Richardson Electronics Ltd (RELL) 2007 Q3 法說會逐字稿

Ladies and gentlemen, thank you very much for standing by and good morning. Welcome to Richardson Electronics third quarter fiscal year 2007 earnings release. At this point we do have all of your phone lines muted or in a listen-only mode. However, after the executive team's prepared remarks, there will be opportunities for your questions and those instructions will be given at that time. [OPERATOR INSTRUCTIONS]

As a reminder ladies and gentlemen, today's call is being recorded for replay purposes and that information will be announced at the conclusion of our call. So with that being said, let's get right to this third quarter agenda. Here with our opening remarks is Chairman and Chief Executive Officer, Mr. Ed Richardson. Please go ahead, sir.

Good morning. Well, I have David DeNeve with me, who is Chief Financial Officer, and Greg Peloquin who is Executive Vice President of the RF and Power division. They are in LaFox and I'm in Houston. I intended to be in LaFox. We were doing -- visiting all the branches of SSD in Canada yesterday and I was in Montreal, and Chicago got snowed in, so it seems like every time we do an investor conference call we have snow for some reason and I came on to Houston. We have a branch here and we're doing some meetings with the SSD branch in Houston today. So, this telephone is not the greatest in the world and we'll do the best we can, sort of by remote control.

As you know, we released earnings last night. We are really excited about the announcement and agreement with Honeywell to sell the SSD Burtek Security Systems division. The sale price on the division is $80 million. Of course, it's subject to government review and regulatory review, particularly in Canada.

The SSD Burtek group is very strong in Canada, probably 65% of the sales of the group are in the Canadian market. And the plan of course is to integrate SSD Burtek with ADI Honeywell's security distribution business. I think it's a tremendous opportunity, both for the Company and the employees, as Honeywell is the number one distributor in the security market on a global basis. On the other hand, it's really an excellent tribute to our whole team -- is that I think Honeywell realizes that the SSD Burtek strategy of technical service and engineered solutions has been gaining market share for them and Honeywell wants to access that strategy and a great team, so I think it's a real tribute to the whole group.

In any case, we hope the transaction will close prior to the end of the fourth quarter, which would be June 1, but it's all subject to government approval, so it may drag over into the first quarter of next year. We'll see.

It's an excellent transaction for us. We think the net proceeds will be about $76 million after expenses. The gain on the sale we estimate to be about $43 million. The way it's structured, it will be nearly a tax-free transaction, as we will use a portion of our NOLs and at the same time the way the transaction is structured, we will be repaying a substantial amount of intercompany debt and as we do that, that will resolve some of our foreign exchange issues.

As you know, we have about $50 million in intercompany debt, primarily Euro-based, and for that reason we have a fair swing on a quarter-to-quarter basis on the foreign exchanges. It's translated to the dollar and through this transaction the majority of that intercompany debt will be repaid and the FX or the foreign exchange issue should be minimized, so that will help a lot.

Certainly the majority of the proceeds will be used to pay down debt and really improve the balance sheet going forward. We estimate that interest expense will decrease about $5 million, and I'll let Dave DeNeve go through those details as far as how the impact of the proceeds are on our balance sheet, but we actually feel in 2006 and in 2007 that it will be accretive based upon our tax rate. I'll let Dave explain that to you in detail.

In reference to sales and earnings, the third quarter we ended at 160.1 million, up 5.3% from the prior year. All of the SPUs were pretty much online again with the exception of the display systems group, which came in substantially below where we thought they should be, and I'll about that in detail.

Gross margin in the third quarter was just about flat at 24.4%. Third quarter operating income increased to $5.6 million from $1.5 million a year ago. The third quarter includes the gain on the sale of one of our buildings, the Cetron building, which was sold for about $3 million, $3.1 million. We had a $2.5 million gain.

We've actually done better in the real estate business currently than any other area. We just have sold a building in Lincoln, England as we do the consolidation and restructuring into our new three hub global structure. We were able to sell some of these buildings and the building in Lincoln, England just closed and I think the gain on that building is in the area of $1.5 million as well.

