Good day, everyone, and welcome to the FY '19 First Quarter Earnings Call for Richardson Electronics. I would like to turn the call over to your host today, Ed Richardson, CEO. Please proceed..

Good morning, and welcome to Richardson Electronics' Conference Call for the first quarter of fiscal year 2019.

Joining me today are Robert Ben, Chief Financial Officer; Wendy Diddell, Chief Operating Officer; Greg Peloquin, General Manager of our Power & Microwave Technologies Group; Pat Fitzgerald, General Manager of Richardson Healthcare; and Jens Ruppert, General Manager of Canvys.

As a reminder, this call is being recorded and will be available for audio playback. I would also like to remind you that we'll be making forward-looking statements and they're based on current expectations and involve risks and uncertainties. Therefore, our actual results could be materially different.

Please refer to our press release and SEC filings for an explanation of our risk factors. Sales in the first quarter were strong and reflect the investments we’ve made in our growth initiatives. We easily beat our FY '18 first quarter sales by nearly 20%.

This is impressive given that we have an extra week last year and the summer quarter is typically one of our weakest due to extended holiday periods outside the U.S. During our first quarter, all three business units exceeded the prior year in sales.

PMT in Canada has performed particularly well by the rollout of 5G and continued strong demand for our custom OEM displays. Healthcare revenues also grew slightly with the launch of our new CT tube, the ALTA750.

As we anticipated, interest in our CT tube is heating up as the availability of a replacement tube becomes known and CT scanners come off OEM service agreements. I’ll now turn the call over to Bob Ben who will share the highlights of our first quarter financial performance.

Then Greg, Pat and Jens will provide more details on their business unit’s performance..

Thank you, Ed, and good morning. I will review our financial results for our first quarter of fiscal year 2019, followed by a review of our cash position. Net sales for the first quarter of fiscal year 2019 were 44.2 million compared to the prior year’s first quarter of 37.0 million which was an increase of 7.2 million or 19.4%.

There were 13 weeks in the first quarter of fiscal 2019 compared to 14 weeks in last year’s first quarter. Net sales increased 5.7 million for PMT, 1.4 million for Canvys and 0.1 million for Richardson Healthcare.

Gross margin for the quarter was 31.6% of net sales compared to 32.8% of net sales in last year’s first quarter primarily due to a change in product mix for both PMT and Richardson Healthcare. Canvys margin as a percent of net sales increased due to an improved product mix and lower costs on selected products sold.

Operating expenses were 13.1 million for the quarter compared to 12.3 million in the first quarter of fiscal 2018. Operating expenses increased due to additional compensation and other expenses primarily related to the increase in net sales.

Operating expenses as a percent of net sales decreased to 29.7% in the current quarter from 33.3% in last year’s first quarter. The company reported 0.9 million of operating income for the first quarter of fiscal 2019 compared to 15,000 of operating income in the first quarter of fiscal 2018.

Results in the first quarter of fiscal 2018 included a 0.2 million gain on disposal of a building. Other expense for the first quarter of fiscal 2019, primarily foreign exchange, was 0.2 million compared to other expense of 0.1 million for the first quarter of fiscal 2018.

There was an income tax provision for the quarter of 0.3 million which reflected a provision for foreign income taxes and no U.S. tax benefit due to the valuation allowance recorded against the net operating loss. Although there is no cash benefit shown on our financial statements from U.S.

net operating losses, we can use our net operating losses to offset any cash tax liability recorded in our U.S. federal income tax return. The remaining amount of federal NOL is 16.5 million. Overall, we had a net income of 0.4 million for the first quarter of fiscal 2019 as compared to a net loss of 0.1 million in the first quarter of fiscal 2018.

Earnings per common share diluted in the first quarter of fiscal 2019 were $0.03. Turning to a review of our cash position. Cash and investments at the end of the first quarter of fiscal 2019 were 54.8 million compared to 60.5 million at the end of fiscal 2018 and 61.4 million at the end of the first quarter of fiscal 2018.

The use of cash in the first quarter of 2019 was primarily due to payments for accounts payable transactions from the fourth quarter of fiscal 2018. During the first quarter of 2019, we repatriated 2.3 million in foreign cash tax in the U.S. Our U.S. cash and investments totaled 28.2 million at the end of the first quarter of fiscal 2019.

We had capital expenditures of 1.1 million in the first quarter of fiscal 2019 compared to 1.0 million in the first quarter of fiscal year 2018.

Approximately 0.4 million related to our investments in our Healthcare growth strategy; 0.3 million to our IT system; 0.1 million to our manufacturing business; and another 0.3 million for facilities and other projects. Lastly, we paid 0.8 million in dividends in the first quarter of fiscal 2019.

Now I will turn the call over to Greg who will discuss the results for our Power & Microwave Technologies group..

Thank you, Bob, and good morning, everyone. In the first quarter of fiscal year 2019, PMT sales were 34.8 million versus 29.1 million in Q1 of FY '18. Based on our Demand Creation model, strong booking trends with our new technology partners, numerous design wins and our unique business model, our business grew 19.4% over prior year.

