Richardson Electronics Ltd (RELL) 2010 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the FY10 third-quarter earnings conference call. My name is Veronica and I will be your operator for today. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session. (Operator Instructions)

I would now like to turn the conference over to your host for today, Mr. Ed Richardson, Chairman, President, and CEO. Please proceed.

Good morning and welcome to our third-quarter conference call. With me today are Kathy Dvorak, Chief Financial Officer; Greg Peloquin, Executive Vice President and General Manager of the RF, Wireless & Power Division; and Wendy Diddell, Executive Vice President Corporate Development, and General Manager of Canvys.

Before we get started I would like to remind everyone that this call will include certain forward-looking information that is subject to a number of risks and uncertainties. Therefore we encourage you to review the Safe Harbor statement found in our press release and to review the detailed description of risk factors in our SEC filings.

I will begin with an overview of the Company's progress, and then Kathy will discuss the details of our financial performance. Greg and Wendy will provide commentary on RFPD and Canvys; and then I will conclude with a few comments on EDG as well as our outlook for the future. After that we will be happy to answer your questions.

Our third-quarter performance demonstrates another solid quarter of progressive improvement for Richardson Electronics. We posted our first year-over-year sales increase in some time. Sales were up 10% in the quarter. Backlog is strong, and we are continuing to expedite inbound shipments to meet customer demand.

Overall the Company's gross margin rate of 24.2% was respectable; and operating expenses were 19.5% of net sales. Operating cash flow was strong in the quarter, and our balance sheet is in great shape. We're paying off our convertible bonds on an accelerated basis, and we have excellent flexibility and liquidity to run our business.

Our performance certainly is a tribute to the collective efforts of Richardson Electronics employees around the world.

Sales for the third quarter were $121.3 million and continue to increase as we progress into the fourth quarter. Our focus remains on improving operating leverage. We continue to reduce our cost structure.

SG&A was down $4 million during the quarter compared to the prior year, and down $13.7 million for the first nine months of this fiscal year compared to the same period last year. We are on track to be below $95 million in total expenses for the year, and our team has become relentless in pursuing operating efficiencies. As a result we believe we can hold expenses at these levels and realize operating leverage as sales continue to improve.

During the quarter we incurred $100,000 of severance expense. Our headcount continues to decline as we pursue efficiencies in every area of the business.

Within our business units, we are seeing signs the economy is improving. In the RF and Wireless market, the buildout of infrastructure in Asia is picking up. Other countries have also announced investments in infrastructure.

We are experiencing renewed optimism as potential opportunities turn into solid orders. Unfortunately the supply of certain RF components remains tight, as our suppliers have not been able to keep up with the renewed strength in demand.

Excitement is also building within the Electron Device Group. We're seeing an excellent increase in sales from our semiconductor wafer fabrication customers.

In addition, overall demand for power grid tubes appears to be picking up. We're working hard to grow our market share by selling a broader range of products to our existing customer base as well as expanding geographically to reach new customers throughout the world. We have strategically positioned ourselves to be the most important channel to market in the tube industry.

Canvys continues to make progress from both the sales and profit perspectives. Sales in the quarter were up 4% compared to the prior year, and backlog is growing as our OEM customers place new orders in anticipation of increased demand.

Looking ahead, we believe that sales for the fourth quarter will be in the range of $130 million to $135 million, with all three business units delivering sales growth over the prior year. Now let's turn the call over to Kathy to present our financial highlights.

Thank you, Ed, and good morning. It certainly is a pleasure to report another quarter where we executed extremely well. Our third quarter includes solid performance represented by improved earnings, positive cash flow, and effective working capital management. The highlight of the quarter was the fact that operating expenses declined to 19.5% of sales; and therefore operating margin rose to 4.7%. Our story truly is about operating leverage.

Highlights of our third quarter include sales for the quarter were up $121.3 million, which was slightly above the high end of our range of guidance provided last quarter. This represents the first quarter where we achieved a year-over-year sales increase since the fourth quarter of fiscal 2008.

Gross margin was 24.2% this quarter, compared to 25% in Q2 and 24.2% during the first quarter. Our gross margin rate fluctuates, reflecting the mix of our business between product lines and geographies.

