Richardson Electronics Ltd (RELL) 2019 Q3 法說會逐字稿

Ladies and gentlemen, welcome, and thank you for joining today's web conference FY '19 Third Quarter Earnings Call for Richardson Electronics. (Operator Instructions) With that, I'll turn the call over to Ed Richardson, CEO. Please go ahead.

Good morning, and welcome to Richardson Electronics conference call for the third quarter of fiscal year 2019. Joining me today are Robert Ben, Chief Financial Officer; Wendy Diddell, Chief Operating Officer and Acting Manager for Richardson Healthcare; Greg Peloquin, General Manager of our Power & Microwave Technologies group; 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 are 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 declined in the third quarter of fiscal year 2019 versus the third quarter of FY '18. This was due to slower demand in the semiconductor wafer fab equipment market, which we've been discussing throughout the year. Q3 and Q4 of FY '18 were huge quarters for the semi-fab industry. We were able to offset some of the decline with continued growth in both the Power & Microwave Group and in Healthcare, which are our 2 key growth initiatives.

We were also pleased that sales of our core industrial power tube business did well during the quarter and is showing year-over-year growth. Canvys had a small sales decline quarter-over-quarter, but is up slightly year-to-date, and continues to deliver more in operating income than the prior year.

Overall, our sales are still above prior year by 5.7% on a year-to-date basis. Gross margin was below prior year's third quarter. This was due primarily to product mix in both PMT and Healthcare. Scrap and inventory-related charges within our Healthcare group also contributed to the decline. We made changes in the quarter, including additional headcount reductions. These changes allowed us to exit the third quarter with full absorption of our manufacturing resources and will help improve gross margin on a perpetual basis. Downsizing our semi-fab manufacturing unit took longer than we anticipated and has resulted in more than $1 million in loss margin as compared to the prior year. Excluding the unusual charges incurred in severance and legal, SG&A continues to be well under control. We eliminated several positions in the quarter that will further reduce our annualized expense. Returning the company to profitability continues to be our priority.

One of our biggest frustrations this year has been the slower-than-anticipated growth in the Healthcare business. We've learned that the barriers to entry in the CT Tube replacement market are more significant than we thought and will take more time to overcome. After the close of our third quarter, the board decided to make a change in the healthcare management. Both Wendy Diddell and I are serving in general management capacity, supported by an excellent and experienced sales and engineering management team from Varex and Philips. We remain committed to our healthcare strategy. We are working closely with the team to expedite the launch of an additional CT Tube, overcome customer concerns and to improve operating performance. Richardson Electronics started out more than 70 years ago, also selling industrial power tools to the aftermarket in competition with the original equipment manufacturers. This is exactly the same strategy we are employing to perpetuate our success in the diagnostic imaging market of healthcare.

I'll now turn the call over to Bob Ben, who will share the highlights of our third quarter and year-to-date financials. Then Greg, Wendy and Jens will provide more details on their business unit performance.

Thank you, Ed, and good morning. I'll review our financial results for our third quarter and first 9 months of fiscal year 2019 followed by a review of our cash position. Net sales for the third quarter of fiscal year 2019 were $39.0 million compared to the prior year's third quarter of $41.6 million, which was a decrease of $2.6 million or 6.3%. Net sales decreased $2.1 million for PMT and $0.6 million for Canvys. Net sales for Richardson Healthcare increased by $0.1 million. Gross margin for the quarter was 31.5% of net sales compared to 33.8% of net sales in last year's third quarter. This was primarily due to a less favorable product mix, higher cost related to CT Tube production and over absorption in LaFox Manufacturing in last year's third quarter that did not repeat. Exiting the third quarter of fiscal 2019, both the CT Tube manufacturing area and LaFox Manufacturing were fully absorbed, and we anticipate this trend to continue, assuming no significant change in demand or production. Operating expenses were $13.1 million for both the third quarter of fiscal 2019 and the third quarter of fiscal 2018. During the quarter, the company incurred $0.1 million of severance expense related to actions taken to reduce costs and $0.2 million in higher legal expenses as compared to prior year. Total legal expenses in the quarter were nearly $0.4 million. These expenses were offset by lower incentive compensation expense.

It's anticipated that the reduction in headcount in the first 9 months of fiscal 2019 will result in at least $1.6 million in annualized savings and cost of sales and operating expenses combined. The company reported an operating loss of $0.8 million for the third quarter of fiscal 2019 compared to an operating income of $1.0 million in the third quarter of fiscal 2018. Excluding the severance expense and higher legal fees, the company would have reported a $0.4 million operating loss for the third quarter of fiscal 2019. Other income for the third quarter of fiscal 2019, including interest income and foreign exchange, was less than $0.1 million compared to other income of less than $0.1 million for the third 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 reported in our U.S. federal income tax returns. The amount of federal NOLs is $14.8 million. Overall, we had a net loss of $1.1 million for the third quarter of fiscal 2019 as compared to a net income of $0.5 million in the third quarter of fiscal 2018.

