Richardson Electronics, LTD.: Form 10-Q for the period ended Nov 30, 2013

Certain statements in this report may constitute “forward-looking” statements within the meaning of the Private Securities Litigation Reform Act of 1995. The terms “may,” “should,” “could,” “anticipate,” “believe,” “continues,” “estimate,” “expect,” “intend,” “objective,” “plan,” “potential,” “project” and similar expressions are intended to identify forward-looking statements. These statements are not guarantees of future performance and involve risks, uncertainties and assumptions that are difficult to predict. These statements are based on management’s current expectations, intentions or beliefs and are subject to a number of factors, assumptions and uncertainties that could cause actual results to differ materially from those described in the forward-looking statements. Factors that could cause or contribute to such differences or that might otherwise impact the business include the risk factors set forth in Item 1A, of our Annual Report on Form 10-K filed on July 26, 2013. We undertake no obligation to update any such factor or to publicly announce the results of any revisions to any forward-looking statements contained herein whether as a result of new information, future events or otherwise.

In addition, while we do, from time to time, communicate with securities analysts, it is against our policy to disclose to them any material non-public information or other confidential commercial information. Accordingly, stockholders should not assume that we agree with any statement or report issued by any analyst irrespective of the content of the statement or report. Thus, to the extent that reports issued by securities analysts contain any projections, forecasts, or opinions, such reports are not our responsibility.

INTRODUCTION

Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) is intended to assist the reader in better understanding our business, results of operations, financial condition, changes in financial condition, critical accounting policies and estimates, and significant developments. MD&A is provided as a supplement to, and should be read in conjunction with, our consolidated financial statements and the accompanying notes appearing elsewhere in this filing. This section is organized as follows:

• Business Overview
• Results of Continuing Operations – an analysis and comparison of our consolidated results of operations for the three and six months ended November 30, 2013, and December 1, 2012, as reflected in our consolidated statements of comprehensive income.
• Liquidity, Financial Position, and Capital Resources – a discussion of our primary sources and uses of cash for the three and six months ended November 30, 2013, and December 1, 2012, and a discussion of changes in our financial position.

Business Overview

Richardson Electronics, Ltd. (“we”, “us”, “the Company”, and “our”) is incorporated in the state of Delaware. We are a leading global provider of engineered solutions, power grid and microwave tubes and related components, and customized display solutions, serving customers in the alternative energy, aviation, broadcast, communications, industrial, marine, medical, military, scientific, and semiconductor markets. Our strategy is to provide specialized technical expertise and “engineered solutions” based on our core engineering and manufacturing capabilities. We provide solutions and add value through design-in support, systems integration, prototype design and manufacturing, testing, logistics, and aftermarket technical service and repair.

Our products include electron tubes and related components, microwave generators, subsystems used in semiconductor manufacturing, and visual technology solutions. These products are used to control, switch or amplify electrical power signals, or are used as display devices in a variety of industrial, commercial, medical, and communication applications.

On September 4, 2012, we acquired the assets of D and C Import-Export, Inc. ("D and C") for approximately $2.6 million. D and C, a Florida-based distributor of power grid tubes and associated RF components, services the broadcast, commercial, industrial, medical, military, and scientific markets. This acquisition provides us with access to additional product lines, vendors, and customers.

On July 5, 2013, we acquired the assets of WVS-Technology ("WVS") for approximately $1.0 million. WVS, located in Meerbusch, Germany, develops and sells RF and microwave products, power grid tubes, vacuum capacitors, as well as industrial microwave equipment. This acquisition provides us with engineering and sales expertise to help expand our presence in the vacuum capacitor market.

We have two operating segments, which we define as follows:

Electron Device Group (“EDG”) provides engineered solutions and distributes electronic components to customers in alternative energy, aviation, broadcast, communications, industrial, marine, medical, military, scientific, and semiconductor markets. EDG focuses on various applications including broadcast transmission, CO2 laser cutting, diagnostic imaging, dielectric and induction heating, high energy transfer, high voltage switching, plasma, power conversion, radar, and radiation oncology. EDG also offers its customers technical services for both microwave and industrial equipment.

