case as I mentioned, we reduced the workforce approximately 80 people and about 35 of those were in sales. There's no question of the 35 even that we eliminated were selling products and had relationships with customers, so when you reduce your sales force, you certainly don't get a positive impact on increased sales, it can only be negative. We don't think that's a major event.

But with some of this uncertainty, we're looking at the fourth quarter to be about 155 million in sales. That's our current projection. Hopefully, we can exceed that, but at the moment we'd like to be conservative in the projections, and we think gross margin will be just about flat with where it currently is.

With the restructuring and the cost reduction, we think SG&A should come in at about 30.6 million. So somewhere in that range, and the good news is we continue to run along with record sales levels, and as we can convert the business from its components roots, the engineered solutions, the gross margins should increase, and as we get costs under control we'll get the Company back to its normal levels of earnings.

Okay, Rod, with that, I think we'll open it up for questions.

[OPERATOR INSTRUCTIONS] Our first question will come from the line of Bill Benton with William Blair. Please go ahead. Your line is open.

Good morning, guys.

Good morning, Bill.

I know you said that you expected probably around 150 million run rate. If I recall, it was a very back-end-loaded quarter. Traditionally the pattern is traditionally back-end loaded, so it really was kind of dependent on February, it sounds like. Was there any area of particular softness that you saw relative to the original expectations? I know you didn't ship about 3.5 million between IPG and display that you might have expected, but obviously there's an incremental -- maybe 5 million or so that you didn't pick up that you would have expected. I'm trying to figure out where that might have been.

You want to comment on that Bruce?

Yes. It was -- just a second here. I think as I mentioned, I think geographically, Europe was probably the most off, as far as that was concerned. And again, I think Ed had mentioned that we had this restructuring initiative going on throughout the entire third quarter, and even though we didn't actually pull the plug until about the week before the quarter ended, there was obviously a lot of disruption in the field. And it was very complicated because this was one that was obviously international focused, and Europe is the one with the heaviest impacted as far as the overall business was concerned.

The Asia thing, as I mentioned, I think that was an aberration. They did very well sequentially, and that was I think because of that one order that we had, and North America also was impacted by this situation with the RF/Wireless order as well. And I think the fact that we didn't book the New York Stock Exchange order that we had anticipated from that standpoint.

On the securities side, I guess, you had said that Canada was up, I think you said 19% or something, which I know the overall segment is up a little over 1 to 2% which suggests, obviously, ex-Canada there was some softness. Was that anticipated, or is there something maybe happening on that front?

Well, in Security they're -- probably both the U.S. and especially Europe were quite soft in the quarter. I don't think we know exactly what the reason was for that. What we're attempting to do is to take the Canadian model that's so successful and see if we can't make that success contagious in the U.S., so we're trying to merge the two operations to get one and one to equal three, if we can, and that's in process.

Okay. In terms of margins, obviously, I'm making some of these adjustments, it looks like some of the wireless margin may have been impacted, maybe some more component shipments into China, maybe that picked up a little bit. Is that a fair statement? And then the other question I had was, on the corporate margin side, you're showing a positive number there, and I'm trying to understand what might be happening there.

Okay. Greg, you want to comment on wireless?

Yes, Bill, you hit it on the head with sales up in China 92%, that's a penetration strategy with a component side doing design in there, and as they evolve more into a newer solutions-type area where we're selling more newer solutions that area will change, but that's lower margin business and the growth was so strong that it did have an effect on the overall margin part of WC [ph].

On corporate, Bill, normally what we do as we go through the quarters is we evaluate our overstock reserve at the total corporate level, and until it gets to be a big enough number we don't affect the SBUs, and obviously this quarter with the business deemphasis in certain SBUs we just applied that corporate provision. So you're going to see that number go back to its normal 620 loss.

I guess -- I guess I don't understand what that -- what exactly you were doing there. You said something about allocating something to the SBUs?

Yes, their portion of the overstock reserve that we had had in corporate prior to this restructuring. So when their numbers get big enough to require the movement of the overstock provision from corporate, we apply it to the SBUs, and we did that this quarter.

Okay. I'll follow up with you off-line on that one. In terms of the reporting side, I guess if the freight -- they're going to require you to expense the freight, I'm guessing inbound, obviously rather than capitalizing that to the cost of the inventory. Have you guys thought about maybe breaking out freight as a separate line item on the income statement?

We hadn't thought about doing it in the summary income statement, but now we do have visibility on our detailed income statement of freight.

