Richardson Electronics Ltd (RELL) 2012 Q3 法說會逐字稿

Good morning, ladies and gentlemen. Welcome to the Fiscal Year 2012 Third Quarter Earnings Conference Call. My name is Chris and I will be your conference moderator for today. Presently, all participants are in a listen-only mode. Later, we will facilitate a question-and-answer session.

(Operator Instructions)

As a reminder, this conference is being recorded for replay purposes. At this time, I would now like to turn the conference over to your presenter for today, Mr. Ed Richardson, Chairman and CEO of Richardson Electronics. Sir, you may proceed.

Good morning, and welcome to our third quarter 2012 conference call. Joining me today are Kathy Dvorak, Chief Financial Officer, and Wendy Diddell, Executive Vice President of Corporate Development and General Manager of Canvys. As a reminder, this call is being recorded and will be available for audio playback on our website. During the call, we may make forward-looking statements and based on certain risk factors, our actual results could differ materially. Please refer to our press release and SEC filings for an explanation of our risk factors.

Sales for the third quarter were $38.3 million, down 3.3% from $39.7 million in last year's third quarter. The decline reflects continued caution from our customer base and ongoing concerns regarding economic recovery and stability. Gross margin, however, improved to 29.5%. Our decline in sales for the quarter was primarily in North America, which represents about 40% of our total sales volume. Recent economic indicators certainly point to improving trends in the US industrial sector. We continued to manage our operating expenses during the third quarter in line with our sales. Operating expenses dropped to $9.5 million, compared to $10.7 million in Q3 of the prior year, and we produced operating income of $1.8 million.

Despite the challenging economic environment, we continue to make progress on a number of initiatives that will position us well for fiscal 2013. We identified areas to streamline and further reduced our operating expenses, which is reflected in the $2.3 million decline in operating expenses through the first nine months of the fiscal year. We acquired Powerlink to provide the services our customers require to increase our share of the $1 billion microwave tube market, and to enable us to sell more power grid tubes to customers that do not have the capability to service their own tube equipment. We added leadership talent to our US manufacturing organization, which will enable us to improve our efficiency, better serve our customers, and win more business.

Many of our customers want to consolidate vendors as a means of controlling costs, and they are looking to Richardson Electronics to provide them with effective manufacturing. We focused the sales team on more profitable higher-growth opportunities such as CO2 laser cutting equipment, which represents one of the largest markets for power grid tubes. In our display business, our sales team is focused on original equipment manufacturers requiring custom displays. Now let me turn the call over to Kathy to present the details of our third-quarter performance.

Thank you, Ed, and good morning. While the general market environment has proven to be a bit more challenging than we anticipated, we still achieved an operating margin of 4.8%, reflecting our commitment to cost reductions. Sales for our third quarter were $38.3 million, down slightly from the prior year's third quarter. Gross margin improved to 29.5%, from 29.1% in last year's third quarter. This increase reflects an improved gross margin rate for both Canvys and EDG. We are closely monitoring all of the components of gross margin, and believe that gross margin will continue its upward trend into our fourth quarter and into fiscal 2013.

We are tightly managing our expenses which include implementing process improvements that result in lower costs. Our operating expenses in the third quarter were $1.2 million less than last year's third quarter, and $2.3 million lower than the first nine months of last year, reflecting the success of our cost-cutting initiatives. Operating expenses for the third quarter as a percentage of sales were 24.7%, down from 27.1% of sales in last year's third quarter. Operating income for the third quarter of fiscal 2012 was $1.8 million, or 4.8% of sales, up from $823,000, or 2.1% of sales during the third quarter of fiscal 2011.

Interest income for the quarter was $357,000, and FX represented a slight gain for the quarter of $19,000. We continue to make every effort to mitigate our currency risk. Income from continuing operations was $2.2 million before tax. Our tax provision from continuing operations was $636,000, or a 28.6% tax rate. After tax, our income from continuing operations generated $1.6 million, or $0.09 per diluted common share.

For the first nine months of fiscal 2012, sales were $119 million, up slightly from $118.1 million of sales in the first nine months of fiscal 2011. Gross margin was $35.7 million, or 30%, compared to $34.7 million, or 29.4%, in the prior year. On a year-to-date basis, operating expenses were $30.2 million, versus $32.5 million in fiscal 2011. Operating income for the first three quarters was $5.6 million, compared to $2.2 million in fiscal 2011. For the first nine months of fiscal 2012, income from continuing operations net of tax was $4.2 million, or $0.25 per diluted share.

