Richardson Electronics, Ltd. (RELL) Q3 2012 Earnings Report, Transcript and Summary

Good morning, ladies and gentlemen, and welcome to the Fiscal Year 2012 Third Quarter Earnings Conference Call. My name is Chris, and I will be your conference moderator for today [Operator Instructions] As a reminder, this conference is being recorded for replay purposes and at this time I would now like to turn the conference over to your host for today, Mr. Ed Richardson, Chairman and CEO of Richardson Electronics. Sir,

Good morning, and welcome to our third quarter 2012 conference call. Joining me today are Kathy Dvorak, the 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 in 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 9 months of the fiscal year. We acquired Powerlink to provide the services our customers require to increase our share of the billion dollar microwave tube market and to enable us to sell more power grid 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 tools. 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 rates for both Canvys and EDG. We are closely monitoring all the components of gross margin and believe that gross margin will continue its upward trends 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 in last year's third quarter and $2.3 million lower than the first 9 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 the 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 9 months of fiscal 2012, sales were $119 million, up slightly from a $118.1 million of sales in the first 9 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 3 quarters was $5.6 million compared to $2.2 million in fiscal 2011. For the first 9 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 remains 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 3 [ph] to 6 months in advance of the inventory received. 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 repurchased 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 repurchase 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 the 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. Again, 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 Healthcare 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 FY 2012. The North America OEM team showed good year-over-year growth as existing customer demand associated with ongoing and new programs drove revenues higher increasing to over $3 million over prior year on an annualized basis. Backlog has continued to increase and we are starting to see new customers come online as a result of our intense cost-cutting activities over the past year. During the quarter, Canvys was nominated for and came in second on 2 of the Top 5 Supplier of the Year categories by one of our largest medical OEM customers. Healthcare sales rebounded nicely in Q3 as we received inventories to fulfill orders awarded late in the second quarter. The healthcare 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, PACS displays and reach more hospitals. Our Image Systems line of displays performs very well against other new brands but it is often a much better value, particularly when coupled with our excellent quality check and insurance plans. Our solutions are very attractive to hospitals that need to replace and upgrade existing tax equipment but 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 opportunity and paying close attention to other costs such as freight, which reduced our margin. We have also been diligent in preparing our bill of materials to ensure all costs are accurately reflected before we close. And working with our timeline sourcing team to take costs down and find more efficient display solutions for our customers. Considering the majority of our customers expect, and even demand, annual cost balance, both our program management and sourcing teams will need to think outside the box to meet these challenges head on, particularly in light of increased labor rates and some of the more traditional low cost countries. We anticipate that fourth quarter revenues will be slightly better than the first 3 quarters this year. We will 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 works, 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 a lighter 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’re 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 are launching a program in the fourth quarter to revise 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 the authorized, independent service companies. We will take 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 the third quarter of the prior year. We expect to see continued improvement in EDG’s margin rate as we increased our CO2 laser tube sales convert mark 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 the needs of our customers. We efficiently serve the aftermarket on a global basis with delivery from stock on highest quality products, vast technical knowledge and strong service capabilities. We’re currently researching the opportunity to expand our replacement products offerings and service the vertical markets, which utilize microwaves 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 reduced costs and improve service on the replacement parts requirements. In addition to focusing on new vertical markets, we are committed to continued market share gains within our existing business. Our combined goal is to double the size of the business in the next 3 to 5 years. We are 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 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 will 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 will continue to invest in our growth initiatives while opportunistically returning cash to our shareholders. At this point, Kathy, Wendy and I will happy to take your questions.

[Operator Instructions] And our first question comes from line of Al Tobia.

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 in a year ago 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? Was that a 1.6% yield or so and no increase in the dividend? Does that tell me that you are more favorably disposed towards returning shares through buyback versus increasing the dividend beyond this?

Well, we have been buying stock back every day as a matter of fact, within the regulations and at the current prices, the repurchase of the stock is the most accretive thing we can do. So that’s certainly priority as long as the price stays in this kind of range.

Okay. So if I address that then, through the first couple of quarters in the repurchase, if I look at the quotes from last year, basically it was said that it is going to take a few months to execute through the $25 million authorization. We are not through the authorization and the first batch of stock that was bought back was brought back at about $13.30 average price. In the last quarter, we reduced the amount of shares back from the purchase, 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 are 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 and which you buy back if you are on a program.

Well, certainly.

So, you are not regulated by the price?

We’re not regulated by the price but we’re regulated by the volume.

But you -- what I am saying is that you’ve lowered the price and you are 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 are 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 the market price of the stock.

