Richardson Electronics Ltd (RELL) 2006 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the FY '06 year-end earnings release conference 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). I would now like to turn the conference over to your host today, Mr. Ed Richardson, CEO. Please begin sir.

Good morning. While at long last, we finally reported the year-end numbers and the fourth quarter as well, as well as the restatement and restructuring plan that we're several months into, which we will talk about as well. Before I have David DeNeve with me who is Chief Financial Officer, Greg Peloquin who is Executive Vice President of the RF Wireless Power Division, and Murray Kennedy who's Executive Vice President of the Electron Device Group.

First, we will talk about the fourth quarter. It was an excellent quarter, at least as far the top line is concerned. We finished the quarter at $171,800,000 in sales, with certainly a record quarter. It was up 16.7% from the prior year, the 16 consecutive quarter of year-over-year growth. And I think there was really no question that our strategy of engineered solutions is working well, well received both by the customers and the vendors and we continue to gain marketshare with the strategy. The real challenge now is trying to get the bottom line to match the top line. And we think we have some programs in place to get there over the next fiscal year, and we will tell you about that.

The quarter was 8.7% higher than any other quarter in the Company's history. The margin also improved in the fourth quarter. Margin was 23.7%, up from 22.1% a year ago. And a lot of this has to do with more of the engineered solutions product going through the channel. We will talk a little bit about that.

The fourth quarter operating income improved to $1.7 million. This also included $2.7 million of severance costs that were included in the fourth quarter as part of the restructuring plan, which we will tell you about. By Strategic Business unit, the RF Wireless Power Division certainly leading the growth of the Company. They were up 21.7% on the quarter to $92.9 million.

Within that, the network access business -- I will get it right yet -- was up 6.4% at $32.2 million. The infrastructure business was up 39.2% at $22.9 million. The passive and interconnect business was up 11.9% at $15 million, and geographically Asia continues to lead the growth. They were up 26.6% in the quarter at $35.7 million. The Electron Device Group, which Murray manages for us, is certainly the most profitable SBU, or strategic business unit, that we have. They were at $24.1 million, with a product margin of 34.5% and the gross margin of 32.8%.

The business would have actually been up more in the quarter. One of our major vendors, the largest vendor that we have in the Electron Device Group is moving a factory in California, and we have shortages there on a number of products that we have on order. We could have shipped at least during the year another $2 million to $3 million worth of tubes if we had had the product. So considering that, they still have an excellent year.

The semiconductor wafer fab business continues to grow nicely. It was up about 12.3% during the year and the margin there is 33.8%. So they have been doing well. We continue to gain marketshare and the legacy tube business that we've been in forever where we started. The Security Systems Division was up 5.6% to $28.4 million. That again is led by our Canadian operation, Virtek. That was up 18.9% in the quarter.

The Display Systems Group had nice growth. They were up 39.3% to $25.1 million. That also includes sales numbers from ACT Kern that we acquired about a year ago in Germany. Within the group, it was led by our Pixelink custom display group. Their business was up 41.7% in the quarter.

Geographically, North America was up 8.6% at $82.7 million. Asia-Pacific again led the growth. They were up 23% for the entire company, sales of $41.3 million. Korea led Asia-Pacific. We see the rollout of 3G continuing in Korea, and Korea was up 41.9% in the quarter to $12.7 million. China continues to grow. They were up 10% at $12.1 million and Southeast Asia was up 48.9% at $7.5 million. Europe was also up nicely. That also included the Kern acquisition, the sales numbers for Kern; that is in Germany. Europe was up 31.9% to $39 million. It was led by Israel where the sales were up 76.8% and Spain where sales were up 35.4%. Latin America finally turned the corner. Latin America was also up. They were up 10.1%. And that was led by Colombia; that was up 27.2%.

Okay for the full year, the sales were $637.9 million, up 10.2% from the prior year. Nice improvement in gross margin. Gross margin was up almost a full point. It improved from 23.5% a year ago to 24.4%, and again that is the amount of engineered solutions that is increasing going through the channel, which is a much higher margin business. Most of our Engineered Solutions business is plus 30% gross margin.

