Richardson Electronics Ltd (RELL) 2006 Q1 法說會逐字稿

Good morning, ladies and gentlemen. Thank you so much for standing by and welcome to the fiscal year 2006 first quarter earnings release conference call for Richardson Electronics. During today's conference, all phone lines will be muted or in a listen-only mode. Following the presentation, there will be an opportunity for questions with instructions being given at that time. (OPERATOR INSTRUCTIONS) As a reminder, today's conference call is being recorded.

At this time I'd like to introduce our first speaker, Chief Executive Officer for Richardson Electronics, Mr. Ed Richardson. Please go ahead, Sir.

Good morning. We are certainly pleased with the sales results from the first quarter that we released last night. If any of you missed the press release, it is on our website, which is www.RELL.com.

I have Bruce Johnson with us this morning, President, and he will talk about the highlights of the quarter; David DeNeve, who is our new Chief Financial Officer, and he will talk about the profit and loss statements and the balance sheet; and Greg Peloquin, the Executive Vice President of the RF & Wireless Group, Executive Vice President of the RF & Wireless Group.

We have completed a restructuring between the Industrial Power Group and the RF & Wireless Group at the end of the first quarter, and Greg will give you some of the details on that restructuring as well.

So again the quarter was a record for us in sales. It is unusual that we'd have record sales in the first quarter of the year. Normally the first quarter, because of the summer quarter being a vacation period, particularly in Europe, that quarter is normally down sequentially about 4% from the fourth quarter of the year. In this case, it was up substantially 14.2% over last year and 7.4% over the fourth quarter.

We did have an extra week in the quarter, which certainly helped. And we also had 3.4 million of sales from A.C.T. Kern, which we acquired at the beginning of the quarter. We will talk a little bit about Kern, a display integration company that we acquired in Germany, and we've now started to integrate that into our Display Systems Group and really have seen some great opportunities through that acquisition.

It was the 13th consecutive quarter of year-over-year growth so there is no question that the customer demand for our product as created by the engineered solutions strategy is working extremely well. We actually had almost 3.8 million -- 3,769,000 -- of pre-tax earnings vs. 1,128,000 a year ago. So basically if we had normalized tax percentages, the earnings would have been substantially higher than what we reported.

Net earnings were $0.09 vs. $0.05 from the prior year's first quarter. Sales and gross margin by strategic business unit, the RF & Wireless Group was up 12.5% to 72.5 million. Gross margin was 22.5, the product margin was up substantially. It was 24.5%. Within that, the network access business was 24.4% up, sales at 34.6 million. The infrastructure portion of the RF & Wireless sales was up substantially as well, at 22.2% increase. Sales at 21.4 million. The passive/interconnect business unit within RF & Wireless also showed some nice growth and Asia geographically was the highest percentage of increase at 38.6%, 28.6 million. And that was led by Korea which we will talk about a little bit. Korea had a really nice quarter as 3G was rolled out in the quarter for Korea.

The Industrial Power Group was up to 9.7% to 32.5 million, still the most profitable business unit we have with gross margin at 30.5. The tube business just keeps going. We continue to gain market share in a world market that is actually declining. Our tube business was up 9.7% in the quarter and at 20.8 million and the gross margin for the tube business again is the highest in the business at 33.3%. The power components portion of that business was up 7.7% at sales of 11.2 million with gross margin at 26.7.

Within IPG, geographically, Asia led the growth at 11.8% and the margin on the IPG sales in Asia are excellent, as well. They were at 31.6% versus 30% a year ago. The Security Systems Division was up 4.4% in sales to 26.9 million. The gross margin actually increased to 26.1 from 25.2 a year ago. This is due to a higher level of product label and engineered solutions sales within the strategic business unit. That business was up 22.1% and the margin on that business was 34.1.

So, obviously, if we can continue to increase the amount of engineered solutions and private-label business through all the SBUs we can certainly increase our overall gross margin.

Within security, geographically, the growth was led again by Canada. The Canadian operation for security is doing extremely well. They were up 16.3% and their margin was 28.8, up from 28.3 a year ago.

The Display Systems Group including Kern -- A.C.T. Kern, the acquisition in Germany -- had really nice growth. They were up 44% in the quarter at 24.5 million and they increased the gross margins slightly from 24.3 a year ago to 24.6. And we think that gross margin will increase on a linear basis as we get more and more of the custom displays through the channel.