SG&A in the third quarter was [22.4] versus [23.3] last year. Within that there was about $1 million of incremental payroll-related expense. We had $1.5 million restructuring savings over last year, which means the payroll-related expenses would have increased $2.5 million without the restructuring. That primarily just has to do with payroll or trying to keep everybody at least on a par with the cost of living increase, which means a 3%, 4% increase each year, so that has a major impact going forward.

There was about $0.4 million of restructuring and severance expense in the quarter, $0.2 million of compensation expense related to stock options, and about $0.5 million gain on the sale of some intellectual property related to our joint venture with VConex.

So, net income was $1 million or $0.06 a share in the third quarter, compared to a net loss a year ago of $1.1 million. By strategic business unit, RFPD or the RF and Wireless group was still doing extremely well. They were up 10.8% to $89.2 million. Margin was about [23.1]; actually, product margin was [24.6].

Within that, the infrastructure business unit was up 45.4% in the quarter to $26.5 million, and geographically, of course, the growth continues to be substantially in Asia wherefore RFPD sales were up 18.5% to $35.4 million. The margin was up nicely; it went up from 23 to 23.9. In Europe, the RF and Wireless sales were up 19.2% to $22.5 million and margin there was 26.5%, so that was good.

Greg, have you got some other highlights you'd like to add for RFPD?

Sure, just a couple more. As Ed mentioned, it was another strong quarter; double-digit growth. In addition to that, our book-to-bill was over one for the 12th straight month, so the health of the business is very, very strong. Within those bookings we had a real nice booking in Asia, Southeast Asia, for an engineered solutions project; it's a broadcast system. The total order is just north of $10 million, of which 4 to 5 of that will ship this year.

As Ed mentioned, China is really leading the charge here as we continue to win design ends for their TD-SCDMA roll out and there's still time to get that done before the Olympics. We have design wins at every major OEM and we, as I mentioned in the last conference call, have already started shipping to these OEMs and we continue to see that pick up in our fourth quarter and then going into next year.

Ed mentioned Europe was also up, and that's just strong growth across three markets -- industrial, broadcast and military. They have the highest margin of any region in the world, so they're doing very, very well. There was a slight dip in margin, gross margin, that was mainly due to our large increase in Asia sales. As we know, that's the lowest margin area of the world, and a slight decrease in our engineered solutions sales. But the fourth quarter in terms of the backlog shows that that will pick back up to the run-rate and we'll end the year over where we ended FY '07 in terms of gross margin. So, business, I guess, in general is very, very healthy. We have a number of large engineered solutions wins to take us into the next fiscal year and end with a strong quarter. Ed?

Okay, Greg, thanks. The electron device group had a nice quarter; they were up 11.3% to $24.4 million, still our most profitable strategic business unit. Their gross margin was 32.5%, so they continued to do well; although the world market for tubes continues to decline about 6% or 8% a year, our tube business in the quarter was up 3.3% at $16.1 million. What's really interesting in driving the business is a semiconductor wafer fab business where we do microwave assemblies was up 36.1% in the quarter to $6 million, and the gross margin on that equipment was 36%, so it's a very profitable business and nice growth for us as well. Those products are manufactured in LaFox, and that's getting to be a larger and larger portion of the electron device group business.

Security systems division was really preoccupied with the due diligence phase that we've been going through but they were still up about 4% in the quarter to $26.2 million. Their margin was up nicely; they were at 26.4 so they continued to do extremely well, particularly in Canada, although in Latin America where we've eliminated local stock, that's hurt us for security. We actually thought security would be sold before now, so we eliminated the local stock in Mexico and Colombia, and we've seen some declines there. So overall for them to be up 4% with declines in Latin America was good.

Facility systems group is certainly where we have the difficulties. This business was down 17% to $19.6 million in the quarter, largely based on project delays. Just over and again we think these large orders are going to come through in a quarter and they get pushed out for one reason or another.