Turning to a review of the results for the first 9 months of fiscal year 2019. Net sales for the first 9 months of fiscal year 2019 were $124.5 million, an increase of 5.7% from the first 9 months of fiscal year 2018 net sales of $117.7 million. There were 39 weeks in the first 9 months of fiscal 2019 compared to 40 weeks in last year's first 9 months. Net sales increased by $5.8 million for PMT, $0.6 million for Canvys and $0.4 million for Richardson Healthcare. Gross margin decreased to 31.5% from 33.6%, primarily reflecting a less favorable product mix and un-manufacturing variances. In fiscal year '18, LaFox Manufacturing was over absorbed as the company worked overtime to meet the demand for the semiconductor wafer fab products. The year-over-year impact was a reduction in gross margin of nearly $1 million or 0.8%. As noted previously, the company has taken action to correct the unfavorable manufacturing variances associated with under absorption.

Operating expenses were $39.6 million for the first 9 months of the fiscal year, which represented an increase of $1.6 million from the first 9 months of the last fiscal year. The increase was due to annual merit increases and other expenses related to the increase in net sales as well as $0.3 million of severance expense and $0.5 million in higher legal expenses.

Operating expenses as a percent of net sales without the severance expense and the higher legal expenses decreased to 31.1% in the first 9 months of fiscal 2019 from 32.3% in last year's first 9 months. Our operating loss for the first 9 months of fiscal year 2019 was $0.4 million as compared to operating income of $1.8 million for the first 9 months of fiscal year 2018, which included a $0.2 million gain from the sale of a building. Excluding the severance expense and higher legal fees in the second and third quarters, the company would have reported an operating income of $0.5 million for the first 9 months of fiscal 2019.

Other income for the first 9 months of fiscal 2019, including interest income and foreign exchange, was $0.2 million compared to other expense of $0.1 million for the first 9 months of fiscal 2018. The income tax provision of $0.8 million primarily reflected a provision for foreign income taxes and no U.S. tax benefit due to the valuation allowance. Loss from continuing operations for the first 9 months of fiscal 2019 was $1.0 million compared to an income from continuing operations of $0.6 million in the first 9 months of fiscal 2018. Excluding the severance expense and higher legal fees in the second and third quarters of fiscal 2019, loss from continuing operations would have been less than $0.1 million. In addition, during the second quarter of fiscal 2018, the company received an income tax refund from the State of Illinois, inclusive of interest and net of professional fees of $1.5 million. This refund was a result of the conclusion of the Illinois amended return related to the sale of RF, Wireless and Power Division in 2011, and was therefore classified as income from discontinued operations.

Overall, we had a net loss of $1.0 million for the first 9 months of fiscal year 2019 as compared to a net income of $2.1 million in the first 9 months of fiscal year 2018.

Turning to a review of our cash position. Cash and investments at the end of the third quarter of fiscal 2019 were $49.4 million compared to $53.2 million at the end of the second quarter of fiscal 2019 and $60.1 million at the end of the third quarter of fiscal 2018. Approximately $1.3 million of the $3.8 million of cash used during the third quarter of fiscal 2019 and $5.2 million of the $11.1 million in cash used during the first 9 months of fiscal 2019 was related to inventory increases for our Richardson Healthcare and PMG growth initiatives. Capital expenditures were $1.0 million in the third quarter of fiscal 2019 compared to $1.5 million in the third quarter of fiscal year 2018. Approximately $0.3 million related to our manufacturing business, $0.3 million to investments in our healthcare growth strategy, $0.2 million to our IT system and another $0.2 million for facilities and other projects. On a year-to-date basis, capital expenditures totaled $3.2 million as compared to $4.2 million in the first 9 months of fiscal 2018. Lastly, we paid $0.8 million in dividends in the third quarter of fiscal 2019.

Now I'll turn the call over to Greg, who will discuss the results of our Power & Microwave Technologies Group.

Thank you, Bob. Good morning, everyone. In our third quarter of fiscal year 2019, PMT sales were $29.7 million versus $31.9 million in Q3 FY '18. Our gross margins in the quarter were 31.6% versus 33.4% in Q3 of last year. Q3 results were greatly affected by the downturn in the semi-fab market. However, this market decline was partially offset by growth in our base tube business and excellent growth in our new technology partners, supporting the RF and Power market. This growth is based on a demand creation model, strong booking trends, numerous design wins and our unique global business model. Our strategy has allowed PMT to grow 6.3% overall so far this year. We've grown the main parts of our business through FY '19. And with a book-to-bill of 1.17 in Q3, we will weather the storm of the semi-fab market decline. We're taking advantage of our long-term customer relationships, while our customer count continues to grow with our ever expanding product range.