Our gross margin did decline slightly to 31.7% compared to 32.9% in Q1 of last year due mainly to product mix. Our improvement in sales and product performance is driven by strong within our core electronic device businesses, including engineered solutions, as well as very strong growth from our new technology partners.

We’re taking advantage of our long-term customer relationships, while our customer count continues to grow with our expanded product range. Favorable market conditions in the industrial, wireless infrastructure and power energy markets are leading this growth.

We are also implementing numerous internal programs to improve efficiencies and inventory turns while taking advantage of our global infrastructure. These actions continue to contribute to the company’s overall profit improvement.

We continue to experience market share gains and revenue growth for both products from both business units; Power & Microwave Group PMG as well as our electronic device group EDG. This growth is being supported by key technology partners such as Qorvo, CPI, MACOM, Anokiwave, USCi, CDE and Thales.

More specifically, key markets and applications showing growth in Q1 include 5G wireless infrastructure, power management, semi fab, broadcast and industrial. Sales in our electronic device group including power grid tubes and accessories as well as engineered solutions we manufacture in LaFox were strong in the quarter.

Sales in the semiconductor fab market increased over prior year and industrial markets in general are performing well. We are excited about the 5G market as it develops throughout the world.

We have added key technology partners in the industry to support the numerous products and applications that will be implemented in the 5G rollout including key technology partners such as Qorvo and MACOM for GaN and other RF and wireless components.

Another key partner is Anokiwave who brings leading core chip technology for 5G phased array smart antennas.

We are also supporting key suppliers focused on test and measurement side of 5G with partners such as Junkosha cable who are supporting next generation of testing equipment needed for 5G and 3Rwave for cutting-edge 5G circulators and isolators.

With these technology partners, we can do component level designing and support the majority of the customers broad level needs. These customers are the key OEMs in the world as well as Tier 2 and Tier 3 customers that are supporting a portion of the larger OEM’s system.

The customers welcome RELL’s local field engineering team in supporting their designs and our technology partners love our global reach and field engineering resources to design in their product and do true Demand Creation.

These rollouts historically take between six and eight years with the high point being around three and four which will put us right into 2020 and 2021.

This growing list of 5G customers are working on 5G technology for numerous applications such as smart logistics, telematics, small cell base station infrastructure, smart cities and homes, machine to machine and other niche applications like critical emergency services and precision agriculture.

5G technology in those applications will eventually touch all aspects of our lives. We’re starting to see more and more pre-production orders for components on designs that have been in place for 9 to 12 months. The list of design wins continues to grow each quarter. We have seen major growth in Q1 of this fiscal year.

We track designs on a global basis and studying our growth in these design wins, it is clear our team continues to do a very good job identifying key suppliers in niche markets and applications. With our team of experienced I/O technical resources, we offer the top design resources in the field to support this growth.

We are adding many new customers each quarter. When you combine that with our backlog, we are confident our growth in revenue and backlog will continue. I can’t stress enough the value of our unparallel capability and global go-to-market strategy that is unique to the RF and power industry.

We can support this back to our revenue gains, our growing list of new customers every quarter and with our targeted list of electronic devices and disruptive technology partners who chose Richardson Electronics to bring their products to market.

Our world-leading position in the manufacturing and distribution of electronic devices supports legacy equipment as well as new equipment where solid state cannot replace tubes. These same customers also need solid state technology.

Through our key technology partners as well as our in-house manufacturing, global field design engineers, and infrastructure, we have proven our ability to support our customers' RF and power needs throughout the world. We do have some headwinds going into Q2 FY '19.

The semi fab market is showing some slowdown, although our customers feel this is temporary. Tariffs on products made in China and sold in the U.S. as well as new China tariffs on U.S. products going into China may also have some short-term effects. So far the impact of these tariffs have been more administrative than anything else.

However, in spite of these challenges, we are committed to finding solutions to continue our improved profitability with top line growth each quarter through the combination of our experienced PMT team and our unique global model. And with that, I’ll turn it over to Pat Fitzgerald and Richardson Healthcare..

Thank you, Greg, and good morning, everyone. I’m happy to report that we began shipments of our newly manufactured CT tube, the ALTA750 for revenue during the first quarter. Sales performance is within expectations and installed base is growing steadily.

Several of our customers who were involved in evaluating the sales performance of the ALTA tube earlier in the year have come back now to buy tubes for other sites. We expect ALTA750 revenue will build throughout FY '19 as people will become aware of the new tube and are able to breakaway for pre-existing commitments with the OEM.

Healthcare sales in the first quarter of fiscal 2019 were 2.2 million, up 5.2% from prior year sales of 2.1 million due primarily to strong equipment and CT tube sales.

Gross margin as a percentage of net sales decreased to 28.6% in the first quarter of fiscal 2019 as compared to 48.8% in the same period last year due primarily to a mix of products that favored lower margin equipment sales and unfavorable manufacturing variances associated with the first full quarter of CT tube production.

While sales of replacement parts were down in the quarter compared to the prior year, we expect several major initiatives to help turn this trend towards the same growth in future quarters.

The first is the availability of our new ALTA replacement tube which we believe will entice hospitals and third parties to service these scanners more than ever before.

Next is investments we are making now on parts for newer CT platforms like Toshiba Prime and Aquilion ONE where we see increasing demand for parts and better margins as compared to parts for older platforms. The last major initiative we see driving growth in replacement part sales is our P3 part contracts.

We signed multiple P3 part contracts in the first quarter. These new P3 agreements are primarily recurring revenue contracts where Richardson has agreed to provide replacement parts and in most cases replacement tubes in exchange for a fixed monthly fee over a three-year period.

P3 contracts are attractive to our customers because it allows them to quickly see the value of the Richardson offering as compared to the OEM and it allows them to budget operating expenses. It also helps overcome any potential resistance to purchasing a newly developed CT tube.

If the tube fails during the contract period, the replacement is on us not the customer. So with P3 we are pairing replacement parts and tubes with servicing and in one large opportunity we have also offered service labor provided by third-party partners.

In that opportunity we had a hospital customer who wanted to train their own engineers and take care of their own equipment themselves but did not believe they could gear up to do so before their current OEM contract expired.

We offered to help them with service labor provided by qualified third parties whose engineers we have trained as a bridge to where they wanted to be. This proposal has been well received and we are now offering service labor as an option to other customers in similar situations.

To be clear, we don’t intend to compete with our third party service partners but in these instances we are bringing good business opportunities to them and it has been well received. Overall, we are currently in negotiations with customers on P3 contracts that would cover hundreds of OEM CT scanners over time as they come off a contract.

CT tube transactional sales led by the new officer were up significantly in the first quarter compared to last year.

We are increasingly selling new ALTA tubes instead of certified pre-owned OEM tubes but we still see a market for pre-owned tubes going forward and we’ll continue to offer these as an option for customers who do not have the budget for a new officer. We also need the pre-owned tubes for our growing business in Europe.

We are working on obtaining CE Mark approval so we may sell our new ALTA tubes throughout Europe and expect to receive approval in the fourth quarter of our fiscal year. At this point, we are not prepared to forecast what percentage of our new ALTA tubes will be sold on a transactional basis versus a P3 agreement.

It is up to the customer to determine which method transactional purchase or full coverage is best for them based on their individual circumstances. Our team of highly experienced tube engineers continues to spend time improving production yield and field performance in the ALTA750 tube, but has also begun work on our next CT replacement tube.

We are aiming to produce the first engineering prototype of this next tube model before the end of fiscal year '19. Equipment sales were up strongly in the quarter compared to prior year. We see equipment sales as strategic to our overall business creating sockets where we can sell replacement parts and tubes in the future.

Equipment in our business has traditionally been sold outside of the U.S. as is with no warranty offer. We are now increasingly offering refurbished pre-owned equipment in the U.S. with the warranty and absence for a P3 agreement following the warranty period.

We are also in the early stages of developing a network of dealers who can sell in services equipment. Our strategy in healthcare has not changed. We are playing a significant role in the development and sales of diagnostic imaging and replacement parts with the goal to help lower the cost of healthcare delivery.

In this regard, the interest of Richardson Electronics and our hospital and third party service partners are well aligned. Hospitals are under more pressure than ever before to reduce operating costs and capital for new equipment purchases is limited. We have made significant investments to support our customers with these challenges.

This includes the ALTA750 that we are staffing in strategic locations throughout the country to support rapid shipment. We now look to our partners to leverage our solutions and grow the service presence in this space so that we can fund the next phases of healthcare development.

With replacement parts, CT and X-ray tubes, service training, refurbished equipment as well as power grid tubes, coil repairs and cryogenic solutions for MRI systems, Richardson Healthcare has established excellent relationships with hospitals and independent service organizations on a global basis.

Over the past several years, we have significant strengthened our value proposition for healthcare providers looking to lower their costs and increase efficiency. The launch of our new ALTA750 CT tube takes us to the next level.

We remain open to additional acquisitions in this market with our primary interest in companies with models that can expand internationally. We’re also evaluating additional partnerships with organic investment in product line expansion in segments that we feel are underserved.

I'll now turn the call over to Jens Ruppert to discuss Canvys first quarter results..

Thanks, Pat, and good morning, everyone. Canvys, which includes engineering, manufacture and sale of custom displays to original equipment manufacturers in the industrial and medical markets, delivered another strong performance with sales of 7.2 million during the first quarter of fiscal 2019, an increase of 24.4% over the same period last year.

We continue having a strong order book performance with a quarterly book-to-bill of 1.25. Our improvement in performance is primarily driven by an increase in customer demand globally. I'm also pleased to report that gross margin increased as a percentage of sales to 32.2% from 26.8% the same period last year.

The year-over-year gross margin increase was related to a favorable product mix. Our backlog increased quarter-over-quarter to the highest level we have seen for over three years and we are cautiously optimistic of our continued strong customer demand throughout North America and Europe.

Our backlog ships over 12 to 24 months and is impacted by customer call off orders that can vary quarter-to-quarter based on customer sales, regulatory issues and other factors. During the quarter, we received several new orders from our medical OEM customers.

Applications include optical biometry, a highly accurate non-invasive automated method for measuring the anatomical characteristics of the eye, and LASIK surgery, the precise and controlled removal of corneal tissue by a special laser that reshapes the cornea.

