Richardson Electronics Ltd (RELL) 2006 Q2 法說會逐字稿

Welcome to the fiscal year '06 second-quarter earnings release. (OPERATOR INSTRUCTIONS). As a reminder, this conference is being recorded. I would now like to turn the conference over to Ed Richardson, Chief Executive Officer. Please go ahead sir.

Good morning. I have Bruce Johnson with me, who is President, as you know, David DeNeve, who is Chief Financial Officer, and Greg Peloquin, who is Executive Vice President of the RF and Power Devices Group; we changed the name from RF and Wireless to RFPD, through a reorganization which we will tell you about. Bruce will go over the highlights of the quarter with you, and Dave will go through the P&L and balance sheet for you.

We actually released earnings last night, as you know. If any of you missed it, it's on our Website, which is www.rell.com. Overall we were extremely pleased with the performance of the Company in reference to operating income, making a fair amount of progress in a number of areas. We keep trying to get the head and the tail to match. The sales number was not what we were looking for. We ended the quarter at 155.8 million, up about 3% from the prior year's second quarter, although it was the 14th consecutive quarter of year-over-year growth.

The second-quarter gross margin improved to 25.4%, which was really excellent, from 24.4 last year. It did include some special sales at high gross margin. And also in the second quarter, the operating income was up 50.8% to 7.4 million; 4.8% of sales from 4.9 million a year ago. So we were really pleased with that increase.

Unfortunately, because of the foreign exchange issue, the earnings per share were $0.03 versus $0.23 in the prior year second quarter. The major impact is this year on the foreign exchange loss, which is basically the indebtedness from our foreign subsidiaries, was $3.8 million. And this is, at least at this point, is a non-cash impact to the Company. The foreign exchange gain as a comparison a year ago was 3.3 million.

Excluding the impact of the foreign exchange in both periods and a favorable income tax adjustment, we got about a $1 million income tax reserve in France that we haven't used, and it's gone through the statute of limitations, so that was reversed in the quarter. But if you took out the foreign exchange issue and the $1 million tax adjustment, earnings per share would have been $0.19 in this quarter versus $0.11 a year ago.

The SBU sales and gross margin versus the prior year, RFPD, which is Greg's group, was up 6.5% to 79.5 million. Margin was about flat at 23.5%. Within the RF and Power Device Group, the network access business was up 24.1%, sales at 30.8 million, and gross margin increased there from 25.3 a year ago to 25.8.

The infrastructure business was actually down. It was down about 7.8% at sales at 18 million. Margin there was about flat at 20.8%. The passive and interconnect business was up 6.9%. Sales there were 14.1 million and margin was 24.4%.

In Asia we saw growth slow somewhat. Asia was up 13.6%. The total business was 28.4 million. They did increase margin somewhat there; it went up from 22.9 a year ago to 23.3.

In the Electron Device Group, which is the new name out of the Industrial Power Group through the restructuring, EDG's business was up 2.8%. This business now is primarily the power grid and the electron tube business. The world market for tubes is actually declining at about 6.8% a year, and we continue to gain market share, which is impressive. This is, of course, our most profitable business unit. Sales were 24.6 in the quarter. Gross margin was 31.5%. So the Electron Device Group already exceeds our corporate objective of 30% gross margin.

The tube business was up 7.4% within that sales number to 22.2 million, and the margin on the tube business was 33.3%, up from 31.4 a year ago. The power components portion of the business was actually off slightly, about 5.8% down. A small portion of the business sales at 6.9 million, and the margin there about 24%. So still the most profitable portion of the organization is the legacy tube business, and we think the refocus with the Electron Device Group will continue to give us sales increases in that business as the industry consolidates.

Security Systems Division was up 3.3% to 28.3 million. Margins were 25.3%. Nice growth in the private-label or engineered solutions portion of the business. That portion of the business was up 9.4% to 9.1 million. Nice margin, 34.9%. And of course, our challenge is to get more and more of the engineered solutions business through the channel. And as we do that, it brings up the overall gross margin.