I don't understand. I am confused again. You bought stock at $13 and change and you bought significant amount of it. You bought a lot more of it – you bought 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 are 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. So somehow you are paying less now than you were a year ago for the company and I just don't understand the thought process. You are -- letting the last sale dictate how much you buy, it doesn't makes sense to me, you should be buying based on what you think the value of the business is, no?

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

Depending on what price you set.

That's 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 are willing to pay, you can buy none and you bought -- I am just looking at numbers, I am just trying to understand the thought process. When you first announced that the cash came in, you spent $20 million in average price at $13.30. Last quarter you spent $1 million at under $12. I am failing to see the word -- what's going on here. You have more cash than when you built cash of the company. In theory, you’ve 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 are setting the price. So 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 you somehow -- you’re not returning the money to shareholders when the money first came in, you said that you were going to do it. I am just confused about the amount of money returned to the shareholders; that’s basically what I am trying to understand.

I certainly appreciate your opinion Al, but you know 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 prices you set. So I mean if you set the price at $10, the maximum volume you can buy will be 0?

The market is setting the prices of stock.

We beg to differ; I would beg to differ; but your comparables are up. That’s -- if you told me that the Russell Index was down 20% that’s fine; your index is up. So you are underperforming your index and you are lowering the price you’re willing to pay for your stock and therefore you are not getting any volume then?

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

So you would be comfortable if the stock drifted down $9 and you had $13 a share in cash, buying it $9.10 and only buying 50 shares a day if it only traded there?

We’ll buy the maximum buying allowed on that day.

Using the prices you set?

No, at the price the market sets.

Okay. Then on the dividend, you are not, you are comfortable with the $0.05 dividend which hasn’t been raised once in last year?

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

You do understand that what’s holding the company back is the lack of either boosting the dividend or more aggressive stock repurchasing right, in terms of the stock pricing. That is given, at least when the Board discusses things or no?

Al, we are doing exactly what we said we were going to do a year ago and we are going to continue to do acquisitions. We are going to continue to buy the stock back. We’ve raised the dividend. We will 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. A $0.05 dividend, I don’t think does anyone any good in terms of a return. So we are sort of between; we’re not buying enough stock because we have 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. And so we’ve got a low growth business; that’s way over capitalized with the small acquisition strategy and very, very minimal return of cash to shareholders and therefore an underperforming asset?

Well, we certainly appreciate your opinion.

Our next question comes from the line of Richard Whitman.

Yes, 2 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...

The accounting definition, because they are over one year.

Okay. And next question is to Ed. Ed, the previous gentleman’s comments, we won’t go over those, certainly an important part of capital allocation includes the stock buybacks 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 and I know you have addressed that you are 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?

Yes, we are actually considering several acquisitions that would be quite meaningful. It’s really too early to give you any further information on that.

But the targets have been identified and 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 and that is just too early.

Our next question comes from the line of Tim Grossman [ph] .

Well, let me first compliment you on doing a good job in a challenging macro world. 4.8% operating margins were quite good, unquestionably you are executing on your business plans and doing a good job of it and hopefully when the macro world improves we will be able to see better numbers from you. So that's the good news and I want to compliment [ph] 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 even the acquisitions that you're talking about that prospectively might help but you know if my calculations are right, I come up with a tangible book value of the company of about $12.40 a share and the stock is selling at $11.50. So we are 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 sort of 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 are going to see something happen that will be accretive and beneficial to the stock. I 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'll be able to demonstrate that to the investment world with some reasonably good accretive acquisitions and I hope that's forthcoming. So 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, 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 buyback plan and 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 value, I’m all for it. But we need to see something and we need to see something quick come out of the company that is meaningful.

Well firstly, thank you for your compliments on the operating performance of the company. We are 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 are 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 and I'm sure they will be communicating that to you as well.

Our next question comes from the line of Charles Fisher [ph].

Nice quarter by the way and I appreciate you keep moving the ball, I mean we had 2 metrics here that I think about as a shareholder of 1% of the company. We have a $12 value of cash and inventory and then we have $5 or $6 stub that heads [ph] on the earnings and it's important that we both take advantage of the $12 stub and that we also move the $5 stub to become $10 or $15 over time because that is going to create as much value as the buybacks, it is really a 2-pronged approach, I think your strategy could be effective with. Ed, could you talk about, we are getting 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% and 10% range over the next couple of 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 are disappointed in the revenue being so flat and impacted as we mentioned by the economic issues in Europe and probably more by the media than anything else that keeps people from buying in the aftermarket part. But we have seen it improve. February was good and March was even better on a run rate basis. So we're hopeful if that's turning around and it's all pretty much revenue based. Kathy and the team have done a great job taking cost out, as you see. So we think it's possible over the next couple of years to move up linear from that of 5% kind of number probably to a 7% at least and we hope to show you progress on that every quarter.