The operating income more than doubled to $16.1 million. Overall, we showed a net loss. We will tell you about that. That included $2.7 million worth of severance costs. That also included the write-down of deferred tax assets which Dave will talk about as well. By Strategic Business Unit, the RF Wireless Power Division was up 12.8% to $334.1 million. And margin was up nicely there too, almost a full point to 22.7%. Again that was led by the network access, which was up 16.9% at $123.2 million for the year.

The infrastructure business was up 10.7% to $80.5 million, and their margin was up about a full 2 points as well. Passive and interconnect was up 4.2% at $55.6 million, and geographically again that was led by Asia, with Korea and China leading the way. Asia was up 22.9% at $125.1 million for RFPD.

What is really encouraging to us, as you know, a year ago we restructured the Electron Device Group and the RF Power Division and included the power conversion product that had been within the Electron Device Group as part of RFPD. And that's really let the engineers, sales engineers focus on power conversion. And that business was up 33% during the year. It increased from $16 million at the time of the transfer of the restructuring to 21.2 over the period. And, Greg, maybe I'll let you comment on some of the highlights within RFPD.

As Ed mentioned, we had a very strong fourth quarter, up 21.7%. That is after a lot of the restructuring was done which really excites us as our profitability continues to grow and it continues into Q1. As Ed mentioned throughout these calls, it's just excellent strategy, excellent suppliers and customers, and a model that continues to gain us marketshare year after year.

The three business units, the Wireless Business Unit after products, as more and more key world suppliers want to get into our model RFMD, RF Microdevices signed Richardson for their new infrastructure products. About 85% of our business is infrastructure type products. The passive RF Group signed a key supplier ATC last year, and that business has doubled over the last 12 months. That is a key supplier within our passive offering to infrastructure customers.

And finally, as Ed mentioned, the power conversion group with the restructuring grew 33%. There has been a lot of changes in product management and the sales structure. So again the growth is strong and the profitability is following it.

Thanks, Greg. The Electron Device Group also did well. In the world market, we projected that the two businesses declining 6% to 8% a year and we continue to gain marketshare. EDG was up 2.5% at $94.4 million. More importantly, their gross margin was 32.2 to lead the Company. Really, the growth area of this business is the semiconductor wafer fab area that has microwave tubes. Primarily, magnetrons included in the equipment. And that business was up 22.5% at 34.8% margin and, Murray, maybe you want to take a minute and give us some of the highlights of the Electron Device Group during the year.

Good morning. The Electron Device Group, as Ed and Greg mentioned, was reorganized back in August, September time frame, and that has allowed us to really focus on two main areas, the semiconductor equipment manufacturing sector and then the legacy tube products. I will talk about a few highlights from each of those areas.

In the semiconductor equipment manufacturing sector, we designed in the sole source retrofit kit for an RF distribution play that a major semiconductor equipment manufacturer and that business will see in the first year $600,000 growing as the years go forward as we retrofit more and more systems. Additionally, we took an order for a prototype system where we developed and designed a high-powered microwave system for a major flat panel display equipment manufacturer. Many of the same processes and procedures that are used in manufacturing semiconductors are also used in manufacturing flat panel displays.

The system we designed will be utilized in the Gen 8 manufacturing process for flat panel displays and the production of Gen 8 will start in mid calendar year 2007. Each of these generators cost approximately $290,000. And the first production built for Gen 8 would be for five systems that would include 20 of these generators. So we are very excited about that business going forward.

On the legacy tube products, we were able to renew a contract for spare parts with a major airborne radar equipment manufacturer, worth over $500,000. And we received a $400,000 order from the Chinese government for power grid tubes and vacuum capacitors to support their national network of shortwave radio transmitters. So we have a lot of positive things going on in the group.

Thanks, Murray. The Security Systems Division was up about 3.1% to $108.8 million. Gross margin there was 25.1%. It was again led by Virtek, our Canadian operation, which was up 13.2%, with sales of $66.2 million, and their gross margin leads the group at 29%. That is primarily due to our private label business increasing within their sales. The private label business was up about 9% to $35 million, with margin there at 33.7%. The real challenge within Security is to get more of the private label business through the channel. And we seem to make progress on that every quarter.

The Display Systems Group was up 21.7% to $95 million in sales and their gross margin increased as well about a full point. They were at 25.8%. That again was led by our custom display group, Pixelink, that's located near Boston. Their sales were up 18.4% to $26.9 million. That has been a terrific acquisition for us. When we acquired Pixelink a number of years ago, they were doing about $3 million in sales. And as you can see this last year, they were nearly at $27 million.

