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Executives

Edward Richardson – President, Chief Executive Officer

Kathleen Dvorak – Chief Financial Officer

Wendy Diddell – Executive Vice President – Corporate Development

Analysts

Robert Moses – RGM Capital

Al Tobia – Sidus Investments

Mark Zinski – 21st Century Equities

Ethan Steinberg – Freiss Associates

Richardson Electronics Limited (RELL) Q2 2011 Earnings Call January 6, 2011 10:00 AM ET

Operator

Welcome to the Fiscal 2011 Second Quarter Earnings conference call. My name is Veronica and I will be your coordinator for today. At this time all participants are in listen-only mode. We will be conducting a Q&A session towards the end of today’s conference. If at any time during the call you require assistance, please press star followed by zero and the coordinator will be happy to assist you.

I would now like to turn the conference over to your host for today’s call, Mr. Ed Richardson. Please proceed.

Edward Richardson

Good morning and thank you for joining our second quarter conference call for fiscal 2011. Joining me on the call today are Kathy Dvorak, Chief Financial Officer, and Wendy Diddell, Executive Vice President – Corporate Development and General Manager – Canvys.

This call will include forward-looking statements that involve risks and uncertainties that could cause our results to differ materially from management’s expectations and plans. We encourage you to review the Safe Harbor statement found in our press release and also to review our most recent regulatory filings for a full description of these risk factors.

As you may know, we are diligently working to complete the sale of our RF, Wireless and Power division, or RFP, to Arrow Electronics. The transaction is expected to close in the next 60 days. I’d like to begin by providing a summary of the transaction and then move on to discuss the operational, financial and strategic outlook for our remaining businesses. Following that, we’ll be happy to take your questions.

In reference to the transaction, the proceeds from the sale will be $210 million with an incremental purchase price adjustment related to a working capital target. Needless to say, this transaction is complex is the sense that we’re separating a large division from a consolidated operating company. Immediately following the closing, we will move into a transition phase where both parties will be providing transitional services to each other. This transition phase will likely take several months. Once this period has ended, we can turn our attention to realigning our cost structure to fit the remaining business units. Our objective is to do everything possible to exit fiscal 2011 with a support function cost structure that enables the remaining business to hit our near-term operating margin target of 5%.

Now let’s get back to our second quarter performance. From a financial statement perspective, RFPD is now shown as a discontinued operation. We achieved strong double-digit growth for the remaining businesses with sales of 23.7% compared to the prior year’s second quarter. Backlog continues to strengthen for the Electron Device Group, or EDG, and Canvys, our display group, which is a very positive sign for the future.

For the combined businesses, we’ve experienced some margin decline. For EDG, this decline is somewhat misleading as it reflects the impact of a strategic alliance with a supplier where we gained incremental sales, although at lower margins. We’re in the process of transitioning our customer base over the next few months to include a greater percentage of aftermarket business that typically comes at higher margins. This should enable us to return to historical margin levels for EDG in fiscal 2012. For Canvys, our gross margin has been affected by the decline in our healthcare business, which traditionally carried higher margins, as well as rising air freight costs and competitive pressures.

With sales increasing by 23.7%, we held our operating expenses on a consolidated basis. Unfortunately, because of accounting for RFPD as a discontinued operation, the only expenses that we can attribute to RFPD are those that are transferring or directly being eliminated as a result of the transaction. The balance of our support function costs are then allocated to EDG and Canvys.

While we show positive operating income, we need to restructure our cost base for the remaining businesses. Cash from operating activities was also positive but our working capital investment also grew, which was necessary to support our growth.

As I mentioned, sales for EDG and Canvys were 41 million in the second quarter. This was stronger than what we’d anticipated and backlog remains solid. Sales for EDG were up 42.4% in the quarter. The continuing sales strength reflects the market’s recognition of our capabilities of the global channel to market. Canvys was down about 5%, due primarily to a significant but non-recurring healthcare project in the first half of FY10. Customers have also been slower and more conservative in resuming prerecession levels of capital spending.

We’re refocusing the business on the OEM market, which has a longer sales cycle but carries higher margins and is a better long-term model for our business. We believe our niche and our strength in the display market is helping our customer design customized displays to projects that will be recurring in nature.

Looking ahead, we believe that our sales for our third quarter of fiscal 2011 will be in the range of 38 million to 40 million, representing a continuation of the double-digit growth that we’ve enjoyed so far this year.

Now I’ll turn the call over to Kathy to present our financial highlights.

