Richardson Electronics, Ltd. (RELL) Q2 2016 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the FY '16 Second Quarter Earnings Call Richardson Electronics. My name is Stephanie, and I will be your operator for today. [Operator Instructions] I would now like to turn the conference over to your host for today, Mr. Ed Richardson, CEO. You may proceed.

Thank you, Stephanie. Good morning, and welcome to Richardson Electronics Conference Call for the Second Quarter Fiscal Year 2016. Joining me today are Robert Ben, Chief Financial Officer; Wendy Diddell, who I'm pleased to announce the board recently promoted to Chief Operating Officer; Greg Peloquin, Executive Vice President and General Manager of our Power & Microwave Technologies Group; Pat Fitzgerald, Executive Vice President and General Manager of Richardson Healthcare; and Jens Ruppert, Executive Vice President and General Manager of Canvys. As a reminder, this call is being recorded and will be available for audio playback on our website. I'd like to remind you that we'll be making forward-looking statements and they're based on current expectations and involve risks and uncertainties. Therefore, our actual results could differ materially. Please refer to our press release and SEC filings for an explanation of our risk factors. Sales performance in the second quarter of fiscal year 2016 was mixed based on business unit and geography. Richardson Healthcare continued to show year-over-year growth on improved margins with the acquisition of IMES in June of this year. The customer response to our standard range of products and services at the recent RSNA show was exceptional. We're being challenged to make more products and brands available faster. We remain convinced that our investments in affordable replacement parts for the health care market will generate increased profits and revenues in the coming quarters. Sales in our Power & Microwave Technologies Group, which encompasses our core EDG business were below prior year, primarily due to slower than expected receipt of new orders. Sales were also impacted by a decline in the broadcast tube sales related to the shift from analog to digital technologies, and declines in our semiconductor wafer fabrication products. Sales in Latin America, particularly in Brazil and the devaluation of the euro, continue to negatively impact sales. We did receive a $6.5 million of new order for PMT after the close of the quarter. Sales in Canvys, our custom display division, were flat to prior year. While revenues in the second quarter were softer than we anticipated, we're pleased with the progress we're making in our growth initiatives. During the quarter, we continued to invest in the health care market. We increased our capabilities to repair CT tubes and we're on track to begin delivering new CT tubes in late fiscal year 2017. Within PMT, our backlog for power conversion technology has increased significantly during the quarter. Although, IT expense was down over the prior year, we also continue to invest in our new IT system focusing on enhancements that will improve productivity. The enthusiasm within the company is at an all-time high. Our employees are excited about the new products we're developing for health care and our investments that are focused on high-growth initiatives. I'll now turn the call over to Bob Ben, who will share the financial details for the second quarter and then Greg, Pat and Jens will share more of the business unit details with you.

