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RAE Systems Inc. (NYSEMKT:RAE)

Q1 2010 Earnings Call

May 5, 2010 04:30 pm ET

Executives

Bob Durstenfeld – Director IR

Robert Chen - CEO

Randy Gausman - CFO

Analysts

Ken Liddy - Wells Fargo

Operator

Welcome to the RAE Systems Inc. 2010 conference call. At this point, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time. As a reminder, today's call is being recorded. I would now like to turn the call over to Bob Durstenfeld, Director of Investors Relations.

Bob Durstenfeld

Thank you. Good afternoon everyone. And thank you for joining us today. With me today are Bob Chen, our Chief Executive Officer and Randy Gausman our Chief Financial Officer. If you have not seen today's earnings release be retrieved from our website at raesystems.com or from marketwire Yahoo finance or similar websites.

If you would like a replay of this conference call it can be retrieved two hours after this call from our website, or from links in the call announcement. I would like to remind you that the matters that we will be discussing today include forward-looking statements and as that term is used in section 21E of the Securities and Exchange Act of 1934 and as such are subject to risks and uncertainties.

Forward-looking statements may include without limitation expressions of believes, anticipation or expectations of management, statements of the industry trends or future results of operations of RAE Systems and its subsidiaries and other statements that are not historical fact. These types of statements address matters that are subject to risks and uncertainties which could cause actual results to differ materially. Factors that could cause or contribute to such differences include but are not limited to general economic and industry factors and their receptiveness of the market to RAE Systems and its products.

In addition to our forward-looking statements, should be considered in the context of other risk factors discussed in our filing with the Securities and Exchange Commission including but not limited to our Annual Report on Form 10-K and form 10-Q filings available online at www.sec.gov or our website. All forward looking statements are based on information available to the company on the date hereof and the company assumes no obligation to update such statements. As a reminder, we will not be commenting on analyst models.

Today, Bob Chen will review our first quarter highlights and business outlook for 2010. Randy Gausman will review the financial results for the first quarter ended March 31st, 2010. Following a brief summary by Bob Chen, we will open up the call for questions and answers.

I will now turn the call over to Bob Chen, Bob, go ahead please.

Bob Chen

Thank you, Bob. Good afternoon and thank you for joining us on our first quarter 2010 conference call. This afternoon, I will make a few comments about our just completed first quarter. And then, I will focus my remarks on the future business outlook for RAE Systems.

For the first quarter of 2010, we posted revenue of $18.8 million, which represents our second best first quarter revenue performance in the company's history. Our gross margin was 54%, our highest gross margin in the last four quarters, also in the first quarter, we recorded a small net loss of $0.01 per share. We are encouraged by our improving operating performance during the current economic environment.

Now, I want to focus my remaining remarks on the future. Our vision for RAE Systems is to be the leading sensing solution provider in the safety and security industry recognized for innovation and business performance. We have established our reputation as the leading innovator of photo ionization detectors and radiation solutions. That we are advancing with a further development of wireless, intelligence, connected sensor networks.

For example, we began by introducing wireless enabled photo ionization detectors, combined with our proprietary RAELink 3 wireless modem. We can now deliver real time GPS location and sensor data over our area wireless sensor network. A RAELink 3 is the bridge to deliver both RAE Systems and third party instrumentation information utilizing the AreaRAE wireless platform.

We have continued our advancement in wireless products with a introduction in 2009 of the AreaRAE Inerts and Mesh Guard. We expect that both of these products will enable us to further penetrate the oil and gas drilling and processing markets worldwide. After the just completed Fire Department Instructors' Conference, we preview ProRAE Guardian, which is an advanced generation virtual command center for intelligent wireless monitoring.

ProRAE Guardian improves the performance levels and ease of the use in the remote monitoring of wireless gas detection systems and networks. The ProRAE Guardian platform enables our customers to monitor wirelessly enabled RAE Systems products and complimentary third party products on a single platform. This is an exciting innovation that will address additional applications about wireless sensor networks in our global markets.

Furthermore, we are continued to make investments in broadening our product portfolio. Developing a new application for our product and evaluating opportunities to expand the applications for our innovative technologies into adjacent markets. We are scaling up our global marketing efforts to educate users on the advantage of deploying wireless technology we were continuing make investments in R&D a priority to develop a new generation of wireless toxic gas and radiation instruments, in addition to intelligence software monitoring systems, while the economic environment remains challenging, and impacts our performance.