Kathleen Dvorak

Thank you, Ed, and good morning. Our second quarter results reflect RFPD as a discontinued operation. All prior periods, as well as our fiscal 2010 balance sheet, have been restated to reflect our discontinued operations activity.

Highlights of our continuing operations during the second quarter include sales of 41 million, up 23.7% from the prior year. Gross margin was 28.8% this quarter compared to 32.9% in last year’s second quarter. As Ed described, our decreased gross margin rate reflects reduced margins in Canvys related to the decline in the healthcare business, as well as the impact of a strategic alliance with an EDG supplier which has contributed significantly to the top line, although at lower margins.

SG&A was 27.3% of sales compared to 32% of sales in the second quarter of fiscal 2010. In terms of dollars, our SG&A is up about 600,000 from last year’s second quarter. This increase is primarily the result of incremental startup costs related to our distribution agreement. We will be incurring these incremental expenses for the third and fourth quarters and then should see lower expenses, combined with more favorable margins, starting in fiscal 2012.

Operating income for the second quarter was 595,000 or 1.5% of net sales. We believe that we will be able to get to a 5% operating margin in a relatively short period of time through a combination of margin improvements and cost reductions.

Interest expense during the quarter was 39,000 compared to 325,000 in the prior year’s quarter. This lower interest expense reflects the retirement of our convertible bonds. Our current borrowing rate is approximately 1.5%.

In the quarter we saw the dollar weaken slightly relative to foreign currencies; therefore, this year’s second quarter earnings were impacted by 197,000 foreign currency loss compared to the 700,000 foreign currency loss we experienced during last year’s second quarter. Our FX translation primarily relates to our U.S. cash held in overseas bank accounts where the functional currency is not the U.S. dollar. Once we complete the transaction, we will temporarily have higher FX exposure as we work to repatriate the cash proceeds.

During the second quarter of 2011, income from continuing operations was 168,000, and EPS was $0.01 per diluted common share compared to a loss from continuing operations of 262,000 in the second quarter of fiscal 2010. Our diluted share count is approximately 18.1 million shares. For modeling purposes, you can use between 18.1 and 18.5 million shares for fiscal 2012.

We continue to focus on our balance sheet, which includes cautiously investing in working capital and minimizing our debt levels. Consequently, our only borrowings outstanding were 18 million under our revolving credit facility at the end of the second quarter, and we had a cash balance of 33 million. Therefore, we ended the quarter in a net cash position of approximately $15 million.

Our accounts receivable balance as of November 27 was 22 million versus 19.8 million at the beginning of our fiscal year. This increase reflects the double-digit growth in sales from our continuing operations, and our DSO improved slightly.

Our inventory was approximately $26.5 million compared to $26.8 million at year-end. Inventory remained relatively flat with an almost 24% increase in sales, reflecting our focus on inventory turns and effective inventory management.

Cash flow generated by operating activities, including RFPD for the quarter, was about 2.8 million. This modest cash flow figure reflects strong income offset by a growing investment in working capital during the quarter. Capital spending for the second quarter was $100,000 and we anticipate minimal capital spending through the balance of the year.

Our tax rate for the remaining businesses for fiscal 2012 should be in the range of 32 to 34%.

Sales momentum continues to build; therefore, our current outlook for sales growth for the third quarter is for year-over-year growth of approximately 10% for our remaining business. Our current focus is on closing the transaction. In the meantime, we are working on a plan to realign our cost structure for the remaining businesses with a goal of attaining a 5% operating margin. Post-transaction, we are confident that we will be able to deliver strong financial and operational performance.

Now I would like to turn the call over to Wendy to discuss the performance and outlook for Canvys.

Wendy Diddell

Thank you, Kathy. Canvys ended the first half of fiscal 2011 with 22.3 million in sales compared to 24.2 million during the same period a year ago. Second quarter sales of 12.3 million represented a significant improvement over our first quarter sales of 10 million. Also on a positive note is the fact that bookings have exceeded billings every month since the beginning of the fiscal year, driving our backlog higher than it has been in more than two years.

Canvys’ OEM business in both North America and Europe is up slightly over the prior year. The OEM business includes display solutions sold to medical and industrial equipment manufacturers. These displays often require touch integration or other customizations such as special housings, electrical or mechanical changes which preclude the ability to use off-the-shelf solutions. OEMs also require longer panel life to avoid costly rework, certifications and retrofits.

