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Executives

Edward J. Richardson – President and Chief Executive Officer

Kathleen S. Dvorak - Chief Financial Officer

Gregory J. Peloquin - Executive Vice President, General Manager Wireless & Power Division

Analysts

Christian Schwab - Craig-Hallum Capital

Robert Damron - 21st Century Equity Research

Al Bhatia - Citigroup

Russ Silvestri - Skiritai Capital

Richardson Electronics, Ltd. (RELL) F1Q09 Earnings Call October 9, 2008 10:00 AM ET

Operator

Welcome to Richardson Electronics first quarter conference call. (Operator Instructions) I would now like to turn the presentation over to your host for today’s conference, Edward Richardson, Chairman of the Board and CEO.

Edward J. Richardson

Thank you for joining our conference call to discuss Richardson Electronics financial performance for the first quarter of fiscal 2009. With me this morning are Kathy Dvorak, Chief Financial Officer, and Greg Peloquin, Executive Vice President and General Manager of the RF Wireless & Power Division. Greg is joining us from France today where he is attending a European sales meeting.

Today’s call includes forward-looking statements such as our view of what the future holds for Richardson Electronics. These statements are projections which are affected by the risks and uncertainties in our business and the market place. We assume no obligation to update our projections as actual results may be materially different. Please refer to the cautionary language in our press release and SEC filings for additional discussion on our forward-looking information.

I will begin today by reviewing the highlights of our first quarter fiscal year 2009 results. Kathy will present further details on our financial performance and then Greg will discuss the results for RFPD. Then I will provide some comments on the Electron Device Group as well as provide an update on our long-term outlook. After that Greg, Kathy, and I will be happy to answer any of your questions.

Before we discuss our financial results I believe it is important to answer the question, what makes Richardson Electronics unique and what differentiates us from our competitors?

First, we have many exclusive distribution agreements with our suppliers because they recognize the strength of our specialized channel-to-market. Second, we are a provider of engineered solutions. Our sales team is primarily comprised of engineers that help our customers design in components for specific applications. Third, we build complete integrated systems to meet our customers’ requirements. As you can see, we are far more than a distributor. We differentiate ourselves through engineered solutions.

Now let’s turn to our first quarter performance. I would like to begin by thanking the entire Richardson team that enabled us to achieve these results in a very challenging global environment.

During the quarter we achieved sales growth of 7.3%, operating income of $4.5 million, net income of $3.7 million, and diluted earnings per common share of $0.20.

Focusing on just the Display Systems Group, sales declined by about 4% while margin improved by about 400 basis points to 25.3%. The decline in sales for DSG was primarily by the overall decline in the health care sector. The improved margins represent our progress in repositioning DSG with a more profitable and sustainable business model.

We are walking away from unprofitable sales, focusing on those customer relationships that provide long-term profitable opportunities. DSG continues to reduce their cost base, allowing them to adjust to sales fluctuations. They have numerous projects underway and their backlog remains strong. We are confident that DSG has a bright future and he have the right team in place to build the business.

We understand the importance of providing our customers with first-rate service. As a result, we are continuously working to improve customer service. We are in the process of tailoring our stocking strategy to serve the specialized needs of our customers within each of our business units. Without a doubt, the REL team is focused and committed to producing solid financial results for 2009.

Now I would like to turn the call over to Kathy to discuss the details of our financial performance.

Kathleen S. Dvorak

I am pleased to announce that we are off to a strong start in our first quarter. Our goal is to run our business to sustain consistent and improved financial and operational performance. Our near-term sales outlook is encouraging. We are working to improve our margins and we will continue to take costs out of our business.

Sales for the quarter were up 7%, driven by strong sales growth within RFPD. While sales for EDG and DSG were down from last year, we are pursuing every opportunity to drive growth as well as capitalizing on pricing initiatives to improve profitability.

Gross margins in the quarter declined to 23.5% compared to 25.2% in the prior year’s quarter. This reflects the fact that RFPD is growing faster than our higher-margin business units and that our Asian operations within RFPD had sales growth of 29%, driven primarily by a large communications infrastructure project within Asia that carried a lower than average margin.

Our SG&A expenses declined to $28.2 million, or 20.3% of net sales, compared to $30.0 million, or 23.1% of sales, in last year’s first quarter. Overall, cost containment actions are gaining traction and we are starting to see our SG&A expense measured as a percent of sales decline. We are spending less money in consulting and overall employee costs. Included in SG&A expense is about $1.2 million of depreciation and amortization expense.