I guess the good news is I was looking at where we are now in March; for DSG we booked $7.4 million and the book-to-bill was 3.19 to 1, and some major orders from our -- one of our partners, Wireless Ronin, for example. We had a $1 million order from them on some large screen displays that are going into a particular project that we're partnering with them. The book-to-bill so far in April is running 1.41 to 1, and there were also some substantial orders in the medical area. There was a $1 million booking in the quarter for GE medical. So there's some good business coming through. Right now the total backlog in DSG is $9.5 million and we're hopeful that a good portion of that will finally be shipped in the fourth quarter, but at this point DSG has been the laggard for us on the strategic business units.

Geographically, North America was just about flat at $74.4 million. Margin for the overall business was 27.7%. Asia-Pacific was up 16.7%, again led by RFPD. Business there was $40.5 million, so they'll finish the year probably 170, $165 million in total; really nice growth in Asia. The margin was pretty good at 24.6%. They were led by China. China was up 45.7%. Sales in China were $14.1 million. The lowest margin, as Greg mentioned, they were at 22%.

Japan was up nicely. They were up 17.6% to $6.2 million, and the margin there is excellent at 28.7. We've been in Japan a long time so the engineered solutions product is coming through there and the margins are what we would look forward to in some of the other Asian areas in the future.

Korea was up about 14.6% at $11.3 million. In Europe, again total sales were up 16.8% at $39.9 million. Margin was down somewhat; they were at 26% overall. Led by France; France was -- their sales were up 26.4 at $5.8 million in the quarter. Their gross margin was good at 30.3%. Israel was up; their sales were up 25.8% at $3.6 million, and gross margin was good there at 25.7.

Germany was up as well; their 24.2% increase in sales at $10.4 million, and nice margin at 28.9. The UK was up at 20.7% with sales at $5.3 million. Their margin was impacted. I don't know really what the issue was there.

Latin America is the laggard, primarily due to SSD as we pulled the local inventory probably prematurely, as we really had anticipated that SSD would have been sold by this time. But Latin America, the sales are down 12.6% to $5.1 million, and the margin was 27%.

All right, that covers the quarter. I'll just touch on the nine months numbers and if you want any more detail, please ask us. The nine-month sales were $491.7 million. They were up 5.5% from the prior year, and the first nine months operating income increased to $15.7 million from $14.4 million last year. That's just sort of the high-level numbers for the first nine months.

By SBU, the RF and Wireless group is up 12.2% for their first nine months at $270.6 million. EDG is up 6% to $74.6 million. SSD was just about flat, up slightly at $80.7 million and DSG was down 10.1% at $62.8 million. So overall, the Company and the SBU, they're right online with the exception of DSG. During the quarter, we completely reorganized DSG, we have a new SBU manager in charge of the group. We're really going -- we've reorganized the medical sales group and we're really looking for some of the impact of the reorganization, refocus and streamlining to occur in the fourth quarter and then going on into next year.

All right, let's see. Let's talk about the restructuring a little bit and then I'll turn it over to Dave. Overall, we're pretty much on plan. We're still targeting about an $8.5 million total savings as compared to the run-rate in the fourth quarter of 2006. So far we've had $4.3 million worth of savings that have been realized in this fiscal year.

We started using the UPS World Ease Program through our hubs in November. That seems to be going extremely well. As you know, we're eliminating quite a number of warehouses and selling some bricks and mortar, reducing the headcount in the logistics area. As part of the program, we've really not tried to analyze what the savings may be as far as freight is concerned by utilizing the inventory hub, so it may be in addition to the $8.5 million.

So we're still targeting about $6 million of restructuring and severance expenses. So far we've taken $4.6 million of restructuring and severance expense to date, $2.7 million in the fourth quarter and $0.9 million in the first quarter of 2007, $0.6 million in the second quarter and $0.4 million in the third quarter. So far, we've cut the workforce by about 60 employees. We also, in addition, have sold the Ingenium Group and it caused us some financial difficulty last year, so if you counted the workforce from there, we've reduced the number of employees by 88.

So that's pretty much where it is. I'll turn it over then to Dave to talk about the balance sheet and the financial highlights.

Thanks, Ed. Looking at the balance sheet, our cash and cash equivalents decreased $4.6 million from year-end to $12.4 million. During the third quarter, the Company successfully implemented a cash sweeping program for all of Europe, which helped minimize the amount of cash that's required to be held by each subsidiary.