OEM projects typically take longer to close but result in recurring business for three to five years or more. In this segment, our business growth is coming from both existing customers in the medical market as well as relatively new customers, including 3M and Varian. Today, OEM business accounts for nearly 65% of Canvys’ business.

Our healthcare business, which includes sales of displays for picture archive and communication systems, or PACS, operating room displays, and related medical equipment directly to hospitals and medical facilities, is project-based. In addition to several well-known brands, we offer our own private label monitors which incorporate our proprietary DICOM calibration software under the Image Systems brand. DICOM, which stands for Digital Image and Communications in Medicine, is the universal format for PACS image storage and transfer.

Canvys’ business in the healthcare segment is down year-to-date versus prior year due to a significant non-recurring order from Phillips which was completed during the first half of fiscal year 2010. We are seeing more quote activity within the healthcare market as hospitals ramp up for increased activity related to healthcare reform. Sales in the healthcare segment account for approximately 20% of Canvys revenue.

Our digital signage business is also project-based. The effectiveness of digital signage is becoming widely recognized and drawing more interest in the industry. While digital signage has significant market size, we have found this to be a highly competitive market influenced heavily by the IT players, including companies like IBM, and often dominated by the large display companies, including Samsung and NEC. At the end of the quarter, our digital signage business was up 26% over prior year. Digital signage sales account for 15% of Canvys revenue.

Total Canvys gross margin for the second quarter was 23.1% versus 27.2% in the prior year. Year-to-date gross margin was 23.2% versus 26.2% a year ago. The decline is primarily due to competitive price pressures, the weakening U.S. dollar, and rising inbound freight costs. However, November gross margin was significantly higher and we believe this trend will continue in the third quarter.

Expense control is an area of ongoing focus for Canvys. Headcount is down to 101 from 103 at the end of the first quarter and 109 during the same period last year.

Another area of focus for Canvys is working capital management. Our working capital efficiency ratio is at the lowest point ever at 17.9%. We are very proud of this achievement as inventory turns have improved to 7.7 times, DSO continues to decline and remains under 40 days, and accounts payable to inventory has increased over 70% during the quarter.

Over the past three years, we took significant costs out of the Canvys organization. We reduced inventory and improved working capital efficiency. We narrowed our focus in Europe to countries with strong OEM potential and selectively walked away from customers on a global basis that did not provide sufficient return.

In the third quarter and beyond, we will drive growth and long-term stability by focusing exclusively on finding and developing new OEM opportunities. This will improve our ability to forecast and enable us to improve our margins. We are identifying potential OEM targets, including those OEM customers currently served by EDG, and reviewing our field sales organization to ensure we have adequate coverage. We are also making changes to our operations team to ensure we can properly serve the OEMs while keeping the salespeople free to find new OEM opportunities.

Today we have a significant number of customers that fall outside the OEM scope. We will continue to work with a limited number of these customers provided they meet minimum buy requirements and ultimately drive recurring revenue. We will pursue other non-OEM projects that are brought to us by our vendors or referred to us by other sources on a case-by-case basis.

Our healthcare strategy remains unchanged. We will continue to focus on Image System brand sales direct to hospitals. We are exploring new technologies as well as new applications using our existing technologies.

Canvys recently attended the RS&A show in November with Hewlett Packard. Selectively, we demonstrated the world’s first known DICOM 3.14 calibrated laptop. The 15-inch and 17-inch HP mobile workstations are ideal for both clinical and diagnostic review of medical images. Radiologists, doctors and clinicians now have the benefit of a mobile workstation without the performance limitations of a typical laptop display.

Other priorities include continued cost reductions and efficiency gains. Our engineering teams will work closely with our vendor partners to redesign displays and improve margins. Through better forecasting, customer and supplier management, we will reduce our inbound freight costs and further improve margins and inventory turns. We look forward to becoming a growing part of Richardson Electronics technology-based future.

Edward Richardson

Thanks, Wendy. Now I’ll conclude with a brief discussion of the Electron Device Group, or EDG. Sales for EDG were extremely strong during the second quarter. Sales increased by 42.4% compared to the prior year’s second quarter. This reflects market recovery combined with market share gains related to a major distribution agreement. Margins declined in the quarter to 32.9% from 33.3% as a result of the mix of sales to OEMs versus end users currently associated with this agreement.

As I mentioned earlier, we’re working to transition this business to include a greater percentage of end user customers which should improve our gross margins from current levels. Operating expenses included some one-time startup costs that are also associated with the distribution agreement. These expenses will continue to be incurred for the balance of fiscal 2011.

Bookings in total for EDG continue to grow. Backlog is currently over 25 million in January.