Our cash and investments at the end of our third quarter were $169.2 million. During the quarter, we spent approximately $1.2 million on share repurchases, and invested a little over $3.5 million in working capital. Our accounts receivable balance remained relatively flat when compared to the start of our fiscal year. As of quarter end, accounts receivable was $22.9 million, versus $22.4 million at the start of our fiscal year. Inventory balances have risen to $38.3 million, compared to $30.9 million at the beginning of the fiscal year. This high level of inventory should start to come down as we adjust our purchasing. Our ability to react to slowing demand is challenging, as we typically place purchase orders three to six months in advance of inventory receipt.

We are committed to executing on our growth strategy, maintaining our focus on working capital management, and keeping our cost structure under control. We believe we will still achieve our operating margin target of 5% and that our investments in working capital will decrease over the next several months. We are committed to returning value to our shareholders. We have re-purchased about 1.8 million shares to date, using approximately $24 million of cash. As of today, there are 16.8 million shares outstanding. Our total share re-purchase authorization remaining is about $26 million.

Our outlook for sales for the fourth quarter of fiscal 2012 is approximately $40 million to $43 million, and accordingly, we expect sales for our fiscal year to be in the range of $160 million to $163 million. Our tax rate reflects a number of factors, as well as a high degree of complexity. We currently have an income tax overpayment of about $5 million, so we do not anticipate the need to make estimated tax payments for fiscal 2012. From a GAAP perspective, we expect our tax rate to be 37% for continuing operations.

In conclusion, we continue to make progress on reducing our cost structure, and believe that we are on track to achieve our operating margin target. Our long-term objective is to grow the business, allowing us to leverage our support function costs and achieve an operating margin above 5%. Now, I would like to turn the call over to Wendy, who will discuss Canvys.

Thank you Kathy, and good morning. Canvys enjoyed another solid quarter, due largely to performance of both the OEM and health care segments in North America. Sales for the division were $11.5 million, relatively flat with Q3 last year, but slightly ahead of our second quarter of FY12. The North America OEM team shows good year over year growth, as existing customer demand associated with ongoing and new programs drove revenues higher, increasing nearly $3 million over prior year on an annualized basis.

Backlog has continued to increase, and we're starting to see new customers come on line as a result of our intense prospecting activities over the past year. During the quarter, Canvys was nominated for and came in second on two of the top five supplier of the year categories by one of our largest medical OEM customers. Health care sales rebounded nicely in Q3, as we received inventory to fulfill orders awarded late in the second quarter.

The health care business is a very efficient working capital model. With the continued pressure on the medical community to find ways to reduce costs, we are looking for other products and services that can be sold to our same customer base, and for new customers who can market our Image Systems brand of PACS displays, and reach more hospitals. Our Image Systems line of displays performs very well against other name brands, but is often a much better value, particularly when coupled with our excellent quality, check, and assurance plans. Our solutions are very attractive to hospitals that need to replace or upgrade existing PACS equipment that have limited funds.

Europe continues to have economic challenges, and our OEM display business in this region continues to struggle as a result. With the addition of a new general manager over Canvys Europe back in October, we've identified market segments we've been serving that have been relatively unencumbered by economic issues. Within these segments, we are targeting new customers who can benefit from our large base of proven custom display designs. This should allow us to shorten the lead time by reducing or even eliminating the time-consuming product development process.

Gross margin was 28%, versus 27% earned in last year's third quarter. The continued success in margin improvement is due to our ongoing focus on finding and nurturing profitable opportunities, and paying close attention to other costs, such as freight, which reduce our margin. We've also been diligent in preparing our billing materials to ensure all costs are accurately reflected before we close, and working with our Taiwan sourcing team to take cost out and find more efficient display solutions for our customers.

Considering the majority of our customers expect and even demand annual cost-downs, both our program management and sourcing teams will need to think outside the box to meet this challenge head-on, particularly in light of increased labor rates in some of the more traditional low-cost countries. We anticipate that fourth-quarter revenues will be slightly better than the first three quarters this year. We'll continue to manage our expenses and inventory in line with our revenue and margin forecast. As with the rest of the company, we are evaluating which parts of our business model work, defining where we generate profitability, and exploring ideas to capitalize on these success areas. We look forward to reporting our full year results and discussing some of these plans with you in July. Thank you. Ed?

Thanks, Wendy. While we are positioning EDG for long-term growth, our short-term performance has not met our expectations. We ended the third quarter at $26.9 million in sales, compared to $28 million in the prior year's third quarter. We experienced the largest shortfall in North America, reflecting lower demand from the semiconductor wafer fab market. The good news is that we are beginning to see signs of recovery in this market, as our backlog continues to improve.