SG&A was $23.7 million or 19.5% of sales, compared to $27.7 million or 25.1% of sales in last year's third quarter. Based on current expense trends our annualized operating expenses for fiscal 2010 should be about $95 million and well below 20% of net sales for Q4.

Headcount of 758 employees is down slightly from last quarter and compares to over 827 employees at this time last year. We have made great strides in eliminating inefficiencies from our operations. This is allowing us to automate, simplify, and permanently reduce our cost structure.

During the quarter we incurred approximately $100,000 of severance expense and $570,000 year-to-date. We will continue to incur severance expense as we go through this process. Fourth-quarter severance expense will be approximately $800,000.

Operating income for the third quarter was $5.7 million or 4.7% of net sales.

One of the areas that impact our earnings is foreign currency translation, as we transact business in many currencies. During the quarter, we saw the US dollar strengthen relative to some of the major foreign currencies in which we transact business. Therefore, this year's third-quarter earnings were favorably impacted by approximately $200,000 of foreign currency gains. The prior year's third quarter also experienced a benefit, of approximately $150,000.

Our foreign exchange gains and losses are primarily attributable to US currency we have in overseas bank accounts, as well as the revaluation of our intercompany balances between our foreign subsidiaries.

During the third quarter, our tax provision was approximately $300,000; and fourth-quarter income tax expense will be in the range of $500,000 to $1 million.

During the third quarter of 2010, net income was $4.5 million or $0.25 per diluted common share, compared to a net loss last year of $11.4 million. Sales for the first three quarters were $346.8 million, down 9.2% compared to the $381.8 million in the prior year.

Gross margin for the first three quarters improved 100 basis points to 24.5% compared to 23.5% during the same period last year. SG&A expenses were $70.3 million or 20.3% of sales.

Operating income was $14.6 million, and operating margin reached 4.2% during the first nine months of fiscal 2010. Income from continuing operations was $10.7 million or $0.60 per diluted share.

We continue to focus on our balance sheet which includes effective working capital management and reducing some of our long-term debt. At the end of our third quarter, we had nothing borrowed under our revolving credit facility.

We repurchased $850,000 of our 7.75% bonds during the month of December and redeemed all $7.6 million of our outstanding 8% bonds in January. As a result, our long-term debt at the end of the third quarter was approximately $44 million. Our cash position at quarter end was $52 million compared to $33 million in the prior year's quarter.

Two weeks ago we redeemed another $10 million of our 7.75% bonds at par value. Therefore our long-term debt as of today is approximately $33.8 million. As a result, our fully diluted share count for the fourth quarter will be around 19.7 million shares due to this additional reduction in our convertible notes.

Our accounts receivable balance as of February 27 was $93.1 million versus $92.5 million at the beginning of our fiscal year. Excluding the impact of foreign exchange, our receivables increased by about $400,000 during the first nine months of fiscal 2010.

Our allowance for doubtful accounts was 2% of accounts receivable as of Q3, compared to 2.6% of accounts receivable at year-end. Our DSO declined almost seven days since the start of our fiscal year due to our credit and collection efforts.

Our inventory was approximately $79.5 million compared to $81.2 million at year-end. Excluding the effects of FX, inventory decreased by $1.9 million during the first nine months.

As our inventory turns improve, a larger portion of our inventory is funded through Accounts Payable, creating positive cash flows from operations. We also continue to negotiate better terms with some of our major vendors.

Excluding the effects of foreign exchange, our accounts payable balance increased by approximately $7 million during the first nine months of fiscal 2010.

Cash flow generated by operating activities during the third quarter was $16 million, compared to use of cash of $2 million during the prior year's third quarter. The cash flow generated by operating activities included $10.4 million of cash generated from working capital management.

Capital spending of $190,000 for Q3 was significantly below current depreciation of $900,000. Year-to-date capital spending was $684,000; and we anticipate that spending will be under $1.5 million for the full fiscal year.

While Q3 was extremely positive, we believe we still have opportunities to further improve our profitability. Therefore we are continuing our efforts to lower our cost structure and streamline our operations to better position us as our business continues to grow.