In summary, I’m very proud of our accomplishments this quarter and the organization’s dedication and focus on the core business while completing the RFPD transaction. Going forward, we’re committed to building the business based upon our strategy of engineered and integrated solutions.

I would like to thank you for your support of Richardson Electronics, and now Kathy, Wendy and I will be happy to take your questions.

Question and Answer Session

Operator

Ladies and gentlemen, if you’d like to ask a question please press star followed by one on your touchtone phone.

Again, if you’d like to ask a question, please press star, one.

Our first question comes from the line of Robert Moses of RGM Capital.

Robert Moses – RGM Capital

Good morning.

Edward Richardson

Good morning.

Robert Moses – RGM Capital

Just two pretty simple questions, more housekeeping. Could you talk about expected depreciation and amortization for maybe the remaining entity as we think about 2012? And I think, Kathy, you mentioned limited CAPEX, but could you just give us some at least estimates for perhaps 2012 on the ongoing business?

Kathleen Dvorak

Yes. Depreciation and amortization should be somewhere around $1 million on a go-forward basis.

Robert Moses – RGM Capital

Okay.

Kathleen Dvorak

What was the other piece you wanted?

Robert Moses – RGM Capital

Just CAPEX. Is CAPEX similar then?

Kathleen Dvorak

CAPEX will be much less than that. I mean, right now in the quarter it was 100,000, so I’d say definitely under a million.

Robert Moses – RGM Capital

Okay. And I think you’d mentioned last call—you mentioned kind of the tax rate today of 32 to 34%. Will you be in a—will cash tax and accrued tax be about the same in 2012, do you think? Are you still benefiting from any tax loss carry-forwards?

Kathleen Dvorak

We will use the majority of that related to the proceeds from the gain on sale, so the taxes will be pretty similar – 32 to 34.

Robert Moses – RGM Capital

Okay. Secondly, could you just talk a little bit about the timing – I think you said next 60 days – just the remaining hurdles. I think the shareholder vote is maybe January 13 or so, I guess, next week. Could you talk about any remaining hurdles and just kind of maybe narrow in that timing a little bit?

Edward Richardson

Sure. Most of the remaining hurdles have to do with foreign governments’ approval of the transaction. We’re selling assets in some 25 countries of the world, and every country requires a filing and approval of the transaction. The remaining hurdles right now are China and then some smaller ones – I think Taiwan and Brazil. We think it’s just red tape. China, for example, takes at least 30 days after the filing, and we understand it was actually filed the 29th of December so that’s some of the holdup. But we really don’t see any other major issues. It’s just going through the process of getting approval from each one of these countries.

Robert Moses – RGM Capital

Okay. And then lastly, I guess, we should expect to hear something regarding the deployment of the cash. We’ll need to wait until this closes sometime within the next 60 days. Would you expect to—just give a sense as to cash utilization, whether it’s earmarked for acquisitions, dividends, buyback, et cetera at that point?

Edward Richardson

Well, I think it’s all of the above. At this juncture, we’ve just in general said it would be a combination of dividends, stock buyback depending on the stock price, and we’re looking at some small bolt-on acquisitions to grow the business going forward. But it’s a combination of those three.

Robert Moses – RGM Capital

Great. Thanks so much.

Edward Richardson

Thank you.

Operator

And our next question comes from the line of Al Tobia from Sidus.

Edward Richardson

Hi Al.

Al Tobia – Sidus Investments

Hi Ed. How are you?

Edward Richardson

I’m doing very well. How about you?

Al Tobia – Sidus Investments

Great. Nice quarter, Ed. Since we talked about the cash, can I just have some housekeeping facts? Do you know how much of the cash will be sort of, quote, trapped overseas?

Edward Richardson

Kathy, you want to take that?

Kathleen Dvorak

Yes. When you’re talking about trapped, you’re talking about—my answer will talk about long-term trapped; and there’s really only about 15 million that will be trapped overseas long-term. The rest is just a timing issue of how fast we can move it back to the U.S.

Al Tobia – Sidus Investments

Okay. And then if—so logically, is that—Ed, as you look at acquisitions, is overseas a good place to think about where you would do acquisitions and therefore that cash could be used without having to repatriate it with a penalty?

Edward Richardson

Well, to some extent. We’re certainly interested in some acquisitions in China. We’ve already been travelling there, talking to some companies in the alternative energy space. But I don’t see anything really major. They’re sort of, as I look at it, small bolt-on acquisitions, and we’d certainly take advantage of the trapped cash in the foreign subsidiaries where we could.