We're also pleased with our results in penetrating the CO2 laser market. We've seen good growth in this product category all year. We've determined that the majority of users in the Asia Pacific region do not have the ability to service or replace tubes in their own equipment, therefore we're launching a program in the fourth quarter to provide CO2 laser tube installation when required with the purchase of each tube in Asia. This service will be provided through a combination of Powerlink-dedicated service technicians and authorized independent service companies. We will kick this program off in Korea and expand it to other areas in Asia as resources are confirmed.

Gross margin for EDG increased slightly to 30.1% in the third quarter fiscal 2012, compared to 30% in third quarter of the prior year. We expect to see continued improvement in EDG's margin rate as we increase our CO2 laser tube sales, convert more OEM to end-user business, and improve efficiency in our engineered solutions business. Inventory increased during the quarter, primarily to support our key supplier agreements and opportunities to procure products prior to price increases. As sales increase, we anticipate inventory will be reduced in the next several quarters. Our success has always been based on listening and responding to the needs of our customers. We efficiently serve the after-market on a global basis with delivery from stock on the highest-quality products, vast technical knowledge, and strong service capabilities.

We are currently researching the opportunity to expand our replacement parts offering and service to vertical markets which utilize microwave and power grid tubes. Our strategy is to leverage our global infrastructure and customer base to become a significant player in vertical markets where we can provide equipment users, reduce cost, and improve service on their replacement parts requirements. In addition to focusing on new vertical markets, we're committed to continued market share gains within our existing business. Our combined goal is to double the size of the business in the next three to five years.

We're confident that as a small player in a very large market, we can overcome some of the challenges presented by the uncertain economy. Sales for Canvys and EDG for the fourth quarter of fiscal 2012 should be in the range of $40 million to $43 million, while sales for the full year of fiscal 2012 should be in the range of $160 million to $163 million. We remain confident that we'll be able to achieve our operating margin target for the year of 5%. Richardson Electronics is committed to growth, and we'll continue to focus on further market penetration, additional acquisitions, and building on the strength of our financial performance. We'll continue to invest in our growth initiatives while opportunistically returning cash to our shareholders. At this point, Kathy, Wendy, and I will be happy to take your questions.

(Operator Instructions)

Al Tobia.

Hi, Ed.

Good morning, Al.

I wanted to address the word opportunistically, and if I go back to the conference call from last year, and I look at some commentary, when -- and a year ago is when the cash first hit the balance sheet of the Company -- basically, your commentary was you intended to buy back stock, wanted to increase the dividend, but going to walk before you run. The dividend was increased to $0.05 back then. What does a $0.05 per quarter dividend that we haven't increased it since, what does that tell me? A 1.6% yield or so, and no increase in the dividend. Does that tell me that you're more favorably disposed towards returning shares through buy-back, versus increasing the dividend beyond this?

Well we've been buying stock back every day, as a matter of fact, within the regulations. At the current prices, the re-purchase of the stock is the most accretive thing we can do, so that's certainly a priority as long as the price stays in this kind of range.

So if I address that then, through the first couple of quarters of the re-purchase, if I look at the quotes from last year, basically it was said that it was going to take a few months to execute through the $25 million authorization. We're not through the authorization, and the first batch of stock that was bought back was bought back at about $13.30 average price. In the last quarter, we reduced the amount of shares back purchased dramatically, and the price was down in the $11 and change range, so what does that tell me about the value of the Company in the last year? Is it down 20% in your eyes?

No, I mean, again we're being opportunistic, but we're regulated as you may well know as to how much stock that we can buy each day.

You govern the price at which you buy it back if you're on a program?

Well certainly.

Right, so you're not regulated by the price?

We're not regulated by the price, but we're regulated by the volume.

But what I'm saying is that you've lowered the price that you were willing to buy the stock back by 20%, yet the Russell Index is up significantly during that period, and you've earned money and built book during that period?

Well, we don't have any intent to set the price of the stock in the marketplace. We're buying opportunistically, as I said.

But isn't the opportunity to buy back based on the value of the Company?

That's true, but I don't intend to pay more than market price of the stock.

I don't understand, I'm confused again. You bought stock at $13 and change and you bought significant amount of it. You bought a lot more of it north of $13 than you bought under $12, yet you've slowed down the amount of stock you bought because you've lowered the price which you're willing to pay. Yet over that time, your comparable companies are up in value and you've earned money over that time and built book and theoretically you've executed on your plan. Somehow you're paying less now than you were a year ago for the Company and I just don't understand the thought process. You're letting the last sale dictate how much you buy doesn't make sense to me. You should be buying based on what you think the value of the business is, no?

We're buying every day the maximum amount of volume that's allowable.

Depending on what price you set.

Not true. We can only buy so much every day.