Canvys provides customized display solutions serving the corporate enterprise, financial, healthcare, industrial, and medical original equipment manufacturer (“OEM”) markets.

We currently have operations in the following major geographic regions:

• North America;
• Asia/Pacific;
• Europe; and
• Latin America.

RESULTS OF CONTINUING OPERATIONS

FINANCIAL SUMMARY – THREE MONTHS ENDED NOVEMBER 30, 2013

• Net sales for the second quarter of fiscal 2014 were $35.4 million, down 3.2%, compared to net sales of $36.6 million during the second quarter of fiscal 2013.
• Gross margin increased to 31.1% during the second quarter of fiscal 2014 compared to 29.3% during the second quarter of fiscal 2013.
• Selling, general, and administrative expenses increased slightly to $10.5 million, or 29.6% of net sales, for the second quarter of fiscal 2014 compared to $10.2 million for the second quarter of fiscal 2013, or 27.9% of net sales, respectively.
• Operating income during the second quarter of fiscal 2014 and fiscal 2013 was $0.5 million, or 1.5% and 1.4% of net sales, respectively.
• Income from continuing operations during the second quarter of fiscal 2014 and fiscal 2013 was $0.6 million, or $0.04 per diluted common share.
• Loss from discontinued operations, net of tax, was $0.1 million during the second quarter of fiscal 2014 compared to $0.2 million during the second quarter of fiscal 2013.
• Net income during the second quarter of fiscal 2014 was $0.5 million, or $0.03 per diluted common share, compared to net income of $0.4 million, or $0.03 per diluted common share, during the second quarter of fiscal 2013.

FINANCIAL SUMMARY – SIX MONTHS ENDED NOVEMBER 30, 2013

• Net sales for the first six months of fiscal 2014 were $69.7 million, down 3.5%, compared to net sales of $72.3 million during the first six months of fiscal 2013.
• Gross margin increased to 30.4% during the first six months of fiscal 2014, compared to 29.6% during the first six months of fiscal 2013.
• Selling, general, and administrative expenses increased slightly to $20.5 million, or 29.5% of net sales, for the first six months of fiscal 2014, compared to $20.4 million, or 28.2% of net sales, for the first six months of fiscal 2013.
• Operating income during the first six months of fiscal 2014 was $0.7 million, or 0.9% of net sales, compared to an operating income of $1.0 million, or 1.4% of net sales, during the first six months of fiscal 2013.
• Income from continuing operations during the first six months of fiscal 2014 was $2.6 million, or $0.18 per diluted common share, versus $1.3 million, or $0.08 per diluted common share, during the first six months of fiscal 2013.
• Loss from discontinued operations, net of tax, was $0.1 million, during the first six months of fiscal 2014, compared to $0.3 million during the first six months of fiscal 2013.
• Net income during the first six months of fiscal 2014 was $2.5 million, or $0.17 per diluted common share, compared to net income of $1.0 million during the first six months of fiscal 2013, or $0.06 per diluted common share.

Net Sales and Gross Profit Analysis

Net sales by segment and percent change for the second quarter and first six months of fiscal 2014 and 2013 were as follows (in thousands):

During the second quarter of fiscal 2014 consolidated net sales decreased 3.2% compared to the second quarter of fiscal 2013. Sales for Canvys declined by 11.0% and sales for EDG declined 0.1%. During the first six months of fiscal 2014 consolidated net sales decreased 3.5% compared to the first six months of fiscal 2013. Sales for Canvys declined by 11.7% and sales for EDG declined 0.3%.

Gross profit by segment and percent of segment net sales for the second quarter and first six months of fiscal 2014 and 2013 were as follows (in thousands):

Gross profit reflects the distribution and manufacturing product margin less manufacturing variances, inventory obsolescence charges, customer returns, scrap and cycle count adjustments, engineering costs, unabsorbed manufacturing labor and overhead, and other provisions.

