Richardson Electronics Ltd (RELL) 2014 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the FY14 second-quarter earnings call. My name is Crystal and I will be your operator for today.

(Operator Instructions)

As a reminder, this conference is being recorded for replay purposes. I would now like to turn the conference over to your host for today, Mr. Ed Richardson, Chairman and CEO of Richardson Electronics, Ltd. Please proceed, sir.

Good morning and welcome to our second-quarter 2014 conference call. Joining me today are Kathy Dvorak, Chief Financial Officer; and Wendy Diddell, Executive Vice President, 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.

Second-quarter revenues were $35.4 million, a 3.2% decrease compared to net sales of $36.6 million in the prior year. Sales for EDG were flat, while sales for Canvys were down 10.9% compared to the prior-year second quarter.

We're not satisfied with these results, and however we saw some encouraging changes in the second quarter of our fiscal year. Sales in November were the highest revenue month of FY14, which makes us optimistic that the balance of FY14 will show increases over the prior year.

We're seeing signs that global economic conditions are improving. The Asia-Pacific region was up 6.5% from the prior year. We're also seeing growth in several key markets, including the industrial and automotive markets, which utilize CO2 laser cutting equipment, as well as the marine market, textile, wood and industrial manufacturing.

During the quarter, we continued to evaluate potential acquisitions in the diagnostic imaging and replacement parts market. We remain convinced that the demand for high-quality replacement parts will increase, as healthcare reform makes it more critical than ever for hospitals to focus on reducing costs in the face of declining diagnostic reimbursement. We firmly believe we can play a significant role as an independent parts supplier in the healthcare market in the future.

Now I'll turn the call over to Kathy Dvorak to present the details of our second-quarter financial performance.

Thank you, Ed. And thank you for taking the time to join us this morning.

Sales in our second quarter were $35.4 million, down 3.2% from the prior year. Gross margin increased to 31.1% of net sales, from 29.3% of net sales in the prior-year second quarter. The improvement in gross margin reflects a reduction of unabsorbed labor and overhead costs within our manufacturing operation, as well as a shift in customer and product mix by geography.

Operating expenses were $10.5 million for the second quarter of fiscal 2014 compared to $10.2 million in the prior year. This increase includes expenses related to strategic initiatives, such as support for our new IT platform and an investment in a new product development team.

Operating income for Q2 was $534,000. As I mentioned before, our challenge is to find opportunities to reduce costs, which allows us to strategically invest in materials of growth.

Interest income for the quarter was $255,000 and FX was a slight gain of $14,000. Income from continuing operations before tax was $788,000.

Our tax provision from continuing operations for the quarter was $157,000, or a 20% effective tax rate. For the total year, our cash tax requirements will remain low, while our effective tax rate will be around 36%, excluding any discreet tax events.

So income from continuing operations for the quarter were $631,000, or $0.04 per diluted common share. Sales for the first half of fiscal 2014 were $69.7 million, down 3.5% compared to $72.3 million during the first half of last year.

Gross margin increased to 30.4% compared to 29.6% during the first half of fiscal 2013. Operating income was $0.7 million compared to $1 million last year, and our income from continuing operations was $2.6 million compared to $1.3 million during the first half of fiscal 2013.

Turning to the balance sheet, cash and investments at quarter-end were $134.1 million. Our increase in inventory since the beginning of our fiscal year of $1.3 million includes approximately $700,000 of inventory related to the WBS acquisition and another $500,000 increase due to foreign currency translation related to the recent strengthening of the euro relative to the US dollar. Also, cash from operating activities during the second quarter was a source of cash of $249,000, which is cash flow net of any effects from foreign currency exchange and acquired businesses.

Looking to the third quarter, we are expecting sales to be in the range of $34 million to $36 million, up slightly from the prior year. The current market dynamics remain challenging and therefore, we are cautiously investing in growth initiatives. We are diligently working on our long-term objectives, which are to identify opportunities to grow sales, to cut costs, and to create shareholder value.

Now, I would like to turn the call over to Wendy to discuss the operating performance of Canvys.

Thanks, Kathy, and good morning, everyone. Canvys finished the second quarter with sales of $9.3 million. This was slightly better than the first quarter, but 11% below second quarter last year. Gross margin was 27%, which was up from 26.6% during the first quarter and flat with second quarter last year.

The team has done an excellent job reducing [in balance rate] costs as a percent of sales through better planning and a reduction in expedited freight requirements. Within our custom OEM display segments, which designs and sells customer-specific display solutions, our European business continued to show improvement in the second quarter. Sales were higher than the first quarter and better than last year's second-quarter sales on a significantly improved margins.

New business played a critical role in sales growth. The North American OEM segment was down compared to the second quarter of fiscal year 2013. The decrease is attributable to the relocation and temporary suspension of purchases by one of our key accounts.

