Richardson Electronics, LTD.: Form 10-Q for the period ended Feb 29, 2020

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 this quarterly report on Form 10Q for the quarter ended February 29, 2020 as well as our Annual Report on Form 10-K filed on August 5, 2019. 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 Operations – an analysis and comparison of our consolidated results of operations for the three and nine month periods ended February 29, 2020 and March 2, 2019, as reflected in our consolidated statements of comprehensive loss.
• Liquidity, Financial Position and Capital Resources – a discussion of our primary sources and uses of cash for the nine month periods ended February 29, 2020 and March 2, 2019, and a discussion of changes in our financial position.

Business Overview

Richardson Electronics, Ltd. is a leading global provider of engineered solutions, power grid and microwave tubes and related consumables; power conversion and RF and microwave components; high value flat panel detector solutions, replacement parts, tubes and service training for diagnostic imaging equipment; and customized display solutions. We serve customers in the alternative energy, healthcare, aviation, broadcast, communications, industrial, marine, medical, military, scientific and semiconductor markets. The Company’s strategy is to provide specialized technical expertise and “engineered solutions” based on our core engineering and manufacturing capabilities. The Company provides solutions and adds value through design-in support, systems integration, prototype design and manufacturing, testing, logistics and aftermarket technical service and repair through its global infrastructure.

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.

We have three operating and reportable segments which we define as follows:

Power and Microwave Technologies Group (“PMT”) combines our core engineered solutions capabilities, power grid and microwave tube business with new RF, Wireless and disruptive power technologies. As a manufacturer, technology partner and authorized distributor, PMT’s strategy is to provide specialized technical expertise and engineered solutions based on our core engineering and manufacturing capabilities on a global basis. We provide solutions and add value through design-in support, systems integration, prototype design and manufacturing, testing, logistics and aftermarket technical service and repair—all through our existing global infrastructure. PMT’s focus is on products for power, RF and microwave applications for customers in 5G, alternative energy, aviation, broadcast, communications, industrial, marine, medical, military, scientific and semiconductor markets. PMT 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. PMT 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 manufacturers markets. Our engineers design, manufacture, source and support a full spectrum of solutions to match the needs of our customers. We offer long term availability and proven custom display solutions that include touch screens, protective panels, custom enclosures, all-in-ones, specialized cabinet finishes and application specific software packages and certification services. Our volume commitments are lower than the large display manufacturers, making us the ideal choice for companies with very specific design requirements. We partner with both private label manufacturing companies and leading branded hardware vendors to offer the highest quality display and touch solutions and customized computing platforms.

Healthcare manufactures, refurbishes and distributes high value replacement parts for the healthcare market including hospitals, medical centers, asset management companies, independent service organizations and multi-vendor service providers. Products include Diagnostic Imaging replacement parts for CT and MRI systems; replacement CT and MRI tubes; CT service training; MRI coils, cold heads and RF amplifiers; hydrogen thyratrons, klystrons, magnetrons; flat panel detector upgrades; and additional replacement solutions currently under development for the diagnostic imaging service market. Through a combination of newly developed products and partnerships, service offerings and training programs, we believe we can help our customers improve efficiency and deliver better clinical outcomes while lowering the cost of healthcare delivery.

We currently have operations in the following major geographic regions: North America, Asia/Pacific, Europe and Latin America.

RESULTS OF OPERATIONS

Financial Summary – Three Months Ended February 29, 2020

• The third quarter of fiscal 2020 and fiscal 2019 each contained 13 weeks.
• Net sales during the third quarter of fiscal 2020 were $38.2 million, a decrease of 2.0%, compared to net sales of $39.0 million during the third quarter of fiscal 2019.
• Gross margin increased to 33.1% during the third quarter of fiscal 2020 compared to 31.5% during the third quarter of fiscal 2019.
• Selling, general and administrative expenses were $12.7 million, or 33.1% of net sales, during the third quarter of fiscal 2020 compared to $13.1 million, or 33.6% of net sales, during the third quarter of fiscal 2019.
• Operating income during the third quarter of fiscal 2020 was $11,000 compared to an operating loss of $0.8 million during the third quarter of fiscal 2019.
• Net loss during the third quarter of fiscal 2020 was $0.1 million compared to net loss of $1.1 million during the third quarter of fiscal 2019.