Consolidated gross profit was $11.0 million during the second quarter of fiscal 2014, compared to $10.7 million during the second quarter of fiscal 2013. Consolidated gross margin as a percentage of net sales increased to 31.1% during the second quarter of fiscal 2014, from 29.3% during the second quarter of fiscal 2013. In addition, gross margin included $0.1 million related to unabsorbed manufacturing labor and overhead from continuing operations during the second quarter of fiscal 2014, compared to $0.3 million during the second quarter of fiscal 2013.

Consolidated gross profit was $21.2 million during the first six months of fiscal 2014, compared to $21.4 million during the first six months of fiscal 2013. Consolidated gross margin as a percentage of net sales increased to 30.4% during the first six months of fiscal 2014, from 29.6% during the first six months of fiscal 2013. In addition, gross margin included $0.3 million related to unabsorbed manufacturing labor and overhead from continuing operations during the first six months of fiscal 2014, compared to $0.5 million during the first six months of fiscal 2013.

Electron Device Group

Net sales for EDG remained flat at $26.2 million during the second quarter of fiscal 2014, compared to the second quarter of fiscal 2013. Net sales of tubes grew in the industrial heating and laser markets but were offset by declines primarily in the broadcast and aviation markets. Gross margin as a percentage of net sales increased to 32.5% during the second quarter of fiscal 2014, as compared to 30.3% during the second quarter of fiscal 2013 primarily due to efficiency gains in manufacturing as well as shifts in product and geographic mix.

Net sales for EDG were $51.6 million during the first six months of fiscal 2014, compared to $51.8 million during the first six months of fiscal 2013. Net sales of tubes improved in the industrial heating, laser and marine markets, but declined primarily in the broadcast and aviation markets. Gross margin as a percentage of net sales increased to 31.7% during the first six months of fiscal 2014, as compared to 30.7% during the first six months of fiscal 2013 primarily due to shifts in product and geographic mix.

Canvys

Canvys net sales decreased 11.0% to $9.3 million during the second quarter of fiscal 2014, from $10.4 million during the second quarter of fiscal 2013. Sales were down in our North America Healthcare market driven by the uncertainty surrounding health care reform and a difficult capital market for hospitals while sales in our North America OEM market were down due to rescheduled deliveries to key accounts partially offset by new programs and customers. Gross margin as a percentage of net sales stabilized at 27.0% during the second quarters of fiscal 2014 and 2013.

Canvys net sales decreased 11.7% to $18.1 million during the first six months of fiscal 2014, from $20.4 million during the first six months of fiscal 2013. Sales were down in our North America Healthcare market driven by the uncertainty surrounding health care reform and a difficult capital market for hospitals. In addition, sales in our North America OEM market were down due to rescheduled deliveries to key accounts partially offset by sales to new customers. Gross margin as a percentage of net sales increased slightly to 26.8% during the first six months of fiscal 2014 as compared to 26.7% during the first six months of fiscal 2013 due to the higher margin business in Europe as well as currency fluctuations and a reduction in freight expense.

Selling, General, and Administrative Expenses

Selling, general, and administrative expenses (“SG&A”) slightly increased to $10.5 million during the second quarter of fiscal 2014 compared to $10.2 million during the second quarter of fiscal 2013. The increase includes a $0.6 million increase of total company support function costs offset by a $0.1 million reduction of SG&A for EDG and a $0.2 million reduction of SG&A for Canvys. SG&A as a percentage of sales from continuing operations increased to 29.6% during the second quarter of fiscal 2014 from 27.9% during the second quarter of fiscal 2013.

Selling, general, and administrative expenses (“SG&A”) remained relatively flat at $20.5 million during the first six months of fiscal 2014 compared to $20.4 million during the first six months of fiscal 2013. The increase includes a $0.6 million increase of total company support function costs offset by a $0.1 million reduction of SG&A for EDG and a $0.4 million reduction of SG&A for Canvys. SG&A as a percentage of sales from continuing operations increased to 29.5% during the first six months of fiscal 2014 from 28.2% during the first six months of fiscal 2013.