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

No, I think you're about right. Currently I think we are 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, 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 and then it's time 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 that it ends up, the stock being available, the time during the day when we can't buy it.

For instance you can't buy the first half an hour or you can't buy the last half an hour and you have got the time from 10:00 to 3:30 that you can be a buyer?

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

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

Yes, and we will buy it, we are 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 .

And maybe that message will get out and the people that sold 300,000 to 400,000 shares in the last week or 2 could have just called you and probably got a $0.30 higher in price, because the price probably dropped $0.30 because of their sells.

It could be, we would certainly buy it.

Okay, well listen Ed, my goal is not what you do in the next 90 days, but the next 3 to 5 years.

We appreciate that, and that’s our mission as well.

Okay, people will crucify me, if you use 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 are able to execute it to buy back lots of stock, certainly in the $12 to $13 range. Buy back the shares, you’ll always have time to doing a special dividend in 2 years or 18 months. You've had a great opportunity here. I know you want to take advantage of it and I know you are going to and I just want to wish you good luck in that endeavor.

Our next question comes from the line of Mark Zinski.

Kathy, I 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 these, I think in the last call you mentioned the support services expenses were brought down. Is that kind of the same scenario this quarter?

Absolutely. I mean we’re looking to continue to streamline things, renegotiating contracts, just finding ways to continue to take costs out of the business.

And 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 are working hard at it.

Okay. And then, in terms of the inventory buildup was fairly substantial. Do you have the expected sales over the next few quarters that you think are anticipated or do you think, you know too much inventory was over estimated the some of the end markets or you know, what I think you mentioned that you expecting inventory to gradually go down over the next few quarters. Is that right?

That’s true, yes. Normally, especially with our larger vendors, every time in this inventory is 6 months and so what we attempt to do is to forecast what are sales are going to be, and as you well know, we forecasted our sales to be higher than they have been in the last quarter for sure. And so that inventory was coming in against the 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 in March, we should be able to reduce the inventory by the end of the fourth quarter. The other side of that is there are some price increases out there and we’ve been able to actually reduced our cost going forward 3% to 5% on products that turn in 4 months and it’s a lot better to have inventory than to get 40 basis points in the bank for the cash. So, it’s a final program [ph] as well.

Okay. And then just in terms of the CO2 laser market, which is pretty correlated with the auto industry, which in general is, I think, exceeding people 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 down turn occurred in the 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. So, what you probably don’t see is that the broadcast [ph] sector and the semiconductor wafer fab sector continue to go down dramatically, but we were able to offset that with the increased sales in CO2 laser business and that’s increasing. So that’s really encouraging. Plus the margin in that business is over 40%. So we have done quite well there and we see that continuing. As I mentioned in the call, we 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 are leveraging our acquisition of Powerlink and our goal is to be able to offer installation on tubes starting in the first quarter of fiscal ‘13 in Asia, and we think in so doing we can even increase that business. So it’s a very substantial opportunity for us to see that business doing very well.

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

Yes. And we will do that either to our own technicians or sort of an authorized repair center kind of agreement where we will work with independent service companies that are already in place. And we will authorize them to do service for us, either as an independent contractor or as a value added reseller. And we intend to have a first center in Korea by June 1, and then probably China and Japan are next, and all 3 of those should be in place in ‘13 – FY ‘13.

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

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

Our next question comes from the line of [indiscernible].

It’s actually [indiscernible] Capital. I am wondering from a gross margin side. You said that you had some room for improvement in the fourth quarter ’13. What sort of magnitude and what’s driving that? Is it just a 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, the last 2 years now and our charter in that agreement was to take OEM business. Historically, this particular vendor had sold the original equipment to manufacturers and allowed them to service their own after-market. And as you may know the market for power grid tubes in particular like the CO2 laser application, 80% of the market today for replacement in existing equipment. So you just basically have 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 that’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 a...

How far along are you with that? I mean what sort of like on percentage terms, how far you did converting that?

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

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

I would say 60%, 65% something like that. I don't have the figure exactly, but I can run it in my head for you all.

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. So I think you can expect the business to go from the low 30s 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 in this quarter or is that a new run rate? Can you help us a little bit there?

Run rate on what?

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 this quarter?

No, that’s a good run rate, however, fourth quarter typically has some onetime expenses that hit it, so I would anticipate that you’re going to see sales improved in Q4, probably some margin improvement, but the operating expense number goes up a bit.

Just in the quarter fourth?

Yes.

Okay. And then Ed, when we originally started talking to you about uses of the cash and you mentioned acquisitions, it sounded like mostly opportunities settle in sort of smaller very, very small companies. And now you are talking about something larger which is a bit of 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 is different lanes of opportunities and then you have outlined so far as far as different business segments or would it be in businesses that you’re already in or is that are largely similar?