But that's absolutely wrong, because if the stock goes up beyond the price you're willing to pay you can buy none, and you bought -- I'm just looking at numbers. I'm just trying to understand the thought process. When you first announced that the cash came in, you spent $20 million at an average price of $13.30. Last quarter, you spent $1 million at under $12. I don't -- I'm failing to see what's going on here. You have more cash than when -- you built cash at the Company.

In theory, you built value in the business by improving your model with the distribution, with the service center approach, and yet you're buying fewer shares at a lower price, and it's not the market, it's you. You're setting the price. I understand if you say you want to lower your price paid on the stock down, but then why not raise the dividend up? Because somehow you're not returning the money to shareholders when the money first came in, you said that you were going to do. I'm just confused about the amount of money returned to the shareholders. That's basically what I'm trying to understand.

Well I certainly appreciate your opinion, Al, but there is a regulation out there that depending upon the volume of the stock that's trading how much we can buy every day and right now, we're buying the maximum volume every day.

Based on the price that you set. So I mean if you set the price at $10 the maximum volume you could buy would be zero.

The market is setting the price of the stock.

We beg to differ. I would beg to differ but your comparables are up. If you told me that the Russell Index was down 20% that's fine. Your index is up, so you're under-performing your index, and you're lowering the price you're willing to pay for your stock, and therefore you're not getting any volume in.

We're doing exactly what we said we were going to do, Al. We're opportunistic. If the market is setting the price of the stock at lower rates, that's what we're going to pay for it. We're not going to raise the price artificially.

So you'd be comfortable if the stock drifted down to $9 and you had $13 a share in cash buying it at $9, $10 and only 50 shares a day if it only traded there?

We'll buy the maximum volume allowed on that day.

Using the price that you set.

No, the price that the market sets.

Okay. Then on the dividend, you're not -- you're comfortable with a $0.05 dividend which hasn't been raised once in the last year?

The Board considers the dividend every quarter, and I'm sure at some point, if they feel that it's the right time to do it, they'll raise the dividend.

You do understand that what's holding the Company back is the lack of either a boost in the dividend, or more aggressive stock re-purchasing, right, in terms of the stock price? That is a given, at least when the Board discusses things? Or no?

Al we're doing exactly what we said we were going to do a year ago and we're going to continue to do acquisitions, we're going to continue to buy the stock back, we've raised the dividend, we'll consider raising the dividend again, and it's the same program that's been in place from day one.

Well, when I read the commentary from day one, it didn't read this way, but a $0.05 dividend I don't think does anyone any good in terms of a return. I mean, we're sort of between. We're not buying enough stock to really do anything meaningful in terms of adding to earnings, and the dividend isn't big enough to justify a yield play in the stock. We've got a low-growth business that's way over-capitalized with a small acquisition strategy, and very, very minimal return of cash to shareholders, and therefore an under-performing asset.

Well we certainly appreciate your opinion.

Right. Thanks, Ed.

Okay.

[Richard Whitman].

Yes, two questions. First is for Kathy. Can you define under non-current investments of roughly $15 million what comprises that, please?

It's CDs and time deposits.

So why would that not be included under cash and cash equivalents or current investments? I don't understand.

The accounting definition, because they are over one year.

Okay. Next question for Ed. The previous gentleman's comments, we won't go over those. Certainly, an important part of capital allocation includes the stock buy-backs and the dividend, but the more important thing in a Company as over-capitalized as you are, is the increase in the value of the Company and the stock price therefore must be determined by acquisitions. I know you've addressed that you're looking at them, but do you have anything on the radar screen that potentially could be large enough to spend a good chunk of your liquidity in making an accretive acquisition?

Oh, yes we're actually considering several acquisitions that would be quite meaningful. It's really too early to give you any further information on that but--

But the targets have been identified and the process has begun of making a serious look or attempt at acquiring businesses which could be accretive to the Company?

The answer is yes but to give you more information than that, it's just too early.

Okay, thank you.

[Ken Grossman].

Good morning, Ed and Kathy. How are you today?

Good morning, Ken. We're fine.

Yes, I bet. Well, let me first compliment you on doing a good job in a challenging macro world.

Thank you.

4.8% operating margins were quite good. Unquestionably, you're executing on your business plan and doing a good job of it, and hopefully when the macro world improves we'll be able to see better numbers from you. That's the good news, and I want to compliment you on that. I don't want to dwell on what Al has said or the previous caller has said, but what the market is telling you, Ed, and maybe the acquisitions that you're talking about that prospectively might help, but if my calculations are right, I come up with a tangible book value of the Company of about $12.40 a share. The stock's selling at $11.50, so we're getting no credit at all for you executing on your business plan, and negative credit for the cash that's on the books, and that's why you're getting these kinds of questions, obviously.