Geographically, North America was up about 5% to $319.4 million. Asia-Pacific led the growth. They were up 18.6% for the year at $148 million. That was led within Asia-Pacific by Korea. Korea was up 35.4% in sales to $43.5 million. China continued to grow, up 7.2% at $43.3 million. More importantly, in China the gross margin was up about 3 full points. So we are seeing more of the Engineered Solutions Business start to catch hold there. And Southeast Asia was up 29.3% as well. Europe was up 13.7% and that, of course, included ACT Kern. Geographically, that was led by Israel. It was up about 16% for the year. And again Latin America finally turned the corner during the year. And Latin America was up just below 14%, with sales at $24.7 million.

So with that, I'll turn it over to Dave to let him talk about the financial difficulties and the resolution thereof during the quarter.

Looking at the fourth quarter, as Ed previously mentioned, our sales increased 16.7% to $172 million as compared to the prior year. The gross margin as a percentage of sales improved from 22.1% last year to 23.7% during the fourth quarter. The improvement in gross margin was due primarily to the increased sales of Engineered Solutions products.

SG&A expenses as a percentage of sales improved to 22.6% during the fourth quarter compared to 23.1% last year. SG&A expenses increased to $38.9 million during the fourth quarter. The increase was primarily due to the $2.7 million of severance expenses recorded during the fourth quarter which is part of the overall restructuring plan that Ed previously discussed.

As a result of the gross margin and SG&A improvement, our operating income improved to $1.7 million during the fourth quarter of fiscal 2006, compared to a loss of $1.4 million last year, excluding the gain on sale of land of $9.9 million that we recorded during the fourth quarter of fiscal 2005.

Overall, net loss in the fourth quarter of fiscal 2006 was $3.6 million. As already mentioned, that quarter included the severance expenses of $2.7 million and it also included an incremental non-cash income tax provision of $2.2 million related to an income tax valuation allowance on certain domestic deferred tax assets.

Looking at the full year, sales increased 10% to $638 million as compared to fiscal 2005. Gross margin as a percentage of sales improved nearly a full point to 24.4% versus 23.5%. The improvement in gross margin was due primarily to improved margins in RFPD, EDG, DSG. SG&A expenses as a percentage of sales improved to 21.9% in 2006 as compared to 22.4% last year. SG&A expenses increased to $139.6 million in all of fiscal 2006. The increase was primarily due to SG&A expenses related to the acquisition of Kern and $2.2 million of incremental severance expenses year-over-year recorded in fiscal 2006.

Even though we anticipated a reduction in year-over-year audit Sarbanes-Oxley in tax expenses due to the restatement, these expenses increased unfortunately approximately $900,000 in fiscal 2006. As a result of the gross margin and SG&A improvement, operating income more than doubled to $16.1 million from $6.2 million last year, excluding the gain on sale of land. Overall, net loss of fiscal 2006 was $2.6 million compared to net loss of $16 million last year.

Moving on to the balance sheet, cash decreased to $17 million from $24.3 million last year. Due to the number of our foreign subsidiaries, we tend to have a large cash balance on the balance sheet at any point in time. Each foreign subsidiary of the Company holds a certain amount of cash for their normal operating activities. The Company's increased its focus in obtaining the cash from its foreign subsidiaries on a regular basis to pay down intercompany payables.

We are currently in the process of implementing a global cash sweeping program for all of Europe during the second quarter of fiscal 2007, followed by Asia-Pacific to minimize the amount of cash required to be held in each subsidiary. Cash will be obtained in the U.S. to pay intercompany payables and will have no income tax consequences.

Accounts receivable increased $9.6 million due to an approximate 13% increase in sales volume during the last two months of fiscal 2006 as compared to fiscal 2005. Inventory increased $117.3 million at year-end. As we have previously discussed, we expected the increase in inventory due to inventory stocking programs to support our anticipated future sales growth. Accounts Payable also increased mainly due to that increase in inventory levels.

Total debt increased $126.8 million versus $120.3 million last year. The increase was due to higher levels of working capital required to support the growth and the acquisition of Kern.