Okay. I didn't know if you were looking to do that from -- just trying to get a sense at where the product margins are at and what maybe -- I don't know how much variability there really is on the freight side.

That's one of the reasons we went to period expenses. There's not a lot of variability.

Okay. Well, thanks, guys. Appreciate it.

We'll next go to the line of Joe Sullivan with Craig-Hallum. Please go ahead.

Couple of questions. First, just so I'm clear, you gave a net-debt number for the current quarter. Can you compare that to what it would have been in your terms for the second quarter, and what led to the change?

The second quarter, we actually ended up with about $1.9 million increase in net debt from the second quarter to the third quarter.

And that was due to what?

Usage.

Okay. On the changes in your business model, kind of looking out farther, what type of balance sheet implications are there in trying to change this lowering the requirements for inventory overseas and so forth, is there positive cash to be mined from the balance sheet?

I think there absolutely is. As we get more visibility on engineered solutions projects and get more clear on a higher level of backlog entering into a quarter, we ought to be -- it ought to help us manage our inventory a lot better.

Any magnitude or how much you think is out there as you change to this?

Well, we have a corporate target of trying to get our days. We're sitting at 90 today and we're trying to get that down to 75.

Okay. The other question, kind of looking out longer term, I know the IPG Group runs at what would be the target model for you, 30+% gross margins, 10% operating margins, what area do you think is closest to moving to that or where would you expect to see that show up again in a different business unit?

Probably the Display Systems Group. Certainly their margins today don't show it, but when you start to look at the Pixelink products where we do these custom displays, the margins are in excess of 30%, and today, the amount of engineered solutions business in the Display Systems Group is increasing faster than anywhere else other than IPG.

Okay. On the cell enhancer side, I don't know if you guys are willing to do this, but if you look at what's coming on line for distribution with the product set, can you help shape 2006 monetarily, what size opportunity is there in '06 for you in that product line?

Greg?

Well, if you look at each of the four cells, I mean, anyone you talk to, I mean, you just do the numbers, we've always looked at the fact that there's 168 million cell phone users in North America. And we're learning as we go and talking to these other channels like the regional service providers and big box retail and even developing the consumer strategy for direct sales. So, we have an internal forecast that will cover our media plan and our inventory, but I don't want to share that over the phone, in terms of competition, because last time I mentioned it they showed up at a customer the next day. But this isn't the cure-all for the Company, in terms of RWC. It will expedite our growth, and to the question you had before, getting that 30% and 10% operating.

One last question for me on the guidance. What tax rate would you expect to show in the Q4, and are there any additional charges that may show up in Q4?

Don't expect any additional charges, and it should be about 36%.

Okay. Great. Thank you.

Thanks, Joe.

Next question will come from the line of Rob Damron with 21st Century Research. Please go ahead.

Just a couple questions on the restructuring again. You mentioned deemphasizing certain product lines. Maybe you could just give a little more information on which lines are you deemphasizing, and what kind of sales did they represent?

Okay. Well, first of all, one of the major ones that we're deemphasizing is the sale of transmitters and studio products for broadcast applications. As you know, Rob, in the past we've sold tubes to radio and TV stations, and so we had expanded the product offering by selling solid-state transmitters that we manufacture in Italy, as well as other studio products. And we found a channel conflict there where we're actually, in certain instances, competing with our customers, because we sell amplifiers and pallets to the Rhode & Schwartz and people who manufacture transmitters. And so that was a bit of a conflict and the business was not particularly successful, so we've made a decision to sell to other transmitter manufacturers the building blocks, the amplifiers and the pallets rather than to sell transmitters and completed equipment to broadcast stations.

One of you gentlemen give me a number on how much business? 4 or 5 million annually is the amount of business that we're looking at. So that was one of the -- probably the major area. There were others, but they're very small.

Okay. And then in terms of when the restructuring really took place, I think Dario mentioned a $1.6 million savings sequentially going from Q3 to Q4. Is that all of the savings, or would we anticipate additional savings if we look into the first quarter of next year?

All the reductions in headcount were completed at the end of Q3, so I think that we're hopefully going to see it in Q 4. Now, we have two programs going here. We've got the reduction in headcount, as well as discretionary spending control program in place, and we may continue to see improvements with respect to discretionary, but with respect to headcount, it's completed. So we should see all the impact in Q4.

Okay. Then just one other question maybe for Ed. Ed, you mentioned you have 70 sales offices around the world with about 35 holding inventory. Do you see opportunities to consolidate sales offices, especially as you move into more of the engineered solutions strategy?