Our third-quarter results have certainly demonstrated the expense leverage that we can realize as sales recover. From a balance sheet perspective we will need to cautiously invest in inventories so that we are able to take full advantage of opportunities as the economic conditions continue to improve.

While sales momentum appears to be strengthening, it is still prudent to plan on a modest 3% to 4% sales increase in 2011. We anticipate that gross margin will remain at about 24%, while expense dollars should increase modestly. As I mentioned before, our goal is to maintain an expense ratio of under 20% for fiscal 2011.

Operating margins should continue to improve and be around 5%. Capital expenditures will be in a range of $2.5 million to $3 million, while D&A should be under $4 million. From a tax perspective, we believed our tax provision requirements will be around $2.5 million to $3 million for fiscal 2011.

In summary, it is clear that the Richardson Electronics team has executed well. Internal drive and commitment to process improvement continues to build. It is this culture shift that allows us to move forward into 2011 with increasing levels of confidence.

We are closely monitoring the controllable aspects of our business and are committed to further expense reduction and process improvement, as well as active management of our working capital investment. On that note, I'd like to turn the call over to Greg to discuss RFPD's performance and outlook.

Think you, Kathy, and good morning, everyone. As Ed mentioned, RFPD had a strong quarter with sales of $87.9 million, up 9.1% over the prior year. Even more encouraging is the strength of our backlog, which continues to grow.

We have a book-to-bill in excess of 1 and expect that trend to continue. Our bookings in Q3 were up over 40%, which is a strong indication that we are also gaining market share from our competitors.

Gross margin for RFPD was down slightly to 21.6% during the third quarter. This is compared to 21.9% we reported last quarter. This is a direct reflection of our geographic mix of business, as business in our higher-margin regions such as North America and Europe is picking up, although at a slower pace than Asia, which is typically our lower-margin region.

On the expense side, RFPD continues to reduce costs in some of our lower-growth areas and we allocate those resources to our high-growth areas within our global markets.

Now let's turn to our key markets. [RF and] microwave we have seen a broad increase in the business as market demand has improved while supplier lead times are extending. The increase in bookings and billings were across all three geographical regions. There was not one market that led the growth as networking, broadcast, defense, and ISM were all up in terms of backlog and billings.

For some time now, we have discussed the infrastructure rollout in China. Sales in our third quarter for China increased as the WCDMA rollout is now underway. Our global strategy and infrastructure allows us to move resources to key growth areas and take advantage of these opportunities, grab market share from our competitors, and increase revenue for our suppliers.

And power conversion, our second-largest business unit, has a niche strategy which is focused on power conversion and alternative energy applications. We continue to see strong bookings and billings in both these applications. If you remember, we completely reorganized this group a few years ago and implemented a global strategy with key suppliers having leading technologies. A majority of revenue came out of Asia, and more specifically China and India.

Based on the changes in government regulations and significant offset incentives, the demand and buildout for wind and solar energy systems has increased dramatically. The growth in India was from wind turbine applications. The growth in China was for both wind and solar applications in the inverter section, using power semiconductors and capacitors. Interconnect products showed growth in test and measurement equipment in China for high-performance interconnect devices and high reliability applications.

Looking at Q4 and outlook into 2011, we continue to see positive signs in the market and believe that our fourth-quarter performance will reflect a strong momentum in this market. As the leading global RF, wireless, and power conversion distributor, we are identifying niche markets to serve that will grow market share for our suppliers and ultimately drive shareholder value.

As a global engineering focused distributor, we need to continuously up our game in inventory management and design resources throughout the world. This means managing for the long term and finding the proper balance between inventory turns, supporting our customers with high in-stock service levels. Our strategy is firmly entrenched in the Group, and we need to have the right inventory at the right time.

We know our global model of engineering-focused distribution is valued by our customers and suppliers. Our global sales engineers and product managers are working every day to help us gain market share and extend our position as the world leader in this marketplace. Our asset management organization spends each day making sure we have the right inventory at the right time.

Our backlog is growing. We're gaining market share. And our future is certainly bright. We are committed to sustaining our redeployment strategy within RFPD, which will lead to even greater profitability in 2011. I look forward to providing you an update on RFPD's continued progress in July.