Financial Summary – Nine Months Ended February 29, 2020

• The first nine months of fiscal 2020 and fiscal 2019 each contained 39 weeks.
• Net sales during the first nine months of fiscal 2020 were $118.5 million, a decrease of 4.8%, compared to net sales of $124.5 million during the first nine months of fiscal 2019.
• Gross margin increased to 32.3% during the first nine months of fiscal 2020 compared to 31.5% during the first nine months of fiscal 2019.
• Selling, general and administrative expenses were $38.7 million, or 32.6% of net sales, during the first nine months of fiscal 2020 compared to $39.6 million, or 31.8% of net sales, during the first nine months of fiscal 2019.
• Operating loss during the first nine months of fiscal 2020 was $0.4 million compared to an operating loss of $0.4 million during the first nine months of fiscal 2019.
• Net loss during the first nine months of fiscal 2020 was $0.6 million compared to net loss of $1.0 million during the first nine months of fiscal 2019.

Net Sales and Gross Profit Analysis

Net sales by segment and percent change during the third quarter and first nine months of fiscal 2020 and fiscal 2019 were as follows (in thousands):

During the third quarter of fiscal 2020, consolidated net sales decreased 2.0% compared to the third quarter of fiscal 2019. Sales for PMT decreased 2.5%, sales for Canvys increased 3.5% and sales for Healthcare decreased 11.9%. The decrease in PMT was mainly due to economic softness in the power grid tube business and the effect of the coronavirus on approximately 5% of our quarter’s shipments, partially offset by growth from our power conversion and RF and microwave components. The increase in Canvys was due to increased customer demand in its North American market. The decrease in Healthcare was due to lower equipment and non-core parts sales, partially offset by an increase in CT tube sales.

During the first nine months of fiscal 2020, consolidated net sales decreased 4.8% compared to the first nine months of fiscal 2019. Sales for PMT decreased 7.9%, sales for Canvys increased 8.3% and sales for Healthcare were flat. The decrease in PMT was mainly due to economic softness in the power grid tube business and a slow ramp up in sales in the semiconductor wafer fab equipment business, partially offset by growth from our power conversion and RF and microwave components. The increase in Canvys was due to increased customer demand in its North American market.

Gross profit by segment and percent of net sales for the third quarter and first nine months of fiscal 2020 and fiscal 2019 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 and other provisions.

Consolidated gross profit increased to $12.7 million during the third quarter of fiscal 2020 compared to $12.3 million during the third quarter of fiscal 2019. Consolidated gross margin as a percentage of net sales increased to 33.1% during the third quarter of fiscal 2020 from 31.5% during the third quarter of fiscal 2019, primarily due to favorable product mix and improved manufacturing efficiencies in both PMT and Healthcare.

Consolidated gross profit decreased to $38.3 million during the first nine months of fiscal 2020 compared to $39.2 million during the first nine months of fiscal 2019. Consolidated gross margin as a percentage of net sales increased to 32.3% during the first nine months of fiscal 2020 from 31.5% during the first nine months of fiscal 2019, primarily due to favorable product mix in Healthcare and improved manufacturing efficiencies in both PMT and Healthcare.

Power and Microwave Technologies Group

PMT net sales decreased 2.5% to $29.0 million during the third quarter of fiscal 2020 from $29.7 million during the third quarter of fiscal 2019. The decrease was mainly due to economic softness in the power grid tube business and the effect of the coronavirus on approximately 5% of our quarter’s shipments, partially offset by growth from our power conversion and RF and microwave components. Gross margin as a percentage of net sales increased to 32.8% during the third quarter of fiscal 2020 as compared to 31.6% during the third quarter of fiscal 2019 primarily due to favorable product mix and improved manufacturing efficiencies.

PMT net sales decreased 7.9% to $89.2 million during the first nine months of fiscal 2020 from $96.8 million during the first nine months of fiscal 2019. The decrease was mainly due to economic softness in the power grid tube business and a slow ramp up in sales in the semiconductor wafer fab equipment business, partially offset by growth from our power conversion and RF and microwave components. Gross margin as a percentage of net sales increased to 32.0% during the first nine months of fiscal 2020 as compared to 31.5% during the first nine months of fiscal 2019 due to improved manufacturing efficiencies.

