Richardson Electronics Ltd (RELL) 2005 Q4 法說會逐字稿

Ladies and gentlemen thank you for standing by and welcome to the fourth quarter and year end earnings release call. At this time, all participants are in a listen-only mode. Later we will conduct a question and answer session and instructions will be given at that time. (Operator Instructions). As a reminder, this call is being recorded today Friday, August 26, 2005. I would now like to turn the call over to Mr. Ed Richardson, CEO and Chairman. Please go ahead, sir.

Good morning, or from where I am at, it's good evening. I am in Seoul, Korea at the moment and it's 11 o'clock at night here. So if I sound a little bit worn, I am. We've been traveling all week but are really pleased that we finally got the quarter and the end of the year filed. And we released the year end and quarter earnings last night at the close of business, and those of course are on our website. If you missed it, it's www.rell.com.

I have Bruce Johnson, President on the line with us, who will go over some of the highlights of the quarter and the year; and Dave DeNeve, who is Chief Financial Officer, will go over the balance sheet and the profit and loss statement; and Greg Peloquin, who's Executive Vice President of the RF and Wireless Group and he's available to answer any questions for you.

So we will start out with the fourth quarter. Sales for the fourth quarter were 147.3 million, it was up about 1.4% from the prior year's fourth quarter. It was the twelfth consecutive quarter of year-over-year growth. Net earnings for the quarter were $0.14 versus $0.18 in the prior year's fourth quarter.

By strategic business unit, the sales and gross margin versus the prior year, the RF and Wireless Group was up about 1% in sales to 68.5 million. Actually, gross margin was down to 20.9, but that had to do with inventory write-offs and some warranty returns in the quarter. If you looked at it on a pure product margin basis, which is the cost of the material subtracted from sales, the product margin for RF and Wireless was 24.8 versus 24.2 from the prior year.

Within that, the Network and Access Group, sales were up 18.3%. The Passive and Interconnect Group, sales were up 15.2%. Asia continued with a nice growth. Asia was up 7.4% at 26.4 million and their gross margin was up 2 full points at 22.9, which was good.

The Industrial Power Group was up 2.5% to 32.3 million. Again, their gross margin was 29.4 versus 31.6. That also had to do with some inventory write-downs during the quarter. If you looked at pure product margin, they were at 31.2%. The Tube business, which was supposed to be long-gone years ago, was still doing nicely; it was up 2.6% in the quarter, had 21.3 million at 31.2% gross margin. The Power Components portion of the business was up 0.4%, just about flat with sales at 10.5 million. Geographically for the Industrial Power Group, Europe was up 9.6% at 30.2% margin.

And then the Security Systems Division in the quarter was up 5.6% to 26.9 million. The gross margin again was down slightly at 25.4, but if you looked at it at pure product margin, product margin was up at 29.3 versus 28.6 from the previous year. The private label or Engineered Solutions portion of the business showed nice growth. They were up 18.8% in the quarter. This was led by Canada where Canadians have done an excellent job in the security business. All year long, they were up 13.3%.

The Display Systems Group was actually down in the quarter 3.5%. We had an order for the New York Stock Exchange of about $1 million that did not get shipped until the first week of the first quarter of this year. We had hoped to get it into last year. But overall, they had an excellent year which we will talk about. The custom display portion of the business was up 27.7% during the quarter, so that was good. And that also included about a $1.5 million order for the New York Stock Exchange, which would have been 2.5 million if we had gotten it all shipped in the quarter.

Geographically, North America was just about flat with sales of 76.2 million. Gross margin was up nicely at 28.2, up about 2.5 points. This was led by Canada, which was up 12.2% at 20.2 million. Gross margin there was also up from 27.5 to 29.8, which was excellent.

The one area where we showed some decline was Europe. Sales in Europe were down 3.7% and the margin was down about a full point in Europe as well. Within Europe, however, Spain was up almost 17% in the quarter. Some nice growth in Israel; they were up 8.5%. France was up 4.4%. We continue to see weakness in Europe.

