Richardson Electronics, Ltd. (RELL) Q4 2012 Earnings Report, Transcript and Summary

Good morning, ladies and gentlemen, and welcome to the Richardson Electronics Fourth Quarter and Fiscal Year 2012 Conference Call. As a reminder, this conference is being recorded for replay purposes. At this time, all participants are in listen-only mode. [Operator Instructions] We will be facilitating a question-and-answer session following the presentation. I would now like to turn the presentation over to your host of today call, Mr. Ed Richardson, Chairman, CEO, and President of Richardson Electronics. Please proceed, sir.

Good morning, and welcome to our fourth quarter 2012 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. Net sales for fiscal 2012 were down slightly to $157.8 million, compared to $158.9 million in fiscal 2011 reflecting the cautious purchasing behavior we experienced from our customers throughout the year. Sales in North America were up slightly while sales in all other areas were down. Canvys sales were up slightly year-over-year, while EDG revenues were slightly below the prior year. Gross margin increased from 29% of sales in fiscal 2011 to 29.6% in fiscal 2012, as a result of our continued effort to shift sales from the OEM to the end user market and to focus on profitable segments of the business. Operating expenses were well below prior year helping us deliver significantly higher operating income of $6.3 million this year compared to $2.8 million last year in spite of the impact of the economic challenges on revenue growth. We recognized that economic recovery remains uncertain, particularly in Europe and Asia, which represented nearly half of our revenue in FY 2012. We continue to believe that there are market factors working in our favor. Strong demand for automobiles, for example, increases the number of laser cutting machines that are in operation, which drives demand for power grid tubes. Healthcare reform and the potential for 40 million new insurers will increase demand for medical equipment and services, which in turn drives demand for glassware such as X-ray tubes, magnetrons, Klystrons, and medical displays. In our FY 2013 planning process, we were careful to maintain a relatively flat cost structure with spending increases primarily tied to initiatives, which support these niche markets and opportunities. We will continue to invest in our service capabilities, which enable us to sell through a broader base of customers who today cannot install replacement tubes without technical support. We continue to look for acquisitions that allow us to leverage our existing customer base and global infrastructure, which will drive down our fixed expenses as a percent of sales. Now, let me turn the call over to Kathy to present the details of our fourth quarter performance.

