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Executives

Jim Jacobson – Director, IR

Drew Moyer – Interim CEO, SVP and CFO

Alan Benjamin – COO

Analysts

Mike Gallo – CL King

Joe Wittine – Longbow Research

Fred Buonocore – CJS Securities

Sanjay Shetty – BOE Securities

Pulse Electronics Corporation (TNL) Q3 2010 Earnings Call Transcript November 8, 2010 5:00 PM ET

Operator

Good afternoon, and welcome to the Pulse Electronics third quarter 2010 results conference call. All participants are currently in a listen-only mode. There will be an opportunity for you to ask questions at the end of today’s presentation. An operator will give instructions on how to ask your questions at that time. (Operator instructions) This conference is being recorded. At this time, I would like to turn the conference call over to Jim Jacobson, Director of Investor Relations. Mr. Jacobson, you may begin

Jim Jacobson

Thank you, Jamie. I’m Jim Jacobson, Director of Investor Relations for Pulse Electronics Corporation. For those of you who may have missed the press release we issued this morning, the company changed its name from Technitrol to Pulse Electronics Corporation. We will discuss this change momentarily.

With me today are Drew Moyer, Pulse Electronics’ Interim Chief Executive Officer and Chief Financial Officer; Alan Benjamin, our Interim Chief Operating Officer; and Mike Ginnetti, our Corporate Controller and Chief Accounting Officer. This afternoon, we will discuss our results for the third quarter of 2010, provide our outlook for the fourth quarter, and discuss the actions we are taking to achieve our operating and financial targets, and then we will take your questions.

Before we begin our presentation, let me take care of four administrative items. First, we will be using a slide presentation to accompany our prepared remarks. A PDF file of the slides has been posted to our website. Go to pulseelectronics.com and click on the link labeled Third Quarter Earnings Materials and then go to the webcast link section in the lower right. Second, this call is being webcast, and a replay will be available on our website for seven days.

Third, we will make statements considered forward-looking within the meaning of Federal Securities Laws. These statements are based on our current knowledge and expectations and are subject to certain risks and uncertainties that make cause actual results to differ materially from the forward-looking statements. For a discussion of such risks and uncertainties, see the Risk Factors section in our most recent 10-K and 10-Q, as well as in certain of our other SEC filings. The company undertakes no obligation to revise or update any forward-looking statement.

And fourth, in this call, all references to operating profit, operating profit margin, and diluted earnings per share are on a non-GAAP basis. These non-GAAP measures exclude non-cash stock-based compensation expense and accelerated depreciation in the third quarter of 2010 as well as severance and impairment costs in other fiscal periods. For a reconciliation to US GAAP results, see slide 23 in our presentation.

Now I’ll turn the call over to Drew.

Drew Moyer

Thanks, Jim. And thank you to everyone joining us on the call today. Our earnings release was distributed after today’s market close. I’ll provide an overview of our third quarter performance and discuss our fourth quarter outlook. Alan will give you an operations update and discuss the primary actions we are taking to achieve our operating profit margin target on annual sales of at least $500 million. Then we will take your questions.

Let me start with slide three. As Jim said, earlier today, we announced the company changed its name to Pulse Electronics Corporation. In connection with the name change, we will change the ticker symbol for our common stock listed on the New York Stock Exchange to PULS from TNL. Our stock will begin trading under the new name and ticker symbol at the start of trading on Monday, November 15, 2010. In the interim, our stock will continue to trade under the TNL ticker.

Pulse Electronics Corporation reflects our focus as a pure-play electronic component manufacturer. Our new name unites our corporate and operational identities and is reinforced by the actions we are taking to integrate the holding company and our operations into a single company. We are simplifying our organizational and business structure to leverage our demonstrated strengths of design engineering and high volume manufacturing expertise.

As the world continues to demand more robust networks, enhanced Internet capabilities, broader wireless connectivity, and more efficient power usage, we stand ready to serve our customers and to generate strong growth and to increase value for our shareholders as one unified electronic components leader, Pulse Electronics Corporation.

We also launched a new website available at www.pulseelectronics.com. The new website will further integrate the corporate and operating companies as well as provide a single presence to customers, shareholders and other key stakeholders.

Now let’s turn to slide number four. I’ll give you my perspective on our third quarter performance. We delivered another strong quarter, generating revenue and operating profit that exceeded our expectations. Our performance reflects solid execution of our strategies. In particular, we capitalized on growth opportunities in the network and power markets. We completed the sale of AMI Doduco and used the proceeds to strengthen our balance sheet and improve our liquidity. We also generated strong cash flow from operations.