We closed other pending orders, where our displays are used at aesthetic laser treatment machines, a market that has seen increased demand. These lasers are used for skin treatments such as scar, stretch mark and wrinkle treatments, tattoo removals, as well as permanent hair reduction.

The digital radiotherapy space continues being a key market we serve. Last quarter, we received a follow-on order for a highly customized product, monitoring patients during radiotherapy. We also won additional orders for displays used in the dental market and for navigation and patient monitoring systems.

In the non-medical space, we received a significant order for All-In-One products as well as monitors used for product dispensers installed in grocery stores. Our sales team is seeing an increased demand for All-In-Ones, or displays that contain processing power, and we have several quotes pending.

It is our belief that All-In-Ones will eventually replace bulky and very often expensive standalone desktop computers. Our engineering team is working on prototypes for a Canvys Internet of Things, or IoT, offering. Our customers will be able to connect our IoT products through the cloud.

This will enable central parameterization and constant monitoring of the operational status of displays. While we had a good start in this fiscal year, we are seeing some headwinds too. The foreign exchange rate, with a weakening euro, is currently working against us.

Approximately 60% of our business is conducted in Europe and we buy most of our components and products in U.S. dollar and sell in euro. We are also seeing program push-outs from our customers tied to changes in regulations and standards that require a considerable amount of our customers’ engineering resources.

There are updated regulatory requirements such as the 4th edition of the EN60601, a relatively new medical standard that takes effect on January 1, 2019, and also a new IT standard, the EN62368 that will eventually replace the current EN60950.

Therefore, products that are just being introduced, or are still in the engineering stage, have to be tested against the newer, often much stricter standards. Meeting new standards may require redesigning existing products, the selection of new components, or even withdrawing the whole concepts.

All of these changes often result in a shortage of engineering resources as our customers juggle many priorities. Product testing to the newer standards creates additional challenges outside our customers’ control. Accredited test labs have to update their equipment first. The demand is high and their schedule is tight.

Thankfully, we prepared ourselves and our customers in advance. Our medical product offering already includes products that are certified according to the newest standards, and the team is working on getting the IT grade products offering tested ahead of the cutoff date that just has been postponed to the end of 2020.

In general, the display market is a very dynamic market. Price pressure continues while testing and documentation requirements are more complex, time consuming and increasing in frequency. In spite of these challenges, with a 3 million increase in our backlog quarter-over-quarter, we are poised for success.

It’s not a matter of if, it’s a matter of when. I will continue to review and adjust our business strategy with the goal of improving the operating performance of the division. Maximizing cash flow is an ongoing priority. We will continue to work with our partners to help us reduce inventory while being able to meet the demands of our customers.

I will now turn the call back over to Ed..

Thank you, gentlemen. It’s clear our strategic objectives are having a positive impact on Richardson Electronics performance. One of our objectives is to utilize our global infrastructure and to capitalize on the investments we’ve made in Healthcare and in the Power & Microwave Group.

We continue to carefully monitor our expenses so that we put more money to the bottom line and improve our return to our investors. In this regard, we are starting the year off strong.

Our new technology group under Greg Peloquin’s leadership is growing rapidly in PMT while our core tube business, EDG, continues to provide the funding for our new initiatives.

We’re closely monitoring the effect of the tariffs on our customers and on our business, and so far the financial impact of the tariffs has been minimal and continues to be more of an administrative burden. Jens Ruppert is clearly positioning Canvys as a leader in the custom display market.

He is finding new opportunities with our long-term customers, and he continues to add more blue-chip companies to our customer list. We must find ways to differentiate ourselves, and Canvys is doing that through new technology offerings, inventory management and a highly technical staff focused on customer requirements.

Our sales in Healthcare are building gradually as Toshiba CT scanners come off OEM service contracts. We’ve already seen this happening since the launch of the tube at the end of FY '18. We’re adding new tube installations on a regular basis.

The sales team is actively engaging with hospitals and service providers and showing them how our solutions help them increase uptime and lower the cost of healthcare. The availability of our new tubes and replacement parts gives them more options than ever. With our P3 agreements, our customers can choose what level of coverage they want.

They can also budget service costs while reducing the risk. As more equipment comes off contract, our sales will increase proportionately. We are working on the development of our next CT tubes. We currently have sufficient capacity to build up to 1,000 tubes per year so we have room to grow without significant capital requirements.

At this point, we’ll be happy to answer a few questions..

We’ll now open for Q&A. [Operator Instructions]. And we do straightaway everyone have Howard Bruce [ph] from Wellington Shield. Thank you, Howard, your live in the call..

Thank you. Ed, Wendy, first of all, congratulations on the quarter..

Thanks, Howard..

Thanks, Howard..

I really want to tell you that the turnaround has been spectacular and as a shareholder I’ve been very pleased about it, so thank you..

Well, we’ve got a great team. They deserve the credit..

Well, you have great leaders too and I appreciate it. The real one question I have, if we go back three, four, five, six months and you were sitting and looking at what you thought would happen for the quarter and for the year.

So the real question is, are you comfortable today as you were then on what you thought – not the quarter but the year will bring us?.

