Richardson Electronics Ltd (RELL) 2019 Q1 法說會逐字稿

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; Patrick 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 3 business units exceeded the prior year sales. PMT and Canvys performed particularly well, [helped by] the rollout of 5G and continued strong demand for our custom OEM displays. Health care 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 units' 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 by $0.7 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 the 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 fiscal 2018 included a $0.2 million gain on the 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 tax benefit shown in 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 was $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 the 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 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 relating to our investments in our health care growth strategy, $0.3 million to our IT system, $0.1 million for 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 the demand creation model, strong booking trends with our new technology partners, numerous design wins that are unique to our global 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 profit performance is driven by growth within our core electron 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 Electron 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 Electron 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 equipment [wafer] fab market increased over prior year and industrial markets, in general, are performing well.

We are excited about the 5G market that has developed 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 again, and other RF and wireless components. Another key partner is Anokiwave, who brings leading core chip technology for 5G phased array smart antennas.

We're also supporting key suppliers focused on the test and measurement side of 5G with partners such as Junkosha, who is 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' board 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 a larger OEM system.

The customers welcome RELL's wealth of field engineering team [and] support their design. And our technology partners love our global reach and field engineering resources to designing their product and to fuel demand creation. These rollouts historically takes between 6 and 8 years with the high point being around 3 and 4 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 emerging services and precision agriculture. 5G technology and all its applications will eventually touch all aspects of our lives.

We're starting to see more and more preproduction orders for components on designs that have been in place for 9 to 12 months. The list of design wins continue to grow each quarter. We have seen major growth in Q1 of this fiscal year.

We track designs on a global basis. In studying our growth in the design [wins] , it is clear our team continues to do a very good job identifying key suppliers, niche markets and applications, through our team of experienced RF technical resources who 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 unparalleled capability and global go-to-market strategy that is unique to the RF and power industry. We can support this fact with our revenue gains, our growing list of new customers every quarter and with our target list of electron device and disruptive technology partners who chose Richardson Electronics to bring their products to market.

Our world-leading position in the manufacturing and distribution of electron devices supports legacy equipment as well as new equipment where solid-state cannot replace tubes, the same customers also that installs this technology. Through our key technology partners as well as our in-house manufacturing, global field design engineers and infrastructure, we have proven our availability to support our customers' RF and power needs throughout the world.

We do have some headwinds going into Q2 of FY '19, the semi fab market is showing some slowdown, although our customers feel this is temporary. There are some products made in China and sold in the U.S. as well as new China tariffs on U.S. products going into China that 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 to top line growth each quarter with the combination of our experienced PMT team and our unique global model.

And with that, I'll turn it over to Pat Fitzgerald in 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 the installed base is growing steadily. Several of our customers who were involved in evaluating the field performance of the ALTA tube earlier in the year have come back now to buy tubes for other sites.

We expect the ALTA750 revenue will build throughout FY '19 as people become aware of the new tube and are able to break away [from] pre-existing commitments with the OEM.

Health care 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 of 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 prior year, we expect several major initiatives to help turn this trend towards sustained 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 in 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 parts contracts. We signed multiple P3 parts 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 3-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 to overcome any potential resistance to purchasing a newly developed CT Tube. If the tube fails during the contract period, a replacement is then offered to the customer. So with P3, we have current replacement parts and tubes for service training. 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 a qualified third party, 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 we'd cover hundreds of OEM CT scanners over time as they come off of contract.

CT Tube transactional sales, led by the new ALTA tube were up significantly in the first quarter compared to last year. We are increasingly selling new ALTA tubes instead of certified preowned OEM tubes, but we still see a market for preowned tubes going forward. And we'll continue to offer these as an option for customers who do not have the budget for a new ALTA tube. We also need the preowned 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 individual circumstances. Our team of highly experienced tube engineers continues to spend time improving production yield and field performance of 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 offered.

We are now increasing the offering with furbished, pre-owned equipment in the U.S. with a warranty and actions for our P3 agreement following the warranty period. We are also in the early stages of developing a network of dealers who can sell and service this equipment.

Our strategy in health care has not changed. We are playing a significant role in the development and sale of diagnostic imaging replacement parts with the goal to help lower the costs of health care 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're stocking in strategic locations throughout the country to support rapid shipment. We now look to our partners to leverage our solution and grow their service presence in this space, so that we can fund the next phase of this health care 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 significantly strengthened our value proposition for health care 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 are also evaluating additional partnerships and organic investment and 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 the engineering, manufacture and sale of custom displays for 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 the quarterly book-to-bill of 1.25. Our improvement in performance is primarily driven by the increase in [capital] demand globally.