Al Tobia – Sidus Investments

Okay. And then just if I run through the balance sheet, it looks like you have about $30 million positive working capital post the deal. Is that about right?

Edward Richardson

Kathy?

Kathleen Dvorak

Yes.

Al Tobia – Sidus Investments

Okay. And I assume that you’re probably a little working capital heavy right now, or no?

Kathleen Dvorak

That’s a fair statement. As both Ed and Wendy described, working capital efficiency has improved for both businesses.

Al Tobia – Sidus Investments

Okay. And so now we pick up about 180 to $185 million worth of cash after the deal closes, right?

Edward Richardson

Yes.

Al Tobia – Sidus Investments

Add that to the 30 that I just mentioned, so we’re about 210, 215. How much cash would go out in the restructuring of the existing businesses?

Edward Richardson

Oh, it’s small. Kathy, can you estimate that?

Kathleen Dvorak

Again, I’d say under a million, 2 million.

Al Tobia – Sidus Investments

Okay. So using 210 to 215 minus 1 to 2 as a range for net cash is probably pretty good. And 18 and very small change million shares is the right share number, correct?

Kathleen Dvorak

Right.

Edward Richardson

Yes.

Al Tobia – Sidus Investments

Okay. So I want to put that aside, so put the balance sheet aside now. For the remaining businesses, the 5% operating margin target, I assume—is that an interim target you’re looking at; meaning that’s where you hope to get post a restructuring, but any growth should come at margins that are above that? I mean, is there leverageable growth as you look forward beyond the 5%, or is that a structural—

Edward Richardson

No, no. That’s based upon the current business without bolt-on acquisitions or the growth that we envision. So that’s—Kathy, I’ll let you comment on it, but that’s really working with the core business as it is today with the restructuring going into FY12.

Kathleen Dvorak

Yes. That truly is our near-term goal. Longer term, we certainly hope to do much better than that.

Edward Richardson

And we think there’s a major opportunity to grow the business. For example, the majority of EDG’s business is in the power grid tube industry, which today is about a $400 million market, and we do, well, possibly 70 million, 80 million in that market. But there is also a microwave tube market that’s about $1 billion which we have very small participation in, and that market—the major vendors are the same vendors that supply power grid tubes to us. They’re Talus, who is probably the largest player at around 250 million in revenue in that business, and then CPI, which is also one of our largest vendors, if not the largest vendor, and they do approximately 225 million in the microwave side of the business; and then L-3, which is the Litton of the past, who is also a major vendor. So by adding some technical resources, we think we can participate in that business, and these are the same vendors that we’ve worked with for years – very similar customer base, the same infrastructure we already have in place. So we think there’s a major opportunity to grow there with a minimal investment.

Al Tobia – Sidus Investments

Okay. So basically it’s more of while this is not a secular growth market in terms of vacuum tubes, you’re underrepresented in some key segments that you can identify and get to sort of quickly; so this 160 million revenue run rate that we’re at now could step up despite this not being a secular growing market.

Edward Richardson

Absolutely.

Al Tobia – Sidus Investments

Right. Thanks a lot.

Edward Richardson

Sure. Thanks, Al.

Operator

Our next question comes from the line of Mark Zinski from 21st Century Equities.

Edward Richardson

Hi Mark.

Mark Zinski – 21st Century Equities

Hi, good morning, and congratulations on the quarter. Were there any transaction costs—material transaction costs for the quarter?

Edward Richardson

Kathy?

Kathleen Dvorak

Yes, there were, and they are in the discontinued operations line.

Mark Zinski – 21st Century Equities

Okay. In terms of EDG’s geographical sales, are you seeing any softness in Europe, for instance?

Edward Richardson

No, not really. Actually, we’ve seen a reversal. Europe has picked up nicely so far in FY11 in the first six months. We’ve actually seen strong growth in Europe, North America and Asia. Some of that has to do with the new distribution agreement we have, but I think we’re seeing strong growth across the board.

Mark Zinski – 21st Century Equities

Okay. And then I just had a question about the—you had mentioned the possibility of a bolt-on acquisition in the alternative energy space, and obviously you’ve built up some nice relationships in that space prior to the divestiture. I’m wondering if you were to go into the manufacturing side, could you leverage those previous relationships, and how does that interplay with the non-compete clause with Arrow?