Within DSG, the medical monitor portion of the business was up 16% to 8.8 million. The custom display business, which has been primarily pixel link in the past was up 44%, now will start to see additions from Kern's custom display business as well in Europe. And the gross margin there was down somewhat but showing some good improvement as well, as far as the new bookings that are coming in.

Geographically, for display North America was up 10.5% to 82.1 million. I don't think that can be right. That has to be geographically for the total. That's for the total group. North America was up 10.5% to 82.1 million. And margin was up to 26.2 from 25.5 a year ago and, again, that was led by Canada. That was up 23.2% with sales of 21.1 million and nice gross margin at 28.5%.

Europe was up 11.2% and that also included Kern's 3.4 million in sales. Europe was 32.8 million in sales. Margin was up nicely at -- up from 28.6 a year ago to 29.3. In Europe, Spain led the growth. They were up 11.8%. Their margin was also up nicely. Their margin increase from 28.4 to 30.6. And in Scandinavia -- again, this is telecom business with the Ericssons and the Nokias of the world -- that business was up 10.8% and the margin there was just about flat at 27.2%.

Asia-Pacific led the overall growth at -- up 29.2%, sales at 37.2 and also had some margin increase. The margin increased from 23.3 to 24.6. The sales growth was led by Korea. Again in Korea, 3G has now been rolled out. Korea was up 52% in the quarter. Last year, Korea did about $30 million in sales in total and, currently, they are on a run rate to do something in excess of 45 million. So really some excellent growth. In this quarter they did 12 million and gross margin was up from 21.5 a year ago to 22.4.

China continued their excellent growth. They were up 29.2%, sales of 11 million, and they did an excellent job increasing margin. Their margin increased from 18% a year ago to 22.4 this year. And we are hopeful that 3G is now going to be rolled out in China, probably the first quarter of calendar 2006. In Japan, business was up 13.4%. And the margin in Japan is excellent at 30.9%.

Latin America is finally starting to show some life. Latin America was up 23.3%. Sales are still small there at about 6 million and margin at about 25.4 overall. The growth was led by Brazil. It was up 36.7% and there, they increased margin from 25.8 to 29.8. Mexico was also up about 11% in sales and Colombia was up 11.8%.

At the end of the quarter, as I mentioned at the beginning of the conference, we've restructured IPG and RFWC. There was about 28 million, 27.5 million worth of power conversion business within the Industrial Power Group that we've now transitioned over to the RF & Wireless Group as part of our focus on engineering solutions.

And I will let Greg tell you about the details of that. But we think that's really going to help us focus our sales force on -- and our engineering team on a worldwide basis and also reduce expenses.

On an annualized basis prior to severance and one-time costs, the restructuring will reduce expenses about 1.3 million. Obviously we are hopeful that sales will grow where we will be adding additional salespeople for each one of the strategic business units. But Day One, it reduces expenses about 1.3 million.

With that, I will turn it over to Dave and Dave will go over the profit and loss statement in the balance sheet with you.

Thanks, Ed. As Ed mentioned, sales increased 14% to the record 158 million. Overall, our gross margin percentage improved to 24.5% versus 24.2% last year primarily due to an improved product mix. SG&A expenses in the first quarter were 33.1 million decreased to 20.9% of sales as compared to 21.1% of sales last year. The increase in SG&A expense dollars was primarily due to the Kern acquisition, approximately 800,000, and then the additional week of payroll and other related expenses of 900,000 in the first quarter of fiscal 2006.

Regarding income taxes, our effective tax rate this quarter was 58.6% in fiscal 2006 versus 29% last year, primarily due to the geographical distribution of taxable income and losses. For the first quarter of fiscal 2006, valuation allowances recorded relating to net operating losses in certain entities.

In addition, the first quarter of fiscal 2006 includes an incremental income tax provision non-cash of 300,000 for income tax exposure that our foreign subsidiaries related to prior years.

Overall, net income in the first quarter was 1.6 million, $0.09 per diluted share, compared to 800,000 or $0.05 per diluted share last year.