Now I would like to turn the call over to Wendy.

Thank you, Greg. Sales for Canvys, our visual technology division, were up 4% during the third quarter compared to the 23% decline reported during the second quarter over the same periods in the prior year.

In the third quarter, Canvys won several new large projects requiring touchscreen integration with large-format displays, including a project for more than 1,300 monitors for a national retail chain and a contract to deliver custom-developed touchscreen integrated panels for a global provider of touchscreen technology.

The industry is projecting shipments of touchscreen modules for professional and digital signage applications to increase from 971,000 units in 2009 to 5.4 million units in 2013. The demand for touchscreen integrated panels is also driving our channel partner strategy. Canvys continues to be seen as a leading provider of custom display solutions for the digital signage market and throughout Q3 embarked on an active channel expansion program to meet the growing needs of pro A/V and IT resellers, as well as digital signage solution providers.

The addition of partners such as Tech Data and ALMO Pro A/V allows us to transition smaller quantity requirements for touchscreen integrated panels and improve focus on opportunities with higher volumes and levels of customization.

The majority of our top OEM customers are still experiencing soft demand for new equipment; and many of our healthcare customers continue to take a wait-and-see attitude on technology implementations. Our stable backlog and increasing projects identified in our pipeline support the assumption that our commitment to provide customers with display solutions that exactly conform to their requirements will be rewarded as business conditions improve.

Gross margin for Canvys continues to show solid improvement, again exceeding 27% for the third quarter, as we did in the second quarter. This reflects positively on our decision to select opportunities and customers which require true display customization, and to ensure our pricing accurately reflects our costs while remaining competitive for the services we offer.

Canvys expenses were flat to prior quarter and expected to decline in the fourth quarter, net of any severance charges based on the headcount reductions made during the back half of the year.

While industry conditions remain challenging, we've been successful improving our bottom-line performance on significantly lower sales in both contribution margin and contribution dollars. We believe we are still well positioned to capitalize on market growth opportunities with the team we have in place and the rigorous process improvements we have implement over the past 24 months.

Now I will turn it back over to Ed.

Thanks, Wendy. Now I will conclude with a brief discussion of the Electron Device Group, or EDG. Sales for EDG during the third quarter were up 18% compared to the prior year's third quarter. Gross margin was 33.3% compared to 30% gross margin achieved during the prior year's third quarter.

We are seeing improvement in the industrial markets as demand for replacement tubes picks up. In addition we are seeing a significant increase in business from semiconductor wafer fabrication customers. We're forecasting this segment of the business to finish the gear over $17 million in sales, compared to $14.1 million last year.

Bookings in total for EDG were $10.18 million in February, the highest level in more than 28 months.

In summary, we have executed well through the first three quarters of fiscal 2010, and we believe that our positive momentum will enable us to end the year in a very strong position. I'm confident that Richardson Electronics' team will continue to deliver profitable sales growth as we enter fiscal 2011. We are a lean and flexible organization and we will continue to drive process efficiencies to further improve our financial and operating performance.

Thank you for your support of Richardson Electronics as we build a stronger Company for the future. Now Kathy, Greg, Wendy, and I will be happy to take your questions.

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

Great quarter, guys. Regarding, Kathy, regarding the debt, $33 million left on the convertible notes at 7.75%, is the plan to -- as we continue to generate internal cash -- to get that down to zero, if it's for sale?

We can redeem that at any time; so yes, that is the plan.

Perfect. Then just remind me, what is your fully diluted share count when that goes to zero?

We will be back to -- it's the 18 million shares.

Yes, okay. I just wanted to double check on that. Then how much of your cash or currency sits in bank accounts outside of the United States?

At this point the majority of the cash is overseas. But we will be able to bring part of that back over time.

Okay. So unlike anybody else -- I guess anybody else that we're talking to -- a strong dollar actually will benefit you on that portion of your business, should the dollar continue to rally over time.

Yes.

Correct. Gross margins, how do you guys -- you kind of tempered that maybe, maybe a little bit. You are at 24% give or take gross margins in 2011. I think before you thought that gross margins could incrementally go up. Can you just give some clarity on that?