The Burtek, or Canadian Security Systems Division, continues to show good growth. They were up 10.8% in the quarter. Sales of 17.2 million. Nice margin improvement; they were at 29.1%.

The Display Systems Group was down about 7.1%, primarily due to this business is very much project-oriented now, has a high engineered solutions content, and we saw a number of projects actually were booked in December after the close of the quarter, where we thought they would be shipped in November. We are seeing a nice turnaround in margin as more and more engineered solutions projects are being pulled through the channel for our Display Systems Group. The gross margin in the quarter went from 22.5% to 27.9%, as more and more of the display products are our own engineered products.

The medical monitor group showed a decline, and again, this was primarily project-based; they were down about 21% at 7.9 million, but the margin increased from 22.5 to 29.2. The custom display area was also down about 3.7%. Bruce will tell you about the bookings in December. We've seen the business come through after the close of the quarter.

Geographically, North America was down just about 1 point, 0.7%. This again was primarily the project business for display; still the majority of our display business is in North America. North America was at 79.2 million in sales. Margin was up; they were at 26.6% gross margin.

Europe has really been a laggard for us. Europe was up 3.7%. This was primarily due to ACT Kern, the acquisition that we completed in the first quarter -- was about 3.5 million in Kern business of the 34.9 in Europe. Margin there was about 26.3. Within Europe, France was up about 7.8% and sales of 5.8 million. The margin was good at 29.2.

In Asia Pacific overall, the Asia Pacific area was up 9.5%. Sales at 34.8 million. Margin at about 23.6. The lowest area, of course, is Korea, although we still see some major increases in sales there. Korea was up 29.9% as 3G rolls out in Korea. However, the margin was at 19.8%, and really looking for some improvement there in the balance of the year.

China was up about 9%. Sales have cooled somewhat in China. Sales at 10.5 million, although the bookings increased substantially, which Bruce will tell you about. And China was able to increase their margin from 17.7 a year ago to 20.8. So that was good performance. And Japan was up about 5.4%. And Japan has excellent margins. They were at 32.7 in the quarter.

Finally, Latin America is turning around -- the smallest area for us in the world, but they were up 20% in sales to 6 million. Gross margin was 27.2. It was led by Brazil, which was up 6.4%, the largest area sales at 2.8 million. Good margin at 31.8%. Mexico was up substantially, but the margins were down and Mexico was up 49%. Still a small area -- 1.9 million in the quarter in sales, and the gross margin was 20.3%. Colombia was up 17.3%; again, sales there were about 1.4 million; margin of 27.5%.

So with that, I'll pass it over to Dave, and he can go through the P&L and the balance sheet for you.

Good morning. As Ed mentioned, sales in the quarter increased 3%, while gross margin as a percentage of those sales improved 100 basis points to 25.4% versus 24.4% last year. SG&A expenses in the second quarter of fiscal 2006 were virtually flat with SG&A expenses last year. As a percent of sales, SG&A expenses decreased to 20.7% versus 21.2% last year. As a result of the gross margin and SG&A improvement, operating income of 7.4 million improved 50.8% compared to the prior year. As Ed mentioned, the second-quarter results for fiscal 2006 include a foreign exchange loss of 3.8 million, and a $3.3 million foreign exchange gain last year.

Regarding income taxes, we continue to experience a high effective income tax rate. As previously discussed, our high effective tax rate is primarily due to the geographical distribution of our taxable income or losses throughout the Company, and also subject to valuation allowance. Overall, net income in the second quarter was 0.5 million, or $0.03 per share, compared to net income of 4 million, or $0.23 per share last year.