Favorable market conditions in the industrial, RF wireless infrastructure and microwave markets are leading the growth. As the market conditions change, we responded quickly through internal initiatives. These include a reduction in force relating to our semi-fab manufactured products in Q2 and Q3 FY '19, in addition to the reallocation to other programs designed to improve the efficiencies and help offset the slowdown. These actions allow us to generate more opportunities in growing markets and using our existing global infrastructure and resources. Our revenue growth with our new technologies is being supported by key partners, such as Qorvo, MACOM, Anokiwave, USCi and Fuji. Our core legacy business continues to be greatly supported by the key tube manufacturers in the industry, such as CPI, Thales, NJRC and Photonis as well as Vishay which is bringing us associated sales revenues with its capacitor products. Key markets and applications that showed growth in Q3 include 5G wireless infrastructure, SATCOM, defense communications, industrial high-power microwave and marine. Specific to the 5G infrastructure markets, we're continuing to gain traction throughout the world. China is the primary market today as they are slightly ahead in putting in their 5G infrastructure. However, we have ever growing design wins in the base station, mobile test equipment and SATCOM applications. We have the world leaders in GaN and beam steering technology, which is the technology of choice for 5G. We're helping our customers get market share. In this 5G rollout, we are primarily focused on the millimeter-wave market. There are numerous technical challenges in designing at these high frequencies. With that, our global experienced team of field sales engineers is even more variable to our customers and suppliers in its wireless infrastructure rollout. We literally have hundreds of ongoing designs throughout the world. Again, the overall growth in these markets will help offset the cyclical sales slowdown in the semiconductor wafer fab equipment market.

So the positive in Q3 is the growth in our core tube business and continued strong growth in PMG. We're very excited about the booking trends in our new markets. With our technology partners, we can do component level design-in and support the majority of customers' board-level designs. These customers are the key OEMs of the world as well as medium-sized customers that are supporting a portion of the larger OEMs' systems. Our customers welcome RELL local field engineering teams to support their designs and our local technology partners love our global reach and ability of our field sales engineering resources to design in their products and do true demand creation. I can't stress enough the value of Richardson Electronics' unparalleled capability and global go-to-market strategy that is unique to the RF and microwave industries. 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. We do have some headwinds going into Q4 FY '19. In Q4 FY '18, we again had very strong shipments into the semi-fab market. Also, lead times are growing in the RF and microwave semiconductor market. However, we have a global forecasting system and have been aggressive in increasing our inventory to offset these extended lead times and have created an opportunity to gain market share. With our growing backlog and reallocation of resources, our ability to grow business with our new technology partners even faster should help offset the revenue and get us back to consistent improved sales and profits. In spite of these challenges, we're 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 go-to-market strategy. With that, I'll turn it over to Wendy and Richardson Healthcare.

Thank you, Greg, and good morning, everyone. As Ed mentioned in his opening remarks, barriers to entering the CT Tube replacement market are more challenging than we initially thought. Over the past several years, Canon improved the quality of its tubes, extending life to 3 years or more. While hospitals and third-party service providers continue to demand third-party replacement tubes to help lower maintenance costs, they expect tubes to last longer than ever. We have been selling the ALTA750 since June of 2018 and our longest installed tubes are nearing one year in clinical use. Sales performance is meeting expectation. We remain confident we will be able to meet the demands of the healthcare industry. In the interim, sales of the ALTA750 are slower than anticipated. Our P3 program is a good option for customers who want to avoid the risk of early tube life failure. P3 agreements are recurring revenue contracts where Richardson agrees to provide replacement parts, and in most cases replacement tubes, in exchange for a fixed monthly fee over a 3-year period. Interest in our P3 programs continues to be very strong. P3 contracts are attracted to our customers because they allow them to quickly see the economic value of the Richardson offering as compared to the OEMs, and it allows them to budget operating expenses. P3 contracts also help overcome any potential resistance to purchasing an alternative to the OEM CT tube. If this tube fails during the contract period, the replacement is on us, not the customer. We are also offering P3s with installation provided by service companies we have trained. Installation can cover the life of the P3 contract or it can be a shorter term depending on the needs of our customers. This option allows our customers to move away from the OEM and to choose between in-house service, a third-party service provider or a combination of both. We do not compete with our customers by providing service. We bring them service opportunities. We do however provide CT system training for the hospitals, IDNs and third-party service organizations as well as 24/7 technical support via phone. We are currently in negotiations with customers to cover hundreds of CT scanners under P3 agreements as the OEM contracts expire. In the third quarter, we nearly doubled the number of systems covered under our P3 agreement. We estimate that 85% of the Toshiba systems in the U.S. are still under a Canon service contract. Even with our P3 agreement, taking systems off the OEM contract carries some additional risk. Typically, these agreements cover several different types of CT scanners as well as other modalities. For example, a hospital may have a Toshiba system in its installed base that uses the ALTA750 D as well as systems that use a slightly different version of the tube, that we refer to as a ALTA750 G. If the hospital wants to remove the systems that use the D versions of the tube, but leave systems using the G under an OEM contract, there is the concern that the OEM will raise the price on the remaining systems. Several large hospital groups have told us that they would like to use our tubes when we have both tubes available. We're addressing this by adding to our engineering resources and increasing our tube development activities. We anticipate having the ALTA750 G available-for-sale mid-calendar year 2020 after concluding clinical trials.