Asia Pacific again did well. They were up a couple of points -- not the kind of growth we had seen, still led by China, who was up 17.4% in the quarter. Japan was up 2.6%.

Latin America finally turned around. Latin America in the quarter was up 20.4% with the margin increasing from 26.6 to 28.4. That was led by Mexico that was up 50%, although it's a small area at a couple million dollars, but they were up nicely. And Columbia was up nearly 40% and Brazil was up 21%, so finally Latin America turning around.

So that's it for the quarter. On the full year, again, we had a record year in sales which we're encouraged with. We're really obviously disappointed in the Company's bottom-line performance, but we finished the year at 578.7 million, up 11.3% from 2004. It was the third consecutive year of growth. All four SBUs in all four geographic areas were up from 2004, so (indiscernible).

The Engineered Solutions strategy is really working well from the customer standpoint and showing nice sales increases. Unfortunately, with the incremental tax provisions and all the additional expense associated with restructuring and Sarbanes-Oxley, we showed a loss of $0.67 versus $0.42 earnings from the previous year. Approximately 13.1 million of incremental tax provisions. Restructuring, there was about 2.2 million of expense, and also inventory overstock due to the restructuring was just about $1 million, about 900,000.

Additional freight expense of about $1 million due to the change in accounting that we discussed in the third quarter, and we had additional expense of about 2.4 million due to Sarbanes-Oxley and additional audit and tax expense versus 2004.

We did have a nice gain on some land that we sold near the building. We had a gain of $9.9 million on land sale.

By strategic business unit, the RF and Wireless Group was up 14.8% to 265.6 million, really nice growth. The gross margin was down from 22.6 to 21.9. This again primarily had to do with inventory reserves. The product margin was actually up; the product margin increased from 24% to 24.4%. Within RFWC, the Network Access portion of the business was up 22% to 105.3 million. Gross margin there also increased from 24 to 24.7. The Passive and Interconnect business was up 18% with sales of 53.3 million. There, the margin was down about a full point from 25.7 to 24.5.

Geographically in the RF and Wireless Group, the growth was led by Asia. Asia was up 23% with total sales for RF and Wireless at 94.3 million. And the gross margin in Asia increased from 23.3 to 22.1, so that's a nice increase.

Industrial Power Group was up 9% for the year to 122.9 million. Their gross margin was off slightly at 30.1, but still the best in the Company. The product margin, however, was 31.1, which was good. The Power Components business was up 17% with sales of 40.7 million and gross margin at 26.1. The Tube business continues to do well, up 4% and total sales of tubes were 80.8 million at 31.5% gross margin.

Again, geographically for the Industrial Power Group, Asia was up 16% to 26.4 million and showed some real nice margin at 30.7%.

The Security Systems Division was up about 3.5% to 105.6 million; and the margin was just about flat -- gross margin at 25.5, but the product margin when you eliminate the inventory reserves, the product margin was up to 27.8 from 27 a year ago. Again, this has largely to do with increased private-label and Engineered Solutions sales. Those sales were up 15% for the Security Systems Division to 32.2 million and the margin on that business was 32.9%.

Geographically, the Security Systems Division again was led by Canada where the business is up 13%. We did 58.5 million of security business in Canada and the margin there really increased nicely; it went up from 27.7 a year ago to 29.6, and that is where they are bringing more and more of the Engineered Solutions business through the channel.

Okay, the Display Systems Group had the largest percentage of increase during the year. They were up 17.5% to 78.1 million. Margin was down somewhat to 22.9. Again, this had to do with inventory reserves; the product margin was 25%. Our Pixelink Group or the custom displays is where the largest growth was, and there they were up 64.7% and their margin was just about flat at 22%. The largest portion of that increase in custom displays was the New York Stock Exchange order where we shipped about 6 million during the year. If we had gotten the final million included in the year, it would have been more, but that has now been shipped in the first quarter of this year.

Okay, geographically, for the year, North America was up 10.2%. We had sales of 303 million, 303.7, with gross margin at 26.4%. The U.S. was up 10.4% and Canada was up 9.6% within that. Europe was up 6.1% with sales of 123.8 million, margin was just about flat at 28.5. Within Europe, Israel was up 20% to 11 million which was really nice growth and that was primarily RF and Wireless products.