Canvys

Canvys net sales increased 3.5% to $7.2 million during the third quarter of fiscal 2020 from $6.9 million during the third quarter of fiscal 2019 due to increased customer demand in its North American market. Gross margin as a percentage of net sales was 32.8% during the third quarter of fiscal 2020, the same as during the third quarter of fiscal 2019.

Canvys net sales increased 8.3% to $22.3 million during the first nine months of fiscal 2020 from $20.6 million during the first nine months of fiscal 2019 primarily due to increased customer demand in its North American market. Gross margin as a percentage of net sales decreased slightly to 32.5% during the first nine months of fiscal 2020 as compared to 32.6% during the first nine months of fiscal 2019.

Healthcare

Healthcare net sales decreased 11.9% to $2.1 million during the third quarter of fiscal 2020 from $2.3 million during the third quarter of fiscal 2019 due to lower equipment and non-core parts sales, partially offset by an increase in CT tube sales. Gross margin as a percentage of net sales increased to 38.3% during the third quarter of fiscal 2020 as compared to 26.2% during the third quarter of fiscal 2019 due to favorable product mix and improved manufacturing efficiencies.

Healthcare net sales were $7.0 million during the first nine months of fiscal 2020, the same as during the first nine months of fiscal 2019 due to higher CT tube sales offset by a decrease in equipment sales in Latin America. Gross margin as a percentage of net sales increased to 35.3% during the first nine months of fiscal 2020 as compared to 28.1% during the first nine months of fiscal 2019 due to favorable product mix and improved manufacturing efficiencies.

Selling, General and Administrative Expenses

Selling, general and administrative expenses decreased to $12.7 million during the third quarter of fiscal 2020 from $13.1 million in the third quarter of fiscal 2019, primarily due to lower severance, legal and professional services expenses, partially offset by higher research and development expenses for Healthcare.

Selling, general and administrative expenses decreased to $38.7 million during the first nine months of fiscal 2020 from $39.6 million in the first nine months of fiscal 2019, primarily due to lower severance, legal and professional services expenses, partially offset by higher research and development expenses for Healthcare.

Other Income/Expense

Other income/expense was income of $0.1 million during the third quarter of fiscal 2020, compared to income of less than $0.1 million during the third quarter of fiscal 2019. Other income/expense during the third quarter of fiscal 2020 included $0.1 million of investment/interest income. Other income/expense during the third quarter of fiscal 2019 included $0.1 million of investment/interest income offset by $0.1 million of foreign exchange losses. 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 $0.2 million during the first nine months of fiscal 2020, compared to income of $0.2 million during the first nine months of fiscal 2019. Other income/expense during the first nine months of fiscal 2020 included $0.3 million of investment/interest income partially offset by $0.1 million of foreign exchange losses. Other income during the first nine months of fiscal 2019 included $0.4 million of investment/interest income partially offset by $0.2 million of foreign exchange losses.

Income Tax Provision

We recorded an income tax provision of $0.4 million and $0.8 million for the first nine months of fiscal 2020 and the first nine months of fiscal 2019, respectively. The effective income tax rate during the first nine months of fiscal 2020 was a tax provision of (365.1)% as compared to a tax provision of (383.3)% during the first nine months of fiscal 2019. The difference in rate during the first nine months of fiscal 2020 as compared to the first nine months of fiscal 2019 reflects changes in our geographical distribution of income (loss). The (365.1)% effective income tax rate differs from the federal statutory rate of 21% as a result of our geographical distribution of income (loss) and the movement of the valuation allowance against our U.S. state and federal net deferred tax assets.

In the normal course of business, we are subject to examination by taxing authorities throughout the world. Generally, years prior to fiscal 2009 are closed for examination under the statute of limitation for U.S. federal, U.S. state and local or non-U.S. tax jurisdictions. Our primary foreign tax jurisdictions are Germany and the Netherlands. We have tax years open in Germany beginning in fiscal 2015 and the Netherlands beginning in fiscal 2012. Germany is currently under audit for fiscal years 2015 through 2018.