Inventory increased $13.7 million from year-end to $131 million at the end of the third quarter to support the growth in sales. In early November, the Company initiated a program to reduce inventory over the next several months, which includes the centralization of inventory and the hubs in Europe and Asia. We expect inventory levels to decrease in the fourth quarter of fiscal 2007.

Total debt increased $6.6 million to $133.4 million from $127 million at year-end. The increase from year-end was primarily due to the higher debt level -- higher levels of inventory.

Looking at cash flow, depreciation and amortization in the third quarter was $1.5 million, which is consistent with the prior year. Net cash used in operating activities in the third quarter was $5.6 million versus cash used last year of $2.2 million. Our capital spending was $2 million in the third quarter versus $1.5 million last year. Capital spending in the third quarter primarily relates to the implementation of supply chain and sales modules of PeopleSoft.

We also wanted to provide you with some additional information regarding SSD. If you look at our fiscal 2007 forecast for SSD, we are anticipating sales of $110 million with operating income of $8.5 million. On an after-tax basis, as most of that income is in Canada where we do indeed pay taxes, the net income for SSD is $4.7 million for fiscal 2007 or estimated at that amount. If you include the interest expense savings of $5 million, we would, in essence, save $300,000 in fiscal 2007 as a result of the sale of SSD.

So with that, I'll turn it back to Ed.

Okay, well, as far as the guidance is concerned, we're still concerned about how to forecast DSG, so we're trying to be fairly conservative. We think that the fourth quarter with the visibility that we have should come in about $175 million. If we can get some of the DSG product shipped, it will come in more than that, but we'd like to be as conservative as we can. Gross profit will be somewhere between [24.5] and [24.7]. SG&A, without restructuring, we think will be about 36.5 million.

So I think that's about as much guidance as we can give for the moment. That, of course, still includes SSD and we're hopeful that the SSD transaction will be closed and completed by the end of the quarter but it may drag on. It just depends on the government approvals coming forward.

So with that, Brent, I will open it up for questions.

Indeed, well, thank you very much, Mr. Richardson, Mr. DeNeve and our host panel today. We do appreciate that. (OPERATOR INSTRUCTIONS) Bill Benton, William Blair.

First I wanted to touch base. Now, Dave, you said -- you compared interest expense to an after-tax net income number for DSG, it sounded like. Was that a pretax interest expense number of $5 million, based on paydown of a little over $50 million in debt?

It's both a pretax and an after-tax number because [they all add] interest expenses in the U.S. and we don't get any tax benefit as a result of that. So it's both pre-and after-tax.

And then, with regard to, I guess, the results this quarter, revenues I think when we talked last quarter you guys thought they might be more flattish. It looks like they took on a little bit more of a seasonal pattern. I know you're highlighting the display, and I realize that Wireless is still strong but it has shown some slowing over the last couple of quarters and I've seen it slowing in North America. So I'm just trying to get a general sense on what you're seeing in the end-market.

Greg?

Yes, again, the book-to-bill is still over 1. We have the backlog to ship $100 million this quarter, which is our goal. But if you look at the bookings and what's currently in terms of our design wins, it's real healthy for us right now. We're grabbing marketshare, we're active in the key markets and, again, with our global footprint, if it's down in North America and that might just be in some cases revenue recognition where the design is being done in North America but being purchased in Asia, so at the time it's kind of hard to match that up.

But we're not seeing any downturn in our key markets. We're seeing an increase in bookings and we'll have a strong model going into next year also and again, hope to show double-digit growth.

Great. Now, if I do the calculation there might be a -- not an equal comparison; that was about 8% growth you're looking for, it sounds like on the Wireless space in the fourth quarter. Now, that's against a 20 -- almost a 22% comparison in the fourth quarter of last year, but is that about what you're looking at? (multiple speakers)

It's going to be a little over that in terms of sales per day, because again there's an extra week in last fiscal year so we'll end the year at a number and in an average week we'll ship $8.5 million. So 8%, if you compare year-to-year, but sales per day will be in the double-digit growth.