Turning to slide five, I’ll review our third quarter results, starting with net sales. Net sales grew 20% to $122 million in the third quarter from $101.4 million in the prior year quarter. We are pleased to report that our $122 million in net sales is the highest sales generated in almost two years. We continued to generate strong growth in our Network and Power product lines.

Network sales increased 70% to $65.2 million from $38.3 million in the prior year quarter. Sales in our Power group grew 59% to $36.8 million in from $23.1 million in the third quarter of 2009. These gains were partially offset by lower sales in our Wireless product group. Sales were $19.9 million in the quarter compared with $39.9 million in the prior year quarter and $22.8 million in the second quarter.

This performance primarily reflects a change one of our large OEM customers made in its supply chain strategy that was announced in the second half of 2009. While our challenge with the revenue level in our Wireless group continues, we are aggressively managing the cost structure in the group and deploying our resources in the technologies and geographies that we yield increasing revenue over the long-term.

As we look forward, we feel good about the relationships we have built with new OEM customers and integration partners and the fact we have won and continued to win new design business. The key is to convert these design wins into meaningful revenue. Alan will provide more details momentarily, but let me be very clear this is a top priority.

Please turn now to slide six, and I’ll review gross profit margin. Gross margin improved to 27.1% in the quarter from 26.9% in the prior year quarter. This improvement was primarily due to strong demand for Network and Power products and the resulting solid labor and capacity utilization in Network and Power and also the successful migration of labor to lower-cost areas in China. These gains were partially offset by higher overall wage rates compared with the prior year quarter as well as lower demand and under utilization in Wireless.

Now let’s move to selling, general and administrative expenses, which are covered on slide seven. SG&A expenses increased 7% to $25.0 million in the quarter from $23.4 million in the prior year quarter. This increase was due primarily to higher commissions and legal costs related to a patent claim, as well as higher incentive compensation. As a percentage of net sales, SG&A expenses improved more than 2.5 percentage points to 20.5%. This gain reflects the strong underlying leverage in our business model on revenue of $122 million.

As you see on slide eight, we more than doubled our operating profit and increased our operating profit margin nearly 3 percentage points to 7.1% in the quarter. These gains reflect the factors I have discussed already; most notably, strong demand for Network and Power products, solid capacity and labor utilization in Network and Power, migration of labor to lower-cost areas in China, and business model leverage. These gains were partially offset by the impact of lower sales in Wireless and higher overall wage rates compared with the prior year quarter.

Turning to slide nine, diluted earnings per share from continuing operations grew 58% to $0.19 in the quarter from $0.12 in the prior year quarter. This bottom line performance was primarily due to our strong operating profit growth. We also benefited from a net foreign currency gain and a lower effective tax rate, which were partially offset by higher interest expense and the inclusion of common share equivalents related to our convertible notes.

Let me provide a few comments on three of these below the operating line items. While our effective tax rate declined to 21.1% from the mid-30s in the prior year quarter, it was consistent with our expectations. Without restructuring charges or non-recurring adjustments, we continue to estimate our tax rate going forward will be in the low-20s.

We experienced higher interest expense in the quarter as a result of the December 2009 issuance of $50 million of convertible notes. These notes have a 7% interest rate, which is higher than the interest rate on our credit facility, which has been approximately 3% in 2010.

Weighted average diluted shares outstanding were $49 million in the quarter compared with $41 million in the third quarter of 2009. This increase reflects the inclusion of the share equivalents related to the convertible notes. As a result of our strong earnings in the third quarter, this was the first quarter the share equivalents were dilutive, and therefore, were included for EPS calculations.

Now, turn to slide 10, balance sheet and cash flow. As I mentioned at the beginning of the call, we completed the divestiture of AMI Doduco in September and used the proceeds to strengthen our balance sheet. We’ve reduced total debt $44.5 million in the quarter to $82.2 million at October 1, 2010.

The sale of AMI Doduco also eliminated commitments under precious metal consignment leases that totaled approximately $113 million at the end of fiscal 2009. We generated strong cash flow in the quarter as a result of our strong profit growth and tight working capital management, notwithstanding higher revenue and business expansion. As you see on the right hand graph on this slide, we generated $12.3 million of cash flow from operations in the quarter.

Now, let me give you a better sense as to where and how we are going to use our cash flow going forward. Please turn to slide 11. Now that we are a pure-play electronic components company, serving growth markets, our primary focus will be organic growth and operational efficiency. Pulse has a long history of innovation.