Thank you, Ed, and good morning, everyone. While sales were below our expectations, we continue to execute extremely well. The fragile state of the global economy continues to create tremendous uncertainty. Despite the challenging environment, which impacted our top line growth, we achieved operating income for fiscal 2012 of $6.3 million or 4% of sales, and income from continuing operations of $8 million or 5.1% of sales. Focusing on the fourth quarter, sales were $38.9 million, down 4.6% from the prior year’s fourth quarter. Gross margin improved to 28.5% from 27.9% in the last year’s fourth quarter. This increase primarily reflects an improved gross margin rate for EDG offset by a decline in Canvys’ gross margin rate. Gross margin for Canvys was impacted by a warranty claim. Adjusting for this, we would have seen an improvement in gross margin for Canvys as well. Overall, we believe that gross margin will continue its upward trends as we progress through fiscal 2013. We continue to tightly manage our expenses. Operating expense dollars in this year’s fourth quarter were $10.4 million, down by $400,000 from the prior year. This included $900,000 of additional expense noted in our press release. Operating income for the fourth quarter of fiscal 2012 was $0.7 million or 1.8% of sales compared to $0.6 million or 1.4% of sales in the fourth quarter of last year. Interest income for the quarter was $384,000 and FX represented a gain of $281,000. Income from continuing operations was $1.4 million before tax. Our tax provision from continuing operations reflects a benefit of $2.4 million related to a change in our position for permanently reinvested foreign earnings. So income from continuing operations after tax was $3.7 million or $0.22 per share. For fiscal 2012, sales were $157.8 million, down slightly from $158.9 million of sales in the prior year. Gross margin was $46.8 million or 29.6% compared to $46.1 million or 29% in fiscal 2011. Operating expenses were $40.6 million versus $43.3 million. Operating income for fiscal 2012 was $6.3 million or 4% compared to $2.8 million in fiscal 2011 or 1.8%. Income from continuing operations net of tax was $8 million or $0.47 per share. Our cash and investments at the end of our fiscal year was $159.6 million. During the quarter, we spent approximately $10.9 million on share repurchases. At year end, accounts receivable was $19.7 million versus $22.4 million at the start of our fiscal year. On a positive note, DSO improved by 4 days and our inventory balance declined by $3.7 million from the third quarter. We are committed to executing on our growth strategies, while keeping our cost structure under control. This will allow us to achieve our operating margin target of 5% in fiscal 2013. We will continue to return value to our shareholders. We have repurchased about 1.9 million shares during fiscal 2012 using approximately $24 million of cash and we have repurchased 2.9 million shares since the inception of our repurchase program. As of today, there are 15.7 million shares outstanding. Our total share repurchase authorization remaining is 38.5 million, which includes the incremental $25 million just authorized by our Board. Our outlook for sales for the first quarter of fiscal 2013 is approximately $36 million to $38 million and accordingly we expect sales for our fiscal year to be in the range of $170 million to $175 million. Capital spending for fiscal 2013 will be about $1 million. We believe our GAAP tax rate will be about 37%, although, we currently have a $6.6 million income tax receivable, which will mean that we will most likely not have a cash outflow for tax payments during this fiscal year. In conclusion, we are confident in our ability to reduce our costs and achieve our operating margin target. Our long-term objective is to grow the business, which will allow 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, everyone. We are very pleased with Canvys performance in FY 2012. Fourth quarter sales were $11.9 million, a 6.5% improvement over prior year. For the full-year Canvys sales were up $45.3 million, or just slightly higher than FY 2011. The North America custom OEM segment led the way finishing the year with significant year-over-year growth in sales and margin improvement through its focus on OEM project selection and pricing. Healthcare also finished the year strong. Although healthcare sales were slightly below prior year on a full-year basis, higher margin and expense control resulted in significant bottom line improvements. Our European segment continues to struggle during the fourth quarter and revenues for the year ended well below prior year. In spite of lingering economic concerns, we remain optimistic that with renewed attention to and accountability for prospecting specifically the identification and targeting of OEM customers in markets that have already shown a propensity to use custom displays that we will see growth beginning later in FY 2013. Canvys’ gross margin for the fourth quarter was 23.3% versus 24.7% earned in last year’s fourth quarter. The gross margin includes a significant charge of $300,000 for a warranty claim. On an adjusted basis, the gross margin would have been 25.8% for the quarter. On a full-year basis, gross margin was 26.9% versus 24.6% last fiscal year, or 27.6% of sales on an adjusted basis. The Canvys team did an excellent job in sourcing and pricing programs, managing manufacturing and engineering resources, and controlling other inventory related costs such as inbound freight and obsolescence. Moving into FY 2013, we expect that healthcare reform will have a positive impact across all of the Canvys’ segments, as demand for digital imaging services will increase the demand for medical equipment and displays. Additional capital is also being deployed by the hospitals to upgrade and replace imaging equipment and infrastructure. The past few years have been difficult on hospital budgets and the technicians have been forced to repair or use equipment that is performing below peak levels. Equipment eventually reaches a point where repairs are no longer practical or even viable. Several of the large display manufacturing companies have indicated an interest in entering the medical display business to help offset losses in the highly competitive consumer market. But we feel our customer approach to the market, addresses niche demand. The economics of doing small production runs do not make sense for these larger manufacturers. Canvys is also considering expansion in other countries where EDG currently has sales and support resources. We are looking for countries where demand for medical service and equipment is growing in line with population increases and rising median incomes and where governments are changing laws to improve the level of medical services provided. This includes countries such as China, India, Brazil and Mexico, just to name a few. While we are optimistic about the future of Canvys, we will remain diligent about expenses and working capital requirements and adjust both if and when needed. We do not have a lot of incremental expense planned for the year. We will add key positions to support modest growth and these will be tied to segment performance and outlook. We look forward to updating you on our progress again at the end of the first quarter. Thanks for your time and interest this morning. Ed?