The volume of quotes for new business continues to strengthen and backlog remains steady. During the second quarter, we began shipping several new displays to high-profile customers and working to corner that field in market. Margins continue to be solid, indicating that our customers see value in our engineering and other services we provide.

Our cost reduction pressure from our customers is tough and ongoing. The team has done an excellent job selling the benefits of customer solutions, but also working through options to lower costs. We are constantly balancing costs, new technologies, features and benefits with our customers and our suppliers.

With our ongoing focus on our two flat displays, we anticipate that margins will continue to hold steady or improve and we expect to reduce our turnaround time on delivering new production requirements. We are also investing time and resources in developing unique display solutions, which we can tailor to our customer requirements. Consolidating our demand around core components allows us to improve our purchasing power and control our own destiny, while increasing our value and perception as a technology leader to our customers.

In our healthcare segment, which includes the sale of picture archiving and communication systems, or PACS displays directly to hospitals, we continue to be challenged with tight capital expenditures budgets and compliance issues associated with new healthcare legislation. In 2013, IHS, a leading provider of critical information which focuses on the healthcare industry, reported that hospital spending reached historic lows with purchases increasing less than 2% over prior year.

This was evident at the RSNA show in November. Attendance was on par with 2012, but in 2012, attendance was down 12% versus 2011. However, on a positive note, it is anticipated that many displays are at the end of their warranty periods and will need to be upgraded. This, coupled with economic improvements, provided cautious optimism that the demand for medical grade displays, particularly in imaging by radiology and surgical segments, will rise significantly over the next three years.

In spite of market conditions, revenues in our healthcare segment improved during the second quarter. While sales were still below the second quarter of last year, sales were much stronger than we reported in the first quarter of FY14. Our backlog in healthcare is building and we've enjoyed several nice project wins in the quarter.

Two of the largest PACS software companies, McKesson and Sectra, recently announced they were opening up their software such that hospitals may select and buy hardware through sources other than the PACS software provider. This is a good opportunity for us, as it expands the size of the third available market.

We will begin shipping our new 6-megapixel display this week, which will further help us grow revenues in the quarter. We firmly believe that if Richardson Electronics expands its footprint in the diagnostic imaging replacement parts market, our opportunities to sell PACS monitors will expand as our reputation as a high-quality replacement parts provider coming into the market.

Our expanding healthcare strategy will improve our potential to sell in new geographical regions, such as China and Latin America, where healthcare facilities are just transitioning to digital technology. There is also an opportunity for us to revisit the PACS display market in parts of Southern Europe, which have been notably slow in adopting PACS.

We will continue to closely manage Canvys expenses and look for ways to improve working capital efficiency. We currently have excess capacity, but we do not want to negatively impact our ability to grow revenues in light of economic improvements and changes in our corporate strategy. Ed will now provide an update on EDG.

Thanks, Wendy. EDG sales in the first quarter were $26.2 million, the same as the prior year. Gross margin increased to 32.5% from 30.3%. We saw signs of global economic improvement as the Asia-Pacific region sales increased 6.5% and Europe finally stabilized.

Demand for industrial products in the textile, wood and plastics industries continued to improve, and as a result, our industrial heating business increased to approximately 15% in the quarter. The CO2 laser 2 business and associated consumable parts also performed well.

On a year-to-date basis, our marine and vacuum capacitor businesses, as well as Power Link, our satellite amplifier repair business, are also up. We're seeing many inquiries for new applications for both RF and microwave generators across various markets and applications, including mining, industrial heating, cooking, drying, and plasma.

We recently booked substantial orders for microwave generators in China, with additional significant projects in the pipeline. The initial prototype order for one project exceeded $1 million in revenue. The customer has the potential for more than 100 of these systems to be installed over an extended period of time.

As mentioned in the first quarter, we've now established a new product development team to support this growth, led by Ted Staub, former engineering manager of Microwave Cavity Labs. MCL was recently acquired by CPI and the manufacturing facility has been relocated to California and Canada.

Several of the MCL engineers have now joined Richardson Electronics as part of our product development team under Ted's management. They will focus on high-voltage power supplies used in microwave generators and other high-powered amplifiers.

We've also added technical support resources in key countries to provide superior customer assistance and drive our sales of more sophisticated engineered solutions such as microwave generators and power supplies. Our goal is to develop our own intellectual property, which we believe will not only create growth for the Company, but also give us more control over our future. We will develop standard products, which can be modified to specific customer applications.

We're also quite pleased with the progress of the engineering firm that we acquired in July in Germany to expand our activity into the power capacitor market. We estimate the power capacitor market to be $200 million annually. The additional resources have helped expand the number of products that we now offer to the power capacitor market.

We are also strengthening our ability to offer solutions to the OEMs. Historically, our focus has been on the replacement market. With our expanded engineering resources, we're developing unique products and expanding our product range with new partnerships.