Net Loss and Per Share Data

Net loss during the third quarter of fiscal 2020 was $0.1 million or ($0.01) per diluted common share and ($0.01) per Class B diluted common share as compared to net loss of $1.1 million during the third quarter of fiscal 2019 or ($0.08) per diluted common share and ($0.08) per Class B diluted common share.

Net loss during the first nine months of fiscal 2020 was $0.6 million or ($0.04) per diluted common share and ($0.04) per Class B diluted common share as compared to net loss of $1.0 million during the first nine months of fiscal 2019 or ($0.07) per diluted common share and ($0.07) per Class B diluted common share.

LIQUIDITY, FINANCIAL POSITION AND CAPITAL RESOURCES

Our operations and cash needs have been primarily financed through cash on hand and investments.

Cash and cash equivalents were $30.9 million at February 29, 2020. Investments included a CD classified as short-term investment of $13.0 million. Total cash and investment was $43.9 million at February 29, 2020. Cash, cash equivalents and investment at February 29, 2020 consisted of $27.7 million in North America, $10.2 million in Europe, $0.8 million in Latin America and $5.2 million in Asia/Pacific. We repatriated $4.4 million total cash from our entities in Germany and the Netherlands in the second quarter of fiscal 2020 and $1.5 million from our entity in Japan in the third quarter of fiscal 2020. A total of $7.5 million was repatriated to the United States in the first nine months of fiscal 2020 from several of our foreign entities, which includes the amounts mentioned above in the second and third quarters of fiscal 2020. Although the Tax Cuts and Jobs Act generally eliminated federal income tax on future cash repatriation to the United States, cash repatriation may be subject to state and local taxes, withholding or similar taxes. See Note 9 “Income Taxes” of the notes to our consolidated financial statements in Part II, Item 8 of our Annual Report on Form 10-K for the year ended June 1, 2019, filed with the SEC on August 5, 2019, for further information.

Cash, cash equivalents and investments were $50.0 million at June 1, 2019. Cash, cash equivalents and investments at June 1, 2019, consisted of $21.5 million in North America, $17.8 million in Europe, $0.9 million in Latin America and $9.8 million in Asia/Pacific. We repatriated $2.3 million total cash from our entities in Japan and Korea in fiscal 2019 and $5.9 million total cash from our entities in Germany and France in fiscal 2019.

We believe that the existing sources of liquidity, including current cash, will provide sufficient resources to meet known capital requirements and working capital needs through the next twelve months.

Cash Flows from Operating Activities

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

Operating activities used $2.4 million of cash during the first nine months of fiscal 2020. We had a net loss of $0.6 million during the first nine months of fiscal 2020, which included non-cash stock-based compensation expense of $0.5 million associated with the issuance of stock option and restricted stock awards, $0.5 million for inventory reserve provisions and depreciation and amortization expense of $2.5 million associated with our property and equipment as well as amortization of our intangible assets. Changes in our operating assets and liabilities resulted in a use of cash of $5.4 million during the first nine months of fiscal 2020, net of foreign currency exchange gains and losses, included an increase in inventory of $4.2 million, a decrease of $2.1 million in accounts payable and a decrease in accrued liabilities of $0.2 million partially offset by a decrease in accounts receivable of $1.1 million. The decrease in our accounts payable was due to timing of payments for some of our larger vendors for both inventory and services. The majority of the inventory increase was to support the continued growth of our electron tube and RF and Power Technologies groups.

Operating activities used $5.2 million of cash during the first nine months of fiscal 2019. We had net loss of $1.0 million during the first nine months of fiscal 2019, which included non-cash stock-based compensation expense of $0.6 million associated with the issuance of stock option and restricted stock awards, $0.6 million for inventory reserve provisions and depreciation and amortization expense of $2.4 million associated with our property and equipment as well as amortization of our intangible assets. Changes in our operating assets and liabilities resulted in a use of cash of $8.0 million during the first nine months of fiscal 2019, net of foreign currency exchange gains and losses, included a decrease of $5.4 million in accounts payable, an increase in inventory of $3.3 million, an increase in accounts receivable of $0.6 million partially offset by an increase in accrued liabilities of $0.9 million and a decrease of $0.3 million in prepaid expenses and other assets. The decrease in our accounts payable was due to timing of payments for some of our larger vendors for both inventory and services. The inventory increase was primarily due to growth in supplying replacement systems and parts to the Healthcare market as well as an increase in components for the production of the ALTA 750 TM CT Tube.