Moving on to the balance sheet, inventory remained relatively flat at 112 million, as compared to inventory levels at the end of the first quarter. As we previously discussed, we expected the increase in inventory from fiscal year end due to inventory stocking programs to support the anticipated sales growth. Accounts Payable increased in line with inventory levels. Total debt decreased 4.4 million during the second quarter and 2.2 million since year end. During the second quarter we completed the sale of 25 million of convertible senior subordinated notes. The proceeds from those notes were ultimately used in December to redeem our existing 8.25 debentures at 17.5 million, and our existing 10.25 debentures at 4.8 million.

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

Thank you, Dave. Good morning. I'm going to review the booking results for the quarter, and then give you the highlights of each one of the individual SBUs.

For the Company overall, our bookings compared to the prior year were down about 2.2%. In RFPD, we increased bookings over the prior year by about 3.3%. And in that unit, our emerging engineered solutions components product line -- this is our product line we're developing proprietary -- became an approved source for Nokia in that quarter, and that followed our approval by Ericsson in the previous quarter. And obviously, with those two companies approving our product, prospects look very, very good going forward.

In RFPD, November sales were very strong, and actually represented their highest single month since fiscal year '04. And we continue to experience record growth and market share gains with our newly-signed American Technical Ceramics; that's the ATC product line which we brought on in the previous quarter.

In EDG, somewhat atypical, the bookings were down 3.9%, primarily due to some softening in the market. But two orders we booked last year, large orders, did not repeat. But the wafer fab market, which we're focusing on now under the new structure, and the medical business are both coming in strong.

During the quarter we were appointed as CPI ECONCO's exclusive international distributor for their full line of rebuilt broadcast and industrial power grid tubes. We also entered into our first formal relationship with Thales Components Corporation as their exclusive distributor in North, Central and South America for their TV tetrodes and [diocrodes] tube product lines. In addition, we were also granted approval to sell their industrial power grid tubes into the same markets on a non-exclusive basis. And in the quarter we were successful in booking over $850,000 of their tube products. This is going to be a major line for us going forward.

Also in the quarter, Taiwan came in as our star geography with an increase for 49% in sales and 73% margin over the prior year. And in Europe, EDG achieved their highest sales month ever in that month.

In security systems, bookings came in about 1.1% over the prior year. Also, November represented their largest sales month ever. And in the quarter, our Burtek operation in Canada, which is doing very well, relocated to an extended 44,000 square foot facility in Toronto.

In display systems, bookings were down about 14.7%, but as Ed had mentioned, many in the projects that we anticipated in November came in in December, and prognosis looks very good. Our backlog remains high; it's over $12 million right now.

Pixelink moved into their new 40,000 square foot facility in Marlborough, Massachusetts. That's about three times larger than their prior facility. And key features within the facility are new ESD production facilities, an environmental testing chamber, and a new engineering lab.

We also acquired the assets of Image Systems Corporation, which is a Minnesota-based engineering and manufacturing company of medical monitors.

And turning to geography, in North America, bookings were off about 14.9% from the prior year, Europe was up about 0.4%, Asia-Pac, as Ed had mentioned, strong 29.6% positive, and Latin America was 41% over the prior year.

I will turn this over to Ed.

Thanks, Bruce. So it was a good quarter, at least operationally. The challenge here is to continue to see sales increase in the topline. I know you're all looking for guidance for the third quarter. Basically, or historically, the third quarter is normally down on a sequential basis about 4% from the second quarter. This is due to the Christmas holidays; we see December normally as a two-week month, and I can tell you that December was pretty much normal for us.

Based upon that, we think the quarter will come in somewhere around 150 million in sales. We did have some unusually-high gross margin sales in the second quarter. We were really pleased they were over 25%, but we think conservatively that the gross margin probably should be more like 24.5, maybe slightly higher if we can perpetuate some of that business in the third quarter, and SG&A at about 33 million. It's almost impossible for us to project what the foreign exchange issue is going to be. Right now it's positive so far this quarter, and at this point we have no way to give you guidance on taxes.