Other Income/Expense

Other income/expense was income of $0.3 million during the second quarter of fiscal 2014, compared to income of $0.1 million during the second quarter of fiscal 2013. The $0.3 million in the second quarter of fiscal 2014 was primarily due to investment income. The $0.1 million in fiscal 2013 was comprised of investment income of $0.4 million offset by a foreign exchange loss of $0.3 million. Our foreign exchange gains and losses are primarily due to the translation of U.S. dollars held in non-U.S. entities. We currently do not utilize derivative instruments to manage our exposure to foreign currency.

Other income/expense was income of $2.6 million during the first six months of fiscal 2014, compared to income of $0.5 million during the first six months of fiscal 2013. Other income/expense during the first six months of fiscal 2014 included an anti-trust class action lawsuit settlement of $2.1 million and investment income of $0.5 million, partially offset by foreign exchange loss of less than $0.1 million. Our foreign exchange gains and losses are primarily due to the translation of U.S. dollars held in non-U.S. entities. We currently do not utilize derivative instruments to manage our exposure to foreign currency.

Income Tax Provision

The effective income tax rate from continuing operations during the first six months of fiscal 2014 was 18.8%, as compared to 15.3% during the first six months of fiscal 2013. The increase in rate during the first six months of fiscal 2014, as compared to fiscal 2013, was due to an increase in the amount of foreign earnings not considered to be permanently reinvested and an increase in forecasted earnings available in foreign jurisdictions for distribution with respect to ASC 740-30, Income Taxes – Other Considerations or Special Areas ("ASC 740-30"). The 18.8% effective income tax rate is lower than the federal statutory rate of 34.0% as a result of our geographical distribution of income and apportionment of income to various states. Additionally, during the second quarter of fiscal 2014, we developed a strategy for the recently acquired German business to pursue increased market opportunities in Germany; therefore, we have changed our position with respect to earnings in Germany which are now considered to be permanently reinvested under ASC 740-30. This change in the Company's assertion further reduced the effective tax rate for the first six months of fiscal 2014 by 7.6%.

In the normal course of business, we are subject to examination by taxing authorities throughout the world. Generally, years prior to fiscal 2006 are closed for examination under the statute of limitation for U.S. federal, state or local, or non-U.S. tax jurisdictions. During fiscal 2013, we completed federal audits in the U.S. for fiscal 2009, 2010, and 2011. Our primary foreign tax jurisdictions are the Netherlands and Germany. We have tax years open in the Netherlands and Germany beginning in fiscal 2008.

As of November 30, 2013, approximately $42.8 million of cumulative positive earnings of some of our foreign subsidiaries are still considered permanently reinvested pursuant to ASC 740-30. Due to various tax attributes that are continuously changing, it is not practical to determine what, if any, tax liability might exist if such earnings were to be repatriated.

As of November 30, 2013, we did not have any worldwide liability for uncertain tax positions related to continuing operations as compared to $0.4 million as of December 1, 2012. Therefore, we have not recorded penalties and interest relating to uncertain tax positions in the income tax expense line item within the unaudited consolidated statements of income and comprehensive income.

It is not expected that there will be a change in the unrecognized tax benefits within the next 12 months.

Discontinued Operations

Financial Summary – Discontinued Operations

Summary financial results for the three months ended November 30, 2013, and December 1, 2012, are presented in the following table (in thousands):

Notes:

(1) Gross profit (loss) for fiscal year 2014 and 2013 includes unabsorbed manufacturing labor and overhead expenses related to the Manufacturing Agreement with RFPD.

Assets and liabilities classified as discontinued operations on our consolidated balance sheets as of November 30, 2013, and June 1, 2013, include the following (in thousands):

In accordance with ASC 230, Statement of Cash Flows, entities are permitted but not required to separately disclose, either in the statement of cash flows or footnotes to the financial statements, cash flows pertaining to discontinued operations. Entities that do not present separate operating cash flow information related to discontinued operations must do so consistently for all periods presented, which may include periods long after the sale or liquidation of the operation. We did not have cash balances that were specific to RFPD and elected not to present separate cash flows from discontinued operations on our statement of cash flows.