Scandinavia was up 11%, with gross margin of 26.4 which was up about 4/10ths of a percent. That was led in Scandinavia by IPG, which was up 29% and the Display Systems Group, which was up 44% in Scandinavia.

Asia Pacific was up 19.9% with sales of 124.8 million. Nice growth in gross margin there, 23.8, up about a point and a half from the year earlier. China was up 60% to 40.4 million. China continues to lead the growth anywhere in the world and that was primarily RFWC that was up.The RF and Wireless Group was up 58% in China. IPG was up nicely too in China, although it's still small for us. They were up 76% during the year, so seeing really excellent growth there.

In Southeast Asia, they were up 22% and the gross margin there was up a full point and a half at 24.5%. Japan was up nicely. They were up 21% for the year at 19.1 million and the highest margins anywhere in Asia, Japan was 35.4%.

Latin America finally on a year-over-year basis reversed their declines. Latin America was up 6.5% with sales of 21.4 million, and they increased their margin a full 3 points; they were up at 27.5%. It was led by Brazil that was up 11% and this was primarily sales of Security Systems products; those sales were up 33%. Colombia was up nicely also. They were 28% and their gross margin was up about a full 2 points, and that was again primarily RF and Wireless products.

Well lots of numbers. That covers it pretty much on the numbers side. With that, I will turn it over to Dave DeNeve and he can talk you through the balance sheet and the P&L. Dave?

Thanks, Ed. As Ed discussed, just to provide a recap -- for the fourth quarter of fiscal 2005, sales increased to 147.3 million, up 1.4% from the prior year. The gross margin for the fourth quarter of fiscal 2005 was 22.2% of sales compared to 25% last year. For the fourth quarter, SG&A expenses increased to 22.7% of sales as compared to 20.7% in the prior year. The increase as Ed mentioned was primarily due to the incremental expense associated with Sarbanes-Oxley and the additional expenses related to the restatements completing during the quarter.

As Ed mentioned as well, we completed the sale of undeveloped real estate near the Company's headquarters resulting in a $9.9 million gain. Overall for the quarter, net income was 2.5 million, $0.14 per share compared to net income of 2.6 million or $0.18 per share last year.

Turning to the full year, sales increased 11.3% to a record 579 million. Gross margin was 23.7% of sales versus 24.6% of sales in fiscal 2004. Incremental inventory write-down charges and additional freight expense mainly due to the change in accounting for freight expense during the third quarter were the primary contributors to the decrease in gross margin percentage.

For the full year, SG&A expenses increased to 22.2% of sales as compared to 20.8% of sales in the prior year. The increase in SG&A expense was primarily due to payroll-related expenses, restructuring expenses recorded during the third quarter of fiscal 2005 and as previously mentioned, expenses associated with Sarbanes-Oxley and additional audit expense.

Regarding income taxes, as Ed mentioned, we recorded incremental income tax provisions during the year of 13 million, primarily an increase of valuation allowance related to the Company's deferred tax assets. Overall, net loss in fiscal 2005 was 11.3 million or $0.67 per share compared to net income of 6 million or $0.42 per share in fiscal 2004.

Moving on to the balance sheet, despite the increase in sales during the fourth quarter of fiscal 2005 as compared to the prior year, accounts receivable remained relatively flat year-over-year. Inventory did increase to 102.3 million as of fiscal year-end versus 92.3 million last year. However, inventory did decrease 4.8 million during the fourth quarter when you compare that to the end of the third quarter. Due to inventory stocking programs and exclusive supplier agreements, the Company expects inventory to increase during the first quarter of fiscal 2006 to support anticipated sales growth.

The decrease in other assets relates to the incremental tax provisions previously discussed. PP&E increased in fiscal 2005 due to capital spending of 7.1 million primarily related to the implementation of PeopleSoft, offset by 5 million of depreciation expense. The accounts payable increased mainly due to the increase in inventory levels previously discussed.