So that's pretty much where we are. Again, we are pleased with the Company's progress on improving gross margins and maintaining or reducing SG&A. The charter now is to increase sales and continue to make improvements.

And with that, Kathy, I will turn it over for questions.

(OPERATOR INSTRUCTIONS). Rob Damron, 21st Century Research.

First of all, Ed, maybe you could give us a little bit more detail on what these special sales were, these high gross margins sales during the quarter. And why won't those continue? What's different about those sales?

As you know, we have very substantial inventory reserves that we've taken, particularly in the RF and wireless area, and the display area. And the guys were successful in selling some of this product where the margins are quite high, and we were just overall able to sell material that normally we would have taken an inventory reserve for. And so that probably -- I don't know -- I think, had an impact of 400,000 or $500,000 on gross margin in the quarter. Would you say that's accurate, Dave? Somewhere in that area?

Yes.

Just looking at the guidance on the operating expense, you mentioned about 33 million, but the -- so that's up a little bit sequentially from the 32.2 million you just announced for this previous quarter, yet the sales will likely be down sequentially. So why would SG&A be up sequentially on lower sales?

Our SG&A for the most part is relatively fixed in payroll. If you recall, our guidance for the second quarter was around 33 million. We had a favorable healthcare experience during the second quarter. We don't know whether or not that will repeat. And then as we got closer to year end, our SOX fees will increase slightly as well.

Okay. That's helpful. And just one other question on the Display Systems Group. You mentioned that some of that business was, I guess, actually sold in December. You thought it might be sold in November. What kind of magnitude are we talking about? What kind of revenue numbers? What kind of revenue swing did we see as a result of that?

There's two or three projects. If they all come through it's probably in the area of 6, $7 million. We've seen probably two of those booked that are 2 or 3 million, something like that.

Lastly, Latin America looked pretty strong. What's really driving the Latin American business, and would you say that kind of growth rate is sustainable?

We're seeing the economy come back in Brazil. We've reorganized in Mexico, and that's starting to show some results. I think overall, it's just the economic condition in Latin America is improving.

[Ed Litman], William Blair.

Ed, the 6 to 7 million that you just quoted in display -- are you referring to the projects that you expect -- that you thought might actually close in this quarter but will -- that you talked about in the release -- that will close in the next coming up quarters?

Those are actually projects, two of which were booked already in December. And I think, Bruce, those will ship in this quarter, won't they?

Yes. They're engineered solutions products at Pixelink primarily. And in fact, even as of yesterday, we just added staff there in anticipation of the business for the third and the fourth quarter.

Were there other projects then in addition to those that you thought were going to ship in this quarter that did get pushed out a little bit?

Yes. There are other projects that are working on both at ACT Kern in Europe, as well as Pixelink here in the U.S. And we're hopeful those will get shipped out before the end of the fiscal year.

Is the ACT business -- is that similar margins to kind of what the -- I guess I'll call it the legacy display business was?

Should be higher.

Okay. And then on the SG&A line, was there any severance that rolled into this quarter that wouldn't be recurring next quarter?

Maybe around 200,000; it was very minimal.

Are we done with the severance going forward, then?

Probably not. We've gone through one phase of restructuring between EDG and RFPD, and we think we will continue to do more streamlining and refining of the organization going forward. We really haven't got a definitive plan in place yet.

Lastly, on the AR line, it looked like it ticked up to 108 million from 104 last quarter, despite not quite that big of a magnitude increase in sales. Is there anything unusual there?

No. Our DSO is roughly 60 days. So if you look at the prior two months of sales for each of those periods, as opposed to the full quarter sales, our DSO actually improved. It's just a function of the timing.

Derrick Wenger, Jefferies & Co.

Could you give me the depreciation and amortization for the quarter, the capital expenditures for the quarter, and the capital expenditure outlook for fiscal year '05/'06?

For the quarter our depreciation and amortization was 1.5 million, and our capital expenditures were 1.6 million.

And the capital expenditure outlook?