Net Income and Per share Data

Net income during the second quarter of fiscal 2014 was $0.5 million, or $0.03 per diluted common share and $0.03 per Class B diluted common share, as compared to net income of $0.4 million during the second quarter of fiscal 2013, or $0.03 per diluted common share and $0.02 per Class B diluted common share.

Net income during the first six months of fiscal 2014 was $2.5 million, or $0.17 per diluted common share and $0.16 per Class B diluted common share, as compared to net income of $1.0 million during the first six months of fiscal 2013, or $0.06 per diluted common share and $0.06 per Class B diluted common share.

LIQUIDITY, FINANCIAL POSITION, AND CAPITAL RESOURCES

Our cash needs have been primarily financed through current and prior year earnings. Cash and cash equivalents for the first quarter ended November 30, 2013, were $92.6 million. In addition, CDs and time deposits classified as short-term investments were $39.5 million and long-term investments were $2.0 million, including equity securities of $0.5 million. Cash and investments at November 30, 2013, consisted of $72.4 million in North America, $20.1 million in Europe, $0.7 million in Latin America, and $40.9 million in Asia/Pacific. At June 1, 2013, cash and cash equivalents were $102.0 million. In addition, CDs and time deposits classified as short-term investments were $39.0 million and long-term investments were $5.4 million, including equity securities of $0.4 million. Cash and investments at June 1, 2013, consisted of $82.1 million in North America, $22.1 million in Europe, $1.2 million in Latin America, and $41.0 million in Asia/Pacific.

Cash Flows from Discontinued Operations

In accordance with ASC 230, Statement of Cash Flows, entities are permitted but not required to separately disclose, either in the statement of cash flows or footnotes to the financial statements, cash flows pertaining to discontinued operations. Entities that do not present separate operating cash flow information related to discontinued operations must do so consistently for all periods presented, which may include periods long after the sale or liquidation of the operation.

We believe we will continue to have sufficient liquidity to fund our future growth strategies for our business in the foreseeable future.

Cash Flows from Operating Activities

The cash flow from operating activities primarily resulted from our net income, adjusted for non-cash items, and changes in our operating assets and liabilities.

Operating activities, which include our discontinued operations, used $0.9 million of cash during the first six months of fiscal 2014. We had net income of $2.5 million during the first six months of fiscal 2014, which included non-cash stock-based compensation expense of $0.4 million associated with the issuance of stock option awards and depreciation and amortization expense of $0.5 million associated with our property and equipment as well as amortization of our intangible assets. Changes in our operating assets and liabilities, net of effects of acquired businesses, used $4.2 million of cash during the first six months of fiscal 2014, due primarily to the increase in our inventory of $0.1 million, a decrease in our accounts payable of $2.2 million, and an increase in our accounts receivable of $1.7 million, partially offset by a decrease in our long-term tax liabilities of $0.5 million. The increase in our inventory was due to an increase in purchases related to specific projects within our Canvys business. The decrease in our accounts payable relates primarily to the timing of payments to some of our major suppliers. The increase in our accounts receivables of $1.7 million was due primarily to a slight increase in our day sales outstanding caused primarily by a shift in customer mix by geography.