Looking at cash flow, net cash provided by operating activities was $5.5 million in fiscal 2006 versus cash used in operating activities of $2 million last year. Capital spending was $6.2 million in fiscal 2006 versus $7 million in fiscal 2005, primarily related to information technology and facility projects.

Now I'll just discuss the restatement. The cumulative restatement impact was $6.4 million. Of that amount, $3.3 million was related to the Italian subsidiary as we have previously disclosed. The majority of the remaining balance related to incremental non-cash income tax provision required during the third quarter of last year to record a valuation allowance on certain deferred tax assets.

For the first six months of fiscal 2006, the impact was non-material as net income actually increased by approximately $100,000. Net loss for fiscal 2005 increased from $11.3 million to $16 million. Net income for fiscal 2004 decreased from $6 million to $5.5 million. We will be filing all the restatement SEC filings required, as well as the current SEC filing later today. As a result, the Company will be in compliance with listing standards of the NASDAQ global market. With that, I'll turn it back to Ed.

I would just like to take a minute to recognize Dave and his entire finance team. They have been working seven days a week now for four or five months trying to make sure that we have all of the foreign subsidiaries audited and well in hand. And we have gone over every one of the subsidiaries. By the way, there are some 23 of them globally and we believe that every possible issue now has been looked at. And we not only had E&Y involved but KPMG and Deloitte & Touche. And we really feel comfortable now that the restatement is behind us. Dave and his team deserve a lot of credit for lots of 70, 80 hour weeks that have been going on. We are hopeful now we can get back to running the business.

I want to talk a little bit about the restructuring plan. Actually, the restructuring plan was approved by the Board in May and we are well on our way to the implementation of a number of stages of the restructuring plan.

As I mentioned, we have 23 foreign subsidiaries and 70 locations all over the world. Last year 62% of our sales were outside of the USA, and we do business in 30 different currencies, again all over the world. Originally, this infrastructure was set up to service the two businesses where we needed local stock and local currency all over the world to support aftermarket types of business.

This infrastructure has become very expensive over the years and with a lot of the modern technology we are able to get same-day shipments, next-day shipments into these countries without having the local brick-and-mortar, if you will, local stock. So we are going to hub-type system where we will have a centralized warehouse in Europe, also a centralized warehouse in Asia, and another one in Latin America to try to streamline this entire structure and take cost out. For instance, in Europe we'll ultimately go from eight warehouses currently down to one or two. And at the same time, we think we can actually improve the service to our customers by doing that as well.

Another issue that is extremely important to us when you look at our track tax structure today, you realize that total taxes are now exceeding 100%. And what we are showing, because of the tremendous infrastructure in the U.S., is losses in the U.S. and areas where we are profitable for instance in Canada, we are fully taxed. And with the type of structure that we're talking about, we can go to a limited risk distributor structure that will allow us to bring more of the income back into the U.S.

Currently we leave about 50% of the income in these foreign subsidiaries and with the hub structure and third parties handling the shipping for us, we can reduce that down to below 5% and will allow us to bring the income back into the U.S., where, as you know, we have large NOLs and basically not pay taxes on the income. So we are hopeful that we can really streamline that system.

We are, as I mentioned, putting a hub into Latin America. We have closed the warehouse in Mexico. We are also closing a warehouse in Colombia. We will maintain our sales forces there. We have already downsized the operation in Brazil. We'll have a centralized hub in Brazil, but the majority of the Latin American business will be served directly out of the U.S.

In Asia it is interesting over the years when we first started developing China, for example, we shipped weekly consolidations from LaFox, from Chicago to Shanghai, and then the shipments were broken down and the individual orders were shipped over China. And we continued that structure. As you can see, China this year was $43 million in sales and so it has gotten to be extremely expensive to do that. And in the meantime, in analyzing the business we found that over 30% of what we're shipping into China is actually made in China. So under our present system, we buy the product in China, bring it to Chicago, and then reship it to China.

With localizing a lot of that process and putting a centralized warehouse into Asia, we can certainly take out a lot of costs. And it is far more cost effective to pull orders and [fill] orders in China than it is in LaFox, Illinois.