Total debt decreased 17.5 million versus last year. The decrease in debt was primarily due to the equity offering completed during the first quarter of fiscal 2005 and the proceeds from the sale of real estate during the fourth quarter of fiscal 2005. With that, I'll pass it over to Bruce for highlights.

Thank you Dave. I'll give you an overview on bookings for the quarter and also the highlights that we have from each one of the individual SBUs.

First of all, for the quarter, bookings were a little soft at 1.8% below the prior year, although I would like to mention that in the quarter that we're now in, that has reversed itself. Wireless came in about 5.4% below the prior year. And within the quarter, three new global distribution agreements were signed. The first one was Sony Ericsson for their machine-to-machine cellular modules for the Americas; with a company called Raltron, a leading manufacturer of high-performance frequency management items for oscillators; and a big one with American Technical Ceramics to an exclusive global agreement. And ATC represents the leading manufacturer of high-performance RF and microwave products, including capacitors and film circuits.

A significant highlight was that our Component Engineered Solutions Group within Wireless has made the approved supplier list at Ericsson in Sweden. As a result, we received our first prototype order for amplifier modules that were designed and developed exclusively for Ericsson by Richardson.

Turning to Industrial Products, IPG, quarter was down about 6.6% from the prior year. Highlights -- our Passive Components Group signed a global agreement with Aavid Thermal Technologies, a leading provider of thermal engineering and management solutions. And Aavid with manufacturing facilities in the USA, Europe and Asia will represent a key ingredient in supporting our growth in Engineered Solutions Products and in this case, for both not only IPG but also the RF Wireless business units as well.

We also entered into an agreement with Semicron in Hong Kong to distribute their power conversion modules and discrete components in China and selected areas of Southeast Asia. Semicron is the world's leading independent manufacturer of power semiconductor devices. And with a great track record of producing devices with innovative packaging,they represent an excellent fit with our Engineered Solutions approach in growing the business.

Turning to Security Systems, bookings there were flat to the prior year. A highlight there was as a result of our ongoing success with Burtek in Canada, we have now consolidated all of all our SSD marketing operations into one North American structure which is now being led by Burtek management. And this change was implemented to facilitate the streamlining of our product lines, further improve our purchasing power by reducing product acquisition costs and improving our overall inventory control.

Turning to Display Systems, which was the frontrunner in bookings for the quarter, it came in 18.4% over the prior year. And of course the major highlight here was the acquisition of ACT Kern, although it did not occur and was not consummated until the current quarter that we're now in.

Turning to the geography, North American bookings came in about 1.7% over the prior year. Europe, as Ed had mentioned, represents our soft geography, down about 13.9%. Asia-Pac was down about 4.5%; that has been reversed in the first quarter, and Latin America came in at about 8.9% below the prior year. I will turn this back over to Ed.

Thanks, Bruce. Well a lot of good things happening. Certainly the overall strategy of Engineered Solutions continues to be extremely well received by both the customers and vendors. We're working hard to streamline the organization, take cost out and return the Company to profitability.

A couple of areas. Bruce mentioned the acquisition of ACT Kern, which I just wanted to underline was completed in July. Actually, I'm in Asia to meet with some of the vendors, partners of ACT Kern. They've really developed a nice network of Asian manufacturers who are manufacturing displays to their designs. And we intend to capitalize on that and I think we have the opportunity to reduce cost on a number of the displays that we supply through the Kern relationship.

Kern is a small company in Germany, very much like our Pixelink group that is located near Boston. We have had an excellent sales group in display in Europe for a number of years, but we really have not had an engineering and display integration center in Europe. And we have known of Kern for several years and we're finally able to put an agreement together with them. They do about $20 million in sales, but 95% of that is in Germany.

So we have now combined our sales group under the Kern management throughout Europe and we think that we really have the opportunity to increase sales and bottom-line earnings through the combination of the two units, and now the opportunity to utilize their sources in Asia for our products on a global basis should really, we hope, get one and one to equal three. So that's what we're working on in that area.