Yes. We’re really pleased with the first quarter. Normally, as I mentioned, our first quarter is the weakest particularly because Southern Europe is closed up in August and that didn’t happen this year.

We were really pleased and even though everyone is talking about a weakness in the semi fab market, our first quarter was actually up substantially compared to last year. So we’re pleased and everything is right on line as far as we’re concerned. Healthcare is doing great..

So then based on our conversations the last three, six months, you would offer no significant negatives in the mix or kind of put it a bit better that you’re looking forward to significant improvements as we go forward?.

We’re right on plan and that plan encompasses significant improvements. So we’re really pleased with where we are right now..

You include medical in that also?.

Absolutely. That’s our future..

That’s all I have. Thank you..

Thanks, Howard..

Thanks, Howard..

Thank you, Howard. The next one everyone is from Eric Landry from BML Capital. Thank you, Eric, your live in the call..

Good morning..

Good morning, Eric..

Hi. So Jens, you were kind of hard to understand so if I may I’d ask that you please go over and review the transcript when it’s public to make sure that they have it all transcribed accurately so we can go back and read it and figure out exactly what you said..

Yes, I think it’s online anyway in a couple of days but I guess we can do that right now..

Okay. Thank you. You did say book-to-bill is 1.25..

Yes..

And it’s the highest backlog that you’ve had in three years, up 3 million from the prior quarter..

More than three years. So I’m with the company now a little bit more than three years that that’s high as I have ever seen..

Okay.

Let me ask you, how much of this sort of increase in the business do you attribute to the strong economy and how much just to you and others being there?.

I would love to say it’s all me. So it’s a positive mix. It’s very hard to say but looking at our new program wins and customer wins we have over the last couple of years, we clearly see an improving business not only by existing customers buying more but we win new programs. So it’s a we [ph] growth..

Okay. Well, great. It’s fantastic. It grew faster than I thought and it looks like it’s actually starting to reaccelerate from what perhaps was maybe a little pause last quarter..

Yes, I remember that we talked about this last call. So yes, we had a small dip last quarter. But as I’ve said in my script that I don’t expect every quarter to increase the revenue, so we are highly up on our customer requesting products from us. So as they sell their products, we sell more.

Sometimes we ship, we have really a great month and then we have another bad month for a couple [indiscernible] it’s really hard to say. But generally speaking again we are poised for growth with a great backlog. The book-to-bill is positive. Even so we had a great quarter. So yes, it’s a very good brand..

Okay, great work. Congratulations.

So Greg, is there any chance that PMT beat the 1.25 book-to-bill that Jens just reported?.

We’re excited to ship our backlog in Q1 and wait for another catch up..

Okay..

But in the growth areas such as 5G, et cetera are higher than that. But in the MRO which is the largest part of our business, obviously even a book-to-bill 1 is strong..

So it’s safe to say in the overall – the whole segment was over – the book-to-bill was over 1..

Just slightly, yes..

Got you, great. Okay, thanks. So everyone seems to be worried about the LAM Research and we saw its comments on release that you’re expecting a “temporary slowdown.” It looks to me like everyone over the next three quarters is expecting somewhere around mid-to-high single digit revenue declines over the next couple of quarters.

If in fact that does happen, if the analysts are correct, is it likely that Richardson’s LAM business would decline by a similar amount, more or less than that, just for the LAM business?.

Well, it’s too early to tell. We actually expected it in the first quarter and compared to last year’s first quarter we were up substantially with that business. So we’ve heard it all. Wendy and I were just out to a vendor conference for LAM where the vendors were there from around the world and their COO made a great presentation.

And they were talking about all the infrastructure investments they’re making and they expect their business to grow $3 billion to $5 billion over the next three or four years and that’s basically what’s happening to them in the last three or four years and that more than doubled our business. So we are now on their key vendor list, thank goodness.

And I think it’s just a matter of time it’s going to continue to take off. We hear everything you hear but we also look at black and white numbers through the first quarter..

Fair enough. I’m just trying to get my arms around it because it seems like it’s quite a drag on the stock.

Greg, is it – how possible is it that a slowdown in LAM could be such that the whole segment doesn’t grow this year? Is that at all likely?.

No. What we’re seeing with LAM is where we would get 12 months worth of visibility in terms of backlog, we’re now seeing three to four months of visibility in terms of backlog. And based on that information, like I said black and white, the worst case will be flat up and through December and have a lot of visibility after that.

In the meantime if I look at the other 12 product lines we have which are in some similar markets but many of them are in other niche RF and microwave markets, those are doing very, very well.

So the top line I don’t know if it will continue with the 20% growth that you’ve seen in FY '18 and then again in Q1, but you will see positive growth, top line growth and will make up the revenue number. And we are continually looking at monthly our SG&A costs to keep the profit percent equivalent.

But there’s no indication that we can continue with boost profitability with top line growth increasing the sales in other segments such as 5G and some even industrial markets are growing for us and medical. So that’s kind of the model that we put together to take advantage of these upticks in LAM and in 5G.

But when there’s a slowdown or a flattening out, we have other niche markets that we can grow with this global infrastructure. So it’s a – I said unique model. That is one of the unique things about it. It kind of protects you from downturns and separate single markets. We’re not a one hit wonder by any means..