We expect future SG&A declines further as we continue to bring down our headcount and streamline our operations. Our headcount is now approximately 920 employees. This number should continue to decline as we begin to change the way we do business and increase our overall productivity.

As I have mentioned before, we continue to do some strategic investing. For example, in the second and third quarters we will be incurring incremental expense related to upgrading our Web presence. This will enable us to capture additional sales.

The implementation of improved cost controls was the primary driver of operating income for the first quarter, of $4.5 million, or 3.2% of net sales, compared to $2.7 million, or 2.1% of net sales, in the prior year.

For the first quarter of 2009 net income was $3.7 million, or $0.20 per diluted common share, compared to a net loss of $400,000 during the first quarter of last year.

Taxes for the first quarter of fiscal 2009 were approximately $900,000 of tax expense and we still anticipate that taxes for the total year will be approximately $3.0 million.

As I have discussed in the past, the volatility of foreign currency relative to the dollar injects our financial statements. During the quarter we recognized about $1.0 million of foreign exchange gain due to the strengthening of the dollar. During the first quarter the U.S. dollar strengthened versus the major foreign currencies in which we transact business. We continue to monitor foreign exchange rates and incorporate them in the decision-making process of buying and selling in all the various countries we transact business.

We now have a stronger balance sheet position, which includes conservative debt levels. Our focus remains on both our P&L as well as our balance sheet. Our incentive plan now includes a component based on our ability to effectively manage our working capital investment.

Our accounts receivables balance as of August 30, 2008, was $105.8 million versus $109.5 million at year end. Excluding the impact of foreign exchange, our receivables decreased by about $1.2 million versus the $3.7 million increase shown on our balance sheet.

Our inventory level was approximately $100.0 million, up about $6.2 million from year end. Excluding the impact of foreign exchange, our inventory level increased by $7.6 million from year end versus the $6.2 million increase shown on the balance sheet.

Our first quarter is typically the weakest quarter in terms of sales growth, therefore inventory levels increase going into Q1 and build for anticipated higher-sales-volume quarters.

Cash provided by the increased accounts payable balance since year end was approximately $3.8 million, net of foreign currency translation. We continue to aggressively negotiate more favorable terms with our suppliers.

Cash flow used by operations for the three-month period ending August 30, 2008, was a slight use of cash of less than $1.0 million as compared to cash provided by operating activities of $6.0 million for the prior year. Our use of cash this quarter represents the increased inventory spend, which is typical for this time of year, partially offset by a reduction in receivables and an increase in payables.

The inventory spending in the first quarter was expected and is common for the type of spending needed to provide for sales growth in the upcoming quarters.

Capital spending for Q1 was just $129,000 versus $1.6 million in the prior year. If you recall, last year we had significant capital spending due to IT-related projects.

Our total debt less cash, or net debt, at the end of the first quarter was approximately $18.6 million compared to about $38.1 million at this time last year.

While Q1 exceeded our expectations, we are realistic about the challenges presented by the current state of the global economy. We are aggressively working to improve our margins and reduce our expenses. At the same time, we are focusing on all areas to increase our operating cash flow and further strengthen our balance sheet.

Second quarter net sales should be in the range of $140.0 million to $145.0 million. And then we expect sales growth for the back half of fiscal 2009 to be in the range of 3% to 4%.

Our 2009 goal is to keep operating expenses as a percentage of net sales below 21%. Using Q1’s margin rate of 23.5% as a base line, we believe we will be able to improve our gross margin rate as we progress through fiscal 2009. Expense reduction is becoming a way of life, and therefore we expect to see a continuous reduction in operating expenses.

In summary, we are leaving no stone unturned as we look for opportunities to further reduce our cost base. As we improve our margins and hold the line on operating costs, we believe our company will be well positioned to deliver improvements to both financial and operational performance in 2009.

Now I would like to turn the call over to Greg to discuss our RFPD business.

Gregory J. Peloquin

I thought we would take the morning looking at the revenue side. The momentum we developed in the fourth quarter last year has continued into the Q1, as you can see. Our sales increased nearly 15% in Q1 compared to the first quarter of fiscal year 2008. This growth was driven by our China team and Phase 2 of the TDS-CDMA roll out is in full swing.

In addition, our power conversion restructuring has continuing to show very strong growth as we focus on the every-growing number of alternative energy opportunities throughout the world.

Area sales improvements were as follows: AsiaPac sales were up 28.9%, North America was up 6%, Europe up 3.5%, and Latin America was up 9.8%. All three major project divisions, within RFPD, contributed to an impressive operating performance and strong growth in Q1. RF active was up 15.6%, RF passive was up 9.2%, and power conversion was up 19.1%.