Moving onto the balance sheet, inventory increased to 112.9 million versus 102.3 million at year-end. As discussed on the last conference call we expected an increase in inventory, due to the inventory stocking program to support our anticipated sales growth. Accounts Payable also increased, mainly due to the increase in the inventory levels.

Total debt during the quarter increased 2.2 million. If you exclude the impact of the current acquisition, the total debt would have decreased by more than 7 million during that quarter. With that I will pass it over to Bruce (indiscernible).

Thank you Dave. I am going to give you the booking numbers for the quarter and also, as Dave had mentioned, highlights under each one of the SBUs.

We had a very good booking quarter. The Company overall was up by (ph) 18.5% sequentially and exactly the same 18.5% in the prior year. Led by the RF & Wireless Group, sequentially up 32.4% and 38.5% over the prior year.

In the quarter, the major focus in RFWC (ph) was on our engineering solutions component group; and we became a qualified vendor of Ericsson for our component engineering solutions. And we are now currently working with them on a base station infrastructure initiative for Europe.

We also developed a design and amplifier module for digital broadcast transmitters for a major OEM in Japan. And piggybacking on that, we now have 3 other OEMs who are now qualifying our product.

We have been very successful in designing in numerous supplier products and engineered solutions in Korea for infrastructure implementation and with the collaboration of a couple of our key vendors have gained market share by designing out our competition. And RFWC also launched what we call our super NLNA (ph) family of engineered solutions component products. And we have already achieved design wins in the military and infrastructure market.

Turning to Industrial Products Group -- IPG -- and as Ed mentioned, the major highlight in the quarter for both RFWC and IPG was the restructuring of the respective business units with the outcome being that IPG is now designated as the Electron Device Group or EDG. And when I finish with my highlights Greg will provide you with the further details of the restructuring.

The other highlight in IPG was that an exclusive agreement was signed for the Americas with Thales Electron Devices Group to distribute their power grid tubes into the TV market and the agreement also gives us authorization to distribute their industrial power grid to products to the rest of the world on a nonexclusive basis.

And our bookings for IPG were up sequentially 16.4% and compared to last year's 6.2%.

Security Systems sequential bookings were up 9.9% and to the prior year's 7.2%. As Ed had mentioned SSD continues to focus on increasing its engineered solutions private-label sales which, obviously, is having a positive impact on margin, as Ed mentioned, by the quarter results 26.1% this year versus 25.2% last year. All product management marketing and operations have now been organizationally centralized, resulting in improved efficiency and elimination of redundancies.

Additionally, the engineered solutions products that were initially launched in Canada are now being introduced in the States with a good reception. This is positive because it demonstrates that our new product management structure, at least in this instance of managing one North American product line, can be very successful in growing profitable sales. In addition, we also derived a margin improvement benefit to increase leverage, thereby reducing our product acquisition costs.

In the Display Systems, sequentially, was down about 6.8% and about 4.2% from the prior year and as we've mentioned numerous times, this is a project-driven business so fluctuations like this are not unusual.

The highlight in the first quarter was the acquisition of A.C.T. Kern, as Ed had mentioned. Certainly, one of the leading display technology companies in Europe and it's located in southern Germany and we believe the A.C.T. Kern group of display specialists, combined with our Pan-European sales and marketing team, are now able to provide our customers with a complete range of Custom Display Solutions. The acquisition also provides us with additional technical resources that will enable us to accelerate and expand our Global Display Solutions business.

Turning to geography, North America was up sequentially 14.6%, 17.1% over the prior year. Europe was up 15.2% sequentially, down slightly 3.1% from the prior year. And as Ed has mentioned in billings but also bookings, Asia-Pac was up 27.6% -- very strong -- and over the prior year 39.6%. And Latin America, which is coming back, was up 67.3%, sequentially 26% over the prior year.

And one thing I did forget to mention and that is that the billing figures are in here for Kern but the booking figures are not included in what I just gave you.

I'll turn this over to Greg.

I will just touch briefly on the restructuring. As we have done for many many quarters, we continue to focus on improving our efficiency and profitability and still finding ways to expedite our transition to and engineered solutions company. And this restructuring supports all three of those objectives.

The restructuring itself had a number of individual objectives, obviously to increase our overall efficiency. What we did, we integrated the IPG power conversion semiconductor products about $27 million in sales into the RFWC global organization. This allowed us to do two things. One, reduce layers in both sales and product management and put the IPG semiconductor sales productline into a strong growth model as you have seen over the years with RFWC.