We are going to focus on our strengths, particularly design engineering and high volume manufacturing. In doing so, we are going to invest in new manufacturing technologies and processes, as well as research and development for next generation technologies in every product division. We are aggressively developing and patenting new technologies that will serve as platforms for future growth. We are planning to add more technical resources in sales and marketing to drive sales as well.

Over time, we will articulate more specific details about certain new technologies and processes, the investment and the expected return. For now, we have a classic great problem and that we have numerous internal investment opportunities. Over time, as we finalize our plans, confirm our IP positions, and become comfortable with competitive and customer-specific confidentiality concerns, we will share more information.

We expect to continue our dividend. While we do not aspire to be a yield-oriented investment, our current yield of about 2% is an attractive component of total return. We will also look to further reduce our debt. As the small companies serving markets that are highly cyclical, we will be prudent with respect to our leverage.

I’ll conclude my remarks now with our outlook for the fourth quarter on slide 12. We’ve factored a number of elements into our outlook for the fourth quarter. First, we typically experience lower sales volume sequentially due to normal seasonality in the consumer and automotive market and the holiday seasons worldwide. Second, our fourth quarter of 2010 contains the customary 13 weeks compared with 14 weeks in the third quarter.

Third, our capacity expansion in the second and third quarters allowed us to take significant market share in our Network, and to a lesser extent, our Power groups. With capacity throughout the industry now at or above demand levels, our revenue will soften in the near-term. Fourth, order rates in the enterprise communication and Internet infrastructure markets have slowed from the robust levels in the second and third quarters of 2010, as customer inventories have increased in recent months.

For the fourth quarter, we anticipate Network and Power will deliver year-over-year sales growth albeit at lower rates than in the very robust second and third quarters. Our Wireless group will continue to negatively impact our consolidated year-over-year performance as the supply chain strategy change of one of our OEM customers did not begin to impact our results until early in 2010.

We expect fourth quarter net sales to range between $90 million and $95 million and non-GAAP operating profit to approximate breakeven. While our sales outlook reflects the cyclicality in certain markets we serve, our operating profit outlook when compared with our third quarter actual results highlights the strong underlying leverage in our business model.

Our operating profit is dramatically affected by different revenue levels that are below, at or above approximately $400 million on an annualized basis. Our strategic actions to simplify the business, rationalize our footprint and reduce our cost structure throughout the company, and particularly in wireless, will lower our breakeven point and provide additional profit opportunities.

Due to the near-term outlook, we are taking a series of actions to manage cost prudently. We will eliminate capacity and certain direct labor, reduce indirect labor in overtime, and combine certain management positions in our operations. Further, we will reduce headcount in our antenna operations, hold the addition of certain new positions, and extend holiday shutdowns in most geographies.

Now, I’ll turn the call over to Alan to provide an operations update and to discuss our operating profit margin objective.

Alan Benjamin

Thanks, Drew. I’ll start on slide 14 with a brief summary of five third quarter operating achievements. First, we made strong progress in migrating to lower-cost labor in China. We ended the quarter with approximately 58% of our labor in the lower-cost areas compared with about 50% at the start of the quarter. Second, our production quality was excellent in the quarter.

Our defects per million were very low, and we improved them during the quarter. This performance was particularly impressive given the production movements I just discussed and the significant increase in capacity that Drew mentioned. As an example, in one of our bellwether product lines, our production quality far exceeds that of our competition and the gap grew larger in the quarter according to our production customers.

Third, we continued our simplification efforts. Drew discussed our new name and the fact that we are integrating the holding company and operations. In addition, we sold an older manufacturing facility in Suzhou and an office in Hong Kong. Fourth, we did an outstanding job with respect to our inventory level. Both our raw materials and finished goods inventory levels ended the quarter at the lowest level in 10 years.

And fifth, we secured a number of important design wins in the quarter in all of our product groups. In networking, we won new ICM business at both existing customers and with new customers. These included new business for 10-gigabit design and several new wins in the telecom infrastructure market. In Power, we were successful with several new high-volume bead and encapsulated transformer program and then some lower volume but longer running weapon and space program in our mil-aero division. In wireless antennas, we had 38 design wins in the third quarter.

Now let’s turn to slide 15, and I will discuss our operating profit margin targets. We are committed to achieving a double-digit operating profit margin on annual sales of at least $500 million. On the right side of the slide, you see the primary contributing factors to achieving this objective. Let me describe each one individually, starting with network on slide 16.

As you know, wage rates have increased throughout China in 2010. With that said, the cost of labor is still lower in central China compared with the coastal region. Furthermore, there is an ample supply of labor inland. Therefore, we are migrating our labor to lower-cost areas. As I said a few moments ago, we ended the quarter with approximately 58% of our labor in lower-cost areas versus about half at the end of the second quarter. Over time, we anticipate 75% to 80% of our labor will be in lower-cost areas.

In addition to leveraging lower-cost labor, we are rationalizing our manufacturing footprint. Today, we operate 10 plants in China. The map on slide 16 highlights our sensible [ph] facilities. Over time, we envision operating fewer facilities. For competitive reasons, I’m not going to discuss our strategic plans. However, for a company of our size, we had an opportunity to optimize our footprint. We are taking action to reduce our dependence on labor as well. The primary steps here center on automating labor-incentive production steps and continuing our very strong LEAN program in manufacturing.

Now turn to slide 17. We are taking four primary actions in wireless. Number one, right-sizing the cost structure; number two, rebuilding cellular antenna sales; number three, growing our non-cellular sales; and number four, exiting the audio business. I’ll cover each of these starting with right-sizing the cost structure. We plan to match our costs with actual and expected revenues for the next 12 to 24 months.

We have already begun fourth quarter actions to reduce direct, indirect, and SG&A costs, while ensuring the appropriate resources to secure future design wins. As we do so, we will be adding resources in certain strategic geographical locations. Rebuilding our cellular antenna revenue will be important for the wireless group. The $20 million in sales we generated in the third quarter was down about 50% from the nearly $40 million we reported in the third quarter of last year, primarily, as Drew said, due to a major OEM’s change in supply chain strategy.

As we’ve discussed during the recent conference calls, we had been very successful securing new design wins with OEMs, CEMs, and vertical integrators. Including the wins from the third quarter, we have secured a total of 79 design wins in calendar 2010. Clearly, the key for us is to convert these wins to meaningful revenue. I can assure you, we will continue to remain intensely focused to do our part. However, for us to be successful, our customers’ underlying products need to be successful in the marketplace.

Candidly, some of the design wins I had mentioned in previous calls for which we had forecast meaningful revenue did not materialize to successful products in the marketplace. On the positive side, our antennas are in some of the highest profile new product launches announced in recent weeks and in the market today. We are cautiously optimistic that these products will be successful.

Another focal point to grow cellular antenna revenue is to diversify our customer base. Through that end, we have one business and preferred vendor status with a number of handset customers. We are investing in new technologies to make this happen. In particular, we have talked about investing in three dimensional LDS technology. Those investments continue.

Furthermore, we are very active in switchable antennas and have begun to see a number of design wins in this area. We recently announced our near field communication stamp antenna for mobile phones and portable wireless devices. The application possibilities for NFC are numerous. For example, phones can be used to read RFID tags or payments, ticketing, security identification and diagnostics.

We will also focus on growing our non-cellular antenna sales for applications such as GPS, smart grid, telematics, location tracking, and machine-to-machine. Currently, we are experiencing strong demand for antennas for smart grid applications. In order to keep up with our growth in non-cellular sales, we are investing in R&D as well as in technical sales and marketing personnel.

Lastly, in wireless, we are exiting our audio business. As we’ve told you on our last conference call, our speaker and receiver business is not large enough to stand alone. It is far smaller than its primary competitor and it lacked global scale. We have retained an advisor, prepared material, and held initial conversations with a number of parties. There is good interest in this business.

Now let’s turn our focus to Power on slide 18. Power group has been growing very well over the last 18 months. Sales rose to nearly $37 million in the third quarter of 2010, up from about $19 million in the second quarter of 2009. Our growth reflects the fact that we changed the focus of the group to expand the offerings into sensing and actual products and to broaden the horizons of the business.

As we say, power is everywhere, and we needed to go after more markets and more business. We want to grow sales for voltage and current sensing products and extend our presence in high-efficiency computing. In addition, we are focused to grow sales with auto manufacturers in China. Virtually every automotive manufacturer has plans for China now, including assembling engines, which is a very positive development for our engine ignition coil business.

As with Network, we are also investing in automation to reduce our dependency on labor as well as taking steps to improve the manufacturing cost structure. Our simplification efforts, which are covered on slide 19, are the last major area to contribute to our double-digit operating margin target.

As Drew said, with the sale of AMI Doduco, a number of distractions are eliminated. We are now a pure-play electronic components company with a single-minded focus to serve our customers and to generate strong organic growth and to increase value for our shareholders. The integration of the holding and operating companies is largely complete.