Global demand remains strongest in the industrial safety and civil defense markets. Our earlier investment in gas detection solutions for the energy market has been rewarded by key wins in the Middle East and petroleum based regions primarily in the Asia-Pacific. The Middle East oil and gas producers have been less impacted by this economic crisis and customers in other industries. Our broad product line enables us to continue serving our customers' needs and positions us to benefit from an improved global economy.

In the America's, our U.S. customers continue to purchase our MultiRAE Plus and compliance forecast and single gas products. Our North American fleet of deployed instruments enables us to sell higher margin replacement parts and consumables. We will be displaying all of our personal portable and wireless industrial safety solutions at the American Industrial Hygiene Conference being held in Denver later this month.

In Europe, first responders are adopting our wireless AreaRAE System, AreaRAE will be one of the products that we feature at the Interschutz International Fire Prevention Rescue, Disaster Relief, and Civil Security trade show being held in June in Germany. In the Middle East, oil producers have been buying our four gas and single gas products.

With the growing interest in our wireless Mesh Guard Systems, both of the Middle East and Southeast Asia oil and gas markets continue to be strong markets for our wireless and compliance products.

In China, our digital coal mine safety product line is being adopted by more and more coal mine operators. We expect this product to be a cornerstone product for the future of our coal mine safety equipment business in China.

Both the energy and steel producer markets are significant growth markets for our China operations. As China produces and consumes greater amounts of fossil fuel base energy, we believe the demand for our wirelessly enabled and compliance products will expand. Nuclear and environmental markets also remain a source of future growth for our China business.

Our goal is to be a leading innovator of safety and security products that deliver wireless real time data to enable our customers to make faster, better decisions to keep people and property safe. As an example, we are all aware of the current oil spill disaster in the Gulf of Mexico. RAE Systems has placed technical personnel on scene and is providing 24/7 support to private, federal and state environmental management responders with the technical experts to deal with their by-products of the spill, including volatile organic compound detection and Benzene monitoring.

RAE Systems has also activated its 24 hour response line. We know that both our AreaRAE wireless networks in the UltraRAE 3000 Benzene monitors have already been deployed on several of the offshore platforms in the area of the spill.

With that I would now like to turn the call over to Randy Gausman, our CFO, for the financial review. Randy, please go ahead.

Randy Gausman

Thank you, Bob. Looking at the first quarter financial results in greater detail, revenue was $18.8 million, or 2% less than the first quarter of 2009. In the first quarter, the Americas contributed 44% of our total revenue. Asia contributed 37% and Europe contributed 19%.

Gross margin for the first quarter was 54%, compared with 49% for the same quart of 2009. The increase in the gross margin was primarily due to a favorable product mix that included an increase in the sales of multi-gas products, sensors and accessories. Total first quarter 2010 operating expenses were $10.4 million or 56% of revenue, compared with $10.4 million or 56% of revenue for the first quarter of 2009.

Although, total operating expenses were essentially flat year-over-year, we made additional investments in sales and marketing to improve our sales information management system, and our international websites. These investments were offset by collections of receivables that had previously been written off as bad debts in the first quarter of 2009.

The first quarter net loss was $364,000 or $0.01 per share compared with a net loss of $988,000, or $0.02 per share for the first quarter of 2009. The improvement in our net loss position was directly attributable to our improved sales product mix in the first quarter.

Focusing on the key balance sheet accounts, we had cash of $18.4 million at March 31st, 2010, compared with $18.5 million at December 31st, 2009. During the quarter, we spent $100,000 on investments in property and equipment.

Accounts receivable was $17.8 million compared with $19.4 million at December 31st, 2009. The change in AR was primarily related to improved collections in our American operations in the first quarter.

Net inventory increased by $200,000 to $12.3 million for the quarter ended March 31st 2010 compared with $12.1 million at December 31st, 2009. The company continues to be actively engaged in discussions with the Department of Justice and the Securities and Exchange Commission to settle the outstanding joint investigation, into the company's alleged violations of the Foreign Corrupt Practices Act and there has been no change in status since our last public disclosure.

