RICHARDSON ELECTRONICS, LTD. - Quarter Report: 2005 December (Form 10-Q)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

For the quarterly period ended December 3, 2005

OR

For the transition period from                      to                     

Commission File Number: 0-12906

RICHARDSON ELECTRONICS, LTD.

(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code: (630) 208-2200

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    x  Yes    ¨  No

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).    x  Yes    ¨  No

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    ¨  Yes    x  No

As of January 10, 2006, there were outstanding 14,322,003 shares of Common Stock, $.05 par value, inclusive of 1,328,961 shares held in treasury, and 3,103,190 shares of Class B Common Stock, $.05 par value, which are convertible into Common Stock of the registrant on a share for share basis.

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PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

Richardson Electronics, Ltd.

Condensed Consolidated Balance Sheets

(in thousands, except per share amounts)

See notes to condensed consolidated financial statements.

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Richardson Electronics, Ltd.

Condensed Consolidated Statements of Operations

and Comprehensive Income

(Unaudited) (in thousands, except per share amounts)

See notes to condensed consolidated financial statements.

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Richardson Electronics, Ltd.

Condensed Consolidated Statements of Cash Flows

(Unaudited) (in thousands)

See notes to condensed consolidated financial statements.

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RICHARDSON ELECTRONICS, LTD.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

(in thousands, except per share amounts and except where indicated)

Note A – Basis of Presentation

The accompanying unaudited Condensed Consolidated Financial Statements have been prepared in accordance with United States generally accepted accounting principles for interim financial information and the instructions to Form 10-Q and Article 10 of Regulation S-K. Accordingly, they do not include all the information and notes required by United States generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments necessary for a fair presentation of the results of interim periods have been made and such adjustments were of a normal and recurring nature. The results of operations and cash flows for the three-month and six-month periods ended December 3, 2005 are not necessarily indicative of the results that may be expected for the fiscal year ended June 3, 2006.

The Company’s fiscal quarter ends on the Saturday nearest the end of the quarter ending month. The first six months of fiscal 2006 contains 27 weeks, and the first six months of fiscal 2005 contains 26 weeks. The additional week occurred in the first quarter of fiscal 2006.

The financial information contained in this report should be read in conjunction with the Company’s Annual Report on Form 10-K for the fiscal year ended May 28, 2005. Certain amounts in prior periods’ financial statements and related notes have been reclassified to conform with the fiscal 2006 presentation. Customer cash discounts were reclassified from selling, general and administrative expenses to net sales. The reclassifications had no impact on net income or stockholders’ equity for any reportable period presented.

Note B – Investment in Marketable Equity Securities

The Company’s investments are primarily equity securities, all of which are classified as available-for-sale and are carried at their fair value based on the quoted market prices. Proceeds from the sale of the securities were $335 and $736 during the second quarter and first six months of fiscal 2006, respectively, and $990 and $1,134 during the same periods of fiscal 2005, all of which were subsequently reinvested. Gross realized gains on those sales were $50 and $101 for the second quarter and first six months of fiscal 2006, respectively, and $88 and $110 for the same periods of fiscal 2005. Gross realized losses on those sales were $42 and $43 for the second quarter and first six months of fiscal 2006, respectively, and $31 and $48 for the same periods of fiscal 2005. Net unrealized holding gains of $191 and $511 for the second quarter and first six months of fiscal 2006, respectively, and $735 and $1,182 for the same periods of fiscal 2005 have been included in accumulated comprehensive income (loss) for fiscal 2006 and 2005.

The following table is the disclosure under Statement of Financial Accounting Standards (SFAS) No. 115, Accounting for Certain Investments in Debt and Equity Securities, for the investment in marketable equity securities with fair values less than cost basis:

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Note C – Assets Held for Sale

On August 4, 2005, the Company entered into a contract to sell approximately 1.5 acres of real estate and a building located in Geneva, Illinois for $3,000. The contract is subject to a number of conditions, including inspections, environmental testing, and other customary conditions. Although the sale of the real estate and building is expected to close within one year from the date of the agreement, the Company cannot give any assurance as to the actual timing or successful completion of the transaction.

Note D – Goodwill and Other Intangible Assets

The Company performed its annual impairment test during the fourth quarter of fiscal 2005. The same methodology was employed in completing the annual impairment test as in applying transitional accounting provisions of SFAS No. 142, Goodwill and Other Intangible Assets. The Company did not find any indication that additional impairment existed, and therefore, no additional impairment loss was recorded as a result of completing the annual impairment test.