Everyone is always asking for guidance. It's certainly difficult. We have seen a nice pickup in sales in the quarter. Normally, the summer quarter is a down quarter for us sequentially from the fourth quarter. Right now, it looks pretty good. We of course have another week or so to go. We think the quarter will come in about 150 million in sales. With another week to go, it looks like it should exceed 150 or right in that area. And gross margin looks pretty good and it's right now running at about 24% overall.

So sales continue to look pretty good. If we can just streamline this organization to get some of the cost out going forward, we think we can return it to profitability and improve things dramatically.

It's very difficult to try to project what bottom-line earnings are going to be. The issue of course is we're really not comfortable with what taxes are going to look like at this point. Currency conversion now becomes an issue with some of the reversals that we worked through last year, so I think all the guidance we want to give you at this moment are sales and gross margin. And as soon as we have more information on the quarter, we will get it to you. With that, Patty, I think we'll open it up for questions.

(OPERATOR INSTRUCTIONS). Joe Sullivan.

Good morning. I was wondering if you could help try to normalize the fourth quarter. In the third quarter, we looked at operating expenses and exed-out a couple of items and it seemed like operating expenses were in the $31.5 million range. This quarter we reported 33.5 million. At the same time, we had taken a headcount reduction in February. So I'm wondering why operating expenses are up and if you can help normalize that.

And then maybe also talk about the gross margin line -- what goes into the product gross margin versus the reported gross margin and what trends we should impart from that?

For the fourth quarter looking at SG&A expenses, as I said the largest increase were due to Sarbanes-Oxley. That was about a 1.5 million increase over the prior year. And the audit expenses related to the restatements were about 0.5 million.

Looking at gross margin, the largest contributors to the decrease during the fourth quarter was incremental inventory charges of 1.5 million as well as settlement of a customer dispute and additional warranty costs of approximately 800,000. Those are the major reconciling items between year-over-year for the fourth quarter.

Just sequentially from the third quarter to the fourth quarter, why would operating expenses be up or your SG&A line be up when you had a headcount reduction?

Our payroll expenses are still up 900,000 year-over-year with the headcount reduction, and then the Sarbanes-Oxley fees were up a million over even the third quarter. That was the biggest increase there.

Okay. As far as the debt covenants and the convertible, can you talk through that -- what you have done, and what kind of impact it has?

Right. First of all, we were not able to include the gain in our calculation of the covenants. As a result, we were not in compliance with the credit agreement. We have received a waiver from the bank, an executed amendment. We get additional flexibility for the first three quarters of fiscal 2006. And in addition, the previous agreement called for 22.3 million of debt that was classified as short-term to be refinanced prior to February 2006; that amendment extends that refinancing requirement back to June.

What was the commentary around the convertible that was in the release?

That's what he is speaking of, Joe. The 22 million is the convertible. The convertible has two pieces. It has a piece of 17 million approximately that is due -- that matures in June of next year, and then it has about 5 million that matures in December. And under the credit agreement, the bank had asked us to have those refinanced in February, and that would make that current debt. And so what we have done now is asked them to waive that covenant, which they have done, and that moves that 22 million out into next year, makes it long-term debt. And we will refinance it between now and then.

And just so I'm clear in reading the numbers, it appears that your total long-term debt went from 134 million in Q3 down to 120 million in Q4, total net debt went from 111 million down to 96. Is that correct?

Yes. We paid down the debt with the cash proceeds from the capital gain on the land and also cash flow, some of the equity offering that we did last year.

Sequentially, though, the improvement largely just with the proceeds from the sale of the land?

Third quarter over fourth quarter, yes.

Okay. The tax rate, there's no guidance you can give or help you can give there? The tax rate in the quarter was 54% reported; that was just due to the sales of land largely?

What is happening with our tax rate, and the Company took a larger charge during the third quarter, is that we have to record a valuation allowance for certain of our subsidiaries that are incurring net operating losses. What that means is positive income that we're getting is fully taxed. The -- I will call it the loss -- at certain subsidiaries does not have a benefit related to that because of the valuation allowance. So in essence, what that is doing is inflating the effective tax rate.