We are reaffirming our 2010 guidance, we continue to expect full year 2010 revenue to be in the range between $83 million and $85 million and we expect a small net loss for the year.

Now, I will turn the call back over to Bob Chen for his closing remarks.

Bob Chen

Thank you, Randy. In summary, we are encouraged by our first quarter revenue. By the way we remain cautious about the business outlook for the remainder of 2010. There continues to be demand for our products and our global diversification should continue to serve us well.

In China, we continue to receive gas detection orders from steel mills and oil, gas and coal mining customers in both the Americas and Europe, demand remains strong for both regulatory driven and industrial application for our products. We will continue to pursue opportunities in the oil and gas industry, industrial safety, hazardous materials management, civil defense and the environmental monitoring markets.

We have several new product introductions planned for later in the year. And we expect that these new products will contribute to future revenue growth and the increased market penetration in the oil and gas industry worldwide. We are focused on being our industry's leading innovator through the advancement of intelligent, connected wireless gas and radiation detection solutions.

This progression of innovation began without advanced technologies, starting with our photo ionization detectors and our wireless AreaRAE products. We expect our growth to continue, with our wireless enabled fix and portable product and we expect it to grow further with our recently introduced ProRAE Guardian virtual commencement of software platform.

I would now like to open the floor to questions.

Question-and-Answer Session

(Operator instructions)

Operator

We will take our first question from Brian Rutenberg with Morgan Keegan.

Unidentified Analyst

Hi this is [Pete Costick] for Brian. I know you said there hasn't really been any movement on the corrupt practices investigation. But do you at least have any better sense of maybe the timing or any kind of update there?

Randy Gausman

Did you say your name was Pete?

Unidentified Analyst

Yes.

Randy Gausman

Hi, Pete. This is Randy. You know, it's, we've had communications with the government, and you know, we continue to be as responsive as we can with them, when they have further inquiries. But we have no real sense of when this will be complete. The level, the nature of the discussions and contacts of the government have been, and just for some additional details, so, I'm hopeful and we are all hopeful that this would be wrapped up soon. But frankly, we have no further intelligence, as to exactly when this thing will be completed.

Unidentified Analyst

Okay. Fair enough. Also I was wondering how much, I know you mentioned, with the oil spill recently, how much potential you think there is, how much growth you might see from both that disaster but then also there was the West Virginia coal mining accident earlier in the year? You have seen any pickup since then, domestically?

Bob Chen

I think there is awareness of the coal mine safety. This is Bob, Pete. We are not really participating the U.S. coal mine safety equipment a market because our product has to be U.S. approved but we have not got our product certified in the U.S. And for the oil spill in the Gulf Coast, in the Gulf of Mexico, I think, our product has already been used and we continue to see demand more for our wireless AreaRAE multi-RAEs and our Benzene monitors and we are prepared to serve that market whenever there is a need, so have technical support, hot lines and also inventory prepared to support.

Operator

Moving on. We will take our next question from Ken Liddy with Wells Fargo.

Ken Liddy - Wells Fargo

Good afternoon. The gross margin was up sharply in the quarter and sharply from the last quarter and sharply year-over-year, I understand it's, the product mix, does it vary greatly by region? You know, Asia, lower gross margin in the United States or vice versa?

Bob Chen

Ken, typically, the gross margin in the Americas and our Asia business is higher than it is in our China business. And in this first quarter, as we indicated that you know we sold a great deal of consumable products, which generally have a higher margin, as well as our multi gas products. So, in terms of, I'm sure your next question would be you know, what's the trend look like. Our expectation is that we'll continue to deliver gross margin for the rest of the year and 50% or better and hopefully, that it will, could even be higher. But our internal projections are that it's probably going to be around 50% or so for the rest of the year.

Ken Liddy - Wells Fargo

Typically, are you closer to 60% in Asia versus the United States 50 in a given year?

Bob Chen

No. I mean, the Americas and Asia are typically in the mid 40, I'm sorry, in the mid-50 percentile. And then, the other regions are lower. So, our aggregate mix is what you see.

Ken Liddy - Wells Fargo

Okay. In the quarter, I noticed you had a nice decline in G&A. Is that from last year's cost cutting measures?