So overall we think the total plan will take about $8.5 million out of our SG&A expense once the plan is fully implemented. And we believe it is going to take the balance of the fiscal year to get the total plan in-place. We took $2.7 million with severance costs in related restructuring cost in the fourth quarter. We will be taking about another million dollars in the first quarter and this quarter and the balance throughout the year. We estimate that the total cost to implement the restructuring is about $6 million in total, and we will see the full impact of the restructuring plan starting in FY 2008.

So that is pretty much the restructuring plan. It is well on its way. I think it has been well-received by the total organization. We have taken out multiple layers of management structure. Within the corporate alone, we have taken out about 35 people and it's really streamlined the organization. We think we will prove improve a lot more going forward.

Talking about forecast, we are almost through the first quarter. The top line business continues to be excellent. We will have a record first quarter for the Company, the highest first quarter in our history. Right now it looks like sales will end somewhere between $162 million and $165 million, depending upon what happens here in the next couple of days, and the gross margin looks good. It is running about 24.5%. Again in the quarter we will have about another million dollars worth of severance and restructuring cost.

And in addition to that, we'll have about $2.7 million of debt extinguishment expenses that have to do with the repurchase of some of our bonds. So that is about where we are. Lots of detail, lots of numbers. And we will open it up for questions from there.

(OPERATOR INSTRUCTIONS). Robert Damron, 21st Century Equity Research.

Congratulations for finally getting the numbers out. I wanted to talk a little bit more about this restructuring and maybe the impact on the balance sheet going -- if we look out a year from now. You know with the consolidated warehouse structure and I am assuming some consolidated inventory as well, should that reduce your inventory needs going forward?

We certainly think so. Obviously right now we're keeping inventory, for instance, in Europe in 8 different warehouses. Lots of time that is a duplication just to cover local stock. Plus there is a lot of cost just transferring inventory from warehouse to warehouse. And so going with one hub, it should eliminate a lot of duplications. I don't think we have really quantified how much that will bring inventory down yet, but we know it will be an improvement for sure.

So none of the expected savings is really from financing of inventory. That $8.5 million doesn't include any potential reduction in financing.

We haven't calculated that into the $8.5 million at all.

And then maybe you could just take us through that $8.5 million where you expect those savings may be in just the large buckets and how you expect that to roll out. I mean will we begin to see that even in Q1?

I'll let Dave take you through the macro numbers, anyway.

All right. As Ed mentioned, we have already eliminated 35 positions in the United States. So as those savings related to those amounts will begin to rollout Q1 and Q2, the expected savings with those are approximately $4.5 million.

In Latin America, as a result of our initiatives that Ed described, we expect to save $2 million on an annual basis, and that will grow out through probably more like the second half of fiscal 2007. Additional savings will be coming from the hubbing of Europe of approximately $500,000 to $1 million. And then we have other areas where we're focusing on making other improvements, eliminating other positions for the balance of the savings, which will again take place throughout fiscal 2007.

Okay. And then you also mentioned a more tax effective supply chain in Europe and other things that you're doing I guess to take advantage of the NOLs in the U.S. So I mean this may be a difficult question to answer, but what should the expected tax rate be into '07, and then maybe into '08?

Right. Exactly. I look more -- future toward FY '08 than FY '07. We are going to do whatever we can this year to reduce it, but it is going to take us awhile to put the appropriate tax structure in place to, in essence, reduce that effective tax rate and reduce the taxes that we are paying internationally and move then to the U.S. where we have the full net operating loss that we can take advantage of. We really expect that to take full force in fiscal 2008. It's tough to predict what the effective tax rate would be right now.

Okay. And then, Ed, I guess I am a little surprised with all the restructuring that is going on that the sales are as strong as they are for Q1. Are you -- has there been any sales disruption? It doesn't seem like there has been, but are you walking away from any sales as a result of this restructuring?

Well, I think we are surprised a little bit too especially in Latin America, for example because we cut the work force in Latin America substantially, yet the business has continued. There are some areas, I am sure, that we have lost some business. It is hard to tell by the numbers. And I think that the wireless business right now is so strong that it is sort of picking up the slack.

Okay. That's fair. I think that's all I have. Well, good luck. Thanks.

Samuel [Bergman], [Bayberry Capital.]

A couple of questions. One regarding the two divisions that are the most profitable right now and having good growth. Wouldn't it be better at this particular time to perhaps spin off a division to the stockholders, or is it more likely that you would sell a division to bring in some nice cash?