The market is saying we have zero confidence in this Company's ability to deploy its cash, so hopefully we're going to see something happen that will be accretive and beneficial to the stock. I just think that from an investor standpoint, a 1.6% dividend yield is a joke. Buying back 100,000 shares last quarter is really not substantive, so hopefully you will be able to demonstrate that to the investment world with some reasonably good accretive acquisitions, and I hope that's forthcoming. I just wanted to give you my opinion out there and just compliment you on executing in a difficult world.

I just also wanted to note and to go on record on this call that I did send a couple of e-mails to the Board requesting that they consider a dividend increase or a more aggressive stock buy-back plan. Obviously, that fell this quarter on deaf ears, but I understand if you have ways to deploy this cash that are effective to maximize shareholder values, I'm all for it. But we need to see something, and we need to see something quick come out of the Company that's meaningful.

Well first, we thank you for your compliments on the operating performance of the Company. We're working hard at that and we think we can improve it going forward. I will say that your communication to the Board was discussed in detail. The Board is asking us to do a use of cash analysis every quarter, and so they considered some of the acquisitions we're looking at and the possible use of cash, and made a decision to defer any other considerations until the next quarter, which it will be reconsidered at that time. I'm sure they will be communicating that to you as well.

Okay, All right, thank you, Ed.

Thank you.

[Charles Fisher].

Good morning, Ed.

Hi, Charles.

Hi, good morning. Nice quarter by the way, and I appreciate you keep moving the ball. We have two metrics here that I think about as a shareholder of 1% of the Company. We have a $12 value of cash in inventory, and then we have a $5 or $6 stub at 10 times earnings. It's important that we both take advantage of the $12 stub and that we also move the $5 stub to become worth $10 or $15 over time, because that's going to create as much value as the buy-backs. It's really a two-prong approach that I think your strategy could be very effective with.

Ed, could you talk about -- we're gaining close to 5% on net margins. As you look a couple of few years out, where do you see that number going? Is 5% kind of the end, or does this have a chance to get to the 7%, 8%, 9%, 10% range over the next couple few years as you continue to drive a little bit of sales through the channel and also continue to watch the expenses?

Well, we think it will increase almost on a linear basis. We're disappointed in the revenue being so flat, and we're impacted as we mentioned by the economic issues in Europe and probably more by the media than anything else that keeps people from buying after-market parts, but we have seen it improve. February was good and March was even better on a run-rate basis. We're hopeful that that's turning around, and it's all pretty much revenue-based. Kathy and the team had done a great job taking costs out, as you see. We think it's possible over the next couple of years to move up linear from that 5% kind of number probably to 7% at least, and we hope to show you progress on that every quarter.

That's great, because obviously you know, you go from 5% to 7% and all of a sudden we're going to maybe make $0.60 or $0.70 and that $5 stub or $6 gets closer to $10, and that's creating a lot of value. I don't want to beat a dead horse here, I just want to ask you about the share buy-back, and I want to understand a technical question. My understanding of the Safe Harbor rules is that you're allowed to buy 25% of the average daily volume, and you have to be the bid, of course you can't be the ask. Last quarter we bought give or take about 1,000 shares a day, volume's probably 30,000 to 50,000 shares a day. Is there something that I'm missing about your limitation under the Safe Harbor rules of buying shares?

No, I think you're about right. Currently, I think we're limited to about 8,000 or 9,000 shares a day, based upon the volume. What happened was, the volume came way down and originally, when we were buying to begin with, we had the opportunity to buy 25,000 to 30,000 shares a day, and now because of the volume being down under the rules, we can only buy up to about 8,000 or 9,000. That's, then it's timed during the day, I'm not happy with it either. Kathy and I talk about this all the time that why aren't we buying more back and what happens is it ends up the stock being available at a time during the day when we can't buy it.

For instance, you can't buy the first half an hour, you can't buy the last half an hour? You've got from 10.00 am to 3.30 pm that you can be a buyer?

Right, so it's not an exact science. I wish it was.

Okay, let me ask you another question. You might not want to answer this, but you're also allowed to buy one block a week. A, do people know that and maybe people on this call can hear this message is, if you're a seller, you can pick up -- someone can call you, and you're allowed to buy one block a week. Is that your understanding, Ed?

Yes, and we'll buy it. We're not being offered blocks, we wish we were.

So the sellers out there on the call, my recommendation is instead of selling in the open market, you can just call the Company and depending on the opportunity, they may buy your shares?

Absolutely.

Maybe that message will get out and the people that sold 300,000 or 400,000 shares in the last week or two could have just called you and probably gotten $0.30 higher in price because the price probably dropped $0.30 because of their sales.

Could be. We'd certainly buy it.