Going forward, we will reduce general, administrative and overhead expenses. As we rationalize our manufacturing footprint, opportunities to reduce cost will materialize. We want to capitalize on these opportunities as well as streamline the number of legal entities throughout the company.

Slide 20, we have outlined the contribution of each of these primary actions and the timeline to achieve our double-digit operation profit margin. We believe Network will add approximately 100 basis points of the needed margin improvement; Wireless will contribute about 250 basis points; Power should add about 150 basis points; and simplification and operating leverage will add the remaining 25 basis points.

Overall, as we execute on these actions, we anticipate producing meaningful progress towards our target in the coming quarters. We believe our double-digit operating profit target is achievable in 18 to 24 months.

Now, I’ll turn the call back to Drew for a brief summary.

Drew Moyer

Thanks, Alan. Before we take your questions, let me summarize the takeaway points from this call. One, we generated strong results in the third quarter, notwithstanding the significant decline in antenna sales. Our strong results provide evidence that we have outlined strong strategies, and as important, we are executing the strategies well. Two, Pulse Electronics is our new name and it represents the fact that we are a new, simpler and more focused company.

Third, while recent order trends have slowed compared to the robust second and third quarters, this management team is on top of it. We have a proactive plan to manage costs prudently in the near-term. Fourth, we are committed to achieving our double-digit operating profit margin targets. We have a clear roadmap and a reasonable timeframe to reach this objective. We look forward to reporting progress to our objectives in future quarters.

Operator, we will now take questions.

Question-and-Answer Session

Operator

(Operator instructions) And our first question comes from Mike Gallo from CL King.

Mike Gallo – CL King

Hi, good afternoon.

Drew Moyer

Hi, Mike.

Mike Gallo – CL King

My first question, just wanted to drill down a little bit into the fourth quarter revenue guidance. If I look by segment at Network and Power, I think Network was about $44 million in the fourth quarter last year; Power was about $25 million. At the low end of your guidance, that would imply it would seem another potential step-down in Wireless if we assume, again, growth in Network and Power. Is that – am I looking at that right or is the growth in Network and Power on a year-over-year basis going to be more moderate than that? Thank you.

Drew Moyer

Mike, I think a little bit of both. I mean, we could have a small step-down yet in Wireless, as we believe that we’re troughing there, but we don’t know exactly how long the trough will be or exactly where the bottom is within a few million dollars a quarter. But certainly in Network and Power, we will not have the kind of growth year-over-year that we had in the second and third quarter.

Mike Gallo – CL King

Okay, great. Just wanted to come back to something from the presentation. I think you highlighted that you expected to see over time about 250 basis point improvement in Wireless op profit. I mean, does that imply that Wireless op profit right now is substantially negative? And if so, can you break out, from a segment point of view, how much the Wireless business is currently losing? Thank you.

Drew Moyer

Well, it is negative right now. That’s, I think, as much as we can say. We don’t provide operating profit by product group. But it is safe to say that it is not contributing at all right now. In fact, it’s losing some money.

Mike Gallo – CL King

Thank you.

Operator

Our next question comes from Joe Wittine from Longbow Research.

Joe Wittine – Longbow Research

Hi, good afternoon. This is Joe calling in for Shawn Harrison here. First, let’s talk about SG&A. Just because there is a lot of moving pieces there, talking about there are some targeted R&D investments, but on the other hand, you’re kind of cutting some costs in certain areas. So maybe the question is, what is assumed from an SG&A on a dollar basis in the fourth quarter guidance? And I also wanted to talk about how you see that trending over the course of the year seeing this, but you’ve mapped out a lot of moves within each business. And then as a third question within that, I guess you mentioned in your earlier comments that there is a hold on hires right now, I think. Just curious, does that include your position and where you stand as an interim for the current term?

Drew Moyer

That last question is a good one I hadn’t thought of. But you would have to ask the Board – I don’t believe so. I mean, the search continues. So I think, otherwise, with respect to your question, the dollar spending in SG&A, like you said, has many, many moving parts. And when you look back at 2009, for example, it seems like a long time ago, but you’ll recall we had a number of items that we knew we are not – could not be sustained things like furloughs and wage cuts and all the draconian actions that had to be taken in the middle of the recession. So right now, I think what Alan is referring to and our intent to invest in a targeted way in certain R&D projects and little more marketing costs, I think that those are essentially going to be paid for by some of the simplification efforts in the savings that we are taking out of, call it, the infrastructure of the business, particularly by combining Pulse and Technitrol as well as by divesting AMI Doduco.