In the 15% range or so?

Okay, Bill. Your math or my math.

And then I wanted to go back on the inventory side a bit. I keep thinking it's going to come down and it keeps going up and this time it went up a lot. So I'm trying to get a general sense -- it feels to me like that obviously sales were maybe a little lighter than you expected but there's obviously some more going on there with regard to the inventory management. If you could give us a little more color on what might be happening there, if there's a certain area that somehow is having a higher level of inventory, how much will go away as a result of the SSD sale as well?

You're right, Bill. We did anticipate a little bit higher sales in Q3, so as a result we did have higher inventory than we expected at the end of the quarter. A large part of that inventory increase is within Wireless, and like I said, beginning in November we put together a plan. We believe in that plan, and we think that inventory will be decreasing in the fourth quarter. SSD's inventory is $18 million as of the end of the third quarter.

But we should see that obviously go away. Now, what is it specifically -- I mean, what is the plan specifically -- what are some of the elements of the plan that are going to reduce the inventory?

Yes, there's actually a number of things in place that -- some of it is based on the implementation of our CRM and SCM programs, which are on schedule for next year. But it's a global forecasting, new global forecasting module that takes part number by customer on a global basis and forecasts it monthly, then it goes into this new program and we're able to make decisions faster in terms of the product coming into our inventory.

You know, we have with all of our suppliers negotiated a minimum of 30-day cancellation windows, push-outs, and we're not taking advantage of that now, but we're doing a better job of it. And so those two things are largely responsible for our numbers for next year, as we implement them this year.

The second thing is on the other side of the business, where customer is king, we have customer loyalty. [We all need sockets.] We have a lot of exclusive agreements and part of that is carrying enough inventory to support that as we continue to get more and more customers referred to us in design wins.

But there's also on the other side, where we do have customers who take advantage of that and continue to push out orders at the end of the quarter, push it and pull out within the 30-day window, which does not allow us to do it. So, there's programs in place for looking at that in detail and making sure we're managing that better. So you know, on average in the fourth quarter our inventory in terms of Wireless decreases $5 million to $6 million, based on the current at the end of the third quarter.

So we're still looking at coming in very close to where we ended FYI '07 in this huge fourth quarter push that we have, and again, $100 million will be a record quarter for us. So, that's kind of in general the programs that are going on.

Great, guys. Thanks.

Christian Schwab, Craig-Hallum Capital.

I just wanted -- Ed, did you say the $175 million?

Yes.

So if we just look at that $15 million, it kind of looks like maybe Greg gives us $10 million and then the other $5 million comes from the other areas. Is that kind of the way to think about it?

Yes.

And then we missed -- in November we missed display by $8 or $9 million and we missed her again here it looks like by a few more million, so is this the type of thing that -- to make sure I understand correctly, we don't believe we're losing any marketshare or we don't believe that that business is no longer going to be shipped; it's just the difficulty in predicting the exact timing. So like you said last quarter, maybe it's May this quarter, maybe it's August of 2008 that we could be very pleasantly surprised with all the business that we've won. Is that correct?

Well, you can certainly see by the backlog where they are. It's a matter of getting these projects shipped and so we're working on that, and we're optimistic they're going to get more of it out in the fourth quarter.

In the meantime, what we're attempting to do is to refocus the business and get more standardized products to sort of fill the peaks and valleys in between these big projects. So that's the program. That's why we really reorganized the entire group and tried to put the right resources in the right places to fix the problem.

Yes, sounds great. And then the hub, the infrastructure going -- recognizing revenue on the three-hub infrastructure and getting 90% of our revenues recognized back to the United States, you know we had to unfortunately pay a very high tax rate again at 60-some-odd percent this quarter. You know, would we kind of view by Q1 of -- well, probably Q2 of next fiscal year, being at more of a normalized tax rate? Most of all those issues -- we're still on track, I guess, for an August 1st hub infrastructure being complete. Is that correct?

That's about right. And Dave, do you want to comment on the tax rate and how soon the LRD structure will impact that and so forth?

