Richardson Electronics Ltd (RELL) 2009 Q3 法說會逐字稿

(audio in progress) 2009 Richardson Electronics earnings conference call. At this time, all participants are in listen-only mode. We will conduct a question-and answer-session after management's remarks. (Operator Instructions)

I would now like to turn the presentation over to your host for today's conference, Chairman, Chief Executive Officer, and President, Mr. Ed Richardson. Sir, you may proceed.

Good morning and thank you for your continued interest in Richardson Electronics. With me today are Kathy Dvorak, Chief Financial Officer, and Greg Peloquin, Executive Vice President and General Manager of the RF, Wireless & Power Division, which is our largest division.

This conference call may include forward-looking statements and therefore actual results may differ materially from expectations. We assume no obligation to update our projections. Please refer to the cautionary language in our press release and SEC filings for additional discussion on our forward-looking information.

I will begin by providing a few brief comments regarding our view of the market and our third-quarter financial performance. Following my comments, Kathy will discuss in greater detail our financial results, and then Greg will discuss the results specific to RFPD. After that I will provide some comments on EDG and Canvys, as well as our view of the Company's future. Finally, we will open the call up for questions.

I would like to first provide a few general comments to put the quarter's performance into perspective. As you are well aware, the deteriorating market conditions have impacted nearly everyone's financial results. Beginning in October we saw our customers become much more cautious as the weakening economy moved to the forefront of the news. Our customers began to push out orders; our backlog declined; and our visibility into the future demand became somewhat limited.

With market activity deteriorating, we saw our third-quarter sales decline by about 20%. Our response to the economic slowdown was immediate. We significantly reduced expenses to keep in line with declining demand. Staffing reductions, which were underway, were accelerated. Underperforming facilities, business lines, and customer accounts were reviewed and acted upon. Discretionary spending and capital expenditures were deferred or eliminated.

These actions combined with a healthy cash balance enable us to remain financially sound so that we can continue to support our customers, employees, and suppliers while maintaining our ability to support selected growth opportunities as the economy recovers.

Now let's turn to our third-quarter performance. EDG's sales were negatively impacted by a number of factors. First, the overall decline in the semiconductor wafer fabrication industry has affected EDG. Second, as the worldwide production slowed, MRO customers began using tubes from sidelined equipment to keep active equipment running. This temporarily allowed them to avoid buying spare parts. Third, sales for EDG were impacted by the analog-to-digital conversion in the broadcast market in the US. The new digital technology presents future opportunities for replacements tubes, called inductive output tubes, used in digital transmitters.

During the past weeks we've talked to the majority of our tube customers. 97% of the equipment that uses EDG's tubes is still in service, ensuring that demand for our products will return.

Sales for Canvys were down 37%. Our healthcare business saw the greatest impact as medical facilities immediately began to delay capital spending on new projects. Conversely, our custom/OEM business has not been as impacted by the economic downturn, and we continue to see new projects. With the significant restructuring and focus on process improvement that has occurred within Canvys over the last 12 months, we believe the division can be profitable even at these lower sales levels.

RFPD, on the other hand, did not experience a sales downturn to the same degree as Canvys and EDG. Sales for RFPD were down about 14%, but the backlog in RFPD is still at a healthy level. We've seen a few cancellations, but nothing meaningful. What we are seeing, though, is more deferrals at this point. Our business in Asia is still growing, as China continues to invest heavily in telecommunications infrastructure.

At this time, we anticipate top-line revenue from the Company in total to be down about 20% for the foreseeable future. Therefore we continue to focus on rightsizing the organization to demonstrate significantly improved and sustainable profitability while maintaining ample liquidity and credit availability.

Now let me turn the call over to Kathy to provide the details behind our third quarter's performance.

Thank you, Ed, and good morning, everyone. Like many companies in our industry, we were impacted by deteriorating market conditions as sales for the third quarter were down significantly from the prior year's third quarter.

Our immediate priorities were to bring our working capital investment into balance, reduce expenses, and position the Company for the long term. I told you before that our goal was to run this business more efficiently, to sustain consistent and improved bottom-line performance; and we are doing just that.