Absolutely. I mean, I think that the difficulty that we have today is we're still sort of 50/50. 50 percent components business, and 50 percent engineered solutions. And so we have to maintain -- we still do $80 million worth of power grid tube business, and that's aftermarket business, where you have to have a local stock and local currency where you can deliver 24 hours to a radio station or to an industrial piece of equipment, and that makes a lot of money for us. But that's going to change, and as we go more towards engineered solutions we don't require all that inventory, you don't require all the people to do the logistics handling and the financial people to handle the numbers and so forth and so on. So we think that we can centralize -- I mean, in Europe alone, we probably have, what, eight warehouses in Europe.

And the other thing that it will do for us, in Sarbanes-Oxley alone, in each one of these countries where we have a foreign sub, we have to comply with all of these regulations just as the U.S. operation which is 300, 400 million have to. So it's a very expensive infrastructure to support from a corporate governance and compliance requirement as well.

So there are all kinds of opportunities to take costs out. And as we get into the engineered solutions side of the business we can do that. How fast we can do it is another question.

Okay. That helps. Thank you and good luck.

Thank you.

Thank you. We'll next go to the line of Charlie Jones with Keybanc. Please go ahead.

Yes, thanks. This is Walt Liptak with Keybanc Capital Markets. Good morning, guys.

Hi, Walt, you changed your name.

Sorry. I guess, first of all, Ed, just as a commentary, I suppose, these cuts that you've made, the 70-plus people, you clearly do have a responsibility to shareholders and we're glad to see it. And my questions are regarding that. And I guess for Bruce, what do you expect will be the -- this has been asked already, but what do you expect the annualize cost savings to be, I guess like in 2006, from the -- from the severance charge that you took?

Between 5 and 6 million is the run rate we've taken out.

And I know in that part, anyways, you've been seeing rising costs in Sarbanes-Oxley. What kind of expense level did you have, or will you have in '05, and then what will that ramp down in to '06?

I think we've been doing a significant amount of it outsourced, just because we don't have enough finance resources to get all the documentation done. We're probably going to spend about a 1.5 million on it in '05 and I would expect a combination of things. One, I think just the bubble of activity will go down, and I think we'll start to bring internal control personnel in-house, which should save us a lot. I wouldn't expect that we'd be spending more than 800,000 on compliance as we go forward. So that's a big reduction in '06.

Okay. So of the incremental expense in '05, 1.5 that will get cut in half, so you'll actually have a lower cost base?

Yes. And I think, Walt, just so we're clear, I think that it's probably going to stay that way, the way it is today, through Q1, just because that's when we're going to be going through a big exercise with respect to year end, and so I don't think you'll see it tailing off until you get towards the end of the year, but I do think we'll see some savings.

That's fine. In the fourth quarter is there anything abnormal about Sarbanes-Oxley in terms of costs that we should know about?

Just the activity level. I mean, this is where it's -- we're really winding down, getting KPMG involved, so it's about -- about $1 million played into our -- like I said to you, it's about 700K incremental for SOX and tax, which was played into our reconciliation where we got to the 30.6 million of SG&A so it's in the 30.6 but it's definitely a bigger number than Q3.

If I might ask you, Dario, a question just to clarify the charges and which line items they were in, I know I can back into some of these, but the 2.2 million severance, what line was in that?

That was SG&A.

And the inventory?

Cost of goods sold.

Freight?

Cost of goods sold.

Bad debt?

SG&A.

Okay. Fine. And obviously the tax provision in the tax line.

Exactly.

Okay. Then the -- I guess the other question I've got is regarding the European softness that you talked about in the first question, the -- you said that Europe was the geographic region for softness in February. Has that continued in the fourth quarter?

It has for the first -- yes, through the first 3 weeks of this month. I'm going over there the week of the 11th. I'm going to spend a week in Europe visiting the countries that I think we're, I'd say, most concerned about right now, and I will have more detail when I return from that trip.

Okay. That's fine. But I guess, in your commentary about Europe you mentioned that wireless seemed like it was doing well in Spain and Scandinavia, et cetera, what would be the product category that's weak?

Security for sure.

Yes, Security is a loss, there's no question about that from that standpoint. And there's a little bit in IPG as well, but mostly from Security.

Thank you.

We'll next go to the line of Steven Lewis with Lewis Capital Management. Please go ahead.

Thank you. Would you mention again, what was the preference payment of 300,000 in the SG&A?

That was just -- there was a bankruptcy proceeding from one of our customers in the past that we got -- they had made certain payments to us, which now they went bankrupt and we had to reimburse them.