Well listen, Ed. My goal is not what you do in the next 90 days, but in the next three to five years.

Well we appreciate that, and that's our mission as well.

Okay. People will crucify me, excuse the expression -- if you raise the dividend, you may push the price up a little bit. You've got a great strategy here as long as you're able to execute it to buy back lots of stock, certainly, the $12 or $13 range. Buy back the shares, you'll always have time for doing a special dividend in two years or 18 months, you've got a great opportunity here. I know you want to take advantage of it. I know you're going to and I just want to wish you good luck in that endeavor.

Thank you very much.

Thanks, Ed.

Mark Zinski.

Yes, good morning.

Hi, Mark.

Hi. Kathy, just wanted to get some color on the -- you did a nice job of bringing down operating expenses. Is there any color on the cost-cutting initiatives, or are these I think in the last call you mentioned support services, expenses were brought down. Is that kind of the same scenario this quarter?

Absolutely, we're looking to continue to streamline things, renegotiating contracts, just finding ways to continue to take cost out of the business.

How far along do you think you are in that process? Obviously do you think there's still some room there?

We are finding room every day, so we're working hard at it.

Okay. In terms of the inventory build-up, was fairly substantial. Do you have expected sales over the next few quarters that you think are anticipated, or do you think too much inventory was -- you over-estimated some of the end markets, or what -- I think you mentioned that you expect inventory to gradually go down over the next few quarters, is that right?

That's true. Normally, especially with our larger vendors, the delivery time in this inventory is six months. What we attempt to do is to forecast what our sales are going to be, and as you well know, we forecasted our sales to be higher than they've been in the last quarter for sure, and so that inventory was coming in against a demand that didn't occur, so we react to that and as we go forward, we order less and as the sales continue to improve, as they did in February and March, we should be able to reduce the inventory by the end of the fourth quarter. The other side of that is there's some price increases out there, and we've been able to actually reduce our costs going forward and 3% to 5% on products that turn in four months, and it's a lot better to have inventory than to get 40 basis points in the bank for the cash, so that's part of the program as well.

Okay. Just in terms of the CO2 laser market, which is pretty correlated with the auto industry, which in general is I think exceeding people's expectations, are you seeing a meaningful replacement cycle begin for the CO2 laser product, and do you expect sort of a meaningful bump in that over the next few quarters?

We absolutely do. What we saw was the downturn occurred in areas like semiconductor wafer fab, the textile market, and the broadcast market, and so what we've done really is to focus our sales team on markets that are growing, and one of the fastest-growing markets in the industrial sector is the CO2 laser business. What you probably don't see is that the broadcast sector in the semiconductor wafer fab sector continued to go down dramatically, but we are able to offset that with the increased sales in the CO2 laser business, and that's increasing, so that's really encouraging. Plus, the margin in that business is over 40%, so we've done quite well there and we see that continuing.

As I mentioned in the call, we've determined that the majority, about 90%, of the users in Asia don't have the ability to replace the tubes in their own equipment, and so we're leveraging our acquisition of Powerlink and our goal is to be able to offer installation on tubes starting in the first quarter of fiscal 2013 in Asia. We think, in so doing, we can even increase that business, so it's a very substantial opportunity for us, and we see that business doing very well.

Okay, and that leads into my last question about the service center expansion plan. I think you mentioned you were going to start with Korea. Do you have -- is there a timetable, do you expect to have several centers established within several countries within Asia in 2013?

Yes, and we'll do that either through our own technicians or sort of a authorized repair center kind of agreement where we'll work with independent service companies that are already in place, and we'll authorize them to do service for us, either as an independent contractor, or as a value-added reseller, and we intend to have the first center in Korea by June 1, and then probably China and Japan are next. All three of those should be in place in FY 2013.

Okay, and then Kathy, did you have a CapEx forecast for 2013?

CapEx should remain relatively low, somewhere around $1 million.

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

Thanks, Mark.

Roman Kuznetsov].

Yes, it's actually Dax at Gates Capital. I'm wondering on the gross margin side, you said that you had some room for improvement in the fourth quarter and into 2013. What sort of magnitude, and what's driving that? Is it just the CO2 laser business?

Well that's certainly part of it. As we've mentioned in the past, we have several very substantial marketing agreements. One of them is fairly new that's been in place now, time flies, two years now, and our charter in that agreement was to take OEM business. Historically, this particular vendor had sold to original equipment manufacturers, and allowed them to service their own after-market. As you may know, the market for power grid tubes, in particular, like the CO2 laser application, 80% of the market today is for replacement in existing equipment, so you just basically had the OEMs acting like distributors and buying the product and reselling it.