One last question for me, just a line item. The interest expense in the quarter was much higher than it had been in any other quarter, it's 3.8 million. What was in that line?

The biggest difference in other expense was actually foreign exchange for the quarter. We had a foreign exchange loss of 1.7 million during the fourth quarter versus just 100,000 last year. That was not interest expense.

Okay. That's it for now. I will maybe come back.

Bill Benton, William Blair.

Good morning guys. Just again maybe going back to this SG&A item, because my sense was that as well that you were going to quite a bit of benefit at the SG&A line out of the headcount reduction in the third quarter, and obviously it picked up, and I realize you had maybe $1 million of incremental SOX expenses. But I'm still trying to reconcile why that line item may be still perking up a little more than expected, on a sequential basis.

Dave DeNeve I understand. There's not a lot more I could add to the fourth-quarter increase, other than the SOX, the audit expenses. We had a minor bad debt expense of about 300,000, but overall the payroll expense still went up year-over-year of 900,000.

Did the payroll expense go up sequentially?

From third quarter to fourth quarter?

Yes.

I don't have that information in front of me.

Okay. As far as the covenant charge, was there something in the other line related to some covenant charge? Maybe some of that negotiation around the --

As far as a charge to earnings?

I'm sorry?

Part of the charge to earnings?

Yes.

No we're going to have to pay an amendment fee that will be recorded in August related to that, about 250,000.

Okay, and that would be in the other line, I presume?

It will be, yes.

Just trying to get a general sense on the kind of ongoing margin. It sounds like the inventory charge, unless I heard you incorrectly, was about 100 bps at the gross margin line. Is that about correct?

Yes.

Okay. And then I guess the normalized -- it sounds like you're looking at 24%, I think you said, Ed.

Right.

This quarter. So it sounds like we should see some improvement off of this quarter. So would you -- that would still be I guess a little bit down, I guess pretty much flattish year-over-year. Where do you expect that gross margin to go, kind of looking forward?

Obviously, the challenge is to get more of the Engineered Solutions product through the channel. And our internal goal is to raise that about a full point during the fiscal year, so that is what we're working against. The encouraging part if you followed the numbers is we're starting to see some improvement in Asia which could have a good impact, because obviously the major growth that we're seeing is in Asia and that has been the lowest margin business in the past.

Right, the components stuff. Okay, where do you -- just to re-circle back on the operating expenses -- where do you ultimately -- you have historically talked about that going to 20% of revenue. When do you guys expect to get there on that target?

That's certainly our goal. Dave, within the plan, what kind of progress do you think we would make on that this year?

I think we are planning on being around the 21% level this year.

Okay. And then I think -- oh, yes. Just in terms of the -- you talked about the inventory levels being up maybe sequentially. Can you just talk about, I guess some of the -- I am presuming the banks aren't maybe wanting you to have your inventory level up. I don't know what the banks are saying with regard to where they want you to take your working capital ratios. Can you talk about what level of flexibility you have on that?

They haven't mentioned anything as far as inventory levels per se. The key for us will be to make sure that we continue to pay down outrdebt and actually just return to more profitable results quarter-to-quarter. I don't think the bank is concerned with our incremental inventory increase in this quarter as long as we are managing working capital in total and continuing to pay down our debt.

Okay, thanks guys.

Robert Damron, 21st Century Research.

Good morning guys. I just wanted to ask you a question about the SG&A expense into Q1. You're not giving any guidance there, but we're in the last week of the quarter. So could you just give us a little bit more color on what are the variables there that could either take that higher or lower this quarter, or what are we still waiting for that could swing that number in the August quarter?

The continuing audit expenses.

Right. We will continue to have additional SOX expenses as we go forward, but the bottom line is that percentage will be reflective of whatever our sales level will be. The 21% level that we talked about is representative of more of what we plan from a sales perspective. But if sales were to fall short, that percentage would go up, and obviously the reversal.

I guess I'm just talking about in absolute terms for the SG&A number during the August quarter, not necessarily as a percentage of sales.