Cash Flows from Investing Activities

The cash flow used in investing activities consisted primarily of purchases of investments and capital expenditures partially offset by proceeds from the maturities of investments.

Cash used in investing activities of $6.2 million during the first nine months of fiscal 2020 included purchases of investments of $13.0 million and $1.2 million in capital expenditures, partially offset by proceeds from the maturities of investments of $8.0 million. Capital expenditures related primarily to capital used for our IT system, Healthcare and LaFox manufacturing businesses.

Cash used in investing activities of $18.7 million during the first nine months of fiscal 2019 included $17.8 million from purchases of investments and $3.2 million in capital expenditures partially offset by proceeds from the maturities of investments of $2.3 million. Capital expenditures relates primarily to our Healthcare growth initiatives, a new air conditioner unit for the global headquarters, investments in our LaFox manufacturing operation and capital used for our IT system.

Our purchases of investments consisted of 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 used in financing activities consisted primarily of cash dividends paid.

Cash used in financing activities of $2.4 million during the first nine months of fiscal 2020 primarily resulted from cash used to pay dividends.

Cash used in financing activities of $2.1 million during the first nine months of fiscal 2019 resulted from $2.3 million of cash used to pay dividends partially offset by $0.2 million of proceeds from the issuance of common stock from stock option exercises.

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

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, 2019, filed August 5, 2019.

(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 February 29, 2020.

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 third quarter of fiscal 2020 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

The Company's operations and financial results are subject to various risks and uncertainties, including those described in Part I, Item 1A, "Risk Factors" in the Company's Annual Report on Form 10-K for the year ended June 1, 2019, filed August 5, 2019. The following supplements and updates the risk factors previously disclosed in our Annual Report on Form 10-K for the year ended June 1, 2019.

Major disruptions to our logistics capability or to the operations of our key vendors or customers could have a material adverse impact on our operations.

We operate our global logistics services through specialized and centralized distribution centers. We depend on third party transportation service providers for the delivery of products to our customers. A major interruption or disruption in service at any of our distribution centers, or a disruption at the operations of any of our significant vendors or customers, for any reason, including reasons beyond our control (such as natural disasters, pandemics (such as the outbreak of a novel strain of coronavirus, now known as COVID-19), work stoppages, power loss, cyber attacks, incidents of terrorism or other significant disruptions of services from our third party providers) could cause cancellations or delays in a significant number of shipments to customers and, as a result, could have a severe impact on our business, operations and financial performance.

In December 2019, an outbreak of COVID-19 virus originated in Wuhan, China, and has since spread to a number of other countries, including the United States. The outbreak and actions taken by the Chinese government resulted in travel restrictions and extended shutdowns of certain businesses in the region. As a result, we experienced cancellations and delays in shipments to our customers in China as well as receiving shipments from our vendors in China during our third quarter of fiscal 2020. On January 30, 2020, the World Health Organization (“WHO”) announced a global health emergency and the risks to the international community as the virus spreads globally. In March 2020, the WHO classified the COVID-19 outbreak as a pandemic, based on the rapid increase in global exposure. In response, the governments of many countries, states, cities and other geographic regions (including areas in which we have operations) have taken preventative or protective actions, such as imposing restrictions on business operations and requiring individuals to stay at home. As the spread of the COVID-19 outbreak continues, our ability to meet customer demands for products may be impaired or, similarly, our customers may experience adverse business consequences due to COVID-19. A resulting reduced demand for products or impaired ability to meet customer demand (including as a result of disruptions at our transportation service providers or vendors) could cause a material adverse effect on our business, operations and financial performance. This is a very dynamic situation and we cannot at this time predict the extent to which the COVID-19 outbreak may impact our future results.