The second thing is it improved our geographic sales coverage for power conversion products. In essence, we have more feet on the strength straight for RFWC's salesforce. And, really, we got to the point where it is cost-prohibitive to put a separate infrastructure in place to support the IPG semiconductors. We see this as being a very positive to our suppliers by IPG products.

Thirdly, it provides us with immediate additional resources to further our transition into engineered solutions products, while continuing to successfully drive our component sales growth. You saw the booking numbers for the quarter. Some of the savings was used to expedite this growth with hiring of design engineers. And, finally, it aligns the global sales and management organizations within the respective RFWC and EDG (ph) strategic business units, thus having efficiency and having one voice, one mission, and again reducing numerous layers in those organizations.

In the end, what you have is EDG which in essence is our tube business which is high margin and the most profitable product lines in the Company. They are not ready to be a cash cow yet. They continue to find numerous opportunities for growth, as Ed had mentioned.

Then we have in terms of RFWC, the fastest-growing SBU in the Company benefits the high growth model, which these semiconductors will take advantage of, reduces our layers in both sales and product management and allows us on a global basis to have one voice in global policies and procedures, and some funding to help this transition towards more engineered solutions sales.

With that, I go back to Ed.

Thanks, Greg. Well it certainly was an excellent quarter tap line. We keep working hard on finding ways to reduce cost and streamline the organization, get us back to record levels of profit as well. I think we know how to do it. The real question at this point is execution. I have an excellent team and we are certainly working towards that end.

I know you are looking for guidance. Normally in the second quarter, our business is up about 9% sequentially from the first quarter. Obviously, we have had a record first quarter. Part of that was the extra week in the quarter so at this point, with the bookings that we have like Bruce has talked about, we're looking at about 160 million in sales for the second quarter.

After having said that, we guided you to 150 million in the first quarter and we exceeded that substantially. So we are still hopeful we can do better than that. We think margin will be about flat. We had a nice increase in the first quarter so we think it should be somewhere around 24.5%. And SG&A, Dave, you thought it would be somewhere around 33.

We believe it will still be in the $33 million to $33.5 million range going forward.

So, that is about as much guidance as we can give you for the moment. We will say that as Bruce told you, bookings are at an all-time high and the business looks excellent right now. Display has a lot of great opportunities. And as 3G is rolled out in Asia, we think the business will continue to increase there substantially. So with that, Kristina, we will turn it over for questions.

+++ q-and-a.

(OPERATOR INSTRUCTIONS) Joe Sullivan with Craig-Hallum.

Congratulations on some progress of their. A couple questions to start. I appreciate the help on the out quarter here and the guidance. What about the tax rate? Do we have any clarity as to what it will look like? Maybe you can also talk about why it was -- more specifically why it was so high in the quarter?

The biggest reason is if you recall during the third quarter last year, the Company had to record valuation allowances for net operating losses in certain of the Company's entities in the past. As a result any losses in those companies going forward, you will not receive that income tax benefit on the income tax provision line. In essence you are reserving for that benefit going forward. And as it is difficult for us to predict which entities we are going to direct ship (ph) into and where the income is going to be generated, it's tough to predict what our effective tax rate will be on a normalized basis.

We are working on many tax planning initiatives to try to utilize as much of that net operating loss as we can. But it is difficult to predict at this time.

Would you expect it's similar to the first quarter or any help at all on where it shakes out over the next several quarters?

I don't we can give you a specific percentage but it should be down from the first quarter. The other issue, which I should let Dave comment on -- a lot of this has very little cash impact. Even in this quarter, the reserves possibly will be used in the future but they have no cash impact today.

Right. In essence, the valuation allowance as well as the $300,000 reserve were recorded they don't have a cash impact, immediately, however we will be able to hopefully utilize those NOLs going forward as we make income in those entities.

As far as the operating expense line, the SG&A, are you looking to take that down? For the current quarter, you are talking about it being flat to maybe slightly up. Is that something that you expect to try and reduce or is that the level and as the operations get larger you continue to layer on top of that?

From overall perspective, we had minimal auto tax in stock expenses during the first quarter. We expect those to go up which will somewhat offset the additional week that we had during the first quarter. But we are continuing to look at ways to reduce our SG&A expenses and our structure that we have in place now. And we hope that that number will go down in the future. We are looking at all those initiatives as we speak.

Our goal is still to get it at 20%. I mean, that is the overall objective. How fast we can get there remains to be seen.

As far as the bookings numbers you gave out, I don't know if you have a consolidated book to bill but maybe you can talk in more detail about what the bookings implied. It sounded like they were extremely strong in the quarter. What does that imply for the results going forward?

I think as the numbers indicate we are very I think bullish about the business, the incoming business that we have right now in all of the individual SBUs. And we are looking forward to a positive quarter and a positive year at Standpoint. There's a number of strategic initiatives that are active in every one of these. We certainly talked about the restructuring of IPG, RFWC. There is no question that is going to be very, very successful with our customers as well as our vendors.

The acquisition of A.C.T. Kern, already, I think is benefiting us in a number of ways, not just in terms of the topline sales, but also in terms of product acquisition cost reduction because of an hour access to other sources of supply which we didn't have before. And I think with a security system if you look and track backwards on the margin, you'll see a steady increase in terms of gross margin because of our efforts there on private label, engineered solution opportunities.

Do you have a consolidated book to bill number for the quarter?

RFWC was just over 1.3 and Joe, just to add to that, the bookings information that we saw in the first quarter isn't any one-hit wonders. It is across three major markets -- digital broadcast, military, and then of course, the infrastructure where, obviously Korea is doing real well but we're also doing real well with infrastructure bookings in North America also, which a lot of that we purchased over in China and in Asia.

So it's not those markets we are saying are going to take off eventually domestically. But we are very active in all three and it is a good booking number. It is not 12-month bookings. It's a shorter time frame so we are very positive about the backlog.

One last question for me. Are there any other initiatives you talked about the restructure between RFWC and IPG? Is there anything else within your interactional operations you are looking at doing?

Yes. We've talked a little bit about this and it is pretty premature but we have 35 foreign subsidiaries all over the world and we have a very complicated complex footprint and especially with today's environment and corporate governance, and Sarbanes-Oxley, it is extremely expensive to monitor and do all the financial controls for all those subs.

So we are looking at trying to consolidate some of these subsidiaries, possibly go more to a hybrid rep structure. The first area that we are looking at is in Latin America but we do think it will be the end of this fiscal year before we can do anything in that way, but we have a complete project underway to study the alternatives there to reduce costs and to simplify the organization.

I lied. One more question just because I got flack for not asking the question last time. Any update on your cell enhancer product?

Yes we have introduced it and have signed contracts with Mido and Barjen (ph). We are now currently -- those of you who are traveling across America to the travel centers, we are in 400 travel center outlets. We were just named Best New Product of the year by Barjen, one of the largest distributors of products into the travel center. And our bookings were up about $2.5 million in Q1. But those are for annual usages that they will pull off as the interest increases.

So it's strong. The margins are very very strong and the sales numbers are good and profitable, sales numbers there. They are not in the lower margins stuff. So we are comfortable with where it's going. And we keep seeing more and more opportunities. We introduced the Nextel product which was very well received in the market.

So Flying J, Petrol, Travel Centers of America. We're in all those stores today.

Bill Benton, William Blair.

Congratulations on the booking number as well. Could you just give us some color on the bookings numbers in terms of were those adjusted by this restructuring on an apples to apples basis? Was there some sort of -- because I know you moved some of the dollars between the two segments there?

The actual restructuring although we took some of the difference costs in the first quarter, the actual restructuring was effective 9/1. So the numbers you are seeing are apples to apples.

Going forward we will change the labels and do pro forma for you.

In terms of the gross margin as well, I know you called for it to improve sequentially. It improved a little bit more. Was there a shift in the mix of the components business. Is that what was going on this quarter?

I think it was just more engineered solutions coming through the channel that has been able to pull the margin up. The largest margin increase we saw was actually in China, which was really good to see, because that has been the lowest margin for us in the world, frankly. But we did see an increase, even with Korea's substantial increase in business, they were able to push their margin up as well. So -- .

So in China just to be -- I mean, you had still good solid component business there. But you just picked up an engineered solution so that the overall mix went up there?

That's right.

The inventory, I know you mentioned that you said that it was going to go up. It went up a little bit, it went up about 10 million or so sequentially. Have you seen that start to come down yet or what is the anticipation of where that goes in the near-term?

It's -- right, as you said, it's at 112 million. Our intent or our goal is to in essence keep that level flat as we go through the next second quarter.

Could you remind us again, what was the idea -- I mean what was the idea behind some of the billing (ph)? I know that you were taking advantage of some purchasing programs, but could you expand on that?

What we have done in several instances, we have added some new supplier agreements that are exclusive on a global basis or a geographic basis and they require us to put in additional inventory to cover those exclusive agreements. So we got an inventory billed when the agreements are initially signed and that's pretty much an overall effect.

Are those several agreements? Or is there, was there one primary supplier there that --?

No, there are several.

There are several. Then could you -- I went back on that release on Kern. I just still don't see any terms to the acquisition. Could you give us a little color around the terms of that acquisition?

Sure. It's a company we have actually been working with for about two years. We finally concluded the agreement so that it was effective at the beginning of the quarter. Kern is a Display Integration company. They are located in Donaueschingen, Germany, which is about an hour from Zürich.

Their total business is about 20 million in sales, $20 million, EUR15 million. 90% of that business is in Germany. And they are very heavy in the engineering side. They are almost -- and Mr. Kern wouldn't like this -- but they are almost a mirror image in my mind of Pixel Inc. We've done very well with the acquisition of Pixel Inc. near Boston who has been doing most of our custom displays in North America.

But for logistics reasons, it is almost impossible to do custom displays in North America and then sell them in Europe. So we were really looking for a display integration center in Europe and Kern fits that exactly. They have about 40 employees. The other issue that they have done very well is that they have used Taiwan and Chinese companies to do their manufacturing. They do the engineering in Germany and then they transfer their production to their partners in Taiwan and China.

We have never done very well in that area. Most of our products have been built in Boston which, as I'm sure you can realize, is not the most cost-effective location to manufacture in the world. So it is going to be sort of two-edged. First I think it will expand our business in Europe, utilizing current engineering resources and our sales team, display sales team in Europe.

Kern is now responsible for all DSP sales in Europe and at the same time our display business which by the way, today is primarily in North America. We will be able to utilize their sources. I was just in Taiwan in August and we are working with all of their vendors so we are able to reduce our cost on existing business in North America by leveraging their relationship with Asian suppliers.

So we are really high on the acquisition. We think it is really strategic. As far as terms are concerned, it is very typical of the way we do acquisitions. It was done on an earnout basis. We basically have a three-year earnout where the principles within Kern's share in the earnings in Europe of the combined sales going forward. It was -- the total acquisition price was about $6 million in that area.

I don't know what it turns out to be, about five or six times EBIT, something like that. But a large portion of it has to do with the future of how successful we are in the earnout.

I thought they said something about that would have gone down 2 million but it went up -- or I'm sorry it would have been down 7 million but it went up because of the acquisition. Were there some other cash components to that?

We did assume a couple million of debt related to Kern as well. That was primarily it.

Great. Let's see I think I maybe just had maybe one final one. Then, I'll let you go there. What was the actual headcount this quarter versus last quarter ending?

It is about 1200 with the addition of Kern. So it is up from something like 1160 to about 1200.

So otherwise pretty flat?

Yes. We -- with the restructuring between IPG and RFWC we took out a number of people but at the same time we were adding engineers so one of them will balance the other.

Congratulations on the bookings again.

Rob Damron with 21st Research.

Just a couple more questions, additional questions on the restructuring. You mentioned $1.3 million in savings annually. Do you expect that beginning in the second fiscal quarter?

On a run rate, yes.

On a run rate basis. Okay. And then, are there some severance charges that will occur this quarter? Will those be one time or are you just going to put those through the income statement?

We required approximately 300,000 of severance charges during the first quarter. We actually anticipate similar severance charges during the second quarter. So it will be consisting quarter over quarter.

They are just run through the SG&A. There was no special charge.

Correct. Got it. Then, once we take the power conversion semiconductor products out of the IPG, what is left for IPG? Is that just the tube business? Or is there anything else, any other products in that category?