Thank you, Ed, and good morning. While I acknowledge the operating loss in our fiscal 2016 second quarter, which was in part due to investments in our growth initiatives, I want to assure you that there are brighter days ahead for our company. In my 5 months since joining Richardson Electronics, I have learned so much about the business and the growth strategies. I can say that I'm even more excited about the growth prospects for our company today than when I started. As it relates to Richardson Healthcare, I was very fortunate to have attended part of the RSNA show in early December. I know that Pat will have much more to say about this terrific marketing opportunity in a few minutes, but I can tell you first hand that the potential for sales growth in this segment of our business is very strong. I would like to now discuss our financial results for our fiscal second quarter. Net sales for the second quarter of fiscal year 2016 were $34.1 million, up 0.7% from the prior year second quarter of $33.8 million. This increase includes sales of our higher margin IMES products, which were partially offset by a decline in our core EDG business in the Power & Microwave Technology, as Ed noted earlier. Gross margin was down slightly to 30.6% from 30.9% last year, reflecting geographic and product mix as well as currency fluctuations. Operating expenses were $13.2 million for the quarter, which represents an increase of $0.6 million from last year second quarter. This increase was due to including the expenses of IMES. However, this was partially offset by reductions in support expenses, including IT and finance. With these additional expenses, our operating loss for the second quarter of fiscal 2016 was $2.5 million as compared to $2.2 million for the second quarter of fiscal 2015. Interest income for the quarter was approximately $0.1 million compared to $0.2 million of last year's -- last fiscal year's second quarter. During the second quarter, there was a foreign currency gain of $0.3 million. The loss from continuing operations before tax was $2 million as compared to $1.9 million in the second quarter of fiscal 2015. We had a tax provision of $0.3 million, which includes primarily estimated foreign income tax expense. In the second quarter fiscal 2015, we had a tax benefit of $0.8 million due to the fact that the company did not record the reserve against its U.S. deferred tax assets until the fourth quarter of fiscal 2015. Bottom line, we had a net loss of $2.3 million for the second quarter of fiscal 2016 as compared to a net loss of $1.1 million in the second quarter of fiscal 2015. Turning to a review of the fiscal year-to-date results. Net sales for the first half of fiscal year 2016 were $71.2 million, up 3.8% from the prior year's first 6 months of $68.5 million. This increase was primarily due to the sales of our new IMES products. Gross margin was down slightly to 30.5% from 30.8% last year. Operating expenses were $25.5 million for the first half, which represents an increase of $1.7 million from last year's first half. This increase was due to including expenses of IMES and the investments in both the Richardson Healthcare and Power & Microwave Technologies growth initiatives. Our operating loss for the first half of fiscal year 2016 was $3.5 million as compared to $2.7 million for the first half of fiscal year 2015. We had a tax provision of $0.6 million, which includes estimated foreign income tax expense and additional tax due in Germany that resulted from an audit. In the first half of fiscal 2015, we had tax benefit of $0.9 million due to the fact that the company did not record the reserve against its U.S. deferred tax assets until the fourth quarter of fiscal 2015. Bottom line, on a year-to-date basis, we had a net loss of $3.7 million as compared to a net loss of $1.1 million in the first half of fiscal 2015. Now turning to a review of our cash position. Cash and investments at quarter end were $79.5 million. Cash used by operating activities were $2.3 million for the second quarter. The $2.3 million use of cash from operating activities, which excludes foreign exchange in acquired businesses includes the $2.3 million net loss and working capital investments of $0.8 million to support future growth initiatives and increase sales. Depreciation and amortization was $0.8 million for the quarter. We had capital expenditures of $0.8 million, approximately $0.4 million relates to our investments in our Healthcare and Power & Microwave Technologies growth strategies, and approximately $0.4 million relates to our IT platform. We spend $1.7 million on repurchasing our shares during the second quarter, and also another $0.8 million was paid out in dividends. Now I would like to turn the call over to Greg, who will discuss the plans for our Power & Microwave Technologies Group. Greg?