Right. The limited risk distributor structure will be in place in August, or either early August or in August. Like you said, beginning with Q2 we do expect to see a normalized tax rate going forward, and like you said the hub structure as we have it set up will also help that tax rate going forward.

Right. And so we get to use some of those NOLs. So on more of a normalized tax rate, you know, maybe starting somewhere in that 30% to 35% area, with the idea that maybe we could get that a little bit lower. Is that the appropriate thinking there?

Yes.

And as we're looking kind of just a bigger picture and longer-term, what do you think the remaining businesses should grow at? The display business is tending to be a little bit lumpier than we'd like to see right now but if we just look at the total aggregate number, the RF and Wireless business, what do you think, Greg, that we can grow that at? Assume the electro device business will be very modest and then what do we think the display business can be at?

We think sort of the blended number in our business planning process falls in right around 10%. That's pretty much where we're at.

Perfect, thank you.

Rob Damron, 21st Century Equities.

Let's see, I want to talk a little bit about just the corporate overhead, now that you're selling the security systems business. Can you talk a little bit about the corporate overhead that was allocated to that business, and is there an opportunity to further reduce the corporate overhead expense going forward?

And just another related question to that is, I know you've been historically talking about like a 20% SG&A expense as a percentage of sales, but now that the sales will overall be lower, is that still the opportunity to get there?

Well, we think so. Where we are is, we need -- and that's what we are shooting at in next year's plan, is to take it out about $20 million out of SG&A for SSD. And we haven't got all that rolled in yet but that's certainly the objective. Dave, do you want to comment further?

No, you're exactly right. We still are targeting the 20% level next year without SSD. We do not allocate any SG&A right now to SSD's results that you see published, but we do believe we still could attain that target of 20% going forward.

Okay, so I mean how would that roll out? Is this something -- the 20% goal, is that something that we wouldn't see until about the fourth quarter of fiscal 2008? Or is that possible to reach that even in Q1 or Q2?

We believe we could reach it by Q2.

Okay.

At run rate.

Okay, that's helpful. And then just on the tax rate one more time, we're expecting -- well, I guess, what are the NOLs that you'll have after this divestiture? How much will your NOL be?

We'll still have gross NOLs in excess of 20 million. Most of the gain on sale is based on this tax structure, not related to the U.S. We're only going to use -- we're going to use less than 10 million for the U.S. gain, so that leaves us the remaining amount for future offsets.

Do you want to give us a guess of where the tax rate could be in fiscal 2008?

Like I told Christian, I believe it will be 30% to 35%, beginning in Q2.

All right, that's helpful. All right, thank you.

(OPERATOR INSTRUCTIONS) Juan Castille, Rumson Capital.

Good morning, guys. I have a question regarding the estimated proceeds of $76 million from SSD. The press release mentions paying down debt on your (technical difficulty) agreement, but I see that your [7 and 3/4] convertible notes are cullable in December of this year, around the time of the closing date of the sale. Can you elaborate on which debt you plan on paying down and your rationale behind it?

Well, obviously, to begin with, we would pay down the bank debt but you know we have been buying the bonds in, as you may be aware, we bought $14 million worth of bonds so far this year and I guess we just look at that sort of on an opportunistic basis, depending upon what price we might be able to repurchase them at.

Okay, I guess that's it. Thank you.

And with that, Mr. Richardson, I'll turn the call back to you. There are no further questions.

All right, well, thank you very much. I can't say or underline again how pleased we are to finally have the SSD transaction at least agreed to. Our job right now, and that's why I'm in Houston, is to work hard in the transition phase and get the deal closed as quickly as we can.

So if you have any other questions, please give us a call. Thank you very much.

Ladies and gentlemen, Mr. Richardson is making today's call available for digitized replay. It's for full months starting at 12.30 PM Central daylight time April 12, all the way through 11.59 PM, August 8th. To access AT&T's executive replay service, please dial 800-475-6701. At the voice prompt, enter today's conference ID, 869436.

And that does conclude our earnings release for this third quarter. Thank you very much for your participation as well as for using AT&T's executive teleconference service. You may now disconnect.