We would say that it's roughly in line with what we've been experiencing at 1.5 million a quarter.

[Kent Shaw], Buckhead Capital.

I just had a couple of quick questions; some of mine have already been answered. Could you tell me what the actual cash taxes were for the quarter?

Because of the situation that we are in, it roughly is the amount that's reported in the income statement. (multiple speakers)

Okay. And is there -- I think I understand what you were trying to tell us about some of the products that were previously reserved, or would have been reserved in this quarter, contributing to the gross margins. Is there -- could you talk a little bit about the progress towards engineered solutions as a whole? Is there a number you can give us as far as percent of sales, like what it was in this quarter versus a year ago or last quarter?

I think what we're looking for on the engineered solutions side -- we're running about 50% of sales, and our plan over five years is to get it up to 65%. And it's pretty much on a linear basis. We're trying to get 2 or 3% improvement annually in that mix of sales. And I think we are right on track to do that at the moment. Certainly we've had better progress in the Display Systems Group and the Electron Device Group. EDG is there already. That's our legacy tube business, and they're probably close to 60% engineered solutions today. The area we have the most opportunity is in Greg's area in RF and wireless, and we're working hard on that.

Is that related -- the discussion there that you had about -- gosh, who was it -- Nokia? Is that directly related to that area?

Yes. Both those products for Ericsson and Nokia are coming out of our component engineered solutions group. And we've been approved and we have a number of design wins, and they should be going into production in our fourth quarter. So we should see an uptick in our ES component engineered solutions sales.

[Warren Clifford], Clifford Capital Management.

Is it not possible to hedge some of these currency exposures?

Yes it is. It is possible, and we do have a program in place. We actually had a board meeting on Tuesday, and that is an issue that was reviewed with the board. We're working with JPMorgan Chase on a hedging program, and we hope to have that in place here shortly.

As far as this last quarter was concerned, was any of your currency exposure hedged during that period?

No.

(technical difficulty) going forward. You guys have been doing great on an operating basis. It's kind of frustrating that we always have these non-operating charges or impacts that obscure your great trend on the operating side of the business.

We're working hard on that. I think the one thing to keep in mind is so far, just like the foreign exchange, it really has no cash impact on the Company. It should be a balance sheet item. But because of the reversal, it's now a P&L issue. And we're working hard to correct that.

Is that all, Mr. Clifford?

Yes.

(OPERATOR INSTRUCTIONS). Rob Damron.

One other question. You've alluded to in the last couple of quarters that you're looking into some of your foreign subsidiaries, and possibly moving more of that fixed cost structure to a variable cost structure. Is that still on track? Are you still reviewing that program? Where are we in that process?

Yes. We actually have a whole plan in place and we're working through that issue. I think probably the first area that we will address is Latin America. And we hope to be in a position to take some kind of action by the end of the fiscal year.

Can you quantify what kind of total revenues that we're talking about here, or total costs, kind of the magnitude of how this might impact the income statement?

It won't impact revenue, we hope, at all. If we do it properly, it's a matter of going from wholly-owned subsidiaries in these small countries, to where the business would actually be handled by exclusive representatives who are current sales managers in those countries, where the business would be transferred to them and they would operate the business for us so that we wouldn't have the asset investment in country. So the sales in topline, the sales should be the same, hopefully even better. We haven't been able to quantify what the cost savings will be yet.

We have no further questions. Please go ahead with any closing remarks.

Thank you very much. We are here for the rest of the week, and happy to answer any additional questions you may have. We appreciate your ongoing investment in the Company. Thanks, Kathy.

You're welcome. Ladies and gentlemen, this conference will be available for replay after 12:30 PM today through midnight, Thursday April 13th. You may access the AT&T executive playback service at any time by dialing 1-800-475-6701 and entering the access code 808051. That does conclude our conference for today. Thank you for your participation and for using AT&T executive teleconference. You may now disconnect.