I'm also pleased to report that gross margin increased over a percentage of sales of 32.2% from 26.8% in the same period last year. The year-over-year gross margin increase was related to a favorable product mix.

Our backlogs increased quarter-over-quarter to the highest level we have seen for over 3 years. And we are cautiously optimistic of our continued strong customer demand through North America and Europe. Our backlog shifts of 12 to 24 months is impact by customer call-offs that can vary quarter-to-quarter based on customer sales, regulatory issues and other factors.

During the quarter, we received 7 new orders from our medical OEM customers. Application includes optical biometry, a highly accurate noninvasive automated method for measuring the anatomical characteristics of the eye; and LASIK surgery, a precise and controlled removal of corneal tissue by a special laser that reshapes the cornea.

We closed other pending orders through our other space, [are used] as a static laser treatment machine. 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 with us. Last quarter, we received a follow-on order for a highly customized product monitoring patients during radiotherapy. We have also one additional order for displays used in the dental market [in] co-navigation and patient monitoring system.

In the non-medical space, we received a significant order for an all-in-one product as well as monitors used for product [dispensers] [installed in grocery stores]. Our space still see 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 stand-alone desktop computers.

Our engineering team is working on prototype for Canvys Internet of Things or IoT offering. Our customers will be able to connect our IoT product through the cloud. This will enable sensors biometrization and constant monitoring of operational status of displays. Despite a good start in this fiscal year, we are seeing some headwinds, too. The foreign exchange rate was a weakening euro that's 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 [token] pushout from our customers. Tighter changes in regulations and standard has required a considerable amount of customers' engineering resources.

There are updated regulatory requirements such as the proposition of the EN 60601, a relatively new medical standard that takes effect on January 1, 2019. And also a new [IT] standard, the EN 62368, which will eventually replace the current EN 60950.

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

All of these changes often result in the shortage of engineering resources as our customers juggle many priorities. Product testing to the newer standard creates additional challenges outside our customers' control. Accredited test labs test out the equipment first. The demand is high, and they are setting the price. Thankfully, we prepare ourselves and our customers in advance. Our medical product offering already includes products that are certified according to the new standard. And the team is working on getting the IT [grade] product offering tested ahead to the cutoff date, which has been postponed through the end of 2020.

In general, the display market is a very dynamic market. Price pressure continue while testing and documentation requirements are more complex, time-consuming and increasing in frequency.

In spite of these challenges, with the $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 [reach] 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 with 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 health care 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 tariff 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's signing 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 health care 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 costs of health care.

The availability of our new tubes and replacement parts gives them more options than ever. With our P3 agreements, our customer 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're 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.

(Operator Instructions) And we do, straightaway, everyone, have Howard Brous from Wellington Shields.

I really want to tell you that the turnaround has been spectacular. And we're all -- 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, so -- and I appreciate it. The real one question I have, if we go back 3, 4, 5, 6 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. I mean, 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, so we were -- we're really pleased. And even though -- I know everyone is talking about the 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. Health care is doing great.

So that's -- based on our conversations in the last 3, 6 months, you would offer no significant negatives in the mix or kind of put it a bit better, does that -- you're looking forward to significant improvements as we go forward?

I think we're right on plan and that plan encompasses significant improvement. So we're really pleased with where we are right now.

Do you include medical in that also?

Absolutely. That's our future.

The next one, everyone, is from Eric Landry from BML Capital.

So, Jens, you were kind of hard to understand, so if I may, I'd ask you to 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 yes, we can do that right now, sure.

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

Yes.

And it's the highest backlog that you've had in 3 years, up $3 million from the prior quarter?

More than 3 years. So I'm with the company now a little bit more than 3 years and it's the highest backlog I have 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 is about us] . I would love to say it's all me. No, 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, I mean, we clearly see an improving business not only by existing customers buying [programs] but I think we'll win new programs. So it's [about new] growth.

Okay. Well, great. I mean, 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 said in my script, I don't expect every quarter to increase the revenue. So -- we are highly up on our customer requesting products from us, so they -- as they sell their product, we sell more. Sometimes we ship -- we have really a great month and then we have another bad month for customers overall, it's pretty hard to say. But generally speaking, again, we are poised for growth with a great backlog, book-to-bill is positive, even so we had a great quarter. So yes, a very good trend.