Okay.

Gentlemen, are you ready for the next questions?.

Yes..

Yes, excellent. Thank you. So this is from Mark Zinski. Mark’s from 21st Century Equity Research. Thank you, Mark, you’re live in the call..

Good morning, everyone, and congratulations on the quarter..

Thanks, Mark..

Greg, in terms of – again, getting back to the semis, do you have granular enough detail to say – to pinpoint certain aspects of the semi market whether it be memory, storage or power and how those individual components of semi are doing and relating to your business?.

It is very hard to break it out because the semiconductor manufacturing market, its wafer fabs have built numerous products.

But one of the things we have seen is this future growth that they’re saying in terms of maybe a slight slowdown at the end of FY '18, but this growth will be building up wafer fabs, updating equipment to build 5G products, 5G dye that goes into dozens and dozens of 5G applications and 5G products.

So my viewpoint is what I’m seeing is going to happen with 5G both handsets, the Internet of Things and infrastructure. The semi fab market is going to have to increase the amount of facilities, in essence, wafers to support that.

That alone makes us comfortable with that as we see 5G growing, we have a real good handle on that that the wafer fab market will have to be set up to support that. And also LAM’s a $4 billion to $5 billion company. We service a portion of this.

So even though their overall might go down, it might not be this large percent for us – I’m sorry 10 billion. They can grow 4 billion to 5 billion..

Okay. And I know you’re sort of the expert on – you’ve seen some of these – you’ve lived it, Greg, the wireless – the previous wireless build outs. How does 5G compare to the previous ones? Any nuanced detail would be great..

I think that when you look at going from 1G to 2G to 3G to 4G, a lot of that was upgrades; upgrading the system with some new technology. 5G is going to literally be a complete overhaul because the data rates are something that we’ve never seen before.

The amount of applications that have been using 5G, all the test equipment that tests the base stations and other products is going to have to grow. We just booked a very large order with Rohde & Schwarz for all their test cables. It just trickles down into a very large overhaul of an entire network. And so there is two main things that I see.

One is a complete overhaul, not an upgrade.

The second thing I see is that the number of base stations are 10x, meaning because of the amount of data and video and everything that’s going to go through your car, through your phone, through your WiFi, there’s going to be a bunch of smaller cells versus the big base stations that you see driving down the road.

In addition to that, the antenna technology which we have the leader in that in these phased array antennas is going to have to completely change. It’s not going to be, if you will, a shock and awe approach and you let your antenna on a new phone grab that signal as you’re driving across the country.

There’s going to be numerous pico and micro cells throughout the country – throughout the world that are going to help support and transfer all this data for Internet of Things, for WiFi, for small cells. And so that is a perfect match for Richardson is because of that a whole new list of customers get involved.

These small niche guys probably don’t get the attention of the larger RF and widest component OEMs but they use the services of Richardson’s global niche RF design engineers located throughout the world, in some cases a drive away to support their technical needs and update them on what the latest and greatest technology is, things like GaN, et cetera.

And so the other aspect of it is the technology choice for these base stations in 3G and 4G with LDMOS. Richardson had a technology partnership with one of the leaders of LDMOS.

This come around the two largest and most advanced producers of GaN technology [indiscernible] and Richardson is the only go-to-market company, if you will, that has both to support the customer needs.

So there are various aspects that’s going through this, every launch not be excited, but this one’s just a little bit different and it’s funny [ph] that it comes after four of these rollouts.

And one thing Richardson knows how to do because we went through a lot of them is how to do that, how to maximize that rollout efficiently, cost effectively, gain market share, gain sockets and get as much profit out of those as we can..

Okay, great. That was very helpful color.

And Bob can I pin you down on a blended tax rate for FY '19 at all?.

Well, as I stated before, our tax provision is just foreign income taxes. So all of our income pretty much is in foreign tax jurisdictions and a lot of that’s in Germany and Italy. So those rates are in the range of upper 20s and low 30s. But in terms of a rate it gets a little confusing because again in the U.S.

we still have the net operating losses for tax purposes. And so from a rate perspective, it’s hard to predict. But I think what we saw in the first quarter is similar to what we’re going to see the rest of the year..

Okay, great.

And then in terms of free cash flow for the year, do you think it’s just going to be sort of a mild burn for FY '19 or is that a good way to think about it?.

Yes, well I think one thing. I mentioned it in my comments. We had a lot of transactions at the end of fiscal 2018 in accounts payable that were really related to 2018 cash use. So I think once you – we saw that in the first quarter that drop in accounts payable and the impact on cash. So that to me was more of a one-time impact from last year.

So when you adjust that into fiscal 2018 cash, I would expect the cash flow used to be slightly higher than what we used in 2018 but not drastically..

Okay.

And then are you seeing some opportunities with the higher interest rates in terms of the short-term security market in terms of reallocating cash a little bit?.

Yes, so I mentioned that we had at the end of the first quarter we had 28.9 million in cash in the U.S. and most of that is currently invested in short-term securities and we’re receiving around 200 basis points on that which is very good compared to the rest of the market..