Thanks, Bob, and good morning, everyone. Last quarter we launched the Power & Microwave Technologies Group. As we mentioned, PMT includes our historical EDG business, plus new technology partners for RF, microwave and power and energy markets. We're focused on developing relationships with the key technology partners, but also disruptive technologies in these high-growth markets while taking advantage of our global infrastructure and customer base. This strategy has gained traction in our second quarter for design wins and strong bookings. Also during the last quarter, we announced agreements with over 8 new suppliers of these key disruptive technologies. This has proven to be successful as design wins and booking rates have increased every month in Q2 and continues into Q3. During the quarter, we book orders for new technologies such as ultra caps, Gallium Nitride and Silicon Carbide, and realized orders resulting from key investments in Electron Device business unit. Even with design cycles in these markets of 6 to 18 months, we're already seeing this design work turn into bookings setting up a strong Q3 and Q4. The management team at PMT has a proven track record of launching new technologies in this market and the recent investment in field sales resources have resulted in an extremely expanded, highly technical field team that is up and running. This, and our unit global capabilities to support these technologies and our technology partners, with the highest design in capabilities and standards for which Richardson Electronics Limited is known for. We will continue to invest in key growth areas of the world as our line cards and capabilities continue to expand. In the second quarter, revenue for PMT was down slightly versus prior year. Sales were $25.2 million versus $26.8 million in Q2 FY '15. Gross margins decreased from 31.9% to 29.9%, mainly due to products and geographic sales mix and the impact of exchange rates. However, our book-to-bill 3 months ratio is currently at very strong 1.15. We had a number of regions that showed strong growth in the quarter, led by our Asia team in China, Korea and Japan. These regions captured market share growth in electron tubes and assemblies. In addition to sales developing from the new rollouts of these new technology suppliers, these gains were offset by a decline in Latin America revenues, again, relating to the challenging market conditions in Brazil and by a slowdown in demand for wafer fabrication equipment in North America, which was a strong market for our engineered solutions group last year. Europe was on par with fiscal year 2015 second quarter revenues. Results on a comparable basis would have been greater, but were negatively impacted by the devaluation of the euro. Demands for tubes continues to be healthy in several key markets. Revenue in both the industrial and medical markets increased, and we had a strong bookings in avionics and marine market. These increases were offset by rapid declines in the broadcast tube market as patients continue to transition from analog to digital, and slowdown within the semiconductor wafer fabrication market. However, we are focused on expanding our customer base and product offering to offset the peak and valleys inherent in these markets. We continue to be excited about FY '16 as we gain momentum with the launch of the Power & Microwave Technologies Group. We have a very strong position in electronic tubes and related assemblies with incredible market share. Demand for product is strong and supplies is strong, and bookings are accelerating already in Q2. With a strong backlog driving us into Q3 and Q4, we are confident that we will finish FY '16 strong and with good momentum going into FY '17. However, there continues to be some red flags out there. The semiconductor wafer fabrication market in North America is still showing a moderate slowdown. As you saw in Q1, Brazil requires an extended recovery plan and fluctuations in foreign currencies versus the dollar continue to create challenges. However, the customers we address with electronic tubes and assemblies that are hungry for our global support, a new technology strategy require a smart investment and some designing time. But this will allow RELL to maintain its large market share for niche products and niche applications. We will see top line growth as our strong Q2 bookings convert to revenue in Q3 and Q4 With that, I will turn over to Pat Fitzgerald to discuss Richardson Healthcare.

Thank you, Greg, and good morning, everyone. Healthcare sales in the second quarter of fiscal 2016 were $3.0 million, up 163.2% over prior year sales of $1.1 million. Sales increased primarily from the acquisition of International Medical Equipment and Service or IMES, which occurred in the first quarter. Sales in our PACS display business were down slightly year-over-year. Gross margin as a percentage of net sales increased to 46.1% during the second quarter of fiscal 2016 as compared to 23.7% in the same period last year due to product mix. IMES products, which consists primarily of high value CT and MRI replacement parts, typically bring in higher margins than PACS displays. Health care providers today are under extreme pressure to reduce costs while gearing up to provide services to more patients. Capital spending and maintenance budgets remain tight and price is increasingly one of the leading factors behind purchasing decisions. As a result, there's a growing demand for an alternative source to the OEMs for replacement parts and service on a global basis. We estimate the global market for diagnostic imaging and replacement parts and service to be between USD 7 billion and USD 8 billion annually. IMES is focused on providing CT and MRI replacement parts, training and technical support to end-user customers who want to maintain their own equipment, as well as the third-party service organizations. The integration of IMES into Richardson Electronics continued to be a major focus this quarter. IMES inventory was migrated over to the Richardson computer system, which allows us to leverage Richardson's global logistics capability. We are now able to deliver time-sensitive replacement parts to 25 key markets, customs cleared in days rather than weeks, which was often the case when IMES customers had to act as their own importer of record. In the U.S. market, and now also within the EU, we are able to offer next flight out service using strategically placed inventory close to our customers. During the second quarter, we realized our first sales of IMES parts from the Richardson logistics center in Amsterdam. Beyond integration, we have also spent considerable time on both the geographic and product line expansion plans. After a careful analysis of potential sites, we have decided to locate the IMES parts and training center for Europe on the existing Richardson campus in Amsterdam. We expect to establish basic operations in Europe before the end of this fiscal year. IMES has historically focused primarily on Toshiba brand equipment. We are in the process now of expanding our product portfolio to include additional brands of CT and MRI parts, as well as repair services for high-value components like MRI coils. In many cases, we've been able to leverage Richardson engineering resources to develop new repair and refurbishment processes, which in the long run will help us with margin development in the IMES business. The company continues to make significant investments in the CT and X-ray tube development and manufacturing capabilities, including capital equipment and experienced engineering resources. Sales of Richardson certified pre-owned tubes increased in the quarter and we are working closely with suppliers and partners to ramp-up production. Tubes produced in LaFox are being sold through the IMES parts business in order to leverage synergies between the product lines. Sales of our Image Systems brand displays for picture archiving and communication systems or PACS and related accessories and equipment for operating rooms were down slightly compared to prior year results. In our wireless flat panel display business, we are building our network of service provider partners who have engineers embedded in their customer sites. We believe these partners have unique insight into which hospitals have both the need and the budget for digital radiography or DR upgrades. We expect this approach to add revenue in this category in future quarters. During the recent Radiological Society of North America or RSNA meeting in Chicago, we spent a considerable amount of time talking to health care providers, asset managers and third-party service companies. A common theme of many of these discussions was that existing customers for IMES parts and tubes were also interested in radiology display and the DR upgrade solutions and vice versa. We believe there is ample synergy between the 2 customer bases and we realized some early sales win again in the second quarter. With IMES parts, CT and X-ray tubes, PACS and operating room displays, wireless ER solutions and power grid tubes, Richardson Healthcare has established excellent relationships with hospitals and independent service organizations on a global basis. Over the past year, we have significantly strengthened our value composition for health care providers looking to lower their cost and increase efficiency. We continue to explore additional acquisitions in this market and are focusing on companies with models that can be expanded internationally and that provide products and services for underserved markets. We are also evaluating partnerships and organic investment in product line expansion. I'll now turn the call over to Jens Ruppert to discuss Canvys second quarter results.