Healthcare sales in the third quarter of fiscal 2019 were $2.3 million, up 6.7% from prior year sales of $2.2 million. Equipment sales as a percent of total sales were higher in the third quarter than prior year. Even though margins are lower, the sale of equipment is strategic to our overall business. It creates pockets into which we can sell the replacement parts and tubes in the future. The majority of the systems sold contain an ALTA750 tube. We removed the used OEM tube, which can then be sold as a certified preowned tube or CPO tube to countries where we do not yet have the registrations for our ALTA750 D. We also sell CPO tubes to customers that want a much lower price and are willing to accept a shorter warranty. Gross margin was 26.2% in the third quarter of fiscal 2019 as compared to 38.3% in the same period last year. The decline in margin is due primarily to the higher percentage of low-margin equipment sales. The margin was also impacted by scrap charges resulting from our manufacturing efforts as well as adjustments to equipment cost bought in earlier periods that were priced above current market value. We have implemented a tighter review process for equipment purchases to reduce the potential for such charges in the future. Excluding these charges, gross margin would have been 34%, still below our target margin, but we expect margins to improve as we sell more tubes and P3 contracts and then in turn some of replacement parts. Our tube manufacturing resources were fully absorbed in the quarter.

During the quarter, we also continued our efforts towards CE approval. CE approval is required to sell over our ALTA tubes throughout Europe. We have completed the process and anticipate receiving final approval before the end of the fiscal year. We're also working on registrations in other countries, including Russia and China. In China, there are more than 20,000 CT systems with plans to grow to 100,000 CT systems within the next 10 years. There are a significant number of CT systems in China that use the ALTA750 or a variation of this tube.

We are absolutely committed to our healthcare strategy. Hospitals continue to be under tremendous pressure to reduce costs. Today, there are no other CT Tube manufacturers focusing solely on the aftermarket. We are playing a significant role in the development and sale of diagnostic imaging replacement parts with the goal to help lower the cost of healthcare on a global basis. We are told repeatedly by hospitals and third-party service companies throughout the world that third-party replacement CT tubes are critical and that they will support us. Once we achieve this level of confidence, we are there for the long haul. I'll now turn the call over to Jens Ruppert to discuss third quarter results for Canvys.

Thanks, Wendy, and good morning, everyone. Canvys, which includes the engineering, manufacture and sale of custom displays to original equipment manufacturers and industrial and medical markets, delivered strong performance with sales of $7 million during the third quarter of fiscal 2019, a decrease of 8.3% over the same period last year. On a year-to-date basis, sales are still nearly 3% above the same period of fiscal year 2018. The revenue decrease in the quarter was related to some onetime projects in fiscal year '18 that didn't repeat this fiscal year. Gross margin decreased as a percentage of sales to 32.8% from 32.9% the same period last year. The year-over-year gross margin decrease was related to an unfavorable product mix. Our backlog increased quarter-over-quarter to a very healthy level, and we are cautiously optimistic of our continued strong customer demand throughout North America and Europe. Our backlog shifts over 12 to 24 months and is impacted by customer call-off orders and can vary quarter-to-quarter based on customer sales, regulatory issues and other factors.

During the quarter, we received 7 new orders from both existing and new medical OEM customers. Applications include displays used during refractive surgery and eye surgery used to improve the refractive state of the eye and decrease or eliminate the dependency of glasses or contact lenses. Corneal cross-linking, a minimally-invasive procedure that combines the use of UVA light and special eyedrops to add stiffness to the cornea which has been weakened by disease or refractive surgery. Macular diagnostics, where our products are used during standard eye examinations; surgical navigation, a system that enables surgeons precisely track the location of the surgical instrument throughout a procedure; patient monitoring where our monitors are installed in the intensive care unit or a remote location such as the central nerve station; DICOM-compliant monochrome displays for C-arms; displays that are used to control a medical device that catches high-resolution images and videos from up to 2 surgical imaging devices; highly customized products to monitor patients during radiotherapy; and surgical displays used during minimally-invasive endoscopic procedures.

In the nonmedical space, we received a follow-up order for large-size ultrahigh definition or 4K display used for a mobile state-of-the-art air traffic control system. Other applications include displays with an embedded RFID reader and to speed up used as human machine interfaces for surface inspection machines; teleprompter, talent monitors and clocks used in the broadcast markets for [helping our] new stations around the world; displays for large-size printing machines used at the billboards; and commercial CT scanners used to scan luggage in airports. CT scanners in such an application offer better threat detection and much faster passenger throughput. We also received orders for displays used for passenger information systems in subways. The request rates for our relatively new 15.6-inch monitor platform have increased significantly. We received inquiries from several new customers that are confronted with end-of-life situations from their mostly commercial monitor suppliers. Our team was able to convert all of these inquiries directly to hard purchase orders. Opportunities like these demonstrate the significant value add we bring to the table through Canvys' product longevity. We work closely with our customers and suppliers, supporting controlled life cycle management. Through this process, we are able to keep products enabled for extended periods of time and provide a smooth transition to newer, more advanced products. We recently started a marketing campaign to leverage the momentum and gain market awareness. Considering all the new programs we are working on, I'm optimistic that we will continue growing our business by adding new customers and programs. I will regularly review and adjust our business strategy with a goal of further improvement in operating performance of the division. Maximizing cash flow is an ongoing priority. We will work closely with our partners to help us reduce inventory by being able to meet the demand of our customers. I will now turn the call back over to Ed.