Again, our global footprint and exclusive supplier agreements and extensive field engineering team allow us to take advantage in areas of the world where there is strong growth while re-deploying resources within areas where there is minimal growth potential. We continue, with this model, to take market share away from our competitors worldwide.

Looking at the profitability side, we continue to focus on improved profitability along with revenue growth. It is important to mention again the numerous processes, policies and procedures that we have implemented to maximize this strong growth model.

Our sales and operations management system enabled us to reduce inventory by $5.2 million over prior year and increased our turns from 4.5x to 5.4x. This, with continued improvement in payment terms with over 23 of key suppliers, has greatly improved our cash flow position in Q1 and will continue going forward.

Q2 outlook, China will continue to have strong growth in Q2. Our power conversion energy group has a strong booking period in Q1 and we expect to see strong growth again in Q2 for this business unit. Therefore we are still expecting to see high- to single-digit growth for the year, and as you can see, we are on the run rate to do that.

In summary, our large investment in our global Web upgrade is still on schedule and on budget. We are very excited to roll this out in Q3. Our new software program, designed to complete and support our global freight recovery initiative, is in place and operational. We continue to invest in emerging markets such as China and India, as both have shown record growth confirming our investment strategy.

Our engineer engineered solution sales grew 13% in Q1 as we continue to add alliance partners and internal engineering capabilities. In fact, we booked a multi-million order in Q1 for a customer in Europe. We worked with one of our key alliance partners to manufacture the part for us, our engineering design team, and our center in North America, characterize the standard product, and perform parts power testing. Results confirm the parts will meet all of our customer’s needs with a high yield.

The initial orders are placed and the forecast is for $10.0 million over the next three to five years, thus continuing the market’s need for engineered solutions capabilities. Again, not too bad for a distributor.

Now, back to you Ed.

Edward J. Richardson

I will briefly provide the highlights for the quarter for the Electron Device Group and then close with some comments on our outlook for the second quarter and the balance of the year.

Sales for EDG were down about $1.0 million from the prior year. The decrease primarily reflects softness in the semiconductor wafer fabrication equipment industry. Gross margin for fiscal year 2009 declined to 30.5% from 32.2%, reflecting a shift in our product mix. We are focusing on margin and believe that we will see improvement for the balance of the year as we shift to selling higher-margin products.

Two weeks ago I attended EDG’s world-wide sales meeting. Our sales force combines the most knowledgeable team of two specialists in the world. We understand the challenges we face but we are confident that we will deliver solid financial performance for this fiscal year.

As Kathy and Greg have indicated, we are building momentum for both sales and profit improvement. The Richardson team fully understands the need to change. While we will continue to work to take customer service to the next level, we are also working to improve gross margins, reduce our cost base, and manage our working capital investment. We are confident that these changes will lay the ground work for future growth and profitability, which we are beginning to see already.

As Kathy mentioned, second quarter net sales should be in the range of $140.0 million to $145.0 million. We expect sales growth for the back half of fiscal year 2009 to be about 3% or 4%. Our 2009 goal is to keep operating expenses as a percentage of net sales below 21%.

We are planning for the challenges that are likely to face many businesses around the world in the months ahead. We are taking strong actions now to make sure we will deliver solid financial performance in 2009, despite the difficult global economic conditions.

For the Richardson team, I want to thank you for your interest and support as we build a stronger company for the future.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Christian Schwab – Craig-Hallum Capital.

Christian Schwab - Craig-Hallum Capital

Kathy, why did the share count bump up 1 million versus last quarter, on a fully diluted basis?

Kathleen S. Dvorak

It really has to do with the diluted impact of options and the impact from the bonds.

Christian Schwab - Craig-Hallum Capital

Can you give us any indication of what you would expect on the fully diluted share count for the remainder of the year?

Kathleen S. Dvorak

18 million is still a good number to use.

Christian Schwab - Craig-Hallum Capital

18 million or 18.9 million?

Kathleen S. Dvorak

I would continue to use the 18.9 million.

Christian Schwab - Craig-Hallum Capital

At what point does the distribution of system kind of help eliminate a lot of the currency translation? This quarter it was a very big positive, roughly $0.06 positive. That could bit us the other way another quarter. At what point do we get that to have a very minimal impact on quarterly results?

Kathleen S. Dvorak

We are working toward that goal. We are taking some actions that will help to mitigate that. Unfortunately we are seeing so much volatility in currencies it’s very difficult to predict at this juncture.