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

No, we decided to ship our backlog in Q1 and wait for them to catch up. But the bill in the growth areas such as 5G, et cetera, are harder than that like in the MRO, which is the largest part of our business, obviously, even a book-to-bill [of] 1 isn't strong, so...

So safe to say, the overall -- the whole segment was -- the book-to-bill was over 1?

Just slightly, yes.

Got you, great, okay. So everyone seems to be worried about the Lam Research and we saw Ed's comments on release, that you're expecting a "temporary slowdown." It looks to me like everyone, over the next 3 quarters, is expecting somewhere around mid- to high single-digit revenue declines over the next couple of quarters. If in case -- 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.

No, it's too early to tell. You know 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, were there -- cost vendors were there from around the world and their COO made a great presentation. And they are talking about all the infrastructure investments they're making and they expect their business to grow $3 billion to $5 billion over the next 3 to 4 years, and that's basically what happened to them in the last 3 or 4 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.

I'm just trying to get my arms around it, because it seems like this is quite a drag on the stock. Greg, is it -- I mean, 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 3 to 4 months of visibility in terms of backlog. And based on that information, like I said, black and white, the worst case would be flat up until December, and not 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 or microwave markets, those are doing very, very well. So the top line -- I don't know if we'll continue with the 28% growth that you've seen in all of -- in FY '18 and then again in Q1. But you will see positive growth, top line growth and we'll make up the revenue number. And we are continually looking at, monthly, our SG&A cost to keep the profit percent same -- equivalent. But there's no indication that we can't continue with improved profitability, with top line growth, by increasing the sales in other segments such as 5G and some of these industrial markets are growing for us in the 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 is a slowdown or a flattening out, we have other niche markets that we can grow with this global infrastructure. So it's a -- I think it's a unique model. That is one of the unique things about it, it kind of protects you from downturns in separate single markets, not a one-hit wonder by any means.

Okay, gentlemen, are you ready for the next question?

Yes.

Yes.

Yes? Excellent, thank you. So this is from Mark Zinski, and Mark's from 21st Century Equity Research.

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'd 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 semi manufacturing market, semiconductor-manufacturing market, it's wafer fabs that build numerous products. 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 out wafer fabs, updating the 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, but the wafer fab market will have to be set-up to support that. And also Lam is a $4 billion to $5 billion company. We service a portion of theirs. So even though they overall might go down, it might not be a large percent for us -- I'm sorry, $10 billion, [if] they're going to grow it by $4 billion to $5 billion.

Okay. So -- and I know you're certainly expert on -- you've seen some of these -- well, you've lived it, Greg, the wireless -- the previous wireless buildouts. 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 have to -- be a complete overhaul. Because the data rates are something that we've never seen before. The amount of applications that are using 5G, all the test equipments, the test, the base stations and other products is going to have to grow. We just booked a very large order with [Roche] for all their test cables. It just trickles down into a very large overhaul of an entire network. And so there's 2 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 station that you see driving down the road. In addition to that, the antenna technology, which we have the leader in that in these [phase] array antennas is going to have to completely change. It's not going to be, if you will, a shotgun approach and you let your antenna and your phone grab that signal as you're driving across the country. It's going to be numerous pico and microcells throughout the country -- throughout the world that are going to help support and transfer all this data for the Internet of Things, for WiFi, for small cells, and so that is a perfect match for Richardson, because of that, a whole new list of customers get involved. The small niche guys that probably don't get the attention of the larger RF providers 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 [invented] technology is, the things like GaN, et cetera.

And so the other aspect of it is the technology of choice for these base stations in 3G and 4G with LDMOS. Richardson had a technology partnership with one of the leaders of LDMOS, this time around the 2 largest and most advanced producers of GaN technology that may come in Qorvo. And Richardson is the only go-to-market company, if you will, that has both to support the customers' needs. So there's various aspects that, going through this every launch, not being excited, but this one's just a little bit different and probably that it comes after 4 of these rollouts. And one thing Richardson knows how to do, because he 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 gain as much profit on those as we can.

Okay, great. 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 our foreign income taxes. So most or -- all of our income pretty much is in foreign tax jurisdictions and a lot of that is 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, I -- 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 used. 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 onetime 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.

So we have Eric Landry, again, from -- sorry, Eric from BML Capital.