This strategy also requires more training at the sales level to ensure we bring value to our customers. As a result of our investment and effort, our revenue and backlogs for power capacitors is increasing.

As we look to the future, Richardson Electronics will continue to build a line of replacement parts for the diagnostic imaging market. Our initial focus is on glassware, which includes flat panel detectors as well as CT and Xray tubes. We're adding a line of flat panel detectors and other high-value components and sub-assemblies to accomplish our objectives through a combination of acquisitions, strategic partnerships, organic growth programs.

We feel there is a major opportunity to become an independent supplier to the healthcare industry of high-quality replacement parts at twice levels well below the OEMs. We're confident that our sales in the diagnostic imaging replacement parts market will expand substantially in the balance of FY14 and more significantly in the FY15 and beyond, which will gradually expand Richardson Electronics' position from a legacy power grid tube provider to a key player in the healthcare industry.

We repeat our commitment to our shareholders that we'll use the funds received from the sale of RFPD in March 2011 to make strategic acquisitions, invest in growth strategies and repurchase stock. Today, we've spent approximately $6 million on acquisitions, which have provided additional resources, customers, and knowledge space support to EDG.

We're investing in resources to develop our own intellectual property and to support more sophisticated sales in the field. We've spent $56 million on our stock buyback program, which has reduced the number of shares outstanding to 14 million. We're confident that our acquisition program will expand substantially in the near future, which will ultimately result in increased revenue and earnings growth.

While economic conditions have made sales growth challenging, we do see the global economy slowly improving. At the same time, we worked hard to improve efficiency throughout the Company and reduce costs within the business wherever possible.

At this point, Kathy, Wendy and I will be happy to answer your questions. Crystal, may we open the line for questions?

(Operator Instructions)

Mark Zinski, 21st Century Equity Research.

Yes, good morning, everyone.

Hi, Mark.

Ed, just wanted to start off with a higher level question. This in-shoring phenomenon with some manufacturing moving from Asia to Mexico, I'm wondering if you've seen any impact from that on your business? And given your pretty wide geographical network, are you pretty much able to accommodate that?

I guess we've seen some of it. We've seen more manufacturing moving from China to countries like Vietnam and possibly India and things of that nature. Certainly, we have 25 foreign subsidiaries all over the world, so it's not an issue to us.

Wherever the customer wants to buy product, we can handle that efficiently. We can move product from anywhere in the world to anywhere in the world in one to three days.

Okay. So there's no real impact on your cost structure from any of these geographical shifts?

No, we're well represented in each one of those countries with sales engineers and we can handle the move seamlessly.

Okay, great. Next, I've got a few questions for Kathy. Kathy, gross margin bumped up nicely on EDG and I am just wondering if there were any kind of permanent actions taken to improve that? And is this gross margin sustainable at all?

Let me take that in pieces and then I'll let Ed comment as well. One of the biggest pieces, as I mentioned in my commentary, was the fact that previously we had lower capacity in manufacturing, so we had unabsorbed overhead, which impacted EDG's margin. Things have improved in that area and as a result, it has contributed to the improvement in margin.

From a product standpoint, I'll turn it over to Ed.

If you watch the fluctuations in our inventory levels, we're inclined to take advantage of buying at old prices when we see price increases from our major vendors. And we've seen some of that.

You saw the inventory bump up in the first quarter of the year and now start to level off in EDG. That was taking advantage of old prices, which have increased the margins to some extent. But we do that on a perpetual basis whenever we can.

Okay, great. And then, Kathy, do you have any visibility on FX volatility for next quarter? I know the euro has strengthened a bit. But have you guys done anything strategically in terms of moving cash around?

We try very hard to keep currencies in the base currency in those countries. I think we've done as much as we can to mitigate holding US dollars in our foreign entities. Other than that, I don't have a lot of visibility into foreign currency.

Okay. And then were there any one-time costs in SG&A this quarter?

Not one-time. Just as I described, again in my commentary, there were additional costs related to the investments in the building the new product development group.

Okay. Would you be able to quantify that at all? Was it material?

$200,000.

Okay. And then lastly, for Wendy, I'm just wondering what the sentiment is with your customer base regarding the Affordable Care Act. Are folks still kind of nervous and unsure what the impact is going to be? Any comments there would be helpful.

Definitely. We're seeing that at the hospital level, where again, money is tight. They are very conscious still of trying to take costs out of their organizational structures and out of their operational costs.

So we see them holding back for as long as they can on hardware purchases. I think they are still investing what available resources they have more in electronic medical records and that side of the business. So I would say definitely, they are still waiting to see exactly how all the rules are going to play out and then how much money they are going to get in reimbursements.

Okay. So really, yes, we still really haven't seen any beginning effects from the Affordable Care Act yet, per se?