Bob Chen

Yeah, there are two things. G&A has come down year-over-year. Last year, we had some additional expenses, related to the investigation and right now, as I commented in my, in our opening remarks, the investigation is right now, there is just not a lot happening at the moment. Plus, we had collected some funds, some receivables from customers in China that we had previously written off a year ago as bad debt. So, we collected them this year and so that's also helped our benefit our G&A expenses in the first quarter.

Ken Liddy - Wells Fargo

And marketing and R&D expenses were up in the quarter year-over-year?

Bob Chen

R&D was up slightly. Reflecting our continuing investment in our digital mind product in the China and sales and marketing is up, we have been historically in the last couple of years, we have been really quite frankly stingy in, spending in the area of marketing and we see an opportunity now to, especially with the introduction of this new product that we talked about the ProRAE Guardian and some other activities. We see a real opportunity for us to strengthen the RAE brand worldwide and get out and promote these new products. So, we are making the informed decision to spend more in marketing to build the RAE brand worldwide.

Ken Liddy - Wells Fargo

Talk a little bit about the coal mines' product in China and first of all, is competition the chief reason why we haven't introduced the product in the United States or tried to get certification in the United States?

Bob Chen

Yeah. The coal mine population in China is about 3 million coalminers underground. I think the U.S. is much smaller, much smaller and also the certification in U.S. is the regulations are very, very stringent and very costly, so we have not taken the measure to get our product certified in the U.S.

Ken Liddy - Wells Fargo

Understood. So, it would be something that once you really see sales in China over year may do it at a later date I guess?

Bob Chen

Yeah that is true.

Ken Liddy - Wells Fargo

How is the digital mine projects going?

Bob Chen

We see that's a bright spot for us, the investment certainly is the right direction for us. We see some early adopt during using our digital coal mine system being expanding to second or third phases. And some new operators are adopting our digital coal mines. We think that is one of the growth engines for us in our coal mine business.

Randy Gausman

Actually, Ken, I would like to add to the comment that Bob made about the digital coal mine product. We actually have four current active projects in China today. And each of those projects are, in terms of their value, they are each in the, several hundred thousand dollars range for each one of those projects. So, we are starting to experience some real, not starting, we have been, and continue to experience strong traction with that product line.

Ken Liddy - Wells Fargo

Are you more optimistic?

Bob Chen

We certainly think the coal mine business, after a little bit setback. I think, we are recovering. We are reasonably confident that the business is recovering.

Randy Gausman

Again, I would like to add to what Bob has said. You know in the past, we have commented about some of the management changes that we have made. And now with our new management team over there, it's been employees close to three quarters of the year now, I think, we are starting to see some real benefit from the experience that they have gained and improved processes they have brought to that operation.

Ken Liddy - Wells Fargo

Do you see the business being more efficient or top-line of growth or both?

Randy Gausman

Both.

Ken Liddy - Wells Fargo

And in the United States, there is still an awful lot of money from the (inaudible) for Homeland Security. Do you see any increased traction there?

Bob Chen

I think, we saw that New York and also the earlier or the Homeland Security issues. Of course there is a lot of awareness. We believe our product will have our fair share of the opportunity to provide the severance.

Ken Liddy - Wells Fargo

And do you feel there is a real material possibility for RAE to see revenue from this unfortunate disaster in the Gulf?

Bob Chen

We come in earlier. Our product, AreaRAE and the Benzene monitor, the UltraRAE and also multi-RAE and our tubes, they are already being deployed and we have an inventory prepared with personnel outside for the users. So, we are prepared and we also have a hotline to provide the support for this unfortunate situation. We are prepared to support.

Ken Liddy - Wells Fargo

Where would you deploy those? Just a little education, how that done?

Bob Chen

The only oil platform, the spill, there is some other adjacent platforms there still pumping oils. So, these workers, they also need to get protected and also some oil get onto the shore, they need to clean up and people working in those areas, they need to protect it. The law specified that you have to have the environment to have the Benzene level below 0.01 ppn. And our product is UltraRAE is the standard product for the oil industry to monitor the Benzene.

Ken Liddy - Wells Fargo

You feel that this, that could have helped to boost sales in other regions of the world for that product?