Thanks, Wendy. We’re definitely pleased with Canvys has begun contributing to the overall profitability of the company in a meaningful way. EDG had a more challenging year, although still highly profitable due to its dependence on markets, which are more susceptible to the economic conditions such as semiconductor wafer fabrication. Sales for FY 2012 finished at $112.6 million, down 1% compared to the prior year. All geographic areas except Europe were below prior year. Performance during FY 2012 represents an 11.4% increase in industrial power grid tube sales primarily due to our exclusive distribution agreements and rising demand for CO2 laser tubes. This was offset by a decline in our broadcast business relating primarily to the conversion of analog to digital broadcasting and the replacement of tube-type equipment with solid state equipment. We also experienced a $3.5 million decline in continuous-wave magnetrons and related assemblies sold primarily into the semiconductor wafer fabrication markets. Gross margin remains flat year-over-year at 30.8%. Throughout FY 2012, we focused our efforts on the CO2 laser market. Early in the year, we determined that the majority of users outside of the United States do not have the ability to replace tubes in their own equipment. Under Powerlink supervision, we’ve now contracted with independent service companies in China, Korea, and Taiwan, and we’re able to offer installation services with the sale of tubes which should give us access to a much larger portion of the market. We will continue to add a combination of independent service companies and field technicians in the major countries of Europe and Asia to service CO2 laser equipment, as well install tubes and consumable parts for our customers. This initiative will help drive improved margins as well as sales in FY 2013. Overall, we remain cautious about an economic recovery in Europe, and the longer terms impact of the downturn in the economy in China. We’ll continue to act conservatively in the new fiscal year. This will not however prevent us from pursuing initiatives and acquisitions, which will take advantage of our resources and infrastructure to sell new products and access additional markets. During the fourth quarter we worked with a consulting firm to evaluate several different market opportunities. Of particular interest, our market is currently dominated by OEMs where there is a large aftermarket in which the OEMs sell parts and service to the customers at extremely high prices, and where market dynamics create a need for independent parts and service providers. Providing users with a cost effective alternative to OEMs who dominate the aftermarket for parts and support has traditionally been Richardson Electronics formula for business success. Of particular interest to us is the healthcare market. For many years, we’ve supplied a range of products to medical OEMs, service providers in hospitals. We spent considerable time over the past 6 months meeting with and listening to biomedical technicians, independent service organizations and medical replacement parts providers. We understand there is a significant opportunity for an independent parts company to help reduce reliance on the OEMs and subsequently cut healthcare costs. While the U.S. is fairly well served, Europe and other developing countries such as China, India and Brazil present a unique opportunity to provide cost effective medical replacement parts and services. We look forward to sharing more of this strategy with you in coming quarters. We anticipate that the sales for Canvys and EDG for the first quarter of fiscal 2013 will be in the range of $36 million to $38 million, while sales for the full year of fiscal 2012 should ramp up and be in the range of $170 million to a $175 million, excluding the impact of acquisitions. We remain confident that we’ll be able to achieve our operating margin target on a full year basis in excess of 5%. We remain 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 on our key initiatives while opportunistically returning cash to shareholders through share repurchase and dividends. We have repurchased 2.5 million shares of stock totaling $32.7 million to date. We announced yesterday, we’ve increased our quarterly dividend by 20% and the board authorized an additional $25 million for share repurchases. At this point, Kathy, Wendy and I will be happy to take your questions.

[Operator Instructions] Our first question comes from the line of Mark Zinski.

First question has to do with Europe, I’ve noticed there some distribution companies have adopted a kind of a formal strategy within Europe in that they are targeting the healthier countries in Europe, say versus like the southern countries in Europe. Have you adopted any kind of strategy similar to that to deal with Europe?

I’m sorry, Mark I really didn’t get it.

Okay. Can you hear me okay?

Yes, yes.

Okay, yes, just wondering if you have any specific strategy for Europe. I’ve noticed some distribution companies are focusing more on the northern countries - the healthier economies in allocating less resources to, for instance the southern countries in Europe?

Okay, well the majority of our business in Europe at least for EDG is for replacement tubes and existing equipment. So we go to the market where that equipment is installed and a much larger portion of that type of equipment is in Germany and some of the economies that are much healthier at the moment. So that’s where our focus is. But we do, do a substantial amount of business in Spain for example. So it’s really, we’ve indentified for instance in the CO2 laser market over 9,000 sockets per tubes. And we know by country where they are, so we spent our time in those countries where the business is and it’s not looking at either Northern Europe or Southern Europe, it's where the sockets are.

Okay. And then can you provide a little more color on the CO2 laser market just in terms of the percentage of sales that you’re deriving from the CO2 laser market or any kind of year-over-year growth figure for that segment?

Well, the growth has been substantial. First look at the overall market, it’s dominated by 2 or 3 very large OEMs and they in the past have serviced the majority of their aftermarket business. So we have tried to, as usual, which has always been our strategy, is to address the users directly, not only for tubes but also consumable parts to go into that equipment. And as I mentioned earlier, we have identified about 9,000 sockets around the world that use our grid tubes in CO2 laser application and we think that there is probably another 3,000 to 5,000 sockets that we haven’t identified. We’ve also as I mentioned in the earlier determined that in Asia particularly where the equipment is fairly new that the users don’t have the ability to replace the tubes in the equipment, so we have developed alliances with third party service organizations and actually employed some of our own technicians, but we can actually install the tubes for the customers to be able to access that market. The business during the year in the CO2 laser area was up about $6 million. So, it’s a substantial increase and a major portion of the increase and power grids is which we talked about earlier, but there is a long way to go and it’s a very substantial market out there, we’re probably half way there.

Okay. Given the recovery in the auto industry and given that there is generally like 2-year replacement cycle on the CO tubes, would you say that that replacement cycle is now kind of in full swing or is there still room for that - room for that to grow?

Well again, this equipment by the way has been sold for over 20 years. Our equipment is out there for a long period of time and the replacement cycle has to do with whether the equipment is used 12 hours a day or 24 hours a day or 8 hours a day and the tubes actually last about 2.5 years to 3 years depending upon how many hours a day they are used. So the replacement cycle is directly dependent upon the production cycles for instance, in the automotive industry, we’ve been told in the U.S. they have even been working 6 days a week and that obviously produces more requirements for replacement tubes. So I think the answer to your question is that the total demand is pretty constant year-over-year and it’s very much dependent upon how many hours a week that equipment is being used. We think for example, if the OEM level is at total purchases of tubes and CO2 laser equipment is probably $25 million somewhere in that area. So there is a way - there's a ways for us to go.

Okay. And then, just last question in terms of your acquisition strategy, I think you mentioned on the last call that you were entertaining the possibility of the - doing a larger acquisition or you are open to the idea of larger acquisitions than maybe you had been in the past. Any update on kind of your thinking in terms of potential acquisitions, what you are seeing out there in the market, and if you are still entertaining potentially a larger acquisition?

What we’re probably considering half a dozen different companies as we speak in various stages, some of them are fairly substantial as far as size is concerned. It all comes down to economics I’m not used to paying a high multiple for companies and what we’re seeing out there right now our multiples they don’t have anything to do with EBIT. They have something more to do with revenue, and we’re not willing to get into that practice at all. It’s always a willing seller and a willing buyer, we keep working the program.

And, our next question comes from the line of Roman [indiscernible].

Hey, guys, just one question. With revenues slated to grow 9%, 10% in 2013 based on your guidance. What kind of increase in working capital will that require or do you think you’ll be able to maintain some of the improvements you guys achieved this year?

Hopefully, we will be able to maintain the improvement. I mean we will see inventory kind of go through cycles for us, we build in Q1, Q2, Q3 and it tends to come down in Q4, but we certainly are looking for working capital to be a source of cash next year.

How much? Any idea?

We will be happy if it’s a small contribution.

And, our next question comes from the line of Mike Chicos [ph].

I had a question for you on the sales guidance we’re seeing. And I was hoping, you’d be able to walk me through. So the first quarter, we’re looking at $36 million to $38 million but for full year, we’re looking at about $170 million. So I just wanted to know, what’s your reason or logic why the revenue would ramp over the course of the upcoming year?

Well, normally the first quarter, just on a calendar basis is our lowest quarter and the reason for it is, Europe especially Southern Europe just about closes up for August. So it tends to be a 2-month quarter for us and we normally see that. The second quarter is the strongest and then it just ramps all year long. Some of that has to do with some of the initiatives that we’re working on as far as being able to actually service and install tubes in Asia. We just started that program actually June 1 to be able to offer installation services on tubes in China and in Korea and Japan. And we intend to open more agreements to install tubes on a global basis and so as we do that, that business will ramp up on a linear basis and impacts the quarters as well.

Okay. And then, that service and installation business that you have in Asia and you’re focusing on also in Europe. Is that the reason why you’re expecting this, let’s say 8% to 10% increase year-over-year in sales?

As far as EDG is concerned, that’s true. Canvys is more OEM focused and its projects that they’re working on that are more long-term. You want to talk to that, Wendy?

You’ve pretty much covered all that. We've -- our entire team is focused on prospecting and making sure that we have new projects that we’re looking at and as I’ve mentioned particularly as we look at Europe, some of its growth and the recovery will come later in the year in the third and fourth quarter as we look towards economic recovery. So, we’re quite optimistic again that our third and fourth quarters will continue to show improvement over the first and second.

Okay and with the - I guess that you had said the Canvys is focused on longer term projects, how long do those projects typically last for?

Yes, that’s the good news. So, they typically take between 6 and 18 months in terms of from the time we start talking to the OEM until the time that we start shipping products. But with the OEM market once you’re in, they don’t like to re-design or re-certify their equipment. So you’re in typically for a minimum and I do mean minimum of 3 to 5 years. A lot of our customers are much longer term than that.

I see, all right. And one other thing that I wanted to ask was regarding the tax provision that you guys had in the fourth quarter of this year. You said that was associated with relocating foreign investments?

No, it had to do with the fact that we have now said those investments cash overseas in certain countries is permanently reinvested for tax purposes.

And our next question comes from the line of Steve Kurtzman.

Could you tell us how much of your cash is held overseas and specifically where it’s held?

Primarily right now I think there is about $40-some million that’s held overseas and it’s in primarily Amsterdam and Asia.

Okay, thank you and you mentioned in your prepared remarks that your SG&A was up about $900,000. Could you elaborate on what the increase costs were?

This has to do with bad debt expense, we had a single large customer that unfortunately didn’t pay us that we had to take that expense. And then we had some severance expense that was somewhat unusual.

So, should we think about $9.5 million as a good SG&A run rate for you guys?

Probably close to 10.

Okay, thank you. And one last question. You guys have done a great job managing costs, could you talk to us about how much variability there is in your cost structure, I mean if there is another hit in sales next year, how much further can you ratchet back the costs?

Well that’s an interesting question. We’re doing everything we can to pull down costs, obviously incentives fluctuate, but we have very much a fixed cost structure. So, we will hold the line as best as we can.

One thing that does happen is that our sales team and throughout the organization, the employees that are highly incentivized on performance. And if we don’t hit the sales number our incentives are not anywhere near as high. So the compensation comes down.

And we have no further questions at this time.

All right, well we thank you very much. I’d like once again to thank all of our employees and partners for their contribution to our success in FY '12. And we look forward to discussing our fiscal 2013 first quarter results with you in October. We wish all of you the best in the coming months. And we’ll speak to you then.

Ladies and gentlemen, we thank you for your participation in today’s conference. This concludes the presentation, and you may now disconnect. Have a good day.