The table below provides changes in carrying value of goodwill by reportable segment which includes RF, Wireless & Power Division (RFPD), Electron Device Group (EDG), Security Systems Division (SSD), and Display Systems Group (DSG):

The addition to goodwill in the first six months of fiscal 2006 represents the acquisition of A.C.T. Kern GmbH & Co. KG (Kern) located in Germany, effective June 1, 2005. The cash outlay for Kern was $6,583, net of cash acquired. Kern is one of the leading display technology companies in Europe with world wide customers in manufacturing, OEM, medicine, multimedia, IT trading, system houses, and other industries.

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The following table provides changes in carrying value of other intangible assets not subject to amortization:

Intangible assets subject to amortization, as well as amortization expense are as follows:

Deferred financing costs increased during the first six months of fiscal 2006 primarily due to the issuance of the Company’s 7 ³/4% convertible senior subordinated notes (7 ³/4% notes) and the 8% convertible senior subordinated notes (8% notes).

Amortization expense for the three-month and six-month periods ended December 3, 2005 and November 27, 2004 is as follows:

The amortization expense associated with the intangible assets subject to amortization is expected to be $317, $391, $391, $390, $302, $242, and $43 in fiscal 2006, 2007, 2008, 2009, 2010, 2011, and 2012, respectively. The weighted average number of years of amortization expense remaining is 7.53.

Note E – Restructuring Charges

As a result of the Company’s fiscal 2005 restructuring initiative, a restructuring charge, including severance and lease termination costs of $2,152, was recorded in selling, general and administrative expenses (SG&A) in the third quarter of fiscal 2005. During the fourth quarter of fiscal 2005, the employee severance and related costs were adjusted, resulting in a $183 decrease in SG&A due to the difference between estimated severance costs and the actual payouts. Severance costs of $1,108 were paid in fiscal 2005. During the first six months of fiscal 2006, severance and lease termination costs of $639 were paid. During the first six months of fiscal 2006, the employee severance and related costs were adjusted resulting in a $110 decrease in SG&A due to the difference between estimated severance costs and

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the actual payouts. The remaining balance payable during fiscal 2006 has been included in accrued liabilities. Terminations affected over 60 employees across various business functions, operating units, and geographic regions. As of December 3, 2005, the following table depicts the amounts associated with the activity related to restructuring by reportable segment:

Note F – Warranties

The Company offers warranties for specific products it manufactures. The Company also provides extended warranties for some products it sells that lengthen the period of coverage specified in the manufacturer’s original warranty. Terms generally range from one to three years.

The Company estimates the cost to perform under its warranty obligation and recognizes this estimated cost at the time of the related product sale. The Company reports this expense as an element of cost of sales in its Condensed Consolidated Statements of Operations. Each quarter, the Company assesses actual warranty costs incurred, on a product-by-product basis, as compared to its estimated obligation. The estimates with respect to new products are based generally on knowledge of the products, are extrapolated to reflect the extended warranty period, and are refined each quarter as better information with respect to warranty experience becomes known.

Warranty reserves are established for costs that are expected to be incurred after the sale and delivery of products under warranty. The warranty reserves are determined based on known product failures, historical experience, and other currently available evidence.

Changes in the warranty reserve for the first six months ended December 3, 2005 were as follows:

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During the second quarter of fiscal 2003, DSG provided a three-year warranty on some of its products. As the extended warranty on the first products sold under the warranty program expired during the second quarter of fiscal 2006, along with additional warranty experience available during the first six months of fiscal 2006, the Company revised its estimate of the warranty reserve to reflect the actual warranty experience to date. As a result, a change in estimate of $946 was recorded during the second quarter of fiscal 2006.

Note G – Debt

Long-term debt consists of the following:

At December 3, 2005, the Company maintained $94,698 in long-term debt, primarily in the form of two issuances of convertible notes and a multi-currency credit agreement. The Company maintained two issuances of convertible debentures in short-term debt at December 3, 2005 in the amount of $17,538 and $4,753 for the 8 ¹/4% convertible senior subordinated debentures (8 ¹/4% debentures) and the 7 ¹/4% convertible subordinated debentures (7 ¹/4% debentures), respectively. This short-term classification resulted from the amended and restated credit agreement requiring the 8 ¹/4% and 7 ¹/4% debentures to be refinanced prior to February 28, 2006. On August 24, 2005, the Company executed an amendment to the amended and restated credit agreement which extended the refinancing requirement for the 8 ¹/4% and 7 ¹/4% debentures to June 10, 2006.