Operating activities, which include our discontinued operations, provided $2.9 million of cash during the first six months of fiscal 2013. We had net income of $1.0 million in the first six months of fiscal 2013, which included non-cash stock-based compensation expense of $0.3 million associated with the issuance of stock option awards and depreciation and amortization expense of $0.6 million associated with our investments in property and equipment as well as amortization of our intangible assets. Changes in our operating assets and liabilities, net of effects of acquired businesses, provided $1.0 million of cash during the first six months of fiscal 2013, due primarily to the decrease in our inventory of $1.7 million, increase in our accounts payable of $1.2 million, partially offset by an increase in our accounts receivable of $1.4 million, and an increase to our prepaid expense of $0.4 million. The decrease in our inventory was the result of reduced inventory purchases during the first six months due to the decline in net sales. The increase in accounts payable of $1.2 million was due primarily to an increase in accrued vouchers of $0.6 million and $0.6 million related to re-classes of customer credit balances in accounts receivable to accounts payable. The increase in our accounts receivable of $1.4 million was due primarily to the timing of customer payments and a $0.6 million reclass of customer credit balances to accounts payable. The increase in prepaid expenses of $0.4 million was due primarily to the renewal of our liability insurance coverage.

Cash Flows from Investing Activities

The cash flow from investing activities has consisted primarily of purchases and maturities of investments and capital expenditures.

Cash provided by investing activities of $1.1 million during the first six months of fiscal 2014 included proceeds from the maturities of investments of $54.5 million, offset by the purchase of investments of $51.6 million, $1.0 million for the acquisition of WVS, and $1.0 million in capital expenditures.

Cash provided by investing activities of $18.8 million during the first six months of fiscal 2013, included proceeds from maturities of investments of $97.5 million, offset by the purchase of investments of $75.6 million, $2.6 million for the acquisition of D and C, and $0.6 million in capital expenditures.

Our purchases and proceeds from investments consist of time deposits and CDs. Purchasing of future investments may vary from period to period due to interest and foreign currency exchange rates.

Cash Flows from Financing Activities

The cash flow from financing activities primarily consists of repurchases of common stock and cash dividends paid.

Cash used in financing activities of $10.2 million during the first six months of fiscal 2014 resulted from $8.7 million of cash used to repurchase common stock under our share repurchase authorization and $1.7 million of cash used to pay dividends, offset by $0.2 million of proceeds from the issuance of common stock.

Cash used in financing activities of $13.3 million during the first six months of fiscal 2013, resulted from $11.6 million of cash used to repurchase common stock and $1.8 million in dividends paid, offset by $0.1 million of proceeds from the issuance of common stock. The repurchase of common stock relates to our share repurchase authorizations.

All payments of dividends are at the discretion of the Board of Directors. Dividend payments will depend on earnings, capital requirements, operating conditions, and other factors that the Board may deem relevant.

We believe that the existing sources of liquidity, including current cash, will provide sufficient resources to meet known capital requirements and working capital needs for the fiscal year ending May 31, 2014.

Risk Management and Market Sensitive Financial Instruments

We are exposed to many different market risks with the various industries we serve. The primary financial risk we are exposed to is foreign currency exchange, as certain operations, assets, and liabilities of ours are denominated in foreign currencies. We manage these risks through normal operating and financing activities.

The interpretation and analysis of these disclosures should not be considered in isolation since such variances in exchange rates would likely influence other economic factors. Such factors, which are not readily quantifiable, would likely also affect our operations. Additional disclosure regarding various market risks are set forth in Part I, Item 1A, “Risk Factors” of our Annual Report on Form 10-K for the year ended June 1, 2013, filed July 26, 2013.

(a) Evaluation of Disclosure Controls and Procedures

Management of the Company, with the participation of the Chief Executive Officer and the Chief Financial Officer, evaluated the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of November 30, 2013.

Disclosure controls and procedures are intended to provide reasonable assurance that information required to be disclosed in the Company’s Exchange Act reports is recorded, processed, summarized, and reported within the time periods specified by the Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to management, including the Company’s Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. Based on this evaluation, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures were effective as of the end of the period covered by this report.

(b) Changes in Internal Control over Financial Reporting

There were no changes in the Company’s internal control over financial reporting identified in connection with the evaluation required by paragraph (d) of Exchange Act Rules 13a-15 or 15d-15 that occurred during the first six months of fiscal 2014 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

There have been no material changes to the risk factors previously disclosed in our Annual Report on Form 10-K for the year ended June 1, 2013, filed July 26, 2013.