As we saw our sales decline, we immediately took action to reduce our operating expenses. Severance expense in the quarter was approximately $1.2 million. In addition, we made the tough decision to forego our plans to proceed with a major IT software development project, which resulted in a $5.8 million charge related to the writeoff of this asset. This does not mean that we will not invest to enhance our systems, but that we can no longer afford a major systems overhaul in the near term.

We are also drilling down into customer profitability metrics and are walking away from business and the related inventory that no longer makes sense for business. These decisions are painful and unfortunately required us to take certain charges; but they are the right decisions for the long-term health of the business.

We do not see a bottom to our cost-cutting and will continue to evaluate our cost structure to identify additional opportunities for cost savings and productivity throughout the Company.

Before I go into the numbers in detail, I would like to mention that I will be discussing certain non-GAAP financial measures. Our non-GAAP financials will help you understand the impact of certain significant charges we have taken this quarter and in last year's third quarter that impact the comparability of our financial results. This will provide you with a better picture of where we are trending with both gross margin and expenses.

Sales for the quarter were down 20.6%. While sales for all three business units have been impacted by the deteriorating economy, we are pursuing every opportunity to drive sales and improve margins.

Gross margin on a GAAP basis declined to 21.5%. This reflects the fact that we wrote off approximately $2 million of inventory related to the exiting of certain geographic markets, certain low-margin customers, and the analog-to-digital broadcast conversion. Adjusting for the inventory writedown, the gross margin comparison is 23.3% in the current quarter compared to 24.5% in the prior year's quarter.

The decline in margin is attributable to the fact that our higher-margin businesses, namely EDG and Canvys, represent a smaller percentage of the mix in this quarter. In addition, we are working on reducing our manufacturing, labor, and overhead cost to match our current production. This underabsorption of labor and overhead caused additional expense of approximately $400,000 for the third quarter. We are addressing this issue by reducing headcount in this area and instituting a furlough for our manufacturing facility.

Our SG&A expenses were $27.7 million or 25.1% of net sales, compared to $32 million or 23% of sales in last year's third quarter. Included in the current quarter's SG&A expense is $1.2 million related to severance and $700,000 related to the writeoff of a long-term note receivable. Excluding these items, SG&A was $25.8 million or 23.3% of sales.

Overall, SG&A expenses continue to come down. Expenses for fiscal 2009 will be below a run rate of $100 million in annualized expense compared to $125 million at the end of fiscal 2008.

Our headcount at the end of February was 827. This represents a year-over-year reduction in headcount of about 13%. We have taken additional actions in March and April and anticipate our headcount to be below 800 by the end of May.

As I mentioned earlier, we made the decision not to proceed with a major systems implementation project. This decision resulted in the writeoff of approximately $5.8 million of capitalized software development costs in the quarter and will help us to reduce future IT spending.

Putting it all together, the operating loss for the third quarter was $9.7 million. Excluding the one-time items that I have just highlighted, operating income for the third quarter of fiscal 2009 would have been at breakeven.

Taxes for the third quarter of fiscal 2009 were approximately $563,000 of tax expense. We still anticipate that taxes for the total year will be under $2.5 million.

For the third quarter of 2009, net loss was $11.4 million compared to a net loss of $2.2 million during the third quarter of last year. Adjusting for the items previously mentioned, the net loss for the quarter would have been $1.7 million.

The volatility of foreign currency relative to the dollar does impact our financial statements. In the third quarter, we recorded a slight FX gain of $153,000. We conduct business in many currencies, and therefore ou4 intercompany activity is susceptible to fluctuations between local currencies and the US dollar. We continue to monitor foreign exchange rates and incorporate them in the decision-making process of buying and selling in all the various countries we transact business.

For the first nine months of fiscal 2009, our sales were down about 7.6%. Gross margin declined slightly to 23.5% compared to 23.6% for the first nine months of 2008. Fiscal 2009 year-to-date operating loss was $300,000 compared to operating income of $4.4 million in fiscal 2008.

We are maintaining our focus on our balance sheet position, which includes conservative debt level. We did not have any bank debt at the end of the third quarter, and our long-term debt was $52.4 million. Our cash position at quarter-end was $32.6 million.