On November 21, 2005, the Company sold $25,000 in aggregate principal amount of 8% convertible senior subordinated notes (8% notes) pursuant to an indenture dated November 21, 2005. The 8% notes bear interest at a rate of 8% per annum. Interest is due on June 15 and December 15 of each year. The 8% notes mature on June 15, 2011. The 8% notes are convertible at the option of the holder, at any time on or prior to maturity, into shares of the Company’s common stock at a price equal to $10.31 per share, subject to adjustment in certain circumstances. In addition, the Company may elect to automatically convert the 8% notes into shares of common stock if the trading price of the common stock exceeds 150% of the conversion price of the 8% notes for at least 20 trading days during any 30 trading day period subject to a payment of three years of interest if the Company elects to convert the 8% notes prior to December 20, 2008.

The indenture provides that on or after December 20, 2008, the Company has the option of redeeming the 8% notes, in whole or in part, for cash, at a redemption price equal to 100% of the principal amount of the 8% notes to be redeemed, plus accrued and unpaid interest, if any, to, but excluding, the redemption date. Holders may require the Company to repurchase all or a portion of their 8% notes for cash upon a change-of-control event, as described in the indenture, at a repurchase price equal to 100% of the principal amount of the 8% notes to be repurchased, plus accrued and unpaid interest, if any, to, but excluding the repurchase date. The 8% notes are unsecured and subordinate to the Company’s existing and future senior

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debt and senior to the Company’s existing 7 ¹/4% debentures and 8 ¹/4% debentures. The 8% notes rank on parity with the Company’s existing 7 ³/4% notes.

The Company used the net proceeds from the sale of the 8% notes to repay amounts outstanding under its amended and restated credit agreement. The Company redeemed all of the outstanding 8 ¹/4% debentures on December 23, 2005 in the amount of $17,538 and redeemed all of the outstanding 7 ¹/4% debentures on December 30, 2005 in the amount of $4,753 by borrowing amounts under the amended and restated credit agreement to effect these redemptions.

In October 2004, the Company renewed its multi-currency revolving credit agreement with the current lending group in the amount of approximately $109,000 (varies based on fluctuations in foreign currency exchange rates). The agreement matures in October 2009, when the outstanding balance at that time will become due. At December 3, 2005, $24,989 was outstanding under the amended and restated credit agreement. The amended and restated credit agreement is principally secured by the Company’s trade receivables and inventory. The amended and restated credit agreement bears interest at applicable LIBOR rates plus a margin, varying with certain financial performance criteria. At December 3, 2005, the applicable margin was 2.25%. Outstanding letters of credit were $2,166 at December 3, 2005, leaving an unused line of $81,536 under the total amended and restated credit agreement; however, this amount was reduced to $29,173 due to maximum permitted leverage ratios. The commitment fee related to the amended and restated credit agreement is 0.25% per annum payable quarterly on the average daily unused portion of the aggregate commitment. The Company’s multi-currency revolving credit agreement consists of the following facilities as of December 3, 2005:

Note: Due to maximum permitted leverage ratios, the amount of the unused line cannot be calculated on a facility-by-facility basis.

On August 24, 2005, the Company executed an amendment to the amended and restated credit agreement. The amendment changed the maximum permitted leverage ratios and the minimum required fixed charge coverage ratios for each of the first three quarters of fiscal 2006 to provide the Company additional flexibility for these periods. In addition, the amendment also provided that the Company will maintain excess availability on the borrowing base of not less than $23,000 until the 8 ¹/4% and 7 ¹/4% debentures were redeemed, at which time the Company will maintain excess availability of the borrowing base of not less than $10,000. The applicable margin pricing was increased by 25 basis points. In addition, the amendment extended the Company’s requirement to refinance the remaining $22,291 aggregate principal amount of the Company’s 7 ¹/4% debentures and the 8 ¹/4% debentures from February 28, 2006 to June 10, 2006.