Thanks, Pat, and good morning, everyone. Canvys, which includes the engineering, manufacture and sales of custom [indiscernible] original equipment manufacturing in industrial and medical markets had sales of $5.9 million during the second quarter of fiscal 2016, flat to the same period last year. Gross margin decreased from 28% to 25.9% due to the decline in the euro exchange rate. The division did a good job in controlling cost and maintaining working capital efficiency. We improved [indiscernible] during quarter as we did the last quarter, and we managed our inventory closely. Order backlog during the quarter decreased from $15.8 million at the end of the first quarter to $13.8 million. We won several new programs from new and existing customers in endoscopy and digital monitoring space, but also in new areas such as graphic or 3D monitoring area. We are currently working on new sites [indiscernible] contracts from other customers and we are confident backlog will increase over the coming months. After we issued the business model and the changes to the organization to leverage synergies between our teams in different locations, we extended our lease in Marlborough [indiscernible] with cost savings over the terms of the lease, plus facility improvements. This will ensure we have no interruptions to our business. I visited many of our suppliers this quarter to learn about the capabilities and new available technologies that we could utilize for our customers, and to ensure we are aligned and ready for new business opportunities. Over the next quarter, I will continue to review and adjust our business strategy with the goal of improving operating performance of the division. It's clear we offer outstanding products and services to our customers. I'll now turn the call back over to Ed.

Thanks, Jens. Lots of work and lots of opportunities. We pass the year behind us, a new IT system in place and significant investments in our management team and growth initiatives, everyone is focused on sales growth. So at the end of second quarter, backlog has increased appreciably. We have received $9 million in new orders the week before Christmas, $6.5 million with PMT and $2.5 million with Canvys. A high percentage of this will likely ship before the end of our fiscal year. We continue to explore acquisitions that are in line with our initiatives and are priced attractively with management which will fit within our culture. Where we see an opportunity but can't find suitable acquisitions, we will invest organically. We're monitoring our use of cash to ensure we have adequate resources when and where we need them. We're meeting with new shareholders on a regular basis and we'll continue to repurchase stock. At this point, we'll be happy to answer a few questions. Stephanie, may we open up the line for questions.

[Operator Instructions] Your first question comes from the line of Mark Zinski representing 21st Century Equity Research.