I guess the best way to answer that, Rob, is that we have got obviously a number of things we are working on right now having to do with taking cost out. In fact, one is in process right now which has not yet been completed; and there is a roadmap that we have developed with one active and a number in the queue. And the thing we've tried to do is to get the fiscal year closed, which was done last night about 11 o'clock I think ; and get these other issues resolved; and then focus our efforts primarily on that. And that is exactly what the effort is going to be going forward.

Maybe you could -- what does the Sarbanes-Oxley expense look like for the August quarter? Or just maybe comparing that versus what you expensed in the May quarter?

We have not analyzed that in total. Like Bruce just said, we have been busy trying to get through our year-end audit. I have not had a chance to analyze that during the first quarter.

One last question for Ed, just in terms of continuing to streamline the organization. Should we anticipate into fiscal '06 additional restructuring, or do you believe you have most of that behind you? Is the organization kind of where you want it to be from a structure, or what else do you have planned from that perspective?

I think we have talked a little bit about this, but I will go back over it again. As we transition more from the components business of the past to the project-based business, it's Engineered Solutions in the future, we obviously have the opportunity to cut back on inventories, in there is not as much need to have the local stock in local currency all over the world. So we're working hard at restructuring around that concept, and it's an ongoing process.

We think there is a fair amount of savings to be had here, but it's going to happen over the next 12 months or so. And I guess the answer is that there will be more restructuring. At this point, we don't have it all in place.

That's fair. Thank you.

Kent Shaw, Buckhead Capital.

Part of my question was answered, but I was wondering if you could elaborate a little bit the comment about the gross margin. I think you said something about a settlement with a customer. Could you just maybe give us a little bit more detail about that and what happened? Is this a common occurrence? What led to it, that type of thing. Thank you.

Bruce, you want me to handle that, or do you want to talk about it?

Greg is here. I think it was in wireless. I think Greg is probably best equipped to handle that.

It was a one-hit wonder. It's not a common occurrence by any means. It was a customer that we worked directly with, the supplier of the product that had an issue with the products working in their system. So we spent six months working with the customer to solve the problem. There was a number of -- a large quantity of products that were sent. So we worked out an agreement with the customer to replace those products and support them on the cost of that, of which we will be shipping the products over the next two quarters to in essence literally make up that difference. So it was a technical issue at a customer that we decided to take the hit in the quarter to support him and his program, which is a 10-year program, and that should all average out at a minimum this fiscal year.

So if I'm understanding you correctly, you're essentially saying it's a longer-term relationship and you're doing your best to make sure you repair that because you see continued revenue from them in the future -- would that be correct?

Absolutely, and this is a huge customer in Asia that we look to benefit our Engineered Solutions capabilities with, which they're very interested in. And this is a component issue, almost a pure distribution part. So we're doing this now to make sure that the long-term relationship is intact.

Okay, excellent. Is there -- at any point, will you be able to offer any guidance as to what type of working capital improvements you might expect over the next year or so?

We can't provide any of that guidance right now. As we move forward, as I get more familiar with the Company, we may be able to do that. But at this point in time, I cannot do that.

Okay. But just so you know, those of us out here would genuinely beinterested in whatever information you can offer along those lines whenever you get to that point. We would -- I'd appreciate it.

As we get more of this streamlining process and restructuring in place, I think we'll be -- we're certainly going to concentrate on that issue and we'll share it with you just as soon as we can.

That would be great, thank you very much. That is all I have.

Johnnie Jensen (ph), McMahon Securities.

Hi, I just had some follow-up questions on your comments on the converts that come due or that you need to refinance by next June. Where are you in that process? Are you looking to replace it with another convert, with straights? And, are you in discussion with underwriters, or what is the situation at this point?

I will give you a little history, and you may know this, but we actually exchanged about $44 million worth of the converts last year. And at that time, we made the decision, we had another, this balance 22, 23 million outstanding. And at the time, we felt we would be able to use our bank lines to go ahead and to call those and pay them off, so that we did not exchange the rest of the bonds. And so we were waiting to look at that to see if we could reduce the interest rate which blended is 7-3/4, or 8%, in line with our bank rates which are somewhere over 4.