Our accounts receivable balance as of February 28 was $92.5 million versus $109.5 million at year-end. Excluding the impact of foreign exchange, our receivables decreased by about $8.7 million versus a $17 million decrease shown on our balance sheet. Our allowance for doubtful accounts increased to 2% of AR from 1.5% of AR at year-end, reflective of the current economic climate.

Our inventory level was approximately $94 million, up slightly from year-end. Excluding the impact of foreign exchange, our inventory level increased by $6.2 million from year-end.

As we mentioned on the last call, the downturn in our sales occurred so rapidly that we were not able to quickly adjust our pipeline of inbound inventory. We are adjusting our purchasing and the inventory levels are coming down.

Our accounts payable balance decreased by $2.8 million since year-end net of foreign currency translation. Unfortunately, sales declined and we were paying our suppliers for inventory that went into stock long before we were selling it to our customers.

Cash flow used by operations for the three-month period ended February 28, 2009, was about $2 million as compared to cash used by operating activities of about $400,000 for the prior year.

As I just described, our use of cash this quarter is the result of the buildup of inventory that was not offset by a corresponding increase in supplier payables. As we bring inventory back in line with our new level of sales, we believe working capital will be a source of cash during the fourth quarter.

Capital spending for Q3 was $389,000 versus $301,000 in the prior year.

While Q3 was disappointing, we believe we are now well positioned for the challenges that lie ahead. We are continuing to reduce our headcount and anticipate severance expense during the fourth quarter will be about $1.5 million. After these actions we anticipate that our annualized operating expenses on a go-forward basis will be under $100 million. This positions us to recognize significantly improved operating performance as the market recovers.

At the same time we are focusing our attention on increasing our operating cash flow and further strengthening our balance sheet position. Without a doubt, these are challenging times requiring extraordinary effort. We have aggressively attacked our cost base and have successfully removed more than $25 million of cost since fiscal 2008.

As we improve our margins and hold the line on operating costs, we believe our Company will be well positioned to deliver sustainable, long-term improvements in both financial and operational performance. Now I would like to turn the call over to Greg to discuss our RFPD business.

Thank you, Kathy. Looking at the revenue side, RFPD finished the first half of FY '09, which ended in November 2008, with sales 5.9% over prior year and a 4.6% improvement in direct operating contribution margin. However, late in the second quarter, we did start to see a decline in bookings as customers in our market became ever more conservative in these uncertain times.

For the quarter, sales were $80.6 million compared to prior year of $93.4 million or a 13% decline. While the sales performance was disappointing, it does compare favorably to the overall market, which has declined on average more than 20%.

For three quarters of the fiscal year, RFPD continues to outperform the market, with sales revenue being virtually flat to prior year at $270 million, which in this economic environment is outstanding.

While pleased with the current overall results this year, we are working to manage our inventory and SG&A to bring them in line with a lower revenue forecast. We are taking every action necessary to win business by deploying resources to maximize the design wins for our suppliers. We continue to scrutinize all expenses and make the necessary decisions to provide RFPD every opportunity to maintain a strong profitability.

Turning to RFPD's key markets, I will begin by discussing infrastructure. As I have mentioned throughout the year, our investment in China over the past three years has continued to pay off as they roll out their 3G infrastructure. Recently I have had the opportunity to meet with our key customers regarding these business opportunities. It was certainly refreshing to see overall excitement related to this rollout.

Richardson's China team produced year-over-year sales growth of 28%. We are seeing the rollout of the WCDMA, which should continue into the early part of 2010. Our key suppliers, specifically Freescale, ATC, and Anaren, have really stepped up to support us.

The networking market unfortunately continues to retrench. Even though we have seen some announcements and additional investment in WiMAX, this continues to be slow. The CATV market is slowing in response to the downturn in the housing market, and our WiFi OEMs are continuing to be very cautious.

In broadcast, we are seeing strong increases in design wins in Europe, with many of the OEMs are introducing their next-generation digital transmitter.

Alternative energy and power conversion investments in renewable energy startups have been slow, but they are growing. There continues to be optimism that the new administration will make much larger investments in these technologies.

So in summary we continue to see uncertainty concerning the economy, which leads to very little visibility and insight into upcoming forecast demand. Market reports continue to show this trend will continue for some time. However, with our global niche model we are working to outperform the market and remain profitable during this downturn.