Bob Chen

I think our product is needed in the oil and gas industry. We think our AreaRAE, our wireless connector and PIDs, and also the Benzene monitor, it's needed around the world in the oil and gas industry.

Ken Liddy - Wells Fargo

And one last question. You re-affirmed guidance on yet a pretty decent, quarter, considering everything. What would have to occur for you to increase guidance? Where would you see the business, in the United States, or China recovering more quickly?

Bob Chen

Well, Ken, we are constantly communicating with our business unit managers, who run our businesses around the world and to assess the situation. And although, our quarter was a good quarter and we were encouraged by our results as we indicated, there is still enough things out there in the world that lead us to conclude that at least at this point, we need to be relatively cautious in our outlook for the rest of the year.

Now, if the economies improve and customers need to restock their equipment and we can generate new activity, particularly in the oil and gas markets then, hopefully that will bode well for the future of the company and particularly this year. But at this time, we are just remaining cautious. We don't want to set expectations.

Randy Gausman

Well, I used to have a boss that said under promise and over deliver, I think, is the course of action we are taking here.

Bob Chen

I guess the thing for me is, you are expecting to roughly $65 million to $70 million, something like that for the rest of the year. And if you feel the gross margin is going to be above 50% and your cost containment measures have seem to be really working, that's a profit. You would have to be at a profit, if there is, always factors that were played out.

Ken Liddy - Wells Fargo

Yes, that's how management objective, we all work toward that goal, we want to get to there. As quickly as we can.

Operator

We will go next Tony (inaudible) with Eastwood Partners.

Unidentified Analyst

Clearly you have a number of initiatives worldwide and when I look at revenue sort of being slight to down over the last few years, in your eyes do you see I am trying to get what it will take to resume some reasonable revenue growth, is it just going to come from the wider ray of products and general economic recovery? Or it is management fee here are two or three areas of products that could really reaccelerate revenue growth?

Bob Durstenfeld

Okay, Tony. This is Bob. We positioned our company with a value proposition with or we call life critical and time critical information, where the gas detaching radiation sensor combined with a wireless connectivity disseminating probation through internet. So, we really provide a value for decision maker to support the magnificence to protect people’s lives and their properties. So, on the oil company, on the civil defense, homeland security, environment we think we definitely provide a very critical important value to those.

So, in the US and the Europe and China maybe have a different phases of development to US focus on government now where there is oil spills in China as the industrialization for the industrial safety in the Middle East its for the oil refinery, the oil productions in Europe as a general industrial safety. So, I think it’s across the board, every sector where product fulfills the needs. So, did I answer your question?

Unidentified Analyst

Well, I’m still trying to get it when you see with everything you have got. I’m still trying to get it why you can’t get revenue getting faster. Is it a question of further sales effort or what do you see it taking to get revenue back growing?

Bob Durstenfeld

I think our revenue, even though in the recessionary period of time, our revenues did not really decline that much in that means and our demand is still there, but when the market turns around the demand rises I think we’ll probably underwrite with the market and the demand is always there, we feel our product is needed as we in the script, we talk about earlier.

Bob Chen

And Tony one other thing that, we believe we are definitely a leader in innovation in our industry in terms of introducing new products and last year we introduced I think I believe eight new products and this year we just announced as we discussed in our opening remarks about our product to ProRAE Guardian which is an intelligent software command modular product and that will connect with other wireless products not only ours but compatible third party wireless products.

And we believe that innovation is starting to introduce an intelligent software platform or again help us grow our business and generate new opportunities for the company and we also as a company believe that the real future in our industry is in the wireless connectivity.

So, in the future as we introduced new products they will all be wireless products, so we think that’s one key element in our product portfolio and product pipeline that will enable us to, if you will jumpstart the growth of the company again.

Unidentified Analyst

That’s very helpful. In terms of the corrupt practices, I think it was implicit in what you said but just to clarify. So, I assume your legal expenses for the quarter were fairly low around that and can you also comment on whether you feel that the amount you reserved that’s still the appropriate amount?

Bob Durstenfeld

Yeah, you are absolutely correct. Our legal expenses given the low level of activity were very low in the quarter compared to the recent past. And as to the amount that we have accrued for the proposed settlement, and at this moment its our best guess of what the ultimate settlement will be of course until we reach the point where the government or we actually have those final discussions, we have no way of knowing whether they are seeing that to be appropriate or not.

Unidentified Analyst

Okay. And one final question. And I agree, I mean the product portfolio is very interesting, you are clearly in the lead in some things and when I compare valuation of the company to people that I would probably consider and now I guess company so its just the valuation the company seem so low. If you settle the corrupt practices investigation in the stock still stay so low would the company consider increasing buyback or taking other extraordinary source of measures to try to improve valuation?

Bob Durstenfeld

I think for all the investor, they don’t like uncertainty I think this FCPA investigations create a little bit of uncertainties, we feel that’s one of the reason our stock is little depressed. So once this is lifted, our board always looks at options, strategic option directions for the company to increase the value of the shareholder all board and that we have working with the management always to look at various strategic options.

Operator

(Operators Instructions). And we’ll take a question from Dr. (inaudible).

Unidentified Analyst

Hi, I’m kind of looking in terms of the valuation of the company, the question that was raised earlier on. Looking at your stock, ten years ago it was at $6 now it’s less than $1, five years ago it was $9, its now down 90%, I mean what is the management doing to get good valuations for the stock? It’s fine to talk all about the corrupt practices settlement that’s more recent, its fine to talk about all the opportunities that exist in the marketplace. But, what is management doing to increase shareholder value? You are being lagging behind every single indicator.

Randall Gausman

Dr. (inaudible)? This is Randy, I’m the CFO. We have been very focused on looking what we can do to reduce our cost structure and we have made great strides in that area. At the same time we have continued to invest in our products, although the devaluation is down, we are in a fairly strong cash position for a company of our size and where as you have you seen this quarter, we have been able to improve our gross operating margins.

So, our focus has been to become a much more efficient operation than we have in the past and then again as I mentioned earlier, invest in developing our product lines specifically in intelligent software. I think those are the things that we can do today to generate long term value for the shareholders.

We know in the past of the price of our stock has been much higher than it is today and I do think as Bob indicated in his remarks, that until we resolve the FCPA matter, that’s probably has some overhang or pressure on the stock because of the uncertainty of that. So we tried to do our best job to be able to help the investors understand what the impact of that’s going to be but I think towards finally ultimately resolved or settled, there is still that level of uncertainty. So, what we are doing to sum up is we are trying to improve our operations and as well as invest in new products and new markets. So, we are trying to run the company as efficiently as we can.

Bob Chen

Dr. (inaudible) this is Bob Chen. Like the Randy said our freights from the FCPA there is uncertainty. We reserve some funds there. But we, and management and the board where will you focus on the fundamental to run good business to continue improve our profitability, gross margin, and improve our revenue growth? I believe once we are able to realize those when I think a smart investor will be able to recognize us. And as I comment earlier, the board also looks at various strategic options to increase the shareholder for the value all the time.

Unidentified Analyst

Because you are playing in a space that is topical, you are playing in a space that there is great demand, there is the mining space you are playing in, the oil spill place you are playing in, you see product software of superior value in terms of innovation. What I find a little bit difficult to understand is why is it not moving to the bottom line in terms of revenues? I mean are doing not a good job marketing yourself or is that’s what’s missing?

Randall Gausman

Well, I answered that, we also commented that we are investing more in marketing today, we had in the past, as we have restructured the company by that I mean taken some cost out of the company. We recognized, we probably cut marketing a little to deep and last year we hired a gentlemen to run our global marketing operations force and we are spending more in that area to build our brand worldwide as well as work with customers to identify new product opportunities.

So we are reinvesting in marketing and we continue to invest in R&D and we’ve got some run over the next couple of years we are going to be introducing some exciting new wireless products. So, we have been in the past, we’ve cut back on some of these investments, we will now see the opportunity and we are trying to position the company to invest more in marketing and products so that when the economy finally turns around in the markets that we are playing will be positioned to grow with those with that turnaround.

Operator

(Operators Instructions). And it appears to be no further questions at this time. I’d turn the conference back over to our speakers for any additional or closing comments.

Bob Durstenfeld

We’ve had a good start for the year and we hope to sustain our current momentum. I’d like to thank you for your continuous support of the RAE Systems and look forward to speaking with you on our second quarter conference call.

Operator

And that does conclude today’s call. We thank you all for your participation.

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