Obviously the performance of the business and some of the things we have done here in restructuring did not allow us to do that. So we're looking now at whether we will exchange those bonds or refinance them in another way. And at the moment, we don't have a formal program in place to do that, but it's certainly a current topic that we will be addressing here in the next quarter or so.

So when you talk about refinancing them in another way, are you talking about -- what are some of those options, just doing a new issue of some sort?

Possibly, and then calling the old issue.

Okay. And if you were not in violation -- well, obviously your bank lines require that you refinance these so you couldn't use your bank lines to take them out. Is that correct?

Not at the moment.

And what exactly -- which covenants exactly are you in violation of on your bank line?

You want to address that, Dave?

Yes. At year end, we were in violation of the fixed charge coverage ratio, which is EBITDA, less capital expenditures, divided by interest expense.

What was the requirement and what was your actual financials?

We actually needed an additional 2.4 million of EBITDA to be in compliance with that covenant at year end.

And was that the only covenant?

Yes, that was the only covenant at year end.

And how much is currently outstanding on the bank lines?

I believe it is in the 120 to 125. The bank line or the total debt?

Bank line.

Our total debt is relatively consistent with where it was at year end, right now. We are generating a lot of cash and paying it down as we go throughout the next week.

Dave, the actual bank indebtedness is what? 60 million?

Right. I think it was 54 million at year end.

Okay. Thank you very much.

Joe Sullivan with Craig-Hallum.

I don’t want to keep beating on it too much, but just wondering about the gross margin line. What is it that is impacting any improvements coming to the gross margin line? I know in the past you have talked about a 30% gross margin goal somewhere out into the future and a 10% operating margin. You're not too far off of that in terms of your operating expense levels. But what is impacting gross margins right now? Do you see that still as a target model somewhere out?

Sure, absolutely. Our goal still is the 30% area and the whole challenge here is to get more of the Engineered Solutions product through the channel. And unfortunately, the majority of the growth that we have seen as we touched on earlier is from Asia where it's primarily components business. But we're actually starting to see some improvement there as well.

I am in Korea at the moment, which is really encouraging. In this quarter alone they are projecting to do $10 million, which would show their business if they continued on that rate up from 30 million last year to 40 million this year. So they are really seeing some nice growth and working hard at getting some Engineered Solutions through it.

But in the meantime, the growth in Asia has been in the low 20s. And it's the newest area to us, takes a while to develop their relationships with the engineers where we can start to get the -- move up the food chain if you will and get more of the design and assembly of the Engineered Solutions into the channel and that is the challenge.

One thing that will help quite a bit, if we can move some of our manufacturing of custom displays into Taiwan through the current relationship, that will help us increase gross margin right away on some of those products. And we're looking at that and have a number of meetings with these manufacturing partners. And it really looks encouraging in that area. So those are all the things we need to do to get those margins up.

At a minimum, you're targeting somewhere in the mid-25% range for the full year in '06?

If we can get a full point gain, we would be pretty happy this year.

Okay. Just given the situation on the cap structure, does that prompt you to take a look at your organizational structure to try and address that?

Yes, for sure. We're going through all those issues and I think you will see a fair amount of progress this year.

And what might be available for you there to try and change that, address your cap structure?

Obviously, there are two areas that I mentioned earlier. As we go more towards the project-paced business, we can certainly bring the inventory levels down which would help a lot.

Okay, thank you.

(Operator Instructions). I'm showing that we have no further questions at this time. Please continue, sir.

Okay, well thank you very much. We certainly appreciate your patience and again, we are happy that the sales continue to increase. It's at least an excellent position to be in to know that the sales portion of the model is working well. And our challenge here over the next fiscal year is to streamline the organization, take cost out where we can and improve gross margin. We think we have a great opportunity to do that and we will continue with the process and share the information with you as we go. And thank you very much. Any of you are welcome to call us later if you have more questions. Thanks, Patty.

Thank you. Ladies and gentlemen, that does conclude our conference for today. Thank you for your participation and using AT&T executive teleconference. You may now disconnect.