I think it's really, one, us trying to be a little conservative. And two, it really is dependent on the mix of business between business units and geographies.

North America and Europe have been slower to come back. If those come back at a faster pace, we should see some benefit to gross margin as well.

Okay, perfect. As we look on the RF component side, Greg, it was highlighted in Ed's prepared comments that some RF components remain tight. Can you highlight anything that specifically is challenging regarding -- as we're hearing from lots of different semiconductor companies that they just can't get enough wafer capacity or test capacity? Is it those type of components or is there something else we should be thinking about that remains tight for the time being?

Christian, nothing specific. It's across the board. On our side, maybe because the bookings are across the board, all types of products, everything from semiconductors to even the passive components and them getting piece parts.

But they're no different than any other company over the last 18 months to two years. They have downsized and their wafer fab capacity is less than it was. We're seeing a nice uptick in bookings. So lead times are going out.

We have haven't experienced an issue yet with being able to service our customers because of the investment we made in our supply chain and sales operation management model.

But, Christian, it's just across the board. It's just capacity issues. As the bookings increase, lead times automatically go out; and then customers may take and give us more visibility. Instead of giving us three months, they give us six months. It's kind of a chain reaction.

So nothing specific though. It's just across the board, capacity issues.

Right. Are you seeing increased visibility? Are you seeing certain important larger customers extend lead times from the 60 to 90 days to 180 days, to help you?

Yes. We work very closely with them on their designs but also on their forecasting, because of the visibility we have with our suppliers. So they have taken our recommendations and have given us an increase everywhere from three to six months more in terms of backlog and forecasting, to allow us to help them make sure they have the right parts at the right time.

Perfect, and how often are they updating that visibility?

Some customers gives us a forecast daily through EDI. So give us forecasts weekly. It varies, but it's --

It's timely nonetheless?

Absolutely.

Perfect. No further questions. Thanks, guys.

Russ Silvestri, Skiritai Capital.

Good morning. If you go around the world, can you kind of talk about the rate of growth from Asia compared to North America compared to Europe? Particularly I guess in the electronic side of the equation.

It changes by SBU, but I will let Greg address it first for RFPD.

Yes, on the growth on the bookings side, where we are seeing this surge in demand, it's double-digit growth in Asia and low single-digit growth in North America and Europe.

We've seen the highest percent from a product point of view in the alternative energy power conversion side, as these governments give leeway and incentives to do it. We are really seeing a pickup in people rolling this form of infrastructure out to support the energy needs.

We are starting to see a nice pickup in the second half of the base station rollout in China, Russ, in that they are having capacity issues already. As you know from a voice point of view it's fine, but as more and more data-centric devices -- BlackBerrys, iPhones, smartphones, netbooks, et cetera -- they are eating up that capacity very, very fast. They're having to put in everything from microwave links to other base stations. And we are seeing a nice tick up in 4G LTE in Japan.

So that's really where the bookings have come from the highest percent point of view. But then as I mentioned before, everything from networking to broadcast to the military defense markets have seen either low double-digit to high single-digit bookings.

Thank you very much. Congratulations. Nice job, Kathy.

Thank you.

Mark Zinski, 21st Century.

Yes, good morning. Congratulations on the quarter. Kathy, could you please confirm again the diluted share count that you are expecting for Q4?

At this point you should probably use 19.7 million.

19.7 million, okay. Great, thanks. And Greg, are you seeing -- you had mentioned the base station buildouts and capacity issues caused by all these handheld devices, et cetera.

Is the North American market -- well, specifically in the US, are the major carriers -- have they begun their significant CapEx spending yet? Or is that developing more slowly? Certainly more slowly than China, is that true?

It's slowly -- I'm not sure if significant would be the word to use. But they're having capacity issues throughout North America with their current base stations. So they are looking at investing, obviously putting in either new base stations or additional base stations from a 4G point of view.

But where we are seeing the uptick in North America are the microwave links and the upgrading the routing and switching capacity, and also putting in wireless LAN to take care of this increase in data traffic that the base stations can't handle.