Okay. Well, it’s the same strategy; there is still bolt-on acquisitions; we went through a process and we’re still going through it of identifying companies that, where there is some kind of advantage for us to leverage our global infrastructure in our vertical markets that we sell into to sell more products. And as we’ve gone through the process we’ve now identified a couple of companies that are larger sized that we really like their model that could get us into those businesses faster. So to give you a description, what we are looking at as we sell in a number of vertical markets, we talked a lot about CO2 laser and that’s one of the smaller verticals but also very interesting to us and we are doing well there. But there are other verticals, for instance, in our business, a very large percentage of Canvys’ products and also the EDG’s products are sold into the medical market and 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 and as well as tubes, there are all kinds of replacement parts that go into those markets. So that’s an example where we could leverage our existing customer base and global infrastructure to sell a lot more of products into a vertical market and those are the kinds of things we’re looking at. Semiconductor wafer fabs, another one, Security, Homeland Security is 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 products 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 makes sense, but obviously it will be a lot of capital deployed and very important for shareholders and I am just wondering about the sort of multiples you are comfortable with and obviously with the price where the stock is now, most of that would be dilutive on an enterprise value basis, but it might make sense if absolute returns were good. So can you give us some sort of level of comfort that you are intensely concerned about the price you pay?

Well, it’s really too early. I mean if you follow my history, and I know there are a lot of people out there impatient about my history, but I don’t think it’s going to change much. And over the years we never paid really premium multiples to companies and we are usually buying private companies and so I don’t think you’ll see anything unusual. What we are looking for is the platform that can allow us to really leverage our global infrastructure to multiply what we are looking at rather quickly. Our objective has been pretty clear and since we’re not making lot of progress on it right now, but our object is that we’ll double the size of this company in the next 3 to 5 years and we think we’d get there faster by doing an acquisition that gives us the platform to expand into these vertical markets more quickly.

Our next question comes from the line of Mike Cikos [ph] .

I just wanted to touch up, Kathy, with the operating expenses declining, we saw stream lining process, cost cutting initiatives, can you give us some more color on what processes and initiatives are going in currently underway?

We are looking at every aspect of the business, every line item. As I said, a lot of it is services that were still you know related to cleaning up things from the transaction. So we’re still incurring costs; so we still have as attrition occurs, we are absorbing those functions with the existing staff; we’re looking 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 can talk about I guess 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?

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 will see that continue almost on a linear basis over the next few years. I don't think you will see more than 1% a year or so but you will see improvement may be a little more if we're lucky.

Our next question comes from the line of Austin Harper [ph] .

My questions have been answered.

The next question comes from 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.

[Operator Instructions] And our next question comes from the line of Robert Moses.

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

Well from an EDG standpoint, the main reason why Europe has been better than North America had to do with the CO2 laser business. We are 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 the 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 in, both in February and March which is good news. At some point we are going to ship that product. So that's a good sign. That is probably the most cyclical business we deal with by the way is the semiconductor wafer fab area. But moreover, the majority of the strength we seem to make our own ways, it's our progress in the CO2 laser market, that’s creating at least stability and if you looked at that segment alone, you’ll see some increases.

Okay. Second thing just really around this use of cash analysis that the Board does every quarter, I shouldn’t say the board does but board reviews, which I think is a great idea and I think the struggle that everyone is having is you have been very crystal clear on the operating margin goals and you have been improving towards that. Certainly revenue hasn't been necessarily what where you had expected some of that, just due to economic weakness. But you could share with us, not specifics but just kind of the balance sheet as you think about doubling the business in the next 3 to 5 years, some of that's going to be organic, some of it's going to be acquisitions. I think there is some concerns that people have that maybe it is the size of the valuation of those acquisitions could be bigger than what was previously thought, but to the extent you can share that information to say, listen over the next 3 to 5 years if we grow our business kind of 10% to 15% a year this is what it’s going to require capital. I know you can't forecast acquisitions, one can be $70 million, one can be $7 million, so that's tough to do. But I think it would give 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 buyback and certain amount. I know you can't give us exactly what you are 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.

Again, I am not trying, you know I understand, I mean I think Ed you know the frustration is a level on the pace, I mean you've been consistent with the message, but I think it’s really the pace and I think that there maybe there's also some 2 factors which may be influenced 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 are not giving the opportunity to buy the shares below tangible book unless business is soft. So I think just as you think about 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. So I think since everyone is getting on the same page, that's more of a comment than a question, just thought it was relevant.

Alright, well we really appreciate that and actually the analysis that you did, some of the ballpark numbers that you used there are not too far away from what we are using in our cash model, so you did very well.

And 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 solid profitability and we 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.