They have the tube business. They also design and manufacture microwave generators for the semiconductor wafer fab industry. That is about when the tubes are the power source for those units but that is $12 or $13 million of their business and it has other related components and circuitry in the microwave generators. So that stays in and the total business is a little over $90 million going forward.

And that starts in Q2. Correct?

Yes.

Then, I saw that the Asia-Pacific gross margins ticked up this quarter. That has been one of the things I guess that has been dragging the gross margins, overall gross margin, down. But it was nice to see that margin tick up. Have you been able to get more of your engineering solutions deployed through Asia? Or what was kind of the driver of the higher gross margin in that region?

Yes. It is much more engineered solutions. In this area it was primarily engineered solutions as it relates to components more than assemblies but that is the driver. It's the mix.

Rob, that is a good example but we have been talking about it for years with Asia where we have to gain their confidence in doing design-in work on what we will call just pure components from, in essence other suppliers. And over the (indiscernible) the years, we've come to them to understand our capabilities. And now we are doing and seeing more and more of them going to us for engineering solutions opportunities, especially as we expedite the infrastructure into Korea.

So it's improving a lot there in Korea we've been talking about.

Last question. I know you've been working hard on getting the operating margin up. Let's talk a little bit about return on capital and talk about the denominator and possibly trying to reduce the overall capital needed to run the business in terms of, I guess, mostly working capital. I know, I think a year or so ago, you put together a program or a differentiated program for compensation, based off of return on assets. Is that continuing? Are you deploying that further through the organization? Is that also a focus for the Company?

While actually for this fiscal year we actually increased the emphasis on return of assets in terms of the delineation of the formula that we had from that standpoint with all of our business units and product managers. Put more emphasis on asset optimization.

Do you think that there is still more opportunity in terms of reducing inventory days throughout the organization?

I think as Dave had mentioned, we are talking about planning a flat number going forward. And that is with an increasing sale so that is going to result in higher turns of inventory. And there's a number of initiatives going on there to further take the inventory down going forward.

Certainly if we implement this hybrid rep structure in lieu of some of the foreign subsidiaries, every one of those foreign subsidiaries has inventory. So if we went to the hybrid structure, that would reduce inventory, for sure.

(OPERATOR INSTRUCTIONS) Stephen Lewis with Lewis Capital Management.

Can you give us the operating cash flow for the quarter or for -- yes, the quarter?

Yes. Net cash provided by operating activities was 5.2 million versus cash in operating activities used last year of 9.6 million.

Where do you stand on your -- to bank loan requirements? What is the leverage ratio versus the 2.35 to 1 requirement?

That was 2.88 versus 3.35 and then fixed charge coverage ratio was 1.56 versus the minimum of 1.25.

What happens when your -- oh, okay, so both of those are in good shape. Now, where is your valuation allowance versus that 17.1 million for the utilization and loss carryforwards?

Our valuation allowance during the first quarter increased about 300,000.

So where is it now?

I will have to get back to you on that number. 300,000 plus whatever it was in the annual report.

Okay. How much of the 8.25 and 7.25 convertible debentures are left versus the 22.3 at the end of the year?

I think you have it. Of the 8.25 and the 7.25, it is 22 million.

So you have reduced to 300,000?

No. It is just the same as it was at the end of the year.

When do you expect to complete the land sale?

It has been completed. It was completed in May.

I thought that was to be completed -- I'm talking about the one that you announced on August 4.

There is another one for 3 million in -- we are selling a building in Geneva the OC Tron (ph) and that is envisioned to close on November 1st.

I thought it was 1.5 million.

No it's 3 million.

3 million and that closes when again?

November 1st.

November 1st and last thing. What is your actual borrowing leeway? When you apply the maximum permitted leverage ratios?

Right now we have access of $9 million.

In other words, that's an increase from the 2.6 million at the end of the year?

Yes. Stephen?

Yes.

Real quick. The valuation allowance went from 17.1 to 17.4.

Gentlemen, we have no further questions at this time. Please continue.

All right. Thank you very much. Again we are really pleased with the sales level in the quarter and the business activity that we see going forward and the challenge right now is to continue to take costs out of the organization and see if we can't improve the earnings going forward as well. If you have any additional questions, please give us a call. We will be in all day. Thank you.

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