Joe Wittine – Longbow Research

Any dollar guide post you can give at least to a bare minimum what to assume within fourth quarter guidance, I guess within that breakeven EBIT option? Down sequentially or –? Any commentary helps. Thanks.

Drew Moyer

Fourth quarter – our guidance has been coming down a little bit, but not dramatically.

Joe Wittine – Longbow Research

Okay. And then on – just as a follow-up. Drew or Alan, any guidance I guess you can give to us on how we get to $500 million in sales over the next 18 to 24 months, granted it’s estimate on ways out? Just which aspects of the business do you expect to see the most growth maybe from a percentage basis that would have to be wireless just below base rent [ph]? But just any kind of commentary – both which business you expect it and how you potentially see that trending should everything go according to plan?

Drew Moyer

Let me just make a comment or two, and then, Alan, you can add some color if you’d like to. Clearly, Wireless is the big ticket item. And I would say that the revenue growth in getting to $500 million strongly parallels the operating margin growth or contribution that we outlined on page 20. So, getting Wireless to contribute another 250 basis points means growing that revenue as we are doing with new customers and integration partners of the large OEMs. So in terms of contribution by product group, I think you can think of it along the same lines as the table in margin improvement on page 20.

Joe Wittine – Longbow Research

Okay. Thanks.

Alan Benjamin

I think that’s largely fair, Drew. Wireless with some of the recent design wins and design activity, we are – as Drew said, we think we are in the trough. How long the trough goes will be – is a little unclear, although we have had some very nice wins that, as I said earlier, we’re cautiously optimistic about. We would then say Power has probably more opportunities for expansion in the medium term, and then we expect continued growth with Network.

Joe Wittine – Longbow Research

Okay. Appreciate the additional comments, Alan. Thanks.

Operator

Our next question comes from Fred Buonocore from CJS Securities.

Fred Buonocore – CJS Securities

Hi, guys. Good evening.

Drew Moyer

Hi, Fred.

Fred Buonocore – CJS Securities

I want to ask kind of a higher level question related to the networking business. When you talk to your customers, what sense are you getting as it relates to this slowdown in demand there and inventory levels, just in terms of how long do you think that levels will be down from what we’ve seen in recent months? Or are we reaching a more normalized run rate that we will see continuing for indefinite future several quarters or so on?

Drew Moyer

Well, couple of comments. I think that people oftentimes still look at the Chinese New Year to be somewhat of a turning point. And right now, as we sit here in November, people are looking at late January and February and saying, well, not necessarily going to build a lot of stuff or plan for before the Chinese New Year and things will be different again after Chinese New Year just like they were this year. So that’s – I mean, I’m not saying that’s right or wrong, but that’s kind of one school of thought. But that would certainly take us into the first quarter at lower levels. The other thing with respect to inventory levels, we track on our own the distribution inventories, and they are definitely up there. And then separately, we can talk to some of the CEMs regarding their inventories for some of the OEMs. And so we’ve got some visibility from them in those reports as well.

Alan Benjamin

It appears – maybe a couple of comments. We’ve been asking a lot of questions of a lot of people that we deal with, all up and down the supply chain. And it appears that there – at the beginning of this year, there was very little inventory anywhere in that chain. And I think that everywhere from our customers’ customers being caught out without necessary equipment and then rolling down as inventories will really extremely low, all the way throughout, it appears to us that maybe there were some over-correction. We’ve been able to identify inventory in a number of places along that chain. And so it appears that our customers’ demand may be moderated. I wouldn’t necessarily say it’s necessarily down, but there is some inventory that they are in the middle at various levels that have to get worked off.

Fred Buonocore – CJS Securities

And then kind of a continuation of that question, when you look at your guidance and you think about how it breaks out into, I guess, the four different components that you’ve identified, how much of that sequential decline from Q3 to Q4 would you attribute just to normal seasonality?

Drew Moyer

I guess we could say probably 10% or something like that. I mean, there is definitely some seasonality, but it’s not a dramatic seasonal cycle.

Fred Buonocore – CJS Securities

And really kind of what I’m building to, realizing you don’t give two-quarter out guidance is to try and get a sense of – if we should be thinking about a Q1 revenue level kind of down in the sub $100 million level or do we pick back up at least the seasonal aspect or seasonable effect and get back up close to that $100 million in Q1 even if the networking products remain at more moderate levels while the inventories worked off and drove, as you pointed out, while in the pre-Chinese New Year period?

Drew Moyer

That’s certainly the big question. And as we wrap up our annual planning cycle right now and through the rest of this month, that’s something that we’re currently addressing and I think everybody in the industry is struggling a little bit with that. So I don’t really have anything specific to add or guess about the first quarter at this time.