So, Ed, I've got one thing here real quick. So it seems like the issue in the 2 markets 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 for -- just to pick a number out here, let's assume 3,000 tubes in 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 then possibly how many in the following fiscal year? Just percentages.

Right. We are working on that data and the guys have done a good job accumulating it. So, yes, 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 or 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 the year right now, when the equipment comes off, but it is linear, that's for sure. And what's happening, of course, is the availability of the tube that becomes common knowledge, and of course, we have all the parts to do service of CT scanners as well. More and more of the health care institutions and service companies that are interested in taking those contracts away from the OEM, and that's where we play.

Okay. So you're not comfortable now quoting, sort of, if half of them may become 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's staggered. So they may have 40, 50 systems on contract but they don't all come off a contract at the same time.

Okay. Lastly, has there been reported issues from the field on the new ALTA750? Or is pretty much everything is 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 tube, if they're going to last 2 years, 3 years, 4 years. And so with the P3 contract, for a monthly charge, all the risk stays with us, and that's just fine. It gives us reoccurring, very predictable revenue and earnings and we also control the tubes that go into that equipment. So I think it's great business. I never thought it would be this way, but so far the requirements are more for P3 contracts than they are devices outright.

Okay, everyone, so we now have Daniel Wolfe from 180 Degree Capital.

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 in some -- 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? Were you -- it's cited...

Well, you referenced in your press release the [semiconductor] -- basically, the 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 the semiconductor wafer fab manufacturers and there's 4 or 5 of them that are major customers. And if you've watched that industry at all from 5 material on down they're all predicting a flattening in that business. And we have been told also from our customers that they anticipate the 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 [want set out in] year. We have visibility through -- right now, through the end of the calendar year. And you could ask 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? Obviously, the issue that could work as opposed to you're seeing end-user slowdown, therefore they are seeing slowdown. It's more a conjecture around what's going to go on with all the tariff?

We -- that's completely another issue. It really has no impact on our portion of the semiconductor wafer fab business. We buy a substantial amount of product that's made in China. Substantial, it's $2 million or $3 million a year, and that product is impacted by the 25% tariff. And what we are doing, we are passing it through to our customer. 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 has a different percentage, so we have to adjust the pass through on every customer and every product. And it's really the administrative burden, a pain in the neck but the financial impact is marginal.

Okay, everyone, we now have [Bruce Hoffman] from [Franklin.]

I have a couple of small ones here. Remind us, what does P3 stand for in the P3 parts contract?

Well, we've got a protect contract. And it's basically an insurance contract for our health care customers. And what we are providing is we will provide a combination or all of the above of parts tubes on a monthly basis to the customer for a monthly charge. So they have a Toshiba CT unit and we will agree to have product available, where we can ship instantly the CT Tube or any of the parts of sale in that equipment and that's based on a monthly charge on a 3-year contract. And then we have versions of that. So if they only want to buy parts or 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 it's very popular, the majority of customer is coming to us once they realize we have the tube, they want to buy the P3 contract that gives them the availability of the tube and all of the parts on a monthly basis on a 3-year contract.

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

We were selling more equipment. In the health care 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 3-year contract for the tube and the parts, charged on a monthly basis. And until we had the tube, we weren't 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 the sale of equipment versus parts and tubes.

Okay. And then the start-up for the manufacture of the 750s, was that -- did that create some ramping costs or inefficiencies that affected margins in the quarter?

Absolutely. Yes, absolutely. Of course, we've spent 4 years developing the tube, 4 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. And of course, we did an acquisition in that area. We bought IMES, that was a parts company for Toshiba parts, the strategic add-on to it. So we spent $25 million to $30 million in 4 years developing the capability. And it's just starting to show traction, and we're really pleased with it.

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, so...

Okay. Do you feel that's attainable with all the recent investment and so on? And 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, 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 that $2.3 million from last year? Or less? More?

[Bruce,] it's Bob Ben. Yes, 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.

And we now have Walter Schenker. And Walter is from MAZ Partners.

It's a long-winded, 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 that 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 to business is under half of sales. So on a capital allocation basis, and 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. You've made your big investments, and that the future looks much clearer than it may have any time in the last few years as you were trying to build new businesses.

Well, that's a question that's asked a lot.

I know.

And I'll tell you where we are. Now 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 regain 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 if [you wait] for us buying stock back right now.

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

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

Well, 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're 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.