Edward Richardson

Okay, well the answer is yes and yes, but let me give you some details behind it. First of all, we’ve had some success over the past few years in manufacturing inverters and converters for the alternative energy market, and also the same market but for battery chargers. Currently, we’re working on a project to provide battery chargers for the Nissan LEAF automobile. And the answer to that is that those sales today are handled through RFPD, but we have a manufacturing agreement with Arrow where, going forward, we can continue to manufacture those products and RFPD will do the distribution for us. On the other hand, if they’re new products that are not currently serviced by RFPD, then we’re free to develop those products and manufacture them for companies as well, particularly if RFPD doesn’t want to distribute them.

So we’re going to continue with that technology. Some of the acquisitions that we’re looking at, particularly in China, are bolt-on acquisitions in the alternative energy space, and what we’re particularly interested in is inverters and converters that would be used in wind and solar applications, or battery chargers for electric cars. So those are some of the opportunities that we’re going to look at. But we’re completely aligned with RFPD and Arrow to go forward with that strategy.

Mark Zinski – 21st Century Equities

Okay. And so then arguably that could ramp up fairly quickly because of some of these existing and prior relationships. Is that fair to say?

Edward Richardson

Well, that remains to be seen. We’re certainly hopeful that it can ramp up, yes.

Mark Zinski – 21st Century Equities

Okay. And then just lastly in terms of kind of the nuances of the new cost structure—for instance, the EDG business, I think you mentioned before has a pretty predictable reorder pattern to it. I’m just wondering in terms of how resources are allocated in terms of sales and engineering, how the new cost structure is going to be different than the previous.

Edward Richardson

I’m not sure I understand, but the areas where we can reduce cost structure are primarily corporate support areas. For instance, in the supply chain area, Arrow will be moving the inventory for RFPD from LaFox to their facility in Reno, Nevada; and so we’ve had – Wendy, you’ve got to help me with this because of supply chain – but we’ve had, like, 35 employees in supply chain in LaFox, something like that, to handle those shipments. And obviously going forward, that means that 70% of the transactions that were handled in LaFox will be handled at Reno, so we have the opportunity to reduce our supply chain personnel, and that’s the kind of thing we’re looking at.

Mark Zinski – 21st Century Equities

Okay, great. That’s it for me. Thank you.

Edward Richardson

Okay.

Operator

And our next question comes from the line of Dan Okray [sp] from—he’s a private investor.

Dan Okray

Thanks for taking my call, guys. You’ve answered the majority of my questions that mostly just had to do to the redeployment of the proceeds from sale, and more specifically the ramp-up period after the deal closes. Like I’d mentioned, you’d mostly answered it, so I do appreciate your answers.

Edward Richardson

Okay, thank you.

Operator

Our next question comes from the line of Ethan Steinberg from Freiss Associates.

Ethan Steinberg – Freiss Associates

Hi guys. Thanks for taking my call. Just a couple questions. I missed the gross margin on EDG—or, I’m sorry, on Canvys for the quarter?

Wendy Diddell

Gross margin for Canvys for the quarter was 23.1%. Year-to-date is 23.2%.

Ethan Steinberg – Freiss Associates

And what was it a year ago—in the quarter a year ago?

Wendy Diddell

A year ago was 27.2 for the quarter, and 26.2 year-to-date.

Ethan Steinberg – Freiss Associates

Okay. And the near term target of 5%, is that mostly or entirely based on OPEX coming down once you realign things for the run rate you’ll be going on the revenues?

Edward Richardson

Yes, it is.

Wendy Diddell

Yes.

Ethan Steinberg – Freiss Associates

Okay. And then I think, Ed, on the last call you said you thought EDG should be a 35% gross margin. I think you said today it should be going up from that 32.9. Are you still thinking 35, or higher or lower?

Edward Richardson

Thirty-five, I think, is a good benchmark. As we mentioned, in the new distribution agreement that we’ve taken on in this last year, we also took on a substantial amount of fairly low margin business or OEM business that had serviced their own aftermarket in the past, and so our objective is to convert that business to the user or aftermarket business, which has really been our strategy for so many years. And as we do that, the margin will increase on a linear basis, so the 35% goal is something I think we can get to for EDG in the next couple of years.

Ethan Steinberg – Freiss Associates

Okay. And maybe I’m just remembering this incorrectly, but I thought last quarter you said that the lower margin piece would continue this quarter and maybe into the quarter we’re now in, but then would pretty quickly move up to 35% or towards that. Am I remembering that correctly or incorrectly?

Edward Richardson

Well, I think it will be linear. You know, it won’t move—you know, you probably look at a point, or maybe a point or two a year, or something like that. We’ll move it as quickly as we can but part of what we’ve seen in this past quarter are some of the OEMs taking advantage of annual contracts and releasing products at the old price ahead of the price increase, and so that had some impact.

Ethan Steinberg – Freiss Associates

Okay. And then what do you think a reasonable gross margin rate for Canvys should be in a normal revenue environment?

Wendy Diddell

I would say it should be back at where it was in the prior years, so 26, 27% range.

Ethan Steinberg – Freiss Associates

Okay. So when we think about where the leverage in the business can go, if you can get to that 5% pretty quickly, just on SG&A you’ve got another, I don’t know, 300 basis points-plus from gross margin in addition to that as those gross margins move up on top of the 5%, right? Am I thinking about that correctly?

Edward Richardson

You are.

Ethan Steinberg – Freiss Associates

Okay.

Edward Richardson

It’s just a matter of how fast we can get there.

Ethan Steinberg – Freiss Associates

Sure. And then do you have any kind of idea of what you think SG&A should be as a percentage of sales, or as a dollar amount?

Edward Richardson

Kathy, you want to address that?

Kathleen Dvorak

I think I’d prefer to just stick to my 5% target. I think you can pretty much do the math. I mean, we’ve got about right now in the current quarter—you have a 1.4 million you’d have to take out of SG&A to get to the target, and if I look at that I’d also say to you that embedded in that 1.4 million is some of the one-time costs that we’ve talked about relative to the exclusive distribution agreement. So you know, to get to the 5% is not that difficult. So right now you’re probably about SG&A of 10 million per quarter.

Ethan Steinberg – Freiss Associates

Okay. And then also--just maybe somebody asked it and I didn’t hear the answer, but as far as what you’re thinking on the cash, and we talked last time about tendering for the stock just because a regular buyback could be pretty slow given liquidity, what are your latest opinions on that assuming the deal goes through as planned?

Edward Richardson

Well, I think we’ve just sort of left it open. We’ve said that we’ll look at the possibility of dividends. A stock buyback, obviously, is about the most accretive thing we can do, depending upon the price of the stock. And then these bolt-on acquisitions, although we haven’t really identified anything, that takes up a lot of cash. But I’ll tell you – our focus right now is trying to conclude the transaction, and we haven’t spent a great deal of time trying to figure out what we’d do with the cash until we’ve got it in the bank.

Ethan Steinberg – Freiss Associates

Yeah, okay. All right, well congrats and thank you for what you’ve done for all of us. We appreciate it.

Edward Richardson

Thank you very much.

Operator

And again, ladies and gentlemen, if you’d like to ask a question, that’s star, one. We have a follow-up question from the line of Robert Moses from RGM Capital.

Robert Moses – RGM Capital

Just one question, relatively new to the Company. But Ed or Kathy, could you give us just some sense as to if EDG is, I don’t know, $100 million business and Canvys is maybe 50, is there a way to break down either the end markets customers, et cetera? You talked about the power grid side, I think, being 70, 80 million. Could you just kind of fill in the blanks just to give me a better sense as to the industry exposures that you have in the separate businesses; and maybe in Canvys it’s largely healthcare but any other end markets of note?

Edward Richardson

Sure. Well, I’ll address EDG and then I’ll let Wendy address Canvys. EDG today is—about 80% of the business is aftermarket, selling replacement tubes and components to users. The other percent, about 20%, is OEM. The largest portion of the OEM business is semiconductor wafer fabrication industry, and so we sell anything from tubes into equipment that’s used for curing silicon, for example, all the way to doing microwave generators which uses a tube as a power source. So the semiconductor wafer fab portion of that business is around 18 to 20 million, something like that; and the balance of the business is primarily aftermarket for replacement tubes that are going into industrial applications for dielectric heating, induction heating, CO2 laser cutting – you know, all kinds of applications for welding plastics and laminating plywood and vulcanizing rubber and heat-treating steel parts. I could go on and on. But it’s a very predictable aftermarket – 25,000 customers all over the world and a really broad base. So that should give you some kind of idea. We can even break it down more for you. We do some in avionics, some in marine.

Wendy, would you like to address the Canvys customer base?

Wendy Diddell

Sure. Within Canvys, we primarily divide the business into the OEM, digital signage, and healthcare segments of the business. The OEM is about 65% of Canvys’ total business, and that’s about 60% which would be more medical related applications and 40% being more what we would call industrial applications. The digital signage business is about 15% of the total, and then the healthcare – and we distinguish healthcare from medical, and the healthcare segment are those PACS displays that are sold directly to the end user, the hospitals themselves – that’s about 20% of the business.

Robert Moses – RGM Capital

That’s very helpful. Thank you.

Operator

And we have a question from the line of Rick Winer from Risk Management.

Edward Richardson

Hi Rick.

Rick Winer – Risk Management

Hi, good morning. What are you looking at your tangible stockholders’ equity to be at the end of next quarter?

Edward Richardson

Kathy?

Kathleen Dvorak

Wow.

Rick Winer – Risk Management

It could be an approximation.

Kathleen Dvorak

You mean after we have the proceeds and everything?

Rick Winer – Risk Management

Yeah, exactly.

Kathleen Dvorak

I think we’ve pretty much heard someone kind of walk through the math on that; and so I haven’t quite calculated where we’re actually going to be, but—I mean, you know where our cash balances are, and you know where everything else is. So I don’t think there’s going to be anything too surprising there.

Rick Winer – Risk Management

Okay, fair enough. I thought I would take a shortcut from doing the math myself.

Edward Richardson

Well, you can almost work the cash. I mean, we’re going to be somewhere with 180, 185 as proceeds from the deal, and we have an additional 15, $20 million worth of cash. So divide that by 18, and I guess you could add in—Kathy, what’s the net asset value of the residual business after the transaction?

Kathleen Dvorak

Well just—I mean, it’s exactly what we’re showing right now. The total assets is the 264 million minus the discontinued, which is the 174.

Rick Winer – Risk Management

Maybe one of these smart analysts on the call has already run through these numbers over the last 30 minutes, and maybe they want to beep back in and give us their summary of what that number would be. If they do, I would welcome hearing that. Thank you. Thank you very much.

Edward Richardson

Al, are you still out there? I know you had worked a number that sounded pretty reasonable. Must have left us.

Operator

And we have Al Tobia.

Edward Richardson

Oh, there’s Al.

Al Tobia – Sidus Investments

Hi, Ed. I had about 11.75 or so of net cash, meaning I took $30 million of your positive working capital and assumed that there was some conversion of cash, and then added that to the 180 to 185 coming in and divided by 18, and I got about 11.75 or so.

Edward Richardson

All right.

Al Tobia – Sidus Investments

And then I think that your long-term assets over your long-term liabilities are also a positive—

Kathleen Dvorak

Yes.

Al Tobia – Sidus Investments

So—because you don’t have really any long-term liabilities.

Edward Richardson

That’s right.

Al Tobia – Sidus Investments

So if I—I’ll check, one second. If I look at that—you know, you only have $8 million of long-term cash and 4 million in long-term liabilities, so let’s call those a wash. So the balance sheet’s pretty simple – it’s all current, right? So 11.75 to $12 is about a net tangible book number, I assume; and you probably have some understated land and things like that there, I guess, right?

Edward Richardson

Yeah, absolutely.

Kathleen Dvorak

(Inaudible) statements.

Al Tobia – Sidus Investments

Right. Maybe Ed’s got some artwork in his office that’s appreciating over time!

Edward Richardson

There’s land and buildings on the books that are almost fully depreciated—not land, but they are certainly worth a lot more than they are on the books for.

Al Tobia – Sidus Investments

And you don’t really—I mean, this is the simplest balance sheet I’ve ever looked at. You have a couple—a little bit of prepaid expense, and I assume your inventories are pretty much dollar good because you’re turning them fast enough, so.

Edward Richardson

Right.

Al Tobia – Sidus Investments

So that’s—yeah, $12. A good number.

Edward Richardson

That’s good. Nice to be in that position.

Al Tobia – Sidus Investments

Exactly.

Edward Richardson

Thanks, Al.

Operator

And now ladies and gentlemen, that does conclude our Q&A portion of the presentation. I’d like to turn the call over to Mr. Richardson for further remarks.

Edward Richardson

Thanks, Francine. Well, once again, I’d like to thank you for your support, and I’m confident that we’ll continue to earn your confidence going forward. We look forward to reporting on the closing of the RFPD transaction in the next few weeks, and then on our ongoing progress in the core business again in April. So thanks for your investment and your recognition of the Company. We look forward to talking to you soon.

Operator

Ladies and gentlemen, that concludes today’s conference. We thank you for your participation. You may now disconnect and have a great day.

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Source: Richardson Electronics CEO Discusses Q2 2011 - Earnings Call Transcript
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