Ed, I just wanted to first sort of hone in on the PMT business. So essentially, there are kind of 2 primary headwinds there geographically with Latin America, I guess, i.e., Brazil, and then versus some vertical weakness in the wafer fabrication business, is that right?

That's correct, yes.

Okay. And how do you -- do you see those headwinds abating anytime soon or will these continue to be a drag for the rest of the year you think?

Well, some of the backlog in the semiconductor wafer fab is starting to come through in that market. We have one very large customer that was down about 40% in the first 6 months and they've just placed some substantial orders that we'll be shipping in the third and fourth quarters, so that should help. Overall, if you look at the semiconductor wafer fab, Mark, I think it's down 2% or 3% or forecasted to be like that. Unfortunately or fortunately, we are very dependent on half a dozen customers in that area and so our fortune sort of ride with their fortunes.

Okay. But gross margin both for PMT and the business looks pretty stable, so you kind of see that continuing then?

Certainly in PMT, that's true. We do -- we have booked some really nice orders, as I mentioned just before Christmas, and one of those orders is a very nice margin so that will help.

Okay. And then I just kind of wanted to frame sort of where we are in terms of investing in the business and trying to get some sales growth and positive earnings. We're still sort of on track for, I guess, Q1 fiscal '17, is that correct?

We're really looking at the fourth quarter of FY '17 when we'll start to deliver new CT tubes and then really gain some traction in that area.

Okay. So the investment pace is going to continue at this level for the next few quarters?

Well, in health care, the majority of the capital expenditure is in this year. We need that equipment up and running to start to produce tubes next year. So most of that capital expenditure is this year and you will see a tail-off next year. And a lot of the capital expenditure within the power conversion side of PMT has to do with people, and we have pretty good staff in place. So we'll see some more of that, but I think it's sort of leveled off.

Okay. And then just lastly on the acquisition front, if you could provide any kind of color as to what you're seeing out there in terms of multiples and the size of potential opportunities?

Sure. Well, most of the businesses that we're looking at are in the health care space. And I can tell you honestly I'm not used to paying the kinds of multiples that those companies are selling for. We continue to look at several companies, but we don't have anything that's really imminent. And with the base that we have in place with IMES and our foundation as a business in CT and X-ray, I think we're well positioned with organic growth. And if we can do an acquisition, fine, but we're not counting on it.

Okay. So you are kind of more focused on organic investment at this point?

That's correct.

[Operator Instructions] Your next question comes from the line of Matthew Miller representing Boyles Asset Management.

A couple questions. To start with, I think at the end of Q4 last year, you talked about sales for this year being $160 million to $170 million or so. The low end of that seems to be challenged at this point halfway through the year, would you comment on the guidance that you've given for sales?

Well, currently, we're not giving guidance. Certainly, we think the second half of the year will be stronger than the first. Obviously, where we're at through the first half, it's going to be at the low end of last year's guidance, which we're no longer really giving.

Okay. But with that guidance that you gave at that point in time, you had talked about reaching breakeven profitability, I think it was Q4 2017 fiscal year. Does that still appear to be part of the plan?

Yes. We're right on track as far as all of the plans in place and we're optimistic that we'll make that plan.

And on that the tube refurbishment business that you've gotten started, are you able to comment on maybe the number of units or the revenue that was generated from the refurbishments in the quarter?

Well, so far, we've repaired 12 CT tubes that we put to stack. Pat, what does the revenue look like out of what we put to stack, do you know?

Total revenue was about $400,000.

Okay. So we're just starting in that area, but we're really encouraged as we study why these tubes are failing and what needs to be repaired. It sort of draws a pattern. So once you learn to repair them, the same kind of phenomenon is happening again and it becomes easier and easier. So we're really encouraged about what we're going to be able to do in the repair capability of CT tubes.

We have no further questions at this time. I would now like to turn the call back to Mr. Ed Richardson for closing remarks.

Thanks, Stephanie. At this point, we'll be happy to answer any questions that you may have further on, if you want to give us a call back. We're really optimistic about the future of the business and what's happening and look forward to reporting increased sales and earnings in the quarters to come. Thanks very much.

Thank you. Ladies and gentlemen, thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Good day.