Thanks, Jens. It remains clear our strategic objectives continue to drive revenue growth and help offset the cyclical nature of the semiconductor wafer fab equipment industry. Our industrial Power Tube business, CMT and Canvys are performing well. As we overcome the barriers to entry in the healthcare market, we anticipate sales and margin to improve on a perpetual basis. We will continue to monitor our performance and make changes as necessary to return the company to profitability. We have an excellent team in place to make that happen.

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

(Operator Instructions) We do have a few questions in the queue. Moving to our first question.

It's Howard Brous. Wendy, tough quarter, but let's talk about what goes on forward. In your press release that I pulled, the majority of Toshiba CT systems sold in the quarter included a ALTA750 tube at a premium price. Can you discuss what you mean by premium price?

We didn't know that. So the systems that we sell don't have a set price. We buy in with different products, obviously, whatever they're available at the market. On average, we're able to increase the sales price for a system, when we include the ALTA750 tube, by about 25%. So it's a nice charge. And then as I mentioned in my presentation, we then get the OEM tube, which we can certify and sell as a preowned. So overall, it's a big tick up for us in terms of margin percentage.

Right, I understand. What do you need to do in terms of ALTA750G to establish greater penetration in the market and what is it going to cost you over the next year?

Okay. So for the G, you're asking specifically about the G, that is in development, as we mentioned, and we are expecting to have the prototype sometime this summer, hopefully June time frame. I guess the cost for that is going to be a little bit less than what it was for the D because there are some similarities, but we would estimate $2 million?

$1.5 million to $2 million.

Yes, $1.5 million to $2 million, and then -- and the critical thing in terms of gaining market penetration, whether it's the D or the G, is really the tube life and being able to prove out through the clinical trials and then, once we have the installation that our tube lasts as long as the OEM's does.

So if we've got a D and a G, is there another letter that comes after that for greater penetration of the market?

There are other variations. Right now, the D and the G are the largest number of tubes that are used in the market. There is also an E and an F. And they are just minor modifications to the D, and we may address that later. But right now we need the G. And we should tell you, just so that you are clear, with the clinical trials, we won't be to market with a tube as far as production is concerned probably over a year or 1.5 years.

All right. You talked about $400,000 as your legal bill last quarter. What was that consisting of besides the litigation? Or was that all the litigation?

That was just litigation.

Based on my discussion with my counsel about the litigation, we're assuming that you'll win it. But what is the ongoing cost over the next period of time quarter-by-quarter until you see a resolution?

Well, right now, the case has been submitted to the judge, and he is going over all the information that both sides have submitted. His docket is rather full, and the experience is that a rule on something like this takes about 5 months. And so right now it's just dormant. There isn't any additional legal cost. And he has -- he can either rule to dismiss the case at that time, and if he does it, it's over. And then depending upon, if he doesn't dismiss it, what his ruling is, probably go forward and we also have to recalculate what the estimated costs will all be from there.

All right. Fair enough. Wendy, you mentioned positive booking trends. Can you be a little bit more specific?

Well, in healthcare, the booking trends are impacted mostly by equipment sales. And so we had several systems that did not book in Q3 that will book in Q4. I think our book-to-bill was 1.17.

Around there...

For healthcare.

All right.

The rest of it is (inaudible). Sorry, go ahead.

You mentioned that sales were meeting your expectations. And yet at the same time, things were slower than anticipated. And I'm not sure I understood the commentary.

Are you referring to my comment where I said that the tube is meeting field expectations, we're talking about the performance of the [tubes as well that is] performing. On the sales side, of course, we're disappointed like you and everyone else that we haven't sold more to date.

One question that I started asking on conference calls, this certainly has nothing to do with the CT tubes. But have you considered, Ed, expanding the Board of Directors for a woman and/or a minority?

Not at the moment. But if you look at our management, we have quite a number of very talented women in management, and we would certainly consider someone on the board that was a woman, for sure.

Okay. I just -- because I would nominate Wendy.

Thank you, Howard.

Now moving to our next question.

Mark Zinski, 21st Century Equities. Greg, I just wanted to sort of home in a little bit on the demand for PMT. Are you saying the headwinds are mostly due to the semiconductor fab market? Or is there some sort of general sort of European-based slowdown as well?

No, the headwinds of the semi-fab market is really headwinds in terms of quarter-over-quarter comparisons. We had -- specific to the fourth quarter, that was the largest quarter of the semiconductor fab shipments. And even though with the bookings and everything that's going on with our core businesses, we've been able to not only exceed that downturn, but we've actually grown the business year-to-date 6.3%. But again, the headwinds are 2 main things, comparing our financials quarter-over-quarter in terms of margin and sales as the downturn in the semi-fab market and then also some of the lead times continue to expand on the semiconductor or the PMG wireless side.