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

Thanks, Mark..

Thank you. So we have Eric Landry from BML Capital. Thank you, Eric, your line is live..

We really didn’t cut you out, Eric..

As you guys get more popular I’ve got to share my time with you with others, no problem at all. So Pat I’ve got one thing here real quick. So it seems like the issue in the tube market is these long-term contracts.

So if we – let’s just assume that the overall market is I don’t know several thousand and maybe a tube gets replaced every other year on average, so let’s just – just to pick a number out here, let’s assume 3,000 tubes is the market annually.

Have you done any work about how many of those tubes are on service contracts now? And if so, how many of them expire say in this fiscal year and then how many in next fiscal year and then possibly how many in the following fiscal year, just percentages?.

We’re working on that data and the guys have done a good job accumulating it. So we don’t know at all for sure but we can tell you that right now still about 85% of the equipment is on contract with the OEM with the manufacturer of the equipment. And then we do know to some extent when those contracts are expiring and we’re all over it.

So we’re talking to the medical institutions and the service companies that are responsible for that equipment as it is coming off a contract. So I’m not sure that answers accurately. I can’t tell you by year right now when the equipment comes off but it’s linear. That’s for sure.

And what’s happening of course is the availability of the tube becomes common knowledge and of course we have all the parts to service those CT scanners as well. More and more of the healthcare institutions and service companies are interested in taking those contracts away from the OEM and that’s where we play..

Okay. So you’re not comfortable now quoting if half of them maybe becomes available --.

No, I couldn’t do that. Maybe in the future we can do that. I know we’re working on it all the time. We know where the equipment is and now we’re accumulating the data on when that equipment comes off contract. And it isn’t easy. Each user, most of it is staggered.

So they may have 40, 50 systems on contract but they don’t all come off a contract at the same time..

Okay, well thank you for that.

Lastly, has there been an reported issues from the field on the new ALTA750 or is it pretty much everything’s fine at this point with regards to it working correctly?.

Yes, I think that we’re right on plan and the one thing that is a little surprising to me but I guess it’s not surprising to Pat is that what’s really popular, the P3 agreements and I think a large portion of our business is going to be in that area in the future, it makes sense because the users don’t know yet how good the quality is of our tubes.

They’re going to last two years, three years, four years. And so with a P3 contract for a monthly charge, all the risk stays with us. And that’s just flat. It gives a recurring very predictable revenue and earnings and we also control the tubes that go into that equipment. So I think it’s a great business.

I never thought it would be this way but so far the requirements are more for P3 contracts than they are to buy tubes outright..

Got you. Okay, thanks. I appreciate it. Good work, folks..

Thanks, Eric..

Okay, everyone. So we now have Daniel Wolfe fromn180 Degree Capital. Thanks, Daniel, you’re live in the call..

Thanks, guys.

Just if you can go back and just tease out your comments about the semi manufacturing slowdown that you cited, sort of what’s – you touched on it but if you can get into a little more detail about specificity, what does that mean? Is it that you’re worried about tariffs, you’re worried about price increases, you’re seeing an end user slowdown, just kind of walk us through that if you don’t mind?.

Could you clarify the question a little bit where you --.

You referenced in your press release the semiconductor – basically the Web wafer slowdown. So I wanted you to just tease on that. It was in your release. You talked about a slowdown in semiconductor, semi manufacturing business.

So just walk us through what that means for you?.

Okay, all right. Well, we don’t really release the details but we can tell you that somewhere between 10% and 15% of our business is with semiconductor wafer fab manufacturers and there is four or five of them that are major customers.

And if you’ve watched that industry at all from five [ph] material on down, they’re all predicting a flattening in that business. And we have been told also from our customers that they anticipate a short-term flattening. At the same time in our first quarter that business was up substantially. So we’re watching it.

We don’t have the visibility that we once had out a year. We have visibility right now through the end of the calendar year. And I guess with all the publication that it’s getting, we’re nervous about it. But so far we haven’t seen the impact..

So it’s more of – as you touched on in your prepared remarks, more of a China tariff issue? So obviously the issue that – as opposed to you’re seeing end users slow down, therefore, they’re seeing slowdown.

It’s more conjecture around what’s going to go on with all the tariffs?.

That’s completely another issue. It really has no impact on our portion of the semiconductor wafer fab business. We buy substantial amount of products that’s made in China. It’s substantial. It’s $2 million or $3 million a year. And that product has been backed by the 25% tariff.

And what we are doing, we are passing it through to our customers and what I can tell you at this point, the financial impact is minimal but the administrative impact is a burden because every transaction is different.

The 25% tariff is charged on our cost but our sell price to the customer is a different percentage, so we have to adjust the pass-through on every customer and every product. And it’s really an administrative burden, a pain in the neck but the financial impact is marginal..

Okay. Thanks, guys..

Thank you..

Okay, everyone. We now have Bruce Hoffman from Franklin [ph]. Thank you, Bruce, your live in the call..

Good morning. Thanks for taking my question. I have a couple small ones here.

Remind us what does P3 stand for in the P3 parts contracts?.

We got a protect contract and it’s basically an insurance contract for our healthcare customers. And what we are providing you is we will provide a combination or all of the above of parts, tubes and on a monthly basis to the customer for a monthly charge.