Do you have other reserves for bankruptcy that -- that have actually happened so far?

There's none to our knowledge that have actually happened already, and we do have what we consider to be adequate bad debt reserves.

Has that increased any in the last several quarters?

Other than this 300K, no.

What was the 800,000 that was expensed on the cost of goods? Something about previously --?

Capitalized freight?

Yes. What was previously capitalized?

The freight on our internal transfers, to be specific, was capitalized in the past, and we moved to reporting freight as a period expense. So until the inventory that we had on hand at the end of Q2 moves through the pipeline, which we've got 90 days worth of inventory, so we expect that we've purged all the previously capitalized freight in inventory, and now where we period expense freight, we should be break even at gross margin. But in the quarter, since we had to purge the inventory that had the freight in it, it did have an impact of 800K.

In the guidance when you mentioned cost of goods sold would be flat, is this flat with the 23.8 reported in the third quarter, or the adjusted, or what?

No, it's flat with the pro forma numbers which are somewhere between 24.5 and 25.

Okay. And could you go over the cash flow for the quarter, please, and was there any?

No, like I said, previously, there was a $1.9 million use.

From operating?

In total.

How about operating?

Operating with the increases in working capital was a positive 700K.

Okay. And then you used about 2 million in capital expenditures?

Actually, capital expenditures in the quarter, I mentioned CapEx year-to-date of 6.5. CapEx in Q3 was 1.8.

1.8. So if you had 700,000 from operating, minus 1.8 capital expenditures, what else is there to get to a negative 1.9?

To get to negative 1.9? Well, there's dividends. I mean, I could go through the whole list of the cash flow statement. I don't actually have it in front of me.

Dividends were about 700,000?

600,000.

600,000.

Yes.

Down from 680,000?

Well, okay, maybe it's 650,000. I don't know the absolute number off the top of my head. I was just saying 600,000, but you're right, it's probably closer to 680,000.

Okay. And on your bank lines, what is your most restrictive covenant that you actually have to report on a quarterly basis?

Well, there's two of them. There's coverage ratio and a leverage ratio, are the two most important, and in the quarter, the leverage ratio is 3.35. We're well within that, and for the coverage ratio it's 1.35, and we're fine with that, too.

How is that defined, coverage ratio?

It's EBITDA minus CapEx over interest.

And what was that figure? What was the figure for the quarter, then?

We haven't published the figure for the quarter, but we're fine with the covenant.

Is that on a nine-month basis? Actually, you have to do it on a quarter and nine months, right?

No, it's all LTM.

Last 12. Okay. And you are within the guidelines there?

Absolutely.

Okay. Thank you.

Thank you.

We'll next go to the line of Greg Goldfelter. He's with Gardner Lewis. Please go ahead. Your line is open.

Just a quick question on the sale of the land. When -- how's that proceeding? Kind of what should we be expecting in terms of the cash generated from that, and what are you carrying it on the balance sheet for now?

We have closing on the land at May 27th, and we're hopeful that that is going to be completed. And the carrying cost of the land was about 1.1 million.

Exactly.

And the sale price of the land is $11 million.

And that will go to pay down the debt?

Yes.

Okay. Thanks.

Thank you.

We'll next go for a follow-up question from the line of Charles Jones with Keybanc. Please go ahead.

Thanks. It's Walt again.

Walt. [ LAUGHTER ]

The question I have is on the -- it sounds like you're getting some traction in the wireless cell booster. I wonder if perhaps you might give us a target of what the revenue would look like in '06, or is it still too small to look at that it way?

We have an internal forecast, Walter, on each of the -- on the OEM side, direct sales, especially retail, and then the consumer side, which we're developing this quarter for the year, then making sure we have the capital and everything ready to go and I don't want to share a number right now, but --.

That's fine.

Again, it will expedite our growth into getting to the 30/20/10 that the Company is driving towards, but we're still seeing 17+% growth on the component and the component engineered solution side.

That's fine. And then you have not mentioned, at least I don't think you've mentioned the home booster, the home cell booster. I had wondered, I guess, where you are with that prototype product or, I guess, how is that going?

Yes, the home booster, the RV and the marine unit will all be shown and introduced at the RCA show next week. So the product is completed, the design is completed, and we will be introducing that at the show. We've just seen so much traction, or more traction on the in-vehicle unit that our media plan and our cost in getting that to market fast, because there's a window of opportunity here centered on that.

Thanks, guys.

Thanks, Walter.

And at this time we have no further questions in queue. Please continue.

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