Fred Buonocore – CJS Securities

Sure. Fair enough. And then if you could clarify on the audio business. You’ve still got the business. You’re looking at the strategic alternatives. You’re still selling products. But is that kind of – you talked about that having been at a $20 million kind of annual run rate level? And did we see some that wind down in Q3? And do we see that continue to wind down in Q4, assuming that you own business through Q4? I mean, how should we think about what’s happening there, what’s the audio business as it relates to your results?

Drew Moyer

The $20 million run rate was historical, I’ll say, trailing 12 months when we announced in the second quarter that we were going to divest it. So I think – and we also said at that time that it was trailing down. We expected it to trail down because one of the reasons we were exiting it was the level of investment that would be required to maintain that and grow new platforms and next technologies. So that’s not the current run rate. It was lower than that in the third quarter and we expect it to continue to tail down.

Fred Buonocore – CJS Securities

So it’s not a major component of your sequential decline for Q4 revenues relative to Q3?

Drew Moyer

No. I would say that’s correct. It is not a major component of the sequential quarter-to-quarter softening that we mentioned.

Fred Buonocore – CJS Securities

Okay. Thank you.

Drew Moyer

Yes.

Operator

Our next question comes from Sanjay Shetty from BOE Securities.

Sanjay Shetty – BOE Securities

Good evening, guys.

Drew Moyer

Hello.

Sanjay Shetty – BOE Securities

Thank you for taking my questions. First of all, I want to talk about the Wireless business. You mentioned about the revenue decline. Now, what should I expect in terms of normalized revenue if the whole of the OEM business that we lost late last year. It gets out of this component, and there is no new net business within this segment.

Drew Moyer

Well, we find it frankly a little hard to imagine that there is no new business or replacement business because we’re already winning some and we already have some. But I think, as we’ve said all along, the timing is not perfect in terms of the decline from the major OEM and the replacement with the new programs at those suppliers and other OEMs. So I’m not sure exactly how to answer the question. I guess in terms of overall revenue and when we believe the trough is over and we’re back to growing, we’ve said that that’s something for the second half of next year and that’s probably still a good assumption there.

Sanjay Shetty – BOE Securities

Okay. Let me phrase it in a different way. Just the loss of OEM business, if that revenue that rolls off in the fourth quarter, what could be like – I'm not saying like it is (inaudible). If the revenue – no net business as an assumption, but in case if that component is taken out, what is the base revenue, normalized revenue for the Wireless business?

Drew Moyer

Well, it would be significantly lower than the $20 million this quarter.

Sanjay Shetty – BOE Securities

Okay.

Drew Moyer

I mean, I can’t – first of all, I’m not sure exactly what the numbers are. And even if I knew them, I’m not sure I could say exactly what it was. But there is still a good component of revenue going to the major OEMs.

Sanjay Shetty – BOE Securities

Okay. Fair enough.

Drew Moyer

In terms of capacity reduction that you’ve talked about –

Alan Benjamin

Let me just add a comment there. Right? I mean, it’s an important distinction that our business in its entirety with that OEM is not going away. Right? We said that it was going away in terms of directly providing product to them plus that’s an important piece of the transition is working with the vertical integrators. And what we are seeing is an increase in programs and increase of revenue that ultimately go to their customer, but come from working with the vertical integrators.

Sanjay Shetty – BOE Securities

Okay. Got it. That helps. In terms of capacity reduction that you spoke about in your comments, you mentioned in the last quarter you added capacity for your two-dimension wireless antenna business. Can you talk about how this capacity reduction as with addition, they complement each other?

Drew Moyer

Yes. I could have been more specific about that. Certainly, in LDS capacity, we’re not reducing capacity at all. We’re continuing to bring on capacity, and there is very good demand for those products. Primarily the capacity reduction is in the network area to reflect the softening there in the order rates.

Sanjay Shetty – BOE Securities

Okay. And in terms of – you mentioned about automating processes and investing in manufacturing technologies. Can we talk about what kind of CapEx you will have by the end – like, what are you looking at the run rate for 2010 and going forward into 2011?

Drew Moyer

Well, we’ve said – forget the second quarter CapEx, I think, was around $3.8 million. And then in this quarter we spent $4 million something. I think that’s a good 3 to 4-ish. It actually satisfies the type of investment that Alan and I referred to. It does not have to be dramatically higher than that. But even that is somewhat dramatically higher than we’ve had for the last couple of years, as we’ve really contained our CapEx as we went through the recession and our deleveraging. So, at depreciation annually of $16 million or thereabouts, I think if we start to model CapEx at something close to depreciation, that’s probably in the ballpark.