Not in a positive way, if you're saying you're not in terms of increased demand for new equipment purchases.

Okay. And then, I'm sorry, one more question. Ed, on the acquisition front, are the multiples looking any better? Any color you can provide on how the acquisition strategy is going would be appreciated.

Okay. I wouldn't say the multiples have changed a whole lot. It depends on what segment you're looking at. Obviously, the three little acquisitions we've done were primarily in the tube distribution business and the service business, and those multiples are pretty reasonable.

We're working hard on several acquisitions. The problem is, it takes a willing buyer and willing seller, so we don't have control over a portion of that equation. We're hopeful that we'll see something rather substantial here in the next six months or so.

Great. Okay, that's it for me. Thank you.

Thank you.

Roman Kuznetsov, Gates Capital.

It's actually Dax. Ed, I was wondering, on the share repurchase program this quarter, were there points where you were restricted from buying stock due to negotiation on acquisition?

Yes, we obviously had some inside information for sure. So we were rather cautious during the quarter.

Okay. And on the acquisition side, you've talked about potential for some acquisitions and they kind of fell through. And for whatever reason, we're not pointing fingers that you should have done them or shouldn't have done them. But hearing a similar line of thinking, hopeful of substantial acquisitions coming up.

Are these different than the ones you were discussing before? Had those traded and these are totally new companies? Or is this re-engaging with some of those potential acquisitions? If we're starting off fresh from new ones, why do you think something will happen soon?

Well, it's sort of a mix. We saw some of the acquisitions that we weren't willing to pay up for, be unsuccessful as far as being sold somewhere else. And some of those have come back to take second look as to what we might be able to do. And some of them are new acquisitions as well.

How would you define substantial?

$50 million in revenue and up.

Okay. And then on the operations side, I think you mentioned something when you were talking about the microwave in Asia, you said you had one order of $1 million for one order. Did I hear you right, you said that there could be the need for up to 100 of these over time?

Yes. Yes, it's a very exciting application. We don't want to go into a lot of detail because it sort of lays out a road map for some of our competition. At this juncture, we have an exclusive position on this particular project. But we're excited about it.

We had the opportunity to visit the prototype system just before Thanksgiving and it's working very well. They have processed a very substantial amount of material through this system and they've proven the prototype works.

This particular industry is government-owned and regulated and the government has now approved the system. So we're really positive that this could be something for the future that's quite substantial.

It's going to take a long time. This first prototype system took six months to install. Fortunately, the company that's doing the installation work is backed by a major company within China. They have lots of cash resources, so if this takes off, they will staff up to facilitate the process.

And when you said up to a 100 over time, did you mean within a couple years? Or are you talking about a longer time-frame?

I would say three or four years, something of that nature. The problem right now is the length of time that it takes to install the system.

The system is, to give you some idea, it's in a building that's probably 250 feet long and 75 feet wide. It's a rather complex system that these generators are used in multiple conveyors in three different phases.

Fortunately, the prototype engineering is completed and it works well. We're just about to receive an order for a second system right now. But it's just going to take time to get these installed.

Would these be at similar gross margins to the overall segment?

Yes.

Okay. Thanks a lot.

Thank you.

(Operator Instructions)

Michael Poulos.

Hi, Ed. Mike Poulos. I was just wondering, haven't followed up on a lot of this.

Do we still house any of the Avnet services from that acquisition a few years back? I know you did serve some of that and got rent from them. Is that still in existence or not?

Yes, Mike, it's Aero. But Aero and Avnet are always confused.

Yes, they still, they have leases on the office facility and some of the warehouse here that's five years. We're three years into that program, so there are two more years to go. And we continue to provide them services, yes.

And I was just wondering, what kind of return do we get on our investment for cash?

Kathy, I'll let you work with that one.

Well, it's a balancing act because our cash is distributed around the world and we need to have liquidity in the event we are able to pursue some of these acquisitions. So obviously at this point, a return on cash is measured in basis points.

Is there anything that precludes us from extending the curve out? Because if we have the cash, it seems like there would be 2% or something like that, two or three years out and you could still borrow against the funds if you do make an acquisition or need it?

That is a possibility, and yes, we have invested in certain, even CDs, we've been able to go out a year or two and get higher returns. But unfortunately, it's nothing like what we would like.

Okay. Well, I hope you address that in the future, because it seems like the opportunity for last year's figures would have about doubled the bottom line if we had got some better interest. Thanks for answering my questions.

Okay.

Thank you.

(Operator Instructions)

At this time, there are no further questions. I would now like to turn the call back over to Mr. Ed Richardson for closing remarks.

Well, thank you, again, for joining us and for ongoing support of Richardson Electronics. We look forward to discussing our FY14 third-quarter results with you in April. We wish you all the best for a happy, healthy and prosperous new year. Thanks a lot.

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect, and have a great day.