Our charter is -- we put this agreement in place was to convert that business from an OEM business. It's very low margin to a user business and for example, in the CO2 laser business, the margins are over 40%, to give you some example. So we have a mix currently where we're still servicing some of the OEMs, and we're working hard to convert that to user business, and as we do that, the margins will come up substantially. We have--

How far along are you with that? What sort of like on percentage terms, how far are you to converting that?

Right now, the margin on that particular agreement is in the low 30%s.

No, I mean the percentage of the conversion from the OEM business to the user business. What -- if 100% is converting all of them, what percentage have you converted to date?

Oh, I would say 60%, 65%, something like that.

Okay.

I don't have the figure exactly but I can run it in my head for you well.

No that's fine, just ballpark.

To give you some idea, we have another agreement with another manufacturer that we've had in place for a long time and the margin on that business is about 36%, and it's primarily all user business. I think you can expect the business to go from the low 30%s where it is today up to that 36% level, and because it's CO2 laser it might even be slightly higher.

Okay, and then on the SG&A side, $9.5 million this quarter. Is there something unusual with this quarter, or is that a new run rate? Can you help us a little bit there?

Kathy?

The run rate on what?

SG&A.

SG&A was about $9.5 million this quarter, I think it was in the $10 million range. Is $9.5 million a good run rate going forward, or is something unusual with this quarter?

No, that's a good run rate; however, fourth quarter typically has some one-time expenses that hit us, so I'd anticipate that you're going to see sales improve in Q4, probably some margin improvement, but the operating expense number goes up a bit.

Just in the fourth quarter?

Yes.

Okay, and then Ed, when we originally started talking to you about uses of cash and you mentioned acquisitions, it sounded like most of the opportunity set was in sort of smaller, very, very small companies, and now you're talking about something larger, which is a bit of a change from what you said. What's changed there to make you believe you can allocate some significant capital to these sort of acquisitions? Maybe the general ballpark size of them, and sort of if there's different lanes of opportunity than you have outlined so far as far as different business segments or would it be in businesses that you're already in, or ones that are largely similar?

Okay, well it's the same strategy. There's still bolt on acquisitions. We went through a process and we're still going through it, of identifying companies where there's some kind of advantage for us to leverage our global infrastructure and our vertical markets that we sell into to sell more products. As we've gone through this process, we've now identified a couple of companies that are a larger size that we really like their model that could get us into those businesses faster.

To give you a description, what we're looking at is we sell a number of vertical markets. We've talked a lot about CO2 laser, and that's one of the smaller verticals, but also very interesting to us and we're doing well there, but there are other verticals. For instance, in our business a very large percentage of Canvys' products and also EDG's products are sold into the medical market. A lot of that is glassware, it's tubes that go into x-ray equipment, into diagnostic imaging equipment, into linear accelerators for cancer treatment. As well as tubes, there are all kinds of replacement parts that go into those markets.

That's an example where we could leverage our existing customer base and global infrastructure to sell a lot more products into a vertical market, and those are the kinds of things we're looking at. Semiconductor wafer fabs another one, security, homeland security's another one. But the base behind all that is that we sell tubes into that market, and we have relationships with those customers today. So it's expanding those relationships to sell more product to the same customer base, on a global basis.

Right, and as far as you can tell from the due diligence that you've done as far as the markets make sense, but obviously it would be a lot of capital to deploy and very important for shareholders. I'm just wondering about the sort of multiples you're comfortable with and obviously, with the price where the stock is now, most of them would be dilutive on an enterprise-value basis, but it might make sense if the absolute returns were good. Can you give us some sort of level of comfort that you're intensely concerned about the price you pay?

Well, it's really too early. If you follow my history -- and I know there are a lot of people out there impatient with my history, but I don't think it's going to change much -- over the years, we've never paid really premium multiples for companies, and we're usually buying private companies, so I don't think you'll see anything unusual. What we're looking for is a platform that can allow us to really leverage our global infrastructure to multiply what we're looking at rather quickly. Our objective has been pretty clear and we're not making a lot of progress on it right now, but our objective is to double the size of this Company in the next three to five years, and we think we can get there faster by doing an acquisition that gives us a platform to expand into these vertical markets more quickly.

Okay, I appreciate it.

Thank you very much.

[Mike Secos].

Hi, team, good morning.

Good morning.

I just wanted to touch up, Kathy, with the operating expenses declining, we saw streamlining processes, cost-cutting initiatives. Can you give us more color on what processes and initiatives are going in currently under way?

Well we're looking at every aspect of the business, every line item. As I said, a lot of it is services that were still related to cleaning up things from the transaction, so we're still incurring costs. We still have, as attrition occurs, we are absorbing those functions with the existing staff. We're looking at freight. We're looking at every piece of expense that we possibly can, and the expense components of margin as well.