Okay. And then, Wendy, I know you just kind of talked extensively about the replacement tube business. But I just wanted to clarify, right now you're -- are you selling 1 model into the market?

That's sort of correct. We have the ALTA750D, which we sell into the market. And we also have the, what we call certified preowned, the CPO tube, which will be Toshiba as well as GE and Philips. But then we also have a third category, where we harvest tubes on equipment, and that has given us access to some Siemens tubes. But as far as tubes that are produced here in our LaFox factory, you're correct, there's just 1 today and then I should also mention because it's been...

Okay. And then there are more in the pipeline, is that -- kind of waiting for a clinical approval?

No. We're not at clinical approval yet on the G. We should have our first prototype for it in the next 60 or 90 days and then we will enter clinical trials. And as Ed mentioned, that will be another 12 months or so or 18 before we release that to the market.

Okay. Great. And then Bob, Greg had mentioned a buildup in inventory to address some of the increase in lead times. Should we expect any material difference in your operating cash flow in the next quarter or 2 because of the inventory build?

Mark, yes, I would expect a slight increase for that. I mean while we are using cash for our growth initiatives, specifically for inventory, there are other parts of the business that do generate cash. So I would say overall, I'd expect a slight increase for those.

Okay. And then just to confirm, you did reactivate the share repurchase plan and there is about $9 million on that plan, is that correct?

That's correct, right.

Now moving to our next question.

It's [Craig Weaver], Invicta Capital. Just a follow-up towards Greg on PMT. What -- it sounds like the semi business has bottomed, yet you did a reduction in force. So I'm just trying to understand, I guess you feel it's not coming back to the old levels or a little more color there?

Yes, the reduction in force was not in people generating revenue. It was on the manufacturing side of the products that we manufacture for the semiconductor wafer fab. And what we did is, we looked at the forecast that we are getting from each of our customers and looked at what was needed to support them with that with lead times, but also to get the under absorption issue out of the way with the downturn that happened fast. That was the biggest issue, it happened faster than we expected and the visibility we had and we didn't get the cost out in time to deal with the under absorption issues.

I guess maybe because I don't have clarity on it, but I guess how -- roughly how big is this? Was this semi and kind of what's it shrunk to. And I guess you don't think it's going back to what it was?

So it -- the coming out of FY '18, the total business was right around $20 million. And right now it's running about $1 million a month. So there's been about $8 million decline. And all of that product is manufactured here in LaFox. So the majority of our manufacturing workforce is dedicated to that product line, and we've cut back accordingly, employees are concerned.

Okay. And I guess just -- so $8 million there. How big has the microwave business become? Obviously, you mentioned it growing helped offset some of that decline, but maybe a little color there?

Yes, it's nowhere near as large as the semi-fab business. But in the microwave products that we manufactured, we moved some of that manufacturing from our factory in France, which we closed a couple of years ago, to our facility here. And we had difficulty getting yields up, but fortunately our team has done a great job and right now we are in full production. Our yields are well over 90%. But that business is $3 million or $4 million, something like that.

A year?

Yes.

But you say that it's growing, I guess with 5G and some of these other millimeter wave opportunities?

Yes, that's different than the products we manufacture. Those are more in the PMG side of PMT. Greg can address that for you.

Yes, really 5G is by far the largest growth this fiscal year. We'll ship, and we're, what, halfway through the fourth quarter. So we'll ship close to $23 million into that market. Last year or fiscal year '18, we shipped about $12 million. So that business has almost doubled in terms of shipments of products and the specific 5G applications worldwide. So it's a real growth for us, and it looks the same going forward.

PMG is inside of PMT, the way you report it?

Yes, PMT is the SBU or the division. Within that division, there's 2 business units, one is EDG, which a majority of that is the legacy business of tubes, but also the manufactured products here in LaFox. And the other business unit is PMG which is the new technologies servicing the new technologies, such as 5G, et cetera. So it's -- those are 2 business units.

So that's more than offset the growth -- the PMG growth has more than offset the semi decline?

Right. And it's been tough the last 2 quarters. It will be tough, but year-over-year growth is not only did we make that up, but we increased the sales of the group 6.3%.

Okay. So if semi has bottomed, right, and sequentially we're talking here, you said the book-to-bill is above 1, right? And PMG is continuing to grow. We should expect that group to grow sequentially?

Yes, in FY '20.

(Operator Instructions) We did receive one more question in the queue.

This is Eric. Greg, is your toughest compare regarding the semiconductor, is that this quarter or was it the just finished quarter?

It will be this quarter, fourth quarter.

Okay, so this is -- okay, so we're in the toughest compare right now?

Yes, this is the...

A year ago, Eric, we did almost $7 million in semi-fab in the fourth quarter. And you can see, I just mentioned that we're running about $1 million a month. So you can do the math. But hopefully all that's going to pick up. So we are...

Okay. And then it gets significantly easier in Q1, 2 and 3, of course?

Right, right. It really started to tail off in Q2. Q1 was still halfway a decent quarter because you're trading a lot of backlog, and we had an easier compare from year to year.

Okay. So Greg, you mentioned that even with this, the toughest compare, you're still 1.17 book-to-bill, right?