We are positioning ourselves to win market share as this market recovers. We continue to take advantage of our global footprint by tackling every business opportunity, with the largest and strongest RF and wireless sales force in the world. We continue to manage our inventory with our inventory management tools.

We are improving all aspects of our business going into 2010 by upgrading our global supply chain, redeploying existing resources to take advantage of growth opportunities throughout the world, and continuing our cost-reduction efforts. We are extremely pleased with our sales and product alignment supporting our China initiative, and we will roll out our new state-of-the-art website in June.

There are many challenges in this current environment, and we remain committed to adapting the business to meet our performance targets. With that, back to you, Ed.

Thanks, Greg. Now let's turn to our other two business units, starting with the Electron Device Group, or EDG. EDG supports the aftermarket for power tubes used in medical, steel, automotive, textile, plastic, semiconductor, and broadcast industries.

EDG has been through a fair number of market economic downturns. It's a resilient business in the sense that purchases can be deferred but ultimately, as production rates normalize, tubes will need to be replaced. So while EDG has been impacted by the downturn, we expect this to be somewhat temporary in nature.

While achieving our sales goals has been challenging, we are closely managing gross margin. Product margin for EDG has improved significantly. Unfortunately, gross margin was impacted by additional inventory reserves resulting from the analog-to-digital conversion as well as underabsorption related to our manufacturing activity. We are taking corrective action and anticipate seeing significantly improved gross margins for EDG in the upcoming quarter.

Just about a year ago we began restructuring our Canvys business unit. At that time, we reduced our cost base, refocused our sales force, and we pared back our inventory investment as we walked away from certain segments of the business. While I'm pleased to report that our global custom OEM business remains strong year-to-date and that Canvys has many new projects under way, unfortunately, business conditions deteriorated and Canvys's performance in the third quarter reflected the reality of a global economic slowdown and the challenging market conditions.

Canvys was negatively impacted by customer postponements, project delays, and the overall decline in the healthcare and digital signage markets. The drop in demand required us to carefully review and pare back marginal market segments and customers, and make further adjustments to our operating cost structure including incremental headcount reductions.

Product margins for Canvys exceeded 30% during the quarter compared to the prior year of 24.6%. The improved margin was the result of many business process improvements Canvys has undertaken, such as streamlining its supplier base, implementing demand planning tools, and training sales teams on finding customers that place value on the customized products and service Canvys offers.

We now have better data to understand which customer relationships are profitable. We know which ones make sense to invest more of our time, energy, and effort.

Canvys has made great strides in reducing expenses across the entire organization, allowing for a stronger foundation to emerge once the markets improve.

As Kathy and Greg have indicated, our balance sheet is in good shape. We are tightly managing our expenses, and we are intensely focusing on cash flow. We are responding to market conditions in a continuous adjustment mode. And you have our commitment that we will continue to reduce our operating cost structure as needed.

The current economic crisis certainly provided a catalyst for us to take aggressive cost-reduction actions. The actions we are taking are not only good for the short-term but the long-term health of our business. Our objective is to eliminate costs permanently by improving the way we do business and to emerge from the period of economic crisis as a stronger organization with the ability to support our loyal customers, employees, and suppliers and return value to our shareholders.

I want to personally thank you for your continued commitment to Richardson Electronics during these harsh economic times and for your support as we build a stronger Company for the future. And now I would like to open up the call for questions.

(Operator Instructions) Christian Schwab, Craig-Hallum Capital.

Hey, Ed. Can you give us an idea of what you're expecting for revenue this next quarter?

Sure. Good morning, Christian. Well, normally our fourth quarter is up about 10% over our third quarter. As I mentioned earlier, right now we are forecasting that the business will continue to be down about 20% from last year.

So if you looked at that, last year in the fourth quarter we were about $155 million. So if you looked at that down 20% you would be somewhere around $125 million. And the reverse of that, if you looked at the quarter being up 10% we did $110 million in the third. So somewhere around $121 million. Somewhere between $120 million and $125 million.

Great. Is there anything we are doing to improve on the gross margins? I know a lot of companies have been in a situation where, given the limited visibility, that customers are constantly changing orders and expediting orders, and people are giving away volume discounts -- are you doing things like that to help the gross margin profile of the Company?

Well, we have worked really hard on increasing the gross margin in our EDG business. It is up actually substantially without the inventory reserve from last year. Also as I mentioned, the Canvys gross margin was 30% in the quarter compared to 24 and a fraction last year. So the margins are improving. It's a little clouded with the inventory reserves that we've taken.

Great. What do you think this is -- what do you think gross margins on a blended basis are next quarter? And how you think that would track if business stabilizes for the next four quarters?

Well, without all the extraordinary items, somewhere around 24.5% blended.

Okay. Do you guys still believe you can increase that? Or do you think that is kind of a steady-state?

No, I think we can increase it, particularly in Canvys and EDG. The RFPD business is very competitive. But in EDG and Canvys both we have an opportunity to increase the margins.

Great. Then lastly, are we still trying to buy back some bonds here?

Absolutely.

Okay. Can you give us any update on how that's going?

Well, we are still shopping, let's put it that way.

All right, great. Thank you.

(Operator Instructions) Mark Zinski, 21st Century Equity.

Yes, good morning. I was wondering about this recent data in February, suggesting somewhat of a turning point for inventory among wholesalers. The inventory-to-sales ratio declined for the first time in about eight months, potentially suggesting kind of an inflection point for, I guess, inventory management through the supply chain.

Can you comment if you are seeing any kind of systemic change now for a possible upturn?

Well, it varies for each one of our divisions or strategic business units. We call it sort of a pipeline syndrome. It especially impacted EDG.

In the tube business, for the first time in all these years of up-and-down economic conditions, we saw EDG decline dramatically. In the last few weeks we have telemarketed the majority of our customers for power grid tubes; and what we've learned is that they've been cannibalizing equipment that is out of service for replacement parts. That can only go on so long. As long as this equipment is in constant service, the tubes need to be replaced about once a year. So we think that that pipeline is pretty well cleaned out now and the sales should increase especially for EDG, and that is starting to improve our inventory, yes.

Okay. In the same vein here with EDG, I'm trying to understand how the digital conversion impacts existing products versus what new applications are out for your products for the digital conversion. So I'm just trying to understand what sort of the net-net of the conversion is.

Okay. Well it's primarily North America where the analog-to-digital conversion occurred primarily in television. What happens, of course, is that they replace the analog transmitters. As you know, our business is an aftermarket business, so the replacement market for tubes going into those analog transmitters no longer exists. Or else if it does exist it is like for standby transmitters and things of that nature.

Of course the transmitters were replaced with new digital transmitters, and it will be a year or so before the tubes in those transmitters need to be replaced. As I mentioned there are tubes in those transmitters like IOTs, which are inductive output tubes; and we see that as a future market, but it will take a year or so before that market kicks.

So our sales in EDG were down about $3 million based upon the analog-to-digital conversion.

Okay, and then --

(multiple speakers) What I can say after that is there are still analog transmitters in use in Latin America and Third World countries. So we are still hopeful that that business won't disappear completely.

Okay. I see. Then in terms of the software development that you're cutting back on, you took the one-time charge here. Was that an ERP system or a Web-based inventory management system?

I will let Kathy comment. IT reports in to her.

It was a part of an ERP system. It was the lead to cash part that was embarked on in a long-term project that had started probably five-plus years ago. We have a current system that is working well, and so we are sticking with the system that we have.

Okay. So you don't see any trade-off in terms of potential efficiencies that could have been gained if you had gone through with the implementation? Or you are comfortable foregoing those?

I'm comfortable foregoing those because the cost of achieving those efficiencies would have been very, very significant, particularly when you look at the size business we are, given the current downturn.

Okay, great. Do you have a diluted share count for the quarter?

Right now I would tell you to use the 17.8 million shares. I mean it changes depending on our profit level whether or not the bonds become dilutive.

Okay. Then a last question, and this is for Greg. Are you seeing any meaningful revenue coming from the India market and the cell tower applications?

We are seeing a lot of design work, design activity. But the revenue stream, we are not expecting that till probably the second half of this calendar year.

Okay.

But we are seeing activity in terms of design work and design registrations with our suppliers.

Okay, great. Well, thank you very much.

[Lee Makin], Courtside Capital.

Hi, everybody. Two questions. On your forecast, Ed, or your thoughts on kind of a 20% year-over-year look, is that a function of a book-to-bill that you are seeing that is staying below 1? Or I guess above 1 on a sequential basis.

Or is that --? Because it seems like your comments about the tubes being reused or not reused, but you know what I mean, would indicate something that where your current growth rate is understating the true market. Why do you think it's that pessimistic out there?

Well, it varies by each one of the business units. Particularly in Canvys we have seen Canvys is more of a project-based business with very leading-edge products focused on healthcare in digital signage and custom OEM. Although we've seen some excellent projects and we've actually booked some orders in that area, the customers continue to push the orders out. They are not taking delivery. So that is in major portion of the decline.

In EDG, we just started I think to see some of the replacement tube business come through. But we haven't had enough upturn to really forecast anything better than what we've seen in the last quarter.

RFPD, Greg commented on it. What we are really seeing is China where things are excellent. As he mentioned, our business in China is up 28% over last year. But North America is an absolute disaster and Europe is down too.

So maybe we are being conservative in our forecast, but right now with the kind of visibility we have it's just difficult to be any more optimistic than that and forecast what we've seen in the last quarter, which is a 20% decline.

Appreciate the candor. How big -- how much of the RFPD business is China?

Greg?

Of the approximate $360 million-plus we'll do, we'll do about $65 million of that in China.

Got you. Thank you. And Kathy, just can you help me understand? Given the normal seasonality of the business as well as all the measures you've taken, what should the cash return from inventory reduction look like over the next quarter, over the next few quarters? How low can you get the inventory to sales over the foreseeable future?

Well, our goal at this point -- I mean we should be able to start really pulling down inventory; but our goal at this point is to be a couple million dollars below last year's ending inventory level.

I see. Can you remind me what that was? I'm sorry, I don't have it in front of me.

$93 million.

Got you. So you're targeting around $90 million or so?

We're trying to get below that. It's -- again, we have this pipeline issue. We've made 12-month commitments with many of our suppliers, so we are doing our very best to continue to pull down inventory.

Would you expect, even if revenues grew then in fiscal 2010 -- I suppose obviously it depends how much -- but that your inventory would continue to decline especially on a ratio basis?

Yes, because we are trying to increase our terms. You know, it's a fine balancing act to pull down our inventory and also be ready for the upturn as the market recovers.

Got you. Okay.

That is kind of the role of a distributor.

No, understood. Ed, it goes I guess to a more basic question, as Kathy said. What is the role -- I mean, how far can you go before your customers or your vendors -- it creates difficulty from a strategic perspective?

You mean as far as inventory cuts?

Yes, in terms of commitments you're giving to your suppliers.

Well, we really have partnerships with our suppliers. In several instances we give them 12-month rolling forecasts. We meet with them every quarter to adjust those forecasts.

I think the partnership we have with the vendors, it's really not an issue. They understand there is an economic downturn and we work together in that area. So I don't see that as an impact on the vendor or customer relationships.

Okay. Last question and a basic one. Could you just explain to me what the difference is between the A shares and the B shares, and why you have the two classes at this point?

Sure. The A shares are common stock; and the B shares have 10 times the voting rights of the common until they are transferred. Once they are transferred they convert to common or A shares.

The B stock receives a smaller dividend than the common stock.

Okay, fair enough. Kathy, the 17.8 million shares reflects both combined?

Yes. It just doesn't include the dilutive impact of the bonds, which kind of moves with the level of earnings.

Understood, great. Okay, thank you for your time.

Thanks very much.

With no further questions in queue, I would like to turn the call back to Mr. Richardson for closing remarks.

Well, despite a weakening economy, our focus for the balance of 2009 and 2010 remains on sales and marketing execution and capturing new opportunities for growth, while keeping tight controls on overall cost structure.

Richardson Electronics is now well positioned to execute in this tough economic environment, and we will exit this downturn as a leaner and stronger Company.

With that Kathy, Greg, and I want to thank you for participating on the call today and for your continued investment in Richardson Electronics. Thank you very much.

Thank you. Ladies and gentlemen, thank you for your participation in today's conference. This concludes your presentation. You may now disconnect. Good day.