So they have a Toshiba CT unit, then we will agree to have product available where we can ship instantly the CT tube or any other parts that fail in that equipment and that’s based on a monthly charge on a three-year contract. And then we have versions of that.

So if they only want to buy parts and only want to be insured for parts, we charge them a monthly charge for parts. And if they want to buy only CT tubes, we can do that. If they want to buy both, fine, that kind of thing.

And so far what we’re seeing is the very popular, the majority of customers coming to us once they realize we have a tube, they want to buy the P3 contracts that gives them the availability of the tube and all the parts on a monthly basis on a three-year contract..

Okay.

And with the introduction of the ALTA750, was that having a depressing effect on gross margins in the Healthcare segment?.

We were seeing more equipment – in the Healthcare segment, we sell refurbished equipment or we sell the parts to maintain that equipment and now we’re doing both.

We’re selling equipment with a P3 contract so a medical institution can buy refurbished equipment from us and along with that they can get a three-year contract for the tube and they are charged on a monthly basis. And until we had the tube, we were getting the P3 contracts. We were selling only equipment which was at a much lower margin.

And the tube has just come to market in June..

What was it about the mix that affected gross margins in the segment in the quarter?.

It was all this fail of equipment versus parts and tubes..

Okay.

And then the startup of the manufacturer of the 750, was that – did that create some ramping costs or inefficiencies that affected margins in the quarter?.

Yes, absolutely. Of course we’ve spent four years developing the tube, four years in August, and we built a factory within a factory. So it’s all brand new equipment. We’ve hired 30 plus engineers and technicians to develop the tube. Of course we did an acquisition in that area.

We bought IMES that was a parts company for Toshiba parts, a strategic add on to it. So we’ve spent $25 million or $30 million in four years developing the capability. And it’s just starting to show traction and we’re really pleased with it..

What would your expectation be that the gross margin in that unit should improve as the year goes on?.

Absolutely. Normally that gross margin should be 40% to 50% and that’s where it’s been in the past..

Okay.

Do you feel that’s attainable with all the recent investment and so on in capacity?.

Yes..

Okay. And then finally I just want to make sure I understood Bob’s comments about cash flows in 2019. Free cash flow was a negative of about 2.3 million in 2018 and then there was this effect coming into 2019 Q1.

When you get to the end of 2019, is the full year free cash flow going to look like at 2.3 from last year or less/more?.

Hi, Bruce. It’s Bob Ben. What I was trying to say before was that we would use a little bit more cash this year relative to last year. So yes, I would expect the free cash flow to be slightly negative again like last year but probably a little bit more..

Okay.

So you weren’t like rolling off that what flowed from last year into the Q1 then?.

No. What I was trying to say is when you adjust for that, that was about 3.5 million of accounts payable at the end of the year that really related to fiscal 2018. And so when you adjust the cash usage in fiscal 2018, that’s around 7.2 million for the year.

And so I expect a similar use of cash but probably a little bit higher than that is what I expect..

Okay. Thank you. That’s it for me..

Thank you. We now have Walter Shanker and Walter is from NAV Partners [ph]. Thank you, Walter, you’re live in the call..

It’s a longwinded somewhat of a rant question the thrust of which is you now have a much clearer path forward. You’ve completed a multiyear program on CT tubes. You’re in the marketplace. It may not be developing.

It maybe a contract as opposed to a sale but you have a pretty clear picture that you’ve succeeded in getting into this marketplace and it’s a good opportunity. You’ve got 5G looking at you so that the business is profitable. The stock sells under book, net of cash. The business is under half of sales.

So on a capital allocation basis, I know this has come up from time-to-time in the past, why is this not a time to seriously consider buying back stock given the discount that you’ve made your big investments and that the future looks much clearer than it may of any time in the last few years as you were trying to build new businesses?.

Well, that’s a question that’s ask a lot and --.

I know..

And I’ll tell you where we are. We have capacity to build about 1,000 CT tubes a year and I would like to exceed that capacity as quickly as possible. And if so, we have 100 plus acres of land here and the building is on the front half, 24 acres.

We’ll be breaking out a wall in the back and building additional building and adding equipment to build more CT tubes and we’re going to need that cash. So that would be a nice problem to have and we’re sort of trying to retain as much cash as we can for that kind of purpose.

I think for investors you get a better return on your investment if that happens than you [would for] us buying stock back right now. It’s my feeling..

Okay. For what it’s worth they are not mutually exclusive if you’re at capacity or approaching capacity on the CT tubes you’re obviously making a substantial amount of money. Cash flow will be meaningfully positive. But I hear the answer and thank you..

Okay. Thank you..

Thank you. So I’ll turn it back now to Ed Richardson. Thank you, Ed, for your closing comments..

Thank you again for joining us and for your ongoing interest in Richardson Electronics. You’re welcome to call us if you have other questions that we were not able to answer on the call. And we look forward to discussing our fiscal 2019 second quarter results with you in January. Thank you very much..

Ed, everyone, thank you. Everyone, that concludes your conference call for today. You may now disconnect. Thank you for joining and have a good day..