Sanjay Shetty – BOE Securities

Okay. So the investments in manufacturing technologies is ongoing right now, it’s not something you plan in the coming quarters?

Drew Moyer

That’s true. That’s true because I would even put some of these laser lines and the LDS, they are not automation per se. They have been a big chunk of our CapEx in recent quarters. And when we get that capacity installed, then we may end up spending some of those dollars in some of these other automation areas.

Sanjay Shetty – BOE Securities

Okay. And do you have any, like, potential buyer for your audio business or you will just let the line, like, go out of business automatically?

Drew Moyer

We actually have a number of potential buyers for that business. So we’re continuing a process there.

Sanjay Shetty – BOE Securities

Okay. That helps. And in terms of your CEO search, how is that going along? Any update on that front?

Drew Moyer

I think it’s progressing pretty well. The Board is committed to doing that effectively, efficiently, and not taking longer than it needs to take while doing it properly. So there is plenty of activity on that front.

Sanjay Shetty – BOE Securities

Could you give any timeline, like, within next – like, before the end of this year or first quarter?

Drew Moyer

I really couldn’t guess, and I know frankly from recruiting any position, things never go quite as quickly or smoothly as you expect them to. So it would be probably a little too much of a guess at this point.

Sanjay Shetty – BOE Securities

All right. That’s it from my end. Thank you very much.

Drew Moyer

Okay. Thanks.

Operator

(Operator instructions) We do have a follow-up question. This is from Mike Gallo from CL King.

Mike Gallo – CL King

Yes. I just had a follow-up question on that Power group. You talked about some potential opportunities within China. I was wondering if you could clarify whether you see potential incremental opportunities with additional OEM or customers or whether you’re just talking about increasing opportunities at some of your historical customers. Thank you.

Alan Benjamin

Yes and yes. I think there’s both opportunities with existing customers as they shift more of their production to China and there are several discussions that we’ve had with new potential customers there.

Sanjay Shetty – BOE Securities

Okay, thank you.

Alan Benjamin

But nothing particularly short-term in automotive. Right? I mean, you probably know that. It’s not quite the same as producing a mobile telephone. So it does take a little while for that business to emerge.

Sanjay Shetty – BOE Securities

Right. Pluses and minuses of that, I guess, but when you do get in stuff, you tend to stay there for some period of time.

Alan Benjamin

Yes, it’s absolutely true.

Sanjay Shetty – BOE Securities

Okay. Thank you.

Operator

And we have one final follow-up question. This comes from Fred Buonocore from CJS Securities.

Fred Buonocore – CJS Securities

Yes, Alan. You had referred to a number of design wins landed year-to-date. Is there any way to kind of quantify how much revenue we are seeing from design wins won, say, over the last 12 months?

Alan Benjamin

You mean design wins in some particular group?

Fred Buonocore – CJS Securities

You know what? You, I think, specified wireless design wins. Maybe just collectively, on a consolidated basis, on certain design wins won over the last – either year-to-date to last 12 months, how much revenue we’re you seeing from those new wins?

Alan Benjamin

I guess what I’m going to do is decline to some degree to answer this quarter because we would say that we’ve had 79 design wins year-to-date in wireless. And so clearly, we’re getting – we're getting a good number of wins. One of the issues is we always take numbers from our customers that say, this program is going to turn into X amount of units, which we then can postulate what our revenue is going to be. I made a comment earlier in the presentation that one of the issues has been there were some product introductions that happened that frankly turned out to be not very big events, I would say. And forecasts were considerably lower. So I hesitate to give a number.

One thing that’s very clear in electronics, new design wins drive business. And it is a measure that we look at each of our divisions and each of our groups every month in terms of the new product revenue, the revenue that’s coming from a product that was designed within the last two years. And we are seeing an upward trend there, which is generally good for the business in its entirety. We’re trying to get specific revenue levels. I’m a little chastened after realizing just how far off some of our customers can be.

Fred Buonocore – CJS Securities

Sure. I understand. I’m just trying to get a sense for maybe on average the amount of time it takes for a design win to convert into what might be a measurable or meaningful revenue. But I realize it’s complicated.

Alan Benjamin

In the mobile phone world, from design win to meaningful revenue is typically going to be about 12 months.

Fred Buonocore – CJS Securities

Okay. That’s helpful.

Drew Moyer

Operator, if there are no further questions, we will let you announce the replay information.

Operator

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