Well, we are certainly considering that option and that may well be something that we will do in the future. It is always a consideration at what price in these divisions are producing nice returns for us and so anything that we do, we certainly want it to be neutral or accretive. We would love to take down the debt and obviously we are really stretched to have enough cash to support the growth of all four SBU's. It is something we are looking hard at.

The display division, what type of capacity right now is that running at?

I don't know if you could gauge it in terms of capacity, but certainly the area where we have in capacity limited is at Pixelink in Boston. And we just moved Pixelink into a new facility back in the end of the fiscal year and they are now in a 50,000 square foot new facility. So that capacity limitation has been eliminated and if necessary, they could go to multiple shifts. So I don't think we see any capacity limitation there now at all.

In that particular division, is there any problem on getting added employees to go to other shifts?

No, really not.

Not at all. The restructuring that you currently are the process of doing, it seems like in the past and of course you had mentioned on the conference call there was a lot of duplication. First of all, why did it take as long as it did to eliminate some of this duplication and are there some duplication that hasn't even been touched and expected in some other restructuring later on?

Well, you know, I guess what happens -- what really put the focus on it more than anything else, good news and bad news, is Sarbanes-Oxley in trying to get all these foreign subs to comply with the new regulations and then obviously some of the restatement issues we have had and found out that we really haven't been controlling the financial portion of some of the foreign subs as well as we should have. So that's put the focus on it.

And then when you start to understand, with modern technology, what you can do to with centralized warehouses, you can eliminate you know the bricks and mortar. You don't need a warehouse in every country. And then we started to study the economics of that. We have, for instance, probably $5 million, $6 million worth of inventory in transit all the time. That issue alone between these multiple warehouses.

So I think there is a lot of things that we can do. Dave's numbers on savings in Europe are really conservative. We did an analysis. For example, it costs us right now about $29 a line item to ship product into Europe out of our existing system. And with a 3PL, we can take that down -- with a third party logistics hub, we can take that down to about $20 to $21 a line item.

So ultimately when the savings start going through the organization which will be in FY '08, I think you will see a lot more savings than what we have projected at this point. Right now this just has to do with elimination of jobs and facilities and things that we have been able to quantify. But I don't think we have really been able to quantify yet what the savings will be in the logistics itself going forward.

I assume you put together some kind of business model for 2007. And I am just wondering the type of growth you see in the first quarter, do you expect that to continue the rest of the year?

Well, our business model says yes. It is a question in my mind. I can tell you the restructuring touches probably 300 or 400 people out of the 1200 that work for the Company. And when people are involved in a restructuring, they spend a lot of time trying to understand how that is going to affect them, rather than selling product.

But so far I think everyone here knows that it is needed. It is obvious the last few years have been less than rewarding for any business. We have -- probably half the people here are some kind of a bonus plan based upon margins, EPS, you name it, and those bonus plans have been nonexistent. So everyone realizes this restructuring needs to take place. And I think they have really gotten behind it. And it is obvious that sales are continuing while the restructuring's going down.

I would assume that morale is pretty strong then because the sales are continuing.

It is right now. It will be a lot stronger after today.

And the last question I wanted to ask you and I'll let somebody else get on the call. In terms of investor relations for the rest of the year, what are your plans?

Well, we want to get out on the street now and be able to talk about the restructuring plan. And we really for the last four or five months and Dave has taken the brunt of it, he and group, but we haven't done anything except just try to get the restatement filed and get the numbers out there and get all this behind us. So now I think we'll be able to get out and tell the story as well.

Thank you. Good luck in the upcoming quarters.

Thank you. We will need it.

Christian Schwab, Craig-Hallum Capital.

Ed or Dave, just back of the envelope. Our $0.21 loss this quarter if we exclude the onetime, the $2.7 million in severance costs, the $2.2 million tax valuation allowance, the $0.21 loss that we have would be $0.07 in earnings. I don't know if that tax effect that right.

For all those items, for the most part, there is no tax effect. The $2.7 million charge to severance expense is a $2.7 million charge to the bottom line. So if you factored that in, your thought process is correct.

Perfect. So then, as we look to next quarter, excluding all the onetimes, would we expect to be -- of course, be operating profitable but would you expect to be profitable in the bottom line as well?