Okay. So right now it's more upgrading current base stations versus a buildout of new stations?

Exactly. It's upgrading the process between the switching and routing centers, which -- they use microwave links and picocells and microcells and that to handle all this new data, the traffic that comes with smartphones and iPhones and everything else.

Okay, great. Kathy, is there any evidence of any type of raw material cost push by your suppliers? Let's say like copper pricing, etc. that they might be trying to push off to you. Or does your business really not at all have any kind of susceptibility to that pricing?

Well, certainly copper has a major impact on power grid tubes. But most of the price increase that we experienced in that area was last year. So I think the pricing has leveled our.

We are probably seeing 3% price increases annually in the power grid business, sometimes up to 5%. Greg, what about in your business?

Yes, like I mentioned earlier, it hasn't been a huge issue in our suppliers, but have been able to support us on keeping our margins at least flat for now. But if this continues and the bookings continue like we have seen in the last two to three months there is going to be issues, and I'm sure there's going to be discussions of cost increases because of the lack of piece parts and materials.

Okay, great. That's it for me. Thank you very much.

(Operator Instructions) Adam Peck, Heartland Advisors.

Good morning, everyone. Kathy, if I work through your numbers for 2011, I end up with free cash flow of anywhere between I would say $15 million and $20 million. Does that sound about right?

Yes, it does.

What -- is the cash level today roughly $41 million?

Is what?

Your cash level after you paid back -- after you bought back the converts?

Yes.

Okay, now how much of that cash today could you use to buy back more of it?

We have a US revolver. We are generating the kind of cash flow dynamics of the business are changing. We are generating more cash in the US, so we are working on it over time.

I mean, we are not borrowed under the US revolver; so we could buy back bonds at any point in time.

Okay. Like you said, that free cash flow number for 2011 should be anywhere between $15 million and $20 million.

Yes.

Which you could use to pay down the debt. So as we look out to 2012, if you can sustain that free cash flow level, what are your free cash flow priorities once you get the balance sheet where you want it?

Well, it would be -- depending on the price of the stock at the time we might buy stock back. It just depends. We want to be opportunistic.

Okay. Are you still looking at the dividend every quarter?

We will maintain the dividend we have now. There was some discussion about increasing the dividend; but one quarter doesn't make a business. So we're going to wait and see if this is going to be sustainable.

Okay, great. Thank you very much.

[Irv Blundell], Heartland.

I just wanted to compliment you. I've heard your calls for many quarters, and you have been working hard at reduction of costs and building the niches of your business. And I think you all should be complimented.

I generally don't present that kind of a statement, but I think that remarkable changes have occurred. And as sales pick up and revenues pick up across this Company, there's potential to go back to some record profits I would think.

I had one question on the subject of tax rates. You had losses overseas. Are you now capturing those losses based on the structure that you have? When will tax rates start climbing?

And can you just discuss maybe, Kathy, the tax rate situation that we're looking at going forward?

Sure. Again it really isn't a good way to look at this Company from a tax rate perspective, because our taxes are more fixed based on foreign operating profits. Which is why I said our tax dollar expense next year should be around $2.5 million to $3 million.

We still have a very significant US NOL which will keep our tax dollar payments low for some time to come.

So does that mean that -- how much is the tax loss carryforward for the US then?

At this point it's $50 million.

$50 million, so that gives a lot of latitude to -- okay, for future help.

It certainly does.

Yes. Thank you.

(Operator Instructions) Ladies and gentlemen, this concludes the question-and-answer session. I will now hand the call over to Mr. Ed Richardson for closing remarks. Please proceed.

Thanks, Veronica. Well, Richardson Electronics has proven its ability to thrive in the most challenging economic environment we have ever faced. It was a difficult period, and it's definitely premature to say it's behind us. However, today we are a new and much stronger Company. And I would like to thank you for your support as we continue to build a new Richardson Electronics that is capable of delivering strong, consistent financial performance for the future.

We look forward to reporting on our progress in July. We want to thank you for your time today and for your continued investment in Richardson Electronics.

Ladies and gentlemen, that concludes today's conference. Thank you for your participation. You may now disconnect. Have a great day.