Christian Schwab - Craig-Hallum Capital

If sales are going to go up and the number of employees is going to go down, why would SG&A as a percentage of revenue increase?

Kathleen S. Dvorak

That was our goal. We are working very hard, we are seeing positive trends to continue to bring it down. As I mentioned, we are doing some strategic investments in Q2 and Q3 relative to the Web upgrade. But certainly we think we are going to be in the low end of those numbers.

Christian Schwab - Craig-Hallum Capital

How much is the Web upgrade going to cost? What should we be modeling as one-time increases in Q2 and Q3 for Web upgrade costs?

Kathleen S. Dvorak

It will be a couple hundred thousand in Q2 and Q3.

Christian Schwab - Craig-Hallum Capital

And what would ultimately be our goal, if we have such a thing, for the number of employees at year end? We’ve got 920 today, I’m sure you’ve got a targeted number, actually for the fiscal year, could you share that with us?

Edward J. Richardson

I would say it’s around 900. We are going to try to do better than that if we can but it’s a timing issue.

Christian Schwab - Craig-Hallum Capital

So the lion’s share of the work, the steady state op-ex of this business, without any travel or added bonus expense, is somewhere in that $28.0 million to $29.0 million range, is that fair?

Kathleen S. Dvorak

Yes.

Christian Schwab - Craig-Hallum Capital

Now that we’ve kind of fixed up the Display group, do you still think that that is a core asset?

Edward J. Richardson

Yes. You know, we think there is quite an opportunity to improve the performance of Display going forward and so we will monitor that very closely and see what it looks in a couple of years.

Operator

Your next question comes from Robert Damron – 21st Century Equity Research.

Robert Damron – 21st Century Equity Research

Kathy, on the operating expense, I think we were modeling a little bit for some severance expense in this quarter and also throughout the year. Has that changed at all? Or what kind of numbers should we anticipate, and did we see any severance expense in this first quarter?

Kathleen S. Dvorak

Yes, there was severance expense included. We are trying to work through all of that and absorb severance within the kind of goals that we’ve set out for you. So when we say we’re going to be below the 21%, we are hopefully managing our numbers so that we can absorb the severance expense and still produce the kind of numbers that we are putting out there.

Robert Damron – 21st Century Equity Research

So what was the severance in Q1?

Kathleen S. Dvorak

It’s several hundred thousand.

Robert Damron – 21st Century Equity Research

And will we be at about that run rate over the next couple of quarters?

Kathleen S. Dvorak

It could be. Again, it’s a timing issue, depending on how we get certain things done. Many of the reductions are contingent on systems and other things that we have to have in place.

Robert Damron – 21st Century Equity Research

And maybe a question for Greg as well. You talked about this major communications infrastructure project that’s going on in Asia. Maybe you can talk through us, how far along are we in that project, how many more quarters will we benefit from that, are we getting a lot of kind of one-time sales from that or is there some momentum that will continue the growth beyond that?

Gregory J. Peloquin

Yes. The project is the infrastructure roll out within China, and before the Olympics they put in Phase 1, which is the cities, etc. Now this is Phase 2 of that TDS-CDMA roll out in which we track that business by tri-global design registration program. And so the large part of this Phase 2 will be in our Q1 and Q2 and then it will be diminished in Q3 and Q4.

But the power conversion business bookings in Q1 and so far in Q2 are very, very strong so that higher-margin business will come in to make up the difference, if you will, in Q3 and Q4.

But that’s the major roll out. Then you will have upgrades and as they continue to upgrade their infrastructure they’re going to put in the WCDMA, wide-band CDMA, infrastructure and we will participate in that, too. But the big numbers are going to come in our Q1 and Q2 and then slow down slightly in Q3 and Q4.

Robert Damron – 21st Century Equity Research

And, Ed, you mentioned in the Display Systems Group one of the areas of growth has been health care but you mentioned that there was a slow down there this last quarter. Can you just give us a little bit of feel on the market and the expectation for that over the next couple of quarters?

Edward J. Richardson

Sure. A primary driver in health care was the roll out of the tax system that [inaudible] archiving communications systems and most of the hospitals have already implemented their first phase of those systems. But really the business from there on, which was originally an engineered solutions kind of business where we were designing systems, has now become more of a commodity business where they are just replacing individual displays and we have chosen either not to participate in the low-margin portion of the business or it’s been certainly a smaller volume. So that’s been the issue.