I guess the issue -- and we aren't even able to calculate it -- is what the tax is going to be. And from an operating income side, I think you'll see substantial improvement going right along, but I don't think either Dave or I are in a position to try to bottom-line it at this juncture.

Okay. Paint a picture for us in 2008 if you will. We got the restructuring in place. We have got the hub infrastructure in place. We are deriving the majority of all of our income out of the United States instead of at a very high tax rates elsewhere. What -- and I would assume that also we will also take care of having to reprice in the debt as well. Is that part of that plan, I mean, mark to market the debt?

I don't think we mark to market the debt.

Well, just in foreign currency fluctuations non-cash.

Foreign exchange. We have a program we are working on to eliminate that situation. I can't tell you that we are absolutely certain we can get that done during the fiscal year, but it's certainly an issue.

We could if the program that we are working on does not happen in this fiscal year, then we will probably start a hedge program of some kind to -- we have about $50 million worth of debt from our foreign subs and that is the foreign exchange roller-coaster that you watch from quarter-to-quarter. We have a plan if we can implement it to eliminate that, but it is probably 50-50 if we can get it done in the fiscal year right now.

The other thing that will help out is if, as we do more localized purchasing in Asia-Pacific and even Europe, we will create the natural hedge and then we will not have as many intercompany balances with the United States if we keep it within that region.

Right. And along the lines of an earlier question, should we decide to sell one of the portfolios within the Company that would net us enough money to pay off at debt, is that correct?

That would take care of that situation, yes.

As we look into 2008 then, let's say that we own all pieces of the Company as it sits today. Can you just kind of broadbase give us a picture what you think it is going to look like, you know, on the gross margin line, what you're going to be spending on operating expenses roughly what kind of taxes you think could pay. Broad, Mack truck.

I don't know. I don't think we can really address the tax situation, but I think sort of in our long-term strategic plan, what we are trying to look at is top line growth of 10%, 15% a year with an SG&A that is up 20 and a gross margin that increases about a full point every year.

Great. So in 2008 you think you'll be sitting approaching 25.5%, 26% gross margins, given the increased Engineered Solutions?

I think that's reasonable.

And SG&A, less than 20% of sales?

Yes.

Fantastic. And then one last question. You guys paid off your convert; it that correct?

We have an agreement with our lenders to repurchase $14 million worth of the convert of the $25 million. And that particular convert converts into common at $10.31, I believe. And so we have an agreement from our lenders to use our bank line to buy in up to $14 million of that, and we intend to do that shortly.

Great. And so, if I remember that correctly, that will stop quite a bit of dilution, about 1.5 million shares of dilution from happening?

It's about 1.4, right.

Fantastic. Thank you.

Bill Benton, William Blair.

Just a follow-up on the operating expenses, maybe question in terms of where that could go. I mean I can look back to 2001 and see you guys up 19% at about half $1 billion in revenue. Obviously, you guys have more revenue today. You guys are making a lot of changes in terms of improving the profitability. Where ultimately do you think you could take those operating expenses and that operating expense ratio to? Would you think you could improve upon that or is there a structural reason you couldn't improve upon that?

Well, I guess we want to make the numbers we predict for awhile. We think we can get, you know, we can improve on that. But I don't think that any of us are really prepared to quantify the impact of the hub structure. And ultimately what we're going to do in Europe, to start out with, is go to what is called a limited risk distributor kind of organization where the subsidiaries in-country will be deemphasized.

We have already done part of that. We no longer have a managing director in Europe. The country managers historically have been country managers. They now report directly into the Strategic Business Unit. So that whole infrastructure is gone -- the layer that were within it -- and the next step then, instead of having individual companies in every country, is to have been basically as sales agents that report directly into the U.S.

Well, I'll come back a little bit on that, but in terms of the inventory -- I know you got the question earlier too. But how much inventory was in the warehouses that you shut down? I know you obviously transferred some of that stuff around, but how much inventory was in the warehouses that you shut down? Was it pretty significant?

The only ones that we have actually shut down at this point are Mexico and Colombia and we are reducing the one in Brazil. But ultimately the ones in Europe will also be closed down.

Off the top of my head, what has Lincoln got? $10 million, thereabout, $10 million, $11 million. And then most of the -- right now we have the European, the largest European warehouse is in Lincoln, England, and it is $10 million, $11 million. And then the other warehouses probably have about million somewhere in that area each. I think Mexico probably had a half million, something of that order. The smaller subs have less inventory, but when you start multiplying that by 23, it becomes a lot.