Yes, 1.17 in the quarter.

Okay. That's not PMG, that's the whole PMT?

That's all of PMT. EDG actually had a positive book-to-bill, but PMG had a very, very strong book-to-bill in Q2 and Q3.

Okay. All right. Wendy, I want to address this D and G issue. It seems like the G issue has come up in recent conversations, but I've heard you talk about it in some investor presentations and we've heard it in the call. But when you first set out to make these tubes, we didn't hear anything about customers' reticence to buy a D because there was no G. And as an investor, it's kind of distressing to hear that, well, we thought that the D would be a smashing success 6 months ago, but now we don't think it's going to be quite the success that it was because there is this reticence that Toshiba is going to raise the price on the G. I'm just wondering why that wasn't -- that information or that sentiment wasn't unearthed prior to you manufacturing the D? What happened there such that -- was -- I'm just kind of wondering how that happened?

Well, I think that -- the market is very dynamic, Eric. It's changing all of the time. As you know, we're pretty well -- we're familiar with what -- Varex, who's the manufacturer, what their production is. And this year, for example, we think that the 750G has grown to where 40%, almost 40% to 50% of their production is now the G versus the D, and that's been going into new equipment, while we've been developing the tube. If you remember, we have been developing D over 4.5 years. So the market has been changing all during that period of time. So we are learning as we go along. I think we mentioned to you one large healthcare organization that we were working with. They have 40 systems -- Toshiba systems on contract with Toshiba. And in their case, 12 of those use the G and 28 use the D. We just -- we know Mayo Clinic really well, for example, and they have 24 Toshiba systems they use. And in their case, where I'm sure they have better financing, they bought more newer equipment and 50% of their Toshiba equipment is the G. So we're learning as we go along in that, again, it's a dynamic market, but it's changing every day. The new production is more heavily geared towards the G, which is a smaller tube, weighs 175 pounds versus 225 pounds for the D, and uses smaller parts, but it's exactly the same concept as far as the tube is concerned. We're optimistic within a year to 18 months, we'll be in the market with that tube as well.

I understand all that, Ed. But they had those -- they probably had that same mix 1.5 years ago, when you started -- or 2 years ago or 3 years ago or whatever it was. Wasn't there any of these customers that said, "Hey, wait a second, it's great that you have the D, but in order to be buying volume from Richardson, we need to have the G as well." I'm just wondering why that wasn't unearthed earlier than when -- than now frankly?

No, it's very basic. I mean the new production, the new CT scanners that are being built are using G. First of all, when the scanners are sold, they are on warranty for 3 years with the factories, so that business is not available to us at all. And then as they come off of warranty, now more and more are the G because that's what's being produced. So it's a learning experience. The market is a dynamic market. Five years ago when we started, it was probably 70%, 80% D and that's changing. The tube lasts 2 to 3 years. So you can do the math, when you see the number of the tubes that are being produced that are going to be out there for replacement 2 to 3 years from now.

So what you're saying is when -- a couple years ago, when you set out to sell this D or develop this D, the G was a lot less significant in the market than it is now. Is that sort of what you're saying?

That is correct.

Okay. Wendy, I think you said there's been more engineering or you implied in your script that there's been more engineering resources thrown at development of the G, is that correct?

That's correct.

Okay. Is it a material amount or is it -- and is that going to change the time frame? Is there any way that you could sort of increase the clinical trials or is that out of your hands?

First we got to get to the prototype. And what we're doing is as we really put that D, the D, not the G, into production and we're getting more comfortable with that, we can take some of those engineering resources and we can have them focus more on the G. So that's kind of where the engineering resources are coming from. So from our perspective, they will expedite the development of the G now that we've got the D under control and in a normal manufacturing process.

So it's not that the company is hiring more engineers, it's just that you're shifting engineers from the D to the G, correct?

That is correct. We've also put incentive programs in place to encourage our engineering team to work overtime, 6, 7 days a week and see if we can't accelerate the process. So we are taking every action we can to move that along, but still in all designing a CT tube is quite a challenge.

Let me ask you this. Is there any way to speed up the, what seems like a pretty standard, year-long process for the clinical trials?

Well, first of all, we run them on scanners here for extended periods of time. What we do, do is we put tubes out in multiple data sites to try to get them into actual use in various environments. That we do do. We did that with the D. But still in all, we are really not comfortable until we have about 12 months of clinical experience in actual application where they're turned off and on and used all day long.

Got you. And what has been the, sort of the field feedback from the D thus far? Is it performing as expected?

Yes, I mean we're working all the time to -- every little thing that we see to improve the areas, and we know that Varex does that too. For example, Wendy mentioned, we're well aware that the lifetime of the Varex tube has been increased. It's gone from probably 2 years when we started into this program, 2-year life, to where it's close to 3 now. So that's typical. Manufacturers are working on these products all the time trying to improve them.

Well, I'm asking about the performance of your tube. Has there been -- has that been expected -- as expected?

Yes, I think we're right in line with where we thought we would be, but that still, every time we go into production, we're looking for ways to improve it. Our challenge is always going to be try to have better life than the OEM.