On the flip side, the digital science business is certainly growing and we are focusing in that area as well. We have a substantial backlog right now of various projects. Unfortunately, in the business when you get a downturn in the economy, the first projects that get pushed out are these new projects like digital science. So we are seeing some push outs in that area as well.

Operator

Your next question comes from Al Bhatia Citigroup.

Al Bhatia - Citigroup

The inventory obviously went up at the end of Q1 to deal with the higher volumes, I guess, coming out of RFPD in this quarter. What kind of expectations do you have for aggregate or turns numbers in the back half of the year, and kind of looking forward, and how much cash can you wring out of inventories here?

Kathleen S. Dvorak

As we progress through Q3 and Q4, you know sales build into Q3 and Q4. Typically a goal to get to at year end is to have a 6 turns by year end. And since Q4 is the strongest sales quarter, that’s really when we start to pull down our inventory levels. So we’re going to see some investing in inventory and we’re doing everything we can to manage that carefully, but we recognize we have to support our customers with an inventory investment.

Al Bhatia - Citigroup

So would it be likely that inventory doesn’t go down sequentially here, that it doesn’t go down until the back half of the year?

Kathleen S. Dvorak

Again, doing everything we can in terms of timing to try to watch this, that may be the case at this juncture, but certainly as we get to Q3 we will start to see inventory come down.

Al Bhatia - Citigroup

And you think you can see gross margin increases in Q3 despite bringing inventories down?

Kathleen S. Dvorak

Yes. As Greg talked about, we’re doing some things, we have some volatility in margins that occurs between quarters and as we look to what’s in the product mix, we are seeing higher-margin products as we go into the next quarters and we are working on our price initiative to increase freight recovery. Those things give us comfort that we should start to see gross margin move back up.

Operator

Your next question comes from Russ Silvestri – Skiritai Capital.

Russ Silvestri - Skiritai Capital

Just a little more meat on the bone on the gross margin. I am just trying to get a better understanding of how much improvement you think there is going forward. Quantifying it is I guess what I’m asking.

Kathleen S. Dvorak

A lot of Q1 and the growth was driven by these Asian sales. Asia has a lower overall gross margin and then you combine it with a fast-growing component sales as opposed to more of the engineered solutions, which Greg has in the pipelines coming up. We should see a fairly significant improvement as we move into Q2 relative to where we were in Q1.

Russ Silvestri - Skiritai Capital

And then in terms of the SG&A, is it all coming out of headcount? Is there anything else that is driving that?

Kathleen S. Dvorak

Well, we’re renegotiating every contract and looking under every stone. So it’s all areas of business are contributing to the decline in SG&A. Headcount is just one piece of it.

Russ Silvestri - Skiritai Capital

Is there a cash conversion cycle goal, for the company?

Kathleen S. Dvorak

We are working on that. It certainly, our objective, we need to convert cash much faster than we have done historically so look for us to continue to make progress, but I can’t tell you at this point we actually have a goal.

Operator

Your next question is a follow up question from Christian Schwab – Craig-Hallum Capital.

Christian Schwab - Craig-Hallum Capital

Greg, can you walk us through what exactly is driving the strong bookings in the power conversion business, maybe some specifics there?

Gregory J. Peloquin

Yes. The largest part was North America and Japan. And what it is a number of our customers are manufacturing equipment and what they are doing is they are converting to support the making of solar cells. And because of the large cost of energy, that is a very, very active market for us right now.

And so it’s mainly the inverter section of the solar and wind-powered generators and we have numerous engineered solutions products and numerous exclusive products from our suppliers to support that. So it’s alternative energy and mainly in the inverter and power supply sections of those systems.

Once again, that’s the Richardson model. We literally have a niche within a niche. And through again partnerships with our suppliers we are able to generate huge dollars in terms of design wins for this roll out of alternative energy.

Christian Schwab - Craig-Hallum Capital

So who are the specific customers that you are selling to for that?

Gregory J. Peloquin

Well, one would be Advanced Energy in Colorado, one of our largest customers for this type of product.

Operator

There are no further questions.

Edward J. Richardson

As you have heard, we are committed to implementing strategies that will improve profits by reducing expenses, enhancing customer service, gaining market share, and ensuring the long-term success of our company. I am confident that our management team will deliver improved performance in 2009 and will position us for even stronger performance in the years ahead.

With that, Kathy, Greg, and I want to thank you for participating in the call today and for your continued investment in Richardson Electronics.

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Source: Richardson Electronics, Ltd. F1Q09 (Qtr End 08/30/08) Earnings Call Transcript
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