Right. I mean you could see potentially $20 million come out of the system?

Well, in '08, by '08. It remains to be seen. But the other thing we are learning too is a lot of Greg's business, the RF and wireless business, is more project-based where you have more visibility -- you know it's something that we work in an engineering cycle for six months or a year. So you don't have to have local stock waiting for the business to materialize. We see it with our Design Opportunity System. We see it coming a long way and don't have to be carrying inventory until it is actually needed.

And then in terms of the restructuring, I know you said you started implementing in May. So I guess what hasn't, I mean, worked to what you would expected so far that you have had to kind of tweak around a little bit or it might be improving upon in future quarters?

Well, I will reverse it. I think Latin America has actually gone smoother than we thought. And it is coming along right on time and maybe even a little ahead of schedule. We are trying to go to a hub structure. The centralized warehouse in Europe will be in Amsterdam. And it takes a fair amount of software and interface with 3PL for the reorder process and the sales forecasting basically to drive demand planning.

And I think that has come a little slower than we had liked. We are going to try it as a prototype using the Electron Device Group product. Obviously the two businesses, our legacy business is the business we know best and it's easier for us to forecast what product to stock.

So we are going to start in November in Amsterdam using EDG as a model on the hub structure and then see how it works. And once we get all the bugs out of the software to drive the system, then we will move RFPD into it. Right now that is forecasted to go in January. So there is a lot involved to consolidate eight locations into one or two and get all the software in place to drive demand planning.

And we are putting in a program here we call Lead to Cash, and that is really upgrading our PeopleSoft system where we will be using sales forecasting to drive demand planning. And that is all part of the process. We have just added a new supply chain manager on a global basis, and he has a lot of experience in supply chain management. He ran an operation for Knowles Electronics. You may know them, Bill. And he had a hub actually in Singapore and he had another one in Ireland. And he's got a lot of experience in this area and he's already brought a lot of new ideas to us and how we can sort of expedite this process.

Great, guys. Thanks a lot.

[Kent Shaw].

Hello.

Was I right in hearing that you thought it was $20 million, or that you thought that the total amount in the subs currently was $20 million.

Could you repeat the question? We lost you there for a minute.

Inventory reduction that you thought might be possible as a result in the change in structure.

Well, what we were talking about is that there is currently probably $20 million plus in the outside warehouses and so I think Bill was speculating if we could eliminate that, obviously some of that inventory will go into the hub so you won't eliminate it all. You eliminate the duplication. We're really haven't tried to quantify yet how much inventory we can reduce, but I think certainly 10% is a conservative number. That would bring it down $10 million. I think $20 million, we won't get it all out of the system.

You think it could be reduced by $10 million?

I think so.

And you have any ideas -- any ideas what the new structure might do for inventory turns longer-term? I mean obviously it is going to improve it, but I'm just trying to get an idea if that is something you guys are focusing on?

Well right now we're running about 90 days inventory and you know we would like to bring that down to 75 or so, but that is sort of a long-term goal.

90 days. That's all I have. Thank you very much.

Christian Schwab, Craig-Hallum.

Just a follow-up on the big picture again, Ed. Let's say we just grow this business 10% over the next couple of years and we keep all our divisions. We get revenue of roughly $770 million. If 2008 is -- if everything gets accomplished here in the next few quarters and goes into 2008 under new operating model, you know then we are getting about 6% operating income, correct? 26% gross margins less than 20% SG&A?

Yes, 5% or 6% in that range.

So let's use 6% for fun. That will get you $46 million in operating income if we also then fix the foreign debt issue, or it is hedged, if you will, then all we have really is the cost of debt at $9 million and some change, is that correct?

Yes.

So that ends up with $37 million in pretax income even if you have an effective tax rate of 30%, which would probably be high, even though you're making $1.50 per share. Is that math right?

The math is right.

The math is right. That's a great objective. We've got a long way to go between here and there, but the math is correct.

Great. That's all I have. Thank you.

I am showing no further questions, sir.

Okay. Well, thank you very much. We're here all day and welcome to answer any other questions you may have, so give us a call. Thanks very much.

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