Okay. Got you. Last thing, Jens, so is it safe to say you have just passed your toughest compare from last year here?

Eric, this is Jens. I'm not sure that I understood your question. You said that I passed what, the revenue over the year or...

Well, if I'm looking at my data correctly, you grew over 50%, is that correct, in this quarter last year, third quarter last year?

Yes, that might be correct. So the full year growth I have is about 30%.

Right, no, no, I'm just trying to figure out whether or not we're past the toughest comparable quarter from last year, which it looked for me...

Yes, we did.

Okay.

Yes. Sorry, now I understood. That last year we had a very good quarter in revenue wise by about $7.6 million Q3 and this year with $7 million, quite a bit behind, but next quarter will be much better in comparison to last year's fourth quarter.

Okay. Got you. So you shrunk -- the Canvys has shrunk 2 quarters in a row here, but there is a decent chance that, that trend may be over.

Yes, absolutely. And again, don't forget, I mean last year, we grew 30% year-over-year. So this year on a year-to-date base, we are still about 3% above last year's performance for the first 3 quarters. So we are progressing on a very, very good year we had last year, so and I'm expecting this improvement to continue, yes.

Yes, the one thing that you should give Jens credit for is although his revenue was down slightly in the quarter, his operating income contribution was higher than it was in the same quarter last year.

And moving to our next question.

This is George Melas from MKH Management. I think the question has already been asked, but I wanted to ask it again on working capital and inventory. Working -- on the inventory side, I think you grew inventory by $8 million last year. So far this year, it's by $3.5 million. I'm just trying to understand the trend and why -- I understand that you are fairly working capital intensive company, but why is the trend so strong there?

George, this is Bob Ben. Regarding inventory and working capital in general, it's really just part of our business. And particularly in the EDG area, we have to stock inventory since it's a MRO-type business. We have to have the inventory available when the customer calls. And in the other businesses, as I noted previously, both the PMG business and Healthcare business are growth strategies. And as you can imagine, we need to stock inventory there in healthcare so that we have components inventory, so we can build the CT tubes as well as the equipment business, which we have to have the equipment on hand in order to sell it. We can't just order it and sell it right away in most cases. So that gives you kind of, I hope, an idea of why we need to stock the inventory. In terms of the trends, yes, last year, in fiscal '18, inventory did grow substantially from fiscal 2017. Of course, sales were up last year back in fiscal '18 year-over-year almost 20%, so I think that certainly drove a lot of that. This year, as you know, sales haven't been up as much. They're still up at a 9-month basis, 5.7%, and so we continue to see increases, but as you noted, it's less. And going forward, I think we're at this moment expecting something similar as to where we're at. We certainly expect more -- some growth in Canvys and PMG next year. And so inventory, I think will continue to go up, but not to the levels probably in fiscal '18, if that's helpful.

Okay. Maybe just a little bit more color, just on numbers. Working capital use has been $8 million this year, year-to-date. You expect that to increase sort of -- you expect working capital use almost every quarter? Or at some point it levels out?

Yes, well, again, I think with sales growth and on a year-to-date basis, we've grown 5.7%, and certainly I expect -- our fourth quarter, by the way, is typically one of our best of the year, so I'm hopeful and optimistic there. And along with sales growth, we typically see growth in inventory and working capital. So yes, I do expect it to go up going forward. Again, our growth initiatives in healthcare and PMG drive some of that too, and those businesses we expect an upward trajectory on, whether it's in the fourth quarter or next year.

Okay, we have one question on chat if there are no other questions from the group verbally. And that question had to deal with we reinstalled the share buyback in the last quarter. Originally, we had 75 million shares approved by the board on the buyback and we bought back 65.5 million or 65.6 million and the board decided to reinitiate the buyback on the remaining 9.5 million. And the question was why we haven't been buying stock in the quarter. As you know, we just finished our board meeting yesterday and we had a rather heated executive session with the entire board and the discussion was on the use of cash, similar to what George was just asking about. So there are 2 issues. First of all, currently we have about $25.1 million of cash in the U.S., which is available to us for cash flow. The balance of the $49.4 million is in foreign entities all over the world. And we've done fairly well moving that cash back, but now it's in most places, been $1 million in this country and $2 million in that country, which takes more time and sometimes there are even larger barriers. So in -- from one year to this quarter, we went from $60.1 million in cash down to $49.4 million. The board is very concerned with the fact that we have $25.1 million in the U.S. As we told you, the barriers to entry in the CT market are telling us it's going to take longer and we need to design additional tubes for the CT applications and the -- unfortunately, the development cost in a CT tube is $5 million a tube. So their charter is save your cash and use it for running the business and investing in healthcare. And for that reason, we haven't been buying stock back. Any other questions?

There are no more questions in the queue. With that, I'll turn the call back over to you, Ed.

Okay. Well, thank you, again, for joining us and for your ongoing interest in Richardson Electronics. You're welcome to call us if you have additional questions. We look forward to discussing our fiscal 2019 fourth quarter in July. Thanks, Kyle.

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