I see, and for the -- I guess for the gross margins then, if you could talk about the year over year improvement that we saw despite the sales decline. Is that just a shift in product mix, or the fact that you have your sales force focusing on more profitable products?

It again, as I mentioned earlier, it's a shift from the OEM business to the user business, which is our historic customer base in some of the new distribution agreements that we have, and you'll see that continue almost on a linear basis over the next few years. I don't think you'll see more than 1% a year or so, but you'll see improvement, maybe a little more if we're lucky.

Okay, terrific. Thank you, guys.

Thank you.

[Austin Harper].

Good morning, thank you, my questions have been answered.

Okay, Austin, thanks.

Al Tobia.

My question was basically answered. I just wanted to get a little more detail on the acquisition criteria in terms of dilution and valuation that you're looking at. But you went through it in enough detail for me.

Okay, thanks, Al.

(Operator Instructions)

Robert Moses.

Hi, Ed and Kathy.

Hi.

Hi, Robert.

Just a couple questions. First, just geographically you had mentioned potentially some signs of improvement that you're seeing in North America, as well as Europe. Could you just maybe expand on that specific to Europe, whether there was maybe some discussion about the OEM business in Europe being weak for Canvys. But just generally, what are you seeing over there, and what gives you optimism we may be seeing improvement there?

Well from the EDG standpoint, the main reason why Europe has been better than North America had to do with the CO2 laser business. We're still seeing some real signs of weakness in Europe in certain sectors, so I don't think the problems are over there yet, it's still a huge challenge. Certainly one thing we are seeing in North America, the weakness all year was in the semiconductor wafer fab business, and the bookings in semiconductor wafer fab have improved dramatically both in February and March which is good news that at some point we're going to ship that product.

That's a good sign, that's probably the most cyclical business we deal with, by the way, is the semiconductor wafer fab area. Moreover, the majority of the strength we seem to make our own waves, it's our progress in the CO2 laser market that's creating the at least stability, and if you looked at that segment alone, some nice increases.

Okay. Second thing just really around this use of cash analysis that the Board does every quarter, I shouldn't say Board does, but Board reviews, which I think is a great idea. I think the struggle that everyone is having is you've been very crystal-clear on the operating margin goals and you've been improving towards that. Certainly revenue hasn't been necessarily where you've expected some of that just due to economic weakness. To the extent you can share with us, not specifics, but just kind of the balance sheet. As you think about doubling the business in the next three to five years, some of that's going to be organic, some of it's going to be acquisitions. I think there's some concerns some people have that maybe either the size or the valuation of those acquisitions could be bigger than what was previously thought.

To the extent you can share any of that information to say listen, over the next three to five years if we grow our business kind of 10% to 15% a year, this is what it's going to require in capital. I know you can't forecast acquisitions. One can be $70 million and one can be $7 million, so that's tough to do. But I think it would get everyone a sense and put everyone on the same page as to listen, of that $170 million, we think $70 million to $100 million could go towards acquisitions, and maybe $50 million could go to buy-back and certain amount -- I know you can't give us exactly what you're giving the Board, but to the extent you can give us some bookends on that, I would just argue that could be helpful for everyone involved.

Kathy do you want to address that?

I agree, Rob.

Okay. Again, I'm not trying -- I understand. I think, Ed, the frustration is the level and the pace. You've been consistent with the message, but I think it's really the pace. I think maybe there's also some -- two factors which maybe influence your view of the stock. One is certainly the valuation, where it's traded in the past, as well as maybe even the business, and when business gets soft, sometimes maybe there's a reluctance to buy shares. But you're not given the opportunity to buy the shares below tangible book unless business is soft.

I think just as you think about just setting the stage, you've done a great job on the income statement. If you could do a better job on the balance sheet and explaining and setting expectations, people that endorse that can stay on the reservation, those that endorse, they can't endorse that or don't want to can sell their shares. I think it's just everyone getting on the same page. That's more of a comment than a question but just thought it was relevant.

All right, well we really appreciate that. Actually, the analysis that you did, just some of the ballpark numbers that you used there are not too far away from what we're using in our cash model so you did very well.

Thank you. Back of the envelope works sometimes.

Okay.

Thanks, Ed.

We have no further questions at this time. I would now like to turn the conference back over to the speakers for any closing remarks.

Thanks, Chris. Well, thank you for joining the call today. We believe that Richardson Electronics is well positioned to deliver on our financial goals. We're gaining market share while delivering a solid profitability. I would like to once again thank all of our employees and our partners for their contribution to our success. We look forward to discussing our fiscal 2012 year-end results with you in July. Thank you very much.

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