At September 3, 2005, the Company was not in compliance with its amended and restated credit agreement covenants with respect to the tangible net worth covenant due solely to the additional goodwill recorded as a result of the Kern acquisition. On October 12, 2005, the Company received a waiver from its lending group for the default and executed an amendment to the amended and restated credit agreement. The amendment changed the minimum tangible net worth requirement to adjust for the goodwill associated with the Kern acquisition. At December 3, 2005, the Company was in compliance with its amended and restated credit agreement covenants.

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Note H – Income Taxes

The effective income tax rates for the second quarter and first six months of fiscal year 2006 were 59.8% and 58.9%, respectively, as compared with 34.0% and 33.1% for the second quarter and first six months of fiscal 2005, respectively. The difference between the effective tax rates as compared to the U.S. federal statutory rate of 34% primarily results from the Company’s geographical distribution of taxable income or losses, and, in the three and six months ended December 3, 2005, subject to valuation allowances related to net operating losses. For the six months ended December 3, 2005, the tax benefit primarily related to domestic net operating losses was limited by the requirement for a valuation allowance of $2,204, which increased the effective income tax rate by 44.5%. The first six months of fiscal 2006 includes an income tax provision of $344 for income tax exposures related to prior years recorded in the first quarter of fiscal 2006. In addition, during the second quarter of fiscal 2006, income tax reserves of approximately $1,000 for certain income tax exposures were reversed because the statute of limitations with respect to these income tax exposures expired.

In May 2005, the Company was informed by one of its foreign subsidiaries that its records may not be adequate to support the taxable revenues and deductions included within tax returns previously filed for the tax years 2003 and 2004. At this time, the Company has not received notification from any tax authority regarding this matter. In December 2005, the Company determined its income tax exposure for the tax year 2003 is less than $100. During the second quarter of fiscal 2006, the Company increased its income tax reserve for this potential exposure, and no additional exposure is anticipated with respect to the tax year 2003. The Company expects to complete its investigation for the tax year 2004 prior to the third quarter ending March 4, 2006. As of January 12, 2006, for the tax year 2004, based on the conclusions reached for the tax year 2003, any material liability is considered to be remote and therefore, no liability with respect to the tax year 2004 has been recorded.

Note I – Calculation of Earnings Per Share

The Company has authorized 30,000 shares of common stock, 10,000 shares of Class B common stock, and 5,000 shares of preferred stock. The Class B common stock has ten votes per share. The Class B common stock has transferability restrictions; however, it may be converted into common stock on a share-for-share basis at any time. With respect to dividends and distributions, shares of common stock and Class B common stock rank equally and have the same rights, except that Class B common stock is limited to 90% of the amount of common stock cash dividends.

The Company has determined that, under Emerging Issues Task Force (EITF) Issue No. 03-6, “Participating Securities and the Two-Class Method under FASB Statement No. 128, Earnings per Share,” a two-class method of computing earnings per share is required. According to the EITF Issue No. 03-6, the Company’s Class B common stock is considered a participating security requiring the use of the two-class method for the computation of basic and diluted earnings per share. The two-class computation method for each period reflects the cash dividends paid per share for each class of stock, plus the amount of allocated undistributed earnings per share computed using the participation percentage which reflects the dividend rights of each class of stock. Basic and diluted earnings per share reflect the application of EITF Issue No. 03-6 and was computed using the two-class method. Prior periods have been restated to reflect this change. The shares of Class B common stock are considered to be participating convertible securities since the shares of Class B common stock are convertible on a share-for-share basis into shares of common stock and may participate in dividends with common stock according to a predetermined formula (90% of the amount of common stock cash dividends).

Diluted earnings per share is calculated by dividing net income, adjusted for interest savings, net of tax, on assumed conversion of convertible debentures and notes, by the actual shares outstanding and share equivalents that would arise from the exercise of stock options, certain restricted stock awards, and the assumed conversion of convertible debentures and notes when dilutive. The Company’s 8 ¹/4% and 7 ¹/4% debentures and its 7 ³/4% and 8% notes are excluded from the calculation for the second quarter and first six months of fiscal 2006, and the Company’s 8 ¹/4% and 7 ¹/4% debentures are excluded from the calculation for the second quarter and first six months of fiscal 2005, as assumed conversion and the effect of the interest savings would be anti-dilutive. The per share amounts presented in the Condensed Consolidated Statements of Operations for the second quarter and first six months of fiscal 2006 and 2005 are based on the following amounts: